Table of Contents

 

 

 

**UNITEDSTATES**

** SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q/A**

 

**(Mark One)**

 
| **x**                                                       | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|-------------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
| ** **                                                  |
| **For the  quarterly period ended****March 31,  2009** |
| ** **                                                  |
| **or**                                                      |
| ** **                                                  |
| **o**                                                       | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

** **

**For the transition period from                            to                            **

** **

**CommissionFile Number****1-10346**

 

**EMRISECORPORATION**

(Exact name ofregistrant as specified in its charter)

 

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

** **

**611 IndustrialWay**

**Eatontown,New Jersey 07224**

(Address of principalexecutive offices) (Zip code)

 

**(732) 389-0355**

(Registrant’s telephone number, including area code)

** **

**Not applicable**

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

 

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

 

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 oNo o

 

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

 

| Large Accelerated Filer  o                                            | Accelerated Filer o          |
|-----------------------------------------------------------------------|------------------------------|
|                                                                  |                         |
| Non-Accelerated  Filer o

(do not check if Smaller Reporting Company) | 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 May 7,2009 was 10,204,079.

 

 

 

----

Table of Contents

 

**EMRISE CORPORATION**

**TABLE OF CONTENTS**

**FORM 10-Q/A**

**FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2009**

 
| **PART I. FINANCIAL INFORMATION**                                                                                               |                                                                                            |
|--------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|
|                                                                                                                                 |                                                                                            |
| **EXPLANATORY  NOTE**                                                                                                                |                                                                                            |
|                                                                                                                                 |                                                                                            |
| **ITEM 1.**                                                                                                                          | **FINANCIAL STATEMENTS**                                                                        |   |
|                                                                                                                                 |                                                                                            |
| Condensed Consolidated Balance Sheets as of  March 31, 2009 (restated) (unaudited) and December 31, 2008                   | 1                                                                                               |
|                                                                                                                                 |                                                                                            |
| Condensed Consolidated Statements of Operations for  the Three Months Ended March 31, 2009 and 2008 (restated) (unaudited)      | 2                                                                                               |
|                                                                                                                                 |                                                                                            |
| Condensed Consolidated Statements of Stockholders’  Equity for the Three Months Ended March 31, 2009(restated) (unaudited) | 3                                                                                               |
|                                                                                                                                 |                                                                                            |
| Condensed Consolidated Statements of Cash Flows for  the Three Months Ended March 31, 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** | 23 |
|                                                                                                                                 |                                                                                            |   |
| **ITEM 3.**                                                                                                                          | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                 | 37 |
|                                                                                                                                 |                                                                                            |   |
| **ITEM 4.**                                                                                                                          | **CONTROLS AND  PROCEDURES**                                                                    | 37 |
|                                                                                                                                 |                                                                                            |   |
| **ITEM 4T.**                                                                                                                         | **CONTROLS AND  PROCEDURES**                                                                    | 37 |
|                                                                                                                                 |                                                                                            |   |
| **PART II  OTHER INFORMATION**                                                                                                  |                                                                                            |
|                                                                                                                                 |                                                                                            |   |
| **ITEM 1.**                                                                                                                          | **LEGAL PROCEEDINGS**                                                                           | 42 |
|                                                                                                                                 |                                                                                            |   |
| **ITEM 1A.**                                                                                                                         | **RISK FACTORS**                                                                                | 42 |
|                                                                                                                                 |                                                                                            |   |
| **ITEM 2.**                                                                                                                          | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                | 43 |
|                                                                                                                                 |                                                                                            |   |
| **ITEM 3.**                                                                                                                          | **DEFAULTS  UPON SENIOR SECURITIES**                                                            | 43 |
|                                                                                                                                 |                                                                                            |   |
| **ITEM 4.**                                                                                                                          | **SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS**                                        | 43 |
|                                                                                                                                 |                                                                                            |   |
| **ITEM 5.**                                                                                                                          | **OTHER INFORMATION**                                                                           | 43 |
|                                                                                                                                 |                                                                                            |   |
| **ITEM 6.**                                                                                                                          | **EXHIBITS**                                                                                    | 44 |
|                                                                                                                                 |                                                                                            |   |
| **SIGNATURES**                                                                                                                       | 45                                                                                              |

 

----

Table of Contents

 

**EXPLANATORY NOTE**

 

The purpose ofthis Amendment No. 1 to Form 10-Q (“Amendment”) is to amend ourinitial filing of a Quarterly Report on Form 10-Q for the quarterly periodended March 31, 2009, filed with the Securities and Exchange Commission (“SEC”)on May 15, 2009 (the “Initial Filing”).

 

On September 30,2009, we filed a Current Report on Form 8-K with the SEC disclosing thatour management concluded that an accounting error had been made in ourhistorical financial statements in relation to the recording of theacceleration of the pro-rata portion of deferred financing costs and debtdiscount as a result of the partial repayment of our Term Loan B on March 20,2009 (as described in Note 2).  As aresult, our financial statements for the quarterly period ended March 31,2009 must be restated (the “Restatement”). In light of the Restatement, the financial statements and otherfinancial information included in the Initial Filing are being restated in thisAmendment.

 

Our Form 10-Qfor the period ended March 31, 2009 is amended and restated in itsentirety as set forth below.

 

Unless specified,the disclosures provided in this document have not been updated for morecurrent information.  Therefore, thisAmendment should be read in conjunction with our other filings made with theSEC subsequent to the date of the Initial Filing.

 

1

----

Table of Contents

 

**PART I— FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**EMRISE CORPORATION**

**CondensedConsolidated Balance Sheets**

(in thousands, except share and per share amounts)

 
| ** **                                                                                                                                                  | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                  | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                                  | ** ** | **(Restated)**     | ** ** | ** **            | ** ** |
|                                                                                                                                                        |       | **(Unaudited)**    |       |                  |       |
| **ASSETS**                                                                                                                                                  |       | ** **         |       |                  |       |
| Current assets:                                                                                                                                             |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                                                                  |       | $                  | 3,629      |                  | $          | 3,242 |   |
| Accounts receivable,  net of allowances for doubtful accounts of $427 at March 31, 2009 and  $501 at December 31, 2008                            |       | 9,475              |       | 10,333                |       |
| Inventories, net                                                                                                                                            |       | 12,300             |       | 12,501                |       |
| Current deferred tax  assets                                                                                                                                |       | 175                |       | 271                   |       |
| Prepaid and other  current assets                                                                                                                           |       | 1,375              |       | 1,283                 |       |
| Current assets of  discontinued operations                                                                                                                  |       | —             |       | 2,724                 |       |
| Total current assets                                                                                                                                        |       | 26,954             |       | 30,354                |       |
|                                                                                                                                                        |       |               |       |                  |       |
| Property, plant and  equipment, net                                                                                                                         |       | 2,768              |       | 2,990                 |       |
| Goodwill                                                                                                                                                    |       | 9,544              |       | 9,657                 |       |
| Intangible assets other  than goodwill, net                                                                                                                 |       | 6,344              |       | 6,618                 |       |
| Deferred tax assets                                                                                                                                         |       | 1,916              |       | 2,191                 |       |
| Other assets                                                                                                                                                |       | 427                |       | 683                   |       |
| Noncurrent assets of  discontinued operations                                                                                                               |       | —             |       | 1,130                 |       |
| Total assets                                                                                                                                                |       | $                  | 47,953     |                  | $          | 53,623 |   |
|                                                                                                                                                        |       |               |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                               |       |               |       |                  |       |
| Current liabilities:                                                                                                                                        |       |               |       |                  |       |
| Accounts payable                                                                                                                                            |       | $                  | 5,739      |                  | $          | 4,625 |   |
| Accrued expenses                                                                                                                                            |       | 6,454              |       | 6,939                 |       |
| Line of credit                                                                                                                                              |       | 4,068              |       | 4,084                 |       |
| Current portion of  long-term debt                                                                                                                          |       | 1,985              |       | 5,121                 |       |
| Notes payable to stockholders,  current portion                                                                                                             |       | 500                |       | 542                   |       |
| Income taxes payable                                                                                                                                        |       | 1,117              |       | 451                   |       |
| Other current  liabilities                                                                                                                                  |       | 357                |       | 357                   |       |
| Current liabilities of  discontinued operations                                                                                                             |       | —             |       | 664                   |       |
| Total current  liabilities                                                                                                                                  |       | 20,220             |       | 22,783                |       |
|                                                                                                                                                        |       |               |       |                  |       |
| Long-term debt, net of  discount of $594 and $980, respectively                                                                                             |       | 6,828              |       | 13,479                |       |
| Notes payable to  stockholders, less current portion                                                                                                        |       | 125                |       | 250                   |       |
| Deferred income taxes                                                                                                                                       |       | 1,927              |       | 2,203                 |       |
| Warrant liability                                                                                                                                           |       | 880                |       | —                |       |
| Other liabilities                                                                                                                                           |       | 476                |       | 503                   |       |
| Noncurrent liabilities  of discontinued operations                                                                                                          |       | —             |       | 401                   |       |
| Total liabilities                                                                                                                                           |       | 30,456             |       | 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; 10,204,079 shares issued and  outstanding at March 31, 2009 and December 31, 2008 |       | 126                |       | 126                   |       |
| Additional paid-in  capital                                                                                                                                 |       | 43,359             |       | 44,806                |       |
| Accumulated deficit                                                                                                                                         |       | (22,743            | )          | (28,101               | )          |
| Accumulated other  comprehensive loss                                                                                                                       |       | (3,245             | )          | (2,827                | )          |
| Total stockholders’  equity                                                                                                                            |       | 17,497             |       | 14,004                |       |
| Total liabilities and  stockholders’ equity                                                                                                            |       | $                  | 47,953     |                  | $          | 53,623 |   |

 

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

 

1

----

Table of Contents

 

**EMRISE CORPORATION**

**Condensed Consolidated Statements of Operations**

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

 
| ** **                                                            | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                            | ** ** | **March 31,**     | ** ** |
| ** **                                                            | ** ** | **2009**               | ** ** | **2008** | ** ** |
| ** **                                                            | ** ** | **(Restated)**         | ** ** | ** ** | ** ** |
| Net Sales                                                             |       | $                      | 14,213     |   | $ | 10,643 |   |
| Cost of Sales                                                         |       | 9,256                  |       | 7,203 |   |
| Gross profit                                                          |       | 4,957                  |       | 3,440 |   |
|                                                                  |       |                   |       |   |   |
| Operating expenses:                                                   |       |                   |       |   |   |
| Selling, general and  administrative                                  |       | 4,547                  |       | 3,538 |   |
| Engineering and product  development                                  |       | 522                    |       | 503 |   |
| Total operating  expenses                                             |       | 5,069                  |       | 4,041 |   |
| Loss from operations                                                  |       | (112                   | )          | (601 | ) |
|                                                                  |       |                   |       |   |   |
| Other income (expense):                                               |       |                   |       |   |   |
| Interest income                                                       |       | 46                     |       | 18 |   |
| Interest expense                                                      |       | (1,556                 | )          | (584 | ) |
| Other, net                                                            |       | (42                    | )          | (17 | ) |
| Total other expense,  net                                             |       | (1,552                 | )          | (583 | ) |
|                                                                  |       |                   |       |   |   |
| Loss before income  taxes                                             |       | (1,664                 | )          | (1,184 | ) |
| Income tax provision                                                  |       | (503                   | )          | 84 |   |
| Loss from continuing  operations                                      |       | (1,161                 | )          | (1,268 | ) |
| Discontinued  operations:                                             |       |                   |       |   |   |
| Income from  discontinued operations including gain on sale of $7,224 |       | 7,402                  |       | 371 |   |
| Tax provision on  discontinued operations                             |       | 1,356                  |       | — |   |
| Net gain on  discontinued operations                                  |       | 6,046                  |       | 371 |   |
|                                                                  |       |                   |       |   |   |
| Net Income (loss)                                                     |       | $                      | 4,885      |   | $ | (897 | ) |
|                                                                  |       |                   |       |   |   |
| Earnings (loss) per  share:                                           |       |                   |       |   |   |
| Basic                                                                 |       | $                      | 0.48       |   | $ | (0.09 | ) |
| Diluted                                                               |       | $                      | 0.48       |   | $ | (0.09 | ) |
|                                                                  |       |                   |       |   |   |
| Weighted average shares  outstanding                                  |       |                   |       |   |   |
| Basic                                                                 |       | 10,204                 |       | 10,204 |   |
| Diluted                                                               |       | 10,239                 |       | 10,204 |   |

* *

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

 

2

----

Table of Contents

 

**EMRISE CORPORATION**

**Condensed 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-based  compensation                                                         |       | —            |       | —      |       | 34              |       | —            |       | —          |       | 34         |       |
| Warrants issued for  services                                                     |       | —            |       | —      |       | 2               |       | —            |       | —          |       | 2          |       |
| Net loss and  comprehensive loss                                                  |       | —            |       | —      |       | —          |       | 4,885             |       | (418            | )          | 4,467      |       |
| Balance at  March 31, 2009                                                   |       | 10,204            |       | $           | 126        |            | $          | 43,359            |       | $               | (22,743    | )          | $          | (3,245 | ) | $ | 17,497 |   |

 

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

 

3

----

Table of Contents

 

**EMRISE CORPORATION**

**Condensed Consolidated Statements of Cash Flows**

(Unaudited)****(in thousands)

 
| ** **                                                                                                                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                                | ** ** | **March 31,**     | ** ** |
| ** **                                                                                                                                | ** ** | **2009**               | ** ** | **2008** | ** ** |
| ** **                                                                                                                                | ** ** | **(Restated)**         | ** ** | ** ** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                                                                                 | ** ** |                   |       |   |   |
| Net Income (loss)                                                                                                                         |       | $                      | 4,885      |   | $ | (897 | ) |
| Adjustments to arrive  at net loss from continuing operations                                                                             |       | (6,046                 | )          | (371 | ) |
| Net loss from  continuing operations                                                                                                      |       | (1,161                 | )          | (1,268 | ) |
| Reconciliation to net  cash provided by (used in) operating activities:                                                                   |       |                   |       |   |   |
| Depreciation and  amortization                                                                                                            |       | 490                    |       | 270 |   |
| Provision for doubtful  accounts                                                                                                          |       | 66                     |       | (41 | ) |
| Provision for inventory  obsolescence                                                                                                     |       | 148                    |       | 186 |   |
| Provision for warranty  reserve                                                                                                           |       | 17                     |       | (103 | ) |
| Deferred taxes                                                                                                                            |       | 14                     |       | (4 | ) |
| Amortization of  deferred issuance costs                                                                                                  |       | 405                    |       | 108 |   |
| Amortization of debt  discount                                                                                                            |       | 386                    |       | 108 |   |
| Stock-based  compensation expense                                                                                                         |       | 34                     |       | 18 |   |
| Warrants issued for  services                                                                                                             |       | 2                      |       | 2 |   |
| Change in common stock  warrant value                                                                                                     |       | (130                   | )          | — |   |
| Changes in assets and  liabilities:                                                                                                       |       |                   |       |   |   |
| Accounts receivable                                                                                                                       |       | 801                    |       | 90 |   |
| Inventories                                                                                                                               |       | 141                    |       | (1,052 | ) |
| Prepaid and other  assets                                                                                                                 |       | 117                    |       | 142 |   |
| Accounts payable and  accrued expenses                                                                                                    |       | (920                   | )          | 97 |   |
| Operating cash flow  used in continuing operations                                                                                        |       | 410                    |       | (1,447 | ) |
| Operating cash flow  provided by discontinued operations                                                                                  |       | 681                    |       | 402 |   |
| Net cash provided by  (used in) operating activities                                                                                      |       | 1,091                  |       | (1,045 | ) |
|                                                                                                                                      |       |                   |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                                                                |       |                   |       |   |   |
| Purchases of property,  plant and equipment                                                                                               |       | (4                     | )          | (28 | ) |
| Additions to intangible  assets                                                                                                           |       | —                 |       | — |   |
| Investing cash flow  used in continuing operations                                                                                        |       | (4                     | )          | (28 | ) |
| Investing cash flow  provided by discontinued operations including proceeds from sale of  subsidiary operations, net of cash              |       | 10,050                 |       | (20 | ) |
| Net cash provided by  (used in) investing activities                                                                                      |       | 10,046                 |       | (48 | ) |
|                                                                                                                                      |       |                   |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                                                                |       |                   |       |   |   |
| Net repayments of lines  of credit                                                                                                        |       | (16                    | )          | (248 | ) |
| Repayments of long-term  debt                                                                                                             |       | (10,200                | )          | (75 | ) |
| Payments of notes to  stockholders                                                                                                        |       | (168                   | )          | (146 | ) |
| Net cash used in  financing activities                                                                                                    |       | (10,384                | )          | (469 | ) |
|                                                                                                                                      |       |                   |       |   |   |
| Effect of exchange rate  changes on cash                                                                                                  |       | (545                   | )          | 252 |   |
| Net increase (decrease)  in cash and cash equivalents                                                                                     |       | 208                    |       | (1,310 | ) |
| Cash and cash  equivalents at beginning of period                                                                                         |       | 3,421                  |       | 4,764 |   |
| Cash and cash  equivalents at end of period                                                                                               |       | $                      | 3,629      |   | $ | 3,454 |   |
|                                                                                                                                      |       |                   |       |   |   |
| **SUPPLEMENTAL  DISCLOSURES OF NON-CASH INVESTING AND****FINANCING  ACTIVITIES:**                                                         |       |                   |       |   |   |
| Acquisition of  equipment through capital lease                                                                                           |       | $                      | 22         |   | $ | 453 |   |
| Cumulative effect of  change in accounting principle - reclassification of common stock warrants to  liability upon adoption of EITF 07-5 |       | $                      | 473        |   | $ | — |   |

 

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

 

4

----

Tableof Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 1 — SUMMARY OF SIGNIFICANTACCOUNTING POLICIES, AS RESTATED**

 

*Organizationand Business*

 

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

 

In March of 2009, the Company sold substantially all the assetsrelated to its subsidiary, EMRISE Electronics Corporation’s (“EEC”), Digitrandivision, and all of the issued and outstanding equity interests of EEC’swholly-owned subsidiary, XCEL Japan, Ltd. (collectively the “DigitranOperations”).  The accompanying financial statements includethe Digitran Operations as a discontinued operation.

 

*Basis of Presentation*

 

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

 

*Comprehensive Income (Loss)*

 

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

 
| ** **                               | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------|------------|------------------------|------------|
| ** **                               | ** ** | **March 31,**     | ** ** |
| ** **                               | ** ** | **2009**               | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(Restated)**         | ** ** | ** ** | ** ** |
| Net income (loss)                        |       | $                      | 4,885      |   | $ | (897 | ) |
| Other comprehensive  income (loss):      |       |                   |       |   |   |
| Foreign currency  translation adjustment |       | (418                   | )          | 226 |   |
| Comprehensive income  (loss)             |       | $                      | 4,467      |   | $ | (671 | ) |

 

5

----

Tableof Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Revenue**Recognition*

 

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

 

The Company recognizesrevenues from U.S. sales of RO Associates Incorporated and all of its U.S.communications equipment business units at the point of shipment of thoseproducts.  An estimate of warranty costis 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 the contractis reached.  Production contracts providefor a specific quantity of products to be produced over a specific period oftime.  Customers issue binding purchaseorders or enter into binding agreements for the products to be produced.  The Company recognizes revenues on theseorders as the products are shipped. Returns are infrequent and permitted only with prior authorizationbecause these products are custom made to order based on binding purchaseorders and are quality tested prior to shipment.  An estimate of warranty cost is recorded atthe time revenue is recognized.

 

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 services such as repairs andmodifications are recognized when the service is completed and invoiced.  For repairs that involve shipment of arepaired product, the Company recognizes repair revenues when the product isshipped back to the customer. Service revenues contribute less than 5% of totalrevenue and, therefore, are considered to be immaterial to overall financialresults.

 

*Reverse Stock Split*

 

On November 19, 2008, the Companycompleted a board of directors approved 1-for-3.75 reverse split of its commonstock.  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.

 

*Income (Loss) Per Share*

 

Basic income (loss) per share is computed by dividingnet loss by the weighted average common shares outstanding during aperiod.  Diluted income (loss) per shareis based on the treasury stock method and includes the dilutive effect of stockoptions and warrants outstanding during the period.  Common share equivalents have been excludedwhere their inclusion would be anti-dilutive. As a result of the loss incurred by the Company for the 2008 period, thepotentially dilutive common shares have been excluded from the 2008 loss pershare 

 

6

----

Tableof Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|
| ** **                                          | ** ** | **March 31,**     | ** ** |
| ** **                                          | ** ** | **2009**               | ** ** | **2008** | ** ** |
| ** **                                          | ** ** | **(Restated)**         | ** ** | ** ** | ** ** |
| NUMERATOR:                                          |       |                   |       |   |   |
| Net income (loss)                                   |       | $                      | 4,885      |   | $ | (897 | ) |
|                                                |       |                   |       |   |   |
| DENOMINATOR:                                        |       |                   |       |   |   |
| Basic weighted average  common shares outstanding   |       | 10,204                 |       | 10,204 |   |
| Effect of dilutive  securities:                     |       |                   |       |   |   |
| Dilutive stock options  and warrants                |       | 35                     |       | — |   |
| Diluted weighted  average common shares outstanding |       | 10,239                 |       | 10,204 |   |
|                                                |       |                   |       |   |   |
| Basic income (loss) per  share                      |       | $                      | 0.48       |   | $ | (0.09 | ) |
|                                                |       |                   |       |   |   |
| Diluted income (loss)  per share                    |       | $                      | 0.48       |   | $ | (0.09 | ) |

 

The following table shows the common stock equivalentsthat were outstanding as of March 31, 2009 and 2008, but were not includedin the computation of diluted earnings per share as a result of the lossincurred by the Company in 2008 or because the options’ or warrants’ exerciseprice was greater than the average market price of the common shares and,therefore, the effect would have been anti-dilutive:

 
| ** **                            | ** ** | ** **     | ** ** | **Range  of**       | ** ** |
|---------------------------------------|------------|----------------|------------|---------------------|------------|
| ** **                            | ** ** | **Number  of** | ** ** | **Exercise  Price** | ** ** |
| ** **                            | ** ** | **Shares**     | ** ** | **Per  Share**      | ** ** |
|                                  |       |           |       |                |       |
| Anti-dilutive common  stock options:  |       |           |       |                |       |
| As of March 31,  2009            |       | 584,000        |       | $1.88 – $7.50  |       |
| As of March 31,  2008            |       | 294,000        |       | $0.75 – $7.50  |       |
|                                  |       |           |       |                |       |
| Anti-dilutive common  stock warrants: |       |           |       |                |       |
| As of March 31,  2009            |       | 1,804,000      |       | $4.31 – $6.49  |       |
| As of March 31,  2008            |       | 1,798,000      |       | $4.13 – $6.49  |       |

 

7

----

Tableof Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Recent Accounting Pronouncements*

 

In February 2007, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159permits an entity to irrevocably elect fair value on a contract-by-contract basisas the initial and subsequent measurement attribute for many financial assetsand liabilities 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 new statement provides a single definition offair value, together with a framework for measuring it, and requires additionaldisclosure about the use of fair value to measure assets and liabilities. SFAS No. 157also emphasizes that fair value is a market-based measurement, not anentity-specific measurement, and sets out a fair value hierarchy, with thehighest priority being quoted prices in active markets. The required effectivedate of SFAS No. 157 is the first quarter of 2008. The adoption of SFAS No. 157for financial assets and liabilities did not have a material effect on theCompany’s consolidated financial statements, but resulted in additionaldisclosures contained herein.  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 Company has evaluated the impact the adoption of SFAS No. 157for non-financial assets and liabilities have 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 replaces SAFS No. 141, “BusinessCombinations.”  SFAS No. 141Restablishes principles and requirements for determining how an enterpriserecognizes and measures the fair value of certain assets and liabilitiesacquired in a business combination, including noncontrolling interests,contingent consideration and certain acquired contingencies.  SFAS No. 141R also requiresacquisition-related transaction expenses and restructuring costs be expensed asincurred 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. 141Rwould have an impact on accounting for any business acquired after theeffective date of this pronouncement.

 

In March 2008, the FASB issued SFAS No. 161,“Disclosures about Derivative Instruments and Hedging Activities.” The newstandard amends SFAS No. 133 and seeks to enhance disclosure about how andwhy a company uses derivative and hedging activities, how derivative instrumentsand related hedged items are accounted for under SFAS No. 133 (and theinterpretations of that standard) and how derivatives and hedging activitiesaffect a company’s financial position, financial performance and cashflows.  SFAS No. 161 is effectivefor financial statements issued for fiscal years and interim periods beginningafter November 15, 2008.  Theadoption of SFAS No. 161 did not have a material effect on the Company’sconsolidated financial statements.

 

In April 2008, the FASB issued FASB StaffPosition (“FSP”) No. FAS 142-3, “Determination of the Useful Life ofIntangible Assets,” (“FSP 142-3”). FSP 142-3 amends the factors that should beconsidered in developing renewal or extension assumptions used to determine theuseful life of a recognized intangible asset under SFAS No. 142, “Goodwilland Other Intangible Assets” and also requires expanded disclosure related tothe determination of intangible asset useful lives. FSP 142-3 is effective forfiscal years beginning after December 15, 2008. Early adoption isprohibited. The adoption of FSP 142-3 did not have a material effect on theCompany’s consolidated financial statements.

 

8

----

Tableof Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(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.

 

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

 

Thefinancials statements for the period ended March 31, 2009 have beenrestated 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 March 31,2009. As a result of the partial repayment on Term Loan B, a pro-rata portionof the balance of deferred financing costs and debt discount were acceleratedand are reflected as an adjustment of $541,000 to interest expense in theaccompanying Condensed Consolidated Statements of Operations for the periodended March 31, 2009.  Theadjustment also impacted the net carrying value of long term debt by $259,000and other various balance sheet items.

 

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

 

***Balance Sheet***

 
| ** **                                       | ** ** | **March 31,  2009** | ** ** |
|--------------------------------------------------|------------|--------------------------|------------|
| ** **                                       | ** ** | **As  reported**         | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                             |       |                     |       |   |   |   |   |
| Other current assets                             |       | $                        | 1,544      |   | $ | (169 | ) | $ | 1,375 |   |
|                                             |       |                     |       |   |   |   |   |
| Total current assets                             |       | $                        | 27,123     |   | $ | (169 | ) | $ | 26,954 |   |
|                                             |       |                     |       |   |   |   |   |
| Other assets                                     |       | $                        | 540        |   | $ | (113 | ) | $ | 427 |   |
|                                             |       |                     |       |   |   |   |   |
| Total assets                                     |       | $                        | 48,235     |   | $ | (282 | ) | $ | 47,953 |   |
|                                             |       |                     |       |   |   |   |   |
| Income taxes payable                             |       | $                        | 1,270      |   | $ | (153 | ) | $ | 1,117 |   |
|                                             |       |                     |       |   |   |   |   |
| Total current  liabilities                       |       | $                        | 20,373     |   | $ | (153 | ) | $ | 20,220 |   |
|                                             |       |                     |       |   |   |   |   |
| Long-term debt                                   |       | $                        | 6,569      |   | $ | 259 |   | $ | 6,828 |   |
|                                             |       |                     |       |   |   |   |   |
| Total liabilities                                |       | $                        | 30,350     |   | $ | 106 |   | $ | 30,456 |   |
|                                             |       |                     |       |   |   |   |   |
| Accumulated deficit                              |       | $                        | (22,355    | ) | $ | (388 | ) | $ | (22,743 | ) |
|                                             |       |                     |       |   |   |   |   |
| Total stockholder’s  equity                 |       | $                        | 17,885     |   | $ | (388 | ) | $ | 17,497 |   |
|                                             |       |                     |       |   |   |   |   |
| Total liabilities and  stockholder’s equity |       | $                        | 48,235     |   | $ | (282 | ) | $ | 47,953 |   |

 

9

----

Table of Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

***Statement of Operations***

 
| ** **                            | ** ** | **Three  Months Ended**  | ** ** |
|---------------------------------------|------------|--------------------------|------------|
| ** **                            | ** ** | **March 31,  2009** | ** ** |
| ** **                            | ** ** | **As  reported**         | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                  |       |                     |       |   |   |   |   |
| Interest expense                      |       | $                        | (1,015     | ) | $ | (541 | ) | $ | (1,556 | ) |
|                                  |       |                     |       |   |   |   |   |
| Pre-tax income                        |       | $                        | (1,123     | ) | $ | (541 | ) | $ | (1,664 | ) |
|                                  |       |                     |       |   |   |   |   |
| Provision (benefit) for  income taxes |       | (350                     | )          | (153 | ) | (503 | ) |
|                                  |       |                     |       |   |   |   |   |
| Net income                            |       | $                        | 5,273      |   | $ | (388 | ) | $ | 4,885 |   |
|                                  |       |                     |       |   |   |   |   |
| Earnings (loss) per  share:           |       |                     |       |   |   |   |   |
| Basic                                 |       | $                        | 0.52       |   | $ | (0.04 | ) | $ | 0.48 |   |
| Diluted                               |       | $                        | 0.51       |   | $ | (0.03 | ) | $ | 0.48 |   |
|                                  |       |                     |       |   |   |   |   |
| Weighted average shares  outstanding  |       |                     |       |   |   |   |   |
| Basic                                 |       | 10,204                   |       | 10,204 |   | 10,204 |   |
| Diluted                               |       | 10,239                   |       | 10,239 |   | 10,239 |   |

 

***Statement of Cash Flows***

 
| ** **                                               | ** ** | **Three  Months Ended**  | ** ** |
|----------------------------------------------------------|------------|--------------------------|------------|
| ** **                                               | ** ** | **March 31,  2009** | ** ** |
| ** **                                               | ** ** | **As  reported**         | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                                     |       |                     |       |   |   |   |   |
| Net income (loss)                                        |       | $                        | 5,273      |   | $ | (388 | ) | $ | 4,885 |   |
|                                                     |       |                     |       |   |   |   |   |
| Net loss from  continuing operations                     |       | $                        | (773       | ) | $ | (388 | ) | $ | (1,161 | ) |
|                                                     |       |                     |       |   |   |   |   |
| Reconciliation to net  cash used in operating activities |       |                     |       |   |   |   |   |
| Amortization of  deferred issuance costs                 |       | $                        | 123        |   | $ | 282 |   | $ | 405 |   |
| Amortization of debt  discount                           |       | $                        | 127        |   | $ | 259 |   | $ | 386 |   |
|                                                     |       |                     |       |   |   |   |   |
| Changes in assets and  liabilities                       |       |                     |       |   |   |   |   |
| Accounts payable and  accrued expenses                   |       | $                        | (767       | ) | $ | (153 | ) | $ | (920 | ) |

 

**NOTE 3 — LIQUIDITY, AS RESTATED**

 

TheCompany reported $4.9 million of net income for the quarter ended March 31,2009.  Included in this net income was a$5.9 million gain (net of tax of $1.4 million) on the disposition of theDigitran Operations (see Note 5).  Absentthis gain, the Company would have incurred a $1.0 million net loss.  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 creditfacility.  The Company may be unable toattain, sustain or increase profitability on a quarterly or annual basis in thefuture. If the Company does not achieve, sustain or increase profitability, itsstock price may decline.  Additionally,the Company has agreed with its lender to raise at least $2 million in netproceeds through the sale of the Company’s and/or its subsidiaries’ stock by nolater than September 30, 2009. Under the terms of the Company’s credit facility, the Company isobligated to remit to its lender $500,000 with respect to the first $2,000,000of net cash proceeds received in connection with the sale of stock, 50% of thenext $1,000,000 of net cash proceeds received in connection with the sale ofstock, and 30% of the net cash proceeds in excess of the first $3,000,000received in connection with the sale of stock. The 

 

10

----

Tableof Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Company is currentlyevaluating a number of options to meet this obligation under its creditfacility, including a possible refinancing of the entire facility.  Givencurrent economic and financial market conditions even a small equity raisecould prove difficult (see Note 12).

 

Recent actions taken bythe SEC against Private Equity Management Group, Inc., an affiliate of theagent of the Company’s lender and the Company’s lender, including an ordergranted in April 2009 by a federal court freezing all assets of PrivateEquity Management Group, Inc. and its affiliates, including the Company’slender, may adversely affect the lender’s ability to continue to provide theCompany funds under the terms of the Revolver (as defined in Note 11below).  At the request of the SEC, the federal court also appointed atemporary receiver of the 1ender’s agent and of the 1ender.  Although theCompany currently believes that the receiver will allow it to continue toborrow funds under the terms of the Revolver, management cannot assure you thatthe receiver will allow the lender to continue to make funds available to theCompany.  If, for any reason, the receiver were to limit or terminate theCompany’s ability to continue to borrow funds under the Revolver (as defined inNote 10 below), the Company’s cash position and its ability to continue day today operations would be adversely affected, almost immediately.  If thatwere to occur, the Company would be required to seek additional and/orreplacement financing immediately.  If the Company is unable to do so, itmay be forced to drastically curtail or cease operations and possibly seekprotection from its creditors under the U. S. Bankruptcy Code.

 

Currently,the Company is in the process of seeking alternate financing from a number ofpossible lenders, including certain banks and lenders which it has maintained afavorable relationship over many years. Although the Company remains hopeful that it will be able tosuccessfully secure replacement financing on a timely basis, management cannotassure you that the Company will be successful in this regard.

 

If the Company is able tocontinue to borrow funds under the terms of its Revolver (as defined in Note 11below), including timely funding by the lender of draw requests, managementbelieves that current and future capital resources, revenues generated fromoperations and other existing sources of liquidity will be adequate to meet theCompany’s anticipated short term, working capital and capital expendituresneeds for at least the next 12 months.  However, if the Companyexperiences a significant loss of revenue or increase in costs, or if thelender fails to fund the Company’s draw requests in a timely manner or at all,then the Company’s cash flow would be negatively impacted resulting in a cashflow deficit which, in turn, will require it to obtain additional or alternatefinancing, with little or no notice.  These potential financing needscould be met in the form of a revised debt structure with the Lender,additional or new financing with another lender or lenders, the sale of assetsto generate cash or the sale of additional equity to raise capital.  TheCompany’s failure to secure additional or alternate financing, if and whenneeded, would have an adverse effect on its operations and/or ability to dobusiness after that date or could restrict its growth, limit its development ofnew products, or hinder its ability to fulfill existing or future orders.

 

**NOTE 4 — ACQUISITION OF ADVANCEDCONTROL COMPONENTS**

 

OnMay 23, 2008, the Company and its wholly-owned subsidiary, EMRISEElectronics Corporation (“EEC”) entered into a Stock Purchase Agreement (the “StockPurchase Agreement”) pursuant to which EEC agreed to acquire Custom Components, Inc.(“CCI”) and its operating subsidiary, Advanced Control Components, Inc. (“ACC”). On August 20, 2008, the Stock Purchase Agreement was amended pursuant toAmendment No. 1 to Stock Purchase Agreement (the “Amendment to PurchaseAgreement,” and collectively with the Stock Purchase Agreement, the “ACCPurchase Agreement”) to, among other things, reduce the initial purchase pricefor all of the capital stock of both CCI and ACC to $12,400,000, subject toadjustments for working capital and net cash.  Additionally, pursuant tothe terms of the Amendment to Purchase Agreement, the Company is obligated topay interest on a principal amount of $600,000 at a rate equal to the primerate as reported in *The Wall StreetJournal *on August 20, 2008 plus 1% for the periodcommencing on August 20, 2008 and ending on the later of November 18,2008 or the actual date such interest payment is made.

 

11

----

Tableof Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Theclosing of the ACC Purchase Agreement occurred on August 20, 2008. Under the terms of the ACC Purchase Agreement, EEC acquired all of the issuedand outstanding shares of common stock of CCI and all of the issued andoutstanding shares of common stock of ACC not owned by CCI (the “Acquisition”). In addition to the purchase price, the Company is obligated to pay up to anadditional $3,000,000 in cash if ACC meets certain operating income targets forone or both of the two 12 month periods following the closing. Additionally, EEC issued Subordinated Secured Contingent Promissory Notes (the “Notes”)to each of the Sellers in the aggregate principal amount of $2,000,000. The Notes become payable if ACC meets certain operating income thresholdsduring the first and second 12 month periods after August 20, 2008. The Notes bear interest at a rate per annum equal to the prime rate asreported in *The Wall StreetJournal *plus 1%.

 

Indetermining the purchase price for the Acquisition, the Company took intoaccount the historical and expected earnings and cash flow of ACC, as well asthe value of companies of a size and in an industry similar to ACC, comparabletransactions and the market for such companies generally.  The purchase price represented a premium ofapproximately $4.1 million over the recorded net worth of ACC’s assets.  The acquisition occurred prior to theeffective date of SFAS No. 141R and the Company did not early adopt theprovisions of this statement.

 

Inconjunction with the Acquisition, the Company commissioned a valuation firm toassist it in determining the fair value of ACC’s tangible assets and theportion of the purchase price that should be allocated to identifiableintangible assets.  The Companyconsidered whether the Acquisition included various types of identifiableintangible assets, including trade names, trademarks, patents, covenants not tocompete, customers, backlog, workforce, technology and software.  As a result of the procedures performed bythe valuation firm and the evaluation of management, the Company determined andrecorded the value of the tangible and intangible assets in its CondensedConsolidated Balance Sheets in accordance with the purchase priceallocation.  The Company has estimatedand recorded the identified intangible assets as follows:  trade name of $1,570,000; covenant not tocompete of $60,000; backlog of $570,000; and customer relationships of$2,550,000.

 

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

 
| Accounts  receivable                      |   | $      | 2,185  |   |
|-------------------------------------------|--------|--------|--------|--------|
| Inventories                               |   | 1,848  |   |
| Property  and equipment                   |   | 1,545  |   |
| Intangible  assets, net                   |   | 4,750  |   |
| Goodwill                                  |   | 4,073  |   |
| 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 

 

12

----

Table of Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Company completed 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**  | ** ** |
|---------------------------------------|------------|--------------------|------------|
| ** **                            | ** ** | **Months Ended**   | ** ** |
| ** **                            | ** ** | **March 31,** | ** ** |
| ** **                            | ** ** | **2008**           | ** ** |
| Net  sales                            |       | $                  | 14,797     |   |
|                                  |       |               |       |
| Net  loss                             |       | $                  | (2,182     | ) |
|                                  |       |               |       |
| Loss  per share:                      |       |               |       |
| Basic                                 |       | $                  | (0.21      | ) |
| Diluted                               |       | $                  | (0.21      | ) |
|                                  |       |               |       |
| Weighted  average shares outstanding: |       |               |       |
| Basic                                 |       | 10,204             |       |
| Diluted                               |       | 10,204             |       |

 

13

----

Tableof Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 5 — DISCONTINUED OPERATIONS**

 

OnMarch 20, 2009, the Company and its wholly-owned subsidiary, EEC, enteredinto an Asset and Stock Purchase Agreement (the “Digitran Purchase Agreement”)with Electro Switch Corp., a Delaware corporation (the “Buyer”) and ESCWorldwide, Inc., a Massachusetts corporation and subsidiary of Buyer (the “StockBuyer”).  At the closing of the Digitran Purchase Agreement on March 20,2009, (i) the Buyer purchased from the Company and EEC substantially allthe assets related to EEC’s Digitran division, and (ii) the Stock Buyerpurchased from EEC all of the issued and outstanding equity interests of itswholly-owned subsidiary, XCEL Japan, Ltd., for an aggregate purchase price ofapproximately $11,560,000 (the “Disposition”).  Under the terms of thePurchase Agreement, the Buyer is obligated to pay up to an additional $500,000in cash to EEC if net sales for the fiscal year ending December 31, 2009related to the businesses that were sold pursuant to the Digitran PurchaseAgreement exceeds $6,835,120.

 

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

 

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

 

In connection with theCompany’s divestiture of its Digitran division, which comprised a portion ofthe Company’s electronic devices segment, the Company incurred approximately$900,000 in cash charges that were paid at closing.  The charges paid atclosing included approximately $100,000 in employee termination costs.  Inaddition, the Company estimates future cash expenditures related to the sale tobe approximately $735,000, which are accrued within “Accrued liabilities”except for income taxes, which are accrued within “Income taxes payable” in theaccompanying condensed consolidated balance sheets.  The Companyanticipates the charges will be comprised of (i) approximately $370,000 incosts related to federal and state income liabilities, (ii) approximately$270,000 in employee termination costs and transaction related employeeincentive bonuses, and (iii) approximately $95,000 in other costs andfees, including additional legal and accounting fees.  Substantially allof the charges are expected to be incurred within 12 months of the closing ofthe sale.

 

14

----

Tableof Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The following tablesummarizes the results from discontinued operations for the three months ended March 31,2009 and 2008 (in thousands):

 
| ** **                                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
|-------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                        |       |     |       |     |       |
| Net Sales                                                   |       | $        | 1,478      |     | $          | 1,604 |   |
| Income from continuing  operations                          |       | $        | 178        |     | $          | 371 |   |
| Gain on sale of  Digitran Operations (net of tax of $1,356) |       | 5,868    |       | —   |       |
| Net Income                                                  |       | $        | 6,046      |     | $          | 371 |   |
|                                                        |       |     |       |     |       |
| Earnings per share:                                         |       |     |       |     |       |
| Basic                                                       |       | $        | 0.59       |     | $          | 0.04 |   |
| Diluted                                                     |       | $        | 0.59       |     | $          | 0.04 |   |
|                                                        |       |     |       |     |       |
| Weighted average shares  outstanding                        |       |     |       |     |       |
| Basic                                                       |       | 10,204   |       | 10,204   |       |
| Diluted                                                     |       | 10,239   |       | 10,204   |       |

 

**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 Option Plan; and

·                  2007 Stock Incentive Plan.

 

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

 

Total stock-based compensation expense included inwages, salaries and related costs was $34,000 and $20,000 for the three monthsended March 31, 2009 and 2008, respectively. These compensation expenseswere charged to selling, general and administrative expenses. As of March 31,2009, the Company had $349,000 of total unrecognized compensation expenserelated to stock option grants, which will be recognized over the remainingweighted average period of two years.

 

**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):

 

15

----

Tableof Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 
| ** **        | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|--------------------|------------|-----------------------|------------|
|              |       | **2009**           | ** ** | **2008**              | ** ** |
|              |       |               |       |                  |       |
| Raw materials     |       | $                  | 9,827      |                  | $          | 10,897 |   |
| Work-in-process   |       | 2,982              |       | 3,513                 |       |
| Finished goods    |       | 4,754              |       | 4,915                 |       |
| Reserves          |       | (5,263             | )          | (5,609                | )          |
| Total inventories |       | $                  | 12,300     |                  | $          | 13,716 |   |

 

**NOTE 8 — OPERATING SEGMENTS, ASRESTATED**

 

The Company has two reportable operating segments:electronic devices and communications equipment. The electronic devices segmentmanufactures and markets electronic power supplies, radio frequency (“RF”) andmicrowave devices and subsystem assemblies. The electronic devices segmentconsists of EEC and its subsidiaries located in the U.S. and England, whichoffer 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 and manufacturingprocesses and marketing strategies.  Eachsegment has discrete financial information and a separate management structure.

 

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

 

During the first quarterof 2009, the Company sold its Digitran Operations (see Note 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 Form 10-Q, theDigitran Operations are reported as a discontinued operation and are excludedfrom the electronics devices segment. Therefore, prior period amounts have been adjusted to conform with thispresentation.  Included in the Company’sreconciliation of segment financial data to the consolidated amounts isunallocated corporate expenses.

 

16

----

Tableof Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 
| ** **                | ** ** | **Three Months Ended** | ** ** |
|---------------------------|------------|------------------------|------------|
| ** **                | ** ** | **March 31,**     | ** ** |
| ** **                | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Net sales                 |       |                   |       |   |   |
| Electronic devices        |       | $                      | 11,595     |   | $ | 7,283 |   |
| Communications  equipment |       | 2,618                  |       | 3,360 |   |
| Total                     |       | $                      | 14,213     |   | $ | 10,643 |   |
|                      |       |                   |       |   |   |
| Operating income (loss)   |       |                   |       |   |   |
| Electronic devices        |       | $                      | 1,562      |   | $ | 453 |   |
| Communications  equipment |       | (452                   | )          | 18 |   |
| Corporate and other       |       | (1,222                 | )          | (701 | ) |
| Total                     |       | $                      | (112       | ) | $ | (230 | ) |

 
| ** **                | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                | ** ** | **2009**           | ** ** | **2008**              | ** ** |
|                      |       | **(Restated)**     |       |                  |       |
| Total assets              |       |               |       |                  |       |
| Electronic devices        |       | $                  | 34,644     |                  | $          | 34,853 |   |
| Communications  equipment |       | 9,187              |       | 10,260                |       |
| Corporate and other       |       | 4,122              |       | 8,510                 |       |
| Total                     |       | $                  | 47,953     |                  | $          | 53,623 |   |

 

**NOTE 9 — GOODWILL**

 

The following tablereflects changes in our goodwill balances, by segment, for the three monthsended March 31, 2009 (in thousands):

 
| ** **                         | ** ** | **Electronic** | ** ** | **Communications** | ** ** | ** ** | ** ** |
|------------------------------------|------------|----------------|------------|--------------------|------------|------------|------------|
| ** **                         | ** ** | **Devices**    | ** ** | **Equipment**      | ** ** | **Total**  | ** ** |
|                               |       |           |       |               |       |       |       |
| Balance at  December 31, 2008 |       | $              | 9,657      |               | $          | —     |       | $ | 9,657 |   |
| Foreign currency  translation      |       | (113           | )          | —             |       | (113       | )          |
| Balance at  March 31, 2009    |       | $              | 9,544      |               | $          | —     |       | $ | 9,544 |   |

 

**NOTE 10 — INCOME TAXES**

 

The effective taxrate for the three month period ended March 31, 2009 was different thanthe 34% U.S. statutory rate primarily because the Company’s foreign entitiesgenerate a tax obligation and related tax expense as a result of their netincome, which cannot be offset by U.S. tax loss carryforwards.

 

The Company adopted FIN 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASBStatement No. 109,” on January 1, 2007. The implementation ofFIN 48 did not result in a material adjustment to the Company’s liability forunrecognized income tax benefits. At the time of adoption and as of March 31,2009, the Company had recorded no net unrecognized tax benefits.

 

17

----

Table of Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

The Company recognizes interest and penalties relatedto uncertain tax positions in interest expense and selling, general andadministrative expense, respectively, in the condensed consolidated statementsof operations and comprehensive income. No interest or penalties wererecognized during 2008. As of March 31, 2009, the Company had nothingaccrued for interest and penalties.

 

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

 

**NOTE 11 — 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 in the original aggregate amount of $26,000,000and is secured by accounts receivable, other rights to payment and generalintangibles, inventories and equipment. The credit facility includes a one yearrevolving credit facility for up to $7,000,000 that may be renewed up to twotimes, each for a period of one year, at the Company’s option, provided thatcertain 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 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%.  The interest rate in effect as of March 31,2009 was the minimum rate of 9.5%.  TheRevolver is subject to various financial covenants on a consolidated basis, includingthe following: EBITDA, measured on a fiscal quarter-end basis, must not be lessthan the scheduled amount for each specified period; the debt service coverageratio, measured quarterly, must be greater than the lesser of the scheduledamount for each specific period or 1.10:1.00; the leverage ratio, measuredquarterly, must not be greater than the scheduled amount for each specifiedperiod, and liquidity, measured quarterly, must not be less than the scheduledamount for each specified period.  Additionally,the Revolver 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 the borrowersnot incurring unfinanced capital expenditures in excess of $62,500 in anyfiscal quarter,****provided however that if theborrowers incur unfinanced capital expenditures of less than $62,500 in anyfiscal quarter, the difference between the amount incurred in a certain fiscalquarter and $62,500 maybe incurred in the two fiscal quarters immediatelyfollowing such fiscal quarter. The Company was not in compliance with itsEBITDA, debt service coverage ratio and leverage ratio covenants at March 31,2009. Additionally, on April 1, 2009 the Company voluntarily elected notto make a required interest payment on amounts borrowed under its creditfacility, which amount has been subsequently paid.  On May 14, 2009, the Company received awaiver from the Lender for these events of default.

 

Asof March 31, 2009, the Company had outstanding borrowings of $4.1 millionunder the Revolver with remaining availability under the formula-basedcalculation of $2.9 million.

 

18

----

Table of Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

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

 

Inthe event of a default and continuation of a default, the Lender may acceleratethe payment of the principal balance requiring the Company to pay the entireindebtedness outstanding on that date. Upon the occurrence and during the continuation of an event of default,the Lender may also elect to increase the interest rate applicable to theoutstanding balance by four percentage points above the per annum interest ratethat would otherwise be applicable.

 

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

 

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

 

On August 20, 2008, in connection with theacquisition of ACC and CCI as discussed in Note 4, the Borrowers and the Lenderamended the credit facility to, among other things, include ACC and CCI asBorrowers and to provide for another term loan in the principal amount of $3million (the “Term Loan C”).  The creditfacility, as so amended, provided for borrowings in the aggregate amount of $26million.

 

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 require scheduled principal and interestpayments commencing September 2009 and a final balloon payment ofprincipal upon maturity on November 30, 2010.  Term Loan C was repaid in full on March 20,2009.  At March 31, 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 B bearinterest at the Base Rate plus 4.25%, subject to a minimum rate of 12.5%, andrequire interest only payments in the first year, scheduled principal plusinterest payments in years two and three, and a final balloon payment at theend of year three.  Interest on the TermLoans is payable monthly.  The Borrowers may make full or partialprepayment of the Term Loans provided that any such prepayment is accompaniedby the applicable prepayment premium.

 

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

 

19

----

Table of Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

The Borrowers have agreed with the Lender to raise at least $2 million innet proceeds through the sale of stock of the Borrowers by no later than September 30,2009.  Under the terms of the creditfacility, the Borrowers are obligated to remit to the Lender $500,000 withrespect to the first $2,000,000 of net cash proceeds received in connectionwith the sale of stock, 50% of the next $1,000,000 of net cash proceedsreceived in connection with the sale of stock, and 30% of the net cash proceedsin excess of the first $3,000,000 received in connection with the sale ofstock.

 

If theCompany is unsuccessful in meeting the Lender’s requirement for additionalcapital by the required due dates and/or if the Company breaches any of itsagreed upon financial covenants under the credit facility, then it will be indefault under the terms of the credit facility. In the event of a default and continuation of a default, whether as aresult of the Company’s inability to raise additional capital or for some otherreason, the Lender may limit future availability under the revolving line ofcredit and/or accelerate the payment of all principal balances and accruedinterest requiring the Company to pay the entire indebtedness under the creditfacility outstanding on that date.  Uponthe occurrence and during the continuation of an event of default, the Lendermay also elect to increase the interest rate applicable to the outstandingbalance of the Term Loans A and B by four percentage points above the per annuminterest rate that would otherwise be applicable.  Any of these conditions could have a materialadverse effect on the Company’s operations and/or ability to conduct businessafter that date.

 

**NOTE 13 — WARRANTS**

 

In connection with entering into the credit facility(discussed in Note11), the Company issued a seven year warrant to PrivateEquity Management Group, Inc., an affiliate of the Lender to purchase upto approximately 776,000 shares of the Company’s common stock on a cash orcashless 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 andreissued in conjunction with an amendment to the credit facility.  Pursuant to the Second Amendment to LoanDocuments, the original warrant was divided into two warrants (each, a “SecondAmended and Restated Warrant” and collectively, the “Second Amended andRestated Warrants”).  Each Second Amended and Restated Warrant covers387,879 shares of the Company’s common stock (which amount reflects the Company’s1-for-3.75 reverse split of its common stock effective November 18,2008).  One of the Second Amended and Restated Warrants provides for anexercise price of $1.99 per share (which amount reflects the Company’s1-for-3.75 reverse split of its common stock effective November 18,2008).  The other Second Amended and Restated Warrant provides for anexercise price of $1.80 per share (which amount reflects the Company’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).

 

20

----

Tableof Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

The exercise price and/or number of shares of commonstock issuable upon exercise of the warrants may be adjusted in certaincircumstances, including certain issuances of securities at a price equal toless than the then current exercise price, subdivisions and stock splits, stockdividends, combinations, reorganizations, reclassifications, consolidations,mergers or sales of properties and assets and upon issuance of certain assetsor securities to holders of the Company’s common stock, as applicable. In June 2008,the FASB ratified the consensus reached on EITF Issue No. 07-5, “DeterminingWhether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock”(“EITF 07-5”). EITF 07-5 clarifies the determination of whether an instrument(or an embedded feature) is indexed to an entity’s own stock, which wouldqualify as a scope exception under SFAS No. 133, Accounting for DerivativeInstruments and Hedging Activities. EITF 07-5 was effective for financialstatements issued for fiscal years beginning after December 15, 2008.  The adoption of EITF 07-5 on January 1,2009, resulted in the reclassification of certain of the Company’s outstandingwarrants from stockholders’ equity to liabilities, which requires the warrantsto be fair valued at each reporting period, with the changes in fair valuerecognized in the Company’s consolidated statement of operations.

 

At January 1, 2009 and March 31, 2009, theCompany had warrants subject to mark to market outstanding to purchase 775,758shares of common stock.  The Companycomputed the fair value of the warrants using a Black-Scholes valuationmodel.  The fair value of these warrantson the date of adoption of January 1, 2009 and on March 31, 2009 wasdetermined using the following assumptions:

 
| ** **               | ** ** | **January 1,  2009** | ** ** | **March 31,  2009** | ** ** |
|--------------------------|------------|---------------------------|------------|--------------------------|------------|
| Dividend  yield          |       | None                      |       | None                     |       |
| Expected  volatility     |       | 105                       | %          | 75                       | %          |
| Risk-free  interest rate |       | 0.88                      | %          | 0.81                     | %          |
| Expected  term           |       | 7  years                  |       | 7  years                 |       |
| Stock  price             |       | $                         | 1.58       |                     | $          | 1.69 |   |
|                          |            |                           |            |                          |            |  |  |

 

On January 1, 2009, the Company recorded acumulative effect of change in accounting principle adjustment to itsaccumulated deficit of $473,000 and a corresponding reclassification of theseoutstanding warrants from stockholders’ equity to warrant liability.  As of and for the quarter ended March 31,2009, the change in fair value of the warrants resulted in a $130,000adjustment to other income (expense) in the consolidated statement ofoperations and a corresponding decrease to the warrant liability.

 

**NOTE 14 — FAIR VALUE MEASUREMENTS**

 

InSeptember 2006, the FASB issued SFAS No. 157, which defines fairvalue, establishes a framework for measuring fair value in generally acceptedaccounting principles and expands disclosures about fair valuemeasurements.  The effective date of thestatement is for all entities with fiscal years beginning after November 15,2007.  In February 2008, the FASBissued FASB Staff Position No. 157-2, which delays the effective date ofSFAS No. 157 for non-financial assets and liabilities to fiscal yearsbeginning after November 15, 2008. The delay pertains to items including, but not limited to, goodwill andother intangible assets.  The Companyadopted the provisions of the standard that were effective as of January 1,2008.  The Company adopted the remainingprovisions of SFAS No. 157 as of January 1, 2009.

 

SFASNo. 157 defines fair value as the price that would be received to sell anasset or paid to transfer a liability (an exit price) in an orderly transactionbetween market participants and also establishes a fair value hierarchy whichrequires an entity to maximize the use of observable inputs and minimize theuse of unobservable inputs when measuring fair value.  The fair value hierarchy distinguishesbetween three levels of inputs that may be utilized when measuring fair valueas follows:

 

21

----

Table of Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

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

 

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

 

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

 

Asof March 31, 2009, the Company was required to apply SFAS No. 157provisions to the derivative that is within the warrant that was issued asconsideration for our credit facility, which is discussed in Note 13 andincluded as a discount on our long-term debt. The derivative was valued using the Black-Scholes model.  The key inputs in the model are as follows:

 
| ** **               | ** ** | **March 31,  2009** | ** ** |
|--------------------------|------------|--------------------------|------------|
| Dividend  yield          |       | None                     |       |
| Expected  volatility     |       | 75                       | %          |
| Risk-free  interest rate |       | 0.81                     | %          |
| Expected  term           |       | 7  years                 |       |
| Stock  price             |       | $                        | 1.69       |   |
|                          |            |                          |            |  |

 

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

 
| ** **                                 | ** ** | **Warrant  Liability** | ** ** |
|--------------------------------------------|------------|------------------------|------------|
| Beginning  balance at January 1, 2009 |       | $                      | 1,010      |   |
| Total  gain realized in earnings           |       | (130                   | )          |
| Ending  balance at March 31, 2009     |       | $                      | 880        |   |

 

22

----

Table of Contents

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

 

**CautionaryStatement**

 

The following discussion should be read in conjunctionwith our unaudited condensed consolidated financial statements and the relatednotes thereto contained in Part I, Item 1 of this Amendment No, 1 to ourQuarterly Report on Form 10-Q. The information contained in this report isnot a complete description of our business or the risks associated with aninvestment in our common stock. We urge you to carefully review and considerthe various disclosures made by us in this Report and in our other reportsfiled with SEC, including our Annual Report on Form 10-K for the yearended December 31, 2008 and subsequent reports on Forms 10-Q and 8-K,which discuss our business in greater detail. This report and the following discussion contain forward-lookingstatements, which generally include the plans and objectives of management forfuture operations, including plans and objectives relating to our futureeconomic performance and our current beliefs regarding revenues we mightgenerate and profits we might earn if we are successful in implementing ourbusiness and growth strategies. The forward-looking statements and associatedrisks may include, relate to or be qualified by other important factors,including, without limitation:

 

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

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

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

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

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

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

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

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

**·**                  exposure to and impacts of various international risks including legal,business, political and economic risks associated with our internationaloperations;

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

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

**·**                  our ability to continue to borrow funds under the terms of our creditfacility in light of certain actions recently taken against Private EquityManagement Group, Inc., an affiliate of our lender and  our lender, by the Securities and ExchangeCommission, or SEC;

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

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

** **

We do not undertake to update, revise or correct anyforward-looking statements.

 

Any of the factors described above or in the “RiskFactors” sections contained in our Annual Report on Form 10-K for the yearended December 31, 2008 and in this report could cause our financialresults, including our net income or loss or growth in net income or loss todiffer materially from prior results, which in turn could, among other things,cause the price of our common stock to fluctuate substantially.

 

23

----

Table of Contents

 

**Recent Transactions**

 

On March 20, 2009, wecompleted the sale of substantially all the assets of the Digitran division ofour 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 switches for the worldwide aerospace,defense and industrial markets. Tokyo-based XCEL Japan Ltd. primarily sold Digitran’s switch productlines in Japan and other countries in Asia. These businesses were part of ourelectronic devices business segment.  TheDigitran Transaction is a milestone in our previously announced strategy todivest non-core businesses and increase our focus on our core competencies,which are discussed in further detail in our December 31, 2008 Form 10-K.For purposes of the following discussion and analysis, the Digitran Operationshave been removed from the prior period comparisons and the quarterly resultsof the Digitran Operations are reported in our Consolidated Statements ofOperations for all periods presented as a discontinued operation.

 

**Business Description**

 

We design, manufacture andmarket proprietary electronic devices and communications equipment foraerospace, defense, industrial, and communications applications. We have operationsin the U.S., England, and France.  We organize our business in two operatingsegments: electronic devices and communications equipment. In the first quarterof 2009, our electronic devices segment contributed approximately 82% ofoverall net sales while the communications segment contributed approximately18% of overall net sales. Our subsidiaries within our electronic devicessegment design, develop, manufactureand market power supplies, radio frequency, or RF, and microwave devices fordefense, aerospace and industrial markets. Our subsidiaries within our communications equipment segmentdesign, develop, manufacture and market network access equipment, includingnetwork timing and synchronization products, for communications applications indefense, public and private networks and industrial markets.

 

Within our electronic devicessegment, we produce a range of power systems and RF and microwave devices.  This segment is primarily “project”driven with the majority of revenues being derived from custom products withlong life cycles and high barriers to entry. The majority of manufacturing and testing is performed in-house orthrough sub-contract manufacturers.  Ourelectronic devices are used in a wide range of military airborne, seaborne andland-based systems, and in-flight entertainment systems, including the latestnext generation in-flight entertainment and communications, or IFE&C,systems — such as applications for mobile phone, e-mail and internetcommunications and real time, on-board satellite and broadcast TV — which arebeing installed in new commercial aircraft as well as being retrofitted intoexisting 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 utility companiesand military applications, including homeland security.

 

**Critical Accounting Policies**

** **

Our discussion and analysis of our financial conditionand results of operations is based upon our consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the U.S. The preparation of these financial statements requires usto make estimates and judgments that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the 

 

24

----

Table of Contents

 

date of the financialstatements and the reported amount of net sales and expenses for each period.The following represents a summary of our critical accounting policies, definedas those policies that we believe are the most important to the portrayal ofour financial condition and results of operations and that require management’smost difficult, subjective or complex judgments, often as a result of the needto make estimates about the effects of matters that are inherently uncertain.

 

***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 ACC and our subsidiaries in England dependsupon the type 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 completed andinvoiced.  For repairs that involveshipment of a repaired product, we recognize repair revenues when the productis shipped back to the customer. Service revenues contribute less than 5% oftotal revenue and, therefore, are considered to be immaterial to overallfinancial results.

 

25

----

Table ofContents

 

***Product Warranty Liabilities***

 

Generally, ourproducts carry a standard one-year, limited parts and labor warranty.  In certain circumstances, we provide atwo-year limited parts and labor warranty. We offer extended warranties beyond two years for an additional cost toour customers.  Products returned underwarranty typically are tested and repaired or replaced at our option.  Historically, we have not experiencedsignificant warranty costs or returns.

 

We record aliability for estimated costs that we expect to incur under our basic limitedwarranties when product revenue is recognized. Factors affecting our warranty liability include the number of unitssold, the types of products involved, historical and anticipated rates of claimand historical and anticipated costs per claim. We periodically assess the adequacy of our warranty liability accrualbased on changes 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 March 31,2009, our total inventory reserves amounted to $5.3 million of which $3.7million, or 21.0% of total inventory, related to our electronic devices segmentand $1.6 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 haveforeign subsidiaries that together accounted for approximately 52.2% and 70.4%of our net revenues, 34.7% and 42.0% of our assets and 27.5% and 41.6% of ourtotal liabilities as of and for the three months ended March 31, 2009 and2008, respectively.  In preparing our consolidated financialstatements, we are required to translate the financial statements of ourforeign subsidiaries from the functional currencies in which they keep theiraccounting records into U.S. dollars. This process results in exchange gainsand losses which, under relevant accounting guidance, are included eitherwithin our statement of operations under the caption “other income (expense)”or as a separate part of our net equity under the caption “accumulated othercomprehensive income (loss).”

 

Under relevant accountingguidance, the treatment of these translation gains or losses depends uponmanagement’s determination of the functional currency of each subsidiary. Thisdetermination involves 

 

26

----

Table ofContents

 

consideration ofrelevant economic facts and circumstances affecting the subsidiary. Generally,the currency in which the subsidiary transacts a majority of its transactions,including billings, financing, payroll and other expenditures, would beconsidered the functional currency. However, management must also consider anydependency of the subsidiary upon the parent and the nature of the subsidiary’soperations.

 

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 financialstatements would be included in other income (expense) within our statement ofoperations.

 

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 $3.2 million and $2.8million that were included as part of accumulated other comprehensive incomewithin our balance sheets at March 31, 2009 and December 31, 2008,respectively. During the three months ended March 31, 2009 and 2008, weincluded translation losses of $420,000 and gains of $229,000, 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 first quarter of 2009, these currenciesinclude the euro, the British pound sterling and, to a lesser extent, theJapanese yen. Any future translation gains or losses could be significantlyhigher or lower than those we recorded for these periods.

 

A 2.5 million Britishpound sterling loan payable from one ofour subsidiaries in England to EMRISE was outstanding as of March 31,2009 ($3.5 million based on the exchange rate at March 31, 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.

 

Inassessing potential impairment of goodwill, we consider these factors as wellas forecasted financial performance of the acquired businesses.  If forecasts are not met, we may have torecord additional impairment charges not previously recognized. In assessingthe recoverability of our goodwill and other intangibles, we must makeassumptions regarding estimated future cash flows and other factors todetermine the fair value of those respective assets. If these estimates ortheir related assumptions change in the future, we may be required to recordimpairment charges for these assets that were not previously recorded.  If that were the case, we would have torecord an expense in order to reduce the carrying value of our goodwill.  Under SFAS No. 142, “Goodwilland Other Intangible Assets”, we are required to analyze our goodwill forimpairment issues at least annually or more frequently if an event occurs orcircumstances change that would more likely than not reduce the fair value of areporting unit below its carrying amount. At March 31, 2009, our reported goodwill totaled $9.5 million.  In assessing the potential impairment ofgoodwill, we consider forecasted financial performance of the acquiredbusinesses to determine the fair value of the respective assets.

 

27

----

Table of Contents

 

**Results of 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 we typically do not have recurring orders.  Exceptions to this include certain long-termmilitary contracts and certain long-term telecommunications contracts.

 

Overall sales increased34% in the first quarter of 2009 as compared to the first quarter of 2008.  Our overall net sales of $14.2 million forthe first quarter of 2009 reflected $5.0 million of net sales contributed byACC, which we acquired on August 20, 2008, and declines in net sales atour U.S. electronic devices subsidiary and both of our communications equipmentsubsidiaries.  These declines werefurther affected by impact of exchange rates between the U.S. dollar and theBritish pound sterling and the euro.

 

Overall gross profit as apercentage of sales increased to 34.9% in the first quarter of 2009 from 32.3%in the first quarter of 2008.  Theincrease in gross profit as a percentage of sales was due to the inclusion ofACC sales and associated gross margins in our results partially offset by adecrease in gross profit as a percentage of sales as a result of a write downof certain inventories at our U.S. power supply division and a decline inmargins at our communications equipment segment associated with lower salesvolumes within that segment.

 

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

 

***Comparisonof the Three Months Ended March 31, 2009 to the Three Months Ended March 31,2008***

 

**Net Sales**

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Variance**                | ** ** |
|---------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **March 31,**     | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**        | ** ** | **2009**               | ** ** | **2008**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                      |       |                   |       |                        |       |   |   |   |   |
| Electronic  devices       |       | $                      | 11,595     |                        | $          | 7,283 |   | $ | 4,312 |   | 59.2 | % |
| *as  % of net sales*      | * *   | *81.6*                 | *%*        | *68.4*                      | *%*        | * * | * * | * * | * * |
| Communications  equipment |       | 2,618                  |       | 3,360                       |       | (742 | ) | (22.1 | )% |
| *as  % of net sales*      | * *   | *18.4*                 | *%*        | *31.6*                      | *%*        | * * | * * | * * | * * |
| Total net sales           |       | $                      | 14,213     |                        | $          | 10,643 |   | $ | 3,570 |   | 33.5 | % |

 

*ElectronicDevices Segment*

 

Theincrease in sales of our electronic devices in the first quarter of 2009 ascompared to the first quarter of 2008 was primarily the result of the inclusionof $5.0 million in net sales from ACC, which was acquired in August 2008.  This increase was partially offset by a decreasein sales at our U.S. power supply division due to economic conditions.  On a local currency basis, net sales at ourforeign electronic device companies were higher in the first quarter of 2009 ascompared to 2008.  However, exchangerates between the U.S. dollar and the British pound sterling negativelyimpacted the consolidated results of our U.K. subsidiaries when translated intoU.S.

 

28

----

Table of Contents

 

dollars.  The translation impact of exchange ratesremains an uncertainty and could negatively or positively impact our overallresults in future periods.

 

Throughoutthe remainder of 2009, we expect quarterly net sales within our electronicdevices segment to increase as compared to each comparable quarter in2008.  This reflects the expectedfavorable impact of including ACC’s net sales in each quarter of 2009 ascompared to only the latter four months in 2008, offset by the anticipatedunfavorable effect of exchange rates expected in 2009 as compared to 2008between the U.S. dollar and the British pound sterling on the translation ofthe financial results of our European operations into U.S. dollars.

 

*CommunicationsEquipment Segment*

 

Thedecrease in sales of our communications equipment in the first quarter of 2009as compared to the first quarter of 2008 is due to an overall decrease inorders and shipments for network access and timing products, especially at ourFrench subsidiary where quarterly net sales were down $0.6 million due largelyto economic impacts 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 accessproducts at our U.S. subsidiary also decreased but were partially offset bystronger sales of telecommunications test equipment.

 

Netsales in our communications equipment segment have been, and are likely tocontinue to be, negatively impacted by the recent economic conditions as manyof our communications equipment products are deemed to be discretionaryexpenditures by our customers and many companies in this industry haveannounced plans to reduce capital expenditures and/or to defer discretionaryspending due to current economic conditions. Once global economic conditions improve, we believe this segment willbenefit more so than our electronic devices segment, which has not beenimpacted as severely due to the defense related nature of that segment.  We also anticipate an ongoing unfavorableeffect of exchange rates throughout 2009 as compared to 2008 between the U.S.dollar and the euro on the translation of our European communications equipmentoperations into U.S. dollars.  Despitethe economic impacts in our communications equipment segment, we had anunusually high backlog of orders in this segment at March 31, 2009 of $0.9million for our telecommunications test equipment primarily for the FederalAviation Administration and the U.S. Navy and expect that these orders will bedelivered in the second half of 2009.

 

29

----

Table of Contents

 

**GrossProfit**

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Variance**                | ** ** |
|---------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **March 31,**     | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**        | ** ** | **2009**               | ** ** | **2008**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                      |       |                   |       |                        |       |   |   |   |   |
| Electronic  devices       |       | $                      | 4,077      |                        | $          | 1,958 |   | $ | 2,119 |   | 108.2 | % |
| *as  a % of net sales*    | * *   | *35.2*                 | *%*        | *26.9*                      | *%*        | * * | * * | * * | * * |
| Communications  equipment |       | 880                    |       | 1,482                       |       | (602 | ) | (40.6 | )% |
| *as  a % of net sales*    | * *   | *33.6*                 | *%*        | *44.1*                      | *%*        | * * | * * | * * | * * |
| Total gross  profit       |       | $                      | 4,957      |                        | $          | 3,440 |   | $ | 1,517 |   | 44.1 | % |
| *Total  gross margin*     | * *   | *34.9*                 | *%*        | *32.3*                      | *%*        |   |   |   |   |

 

*ElectronicDevices Segment*

 

Theincrease in gross profit, as a percentage of net sales, for our electronicdevices segment from 26.9% in the first quarter of 2008 to 35.2% in the firstquarter of 2009 is primarily the result of the inclusion of higher marginproducts at ACC and a substantial increase in gross profit as a percentage ofsales at our European operations.  Thisincrease was partially offset by a reduction in gross margin at our U.S. powersupply division due to a write down of approximately $0.3 million of certaininventories to the lower of cost or market during the first quarter of2009.  We do not expect to incur anyfurther write downs at our U.S. power supply division.

 

Weexpect that during 2009, overall gross margins in our electronic devicessegment will improve slightly over those gross margins reported for the firstquarter of 2009, which was lower than normal due to the inventory writedowns.  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.  However, we expect theseimprovements to be partially offset by the negative impact of exchange rates ongross profit in 2009 as compared to 2008 due to unfavorable exchange rates betweenthe U.S. dollar and the British pound sterling on the translation of thefinancial results of our European operations into U.S. dollars.

 

*CommunicationsEquipment Segment*

 

Thedecrease in gross margin for our communications equipment segment from 44.1% inthe first quarter of 2008 to 33.6% in the first quarter of 2009 is primarilythe result of decreased sales of higher margin network access products due to aslow-down of purchases being made by our customers of these products.  Gross margins were also unfavorably impactedas a result of the changes in foreign currency exchange rates between the U.S.dollar and the euro in the first quarter of 2009 as compared to the firstquarter of 2008.

 

We are hopeful during2009 that this segment will be able to return to higher gross margins, such asthose recently 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 areuncertain as to exactly when this segment will be return to higher grossmargins levels.  Further, we experiencevolatility quarter to quarter due to changes in product mix and timing ofshipments.  

 

30

----

Table of Contents

 

**OperatingExpenses**

 
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Variance**                | ** ** |
|--------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                           | ** ** | **March 31,**     | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**                   | ** ** | **2009**               | ** ** | **2008**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                 |       |                   |       |                        |       |   |   |   |   |
| Selling, general  and administrative |       | $                      | 4,547      |                        | $          | 3,538 |   | $ | (1,009 | ) | (28.5 | )% |
| *as  % of net sales*                 | * *   | *32.0*                 | *%*        | *33.2*                      | *%*        | * * | * * | * * | * * |
| Engineering and  product development |       | 522                    |       | 503                         |       | (19 | ) | (3.8 | )% |
| *as  % of net sales*                 | * *   | *3.7*                  | *%*        | *4.7*                       | *%*        | * * | * * | * * | * * |
| Total operating  expenses            |       | $                      | 5,069      |                        | $          | 4,041 |   | $ | (1,028 | ) | (25.4 | )% |

 

*Selling,general and administrative expenses*

 

Theincrease in selling, general and administrative expenses is primarily theresult of approximately $1.3 million of additional expenses relating to ACC,which was absent in the first quarter of 2008. These increases were partially offset by decreases in selling, generaland administrative expenses at nearly all of our business units, including ourcorporate office.

 

During 2009, we expectselling, general and administrative expense to be higher on a quarterly basisin each quarter of 2009 as compared to each quarter in 2008.  The anticipated increases in 2009 over 2008quarterly expenses is primarily due to the inclusion of ACC’s expenses in 2009as compared to only including such expense during the last four months of 2008,as well as higher anticipated costs relating to Sarbanes-Oxley compliance dueto the fact that we are now subject to the Sarbanes-Oxley Act Section 404external audit requirements. Additionally, we expect to incur one-time redundancy costs ofapproximately $0.2 million in the second quarter of 2009 associated with therestructuring of personnel at several of our facilities.  However we expect future quarters in 2009 totrend lower as compared to the first quarter of 2009.  The lower expected costs in future quartersof 2009 as compared to the first quarter of 2009 reflect lower expectedexpenses primarily due to significant restructuring efforts at both ourbusiness units and at our corporate office, which we expect to complete in thefirst half of 2009, which include reduction in headcount, outsourcing certaincentralized services and a reduction in facility costs.

 

*Engineeringand product development*

 

Theslight increase in engineering and product development costs is primarily dueto the added engineering costs at ACC offset by a reduction in engineeringcosts for our TiemPoTM product line as compared to the prior yearperiod where development efforts were at a higher level than are currentlyrequired.

 

Duringthe remainder of 2009, engineering and product development expenses areexpected to be lower than comparable 2008 quarterly expenses, but higher thanthe first quarter of 2009.  This reflectsthe impact of ACC’s expenses for the full 12 months in 2009 offset by lowerexpected development efforts for our TiemPoTM product line as a result of fewer developmentrequirements going forward as compared to the prior year.

 

**Interestexpense**

 

Interestexpense was $1.6 million for the three months ended March 31, 2009compared to $0.6 million for the three months ended March 31, 2008 due tothe acceleration of deferred financing costs and debt discount amortizationassociated with the partial repayment of our Term Loan B, higher outstandingloan and line of credit balances and higher interest rates on portions of thoseloan balances in the first quarter of 2009 as compared to the first quarter of2008.  Included in interest expense inthe first quarter of 2009 were $0.8 million of non-cash amortization ofdeferred financing costs and non-cash amortization of debt discount compared to$0.2 million in the first quarter of 2008. We expect quarterly interest expense for the remainder of 2009 todecrease from the comparable prior year periods and as compared to the firstquarter of 2009 as a result of the lower outstanding

 

31

----

Table of Contents

 

loan balances as we usedthe proceeds from the sale of our Digitran Operations to pay down outstandingacquisition loans by approximately $10 million.

 

**Otherincome (expense)**

 

Werecorded other expense of $42,000 for the three months ended March 31,2009 compared to $17,000 for the same period of 2008.  Other income (expense) consists primarily ofshort-term exchange rate gains and losses associated with the volatility of theU.S. dollar to the British pound sterling and euro on the current portion ofcertain assets and liabilities and fair value adjustments on warrants.

 

**Incometax expense**

 

Incometax benefit amounted to $0.5 million for the three months ended March 31,2009 compared to income tax expense of $0.1 million for the same period of2008.  The company recorded an income taxbenefit as the result of losses incurred in the first quarter of 2008.  This benefit was partially offset by incometax expense incurred primarily as the result of foreign income tax on foreignearned profits in Europe and Japan and New Jersey state income taxes on incomegenerated by ACC.

 

**Net gainon discontinued operations**

 

Inconnection with the sale of our Digitran Operations on March 20, 3009, wereported income from our discontinued Digitran Operations of $7.4 millionduring the first quarter of 2009, which includes a $7.2 million gain on thesale of assets.  In the first quarter of2008, these operations contributed comparative income of $0.2 million.  In connection with this sale and the incomegenerated from the discontinued operations, we recorded a tax provision of $1.4million, during the first quarter of 2009, and no tax provision in connectionwith these operations during the first quarter of 2008.

 

**Netincome (loss)**

 

Wereported net income of $4.9 million in the first quarter of 2009 and a net lossof $0.9 million in the first quarter of 2008. Included in net income in the first quarter of 2009 was a $7.2 milliongain on the sale of Digitran, approximately $0.3 million in inventory writedowns, and approximately, $0.5 million in accelerated amortization of deferredfinancing costs and debt discount associated with the partial repayment of ourTerm Loan B, $0.2 million in short-term exchange rate losses associated withthe volatility of the U.S. dollar to the British pound sterling and euro on thecurrent portion of certain assets and liabilities.  Excluding the one-time gain reported in thefirst quarter of 2009, we anticipate net income (loss) to improve in futurequarters, due in large part to the recent restructuring efforts beingcompleted, and also due to lower anticipated interest expense in futurequarters due to our significant reduction of debt by approximately $10 millionduring the first quarter of 2009.

 

**Liquidity and 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 quarter of 2009, we fundedour daily cash flow requirements through funds provided by operations andthrough borrowings under our credit facility with GVEC Resource IV Inc. (“GVEC”or the “Lender”).  Working capital was$6.7 million at March 31, 2009 as compared to $7.6 million at December 31,2008. The decrease in working capital is primarily due to the sale of ourDigitran Operations, which had net current assets of $2.6 million at March 20,2009.  At March 31, 2009 and December 31,2008, we had accumulated deficits of$22.3 million and $28.1 million, respectively, andcash and cash equivalents of $3.6 million and $3.4 million, respectively.

 

Net cash generated inoperating activities during the first quarter of 2009 totaled $1.1million.  Our reported net income of $4.9million included a gain on the sale of assets of $7.2 million.  Significant non-cash

 

32

----

Table ofContents

 

adjustments to ourfirst quarter net income include (i) the amortization of debt discount andamortization of deferred financing cost which, on a combined basis, totaled$0.8 million during the quarter, both of which are non-cash components ofinterest expense associated with our credit facility and (ii) depreciationand amortization expense which totaled $0.5 million.  Significant sources and uses of cashassociated with operating activities during the quarter included an decrease inaccounts payable and accrued expenses which used cash of $0.9 million.  The lower accrued expenses are due primarilyto payments for previously accrued amounts offset in part by higher taxaccruals associated with the sale of our Digitran Operations in March 2009.  Accounts payable is higher due to increasedpurchases to support higher anticipated shipments, especially at our ACCsubsidiary, and also due to timing of payments. In addition, during the quarter, our accounts receivable decreased byapproximately $0.8 million, due to collections being received on our higherfourth quarter 2008 shipments and also due to increased efforts to collectoutstanding balances on a more timely basis.

 

Cashgenerated from our investing activities during the first quarter of 2009totaled $10.0 million. This amount consisted entirely of net cash proceedsgenerated by the sale of our Digitran Operations.

 

Cashused in financing activities during the first quarter of 2009 totaled $10.4million, all of which represents repayments of principal owed on long term debt and/or notes tostockholders, including the $9.9 million generated by the sale of our DigitranOperations, all of which was used to partially repay the $13 million in termdebt that we acquired in connection with our purchase of ACC in August 2008.

 

As of March 31, 2009, we had outstanding borrowings of $4.1million under the revolving loan portion of our credit facility.  At March 31, 2009, we had remainingactual availability under a formula-based calculation of $2.9 million under thecredit facility.  Actual remaining availability representsthe additional amount we were eligible to borrow as of March 31,2009.  The full $7 million availableunder our revolving line of credit fluctuates periodically throughout eachmonth depending on timing of borrowings and repayments.  On May 11, 2009 we had outstandingborrowings of $4.3 million under the revolving line of credit and approximately$2.7 of remaining availability under the credit facility.

 

In addition to therevolving lines of credit, at March 31, 2009, we had long-term loans andcapitalized lease and equipment loan obligations totaling $8.6 million, thecurrent portion of which loans and obligations totaled $2.0 million.

 

Ourbacklog decreased to $29.6million as of March 31, 2009 as comparedto $34.7 million as of December 31,2008. The decrease is, in part, due to the sale of the Digitran Operations,which contributed $1.5 million in backlog to the December 31, 2008 backlogamount, and the reduction of backlog at all of our electronic devices businessunits as we satisfied much higher shipments on existing contracts during thefourth quarter of 2008 compared to previous quarters.  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 March 31, 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, which businesstends to deliver standard or modified standard products from stock as ordersare received. We believe that the majority of our current backlog is shippablewithin the next 12 months.  However,there can be no assurance that we will be successful in fulfilling such ordersand commitments in a timely manner or that we will ultimately recognize asrevenue 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 amended the creditfacility to include ACC and CCI as borrowers and to, among other things, includea term loan in the principal amount of $3,000,000 (the “Term Loan C”).  Inconnection with Digitran Transaction we repaid approximately $10million in March 2009.  As of March 31, 2009, weowed a total of $12.9 million under the terms of the credit facility.

 

33

----

Table ofContents

 

Thecredit facility currently consists of (i) a one year revolving loan for upto $7 million that may be renewed on November 30, 2009 for a period of oneyear (the “Revolver”), and (ii) two term loans (Term Loan A and Term LoanB) with an aggregate net outstanding principal amount of $8.8 million. The termloans require scheduled principal and interest payments commencing September 2009and a 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.

 

TheRevolver is formula-based and generally provides that the outstandingborrowings under the line of credit may not exceed an aggregate of 85% ofeligible accounts receivable, plus 10% of the value of eligible raw materialsnot to exceed $600,000, plus 50% of the value of eligible finished goodsinventory not to exceed $1,500,000, minus the aggregate amount of reserves thatmay be established by the Lender.  TheRevolver has a maturity date of November 30, 2009, unless it is renewed bythe Lender in which case the maturity date will be extended to November 30,2010.

 

Intereston the Revolver is payable monthly.  The interest rate is variable and isadjusted monthly based on prime rate as published in the “Money Rates” columnof*The Wall Street Journal* (the “BaseRate”) plus 1.25%, subject to a minimum rate of 9.5%.  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 March 31, 2009 we were not in compliance with theEBITDA, debt service coverage ratio and leverage ratio financialcovenants.  In addition, on April 1,2009, we voluntarily elected not to make a required interest payment on amountsborrowed under our credit facility, which amount has been subsequentlypaid.  On May 14, 2009 we obtained awaiver from our Lender for these events of default.

 

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

 

Upon the sale ordisposition by borrowers or any of their subsidiaries of property or assets, wemay be obligated to prepay the Revolver and the term loans with the net cashproceeds received in connection with such sales or dispositions to the extentthat the aggregate amount of net cash proceeds received and not paid to GVEC asa prepayment for all such sales or disposition exceed $150,000 in any fiscalyear.

 

If the Lender terminatesthe credit facility during a default period or if we prepay the Revolver or theTerm Loans prior to November 30, 2009, then we are subject to a penaltyequal to 2% of the outstanding principal balance of the Revolver and the TermLoans.  The Revolver is subject to an unused line fee of 0.5% per annum,payable monthly, on any unused portion of the revolving credit facility.

 

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.

 

Wehave agreed with our Lender to raise at least $2 million in net proceedsthrough the sale of stock of the borrowers by no later than September 30,2009.  Under the terms of the creditfacility, we are obligated to remit to our Lender $500,000 with respect to thefirst $2,000,000 of net cash proceeds received in connection with

 

34

----

Table of Contents

 

the sale of stock, 50% ofthe next $1,000,000 of net cash proceeds received in connection with the saleof stock, and 30% of the net cash proceeds in excess of the first $3,000,000received in connection with the sale of stock.

 

We arecurrently evaluating a number of options to meet this obligation under ourcredit facility, including a possible refinancing of the entire facility. Given current economic and financial market conditions even a small equityraise could prove difficult.  If we are successful in structuring anequity raise acceptable to us and our Lender, it may result in substantialdilution to our stockholders.

 

If weare unsuccessful in meeting our Lender’s requirement for additional capital bythe required due dates and/or if we breach any of our agreed upon financialcovenants under the credit facility, then we will be in default under the termsof our credit facility.  In the event of a default and continuation of adefault, whether as a result of our inability to raise additional capital orfor some other reason, the Lender may limit future availability under ourrevolving line of credit and/or accelerate the payment of all principal balancesand accrued interest requiring us to pay the entire indebtedness under ourcredit facility outstanding on that date.  Upon the occurrence and duringthe continuation of an event of default, the Lender may also elect to increasethe interest rate applicable to the outstanding balance of the Term Loans A andB by four percentage points above the per annum interest rate that wouldotherwise be applicable.  Any of these conditions could have a materialadverse effect on our operations and/or ability to conduct business after thatdate.

 

Recentactions taken by the SEC against Private Equity Management Group, Inc., anaffiliate of our Lender, including an order granted in April 2009 by afederal court freezing all assets of Private Equity Management Group, Inc.and its affiliates, including our Lender, may adversely affect our Lender’sability to continue to provide us funds under the terms of the Revolver. At the request of the SEC, 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, we cannot assure you that the receiver will allow ourLender to continue to make funds available to us.  If, for any reason, thereceiver 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 drasticallycurtail or cease operations and possibly seek protection from our creditorsunder the U. S. Bankruptcy Code.

 

Currently, we are in the process of seekingalternate financing from a number of possible lenders, including certain banksand lenders which we have maintained a favorable relationship over manyyears.  Although we remain hopeful thatwe will be able to successfully secure replacement financing on a timely basis,we cannot assure you that we will be successful in this regard.

 

If weare able to continue to borrow funds under the terms of our Revolver (includingtimely funding by our Lender of draw requests), we believe that current andfuture capital resources, revenues generated from operations and other existingsources of liquidity will be adequate to meet our anticipated short term,working capital and capital expenditures needs for at least the next 12 months. However, if we experience a significant loss of revenue or increase in costs,or if our Lender fails to fund our draw requests in a timely manner or at all,then our cash flow would be negatively impacted resulting in a cash flowdeficit which, in turn, will require us to obtain additional or alternatefinancing, with little or no notice.  These potential financing needscould be met in the form of a revised debt structure with our Lender,additional or new financing with another lender or lenders, the sale of assetsto generate cash or the sale of additional equity to raise capital.  Ourfailure to secure additional or alternate financing, if and when needed, wouldhave an adverse effect on our operations and/or ability to do business afterthat date or could restrict our growth, limit our development of new products,or hinder our ability to fulfill existing or future orders.

 

**Effects ofInflation**

** **

Theimpact of inflation and changing prices has not been significant on thefinancial condition or results of operations of either our company or ouroperating subsidiaries.

 

35

----

Table ofContents

 

**Impacts of NewAccounting 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 our financial condition or results ofoperations.

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements.” This newstatement provides a single definition of fair value, together with a frameworkfor measuring it, and requires additional disclosure about the use of fairvalue to measure assets and liabilities. SFAS No. 157 also emphasizes thatfair value is a market-based measurement, not an entity-specific measurement,and sets out a fair value hierarchy, with the highest priority being quotedprices in active markets. The required effective date of SFAS No. 157 isthe first quarter of 2008. The adoption of SFAS No. 157 for financialassets and liabilities did not have a material effect on our 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, except thosethat are recognized or disclosed at fair value in the financial statements on arecurring basis.  We have evaluated theimpact the adoption of SFAS No. 157 for non-financial assets andliabilities have determined that the adoption of SFAS No. 157-2 did nothave a material effect on our consolidated financial statements.

 

In December 2007,the FASB issued SFAS No. 141R, “Business Combinations,” which replacesSAFS 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. 141Rwould have an impact on accounting for any business acquired after theeffective date 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 our 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 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, theFASB ratified the consensus reached on EITF Issue No. 07-5, “DeterminingWhether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock”(“EITF 07-5”). EITF 07-5 clarifies the determination of whether an instrument(or an embedded feature) is indexed to an entity’s own stock, which

 

36

----

Table of Contents

 

would qualify as a scope exception under SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities. EITF 07-5 iseffective for financial statements issued for fiscal years beginning after December 15,2008. Early adoption for an existing instrument is not permitted. We adoptedEITF 07-5 on January 1, 2009. See Note 13 **—**Warrants below for discussion of the impact of the adoptionof EITF 07-5 on our outstanding stock warrants and its consolidated financialstatements.

 

**ITEM3.                  QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

** **

Notapplicable.

 

**ITEM 4.                  CONTROLS AND PROCEDURES.**

 

Not applicable.

 

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

 

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

 

Weconducted an evaluation under the supervision and with the participation of ourmanagement, including our Chief Executive Officer and Vice President Financeand Administration, our principal accounting officer, of the effectiveness ofthe design and operation of our disclosure controls and procedures.  The term “disclosure controls and procedures,”as defined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (“Exchange Act”), means controls and otherprocedures of a company that are designed to ensure that information requiredto be disclosed by the company in the reports it files or submits under theExchange Act is recorded, processed, summarized and reported, within the timeperiods specified in the SEC’s rules and forms.  Disclosure controls and procedures alsoinclude, without limitation, controls and procedures designed to ensure thatinformation required to be disclosed by a company in the reports that it filesor 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 ExecutiveOfficer and Vice President Finance and Administration concluded as of March 31,2009 that our disclosure controls and procedures were not effective at thereasonable assurance level due to the material weaknesses discussed immediatelybelow.

 

In light of the four materialweaknesses described below, we performed additional analysis and otherpost-closing procedures to ensure that our consolidated financial statementswere prepared in accordance with generally accepted accounting principles.  Accordingly, we believe that the consolidatedfinancial statements included in this report fairly present, in all materialrespects, our financial condition, results of operations and cash flows for theperiods presented.

 

***Management’s Report on Internal Control OverFinancial Reporting***

*** ***

Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting as defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act. Our internal control over financialreporting is designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. Ourinternal control over financial reporting includes those policies andprocedures that:

 

(i)                                     pertain to the maintenanceof records that, in reasonable detail, accurately and fairly reflect thetransactions and dispositions of our assets;

 

(ii)                                  provide reasonable assurancethat transactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, andthat our

 

37

----

Table of Contents

 

receipts and expenditures are being made only in accordance withauthorizations of our management and directors; and

 

(iii)                               provide reasonable assuranceregarding prevention or timely detection of unauthorized acquisition, use ordisposition of our assets that could have a material affect on our financialstatements.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

Amaterial weakness in internal control over financial reporting is defined bythe Public Company Accounting Oversight Board’s Audit Standard No. 5 asbeing a deficiency, or a combination of deficiencies, in internal control overfinancial reporting, such that there is a reasonable possibility that amaterial misstatement of the company’s annual or interim financial statementswill not be prevented or detected on a timely basis.

 

Managementassessed and evaluated the effectiveness of our internal control over financialreporting as of March 31, 2009. Based on the results of management’sassessment and evaluation, our Chief Executive Officer and Vice PresidentFinance and Administration concluded that as of March 31, 2009 thefollowing four material weaknesses in our internal control over financialreporting existed:

 

(1)                                  We did not effectivelyimplement comprehensive entity-level internal controls.

 

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

 

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

 

(4)                                  We did not maintain effective controlsover recording and reporting the acceleration of certain components of ourcredit facility.

 

Theforegoing material weaknesses are described in detail below under the caption “MaterialWeaknesses and Related Remediation Initiatives.”**As a result of these material weaknesses, our ChiefExecutive Officer and Vice President Finance and Administration concluded thatwe did not maintain effective internal control over financial reporting as of March 31,2009. If not remediated, thesematerial weaknesses could result in one or more material misstatements in ourreported financial statements in a future annual or interim period.

 

Inmaking its assessment of our internal control over financial reporting,management used criteria issued by the Committee of Sponsoring Organizations ofthe Treadway Commission (“COSO”) in its *InternalControl-Integrated Framework*. Because of the material weaknessesdescribed above, management believes that, as of March 31, 2009, we didnot maintain effective internal control over financial reporting.

 

Anindependent consulting firm assisted management with its assessment of theeffectiveness of our internal control over financial reporting, including scopedetermination, planning, staffing, documentation, portions of testing, portionsof remediation and portions of overall program management of the assessmentproject.

 

ThisReport does not include an attestation report of our independent registeredpublic accounting firm regarding internal control over financialreporting.  Management’s report was notsubject to attestation by our independent registered public accounting firmpursuant to temporary rules of the SEC that permit us to provide onlymanagement’s report in this Report.

 

38

----

Tableof Contents

 

***Inherent Limitations on the Effectiveness ofControls***

*** ***

Managementdoes not expect that our disclosure controls and procedures or our internalcontrol over financial reporting will prevent or detect all errors and allfraud. A control system, no matter how well conceived and operated, can provideonly reasonable, not absolute, assurance that the objectives of the controlsystems are met. Further, the design of a control system must reflect the factthat there are resource constraints, and the benefits of controls must beconsidered relative to their costs. Because of the inherent limitations in acost-effective control system, no evaluation of internal control over financialreporting can provide absolute assurance that misstatements due to error orfraud will not occur or that all control issues and instances of fraud, if any,have been or will be detected.

 

Theseinherent limitations include the realities that judgments in decision-makingcan be faulty and that breakdowns can occur because of a simple error ormistake. Controls can also be circumvented by the individual acts of somepersons, by collusion of two or more people, or by management override of thecontrols. The design of any system of controls is based in part on certainassumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions. Projections of any evaluation of controlseffectiveness to future periods are subject to risks. Over time, controls maybecome inadequate because of changes in conditions or deterioration in thedegree of compliance with policies or procedures.

*** ***

***Material Weaknesses and Related RemediationInitiatives***

*** ***

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 ofdeveloping specific action plans to remediate the material weaknessesidentified above and discussed more fully below.  We expect to complete these various actionplans by June 30, 2009.  If we areable to complete these action plans by that date, we anticipate that allcontrol deficiencies and material weaknesses will be remediated by December 31,2009.

 

(1)           Wedid not effectively implement comprehensive entity-level internalcontrols, asevidenced by the following control deficiencies:

 

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

 

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

 

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

 

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

 

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

 

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

 

39

----

Table of Contents

 

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

 

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

 

(2)           Wedid not maintain effective controls over changes to critical financialreporting applications and over access to these applications and related data,as evidenced by the fact that certain of our personnel had unrestricted accessto various 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)           Wedid not maintain a sufficient level of information technology personnel toexecute general computing controls over our information technology structure,which include the implementation and assessment of information technologypolicies and procedures. This control deficiency did not result in an auditadjustment to our 2008 interim or annual consolidated financial statements, butcould result in a material misstatement of significant accounts or disclosures,which would not have been prevented or detected.

 

(4)           We did not maintain effective controlsover recording and reporting the acceleration of certain components of ourcredit facility.  As a result of a review of our historical financialstatements, management concluded that our controls over recording of theacceleration of certain components of our credit facility 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 recordingof the acceleration of certain components of our credit facility represented amaterial weakness.

 

***Remediation of Internal Control Deficiencies andExpenditures***

*** ***

The above materialweaknesses resulted in adjustments to our consolidated financial statements forthe quarter ended March 31, 2009. In addition, it is reasonably possible that, if not remediated, one ormore of the material weaknesses described above could result in a materialmisstatement in our reported financial statements that might result in amaterial misstatement 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 level of control procedures related to all of our manufacturinglocations and our corporate offices.  Theaudit committee will also work directly with management and outside consultants,as necessary to ensure that board level deficiencies are addressed.  We are uncertain at this time of the costs toremediate all of the above listed material weaknesses, however, we anticipatethe cost to be in the range of $200,000 to $400,000 (including the cost of theconsolidation software described above), most of which costs we expect to incurin 2009.  We cannot guarantee that theactual costs to remediate these deficiencies will not exceed this amount.

 

40

----

Table ofContents

 

Through these steps, webelieve that we are addressing the deficiencies that affected our internalcontrol over financial reporting as of March 31, 2009. Because theremedial actions require hiring of additional personnel, upgrading certain ofour information technology systems, and relying extensively on manual reviewand approval, the successful operation of these controls for at least several quartersmay be required before management may be able to conclude that the materialweakness has been remediated.  We intendto continue to evaluate and strengthen our internal control over financialreporting systems. These efforts require significant time and resources.  If we are unable to establish adequateinternal control over financial reporting systems, we may encounterdifficulties in the audit or review of our financial statements by ourindependent registered public accounting firm, which in turn may have amaterial adverse effect on our ability to prepare financial statements inaccordance with GAAP and to comply with our SEC reporting obligations.

 

Inlight of the material weaknesses described above, we performed additionalanalysis and other post-closing procedures to ensure that our financialstatements were prepared in accordance with generally accepted accountingprinciples. Accordingly, we believe that the financial statements included inthis report fairly present, in all material respects, our financial condition,results of operations, changes in shareholder’s equity and cash flows for theperiods presented.

 

***Changes in Internal Control over Financial Reporting***

 

Therehas been no change in our internal control over financial reporting (as definedin Rules 13a-15(f) and 15d-15(f) under the Exchange Act) duringthe most recently completed fiscal quarter that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

41

----

Tableof Contents

 

**PART II — OTHER INFORMATION**

 

**ITEM 1.****                                                 ****LEGALPROCEEDINGS.**

 

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

 

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

 

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

 

***Recentactions taken by the SEC against an affiliate of our lender may adverselyaffect our ability to continue to borrow funds under the terms of our revolvingcredit facility with our lender.  If ourlender limits or terminates our ability to borrow funds  under the revolving credit facility, our cashposition and our ability to continue day to operations would be adverselyaffected, almost immediately.***

 

Recent actions taken by theSEC against PrivateEquity Management Group, Inc., an affiliate of our lenderand our lender, including an order granted in April 2009 by a federalcourt freezing all assets of Private Equity Management Group, Inc. and its affiliates,including our lender, may adversely affect our lender’s ability to continue toprovide us funds under the terms of our revolving credit facility.  At the request of the SEC, the federal courtalso appointed a temporary receiver of our lender’s agent and of ourlender.  If, for any reason, the receiverwere to limit or terminate our ability to continue to borrow funds under ourrevolving credit facility, our cash position and our ability to continue day today operations would be adversely affected, almost immediately.  If that were to occur, we would be requiredto seek additional and/or replacement financing immediately.  If we are unable to do so, we may be forcedto drastically curtail or cease operations and possibly seek protection fromour creditors under the U. S. Bankruptcy Code.

 

***Wehave material weaknesses in our internal control over financial reportingstructure which has resulted in the restatement of our financial statements forthe quarterly periods ended March 31, 2009 and June 30, 2009, anduntil remedied, may cause errors in our financial statements that could requirerestatements of our financial statements and investors may lose confidence inour reported financial information, which could lead to a decline in our stockprice.***

 

We have identified four materialweaknesses****in our internal control over financialreporting and cannot assure you that additional material weaknesses will not beidentified in the future.  Management hasconcluded that (i) we did not effectively implement comprehensiveentity-level internal controls; (ii) we did not maintain effective controls over changes tocritical financial reporting applications and over access to these applicationsand related data; (iii) we did not maintain a sufficient level ofinformation technology personnel to execute general computing controls over ourinformation technology structure; and (iv) we did not maintain effectivecontrols over recording and reporting the acceleration of certain components ofour credit facility represented materialweaknesses in our internal control over financial reporting.  As a result of these material weaknesses, werestated our financial statements for the quarterly periods ended March 31,2009 and June 30, 2009.  If ourinternal control over financial reporting or disclosure controls and proceduresare not effective, there may be errors in our financial statements that couldrequire additional restatements and investors may lose confidence in our reportedfinancial information, which could lead to a decline in our stock price.

 

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

 

42

----

Tableof Contents

 

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

 

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

 

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

 

**Unregistered Sales of Equity Securities**

 

None.

 

**Dividends**

 

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

 

**ITEM 3.****                                                 ****DEFAULTS UPONSENIOR SECURITIES.**

 

None.

 

**ITEM 4.****                                                 ****SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS.**

 

None

 

**ITEM 5.****                                                 ****OTHERINFORMATION.**

 

None.

 

43

----

Tableof Contents

 

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

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                                           |
| 10.1       |       | Amendment  Number 2 to Loan Documents dated February 12, 2009 by and among EMRISE  Corporation, EMRISE Electronics Corporation, CXR Larus Corporation, RO  Associates Incorporated, Advanced Control Components, Inc., Custom  Components, Inc. and GVEC Resource IV Inc.(1)                                    |
|       |       |                                                                                                                                                                                                                                                                                                                           |
| 10.2       |       | Second  Amended and Restated Warrant dated February 12, 2009 issued to Private  Equity Management Group, LLC (1)                                                                                                                                                                                                          |
|       |       |                                                                                                                                                                                                                                                                                                                           |
| 10.3       |       | Second  Amended and Restated Warrant dated February 12, 2009 issued to Private  Equity Management Group, LLC (1)                                                                                                                                                                                                          |
|       |       |                                                                                                                                                                                                                                                                                                                           |
| 10.4       |       | Asset  and Stock Purchase Agreement, dated March 20, 2009, by and among EMRISE  Corporation, EMRISE Electronics Corporation, Electro Switch Corp., and ESC  Worldwide, Inc. (2)                                                                                                                                      |
|       |       |                                                                                                                                                                                                                                                                                                                           |
| 10.5       |       | Forbearance  Agreement and Amendment Number 3 to Loan Documents, dated March 20,  2009, by and among EMRISE Corporation, EMRISE Electronics Corporation, CXR  Larus Corporation, RO Associates Incorporated, Advanced Control  Components, Inc., Custom Control Components, Inc. and GVEC Resource  IV Inc. (2) |
|       |       |                                                                                                                                                                                                                                                                                                                           |
| 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 Vice President Finance and Administration Pursuant to  18 U.S.C. Section 350, as Adopted Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                                                                                                               |

 

----

(1)  Filed as anexhibit to the Registrant’s current report on Form 8-K for February 12,2009 and incorporated herein by reference.

 

(2)  Filed as anexhibit to the Registrant’s current report on Form 8-K for March 20,2009 and incorporated herein by reference.

 

44

----

Tableof Contents

 

**SIGNATURES**

 

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

 
|                         | EMRISE CORPORATION |
|------------------------------|--------------------|
|                         |               |
| Dated:  October 2, 2009 | By:                | /S/  CARMINE T. OLIVA |
|                         |               | Carmine  T. Oliva, |
|                         |               | Chief  Executive Officer |
|                         |               |   |
|                         |               |   |
| Dated:  October 2, 2009 | By:                | /S/  D. JOHN DONOVAN |
|                         |               | D.  John Donovan, Chief Financial Officer (principal financial and accounting  officer) |

 

45

----

Tableof Contents

 

**INDEX TO EXHIBITS ATTACHED TOTHIS REPORT**

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

 

46

----