Table of Contents

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**UNITEDSTATES**

** SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

** **

**FORM 10-Q/A**

** **

**(Mark One)**

** **

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

** **

**For thequarterly period ended****September 30,2009**

** **

**or**

** **

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

** **

**For the transition period from                     to                     **

** **

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

** **

**EMRISECORPORATION**

(Exact name ofregistrant as specified in its charter)

 

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

 

**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 suchreports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes x   No o

 

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

 

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

 

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

 

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

 

The number of sharesoutstanding of the Registrant’s common stock, $0.0033 par value, as of November 6,2009 was 10,213,412.

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Table ofContents

 

**EMRISE CORPORATION**

**TABLE OF CONTENTS**

**FORM 10-Q**

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2009**

 

**PART I. FINANCIAL INFORMATION**

 
| **EXPLANATORY  NOTE**  |                                                                                                                                          |
|------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------|
| ** **             | ** **                                                                                                                                    |   |
| **ITEM 1.**            | **FINANCIAL STATEMENTS**                                                                                                                      |   |
|                   |                                                                                                                                          |
|                   | Condensed  Consolidated Balance Sheets as of September 30, 2009 (restated)  (unaudited) and December 31, 2008                       | 1 |
|                   |                                                                                                                                          |   |
|                   | Condensed Consolidated Statements of Operations for  the Three and Nine Months Ended September 30, 2009 and 2008 (restated)  (unaudited) | 2 |
|                   |                                                                                                                                          |   |
|                   | Condensed Consolidated Statements of Stockholders’  Equity for the Nine Months Ended September 30, 2009 (restated)  (unaudited)     | 3 |
|                   |                                                                                                                                          |   |
|                   | Condensed Consolidated Statements of Cash Flows for  the Nine Months Ended September 30, 2009 and 2008 (restated) (unaudited)            | 4 |
|                   |                                                                                                                                          |   |
|                   | Notes to Condensed Consolidated Financial Statements  (unaudited)                                                                             | 6 |
|                   |                                                                                                                                          |
| **ITEM 2.**            | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**                                               | 27 |
|                   |                                                                                                                                          |   |
| **ITEM 3.**            | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                                               | 48 |
|                   |                                                                                                                                          |   |
| **ITEM 4.**            | **CONTROLS AND  PROCEDURES**                                                                                                                  | 48 |
|                   |                                                                                                                                          |   |
| **ITEM 4T.**           | **CONTROLS AND  PROCEDURES**                                                                                                                  | 48 |
|                   |                                                                                                                                          |   |
| **PART II**       |                                                                                                                                          |
| **OTHER  INFORMATION** |                                                                                                                                          |
|                   |                                                                                                                                          |   |
| **ITEM  6.**           | **EXHIBITS**                                                                                                                                  | 52 |
|                   |                                                                                                                                          |   |
| **SIGNATURES**         | 53                                                                                                                                            |
|                        |                                                                                                                                               |  |  |

 

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Table of Contents

 

**EXPLANATORY NOTE**

 

The purpose of this Amendment No. 2 to Form 10-Q (“Amendment”)is to amend our original filing of a Quarterly Report on Form 10-Q for thequarterly period ended September 30, 2009, filed with the Securities andExchange Commission (“SEC”) on November 14, 2009 (the “initial filing”).

 

On April 15, 2010, we filed a Current Report on Form 8-K withthe SEC disclosing that our audit committee concluded, based on informationpresented by its independent registered accounting firm, that an error in thecomputation and presentation of the Company’s income tax expense andliabilities had been made in our historical financial statements.  The change affects primarily theclassification of income tax expense/benefit between discontinued operationsand continuing operations and, to a lesser extent, the recording of Federalalternative minimum tax.

 

EMRISE (the “Company”) is the U.S. parent ofboth U.S. and foreign subsidiaries.  TheCompany’s credit facility, which includes term debt and a revolver, wasstructured such that the assets of all of the U.S. and U.K. subsidiaries werepledged as collateral and that those assets were to be included in theborrowing base for the revolver. Additionally, the Company’s lender required that each of the foreignsubsidiaries provide a guaranty on the credit facility.  During the course of the audit of our 2009financial statements and as a result of the structure of the credit facility,the Company has determined that Internal Revenue Code (“IRC”) §956 requiresadjustment of taxable income in each of the years since the inception of thecredit facility because the earnings and profits of the foreign subsidiariesare considered deemed distributions to the U.S. Although the Company has net operating loss carryforwards available tooffset the resulting increases to its regular taxable income, the Company issubject to alternative minimum tax (“AMT”) because the carryforwards do notprovide a complete offset in calculating AMT income.  The Company computed the AMT, applying theestimated foreign tax credits generated from application of IRC §956 thatbecame available as offsets to the AMT obligation.  As a result, the Company is restating itsfinancial statements for the interim period ended September 30, 2009 (the “Restatement”).  The impact of the Restatement is toreclassify tax expense from discontinued operations to continuing operationsand to record an incremental AMT associated with the §956 income.  In light of the Restatement, the financialstatements and other financial information included in the initial filing arebeing restated in this Amendment.  Thisrestatement affected Item 1, Financial Statements and related disclosures inItem 2, Management’s Discussion and Analysis of Financial Condition and Resultsof Operations as it relates to income taxes, income from discontinuedoperations and liquidity.

 

Since the changes to our 10-Q are limited to the tax related issuesdescribed above, our Form 10-Q/A Amendment No. 2 for the period endedSeptember 30, 2009 amends and restates Part I and Part II, Item6 in its entirety as set forth in this document.

 

Unless specified, the disclosures provided in this document have notbeen updated for more current information. Therefore, this Amendment should beread in conjunction with our other filings made with the SEC subsequent to thedate of the initial filing.

 

 

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**PART I — FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**EMRISE CORPORATION**

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

 
| ** **                                                                                                                                                                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                    | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                                                                    | ** ** | **(Restated)**         | ** ** | ** **            | ** ** |
| ** **                                                                                                                                                                                    | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                    |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                               |       |                   |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                    |       | $                      | 3,867      |                  | $          | 3,242 |   |
| Accounts receivable,  net of allowances for doubtful accounts of $203 at September 30, 2009  and $501 at December 31, 2008                                                          |       | 8,187                  |       | 10,333                |       |
| Inventories, net                                                                                                                                                                              |       | 11,926                 |       | 12,501                |       |
| Current deferred tax  assets                                                                                                                                                                  |       | 22                     |       | 271                   |       |
| Prepaid and other  current assets                                                                                                                                                             |       | 1,185                  |       | 1,283                 |       |
| Current assets of  discontinued operations                                                                                                                                                    |       | —                 |       | 2,724                 |       |
| Total current assets                                                                                                                                                                          |       | 25,187                 |       | 30,354                |       |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| Property, plant and  equipment, net                                                                                                                                                           |       | 2,484                  |       | 2,990                 |       |
| Goodwill                                                                                                                                                                                      |       | 14,220                 |       | 9,657                 |       |
| Intangible assets other  than goodwill, net                                                                                                                                                   |       | 5,294                  |       | 6,618                 |       |
| Deferred tax assets                                                                                                                                                                           |       | 1,766                  |       | 2,191                 |       |
| Other assets                                                                                                                                                                                  |       | 248                    |       | 683                   |       |
| Noncurrent assets of  discontinued operations                                                                                                                                                 |       | —                 |       | 1,130                 |       |
| Total assets                                                                                                                                                                                  |       | $                      | 49,199     |                  | $          | 53,623 |   |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                 |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                          |       |                   |       |                  |       |
| Accounts payable                                                                                                                                                                              |       | $                      | 4,197      |                  | $          | 4,625 |   |
| Accrued expenses                                                                                                                                                                              |       | 6,279                  |       | 6,939                 |       |
| Line of credit                                                                                                                                                                                |       | 4,032                  |       | 4,084                 |       |
| Current portion of  long-term debt, net of discount of $416                                                                                                                                   |       | 8,549                  |       | 5,121                 |       |
| Notes payable to  stockholders, current portion                                                                                                                                               |       | 375                    |       | 542                   |       |
| Income taxes payable                                                                                                                                                                          |       | 745                    |       | 451                   |       |
| Other current liabilities                                                                                                                                                                     |       | 2,068                  |       | 357                   |       |
| Current liabilities of  discontinued operations                                                                                                                                               |       | —                 |       | 664                   |       |
| Total current  liabilities                                                                                                                                                                    |       | 26,245                 |       | 22,783                |       |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| Long-term debt, net of  discount of $980 at December 31, 2008                                                                                                                            |       | 218                    |       | 13,479                |       |
| Notes payable to  stockholders, less current portion                                                                                                                                          |       | 2,959                  |       | 250                   |       |
| Deferred income taxes                                                                                                                                                                         |       | 1,824                  |       | 2,203                 |       |
| Warrant liability                                                                                                                                                                             |       | 641                    |       | —                |       |
| Other liabilities                                                                                                                                                                             |       | 422                    |       | 503                   |       |
| Noncurrent liabilities  of discontinued operations                                                                                                                                            |       | —                 |       | 401                   |       |
| Total liabilities                                                                                                                                                                             |       | 32,309                 |       | 39,619                |       |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| Commitments and  contingencies                                                                                                                                                                |       |                   |       |                  |       |
|                                                                                                                                                                                          |       |                   |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                    |       |                   |       |                  |       |
| Preferred stock,$0.01  par value. Authorized 10,000,000 shares, zero shares issued and outstanding                                                                                            |       | —                 |       | —                |       |
| Common stock,$0.0033  par value. Authorized 150,000,000 shares; 10,213,412 and 10,204,079 shares  issued and outstanding at September 30, 2009 and December 31, 2008,  respectively |       | 126                    |       | 126                   |       |
| Additional paid-in  capital                                                                                                                                                                   |       | 43,444                 |       | 44,806                |       |
| Accumulated deficit                                                                                                                                                                           |       | (25,113                | )          | (28,101               | )          |
| Accumulated other  comprehensive loss                                                                                                                                                         |       | (1,567                 | )          | (2,827                | )          |
| Total stockholders’  equity                                                                                                                                                              |       | 16,890                 |       | 14,004                |       |
| Total liabilities and  stockholders’ equity                                                                                                                                              |       | $                      | 49,199     |                  | $          | 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** | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                       | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                       | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                       | ** ** | **(Restated)**         | ** ** | ** **             | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
|                                                                             |       |                   |       |                   |       |   |   |   |   |
| Net Sales                                                                        |       | $                      | 14,319     |                   | $          | 13,078 |   | $ | 42,802 |   | $ | 35,743 |   |
| Cost of Sales                                                                    |       | 8,998                  |       | 8,685                  |       | 27,065 |   | 24,197 |   |
| Gross profit                                                                     |       | 5,321                  |       | 4,393                  |       | 15,737 |   | 11,546 |   |
|                                                                             |       |                   |       |                   |       |   |   |   |   |
| Operating expenses:                                                              |       |                   |       |                   |       |   |   |   |   |
| Selling, general and  administrative                                             |       | 4,592                  |       | 3,522                  |       | 13,486 |   | 10,589 |   |
| Engineering and product  development                                             |       | 733                    |       | 474                    |       | 1,971 |   | 1,585 |   |
| Loss on asset  impairment                                                        |       | 619                    |       | —                 |       | 619 |   | — |   |
| Total operating  expenses                                                        |       | 5,944                  |       | 3,996                  |       | 16,076 |   | 12,174 |   |
| Income (loss) from  operations                                                   |       | (623                   | )          | 397                    |       | (339 | ) | (628 | ) |
|                                                                             |       |                   |       |                   |       |   |   |   |   |
| Other income (expense):                                                          |       |                   |       |                   |       |   |   |   |   |
| Interest income                                                                  |       | 18                     |       | 38                     |       | 87 |   | 79 |   |
| Interest expense                                                                 |       | (793                   | )          | (816                   | )          | (3,191 | ) | (2,004 | ) |
| Other, net                                                                       |       | (24                    | )          | (167                   | )          | 144 |   | (64 | ) |
| Total other expense,  net                                                        |       | (799                   | )          | (945                   | )          | (2,960 | ) | (1,989 | ) |
|                                                                             |       |                   |       |                   |       |   |   |   |   |
| Loss before income  taxes                                                        |       | (1,422                 | )          | (548                   | )          | (3,299 | ) | (2,617 | ) |
| Income tax provision  (benefit)                                                  |       | 263                    |       | 313                    |       | 635 |   | 393 |   |
| Loss from continuing  operations                                                 |       | (1,685                 | )          | (861                   | )          | (3,934 | ) | (3,010 | ) |
| Discontinued  operations:                                                        |       |                   |       |                   |       |   |   |   |   |
| Income (loss) from  discontinued operations including gain on sale of $6,995 YTD |       | (132                   | )          | 1,194                  |       | 7,156 |   | 2,190 |   |
| Tax provision (benefit)  on discontinued operations                              |       | —                 |       | —                 |       | 707 |   | — |   |
| Net income (loss) from  discontinued operations                                  |       | (132                   | )          | 1,194                  |       | 6,449 |   | 2,190 |   |
|                                                                             |       |                   |       |                   |       |   |   |   |   |
| Net Income (loss)                                                                |       | $                      | (1,817     | )                      | $          | 333 |   | $ | 2,515 |   | $ | (820 | ) |
|                                                                             |       |                   |       |                   |       |   |   |   |   |
| Earnings (loss) per  share:                                                      |       |                   |       |                   |       |   |   |   |   |
| Basic                                                                            |       | $                      | (0.18      | )                      | $          | 0.03 |   | $ | 0.25 |   | $ | (0.08 | ) |
| Diluted                                                                          |       | $                      | (0.18      | )                      | $          | 0.03 |   | $ | 0.25 |   | $ | (0.08 | ) |
|                                                                             |       |                   |       |                   |       |   |   |   |   |
| Weighted average shares  outstanding                                             |       |                   |       |                   |       |   |   |   |   |
| Basic                                                                            |       | 10,213                 |       | 10,201                 |       | 10,208 |   | 10,201 |   |
| Diluted                                                                          |       | 10,213                 |       | 10,201                 |       | 10,208 |   | 10,201 |   |

 

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

 

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Stockholders’Equity**

**(Restated)**

(Unaudited)****(in thousands)

* *
| ** **                                                                                          | ** ** | ** **       | ** ** | ** **  | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------|------------|-------------|------------|-----------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                                          | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **        | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                                                                                          | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                                                                                          | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**       | ** ** | **Loss**        | ** ** | **Total**  | ** ** |
|                                                                                                |       |             |       |        |       |            |       |              |       |            |       |       |       |
| Balance at  December 31, 2008                                                                  |       | 10,204           |       | $           | 126        |            | $          | 44,806            |       | $               | (28,101    | )          | $          | (2,827 | ) | $ | 14,004 |   |
| Cumulative effect of  change in accounting principle due to adoption of updated derivative guidance |       | —           |       | —      |       | (1,483          | )          | 473               |       | —          |       | (1,010     | )          |
| Stock option exercises                                                                              |       | 9                |       | —      |       | 7               |       | —            |       | —          |       | 7          |       |
| Stock-based  compensation                                                                           |       | —           |       | —      |       | 112             |       | —            |       | —          |       | 112        |       |
| Warrants issued for  services                                                                       |       | —           |       | —      |       | 2               |       | —            |       | —          |       | 2          |       |
| Net income and  comprehensive income                                                                |       | —           |       | —      |       | —          |       | 2,515             |       | 1,260           |       | 3,775      |       |
| Balance at  September 30, 2009                                                                 |       | 10,213           |       | $           | 126        |            | $          | 43,444            |       | $               | (25,113    | )          | $          | (1,567 | ) | $ | 16,890 |   |

 

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

 

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Cash Flows**

(Unaudited)****(in thousands)

 
| ** **                                                                                                                             | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                             | ** ** | **September 30,** | ** ** |
| ** **                                                                                                                             | ** ** | **2009**               | ** ** | **2008** | ** ** |
| ** **                                                                                                                             | ** ** | **(Restated)**         | ** ** | ** ** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                                                                              |       |                   |       |   |   |
| Net Income (loss)                                                                                                                      |       | $                      | 2,515      |   | $ | (820 | ) |
| Adjustments to arrive  at net loss from continuing operations                                                                          |       | (6,449                 | )          | (2,324 | ) |
| Net loss from  continuing operations                                                                                                   |       | (3,934                 | )          | (3,144 | ) |
| Reconciliation to net  cash provided by (used in) operating activities:                                                                |       |                   |       |   |   |
| Depreciation and  amortization                                                                                                         |       | 1,465                  |       | 744 |   |
| Provision for doubtful  accounts                                                                                                       |       | 84                     |       | 138 |   |
| Provision for inventory  obsolescence                                                                                                  |       | 395                    |       | 453 |   |
| Provision for warranty  reserve                                                                                                        |       | (121                   | )          | (86 | ) |
| Deferred taxes                                                                                                                         |       | (62                    | )          | (88 | ) |
| Gain on sale of assets                                                                                                                 |       | —                 |       | (94 | ) |
| Amortization of  deferred issuance costs                                                                                               |       | 616                    |       | 339 |   |
| Amortization of debt  discount                                                                                                         |       | 564                    |       | 338 |   |
| Stock-based  compensation expense                                                                                                      |       | 114                    |       | 61 |   |
| Change in common stock  warrant value                                                                                                  |       | (369                   | )          | — |   |
| Loss on impairment of  assets                                                                                                          |       | 619                    |       | — |   |
| Changes in assets and  liabilities:                                                                                                    |       |                   |       |   |   |
| Accounts receivable                                                                                                                    |       | 2,104                  |       | 374 |   |
| Inventories                                                                                                                            |       | (96                    | )          | 228 |   |
| Prepaid and other  assets                                                                                                              |       | (82                    | )          | 73 |   |
| Accounts payable and  accrued expenses                                                                                                 |       | (1,863                 | )          | (2,598 | ) |
| Operating cash flow  provided by (used in) continuing operations                                                                       |       | (566                   | )          | (3,262 | ) |
| Operating cash flow  provided by discontinued operations                                                                               |       | 1,313                  |       | 2,644 |   |
| Net cash provided by  (used in) operating activities                                                                                   |       | 747                    |       | (618 | ) |
|                                                                                                                                   |       |                   |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                                                             |       |                   |       |   |   |
| Purchases of property, plant  and equipment                                                                                            |       | (32                    | )          | (41 | ) |
| Payments received on  notes receivable                                                                                                 |       | —                 |       | 40 |   |
| Purchase of ACC, net of  cash acquired                                                                                                 |       | 188                    |       | (12,356 | ) |
| Investing cash flow  provided by (used in) continuing operations                                                                       |       | 156                    |       | (12,357 | ) |
| Investing cash flow  provided by (used in) discontinued operations including proceeds from sale of  subsidiary operations, net of cash |       | 10,051                 |       | (71 | ) |
| Net cash provided by  (used in) investing activities                                                                                   |       | 10,207                 |       | (12,428 | ) |
|                                                                                                                                   |       |                   |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                                                             |       |                   |       |   |   |
| Proceeds from issuance of  debt                                                                                                        |       | —                 |       | 13,000 |   |
| Net borrowings  (repayments) of lines of credit                                                                                        |       | (52                    | )          | 1,815 |   |
| Repayments of long-term  debt                                                                                                          |       | (10,823                | )          | (70 | ) |
| Payments of notes to  stockholders                                                                                                     |       | (418                   | )          | (396 | ) |
| Proceeds from exercise  of stock options and warrants                                                                                  |       | 7                      |       | — |   |
| Financing cash flow  provided by (used in) continuing operations                                                                       |       | (11,286                | )          | 14,349 |   |
| Financing cash flow  used in discontinued operations                                                                                   |       | —                 |       | (71 | ) |
| Net cash provided by  (used in) financing activities                                                                                   |       | (11,286                | )          | 14,278 |   |
| Effect of exchange rate  changes on cash                                                                                               |       | 778                    |       | (729 | ) |
| Net increase in cash  and cash equivalents                                                                                             |       | 446                    |       | 503 |   |
| Cash and cash  equivalents at beginning of period                                                                                      |       | 3,421                  |       | 4,764 |   |
| Cash and cash  equivalents at end of period                                                                                            |       | $                      | 3,867      |   | $ | 5,267 |   |

 

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

 

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

(Unaudited)****(in thousands)

 
| ** **                                                                                                                                                     | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                     | ** ** | **September 30,** | ** ** |
| ** **                                                                                                                                                     | ** ** | **2009**               | ** ** | **2008** | ** ** |
| **SUPPLEMENTAL  DISCLOSURES OF NON-CASH INVESTING AND****FINANCING  ACTIVITIES:**                                                                              |       |                   |       |   |   |
| Acquisition of  equipment through capital lease                                                                                                                |       | $                      | 119        |   | $ | 453 |   |
| Cumulative effect of  change in accounting principle - reclassification of common stock warrants to  liability upon adoption of updates to derivative guidance |       | $                      | 473        |   | $ | — |   |
| Issuance of notes and  accruals relating to ACC purchase adjustment                                                                                            |       | $                      | 4,278      |   | $ | — |   |

 

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

 

5

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Table of Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

*Organization and Business*

 

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

 

In March of 2009, the Company sold substantially all the assetsrelated to the Digitran division of the Company’s wholly-owned subsidiary,EMRISE Electronics Corporation’s (“EEC”), 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.

 

*Basisof Presentation*

 

The accompanying unaudited condensed consolidatedfinancial statements have been prepared in accordance with the rules andregulations of the Securities and Exchange Commission (“Commission”) andtherefore do not include all information and footnotes necessary for a completepresentation of the financial position, results of operations and cash flows inconformity with accounting principles generally accepted in the U.S. (“GAAP”).  The year end balance sheet was derived fromthe audited financial statements at that date, but does not include all of theinformation and footnotes required by GAAP for complete financialstatements.  The unaudited condensedconsolidated financial statements do, however, reflect all adjustments,consisting of only normal recurring adjustments, which are, in the opinion ofmanagement, necessary to state fairly the financial position as of September 30,2009 and the results of operations and cash flows for the related interimperiods ended September 30, 2009 and 2008. However, these results are notnecessarily indicative of results for any other interim period or for the year.The accompanying unaudited condensed consolidated financial statements shouldbe read in conjunction with the Company’s audited consolidated financialstatements included in its annual report on Form 10-K for the year ended December 31,2008 as filed with the Commission.

 

*ComprehensiveIncome (Loss)*

 

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

 
| ** **                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                               | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                               | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(Restated)**         | ** ** | ** **             | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
| Net income (loss)                        |       | $                      | (1,817     | )                      | $          | 333 |   | $ | 2,515 |   | $ | (820 | ) |
| Other comprehensive  income (loss):      |       |                   |       |                   |       |   |   |   |   |
| Foreign currency  translation adjustment |       | (113                   | )          | (1,639                 | )          | 1,260 |   | (1,415 | ) |
| Comprehensive income  (loss)             |       | $                      | (1,930     | )                      | $          | (1,306 | ) | $ | 3,775 |   | $ | (2,235 | ) |

 

6

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Revenue Recognition*

 

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

 

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

 

Revenue recognition forproducts and services provided by the Company’s subsidiaries in England and itsU.S. subsidiary, ACC, depends upon the type of contract involved.  Engineering/design services contractsgenerally entail design and production of a prototype over a term of up toseveral years, with revenue deferred until each milestone defined in the contractis reached.  Production contracts providefor a specific quantity of products to be produced over a specific period oftime.  Customers issue binding purchaseorders or enter into binding agreements for the products to be produced.  The Company recognizes revenues on theseorders as the products are shipped. Returns are infrequent and permitted only with prior authorizationbecause these products are custom made to order based on binding purchaseorders and are quality tested prior to shipment.  An estimate of warranty cost is recorded atthe time revenue is recognized.

 

The Company recognizesrevenues for products sold by its subsidiary in France at the point ofshipment.  Customer discounts areincluded in the product price list provided to the customer.  Returns are infrequent and permitted onlywith prior authorization because these products are shipped based on bindingpurchase orders and are quality tested prior to shipment.  An estimate of warranty cost is recorded atthe time revenue is recognized.

 

Revenues 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.

 

*ReverseStock Split*

 

On November 19, 2008, the Company completed a 1-for-3.75 reversesplit of its common stock.  All commonstock, stock options and warrants to purchase common stock and earnings pershare amounts have been retroactively restated as if the reverse stock splitoccurred at the beginning of the periods presented.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Income(Loss) Per Share*

 

Basic income (loss) per share is computed by dividingnet loss by the weighted average common shares outstanding during aperiod.  Diluted income (loss) per shareis based on the treasury stock method and includes the dilutive effect of stockoptions and warrants outstanding during the period.  Common share equivalents have been excludedwhere their inclusion would be anti-dilutive. As a result of the loss from continuing operations incurred by theCompany for the three and nine month periods ended September 30, 2009, andthe nine month period ended September 30, 2008, the potentially dilutivecommon shares have been excluded from the loss per share computation for theseperiods because their inclusion would have been anti-dilutive.  The following table illustrates the computationof basic and diluted income (loss) per share (in thousands, except per shareamounts):

 
| ** **                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                          | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                          | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                          | ** ** | **(Restated)**         | ** ** | ** **             | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
| NUMERATOR:                                          |       |                   |       |                   |       |   |   |   |   |
| Net income (loss)                                   |       | $                      | (1,817     | )                      | $          | 333 |   | $ | 2,515 |   | $ | (820 | ) |
|                                                |       |                   |       |                   |       |   |   |   |   |
| DENOMINATOR:                                        |       |                   |       |                   |       |   |   |   |   |
| Basic weighted average  common shares outstanding   |       | 10,213                 |       | 10,201                 |       | 10,208 |   | 10,201 |   |
| Effect of dilutive  securities:                     |       |                   |       |                   |       |   |   |   |   |
| Dilutive stock options  and warrants                |       | —                 |       | —                 |       | — |   | — |   |
| Diluted weighted  average common shares outstanding |       | 10,213                 |       | 10,201                 |       | 10,208 |   | 10,201 |   |
|                                                |       |                   |       |                   |       |   |   |   |   |
| Basic income (loss) per  share                      |       | $                      | (0.18      | )                      | $          | 0.03 |   | $ | 0.25 |   | $ | (0.08 | ) |
|                                                |       |                   |       |                   |       |   |   |   |   |
| Diluted income (loss)  per share                    |       | $                      | (0.18      | )                      | $          | 0.03 |   | $ | 0.25 |   | $ | (0.08 | ) |

 

The following table shows the common stock equivalentsthat were outstanding as of September 30, 2009 and 2008, but were notincluded in the computation of diluted earnings per share as a result of theloss incurred by the Company in the three month period ended September 30,2009, and the nine month period ended September 30, 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  September 30, 2009        |       | 637,625        |       | $1.53 – $7.50  |       |
| As of  September 30, 2008        |       | 546,933        |       | $0.75 – $7.50  |       |
|                                  |       |           |       |                |       |
| Anti-dilutive common  stock warrants: |       |           |       |                |       |
| As of September 30,  2009        |       | 1,791,079      |       | $4.31 – $6.49  |       |
| As of  September 30, 2008        |       | 1,797,867      |       | $4.13 – $6.49  |       |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Recent Accounting Pronouncements*

 

**Adopted**

 

**FASB Accounting Standards Codification.****TM**  On September 30,2009, the Company adopted changes issued by the Financial Accounting StandardsBoard (“FASB”) to the authoritative hierarchy of GAAP.  These changes establish the FASB AccountingStandards CodificationTM (“Codification”)as the source of authoritative accounting principles recognized by the FASB tobe applied by nongovernmental entities in preparation of financial statementsin conformity with GAAP.  Rules andinterpretive releases of the Securities and Exchange Commission (“SEC”) under authorityof federal securities laws are also sources of authoritative GAAP for SECregistrants.  The FASB will no longerissue new standards in the form of Statements, FASB Staff Positions, orEmerging Issues Task Force Abstracts; instead the FASB will issue AccountingStandards Updates.  Accounting StandardsUpdates will not be authoritative in their own right as they will only serve toupdate the Codification.  These changesand the Codification itself do not change GAAP. Other than the manner in which new accounting guidance is referenced,the adoption of these changes had no impact on the Company’s consolidatedfinancial statements.

 

**Fair Value Measurements and Disclosure**. In January 2009, the Company adopted changes issued by the FASB tofair value accounting and reporting as it relates to non-financial assets andnon-financial liabilities that are not recognized or disclosed at fair value inthe financial statements on at least an annual basis.  These changes define fair value, establish aframework for measuring fair value under GAAP and expand disclosures about fairvalue measurements.  This guidanceapplies to other GAAP that require or permit fair value measurements and is tobe applied prospectively with limited exceptions.  The adoption of these changes, as it relatesto non-financial assets and liabilities, had no impact on the Company’sfinancial statements.

 

**Business Combinations**. On January 1, 2009, the Company adopted an update to existingaccounting standards for business combinations. The update, which retains the underlying concepts of the originalstandard in that all business combinations are still required to be accountedfor at fair value under the acquisition method of accounting, changes themethod of applying the acquisition method. Acquisition costs are no longer considered part of the fair value of anacquisition and will generally be expensed as incurred, non-controllinginterests are valued at fair value at the acquisition date, in-process researchand development is recorded at fair value as an indefinite-lived intangibleasset at the acquisition date, restructuring costs associated with a businesscombination are generally expensed subsequent to the acquisition date, andchanges in deferred tax asset valuation allowances and income tax uncertaintiesafter the acquisition date generally will affect income tax expense.

 

In April 2009, the FASB issued a further updatein relation to accounting for assets acquired and liabilities assumed in abusiness combination that arise from contingencies, which amends the previousguidance to require contingent assets acquired and liabilities assumed in abusiness combination to be recognized at fair value on the acquisition date iffair value can be reasonably estimated during the measurement period.  If fair value cannot be reasonably estimatedduring the measurement period, the contingent asset or liability would berecognized in accordance with standards and guidance on accounting forcontingencies and reasonable estimateion of the amount of a loss.  Further, this update eliminated the specificsubsequent accounting guidance for contingent assets and liabilities withoutsignificantly revising the original guidance. However, contingent consideration arrangements of an acquiree assumed bythe acquirer in a business combination would still be initially andsubsequently measured at fair value. These updates are applicable prospectively to business combinations forwhich the acquisition date is on or after January 1, 2009.  The adoption of these provisions will have animpact on accounting for any business acquired after January 1, 2009.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Derivatives and Hedging**. On January 1, 2009, the Company adopted changes issued by the FASBto disclosures about derivative instruments and hedging activities.  These changes require enhanced disclosuresabout an entity’s derivative and hedging activities, including (i) how andwhy an entity uses derivative instruments, (ii) how derivative instrumentsand related hedged items are accounted for, and (iii) how derivativeinstruments and related hedged items affect an entity’s financial position,financial performance and cash flows. Other than the required disclosures, the adoption of these changes hadno impact on the Company’s consolidated financial statements.

 

On January 1, 2009, the Company adopted an updateissued by the FASB to the accounting for instruments (or embedded features)indexed to an entity’s own stock.  Thesechanges clarify the determination of whether an instrument (or embeddedfeature) is indexed to an entity’s own stock, which would qualify as a scopeexception under previously issued guidance. The adoption of these changes resulted in the reclassification ofcertain of the Company’s outstanding warrants from stockholders’ equity toliabilities, which requires the warrants to be fair valued at each reportingperiod, with the changes in fair value recognized in the Company’s consolidatedstatement of operations.  See Note 12 -Warrants.

 

**Intangibles — Goodwill and Other**. On January 1, 2009, the Company adopted changes issued by the FASBto account for intangible assets.  Thesechanges amend the factors that should be considered in developing renewal orextension assumptions used to determine the useful life of a recognizedintangible asset in order to improve the consistency between the useful life ofa recognized intangible asset outside of a business combination and the periodof expected cash flows used to measure the fair value of an intangible asset ina business combination.  The adoption ofthese changes did not have an impact on the Company’s consolidated financialstatements.

 

**Financial Instruments**. On June 30, 2009, the Company adopted an update to accountingstandards for disclosures about the fair value of financial instruments, whichrequires publicly-traded companies to provide disclosures on the fair value offinancial instruments in the interim financial statements.  Other than the required disclosures, theadoption of this update had no impact on the Company’s consolidated financialstatements.

 

**Subsequent Events**.  On June 30,2009, the Company adopted changes issued by the FASB to accounting for anddisclosure of events that occur after the balance sheet date but beforefinancial statements are issued or are available to be issued, otherwise knownas “subsequent events.”  Specifically,these changes set forth (1) the period after the balance sheet date duringwhich management of a reporting entity should evaluate events or transactionsthat may occur for potential recognition or disclosure in the financial statements:(2) the circumstances under which an entity should recognize events ortransactions occurring after the balance sheet date in its financialsstatements; and (3) the disclosures that an entity should make aboutevents or transactions that occurred after the balance sheet date.  The adoption of these changes did not have amaterial impact on the Company’s financial statements.

 

**Issued, but not adopted**

 

**Fair Value Measurements and Disclosure**. In August 2009, the FASB issued an update to the fair valuemeasurement guidance to clarify how an entity should measure liabilities atfair value.  The update reaffirms fairvalue is based on an orderly transaction between market participants, eventhough liabilities are infrequently transferred due to contractual or otherlegal restrictions.  However, identicalliabilities traded in the active market should be used when available.  When quoted prices are not available, thequoted price of the identical liability traded as an asset, quoted prices forsimilar liabilities or similar liabilities traded as an asset, or anothervaluation approach should be used.  Thisupdate also clarifies that restrictions preventing the transfer of a liabilityshould not be considered as a separate input or adjustment in the measurementof fair value.  The Company will adopt

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

this update for fairvalue measurements of liabilities effective October 1, 2009, which it doesnot expect to have a material impact on its consolidated financial statements.

 

**Revenue Recognition**.  In October 2009,the FASB issued an update to existing guidance on revenue recognition forarrangements with multiple deliverables. This update will allow companies to allocate consideration received forqualified separate deliverables using estimated selling prices for bothdelivered and undelivered items when vendor-specific objective evidence orthird-party evidence is unavailable. Additional disclosures discussing the nature of multiple elementarrangements, the types of deliverables under the arrangements, the generaltiming of their delivery, and significant factors and estimates used todetermine estimated selling prices are required.  The Company will adopt this update for newrevenue arrangements entered into or materially modified beginning January 1,2011.  The Company is still evaluatingthe impact, if any, of the adoption of this new revenue recognition guidance onits consolidated financial statements.

 

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

 

Thefinancial statements as of and for the period ended September 30, 2009have been restated to correct an error in the computation and presentation ofthe Company’s income tax expense and liabilities.  The Company is the U.S. parent of both U.S.and foreign subsidiaries.  The Company’scredit facility (as described in Notes 11 and 12) was structured such that theassets of all of the U.S. and U.K. subsidiaries were pledged as collateral andthat those assets be included in the borrowing base for the revolver.  Additionally, the Lender required that eachof the foreign subsidiaries provide a guaranty on the credit facility.  During the audit of the Company’s 2009financial statements and as a result of this structure, the Company hasdetermined that Internal Revenue Code (“IRC”) §956 requires adjustment oftaxable income in each of the years since the inception of the creditfacility.  Although the Company has netoperating loss carryforwards available to offset the resulting increases to itsregular taxable income, the Company is subject to alternative minimum tax (“AMT”)because the carryforwards do not provide a complete offset in calculating AMTincome.  The Company computed the AMT,applying the estimated foreign tax credits generated from application of IRC§956 that became available as offsets to the AMT obligation.  As a result, the Company is restating itsfinancial statements for the interim period ended September 30, 2009.  The impact of this restatement is toreclassify tax expense from discontinued operations to continuing operationsand record the incremental AMT associated with the §956 income.

 

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

 

***Balance Sheet***

 
| ** **                                       | ** ** | **September 30,  2009** | ** ** |
|--------------------------------------------------|------------|------------------------------|------------|
| ** **                                       | ** ** | **As  reported**             | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                             |       |                         |       |   |   |   |   |
| Income taxes payable                             |       | $                            | 662        |   | $ | 83 |   | $ | 745 |   |
|                                             |       |                         |       |   |   |   |   |
| Total current  liabilities                       |       | $                            | 26,162     |   | $ | 83 |   | $ | 26,245 |   |
|                                             |       |                         |       |   |   |   |   |
| Total liabilities                                |       | $                            | 32,226     |   | $ | 83 |   | $ | 32,309 |   |
|                                             |       |                         |       |   |   |   |   |
| Accumulated deficit                              |       | $                            | (25,030    | ) | $ | (83 | ) | $ | (25,113 | ) |
|                                             |       |                         |       |   |   |   |   |
| Total stockholder’s equity                  |       | $                            | 16,973     |   | $ | (83 | ) | $ | 16,890 |   |
|                                             |       |                         |       |   |   |   |   |
| Total liabilities and  stockholder’s equity |       | $                            | 49,199     |   | $ | — |   | $ | 49,199 |   |

 

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** **

**EMRISECORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

***Statement of Operations***

 
| ** **                                | ** ** | **Three  Months Ended**      | ** ** | **Nine  Months Ended**       | ** ** |
|-------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                | ** ** | **September 30,  2009** | ** ** | **September 30,  2009** | ** ** |
| ** **                                | ** ** | **As  reported**             | ** ** | **Adjustment**               | ** ** | **Restated** | ** ** | **As  reported** | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                      |       |                         |       |                         |       |   |   |   |   |   |   |   |   |
| Pre-tax loss                              |       | $                            | (1,422     | )                            | $          | — |   | $ | (1,422 | ) | $ | (3,299 | ) | $ | — |   | $ | (3,299 | ) |
| Provision (benefit) for  income taxes     |       | (238                         | )          | 501                          |       | 263 |   | (596 | ) | 1,231 |   | 635 |   |
| Loss from continuing  operations          |       | (1,184                       | )          | (501                         | )          | (1,685 | ) | (2,703 | ) | (1,231 | ) | (3,934 | ) |
| Discontinued  operations:                 |       |                         |       |                         |       |   |   |   |   |   |   |   |   |
| Income from  discontinued operations      |       | (132                         | )          | —                       |       | (132 | ) | 7,156 |   | — |   | 7,156 |   |
| Tax provision on  discontinued operations |       | 510                          |       | (510                         | )          | — |   | 1,855 |   | (1,148 | ) | 707 |   |
| Net gain on  discontinued operations      |       | (642                         | )          | 510                          |       | (132 | ) | 5,301 |   | 1,148 |   | 6,449 |   |
|                                      |       |                         |       |                         |       |   |   |   |   |   |   |   |   |
| Net income                                |       | $                            | (1,826     | )                            | $          | 9 |   | $ | (1,817 | ) | $ | 2,598 |   | $ | (83 | ) | $ | 2,515 |   |
|                                      |       |                         |       |                         |       |   |   |   |   |   |   |   |   |
| Earnings (loss) per  share:               |       |                         |       |                         |       |   |   |   |   |   |   |   |   |
| Basic                                     |       | $                            | (0.18      | )                            | $          | 0.00 |   | $ | (0.18 | ) | $ | 0.25 |   | $ | 0.00 |   | $ | 0.25 |   |
| Diluted                                   |       | $                            | (0.18      | )                            | $          | 0.00 |   | $ | (0.18 | ) | $ | 0.25 |   | $ | 0.00 |   | $ | 0.25 |   |
|                                      |       |                         |       |                         |       |   |   |   |   |   |   |   |   |
| Weighted average shares  outstanding      |       |                         |       |                         |       |   |   |   |   |   |   |   |   |
| Basic                                     |       | 10,213                       |       | 10,213                       |       | 10,213 |   | 10,208 |   | 10,208 |   | 10,208 |   |
| Diluted                                   |       | 10,213                       |       | 10,213                       |       | 10,213 |   | 10,208 |   | 10,208 |   | 10,208 |   |

 

***Statement of CashFlows***

 
| ** **                                                       | ** ** | **Nine  Months Ended**       | ** ** |
|------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                       | ** ** | **September 30,  2009** | ** ** |
| ** **                                                       | ** ** | **As  reported**             | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                                             |       |                         |       |   |   |   |   |
| Net income (loss)                                                |       | $                            | 2,598      |   | $ | (83 | ) | $ | 2,515 |   |
| Adjustments to arrive  at net loss from continuing operations    |       | (5,301                       | )          | (1,148 | ) | (6,449 | ) |
| Net loss from  continuing operations                             |       | (2,703                       | )          | (1,231 | ) | (3,934 | ) |
|                                                             |       |                         |       |   |   |   |   |
| Changes in assets and  liabilities                               |       |                         |       |   |   |   |   |
| Accounts payable and  accrued expenses                           |       | $                            | (1,946     | ) | $ | 83 |   | $ | (1,863 | ) |
|                                                             |       |                         |       |   |   |   |   |
| Operating cash flow  provided by (used in) continuing operations |       | $                            | 582        |   | $ | (1,148 | ) | $ | (566 | ) |
|                                                             |       |                         |       |   |   |   |   |
| Operating cash flow  provided by discontinued operations         |       | $                            | 165        |   | $ | 1,148 |   | $ | 1,313 |   |

 

**NOTE 3 — GOING CONCERN, ASRESTATED**

 

Theaccompanying consolidated financial statements have been prepared in conformitywith GAAP, which contemplate the continuation of the Company as a goingconcern.  The Company reported a net lossfor the quarter ended September 30, 2009 of $1.8 million and net incomefor the nine months ended September 30, 2009 of $2.5 million.  Included in net income for the nine monthperiod was $6.4 million in income/gain (net of taxes of $0.7 million) fromdiscontinued operations related to the disposition of the Company’s DigitranOperations (see Note 4).  Absent thisincome/gain, the Company would have incurred a $3.9 million net loss for thenine months ended September 30, 2009. The Company also reported negative working capital from continuingoperations of $1.1 million at September 30, 2009 and positive workingcapital from continuing operations of $5.5 

 

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**EMRISECORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

millionat December 31, 2008.  The Company’scurrent business plan for the next 12 months requires additional funding beyondits anticipated cash flows from operations. These and other factors described in more detail below raise substantialdoubt about the Company’s ability to continue as a going concern.

 

Theability of the Company to continue as a going concern is dependent upon itsability to (i) raise $3 million (net of transaction costs) in equitycapital by December 31, 2009, (ii) repay its credit facility on orprior to its maturity on June 30, 2010, (iii) obtain alternatefinancing to fund the Company’s operations after June 30, 2010, and (iv) achieveprofitable operations.  The accompanyingconsolidated financial statements do not include any adjustments that might benecessary if the Company is unable to continue as a going concern.

 

If the Company’s netlosses continue, the Company may experience negative cash flow, which mayprevent it from continuing operations. Additionally, losses may result in a default on the Company’s debtcovenants associated with its credit facility. If the Company is not be able to attain, sustain and increaseprofitability on a quarterly or annual basis, the Company may not be able tocontinue its operations and its stock price may decline.

 

Currently,the Company is in the process of seeking alternate financing from a number ofpossible participants, including traditional lenders, equity participants andmezzanine lenders.  The Company hasengaged financial advisors, Boenning & Scattergood, to assist in thisregard.  Although the Company remainshopeful that it will be able to successfully raise at least $3.0 million inequity capital by December 31, 2009 and secure replacement financing on orprior to June 30, 2010, when its current credit facility matures, noassurances can be made that the Company will be successful in this regard.

 

If the Company cannotmeet its obligations under the terms of its credit facility and if the lenderdoes not waive or renegotiate these obligations, then the Company would be indefault under the terms of its credit facility.

 

In the event of adefault and continuation of a default, the lender may limit future availabilityunder the Revolver (as defined in Note 11) and/or accelerate the payment of allprincipal balances and accrued interest requiring the Company to pay the entireindebtedness under the credit facility outstanding on that date.  As of November 1,2009, $12.5 million was outstanding under the credit facility. The Company doesnot have the ability to pay this amount if the lender accelerated the paymentof the outstanding amount under the credit facility upon a default.

 

Upon the occurrence andduring the continuation of an event of default, the lender may also elect toincrease the interest rate applicable to the outstanding balance of the TermLoans A and B (as defined in Note 12) by four percentage points above the perannum interest rate that would otherwise be applicable.  Additionally, ifthe lender terminates the credit facility during a default period or if theCompany prepays the Revolver or the Term Loans prior to November 30, 2009,then the Company is subject to a penalty equal to 2% of the outstandingprincipal balance of the Revolver and the Term Loans.

 

If the Company is unableto (i) raise the requisite amount of equity capital by December 31,2009 required under the terms of the Company’s credit facility, (ii) continueto borrow funds under the terms of the Revolver, for any reason, through June 30,2010, or (iii) obtain alternate financing to replace its credit facilityprior to June 30, 2010, the Company does not believe that current andfuture capital resources, revenues generated from operations and other existingsources of liquidity will be adequate to meet its anticipated short term,working capital and capital expenditures needs for the next 12 months. Further, if for any reason, the Company is not able to continue to borrow fundsunder the terms of the Revolver or if it experiences a significant loss ofrevenue or increase in costs, then its cash flow would be negatively impactedresulting in a cash flow deficit which, in turn, will require it to obtainadditional or alternate financing, with little or no notice.  Thesepotential financing needs could be met in the form of a revised debt structurewith the Company’s current lender, additional or new financing with anotherlender or lenders, the sale of assets to generate cash or the sale ofadditional equity to raise 

 

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**EMRISECORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

capital.  Failure tosecure additional or alternate financing, if and when needed, would have anadverse effect on the Company’s operations and/or ability to do business afterthat date or could restrict the Company’s growth, limit its development of newproducts, or hinder its ability to fulfill existing or future orders.

 

Ifthe Company is unsuccessful in securing the necessary financing to continueoperations, when needed, then the Company may be forced to seek protection under the U.S. Bankruptcy Code or be forcedinto liquidation or substantially restructuring or altering the Company’sbusiness operations and/or debt obligations.

 

**NOTE 4 — ACQUISITION OF ADVANCEDCONTROL COMPONENTS**

 

OnAugust 20, 2008, the Company and its wholly-owned subsidiary, EEC,acquired all of the issued and outstanding shares of common stock of CCI andall of the issued and outstanding shares of common stock of ACC not owned byCCI (the “Acquisition”).  In addition to the purchase price, the Companyis obligated to pay up to an additional $3,000,000 in cash if ACC meets certainoperating income targets for one or both of the two 12 month periods followingthe closing.  Additionally, EEC issued Subordinated Secured ContingentPromissory Notes (the “Notes”) to each of the sellers in the aggregateprincipal amount of $2,000,000.  The Notes become payable if ACC meetscertain operating income thresholds during the first and second 12 monthperiods after August 20, 2008.  The Notes bear interest at a rateper annum equal to the prime rate as reported in *The Wall Street Journal *plus 1%.  Interest accrues on the principal balancebeginning August 20, 2008 with interest measured as of the beginning ofeach quarter after that date.  Nointerest payments are due during the first 12 months.  Interest is due at the beginning of eachquarter after November 2009.  As of September 30,2009, ACC had met its operating income targets associated with the Notes and assuch the Company recorded a note payable of $2,000,000.  In addition, the Company recorded additionalamounts due under the Notes of $960,000 associated with a working capitaladjustment pursuant to the sales purchase agreement.  The Notes, which total $3.0 million as of September 30,2009, are due on or prior to November 21, 2010.

 

Additionally,at September 30, 2009, the Company recorded in other current liabilities$1.0 million associated with the first 12 month measurement period for thecontingent cash obligation and $300,000 representing an adjustment to workingcapital and net cash.  This amount, whichtotals $1.3 million as of September 30, 2009 is due to the sellers on orprior to November 21, 2009.  TheCompany expects to record additional purchase price adjustments associated withthe contingent cash obligation when such obligation is earned.  The second and final 12 month measurement periodbegins August 20, 2009 and ends on August 19, 2010.  During this second measurement period, anyamounts in excess of $1 million of earnings before interest expense and incometaxes earned by ACC accrue to the sellers. The maximum amount that can accrue to the sellers is $1 million,including the $1 million that is already accrued as of September 30,2009.  All amounts accrued to the sellersafter September 30, 2009 are due in November 2010.

 

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**EMRISECORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 5 — DISCONTINUED OPERATIONS,AS RESTATED**

 

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

 

TheBuyer acquired all of the intellectual property, cash, accounts receivable, inventory,customer support and relationships, software and product development, and realproperty lease related to the Digitran division, which, prior to itsacquisition, was in the business of manufacturing a line of electromechanicalswitches comprised of digital and rotary switches used for routing electronicsignals.  The Stock Buyer acquired XCEL Japan, Ltd., which, prior to itsacquisition, was engaged in the business of selling and distributing Digitrandivision products in the Asia Pacific market.  EEC retained all accountspayable and certain other assets and liabilities related to the Digitrandivision.  The Company continues to operate its communications equipmentsegment and the power systems radio frequency (“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 terminationcosts. Subsequent to closing, the Company paid $280,000 of previouslyaccrued costs, including a portion of the federal and state income taxliabilities, employee termination costs and transaction related employeebonuses and legal fees.  At September 30,2009, the Company estimates future cash expenditures related to the sale to beapproximately $150,000 primarily for employee termination costs and transactionrelated employee bonuses, which were accrued within “Accrued liabilities”except for income taxes, which were accrued within “Income taxes payable” inthe accompanying condensed consolidated balance sheets.   In addition, the Company has accrued $422,000related to a purchase price adjustment owed to the Buyer in connection with thetransaction.

 

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**EMRISECORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 
| ** **                                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                       | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                       | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                       | ** ** | **(Restated)**         | ** ** | ** **             | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
|                                                             |       |                   |       |                   |       |   |   |   |   |
| Net Sales                                                        |       | $                      | —     |                   | $          | 2,609 |   | $ | 1,478 |   | $ | 6,240 |   |
|                                                             |       |                   |       |                   |       |   |   |   |   |
| Income from operations                                           |       | $                      | —     |                   | $          | 1,194 |   | $ | 178 |   | $ | 2,190 |   |
| Gain (loss) on sale of  Digitran Operations (net of tax of $707) |       | (132                   | )          | —                 |       | 6,271 |   | — |   |
| Net (loss) Income                                                |       | $                      | (132       | )                      | $          | 1,194 |   | $ | 6,449 |   | $ | 2,190 |   |

 

**NOTE 6 — STOCK-BASED COMPENSATION**

 

The Company has fivestock option plans:

 

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

·                  1993 Stock Option Plan;

·                  1997 Stock Incentive Plan;

·                  Amended and Restated 2000 Stock Option Plan; and

·                  2007 Stock Incentive Plan.

 

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

 

Total stock-based compensation expense included inwages, salaries and related costs was $36,000 and $28,000 for the three monthsended September 30, 2009 and 2008, respectively and $114,000 and $61,000for the nine months ended September 30, 2009 and 2008, respectively.  These compensation expenses were charged toselling, general and administrative expenses. As of September 30, 2009,the Company had $271,000 of total unrecognized compensation expense related tostock option grants, which will be recognized over the remaining weightedaverage period of two years.

 

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**EMRISECORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 7 — INVENTORIES**

 

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

 
| ** **        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|------------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2009**               | ** ** | **2008**              | ** ** |
|              |       |                   |       |                  |       |
| Raw materials     |       | $                      | 10,223     |                  | $          | 10,093 |   |
| Work-in-process   |       | 3,134                  |       | 3,319                 |       |
| Finished goods    |       | 4,301                  |       | 4,311                 |       |
| Reserves          |       | (5,732                 | )          | (5,222                | )          |
| Total inventories |       | $                      | 11,926     |                  | $          | 12,501 |   |

 

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

 

**NOTE 8 — OPERATING SEGMENTS**

 

The Company has two reportable operating segments:electronic devices and communications equipment. The electronic devices segmentmanufactures and markets electronic power supplies, RF and microwave devicesand subsystem assemblies. The electronic devices segment consists of EEC andits subsidiaries located in the U.S. and England, which offer the same orsimilar products to similar customers. The communications equipment segment designs, manufactures anddistributes network access products and timing and synchronization products.  The communications equipment segment consistsof operating entities CXR Larus Corporation located in the U.S. and CXRAnderson Jacobson located in France, both of which offer the same or similarproducts to similar customers.  Bothsegments operate in the U.S., European and Asian markets, but have distinctlydifferent customers, design and manufacturing processes and marketingstrategies.  Each segment has discretefinancial information and a separate management structure.

 

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

 

During the first quarterof 2009, the Company sold its Digitran Operations (see Note 5), which were partof its electronic devices segment.  Thistransaction resulted in differences in the basis of segmentation from theamounts disclosed in the Company’s audited consolidated financial statementsincluded in its annual report on Form 10-K for the year ended December 31,2008.  In this report, the DigitranOperations are reported as a discontinued operation and are excluded from theelectronics devices segment.  Therefore,prior period amounts have been adjusted to conform to this presentation.  Included in the Company’s reconciliation ofsegment financial data to the consolidated amounts is unallocated corporateexpenses.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                | ** ** | **2009**                         | ** ** | **2008**                        | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net sales                 |       |                             |       |                            |       |   |   |   |   |
| Electronic  devices       |       | $                                | 10,987     |                            | $          | 9,915 |   | $ | 34,231 |   | $ | 25,358 |   |
| Communications  equipment |       | 3,332                            |       | 3,163                           |       | 8,571 |   | 10,385 |   |
| Discontinued  Operations  |       | —                           |       | 2,609                           |       | — |   | 6,240 |   |
| Total                     |       | $                                | 14,319     |                            | $          | 15,687 |   | $ | 42,802 |   | $ | 41,983 |   |
|                      |       |                             |       |                            |       |   |   |   |   |
| Operating income  (loss)  |       |                             |       |                            |       |   |   |   |   |
| Electronic  devices       |       | $                                | 813        |                            | $          | 1,307 |   | $ | 4,307 |   | $ | 2,426 |   |
| Communications  equipment |       | (307                             | )          | (9                              | )          | (1,224 | ) | (81 | ) |
| Discontinued  Operations  |       | —                           |       | 1,194                           |       | — |   | 2,190 |   |
| Corporate and  other      |       | (1,129                           | )          | (901                            | )          | (3,422 | ) | (2,972 | ) |
| Total                     |       | $                                | (623       | )                               | $          | 1,591 |   | $ | (339 | ) | $ | 1,563 |   |

 
| ** **                | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| Total assets              |       |                   |       |                  |       |
| Electronic  devices       |       | $                      | 37,110     |                  | $          | 34,853 |   |
| Communications  equipment |       | 8,778                  |       | 10,260                |       |
| Discontinued  Operations  |       | —                 |       | 3,600                 |       |
| Corporate and  other      |       | 3,311                  |       | 4,910                 |       |
| Total                     |       | $                      | 49,199     |                  | $          | 53,623 |   |

 

**NOTE 9 —GOODWILL AND OTHER INTANGIBLE ASSETS**

 

Thefollowing table reflects changes in the Company’s goodwill balances, bysegment, for the nine months ended September 30, 2009 (in thousands):

 
| ** **                                      | ** ** | **Electronic** | ** ** | **Communications** | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|----------------|------------|--------------------|------------|------------|------------|
| ** **                                      | ** ** | **Devices**    | ** ** | **Equipment**      | ** ** | **Total**  | ** ** |
|                                            |       |           |       |               |       |       |       |
| Balance at  December 31, 2008              |       | $              | 9,657      |               | $          | —     |       | $ | 9,657 |   |
| Purchase price adjustment  for ACC (see Note 3) |       | 4,090          |       | —             |       | 4,090      |       |
| Foreign currency  translation                   |       | 473            |       | —             |       | 473        |       |
| Balance at  September 30, 2009             |       | $              | 14,220     |               | $          | —     |       | $ | 14,220 |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

Otherintangible assets consist primarily of trademarks, trade names and technologyacquired.  The original cost and accumulatedamortization of these intangible assets consisted of the following (inthousands):

 
| ** **                             | ** ** | **September 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **                             | ** ** | **Electronic**              | ** ** | **Communications**         | ** ** | ** ** | ** ** | **Electronic** | ** ** | **Communications** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Devices**                 | ** ** | **Equipment**              | ** ** | **Total** | ** ** | **Devices** | ** ** | **Equipment** | ** ** | **Total** | ** ** |
|                                   |       |                        |       |                       |       |   |   |   |   |   |   |   |   |
| **Intangibles with definite lives:**   |       |                        |       |                       |       |   |   |   |   |   |   |   |   |
| Technology acquired                    |       | $                           | —     |                       | $          | 1,150 |   | $ | 1,150 |   | $ | 500 |   | $ | 1,150 |   | $ | 1,650 |   |
| Customer relationships                 |       | 2,550                       |       | 200                        |       | 2,750 |   | 2,900 |   | 200 |   | 3,100 |   |
| Trade name                             |       | 1,570                       |       | —                     |       | 1,570 |   | 1,570 |   | — |   | 1,570 |   |
| Covenant-not-to-compete                |       | 260                         |       | —                     |       | 260 |   | 260 |   | — |   | 260 |   |
| Patents                                |       | —                      |       | —                     |       | — |   | — |   | — |   | — |   |
| Patents-in-progress                    |       | —                      |       | —                     |       | — |   | — |   | — |   | — |   |
| Backlog                                |       | 770                         |       | —                     |       | 770 |   | 770 |   | — |   | 770 |   |
|                                   |       | 5,150                       |       | 1,350                      |       | 6,500 |   | 6,000 |   | 1,350 |   | 7,350 |   |
| Accumulated amortization               |       | (1,348                      | )          | (708                       | )          | (2,056 | ) | (974 | ) | (608 | ) | (1,582 | ) |
| Carrying Value                         |       | 3,802                       |       | 642                        |       | 4,444 |   | 5,026 |   | 742 |   | 5,768 |   |
|                                   |       |                        |       |                       |       |   |   |   |   |   |   |   |   |
| **Intangibles with indefinite lives:** |       |                        |       |                       |       |   |   |   |   |   |   |   |   |
| Trademarks and trade names             |       | 850                         |       | —                     |       | 850 |   | 850 |   | — |   | 850 |   |
| Total intangible assets, net           |       | $                           | 4,652      |                       | $          | 642 |   | $ | 5,294 |   | $ | 5,876 |   | $ | 742 |   | $ | 6,618 |   |

 

Inaccordance with FASB guidance for accounting for the impairment or disposal oflong-lived assets, the Company reevaluates the carrying value of identifiableintangible and long-lived assets for impairment whenever events or changes incircumstances indicate that the carrying value may not be recoverable.

 

In September 2009,the Company engaged  an investmentbanking firm to evaluate the feasibility of selling RO Associates Incorporated(“RO”), a wholly-owned subsidiary of the Company that operates within  the Company’s electronic devices segment,with the intent to gauge the level of interest from outside parties to purchasethe capital stock or all or substantially all of the assets of RO and todetermine possible values ascribed to RO by such parties in connection withsuch a potential sale of RO.

 

As of September 30,2009, discussions with potential buyer for RO had commenced.  However, due the historical and ongoinglosses of RO, it was uncertain as of that date whether or not any offers wouldbe received or, even if such offers were received, whether such offers would bein a value range acceptable to the Company’s Board of Directors.  As a result of the uncertainty surroundingany plan to dispose of RO and the lack of probability of being able to sell,the Company determined that it was inappropriate to classify the RO businessunit as held for sale at September 30, 2009.

 

Subsequentto September 30, 2009, presentations were made to all interested buyers,and in November 2009, the Company received more than one bona fide offerto purchase substantially all of the assets of RO.  Based on the receipt of these offers, theCompany intends to pursue negotiations for the sale of substantially all of theassets of RO with the intent of consummating such a sale of RO by December 31,2009.

 

As a result of the current expectation that RO wouldbe sold before the end of the estimated useful lives of its long-lived assets,the Company performed an assessment of recoverability associated with thelong-lived assets of RO.  In connectionwith that assessment, an impairment loss of $619,000 was recognized, which isincluded in the Company’s statement of operations as “Loss on Impairment ofAssets” for the three and nine months ended

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

September 30,2009, representing the write-off of long-lived assets other than goodwill andindefinite life intangibles.

 

**NOTE 10 — INCOME TAXES, AS RESTATED**

 

The effective tax ratefor the three month period ended September 30, 2009 was different than the34% U.S. statutory rate primarily because the Company’s foreign entitiesgenerate a tax obligation and related tax expense as a result of their netincome in their respective foreign locations (either England or France), whichcannot be offset by U.S. tax losses or by U.S. tax loss carryforwards.

 

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

 

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

 

The Company files incometax returns in the United States federal jurisdiction, the United Kingdom andFrance and in the state jurisdictions of California, Texas, Pennsylvania andNew Jersey. The Company is no longer subject to United States federal and statetax examinations for years before 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 11 — LINE OF CREDIT**

 

TheCompany and its direct subsidiaries, EEC, CXR Larus Corporation and ROAssociates Incorporated (collectively, the “Borrowers”), are parties to aCredit Agreement (as amended from time to time the “Credit Agreement”) withGVEC Resource IV Inc. (the “Lender”) providing for a credit facility whichincludes term loans and a revolving credit facility and is secured by accountsreceivable, other rights to payment and general intangibles, inventories andequipment. The credit facility includes a revolving credit facility for up to$7,000,000 that expires on June 30, 2010 (the “Revolver”).  The credit facility also includes two termloans (see Note 12).

 

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

 

Intereston the Revolver is payable monthly.  Theinterest rate is variable and is adjusted monthly based on the prime rate as publishedin the “Money Rates” column of *The Wall Street Journal*(the “Base Rate”) plus 1.25%, subject to a minimum rate of 9.5% per annum.  The interest rate in effect as of September 30,2009 was the minimum rate of 9.5%.  TheRevolver is subject to various financial covenants on a consolidated basis,including the following: EBITDA, as defined in the Credit Agreement, measuredon a fiscal quarter-end basis, must not be less than $250,000 for the periodended September 30, 2009, $550,000 for the period ended December 31,2009 and $1,450,000 for the period ended March 31, 2010; the leverageratio, as defined by the 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

Credit Agreement,measured quarterly, must not be greater than 1.70:1.00 for the period ended September 30,2009, 1.50:1.00 for the period ended December 31, 2009 and 1.40:1.00 forthe period ended March 31, 2010; and liquidity, as defined by the Credit Agreement, measured quarterly,must not be less than $2,800,000 for the period ended December 31, 2009and $2,700,000 for the period ended March 31, 2010.  Additionally, the Revolver is subject to theBorrowers not incurring capital expenditures (a) in excess of $600,000 forthe fiscal year ending December 31, 2009, and (b) in excess of$1,800,000 for the fiscal year ending December 31, 2010.  Additionally, the Revolver is subject to the Borrowersnot incurring unfinanced capital expenditures in excess of $62,500 in anyfiscal quarter and the Borrowers not incurring purchase money commitments inexcess of $2 million over the life of the facility.  However, if the Borrowers incur unfinancedcapital expenditures of less than $62,500 in any fiscal quarter, the differencebetween the amount incurred in a certain fiscal quarter and $62,500 maybeincurred in the two fiscal quarters immediately following such fiscal quarter.The Company was in compliance with all covenants at September 30, 2009, asamended.  See Note 14.

 

As of September 30, 2009, the Company hadoutstanding borrowings of $4.0 million under the Revolver with remainingavailability under the formula-based calculation of $3.0 million.

 

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.

 

See related Note 3 “Going Concern” and Note 12 “Debt” regardingadditional terms and conditions associated with the overall credit facility andrisks associated with this credit facility.

 

**NOTE 12 —DEBT**

 

On August 20, 2008,in connection with the acquisition of ACC and CCI as discussed in Note 3, theBorrowers and the Lender amended the credit facility to, among other things,include ACC and CCI as Borrowers and to provide for another term loan in theprincipal amount of $3 million (the “Term Loan C”).  The credit facility, as so amended, providedfor borrowings in the aggregate amount of $26 million, including the $7 millionrevolving facility described in Note 10.

 

Thecredit facility consists of (i) the Revolver, (ii) a term loan in theprincipal amount of $6 million which is due June 30, 2010 (“Term Loan A”),(iii) a term loan in the original principal amount of $10 million, whichis due on June 30, 2010 (“Term Loan B”), and (iv) Term Loan C.  Term Loan A was fully funded on November 30,2007 while Term Loans B and C were fully funded on August 20, 2008 inconnection with the acquisition of ACC. Term Loan A and Term Loan B require acombined scheduled principal payment of $75,000 on October 1, 2009,$100,000 on November 1, 2009, $150,000 on December 1, 2009 andapproximately $287,000 commencing on January 1, 2010 and continuing on thefirst day of each of the 5 consecutive months thereafter.  The facility also requires monthly interestpayments and a final balloon payment of principal upon maturity on June 30,2010.  Term Loan C was repaid in full on March 20,2009.  At September 30, 2009, theoutstanding principle balance on Term Loan A was $5.8 million and theoutstanding principle balance on Term Loan B was $2.9 million.  As a result of the partial repayment on TermLoan B in March 2009, a pro-rata portion of the balance of deferredfinancing costs and debt discount were accelerated and are reflected as anadjustment to interest expense in the accompanying Condensed ConsolidatedStatements of Operations for the nine months ended September 30, 2009.

 

TheTerm Loans A and B bear interest at the Base Rate plus 4.25%, subject to aminimum rate of 12.5% per annum, and require interest only payments in thefirst year, scheduled principal plus interest payments in years two and three,and a final balloon payment at June 30, 2010.  Interest on the Term Loans is payablemonthly.  The Borrowers may make full or partial prepayment ofthe Term Loans provided that any such prepayment is accompanied by theapplicable prepayment premium.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

Upon the sale or disposition by the Borrowers or anyof their subsidiaries of property or assets, the Borrowers may be obligated toprepay the Revolver and the term loans with the net cash proceeds received inconnection with such sales or dispositions to the extent that the aggregateamount of net cash proceeds received, and not paid to the Lender as aprepayment, for all such sales or dispositions exceed $150,000 in any fiscalyear.  However, to the extent the Company sells assetsafter August 14, 2009 and prior to January 1, 2010, 75% of the netcash proceeds of such sale must be used to prepay the Company’s outstandingobligations to the Lender.

 

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

 

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

 

The Borrowers have agreedwith the Lender to raise at least $3 million in net cash proceeds through thesale of stock of the Borrowers by no later than December 31, 2009.  Under the terms of the credit facility, theBorrowers are obligated to remit to the Lender 50% of the first $3 million ofnet cash proceeds received and 30% of the net cash proceeds received in excessof the first $3 million.  See Note 2.

 

See Note 2, Note 10, and Note 14 regarding additional terms andconditions associated with the Company’s credit facility and risks associatedwith this credit facility.

 

**NOTE 13 — WARRANTS**

 

Inconnection with entering into the credit facility (discussed in Note10), theCompany issued a seven year warrant to Private Equity Management Group, Inc.,an affiliate of the Lender, to purchase up to 775,758 shares of the Company’scommon stock on a cash or cashless basis at an exercise price of $4.13 pershare.  The estimated fair value of thewarrants was $1.5 million, which was calculated using the Black-Scholes pricingmodel.  The warrants were originallyaccounted for as debt discount and the adjustment resulting from the repricingof the warrants increased the debt discount, which is being amortized over theremaining life of the credit facility. The warrants were previously recorded in stockholder’s equity.

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

Theexercise price and/or number of shares of common stock issuable upon exerciseof the warrants may be adjusted in certain circumstances, including certainissuances of securities at a price equal to less than the then current exerciseprice, subdivisions and stock splits, stock dividends, combinations,reorganizations, reclassifications, consolidations, mergers or sales ofproperties and assets and upon issuance of certain assets or securities toholders of the Company’s common stock, as applicable. On January 1, 2009,the Company adopted updates to how instruments indexed in an entity’s own stockare accounted for, which resulted in the reclassification of certain of theCompany’s outstanding warrants from stockholders’ equity to liabilities, whichrequires the warrants to be fair valued at each reporting period, with thechanges in fair value recognized in the Company’s consolidated statement ofoperations.

 

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

 
| ** **              | ** ** | **January 1, 2009** | ** ** | **September 30, 2009** | ** ** |
|-------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Dividend yield          |       | None                     |       | None                        |       |
| Expected volatility     |       | 105                      | %          | 70                          | %          |
| Risk-free interest rate |       | 0.88                     | %          | 0.95                        | %          |
| Expected term           |       | 7 years                  |       | 7 years                     |       |
| Stock price             |       | $                        | 1.58       |                        | $          | 1.38 |   |
|                         |            |                          |            |                             |            |  |  |

 

On January 1,2009, the Company recorded a cumulative effect of change in accountingprinciple adjustment to its accumulated deficit of $473,000 and a correspondingreclassification of these outstanding warrants from stockholders’ equity towarrant liability.  As of and for thethree and nine month periods ended September 30, 2009, the change in fairvalue of the warrants resulted in a $53,000 expense and $369,000 incomeadjustment, respectively, to other income (expense) in the consolidatedstatement of operations and a corresponding increase or decrease to the warrantliability.

 

**NOTE 14 — FAIR VALUE MEASUREMENTS**

 

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

 

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

 

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

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

Asof September 30, 2009, the Company was required to apply updated FASB guidanceto the derivative that is within the warrant that was issued as considerationfor the Company’s credit facility, which is discussed in Note 12 and includedas a discount on the Company’s long-term debt. The derivative was valued using the Black-Scholes model.  The key inputs in the model are as follows:

 
| ** **               | ** ** | **September 30,  2009** | ** ** |
|--------------------------|------------|------------------------------|------------|
| Dividend  yield          |       | None                         |       |
| Expected  volatility     |       | 70                           | %          |
| Risk-free  interest rate |       | 0.95                         | %          |
| Expected  term           |       | 7  years                     |       |
| Stock  price             |       | $                            | 1.38       |   |
|                          |            |                              |            |  |

 

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 (in thousands):

 
| ** **                                 | ** ** | **Warrant  Liability** | ** ** |
|--------------------------------------------|------------|------------------------|------------|
|                                       |       |                   |       |
| Beginning  balance at January 1, 2009 |       | $                      | 1,010      |   |
| Total  gain realized in earnings           |       | (369                   | )          |
| Ending  balance at September 30, 2009 |       | $                      | 641        |   |

 

**NOTE 15 — SUBSEQUENT EVENTS, ASRESTATED**

 

In connection with the preparation of the Company’sfinancial statements at September 30, 2009, subsequent events through November 14,2009, the date the financial statements were available for issuance, have beenevaluated and the following subsequent events were identified:

 

*AssetsHeld for Sale*

 

In September 2009,the Company engaged an investment banking firm to evaluate the feasibility ofselling the capital stock or substantially all of the assets of RO and todetermine possible values ascribed to RO by potential buyers in connection withsuch a potential sale of RO.

 

As of September 30,2009, discussions with a potential buyer for RO had commenced.  However, due the historical and ongoinglosses of RO, it was uncertain as of that date whether any offers would bereceived or, even if such offers were received, whether such offers would be ina value range acceptable to the Company’s Board of Directors.  As a result of the uncertainty surroundingany plan to dispose of RO and the lack of probability of a successful sale, theCompany determined that it was inappropriate to classify the RO business unitas held for sale at September 30, 2009.

 

Subsequentto September 30, 2009, presentations were made to all interested buyers,and in November 2009, the Company received more than one bona fide offerto purchase substantially all of the assets of RO.  Based on the receipt of these offers, theCompany intends to pursue negotiations for the sale of substantially all of theassets of RO with the intent of consummating such a sale of RO by December 31,2009.

 

As a result of the current expectation thatsubstantially all of the assets of RO would be sold before the end of theestimated useful lives of RO’s long-lived assets, the Company performed anassessment of recoverability on November 9, 2009 associated with thelong-lived assets of RO.  In connectionwith that assessment, an impairment loss of $619,000 was recognized, which isincluded in the Company’s statement of 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

operationsas “Loss on Impairment of Assets” for the three and nine months ended September 30,2009, representing the write-off of long lived assets other than goodwill andindefinite life intangibles.

 

TheCompany expects to incur a loss on the sale of the RO assets in the event asale transaction is completed primarily due to the allocated goodwill from theelectronic devices reporting unit.

 

ROcontributed $617,000 of net sales or 4.3% of the Company’s net sales and anoperating loss of $162,000 of the Company’s total operating loss fromcontinuing operations of $623,000 for the three months ended September 30,2009.  RO contributed $1.9 million of netsales or 4.5% of the Company’s net sales and an operating loss of $0.8 millionof the Company’s total operating loss from continuing operations of $339,000for the nine months ended September 30, 2009.  The following table reflects the majorclasses of assets and liabilities for RO for the periods presented, includingthe impairment discussed above (in thousands):

 
| ** **                                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| Cash and cash  equivalents                  |       | $                      | —     |                  | $          | (43 | ) |
| Accounts  receivable, net                   |       | 313                    |       | 409                   |       |
| Inventory, net                              |       | 1,420                  |       | 1,960                 |       |
| Prepaids and  other current assets          |       | 18                     |       | 5                     |       |
| Total current  assets                       |       | 1,751                  |       | 2,331                 |       |
|                                        |       |                   |       |                  |       |
| Property, plant  and equipment, net         |       | —                 |       | 211                   |       |
| Goodwill                                    |       | 1,218                  |       | 1,218                 |       |
| Intangible  assets other than goodwill, net |       | 350                    |       | 917                   |       |
| Total Assets                                |       | $                      | 3,319      |                  | $          | 4,677 |   |
|                                        |       |                   |       |                  |       |
| Total current  liabilities                  |       | $                      | 449        |                  | $          | 441 |   |

 

*Amendmentto Credit Facility*

 

On November 3, 2009, the Borrowers and theLender entered into Amendment No. 6 to Loan Documents (the “SixthAmendment”).  Pursuant to the terms ofthe Sixth Amendment, the Credit Agreement was amended to change the expirationdate of the Credit Agreement from November 30, 2010 to June 30,2010.  As such, all amounts outstandingunder the terms of the Credit Agreement (including unpaid principal balance andall accrued and unpaid interest under the term loans and the Revolver (asdefined below)) will become due and payable on June 30, 2010, and theCompany will be unable to borrow under the Revolver after that date.  All amounts outstanding under the creditfacility are classified as current liabilities as a component of either “currentportion of long-term debt” or as “line of credit” in the consolidated balancesheet at September 30, 2009.

 

In addition, the Borrowers and the Lender agreed torevise the schedule of principal payments due pursuant to the terms of theSixth Amendment such that the Borrowers are now obligated to make monthlyprincipal payments to the Lender of (i) $100,000 on November 1, 2009,(ii) $150,000 on December 1, 2009 and (iii) approximately$287,000 commencing on January 1, 2010 and continuing on the first day ofeach of the five consecutive months thereafter. A balloon payment of $6.9 million will be due and payable on June 30,2010.

 

Further, the Borrowers and Lender agreed to revisecertain of the financial covenants related to the Revolver.  Under the terms of the Credit Agreement, asamended by the Sixth Amendment, the Revolver is subject to various financialcovenants on a consolidated basis, including the following: EBITDA, as definedin the 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

CreditAgreement, measured on a fiscal quarter-end basis, must not be less than$250,000 for the period ended September 30, 2009, $550,000 for the periodended December 31, 2009 and $1,450,000 for the period ended March 31,2010; the leverage ratio, as defined by the Credit Agreement, measuredquarterly, must not be greater than 1.70:1.00 for the period ended September 30,2009, 1.50:1.00 for the period ended December 31, 2009 and 1.40:1.00 forthe period ended March 31, 2010; and liquidity, as defined by the CreditAgreement, measured quarterly, must not be less than $2,800,000 for the periodended December 31, 2009 and $2,700,000 for the period ended March 31,2010.  Additionally, the Revolver issubject to the Borrowers not incurring capital expenditures (a) in excessof $600,000 for the fiscal year ending December 31, 2009, and (b) inexcess of $1,800,000 for the fiscal year ending December 31, 2010.  Additionally, the Revolver is subject to theBorrowers not incurring unfinanced capital expenditures in excess of $62,500 inany fiscal quarter and the Borrowers not incurring purchase money commitmentsin excess of $2 million over the life of the facility.  However, if the Borrowers incur unfinancedcapital expenditures of less than $62,500 in any fiscal quarter, the differencebetween the amount incurred in a certain fiscal quarter and $62,500 maybeincurred in the two fiscal quarters immediately following such fiscal quarter.

 

Pursuantto the terms of the Sixth Amendment, the Borrowers (i) paid to PrivateEquity Management Group, Inc. (“PEMG”) an amount equal to $100,000 uponthe closing of the Sixth Amendment and (ii) agreed to pay an additional$100,000 to PEMG on the earlier of March 31, 2010 or the repayment in fullof the amounts due and payable under the terms of the Credit Agreement.  The foregoing payments represent an advisoryfee to PEMG in consideration of PEMG’s advice in connection with the SixthAmendment.

 

On November 13, 2009, the Borrowers and theLender entered into Amendment No. 7 to Loan Documents (the “SeventhAmendment”).  Pursuant to the terms ofthe Seventh Amendment, the definition of the term “EBITDA” in the CreditAgreement was amended such that (i) any non-cash impairmentassociated with the write down of the long-lived assets of RO, a Borrower underthe credit facility, and (ii) any loss or non-cash impairment associatedwith the discontinuation of operations, pursuant to a sale or otherwise, of ROrecorded in the Parent’s and Subsidiaries’ consolidated financial statements inany period ending on or prior to December 31, 2009 were excludedfrom the definition of EBITDA.  Pursuantto the terms of the Seventh Amendment, the Borrowers paid to PEMG an amountequal to $15,000 upon the closing of the Seventh Amendment.

 

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

 

**CautionaryStatement**

 

The following discussionshould be read in conjunction with our unaudited condensed consolidatedfinancial statements and the related notes thereto contained in Part I,Item 1 of this Quarterly Report on Form 10-Q. The information contained inthis report is not a complete description of our business or the risksassociated with an investment in our common stock. We urge you to carefullyreview and consider the various disclosures made by us in this report and inour other reports filed with the Securities and Exchange Commission, orCommission, including our Annual Report on Form 10-K for the year ended December 31,2008 and subsequent reports on Forms 10-Q/A and 8-K, which discuss our businessin greater detail.  This report and thefollowing discussion contain forward-looking statements within the meaning of Section 21Eof the Securities Exchange Act of 1934, as amended, which generally include theplans and objectives of management for future operations, including plans andobjectives relating to our future economic performance and our current beliefsregarding revenues we might generate and profits we might earn if we aresuccessful in implementing our business and growth strategies. Theforward-looking statements and associated risks may include, relate to or bequalified by other important factors, including, without limitation:

 

**·**                  our ability to continue to borrow funds under the terms of our creditfacility (see “ — Liquidity and Capital Resources”);

**·**                  our ability to raise at least $3 million in net cash proceeds through thesale of stock of the Company or its subsidiaries by no later than December 31,2009, as required by our lender under the terms of the credit facility;

**·**                  our ability to find and secure alternate financing to our current creditfacility on or before June 30, 2010;

**·**                  exposure to and impacts of various international risks including legal,business, political and economic risks associated with our internationaloperations, including risks associated with foreign currency translation (see “-ForeignCurrency Translation”);

**·**                  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;

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

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

**·**                  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 capital thanus and have significant resources in comparison to us.

 

**We do notundertake to update, revise or correct any forward-looking statements.**

 

Any of the factorsdescribed above or in the “Risk Factors” sections contained in our AnnualReport on Form 10-K for the year ended December 31, 2008, ourQuarterly Reports on Form 10-Q/A for the quarterly period ended March 31,2009 and June 30, 2009, and in this report could cause our financialresults, including our 

 

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net income or lossor growth in net income or loss to differ materially from prior results, whichin turn could, among other things, cause the price of our common stock tofluctuate substantially.

 

**RecentTransactions**

 

OnMarch 20, 2009, we completed the sale of substantially all the assets ofthe Digitran division of our wholly-owned subsidiary, EMRISE ElectronicsCorporation, or EEC, and all the capital stock of ECC’s wholly-ownedsubsidiary, XCEL Japan Ltd., which primarily acted as a sales office for theDigitran division, to Electro Switch Corp. In this report we refer to the businesses of the Digitran Division andXCEL Japan, Ltd. as the “Digitran Operations,” and we refer to the sale of theDigitran division and XCEL Japan, Ltd. as the “Digitran Transaction.”  Within our Digitran division we manufactured,marketed and sold electro-mechanical digital and new patented technology verylow profileTM rotary switches for the worldwide aerospace,defense and industrial markets. Tokyo-based XCEL Japan Ltd. primarily sold Digitran’s switch productlines in Japan and other countries in Asia. These businesses were part of ourelectronic devices business segment.   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.

 

**BusinessDescription**

 

Wedesign, manufacture and market proprietary electronic devices andcommunications equipment for aerospace, defense, industrial, and communicationsapplications. We have operations in the U.S., England, and France.  We organize our business in two operating segments:electronic devices and communications equipment. In the first nine months of2009, our electronic devices segment contributed approximately 80% of overallnet sales while the communications segment contributed approximately 20% ofoverall net sales. Our subsidiaries within our electronic devices segment design, develop, manufacture and market powersupplies, radio frequency, or RF, and microwave devices for defense, aerospaceand industrial markets.  Oursubsidiaries within our communications equipment segment design, develop,manufacture and market network access equipment, including network timing andsynchronization products, for communications applications in defense, publicand private networks and industrial markets, including utilities andtransportation.

 

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

 

Within ourcommunications equipment segment, we produce a range of network access equipment,including network timing and synchronization products, for public and privatecommunications networks.  This segment is“end user product” based with a traditional cycle of internally fundeddevelopment and marketing prior to selling via direct and indirect saleschannels.  Manufacturing is primarilyoutsourced.  Our communications equipmentis used in a broad range of network applications primarily for privatecommunications networks, public communications carriers, and also for utilitycompanies and military applications, including homeland security.

 

**CriticalAccounting Policies**

** **

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

 

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

 

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

 

Wederive revenues from sales of electronic devices and communications equipmentproducts and services.  Our sales arebased upon written agreements or purchase orders that identify the type andquantity of the item and/or services being purchased and the purchaseprice.  We recognize revenues whenshipment of products has occurred or services have been rendered, nosignificant obligations remain on our part, and collectability is reasonablyassured based on our credit and collections practices and policies.

 

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

 

Revenuerecognition for products and services provided by our U.S. subsidiary, AdvancedControl Components, Inc., or ACC, and our subsidiaries in England dependupon 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.

 

Werecognize revenues for products sold by our subsidiary in France at the pointof shipment.  Customer discounts areincluded in the product price list provided to the customer.  Returns are infrequent and permitted onlywith prior authorization because these products are shipped based on bindingpurchase orders and are quality tested prior to shipment.  An estimate of warranty cost is recorded atthe time revenue is recognized.

 

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

 

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***Product Warranty Liabilities***

 

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

 

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

 

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

 

Our electronic devicessegment finished goods inventories generally are built to order.  Our communications equipment inventoriesgenerally are built to forecast, which requires us to produce a larger amountof finished goods in our communications equipment business so that ourcustomers can be served promptly.  Ourproducts consist of numerous electronic and other materials, which necessitatethat we exercise detailed inventory management. We value our inventory at the lower of the actual cost to purchase ormanufacture the inventory (first-in, first-out) or the current estimated marketvalue of the inventory (net realizable value). We perform cycle counts ofinventories using an ABC inventory methodology, which groups inventory itemsinto prioritized cycle counting categories, or we conduct physical inventoriesat least once a year.  We regularlyreview inventory quantities on hand and record a provision for excess andobsolete inventory based primarily on our estimated forecast of product demandand production requirements for the next 12 to 24 months. Additionally, todetermine inventory write-down provisions, we review product line inventorylevels and individual items as necessary and periodically review assumptionsabout forecasted demand and market conditions. Any inventory that we determine to be obsolete, either in connectionwith the physical count or at other times of observation, are reserved for andsubsequently written-off.  As of September 30,2009, our total inventory reserves amounted to $5.7 million, of which $3.9million, or 22.0% of total inventory, related to our electronic devices segmentand $1.8 million, or 10% of total inventory, related to our communicationsequipment segment.

 

The electronic devicesand communications equipment industries are characterized by rapidtechnological change, frequent new product development, and rapid productobsolescence that could result in an increase in the amount of obsoleteinventory quantities on hand. Also, our estimates of future product demand mayprove to be inaccurate, in which case we may have understated or overstated theprovision required for excess and obsolete inventory. Although we make everyeffort to ensure the accuracy of our forecasts of future product demand, anysignificant unanticipated changes in demand or technological developments couldhave a significant impact on the value of our inventory and our reportedoperating results.

 

***Foreign Currency Translation***

 

We haveforeign subsidiaries that together accounted for approximately 51.8% and 67.1%of our net revenues, 36.4% and 29.5% of our assets and 23.3% and 20.7% of ourtotal liabilities as of and for the nine months ended September 30, 2009and 2008, respectively.  In preparing our consolidated financialstatements, we are required to translate the financial statements of ourforeign subsidiaries from the functional currencies in which they keep theiraccounting records into U.S. dollars. This process results in exchange gainsand losses which, under relevant accounting guidance, are included eitherwithin our statement of operations under the caption “other income (expense)”or as a separate part of our net equity under the caption “accumulated othercomprehensive income (loss).”

 

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

 

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

 

If management deems anysubsidiary’s functional currency to be its local currency, then any gain orloss associated with the translation of that subsidiary’s financial statementsis included as a separate component of stockholders’ equity in accumulatedother comprehensive income (loss). However, if management deems the functional currency to be U.S. dollars,then any gain or loss associated with the translation of these financialstatements would be included in other income (expense) within our statement ofoperations.

 

If we dispose of any ofour subsidiaries, any cumulative translation gains or losses previouslyreported as a component of stockholder’s equity in accumulated othercomprehensive income (loss) would be realized into our statement of operations.If we determine that there has been a change in the functional currency of asubsidiary to U.S. dollars, then any translation gains or losses arising afterthe date of the change would be included within our statement of operations.

 

Based on our assessmentof the factors discussed above, we consider the functional currency of each ofour international subsidiaries to be each subsidiary’s local currency.Accordingly, we had cumulative translation losses of $1.6 million and $2.8million that were included as part of accumulated other comprehensive incomewithin our balance sheets at September 30, 2009 and December 31,2008, respectively. During the three months ended September 30, 2009 and2008, we included translation losses of $0.1 million and $1.4 million,respectively, under accumulated other comprehensive income and during the ninemonths ended September 30, 2009 and 2008, we included translation gains of$1.3 million and losses of $1.6 million, respectively, under accumulated othercomprehensive income.

 

Themagnitude of these gains or losses depends upon movements in the exchange ratesof the foreign currencies in which we transact business as compared to thevalue of the U.S. dollar. During the three and nine months ended September 30,2009, these currencies include the euro and the British pound sterling. Anyfuture translation gains or losses could be significantly higher or lower thanthose we recorded for these periods.

 

A 2.5 million Britishpound sterling loan payable from one ofour subsidiaries in England to EMRISE was outstanding as of September 30,2009 ($4.0 million based on the exchange rate at September 30, 2009).  Exchange rate losses and gains on thelong-term portion of this loan are recorded in cumulative translation gains orlosses in the equity section of the balance sheet.

 

***Intangibles, Including Goodwill***

 

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

 

Inassessing potential impairment of goodwill, we consider these factors as wellas forecasted financial performance of the acquired businesses.  If forecasts are not met, we may have torecord additional impairment charges not previously recognized. In assessingthe recoverability of our goodwill and other intangibles, we must makeassumptions regarding estimated future cash flows and other factors todetermine the fair value of those respective assets. If these estimates ortheir related assumptions change in the future, we may be required to record impairmentcharges for these assets that were not previously recorded.  If that were the case, we would have torecord an expense in order to reduce the carrying value of our goodwill.  Under FASB guidance for goodwill and other intangible assets, we are required to analyze our goodwill forimpairment issues at least annually or more frequently if an event occurs orcircumstances change that would more likely than not reduce the fair value of areporting unit below its carrying amount. At September 30, 2009, our reported goodwill totaled $14.2million.  In assessing the potentialimpairment of goodwill, we consider forecasted financial performance of theacquired businesses to determine the fair value of the respective assets.

 

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Inaccordance with FASB guidance for accounting for the impairment or disposal oflong-lived assets, we reevaluate the carrying value of identifiable intangibleand long-lived assets for impairment whenever events or changes incircumstances indicate that the carrying value may not be recoverable.  As a result of the current expectation thatsubstantially all of the assets of our subsidiary, RO Associates Incorporated,or RO, would be sold before the end of the estimated useful lives of itslong-lived assets, we performed an assessment of recoverabilityassociated with the long-lived assets of RO. In connection with that assessment, an impairment loss of $619,000 wasrecognized, which is included in our statement of operations as “Loss onImpairment of Assets” for the three and nine months ended September 30,2009, representing the write-off of long lived assets other than goodwill andindefinite life intangibles..

 

**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 most of our sales are for custom products and we typically do nothave recurring orders for standard products. Exceptions to this include certain long-term military contracts andcertain long-term telecommunications contracts.

 

Overall sales fromcontinuing operations increased $1.2 million, or 10%, in the third quarter of2009 as compared to the third quarter of 2008. Our overall net sales of $14.3 million for the third quarter of 2009reflected $2.8 million of additional net sales contributed by ACC, which weacquired on August 20, 2008, and increases from our U.S. communicationsequipment subsidiary, offset by declines in net sales at all of our otherelectronic devices subsidiaries and our French communications equipmentsubsidiary.  While our Frenchcommunication subsidiary experienced a decline in sales due to the impact ofthe global economic crisis, the declines at our other foreign units werelargely due to the impact of exchange rates between the U.S. dollar and theBritish pound sterling and the euro. Sales from continuing operations for the first nine months in 2009increased $7.1 million, or 20%, compared to the first nine months of 2008, withACC contributing approximately $13.3 million of additional net sales during thefirst nine months of 2009 as compared to the same period in 2008, offset bydeclines in net sales at all of our electronic devices subsidiaries and ourFrench communications equipment subsidiary.

 

Overall gross profit fromcontinuing operations, as a percentage of sales, increased to 37.0% in thethird quarter of 2009 from 33.4% in the third quarter of 2008.  The increase in gross profit as a percentageof sales was due primarily to the inclusion of ACC sales in 2009 and associatedgross margins in our results partially offset by a slight decrease in grossprofit as a percentage of sales within our communication segment as a result oflower sales volumes within that segment. Gross profit from continuing operations, as a percentage of sales,increased to 36.8% in the first nine months of 2009 compared to 32.2% for thesame period of 2008.

 

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

 

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

 

**Net Sales**

 
| ** **                                  | ** ** | **Three Months Ended** | ** ** | **Variance**                | ** ** |
|---------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                  | ** ** | **September 30,** | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**                          | ** ** | **2009**               | ** ** | **2008**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                        |       |                   |       |                        |       |   |   |   |   |
| Electronic  devices                         |       | $                      | 10,987     |                        | $          | 9,915 |   | $ | 1,072 |   | 10.8 | % |
| *as  % of net sales*                        | * *   | *76.7*                 | *%*        | *75.8*                      | *%*        | * * | * * | * * | * * |
| Communications  equipment                   |       | 3,332                  |       | 3,163                       |       | 169 |   | 5.3 | % |
| *as  % of net sales*                        | * *   | *23.3*                 | *%*        | *24.2*                      | *%*        | * * | * * | * * | * * |
| Total net sales  from continuing operations |       | 14,319                 |       | 13,078                      |       | 1,241 |   | 9.5 | % |
| Discontinued  operations                    |       | —                 |       | 2,609                       |       |   |   |   |   |
| Total net sales                             |       | $                      | 14,319     |                        | $          | 15,687 |   |   |   |   |   |
|                                             |            |                        |            |                             |            |  |  |  |  |  |  |  |

 

*ElectronicDevices Segment*

 

Theapproximately 11% increase in sales of our electronic devices in the thirdquarter of 2009 as compared to the third quarter of 2008 was primarily theresult of the inclusion in the third quarter of 2009 of $4.5 million in netsales from ACC, which we acquired in August 2008, compared to only $1.7 millionof ACC net sales included in the third quarter of 2008.  This increase was partially offset by adecrease in sales at all of our other electronic devices subsidiaries.  Our U.S. power supply division had a decreaseof approximately $0.1 million due to economic conditions.  The remaining decrease of $1.7 million insales within our electronic devices segment is related to our two electronicdevice foreign subsidiaries and is primarily due to the impact of exchangerates between the British pound sterling and the U.S. dollar.  On a local currency basis, net sales at ourforeign electronic device companies were slightly lower in the third quarter of2009 as compared to the same quarter in 2008 due primarily to the scheduledconclusion of a large customer contract during the fourth quarter of 2008,which contract contributed significantly to the third quarter of 2008.  However, exchange rates between the U.S.dollar and the British pound sterling negatively impacted the consolidatedresults of our U.K. subsidiaries when translated into U.S. dollars.  Our electronic devices subsidiaries in theU.K. experienced an 8% decrease in sales in local currency, the British poundsterling, for the third quarter of 2009 compared to the third quarter of2008.  However, when translated into U.S.dollars, these subsidiaries experienced a 21% decline in net sales for the sameperiod with the difference from 8% to 21% being due to the impact of exchangerates.

 

In thefourth quarter of 2009, we expect net sales within our electronic devicessegment to be consistent with sales in the fourth quarter of 2008.  In 2010, we expect overall sales levelswithin our electronic devices segment to increase slightly above 2009 levels,as we attempt to continue to grow the business in a very challengingeconomy.  Exchange rates remain anuncertainty and could impact our sales positively or negatively throughout 2009as compared to 2008 and into 2010 as compared to 2009.  The relationship between the British poundsterling and the U.S. dollar can have a significant impact on the results ofour European electronic device operations as those results are translated intoU.S. dollars.

 

*CommunicationsEquipment Segment*

 

Theapproximately 5% increase in sales of our communications equipment in the thirdquarter of 2009 as compared to the third quarter of 2008 is due to a $0.3million increase in sales at our U.S. subsidiary substantially associated withtest equipment sales to satisfy government contracts.  This increase was partially offset by decreasesat our French subsidiary where we are continuing to experience the negativeimpact of poor global economic conditions, especially by the French government,including the French Defense Ministry.

 

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 capital expenditures for ourcustomers and many companies in this industry have announced plans to reduce 

 

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and/or defer capitalexpenditures and/or discretionary spending due to current economic conditionsand continue to run their networks with their existing equipment.  We believe that public communication carriersand private networks can only maintain this strategy for a short period of timebefore reinvesting in their networks. Accordingly, once global economic conditions improve, we believe thissegment will benefit more so than our electronic devices segment, which has notbeen impacted as severely due to the defense related nature of that segment.

 

Netsales in this segment are expected to increase in the fourth quarter of 2009,as compared to earlier quarters in 2009 primarily due to expected increases insales at our U.S. subsidiary substantially associated with test equipment salesto satisfy government contracts already in our backlog.  Moving into 2010, we expect higher salesthroughout the year in this segment as compared to 2009.  We expect increased sales at our U.S.subsidiary due to additional scheduled and expected test equipment sales tosatisfy government contracts already in our backlog and higher expected salesof timing and synchronization products. We also expect higher sales at our French subsidiary where we believesales will improve throughout the year in connection with a gradual improvementin the French economy, which based on recent ordering patterns at our Frenchsubsidiary, we believe is beginning to occur.

 

Exchangerates remain an uncertainty and could impact our sales positively or negativelythroughout the remainder of 2009 as compared to 2008.  The relationship between the euro as comparedto the U.S. dollar can have a significant impact on the results of our Europeancommunication segment operations as those results are translated into U.S.dollars.

 

**GrossProfit**

 
| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Variance**                | ** ** |
|--------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **September 30,** | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**                               | ** ** | **2009**               | ** ** | **2008**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                             |       |                   |       |                        |       |   |   |   |   |
| Electronic  devices                              |       | $                      | 4,064      |                        | $          | 3,133 |   | $ | 931 |   | 29.7 | % |
| *as  a % of net sales*                           | * *   | *37.0*                 | *%*        | *31.6*                      | *%*        | * * | * * | * * | * * |
| Communications  equipment                        |       | 1,257                  |       | 1,241                       |       | 16 |   | 1.3 | % |
| *as  a % of net sales*                           | * *   | *37.7*                 | *%*        | *39.2*                      | *%*        | * * | * * | * * | * * |
| Total gross  profit from continuing operations   |       | 5,321                  |       | 4,374                       |       | 947 |   | 21.7 | % |
| *Total  gross margin from continuing operations* | * *   | *37.2*                 | *%*        | *33.4*                      | *%*        |   |   |   |   |
| Discontinued  operations                         |       | —                 |       | 1,934                       |       |   |   |   |   |
| Total gross  profit                              |       | $                      | 5,321      |                        | $          | 6,308 |   |   |   |   |   |
|                                                  |            |                        |            |                             |            |  |  |  |  |  |  |  |

 

*ElectronicDevices Segment*

 

Theincrease in gross profit, as a percentage of net sales, for our electronicdevices segment from 31.6% in the third quarter of 2008 to 37.3% in the thirdquarter of 2009 is primarily the result of the inclusion of higher marginproducts at ACC.  These increases wereoffset by slightly lower gross profit, as a percentage of sales, at one of ourU.K. subsidiaries, due to lower sales, change in product mix and also due tothe impact of exchange rates.

 

In2010, we expect overall gross margins in our electronic devices segment willremain consistent or will improve slightly as compared to the gross marginsachieved throughout 2009.  During theremainder of 2009 and throughout 2010, we may experience quarter to quartervariability in gross margin 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.  Exchangerates remain an uncertainty and could impact our gross profit positively ornegatively through the remainder of 2009 and throughout 2010.  The relationship between the British poundsterling and the U.S. dollar can have a 

 

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significant impact on theresults of our European electronic device operations as those results aretranslated into U.S. dollars.

 

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*CommunicationsEquipment Segment*

 

Thedecrease in gross margin as a percentage of net sales for our communicationsequipment segment from 39.2% in the third quarter of 2008 to 37.7% in the thirdquarter of 2009 is primarily the result of declining sales at our Frenchsubsidiary, partially offset by improvements in gross margins at our U.S.communication subsidiary.  Gross profit,both as a percentage of sales and on an actual dollar basis, were also slightlyunfavorably impacted as a result of the changes in foreign currency exchangerates between the U.S. dollar and the euro in the third quarter of 2009 ascompared to the third quarter of 2008.

 

Weexpect that in the fourth quarter of 2009 that this segment will continue toperform at levels consistent with gross margins achieved throughout 2009, butat a higher level of net sales.  During2010, we expect this segment to achieve higher gross margin levels than thoseachieved throughout 2009 due to higher sales volume and an anticipated changein product mix to include more products with a higher gross profit.  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 return to higher gross marginslevels.  Further, we expect that we willcontinue to experience volatility on a quarter to quarter basis due to changesin product mix, timing of shipments, and the impact of exchange rates.

 

**OperatingExpenses**

 
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Variance**                | ** ** |
|------------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                           | ** ** | **September 30,** | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**                                   | ** ** | **2009**               | ** ** | **2008**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                                 |       |                   |       |                        |       |   |   |   |   |
| Selling, general  and administrative                 |       | $                      | 4,592      |                        | $          | 3,522 |   | $ | (1,070 | ) | (30.4 | )% |
| *as  % of net sales*                                 | * *   | *32.1*                 | *%*        | *26.9*                      | *%*        | * * | * * | * * | * * |
| Engineering and  product development                 |       | 733                    |       | 474                         |       | (259 | ) | (54.6 | )% |
| *as  % of net sales*                                 | * *   | *5.1*                  | *%*        | *3.6*                       | *%*        | * * | * * | * * | * * |
| Loss on asset  impairment                            |       | 619                    |       | —                      |       | (619 | ) | 100.0 | % |
| Total operating  expenses from continuing operations |       | 5,944                  |       | 3,996                       |       | (1,948 | ) | (48.7 | )% |
| Discontinued  operations                             |       | —                 |       | 721                         |       |   |   |   |   |
| Total operating  expenses                            |       | $                      | 5,944      |                        | $          | 4,717 |   |   |   |   |   |
|                                                      |            |                        |            |                             |            |  |  |  |  |  |  |  |

 

*Selling,general and administrative expenses*

 

Theincrease in selling, general and administrative (“SG&A”) expenses isprimarily the result of approximately $0.8 million of additional expensesrelating to ACC, which were present for only a portion of the third quarter of2008.  Additionally, we incurredapproximately $0.2 million of employee termination costs in the third quarterof 2009 associated with employee termination costs at our French subsidiary andapproximately $0.1 million of legal, audit and investment banking relatedexpenses associated with our various refinancing efforts.  These increases were partially offset bydecreases in selling, general and administrative expenses at nearly all of ourbusiness units achieved in connection with our cost reduction efforts.

 

During the fourth quarterof 2009, we expect SG&A expense to be consistent with previous quarterlyexpenses throughout 2009 and slightly lower as compared to the fourth quarterin 2008.  In 2010, we expect general andadministrative expenses to be approximately $1 million lower than 2009 expensesas we realize the full impact or our significant cost reduction efforts at bothour business units and at our corporate office.

 

*Engineeringand product development*

 

Theincrease in engineering and product development costs is primarily due to theadded engineering costs at ACC in the third quarter of 2009 compared to only apartial quarter of 2008.

 

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Engineering costs duringthe fourth quarter of 2009 and throughout 2010 are expected to remainconsistent with expense levels in 2009. Amounts are expected to vary by quarter depending on particular needswithin each segment, including ongoing development efforts for our TiemPoTM product line.

 

*Loss on asset impairment*

 

As a result of thecurrent expectation that substantially all of the assets of RO will likely besold before the end of the estimated useful lives of its long-lived assets, weperformed an assessment of recoverability associated with the long-lived assetsof RO.  In connection with thatassessment, an impairment loss of $619,000 was recognized, which is included inour statement of operations as “Loss on Impairment of Assets” for the threemonths ended September 30, 2009, representing the write-off oflong lived assets other than goodwill and indefinite life intangibles.

 

**Interest expense**

 

Interest expense was $0.8million for the three months ended September 30, 2009 compared to $0.8million for the three months ended September 30, 2008.  Included in interest expense in the thirdquarter of 2009 were $186,000 of non-cash amortization of deferred financingcosts and non-cash amortization of debt discount compared to $247,000 in thethird quarter of 2008 and $0.1 million in fees to our lender for an amendmentto our credit agreement.

 

**Other income (expense)**

 

We recorded other expenseof $24,000 for the three months ended September 30, 2009 compared to$167,000 for the same period of 2008. Other income (expense) consists primarily of (i) short-termexchange rate gains and losses associated with the volatility of the U.S.dollar to the British pound sterling and euro on the current portion of certainassets and liabilities and, (ii) fair value adjustments on warrants duringthe third quarter of 2009.  The change inthe fair value of warrants during the third quarter of 2009 resulted in expenseof $53,000, which was not present in 2008. The offsetting income of $29,000 for the third quarter of 2009 waspredominantly related to short-term exchange rate gains.

 

**Income tax expense**

 

Income tax expenseamounted to $263,000 for the three months ended September 30, 2009compared to expense of $313,000 for the same period of 2008.  We recorded income tax expense primarily asthe result of foreign income tax on foreign earned profits in Europe and NewJersey state income taxes on income generated by ACC.

 

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

 

**Net gain on discontinuedoperations**

 

In connection with thesale of our Digitran Operations on March 20, 2009, we reclassified theincome from our Digitran Operations to discontinued operations and recorded again (net of taxes) on the sale of the Digitran Operations.  In the third quarter of 2009, we recorded adecreasing adjustment to the gain on the sale of Digitran $0.1 millionassociated with certain purchase price adjustments associated with thetransaction and adjusted the taxes to properly reflect the portion of the taxprovision allocable to discontinued operations. In the third quarter of 2008, these operations contributed comparativeincome of $1.2 million.

 

We expect that during thefourth quarter of 2009 we may sell substantially all of the assets of RO.  Upon concluding such a transaction, we wouldreclassify RO as a discontinued operation in our consolidated financial 

 

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statements.  The reclassification of RO to discontinuedoperations would result in a loss from discontinued operations as a result ofreclassifying all of RO’s net losses. Additionally, we may incur a loss on the sale, which would also beclassified under discontinued operations.

 

**Net loss**

 

We reported a net loss of$1.8 million in the third quarter of 2009 and net income of $0.3 million in thethird quarter of 2008.  Included in ournet loss for the third quarter of 2009 is $0.6 million of non-cash impairmentlosses associated with an impairment analysis performed on RO’s assets,approximately $0.2 million in severance expense associated with our costreduction efforts, approximately $0.1 million of SG&A expenses incurred inconnection with our various refinancing efforts and $0.1 million in expenseassociated with the sale of Digitran Operations, among other things describedin more detail above.  We anticipate ournet loss to improve in future quarters, due in large part to the recent costreduction efforts, which we anticipate being concluded during the fourthquarter of 2009.

 

***Comparisonof the Nine months Ended September 30, 2009 to the Nine months Ended September 30,2008***

 

**Net Sales**

 
| ** **                                  | ** ** | **Nine  Months Ended** | ** ** | **Variance**                 | ** ** |
|---------------------------------------------|------------|------------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | **September 30,** | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in thousands)**                          | ** ** | **2009**               | ** ** | **2008**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                        |       |                   |       |                         |       |   |   |   |   |
| Electronic devices                          |       | $                      | 34,231     |                         | $          | 25,358 |   | $ | 8,873 |   | 35.0 | % |
| *as %  of net sales*                        | * *   | *80.0*                 | *%*        | *70.9*                       | *%*        | * * | * * | * * | * * |
| Communications  equipment                   |       | 8,571                  |       | 10,385                       |       | (1,814 | ) | (17.5 | )% |
| *as %  of net sales*                        | * *   | *20.0*                 | *%*        | *29.1*                       | *%*        | * * | * * | * * | * * |
| Total net sales from  continuing operations |       | 42,802                 |       | 35,743                       |       | 7,059 |   | 19.7 | % |
| Discontinued operations                     |       | —                 |       | 6,240                        |       |   |   |   |   |
| Total net sales                             |       | $                      | 42,802     |                         | $          | 41,983 |   |   |   |   |   |
|                                             |            |                        |            |                              |            |  |  |  |  |  |  |  |

 

*Electronic Devices Segment*

 

The approximately 35%increase in sales of our electronic devices in the nine months ended September 30,2009 as compared to the same period of 2008 was primarily the result of theinclusion of $15.0 million in net sales from ACC, which we acquired in August 2008,compared to only $1.7 million of ACC net sales included in the nine monthsended September 30, 2008.  Thisincrease was partially offset by a decrease in sales at all of our otherelectronic devices subsidiaries.  Netsales at our U.S. power supply division decreased approximately $1.1 millionduring the first nine months of 2009 as a result of adverse economicconditions.  The remaining decrease of$3.3 million in net sales for this segment related to our foreign subsidiaries,primarily due to the impact of exchange rates on foreign currency.  On a local currency basis, net sales at bothof our foreign electronic device companies were higher in the nine months endedSeptember 30, 2009 as compared to the same period of 2008.  However, exchange rates between the U.S.dollar and the British pound sterling negatively impacted the consolidatedresults of our U.K. subsidiaries when translated into U.S. dollars.  Our electronic devices subsidiaries in theU.K. experienced a 6% increase in sales in local currency, the British poundsterling, for the nine months ending September 30, 2009 compared to thesame period of 2008.  However, whentranslated into U.S. dollars, these subsidiaries experienced a 16% decline innet sales for the same period with the difference from 6% to 16% being due tothe impact of exchange rates.

 

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*Communications Equipment Segment*

 

The approximately 18%decrease in sales of our communications equipment in the nine months ended September 30,2009 as compared to the same period in 2008 is due to an overall decrease inorders and shipments for network access products, especially at our Frenchsubsidiary.  Net sales at our Frenchsubsidiary were down $1.9 million in the first nine months of 2009 compared tothe first nine months of 2008 due largely to the impacts of the global economiccrisis and spending reductions, especially by the French government, includingthe French Defense Ministry.  Thesedecreases were offset slightly by higher test equipment sales in the thirdquarter of 2009 by our U.S. communications subsidiary.  Net sales at our French subsidiary were alsoslightly impacted by the unfavorable effects of exchange rates in 2009 ascompared to 2008 between the U.S. dollar and the euro on the translation of thefinancial results of our European operations into U.S. dollars.  Our French subsidiary experienced a 23%decrease in sales in local currency, the euro, for the nine months ending September 30,2009 compared to the same period of 2008. However, when translated into U.S. dollars, our French subsidiaryexperienced a 28% decline in net sales for the same period with the differencefrom 23% to 28% being due to the impact of exchange rates.

 

**Gross Profit**

 
| ** **                                       | ** ** | **Nine  Months Ended** | ** ** | **Variance**                 | ** ** |
|--------------------------------------------------|------------|------------------------|------------|------------------------------|------------|
| ** **                                       | ** ** | **September 30,** | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in thousands)**                               | ** ** | **2009**               | ** ** | **2008**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                             |       |                   |       |                         |       |   |   |   |   |
| Electronic devices                               |       | $                      | 12,734     |                         | $          | 7,273 |   | $ | 5,461 |   | 75.1 | % |
| *as a  % of net sales*                           | * *   | *37.2*                 | *%*        | *28.7*                       | *%*        | * * | * * | * * | * * |
| Communications equipment                         |       | 3,003                  |       | 4,254                        |       | (1,251 | ) | (29.4 | )% |
| *as a  % of net sales*                           | * *   | *35.0*                 | *%*        | *41.0*                       | *%*        | * * | * * | * * | * * |
| Total gross profit from  continuing operations   |       | 15,737                 |       | 11,527                       |       | 4,210 |   | 36.5 | % |
| *Total  gross margin from continuing operations* | * *   | *36.8*                 | *%*        | *32.2*                       | *%*        |   |   |   |   |
| Discontinued operations                          |       | —                 |       | 4,179                        |       |   |   |   |   |
| Total gross profit                               |       | $                      | 15,737     |                         | $          | 15,706 |   |   |   |   |   |
|                                                  |            |                        |            |                              |            |  |  |  |  |  |  |  |

 

*Electronic Devices Segment*

 

The increase in grossprofit, as a percentage of net sales, for our electronic devices segment from28.7% in the first nine months of 2008 to 37.2% in the first nine months of2009 is primarily the result of the inclusion of higher margin products at ACCand an increase in gross profit as a percentage of sales at our Europeanoperations due to the effects of higher sales volumes, favorable product mixand the impacts of our cost reduction efforts resulting in lower fixed overheadmanufacturing costs..  This increase waspartially offset by a reduction in gross margin at our U.S. power supplydivision due to a write down of approximately $0.3 million of certaininventories to the lower of cost or market during the first quarter of 2009 andapproximately $0.1 million of severance costs incurred in the second quarter of2009 associated with our cost reduction efforts.

 

*Communications Equipment Segment*

 

The decrease in grossmargin for our communications equipment segment from 41.0% in the first ninemonths of 2008 to 35.0% in the first nine months of 2009 is primarily theresult of decreased sales of both network access products and timing andsynchronization products due to a slow-down of purchases being made by ourcustomers of these products.  Grossprofit, both as a percentage of net sales and on an actual dollar basis, wasalso unfavorably impacted as a result of the changes in foreign currencyexchange rates between the U.S. dollar and the euro in the first nine months of2009 as compared to the same period of 2008.

 

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**Operating Expenses**

 
| ** **                                           | ** ** | **Nine  Months Ended** | ** ** | **Variance**                 | ** ** |
|------------------------------------------------------|------------|------------------------|------------|------------------------------|------------|
| ** **                                           | ** ** | **September 30,** | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in thousands)**                                   | ** ** | **2009**               | ** ** | **2008**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                                 |       |                   |       |                         |       |   |   |   |   |
| Selling, general and  administrative                 |       | $                      | 13,486     |                         | $          | 10,589 |   | $ | (2,897 | ) | (27.4 | )% |
| *as %  of net sales*                                 | * *   | *31.5*                 | *%*        | *29.6*                       | *%*        | * * | * * | * * | * * |
| Engineering and product  development                 |       | 1,971                  |       | 1,585                        |       | (386 | ) | (24.4 | )% |
| *as %  of net sales*                                 | * *   | *4.6*                  | *%*        | *4.4*                        | *%*        | * * | * * | * * | * * |
| Loss on asset  impairment                            |       | 619                    |       | —                       |       | (619 | ) | 100.0 | % |
| Total operating  expenses from continuing operations |       | 16,076                 |       | 12,174                       |       | (3,902 | ) | (32.1 | )% |
| Discontinued operations                              |       | —                 |       | 1,970                        |       |   |   |   |   |
| Total operating  expenses                            |       | $                      | 16,076     |                         | $          | 14,144 |   |   |   |   |   |
|                                                      |            |                        |            |                              |            |  |  |  |  |  |  |  |

 

*Selling, general andadministrative expenses*

 

The increase in SG&Ais primarily the result of approximately $3.8 million of additional expensesrelating to ACC, which we acquired in August 2008, and therefore weincurred such expense during only a portion of the third quarter of 2008compared to the entire third quarter of 2009. These increases were partially offset by significant decreases inSG&A at most of our business units, primarily as a result of cost reductionactivities.

 

*Engineering and productdevelopment*

 

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

 

*Loss on asset impairment*

 

As a result of thecurrent expectation that substantially all of the assets of RO will likely besold before the end of the estimated useful lives of its long-lived assets, weperformed an assessment of recoverability associated with the long-lived assetsof RO.  In connection with thatassessment, an impairment loss of $619,000 was recognized, which is included inour statement of operations as “Loss on Impairment of Assets” for the ninemonths ended September 30, 2009, representing the write-off oflong lived assets other than goodwill and indefinite life intangibles.

 

**Interest expense**

 

Interest expense was $3.2million for the nine months ended September 30, 2009 compared to $2.0million for the nine months ended September 30, 2008.  Included in interest expense in the firstnine months of 2009 were $0.3 million in fees paid to our lender in connectionwith modifications to our credit facility in the first nine months of 2009, and$1.2 million of non-cash amortization of deferred financing costs and non-cashamortization of debt discount, including $0.5 million due to the accelerationof deferred financing costs and debt discount amortization associated with thepartial repayment of our Term Loan B in the first quarter of 2009, compared to$0.7 million of non-cash amortization in the first nine months of 2008.

 

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**Other income (expense)**

 

We recorded other incomeof $144,000 for the nine months ended September 30, 2009 compared toexpense of $64,000 for the same period of 2008. Other income (expense) consists primarily of (i) short-term exchangerate gains and losses associated with the volatility of the U.S. dollar to theBritish pound sterling and euro on the current portion of certain assets andliabilities and (ii) fair value adjustments on warrants.  The change in the fair value of warrantsduring the first nine months of 2009 resulted in income of $369,000, which wasnot present in 2008.  The remainingexpense of $225,000 for the nine months ended September 30, 2009 waspredominantly related to short-term exchange rate losses.

 

**Income tax expense**

 

Income tax expenseamounted to $0.6 million for the nine months ended September 30, 2009compared to income tax expense of $0.4 million for the same period of2008.  We recorded income tax expenseincurred primarily as the result of foreign income tax on foreign earnedprofits in Europe and New Jersey state income taxes on income generated by ACC.

 

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

 

**Net gain on discontinuedoperations**

 

In connection with thesale of our Digitran Operations on March 20, 2009, we reported income fromour discontinued Digitran Operations of $6.4 million (net of $0.7 million intaxes) during the first nine months of 2009, which includes a $7.0 million gainon the sale of assets.  In the first ninemonths of 2008, these operations contributed comparative income of $2.2million.

 

**Net income (loss)**

 

We reported net income of$2.5 million in the nine months ended September 30, 2009 and a net loss of$0.8 million in the same period of 2008. Included in net income in the first nine months of 2009 was a $6.4million (net of $0.7 million in taxes) income/gain on discontinued operationsassociated with the sale of our Digitran Operations, approximately $0.3 millionin inventory write downs, $0.5 million in accelerated amortization of deferredfinancing costs and debt discount associated with the partial repayment of ourTerm Loan B in March 2009, $0.6 million of impairment losses associatedwith an impairment analysis performed on RO’s assets, $0.5 million of employeetermination costs associated with the cost reduction efforts at several of ourfacilities, $0.2 million in fees associated with a waiver and amendmentreceived from our lender in the first nine months of 2009 and $0.1 million ofexpenses incurred in connection with various refinancing efforts.  We anticipate net loss to improve in futureperiods, due in large part to our recent cost reduction efforts, which weanticipate being concluded during the fourth quarter of 2009.

 

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**Liquidity and CapitalResources**

 

In making an assessment of our liquidity, we believethat the items in our financial statements that are most relevant to our ongoingoperations are working capital, cash generated from operating activities andcash available from financing activities. During the first nine months of 2009, we funded our daily cash flowrequirements through funds provided by operations and through borrowings underour credit facility with GVEC Resource IV Inc. (“GVEC” or the “Lender”).  Working capital from continuing operationswas a negative $1.1 million at September 30, 2009 as compared to apositive $5.5 million at December 31, 2008. Significant items thatpositively impacted working capital from continuing operations from December 31,2008 until September 30, 2009 are (i) an increase in cash ofapproximately $0.5 million, (ii) accrual of $1.0 million in additionalcontingent cash consideration associated with the acquisition of ACC and (iii) adecrease in accounts payable and accrued expenses of $1.9 million. Workingcapital from continuing operations from December 31, 2008 until September 30,2009 was negatively impacted most significantly by the reclassification of ourTerm Loan A and B from long-term to short-term as a result of their June 30,2010 maturity date, the accrual of additional contingent cash considerationassociated with the acquisition of ACC and, to a lesser extent, a decrease in accountsreceivable from continuing operations of $2.1 million due to improvedcollections.  At September 30, 2009and December 31, 2008, we had accumulated deficitsof $25.1 million and $28.1 million, respectively, and cash and cash equivalents of$3.9 million and $3.2million, respectively.  Our cash balances are often significantlyhigher at the end of the month than at other times throughout the remainder ofthe month as a result of borrowings under our credit facility generallyoccurring toward the end of the month and timing of payments to vendors in theform of accounts payable, payroll and interest payments generally occurring atthe beginning of the month.

 

Net cash provided by operating activities during thefirst nine months of 2009 totaled $0.7 million. Our reported net income of $2.5 million included a gain on the sale ofthe Digitran Operations of $6.4 million, net of taxes of $1.9 million.  Significant non-cash adjustments to our netincome from continuing operations for the nine months ended September 30,2009 include (i) the amortization of debt discount and amortization ofdeferred financing costs which, on a combined basis, totaled $1.2 million, bothof which are non-cash components of interest expense associated with our creditfacility, (ii) depreciation and amortization expense which totaled $1.5million, (iii) a non-cash impairment charge at our RO subsidiary for $0.6million, and (iv) a change in fair value of common stock warrants whichcontributed $0.4 million as non-cash component of net income.  Significant uses of cash associated withoperating activities during the nine month period ended September 30, 2009included a decrease in accounts payable and accrued liabilities byapproximately $1.9 million, in part due to payments made on previously accruedamounts related to the sale of the Digitran Operations and timing of vendorpayments.  The primary source of cashassociated with operating activities during the nine month period was adecrease in accounts receivable, which decreased by approximately $2.1 million,due primarily to increased efforts to collect outstanding balances on a moretimely basis.

 

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

 

Cash used in financing activitiesduring the first nine months of 2009 totaled $11.3 million, which consisted of$11.2 million in repayments of principal owed on long term debt and notes to stockholders, offset by$0.1 million in net borrowings on our revolving credit facility.

 

As of September 30,2009, we had outstanding borrowings of $4.0 million under the revolving loanportion of our credit facility.  At September 30,2009, we had remaining actual availability under a formula-based calculation of$3.0 million under the credit facility.  Actual remaining availability representsthe additional amount we were eligible to borrow as of September 30,2009.  The full $7 million availableunder our revolving line of credit fluctuates periodically throughout eachmonth depending on timing of borrowings and repayments.

 

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In addition to the revolving lines of credit, at September 30,2009, we had long-term loans and capitalized lease and equipment loanobligations totaling $12.1 million, the current portion of which loans andobligations totaled $8.9 million.  Wealso had $1.3 million in contingent cash payments and cashadjustments due to the Sellers of ACC, which payments are due on or before November 21,2009.

 

Our backlog from continuingoperations decreased to $27.2million as of September 30, 2009 ascompared to $33.0 million as of December 31,2008. The decrease is due to the reduction of backlog at all of our electronicdevices business units as we satisfied existing contracts during the first ninemonths of 2009.  We experienced a slightincrease in backlog at our U.S. communications equipment business unitassociated with new orders for telecommunications test equipment.  The amount of backlog orders representsrevenue that we anticipate recognizing in the future, as evidenced by purchaseorders and other purchase commitments received from customers, but on whichwork has not yet been initiated or with respect to which work is currently inprogress. Our backlog as of September 30, 2009 was approximately 92%related to our electronic devices business, which business tends to provide uswith long lead-times for our manufacturing processes due to the custom natureof the products, and approximately 8% related to our communications equipmentbusiness, which business tends to deliver standard or modified standardproducts from stock as orders are received. We believe that the majority of ourcurrent backlog will be shipped within the next 12 months.  However, there can be no assurance that wewill be successful in fulfilling such orders and commitments in a timely manneror that we will ultimately recognize as revenue the amounts reflected as backlog.

 

We and our direct subsidiaries, EEC, CXR Larus, RO andACC are parties to a Credit Agreement, as amended, with the Lender, providingfor a credit facility in the aggregate amount of $26,000,000.  As of September 30, 2009, we owed atotal of $12.7 million under the terms of the credit facility.

 

The credit facilitycurrently consists of (i) a revolving loan for up to $7 million thatexpires on June 30, 2010 (the “Revolver”), and (ii) two term loans(Term Loan A and Term Loan B) with an aggregate net outstanding principalamount of $8.5 million as of November 1, 2009. The term loans requireremaining combined scheduled principal payment of $150,000 on December 1,2009 and approximately $287,000 commencing on January 1, 2010 andcontinuing on the first day of each of the 5 consecutive monthsthereafter.  The facility also requiresmonthly interest payments and a final balloon payment of principal uponmaturity on June 30, 2010.  Total remaining aggregate principalpayments on Term Loan A and Term Loan B are $150,000 in 2009 and $8.4 millionin 2010.

 

The Revolver isformula-based and generally provides that the outstanding borrowings under theline of credit may not exceed an aggregate of 85% of eligible accountsreceivable, plus 10% of the value of eligible raw materials not to exceed$600,000, plus 50% of the value of eligible finished goods inventory not toexceed $1,500,000, minus the aggregate amount of reserves that may beestablished by the Lender.  The Revolverhas a maturity date of June 30, 2009.

 

Interest on the Revolveris payable monthly.  The interest rate is variable and is adjusted monthlybased on the prime rate as published in the “Money Rates” column of*The Wall Street Journal* (the “Base Rate”)plus 1.25%, subject to a minimum rate of 9.5% per annum.  The Revolver issubject to various financial covenants on a consolidated basis, including thefollowing: EBITDA, as defined by the Credit Agreement, measured on a fiscalquarter-end basis, must not be less than $250,000 for the period ended September 30,2009, $550,000 for the period ended December 31, 2009 and $1,450,000 forthe period ended March 31, 2010; the leverage ratio, as defined by theCredit Agreement, measured quarterly, must not be greater than 1.70:1.00 forthe period ended September 30, 2009, 1.50:1.00 for the period ended December 31,2009 and 1.40:1.00 for the period ended March 31, 2010;  and liquidity, as defined by the CreditAgreement, measured quarterly, must not be less than $2,800,000 for the periodended December 31, 2009 and $2,700,000 for the period ended March 31,2010.  Additionally, the Revolver issubject to the Borrowers not incurring capital expenditures (a) in excessof $600,000 for the fiscal year ending December 31, 2009, and (b) inexcess of $1,800,000 for the fiscal year ending December 31, 2010.  Additionally, the Revolver is subject to the Borrowersnot incurring unfinanced capital expenditures in excess of $62,500 in anyfiscal quarter and the borrowers not incurring purchase money commitments inexcess of $2 million over the life of the facility.  However, if the borrowers incur unfinancedcapital expenditures of less 

 

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than $62,500 in any fiscal quarter, the difference between the amountincurred in a certain fiscal quarter and $62,500 maybe incurred in the twofiscal quarters immediately following such fiscal quarter. The Company was incompliance with all covenants at September 30, 2009.

 

The term loans bear interestat the Base Rate plus 4.25%, subject to a minimum rate of 12.5% per annum.  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.

 

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.  However, to the extent we sell assets after August 14,2009 and prior to January 1, 2010, only 75% of the net cash proceeds ofsuch sale must be used to prepay our outstanding obligations to the Lender.

 

To secure payment of the indebtedness of borrowers underthe credit facility, the borrowers irrevocably pledged and assigned to, andgranted to the Lender a continuing security interest in all the personalproperty of the borrowers including the borrowers’ interest in any depositaccounts, the stock of each of the borrowers’ subsidiaries, the intellectualproperty owned by each of the borrowers, and the proceeds of the intellectualproperty owned by each of the borrowers.  In an event of default, theLender may, at its option, exercise any or all remedies available to it withrespect to the collateral.  In addition, certain of the borrowers’ foreignsubsidiaries have agreed to guaranty the borrowers’ performance under thecredit facility.

 

Ourcurrent business plan requires additional funding beyond our anticipated cashflows from operations.  These and otherfactors described in more detail below raise substantial doubt about ourability to continue as a going concern. Our ability to continue as a going concern is dependent upon our abilityto (i) raise $3 million in equity capital by December 31, 2009 asrequired under the terms of our credit facility, (ii) repay our creditfacility on or prior to its maturity on June 30, 2010, (iii) obtainalternate financing to fund operations after June 30, 2009 and (iv) achieveprofitable operations.

 

If our net lossescontinue, we may experience negative cash flow, which may prevent us fromcontinuing operations.  Additionally,losses may result in a default on our debt covenants associated with the creditfacility.  If we are not able to attain,sustain or increase profitability on a quarterly or annual basis, we may not beable to continue operations and our stock price may decline.

 

Currently,we are in the process of seeking alternate financing from a number of possibleparticipants, including traditional lenders, equity participants and mezzaninelenders.  We have engaged financialadvisors, Boenning & Scattergood, to assist in this regard.  Although we remain hopeful that we will beable to successfully raise at least $3 million in equity capital by December 31,2009 and secure replacement financing on or prior to June 30, 2010, whenour current credit facility matures, no assurances can be made that we will besuccessful in this regard.

 

If we cannot meet ourobligations under our credit facility and if our lender does not waive orrenegotiate these obligations, then we would be in default under the terms ofour credit facility.

 

In the event of adefault and continuation of a default, the lender may limit future availabilityunder the Revolver and/or accelerate the payment of all principal balances andaccrued interest requiring us to pay the entire indebtedness under the creditfacility outstanding on that date.  As of November 1, 2009, $13.6million was outstanding under the credit facility. We do not have the abilityto pay this amount if the lender accelerated the payment of the outstandingamount under the credit facility upon a default.

 

Upon the occurrence andduring the continuation of an event of default, the lender may also elect toincrease the interest rate applicable to the outstanding balance of the TermLoans A and B by four percentage 

 

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pointsabove the per annum interest rate that would otherwise be applicable. Additionally, if the lender terminates the credit facility during a defaultperiod or if we prepay the Revolver or the Term Loans prior to November 30,2009, then we are subject to a penalty equal to 2% of the outstanding principalbalance of the Revolver and the Term Loans.

 

If we are unable to (i) raisethe requisite amount of equity capital by December 31, 2009 as requiredunder the terms of our credit facility, (ii) continue to borrow fundsunder the terms of the Revolver, for any reason, through June 30, 2010, or(iii) obtain alternate financing to replace our credit facility prior to June 30,2010, we do not believe that current and future capital resources, revenuesgenerated from operations and other existing sources of liquidity will beadequate to meet our anticipated short term, working capital and capitalexpenditures needs for the next 12 months.  Further, if for any reason, weare not able to continue to borrow funds under the terms of the Revolver or ifwe experience a significant loss of revenue or increase in costs, then our cashflow would be negatively impacted resulting in a cash flow deficit which, inturn, will require us to obtain additional or alternate financing, with littleor no notice.  These potential financing needs could be met in the form ofa revised debt structure with our current lender, additional or new financingwith another lender or lenders, the sale of assets to generate cash or the saleof additional equity to raise capital.  Failure to secure additional oralternate financing, if and when needed, would have an adverse effect on ouroperations and/or ability to do business after that date or could restrict ourgrowth, limit the development of new products, or hinder our ability to fulfillexisting or future orders.

 

Ifwe are unsuccessful in securing the necessary financing to continue operations,when needed, then we may be forced toseek protection under the U.S. Bankruptcy Code or be forced into liquidation orsubstantially restructuring or altering our business operations and/or debtobligations.

 

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**Effects of Inflation**

 

The impact of inflation and changingprices has not been significant on the financial condition or results ofoperations of either our company or our operating subsidiaries.

 

**Impacts of NewAccounting Pronouncements**

 

**FASB Accounting Standards Codification.****TM**  On September 30,2009, we adopted changes issued by the Financial Accounting Standards Board (“FASB”)to the authoritative hierarchy of Generally Accepted Accounting Principles (“GAAP”).  These changes establish the FASB AccountingStandards CodificationTM (“Codification”)as the source of authoritative accounting principles recognized by the FASB tobe applied by nongovernmental entities in preparation of financial statementsin conformity with GAAP.  Rules andinterpretive releases of the Securities and Exchange Commission (“SEC”) underauthority of federal securities laws are also sources of authoritative GAAP forSEC registrants.  The FASB will no longerissue new standards in the form of Statements, FASB Staff Positions, orEmerging Issues Task Force Abstracts; instead the FASB will issue AccountingStandards Updates.  Accounting StandardsUpdates will not be authoritative in their own right as they will only serve toupdate the Codification.  These changes andthe Codification itself do not change GAAP. Other than the manner in which new accounting guidance is referenced,the adoption of these changes had no impact on our consolidated financialstatements.

 

**Fair Value Measurements and Disclosure**. In January 2009, we adopted changes issued by the FASB to fairvalue accounting and reporting as it relates to non-financial assets andnon-financial liabilities that are not recognized or disclosed at fair value inthe financial statements on at least an annual basis.  These changes define fair value, establish aframework for measuring fair value in GAAP and expend disclosures about fairvalue measurements.  This guidanceapplies to other GAAP that require or permit fair value measurements and is tobe applied prospectively with limited exceptions.  The adoption of these changes, as it relatesto non-financial assets and liabilities, had no impact on our financialstatements.

 

**Business Combinations**. On January 1, 2009, we adopted an update to existing accounting standardsfor business combinations.  The update,which retains the underlying concepts of the original standard in that allbusiness combinations are still required to be accounted for at fair valueunder the acquisition method of accounting, changes the method of applying theacquisition method.  Acquisition costsare no longer considered part of the fair value of an acquisition and willgenerally be expensed as incurred, non-controlling interests are valued at fairvalue at the acquisition date, in-process research and development is recordedat fair value as an indefinite-lived intangible asset at the acquisition date,restructuring costs associated with a business combination are generallyexpensed subsequent to the acquisition date, and changes in deferred tax assetvaluation allowances and income tax uncertainties after the acquisition dategenerally will affect income tax expense.

 

In April 2009, the FASB issued a further updatein relation to accounting for assets acquired and liabilities assumed in abusiness combination that arise from contingencies, which amends the previousguidance to require contingent assets acquired and liabilities assumed in abusiness combination to be recognized at fair value on the acquisition date iffair value can be reasonably estimated during the measurement period.  If fair value cannot be reasonably estimatedduring the measurement period, the contingent asset or liability would berecognized in accordance with standards and guidance on accounting forcontingencies and reasonable estimateion of the amount of a loss.  Further, this update eliminated the specificsubsequent accounting guidance for contingent assets and liabilities withoutsignificantly revising the original guidance. However, contingent consideration arrangements of an acquiree assumed bythe acquirer in a business combination would still be initially andsubsequently measured at fair value. These updates are applicable prospectively to business combinations forwhich the acquisition date is on or after January 1, 2009.  The adoption of these provisions will have animpact on accounting for any business acquired after January 1, 2009.

 

**Derivatives and Hedging**. On January 1, 2009, we adopted changes issued by the FASB todisclosures about derivative instruments and hedging activities.  These changes require enhanced disclosuresabout an entity’s 

 

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derivative and hedging activities, including (i) how and why anentity uses derivative instruments, (ii) how derivative instruments andrelated hedged items are accounted for, and (iii) how derivativeinstruments and related hedged items affect an entity’s financial position,financial performance and cash flows. Other than the required disclosures, the adoption of these changes hadno impact on our consolidated financial statements.

 

On January 1, 2009, we adopted an update issuedby the FASB to the accounting for instruments (or embedded features) indexed toan entity’s own stock.  These changesclarify the determination of whether an instrument (or embedded feature) isindexed to an entity’s own stock, which would qualify as a scope exceptionunder previously issued guidance.  Theadoption of these changes resulted in the reclassification of certain of ouroutstanding warrants from stockholders’ equity to liabilities, which requiresthe warrants to be fair valued at each reporting period, with the changes infair value recognized in our consolidated statement of operations.

 

**Intangibles — Goodwill and Other**. On January 1, 2009, we adopted changes issued by the FASB toaccount for intangible assets.  Thesechanges amend the factors that should be considered in developing renewal orextension assumptions used to determine the useful life of a recognizedintangible asset in order to improve the consistency between the useful life ofa recognized intangible asset outside of a business combination and the periodof expected cash flows used to measure the fair value of an intangible asset ina business combination.  The adoption ofthese changes did not have an impact on our consolidated financial statements.

 

**Financial Instruments**. On June 30, 2009, we adopted an update to accounting standards fordisclosures about the fair value of financial instruments, which requirespublicly-traded companies to provide disclosures on the fair value of financialinstruments in the interim financial statements.  Other than the required disclosures, theadoption of this update had no impact on our consolidated financial statements.

 

**Subsequent Events**.  On June 30,2009, we adopted changes issued by the FASB to accounting for and disclosure ofevents that occur after the balance sheet date but before financial statementsare issued or are available to be issued, otherwise known as “subsequentevents.”  Specifically, these changes setforth (1) the period after the balance sheet date during which managementof a reporting entity should evaluate events or transactions that may occur forpotential recognition or disclosure in the financial statements: (2) thecircumstances under which an entity should recognize events or transactionsoccurring after the balance sheet date in its financials statements; and (3) thedisclosures that an entity should make about events or transactions thatoccurred after the balance sheet date. The adoption of these changes did not have a material impact on ourfinancial statements.

 

**Fair Value Measurements and Disclosure**. In August 2009, the FASB issued an update to the fair valuemeasurement guidance to clarify how an entity should measure liabilities atfair value.  The update reaffirms fairvalue is based on an orderly transaction between market participants, even thoughliabilities are infrequently transferred due to contractual or other legalrestrictions.  However, identicalliabilities traded in the active market should be used when available.  When quoted prices are not available, thequoted price of the identical liability traded as an asset, quoted prices forsimilar liabilities or similar liabilities traded as an asset, or anothervaluation approach should be used.  Thisupdate also clarifies that restrictions preventing the transfer of a liabilityshould not be considered as a separate input or adjustment in the measurementof fair value.  We will adopt this updatefor fair value measurements of liabilities effective October 1, 2009,which we do not expect to have a material impact on our consolidated financial statements.

 

**Revenue Recognition**.  In October 2009,the FASB issued an update to existing guidance on revenue recognition forarrangements with multiple deliverables. This update will allow companies to allocate consideration received forqualified separate deliverables using estimated selling prices for bothdelivered and undelivered items when vendor-specific objective evidence orthird-party evidence is unavailable. Additional disclosures discussing the nature of multiple elementarrangements, the types of deliverables under the arrangements, the generaltiming of their deliver, and significant factors and estimates used todetermine estimated selling prices are required.  We will adopt this update for new revenuearrangements entered into or 

 

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materially modified beginning January 1, 2011.  We are still evaluating the impact, if any,this update may have on our consolidated financial statements.

 

**ITEM 3.                  QUANTITATIVE AND QUALITATIVEDISCLOSURES 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 evaluationunder the supervision and with the participation of our management, includingour Chief Executive Officer and Chief Financial Officer, our principalaccounting officer, of the effectiveness of the design and operation of our disclosurecontrols and procedures.  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 Commission’s rules andforms.  Disclosure controls andprocedures also include, without limitation, controls and procedures designedto ensure that information required to be disclosed by a company in the reportsthat it files or submits under the Exchange Act is accumulated and communicatedto the company’s management, including its principal executive and principalfinancial officers, or persons performing similar functions, as appropriate, toallow timely decisions regarding required disclosure.  Based on this evaluation, our Chief ExecutiveOfficer and Chief Financial Officer concluded as of September 30, 2009that our disclosure controls and procedures were not effective at thereasonable assurance level due to the material weaknesses discussed below.

 

Inlight of the four material weaknesses described below, we performed additionalanalysis and other post-closing procedures to ensure that our consolidatedfinancial statements were prepared in accordance with generally acceptedaccounting principles.  Accordingly, webelieve that the consolidated financial statements included in this reportfairly present, in all material respects, our financial condition, results ofoperations and cash flows for the periods presented.

 

Our Chief Executive Officerand Chief Financial Officer concluded that as of September 30, 2009 thefollowing five material weaknesses existed:

 

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

 

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

 

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

 

(4)                                 We did notmaintain effective controls over recording and reporting the acceleration ofcertain components of our credit facility and the classification of theissuance of a note relating to a purchase price adjustment.

 

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

 

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Ifnot remediated, these material weaknesses could result in one or more materialmisstatements in our reported financial statements in a future annual orinterim period.

 

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

*** ***

Management does not expectthat our disclosure controls and procedures or our internal control overfinancial reporting will prevent or detect all errors and all fraud. A controlsystem, no matter how well conceived and operated, can provide only reasonable,not absolute, assurance that the objectives of the control systems are met.Further, the design of a control system must reflect the fact that there areresource constraints, and the benefits of controls must be considered relativeto their costs. Because of the inherent limitations in a cost-effective controlsystem, no evaluation of internal control over financial reporting can provideabsolute assurance that misstatements due to error or fraud will not occur orthat all control issues and instances of fraud, if any, have been or will bedetected.

 

These inherent limitationsinclude the realities that judgments in decision-making can be faulty and thatbreakdowns can occur because of a simple error or mistake. Controls can also becircumvented by the individual acts of some persons, by collusion of two ormore people, or by management override of the controls. The design of anysystem of controls is based in part on certain assumptions about the likelihoodof future events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions. Projections ofany evaluation of controls effectiveness to future periods are subject torisks. Over time, controls may become inadequate because of changes inconditions or deterioration in the degree of compliance with policies orprocedures.

 

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

*** ***

Set forth below is a summary of the varioussignificant deficiencies which caused management to conclude that we had thefour material weaknesses identified above. Through the efforts of management, external consultants and our AuditCommittee, we are currently in the process of executing specific action plansto remediate the material weaknesses identified above and discussed more fullybelow.  We expect to complete thesevarious action plans by March 31, 2010. If we are able to complete these actions by that date, we anticipatethat all control deficiencies and material weaknesses will be remediated by June 30,2010.

 

(1)           We did not effectively implement comprehensiveentity-level internal controls, as evidenced by the following 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 financialreporting.

 

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

 

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

 

(3)           We did not maintain a sufficientlevel of information technology personnel to execute general computing controlsover our information technology structure, which include the implementation andassessment of information technology policies and procedures. This controldeficiency did not result in an audit adjustment to our 2008 interim or annualconsolidated financial statements, but could result in a material misstatementof significant accounts or disclosures, which would not have been prevented ordetected.

 

(4)           We did not maintaineffective controls over recording and reporting the acceleration of certaincomponents of our credit facility and the classification of the issuance of anote relating to a purchase price adjustment.  As a result of a review ofour historical financial statements, management concluded that our controlsover (a) recording the acceleration of certain components of our creditfacility and (b) classifying the issuance of a note relating to a purchaseprice adjustment were not in accordance with GAAP.  Based upon this conclusion, the AuditCommittee of our board of directors and our senior management decided, in thethird quarter of 2009, to restate our historical financial statements for eachof the quarterly periods ended March 31, 2009 and June 30, 2009.  Management evaluated the impact of thisrestatement on our assessment of our disclosure controls and procedures andconcluded that the control deficiency that resulted in the incorrect (a) recordingof the acceleration of certain components of our credit facility and (b) classificationof the issuance of a note relating to a purchase price adjustment represented amaterial weakness.

 

(5)           We are a relatively complex company with operationsconducted in multiple countries, multiple currencies and multiple languages.  We have divested four separate operations inthe past 18 months, acquired a large subsidiary during the same time, and weare in the process of divesting additional assets in order to repay our currentobligations.  All of these transactionsgive rise to complex accounting and tax treatments.  Our finance team is a relatively small butexperienced staff. Although we believe the accounting staff are qualified toperform their functions, due to reasons above, the quantity of staff may beinsufficient to deal with the work load and complexities created, which couldresult in material misstatements to our financial statements.

 

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

*** ***

The above material weaknesses resulted in adjustmentsto our consolidated financial statements for the quarter ended March 31,2009 and June 30, 2009.  Inaddition, it is reasonably possible that, if not remediated, one or more of thematerial weaknesses described above could result in a material misstatement inour reported financial statements that might result in a material misstatementin a future annual or interim period.

 

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In addition to the developing specific action plansfor each of the above material weaknesses, we are taking steps to unify thefinancial reporting of all of our divisions. Accordingly, we are planning to implement a centralized consolidation softwarepackage which we believe will facilitate this process and will assist in theremediation of many of the above listed deficiencies.

 

In addition, our audit committee has authorized thehiring of additional temporary staff and/or the use of financial andinformation technology consultants, as necessary, to ensure that we have thedepth and experience to remediate the above listed material weaknesses,including the implementation and monitoring of the appropriate level of controlprocedures related to all of our manufacturing locations and our corporateoffices.  The audit committee will alsowork directly with management and outside consultants, as necessary to ensurethat board level deficiencies are addressed. We are uncertain at this time of the costs to remediate all of the abovelisted material weaknesses, however, we anticipate the cost to be in the rangeof $200,000 to $400,000 (including the cost of the consolidation softwaredescribed above), most of which costs we expect to incur in the first half of2010.  We cannot guarantee that theactual costs to remediate these deficiencies will not exceed this amount.

 

Through these steps, we believe that we are addressingthe deficiencies that affected our internal control over financial reporting asof September 30, 2009. Because the remedial actions require hiring ofadditional personnel, upgrading certain of our information technology systems,and relying extensively on manual review and approval, the successful operationof these controls for at least several quarters may be required beforemanagement may be able to conclude that the material weakness has beenremediated.  We intend to continue toevaluate and strengthen our internal control over financial reporting systems.These efforts require significant time and resources.  If we are unable to establish adequateinternal control over financial reporting systems, we may encounterdifficulties in the audit or review of our financial statements by ourindependent registered public accounting firm, which in turn may have amaterial adverse effect on our ability to prepare financial statements inaccordance with GAAP and to comply with our Commission reporting obligations.

 

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

*** ***

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

 

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**PART II — OTHER INFORMATION**

 

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

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                     |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                |
| 10.1       |       | Amendment Number 5 to  Loan Documents, dated August 14, 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.(1) |
|       |       |                                                                                                                                                                                                                                                                                                |
| 31.1       |       | Certification of  Principal Executive Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                  |
|       |       |                                                                                                                                                                                                                                                                                                |
| 31.2       |       | Certification of  Principal Financial Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                  |
|       |       |                                                                                                                                                                                                                                                                                                |
| 32.1       |       | Certification of Chief  Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.  Section 350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002                                                                                                      |

 

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(1)  Filed as anexhibit to the Registrant’s quarterly report on Form 10-Q for June 30,2009 filed with the Securities and Exchange Commission on August 14, 2009and incorporated herein by reference.

 

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**SIGNATURES**

 

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

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

 

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**INDEX TO EXHIBITS ATTACHED TOTHIS REPORT**

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

 

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