Table of Contents

** **

 

** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

| **x**                                                                                                                                                                                                                                           | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                            |
| **For the quarterly period  ended****September 30, 2010**                                                                                                                                                                                  |
| ** **                                                                                                                                                                                                                                      |
| **or**                                                                                                                                                                                                                                          |
|                                                                                                                                                                                                                                            |
| **o**                                                                                                                                                                                                                                           | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|                                                                                                                                                                                                                                            |
| **For the transition  period from                    to                 ** |

** **

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

 

**EMRISECORPORATION**

(Exact name of registrant as specified in its charter)

 

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

** **

**2530Meridian Parkway**

**Durham,North Carolina 27713**

(Address of principalexecutive offices) (Zip code)

 

**(408) 200-3040**

(Registrant’s telephone number, including area code)

 

**611 Industrial Way, Eatontown, NJ 07724**

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

 

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

 

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

 

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

 

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

 

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

 

The number of sharesoutstanding of the Registrant’s common stock, $0.0033 par value, as of November 10,2010 was 10,667,337.

 

 

 

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Table ofContents

 

**EMRISE CORPORATION**

**TABLE OF CONTENTS**

**FORM 10-Q**

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2010**

 
| **PART I  FINANCIAL INFORMATION**                                                                                             |
|------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                         |   |
| **ITEM 1.**                                                                                                                        | **FINANCIAL  STATEMENTS** |   |
| ** **                                                                                                                         |   |
| Condensed Consolidated  Balance Sheets as of September 30, 2010 (unaudited) and December 31,  2009                       | 1 |
|                                                                                                                               |   |
| Condensed Consolidated  Statements of Operations for the Three and Nine Months Ended  September 30, 2010 and 2009 (unaudited) | 2 |
|                                                                                                                               |   |
| Condensed  Consolidated Statements of Stockholders’ Equity for the Nine Months Ended  September 30, 2010 (unaudited)     | 3 |
|                                                                                                                               |   |
| Condensed  Consolidated Statements of Cash Flows for the Nine Months Ended  September 30, 2010 and 2009 (unaudited)           | 4 |
|                                                                                                                               |   |
| Notes to  Condensed Consolidated Financial Statements (unaudited)                                                                  | 6 |
|                                                                                                                               |   |
| **ITEM 2.**                                                                                                                        | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** | 23 |
|                                                                                                                               | ** ** |   |
| **ITEM 3.**                                                                                                                        | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK** | 41 |
|                                                                                                                               |   |   |
| **ITEM 4T.**                                                                                                                       | **CONTROLS  AND PROCEDURES** | 41 |
| ** **                                                                                                                         | ** ** |   |
| **PART II**                                                                                                                   |
| **OTHER INFORMATION**                                                                                                              |
|                                                                                                                               | ** ** |   |
| **ITEM 2.**                                                                                                                        | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS** | 44 |
| ** **                                                                                                                         | ** ** |   |
| **ITEM 6.**                                                                                                                        | **EXHIBITS** | 45 |
| ** **                                                                                                                         | ** ** |   |
| **SIGNATURES**                                                                                                                     | 47 |

 

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Tableof Contents

** **

**PART I — FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIALSTATEMENTS**

** **

**EMRISE CORPORATION**

**Condensed Consolidated Balance Sheets**(in thousands, except share and pershare amounts)

** **
| ** **                                                                                                                                                                             | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                             | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                                                             | ** ** | **(unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                             |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                        |       |                   |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                             |       | $                      | 5,798      |                  | $          | 3,994 |   |
| Accounts receivable,  net of allowances for doubtful accounts of $151 at September 30, 2010  and $160 at December 31, 2009                                                   |       | 5,035                  |       | 6,059                 |       |
| Inventories                                                                                                                                                                            |       | 7,116                  |       | 8,031                 |       |
| Current deferred tax  assets                                                                                                                                                           |       | —                 |       | 158                   |       |
| Prepaid and other  current assets                                                                                                                                                      |       | 1,912                  |       | 841                   |       |
| Current assets of  discontinued operations                                                                                                                                             |       | —                 |       | 6,368                 |       |
| Total current assets                                                                                                                                                                   |       | 19,861                 |       | 25,451                |       |
|                                                                                                                                                                                   |       |                   |       |                  |       |
| Property, plant and  equipment, net                                                                                                                                                    |       | 859                    |       | 987                   |       |
| Goodwill                                                                                                                                                                               |       | 4,935                  |       | 2,878                 |       |
| Intangible assets other  than goodwill, net                                                                                                                                            |       | 1,006                  |       | 1,107                 |       |
| Deferred tax assets                                                                                                                                                                    |       | 509                    |       | 308                   |       |
| Other assets                                                                                                                                                                           |       | 84                     |       | 121                   |       |
| Noncurrent assets of  discontinued operations                                                                                                                                          |       | —                 |       | 19,425                |       |
| Total assets                                                                                                                                                                           |       | $                      | 27,254     |                  | $          | 50,277 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                          |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                   |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                       |       | $                      | 3,466      |                  | $          | 2,734 |   |
| Accrued expenses                                                                                                                                                                       |       | 5,086                  |       | 5,232                 |       |
| Line of credit                                                                                                                                                                         |       | —                 |       | 5,156                 |       |
| Current portion of  long-term debt, net of discount of $0 and $290                                                                                                                     |       | 169                    |       | 8,109                 |       |
| Notes payable to  stockholders, current portion                                                                                                                                        |       | 56                     |       | 348                   |       |
| Income taxes payable                                                                                                                                                                   |       | —                 |       | 604                   |       |
| Other current  liabilities                                                                                                                                                             |       | 329                    |       | 370                   |       |
| Current liabilities of  discontinued operations                                                                                                                                        |       | —                 |       | 6,994                 |       |
| Total current  liabilities                                                                                                                                                             |       | 9,106                  |       | 29,547                |       |
|                                                                                                                                                                                   |       |                   |       |                  |       |
| Long-term debt                                                                                                                                                                         |       | 3,953                  |       | 2,938                 |       |
| Deferred income taxes                                                                                                                                                                  |       | 315                    |       | 144                   |       |
| Other liabilities                                                                                                                                                                      |       | 1,155                  |       | 688                   |       |
| Noncurrent liabilities  of discontinued operations                                                                                                                                     |       | —                 |       | 1,572                 |       |
| Total liabilities                                                                                                                                                                      |       | 14,529                 |       | 34,889                |       |
| Commitments and  contingencies                                                                                                                                                         |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                                                             |       |                   |       |                  |       |
| Preferred stock,$0.01  par value. Authorized 10,000,000 shares no shares issued and oustanding                                                                                         |       | —                 |       | —                |       |
| Common stock,$0.0033  par value. Authorized 150,000,000 shares; 10,630,739 and 10,213,214 issued  and outstanding at September 30, 2010 and December 31, 2009,  respectively |       | 128                    |       | 126                   |       |
| Additional paid-in  capital                                                                                                                                                            |       | 44,035                 |       | 43,480                |       |
| Accumulated deficit                                                                                                                                                                    |       | (29,440                | )          | (26,586               | )          |
| Accumulated other  comprehensive loss                                                                                                                                                  |       | (1,998                 | )          | (1,632                | )          |
| Total stockholders’ equity                                                                                                                                                        |       | 12,725                 |       | 15,388                |       |
| Total liabilities and  stockholders’ equity                                                                                                                                       |       | $                      | 27,254     |                  | $          | 50,277 |   |

 

*The accompanying Notes are an integral part of these CondensedConsolidated Financial Statements*

 

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Operations**

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

 
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                      | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                      | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Net Sales                                                                       |       | $                                | 7,790      |                            | $          | 9,260 |   | $ | 21,356 |   | $ | 25,970 |   |
| Cost of Sales                                                                   |       | 5,472                            |       | 6,109                           |       | 15,146 |   | 17,180 |   |
| Gross profit                                                                    |       | 2,318                            |       | 3,151                           |       | 6,210 |   | 8,790 |   |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Operating expenses:                                                             |       |                             |       |                            |       |   |   |   |   |
| Selling, general and  administrative                                            |       | 2,491                            |       | 3,257                           |       | 7,591 |   | 9,179 |   |
| Engineering and product  development                                            |       | 458                              |       | 435                             |       | 1,382 |   | 1,274 |   |
| Employee transaction  costs                                                     |       | 872                              |       | —                          |       | 872 |   | — |   |
| Total operating  expenses                                                       |       | 3,821                            |       | 3,692                           |       | 9,845 |   | 10,453 |   |
| Loss from operations                                                            |       | (1,503                           | )          | (541                            | )          | (3,635 | ) | (1,663 | ) |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Other income (expense):                                                         |       |                             |       |                            |       |   |   |   |   |
| Interest income                                                                 |       | 36                               |       | 18                              |       | 83 |   | 87 |   |
| Interest expense                                                                |       | (303                             | )          | (742                            | )          | (1,873 | ) | (3,066 | ) |
| Other, net                                                                      |       | (285                             | )          | (25                             | )          | 6 |   | 133 |   |
| Gain on extinguishment  of debt                                                 |       | 450                              |       | —                          |       | 450 |   | — |   |
| Total other expense, net                                                        |       | (102                             | )          | (749                            | )          | (1,334 | ) | (2,846 | ) |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Loss before income  taxes                                                       |       | (1,605                           | )          | (1,290                          | )          | (4,969 | ) | (4,509 | ) |
| Income tax provision  (benefit)                                                 |       | (208                             | )          | 215                             |       | (647 | ) | 490 |   |
| Loss from continuing  operations                                                |       | (1,397                           | )          | (1,505                          | )          | (4,322 | ) | (4,999 | ) |
| Discontinued  operations:                                                       |       |                             |       |                            |       |   |   |   |   |
| Income from  discontinued operations including gain (loss) on sale (see Note 3) |       | 338                              |       | (312                            | )          | 2,225 |   | 8,366 |   |
| Tax provision on  discontinued operations                                       |       | 48                               |       | —                          |       | 757 |   | 852 |   |
| income (loss) from  discontinued operations                                     |       | 290                              |       | (312                            | )          | 1,468 |   | 7,514 |   |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Net (loss) income                                                               |       | $                                | (1,107     | )                               | $          | (1,817 | ) | $ | (2,854 | ) | $ | 2,515 |   |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Weighted average shares  outstanding                                            |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                           |       | 10,319                           |       | 10,213                          |       | 10,256 |   | 10,213 |   |
| Diluted                                                                         |       | 10,319                           |       | 10,213                          |       | 10,256 |   | 10,213 |   |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Earnings (loss) per  share:                                                     |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                           |       |                             |       |                            |       |   |   |   |   |
| Continuing operations                                                           |       | $                                | (0.14      | )                               | $          | (0.15 | ) | $ | (0.42 | ) | $ | (0.49 | ) |
| Discontinued operations                                                         |       | $                                | 0.03       |                            | $          | (0.03 | ) | $ | 0.14 |   | $ | 0.74 |   |
| Net earnings (loss)                                                             |       | $                                | (0.11      | )                               | $          | (0.18 | ) | $ | (0.28 | ) | $ | 0.25 |   |
| Diluted                                                                         |       |                             |       |                            |       |   |   |   |   |
| Continuing operations                                                           |       | $                                | (0.14      | )                               | $          | (0.15 | ) | $ | (0.42 | ) | $ | (0.49 | ) |
| Discontinued operations                                                         |       | $                                | 0.03       |                            | $          | (0.03 | ) | $ | 0.14 |   | $ | 0.74 |   |
| Net earnings (loss)                                                             |       | $                                | (0.11      | )                               | $          | (0.18 | ) | $ | (0.28 | ) | $ | 0.25 |   |

 

*The accompanying Notes are an integral part of these CondensedConsolidated Financial Statements*

 

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Stockholders’Equity**

(Unaudited) ****(in thousands)

* *
| ** **                          | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|-------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                          | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **        | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                          | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                          | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**       | ** ** | **Loss**        | ** ** | **Total**  | ** ** |
|                                |       |                  |       |        |       |            |       |              |       |            |       |       |       |
| Balance at  December 31, 2009  |       | 10,213                |       | $           | 126        |            | $          | 43,480            |       | $               | (26,586    | )          | $          | (1,632 | ) | $ | 15,388 |   |
| Stock-based  compensation           |       | —                |       | —      |       | 107             |       | —            |       | —          |       | 107        |       |
| Stock issued to retire  debt        |       | 418                   |       | 2           |       | 448             |       | —            |       | —          |       | 450        |       |
| Net loss and  comprehensive loss    |       | —                |       | —      |       | —          |       | (2,854            | )          | (366            | )          | (3,220     | )          |
| Balance at  September 30, 2010 |       | 10,631                |       | $           | 128        |            | $          | 44,035            |       | $               | (29,440    | )          | $          | (1,998 | ) | $ | 12,725 |   |

 

*The accompanying Notes are an integral part of these CondensedConsolidated Financial Statements*

 

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Cash Flows**

(Unaudited)****(in thousands)

 
| ** **                                                                                                                   | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                   | ** ** | **September 30,**          | ** ** |
| ** **                                                                                                                   | ** ** | **2010**                        | ** ** | **2009** | ** ** |
|                                                                                                                         |       |                            |       |   |   |
| **CASH FLOWS  FROM OPERATING ACTIVITIES**                                                                                    | ** ** | ** **                      | ** ** |   | ** ** |
| Net Income (loss)                                                                                                            |       | $                               | (2,854     | ) | $ | 2,515 |   |
| Adjustments to arrive  at net loss from continuing operations                                                                |       | (1,468                          | )          | (7,514 | ) |
| Net loss from  continuing operations                                                                                         |       | (4,322                          | )          | (4,999 | ) |
| Reconciliation to net  cash provided by operating activities:                                                                |       |                            |       |   |   |
| Depreciation and  amortization                                                                                               |       | 341                             |       | 414 |   |
| Provision for doubtful  accounts                                                                                             |       | 53                              |       | 28 |   |
| Provision for warranty  reserve                                                                                              |       | 38                              |       | (165 | ) |
| Deferred taxes                                                                                                               |       | 128                             |       | (62 | ) |
| Loss on sale of assets                                                                                                       |       | 14                              |       | — |   |
| Gain on extinguishment  of debt                                                                                              |       | (450                            | )          | — |   |
| Amortization of  deferred issuance costs                                                                                     |       | 316                             |       | 616 |   |
| Amortization of debt  discount                                                                                               |       | 290                             |       | 564 |   |
| Stock-based expense                                                                                                          |       | 107                             |       | 114 |   |
| Change in fair value of  common stock warrant                                                                                |       | 123                             |       | (369 | ) |
| Changes in assets and  liabilities:                                                                                          |       |                            |       |   |   |
| Accounts receivable                                                                                                          |       | 976                             |       | 2,043 |   |
| Inventories                                                                                                                  |       | 916                             |       | (109 | ) |
| Prepaid and other  assets                                                                                                    |       | (1,350                          | )          | (70 | ) |
| Accounts payable and  accrued expenses                                                                                       |       | 588                             |       | 36 |   |
| Operating cash flow  used in continuing operations                                                                           |       | (2,232                          | )          | (1,959 | ) |
| Operating cash flow  provided by discontinued operations                                                                     |       | 568                             |       | 3,020 |   |
| Net cash (used in)  provided by operating activities                                                                         |       | (1,664                          | )          | 1,061 |   |
|                                                                                                                         |       |                            |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                                                   |       |                            |       |   |   |
| Purchases of property,  plant and equipment                                                                                  |       | (33                             | )          | (7 | ) |
| Investing cash flow  used in continuing operations                                                                           |       | (33                             | )          | (7 | ) |
| Investing cash flow  provided by discontinued operations including proceeds from sale of  subsidiary operations, net of cash |       | 17,749                          |       | 10,213 |   |
| Net cash provided by  investing activities                                                                                   |       | 17,716                          |       | 10,206 |   |
|                                                                                                                         |       |                            |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                                                   |       |                            |       |   |   |
| Borrowings from lines  of credit                                                                                             |       | 28,888                          |       | 42,301 |   |
| Repayments of lines of  credit                                                                                               |       | (34,044                         | )          | (42,353 | ) |
| Repayments of long-term  debt                                                                                                |       | (8,427                          | )          | (10,675 | ) |
| Payments of notes to  stockholders                                                                                           |       | (292                            | )          | (418 | ) |
| Proceeds from exercise  of stock options and warrants                                                                        |       | —                          |       | 7 |   |
| Financing cash flow  used in continuing operations                                                                           |       | (13,875                         | )          | (11,138 | ) |
| Financing cash flow  used in discontinued operations                                                                         |       | (107                            | )          | (149 | ) |
| Net cash used in  financing activities                                                                                       |       | (13,982                         | )          | (11,287 | ) |
|                                                                                                                         |       |                            |       |   |   |
| Effect of exchange rate  changes on cash                                                                                     |       | (266                            | )          | 775 |   |
| Net increase in cash  and cash equivalents                                                                                   |       | 1,804                           |       | 755 |   |
| Cash and cash  equivalents at beginning of period                                                                            |       | 3,994                           |       | 3,001 |   |
| Cash and cash  equivalents at end of period                                                                                  |       | $                               | 5,798      |   | $ | 3,756 |   |

* *

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

 

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**EMRISE CORPORATION**

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

(Unaudited)****(in thousands)

 
| **SUPPLEMENTAL  DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:**                                                             |   |   |   |   |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|
| Acquisition of  equipment through capital lease                                                                                           |   | $      | 112    |   | $      | 52 |   |
| Cumulative effect of  change in accounting principle - reclassification of common stock warrants to  liability upon adoption of EITF 07-5 |   | $      | — |   | $      | 473 |   |
| Issuance of notes  relating to ACC purchase adjustment                                                                                    |   | $      | — |   | $      | 3,116 |   |
| Stock issued to retire  debt                                                                                                              |   | $      | 450    |   | $      | — |   |

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 1 — SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

*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 (the “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 England. The subsidiaries within the communications equipment segmentdesign, develop, manufacture and market network access equipment, includingnetwork timing and synchronization products and operate out of facilitieslocated in the U.S. and France.

 

*Basis of Presentation*

 

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with the rules and regulations of the U.S. Securities andExchange Commission (the “SEC”) and therefore do not include all informationand footnotes 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 September 30, 2010and the results of operations and cash flows for the related interim periodsended September 30, 2010 and 2009. However, these results are notnecessarily indicative of results for any other interim period or for the year.The accompanying unaudited condensed consolidated financial statements shouldbe read in conjunction with the Company’s audited consolidated financialstatements included in its annual report on Form 10-K and Form 10-K/Afor the year ended December 31, 2009 as filed with the SEC and the Company’srestated Form 10-K, Part II, Item 8 as of December 31, 2009as filed with the SEC as an exhibit to Form 8-K on July 7, 2010.

 

InMarch of 2009, the Company sold substantially all of the assets related tothe Digitran division of the Company’s wholly-owned subsidiary, EMRISEElectronics Corporation’s (“EEC”), and all of the issued and outstanding equityinterests of EEC’s wholly-owned subsidiary, XCEL Japan, Ltd. (collectivelythe “Digitran Operations”).  The accompanying financialstatements include the Digitran Operations as a discontinued operation for allperiods presented.

 

In March of 2010,EMRISE completed the sale of substantially all of the assets of EEC’ssubsidiary, RO Associates, to Massachusetts based Astrodyne Corporation.  In this Quarterly Report on Form 10-Q,we refer to the businesses of RO Associates as the “RO Operations” or “RO,” andwe refer to the sale of the RO Associates’ assets as the “RO Transaction.”  The accompanying financial statements includethe RO Operations as a discontinued operation for all periods presented.

 

On August 31, 2010,EMRISE completed the sale of all of the issued and outstanding shares of commonstock of EEC’s subsidiary, Advanced Control Components, Inc. (“ACC”) andall of the issued and outstanding shares of common stock of Custom Components, Inc.(“CCI”) (collectively the “ACC Operations”). The accompanying financial statements include the ACC Operations as adiscontinued operation for all periods presented.

 

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Table of Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Comprehensive (Loss) Income*

 

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

 
| ** **                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                               | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                     |       |                             |       |                            |       |   |   |   |   |
| Net (loss) income                        |       | $                                | (1,107     | )                               | $          | (1,817 | ) | $ | (2,854 | ) | $ | 2,515 |   |
| Other comprehensive  income (loss):      |       |                             |       |                            |       |   |   |   |   |
| Foreign currency  translation adjustment |       | 665                              |       | (113                            | )          | (366 | ) | 1,260 |   |
| Comprehensive (loss)  income             |       | $                                | (442       | )                               | $          | (1,930 | ) | $ | (3,220 | ) | $ | 3,775 |   |

* *

*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 that identifythe type and quantity of the item and/or services being purchased and thepurchase price.  The Company recognizesrevenues when shipment of products has occurred or services have been rendered,no significant obligations remain on the part of the Company, andcollectability is reasonably assured based on the Company’s credit andcollections practices and policies.

 

TheCompany recognizes revenues from its U.S. communications equipment businessunit 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 becausesales are final and the Company tests its products for quality prior to shipmentto ensure products meet the specifications of the binding purchase orders underwhich those products are shipped. Normally, when a customer requests andreceives authorization to return a product, the request is accompanied by apurchase order for a repair or for a replacement product.

 

Revenuerecognition for products and services provided by the Company’s 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 to severalyears, with revenue deferred until each milestone defined in the contract isreached.  Production contracts providefor a specific quantity of products to be produced over a specific period oftime.  Customers issue binding purchaseorders or enter into binding agreements for the products to be produced.  The Company recognizes revenues on theseorders as the products are shipped. Returns are infrequent and permitted only with prior 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.

 

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.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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.

 

*Loss Per Share from ContinuingOperations*

* *

Basic loss per share from continuing operations iscomputed by dividing net loss from continuing operations by the weightedaverage common shares outstanding during a period.  Diluted loss per share from continuingoperations is based on the treasury stock method and includes the dilutiveeffect of stock options and warrants outstanding during the period.  Common share equivalents have been excludedwhere their inclusion would be anti-dilutive. As a result of the losses from continuing operations incurred by theCompany for the periods ended September 30, 2010 and 2009, the potentiallydilutive common shares have been excluded from the loss per share computationbecause their inclusion would have been anti-dilutive.  The following table illustrates thecomputation of basic and diluted loss per share from continuing operations (inthousands, except per share amounts):

* *
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                   | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                   | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                         |       |                             |       |                            |       |   |   |   |   |
| NUMERATOR:                                                   | ** ** | ** **                       | ** ** | ** **                      |       |   |   |   |   |
| Net (loss) income                                            |       | $                                | (1,107     | )                               | $          | (1,817 | ) | $ | (2,854 | ) | $ | 2,515 |   |
| Less: Net (loss) income  from discontinued operations        |       | 290                              |       | (312                            | )          | 1,468 |   | 7,514 |   |
| Net loss from  continuing operations                         |       | $                                | (1,397     | )                               | $          | (1,505 | ) | $ | (4,322 | ) | $ | (4,999 | ) |
|                                                         |       |                             |       |                            |       |   |   |   |   |
| DENOMINATOR:                                                 |       |                             |       |                            |       |   |   |   |   |
| Basic weighted average  common shares outstanding            |       | 10,319                           |       | 10,213                          |       | 10,256 |   | 10,213 |   |
| Diluted weighted  average common shares outstanding          |       | 10,319                           |       | 10,213                          |       | 10,256 |   | 10,213 |   |
|                                                         |       |                             |       |                            |       |   |   |   |   |
| Basic and diluted loss  per share from continuing operations |       | $                                | (0.14      | )                               | $          | (0.15 | ) | $ | (0.42 | ) | $ | (0.49 | ) |

 

The following table showsthe common stock equivalents that were outstanding as of September 30,2010 and 2009, but were not included in the computation of diluted earnings pershare because the options’ or warrants’ exercise price was greater than theaverage market price of the common shares and, therefore, the effect would havebeen anti-dilutive:

 
| ** **                            | ** ** | ** **         | ** ** | **Range of**       | ** ** |
|---------------------------------------|------------|--------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **Number of** | ** ** | **Exercise Price** | ** ** |
| ** **                            | ** ** | **Shares**         | ** ** | **Per Share**      | ** ** |
|                                  |       |               |       |                    |       |
| Anti-dilutive common  stock options:  |       |               |       |                    |       |
| As of  September 30, 2010        |       | 647,423            |       | $1.31 — $7.50      |       |
| As of  September 30, 2009        |       | 637,625            |       | $1.53 — $7.50      |       |
|                                  |       |               |       |                    |       |
| Anti-dilutive common  stock warrants: |       |               |       |                    |       |
| As of  September 30, 2010        |       | 8,334              |       | $4.31 — $4.31      |       |
| As of  September 30, 2009        |       | 1,791,079          |       | $1.80 — $6.49      |       |

 

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** **

**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*RecentAccounting Pronouncements*

 

**Adopted**

 

None.

 

**Issued,but not adopted**

 

**Revenue Recognition**. In October 2009, the FASB issued an update to existing guidance onrevenue recognition for arrangements with multiple deliverables.  This update will allow companies to allocateconsideration received for qualified separate deliverables using estimatedselling prices for both delivered and undelivered items when vendor-specificobjective evidence or third-party evidence is unavailable.  Additional disclosures discussing the natureof multiple element arrangements, the types of deliverables under thearrangements, the general timing of their delivery, and significant factors andestimates used to determine estimated selling prices are required.  The Company will adopt this update for newrevenue arrangements entered into or materially modified beginning January 1,2011.  The Company does not expect theadoption of this new revenue recognition guidance to have a material effect onits condensed consolidated financial statements.

 

**NOTE 2 —LIQUIDITY**

 

The Company reported a net loss from continuingoperations for the three and nine months ended September 30, 2010 of $1.4million and $4.3 million, respectively (including non-recurring employee andother transaction costs related to transaction activities of $1.2 million and$1.4 million for the three and nine months ended September 30, 2010,respectively).  The Company also reportednegative working capital from continuing operations of $3.5 million at December 31,2009.  As a result of the ACC Transactionand the resulting repayment of debt (see Note 11), the Company reportedpositive working capital from continuing operations of $10.8 million at September 30,2010.  In combination with the proceedsreceived from the sale of the ACC Operations and the cash flow from operations,the Company believes it has sufficient funding to support its working capitalrequirements during the next 12 months.  The Company is still evaluating the funding requirements tosupport its business plan beyond 12 months.

 

The ability of the Company to support its businessplan is dependent upon its ability to achieveprofitable operations, manage costs and satisfy long-term debt serviceobligations, which will begin in the first quarter of 2012. Management believesthe Company will be able to achieve profitability, manage costs and satisfy itsdebt service obligations.  However, if itis unable to do so, the Company may be required to sell additional assets orstock, complete a recapitalization, or consummate a merger transaction in orderto continue operations.

 

Ifthe Company’s net losses from operations continue, it will likely experiencenegative cash flow and if the Company is not able to attain, sustain orincrease profitability on a quarterly or annual basis, it may not be able tocontinue operations.

 

Toaddress these potential financing needs, the Company may need to explore arevised debt structure with its existing Lenders; additional or new financingwith another lender or lenders; expedite the sale of additional assets togenerate cash; complete a recapitalization of the Company, or consummate amerger or other transaction. Successfully executing these strategies is uncertain and there are manyrisks associated with attempting to execute each, in addition to the risks anduncertainties of the short and long term impact of executing any of thesestrategies.   Failure to meet theCompany’s financing requirements, if and when needed, would have an adverseeffect on the Company’s operations and/or ability to do business after thatdate or could restrict its growth, limit the development of new products,hinder its ability to fulfill existing or future orders or negatively affectits ability to secure new customers or product orders.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 3 —DISCONTINUED OPERATIONS**

 

*DigitranOperations*

 

OnMarch 20, 2009, the Company and EEC entered into an Asset and StockPurchase Agreement (the “Digitran Purchase Agreement”) with Electro SwitchCorp., a Delaware corporation (the “Buyer”) and ESC Worldwide, Inc., aMassachusetts corporation and subsidiary of Buyer (the “Stock Buyer”).  Atthe closing of the transaction pursuant to the Digitran Purchase Agreement onMarch 20, 2009, (i) the Buyer purchased from the Company and EECsubstantially all of the assets related to EEC’s Digitran division, and(ii) the Stock Buyer purchased from EEC all of the issued and outstandingequity interests of its wholly-owned subsidiary, XCEL Japan, Ltd., for anaggregate purchase price of approximately $11,560,000 (the “Disposition”). Under the terms of the Digitran Purchase Agreement, the Buyer wasobligated to pay an additional $0.4 million in cash to EEC that was contingentupon net sales for the fiscal year ending December 31, 2009 related to thebusinesses that were sold pursuant to the Digitran Purchase Agreement exceeding$6,835,120.

 

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

 

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

 

TheCompany has classified the Digitran Operations, which was a component of itselectronic devices segment, as a discontinued operation in the accompanyingconsolidated financial statements for all periods presented.

 

*ROOperations*

 

OnMarch 22, 2010, EEC, a wholly-owned subsidiary of the Company, enteredinto and consummated the closing under an asset purchase agreement by and amongAstrodyne Corporation (“Astrodyne”), RO, and EEC dated March 22, 2010 (the“RO Purchase Agreement”) pursuant to which Astrodyne purchased substantiallyall of the assets, properties, and business as a going concern of RO.  The assets of RO that were sold andtransferred to Astrodyne include, but are not limited to, the following:  (i) machinery and equipment; (ii) rawmaterials, work-in-process, and finished goods relating to RO; (iii) tangiblepersonal property, such as office furniture and equipment; (iv) advancepayments, rental deposits, and other similar assets; (v) rights topayments from customers; (vi) books and records; (vii) rights undercertain contracts; (viii) intangible rights and property, such as goodwilland rights in and to the name “RO Associates,” product names, trade names,trademarks, fictitious names and service marks; (ix) information and data;(x) unfilled purchase and sale orders; (xi) governmentalauthorizations relating to RO’s business and pending applications in connectionwith such authorizations; (xii) RO’s rights to its business ofmanufacturing and selling standard, high-density AC to DC, and DC to DCconverters (the “Business”); and (xiii) all claims, causes of action, andjudgments relating to the Business.  Suchsale and transfer was deemed to be a disposition of an insignificant amount ofassets by the Company and EEC.  

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

ROretained certain rights, as fully described in the RO Purchase Agreement,including certain records, rights to benefits plans and insurance policies andproceeds, and certain assets.

 

Aspart of the transactions contemplated by the RO Purchase Agreement, Astrodyneassumed certain specified liabilities of RO pursuant to an Assignment andAssumption Agreement by and between Astrodyne and RO (the “Assignment andAssumption Agreement”).  Pursuant to theRO Purchase Agreement, EEC also agreed to guarantee the full, complete, andtimely compliance with and performance of all agreements, covenants andobligations of RO in connection with the RO Transaction.

 

Astrodynepaid RO an aggregate purchase price for the RO Transaction of $1,000,000, plusthe assumption of certain liabilities pursuant to the Assignment and AssumptionAgreement, subject to a purchase price adjustment.  As additional consideration for Astrodyne’sentry into the RO Purchase Agreement and consummation of the contemplatedtransactions under such agreement, EEC and RO agreed that, for a certain periodimmediately following the closing date, they would not compete with theBusiness, perform services for any person in competition with the Business orsolicit certain specified customers of the Business, or hire any employees ofAstrodyne or its affiliates.

 

Inconnection with the Company’s divestiture of RO, which comprised a portion ofthe Company’s electronic devices segment, the Company incurred approximately$0.4 million in charges relating to legal, accounting and investment bankingfees.  The Company does not expect toincur any additional costs associated with this transaction.  The Company incurred a loss on the sale ofthe RO assets of approximately $0.5 million.

 

TheCompany has classified RO, which is a component of its electronic devicessegment, as discontinued operations in the accompanying consolidated financialstatements for all periods presented.

 

*ACCOperations*

 

OnJune 7, 2010, EEC, a wholly-owned subsidiary of the Company, entered intoa Stock Purchase Agreement by and among Aeroflex Incorporated, as buyer, andEEC, as seller, relating to the sale of all of the issued and outstandingshares of common stock of ACC and all of the issued and outstanding shares ofcommon stock of CCI (the “ACC Purchase Agreement”), which was subsequentlyassigned by Aeroflex Incorporated to its subsidiary, Aeroflex/KDI, Inc. (“Aeroflex”).

 

OnAugust 31, 2010, EEC completed its previously announced sale to Aeroflexof all of the issued and outstanding shares of ACC and all of the issued andoutstanding shares of common stock of CCI (the “ACC Transaction”) pursuant tothe Purchase Agreement.

 

The ACC Transactionconsisted of an aggregate purchase price of $20 million in cash (the “PurchasePrice”).  An amount equal to $0.8 millionwas placed in a 12-month escrow account pursuant to an agreement betweenAeroflex and EEC to satisfy any indemnification claims.  Following the 12-month escrow period, anyunused funds in the account will be returned to the Company.  In addition, the following amounts weresatisfied out of the Purchase Price:  (i) $10.6million to the Company’s senior lender, representing the aggregate amount ofthe indebtedness owed by EEC to the senior lender, which was satisfied bypayment of $9.6 million in cash and by delivering a two-year, interest bearingnote in the amount of $1 million described herein, and (ii) $3.1 millionin cash and a $2.8 million, three-year, interest bearing note, both insatisfaction of the deferred purchase price and contingent payments owed by EECto certain of ACC’s previous shareholders, Charles S. Brand, Thomas P.M.Couse, Joanne Couse and Michael Gaffney (collectively, the “Former Shareholders”),as further described in Note 10.  ThePurchase Price was also adjusted by $0.8 million based on the estimated levelof adjusted net working capital of ACC at the closing of the Transaction, subjectto final determination pursuant to the procedures set forth in the PurchaseAgreement.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Inconnection with the ACC Transaction, the Company incurred approximately $1.4million in closing costs including legal, accounting and investment advisoryfees.  The Company does not expect toincur any additional costs associated with this transaction with the exceptionof any adjustment to working capital as mentioned above.  The Company incurred a loss on the ACCTransaction of approximately $0.3 million.

 

TheCompany has classified the ACC Operations, which was a component of itselectronic devices segment, as discontinued operations in the accompanyingunaudited consolidated financial statements for all periods presented.

 

TheACC Operations was a substantial portion of the Company’s assets in theelectronic devices segment.  These assetscontributed approximately $20 million or 37% of the Company’s net sales andapproximately $3 million of the Company’s total operating income fromcontinuing operations of $1.4 million for 2009.

 

Thefollowing table summarizes those components of the statements of operations fordiscontinued, which are associated with the electronic devices segment, for thethree months ended September 30, 2010 and 2009 (in thousands, except pershare amounts):

 
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **September 30, 2010** | ** ** | **September 30, 2009** | ** ** |
| ** **                           | ** ** | **RO**                           | ** ** | **ACC**                          | ** ** | ** ** | ** ** | **Digitran** | ** ** | **RO** | ** ** | **ACC** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **Operations**                   | ** ** | **Operations**                   | ** ** | **Total** | ** ** | **Operations** | ** ** | **Operations** | ** ** | **Operations** | ** ** | **Total** | ** ** |
|                                 |       |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Net Sales                            |       | $                                | —     |                             | $          | 2,848 |   | $ | 2,848 |   | $ | — |   | $ | 617 |   | $ | 4,442 |   | $ | 5,059 |   |
|                                 |       |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from operations        |       | $                                | 8          |                             | $          | 762 |   | $ | 770 |   | $ | — |   | $ | (781 | ) | $ | 699 |   | $ | (82 | ) |
|                                 |       |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Other income (expense)               |       | —                           |       | (69                              | )          | (69 | ) | — |   | — |   | (50 | ) | (50 | ) |
| Loss on sale                         |       | (45                              | )          | (318                             | )          | (363 | ) | (132 | ) | — |   | — |   | (132 | ) |
| Provision for income taxes           |       | —                           |       | 48                               |       | 48 |   | — |   | — |   | 48 |   | 48 |   |
| Net (loss) income                    |       | $                                | (37        | )                                | $          | 327 |   | $ | 290 |   | $ | (132 | ) | $ | (781 | ) | $ | 601 |   | $ | (312 | ) |
|                                 |       |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| (Loss) earnings per share:           |       |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Basic                                |       | $                                | (0.00      | )                                | $          | 0.03 |   | $ | 0.03 |   | $ | (0.01 | ) | $ | (0.08 | ) | $ | 0.06 |   | $ | (0.03 | ) |
| Diluted                              |       | $                                | (0.00      | )                                | $          | 0.03 |   | $ | 0.03 |   | $ | (0.01 | ) | $ | (0.08 | ) | $ | 0.06 |   | $ | (0.03 | ) |
|                                 |       |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Weighted average shares outstanding: |       |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Basic                                |       | 10,319                           |       | 10,319                           |       | 10,319 |   | 10,213 |   | 10,213 |   | 10,213 |   | 10,213 |   |
| Diluted                              |       | 10,319                           |       | 10,319                           |       | 10,319 |   | 10,213 |   | 10,213 |   | 10,213 |   | 10,213 |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The following table summarizes those components ofthe statements of operations for discontinued, which are associated with theelectronic devices segment, for the nine months ended September 30, 2010and 2009 (in thousands, except per share amounts): 

 
| ** **                           | ** ** | **Nine Months Ended**  | ** ** | **Nine Months Ended**  | ** ** |
|--------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **September 30, 2010** | ** ** | **September 30, 2009** | ** ** |
| ** **                           | ** ** | **RO**                           | ** ** | **ACC**                          | ** ** | ** ** | ** ** | **Digitran** | ** ** | **RO** | ** ** | **ACC** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **Operations**                   | ** ** | **Operations**                   | ** ** | **Total** | ** ** | **Operations** | ** ** | **Operations** | ** ** | **Operations** | ** ** | **Total** | ** ** |
|                                 |       |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Net Sales                            |       | $                                | 442        |                             | $          | 13,546 |   | $ | 13,988 |   | $ | 1,478 |   | $ | 1,934 |   | $ | 14,898 |   | $ | 18,310 |   |
|                                 |       |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from operations        |       | $                                | 190        |                             | $          | 3,129 |   | $ | 3,319 |   | $ | 178 |   | $ | (1,435 | ) | $ | 2,758 |   | $ | 1,501 |   |
|                                 |       |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Other income (expense)               |       | 1                                |       | (281                             | )          | (280 | ) | — |   | 9 |   | (123 | ) | (114 | ) |
| (Loss) gain on sale                  |       | (496                             | )          | (318                             | )          | (814 | ) | 6,978 |   | — |   | — |   | 6,978 |   |
| Provision for income taxes           |       | —                           |       | 757                              |       | 757 |   | 707 |   | — |   | 145 |   | 852 |   |
| Net (loss) income                    |       | $                                | (305       | )                                | $          | 1,773 |   | $ | 1,468 |   | $ | 6,449 |   | $ | (1,426 | ) | $ | 2,490 |   | $ | 7,513 |   |
|                                 |       |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| (Loss) earnings per share:           |       |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Basic                                |       | $                                | (0.03      | )                                | $          | 0.17 |   | $ | 0.14 |   | $ | 0.63 |   | $ | (0.14 | ) | $ | 0.24 |   | $ | 0.74 |   |
| Diluted                              |       | $                                | (0.03      | )                                | $          | 0.17 |   | $ | 0.14 |   | $ | 0.63 |   | $ | (0.14 | ) | $ | 0.24 |   | $ | 0.74 |   |
|                                 |       |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Weighted average shares outstanding: |       |                             |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Basic                                |       | 10,256                           |       | 10,256                           |       | 10,256 |   | 10,213 |   | 10,213 |   | 10,213 |   | 10,213 |   |
| Diluted                              |       | 10,256                           |       | 10,256                           |       | 10,256 |   | 10,213 |   | 10,213 |   | 10,213 |   | 10,213 |   |

 

Thefollowing table reflects the major classes of assets and liabilities fordiscontinued operations as of December 31, 2009 (in thousands): 

 

| ** **                                 | ** ** | **RO** | ** ** | **ACC** | ** ** | **Total** | ** ** |
|--------------------------------------------|------------|--------|------------|---------|------------|-----------|------------|
| Cash and cash equivalents                  |       | $      | (24        | )       | $          | 52        |       | $ | 28 |   |
| Accounts receivable, net                   |       | 431    |       | 2,189   |       | 2,620     |       |
| Inventory, net                             |       | 1,058  |       | 2,495   |       | 3,553     |       |
| Prepaids and other current assets          |       | 31     |       | 136     |       | 167       |       |
| Total current assets                       |       | 1,496  |       | 4,872   |       | 6,368     |       |
|                                       |       |   |       |    |       |      |       |
| Property, plant and equipment, net         |       | — |       | 1,326   |       | 1,326     |       |
| Goodwill                                   |       | — |       | 12,755  |       | 12,755    |       |
| Intangible assets other than goodwill, net |       | — |       | 3,774   |       | 3,774     |       |
| Other noncurrent assets                    |       | — |       | 1,570   |       | 1,570     |       |
| Total assets                               |       | $      | 1,496      |    | $          | 24,297    |       | $ | 25,793 |   |
|                                       |       |   |       |    |       |      |       |
| Total current liabilities                  |       | $      | 745        |    | $          | 6,249     |       | 6,994 |   |
|                                       |       |   |       |    |       |      |       |
| Total long-term liabilities                |       | $      | —     |    | $          | 1,572     |       | 1,572 |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 4 —STOCK-BASED COMPENSATION**

 

TheCompany has the following five stock option plans, which are described morefully in the Company’s Annual Report on Form 10-K for the year ending December 31,2009:

 

·                  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 Company’s board ofdirectors does not intend to issue any additional options under the EmployeeStock and Stock Option Plan, 1993 Stock Option Plan, 1997 Stock Incentive Planor Amended and Restated 2000 Stock Option Plan.

 

Total stock-basedcompensation expense included in wages, salaries and related costs was $34,000and $36,000 for the three months ended September 30, 2010 and 2009,respectively, and $107,000 and $114,000 for the nine months ended September 30,2010 and 2009, respectively. These compensation expenses were charged toselling, general and administrative expenses. As of September 30, 2010,the Company had $128,000 of total unrecognized compensation expense related tostock option grants, which will be recognized over the remaining weightedaverage period of two years.

 

**NOTE 5 —INVENTORIES**

 

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

 
| ** **        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|------------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2010**               | ** ** | **2009**              | ** ** |
|              |       |                   |       |                  |       |
| Raw materials     |       | $                      | 2,909      |                  | $          | 3,791 |   |
| Work-in-process   |       | 1,760                  |       | 1,792                 |       |
| Finished goods    |       | 2,447                  |       | 2,448                 |       |
| Total inventories |       | $                      | 7,116      |                  | $          | 8,031 |   |

 

**NOTE 6 —OPERATING SEGMENTS**

 

The Company has tworeportable operating segments: electronic devices and communications equipment.The electronic devices segment manufactures and markets electronic powersupplies, RF and microwave devices and subsystem assemblies. The electronicdevices segment consists of the Company’s two electronic device subsidiarieslocated in England, both of which offer the same or similar products to thesame or similar customers.  Thecommunications equipment segment designs, manufactures and distributes networkaccess products and timing and synchronization products.  The communications equipment segment consistsof operating entities CXR Larus Corporation (“CXR Larus”), which is located inthe U.S., and CXR Anderson Jacobson (“CXR AJ”), which is located in France,both of which offer the same or similar products to similar customers.  Both segments operate primarily in the U.S.and European markets, but they have distinctly different customers, design andmanufacturing processes and marketing strategies.  Each segment has discrete financialinformation and a separate management structure.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The Company evaluatesperformance based upon contribution margin of the segments and also upon profitor loss from operations before income taxes exclusive of nonrecurring gains andlosses. The Company accounts for intersegment sales at pre-determined pricesnegotiated between the individual segments.

 

During the firstquarter of 2009, the Company sold its Digitran Operations, during the firstquarter of 2010, the Company sold its RO Operations and during the thirdquarter of 2010, the Company sold its ACC Operations (see Note 3), all of whichwere part of its electronic devices segment. These transactions resulted in differences in the basis of segmentationfrom the amounts disclosed in the Company’s unaudited condensed consolidatedfinancial statements included in its quarterly report on Form 10-Q for thethree and nine months ended September 30, 2010 and 2009.  In this report, the Digitran Operations, ROOperations and ACC Operations are reported as discontinued operations and areexcluded from the electronics devices segment. Therefore, prior period amounts have been adjusted to conform to thispresentation.

 

Selected financialdata for each of the Company’s operating segments reconciled to theconsolidated totals is shown below (in thousands):

 
| ** **                                 | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                 | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                 | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
| Net sales                                  |       |                             | ** ** | ** **                      |       |   |   |   |   |
| Electronic devices                         |       | $                                | 4,285      |                            | $          | 5,928 |   | $ | 12,680 |   | $ | 17,399 |   |
| Communications  equipment                  |       | 3,505                            |       | 3,332                           |       | 8,676 |   | 8,571 |   |
| Net sales from  continuing operations      |       | 7,790                            |       | 9,260                           |       | 21,356 |   | 25,970 |   |
| Discontinued operations                    |       | 2,848                            |       | 5,059                           |       | 13,988 |   | 16,832 |   |
| Total net sales                            |       | $                                | 10,638     |                            | $          | 14,319 |   | $ | 35,344 |   | $ | 42,802 |   |
|                                       |       |                             |       |                            |       |   |   |   |   |
| Operating loss                             |       |                             |       |                            |       |   |   |   |   |
| Electronic devices                         |       | $                                | 301        |                            | $          | 895 |   | $ | 988 |   | $ | 3,061 |   |
| Communications  equipment                  |       | 149                              |       | (307                            | )          | (542 | ) | (1,225 | ) |
| Corporate and other                        |       | (1,953                           | )          | (1,129                          | )          | (4,081 | ) | (3,499 | ) |
| Operating loss from  continuing operations |       | (1,503                           | )          | (541                            | )          | (3,635 | ) | (1,663 | ) |
| Discontinued operations                    |       | 770                              |       | (82                             | )          | 3,319 |   | 1,324 |   |
| Total operating loss                       |       | $                                | (733       | )                               | $          | (623 | ) | $ | (316 | ) | $ | (339 | ) |

 
| ** **                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |   |   |   |   |
|------------------------------------------|------------|------------------------|------------|-----------------------|------------|--------|--------|--------|--------|
| ** **                               | ** ** | **2010**               | ** ** | **2009**              | ** ** |   |   |   |   |
| Total assets                             | ** ** | ** **             | ** ** |                  | ** ** |   |   |   |   |
| Electronic devices                       |       | $                      | 14,894     |                  | $          | 12,273 |   |   |   |   |   |
| Communications  equipment                |       | 8,060                  |       | 8,439                 |       |   |   |   |   |
| Corporate and other                      |       | 4,300                  |       | 3,772                 |       |   |   |   |   |
| Total assets from  continuing operations |       | 27,254                 |       | 24,484                |       |   |   |   |   |
| Discontinued operations                  |       | —                 |       | 25,793                |       |   |   |   |   |
| Total assets                             |       | $                      | 27,254     |                  | $          | 50,277 |   |   |   |   |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 7— GOODWILL**

 

Thefollowing table reflects changes in our goodwill balances, by segment, for thenine months ended September 30, 2010 (in thousands):

 
| ** **                                       | ** ** | **Electronic** | ** ** | **Communications** | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|----------------|------------|--------------------|------------|------------|------------|
| ** **                                       | ** ** | **Devices**    | ** ** | **Equipment**      | ** ** | **Total**  | ** ** |
|                                             |       |           |       |               |       |       |       |
| Balance at  December 31, 2009               |       | $              | 2,878      |               | $          | —     |       | $ | 2,878 |   |
| Allocation of goodwill  to continuing operations |       | 1,934          |       | —             |       | 1,934      |       |
| Foreign currency  translation                    |       | 123            |       | —             |       | 123        |       |
| Balance at  September 30, 2010              |       | $              | 4,935      |               | $          | —     |       | $ | 4,935 |   |

 

The increase in goodwillduring the nine months ended September 30, 2010 was the result of theCompany completing the sale of the ACC Operations, which allowed it to place afinal fair value on that business unit. As a result, in accordance with FASBguidance, the Company adjusted its allocation of goodwill at September 30,2010 between continuing operations and discontinued operations resulting in anadditional $1.9 million allocated to the portion of the electronic devicesreporting unit remaining in continuing operations.

 

**NOTE 8 — INCOME TAXES**

 

The effective taxrate for the nine month period ended September 30, 2010 was different thanthe 34% U.S. statutory rate primarily because the Company’s foreign entitiesgenerate a tax obligation and related tax expense as a result of their netincome, which cannot be offset by U.S. tax loss carryforwards.

 

The Company’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 Agreement described in Notes 9 and 10, the foreignsubsidiaries have issued guarantees on the Credit Agreement and, as a result,under IRC §956, have been deemed to have distributed these earnings to fundU.S. operations.  This has resulted inU.S. federal taxable income and an increase in U.S. tax liability, which hasbeen reduced through utilization of available net operating loss carryforwardsand foreign tax credits.  However, 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 in taxobligations.

 

The Company adopted FASBguidance for accounting for uncertainty in income taxes on January 1,2007. The implementation of this guidance did not result in a materialadjustment to the Company’s liability for unrecognized income tax benefits. Atthe time of adoption and as of September 30, 2010, the Company hadrecorded no net unrecognized tax benefits. The Company currently has no open matters with tax authorities nor is itengaged in an examination by any tax authority. The Company recognizes interest and penalties related to uncertain taxpositions in interest expense and selling, general and administrative expense, respectively,in the condensed consolidated statements of operations and comprehensiveincome. No interest or penalties were recognized during the first nine monthsof 2010. As of September 30, 2010, the Company had nothing accrued forinterest and penalties.

 

The Company files incometax returns in the United States federal jurisdiction, the United Kingdom andFrance, and in the state jurisdictions of California, Texas, Pennsylvania andNew Jersey. The Company is no longer subject to United States federal and statetax examinations for years before 2006 and 2005, respectively, and is no longersubject to tax examinations for the United Kingdom and Japan for years prior to2008, and for France for years prior to 2006.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 9 — LINES OF CREDIT**

 

TheCompany and certain of its subsidiaries, including EEC and CXR Larus, CCI, ACCand EMRISE Power Systems, Incorporated (collectively, the “Borrowers”),were parties to a Credit Agreement (as amended from time to time, the “CreditAgreement”) with GVEC Resource IV Inc., an affiliate of Private EquityManagement Group LLC (“PEM Group”) (the “Lender”) providing for a CreditAgreement which included term loans and a revolving credit facility and wassecured by accounts receivable, other rights to payment and generalintangibles, inventories and equipment. The Credit Agreement included arevolving credit facility for up to $7 million, which expired onAugust 31, 2010 (the “Revolver”).

 

Theclosing of the ACC Transaction satisfied the Company’s obligations to theLender under the Credit Agreement, as EEC and the Company used a portion of thenet proceeds from the ACC Transaction to pay the obligations to the Lenderpursuant to the ACC Purchase Agreement. The entire outstanding principal balance of the Revolver was paid infull on August 31, 2010.  There areno outstanding borrowings on the Revolver as of September 31, 2010 and nofurther borrowings are available under the amended Credit Agreement.

 

On August 31, 2010, two of the Company’sUK subsidiaries, Pascall Electronics Limited (“Pascall”) and XCEL PowerSystems, Ltd. (“XCEL”), each entered into a Receivables Finance Agreementwith LloydsTSB Commercial Finance (“Lloyds”) (each, a “Receivables FinanceAgreement” and, collectively, the “Receivables Finance Agreements”), pursuantto which Lloyds agreed to provide Pascall and XCEL a credit facility to supporttheir UK operations in the aggregate principal amount of £2,75 million ($4.3million based on the exchange rate on September 30, 2010), in each case atan advance rate of 85%, a discount charge of 2.5% above the base rate, and aservice fee of 0.2%.  The ReceivablesFinance Agreement between Pascall and Lloyds is secured by the All AssetsDebenture, dated August 31, 2010, Given by Pascall Electronics Limited infavour of Lloyds TSB Commercial Finance Limited (the “Pascall Debenture”) andthe Receivables Finance Agreement between XCEL and Lloyds is secured by the AllAssets Debenture, dated August 31, 2010, Given by XCEL Power SystemsLimited in favour of Lloyds TSB Commercial Finance Limited (the “XCELDebenture”).  The security interestsgiven to Lloyds pursuant to the Pascall Debenture and the XCEL Debenture aresenior to the security interests of both PEM and the former shareholders of ACC(the “Former Shareholders”).  TheReceivables Finance Agreements bear interest at the base rate plus 2.5% on theoutstanding balance and is paid monthly.

 

As of September 30, 2010, Pascall and XCEL had no outstandingborrowings under the Receivables Finance Agreements.

 

On September 20, 2010, the Company’s French subsidiary, CXR AJentered into an accounts receivable financing arrangement with FACTOCIC S.A., asubsidiary of CIC Group (“CIC”) (the “CIC Agreement”), pursuant to which CICagreed to provide CXR AJ a financing arrangement to support its French operationsin the aggregate principal amount of €1.35 million ($1.8 million based on theexchange rate on September 30, 2010) at an advance rate of 90% ofpresented receivables.  The CIC Agreementbears interest at the three month EURIBOR plus 1.4%.

 

As of September 30, 2010, CXR AJ had no outstanding borrowings underthe CIC Agreement.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 10— DEBT**

 

TheCredit Agreement, as described in Note 9, consisted of the Revolver (see Note 9— “Lines of Credit) and three term loans: (i) a term loan in the originalprincipal amount of $6 million (“Term Loan A”), (ii) a term loan in theoriginal principal amount of $10 million (“Term Loan B”) and (iii) a termloan in the original principal amount of $3 million (“Term Loan C”).  Term Loan A was fully funded onNovember 30, 2007 while Term Loans B and C were fully funded onAugust 20, 2008 in connection with the acquisition of ACC. $6.8 million ofTerm Loan B and all of Term Loan C was repaid in March 2009, in connectionwith the sale of the Company’s Digitran Operations.  The remaining outstanding principal balanceof Term Loan B of $2.1 million and $4.0 million of Term Loan A was repaid onAugust 31, 2010 in connection with the ACC Transaction.

 

On August 31, 2010,the Borrowers and the Lender entered into Amendment Number 16 to Loan Documents(“Amendment 16”), which amends the Credit Agreement as of such date.  Pursuant to Amendment 16, the Lender, amongother things, (i) provided a term loan of up to $1 million to theBorrowers, as further described below, (ii) terminated and released all ofthe Lender’s security interests in the assets of ACC and CCI,(iii) provided consent to the consummation of the transactionscontemplated by a Master Agreement, dated June 7, 2010, by and among theCompany, EEC, CXR Larus, Pascall, XCEL, CXR AJ, and the Former Shareholders,(the “Master Agreement”), as further described below, (iv) waivedapproximately $0.2 million in amendment and waiver fees owing to the Lender,and (v) provided for the execution and delivery of the Deeds of Priorityin favor of Lloyds with respect to the Receivables Finance Agreements providedby Lloyds to each of XCEL and Pascall, as further described in Note 9.

 

Also in connection withAmendment 16, the Lender accepted an Amended and Restated Term Loan A Note,dated August 31, 2010, which is a two-year, interest bearing secured notein the principal amount of $1.0 million (the “PEM Note”).  The PEM Note will be payable interest only ona monthly basis for the first 18 months, with equal monthly payments ofprincipal plus interest due thereafter through maturity.  The PEM Note will be payable at a rate of12.5% per annum during the first 12 months and 15.5% per annum thereafter untilpaid in full, plus any applicable default rate or late fees.

 

As part of theconsideration for entering into the Credit Agreement in 2007, the Companyissued warrants to purchase 775,758 shares of the Company’s common stock with afair value of $1.5 million, which was accounted for as a discount to the CreditAgreement and was amortized over the term of the Credit Agreement.  In connection with the ACC Transaction, theCompany repurchased these warrants, which resulted in a gain as the fair valueof the warrants exceeded the purchase price. See Note 11.

 

The changes tothe Credit Agreement discussed above resulted in accounting for the transactionas an extinguishment of debt in the accompanying condensed consolidatedfinancial statements.  As a result, theCompany recorded a gain on extinguishment of debt of $0.5 million, whichincludes the gain on the warrant repurchase of $0.3 million, the reversal ofthe $0.2 million in fees previously owed to the Lender, and all costsassociated with the amendment.

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Former Shareholder Debt*

 

In connection with the ACC Transaction,pursuant to the Master Agreement, EEC used a portion of the proceeds from thesale of ACC to pay approximately half of the $6.6 million secured debt owed tothe Former Shareholders, which amounts were owed in connection with deferredpurchase price obligations, contingent notes and other related payments.  Such payments were made, in part, to repayMr. Gaffney in full.  In addition, Mr. Brandalso accepted $450,000 worth of the Company’s common stock as partial paymenton his Amended Subordinated Contingent Note pursuant to a Stock IssuanceAgreement, dated August 31, 2010, by and between Mr. Brand and theCompany (the “Stock Issuance Agreement”).  See Note 12.

 

The Former Shareholders’ subordinated securedcontingent promissory notes, which EEC issued in May 2008 and which weresubsequently amended in November 2009, were amended by AmendmentNo. 2, effective August 31, 2010 (the “Amended SubordinatedContingent Notes”).  The AmendedSubordinated Contingent Notes bear interest at the prime rate as reported inThe Wall Street Journal plus 1% and mature on August 31, 2013 (“MaturityDate”).  Interest is payable quarterlybeginning October 1, 2010 through the Maturity Date.  No principal payments are due untilOctober 1, 2012, when quarterly principal payments in the amount of $0.2million will be paid with the outstanding principal balance due at the MaturityDate.  As of September 30, 2010, theCompany had $2.9 million outstanding principal balance under the AmendedSubordinated Contingent Notes.

 

**NOTE 11 — WARRANTS**

 

In connection with entering into the CreditAgreement in 2007 (discussed in Notes 9 and 10), the Company issued a sevenyear warrant to PEM Group, an affiliate of the Lender, to purchase up to775,758 shares of the Company’s common stock on a cash or cashless basis at anoriginal exercise price of $4.13 per share, (which amount reflects theCompany’s 1-for-3.75 reverse split of its common stock effectiveNovember 18, 2008).  The estimatedfair value of the warrants was $1.5 million, which was calculated using theBlack-Scholes pricing model.  The warrantswere originally accounted for as debt discount and the adjustment resultingfrom the repricing of the warrants increased the debt discount, which is beingamortized over the remaining life of the Credit Agreement.  The warrants were previously recorded instockholder’s equity.

 

In February 2009, the warrants wereamended and reissued in conjunction with an amendment to the CreditAgreement.  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 effectiveNovember 18, 2008).  One of the Second Amended and Restated Warrantsprovides for an exercise price of $1.99 per share (which amount reflects theCompany’s 1-for-3.75 reverse split of its common stock effectiveNovember 18, 2008).  The other Second Amended and Restated Warrantprovides for an exercise price of $1.80 per share (which amount reflects theCompany’s 1-for-3.75 reverse split of its common stock effectiveNovember 18, 2008 and a reduction from a post-split exercise price of$3.06 per share).

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The exercise price and/or number of shares ofcommon stock issuable upon exercise of the warrants may be adjusted in certaincircumstances, including certain issuances of securities at a price equal toless than the then current exercise price, subdivisions and stock splits, stockdividends, combinations, reorganizations, reclassifications, consolidations,mergers or sales of properties and assets and upon issuance of certain assetsor securities to holders of the Company’s common stock, as applicable. OnJanuary 1, 2009, the Company adopted FASB guidance which affected how instrumentsindexed to an entity’s own stock are accounted for.  The adoption of the revised FASB guidanceresulted in the reclassification of the PEM Group warrants from stockholders’equity to liabilities, and required that the warrants be fair valued pursuant to“mark to market” provisions at each reporting period, with the changes in fairvalue recognized in the Company’s consolidated statement of operations.

 

At December 31, 2009,the Company had warrants subject to “mark to market” provisions outstanding topurchase 775,758 shares of common stock. The Company computed the fair value of the warrants using aBlack-Scholes valuation model.  The fairvalue of these warrants on December 31, 2009 was determined using thefollowing assumptions:

 

 
| ** **               | ** ** | **December 31, 2009** | ** ** |
|--------------------------|------------|---------------------------------|------------|
| Dividend  yield          |       | None                            |       |
| Expected  volatility     |       | 71                              | %          |
| Risk-free  interest rate |       | 1.14                            | %          |
| Expected  term           |       | 7  years                        |       |
| Stock  price             |       | $                               | 0.76       |   |
|                          |            |                                 |            |  |

 

During the three monthsended September 30, 2010, the change in fair value of the warrantsresulted in a $0.2 million decrease to other income (expense) in the unauditedcondensed consolidated statement of operations and a corresponding increase tothe warrant liability.  During the ninemonths ended September 30, 2010, the change in fair value of the warrantsresulted in a $0.1 million decrease to other income (expense) in the unauditedcondensed consolidated statement of operations and a corresponding increase tothe warrant liability.

 

OnAugust 31, 2010, the Company completed a transaction with PEM Groupinvolving the repurchase of the two outstanding stock warrants for an aggregatepurchase price of $100,000 pursuant to a Warrant Purchase Agreement by andamong the Company and PEM Group that was entered into on August 30,2010.  The Company recorded a gain on therepurchase of the warrants of $0.3 million as a result of the fair value of thewarrants exceeding the purchase price. The gain on the repurchase of the warrants was recorded as part of thegain on the extinguishment of debt in the unaudited condensed consolidatedstatements of operations.

** **

**NOTE 12 — STOCKHOLDER’S EQUITY**

 

In connection with the ACC Transaction,Mr. Brand accepted $450,000 worth of the Company’s common stock as partialpayment on his Amended Subordinated Contingent Note pursuant to the StockIssuance Agreement.  See Note 10.  The Company issued Mr. Brand 417,525shares of Company common stock pursuant to the Stock Issuance Agreement, whichwas calculated using a per share price of $1.07778.  The per share price was determined byapplying a 15% premium to $0.9372, the volume weighted average price of theshares from June 8, 2010 through June 10, 2010, as required by theMaster Agreement.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 13 — FAIR VALUE MEASUREMENTS**

 

FASBguidance for fair value measurements defines fair value as the price that wouldbe received to sell an asset or paid to transfer a liability (an exit price) inan orderly transaction between market participants and also establishes a fairvalue hierarchy which requires an entity to maximize the use of observableinputs and minimize the use of unobservable inputs when measuring fairvalue.  The fair value hierarchydistinguishes between three levels of inputs that may be utilized whenmeasuring fair value as follows:

 

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

 

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

 

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

 

Asof January 1, 2009, the Company was required to apply updated FASBguidance to the derivative that is within the warrant that was issued asconsideration for the Company’s Credit Agreement as discussed in Note 10 and,which was included as a discount on the Company’s long-term debt as ofDecember 31, 2009.  The warrantswere repurchased on August 30, 2010 (see Note 11).  The derivative was valued using theBlack-Scholes model at August 30, 2010 to determine the value just priorto the repurchase.  The key inputs in themodel at August 30, 2010 are as follows:

 

 
| ** **               | ** ** | **August 30, 2010** | ** ** |
|--------------------------|------------|-------------------------------|------------|
| Dividend  yield          |       | None                          |       |
| Expected  volatility     |       | 101                           | %          |
| Risk-free  interest rate |       | 0.50                          | %          |
| Expected  term           |       | 7  years                      |       |
| Stock  price             |       | $                             | 0.74       |   |
|                          |            |                               |            |  |

 

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

 

 
| ** **                                   | ** ** | **Warrant Liability** | ** ** |
|----------------------------------------------|------------|----------------------------|------------|
|                                         |       |                       |       |
| Beginning  balance at December 31, 2009 |       | $                          | 292        |   |
| Total  expense recognized in earnings        |       | 123                        |       |
| Fair  value of warrants repurchased          |       | (415                       | )          |
| Ending  balance at September 30, 2010   |       | $                          | —     |   |

 

Cash,accounts receivable, accounts payable and accrued expenses reflected in theunaudited condensed consolidated balance sheets are a reasonable estimate oftheir fair value due to the short term nature of these instruments.  The carrying value of the Company’sborrowings is a reasonable estimate of its fair value as borrowings under theCompany’s credit arrangements have variable rates that reflect currentlyavailable terms and 

 

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** **

**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

conditionsfor similar debt.  As ofSeptember 30, 2010, the Company did not have any financial assets andliabilities measured at fair value on a recurring basis that would be subjectto the disclosure provisions of FASB guidance noted above.

 

**NOTE 14 — CASUALTY LOSS**

 

OnSeptember 27, 2010, the Company’s French subsidiary, CXR AJ, sustainedsignificant damage to a portion of the building comprising its Abondant, Francefacility as a result of a fire.  Theportion of the building damaged was primarily used for raw materialsstorage.  Virtually all of the rawmaterials that were on-site were destroyed in the fire.  CXR AJ’s main operating facility, whichincludes administration, finance, sales and engineering, was not damaged by thefire.  Immediately after the fire, CXRAJ’s insurer was on-site evaluating the damage. CXR AJ maintains adequate insurance coverage for such events and itanticipates that any business interruption impact will be recoverable under theinsurance policy.  The insurance companyintends to provide an advance of funds in early November 2010, which willbe applied towards replacement of the raw materials that were destroyed by thefire.  CXR AJ is still evaluating theimpact of the fire on CXR AJ’s future operations, including the effects of thisevent on CXR AJ’s liquidity and cash flows.

Asof September 30, 2010, the Company recorded an impairment for the rawmaterials inventory destroyed by the fire of €0.8 million (approximately $1.1million at the September 30, 2010 exchange rate).  As the CXR AJ insurance policy covers thisinventory amount and the insurance company has confirmed that this inventory iscovered under replacement cost, the Company has recorded a receivable for thesame amount as the impairment loss.

 

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

 

**Cautionary Statement**

 

Thefollowing discussion should be read in conjunction with our unaudited condensedconsolidated financial statements and the related notes thereto contained inPart I, Item 1 of this Quarterly Report on Form 10-Q. Theinformation contained in this report is not a complete description of our businessor the risks associated with an investment in our common stock. We urge you tocarefully review and consider the various disclosures made by us in thisQuarterly Report on Form 10-Q and in our other reports filed with the U.S.Securities and Exchange Commission (the “SEC”), including our Annual Report onForm 10-K for the year ended December 31, 2009, as amended, andsubsequent Quarterly Reports on Form 10-Q and Current Reports onForm 8-K, which discuss our business in greater detail.  This report and the following discussioncontain forward-looking statements, which generally include the plans,objectives and expectations of management for future operations, includingplans, objectives and expectations relating to our future economic performanceand our current beliefs regarding revenues we might generate and profits wemight earn if we are successful in implementing our business and growthstrategies. The forward-looking statements and associated risks may include,relate to or be qualified by other important factors, including, withoutlimitation:

 

·                  the ongoingrevenues and profitability of the Company will be substantially reduced as aresult of our sale of ACC;

·                  the potential negative impact on shipments and long-term contracts as aresult of the fire loss at our French facility;

·                  our ability to successfully enter into strategic alliances or merge withor acquire other companies in the communications business segment;

·                  our ability to organically grow our European based aerospace and defensedivisions;

·                  exposure to and impacts of various international risks including legal,business, political and economic risks associated with our internationaloperations, also including the impact of foreign currency translation;

·                  our inability to compete directly against ACC, RO Associates or theDigitran Operations as a result of previous sales of such whereby we areprohibited under the relevant sales agreements;

·                  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 and unanticipated trends in our financial condition andresults of operations;

·                  our ability to meet our working capital and other financing needs;

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

·                  our ability to secure long term purchase orders;

·                  our ability to deliver against existing or future backlog;

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

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

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

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

·                  the impact of current and/or future economic conditions, including butnot limited to the overall condition of the stock market, the overall creditmarket, the global recession, political, economic and/or other constraintswhich are or may negatively impact the industries in which we participateand/or the ability for us to market the products which we sell;

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

·                  our ability to sell additional assets, complete a recapitalization, orconsummate a merger or other type of transaction, if necessary.

 

Wedo not undertake to update, revise or correct any forward-looking statements.

 

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Anyof the factors described above or in the “Risk Factors” sections contained inour Annual Report on Form 10-K for the year ended December 31, 2009,as amended, could cause our financial results, including our net income or lossor growth in net income or loss to differ materially from prior results, whichin turn could, among other things, cause the price of our common stock tofluctuate substantially.

 

**RecentDevelopments**

 

On September 27, 2010, the Company’sFrench subsidiary, CXR AJ, sustained significant damage to a portion of thebuilding comprising its Abondant, France facility as a result of a fire.  The portion of the building damaged wasprimarily used for raw materials storage. Virtually all of the raw materials that were on-site were destroyed inthe fire.  CXR AJ’s main operatingfacility, which includes administration, finance, sales and engineering, wasnot damaged by the fire.  CXR AJ is stillevaluating the impact of the fire on CXR AJ’s future operations, including theeffects of this event on CXR AJ’s liquidity and cash flows.

 

OnAugust 31, 2010, EEC completed the sale to Aeroflex of all of the issuedand outstanding shares of ACC and all of the issued and outstanding shares ofcommon stock of CCI (the “ACC Transaction”) pursuant to the June 7 ACCPurchase Agreement.

 

OnJune 7, 2010, EMRISE Electronics Corporation (“EEC”), a wholly-ownedsubsidiary of EMRISE Corporation (the “Company”), entered into a Stock PurchaseAgreement by and among Aeroflex Incorporated (“Aeroflex”), as buyer, and EEC,as seller, relating to the sale of all of the issued and outstanding shares ofcommon stock of Advanced Control Components, Inc. (“ACC”) and all of theissued and outstanding shares of common stock of Custom Components, Inc. (“CCI”)(collectively the “ACC Operations”) (the “ACC Purchase Agreement”), which wassubsequently assigned by Aeroflex to its subsidiary, Aeroflex/KDI, Inc.

 

Atthe closing of the ACC Transaction, the Company received net proceeds, afterclosing costs, of $17.0 million.  Theconsideration for the ACC Transaction consisted of an aggregate purchase priceof $20 million in cash (the “Purchase Price”). An amount equal to $0.8 million was placed in a 12-month escrow accountpursuant to an agreement between Aeroflex and EEC to satisfy anyindemnification claims.  Following the12-month escrow period, any unused funds in the account will be returned to theCompany.  In addition, the followingamounts were satisfied out of the Purchase Price:  (i) $10.6 million to the Company’ssenior lender, which represents the aggregate amount of the indebtedness owedby EEC to the senior lender, which was satisfied by payment of $9.6 million incash and by delivering a two-year interest bearing note in the amount of $1million, and (ii) $3.1 million in cash and a $2.8 million, three-yearinterest bearing note, both in satisfaction of the deferred purchase price andcontingent payments owed by EEC to certain of ACC’s previous shareholders,Charles S. Brand, Thomas P.M. Couse, Joanne Couse and Michael Gaffney(collectively, the “Former Shareholders”). The Purchase Price was also adjusted by $0.8 million based on theestimated level of adjusted net working capital of ACC at the closing of theTransaction, subject to final determination pursuant to the procedures setforth in the Purchase Agreement.

 

InMarch of 2009, the Company sold substantially all of the assets related tothe Digitran division of EEC, and all of the issued and outstanding equityinterests of EEC’s wholly-owned subsidiary, XCEL Japan, Ltd.(collectively, the “Digitran Operations”). In March of 2010, the Company completed the sale of substantiallyall of the assets of EEC’s subsidiary, RO Associates (the “RO Operations”).

 

TheCompany has classified the ACC Operations, RO Operations and DigitranOperations as discontinued and held for sale operations in the accompanyingManagement’s Discussion and Analysis of Financial Condition and Results ofOperations for all periods presented.

 

**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 operatingsegments: electronic devices and communications equipment. 

 

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Inthe third quarter of 2010, our electronic devices segment contributedapproximately 55% of overall net sales while the communications segmentcontributed approximately 45% of overall net sales. Our subsidiaries within ourelectronic devices segment design,develop, manufacture and market power supplies, radio frequency, or RF, andmicrowave devices for defense, aerospace and industrial markets.  Our subsidiaries within ourcommunications equipment segment design, develop, manufacture and marketnetwork access equipment, including network timing and synchronizationproducts, for communications applications in defense, public and privatenetworks and industrial markets.

 

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

 

Withinour communications 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.

 

**Critical Accounting Policies**

 

Ourdiscussion and analysis of our financial condition and results of operations isbased upon our consolidated financial statements, which have been prepared inaccordance with GAAP. The preparation of these financial statements requires usto make estimates and judgments that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amount of net sales and expenses foreach period. The following represents a summary of our critical accountingpolicies, defined as those policies that we believe are the most important tothe portrayal of our financial condition and results of operations and thatrequire management’s most difficult, subjective or complex judgments, often asa result of the need to make estimates about the effects of matters that areinherently uncertain.

 

***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 purchase price.  We recognize revenues when shipment ofproducts has occurred or services have been rendered, no significantobligations remain on our part, and collectability is reasonably assured basedon our credit and collections practices and policies.

 

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.  Productreturns are infrequent and require prior authorization because our sales arefinal and we quality test our products prior to shipment to ensure the productsmeet the specifications of the binding purchase orders under which thoseproducts 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 our subsidiaries in Englanddepends upon the type of contract involved. Engineering/design services contracts generally entail design andproduction of a prototype over a term of up to several years, with revenuedeferred until each milestone defined in the contract is 

 

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reached.  Production contracts provide for a specificquantity of products to be produced over a specific period of time.  Customers issue binding purchase orders orenter into binding agreements for the products to be produced.  We recognize revenues on these orders as theproducts are shipped.  Returns areinfrequent and permitted only with prior authorization because these productsare custom made to order based on binding purchase orders and are qualitytested prior to shipment.  An estimate ofwarranty cost is recorded at the time revenue is recognized.

 

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.

 

***Product Warranty Liabilities***

 

Generally, our productscarry 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 a liability forestimated costs that we expect to incur under our basic limited warranties whenproduct revenue is recognized.  Factorsaffecting our warranty liability include the number of units sold, the types ofproducts involved, historical and anticipated rates of claim and historical andanticipated costs per claim.  Weperiodically assess the adequacy of our warranty liability accrual based onchanges in these factors.

 

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

 

Ourelectronic devices segment finished goods inventories generally are built toorder.  Our communications equipmentinventories generally are built to forecast, which requires us to produce alarger amount of finished goods in our communications equipment business sothat our customers can be served promptly. Our products consist of numerous electronic and other materials, whichnecessitate that we exercise detailed inventory management.  We value our inventory at the lower of theactual cost to purchase or manufacture the inventory (first-in, first-out) orthe current estimated market value of the inventory (net realizable value). Weperform cycle counts of inventories using an ABC inventory methodology, whichgroups inventory items into prioritized cycle counting categories, or weconduct physical inventories at least once a year.  We regularly review inventory quantities onhand and record a provision for excess and obsolete inventory based primarilyon our estimated forecast of product demand and production requirements for thenext 12 to 24 months. Additionally, to determine inventory write-downprovisions, we review product line inventory levels and individual items asnecessary and periodically review assumptions about forecasted demand andmarket conditions.  Any inventory that wedetermine to be obsolete, either in connection with the physical count or atother times of observation, are reserved for and subsequently written-off.

 

Theelectronic devices and communications equipment industries are characterized byrapid technological 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.

 

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***Foreign Currency Translation***

 

Wehave foreign subsidiaries that together accounted for approximately 81% and 85%of our net revenues from continuing operations for the nine months endedSeptember 30, 2010 and 2009, respectively, and 64% and 69% of our assetsand 70% and 29% of our total liabilities as of September 30, 2010 andDecember 31, 2009, respectively.  Inpreparing our consolidated financial statements, we are required to translatethe financial statements of our foreign subsidiaries from the functionalcurrencies in which they keep their accounting records into U.S. dollars. Thisprocess results in exchange gains and losses which, under relevant accountingguidance, are included either within our statement of operations under thecaption “other income (expense)” or as a separate part of our net equity underthe caption “accumulated other comprehensive income (loss).”

 

Underrelevant accounting guidance, the treatment of these translation gains orlosses depends upon management’s determination of the functional currency ofeach subsidiary. This determination involves consideration of relevant economicfacts and circumstances affecting the subsidiary. Generally, the currency inwhich the subsidiary transacts a majority of its transactions, includingbillings, financing, payroll and other expenditures, would be considered thefunctional currency. However, management must also consider any dependency of thesubsidiary upon the parent and the nature of the subsidiary’s operations.

 

Ifmanagement deems any subsidiary’s functional currency to be its local currency,then any gain or loss associated with the translation of that subsidiary’sfinancial statements is included as a separate component of stockholders’equity in accumulated other comprehensive income (loss).  However, if management deems the functionalcurrency to be U.S. dollars, then any gain or loss associated with thetranslation of these financial statements would be included in other income(expense) within our statement of operations.

 

Ifwe dispose of any of our subsidiaries, any cumulative translation gains orlosses would be realized into our statement of operations. If we determine thatthere has been a change in the functional currency of a subsidiary to U.S.dollars, then any translation gains or losses arising after the date of thechange would be included within our statement of operations.

 

Basedon our assessment of the factors discussed above, we consider the functionalcurrency of each of our international subsidiaries to be each subsidiary’slocal currency. Accordingly, we had cumulative translation losses of $2.0million and $1.6 million that were included as part of accumulated othercomprehensive loss within our balance sheets at September 30, 2010 andDecember 31, 2009, respectively. During the three months endedSeptember 30, 2010 and 2009, we included translation gains of $0.7 millionand losses of $0.1 million, respectively, under accumulated other comprehensiveloss.  During the nine months endedSeptember 30, 2010 and 2009, we included translation losses of $0.4million and gains of $1.3 million, respectively, under accumulated othercomprehensive loss.

 

The magnitude of these gains or losses depends uponmovements in the exchange rates of the foreign currencies in which we transactbusiness as compared to the value of the U.S. dollar. During the third quarterof 2010 and 2009, these currencies primarily included the euro and the Britishpound sterling. Any future translation gains or losses could be significantlyhigher or lower than those we recorded for these periods.

 

A2.5 million British pound sterling loan payable from one of our subsidiaries in England to EMRISE was outstanding as ofSeptember 30, 2010 ($4.0 million based on the exchange rate atSeptember 30, 2010).  Exchange ratelosses and gains on the long-term portion of this loan are recorded incumulative translation gains or losses in the equity section of the balancesheet.

*** ***

***Intangibles, Including Goodwill***

 

Weperiodically evaluate our intangibles, including goodwill, for potentialimpairment. Our judgments regarding the existence of impairment are based onmany factors including market conditions and operational performance of ouracquired businesses.

 

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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 FASB guidance related to goodwill andother intangible assets, we are required to analyze our goodwill for impairmentissues at least annually or more frequently if an event occurs or circumstanceschange that would more likely than not reduce the fair value of a reportingunit below its carrying amount.  AtSeptember 30, 2010, our reported goodwill totaled $4.9 million.

 

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**Results of Operations**

 

**Overview**

 

Amajority of our products are customized to the unique specifications of ourcustomers and are subject to variable timing of delivery.  Shipments of products can be accelerated ordelayed due to many reasons including, but not limited to, exceeding or notmeeting customer contract requirements, a change in customer timing orspecifications, technology related issues and production related issues.  Comparability of our revenues and grossprofit is difficult from period to period due to this product variability.  Exceptions to this include certain long-termmilitary contracts and certain long-term telecommunications contracts.

 

Overallsales from continuing operations decreased 15.9% in the third quarter of 2010as compared to the third quarter of 2009. Our overall net sales of $7.8 million for the third quarter of 2010reflected declines in net sales volume at our subsidiaries in England, whichwere partially offset by increases in net sales volume in both of ourcommunications equipment subsidiaries. The declines were also affected by the negative impact of exchange ratesbetween the U.S. dollar and the British pound sterling and the euro.

 

Overallgross profit, as a percentage of sales, from continuing operations decreased to29.8% in the third quarter of 2010 from 34.0% in the third quarter of 2009, butis consistent with second quarter 2010 gross profit, as a percentage ofsales.  The decrease in gross profit, asa percentage of sales, from continuing operations from third quarter 2009 wasprimarily due to the decline in gross margins within our electronic devicessegment and our French communications equipment subsidiary, which was partiallyoffset by improvements in gross profit, as a percentage of sales, within ourU.S. communications equipment subsidiary.

 

Thefollowing is a detailed discussion of our results of operations by businesssegment.  As a result of the sale of theDigitran Operations in March of 2009, the sale of the RO Operations inMarch of 2010 and the sale of the ACC Operations in August of 2010,for purposes of the following discussion and analysis, the Digitran, RO and ACCOperations have been removed from the prior period comparisons and are reportedas discontinued operations for all periods presented.

 

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*** ***

***Comparison of the Three Months Ended September 30, 2010 to theThree Months Ended September 30, 2009***

 

**NetSales**

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** | **Variance**                     | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                     | ** ** | **September 30,**           | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**                        | ** ** | **2010**                         | ** ** | **2009**                         | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                           |       |                             |       |                             |       |   |   |   |   |
| Electronic  devices                            |       | $                                | 4,285      |                             | $          | 5,928 |   | $ | (1,643 | ) | (27.7 | )% |
| *as % of net sales from continuing operations* | * *   | *55.0*                           | *%*        | *64.0*                           | *%*        | * * | * * | * * | * * |
| Communications  equipment                      |       | 3,505                            |       | 3,332                            |       | 173 |   | 5.2 | % |
| *as % of net sales from continuing operations* | * *   | *45.0*                           | *%*        | *36.0*                           | *%*        | * * | * * | * * | * * |
| Total  net sales from continuing operations    |       | 7,790                            |       | 9,260                            |       | (1,470 | ) | (15.9 | )% |
| Discontinued  operations                       |       | 2,848                            |       | 5,059                            |       |   |   | * * |   |
| Total  net sales                               |       | $                                | 10,638     |                             | $          | 14,319 |   |   |   |   |   |
|                                                |            |                                  |            |                                  |            |  |  |  |  |  |  |  |

 

*ElectronicDevices Segment*

 

Thedecrease in sales of our electronic devices segment in the third quarter of2010 as compared to the third quarter of 2009 was primarily due to delays inthe production schedule for the European fighter aircraft (Typhoon) and othermilitary power supply projects. Additionally, and equally as contributory, a significant portion of ourbusiness at our U.K. subsidiaries is transacted in U.S. dollars and wasnegatively impacted by exchange rate fluctuations, albeit to a lesser extentthan previous periods, as the subsidiary’s local currency is the British poundsterling.  The translation impact ofexchange rates remains an uncertainty and could negatively or positively impactour overall results in future periods.

 

Weexpect quarterly sales volumes in the fourth quarter of 2010 to be slightlyhigher than third quarter 2010 levels due to an expected increase in In FlightEntertainment (“IFE”) during the fourth quarter of 2010 as a result of ordersreceived and a potential for a slight increase in military power supplyorders.  The backlog for our electronicdevices segment has increased significantly over the 2009 third quarter and the2010 second quarter.

 

*CommunicationsEquipment Segment*

 

Theincrease in net sales within our communications equipment segment in the thirdquarter of 2010 compared to 2009 was due to increased sales volume in both ofour communications equipment subsidiaries. Our French subsidiary has experienced increases in orders and resultingshipments for networking equipment, partially offset by the negative effect ofexchange rate fluctuations between the U.S. dollar and the euro.  Net sales of test equipment at our U.S.communications equipment subsidiary remains strong as a result of our FederalAviation Administration (“FAA”) and U.S. military contracts and is a primaryreason for the increase in sales compared to the 2009 third quarter.  We also experienced an increase in net salesof our timing equipment over the prior year quarter.

 

Bothof our communications equipment subsidiaries have a strong backlog going intothe fourth quarter of 2010.  We continueto make efforts to increase our commercial business for our French operationsand are experiencing the positive effects of those efforts.  We expect sales at our French subsidiary tobe lower in the fourth quarter of 2010 as a result of the damage sustained fromthe fire at the end of September, as further described in Note 14 in theaccompanying notes to unaudited condensed consolidated financialstatements.  However, we are stillevaluating the actual impact of the fire damage on our operations and ourFrench subsidiary’s ability to ship product beginning in the first quarter of2011.  We expect sales at our U.S.communications equipment subsidiary to be higher in the fourth quarter of 2010compared to the third quarter of 2010 as a result of the ongoing contracts withthe FAA and U.S. military and anticipated orders for network timing products.

 

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**GrossProfit**

 

*ElectronicDevices Segment*

 
| ** **                                      | ** ** | **Three Months Ended** | ** ** | **Variance**                     | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                      | ** ** | **September 30,**           | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**                         | ** ** | **2010**                         | ** ** | **2009**                         | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                            |       |                             |       |                             |       |   |   |   |   |
| Electronic  devices                             |       | $                                | 1,018      |                             | $          | 1,894 |   | $ | (876 | ) | (46.3 | )% |
| *as % of net sales from continuing operations*  | * *   | *23.8*                           | *%*        | *32.0*                           | *%*        | * * | * * | * * | * * |
| Communications  equipment                       |       | 1,300                            |       | 1,257                            |       | 43 |   | 3.4 | % |
| *as % of net sales from continuing operations*  | * *   | *37.1*                           | *%*        | *37.7*                           | *%*        | * * | * * | * * | * * |
| Total  gross profit from continuing operations  |       | 2,318                            |       | 3,151                            |       | (833 | ) | (26.4 | )% |
| *Total gross margin from continuing operations* | * *   | *29.8*                           | *%*        | *34.0*                           | *%*        | * * | * * | * * | * * |
| Discontinued  operations                        |       | 1,288                            |       | 2,170                            |       |   |   |   |   |
| Total  gross profit                             |       | $                                | 3,606      |                             | $          | 5,321 |   |   |   |   |   |
|                                                 |            |                                  |            |                                  |            |  |  |  |  |  |  |  |

 

Thedecrease in gross profit, as a percentage of net sales, for our electronicdevices segment from 32.0% in the third quarter of 2009 to 23.8% in the thirdquarter of 2010 is primarily due to the decrease in volume of sales, asdiscussed above, and also due to changes in product mix as a result of a shiftbetween military and commercial sales and the negative impact of exchange ratefluctuations between the U.S. dollar and the British pound sterling.

 

Weexpect that gross profit, as a percentage of sales, in the fourth quarter of2010 will be slightly above those levels achieved in the third quarter of 2010as a result of expected changes in product mix to higher margin products andthe improvement of sales volumes.

 

*CommunicationsEquipment Segment*

 

Theslight decrease in gross profit, as a percentage of sales, for ourcommunications equipment segment from 37.7% in the third quarter of 2009 to37.1% in the third quarter of 2010 is primarily the result of sales of testinstruments, which carry a lower margin, and the negative impact of exchangerates between the U.S. dollar and the euro at our French subsidiary.  These decreases were partially offset byincreases in gross profit, as a percentage of sales, at our U.S. communicationsequipment subsidiary primarily due to an increase in sales volume of highermargin network access timing products during the quarter.

 

Weexpect that gross profit, as a percentage of sales, for the fourth quarter of2010 will remain relatively consistent with the gross profit, as a percentage,of sales experienced in the third quarter of 2010.

 

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**OperatingExpenses**

 
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Variance**                     | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                           | ** ** | **September 30,**           | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**                              | ** ** | **2010**                         | ** ** | **2009**                         | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                                 |       |                             |       |                             |       |   |   |   |   |
| Selling,  general and administrative                 |       | $                                | 2,491      |                             | $          | 3,257 |   | $ | 766 |   | 23.5 | % |
| *as % of net sales from continuing operations*       | * *   | *32.0*                           | *%*        | *35.2*                           | *%*        | * * | * * | * * | * * |
| Engineering  and product development                 |       | 458                              |       | 435                              |       | (23 | ) | (5.3 | )% |
| *as % of net sales from continuing operations*       | * *   | *5.9*                            | *%*        | *4.7*                            | *%*        | * * | * * | * * | * * |
| Employee  transaction costs                          |       | 872                              |       | —                           |       | (872 | ) | 100.0 | % |
| Total  operating expenses from continuing operations |       | 3,821                            |       | 3,692                            |       | (129 | ) | (3.5 | )% |
| Discontinued  operations                             |       | 518                              |       | 2,252                            |       |   |   |   |   |
| Total  operating expenses                            |       | $                                | 4,339      |                             | $          | 5,944 |   |   |   |   |   |
|                                                      |            |                                  |            |                                  |            |  |  |  |  |  |  |  |

 

*Selling,general and administrative expenses*

 

Generaland administrative expenses decreased in the third quarter of 2010 as comparedto 2009 primarily related to cost savings realized in the current year as aresult of headcount reductions, salary reductions and facility closures in theprior year.  Partially offsetting thesedecreases, we experienced some minor increases in facility expense during thequarter due to slightly higher facility costs at our U.S. communicationsequipment subsidiary, CXR Larus Incorporated (“CXR Larus”).  CXR Larus and RO shared a facility prior tothe sale of the RO Operations in March 2010, but subsequent to the sale,CXR Larus is burdened with the entire facility cost. The facility lease at CXRLarus ends in June of 2011, at which time we anticipate moving to a lessexpensive facility or negotiating a reduced rate at the current facility.  Additionally, during the quarter we incurred$0.3 million of costs associated with transaction activities, which are inexcess of the costs we would have normally incurred if we had not been engagedin such transaction activities.

 

Duringthe fourth quarter of 2010, we expect selling, general and administrativeexpense to be lower than the 2009 comparative period as we see the affects ofthe cost reduction actions taken in 2009, which included headcount reductions,office closures in France and California, and an overall decrease in thecorporate budget as the majority of these non-recurring costs mentioned aboveare eliminated.  In addition, we havefurther reduced corporate general and administrative costs as a result ofadditional headcount reductions subsequent to the ACC Transaction, which willfavorably impact our selling, general and administrative costs going forward.

 

*Engineeringand product development*

 

Theslight increase in engineering and product development costs is primarily dueto an increase in investment in engineering and product development at ourcommunications equipment subsidiaries to further develop our next generationnetwork timing products and support existing products.

 

Duringthe fourth quarter of 2010, engineering and product development expenses areexpected to increase as we continue to invest in our existing products.

 

*Employeetransaction costs*

 

Asa result of the ACC Transaction, we incurred $0.9 million in employeetransaction costs for employees of EMRISE, which remain in continuingoperations and are non-recurring. Effective September 1, 2010, the employment three corporatepersonnel, including our former Chief Financial Officer, was terminated, bymutual agreement, as part of a realignment of our corporate financeorganization in connection with the significant changes caused by the sale ofthe ACC Operations and other divisions including the RO Operations and DigitranOperations.  Additionally, inconsideration for forfeiting their change in control provision within theirexisting 

 

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employmentcontracts, our Chief Executive Officer and our President and Chief OperatingOfficer both received a transaction payment.

 

**Interestexpense**

 

Interestexpense was $0.3 million for the three months ended September 30, 2010compared to $0.7 million for the three months ended September 30, 2009 dueto lower outstanding loan balances, the conclusion of amortizing the debtdiscount and deferred financing costs incurred in 2007 and the repayment of asubstantial portion of our senior lender debt in August of 2010.  We expect quarterly interest expense for thefourth quarter of 2010 to decrease significantly from the comparable prior yearperiod due to the substantially lower outstanding loan balances resulting fromthe repayment of debt from the proceeds of the ACC Transaction.

 

**Otherincome and expense**

 

Werecorded other expense of $0.3 million in the third quarter of 2010 compared to$25,000 in the third quarter of 2009. Other income and expense consists primarily of (i) fair valueadjustments on warrants and (ii) short-term exchange rate gains and lossesassociated with the volatility of the U.S. dollar to the British pound sterlingand euro on the current portion of certain assets and liabilities.  The change in the fair value of warrantsduring the three months ending September 30, 2010 resulted in expense of$0.2 million compared to expense of $0.1 million in the same period of2009.  The remaining expense of $0.1million for the third quarter of 2010 was predominantly related to short-termexchange rate losses.

 

**Gain onextinguishment of debt**

 

Werecorded a gain on the extinguishment of debt of $0.5 million in the thirdquarter of 2010 as a result of the substantial modification of the creditfacility with our senior lender.  On August 31,2010, we repaid all except $1 million of debt owed to our senior lender andamended the Credit Agreement substantially for amount, terms, rates andrepayment.  This resulted in thetransaction being accounted for as an extinguishment of debt.  In connection with the transaction, thesenior lender waived the deferred fees owed to them at maturity and agreed tosell the warrants held by their affiliate for $100,000.  The gain on extinguishment of debt includesthe amount of fair value of the warrants that exceeded the purchase price of$0.3 million, the reversal of the deferred fees and the legal costs associatedwith the transaction.  See Note 11 in theaccompanying notes to condensed consolidated financial statements.

 

**Incometax provision (benefit)**

 

Incometax benefit amounted to $0.2 million for the third quarter of 2010 compared toexpense of $0.2 million for the third quarter of 2009.  We recorded income tax expense in the 2009period primarily as a result of foreign income tax on foreign earned profits inEurope.  The income tax benefit in thethird quarter of 2010 was related to the losses from continuing operations thatwe incurred during the quarter.

 

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 in taxobligations in 2010.

 

**(Loss)Income from discontinued operations**

 

Wereported net income from discontinued operations of $0.3 million during thethird quarter of 2010 compared to a net loss of $0.3 million during the thirdquarter of 2009.  The income fromdiscontinued operations included a $0.3 million loss on the sale of the ACCOperations, offset by operating profits for the ACC Operations.  The loss from discontinued operations for thethird quarter of 2009 relates to a purchase price adjustment for the DigitranOperations, the operating losses incurred by the RO Operations, partially offsetby operating income from the ACC Operations.

 

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**Net(loss) income**

 

Wereported a net loss of $1.1 million in the third quarter of 2010 compared to$1.8 million in the third quarter of 2009. Included in net loss in the third quarter of 2010 was an overall declinein net sales and gross profit from continuing operations, $0.9 million innon-recurring employee transaction costs and $0.3 million in non-recurringcosts associated with transaction activities resulting in a loss fromcontinuing operations of $1.4 million, offset by income on discontinuedoperations discussed above of $0.3 million. We expect net loss from continuing operations for the fourth quarter of2010 to improve as a result of additional headcount reductions and lowerinterest expense.

 

***Comparison of the Nine Months Ended September 30, 2010 to the NineMonths Ended September 30, 2009***

 

**NetSales**

 
| ** **                                     | ** ** | **Nine Months Ended** | ** ** | **Variance**                     | ** ** |
|------------------------------------------------|------------|---------------------------------|------------|----------------------------------|------------|
| ** **                                     | ** ** | **September 30,**          | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**                        | ** ** | **2010**                        | ** ** | **2009**                         | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                           |       |                            |       |                             |       |   |   |   |   |
| Electronic  devices                            |       | $                               | 12,680     |                             | $          | 17,399 |   | $ | (4,719 | ) | (27.1 | )% |
| *as % of net sales from continuing operations* | * *   | *59.4*                          | *%*        | *67.0*                           | *%*        | * * | * * | * * | * * |
| Communications  equipment                      |       | 8,676                           |       | 8,571                            |       | 105 |   | 1.2 | % |
| *as % of net sales from continuing operations* | * *   | *40.6*                          | *%*        | *33.0*                           | *%*        | * * | * * | * * | * * |
| Total  net sales from continuing operations    |       | 21,356                          |       | 25,970                           |       | (4,614 | ) | (17.8 | )% |
| Discontinued  operations                       |       | 13,988                          |       | 16,832                           |       |   |   | * * |   |
| Total  net sales                               |       | $                               | 35,344     |                             | $          | 42,802 |   |   |   |   |   |
|                                                |            |                                 |            |                                  |            |  |  |  |  |  |  |  |

 

*ElectronicDevices Segment*

 

Thedecrease in sales of our electronic devices in the nine months ending September 30,2010 as compared to the same period of 2009 was primarily due to lower volumeas a result of the global economic conditions, delays in the productionschedule for the European fighter aircraft (Typhoon) and other military powersupply projects.  Additionally, InFlight Entertainment (“IFE”) has experienced delays in orders and one largecontract at one of our U.K. subsidiaries concluded in the second quarter of2009.  Additionally, a significantportion of our business at U.K. subsidiaries is transacted in U.S. dollars andwas negatively impacted by exchange rate fluctuations, as the subsidiary’slocal currency is the British pound sterling. The translation impact of exchange rates remains an uncertainty andcould negatively or positively impact our overall results in future periods.

 

*CommunicationsEquipment Segment*

 

Duringthe nine months ending September 30, 2010, net sales within ourcommunications equipment segment remained relatively consistent with the sameperiod of 2009.  We experienced anincrease in sales of test equipment to the FAA and the U.S. military at ourU.S. communications equipment subsidiary, offset by a decrease in orders and shipmentsfor network timing products at our French subsidiary due largely to economicimpacts and spending reductions by the French Defense Ministry.

 

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**GrossProfit**

 
| ** **                                      | ** ** | **Nine Months Ended** | ** ** | **Variance**                     | ** ** |
|-------------------------------------------------|------------|---------------------------------|------------|----------------------------------|------------|
| ** **                                      | ** ** | **September 30,**          | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**                         | ** ** | **2010**                        | ** ** | **2009**                         | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                            |       |                            |       |                             |       |   |   |   |   |
| Electronic  devices                             |       | $                               | 3,101      |                             | $          | 5,787 |   | $ | (2,686 | ) | (46.4 | )% |
| *as % of net sales from continuing operations*  | * *   | *24.5*                          | *%*        | *33.3*                           | *%*        | * * | * * | * * | * * |
| Communications  equipment                       |       | 3,109                           |       | 3,003                            |       | 106 |   | 3.5 | % |
| *as % of net sales from continuing operations*  | * *   | *35.8*                          | *%*        | *35.0*                           | *%*        | * * | * * | * * | * * |
| Total  gross profit from continuing operations  |       | 6,210                           |       | 8,790                            |       | (2,580 | ) | (29.4 | )% |
| *Total gross margin from continuing operations* | * *   | *29.1*                          | *%*        | *33.8*                           | *%*        |   |   |   |   |
| Discontinued  operations                        |       | 7,011                           |       | 6,947                            |       |   |   |   |   |
| Total  gross profit                             |       | $                               | 13,221     |                             | $          | 15,737 |   |   |   |   |   |
|                                                 |            |                                 |            |                                  |            |  |  |  |  |  |  |  |

 

*ElectronicDevices Segment*

 

Thedecrease in gross profit, as a percentage of net sales, for our electronicdevices segment from 33.3% in the nine months ending September 30, 2009,to 24.5% in the same period of 2010 is primarily due to the decrease in volumeof sales as discussed above and also due to changes in product mix and thenegative impact of exchange rate fluctuations between the U.S. dollar and theBritish pound sterling.

 

*CommunicationsEquipment Segment*

 

Theincrease in gross profit, as a percentage of sales, for our communicationsequipment segment from 35.0% in the nine months ending September 30, 2009,to 35.8% in the same period of 2010 is primarily the result of increases ingross margins at our U.S. communications equipment subsidiary primarily due toan increase in sale of higher margin network timing products, partially offsetby unfavorable impacts as a result of the changes in foreign currency exchangerates between the U.S. dollar and the euro.

 

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**OperatingExpenses**

 
| ** **                                           | ** ** | **Nine Months Ended** | ** ** | **Variance**                     | ** ** |
|------------------------------------------------------|------------|---------------------------------|------------|----------------------------------|------------|
| ** **                                           | ** ** | **September 30,**          | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**                              | ** ** | **2010**                        | ** ** | **2009**                         | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                                 |       |                            |       |                             |       |   |   |   |   |
| Selling,  general and administrative                 |       | $                               | 7,591      |                             | $          | 9,179 |   | $ | 1,588 |   | 17.3 | % |
| *as % of net sales from continuing operations*       | * *   | *35.5*                          | *%*        | *35.3*                           | *%*        | * * | * * | * * | * * |
| Engineering  and product development                 |       | 1,382                           |       | 1,274                            |       | (108 | ) | (8.5 | )% |
| *as % of net sales from continuing operations*       | * *   | *6.5*                           | *%*        | *4.9*                            | *%*        | * * | * * | * * | * * |
| Employee  transaction costs                          |       | 872                             |       | —                           |       | (872 | ) | 100.0 | % |
| Total  operating expenses from continuing operations |       | 9,845                           |       | 10,453                           |       | 608 |   | 5.8 | % |
| Discontinued  operations                             |       | 3,692                           |       | 5,623                            |       |   |   |   |   |
| Total  operating expenses                            |       | $                               | 13,537     |                             | $          | 16,076 |   |   |   |   |   |
|                                                      |            |                                 |            |                                  |            |  |  |  |  |  |  |  |

 

*Selling,general and administrative expenses*

 

Thedecrease in selling, general and administrative expenses is primarily theresult of the cost reduction activities implemented in 2009, which includedheadcount reductions, office closures in France and California, and an overalldecrease in corporate expenses.  Alsocontributing to the decrease was the impact of the headcount reductions in thefirst half of 2009, which resulted in employee termination costs that were notpresent in the nine months ending September 30, 2010.  These decreases were offset slightly by CXRLarus absorbing all of the facility costs at its location in the second andthird quarter of 2010 where it had previously shared costs with the ROOperations.  However, selling, generaland administrative costs, as a percentage of sales, remained relativelyconsistent with the current year period reflecting certain costs forconsulting, legal and audit of approximately $0.5 million that will not recurin future periods.  We have madeadditional headcount reductions for our corporate headquarters as a result ofthe ACC Transaction.

 

*Engineeringand product development*

 

Theincrease in engineering and product development costs is primarily due tocommunications equipment subsidiaries related to development of upgrades andenhancements to our next generation network timing products and enhancements ofexisting products.

 

*Employeetransaction costs*

 

Asa result of the ACC Transaction, we incurred $0.9 million in employeetransaction costs for employees of EMRISE, which remain in continuingoperations and are non-recurring. Effective September 1, 2010, the employment of three corporatepersonnel, including our former Chief Financial Officer, was terminated, bymutual agreement, as part of a realignment of our corporate financeorganization in connection with the significant changes caused by the sale ofthe ACC Operations and other divisions, including the RO Operations andDigitran Operations.  Additionally, inconsideration for forfeiting their change in control provision within theirexisting employment contracts, our Chief Executive Officer and our Presidentand Chief Operating Officer both received a transaction payment.

 

**Interestexpense**

 

Interestexpense was $1.9 million for the nine months ending September 30, 2010compared to $3.1 million for the nine months ending September 30, 2009 dueto substantially lower outstanding loan balances.  Additionally, in the nine months ending September 30,2009, we accelerated the amortization of deferred financing costs and debtdiscount in the amount of $0.5 million associated with the partial repayment ofour Term Loan B, which was absent in the same period of 2010.  Included in interest expense in the ninemonths ending 

 

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September 30,2010 was $0.6 million of non-cash amortization of deferred financing costs andnon-cash amortization of debt discount compared to $1.2 million in the sameperiod of 2009.

 

**Otherincome and expense**

 

Werecorded other income of $6,000 in the nine months ending September 30,2010 compared to $0.1 million in the same period of 2009.  Other income and expense consists primarilyof (i) fair value adjustments on warrants and (ii) short-termexchange rate gains and losses associated with the volatility of the U.S. dollarto the British pound sterling and euro on the current portion of certain assetsand liabilities.  The change in the fairvalue of warrants during the nine months ending September 30, 2010resulted in expense of $0.1 million compared to income of $0.4 million in thesame period of 2009.  The remainingincome of $0.1 million for the nine months ending September 30, 2010 waspredominantly related to short-term exchange rate gains.

 

**Gain onextinguishment of debt**

 

Werecorded a gain on the extinguishment of debt of $0.5 million in the thirdquarter of 2010 as a result of the substantial modification of the creditfacility with our senior lender.  On August 31,2010, we repaid all except $1 million of debt owed to our senior lender andamended the Credit Agreement substantially for amount, terms, rates andrepayment.  This resulted in thetransaction being accounted for as an extinguishment of debt.  In connection with the transaction, thesenior lender waived the deferred fees owed to them at maturity and agreed tosell the warrants held by their affiliate for $100,000.  The gain on extinguishment of debt includesthe amount of fair value of the warrants that exceeded the purchase price of$0.3 million, the reversal of the deferred fees and the legal costs associatedwith the transaction.  See Note 11 in theaccompanying notes to condensed consolidated financial statements.

 

**Incometax provision (benefit)**

 

Incometax benefit amounted to $0.6 million for the nine months ending September 30,2010 compared to expense of $0.5 million for the same period of 2009.  We recorded income tax expense in the 2009period primarily as a result of foreign income tax on foreign earned profits inEurope.  The income tax benefit in the2010 period was related to the losses from continuing operations that weincurred during 2010.

 

**(Loss)Income from discontinued operations**

 

Inconnection with the sale of the RO Operations on March 20, 2010 and thesale of the ACC Operations on August 31, 2010, we reported income fromdiscontinued operations of $1.5 million (net of tax of $0.8 million) during thenine months ending September 30, 2010, which includes a $0.5 million losson the sale of the RO Operations and a $0.3 million loss on the sale of the ACCOperations, offset by $1.9 million in operating income from thosesubsidiaries.  We reported income fromdiscontinued operations of $7.5 million during the nine months ending September 30,2009, which includes a $7.2 million gain on the sale of the DigitranOperations.

 

**Net income(loss)**

 

Wereported a net loss of $2.9 million in the nine months ending September 30,2010 and net income of $2.5 million in the same period of 2009.  Included in net loss in the 2010 period was anoverall decline in net sales and gross profit from continuing operations, $0.9million in non-recurring employee transaction costs, $0.5 million innon-recurring costs associated with transaction activities and $1.9 million ofinterest expense, which were partially offset by $0.5 million gain on extinguishmentof debt and $1.5 million of income from discontinued operations, discussedabove.

 

**Liquidity and CapitalResources**

 

Inmaking an assessment of our liquidity, we believe that the items in ourfinancial statements that are most relevant to our ongoing operations areworking capital, cash generated from operating activities and cash availablefrom financing activities.  We fund ourdaily cash flow requirements through funds provided by 

 

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operationsand through borrowings under our various lines of credit.  Working capital from continuing operationswas $10.8 million at September 30, 2010 as compared to negative $3.5million at December 31, 2009.  Theincrease in working capital was the result of the repayment of substantiallyall of the debt owed to GVEC Resource IV Inc. (“Lender”) and an increase incash balances from the proceeds of the ACC Transaction.  At September 30, 2010 andDecember 31, 2009, we had accumulated deficits of $29.4 million and $26.6million, respectively, and cash and cash equivalents of $5.8 million and $4.0million, respectively.

 

Netcash used in operating activities during the nine months ended September 30,2010 totaled $1.7 million.  Significantnon-cash adjustments to our net loss for 2010 include (i) the amortizationof debt discount and amortization of deferred financing costs which, on acombined basis, totaled $0.6 million, both of which are non-cash components ofinterest expense associated with our Credit Agreement, and(ii) depreciation and amortization expense which totaled $0.8 million.  The primary significant use of cashassociated with operating activities during the nine months ending September 30,2010 was an increase in prepaid and other assets by approximately $1.4 millionprimarily associated with a receivable recorded for insurance recoveries fromthe fire at CXR AJ.  The primary sourcesof cash associated with operating activities during the nine months ending September 30,2010 included a decrease in accounts receivable, which decreased by $1.0million, due primarily to steady collections on sales and lower sales in 2010,a decrease in inventory of $0.9 million primarily due to the impairment of rawmaterials inventory destroyed in the fire at CXR AJ, and an increase inaccounts payable and accrued expenses of $0.6 million primarily related totransaction costs accrued at the time of the ACC Transaction.

 

Cashgenerated from our investing activities during the nine months ending September 30,2010 totaled $17.7 million. This amount consisted primarily of net cashproceeds generated by the March 2010 sale of the RO Operations and the August 2010sale of the ACC Operations.

 

Cashused in financing activities during the nine months ending September 30,2010 totaled $14.0 million, which was primarily from the repayment of $9.5 millionof debt owed to the Lender and $3.1 million owed to the Former Shareholders.

 

AtSeptember 30, 2010, we had total debt obligations of $4.2 million.  Total debt includes a term loan to the Lenderof $1.0 million, notes payable to stockholders of less than $0.1 million,capital lease obligations of $0.3 million and notes payable to the FormerShareholders of $2.8 million, the current portion of which loans andobligations totaled $0.2 million.

 

OnAugust 31, 2010, two of our UK subsidiaries, Pascall Electronics Limited (“Pascall”)and XCEL Power Systems, Ltd. (“XCEL”), each entered into a ReceivablesFinance Agreement with Lloyds (each, a “Receivables Finance Agreement” and,collectively, the “Receivables Finance Agreements”), pursuant to which Lloydsagreed to provide Pascall and XCEL a credit facility to support their UKoperations in the aggregate principal amount of £2,75 million ($4.3 millionbased on the exchange rate on September 30, 2010), in each case at anadvance rate of 85%, a discount charge of 2.5% above the base rate, and aservice fee of 0.2%.  The ReceivablesFinance Agreements bear interest at the base rate plus 2.5% on the outstandingbalance and is paid monthly.

 

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As of September 30,2010, Pascall and XCEL had no outstanding borrowings under the ReceivablesFinance Agreements.

 

On September 20,2010, our French subsidiary, CXR Anderson Jacobson (“CXR AJ”) entered into aFactoring Agreement with FACTOCIC S.A., a subsidiary of CIC Group (“CIC”) (the “CICAgreement”), pursuant to which CIC agreed to provide CXR AJ a financingarrangement to support its French operations in the aggregate principal amountof €1.35 million ($1.8 million based on the exchange rate on September 30,2010) at an advance rate of 90% of presented trade receivables.  The CIC Agreement bears interest at the threemonth EURIBOR plus 1.4%.

 

As of September 30,2010, CXR AJ had no outstanding borrowings under the CIC Agreement.

 

Ourbacklog from continuing operations was $18.6 million as of September 30,2010 as compared to $16.9 million as of December 31, 2009. The amount ofbacklog orders represents revenue that we anticipate recognizing in the future,as evidenced by purchase orders and other purchase commitments received fromcustomers, but on which work has not yet been initiated or with respect towhich work is currently in progress. Our backlog as of September 30, 2010was approximately 86% related to our electronic devices business, whichbusiness tends to provide us with long lead-times for our manufacturingprocesses due to the custom nature of the products, and approximately 14%related to our communications equipment business, which business tends todeliver standard or modified standard products from stock as orders arereceived. We believe that the majority of our current backlog will be shippedwithin the next 12 months.  However, therecan be no assurance that we will be successful in fulfilling such orders andcommitments in a timely manner or that we will ultimately recognize as revenuethe amounts reflected as backlog.

 

*CreditAgreement*

 

EMRISE(including each of its direct subsidiaries), are parties to a Credit Agreement,as amended, with the Lender, providing for a Credit Agreement in the aggregateamount of $26 million.  As of September 30,2010, we owed a total of $1.0 million under the terms of the CreditAgreement.  All references to the CreditAgreement herein refer to the Credit Agreement as amended.

 

TheCredit Agreement consisted of the Revolver and three term loans (i) a termloan in the original principal amount of $6 million (“Term Loan A”), (ii) aterm loan in the original principal amount of $10 million (“Term Loan B”) and (iii) aterm loan in the original principal amount of $3 million (“Term Loan C”).  Term Loan A was fully funded on November 30,2007 while Term Loans B and C were fully funded on August 20, 2008 inconnection with the acquisition of ACC. $6.8 million of Term Loan B and all ofTerm Loan C was repaid in March 2009, in connection with the sale of theDigitran Operations.  The remainingoutstanding principal balance of Term Loan B of $2.1 million and $4.0 millionof Term Loan A was repaid on August 31, 2010 in connection with the ACCTransaction.

 

OnAugust 31, 2010, the Borrowers and the Lender entered into AmendmentNumber 16 to Loan Documents (“Amendment 16”), which amends the Credit Agreementas of such date.  Pursuant to Amendment16, the Lender, among other things, (i) provided a term loan of up to $1million to the Borrowers, (ii) terminated and released all of the Lender’ssecurity interests in the assets of ACC and CCI, (iii) provided consent tothe consummation of the transactions contemplated by a Master Agreement, dated June 7,2010, by and among the Company, EEC, CXR Larus, Pascall, XCEL, CXR AJ, and theFormer Shareholders, (the “Master Agreement”), as further described below, (iv) waivedapproximately $0.2 million in amendment and waiver fees owing to the Lender,and (v) provided for the execution and delivery of the Deeds of Priorityin favor of Lloyds with respect to the Receivables Finance Agreements providedby Lloyds to each of XCEL and Pascall.

 

Alsoin connection with Amendment 16, the Lender accepted an Amended and RestatedTerm Loan A Note, dated August 31, 2010, which is a two-year interestbearing secured note in the principal amount of $1.0 million (the “PEM Note”).  The PEM Note will be payable interest only ona monthly basis for the first 18 

 

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months,with equal monthly payments of principal plus interest due thereafter through maturity.  The PEM Note will be payable at a rate of12.5% per annum during the first 12 months and 15.5% per annum thereafter untilpaid in full, plus any applicable default rate or late fees.

 

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

 

*FormerShareholder Debt*

 

TheFormer Shareholders’ subordinated secured contingent promissory notes, whichEEC issued in May 2008 and which were subsequently amended in November 2009,were amended by Amendment No. 2, effective August 31, 2010 (the “AmendedSubordinated Contingent Notes”).  TheAmended Subordinated Contingent Notes bear interest at the prime rate asreported in The Wall Street Journal plus 1% and mature on August 31, 2013(the “Maturity Date”).  Interest ispayable quarterly beginning October 1, 2010 through the MaturityDate.  No principal payments are dueuntil October 1, 2012, when quarterly principal payments in the amount of$0.2 million will be paid with the outstanding principal balance due at theMaturity Date.  As of September 30,2010, the Company had $2.9 million outstanding principal balance under theAmended Subordinated Contingent Notes.

 

*Liquidity*

 

In combination with the net cash proceeds of thesale of the ACC Operations and the cash flow from operations, we believe wehave sufficient funding to support our working capital requirements during thenext 12 months.  We are stillevaluating the funding requirements to support our business plan beyond 12months.

 

Our ability to support our business plan isdependent upon our ability to achieve profitable operations, manage costs andsatisfy long-term debt service obligations, which will begin in the firstquarter of 2012. Management believes we will be able to achieve profitability,manage costs and satisfy our debt service obligations.  However, if we are unable to do so, we may berequired to sell additional assets or stock, complete a recapitalization, orconsummate a merger transaction in order to continue operations.

 

Ifour net losses from operations continue, we will likely experience negativecash flow and if we are not able to attain, sustain or increase profitabilityon a quarterly or annual basis, we may not be able to continue operations.

 

To address these potential financing needs, we may explore a reviseddebt structure with our existing lenders; additional or new financing withanother lender or lenders; expedite the sale of additional assets to generatecash; complete a recapitalization, or consummate a merger or othertransaction.  Successfully executingthese strategies is uncertain and there are many risks associated withattempting to execute each, in addition to the risks and uncertainties of theshort and long term impact of executing on any of these strategies.   Failure to meet our financingrequirements, if and when needed, would have an adverse effect on ouroperations and/or ability to do business after that date or could restrict ourgrowth, limit the development of new products, hinder our ability to fulfillexisting or future orders or negatively affect our ability to secure newcustomers or product orders.

 

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**Effects of Inflation**

 

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

 

**Impacts of New AccountingPronouncements**

 

**Revenue Recognition**.  In October 2009, the FinancialAccounting Standards Board (“FASB”) issued an update to existing guidance onrevenue recognition for arrangements with multiple deliverables.  This update will allow companies to allocateconsideration received for qualified separate deliverables using estimatedselling prices for both delivered and undelivered items when vendor-specific objectiveevidence or third-party evidence is unavailable.  Additional disclosures discussing the natureof multiple element arrangements, the types of deliverables under thearrangements, the general timing of their delivery, and significant factors andestimates used to determine estimated selling prices are required.  We will adopt this update for new revenuearrangements entered into or materially modified beginning January 1,2011.  We are still evaluating theimpact, if any, of the adoption of this new revenue recognition guidance on ourcondensed consolidated financial statements.

 

**ITEM 3.      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

Notapplicable.

 

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

 

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

 

Management is responsiblefor establishing and maintaining adequate internal control over financialreporting. The Company maintains disclosure controls and procedures that aredesigned to ensure that information required to be disclosed in the Company’sreports pursuant to the Securities Exchange Act of 1934, as amended, isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms, and that such information is accumulated andcommunicated to the Company’s management, including its Principal ExecutiveOfficer and Principal Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement necessarily was required to apply its judgment in evaluating thecost-benefit relationship of possible controls and procedures.

 

Based on an evaluation ofour disclosure controls and procedures required by paragraph (b) of Rule 13a-15or Rule 15d-15, as of September 30, 2010, our Principal ExecutiveOfficer and Principal Financial Officer have concluded that our disclosurecontrols and procedures were not effective, because of the four materialweaknesses set forth below that were identified as part of our evaluation ofthe effectiveness of our internal controls over financial reporting at December 31,2009.

 

***Summary of Material Weaknesses***

 

Set forth below is a summaryof the various significant deficiencies which caused management to concludethat we had four material weaknesses.

 

(1) We did noteffectively implement comprehensive entity-level internal controls, asevidenced by the following control deficiencies:

 

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· Entity Level InternalControl Evaluation. We did not formally consider entity-wide controls that arepervasive across our company when considering whether control activities aresufficient to address identified risks.

 

· Fraud Considerations. Wedid not conduct regular formalized assessments to consider risk factors thatinfluence the likelihood of someone committing a fraud and the impact of afraud on our financial reporting.

 

· Objective Evaluation ofInternal Controls. We did not use an internal audit function or other objectiveparty to provide an objective perspective on key elements of the internalcontrol system.

 

· Assessment of InformationTechnology. We did not formally evaluate the extent of the needed informationtechnology controls in relation to our assessment of processes and systemssupporting financial reporting.

 

· Information Technology. Wedid not have sufficient information technology controls, where applicable,designed and implemented to support the achievement of financial reportingobjectives.

 

· Ongoing and SeparateEvaluations. We did not effectively create and maintain effective evaluationson the progress of our remediation efforts nor the constant evaluations of theoperating effectiveness of our internal controls over financial reporting.

 

· Reporting Deficiencies. Wedid not perform timely and sufficient internal or external reporting of ourprogress and evaluation of prior year material weaknesses or the current fiscalyear internal control deficiencies.

 

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

 

(3) We did not maintaina sufficient level of information technology personnel to execute generalcomputing controls over our information technology structure, which include theimplementation and assessment of information technology policies andprocedures. This control deficiency did not result in an audit adjustment toour 2010 interim or 2009 annual consolidated financial statements, but couldresult in a material misstatement of significant accounts or disclosures, whichwould not have been prevented or detected.

 

(4) We are a relativelycomplex company with operations conducted in multiple countries, multiplecurrencies and multiple languages. We have divested four separate operations inthe past 18 months, acquired a large subsidiary during the same time, and weare in the process of divesting additional assets in order to repay our currentobligations. All of these transactions give rise to complex accounting and taxtreatments. Most recently, we have been concentrating our efforts in securingamendments to our current Credit Agreement and ensuring adherence to milestonesset forth in our most recent Credit Agreement amendment. Our finance team is a relativelysmall but experienced staff. Although we believe the accounting staff arequalified to perform their functions, due to reasons above, the quantity ofstaff may be insufficient to deal with the work load and complexities created,which could result in material misstatements to our financial statements.

 

***Remediation of Internal Control Deficiencies***

 

Through the efforts ofmanagement, external consultants and our Audit Committee, we are currently inthe process of executing specific action plans to remediate the materialweaknesses identified above. If we are 

 

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able to complete theseactions in a timely manner, we anticipate that all control deficiencies andmaterial weaknesses will be remediated in 2011.

 

We are developing specificaction plans for each of the above material weaknesses. In addition, we haveretained an external tax consulting firm to prepare the tax provision on aquarterly and annual basis and review our complex tax treatments, which we hopewill resolve one of our material weaknesses in 2010.  The audit committee will also work directlywith management and outside consultants, as necessary, to ensure that boardlevel deficiencies are addressed.

 

We are uncertain at thistime of the costs to remediate all of the above listed material weaknesses,however, we anticipate the cost to be in the range of $50,000 to $100,000, mostof which costs we expect to incur during 2011. We cannot guarantee that theactual costs to remediate these deficiencies will not exceed this amount.

 

Through these steps, webelieve that we are addressing the deficiencies that affected our internalcontrol over financial reporting. Because the remedial actions require hiringof additional resources, upgrading certain of our information technologysystems, and relying extensively on manual review and approval, the successfuloperation of these controls for at least several quarters may be requiredbefore management may be able to conclude that the material weaknesses havebeen remediated. We intend to continue to evaluate and strengthen our internalcontrol over financial reporting systems. These efforts require significant timeand resources. If we are unable to establish adequate internal control overfinancial reporting systems, we may encounter difficulties in the audit orreview of our financial statements by our independent registered publicaccounting firm, which in turn may have a material adverse effect on ourability to prepare financial statements in accordance with GAAP and to complywith our SEC reporting obligations.

 

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

 

There has been no change inour internal control over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) during the most recently completedfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting, except forthe engagement of a tax consulting firm to prepare our quarterly and annual taxprovisions and evaluate tax complex tax positions, which will assist inremediation of the above material weaknesses.

 

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**PART II— OTHER INFORMATION**

 

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

 

***Common Stock Issuance to Charles Brand***

 

Inconnection with the ACC Transaction, pursuant to the Master Agreement, Mr. Brandaccepted $450,000 worth of the Company’s common stock pursuant to a StockIssuance Agreement, dated August 31, 2010, by and between Mr. Brandand the Company (the “Stock Issuance Agreement”).  The Company issued to Mr. Brand 417,525shares of Company common stock pursuant to the Stock Issuance Agreement, whichwas calculated using a per share price of $1.07778.  The per share price was determined byapplying a 15% premium to $0.9372, the volume weighted average price of theshares from June 8, 2010 through June 10, 2010, as required by theMaster Agreement.  Such issuance was madein a private transaction exempt from registration pursuant to Section 4(2) ofthe Securities Act of 1933, as amended. The shares were issued as partial payment on Mr. Brand’s AmendedSubordinated Contingent Note, reducing the principal by $450,000, and with nocash consideration.

 

***Issuer Purchases of EquitySecurities***

 
| **Period**                                 | ** ** | **Total Number  of Shares  Purchased(1)** | ** ** | **Average Price  Paid Per Share** | ** ** | **Total Number of  Shares Purchased  as Part of Publicly  Announced Plans  or Programs** | ** ** | **Maximum Number  of Shares that May Yet  Be Purchased Under  the Plans or Program** | ** ** |
|--------------------------------------------|------------|-----------------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|------------|
| July 1 - July 31, 2010           |       | —                                              |       | —                                           |       | N/A                                                                                                                              |       | N/A                                                                                                                                    |       |
| August 1 - August 31, 2010       |       | 775,758                                             |       | N/A                                              |       | N/A                                                                                                                              |       | N/A                                                                                                                                    |       |
| September 1 - September 30, 2010 |       | —                                              |       | —                                           |       | N/A                                                                                                                              |       | N/A                                                                                                                                    |       |

 

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(1) On August 31, 2010, the Company closed on a transaction with PEM involvingthe purchase from PEM of two warrants for an aggregate purchase price of $100,000,each warrant representing the right to purchase 387,879 shares of common stockof the Company and which were originally issued by the Company to PEM on November 30,2007 and amended and restated on February 12, 2009, pursuant to a WarrantPurchase Agreement by and among the Company and PEM that was entered into on August 30,2010.

 

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

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                             |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                        |
| 10.1       |       | Amended  and Restated Term Loan A Note, dated August 31, 2010, executed by EMRISE  Corporation, EMRISE Electronics Corporation, and CXR Larus Corporation in  favor of GVEC Resource IV Inc. (1)                                                                                                       |
|       |       |                                                                                                                                                                                                                                                                                                        |
| 10.2       |       | Amendment  Number 14 to Loan Documents dated as of August 31, 2010 by and among  EMRISE Corporation, EMRISE Electronics Corporation, CXR Larus Corporation,  Advanced Control Components, Inc., Custom Components, Inc., GVEC  Resource IV Inc. and Private Equity Management Group LLC. *   |
|       |       |                                                                                                                                                                                                                                                                                                        |
| 10.3       |       | Amendment  Number 15 to Loan Documents dated as of August 31, 2010 by and among  EMRISE Corporation, EMRISE Electronics Corporation, CXR Larus Corporation,  Advanced Control Components, Inc., Custom Components, Inc., GVEC  Resource IV Inc. and Private Equity Management Group LLC. *   |
|       |       |                                                                                                                                                                                                                                                                                                        |
| 10.4       |       | Amendment  Number 16 to Loan Documents dated as of August 31, 2010 by and among  EMRISE Corporation, EMRISE Electronics Corporation, CXR Larus Corporation,  Advanced Control Components, Inc., Custom Components, Inc., GVEC  Resource IV Inc. and Private Equity Management Group LLC. (1) |
|       |       |                                                                                                                                                                                                                                                                                                        |
| 10.5       |       | Amended  and Restated Security Agreement, dated August 31, 2010, by and among  EMRISE Electronics Corporation, EMRISE Corporation, CXR Larus Corporation,  Pascall Electronics Limited, XCEL Power Systems, Ltd., Charles S. Brand,  Thomas P.M. Couse and Joanne Couse.(1)                  |
|       |       |                                                                                                                                                                                                                                                                                                        |
| 10.6       |       | Form of  Amendment No. 2 to Subordinated Contingent Secured Promissory Notes  issued by EMRISE Electronics Corporation, Charles S. Brand, Thomas P.M.  Couse, and Joanne Couse.(1)                                                                                                           |
|       |       |                                                                                                                                                                                                                                                                                                        |
| 10.7       |       | Stock  Issuance Agreement, dated August 31, 2010, by and between Charles Brand  and EMRISE Corporation.(1)                                                                                                                                                                                             |
|       |       |                                                                                                                                                                                                                                                                                                        |
| 10.8       |       | Form of  Receivables Finance Agreement, dated August 31, 2010, between Lloyds TSB  Commercial Finance Limited and Pascall Electronics Limited.(1)                                                                                                                                                 |
|       |       |                                                                                                                                                                                                                                                                                                        |
| 10.9       |       | Form of  Receivables Finance Agreement, dated August 31, 2010, between Lloyds TSB  Commercial Finance Limited and XCEL Power Systems Limited.(1)                                                                                                                                                  |
|       |       |                                                                                                                                                                                                                                                                                                        |
| 10.10      |       | Form of  All Assets Debenture Given by Pascall Electronics Limited in Favour of Lloyds  TSB Commercial Finance Limited.(1)                                                                                                                                                                             |
|       |       |                                                                                                                                                                                                                                                                                                        |
| 10.11      |       | Form of  All Assets Debenture Given by XCEL Power Systems Limited in Favour of Lloyds  TSB Commercial Finance Limited.(1)                                                                                                                                                                              |
|       |       |                                                                                                                                                                                                                                                                                                        |
| 10.12      |       | Warrant  Purchase Agreement, dated August 31, 2010, by and among EMRISE  Corporation and Private Equity Management Group, LLC.(1)                                                                                                                                                                      |
|       |       |                                                                                                                                                                                                                                                                                                        |
| 10.13      |       | Form of  Separation and Release Agreement, dated August 31, 2010, by and between  EMRISE Corporation and D. John Donovan.(1)                                                                                                                                                                      |
|       |       |                                                                                                                                                                                                                                                                                                        |
| 10.14      |       | The  English translation of a Factoring Agreement dated September 20, 2010 by  and between CXR Anderson Jacobson and Factocic S.A.*                                                                                                                                                                    |
|       |       |                                                                                                                                                                                                                                                                                                        |
| 31.1       |       | Certification  of Principal Executive Officer required by Rule 13a-14(a) or  15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*                                                                      |

 

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|   |   |                                                                                                                                                                                                                                   |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.2   |   | Certification  of Principal Financial Officer required by Rule 13a-14(a) or  15d-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 Principal Executive Officer Pursuant to 18 U.S.C. Section 1350,  as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*                                                               |
|   |   |                                                                                                                                                                                                                                   |
| 32.2   |   | Certification  of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350,  as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*                                                               |

 

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* Filed herewith.

 

(1) Incorporated by reference to the Company’sCurrent Report on Form 8-K filed on September 7, 2010.

 

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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: November 15, 2010 | By:                | /s/  CARMINE T. OLIVA |
|                          |               | Carmine  T. Oliva, |
|                          |               | Chief  Executive Officer (Principal Executive Officer) |
|                          |               |   |
| Dated: November 15, 2010 | By:                | /s/  BRANDI L. FESTA |
|                          |               | Brandi  L. Festa, |
|                          |               | Director  of Finance and Administration |
|                          |               | (Principal  Financial and Accounting Officer) |

 

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**INDEXTO EXHIBITS ATTACHED TO THIS REPORT**

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                         |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                              |
| 10.2       |       | Amendment  Number 14 to Loan Documents dated as of August 31, 2010 by and among  EMRISE Corporation, EMRISE Electronics Corporation, CXR Larus Corporation,  Advanced Control Components, Inc., Custom Components, Inc., GVEC  Resource IV Inc. and Private Equity Management Group LLC. |
|       |       |                                                                                                                                                                                                                                                                                                    |
| 10.3       |       | Amendment  Number 15 to Loan Documents dated as of August 31, 2010 by and among  EMRISE Corporation, EMRISE Electronics Corporation, CXR Larus Corporation,  Advanced Control Components, Inc., Custom Components, Inc., GVEC  Resource IV Inc. and Private Equity Management Group LLC. |
|       |       |                                                                                                                                                                                                                                                                                                    |
| 10.14      |       | The  English translation of a Factoring Agreement dated September 20, 2010 by  and between CXR Anderson Jacobson and Factocic S.A.                                                                                                                                                                 |
|       |       |                                                                                                                                                                                                                                                                                                    |
| 31.1       |       | Certification  of Principal Executive Officer required by Rule 13a-14(a) or  15d-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) or  15d-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 Principal Executive Officer Pursuant to 18 U.S.C. Section 1350,  as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                 |
|       |       |                                                                                                                                                                                                                                                                                                    |
| 32.2       |       | Certification  of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350,  as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                 |

 

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