Tableof Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q/A**

 

**(MarkOne)**

 

| **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                            **

 

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

 

**EMRISE CORPORATION**

(Exact name of registrant as specified in its charter)

 

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

 

**611 Industrial Way**

**Eatontown,New Jersey 07224**

(Address of principal executive offices) (Zipcode)

 

**(732)389-0355**

(Registrant’s telephone number, includingarea code)

 

**Notapplicable**

(Former name, former address and formerfiscal year, if changed since last report)

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes x   No o

 

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

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,a non-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 (do not check if Smaller Reporting Company) o |   | Smaller  Reporting Company x |
|                                                                      |        |                              |  |  |

 

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

 

The number ofshares outstanding of the Registrant’s common stock, $0.0033 par value, as of May 7,2009 was 10,204,079.

 

 

 

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**EMRISECORPORATION**

**TABLE OF CONTENTS**

**FORM 10-Q/A**

**FOR THEQUARTERLY 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** | 25 |
|                                                                                                                                   |   |   |
| **ITEM 3.**                                                                                                                            | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK** | 39 |
|                                                                                                                                   |   |   |
| **ITEM 4.**                                                                                                                            | **CONTROLS AND  PROCEDURES** | 39 |
|                                                                                                                                   |   |   |
| **ITEM 4T.**                                                                                                                           | **CONTROLS AND PROCEDURES** | 39 |
|                                                                                                                                   |   |   |
| **PART II**                                                                                                                       |
| **OTHER  INFORMATION**                                                                                                                 |
|                                                                                                                                   |   |   |
| **ITEM  6.**                                                                                                                           | **EXHIBITS** | 44 |
|                                                                                                                                   |   |   |
| **SIGNATURES**                                                                                                                         | 45 |

 

 

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**EXPLANATORYNOTE**

 

The purpose of thisAmendment No. 2 to Form 10-Q (“Amendment”) is to amend our Amendment No. 1filing of a Quarterly Report on Form 10-Q for the quarterly period ended March 31,2009, filed with the Securities and Exchange Commission (“SEC”) on October 2,2009 (the “Amendment No. 1”), which amended our initial filing of aQuarterly Report on Form 10Q for the same period, filed with the SEC on May 15,2009.

 

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

 

EMRISE(the “Company”) is the U.S. parent of both U.S. and foreign subsidiaries.  The Company’s credit facility, which includesterm debt and a revolver, was structured such that the assets of all of theU.S. and U.K. subsidiaries were pledged as collateral and that those assetswere to be included in the borrowing base for the revolver.  Additionally, the Company’s lender requiredthat each of the foreign subsidiaries provide a guaranty on the creditfacility.  During the course of the auditof our 2009 financial statements and as a result of the structure of the creditfacility, the Company has determined that Internal Revenue Code (“IRC”) §956requires adjustment of taxable income in each of the years since the inceptionof the credit facility because the earnings and profits of the foreignsubsidiaries are considered deemed distributions to the U.S.  Although the Company has net operating losscarryforwards available to offset the resulting increases to its regulartaxable income, the Company is subject to alternative minimum tax (“AMT”)because the carryforwards do not provide a complete offset in calculating AMTincome.  The Company computed the AMT,applying the estimated foreign tax credits generated from application of IRC§956 that became available as offsets to the AMT obligation.  As a result, the Company is restating itsfinancial statements for the interim period ended March 31, 2009 (the “Restatement”).  The impact of the Restatement is toreclassify tax expense from discontinued operations to continuing operationsand to record an incremental AMT associated with the §956 income.  In light of the Restatement, the financialstatements and other financial information included in the Amendment No. 1are being restated in this Amendment. This restatement affected Item 1, Financial Statements and relateddisclosures in Item 2, Management’s Discussion and Analysis of FinancialCondition and Results of Operations as it relates to income taxes, income fromdiscontinued operations and liquidity.

 

Since the changes to our10-Q are limited to the tax related issues described above, our Form 10-Q/AAmendment No. 2 for the period ended March 31, 2009 amends andrestates Part I and Part II, Item 6 in its entirety as set forth inthis document.

 

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

 

 

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**PART I— FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIALSTATEMENTS**

 

**EMRISECORPORATION**

**Condensed Consolidated 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                                                                                                                                       |       | 1,165              |       | 451                   |       |
| Other current  liabilities                                                                                                                                  |       | 357                |       | 357                   |       |
| Current  liabilities of discontinued operations                                                                                                             |       | —             |       | 664                   |       |
| Total current  liabilities                                                                                                                                  |       | 20,268             |       | 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                                                                                                                                          |       | 30,504             |       | 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                                                                                                                                        |       | (22,791            | )          | (28,101               | )          |
| Accumulated  other comprehensive loss                                                                                                                       |       | (3,245             | )          | (2,827                | )          |
| Total  stockholders’ equity                                                                                                                            |       | 17,449             |       | 14,004                |       |
| Total  liabilities and stockholders’ equity                                                                                                            |       | $                  | 47,953     |                  | $          | 53,623 |   |

 

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

 

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**EMRISECORPORATION**

**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                                                 |       | 194                    |       | 84 |   |
| Loss from  continuing operations                                      |       | (1,858                 | )          | (1,268 | ) |
| Discontinued  operations:                                             |       |                   |       |   |   |
| Income from  discontinued operations including gain on sale of $7,224 |       | 7,402                  |       | 371 |   |
| Tax provision on  discontinued operations                             |       | 707                    |       | — |   |
| Net income from  discontinued operations                              |       | 6,695                  |       | 371 |   |
|                                                                  |       |                   |       |   |   |
| Net Income  (loss)                                                    |       | $                      | 4,837      |   | $ | (897 | ) |
|                                                                  |       |                   |       |   |   |
| Earnings (loss)  per share:                                           |       |                   |       |   |   |
| Basic                                                                 |       | $                      | 0.47       |   | $ | (0.09 | ) |
| Diluted                                                               |       | $                      | 0.47       |   | $ | (0.09 | ) |
|                                                                  |       |                   |       |   |   |
| Weighted average  shares outstanding                                  |       |                   |       |   |   |
| Basic                                                                 |       | 10,204                 |       | 10,204 |   |
| Diluted                                                               |       | 10,204                 |       | 10,204 |   |

 

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

 

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**EMRISECORPORATION**

**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                                                  |       | —           |       | —      |       | —          |       | 4,837             |       | (418            | )          | 4,419      |       |
| Balance at  March 31, 2009                                                   |       | 10,204           |       | $           | 126        |            | $          | 43,359            |       | $               | (22,791    | )          | $          | (3,245 | ) | $ | 17,449 |   |

 

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

 

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**EMRISECORPORATION**

**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)                                                                                                                        |       | $                      | 4,837      |   | $ | (897 | ) |
| Adjustments to  arrive at net loss from continuing operations                                                                             |       | (6,695                 | )          | (371 | ) |
| Net loss from  continuing operations                                                                                                      |       | (1,858                 | )          | (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                                                                                                    |       | (872                   | )          | 97 |   |
| Operating cash  flow used in continuing operations                                                                                        |       | (239                   | )          | (1,447 | ) |
| Operating cash  flow provided by discontinued operations                                                                                  |       | 1,330                  |       | 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        |   | $ | — |   |

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

*Organizationand Business*

 

EMRISECorporation (the “Company”) designs, manufactures and markets proprietaryelectronic devices and communications equipment for aerospace, defense,industrial, and communications applications. The Company has operations in theUnited States (“U.S.”), England and France. The Companyconducts its business through two operating segments: electronic devices andcommunications equipment. The subsidiaries within the electronic devicessegment design, develop, manufactureand market electronic devices for defense, aerospace and industrial markets andoperate out of facilities located in the U.S. and England.  The subsidiaries within thecommunications equipment segment design, develop, manufacture and marketnetwork access equipment, including network timing and synchronization productsand operate out of facilities located in the U.S. and France.

 

InMarch of 2009, the Company sold substantially all the assets related toits subsidiary, EMRISE Electronics Corporation’s (“EEC”), Digitran division,and all of the issued and outstanding equity interests of EEC’s wholly-ownedsubsidiary, XCEL Japan, Ltd. (collectively the “Digitran Operations”). The accompanying financial statements include the Digitran Operations asa discontinued operation.

 

*Basis of Presentation*

 

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

 

*Comprehensive Income (Loss)*

 

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

 
| ** **                               | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------|------------|------------------------|------------|
| ** **                               | ** ** | **March 31,**     | ** ** |
| ** **                               | ** ** | **2009**               | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(Restated)**         | ** ** | ** ** | ** ** |
| Net income  (loss)                       |       | $                      | 4,837      |   | $ | (897 | ) |
| Other  comprehensive income (loss):      |       |                   |       |   |   |
| Foreign currency  translation adjustment |       | (418                   | )          | 226 |   |
| Comprehensive  income (loss)             |       | $                      | 4,419      |   | $ | (671 | ) |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Revenue**Recognition*

 

TheCompany derives revenues from sales of electronic devices and communicationsequipment products and services.  TheCompany’s sales are based upon written agreements or purchase orders thatidentify the type and quantity of the item and/or services being purchased andthe purchase price.  The Companyrecognizes revenues when shipment of products has occurred or services havebeen rendered, no significant obligations remain on the part of the Company,and collectability is reasonably assured based on the Company’s credit and collectionspractices and policies.

 

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

 

Revenuerecognition for products and services provided by the Company’s subsidiaries inEngland and its U.S. subsidiary, ACC, depends upon the type of contractinvolved.  Engineering/design servicescontracts generally entail design and production of a prototype over a term ofup to several years, with revenue deferred until each milestone defined in thecontract is reached.  Productioncontracts provide for a specific quantity of products to be produced over aspecific period of time.  Customers issuebinding purchase orders or enter into binding agreements for the products to beproduced.  The Company recognizesrevenues on these orders as the products are shipped.  Returns are infrequent and permitted onlywith prior authorization because these products are custom made to order basedon binding purchase orders and are quality tested prior to shipment.  An estimate of warranty cost is recorded atthe time revenue is recognized.

 

TheCompany recognizes revenues for products sold by its subsidiary in France atthe point of shipment.  Customerdiscounts are included 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.  Revenuesfrom services such as repairs and modifications are recognized when the serviceis completed and invoiced.  For repairsthat involve shipment of a repaired product, the Company recognizes repairrevenues when the product is shipped back to the customer. Service revenuescontribute less than 5% of total revenue and, therefore, are considered to beimmaterial to overall financial results.

 

*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) pershare is computed by dividing net loss by the weighted average common sharesoutstanding during a period.  Dilutedincome (loss) per share is based on the treasury stock method and includes thedilutive effect of stock options and warrants outstanding during theperiod.  Common share equivalents havebeen excluded where their inclusion would be anti-dilutive.  As a result of the loss incurred by theCompany for the 2008 period, the potentially dilutive common shares have beenexcluded from the 2008 loss per share 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

computationbecause their inclusion would have been anti-dilutive.  The following table illustrates thecomputation of basic and diluted income (loss) per share (in thousands, exceptper share amounts):

 
| ** **                                          | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|
| ** **                                          | ** ** | **March 31,**     | ** ** |
| ** **                                          | ** ** | **2009**               | ** ** | **2008** | ** ** |
| ** **                                          | ** ** | **(Restated)**         | ** ** | ** ** | ** ** |
| NUMERATOR:                                          |       |                   |       |   |   |
| Net income  (loss)                                  |       | $                      | 4,837      |   | $ | (897 | ) |
|                                                |       |                   |       |   |   |
| DENOMINATOR:                                        |       |                   |       |   |   |
| Basic weighted  average common shares outstanding   |       | 10,204                 |       | 10,204 |   |
| Effect of  dilutive securities:                     |       |                   |       |   |   |
| Dilutive stock  options and warrants                |       | —                 |       | — |   |
| Diluted weighted  average common shares outstanding |       | 10,204                 |       | 10,204 |   |
|                                                |       |                   |       |   |   |
| Basic income  (loss) per share                      |       | $                      | 0.47       |   | $ | (0.09 | ) |
|                                                |       |                   |       |   |   |
| Diluted income  (loss) per share                    |       | $                      | 0.47       |   | $ | (0.09 | ) |

 

The following table showsthe common stock equivalents that were outstanding as of March 31, 2009and 2008, but were not included in the computation of diluted earnings pershare as a result of the loss incurred by the Company in 2008 or because theoptions’ or warrants’ exercise price was greater than the average market priceof the common shares and, therefore, the effect would have been anti-dilutive:

 
| ** **                            | ** ** | ** **    | ** ** | **Range of**       | ** ** |
|---------------------------------------|------------|---------------|------------|--------------------|------------|
| ** **                            | ** ** | **Number of** | ** ** | **Exercise Price** | ** ** |
| ** **                            | ** ** | **Shares**    | ** ** | **Per Share**      | ** ** |
|                                  |       |          |       |               |       |
| Anti-dilutive  common stock options:  |       |          |       |               |       |
| As of  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 |       |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Recent AccountingPronouncements*

 

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

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements.” This 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 the Company’sconsolidated financial statements, but resulted in additional disclosurescontained 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 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 the Company’s consolidated financial statements.

 

In April 2008, theFASB issued FASB Staff Position (“FSP”) No. FAS 142-3, “Determination ofthe Useful Life of Intangible Assets,” (“FSP 142-3”). FSP 142-3 amends thefactors that should be considered in developing renewal or 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 the Company’s consolidated financial statements.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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 would qualifyas a scope exception under SFAS No. 133, Accounting for DerivativeInstruments and Hedging Activities. EITF 07-5 is effective for financialstatements issued for fiscal years beginning after December 15, 2008.Early adoption for an existing instrument is not permitted. The Company adoptedEITF 07-5 on January 1, 2009. See Note 13 **—**Warrants below for discussion of the impact of the adoptionof EITF 07-5 on the Company’s outstanding stock warrants and its consolidatedfinancial statements.

 

**NOTE 2 —RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS**

 

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

 

The financial statements as of and for the periodended March 31, 2009 have been restated to correct an error in accountingtreatment for certain transactions.  TheCompany used $7.0 million of the proceeds of the sale of the Digitran Operations on March 20,2009 to repay a portion 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 period endedMarch 31, 2009.  The adjustment alsoimpacted the net carrying value of long term debt by $259,000 and other variousbalance sheet items.

 

Thefollowing table illustrates the correction as it is associated with certainline items in the financial 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 |   |

 

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**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                               |       | $                       | 0.52       |   | $ | (0.04 | ) | $ | 0.48 |   |
|                                  |       |                    |       |   |   |   |   |
| Weighted average  shares outstanding  |       |                    |       |   |   |   |   |
| Basic                                 |       | 10,204                  |       | 10,204 |   | 10,204 |   |
| Diluted                               |       | 10,204                  |       | 10,204 |   | 10,204 |   |

 

***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 | ) |

 

*AmendmentNo. 2*

 

The financial statements as of and for the periodended March 31, 2009 have been restated to correct an error in thecomputation and presentation of the Company’s income tax expense andliabilities.  The Company is the U.S.parent of both U.S. and foreign subsidiaries. The Company’s credit facility (as described in Notes 11 and 12) wasstructured such that the assets of all of the U.S. and U.K. subsidiaries werepledged as collateral and that those assets be included in the borrowing basefor the revolver.  Additionally, theLender required that each of the foreign subsidiaries provide a guaranty on thecredit facility.  During the audit of theCompany’s 2009 financial statements and as a result of this structure, theCompany has determined that Internal Revenue Code (“IRC”) §956 requiresadjustment of taxable income in each of the years since the inception of thecredit facility.  Although the Companyhas net operating loss carryforwards available to offset the resultingincreases to its regular taxable income, the Company is subject to alternativeminimum tax (“AMT”) because the carryforwards do not provide a complete offsetin calculating AMT income.  The Companycomputed the AMT, applying the estimated foreign tax credits generated fromapplication of IRC §956 that became available as offsets to the AMTobligation.  As a result, the Company isrestating its financial statements for the interim period ended March 31,

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

Thefollowing table illustrates the correction as it is associated with certainline items in the financial statements (in thousands):

 

***Balance Sheet***
| ** **                                       | ** ** | **March 31, 2009** | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **As reported in**      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                       | ** ** | **Amendment 1**         | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                             |       |                    |       |   |   |   |   |
| Income taxes  payable                            |       | $                       | 1,117      |   | $ | 48 |   | $ | 1,165 |   |
|                                             |       |                    |       |   |   |   |   |
| Total current  liabilities                       |       | $                       | 20,220     |   | $ | 48 |   | $ | 20,268 |   |
|                                             |       |                    |       |   |   |   |   |
| Total liabilities                                |       | $                       | 30,456     |   | $ | 48 |   | $ | 30,504 |   |
|                                             |       |                    |       |   |   |   |   |
| Accumulated  deficit                             |       | $                       | (22,743    | ) | $ | (48 | ) | $ | (22,791 | ) |
|                                             |       |                    |       |   |   |   |   |
| Total  stockholder’s equity                 |       | $                       | 17,497     |   | $ | (48 | ) | $ | 17,449 |   |
|                                             |       |                    |       |   |   |   |   |
| Total  liabilities and stockholder’s equity |       | $                       | 47,953     |   | $ | — |   | $ | 47,953 |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

***Statement of Operations***
| ** **                                | ** ** | **Three Months Ended**  | ** ** |
|-------------------------------------------|------------|-------------------------|------------|
| ** **                                | ** ** | **March 31, 2009** | ** ** |
| ** **                                | ** ** | **As reported in**      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                | ** ** | **Amendment 1**         | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                      |       |                    |       |   |   |   |   |
| Pre-tax loss                              |       | $                       | (1,664     | ) | $ | — |   | $ | (1,664 | ) |
| Provision  (benefit) for income taxes     |       | (503                    | )          | 697 |   | 194 |   |
| Loss from  continuing operations          |       | (1,161                  | )          | (697 | ) | (1,858 | ) |
| Discontinued  operations:                 |       |                    |       |   |   |   |   |
| Income from  discontinued operations      |       | 7,402                   |       | — |   | 7,402 |   |
| Tax provision on  discontinued operations |       | 1,356                   |       | (649 | ) | 707 |   |
| Net gain on  discontinued operations      |       | 6,046                   |       | 649 |   | 6,695 |   |
|                                      |       |                    |       |   |   |   |   |
| Net income                                |       | $                       | 4,885      |   | $ | (48 | ) | $ | 4,837 |   |
|                                      |       |                    |       |   |   |   |   |
| Earnings (loss)  per share:               |       |                    |       |   |   |   |   |
| Basic                                     |       | $                       | 0.48       |   | $ | (0.01 | ) | $ | 0.47 |   |
| Diluted                                   |       | $                       | 0.48       |   | $ | (0.01 | ) | $ | 0.47 |   |
|                                      |       |                    |       |   |   |   |   |
| Weighted average  shares outstanding      |       |                    |       |   |   |   |   |
| Basic                                     |       | 10,204                  |       | — |   | 10,204 |   |
| Diluted                                   |       | 10,204                  |       | — |   | 10,204 |   |

 

***Statement of Cash Flows***
| ** **                                                            | ** ** | **Three Months Ended**  | ** ** |
|-----------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                            | ** ** | **March 31, 2009** | ** ** |
| ** **                                                            | ** ** | **As reported in**      | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                            | ** ** | **Amendment 1**         | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                                                  |       |                    |       |   |   |   |   |
| Net income  (loss)                                                    |       | $                       | 4,885      |   | $ | (48 | ) | $ | 4,837 |   |
| Adjustments to  arrive at net loss from continuing operations    |       | (6,046                  | )          | (649 | ) | (6,695 | ) |
| Net loss from  continuing operations                                  |       | (1,161                  | )          | (697 | ) | (1,858 | ) |
|                                                                  |       |                    |       |   |   |   |   |
| Changes in  assets and liabilities                                    |       |                    |       |   |   |   |   |
| Accounts payable  and accrued expenses                                |       | $                       | (920       | ) | $ | 48 |   | $ | (872 | ) |
|                                                                  |       |                    |       |   |   |   |   |
| Operating cash  flow provided by (used in) continuing operations |       | $                       | 410        |   | $ | (649 | ) | $ | (239 | ) |
|                                                                  |       |                    |       |   |   |   |   |
| Operating cash  flow provided by discontinued operations         |       | $                       | 681        |   | $ | 649 |   | $ | 1,330 |   |

 

**NOTE 3 —LIQUIDITY, AS RESTATED**

 

The Company reported $4.8 million of net income forthe quarter ended March 31, 2009. Included in this net income was a $6.5 million gain (net of tax of $0.7million) on the disposition of the Digitran Operations (see Note 5).  Absent this gain, the Company would haveincurred a $1.7 million net loss.  If the Company’s net losses continue, itmay experience negative cash flow, which may hamper current operations and may preventthe Company from expanding its business. Additionally, such losses may result in a default on the Company’s debtcovenants associated with its credit facility. The Company may be unable to attain, sustain or increase 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

profitability on aquarterly or annual basis in the future. If the Company does not achieve,sustain or increase profitability, its stock price may decline.  Additionally, the Company has agreed with itslender to raise at least $2 million in net proceeds through the sale of theCompany’s and/or its subsidiaries’ stock by no later than September 30,2009.  Under the terms of the Company’scredit facility, the Company is obligated to remit to its 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.  The 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).

 

Recentactions taken by the SEC against Private Equity Management Group, Inc., anaffiliate of the agent of the Company’s lender and the Company’s lender,including an order granted in April 2009 by a federal court freezing allassets of Private Equity Management Group, Inc. and its affiliates,including the Company’s lender, may adversely affect the lender’s ability tocontinue to provide the Company funds under the terms of the Revolver (asdefined in Note 11 below).  At the request of the SEC, the federal court alsoappointed a temporary receiver of the 1ender’s agent and of the 1ender. Although the Company currently believes that the receiver will allow it tocontinue to borrow funds under the terms of the Revolver, management cannotassure you that the receiver will allow the lender to continue to make fundsavailable to the Company.  If, for any reason, the receiver were to limitor terminate the Company’s ability to continue to borrow funds under theRevolver (as defined in Note 10 below), the Company’s cash position and itsability to continue day to day operations would be adversely affected, almostimmediately.  If that were to occur, the Company would be required to seekadditional and/or replacement financing immediately.  If the Company is unableto do so, it may be forced to drastically curtail or cease operations andpossibly seek protection from its creditors under the U. S. Bankruptcy Code.

 

Currently, the Company is in the process of seekingalternate financing from a number of possible lenders, including certain banksand lenders which it has maintained a favorable relationship over manyyears.  Although the Company remainshopeful that it will be able to successfully secure replacement financing on atimely basis, management cannot assure you that the Company will be successfulin this regard.

 

If theCompany is able to continue to borrow funds under the terms of its Revolver (asdefined in Note 11 below), including timely funding by the lender of drawrequests, management believes that current and future capital resources,revenues generated from operations and other existing sources of liquidity willbe adequate to meet the Company’s anticipated short term, working capital andcapital expenditures needs for at least the next 12 months.  However, if theCompany experiences a significant loss of revenue or increase in costs, or ifthe lender fails to fund the Company’s draw requests in a timely manner or atall, then the Company’s cash flow would be negatively impacted resulting in acash flow deficit which, in turn, will require it to obtain additional oralternate financing, with little or no notice.  These potential financingneeds could 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 do businessafter that date or could restrict its growth, limit its development of newproducts, or hinder its ability to fulfill existing or future orders.

 

**NOTE 4 —ACQUISITION OF ADVANCED CONTROL COMPONENTS**

 

On May 23, 2008, the Company and itswholly-owned subsidiary, EMRISE Electronics Corporation (“EEC”) entered into aStock Purchase Agreement (the “Stock Purchase Agreement”) pursuant to which EECagreed to acquire Custom Components, Inc. (“CCI”) and its operatingsubsidiary, Advanced Control Components, Inc. (“ACC”).  On August 20,2008, the Stock Purchase Agreement was amended pursuant to Amendment No. 1

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

toStock Purchase Agreement (the “Amendment to Purchase Agreement,” andcollectively with the Stock Purchase Agreement, the “ACC Purchase Agreement”)to, among other things, reduce the initial purchase price for all of thecapital stock of both CCI and ACC to $12,400,000, subject to adjustments forworking capital and net cash.  Additionally, pursuant to the terms of theAmendment to Purchase Agreement, the Company is obligated to pay interest on aprincipal amount of $600,000 at a rate equal to the prime rate as reportedin *The Wall Street Journal *onAugust 20, 2008 plus 1% for the period commencing on August 20, 2008and ending on the later of November 18, 2008 or the actual date suchinterest payment is made.

 

The closing of the ACC Purchase Agreement occurredon August 20, 2008.  Under the terms of the ACC Purchase Agreement,EEC acquired all of the issued and outstanding shares of common stock of CCIand all of the issued and outstanding shares of common stock of ACC not ownedby CCI (the “Acquisition”).  In addition to the purchase price, theCompany is obligated to pay up to an additional $3,000,000 in cash if ACC meetscertain operating income targets for one or both of the two 12 month periodsfollowing the closing.  Additionally, EEC issued Subordinated SecuredContingent Promissory Notes (the “Notes”) to each of the Sellers in theaggregate principal amount of $2,000,000.  The Notes become payable if ACCmeets certain operating income thresholds during the first and second 12 monthperiods after August 20, 2008.  The Notes bear interest at a rateper annum equal to the prime rate as reported in *The Wall Street Journal *plus 1%.

 

In determining the purchase price for the Acquisition,the Company took into account the historical and expected earnings and cashflow of ACC, as well as the value of companies of a size and in an industrysimilar to ACC, comparable transactions and the market for such companiesgenerally.  The purchase pricerepresented a premium of approximately $4.1 million over the recorded net worthof ACC’s assets.  The acquisitionoccurred prior to the effective date of SFAS No. 141R and the Company didnot early adopt the provisions of this statement.

 

In conjunction with the Acquisition, the Companycommissioned a valuation firm to assist it in determining the fair value of ACC’stangible assets and the portion of the purchase price that should be allocatedto identifiable intangible assets.  TheCompany considered whether the Acquisition included various types ofidentifiable intangible assets, including trade names, trademarks, patents,covenants not to compete, customers, backlog, workforce, technology andsoftware.  As a result of the proceduresperformed by the valuation firm and the evaluation of management, the Companydetermined and recorded the value of the tangible and intangible assets in itsCondensed Consolidated 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.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Thefollowing table summarizes the assets and liabilities assumed in connectionwith the Acquisition (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 |   |

 

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

 
| ** **                           | ** ** | **For the Three********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                                                      |       |

 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 5 —DISCONTINUED OPERATIONS**

 

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

 

The Buyer acquired all of the intellectual property,cash, accounts receivable, inventory, customer support and relationships,software and product development, and real property lease related to theDigitran division, which, prior to its acquisition, was in the business ofmanufacturing a line of electromechanical switches comprised of digital androtary switches used for routing electronic signals.  The Stock Buyeracquired XCEL Japan, Ltd., which, prior to its acquisition, was engaged in thebusiness of selling and distributing Digitran division products in the AsiaPacific market.  EEC retained all accounts payable and certain otherassets and liabilities related to the Digitran division.  The Companycontinues to operate its communications equipment segment and the power systemsRF and microwave devices product lines in its electronic devices segment.

 

The Digitran Purchase Agreement contains five yearnoncompetition and non-solicitation provisions covering the Company, EEC andeach of their respective affiliates.  In addition, the Company and EECprovided customary indemnification rights to the Buyer and Stock Buyer inconnection with the Disposition.

 

Inconnection with the Company’s divestiture of its Digitran division, whichcomprised a portion of the Company’s electronic devices segment, the Companyincurred approximately $900,000 in cash charges that were paid atclosing.  The charges paid at closing included approximately $100,000 inemployee termination costs.  In addition, the Company estimates futurecash expenditures related to the sale to be approximately $735,000, which areaccrued within “Accrued liabilities” except for income taxes, which are accruedwithin “Income taxes payable” in the accompanying condensed consolidatedbalance sheets.  The Company anticipates the charges will be comprised of (i) approximately$370,000 in costs 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.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Thefollowing table summarizes the results from discontinued operations for thethree months ended March 31, 2009 and 2008 (in thousands):

 
| ** **                                                  | ** ** | **2009**       | ** ** | **2008**   | ** ** |
|-------------------------------------------------------------|------------|----------------|------------|------------|------------|
| ** **                                                  | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
|                                                        |       |           |       |       |       |
| Net Sales                                                   |       | $              | 1,478      |       | $          | 1,604 |   |
|                                                        |       |           |       |       |       |
| Income from  operations                                     |       | $              | 178        |       | $          | 371 |   |
| Gain on sale of  Digitran Operations   (net of tax of $707) |       | 6,517          |       | —     |       |
| Net Income                                                  |       | $              | 6,695      |       | $          | 371 |   |

 

**NOTE 6 —STOCK-BASED COMPENSATION**

 

TheCompany has five stock 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 directorsdoes not intend to issue any additional options under the Employee Stock andStock Option Plan, 1993 Stock Option Plan, 1997 Stock Incentive Plan or Amendedand Restated 2000 Stock Option Plan.

 

Total stock-basedcompensation expense included in wages, salaries and related costs was $34,000and $20,000 for the three months ended March 31, 2009 and 2008, respectively.These compensation expenses were charged to selling, general and administrativeexpenses. As of March 31, 2009, the Company had $349,000 of totalunrecognized compensation expense related to stock option grants, which will berecognized over the remaining weighted average period of two years.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 7 —INVENTORIES**

 

Inventoriesare stated at the lower of cost (first-in, first-out method) or market (netrealizable value) and consisted of the following (in thousands):

 
| ** **         | ** ** | **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, AS RESTATED**

 

The Company has tworeportable operating segments: electronic devices and communications equipment.The electronic devices segment manufactures and markets electronic powersupplies, radio frequency (“RF”) and microwave devices and subsystemassemblies. The electronic devices segment consists of EEC and its subsidiarieslocated in the U.S. and England, which offer the same or similar products tosimilar customers.  The communicationsequipment segment designs, manufactures and distributes network access productsand timing and synchronization products. The communications equipment segment consists of operating entities CXRLarus Corporation located in the U.S. and CXR Anderson Jacobson located inFrance, both of which offer the same or similar products to similarcustomers.  Both segments operate in theU.S., European and Asian markets, but have distinctly different customers,design and manufacturing processes and marketing strategies.  Each segment has discrete financialinformation and a separate management structure.

 

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

 

During the first quarterof 2009, the Company sold its Digitran Operations (see Note 5), which were partof its electronic devices segment.  Thistransaction resulted in differences in the basis of segmentation from theamounts disclosed in the Company’s audited consolidated financial statementsincluded in its annual report on Form 10-K for the year ended December 31,2008.  In this 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.

 

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**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**

 

Thefollowing table reflects changes in our goodwill balances, by segment, for thethree months ended 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, AS RESTATED**

 

The effective tax ratefor the three month period ended March 31, 2009 was different than the 34%U.S. statutory rate primarily because the Company’s foreign entities generate atax obligation and related tax expense as a result of their net income, whichcannot be offset by U.S. tax loss carryforwards.

 

The Company’s business issubject to regulation under a wide variety of U.S. federal, state and foreigntax laws, regulations and policies.  Themajority of the Company’s foreign subsidiaries have earnings and profits thatare reinvested indefinitely.  However,under the credit facility described in Notes 11 and 12 the foreign subsidiarieshave issued guarantees on the credit facility and, as a result, under IRC §956have been deemed to 

 

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distribute theseearnings to fund U.S. operations.  Thishas resulted in U.S. federal taxable income and an increase in U.S. taxliability, which has been reduced through utilization of available netoperating loss carryforwards and foreign tax credits.

 

The Company adopted FIN48, “Accounting for Uncertainty inIncome Taxes — an interpretation of FASB Statement No. 109,” on January 1,2007. The implementation of FIN 48 did not result in a material adjustment tothe Company’s liability for unrecognized income tax benefits. At the time ofadoption and as of March 31, 2009, the Company had recorded no netunrecognized tax benefits.

 

The Company recognizesinterest and penalties related to uncertain tax positions in interest expenseand selling, general and administrative expense, respectively, in the condensedconsolidated statements of operations and comprehensive income. No interest orpenalties were recognized during 2008. As of March 31, 2009, the Companyhad nothing accrued for interest and penalties.

 

The Company files incometax returns in the United States federal jurisdiction, the United Kingdom,France and Japan, and in the state jurisdictions of California, Texas,Pennsylvania and New Jersey. The Company is no longer subject to United Statesfederal and state tax examinations for years before 2005 and 2004,respectively, and is no longer subject to tax examinations for the UnitedKingdom and Japan for years prior to 2007, and for France for years prior to2005.

 

**NOTE 11 — LINE OF CREDIT**

 

TheCompany and its direct subsidiaries, EEC, CXR Larus Corporation and ROAssociates Incorporated (collectively, the “Borrowers”) are parties to a CreditAgreement (as amended from time to time the “Credit Agreement”) with GVECResource IV Inc. (the “Lender”) providing for a credit facility in the originalaggregate amount of $26,000,000 and is secured by accounts receivable, otherrights to payment and general intangibles, inventories and equipment. Thecredit facility includes a one year revolving credit facility for up to$7,000,000 that may be renewed up to two times, each for a period of one year,at the Company’s option, provided that certain conditions precedent are met(the “Revolver”).  The credit facilityalso includes two term loans (see Note 12).

 

TheRevolver is formula-based and which 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, inwhich case the maturity date will be extended to November 30, 2010.

 

Intereston the Revolver is payable monthly.  Theinterest rate is variable and is adjusted monthly based on prime rate aspublished in the “Money Rates” column of *The Wall Street Journal*(the “Base Rate”) 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,including the following: EBITDA, measured on a fiscal quarter-end basis, mustnot be less than the scheduled amount for each specified period; the debtservice coverage ratio, measured quarterly, must be greater than the lesser ofthe scheduled amount for each specific period or 1.10:1.00; the leverage ratio,measured quarterly, must not be greater than the scheduled amount for eachspecified period, and liquidity, measured quarterly, must not be less than thescheduled amount for each specified period. Additionally, the Revolver is subject to the Borrowers not incurringcapital expenditures (a) in excess of $600,000 for the fiscal year ending December 31,2009, and (b) in excess of $1,800,000 for the fiscal year ending December 31,2010.  Additionally, the Revolver 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 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

between the amountincurred in a certain fiscal quarter and $62,500 maybe incurred in the twofiscal quarters immediately following such fiscal quarter. The Company was notin compliance with its EBITDA, debt service coverage ratio and leverage ratiocovenants at March 31, 2009. Additionally, on April 1, 2009 theCompany voluntarily elected not to make a required interest payment on amountsborrowed under its credit facility, which amount has been subsequentlypaid.  On May 14, 2009, the Companyreceived a waiver from the Lender for these events of default.

 

As of March 31, 2009, the Company hadoutstanding borrowings of $4.1 million under the Revolver with remainingavailability under the formula-based calculation of $2.9 million.

 

Upon the sale or disposition by the Borrowers or anyof their subsidiaries of property or assets, the Borrowers may be obligated toprepay the Revolver and the term loans with the net cash proceeds received inconnection with such sales or dispositions to the extent that the aggregateamount of net cash proceeds received, and not paid to the Lender as aprepayment, for all such sales or dispositions exceed $150,000 in any fiscal year.

 

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

 

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, AS RESTATED**

 

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

 

Thecredit facility consists of (i) the Revolver, (ii) a term loan in theprincipal amount of $6 million which is due November 30, 2010 (“Term LoanA”), (iii) a term loan in the original principal amount of $10 million,which is due on November 30, 2010 (“Term Loan B”), and (iv) Term LoanC.  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.

 

TheTerm Loans A and B bear interest at the Base Rate plus 4.25%, subject to aminimum rate of 12.5%, and require interest only payments in the first year,scheduled principal plus interest payments in years two and three, and a finalballoon payment at the end of year three. Interest on the Term Loans is payable monthly.  The Borrowers may make full or partial prepayment ofthe Term Loans provided that any such prepayment is accompanied by theapplicable prepayment premium.

 

As part of theconsideration for entering into the Credit Agreement, the Company issuedwarrants to purchase 788,000 shares of the Company’s common stock with a fairvalue of $1.5 million, which is accounted for as a discount to the CreditFacility and is amortized over the term of the Credit Agreement.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(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**

 

Inconnection with entering into the credit facility (discussed in Note11), theCompany issued a seven year warrant to Private Equity Management Group, Inc.,an affiliate of the Lender to purchase up to approximately 776,000 shares ofthe Company’s common stock on a cash or cashless basis at an exercise price of$4.13 per share.  The estimated fairvalue of the warrants was $1.5 million, which was calculated using theBlack-Scholes pricing model.  Thewarrants were originally accounted for as debt discount and the adjustmentresulting from the repricing of the warrants increased the debt discount, whichis being amortized over the remaining life of the credit facility.  The warrants were previously recorded instockholder’s equity.

 

In February 2009,the warrants were amended and reissued in conjunction with an amendment to thecredit facility.  Pursuant to the SecondAmendment to Loan Documents, the original warrant was divided into two warrants(each, a “Second Amended and Restated Warrant” and collectively, the “SecondAmended and Restated Warrants”).  Each Second Amended and Restated Warrantcovers 387,879 shares of the Company’s common stock (which amount reflects theCompany’s 1-for-3.75 reverse split of its common stock effective November 18,2008).  One of the Second Amended and Restated Warrants provides for anexercise price of $1.99 per share (which amount reflects the Company’s1-for-3.75 reverse split of its common stock effective November 18,2008).  The other Second Amended and Restated Warrant provides for anexercise price of $1.80 per share (which amount reflects the Company’s1-for-3.75 reverse split of its common stock effective November 18, 2008and a reduction from a post-split exercise price of $3.06 per share).

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Theexercise price and/or number of shares of common stock issuable upon exerciseof the warrants may be adjusted in certain circumstances, including certainissuances of securities at a price equal to less than the then current exerciseprice, subdivisions and stock splits, stock dividends, combinations,reorganizations, reclassifications, consolidations, mergers or sales of propertiesand assets and upon issuance of certain assets or securities to holders of theCompany’s common stock, as applicable. In June 2008, the FASB ratified theconsensus reached on EITF Issue No. 07-5, “Determining Whether anInstrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF07-5”). EITF 07-5 clarifies the determination of whether an instrument (or anembedded feature) is indexed to an entity’s own stock, which would qualify as ascope exception under SFAS No. 133, Accounting for Derivative Instrumentsand Hedging Activities. EITF 07-5 was effective for financial statements issuedfor 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, the Company had warrants subject to mark tomarket outstanding to purchase 775,758 shares of common stock.  The Company computed the fair value of thewarrants using a Black-Scholes valuation model. The fair value of these warrants on the date of adoption of January 1,2009 and on March 31, 2009 was determined 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 a cumulative effect of change in accountingprinciple adjustment to its accumulated deficit of $473,000 and a correspondingreclassification of these outstanding warrants from stockholders’ equity towarrant liability.  As of and for thequarter ended March 31, 2009, the change in fair value of the warrantsresulted in a $130,000 adjustment to other income (expense) in the consolidatedstatement of operations and a corresponding decrease to the warrant liability.

 

**NOTE 14 — FAIR VALUE MEASUREMENTS**

 

In September 2006, the FASB issued SFAS No. 157,which defines fair value, establishes a framework for measuring fair value ingenerally accepted accounting principles and expands disclosures about fairvalue measurements.  The effective dateof the statement 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.

 

SFAS No. 157 defines fair value as the pricethat would be received to sell an asset or paid to transfer a liability (anexit price) in an orderly transaction between market participants and alsoestablishes a fair value hierarchy which requires an entity to maximize the useof observable inputs and minimize the use of unobservable inputs when measuringfair value.  The fair value hierarchydistinguishes between three levels of inputs that may be utilized whenmeasuring fair value as follows:

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Level 1 — Inputs are unadjusted quoted prices inactive markets for identical assets or liabilities available at the measurementdate.

 

Level 2 — Inputs are unadjusted quoted prices forsimilar assets and liabilities in active markets, quoted prices for identicalor similar assets and liabilities in markets that are not active, inputs otherthan quoted prices that are observable, and inputs derived from or corroboratedby observable market data.

 

Level 3 — Inputs that are unobservable inputs whichreflect the reporting entity’s own assumptions on what assumptions the marketparticipants would use in pricing the asset or liability based on the best availableinformation.

 

As of March 31, 2009, the Company was requiredto apply SFAS No. 157 provisions to the derivative that is within thewarrant that was issued as consideration for our credit facility, which isdiscussed in Note 13 and included as a discount on our long-term debt.  The derivative was valued using theBlack-Scholes model.  The key inputs inthe 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       |   |
|                         |            |                         |            |  |

 

The derivative is measured at fair value on arecurring basis using significant observable inputs (Level 2).  The amount of total gain in earnings for theperiod 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        |   |

 

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

 

**CautionaryStatement**

 

The following discussionshould be read in conjunction with our unaudited condensed consolidatedfinancial statements and the related notes thereto contained in Part I,Item 1 of this Amendment No, 1 to our Quarterly Report on Form 10-Q. Theinformation contained in this report is not a complete description of ourbusiness or the risks associated with an investment in our common stock. Weurge you to carefully review and consider the various disclosures made by us inthis Report and in our other reports filed with SEC, including our AnnualReport on Form 10-K for the year ended December 31, 2008 andsubsequent reports on Forms 10-Q and 8-K, which discuss our business in greaterdetail.  This report and the followingdiscussion contain forward-looking statements, which generally include theplans and objectives of management for future operations, including plans andobjectives relating to our future economic performance and our current beliefsregarding revenues we might generate and profits we might earn if we aresuccessful in implementing our business and growth strategies. Theforward-looking statements and associated risks may include, relate to or bequalified by other important factors, including, without limitation:

 

**·**                  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 toupdate, revise or correct any forward-looking statements.

 

Any of the factorsdescribed above or in the “Risk Factors” sections contained in our AnnualReport on Form 10-K for the year ended December 31, 2008 and in thisreport could cause our financial results, including our net income or loss orgrowth in net income or loss to differ materially from prior results, which inturn could, among other things, cause the price of our common stock tofluctuate substantially.

 

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**RecentTransactions**

 

OnMarch 20, 2009, we completed the sale of substantially all the assets ofthe Digitran division of our wholly-owned subsidiary, EMRISE ElectronicsCorporation, or EEC, and all the capital stock of ECC’s wholly-ownedsubsidiary, XCEL Japan Ltd., which primarily acted as a sales office for theDigitran division, to Electro Switch Corp. In this report we refer to the businesses of the Digitran Division andXCEL Japan, Ltd. as the “Digitran Operations,” and we refer to the sale of theDigitran division and XCEL Japan, Ltd. as the “Digitran Transaction.”  Within our Digitran division we manufactured,marketed and sold electro-mechanical digital and new patented technology verylow 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.

 

**BusinessDescription**

 

Wedesign, manufacture and market proprietary electronic devices andcommunications equipment for aerospace, defense, industrial, and communicationsapplications. We have operations in the U.S., England, and France.  We organize our business in two operating segments:electronic devices and communications equipment. In the first quarter of 2009,our electronic devices segment contributed approximately 82% of overall netsales while the communications segment contributed approximately 18% of overallnet sales. Our subsidiaries within our electronic devices segment design, develop, manufacture and market powersupplies, radio frequency, or RF, and microwave devices for defense, aerospaceand industrial markets.  Oursubsidiaries within our communications equipment segment design, develop,manufacture and market network access equipment, including network timing andsynchronization products, for communications applications in defense, publicand private networks and industrial markets.

 

Withinour electronic devices segment, we produce a range of power systems and RF and microwave devices.  Thissegment is primarily “project” driven with the majority of revenues beingderived from custom products with long life cycles and high barriers toentry.  The majority of manufacturing andtesting is performed in-house or through sub-contract manufacturers.  Our electronic devices are used in a widerange of military airborne, seaborne and land-based systems, and in-flightentertainment systems, including the latest next generation in-flightentertainment and communications, or IFE&C, systems — such as applicationsfor mobile phone, e-mail and internet communications and real time, on-board satelliteand broadcast TV — which are being installed in new commercial aircraft as wellas being retrofitted into existing commercial aircraft.

 

Within ourcommunications equipment segment, we produce a range of network accessequipment, including network timing and synchronization products, for publicand private communications networks. This segment is “end user product” based with a traditional cycle ofinternally funded development and marketing prior to selling via direct andindirect sales channels.  Manufacturingis primarily outsourced.  Ourcommunications equipment is used in a broad range of network applicationsprimarily for private communications networks, public communications carriers,and also for utility companies and military applications, including homelandsecurity.

 

**CriticalAccounting Policies**

** **

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

 

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date of thefinancial statements and the reported amount of net sales and expenses for eachperiod. The following represents a summary of our critical accounting policies,defined as those policies that we believe are the most important to theportrayal of our financial condition and results of operations and that requiremanagement’s most difficult, subjective or complex judgments, often as a resultof the need to make estimates about the effects of matters that are inherentlyuncertain.

 

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

 

Wederive revenues from sales of electronic devices and communications equipmentproducts and services.  Our sales arebased upon written agreements or purchase orders that identify the type andquantity of the item and/or services being purchased and the purchaseprice.  We recognize revenues whenshipment of products 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.

 

Werecognize revenues from domestic sales of our electronic devices andcommunications equipment at the point of shipment of those products.  An estimate of warranty cost is recorded atthe time the revenue is recognized. Product returns are infrequent and require prior authorization becauseour sales are final and we quality test our products prior to shipment to ensurethe products meet the specifications of the binding purchase orders under whichthose products are shipped. Normally, when a customer requests and receivesauthorization to return a product, the request is accompanied by a purchaseorder for a repair or for a replacement product.

 

Revenuerecognition for products and services provided by ACC and our subsidiaries inEngland depends upon the type of contract involved.  Engineering/design services contractsgenerally entail design and production of a prototype over a term of up toseveral years, with revenue deferred until each milestone defined in thecontract is reached.  Productioncontracts provide for a specific quantity of products to be produced over aspecific period of time.  Customers issuebinding purchase orders or enter into binding agreements for the products to beproduced.  We recognize revenues on theseorders as the products are shipped. Returns are infrequent and permitted only with prior authorizationbecause these products are custom made to order based on binding purchaseorders and are quality tested prior to shipment.  An estimate of warranty cost is recorded atthe time revenue is recognized.

 

Werecognize revenues for products sold by our subsidiary in France at the pointof shipment.  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.

 

Revenuesfrom services such as repairs and modifications are recognized when the serviceis completed and invoiced.  For repairsthat involve shipment of a repaired product, we recognize repair revenues whenthe product is shipped back to the customer. Service revenues contribute lessthan 5% of total revenue and, therefore, are considered to be immaterial tooverall financial results.

 

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***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 

 

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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 $2.8 million that wereincluded as part of accumulated other comprehensive income within our balancesheets at March 31, 2009 and December 31, 2008, respectively. Duringthe three months ended March 31, 2009 and 2008, we included translationlosses of $420,000 and gains of $229,000, respectively, under accumulated othercomprehensive 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.

 

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**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 adecrease in sales at our U.S. power supply division due to economicconditions.  On a local currency basis,net sales at our foreign electronic device companies were higher in the firstquarter of 2009 as compared to 2008. However, exchange rates between the U.S. dollar and the British poundsterling negatively impacted the consolidated results of our U.K. subsidiarieswhen translated into U.S. 

 

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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.

 

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**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 ratesbetween 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 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 arehopeful during 2009 that this segment will be able to return to higher grossmargins, such as those recently achieved throughout the latter part of2008.  However, due to current economicconditions and the impact such conditions are having on this segment’s sales,we are uncertain 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.  

 

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**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 

 

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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 expense amounted to $0.2 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 income taxexpense 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.

 

TheCompany has exhausted a significant portion of its net operating lossesavailable to be carried forward into future periods and, as a result, anyincome from operations and/or gain on sales of assets could result insignificant tax obligations.

 

**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 $0.7million, 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 $4.8 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 

 

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had accumulated deficits of $22.8 millionand $28.1 million, respectively, and cash 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 $4.8million included a gain on the sale of assets of $7.2 million.  Significant non-cash adjustments to our firstquarter 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 a 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 for ourmanufacturing processes due to the custom nature of the products, andapproximately 5% related to our communications equipment business, whichbusiness tends to deliver standard or modified standard products from stock asorders are received. We believe that the majority of our current backlog isshippable within the next 12 months. However, there can be no assurance that we will be successful infulfilling such orders and commitments in a timely manner or that we willultimately recognize as revenue the amounts reflected as backlog.

 

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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,include a term loan in the principal amount of $3,000,000 (the “Term Loan C”). In connection 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.

 

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 all 

 

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remedies availableto it with respect to the collateral.  In addition, certain of theborrowers’ foreign subsidiaries have agreed to guaranty the borrowers’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 the sale ofstock, 50% of the next $1,000,000 of net cash proceeds received in connectionwith the sale of stock, and 30% of the net cash proceeds in excess of the first$3,000,000 received 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 principalbalances and accrued interest requiring us to pay the entire indebtedness underour credit facility outstanding on that date.  Upon the occurrence andduring the continuation of an event of default, the Lender may also elect toincrease the interest rate applicable to the outstanding balance of the TermLoans A and B by four percentage points above the per annum interest rate thatwould otherwise be applicable.  Any of these conditions could have amaterial adverse effect on our operations and/or ability to conduct businessafter that date.

 

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 12months.  However, if we experience a significant loss of revenue orincrease in costs, or if our Lender fails to fund our draw requests in a timelymanner or at all, then our cash flow would be negatively impacted resulting ina cash flow deficit which, in turn, will require us to obtain additional oralternate financing, with little or no notice.  These potential financingneeds could 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 

 

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business after that dateor could restrict our growth, limit our development of new products, or hinderour ability to fulfill existing or future orders.

 

**Effects of Inflation**

** **

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

 

**Impacts of New Accounting Pronouncements**

** **

In February 2007,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 159, “The Fair Value Option forFinancial Assets and Financial Liabilities.” SFAS No. 159 permits anentity to irrevocably elect fair value on a contract-by-contract basis as theinitial and subsequent measurement attribute for many financial assets andliabilities and certain other items including insurance contracts. Entitieselecting the fair value option would be required to recognize changes in fairvalue in earnings and to expense upfront cost and fees associated with the itemfor which the fair value option is elected. SFAS No. 159 is effective forfiscal years beginning after November 15, 2007. The adoption of SFAS No. 159did not have a material effect on 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, exceptthose that are recognized or disclosed at fair value in the financialstatements on a recurring basis.  We haveevaluated the impact the adoption of SFAS No. 157 for non-financial assetsand liabilities have determined that the adoption of SFAS No. 157-2 didnot have 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 

 

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the determinationof intangible asset useful lives. FSP 142-3 is effective for fiscal years beginningafter December 15, 2008. Early adoption is prohibited. The adoption of FSP142-3 did not have a material 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 wouldqualify as a scope exception under SFAS No. 133, Accounting for DerivativeInstruments and Hedging Activities. EITF 07-5 is effective for financialstatements issued for fiscal years beginning after December 15, 2008.Early adoption for an existing instrument is not permitted. We adopted EITF07-5 on January 1, 2009. See Note 13 **—**Warrantsbelow for discussion of the impact of the adoption of EITF 07-5 on ouroutstanding stock warrants and its consolidated financial statements.

 

**ITEM 3.                  QUANTITATIVEAND QUALITATIVE 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 Executive Officer and Vice PresidentFinance and Administration concluded as of March 31, 2009 that ourdisclosure controls and procedures were not effective at the reasonableassurance level due to the material weaknesses discussed immediately below.

 

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 

 

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preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. Our internal control overfinancial reporting includes those policies and procedures that:

 

(i)                                     pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of our assets;

 

(ii)                                  providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that our receipts and expenditures are being madeonly in accordance with authorizations of our management and directors; and

 

(iii)                               providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of our assets that could have a material affecton our financial statements.

 

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 may becomeinadequate because of changes in conditions, or that the degree of compliancewith 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 statements willnot 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 five material weaknesses in our internal control over financialreporting existed:

 

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

 

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

 

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

 

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

 

(5)                                  We did notmaintain a sufficient level of resources within our accounting department.

 

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.

 

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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.

 

***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)           We did not effectivelyimplement comprehensive entity-level internal controls, as evidenced by the following controldeficiencies:

 

·                  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.

 

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·                  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, where applicable,designed and implemented to support the achievement of financial reportingobjectives.

 

·                  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.

 

(5)           Weare a relatively complex company with operations conducted in multiplecountries, multiple currencies and multiple languages.  We have divestedfour separate operations in the past 18 months, acquired a large subsidiaryduring the same time, and we are in the process of divesting additional assetsin order to repay our current obligations.  All of these transactions giverise to complex accounting and tax treatments. Our finance team is a relatively small but experienced staff. Althoughwe believe the accounting staff are qualified to perform their functions, dueto reasons above, the quantity of staff may be insufficient to deal with thework load and complexities created, which could result in materialmisstatements to our financial statements.

 

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***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 outsideconsultants, as necessary to ensure that board level deficiencies areaddressed.  We are uncertain at this timeof the costs to remediate all of the above listed material weaknesses, however,we anticipate the cost to be in the range of $200,000 to $400,000 (includingthe cost of the consolidation software described above), most of which costs weexpect to incur in 2009.  We cannotguarantee that the actual costs to remediate these deficiencies will not exceedthis amount.

 

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 severalquarters may be required before management may be able to conclude that thematerial weakness has been remediated. We intend to continue to evaluate and strengthen our internal controlover financial reporting systems. These efforts require significant time andresources.  If we are unable to establishadequate internal control over financial reporting systems, we may encounterdifficulties in the audit or review of our financial statements by 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.

 

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**PART II — OTHERINFORMATION**

 

**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                                                                                                              |

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(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.

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                       | EMRISE CORPORATION |
|----------------------------|--------------------|
|                       |               |   |
| Dated: April 15, 2010 | By:           | /S/ CARMINE T. OLIVA |
|                       |               | Carmine T. Oliva,

Chief Executive Officer |
|                       |               |   |
|                       |               |   |
| Dated: April 15, 2010 | By:           | /S/ D. JOHN DONOVAN |
|                       |               | D. John Donovan, 

Chief Financial Officer 

(principal financial and  accounting officer) |

 

 

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**INDEX TOEXHIBITS ATTACHED TO THIS REPORT**

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

 

 

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