Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

** **

**(Mark One)**

 

**x****      QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended****March 31,2009**

 

**or**

 

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the transition period from                            to                            **

 

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

** **

**EMRISECORPORATION**

(Exact name ofregistrant as specified in its charter)

 

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

 

**611Industrial Way**

**Eatontown,New Jersey 07224**

(Address of principalexecutive offices) (Zip code)

 

**(732) 389-0355**

(Registrant’s telephone number, including area code)

 

**Not applicable**

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

 

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

 

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

 

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

 

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

(do not check if Smaller Reporting Company) |   | Smaller  Reporting Company x |

 

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

 

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

** **

 

** **

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Table of Contents

 

**EMRISE CORPORATION**

**TABLE OF CONTENTS**

**FORM 10-Q**

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

** **
| **PART I. FINANCIAL INFORMATION**                                                                                     |                                                                                            |
|----------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|
| ** **                                                                                                                 | ** **                                                                                      |   |
| **ITEM 1.**                                                                                                                | **FINANCIAL  STATEMENTS**                                                                       |   |
|                                                                                                                       |                                                                                            |   |
| Condensed Consolidated  Balance Sheets as of March 31, 2009 (unaudited) and December 31,  2008                   | 1                                                                                               |
|                                                                                                                       |                                                                                            |
| Condensed Consolidated  Statements of Operations for the Three Months Ended March 31, 2009 and  2008 (unaudited)      | 2                                                                                               |
|                                                                                                                       |                                                                                            |
| Condensed  Consolidated Statements of Stockholders’ Equity for the Three Months Ended  March 31, 2009(unaudited) | 3                                                                                               |
|                                                                                                                       |                                                                                            |
| Condensed  Consolidated Statements of Cash Flows for the Three Months Ended  March 31, 2009 and 2008 (unaudited)      | 4                                                                                               |
|                                                                                                                       |                                                                                            |
| Notes to  Condensed Consolidated Financial Statements (unaudited)                                                          | 5                                                                                               |
|                                                                                                                       |                                                                                            |   |
| **ITEM 2.**                                                                                                                | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** | 21 |
|                                                                                                                       |                                                                                            |   |
| **ITEM 3.**                                                                                                                | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                 | 35 |
|                                                                                                                       |                                                                                            |   |
| **ITEM 4.**                                                                                                                | **CONTROLS AND  PROCEDURES**                                                                    | 35 |
|                                                                                                                       |                                                                                            |   |
| **ITEM 4T.**                                                                                                               | **CONTROLS AND  PROCEDURES**                                                                    | 35 |
|                                                                                                                       |                                                                                            |   |
| **PART II  OTHER INFORMATION**                                                                                        |                                                                                            |
| ** **                                                                                                                 | ** **                                                                                      |   |
| **ITEM 1.**                                                                                                                | **LEGAL PROCEEDINGS**                                                                           | 40 |
|                                                                                                                       |                                                                                            |   |
| **ITEM 1A.**                                                                                                               | **RISK FACTORS**                                                                                | 40 |
|                                                                                                                       |                                                                                            |   |
| **ITEM 2.**                                                                                                                | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                | 40 |
|                                                                                                                       |                                                                                            |   |
| **ITEM 3.**                                                                                                                | **DEFAULTS  UPON SENIOR SECURITIES**                                                            | 40 |
|                                                                                                                       |                                                                                            |   |
| **ITEM 4.**                                                                                                                | **SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS**                                        | 40 |
|                                                                                                                       |                                                                                            |   |
| **ITEM 5.**                                                                                                                | **OTHER INFORMATION**                                                                           | 41 |
|                                                                                                                       |                                                                                            |   |
| **ITEM 6.**                                                                                                                | **EXHIBITS**                                                                                    | 42 |
|                                                                                                                       |                                                                                            |   |
| **SIGNATURES**                                                                                                             | 43                                                                                              |

 

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Table of Contents

 

**PART I— FINANCIAL INFORMATION**

** **

**ITEM 1. FINANCIAL STATEMENTS**

 

**EMRISE CORPORATION**

**Condensed Consolidated Balance Sheets**

(in thousands,except share and per share amounts)

 
| ** **                                                                                                                                                  | ** ** | **March 31,** | ** **   | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|--------------|-----------------------|------------|
| ** **                                                                                                                                                  | ** ** | **2009**           | ** **   | **2008**              | ** ** |
| ** **                                                                                                                                                  | ** ** | **(Unaudited)**    | ** **   | ** **            | ** ** |
| **ASSETS**                                                                                                                                                  |       |               |         |                  |       |
| Current assets:                                                                                                                                             |       |               |         |                  |       |
| Cash and cash  equivalents                                                                                                                                  |       | $                  |  3,629  |                  | $          |  3,242 |   |
| Accounts  receivable, net of allowances for doubtful accounts of $427 at March 31,  2009 and $462 at December 31, 2008                            |       | 9,475              |         | 10,333                |       |
| Inventories, net                                                                                                                                            |       | 12,300             |         | 12,501                |       |
| Current deferred  tax assets                                                                                                                                |       | 175                |         | 271                   |       |
| Prepaid and  other current assets                                                                                                                           |       | 1,544              |         | 1,283                 |       |
| Current assets  of discontinued operations                                                                                                                  |       | —             |         | 2,724                 |       |
| Total current  assets                                                                                                                                       |       | 27,123             |         | 30,354                |       |
|                                                                                                                                                        |       |               |         |                  |       |
| Property, plant  and equipment, net                                                                                                                         |       | 2,768              |         | 2,990                 |       |
| Goodwill                                                                                                                                                    |       | 9,544              |         | 9,657                 |       |
| Intangible  assets other than goodwill, net                                                                                                                 |       | 6,344              |         | 6,618                 |       |
| Deferred tax  assets                                                                                                                                        |       | 1,916              |         | 2,191                 |       |
| Other assets                                                                                                                                                |       | 540                |         | 683                   |       |
| Noncurrent  assets of discontinued operations                                                                                                               |       | —             |         | 1,130                 |       |
| Total assets                                                                                                                                                |       | $                  |  48,235 |                  | $          |  53,623 |   |
|                                                                                                                                                        |       |               |         |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                               |       |               |         |                  |       |
| Current  liabilities:                                                                                                                                       |       |               |         |                  |       |
| Accounts payable                                                                                                                                            |       | $                  |  5,739  |                  | $          |  4,625 |   |
| Accrued expenses                                                                                                                                            |       | 6,454              |         | 6,939                 |       |
| Line of credit                                                                                                                                              |       | 4,068              |         | 4,084                 |       |
| Current portion  of long-term debt                                                                                                                          |       | 1,985              |         | 5,121                 |       |
| Notes payable to  stockholders, current portion                                                                                                             |       | 500                |         | 542                   |       |
| Income taxes  payable                                                                                                                                       |       | 1,270              |         | 451                   |       |
| Other current  liabilities                                                                                                                                  |       | 357                |         | 357                   |       |
| Current  liabilities of discontinued operations                                                                                                             |       | —             |         | 664                   |       |
| Total current  liabilities                                                                                                                                  |       | 20,373             |         | 22,783                |       |
|                                                                                                                                                        |       |               |         |                  |       |
| Long-term debt,  net of discount of $853 and $980, respectively                                                                                             |       | 6,569              |         | 13,479                |       |
| Notes payable to  stockholders, less current portion                                                                                                        |       | 125                |         | 250                   |       |
| Deferred income  taxes                                                                                                                                      |       | 1,927              |         | 2,203                 |       |
| Warrant  liability                                                                                                                                          |       | 880                |         | —                |       |
| Other  liabilities                                                                                                                                          |       | 476                |         | 503                   |       |
| Noncurrent  liabilities of discontinued operations                                                                                                          |       | —             |         | 401                   |       |
| Total  liabilities                                                                                                                                          |       | 30,350             |         | 39,619                |       |
|                                                                                                                                                        |       |               |         |                  |       |
| Commitments and  contingencies                                                                                                                              |       |               |         |                  |       |
|                                                                                                                                                        |       |               |         |                  |       |
| Stockholders’  equity:                                                                                                                                 |       |               |         |                  |       |
| Preferred  stock,$0.01 par value. Authorized 10,000,000 shares, zero shares issued and  outstanding                                                         |       | —             |         | —                |       |
| Common stock,$0.0033  par value. Authorized 150,000,000 shares; 10,204,079 shares issued and  outstanding at March 31, 2009 and December 31, 2008 |       | 126                |         | 126                   |       |
| Additional  paid-in capital                                                                                                                                 |       | 43,359             |         | 44,806                |       |
| Accumulated  deficit                                                                                                                                        |       | (22,355            | )            | (28,101               | )          |
| Accumulated  other comprehensive loss                                                                                                                       |       | (3,245             | )            | (2,827                | )          |
| Total  stockholders’ equity                                                                                                                            |       | 17,885             |         | 14,004                |       |
| Total  liabilities and stockholders’ equity                                                                                                            |       | $                  |  48,235 |                  | $          |  53,623 |   |

 

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

 

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Operations**

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

 
| ** **                                                            | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                            | ** ** | **March 31,**     | ** ** |
| ** **                                                            | ** ** | **2009**               | ** ** | **2008** | ** ** |
|                                                                  |       |                   |       |   |   |
| Net Sales                                                             |       | $                      | 14,213     |   | $ | 10,643 |   |
| Cost of Sales                                                         |       | 9,256                  |       | 7,203 |   |
| Gross profit                                                          |       | 4,957                  |       | 3,440 |   |
|                                                                  |       |                   |       |   |   |
| Operating expenses:                                                   |       |                   |       |   |   |
| Selling, general  and administrative                                  |       | 4,547                  |       | 3,538 |   |
| Engineering and  product development                                  |       | 522                    |       | 503 |   |
| Total operating  expenses                                             |       | 5,069                  |       | 4,041 |   |
| Loss from  operations                                                 |       | (112                   | )          | (601 | ) |
|                                                                  |       |                   |       |   |   |
| Other income  (expense):                                              |       |                   |       |   |   |
| Interest income                                                       |       | 46                     |       | 18 |   |
| Interest expense                                                      |       | (1,015                 | )          | (584 | ) |
| Other, net                                                            |       | (42                    | )          | (17 | ) |
| Total other  expense, net                                             |       | (1,011                 | )          | (583 | ) |
|                                                                  |       |                   |       |   |   |
| Loss before  income taxes                                             |       | (1,123                 | )          | (1,184 | ) |
| Income tax  provision                                                 |       | (350                   | )          | 84 |   |
| Loss from  continuing operations                                      |       | (773                   | )          | (1,268 | ) |
| Discontinued  operations:                                             |       |                   |       |   |   |
| Income from  discontinued operations including gain on sale of $7,224 |       | 7,402                  |       | 371 |   |
| Tax provision on  discontinued operations                             |       | 1,356                  |       | — |   |
| Net gain on  discontinued operations                                  |       | 6,046                  |       | 371 |   |
|                                                                  |       |                   |       |   |   |
| Net Income  (loss)                                                    |       | $                      | 5,273      |   | $ | (897 | ) |
|                                                                  |       |                   |       |   |   |
| Earnings (loss)  per share:                                           |       |                   |       |   |   |
| Basic                                                                 |       | $                      | 0.52       |   | $ | (0.09 | ) |
| Diluted                                                               |       | $                      | 0.51       |   | $ | (0.09 | ) |
|                                                                  |       |                   |       |   |   |
| Weighted average  shares outstanding                                  |       |                   |       |   |   |
| Basic                                                                 |       | 10,204                 |       | 10,204 |   |
| Diluted                                                               |       | 10,239                 |       | 10,204 |   |

 

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

 

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**EMRISECORPORATION**

**Condensed Consolidated Statements of Stockholders’Equity**

(Unaudited)****(in thousands)

* *
| ** **                                                                        | ** ** | ** **       | ** ** | ** **  | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------|------------|-------------|------------|-----------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                        | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **        | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                                                                        | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                                                                        | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**       | ** ** | **Loss**        | ** ** | **Total**  | ** ** |
|                                                                              |       |             |       |        |       |            |       |              |       |            |       |       |       |
| Balance  at December 31, 2008                                                |       | 10,204           |       | $           | 126        |            | $          | 44,806            |       | $               | (28,101    | )          | $          | (2,827 | ) | $ | 14,004 |   |
| Cumulative  effect of change in accounting principle due to adoption of EITF 07-5 |       | —           |       | —      |       | (1,483          | )          | 473               |       | —          |       | (1,010     | )          |
| Stock-based  compensation                                                         |       | —           |       | —      |       | 34              |       | —            |       | —          |       | 34         |       |
| Warrants  issued for services                                                     |       | —           |       | —      |       | 2               |       | —            |       | —          |       | 2          |       |
| Net  loss and comprehensive loss                                                  |       | —           |       | —      |       | —          |       | 5,273             |       | (418            | )          | 4,855      |       |
| Balance  at March 31, 2009                                                   |       | 10,204           |       | $           | 126        |            | $          | 43,359            |       | $               | (22,355    | )          | $          | (3,245 | ) | $ | 17,885 |   |

 

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

 

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**EMRISECORPORATION**

**Condensed Consolidated Statements of Cash Flows**

(Unaudited)****(in thousands)

 
| ** **                                                                                                                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                                | ** ** | **March 31,**     | ** ** |
| ** **                                                                                                                                | ** ** | **2009**               | ** ** | **2008** | ** ** |
|                                                                                                                                      |       |                   |       |   |   |
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                                                                                  |       |                   |       |   |   |
| Net  Income (loss)                                                                                                                        |       | $                      | 5,273      |   | $ | (897 | ) |
| Adjustments  to arrive at net loss from continuing operations                                                                             |       | (6,046                 | )          | (371 | ) |
| Net  loss from continuing operations                                                                                                      |       | (773                   | )          | (1,268 | ) |
| Reconciliation  to net cash provided by (used in) operating activities:                                                                   |       |                   |       |   |   |
| Depreciation  and amortization                                                                                                            |       | 490                    |       | 270 |   |
| Provision  for doubtful accounts                                                                                                          |       | 66                     |       | (41 | ) |
| Provision  for inventory obsolescence                                                                                                     |       | 148                    |       | 186 |   |
| Provision  for warranty reserve                                                                                                           |       | 17                     |       | (103 | ) |
| Deferred  taxes                                                                                                                           |       | 14                     |       | (4 | ) |
| Amortization  of deferred issuance costs                                                                                                  |       | 123                    |       | 108 |   |
| Amortization  of debt discount                                                                                                            |       | 127                    |       | 108 |   |
| Stock-based  compensation expense                                                                                                         |       | 34                     |       | 18 |   |
| Warrants  issued for services                                                                                                             |       | 2                      |       | 2 |   |
| Change  in common stock warrant value                                                                                                     |       | (130                   | )          | — |   |
| Changes in assets and  liabilities:                                                                                                       |       |                   |       |   |   |
| Accounts  receivable                                                                                                                      |       | 801                    |       | 90 |   |
| Inventories                                                                                                                               |       | 141                    |       | (1,052 | ) |
| Prepaid  and other assets                                                                                                                 |       | 117                    |       | 142 |   |
| Accounts  payable and accrued expenses                                                                                                    |       | (767                   | )          | 97 |   |
| Operating  cash flow used in continuing operations                                                                                        |       | 410                    |       | (1,447 | ) |
| Operating  cash flow provided by discontinued operations                                                                                  |       | 681                    |       | 402 |   |
| Net  cash provided by (used in) operating activities                                                                                      |       | 1,091                  |       | (1,045 | ) |
|                                                                                                                                      |       |                   |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                                                                 |       |                   |       |   |   |
| Purchases  of property, plant and equipment                                                                                               |       | (4                     | )          | (28 | ) |
| Additions  to intangible assets                                                                                                           |       | —                 |       | — |   |
| Investing  cash flow used in continuing operations                                                                                        |       | (4                     | )          | (28 | ) |
| Investing  cash flow provided by discontinued operations including proceeds from sale of  subsidiary operations, net of cash              |       | 10,050                 |       | (20 | ) |
| Net  cash provided by (used in) investing activities                                                                                      |       | 10,046                 |       | (48 | ) |
|                                                                                                                                      |       |                   |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                                                                 |       |                   |       |   |   |
| Net  repayments of lines of credit                                                                                                        |       | (16                    | )          | (248 | ) |
| Repayments  of long-term debt                                                                                                             |       | (10,200                | )          | (75 | ) |
| Payments  of notes to stockholders                                                                                                        |       | (168                   | )          | (146 | ) |
| Net  cash used in financing activities                                                                                                    |       | (10,384                | )          | (469 | ) |
|                                                                                                                                      |       |                   |       |   |   |
| Effect  of exchange rate changes on cash                                                                                                  |       | (545                   | )          | 252 |   |
| Net increase  (decrease) in cash and cash equivalents                                                                                     |       | 208                    |       | (1,310 | ) |
| Cash  and cash equivalents at beginning of period                                                                                         |       | 3,421                  |       | 4,764 |   |
| Cash  and cash equivalents at end of period                                                                                               |       | $                      | 3,629      |   | $ | 3,454 |   |
|                                                                                                                                      |       |                   |       |   |   |
| **SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING  AND FINANCING ACTIVITIES:**                                                             |       |                   |       |   |   |
| Acquisition  of equipment through capital lease                                                                                           |       | $                      | 22         |   | $ | 453 |   |
| Cumulative  effect of change in accounting principle - reclassification of common stock  warrants to liability upon adoption of EITF 07-5 |       | $                      | 473        |   | $ | — |   |

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 1 — SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

*Organizationand Business*

 

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

 

In March of 2009, the Company soldsubstantially all the assets related to its subsidiary, EMRISE ElectronicsCorporation’s (“EEC”), Digitran division, and all of the issued and outstandingequity interests of EEC’s wholly-owned subsidiary, XCEL Japan, Ltd.(collectively the “Digitran operations”).  Theaccompanying financial statements include the Digitran operations as adiscontinued operation.

 

*Basis of Presentation*

 

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

 

*Comprehensive Income (Loss)*

 

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

 
| ** **                               | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------|------------|------------------------|------------|
| ** **                               | ** ** | **March 31,**     | ** ** |
| ** **                               | ** ** | **2009**               | ** ** | **2008** | ** ** |
|                                     |       |                   |       |   |   |
| Net income  (loss)                       |       | $                      | 5,273      |   | $ | (897 | ) |
| Other  comprehensive income (loss):      |       |                   |       |   |   |
| Foreign currency  translation adjustment |       | (418                   | )          | 226 |   |
| Comprehensive  income (loss)             |       | $                      | 4,855      |   | $ | (671 | ) |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Revenue**Recognition*

 

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

 

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

 

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

 

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.

 

Revenues fromservices such as repairs and modifications are recognized when the service iscompleted and invoiced.  For repairs thatinvolve shipment of a repaired product, the Company recognizes repair revenueswhen the product is shipped back to the customer. Service revenues contributeless than 5% of total revenue and, therefore, are considered to be immaterialto overall financial results.

 

*Reverse Stock Split*

 

On November 19, 2008, the Companycompleted a board of directors approved 1-for-3.75 reverse split of its commonstock.  All common stock, stock optionsand warrants to purchase common stock and earnings per share amounts have beenretroactively restated as if the reverse stock split occurred at the beginningof the periods presented.

 

*Income (Loss) Per Share*

 

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

 

6

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 
| ** **                                          | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|
| ** **                                          | ** ** | **March 31,**     | ** ** |
| ** **                                          | ** ** | **2009**               | ** ** | **2008** | ** ** |
|                                                |       |                   |       |   |   |
| NUMERATOR:                                          |       |                   |       |   |   |
| Net income  (loss)                                  |       | $                      | 5,273      |   | $ | (897 | ) |
|                                                |       |                   |       |   |   |
| DENOMINATOR:                                        |       |                   |       |   |   |
| Basic weighted  average common shares outstanding   |       | 10,204                 |       | 10,204 |   |
| Effect of  dilutive securities:                     |       |                   |       |   |   |
| Dilutive stock  options and warrants                |       | 35                     |       | — |   |
| Diluted weighted  average common shares outstanding |       | 10,239                 |       | 10,204 |   |
|                                                |       |                   |       |   |   |
| Basic income  (loss) per share                      |       | $                      | 0.52       |   | $ | (0.09 | ) |
|                                                |       |                   |       |   |   |
| Diluted income  (loss) per share                    |       | $                      | 0.51       |   | $ | (0.09 | ) |

 

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

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*RecentAccounting Pronouncements*

 

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

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements.” This newstatement provides a single definition of fair value, together with a frameworkfor measuring it, and requires additional disclosure about the use of fairvalue to measure assets and liabilities. SFAS No. 157 also emphasizes thatfair value is a market-based measurement, not an entity-specific measurement,and sets out a fair value hierarchy, with the highest priority being quotedprices in active markets. The required effective date of SFAS No. 157 isthe first quarter of 2008. The adoption of SFAS No. 157 for financialassets and liabilities did not have a material effect on the Company’sconsolidated financial statements, but resulted in additional disclosurescontained herein.  In February 2008,the FASB issued Staff Position No. 157-2, which delayed by one year theeffective date of SFAS No. 157 for all non-financial assets andliabilities, except those that are recognized or disclosed at fair value in thefinancial statements on a recurring basis. The Company has evaluated the impact the adoption of SFAS No. 157for non-financial assets and liabilities have determined that the adoption ofSFAS No. 157-2 will not have a material effect on its consolidatedfinancial statements.

 

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

 

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

 

In April 2008, theFASB issued FASB Staff Position (“FSP”) No. FAS 142-3, “Determination ofthe Useful Life of Intangible Assets,” (“FSP 142-3”). FSP 142-3 amends thefactors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible assetunder SFAS No. 142, “Goodwill and Other Intangible Assets” and alsorequires expanded disclosure related to the determination of intangible assetuseful lives. FSP 142-3 is effective for fiscal years beginning after 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

December 15,2008. Early adoption is prohibited. The Company is currently evaluating theimpact the adoption of FSP 142-3 will have on its consolidated financialstatements.

 

In June 2008, theFASB ratified the consensus reached on EITF Issue No. 07-5, “DeterminingWhether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock”(“EITF 07-5”). EITF 07-5 clarifies the determination of whether an instrument(or an embedded feature) is indexed to an entity’s own stock, which wouldqualify as a scope exception under SFAS No. 133, Accounting for DerivativeInstruments and Hedging Activities. EITF 07-5 is effective for financialstatements issued for fiscal years beginning after December 15, 2008.Early adoption for an existing instrument is not permitted. The Company adoptedEITF 07-5 on January 1, 2009. See Note 12 **—**Warrants below for discussion of the impact of the adoptionof EITF 07-5 on the Company’s outstanding stock warrants and its consolidatedfinancial statements.

 

**NOTE 2 —LIQUIDITY**

 

The Company reported $5.3 million of net income forthe quarter ended March 31, 2009. Included in this net income was a $5.9 million gain (net of tax of $1.4million) on the disposition of the Company’s Digitran division and its Japanesesubsidiary, XCEL Japan, Ltd. (see Note 4). Absent this gain, the Company would have incurred a $0.6 million netloss.  If the Company’s net losses continue, it mayexperience negative cash flow, which may hamper current operations and mayprevent the Company from expanding its business.  Additionally, such losses may result in adefault on the Company’s debt covenants associated with its creditfacility.  The Company may be unable toattain, sustain or increase profitability on a quarterly or annual basis in thefuture. If the Company does not achieve, sustain or increase profitability, itsstock price may decline.  Additionally,the Company has agreed with its lender to raise at least $2 million in netproceeds through the sale of the Company’s and/or its subsidiaries’ stock by nolater than September 30, 2009. Under the terms of the Company’s credit facility, the Company isobligated to remit to its lender $500,000 with respect to the first $2,000,000of net cash proceeds received in connection with the sale of stock, 50% of thenext $1,000,000 of net cash proceeds received in connection with the sale ofstock, and 30% of the net cash proceeds in excess of the first $3,000,000received in connection with the sale of stock. The Company is currently evaluating a number of options to meet thisobligation under its credit facility, including a possible refinancing of theentire facility.  Given current economic and financial market conditionseven a small equity raise could prove difficult (see Note 11).

 

Recentactions taken by the SEC against Private Equity Management Group, Inc. (“PEMG”),an affiliate of the Company’s lender, including an order granted in April 2009by a federal court freezing all assets of PEMG and its affiliates, whichincludes the Company’s lender, may adversely affect the lender’s ability tocontinue to provide the Company funds under the terms of the Revolver (as definedin Note 10 below).  At the request of theSEC, the federal court also appointed a temporary receiver of PEMG and of the1ender.  Although the Company currentlybelieves that the receiver will allow it to continue to borrow funds under theterms of the Revolver, the Company cannot make assurances that the receiverwill allow the lender to continue to make funds available to the Company.  If, for any reason, the receiver were tolimit or terminate the Company’s ability to continue to borrow funds under theRevolver (as defined in Note 10 below), the Company’s cash position and itsability to continue day to day operations would be adversely affected, almostimmediately.  If that were to occur, theCompany would be required to seek additional and/or replacement financingimmediately.  If the Company is unable todo so, it may be forced to drastically curtail or cease operations and possiblyseek protection from its creditors under the U. S. Bankruptcy Code.

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

If the Company is able tocontinue to borrow funds under the terms of its Revolver (as defined in Note 10below), including timely funding by the lender of draw requests, managementbelieves that current and future capital resources, revenues generated fromoperations and other existing sources of liquidity will be adequate to meet theCompany’s anticipated short term, working capital and capital expendituresneeds for at least the next 12 months.  However, if the Companyexperiences a significant loss of revenue or increase in costs, or if the lenderfails to fund the Company’s draw requests in a timely manner or at all, thenthe Company’s cash flow would be negatively impacted resulting in a cash flowdeficit which, in turn, will require it to obtain additional or alternatefinancing, with little or no notice.  These potential financing needscould be met in the form of a revised debt structure with the Lender,additional or new financing with another lender or lenders, the sale of assetsto generate cash or the sale of additional equity to raise capital.  TheCompany’s failure to secure additional or alternate financing, if and whenneeded, would have an adverse effect on its operations and/or ability to dobusiness after that date or could restrict its growth, limit its development ofnew products, or hinder its ability to fulfill existing or future orders.

 

**NOTE 3 — ACQUISITION OF ADVANCEDCONTROL COMPONENTS**

 

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

 

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

 

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

 

Inconjunction with the Acquisition, the Company commissioned a valuation firm toassist it in determining the fair value of ACC’s tangible assets and theportion of the purchase price that should be allocated to identifiableintangible assets.  The Companyconsidered whether the Acquisition included various types of identifiableintangible assets, including trade names, trademarks, patents, covenants not tocompete, customers, backlog, workforce, technology and software.  As a result of the procedures performed bythe valuation firm and the evaluation of management, the Company determined andrecorded the value of the tangible and intangible assets in its CondensedConsolidated Balance Sheets in accordance with the purchase priceallocation.  The 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Companyhas estimated and recorded the identified intangible assets as follows:  trade name of $1,570,000; covenant not tocompete of $60,000; backlog of $570,000; and customer relationships of$2,550,000.

 

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

 
| Accounts  receivable                      |   | $      | 2,185  |   |
|-------------------------------------------|--------|--------|--------|--------|
| Inventories                               |   | 1,848  |   |
| Property and  equipment                   |   | 1,545  |   |
| Intangible  assets, net                   |   | 4,750  |   |
| Goodwill                                  |   | 4,073  |   |
| Other assets                              |   | 244    |   |
| Total assets  acquired                    |   | 14,645 |   |
| Accounts payable  and accrued liabilities |   | (1,678 | )      |
| Other  liabilities                        |   | (611   | )      |
| Total  liabilities assumed                |   | (2,289 | )      |
| Net assets  acquired                      |   | $      | 12,356 |   |

 

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

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

 

**NOTE 4 — DISCONTINUED OPERATIONS**

 

OnMarch 20, 2009, the Company and its wholly-owned subsidiary, EEC, enteredinto an Asset and Stock Purchase Agreement (the “Digitran Purchase Agreement”)with Electro Switch Corp., a Delaware 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

corporation(the “Buyer”) and ESC Worldwide, Inc., a Massachusetts corporation andsubsidiary of Buyer (the “Stock Buyer”).  At the closing of the DigitranPurchase Agreement on March 20, 2009, (i) the Buyer purchased fromthe Company and EEC substantially all the assets related to EEC’s Digitrandivision, and (ii) the Stock Buyer purchased from EEC all of the issuedand outstanding equity interests of its wholly-owned subsidiary, XCEL Japan,Ltd., for an aggregate purchase price of approximately $11,560,000 (the “Disposition”). Under the terms of the Purchase Agreement, the Buyer is obligated to payup to an additional $500,000 in cash to EEC if net sales for the fiscal yearending December 31, 2009 related to the businesses that were sold pursuantto the Digitran Purchase Agreement exceeds $6,835,120.

 

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

 

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

 

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

 

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

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

 

**NOTE 5 — STOCK-BASED COMPENSATION**

 

The Company has fivestock option plans:

 

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

·                  1993 StockOption Plan;

·                  1997 StockIncentive Plan;

·                  Amended andRestated 2000 Stock Option Plan; and

·                  2007 StockIncentive Plan.

 

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

 

Total stock-based compensation expense included inwages, salaries and related costs was $34,000 and $20,000 for the three monthsended March 31, 2009 and 2008, respectively. These compensation expenseswere 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

charged to selling,general and administrative expenses. As of March 31, 2009, the Company had$349,000 of total unrecognized compensation expense related to stock optiongrants, which will be recognized over the remaining weighted average period oftwo years.

 

**NOTE 6 — INVENTORIES**

 

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

 
| ** **         | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------|------------|--------------------|------------|-----------------------|------------|
| ** **         | ** ** | **2009**           | ** ** | **2008**              | ** ** |
|               |       |               |       |                  |       |
| Raw materials      |       | $                  | 9,827      |                  | $          | 10,093 |   |
| Work-in-process    |       | 2,982              |       | 3,319                 |       |
| Finished goods     |       | 4,754              |       | 4,312                 |       |
| Reserves           |       | (5,263             | )          | (5,223                | )          |
| Total  inventories |       | $                  | 12,300     |                  | $          | 12,501 |   |

 

**NOTE 7 — OPERATING SEGMENTS**

 

The Company has two reportable operating segments:electronic devices and communications equipment. The electronic devices segmentmanufactures and markets electronic power supplies, radio frequency (“RF”) andmicrowave devices and subsystem assemblies. The electronic devices segmentconsists of EEC and its subsidiaries located in the U.S. and England, whichoffer the same or similar products to similar customers.  The communications equipment segment designs,manufactures and distributes network access products and timing andsynchronization products.  Thecommunications equipment segment consists of operating entities CXR LarusCorporation located in the U.S. and CXR Anderson Jacobson located in France,both of which offer the same or similar products to similar customers.  Both segments operate in the U.S., Europeanand Asian markets, but have distinctly different customers, design andmanufacturing processes and marketing strategies.  Each segment has discrete financialinformation and a separate management structure.

 

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

 

During the first quarterof 2009, the Company sold its Digitran Operations (see Note 4), which were partof its electronic devices segment.  Thistransaction resulted in differences in the basis of segmentation from theamounts disclosed in the Company’s audited consolidated financial statementsincluded in its annual report on Form 10-K for the year ended December 31,2008.  In this Form 10-Q, theDigitran Operations are reported as a discontinued operation and are excludedfrom the electronics devices segment. Therefore, prior period amounts have been adjusted to conform with thispresentation.  Included in the Company’sreconciliation of segment financial data to the consolidated amounts isunallocated corporate expenses.

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 
| ** **                | ** ** | **Three Months Ended** | ** ** |
|---------------------------|------------|------------------------|------------|
| ** **                | ** ** | **March 31,**     | ** ** |
| ** **                | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Net sales                 |       |                   |       |   |   |
| Electronic  devices       |       | $                      | 11,595     |   | $ | 7,283 |   |
| Communications  equipment |       | 2,618                  |       | 3,360 |   |
| Total                     |       | $                      | 14,213     |   | $ | 10,643 |   |
|                      |       |                   |       |   |   |
| Operating income  (loss)  |       |                   |       |   |   |
| Electronic  devices       |       | $                      | 1,562      |   | $ | 453 |   |
| Communications  equipment |       | (452                   | )          | 18 |   |
| Corporate and  other      |       | (1,222                 | )          | (701 | ) |
| Total                     |       | $                      | (112       | ) | $ | (230 | ) |
|                      |       |                   |       |   |   |
| ** **                | ** ** | **March 31,**     | ** ** | **December 31,** | ** ** |
| ** **                | ** ** | **2009**               | ** ** | **2008** | ** ** |
| Total assets              |       |                   |       |   |   |
| Electronic  devices       |       | $                      | 34,644     |   | $ | 34,853 |   |
| Communications  equipment |       | 9,187                  |       | 10,260 |   |
| Corporate and  other      |       | 4,404                  |       | 8,510 |   |
| Total                     |       | $                      | 48,235     |   | $ | 53,623 |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 8 — GOODWILL**

 

The following table reflects changes in our goodwillbalances, by segment, for the three months ended March 31, 2009 (inthousands):

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

 

**NOTE 9 — INCOME TAXES**

 

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

 

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

 

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

 

The Company files income tax returns in the UnitedStates federal jurisdiction, the United Kingdom, France and Japan, and in thestate jurisdictions of California, Texas, Pennsylvania and New Jersey. TheCompany is no longer subject to United States federal and state taxexaminations for years before 2005 and 2004, respectively, and is no longersubject to tax examinations for the United Kingdom and Japan for years prior to2007, and for France for years prior to 2005.

 

**NOTE 10 — LINE OF CREDIT**

 

The Company and itsdirect subsidiaries, EEC, CXR Larus Corporation and RO Associates Incorporated(collectively, the “Borrowers”) are parties to a Credit Agreement (as amendedfrom time to time the “Credit Agreement”) with GVEC Resource IV Inc. (the “Lender”)providing for a credit facility in the original aggregate amount of $26,000,000and is secured by accounts receivable, other rights to payment and generalintangibles, inventories and equipment. The credit facility includes a one yearrevolving credit facility for up to $7,000,000 that may be renewed up to twotimes, each for a period of one year, at the Company’s option, provided thatcertain conditions precedent are met (the “Revolver”).  The credit facility also includes two termloans (see Note 11).

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

has a maturity date of November 30,2009 unless it is renewed, in which case the maturity date will be extended to November 30,2010.

 

Interest on the Revolveris payable monthly.  The interest rate isvariable and is adjusted monthly based on prime rate as published in the “MoneyRates” column of *The Wall Street Journal* (the “BaseRate”) plus 1.25%, subject to a minimum rate of 9.5%.  The interest rate in effect as of March 31,2009 was the minimum rate of 9.5%.  TheRevolver is subject to various financial covenants on a consolidated basis, includingthe following: EBITDA, measured on a fiscal quarter-end basis, must not be lessthan the scheduled amount for each specified period; the debt service coverageratio, measured quarterly, must be greater than the lesser of the scheduledamount for each specific period or 1.10:1.00; the leverage ratio, measuredquarterly, must not be greater than the scheduled amount for each specifiedperiod, and liquidity, measured quarterly, must not be less than the scheduledamount for each specified period.  Additionally,the Revolver is subject to the Borrowers not incurring capital expenditures (a) inexcess of $600,000 for the fiscal year ending December 31, 2009, and (b) inexcess of $1,800,000 for the fiscal year ending December 31, 2010.  Additionally, the Revolver is subjectto the borrowers not incurring unfinanced capital expenditures in excess of$62,500 in any fiscal quarter,****providedhowever that if the borrowers incur unfinanced capital expenditures of lessthan $62,500 in any fiscal quarter, the difference between the amount incurredin a certain fiscal quarter and $62,500 maybe incurred in the two fiscalquarters immediately following such fiscal quarter. The Company was not incompliance with its EBITDA, debt service coverage ratio and leverage ratiocovenants at March 31, 2009. Additionally, on April 1, 2009 theCompany voluntarily elected not to make a required interest payment on amountsborrowed under its credit facility, which amount has been subsequentlypaid.  On May 14, 2009, the Companyreceived a waiver from the Lender for these events of default.

 

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

 

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

 

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

 

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

 

**NOTE 11 — LONG-TERM DEBT**

 

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

 

The credit facility consistsof (i) the Revolver, (ii) a term loan in the principal amount of $6 million whichis due November 30, 2010 (“Term Loan A”), (iii) a term loan in the original principalamount of $10 million, which is due on November 30, 2010 (“Term Loan B”), and (iv)Term Loan C.  Term Loan A was fully fundedon 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

November 30, 2007 while TermLoans B and C were fully funded on August 20, 2008 in connection with the acquisitionof ACC.  Term Loan A and Term Loan B requirescheduled principal and interest payments commencing September 2009 and a finalballoon payment of principal upon maturity on November 30, 2010.  Term Loan C was repaid in full on March 20, 2009.  At March 31, 2009, the outstanding principle balanceon Term Loan A was $5.8 million and the outstanding principle balance on Term LoanB was $3.0 million.

 

The Term Loans A and B bearinterest at the Base Rate plus 4.25%, subject to a minimum rate of 12.5%, andrequire interest only payments in the first year, scheduled principal plusinterest payments in years two and three, and a final balloon payment at theend of year three.  Interest on the TermLoans is payable monthly.  TheBorrowers may make full or partial prepayment of the Term Loans provided thatany such prepayment is accompanied by the applicable prepayment premium.

 

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

 

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

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 12 — WARRANTS**

 

In connection with entering into the credit facility(discussed in Note11), the Company issued a seven year warrant to PrivateEquity Management Group, Inc., an affiliate of the Lender, to purchase up toapproximately 776,000 shares of the Company’s common stock on a cash orcashless basis at an exercise price of $4.13 per share.  The estimated fair value of the warrants was$1.5 million, which was calculated using the Black-Scholes pricing model.  The warrants were originally accounted for asdebt discount and the adjustment resulting from the repricing of the warrantsincreased the debt discount, which is being amortized over the remaining lifeof the credit facility.  The warrantswere previously recorded in stockholder’s equity.

 

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

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

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

 

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

 

**NOTE 13 — FAIR VALUE MEASUREMENTS**

 

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

 

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

 

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 in pricingthe asset or liability based on the best available information.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Asof March 31, 2009, the Company was required to apply SFAS No. 157provisions to the derivative that is within the warrant that was issued asconsideration for our credit facility, which is discussed in Note 12 andincluded as a discount on our long-term debt. The derivative was valued using the Black-Scholes model.  The key inputs in the model are as follows:

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

 

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

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

 

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

 

**CautionaryStatement**

 

The following discussion should be read in conjunctionwith our unaudited condensed consolidated financial statements and the relatednotes thereto contained in Part I, Item 1 of this Quarterly Report on Form 10-Q.The information contained in this report is not a complete description of ourbusiness or the risks associated with an investment in our common stock. Weurge you to carefully review and consider the various disclosures made by us inthis Report and in our other reports filed with SEC, including our AnnualReport on Form 10-K for the year ended December 31, 2008 andsubsequent reports on Forms 10-Q and 8-K, which discuss our business in greaterdetail.  This report and the followingdiscussion contain forward-looking statements, which generally include theplans and objectives of management for future operations, including plans andobjectives relating to our future economic performance and our current beliefsregarding revenues we might generate and profits we might earn if we aresuccessful in implementing our business and growth strategies. Theforward-looking statements and associated risks may include, relate to or bequalified by other important factors, including, without limitation:

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

** **

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

 

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

 

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**Recent Transactions**

 

On March 20, 2009, wecompleted the sale of substantially all the assets of the Digitran division ofour wholly-owned subsidiary, EMRISE Electronics Corporation, or EEC, and allthe capital stock of ECC’s wholly-owned subsidiary, XCEL Japan Ltd., whichprimarily acted as a sales office for the Digitran division, to Electro SwitchCorp.  In this report we refer to thebusinesses of the Digitran Division and XCEL Japan, Ltd. as the “DigitranOperations,” and we refer to the sale of the Digitran division and XCEL Japan,Ltd. as the “Digitran Transaction.” Within our Digitran division we manufactured, marketed and soldelectro-mechanical digital and new patented technology very low profileTM rotary switches for the worldwide aerospace,defense and industrial markets.  Tokyo-basedXCEL Japan Ltd. primarily sold Digitran’s switch product lines in Japan andother countries in Asia. These businesses were part of our electronic devicesbusiness segment.  The DigitranTransaction is a milestone in our previously announced strategy to divestnon-core businesses and increase our focus on our core competencies, which arediscussed in further detail in our December 31, 2008 Form 10-K. Forpurposes of the following discussion and analysis, the Digitran Operations havebeen removed from the prior period comparisons and the quarterly results of theDigitran Operations are reported in our Consolidated Statements of Operationsfor all periods presented as a discontinued operation.

 

**Business Description**

 

We design, manufacture andmarket proprietary electronic devices and communications equipment foraerospace, defense, industrial, and communications applications. We haveoperations in the U.S., England, and France. We organizeour business in two operating segments: electronic devices and communicationsequipment. In the first quarter of 2009, our electronic devices segmentcontributed approximately 82% of overall net sales while the communicationssegment contributed approximately 18% of overall net sales. Our subsidiarieswithin our electronic 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.

 

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

 

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

 

**Critical Accounting Policies**

** **

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

 

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

 

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

 

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

 

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

 

Revenue recognition forproducts and services provided by ACC and our subsidiaries in England dependsupon the type of contract involved. Engineering/design services contracts generally entail design andproduction of a prototype over a term of up to several years, with revenuedeferred until each milestone defined in the contract is reached.  Production contracts provide for a specificquantity of products to be produced over a specific period of time.  Customers issue binding purchase orders orenter into binding agreements for the products to be produced.  We recognize revenues on these orders as theproducts are shipped.  Returns areinfrequent and permitted only with prior authorization because these productsare custom made to order based on binding purchase orders and are qualitytested prior to shipment.  An estimate ofwarranty cost is recorded at the time revenue is recognized.

 

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

 

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

 

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***Product Warranty Liabilities***

 

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

 

We record aliability for estimated costs that we expect to incur under our basic limitedwarranties when product revenue is recognized. Factors affecting our warranty liability include the number of unitssold, the types of products involved, historical and anticipated rates of claimand historical and anticipated costs per claim. We periodically assess the adequacy of our warranty liability accrualbased on changes in these factors.

 

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

 

Our electronic devices segment finished goodsinventories generally are built to order. Our communications equipment inventories generally are built toforecast, which requires us to produce a larger amount of finished goods in ourcommunications equipment business so that our customers can be servedpromptly.  Our products consist ofnumerous electronic and other materials, which necessitate that we exercisedetailed inventory management.  We valueour inventory at the lower of the actual cost to purchase or manufacture theinventory (first-in, first-out) or the current estimated market value of theinventory (net realizable value). We perform cycle counts of inventories usingan ABC inventory methodology, which groups inventory items into prioritizedcycle counting categories, or we conduct physical inventories at least once ayear.  We regularly review inventory quantitieson hand and record a provision for excess and obsolete inventory basedprimarily on our estimated forecast of product demand and productionrequirements for the next 12 to 24 months. Additionally, to determine inventorywrite-down provisions, we review product line inventory levels and individualitems as necessary and periodically review assumptions about forecasted demandand market conditions.  Any inventorythat we determine to be obsolete, either in connection with the physical countor at other times of observation, are reserved for and subsequentlywritten-off.  As of March 31, 2009,our total inventory reserves amounted to $5.3 million of which $3.7 million, or21.0% of total inventory, related to our electronic devices segment and $1.6million, or 9% of total inventory, related to our communications equipmentsegment.

 

The electronic devices and communications equipmentindustries are characterized by rapid technological change, frequent newproduct development, and rapid product obsolescence that could result in anincrease in the amount of obsolete inventory quantities on hand. Also, ourestimates of future product demand may prove to be inaccurate, in which case wemay have understated or overstated the provision required for excess and obsoleteinventory. Although we make every effort to ensure the accuracy of ourforecasts of future product demand, any significant unanticipated changes indemand or technological developments could have a significant impact on thevalue of our inventory and our reported operating results.

 

***Foreign Currency Translation***

 

We have foreign subsidiaries thattogether accounted for approximately 52.2% and 70.4% of our net revenues, 34.7%and 42.0% of our assets and 27.5% and 41.6% of our total liabilities as of andfor the three months ended March 31, 2009 and  2008, respectively.  In preparing our consolidated financial statements, weare required to translate the financial statements of our foreign subsidiariesfrom the functional currencies in which they keep their accounting records intoU.S. dollars. This process results in exchange gains and losses which, underrelevant accounting guidance, are included either within our statement ofoperations under the caption “other income (expense)” or as a separate part ofour net equity under the caption “accumulated other comprehensive income(loss).”

 

Under relevant accounting guidance, the treatment ofthese translation gains or losses depends upon management’s determination ofthe functional currency of each subsidiary. This determination involves 

 

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

 

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

 

If we dispose of any of our subsidiaries, anycumulative translation gains or losses would be realized into our statement ofoperations. If we determine that there has been a change in the functionalcurrency of a subsidiary to U.S. dollars, then any translation gains or lossesarising after the date of the change would be included within our statement ofoperations.

 

Based on our assessment of the factors discussedabove, we consider the functional currency of each of our internationalsubsidiaries to be each subsidiary’s local currency. Accordingly, we hadcumulative translation losses of $3.2 million and $2.8 million that wereincluded as part of accumulated other comprehensive income within our balancesheets at March 31, 2009 and December 31, 2008, respectively. Duringthe three months ended March 31, 2009 and 2008, we included translationlosses of $420,000 and gains of $229,000, respectively, under accumulated othercomprehensive income.

 

The magnitude of these gainsor losses depends upon movements in the exchange rates of the foreigncurrencies in which we transact business as compared to the value of the U.S.dollar. During the first quarter of 2009, these currencies include the euro,the British pound sterling and, to a lesser extent, the Japanese yen. Anyfuture translation gains or losses could be significantly higher or lower thanthose we recorded for these periods.

 

A 2.5 million British pound sterling loan payable fromone of our subsidiaries in Englandto EMRISE was outstanding as of March 31, 2009 ($3.5 million based on theexchange rate at March 31, 2009). Exchange rate losses and gains on the long-term portion of this loan arerecorded in cumulative translation gains or losses in the equity section of thebalance sheet.

 

***Intangibles, Including Goodwill***

 

We periodically evaluate our intangibles, includinggoodwill, for potential impairment. Our judgments regarding the existence ofimpairment are based on many factors including market conditions andoperational performance of our acquired businesses.

 

In assessing potential impairment ofgoodwill, we consider these factors as well as forecasted financial performanceof the acquired businesses.  If forecastsare not met, we may have to record additional impairment charges not previouslyrecognized. In assessing the recoverability of our goodwill and otherintangibles, we must make assumptions regarding estimated future cash flows andother factors to determine the fair value of those respective assets. If theseestimates or their related assumptions change in the future, we may be requiredto record impairment charges for these assets that were not previouslyrecorded.  If that were the case, wewould have to record an expense in order to reduce the carrying value of ourgoodwill.  Under SFAS No. 142,“Goodwill and Other Intangible Assets”, we are required to analyze our goodwillfor impairment issues at least annually or more frequently if an event occursor circumstances change that would more likely than not reduce the fair valueof a reporting unit below its carrying amount. At March 31, 2009, our reported goodwill totaled $9.5 million.  In assessing the potential impairment ofgoodwill, we consider forecasted financial performance of the acquiredbusinesses to determine the fair value of the respective assets.

 

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**Results of Operations**

 

**Overview**

** **

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

 

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

 

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

 

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

 

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

 

**Net Sales**

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

 

*ElectronicDevices Segment*

 

Theincrease in sales of our electronic devices in the first quarter of 2009 ascompared to the first quarter of 2008 was primarily the result of the inclusionof $5.0 million in net sales from ACC, which was acquired in August 2008.  This increase was partially offset by adecrease in sales at our U.S. power supply division due to economicconditions.  On a local currency basis,net sales at our foreign electronic device companies were higher in the firstquarter of 2009 as compared to 2008. However, exchange rates between the U.S. dollar and the British poundsterling negatively impacted the consolidated results of our U.K. subsidiarieswhen translated into U.S. 

 

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dollars.  The translation impactof exchange rates remains an uncertainty and could negatively or positivelyimpact our overall results in future periods.

 

Throughoutthe remainder of 2009, we expect quarterly net sales within our electronic devicessegment to increase as compared to each comparable quarter in 2008.  This reflects the expected favorable impactof including ACC’s net sales in each quarter of 2009 as compared to only thelatter four months in 2008, offset by the anticipated unfavorable effect ofexchange rates expected in 2009 as compared to 2008 between the U.S. dollar andthe British pound sterling on the translation of the financial results of ourEuropean operations into U.S. dollars.

 

*CommunicationsEquipment Segment*

 

Thedecrease in sales of our communications equipment in the first quarter of 2009as compared to the first quarter of 2008 is due to an overall decrease inorders and shipments for network access and timing products, especially at ourFrench subsidiary where quarterly net sales were down $0.6 million due largelyto economic impacts and spending reductions by the French DefenseMinistry.  Net sales at our Frenchsubsidiary were also impacted by the unfavorable effects of exchange rates in2009 as compared to 2008 between the U.S. dollar and the euro on thetranslation of the financial results of our European operations into U.S.dollars.  Sales for network accessproducts at our U.S. subsidiary also decreased but were partially offset bystronger sales of telecommunications test equipment.

 

Netsales in our communications equipment segment have been, and are likely tocontinue to be, negatively impacted by the recent economic conditions as manyof our communications equipment products are deemed to be discretionary expendituresby our customers and many companies in this industry have announced plans toreduce capital expenditures and/or to defer discretionary spending due tocurrent economic conditions.  Once globaleconomic conditions improve, we believe this segment will benefit more so thanour electronic devices segment, which has not been impacted as severely due tothe defense related nature of that segment. We also anticipate an ongoing unfavorable effect of exchange ratesthroughout 2009 as compared to 2008 between the U.S. dollar and the euro on thetranslation of our European communications equipment operations into U.S.dollars.  Despite the economic impacts inour communications equipment segment, we had an unusually high backlog oforders in this segment at March 31, 2009 of $0.9 million for ourtelecommunications test equipment primarily for the Federal AviationAdministration and the U.S. Navy and expect that these orders will be deliveredin the second half of 2009.

 

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**GrossProfit**

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

 

*ElectronicDevices Segment*

 

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

 

Weexpect that during 2009, overall gross margins in our electronic devicessegment will improve slightly over those gross margins reported for the firstquarter of 2009, which was lower than normal due to the inventory writedowns.  During 2009 we may experiencequarter to quarter variability due to product mix differences and resultingdifferentials associated with lower gross margins on our electronic devicesused in commercial applications as compared to gross margins on our electronicdevices used in military applications. We expect ACC to contribute positively to our gross profit throughout2009.  However, we expect theseimprovements to be partially offset by the negative impact of exchange rates ongross profit in 2009 as compared to 2008 due to unfavorable exchange ratesbetween the U.S. dollar and the British pound sterling on the translation ofthe financial results of our European operations into U.S. dollars.

 

*CommunicationsEquipment Segment*

 

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

 

We are hopeful during2009 that this segment will be able to return to higher gross margins, such asthose recently achieved throughout the latter part of 2008.  However, due to current economic conditionsand the impact such conditions are having on this segment’s sales, we areuncertain as to exactly when this segment will be return to higher grossmargins levels.  Further, we experiencevolatility quarter to quarter due to changes in product mix and timing ofshipments.  

 

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**OperatingExpenses**

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

 

*Selling,general and administrative expenses*

 

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

 

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

 

*Engineeringand product development*

 

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

 

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

 

**Interestexpense**

 

Interestexpense was $1.0 million for the three months ended March 31, 2009compared to $0.6 million for the three months ended March 31, 2008 due tohigher outstanding loan and line of credit balances and higher interest rateson portions of those loan balances in the first quarter of 2009 as compared tothe first quarter of 2008.  Included ininterest expense in the first quarter of 2009 were $0.3 million of non-cashamortization of deferred financing costs and non-cash amortization of debtdiscount compared to $0.2 million in the first quarter of 2008.  We expect quarterly interest expense for theremainder of 2009 to decrease from the comparable prior year periods and ascompared to the first quarter of 2009 as a result of the lower outstanding loanbalances as we 

 

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used the proceeds from the sale of our Digitran Operations to pay downoutstanding acquisition loans by approximately $10 million.

 

**Otherincome (expense)**

 

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

 

**Incometax expense**

 

Incometax benefit amounted to $0.4 million for the three months ended March 31,2009 compared to income tax expense of $0.1 million for the same period of2008.  The company recorded an income taxbenefit as the result of losses incurred in the first quarter of 2008.  This benefit was partially offset by incometax expense incurred primarily as the result of foreign income tax on foreignearned profits in Europe and Japan and New Jersey state income taxes on incomegenerated by ACC.

 

**Net gainon discontinued operations**

 

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

 

**Netincome (loss)**

 

Wereported net income of $5.3 million in the first quarter of 2009 and a net lossof $0.9 million in the first quarter of 2008. Included in net income in the first quarter of 2009 was a $7.2 milliongain on the sale of Digitran, approximately $0.3 million in inventory writedowns, and approximately $0.2 million in short-term exchange rate lossesassociated with the volatility of the U.S. dollar to the British pound sterlingand euro on the current portion of certain assets and liabilities.  Excluding the one-time gain reported in thefirst quarter of 2009, we anticipate net income (loss) to improve in futurequarters, due in large part to the recent restructuring efforts beingcompleted, and also due to lower anticipated interest expense in futurequarters due to our significant reduction of debt by approximately $10 millionduring the first quarter of 2009.

 

**Liquidity and Capital Resources**

** **

In making an assessmentof our liquidity, we believe that the items in our financial statements thatare most relevant to our ongoing operations are working capital, cash generatedfrom operating activities and cash available from financing activities.  During the first quarter of 2009, we fundedour daily cash flow requirements through funds provided by operations andthrough borrowings under our credit facility with GVEC Resource IV Inc. (“GVEC”or the “Lender”).  Working capital was$6.8 million at March 31, 2009 as compared to $7.6 million at December 31,2008. The decrease in working capital is primarily due to the sale of ourDigitran Operations, which had net current assets of $2.6 million at March 20,2009.  At March 31, 2009 and December 31,2008, we had accumulated deficits of$22.3 million and $28.1 million, respectively, andcash and cash equivalents of $3.6 million and $3.4 million, respectively.

 

Net cash generated inoperating activities during the first quarter of 2009 totaled $1.1million.  Our reported net income of $5.3million included a gain on the sale of assets of $7.2 million.  Significant non-cash adjustments to our firstquarter net income include (i) the amortization of debt discount andamortization of 

 

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deferred financingcost which, on a combined basis, totaled $0.25 million during the quarter, bothof which are non-cash components of interest expense associated with our creditfacility and (ii) depreciation and amortization expense which totaled $0.5million.  Significant sources and uses ofcash associated with operating activities during the quarter included anincrease in accounts payable and accrued expenses which generated cash of $1.0million.  The higher accrued expenses aredue primarily to higher tax accruals associated with the sale of our DigitranOperations in March 2009.  Accountspayable is also higher due to increased purchases to support higher anticipatedshipments, especially at our ACC subsidiary, and also due to timing ofpayments.  In addition, during thequarter, our accounts receivable decreased by approximately $1.0 million, dueto collections being received on our higher fourth quarter 2008 shipments andalso due to increased efforts to collect outstanding balances on a more timelybasis.

 

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

 

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

 

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

 

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

 

Ourbacklog decreased to $29.6million as of March 31, 2009 as comparedto $34.7 million as of December 31,2008. The decrease is, in part, due to the sale of the Digitran Operations,which contributed $1.5 million in backlog to the December 31, 2008 backlogamount, and the reduction of backlog at all of our electronic devices businessunits as we satisfied much higher shipments on existing contracts during thefourth quarter of 2008 compared to previous quarters.  We experienced a slight increase in backlogat our U.S. communications equipment business unit associated with new ordersfor telecommunications test equipment. The amount of backlog orders represents revenue that we anticipaterecognizing in the future, as evidenced by purchase orders and other purchasecommitments received from customers, but on which work has not yet beeninitiated or with respect to which work is currently in progress. Our backlogas of March 31, 2009 was approximately 95% related to our electronicdevices business, which business tends to provide us with long lead-times forour manufacturing processes due to the custom nature of the products, andapproximately 5% related to our communications equipment business, whichbusiness tends to deliver standard or modified standard products from stock asorders are received. We believe that the majority of our current backlog isshippable within the next 12 months. However, there can be no assurance that we will be successful infulfilling such orders and commitments in a timely manner or that we willultimately recognize as revenue the amounts reflected as backlog.

 

On November 30,2007, we and our direct subsidiaries, EEC, CXR Larus and RO Associates enteredinto a Credit Agreement with the Lender, providing for a credit facility in theaggregate amount of $23,000,000.  On August 20,2008, in connection with the acquisition of ACC and CCI, we amended the creditfacility to include ACC and CCI as borrowers and to, among other things,include a term loan in the principal amount of $3,000,000 (the “Term Loan C”). In connection with Digitran Transaction we repaid approximately $10million in March 2009.  As of March 31, 2009, weowed a total of $12.9 million under the terms of the credit facility.

 

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Thecredit facility currently consists of (i) a one year revolving loan for upto $7 million that may be renewed on November 30, 2009 for a period of oneyear (the “Revolver”), and (ii) two term loans (Term Loan A and Term LoanB) with an aggregate net outstanding principal amount of $8.8 million. The termloans require scheduled principal and interest payments commencing September 2009and a final balloon payment of principal upon maturity on November 30,2010.  Total aggregate principal payments on Term Loan A and Term Loan Bare $1.1 million in 2009 and $7.9 million in 2010.

 

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

 

Intereston the Revolver is payable monthly.  The interest rate is variable and isadjusted monthly based on prime rate as published in the “Money Rates” columnof*The Wall Street Journal* (the “BaseRate”) plus 1.25%, subject to a minimum rate of 9.5%.  The Revolver issubject to various financial covenants on a consolidated basis, includingEBITDA, measured on a fiscal quarter-end basis, must not be less than thescheduled amount for each specified period; the debt service coverage ratio,measured quarterly, must be greater than the lesser of the scheduled amount foreach specific period or 1.10:1.00; minimum liquidity above the scheduledamount, unfinanced capital expenditures not in excess of $62,500 per quarter,and the leverage ratio, measured quarterly, must not be greater than thescheduled amount for each specified period.  Additionally, the Revolver issubject to the borrowers not incurring purchase money commitments in excess of$2 million.  As of March 31, 2009 we were not in compliance with theEBITDA, debt service coverage ratio and leverage ratio financialcovenants.  In addition, on April 1,2009, we voluntarily elected not to make a required interest payment on amountsborrowed under our credit facility, which amount has been subsequentlypaid.  On May 14, 2009 we obtained awaiver from our Lender for these events of default.

 

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

 

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

 

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

 

To secure payment of theindebtedness of borrowers under the credit facility, the borrowers irrevocablypledged and assigned to, and granted to the Lender a continuing securityinterest in all the personal property of the borrowers including the borrowers’interest in any deposit accounts, the stock of each of the borrowers’subsidiaries, the intellectual property owned by each of the borrowers, and theproceeds of the intellectual property owned by each of the borrowers.  Inan event of default, the Lender may, at its option, exercise any or allremedies available to it with respect to the collateral.  In addition,certain of the borrowers’ foreign subsidiaries have agreed to guaranty theborrowers’ performance under the credit facility.

 

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

 

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the sale of stock, 50% of the next $1,000,000 of net cash proceedsreceived in connection with the sale of stock, and 30% of the net cash proceedsin excess of the first $3,000,000 received in connection with the sale ofstock.

 

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

 

If weare unsuccessful in meeting our Lender’s requirement for additional capital bythe required due dates and/or if we breach any of our agreed upon financialcovenants under the credit facility, then we will be in default under the termsof our credit facility.  In the event of a default and continuation of a default,whether as a result of our inability to raise additional capital or for someother reason, the Lender may limit future availability under our revolving lineof credit and/or accelerate the payment of all principal balances and accruedinterest requiring us to pay the entire indebtedness under our credit facilityoutstanding on that date.  Upon the occurrence and during the continuationof an event of default, the Lender may also elect to increase the interest rateapplicable to the outstanding balance of the Term Loans A and B by fourpercentage points above the per annum interest rate that would otherwise beapplicable.  Any of these conditions could have a material adverse effecton our operations and/or ability to conduct business after that date.

 

Recentactions taken by the SEC against Private Equity Management Group, Inc., orPEMG, an affiliate of, our Lender including an order granted in April 2009by a federal court freezing all assets of PEMG and its affiliates, whichincludes our Lender, may adversely affect our Lender’s ability to continue toprovide us funds under the terms of the Revolver.  At the request of theSEC, the federal court also appointed a temporary receiver of PEMG and of ourLender.  Although we currently believe that the receiver will allow us tocontinue to borrow funds under the terms of the Revolver, we cannot assure youthat the receiver will allow our Lender to continue to make funds available tous.  If, for any reason, the receiver were to limit or terminate ourability to continue to borrow funds under the Revolver, our cash position andour ability to continue day to day operations would be adversely affected,almost immediately.  If that were to occur, we would be required to seekadditional and/or replacement financing immediately.  If we are unable todo so, we may be forced to drastically curtail or cease operations and possiblyseek protection from our creditors under the U. S. Bankruptcy Code.

 

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

 

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

 

**Effects ofInflation**

** **

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

 

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**Impactsof New Accounting Pronouncements**

 

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

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements”. This newstatement provides a single definition of fair value, together with a frameworkfor measuring it, and requires additional disclosure about the use of fairvalue to measure assets and liabilities. SFAS No. 157 also emphasizes thatfair value is a market-based measurement, not an entity-specific measurement,and sets out a fair value hierarchy, with the highest priority being quotedprices in active markets. The required effective date of SFAS No. 157 isthe first quarter of 2008. The adoption of SFAS No. 157 for financialassets and liabilities did not have a material effect on our consolidatedfinancial statements, but resulted in additional disclosures.  In February 2008, the FASB issued StaffPosition No. 157-2, which delayed by one year the effective date of SFAS No. 157for all non-financial assets and liabilities, except those that are recognizedor disclosed at fair value in the financial statements on a recurringbasis.  The adoption of SFAS No. 157for non-financial assets and liabilities did not have a material effect on ourconsolidated financial statements.

 

In December 2007,the FASB issued SFAS No. 141R, “Business Combinations,” which replacesSAFS No. 141, “Business Combinations.” SFAS No. 141R establishes principles and requirements for determininghow an enterprise recognizes and measures the fair value of certain assets andliabilities acquired in a business combination, including noncontrollinginterests, contingent consideration and certain acquired contingencies.  SFAS No. 141R also requiresacquisition-related transaction expenses and restructuring costs be expensed asincurred rather than capitalized as a component of the businesscombination.  SFAS No. 141R iseffective for fiscal years beginning after December 15, 2008. SFAS No. 141Rwill be applicable prospectively to business combinations for which theacquisition date is on or after January 1, 2009.  SFAS No. 141R would have an impact onaccounting for any business acquired after the effective date of thispronouncement.

 

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

 

In April 2008,the FASB issued FASB Staff Position (“FSP”) No. FAS 142-3, “Determinationof the Useful Life of Intangible Assets,” (“FSP 142-3”). FSP 142-3 amends thefactors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible assetunder SFAS No. 142, “Goodwill and Other Intangible Assets” and alsorequires expanded disclosure related to the determination of intangible assetuseful lives. FSP 142-3 is effective for fiscal years beginning after December 15,2008. Early adoption is prohibited. We are currently evaluating the impact theadoption of FSP 142-3 will have on our consolidated financial statements.

 

In June 2008, the FASB ratified the consensusreached on EITF Issue No. 07-5, “Determining Whether an Instrument (or EmbeddedFeature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5clarifies the determination of whether an instrument (or an embedded feature)is indexed to an entity’s own stock, which would qualify as a scope exceptionunder SFAS No. 133, Accounting for Derivative Instruments and Hedging 

 

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Activities. EITF 07-5 is effective for financialstatements issued for fiscal years beginning after December 15, 2008.Early adoption for an existing instrument is not permitted. We adopted EITF07-5 on January 1, 2009. See Note 12 **—**Warrantsin the accompany notes to condensed consolidated financial statements in thisreport for discussion of the impact of the adoption of EITF 07-5 on ouroutstanding stock warrants and our consolidated financial statements.

 

**ITEM 3.**                 QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK.

** **

Not applicable.

 

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

 

Not applicable.

 

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

 

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

*** ***

We conducted an evaluation under the supervision and with theparticipation of our management, including our Chief Executive Officer and VicePresident Finance and Administration, our principal accounting officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures.  The term “disclosurecontrols and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (“Exchange Act”), meanscontrols and other procedures of a company that are designed to ensure thatinformation required to be disclosed by the company in the reports it files orsubmits under the Exchange Act is recorded, processed, summarized and reported,within the time periods specified in the SEC’s rules and forms.  Disclosure controls and procedures alsoinclude, without limitation, controls and procedures designed to ensure thatinformation required to be disclosed by a company in the reports that it filesor submits under the Exchange Act is accumulated and communicated to thecompany’s management, including its principal executive and principal financialofficers, or persons performing similar functions, as appropriate, to allowtimely decisions regarding required disclosure. Based on this evaluation, our Chief Executive Officer and Vice PresidentFinance and Administration concluded as of March 31, 2009 that ourdisclosure controls and procedures were not effective at the reasonableassurance level due to the material weaknesses discussed immediately below.

 

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

 

***Management’s Report on Internal Control Over Financial Reporting***

*** ***

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

 

(i)                                     pertain to the maintenance of records that,in reasonable detail, accurately and fairly reflect the transactions anddispositions of our assets;

 

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

 

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receipts and expenditures are being made only inaccordance with authorizations of our management and directors; and

 

(iii)                             provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof our assets that could have a material affect on our financial statements.

 

Because of its inherent limitations, internal control over financialreporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk thatcontrols may become inadequate because of changes in conditions, or that thedegree of compliance with the policies or procedures may deteriorate.

 

A material weakness in internal control over financial reporting isdefined by the Public Company Accounting Oversight Board’s Audit Standard No. 5as being a deficiency, or a combination of deficiencies, in internal controlover financial reporting, such that there is a reasonable possibility that amaterial misstatement of the company’s annual or interim financial statementswill not be prevented or detected on a timely basis.

 

Management assessed and evaluated the effectiveness of our internalcontrol over financial reporting as of March 31, 2009. Based on theresults of management’s assessment and evaluation, our Chief Executive Officerand Vice President Finance and Administration concluded that as of March 31,2009 the following three material weaknesses in our internal control overfinancial reporting existed:

 

(1)                                We did not effectively implementcomprehensive entity-level internal controls.

 

(2)                                Wedid not maintain effective controls over changes to critical financialreporting applications and over access to these applications and related data.

 

(3)                                Wedid not maintain a sufficient level of information technology personnel toexecute general computing controls over our information technology structure.

 

The foregoing material weaknesses are described in detail below underthe caption “Material Weaknesses and Related Remediation Initiatives.”**As a result of these material weaknesses,our Chief Executive Officer and Vice President Finance and Administrationconcluded that we did not maintain effective internal control over financialreporting as of March 31, 2009. If not remediated, thesematerial weaknesses could result in one or more material misstatements in ourreported financial statements in a future annual or interim period.

 

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

 

An independent consulting firm assisted management with its assessmentof the effectiveness of our internal control over financial reporting,including scope determination, planning, staffing, documentation, portions oftesting, portions of remediation and portions of overall program management ofthe assessment project.

 

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

 

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

 

Management does not expect that our disclosure controls and proceduresor our internal control over financial reporting will prevent or detect allerrors and all fraud. A control system, no matter how well conceived andoperated, can provide only reasonable, not absolute, assurance that theobjectives of the control systems are met. Further, the design of a controlsystem must reflect the fact that there are resource constraints, and thebenefits of controls must be considered relative to their costs. Because of theinherent limitations in a cost-effective control system, no evaluation ofinternal control over financial reporting can provide absolute assurance thatmisstatements due to error or fraud will not occur or that all control issuesand instances of fraud, if any, have been or will be detected.

 

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

 

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

*** ***

Set forth below isa summary of the various significant deficiencies which caused management toconclude that we had the three material weaknesses identified above.  Through the efforts of management, externalconsultants and our Audit Committee, we are currently in the process of developingspecific action plans to remediate the material weaknesses identified above anddiscussed more fully below.  We expect tocomplete these various action plans by June 30, 2009.  If we are able to complete these action plansby that date, we anticipate that all control deficiencies and materialweaknesses will be remediated by December 31, 2009.

 

(1)           Wedid not effectively implementcomprehensive entity-level internal controls, as evidenced by thefollowing control deficiencies:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

(3)           Wedid not maintain a sufficient level of information technology personnel toexecute general computing controls over our information technology structure,which include the implementation and assessment of information technologypolicies and procedures. This control deficiency did not result in an auditadjustment to our 2008 interim or annual consolidated financial statements, butcould result in a material misstatement of significant accounts or disclosures,which would not have been prevented or detected.

 

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

*** ***

The above materialweaknesses did not result in adjustments to our consolidated financialstatements for the quarter ended March 31, 2009, however, it is reasonablypossible that, if not remediated, one or more of the material weaknessesdescribed above could result in a material misstatement in our reportedfinancial statements that might result in a material misstatement in a futureannual or interim period.

 

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

 

In addition, ouraudit committee has authorized the hiring of additional temporary staff and/orthe use of financial and information technology consultants, as necessary, toensure that we have the depth and experience to remediate the above listedmaterial weaknesses, including the implementation and monitoring of theappropriate level of control procedures related to all of our manufacturinglocations and our corporate offices.  Theaudit committee will also work directly with management and outsideconsultants, as necessary to ensure that board level deficiencies areaddressed.  We are uncertain at this timeof the costs to remediate all of the above listed material weaknesses, however,we anticipate the cost to be in the range of $200,000 to $400,000 (includingthe cost of the consolidation software described above), most of which costs weexpect to incur in 2009.  We cannotguarantee that the actual costs to remediate these deficiencies will not exceedthis amount.

 

Through thesesteps, we believe that we are addressing the deficiencies that affected ourinternal control over financial reporting as of March 31, 2009. Becausethe remedial actions require hiring of additional personnel, upgrading certainof our information technology systems, and relying extensively on manual reviewand approval, the successful operation of these controls for at least severalquarters may be required before management may be able to conclude that thematerial weakness has been remediated. We intend to continue to evaluate and strengthen our internal controlover financial reporting systems. These efforts require significant time andresources.  If we are unable to establishadequate internal control over financial reporting systems, we may encounterdifficulties in the audit or review of our financial statements by ourindependent registered public accounting firm, which in turn may have amaterial adverse effect on our ability to prepare financial statements inaccordance with GAAP and to comply with our SEC reporting obligations.

 

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

*** ***

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

 

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**PART II — OTHER INFORMATION**

 

**ITEM 1.****                 LEGAL PROCEEDINGS.**

 

Various legal actionsand claims may arise against us in the ordinary course of business. In theopinion of management, the ultimate resolution of such possible legal actionsand claims will not have a material adverse effect on our consolidatedfinancial position or our results of operations.

 

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

 

Item 1A of Part Iof our Form 10-K for the year ended December 31, 2008 summarizesvarious material risks that investors should carefully consider before decidingto buy or maintain an investment in our common stock.  Any of those risks, and the additional riskfactor described below, if they actually occur, would likely harm our business,financial condition and results of operations and could cause the trading priceof our common stock to decline.

 

***Recentactions taken by the SEC against an affiliate of our lender may adverselyaffect our ability to continue to borrow funds under the terms of our revolvingcredit facility with our lender.  If ourlender limits or terminates our ability to borrow funds under the revolvingcredit facility, our cash position and our ability to continue day tooperations would be adversely affected, almost immediately.***

 

Recent actions taken by the SEC against Private Equity ManagementGroup, Inc., or PEMG, an affiliate of our lender, including an order granted inApril 2009 by a federal court freezing all assets of PEMG and itsaffiliates, which includes our lender, may adversely affect our lender’sability to continue to provide us funds under the terms of our revolving creditfacility.  At the request of the SEC, thefederal court also appointed a temporary receiver of PEMG and of ourlender.  If, for any reason, the receiverwere to limit or terminate our ability to continue to borrow funds under ourrevolving credit facility, our cash position and our ability to continue day today operations would be adversely affected, almost immediately.  If that were to occur, we would be requiredto seek additional and/or replacement financing immediately.  If we are unable to do so, we may be forcedto drastically curtail or cease operations and possibly seek protection fromour creditors under the U. S. Bankruptcy Code.

 

**ITEM 2.****                                                  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OFPROCEEDS.**

 

**Unregistered Sales of Equity Securities**

 

None.

 

**Dividends**

 

We have notdeclared or paid any cash dividends on our capital stock in the past, and we donot anticipate declaring or paying cash dividends on our common stock in theforeseeable future.  We will paydividends on our common stock only if and when declared by our board ofdirectors.  Our board of directors’ability to declare a dividend is subject to restrictions imposed by Delawarelaw.  In determining whether to declaredividends, the board of directors will consider these restrictions as well asour financial condition, results of operations, working capital requirements,future prospects and other factors it considers relevant.

 

**ITEM 3.****                                                   DEFAULTS UPON SENIOR SECURITIES.**

 

None.

 

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

 

None

 

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**ITEM 5.****                                                   OTHER INFORMATION.**

 

None.

 

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

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                                           |
| 10.1       |       | Amendment Number 2 to  Loan Documents dated February 12, 2009 by and among EMRISE Corporation,  EMRISE Electronics Corporation, CXR Larus Corporation, RO Associates  Incorporated, Advanced Control Components, Inc., Custom  Components, Inc. and GVEC Resource IV Inc.(1)                                    |
|       |       |                                                                                                                                                                                                                                                                                                                           |
| 10.2       |       | Second Amended and  Restated Warrant dated February 12, 2009 issued to Private Equity  Management Group, LLC (1)                                                                                                                                                                                                          |
|       |       |                                                                                                                                                                                                                                                                                                                           |
| 10.3       |       | Second Amended and  Restated Warrant dated February 12, 2009 issued to Private Equity  Management Group, LLC (1)                                                                                                                                                                                                          |
|       |       |                                                                                                                                                                                                                                                                                                                           |
| 10.4       |       | Asset and Stock  Purchase Agreement, dated March 20, 2009, by and among EMRISE  Corporation, EMRISE Electronics Corporation, Electro Switch Corp., and ESC  Worldwide, Inc. (2)                                                                                                                                      |
|       |       |                                                                                                                                                                                                                                                                                                                           |
| 10.5       |       | Forbearance Agreement  and Amendment Number 3 to Loan Documents, dated March 20, 2009, by and  among EMRISE Corporation, EMRISE Electronics Corporation, CXR Larus  Corporation, RO Associates Incorporated, Advanced Control  Components, Inc., Custom Control Components, Inc. and GVEC Resource  IV Inc. (2) |
|       |       |                                                                                                                                                                                                                                                                                                                           |
| 31.1       |       | Certification of  Principal Executive Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                             |
|       |       |                                                                                                                                                                                                                                                                                                                           |
| 31.2       |       | Certification of  Principal Financial Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                             |
|       |       |                                                                                                                                                                                                                                                                                                                           |
| 32.1       |       | Certification of Chief  Executive Officer and Vice President Finance and Administration Pursuant to  18 U.S.C. Section 350, as Adopted Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                                                                                                               |

 

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

 

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

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

 
|                      | EMRISE CORPORATION |
|---------------------------|--------------------|
|                      |               |
| Dated:  May 15, 2009 | By:                | /S/  CARMINE T. OLIVA |
|                      |               | Carmine  T. Oliva, |
|                      |               | Chief  Executive Officer |
|                      |               |   |
|                      |               |   |
| Dated:  May 15, 2009 | By:                | /S/  D. JOHN DONOVAN |
|                      |               | D.  John Donovan, Vice President Finance and Administration (principal financial  and accounting officer) |

 

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**INDEX TOEXHIBITS ATTACHED TO THIS REPORT**

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

 

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