Table ofContents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(MarkOne)**

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

 

**For the quarterly period ended****June 30,2010**

 

**or**

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

 

**For the transition period from                to                **

 

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

 

**EMRISE CORPORATION**

(Exact name of registrant as specified in its charter)

 

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

 

**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)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes x  No o

 

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

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

 

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

 

Indicateby check mark whether the registrant is a shell company (as defined inRule 12b-2 of the Exchange Act). Yes o  No x

 

Thenumber of shares outstanding of the Registrant’s common stock, $0.0033 parvalue, as of August 9, 2010 was 10,213,214.

 

 

 

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Tableof Contents

 

**EMRISE CORPORATION**

**TABLE OF CONTENTS**

**FORM 10-Q**

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

 
| **PART IFINANCIAL INFORMATION** |
|--------------------------------------|
| ** **                           |
| **ITEM 1.**                          | **FINANCIAL  STATEMENTS** |   |   |
| ** **                           | ** ** |   |   |
|                                 | Condensed  Consolidated Balance Sheets as of June 30, 2010 (unaudited) and  December 31, 2009 |   | 1 |
|                                 |   |   |   |
|                                 | Condensed  Consolidated Statements of Operations for the Three and Six Months Ended  June 30, 2010 and 2009 (unaudited) |   | 2 |
|                                 |   |   |   |
|                                 | Condensed  Consolidated Statements of Stockholders’ Equity for the Six Months Ended  June 30, 2010 (unaudited) |   | 3 |
|                                 |   |   |   |
|                                 | Condensed  Consolidated Statements of Cash Flows for the Six Months Ended June 30,  2010 and 2009 (unaudited) |   | 4 |
|                                 |   |   |   |
|                                 | Notes to Condensed Consolidated Financial Statements  (unaudited) |   | 6 |
|                                 |   |   |   |
| **ITEM 2.**                          | **MANAGEMENT’S DISCUSSION AND ANALYSIS  OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** | ** ** | 25 |
| ** **                           | ** ** | ** ** |   |
| **ITEM 3.**                          | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK** | ** ** | 43 |
| ** **                           | ** ** | ** ** |   |
| **ITEM 4T.**                         | **CONTROLS AND  PROCEDURES** |   | 43 |
| ** **                           | ** ** |   |   |
| **PART IIOTHER INFORMATION**    |
| ** **                           |
| **ITEM 6.**                          | **EXHIBITS** |   | 46 |
| ** **                           | ** ** |   |   |
| **SIGNATURES**                       |   | 47 |
|                                      |  |  |  |  |

 

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Table of Contents

 

**PART I — FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIALSTATEMENTS**

 

**EMRISE CORPORATION**

**Condensed ConsolidatedBalance Sheets**

(inthousands, except share and per share amounts)

 
| ** **                                                                                                                                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                          | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                          | ** ** | **(unaudited)**   | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                          |       |              |       |                  |       |
| Current  assets:                                                                                                                                    |       |              |       |                  |       |
| Cash  and cash equivalents                                                                                                                          |       | $                 | 1,987      |                  | $          | 3,994 |   |
| Accounts  receivable, net of allowances for doubtful accounts of $125 at June 30, 2010  and $160 at December 31, 2009                     |       | 4,228             |       | 6,059                 |       |
| Inventories                                                                                                                                         |       | 7,203             |       | 8,031                 |       |
| Current  deferred tax assets                                                                                                                        |       | 117               |       | 158                   |       |
| Prepaid  and other current assets                                                                                                                   |       | 771               |       | 841                   |       |
| Current  assets of discontinued and held for sale operations                                                                                        |       | 5,935             |       | 6,368                 |       |
| Total  current assets                                                                                                                               |       | 20,241            |       | 25,451                |       |
|                                                                                                                                                |       |              |       |                  |       |
| Property,  plant and equipment, net                                                                                                                 |       | 784               |       | 987                   |       |
| Goodwill                                                                                                                                            |       | 3,484             |       | 2,878                 |       |
| Intangible  assets other than goodwill, net                                                                                                         |       | 1,040             |       | 1,107                 |       |
| Deferred  tax assets                                                                                                                                |       | 500               |       | 308                   |       |
| Other  assets                                                                                                                                       |       | 88                |       | 121                   |       |
| Noncurrent  assets of discontinued and held for sale operations                                                                                     |       | 18,040            |       | 19,425                |       |
| Total  assets                                                                                                                                       |       | $                 | 44,177     |                  | $          | 50,277 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                      |       |              |       |                  |       |
| Current  liabilities:                                                                                                                               |       |              |       |                  |       |
| Accounts  payable                                                                                                                                   |       | $                 | 3,064      |                  | $          | 2,734 |   |
| Accrued  expenses                                                                                                                                   |       | 4,102             |       | 5,232                 |       |
| Line  of credit                                                                                                                                     |       | 3,556             |       | 5,156                 |       |
| Current  portion of long-term debt, net of discount of $0 and $290                                                                                  |       | 7,569             |       | 8,109                 |       |
| Notes  payable to stockholders, current portion                                                                                                     |       | 179               |       | 348                   |       |
| Income  taxes payable                                                                                                                               |       | 289               |       | 604                   |       |
| Other  current liabilities                                                                                                                          |       | 356               |       | 370                   |       |
| Current  liabilities of discontinued and held for sale operations                                                                                   |       | 6,619             |       | 6,994                 |       |
| Total  current liabilities                                                                                                                          |       | 25,734            |       | 29,547                |       |
|                                                                                                                                                |       |              |       |                  |       |
| Long-term  debt                                                                                                                                     |       | 2,883             |       | 2,938                 |       |
| Deferred  income taxes                                                                                                                              |       | 315               |       | 144                   |       |
| Other  liabilities                                                                                                                                  |       | 1,386             |       | 688                   |       |
| Noncurrent  liabilities of discontinued and held for sale operations                                                                                |       | 1,175             |       | 1,572                 |       |
| Total  liabilities                                                                                                                                  |       | 31,493            |       | 34,889                |       |
| Commitments  and contingencies                                                                                                                      |       |              |       |                  |       |
| Stockholders’  equity:                                                                                                                         |       |              |       |                  |       |
| Preferred  stock,$0.01 par value. Authorized 10,000,000 shares, no shares issued and  outstanding                                                   |       | —            |       | —                |       |
| Common  stock,$0.0033 par value. Authorized 150,000,000 shares; 10,213,214 issued and  outstanding at June 30, 2010 and December 31, 2009 |       | 126               |       | 126                   |       |
| Additional  paid-in capital                                                                                                                         |       | 43,554            |       | 43,480                |       |
| Accumulated  deficit                                                                                                                                |       | (28,333           | )          | (26,586               | )          |
| Accumulated  other comprehensive loss                                                                                                               |       | (2,663            | )          | (1,632                | )          |
| Total  stockholders’ equity                                                                                                                    |       | 12,684            |       | 15,388                |       |
| Total  liabilities and stockholders’ equity                                                                                                    |       | $                 | 44,177     |                  | $          | 50,277 |   |

 

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

 

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**EMRISE CORPORATION**

**Condensed ConsolidatedStatements of Operations**

(Unaudited)****(in thousands, except per shareamounts)

 
| ** **                                                                            | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                            | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                                            | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                                  |       |                   |       |                 |       |   |   |   |   |
| Net  Sales                                                                            |       | $                      | 6,474      |                 | $          | 8,189 |   | $ | 13,566 |   | $ | 16,710 |   |
| Cost  of Sales                                                                        |       | 4,533                  |       | 5,527                |       | 9,674 |   | 11,071 |   |
| Gross  profit                                                                         |       | 1,941                  |       | 2,662                |       | 3,892 |   | 5,639 |   |
|                                                                                  |       |                   |       |                 |       |   |   |   |   |
| Operating  expenses:                                                                  |       |                   |       |                 |       |   |   |   |   |
| Selling,  general and administrative                                                  |       | 2,566                  |       | 2,905                |       | 5,099 |   | 5,922 |   |
| Engineering  and product development                                                  |       | 402                    |       | 470                  |       | 925 |   | 839 |   |
| Total  operating expenses                                                             |       | 2,968                  |       | 3,375                |       | 6,024 |   | 6,761 |   |
| Loss  from operations                                                                 |       | (1,027                 | )          | (713                 | )          | (2,132 | ) | (1,122 | ) |
|                                                                                  |       |                   |       |                 |       |   |   |   |   |
| Other  income (expense):                                                              |       |                   |       |                 |       |   |   |   |   |
| Interest  income                                                                      |       | 32                     |       | 23                   |       | 47 |   | 69 |   |
| Interest  expense                                                                     |       | (746                   | )          | (779                 | )          | (1,570 | ) | (2,324 | ) |
| Other,  net                                                                           |       | 147                    |       | 201                  |       | 291 |   | 159 |   |
| Total  other expense, net                                                             |       | (567                   | )          | (555                 | )          | (1,232 | ) | (2,096 | ) |
|                                                                                  |       |                   |       |                 |       |   |   |   |   |
| Loss  before income taxes                                                             |       | (1,594                 | )          | (1,268               | )          | (3,364 | ) | (3,218 | ) |
| Income  tax provision (benefit)                                                       |       | (303                   | )          | 125                  |       | (439 | ) | 275 |   |
| Loss  from continuing operations                                                      |       | (1,291                 | )          | (1,393               | )          | (2,925 | ) | (3,493 | ) |
| Discontinued  and held for sale operations:                                           |       |                   |       |                 |       |   |   |   |   |
| Income  from discontinued and held for sale operations including gain on sale in 2009 |       | 975                    |       | 942                  |       | 1,887 |   | 8,630 |   |
| Tax  provision on discontinued and held for sale operations                           |       | 479                    |       | 54                   |       | 709 |   | 805 |   |
| Net  income on discontinued and held for sale operations                              |       | 496                    |       | 888                  |       | 1,178 |   | 7,825 |   |
|                                                                                  |       |                   |       |                 |       |   |   |   |   |
| Net  (loss) income                                                                    |       | $                      | (795       | )                    | $          | (505 | ) | $ | (1,747 | ) | $ | 4,332 |   |
|                                                                                  |       |                   |       |                 |       |   |   |   |   |
| Weighted  average shares outstanding                                                  |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                                 |       | 10,213                 |       | 10,205               |       | 10,213 |   | 10,205 |   |
| Diluted                                                                               |       | 10,213                 |       | 10,205               |       | 10,213 |   | 10,205 |   |
|                                                                                  |       |                   |       |                 |       |   |   |   |   |
| Earnings  (loss) per share:                                                           |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                                 |       |                   |       |                 |       |   |   |   |   |
| Continuing  operations                                                                |       | $                      | (0.13      | )                    | $          | (0.14 | ) | $ | (0.29 | ) | $ | (0.34 | ) |
| Discontinued  operations                                                              |       | $                      | 0.05       |                 | $          | 0.09 |   | $ | 0.12 |   | $ | 0.77 |   |
| Net  earnings (loss)                                                                  |       | $                      | (0.08      | )                    | $          | (0.05 | ) | $ | (0.17 | ) | $ | 0.42 |   |
| Diluted                                                                               |       |                   |       |                 |       |   |   |   |   |
| Continuing  operations                                                                |       | $                      | (0.13      | )                    | $          | (0.14 | ) | $ | (0.29 | ) | $ | (0.34 | ) |
| Discontinued  operations                                                              |       | $                      | 0.05       |                 | $          | 0.09 |   | $ | 0.12 |   | $ | 0.77 |   |
| Net  earnings (loss)                                                                  |       | $                      | (0.08      | )                    | $          | (0.05 | ) | $ | (0.17 | ) | $ | 0.42 |   |

 

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

 

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**EMRISE CORPORATION**

**Condensed ConsolidatedStatements of Stockholders’ Equity**

(Unaudited) ****(in thousands)

 
| ** **                         | ** ** | ** **        | ** ** | ** **  | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|------------------------------------|------------|-------------------|------------|-------------|------------|-----------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                         | ** ** | ** **        | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **        | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                         | ** ** | **Common  Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                         | ** ** | **Shares**        | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**       | ** ** | **Loss**        | ** ** | **Total**  | ** ** |
|                               |       |              |       |        |       |            |       |              |       |            |       |       |       |
| Balance  at December 31, 2009 |       | 10,213            |       | $           | 126        |            | $          | 43,480            |       | $               | (26,586    | )          | $          | (1,632 | ) | $ | 15,388 |   |
| Stock-based  compensation          |       | —            |       | —      |       | 74              |       | —            |       | —          |       | 74         |       |
| Warrants  issued for services      |       | —            |       | —      |       | —          |       | —            |       | —          |       | —     |       |
| Net  loss and comprehensive loss   |       | —            |       | —      |       | —          |       | (1,747            | )          | (1,031          | )          | (2,778     | )          |
| Balance  at June 30, 2010     |       | 10,213            |       | $           | 126        |            | $          | 43,554            |       | $               | (28,333    | )          | $          | (2,663 | ) | $ | 12,684 |   |

 

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

 

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**EMRISE CORPORATION**

**Condensed ConsolidatedStatements of Cash Flows**

(Unaudited)****(in thousands)

 
| ** **                                                                                                                   | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                                   | ** ** | **June 30,**    | ** ** |
| ** **                                                                                                                   | ** ** | **2010**             | ** ** | **2009** | ** ** |
|                                                                                                                         |       |                 |       |   |   |
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                                                                     | ** ** | ** **           | ** ** |   | ** ** |
| Net  Income (loss)                                                                                                           |       | $                    | (1,747     | ) | $ | 4,332 |   |
| Adjustments  to arrive at net loss from continuing operations                                                                |       | (1,178               | )          | (7,825 | ) |
| Net  loss from continuing operations                                                                                         |       | (2,925               | )          | (3,493 | ) |
| Reconciliation  to net cash provided by operating activities:                                                                |       |                 |       |   |   |
| Depreciation  and amortization                                                                                               |       | 227                  |       | 266 |   |
| Provision  for doubtful accounts                                                                                             |       | 11                   |       | 13 |   |
| Provision  for warranty reserve                                                                                              |       | 32                   |       | (97 | ) |
| Deferred  taxes                                                                                                              |       | 20                   |       | (292 | ) |
| Loss  on sale of assets                                                                                                      |       | 14                   |       | — |   |
| Amortization  of deferred issuance costs                                                                                     |       | 316                  |       | 519 |   |
| Amortization  of debt discount                                                                                               |       | 290                  |       | 475 |   |
| Stock-based  expense                                                                                                         |       | 74                   |       | 77 |   |
| Change  in fair value of common stock warrant                                                                                |       | (75                  | )          | (423 | ) |
| Changes  in assets and liabilities:                                                                                          |       |                 |       |   |   |
| Accounts  receivable                                                                                                         |       | 1,837                |       | 1,905 |   |
| Inventories                                                                                                                  |       | 829                  |       | (1,109 | ) |
| Prepaid  and other assets                                                                                                    |       | (197                 | )          | (142 | ) |
| Accounts  payable and accrued expenses                                                                                       |       | (599                 | )          | 302 |   |
| Operating  cash flow provided by continuing operations                                                                       |       | (146                 | )          | (1,999 | ) |
| Operating  cash flow provided by discontinued operations                                                                     |       | 815                  |       | 1,357 |   |
| Net  cash provided by operating activities                                                                                   |       | 669                  |       | (642 | ) |
|                                                                                                                         |       |                 |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                                                    |       |                 |       |   |   |
| Purchases  of property, plant and equipment                                                                                  |       | (33                  | )          | (51 | ) |
| Investing  cash flow used in continuing operations                                                                           |       | (33                  | )          | (51 | ) |
| Investing  cash flow provided by discontinued operations including proceeds from sale of  subsidiary operations, net of cash |       | 830                  |       | 10,232 |   |
| Net  cash provided by investing activities                                                                                   |       | 797                  |       | 10,181 |   |
|                                                                                                                         |       |                 |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                                                    |       |                 |       |   |   |
| Borrowings  from lines of credit                                                                                             |       | 22,070               |       | 28,395 |   |
| Repayments  of lines of credit                                                                                               |       | (23,670              | )          | (26,867 | ) |
| Repayments  of long-term debt                                                                                                |       | (874                 | )          | (10,126 | ) |
| Payments  of notes to stockholders                                                                                           |       | (169                 | )          | (293 | ) |
| Proceeds  from exercise of stock options and warrants                                                                        |       | —               |       | 7 |   |
| Financing  cash flow used in continuing operations                                                                           |       | (2,643               | )          | (8,884 | ) |
| Financing  cash flow used in discontinued operations                                                                         |       | (80                  | )          | (162 | ) |
| Net  cash used in financing activities                                                                                       |       | (2,723               | )          | (9,046 | ) |
|                                                                                                                         |       |                 |       |   |   |
| Effect  of exchange rate changes on cash                                                                                     |       | (751                 | )          | 785 |   |
| Net  (decrease) increase in cash and cash equivalents                                                                        |       | (2,008               | )          | 1,278 |   |
| Cash  and cash equivalents at beginning of period                                                                            |       | 3,995                |       | 3,001 |   |
| Cash  and cash equivalents at end of period                                                                                  |       | $                    | 1,987      |   | $ | 4,279 |   |

 

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

 

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Cash Flows (Continued)**

(Unaudited)****(in thousands)

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

 

*The accompanying Notes are anintegral part of these Condensed Consolidated Financial Statements*

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 1 — SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

*Organization and Business*

 

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

* *

*Basis of Presentation*

 

Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with the rules and regulations of the U.S. Securitiesand Exchange Commission (“SEC”) and therefore do not include all informationand footnotes necessary for a complete presentation of the financial position,results of operations and cash flows in conformity with accounting principlesgenerally accepted in the U.S. (“GAAP”). The year end balance sheet was derived from the audited financialstatements at that date, but does not include all of the information andfootnotes required by GAAP for complete financial statements.  The unaudited condensed consolidatedfinancial statements do, however, reflect all adjustments, consisting of onlynormal recurring adjustments, which are, in the opinion of management,necessary to state fairly the financial position as of June 30, 2010 and theresults of operations and cash flows for the related interim periods ended June30, 2010 and 2009. However, these results are not necessarily indicative ofresults for any other interim period or for the year. The accompanyingunaudited condensed consolidated financial statements should be read inconjunction with the Company’s audited consolidated financial statementsincluded in its annual report on Form 10-K and Form 10-K/A for the year endedDecember 31, 2009 as filed with the SEC.

 

InMarch of 2009, the Company sold substantially all of the assets related to theDigitran division of the Company’s wholly-owned subsidiary, EMRISE ElectronicsCorporation’s (“EEC”), and all of the issued and outstanding equity interestsof EEC’s wholly-owned subsidiary, XCEL Japan, Ltd. (collectively the “DigitranOperations”).  The accompanying financialstatements include the Digitran Operations as a discontinued operation for allperiods presented.

 

OnMarch 22, 2010, EMRISE completed the sale of substantially all of the assets ofEEC’s subsidiary, RO Associates, to Massachusetts based AstrodyneCorporation.  In this Quarterly Report onForm 10-Q, we refer to the businesses of RO Associates as the “RO Operations”or “RO,” and we refer to the sale of the RO Associates’ assets as the “ROTransaction.”  The accompanying financialstatements include the RO Operations as a discontinued operation for allperiods presented.

 

On June 7, 2010, AeroflexIncorporated (‘‘Aeroflex’’ or “Buyer”) and EMRISE Electronics Corporation (“EEC”or ‘‘Seller’’) entered into a Stock Purchase Agreement (the ‘‘ACC PurchaseAgreement’’) relating to the sale of all of the issued and outstanding sharesof common stock of Advanced Control Components, Inc. (“ACC”) and all of theissued and outstanding shares of common stock of Custom Components, Inc. (“CCI”)(collectively the “ACC Operations”).  Theaccompanying financial statements include the ACC Operations as discontinuedoperations and assets held for sale for all periods presented.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Comprehensive Income (Loss)*

 

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

 
| ** **                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                               | ** ** | **June 30,**           | ** ** | **June 30,**         | ** ** |
| ** **                               | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                     | ** ** | ** **             |       | ** **           |       |   |   |   |   |
| Net  (loss) income                       |       | $                      | (795       | )                    | $          | (505 | ) | $ | (1,747 | ) | $ | 4,332 |   |
| Other  comprehensive income (loss):      |       |                   |       |                 |       |   |   |   |   |
| Foreign  currency translation adjustment |       | (32                    | )          | 1,791                |       | (1,031 | ) | 1373 |   |
| Comprehensive  (loss) income             |       | $                      | (827       | )                    | $          | 1,286 |   | $ | (2,778 | ) | $ | 5,705 |   |

 

*Revenue**Recognition*

 

TheCompany derives revenues from sales of electronic devices and communications equipmentproducts and services.  The Company’ssales are based upon written agreements or purchase orders that identify thetype and quantity 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.

 

TheCompany recognizes revenues from its U.S. communications equipment businessunit at the point of shipment of those products.  An estimate of warranty cost is recorded atthe time the revenue is recognized. Product returns are infrequent and require prior authorization becausesales are final and the Company tests its products for quality prior toshipment to ensure products meet the specifications of the binding purchaseorders under which those products are shipped. Normally, when a customerrequests and receives authorization to return a product, the request isaccompanied by a purchase order for a repair or for a replacement product.

 

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

 

TheCompany recognizes revenues for products sold by its subsidiary in France atthe point of shipment.  Customerdiscounts are included in the product price list provided to the customer.  Returns are infrequent and permitted onlywith prior authorization because these products are shipped based on bindingpurchase orders and are quality tested prior to shipment.  An estimate of warranty cost is recorded atthe time revenue is recognized.

 

7

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Table of Contents

 

**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Revenuesfrom services such as repairs and modifications are recognized when the serviceis completed and invoiced.  For repairsthat involve shipment of a repaired product, the Company recognizes repairrevenues when the product is shipped back to the customer. Service revenuescontribute less than 5% of total revenue and, therefore, are considered to beimmaterial to overall financial results.

* *

*Loss Per Share from Continuing Operations*

 

Basicloss per share from continuing operations is computed by dividing net loss fromcontinuing operations by the weighted average common shares outstanding duringa period.  Diluted loss per share fromcontinuing operations is based on the treasury stock method and includes thedilutive effect of stock options and warrants outstanding during theperiod.  Common share equivalents havebeen excluded where their inclusion would be anti-dilutive.  As a result of the losses from continuingoperations incurred by the Company for the second quarter of 2010 and 2009, thepotentially dilutive common shares have been excluded from the loss per sharecomputation because their inclusion would have been anti-dilutive.  The following table illustrates thecomputation of basic and diluted loss per share from continuing operations (inthousands, except per share amounts):

 
| ** **                                                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                       | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                             |       |                             |       |                           |       |   |   |   |   |
| NUMERATOR:                                                       |       |                             |       |                           |       |   |   |   |   |
| Net (loss) income                                                |       | $                                | (795       | )                              | $          | (505 | ) | $ | (1,747 | ) | $ | 4,332 |   |
| Less: net income from discontinued and held for  sale operations |       | 496                              |       | 888                            |       | 1,178 |   | 7,825 |   |
| Net loss from continuing operations                              |       | $                                | (1,291     | )                              | $          | (1,393 | ) | $ | (2,925 | ) | $ | (3,493 | ) |
|                                                             |       |                             |       |                           |       |   |   |   |   |
| DENOMINATOR:                                                     |       |                             |       |                           |       |   |   |   |   |
| Basic weighted average common shares outstanding                 |       | 10,213                           |       | 10,205                         |       | 10,213 |   | 10,205 |   |
| Effect of dilutive securities:                                   |       |                             |       |                           |       |   |   |   |   |
| Dilutive stock options and warrants                              |       | —                           |       | —                         |       | — |   | — |   |
| Diluted weighted average common shares outstanding               |       | 10,213                           |       | 10,205                         |       | 10,213 |   | 10,205 |   |
|                                                             |       |                             |       |                           |       |   |   |   |   |
| Basic and diluted loss per share from continuing  operations     |       | $                                | (0.13      | )                              | $          | (0.14 | ) | $ | (0.29 | ) | $ | (0.34 | ) |

 

Thefollowing table shows the common stock equivalents that were outstanding as ofJune 30, 2010 and 2009, but were not included in the computation of dilutedearnings per share because the options’ or warrants’ exercise price was greaterthan the average market price of the common shares and, therefore, the effectwould have been anti-dilutive:

 
| ** **                            | ** ** | **Number of  Shares** | ** ** | **Range of  Exercise Price  Per Share** | ** ** |
|---------------------------------------|------------|-----------------------|------------|-----------------------------------------|------------|
|                                  |       |                  |       |                                    |       |
| Anti-dilutive  common stock options:  |       |                  |       |                                    |       |
| As  of June 30, 2010                  |       | 674,000               |       | $1.31 – $7.50                      |       |
| As  of June 30, 2009                  |       | 651,000               |       | $1.53 – $7.50                      |       |
|                                  |       |                  |       |                                    |       |
| Anti-dilutive  common stock warrants: |       |                  |       |                                    |       |
| As  of June 30, 2010                  |       | 784,000               |       | $1.80 – $4.31                      |       |
| As  of June 30, 2009                  |       | 1,804,000             |       | $1.80 – $6.49                      |       |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

* *

*RecentAccounting Pronouncements*

 

**Adopted**

 

**None.**

 

**Issued,but not adopted**

 

**Revenue Recognition**.  In October 2009, the FASB issued an update toexisting guidance on revenue recognition for arrangements with multipledeliverables.  This update will allowcompanies to allocate consideration received for qualified separatedeliverables using estimated selling prices for both delivered and undelivereditems when vendor-specific objective evidence or third-party evidence isunavailable.  Additional disclosuresdiscussing the nature of multiple element arrangements, the types ofdeliverables under the arrangements, the general timing of their delivery, andsignificant factors and estimates used to determine estimated selling pricesare required.  The Company will adoptthis update for new revenue arrangements entered into or materially modifiedbeginning January 1, 2011.  The Companyis still evaluating the impact, if any, of the adoption of this new revenuerecognition guidance on its condensed consolidated financial statements.

 

InMarch 2010, the FASB ratified accounting guidance on defining a milestoneand determining when it may be appropriate to apply the milestone method ofrevenue recognition for research or development transactions. This guidanceprovides criteria that must be met to recognize consideration that iscontingent upon achievement of a substantive milestone in its entirety in the periodin which the milestone is achieved. The amendment is effective for milestonesachieved in fiscal years beginning on or after June 15, 2010. Earlyadoption is allowed. The Company is currently evaluating the impact of theadoption of this amendment on its condensed consolidated financial statements.

 

**NOTE 2 —GOING CONCERN**

 

The accompanying condensed consolidated financialstatements have been prepared in conformity with GAAP, which contemplate thecontinuation of the Company as a going concern. The Company reported a net loss from continuing operations for the threeand six months ended June 30, 2010 of $1.3 million and $2.9 million,respectively.  The Company also reportednegative working capital from continuing operations of $4.8 million at June 30,2010 and negative working capital from continuing operations of $3.5 million atDecember 31, 2009.  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.  The accompanyingconsolidated financial statements do not include any adjustments that mightresult from the outcome of this uncertainty.

 

The ability of the Company to continue as a goingconcern is dependent upon its ability to (i) achieve the milestonesrelated to the sale of a significant portion of its assets as required by theCredit Agreement between now and August 31, 2010, including obtainingstockholder approval to consummate the pending sale of ACC, (ii) repay theCredit Agreement on or prior to its maturity on August 31, 2010, (iii) obtainalternate financing to fund operations after August 31, 2010 and (iv) achieveprofitable operations. Further, following the successful sale of ACC,management believes the Company will, by necessity, be required to selladditional stock or assets, complete a recapitalization, or consummate a mergertransaction in order to continue operations.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Inconnection with the obligation to sell certain assets, the Company is obligatedto achieve certain sale-related milestones, the most immediate of which includes obtaining stockholder approval toconsummate the pending sale of ACC by August 31, 2010.  Also, pursuant to the Credit Agreement, asamended, as further described in Notes 9 and 10 herein, a termination of theACC Purchase Agreement, which became terminable by either party at any time onAugust 1, 2010, is an event of default. As of the date of this filing, theCompany believes it will be able to achieve such milestones and does notanticipate termination of the ACC Purchase Agreement, but no assurances can beprovided in this regard.

 

Ifthe Company’s net losses from continuing operations continue, it will likelyexperience negative cash flow, which may prevent the Company from continuingoperations.  If the Company is not ableto attain, sustain or increase profitability on a quarterly or annual basis, itmay not be able to continue operations.

 

Uponthe occurrence and during the continuation of an event of default, the Lendermay also elect to increase the interest rate applicable to the outstandingbalance of the Term Loans A and B by four percentage points above the per annuminterest rate that would otherwise be applicable.  Additionally, if theLender terminates the Credit Agreement during a default period, then theCompany is subject to a penalty equal to 2% of the outstanding principalbalance of the Revolver and the Term Loans.

 

If the Company (i) defaults under the Credit Agreement for anyreason, (ii) is unable to timely obtain stockholder approval and completethe sale of ACC in order to repay its obligations prior to August 31, 2010as agreed with its Lender, (iii) cannot borrow funds under the terms of itsrevolving credit facility,  for anyreason, through August 31, 2010, or (iv) fails to obtain alternatefinancing to replace its Credit Agreement prior to August 31, 2010 or anew revolving credit facility once the current Credit Agreement is paid infull, then the Company does not believe that current and future capitalresources, revenues generated from operations and other existing sources ofliquidity will be adequate to meet its anticipated short term, working capitaland capital expenditure needs for the next 12 months.  To address thesepotential financing needs, the Company may need to explore a revised debtstructure with its Lender; additional or new financing with another lender orlenders; expedite the sale of certain assets to generate cash; complete arecapitalization of the Company, or consummate a merger or othertransaction.  Successfully executingthese strategies is uncertain and there are many risks associated withattempting to execute each, in addition to the risks and uncertainties of the shortand long term impact of executing on any of these strategies.   Failure to meet the Company’s financingrequirements, if and when needed, would have an adverse effect on the Company’soperations and/or ability to do business after that date or could restrict itsgrowth, limit the development of new products, hinder its ability to fulfillexisting or future orders or negatively affect its ability to secure newcustomers or product orders.

 

Further,if the sale of ACC is successful,  theCompany expects to continue to experience losses from its continuing operationsand negative cash flow subsequent to such sale, which may require the Companyto sell additional assets, complete arecapitalization, or consummate a merger transaction.  Selling additional assets, completinga recapitalization or consummating a merger transaction following thesuccessful sale of ACC may prove to be difficult given the current economicconditions and because of the Company’s financial condition. Further, even ifthe Company is successful in completing the transaction, such transaction mayprove to be dilutive to the existing stockholders.

 

Ifthe Company is unsuccessful in timely obtaining stockholder approval,completing the sale of ACC, and repaying its obligations as agreed with itsLender by August 31, 2010, or if it is unsuccessful in securing thenecessary financing to continue operations by August 31, 2010 or otherwisewhen needed, then it may be forced toseek protection under the U.S. Bankruptcy Code or be forced into liquidation orsubstantially restructuring or altering its business operations and/or debtobligations.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 3— DISCONTINUED AND HELD FOR SALE OPERATIONS**

 

*DigitranOperations*

 

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

 

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

 

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

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Thefollowing table summarizes the results from discontinued operations for thethree and six months ended June 30, 2009 (in thousands):

 
| ** **                                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                       | ** ** | **June 30,**                     | ** ** | **June 30,**                   | ** ** |
| ** **                                                       | ** ** | **2009**                         | ** ** | **2009**                       | ** ** |
|                                                             |       |                             |       |                           |       |
| Net Sales                                                        |       | $                                | —     |                           | $          | 1,478 |   |
|                                                             |       |                             |       |                           |       |
| Income from operations                                           |       | $                                | —     |                           | $          | 178 |   |
| Gain (loss) on sale of  Digitran Operations (net of tax of $707) |       | (114                             | )          | 6,403                          |       |
| Net (loss) Income                                                |       | $                                | (114       | )                              | $          | 6,581 |   |
|                                                             |       |                             |       |                           |       |
| (Loss) earnings per  share:                                      |       |                             |       |                           |       |
| Basic                                                            |       | $                                | (0.01      | )                              | $          | 0.64 |   |
| Diluted                                                          |       | $                                | (0.01      | )                              | $          | 0.64 |   |
|                                                             |       |                             |       |                           |       |
| Weighted average shares  outstanding                             |       |                             |       |                           |       |
| Basic                                                            |       | 10,205                           |       | 10,205                         |       |
| Diluted                                                          |       | 10,205                           |       | 10,205                         |       |

 

*ROAssociates*

 

OnMarch 22, 2010, EEC, a wholly-owned subsidiary of the Company, entered into andconsummated the closing under an asset purchase agreement by and amongAstrodyne Corporation (“Astrodyne”), RO, and EEC dated March 22, 2010 (the “ROPurchase Agreement”) pursuant to which Astrodyne purchased substantially all ofthe assets, properties, and business as a going concern of RO.  The assets of RO that were sold andtransferred to Astrodyne include, but are not limited to, the following:  (i) machinery and equipment; (ii) rawmaterials, work-in-process, and finished goods relating to RO; (iii) tangiblepersonal property, such as office furniture and equipment; (iv) advancepayments, rental deposits, and other similar assets; (v) rights to paymentsfrom customers; (vi) books and records; (vii) rights under certain contracts;(viii) intangible rights and property, such as goodwill and rights in and tothe name “RO Associates,” product names, trade names, trademarks, fictitiousnames and service marks; (ix) information and data; (x) unfilled purchase andsale orders; (xi) governmental authorizations relating to RO’s business andpending applications in connection with such authorizations; (xii) RO’s rightsto its business of manufacturing and selling standard, high-density AC to DC,and DC to DC converters (the “Business”); and (xiii) all claims, causes ofaction, and judgments relating to the Business. Such sale and transfer was deemed to be a disposition of aninsignificant amount of assets by the Company and EEC.  RO retained certain rights, as fully describedin the RO Purchase Agreement, including certain records, rights to benefits plansand insurance policies and proceeds, and certain assets.

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

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

 

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

 

Thefollowing table summarizes the results from discontinued operations for thethree and six months ended June 30, 2010 and 2009 (in thousands):

 
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                           | ** ** | **June 30,**           | ** ** | **June 30,**         | ** ** |
| ** **                           | ** ** | **2010**               | ** ** | **2009**             | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                           | ** ** | ** **             | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net Sales                            |       | $                      | —     |                 | $          | 674 |   | $ | 442 |   | $ | 1,317 |   |
|                                 |       |                   |       |                 |       |   |   |   |   |
| Income (loss) from  operations       |       | $                      | (29        | )                    | $          | (118 | ) | $ | 182 |   | $ | (653 | ) |
|                                 |       |                   |       |                 |       |   |   |   |   |
| Other income (expense)               |       | 1                      |       | 10                   |       | 1 |   | 9 |   |
| Loss on sale of RO  Operations       |       | (1                     | )          | —               |       | (451 | ) | — |   |
| Net loss                             |       | $                      | (29        | )                    | $          | (108 | ) | $ | (268 | ) | $ | (644 | ) |
|                                 |       |                   |       |                 |       |   |   |   |   |
| Loss per share:                      |       |                   |       |                 |       |   |   |   |   |
| Basic                                |       | $                      | (0.00      | )                    | $          | (0.01 | ) | $ | (0.03 | ) | $ | (0.06 | ) |
| Diluted                              |       | $                      | (0.00      | )                    | $          | (0.01 | ) | $ | (0.03 | ) | $ | (0.06 | ) |
|                                 |       |                   |       |                 |       |   |   |   |   |
| Weighted average shares  outstanding |       |                   |       |                 |       |   |   |   |   |
| Basic                                |       | 10,213                 |       | 10,205               |       | 10,213 |   | 10,205 |   |
| Diluted                              |       | 10,213                 |       | 10,205               |       | 10,213 |   | 10,205 |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Thefollowing table reflects the major classes of assets and liabilities of the ROOperations at the balance sheet date for the periods presented (in thousands):

 
| ** **                         | ** ** | **June  30, 2010** | ** ** | **December  31, 2009** | ** ** |
|------------------------------------|------------|--------------------|------------|------------------------|------------|
| Cash and cash  equivalents         |       | $                  | —     |                   | $          | (24 | ) |
| Accounts receivable,  net          |       | —             |       | 431                    |       |
| Inventory, net                     |       | —             |       | 1,059                  |       |
| Prepaids and other  current assets |       | —             |       | 31                     |       |
| Total current assets               |       | $                  | —     |                   | $          | 1,497 |   |
|                               |       |               |       |                   |       |
| Total current  liabilities         |       | $                  | —     |                   | $          | 745 |   |

 

*AssetsHeld for Sale*

 

Inconnection with the Credit Agreement, as amended, the Company is required tosell a significant portion of its assets by August 31, 2010 in order to repaythe debt obligations owed to Lender.

 

On June 7, 2010, the Companyentered into the ACC Purchase Agreement. Pursuant to the ACC PurchaseAgreement, EEC will sell to Aeroflex the ACC Operations, which are currentlyowned by EEC (the ‘‘ACC Transaction’’). In exchange for the ACC Operations,Aeroflex has agreed to pay EEC an aggregate purchase price of $20,000,000 incash (the ‘‘Purchase Price’’). An amount equal to $1,000,000 will be placed inan escrow account to satisfy any indemnification claims. Approximately $14.6million of proceeds from the ACC Transaction will be used to pay down all ofthe Company’s revolver with its principal lender, a significant portion of itsterm debt with the same lender and a majority of the Company’s obligations tothe previous owners of ACC. The Company anticipates retaining approximately$3.8 million in long term debt payable to both its current lender and theprevious owners of ACC, all of which has a maturity of at least two years orlonger, $1 million of which is included as continuing operations in currentportion of long-term debt and $2.8 million is included in long-term debt in theaccompanying condensed consolidated balance sheet. The Purchase Price may alsobe adjusted based on the level of adjusted net working capital of ACC at theclosing of the ACC Transaction.

 

In addition, on June 7, 2010the Company entered into a Master Agreement, by and among the Company, EEC, CXRLarus Corporation, Pascall Electronics Limited, XCEL Power Systems, Ltd., CXRAnderson Jacobson SAS, Charles S. Brand, Thomas P.M. Couse, Joanne Couse,and Michael Gaffney, (the “Master Agreement”), pursuant to which EEC will alsouse a portion of the proceeds from the sale of ACC to pay approximately half ofthe approximately $6.6 million secured debt owed to certain of ACC’s previousshareholders, Charles S. Brand, Thomas P.M. Couse, Joanne Couse andMichael Gaffney (collectively, the “Former Shareholders”), which amounts areowed in connection with deferred purchase price obligations, contingent notesand other related payments.  Mr. Brand will also accept $450,000worth of the Company’s common stock as partial payment on his contingent note,with the per share valuation based on 115% of the volume weighted average priceof the shares over a three-day period.  The aggregate remaining balanceowed to the Former Shareholders will be approximately $2.8 million.  Thematurity date of the remaining debt has been moved to three years from closing,with quarterly interest payments at prime plus 1% during the first two yearsand quarterly principal payments of $237,000 each beginning on July 2,2012 with a balloon payment of principal on the maturity date of approximately$1.9 million.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The closing of the ACCTransaction is subject to stockholder approval, compliance with the New JerseyIndustrial Site Recovery Act, N.J.S.A. 13:1K-6 et seq., including, withoutlimitation, the General Information Notice, with respect to its New JerseyProperties, obtaining the consent of ACC’s senior lender and the Former Shareholders,(both of which have been received) and other customary closing conditions. Theclosing of the ACC Transaction will satisfy the final milestone under theCredit Agreement. The ACC Purchase Agreement also contains customaryrepresentations, warranties, covenants, agreements and indemnities for both theCompany and Aeroflex.

 

In addition, from the dateof the ACC Purchase Agreement through the closing date of the ACC Transaction,the Company has agreed that neither it nor its affiliates will encourage, solicit,initiate or participate in discussions concerning any alternative acquisitionproposal relating to ACC or CCI, provided that the Company may entertain a bonafide proposal for an acquisition under certain circumstances. In the event thatthe ACC Purchase Agreement is terminated either because the Company’s board ofdirectors changes its recommendation that the Company’s stockholders vote infavor of the ACC Transaction or the Company breaches its obligations under theexclusivity provision of the ACC Purchase Agreement, then the Company will berequired to pay to Aeroflex a break up fee equal to 4% of the Purchase Price,or $800,000, plus any out of pocket fees, costs and expenses actually incurredand paid by Aeroflex to third party advisors in connection with the ACCPurchase Agreement, up to a maximum of $200,000.

 

The Company’s stockholderswill be asked to consider and vote upon the approval and adoption of the ACCPurchase Agreement at the 2010 annual meeting of stockholders to be held onAugust 30, 2010. Assuming the stockholders approve the ACC Transaction, it isexpected to close on August 31, 2010.

 

Theassets identified as held for sale in the accompanying Condensed ConsolidatedBalance Sheets represent the assets of the ACC Operations, which is asubstantial portion of the Company’s assets in the electronic devicessegment.  These assets contributedapproximately $20 million of net sales or 37% of the Company’s net sales andoperating income of approximately $3 million of the Company’s total operatingincome from continuing operations of $1.4 million for 2009.

 

TheCompany has classified these assets as discontinued and held for saleoperations in the accompanying condensed consolidated financial statements forall periods presented.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Thefollowing table summarizes the results from the identified assets held for salefor the three and six months ended June 30, 2010 and 2009 (in thousands):

 
| ** **                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                           | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                 |       |                             | ** ** | ** **                     |       |   | ** ** | ** ** | ** ** |
| Net  Sales                           |       | $                                | 5,488      |                           | $          | 5,407 |   | $ | 10,698 |   | $ | 10,456 |   |
|                                 |       |                             |       |                           |       |   |   |   |   |
| Income  from operations              |       | $                                | 1,108      |                           | $          | 1,227 |   | $ | 2,366 |   | $ | 2,059 |   |
|                                 |       |                             |       |                           |       |   |   |   |   |
| Other  expense                       |       | (104                             | )          | (63                            | )          | (212 | ) | (73 | ) |
| Provision  for income taxes          |       | 479                              |       | 53                             |       | 709 |   | 97 |   |
| Net  income                          |       | $                                | 525        |                           | $          | 1,111 |   | $ | 1,445 |   | $ | 1,889 |   |
|                                 |       |                             |       |                           |       |   |   |   |   |
| Earnings  per share:                 |       |                             |       |                           |       |   |   |   |   |
| Basic                                |       | $                                | 0.05       |                           | $          | 0.11 |   | $ | 0.14 |   | $ | 0.19 |   |
| Diluted                              |       | $                                | 0.05       |                           | $          | 0.11 |   | $ | 0.14 |   | $ | 0.19 |   |
|                                 |       |                             |       |                           |       |   |   |   |   |
| Weighted  average shares outstanding |       |                             |       |                           |       |   |   |   |   |
| Basic                                |       | 10,213                           |       | 10,205                         |       | 10,213 |   | 10,205 |   |
| Diluted                              |       | 10,213                           |       | 10,205                         |       | 10,213 |   | 10,205 |   |

 

Thefollowing table reflects the major classes of assets and liabilities of the ACCOperations, which are classified as held for sale for the periods presented (inthousands):

 
| ** **                                  | ** ** | **June 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|---------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Cash  and cash equivalents                  |       | $                           | 413        |                            | $          | 52 |   |
| Accounts  receivable, net                   |       | 3,023                       |       | 2,189                           |       |
| Inventory,  net                             |       | 2,350                       |       | 2,495                           |       |
| Prepaids  and other current assets          |       | 149                         |       | 136                             |       |
| Total  current assets                       |       | 5,935                       |       | 4,872                           |       |
|                                        |       |                        |       |                            |       |
| Property,  plant and equipment, net         |       | 1,185                       |       | 1,326                           |       |
| Goodwill                                    |       | 12,020                      |       | 12,755                          |       |
| Intangible  assets other than goodwill, net |       | 3,621                       |       | 3,774                           |       |
| Other                                       |       | 1,214                       |       | 1,570                           |       |
| Total  assets                               |       | $                           | 23,975     |                            | $          | 24,297 |   |
|                                        |       |                        |       |                            |       |
| Total  current liabilities                  |       | $                           | 6,619      |                            | $          | 6,249 |   |
|                                        |       |                        |       |                            |       |
| Total  long-term liabilities                |       | $                           | 1,175      |                            | $          | 1,572 |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 4— STOCK-BASED COMPENSATION**

 

TheCompany has the following five stock option plans, which are described morefully in the Company’s Annual Report on Form 10-K for the year ending December31, 2009:

 

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

·                  1993 Stock Option Plan;

·                  1997 Stock Incentive Plan;

·                  Amended and Restated 2000 Stock Option Plan;and

·                  2007 Stock Incentive Plan.

 

TheCompany’s board of directors does not intend to issue any additional optionsunder the Employee Stock and Stock Option Plan, 1993 Stock Option Plan, 1997Stock Incentive Plan or Amended and Restated 2000 Stock Option Plan.

 

Totalstock-based compensation expense included in wages, salaries and related costswas $38,000 and $41,000 for the three months ended June 30, 2010 and 2009,respectively, and $74,000 and $75,000 for the six months ended June 30, 2010and 2009, respectively. These compensation expenses were charged to selling,general and administrative expenses. As of June 30, 2010, the Company had$162,000 of total unrecognized compensation expense related to stock optiongrants, which will be recognized over the remaining weighted average period oftwo years.

 

**NOTE 5 —INVENTORIES**

 

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

 
| ** **         | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------|------------|--------------|------------|------------------|------------|
| ** **         | ** ** | **2010**     | ** ** | **2009**         | ** ** |
|               |       |         |       |             |       |
| Raw  materials     |       | $            | 3,540      |             | $          | 3,791 |   |
| Work-in-process    |       | 1,551        |       | 1,792            |       |
| Finished  goods    |       | 2,112        |       | 2,448            |       |
| Total  inventories |       | $            | 7,203      |             | $          | 8,031 |   |

 

**NOTE 6 —OPERATING SEGMENTS**

 

TheCompany has two reportable operating segments: electronic devices andcommunications equipment. The electronic devices segment manufactures andmarkets electronic power supplies, RF and microwave devices and subsystemassemblies. The electronic devices segment consists of the Company’s twoelectronic device subsidiaries located in England, both of which offer the sameor similar products to the same or similar customers.  The communications equipment segment designs,manufactures and distributes network access products and timing andsynchronization products.  Thecommunications equipment segment consists of operating entities CXR LarusCorporation located in the U.S. and CXR Anderson Jacobson located in France,both of which offer the same or similar products to similar customers.  Both segments operate primarily in the U.S.and European markets, but they have distinctly different customers, design andmanufacturing processes and marketing strategies.  Each segment has discrete financialinformation and a separate management structure.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

TheCompany evaluates performance based upon contribution margin of the segmentsand also upon profit or loss from operations before income taxes exclusive ofnonrecurring gains and losses. The Company accounts for intersegment sales atpre-determined prices negotiated between the individual segments.

 

Duringthe first quarter of 2009, the Company sold its Digitran Operations and duringthe first quarter of 2010, the Company sold its RO Operations (see Note 3),both of which were part of its electronic devices segment.  These transactions resulted in differences inthe basis of segmentation from the amounts disclosed in the Company’s unauditedcondensed consolidated financial statements included in its quarterly report onForm 10-Q for the three and six months ended June 30, 2010 and 2009.  The RO Operations were included asdiscontinued and held for sale operations at December 31, 2009.  Additionally, at June 30, 2010, the Companyhad classified assets of its ACC Operations within its electronic devicessegment as assets held for sale in the accompanying consolidated financialstatements.  In this report, the DigitranOperations, RO Operations and ACC Operations are reported as discontinued andheld for sale operations and are excluded from the electronics devicessegment.  Therefore, prior period amountshave been adjusted to conform to this presentation.

 

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

 
| ** **                                 | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                 | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
| Net  sales                                 |       |                             |       |                           |       |   |   |   |   |
| Electronic  devices                        |       | $                                | 3,958      |                           | $          | 5,568 |   | $ | 8,396 |   | $ | 11,471 |   |
| Communications  equipment                  |       | 2,516                            |       | 2,621                          |       | 5,170 |   | 5,239 |   |
| Net  sales from continuing operations      |       | 6,474                            |       | 8,189                          |       | 13,566 |   | 16,710 |   |
| Discontinued  and held for sale operations |       | 5,488                            |       | 6,081                          |       | 11,140 |   | 11,773 |   |
| Total  net sales                           |       | $                                | 11,962     |                           | $          | 14,270 |   | $ | 24,706 |   | $ | 28,483 |   |
|                                       |       |                             |       |                           |       |   |   |   |   |
| Operating  income (loss)                   |       |                             |       |                           |       |   |   |   |   |
| Electronic  devices                        |       | $                                | 211        |                           | $          | 901 |   | $ | 688 |   | $ | 2,205 |   |
| Communications  equipment                  |       | (213                             | )          | (466                           | )          | (692 | ) | (917 | ) |
| Corporate  and other                       |       | (1,025                           | )          | (1,148                         | )          | (2,128 | ) | (2,410 | ) |
| Operating  loss from continuing operations |       | (1,027                           | )          | (713                           | )          | (2,132 | ) | (1,122 | ) |
| Discontinued  and held for sale operations |       | 1,079                            |       | 1,109                          |       | 2,549 |   | 1,406 |   |
| Total  operating income (loss)             |       | $                                | 52         |                           | $          | 396 |   | $ | 417 |   | $ | 284 |   |

 
| ** **                                 | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |   |   |   |   |
|--------------------------------------------|------------|--------------|------------|------------------|------------|--------|--------|--------|--------|
| ** **                                 | ** ** | **2010**     | ** ** | **2009**         | ** ** |   |   |   |   |
| Total  assets                              | ** ** | ** **   | ** ** | ** **       | ** ** |   |   |   |   |
| Electronic  devices                        |       | $            | 10,582     |             | $          | 12,273 |   |   |   |   |   |
| Communications  equipment                  |       | 7,128        |       | 8,439            |       |   |   |   |   |
| Corporate  and other                       |       | 2,492        |       | 3,772            |       |   |   |   |   |
| Total  assets from continuing operations   |       | 20,202       |       | 24,484           |       |   |   |   |   |
| Discontinued  and held for sale operations |       | 23,975       |       | 25,793           |       |   |   |   |   |
| Total  assets                              |       | $            | 44,177     |             | $          | 50,277 |   |   |   |   |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 7— GOODWILL**

 

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

 
| ** **                                       | ** ** | **Electronic** | ** ** | **Communications** | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|----------------|------------|--------------------|------------|------------|------------|
| ** **                                       | ** ** | **Devices**    | ** ** | **Equipment**      | ** ** | **Total**  | ** ** |
|                                             |       |           |       |               |       |       |       |
| Balance  at December 31, 2009                    |       | $              | 2,878      |               | $          | —     |       | $ | 2,878 |   |
| Allocation  of goodwill to continuing operations |       | 655            |       | —             |       | 655        |       |
| Foreign  currency translation                    |       | (49            | )          | —             |       | (49        | )          |
| Balance  at June 30, 2010                        |       | $              | 3,484      |               | $          | —     |       | $ | 3,484 |   |

 

The increase in goodwillduring the six months ended June 30, 2010 was the result of the Companyfinalizing its 2010 forecast, taking into consideration actual results and newbusiness prospects. Additionally, the Company had obtained offers on ACC, whichallowed it to place an “expected third party” fair value on that business unit.As a result, in accordance with FASB guidance, the Company was required toreallocate the goodwill at March 31, 2010 because the relative fair values ofthe portion of the reporting unit remaining increased from December 31, 2009 toMarch 31, 2010 based upon positive operational results and prospects resultingin an additional $655,000 allocated to that portion of the reporting unitremaining in continuing operations.

 

**NOTE 8 — INCOME TAXES**

 

Theeffective tax rate for the six month period ended June 30, 2010 was differentthan the 34% U.S. statutory rate primarily because the Company’s foreignentities generate a tax obligation and related tax expense as a result of theirnet income, which cannot be offset by U.S. tax loss carryforwards.

 

TheCompany’s business is subject to regulation under a wide variety of U.S.federal, state and foreign tax laws, regulations and policies.  The majority of the Company’s foreignsubsidiaries have earnings and profits that are reinvested indefinitely.  However, under the Credit Agreement describedin Notes 9 and 10, the foreign subsidiaries have issued guarantees on theCredit Agreement and, as a result, under IRC §956, have been deemed to havedistributed 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.  However, the Company hasexhausted a significant portion of its net operating losses available to becarried forward into future periods and, as a result, any income fromoperations and/or gain on sales of assets could result in tax obligations.

 

TheCompany adopted FASB guidance for accounting for uncertainty in income taxes onJanuary 1, 2007. The implementation of this guidance did not result in amaterial adjustment to the Company’s liability for unrecognized income taxbenefits. At the time of adoption and as of December 31, 2009, the Company hadrecorded no net unrecognized tax benefits. The Company currently has no open matters with tax authorities nor is itengaged in an examination by any tax authority. The Company recognizes interest and penalties related to uncertain taxpositions in interest expense and selling, general and administrative expense,respectively, in the condensed consolidated statements of operations andcomprehensive income. No interest or penalties were recognized during the firstsix months of 2010. As of June 30, 2010, the Company had nothing accrued forinterest and penalties.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

TheCompany files income tax returns in the United States federal jurisdiction, theUnited Kingdom and France, and in the state jurisdictions of California, Texas,Pennsylvania and New Jersey. The Company is no longer subject to United Statesfederal and state tax examinations for years before 2006 and 2005,respectively, and is no longer subject to tax examinations for the UnitedKingdom and Japan for years prior to 2008, and for France for years prior to2006.

 

**NOTE 9 — LINE OF CREDIT**

 

TheCompany and certain of its subsidiaries, including EEC and CXR LarusCorporation, CCI, ACC and EMRISE Power Systems, Incorporated (collectively, the“Borrowers”), are parties to a Credit Agreement (as amended from time to time,the “Credit Agreement”) with GVEC Resource IV Inc., an affiliate of PrivateEquity Management Group LLC (“PEM Group”) (the “Lender”) providing for a CreditAgreement which includes term loans and a revolving credit facility and issecured by accounts receivable, other rights to payment and generalintangibles, inventories and equipment. The Credit Agreement includes arevolving credit facility for up to $7,000,000 that expires on August 31, 2010(the “Revolver”).

 

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

 

Intereston the Revolver is payable monthly.  Theinterest rate is variable and is adjusted monthly based on the prime rate aspublished in the “Money Rates” column of *The Wall Street Journal*(the “Base Rate”) plus 1.25%, subject to a minimum rate of 9.5% per annum.  The interest rate in effect as of December31, 2009 was the minimum rate of 9.5%. The Revolver is subject to the Borrowers not incurring capitalexpenditures in excess of $1,800,000 for the fiscal year ending December 31,2010.  Additionally, the Revolver issubject to the Borrowers not incurring unfinanced capital expenditures inexcess of $62,500 in any fiscal quarter and the Borrowers not incurringpurchase money commitments in excess of $2 million over the life of thefacility.  However, if the Borrowersincur unfinanced capital expenditures of less than $62,500 in any fiscalquarter, the difference between the amount incurred in a certain fiscal quarterand $62,500 may be incurred in the two fiscal quarters immediately followingsuch fiscal quarter. The Company was in compliance with these covenants at June30, 2010.

 

Asof June 30, 2010, the Company had outstanding borrowings of $3.6 million underthe Revolver with remaining availability under the formula-based calculation of$2.0 million.

 

In connectionwith entering into the Credit Agreement, the Borrowers issued a Revolver LoanNote dated November 30, 2007 (the “Revolver Note”) to the Lender in theprincipal amount of $7,000,000.  TheRevolver Note is governed by the terms of the Credit Agreement.

 

See related Note2 “Going Concern” and Note 10 “Debt” regarding additional terms and conditionsassociated with the overall Credit Agreement and risks associated with theCredit Agreement.

 

**NOTE 10—DEBT**

 

TheCredit Agreement, as described in Note 9, consists of (i) the Revolver(see Note 9 — “Line of Credit”), (ii) a term loan in the originalprincipal amount of $6 million, of which $5.2 million was outstanding as ofJune 30, 2010 and is due August 31, 2010 (“Term Loan A”), (iii) a termloan in the original principal amount of $10 million, of which $2.3 million wasoutstanding as of June 30, 2010 and is due on August 31, 2010 (“Term Loan B”),and (iv) Term Loan C, which originally provided for a principal amount of $3million and has since been retired.  TermLoan A was fully funded on November 30, 2007 while Term Loans B and C werefully funded on August 20, 2008 in connection with the acquisition of ACC.$6.8 million of Term Loan B and all of Term Loan C was repaid in March 2009, inconnection with the sale of the Company’s Digitran Operations.  Term Loan A and Term Loan B require anaggregate scheduled principal payment of $75,000 bi-weekly beginning onFebruary 1, 2010 through the maturity date. The facility also requires monthly interest payments and a final balloonpayment of $7.1 million upon maturity.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

TheTerm Loans A and B bear interest at the Base Rate plus 4.25%, subject to aminimum rate of 12.5% per annum, and required interest only payments in thefirst year, scheduled principal plus interest payments in years two and three,and a final balloon payment at August 31, 2010.  Interest on the Term Loans is payablemonthly.

 

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 CreditAgreement and is amortized over the term of the Credit Agreement.  See Note 11.

 

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, in order to repay its obligations,the Borrowers agreed to sell a significant portion of its assets in 2010.  As discussed further in Note 3, these assetscontributed approximately $20 million of net sales or 37% of the Company’s netsales and operating income of approximately $3 million of the Company’s totaloperating income from continuing operations of $1.4 million for 2009.  The Company will retain a percentage of theproceeds of some of such sales for working capital and, pursuant to suchagreement, will use the remaining proceeds to pay down a significant portion ofthe obligations owed to the Lender.

 

Ifthe Lender terminates the Credit Agreement during a default period, then theCompany is subject to a penalty equal to 2% of the outstanding principalbalance of the Revolver and the Term Loans.  The Revolver is subject to anunused line fee of 0.5% per annum, payable monthly, on any unused portion ofthe revolving credit facility.

 

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

 

Pursuantto a January 2010 amendment to the Credit Agreement, the Borrowers haveagreed with the Lender that it has the right to appoint an outside observer toreview the Borrower’s books and records and business operations, with certainlimitations designed to minimize disruption to the business operations of theBorrowers.  The Borrowers are alsoobligated to provide financial information and status reports to the Lender ona regular basis.  In addition, pursuantto that amendment, certain fees (including a $200,000 advisory fee arising inconnection with that amendment, which is recorded in accrued expenses in theaccompanying consolidated balance sheet) and certain expenses owed by theBorrowers have been deferred until the Maturity Date of August 31,2010.  Under the terms of the CreditAgreement, as amended, the Borrowers agreed to sell a significant portion ofits assets by August 31, 2010 and committed to certain milestone eventsassociated with the sales process. Failure to achieve these milestones and/or failure to sell the requiredassets by the agreed upon dates, all of which are as of August 31, 2010 orprior, can result in a default under the Credit Agreement.  Additionally, pursuant to the CreditAgreement, as amended, a termination of the ACC Purchase Agreement, whichbecame terminable by either party at any time on August 1, 2010, is anevent of default.

 

See Note 2 andNote 9 regarding additional terms and conditions associated with the Company’sCredit Agreement and risks associated with this Credit Agreement.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 11 — WARRANTS**

 

Inconnection with entering into the Credit Agreement (discussed in Note 10), theCompany issued a seven year warrant to PEM Group, an affiliate of the Lender,to purchase up to 775,758 shares of the Company’s common stock on a cash orcashless basis at an original exercise price of $4.13 per share, (which amountreflects the Company’s 1-for-3.75 reverse split of its common stock effectiveNovember 18, 2008).  The estimatedfair value of the warrants was $1.5 million, which was calculated using theBlack-Scholes pricing model.  Thewarrants were originally accounted for as debt discount and the adjustmentresulting from the repricing of the warrants increased the debt discount, whichis being amortized over the remaining life of the Credit Agreement.  The warrants were previously recorded instockholder’s equity.

 

InFebruary 2009, the warrants were amended and reissued in conjunction withan amendment to the Credit Agreement. Pursuant to the Second Amendment to Loan Documents, the original warrantwas divided into two warrants (each, a “Second Amended and Restated Warrant”and collectively, the “Second Amended and Restated Warrants”).  EachSecond Amended and Restated Warrant covers 387,879 shares of the Company’scommon stock (which amount reflects the Company’s 1-for-3.75 reverse split ofits common stock effective November 18, 2008).  One of the SecondAmended and Restated Warrants provides for an exercise price of $1.99 per share(which amount reflects the Company’s 1-for-3.75 reverse split of its commonstock effective November 18, 2008).  The other Second Amended andRestated Warrant provides for an exercise price of $1.80 per share (whichamount reflects the Company’s 1-for-3.75 reverse split of its common stockeffective November 18, 2008 and a reduction from a post-split exerciseprice of $3.06 per share).

 

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. As part of the ACCTransaction, the Company has offered to issue and Charles Brand has agreedto accept $450,000 worth of the Company’s common stock as partial payment onhis contingent note, with the per share valuation based on 115% of the volumeweighted average price of the shares over a three-day period.  Upon the successful completion of the ACCTransaction and as a result of the above additional issuance of shares, theCompany will be required to adjust the exercise price and/or issue additionalshares of common stock to the PEM Group pursuant to the warrant terms.  The Company is currently evaluating theimpact of the transaction on the PEM Group warrants.

 

OnJanuary 1, 2009, the Company adopted FASB updates which affected howinstruments indexed to an entity’s own stock are accounted for.  The adoption of the revised FASB guidanceresulted in the reclassification of the PEM Group warrants from stockholders’equity to liabilities, and now requires that the warrants to be fair valuedpursuant to “mark to market” provisions at each reporting period, with thechanges in fair value recognized in the Company’s consolidated statement ofoperations.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

AtJune 30, 2010 and December 31, 2009, the Company had warrants subjectto “mark to market” provisions outstanding to purchase 775,758 shares of commonstock.  The Company computed the fairvalue of the warrants using a Black-Scholes valuation model.  The fair value of these warrants on the dateof adoption of June 30, 2010 and on December 31, 2009 was determinedusing the following assumptions:

 
| ** **              | ** ** | **June 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|-------------------------|------------|------------------------|------------|----------------------------|------------|
| Dividend yield          |       | None                   |       | None                       |       |
| Expected volatility     |       | 90                     | %          | 71                         | %          |
| Risk-free interest rate |       | 0.61                   | %          | 1.14                       | %          |
| Expected term           |       | 7 years                |       | 7 years                    |       |
| Stock price             |       | $                      | 0.48       |                       | $          | 0.76 |   |
|                         |            |                        |            |                            |            |  |  |

 

Duringthe three months ended June 30, 2010, the change in fair value of thewarrants resulted in a $283,000 increase to other income (expense) in thecondensed consolidated statement of operations and a corresponding decrease tothe warrant liability.  During the sixmonths ended June 30, 2010, the change in fair value of the warrantsresulted in a $75,000 increase to other income (expense) in the condensedconsolidated statement of operations and a corresponding decrease to thewarrant liability.

 

**NOTE 12 — FAIR VALUE MEASUREMENTS**

 

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

 

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

 

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

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Asof January 1, 2009, the Company was required to apply updated FASBguidance to the derivative that is within the warrant that was issued asconsideration for the Company’s Credit Agreement, which is discussed in Note 10and included as a discount on the Company’s long-term debt.  The derivative was valued using theBlack-Scholes model.  The key inputs inthe model at June 30, 2010 are as follows:

 
| ** **              | ** ** | **June 30, 2010** | ** ** |
|-------------------------|------------|------------------------|------------|
| Dividend yield          |       | None                   |       |
| Expected volatility     |       | 90                     | %          |
| Risk-free interest rate |       | 0.61                   | %          |
| Expected term           |       | 7 years                |       |
| Stock price             |       | $                      | 0.48       |   |
|                         |            |                        |            |  |

 

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

 
| ** **                                  | ** ** | **Warrant Liability** | ** ** |
|---------------------------------------------|------------|-----------------------|------------|
|                                        |       |                  |       |
| Beginning balance at December 31, 2009 |       | $                     | 292        |   |
| Total income realized in earnings           |       | (75                   | )          |
| Ending balance at June 30, 2010        |       | $                     | 217        |   |

 

**NOTE 13 — SUBSEQUENT EVENTS**

 

*Amendment to Credit Agreement*

 

On July 16, 2010, theBorrowers and the Lender entered into Amendment Number 14 to Loan Documents (‘‘Amendment14’’), which amended the Credit Agreement to extend the Maturity Date from July 16,2010 to July 31, 2010 and modified the schedule for certain milestoneevents related to the process for the sale of certain assets of the Borrowers.

 

As of July 31, 2010,the Borrowers and the Lender entered into Amendment Number 15 to Loan Documents(‘‘Amendment 15’’), which amended the Credit Agreement to extend the MaturityDate from July 31, 2010 to August 31, 2010 and modified the schedulefor certain milestone events related to the process for the sale of certainassets of the Borrowers. Amendment 15 further provides that a termination ofthe ACC Purchase Agreement, which became terminable by either party at any timeon August 1, 2010, is an event of default. Except for these amendments,the Credit Agreement remains in full force and effect.

 

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

 

**Cautionary Statement**

 

Thefollowing discussion should be read in conjunction with our unaudited condensedconsolidated financial statements and the related notes thereto contained in Part I, Item1 of this Quarterly Report on Form 10-Q. The information contained in thisreport is not a complete description of our business or the risks associatedwith an investment in our common stock. We urge you to carefully review andconsider the various disclosures made by us in this Quarterly Report on Form 10-Qand in our other reports filed with the U.S. Securities and Exchange Commission(the “SEC”), including our Annual Report on Form 10-K for the year ended December 31,2009 and subsequent reports on Forms 10-Q and 8-K, which discuss our businessin greater detail.  This report and thefollowing discussion contain forward-looking statements, which generallyinclude the plans, objectives and expectations of management for futureoperations, including plans, objectives and expectations relating to our futureeconomic performance and our current beliefs regarding revenues we mightgenerate and profits we might earn if we are successful in implementing ourbusiness and growth strategies. The forward-looking statements and associatedrisks may include, relate to or be qualified by other important factors,including, without limitation:

 

·                  our ability to continue to borrow funds under the revolver terms of ourCredit Agreement;

·                  our ability to sell assets and achieve the milestones for suchtransactions, as required by our Lender under the terms of the CreditAgreement;

·                  our ability to obtain the required stockholder approval for the pendingtransaction to sell Advanced Control Components, Inc. (“ACC”) at our August 30,2010 annual stockholder meeting or subsequent meetings in the case ofadjournment, etc.;

·                  our ability to negotiate further extensions with our lender to ourexisting credit facility beyond August 31, 2010 if required;

·                  Any action taken by the pending buyer of ACC to terminate the existingACC purchase agreement before stockholder approval is obtained to complete thetransaction;

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

·                  the ongoing revenues and profitability of the Company will besubstantially reduced as a result of our sale of ACC in order to satisfy ourdebt obligations.  This will have amaterial adverse effect on the Company’s operations, financial condition andability to continue operations;

·                  our ability to find and secure alternate financing to our current CreditAgreement on or before August 31, 2010, including a replacement revolverfacility in the event the obligations under the current facility are paid infull;

·                  our inability to compete directly against ACC, RO Associates or theDigitran Operations as a result of previous or currently contemplated sales ofsuch whereby we are prohibited under the relevant sales agreements;

·                  our ability to successfully merge with or acquire other companies in thecommunications business segment;

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

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

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

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

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

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

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

·                  our ability to secure long term purchase orders;

·                  our ability to deliver against existing or future backlog;

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

 

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·                  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, the global recession, political, economic and/or other constraintswhich are or may negatively impact the industries in which we participateand/or the ability for us to market the products which we sell; and

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

 

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

 

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

 

**RecentDevelopments**

 

On June 7, 2010, theCompany entered into a Stock Purchase Agreement by and among AeroflexIncorporated (‘‘Aeroflex’’), as buyer, and EMRISE Electronics Corporation (“EEC”),as seller, relating to the sale of all of the issued and outstanding shares ofcommon stock of ACC and Custom Components, Inc. (“CCI”) (the ‘‘ACCPurchase Agreement’’). Pursuant to the ACC Purchase Agreement, EEC will sell toAeroflex (a) all of the outstanding shares of common stock of CCI, whichcurrently owns 80% of the issued and outstanding shares of common stock of ACC,and (b) the remaining 20% of the issued and outstanding shares of ACC(collectively, the ‘‘Shares’’), which are currently owned by EEC (the ‘‘ACCTransaction’’). In exchange for the Shares, Aeroflex has agreed to pay EEC anaggregate purchase price of $20,000,000 in cash (the ‘‘Purchase Price’’). Anamount equal to $1,000,000 will be placed in an escrow account to satisfy anyindemnification claims. Approximately $14.6 million of proceeds from thetransaction will be used to pay down all of the Company’s revolver with itsprincipal lender, a significant portion of its term debt with the same lenderand a majority of the Company’s obligations to the previous owners of ACC. TheCompany anticipates retaining approximately $3.8 million in long term debtpayable to both its current lender and the previous owners of ACC, all of whichhas a maturity of at least two years or longer. The Purchase Price may also beadjusted based on the level of adjusted net working capital of ACC at theclosing of the ACC Transaction.

 

In addition, on June 7,2010 the Company entered into a Master Agreement, by and among the Company,EEC, CXR Larus Corporation, Pascall Electronics Limited, XCEL Power Systems, Ltd.,CXR Anderson Jacobson SAS, Charles S. Brand, Thomas P.M. Couse, JoanneCouse, and Michael Gaffney, (the “Master Agreement”), pursuant to which EECwill also use a portion of the proceeds from the sale of ACC to payapproximately half of the approximately $6.6 million secured debt owed tocertain of ACC’s previous shareholders, Charles S. Brand, Thomas P.M.Couse, Joanne Couse and Michael Gaffney (collectively, the “Former Shareholders”),which amounts are owed in connection with deferred purchase price obligations,contingent notes and other related payments.  Mr. Brand will alsoaccept $450,000 worth of the Company’s common stock as partial payment on hiscontingent note, with the per share valuation based on 115% of the volumeweighted average price of the shares over a three-day period.  Theaggregate remaining balance owed to the previous owners of ACC will beapproximately $2.8 million (included in the $3.8 million discussedabove).  The maturity date of the remaining debt has been moved to threeyears from closing, with quarterly interest payments at prime plus 1% duringthe first two years and quarterly principal payments of $237,000 each beginningon July 2, 2012 with a balloon payment of principal on the maturity dateof approximately $1.9 million.

 

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The closing of the ACCTransaction is subject to stockholder approval, compliance with the New JerseyIndustrial Site Recovery Act, N.J.S.A. 13:1K-6 et seq., including, withoutlimitation, the General Information Notice, with respect to its New JerseyProperties, obtaining the consent of ACC’s senior lender and certain of theFormer Shareholders, (both of which have been received) and other customaryclosing conditions. The closing of the ACC Transaction will satisfy the finalmilestone under the Credit Agreement. The ACC Purchase Agreement also containscustomary representations, warranties, covenants, agreements and indemnitiesfor both the Company and Aeroflex.

 

The Company’s stockholderswill be asked to consider and vote upon the approval and adoption of the ACCPurchase Agreement at the 2010 annual meeting of stockholders to be held on August 30,2010. Assuming the stockholders approve the ACC Transaction, the ACCTransaction is expected to close shortly after such meeting.

 

TheCompany has classified these assets as discontinued and held for saleoperations in the accompanying Management’s Discussion and Analysis ofFinancial Condition and Results of Operations for all periods presented.

 

**BusinessDescription**

 

Wedesign, manufacture and market proprietary electronic devices andcommunications equipment for aerospace, defense, industrial, and communicationsapplications. We have operations in the U.S., England, and France.  We organize our business in two operatingsegments: electronic devices and communications equipment. In the secondquarter of 2010, our electronic devices segment contributed approximately 61%of overall net sales while the communications segment contributed approximately39% of overall net sales. Our subsidiaries within our electronic devices segmentdesign, develop, manufacture and marketpower supplies, radio frequency, or RF, and microwave devices for defense,aerospace and industrial markets.  Oursubsidiaries within our communications equipment segment design, develop,manufacture and market network access equipment, including network timing andsynchronization products, for communications applications in defense, publicand private networks and industrial markets.

 

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

 

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

 

**Critical Accounting Policies**

 

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

 

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

 

Wederive revenues from sales of electronic devices and communications equipmentproducts and services.  Our sales arebased upon written agreements or purchase orders that identify the type andquantity of the item and/or services being purchased and the purchase price.  We recognize revenues when shipment ofproducts has occurred or services have been rendered, no significantobligations remain on our part, and collectability is reasonably assured basedon our credit and collections practices and policies.

 

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

 

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

 

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

 

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

 

***Product Warranty Liabilities***

 

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

 

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

 

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

 

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

 

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

 

***Foreign Currency Translation***

 

Wehave foreign subsidiaries that together accounted for approximately 81% and 86%of our net revenues from continuing operations for the six months ended June30, 2010 and 2009, respectively and, 74% and 69% of our assets and 29% and 29%of our total liabilities as of June 30, 2010 and December 31, 2009,respectively.  In preparing ourconsolidated financial statements, we are required to translate the financialstatements of our foreign subsidiaries from the functional currencies in whichthey keep their accounting records into U.S. dollars. This process results inexchange gains and losses which, under relevant accounting guidance, areincluded either within our statement of operations under the caption “otherincome (expense)” or as a separate part of our net equity under the caption “accumulatedother comprehensive income (loss).”

 

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

 

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

 

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

 

Basedon our assessment of the factors discussed above, we consider the functionalcurrency of each of our international subsidiaries to be each subsidiary’slocal currency. Accordingly, we had cumulative translation losses of $2.7million and $1.6 million that were included as part of accumulated othercomprehensive loss within our balance sheets at June 30, 2010 andDecember 31, 2009, respectively. During the three months ended June 30,2010 and 2009, we included translation losses of $32,000 and gains of $1.8million, respectively, under accumulated other comprehensive loss.  During the six months ended June 30,2010 and 2009, we included translation losses of $1.0 million and gains of $1.4million, respectively, under accumulated other comprehensive loss.

 

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The magnitude of these gains or losses depends uponmovements in the exchange rates of the foreign currencies in which we transactbusiness as compared to the value of the U.S. dollar. During the second quarterof 2010 and 2009, these currencies primarily included the euro and the Britishpound sterling in the period ended June 30, 2009. Any future translationgains or losses could be significantly higher or lower than those we recordedfor these periods.

 

A2.5 million British pound sterling loan payable from one of our subsidiaries in England to EMRISE was outstanding as ofJune 30, 2010 ($3.8 million based on the exchange rate at June 30,2010).  Exchange rate losses and gains onthe long-term portion of this loan are recorded in cumulative translation gainsor losses in the equity section of the balance sheet.

 

***Intangibles, Including Goodwill***

 

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

 

Inassessing potential impairment of goodwill, we consider these factors as wellas forecasted financial performance of the acquired businesses.  If forecasts are not met, we may have torecord additional impairment charges not previously recognized. In assessingthe recoverability of our goodwill and other intangibles, we must makeassumptions regarding estimated future cash flows and other factors todetermine the fair value of those respective assets. If these estimates ortheir related assumptions change in the future, we may be required to recordimpairment charges for these assets that were not previously recorded.  If that were the case, we would have torecord an expense in order to reduce the carrying value of our goodwill.  Under FASB guidance related to goodwill andother intangible assets, we are required to analyze our goodwill for impairmentissues at least annually or more frequently if an event occurs or circumstanceschange that would more likely than not reduce the fair value of a reportingunit below its carrying amount.  At June 30,2010, our reported goodwill totaled $15.5 million of which $12.0 million hadbeen allocated to assets held for sale. We evaluated the fair value of the electronic devices reporting unit at June 30,2010 and determined that no impairment of goodwill existed at that date.  In assessing the potential impairment ofgoodwill, we consider forecasted financial performance of the acquired businessesto determine the fair value of the respective assets.

 

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**Results of Operations**

 

**Overview**

 

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

 

Overallsales from continuing operations decreased 20.9% in the second quarter of 2010as compared to the second quarter of 2009. Our overall net sales of $6.5 million for the second quarter of 2010reflected declines in net sales at all of our subsidiaries.  These declines were part volume decreases andequally affected by the negative impact of exchange rates between the U.S.dollar and the British pound sterling and the euro.

 

Overallgross profit as a percentage of sales from continuing operations decreased to30.0% in the second quarter of 2010 from 32.5% in the second quarter of 2009,which is an improvement over first quarter 2010.  The decrease in gross profit, as a percentageof sales, from continuing operations was primarily due to the decline in grossmargins within our electronic devices segment and our French communicationsequipment subsidiary associated with lower sales volumes, which was partiallyoffset by improvements in gross profit, as a percentage of sales, within ourU.S. communications equipment subsidiary.

 

Thefollowing is a detailed discussion of our results of operations by businesssegment.  As a result of the sale of theDigitran Operations in March of 2009 and the sale of the RO Operations in March of2010, for purposes of the following discussion and analysis, the DigitranOperations and the RO Operations have been removed from the prior periodcomparisons and the quarterly results of the RO Operations are reported as adiscontinued operation for all periods presented.  Additionally, as a result of the pending saleof ACC, for the purposes of the following discussion and analysis, the ACCOperations have been reported as a discontinued and held for sale operation forall periods presented.

 

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***Comparison of the Three Months Ended June 30, 2010 to the ThreeMonths Ended June 30, 2009***

 

**NetSales**

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** | **Variance**                | ** ** |
|------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                     | ** ** | **June 30,**      | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in  thousands)**                            | ** ** | **2010**               | ** ** | **2009**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                           |       |                   |       |                        |       |   |   |   |   |
| Electronic  devices                            |       | $                      | 3,958      |                        | $          | 5,568 |   | $ | (1,610 | ) | (28.9 | )% |
| *as % of net sales from continuing operations* | * *   | *61.1*                 | *%*        | *68.0*                      | *%*        | * * | * * | * * | * * |
| Communications  equipment                      |       | 2,516                  |       | 2,621                       |       | (105 | ) | (4.0 | )% |
| *as % of net sales from continuing operations* | * *   | *38.9*                 | *%*        | *32.0*                      | *%*        | * * | * * | * * | * * |
| Total  net sales from continuing operations    |       | 6,474                  |       | 8,189                       |       | (1,715 | ) | (20.9 | )% |
| Discontinued  operations                       |       | 5,488                  |       | 6,081                       |       |   |   |   |   |
| Total  net sales                               |       | $                      | 11,962     |                        | $          | 14,270 |   |   |   |   |   |
|                                                |            |                        |            |                             |            |  |  |  |  |  |  |  |

 

*ElectronicDevices Segment*

 

Thedecrease in sales of our electronic devices in the second quarter of 2010 ascompared to the second quarter of 2009 was primarily as a result of the globaleconomic conditions, which delayed In-flight Entertainment (“IFE”) orders, anda gap in the production schedule for the European fighter aircraft (Typhoon)and other military power supply projects. Additionally, and equally as contributory, a significant portion of ourbusiness at U.K. subsidiaries is transacted in U.S. dollars and was negativelyimpacted by exchange rate fluctuations, as the subsidiary’s local currency isthe British pound sterling.  Thetranslation impact of exchange rates remains an uncertainty and couldnegatively or positively impact our overall results in future periods.

 

Weexpect quarterly sales volumes throughout 2010 to remain relatively consistentwith second quarter 2010 levels although we do expect to see an increase in IFEduring the second half of 2010 as a result of orders received.

 

*CommunicationsEquipment Segment*

 

Secondquarter 2010 net sales within our communications equipment segment decreasedslightly from the 2009 second quarter. Net sales at our French subsidiary continue to be impacted by thedownturn in the economy year over year. In 2008, the French government implemented a spending freeze as a resultof the global economic crisis.  In part,due to these spending reductions by the French government, we experiencedsignificant reductions in our net sales in 2009 over 2008.  While we are still experiencing declines innet sales in 2010, they are far less, from a trending perspective, than weexperienced in 2009.  Net sales of testequipment at our U.S. communications equipment subsidiary have been strong inrecent quarters primarily as a result of our Federal Aviation Administration (“FAA”)and U.S. military contracts; however, sales for the second quarter of 2010 wereslightly lower than the same quarter in 2009 due to timing of receipt oforders.

 

Netsales in our French communications equipment subsidiary have been, and arelikely to continue to be, negatively impacted by the recent economicconditions, as the French government continues to defer discretionary spendingdue to current economic conditions.  Weare making efforts to increase our commercial business for our Frenchoperations.  We expect sales at our U.S.communications equipment subsidiary to remain stable throughout 2010 as aresult of the ongoing contracts with the FAA and U.S. military.

 

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**GrossProfit**

 

*ElectronicDevices Segment*

 
| ** **                                      | ** ** | **Three Months Ended** | ** ** | **Variance**                | ** ** |
|-------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                      | ** ** | **June 30,**      | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in  thousands)**                             | ** ** | **2010**               | ** ** | **2009**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                            |       |                   |       |                        |       |   |   |   |   |
| Electronic  devices                             |       | $                      | 978        |                        | $          | 1,796 |   | $ | (818 | ) | (45.5 | )% |
| *as % of net sales from continuing operations*  | * *   | *24.7*                 | *%*        | *32.3*                      | *%*        | * * | * * | * * | * * |
| Communications  equipment                       |       | 963                    |       | 866                         |       | 97 |   | 11.2 | % |
| *as % of net sales from continuing operations*  | * *   | *38.3*                 | *%*        | *33.0*                      | *%*        | * * | * * | * * | * * |
| Total  gross profit from continuing operations  |       | 1,941                  |       | 2,662                       |       | (721 | ) | (27.1 | )% |
| *Total gross margin from continuing operations* | * *   | *30.0*                 | *%*        | *32.5*                      | *%*        | * * | * * | * * | * * |
| Discontinued  operations                        |       | 2,910                  |       | 2,797                       |       |   |   |   |   |
| Total  gross profit                             |       | $                      | 4,851      |                        | $          | 5,459 |   |   |   |   |   |
|                                                 |            |                        |            |                             |            |  |  |  |  |  |  |  |

 

Thedecrease in gross profit, as a percentage of net sales, for our electronicdevices segment from 32.3% in the second quarter of 2009 to 24.7% in the secondquarter of 2010 is primarily due to the decrease in volume of sales, asdiscussed above, and also due to changes in product mix and the negative impactof exchange rate fluctuations between the U.S. dollar and the British poundsterling.

 

Weexpect that gross profit, as a percentage of sales, will be at or slightlyabove those levels achieved in the second quarter of 2010, with the possibilityof some improvement throughout the remainder of the year.

 

*CommunicationsEquipment Segment*

 

Theincrease in gross profit, as a percentage of sales, for our communicationsequipment segment from 33.0% in the second quarter of 2009 to 38.3% in thesecond quarter of 2010 is primarily the result of increases in gross margins atour U.S. communications equipment subsidiary primarily due to an increase insales volume of higher margin network access timing products during thequarter.

 

Weexpect that gross profit, as a percentage of sales, will remain consistent withsecond quarter 2010 levels for the remainder of 2010.

 

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**OperatingExpenses**

 
| ** **                                           | ** ** | **Three Months Ended** | ** ** | **Variance**                | ** ** |
|------------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                                           | ** ** | **June 30,**      | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in  thousands)**                                  | ** ** | **2010**               | ** ** | **2009**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| ** **                                           | ** ** | ** **             | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Selling,  general and administrative                 |       | $                      | 2,566      |                        | $          | 2,905 |   | $ | 339 |   | 11.7 | % |
| *as % of net sales from continuing operations*       | * *   | *39.6*                 | *%*        | *35.5*                      | *%*        | * * | * * | * * | * * |
| Engineering  and product development                 |       | 402                    |       | 470                         |       | 68 |   | 14.5 | % |
| *as % of net sales from continuing operations*       | * *   | *6.2*                  | *%*        | *5.7*                       | *%*        | * * | * * | * * | * * |
| Total  operating expenses from continuing operations |       | 2,968                  |       | 3,375                       |       | 407 |   | 12.1 | % |
| Discontinued  operations                             |       | 1,831                  |       | 1,688                       |       |   |   |   |   |
| Total  operating expenses                            |       | $                      | 4,799      |                        | $          | 5,063 |   |   |   |   |   |
|                                                      |            |                        |            |                             |            |  |  |  |  |  |  |  |

 

*Selling,general and administrative expenses*

 

Generaland administrative expenses decreased in the second quarter of 2010 as comparedto 2009. The decrease primarily related to cost savings realized in the currentyear as a result of headcount reductions in the prior year. During the secondquarter of 2009, we incurred additional employee termination costs that werenot present in the second quarter of 2010. Partially offsetting these decreases,we experienced some minor increases in facility expense during the quarter dueto slightly higher facility costs at our U.S. communications equipmentsubsidiary, CXR Larus Incorporated (“CXR”). CXR and RO shared a facility prior to the sale of the RO Operations in March 2010,but subsequent to the sale, CXR is burdened with the entire facility costs. Thefacility lease at CXR ends in June of 2011, at which time we anticipatemoving to a less expensive facility or negotiating a reduced rate at thecurrent facility.

 

During2010, we expect selling, general and administrative expense to be lower thanthe 2009 comparative periods as we see the affects of the cost reductionactions taken in 2009, which included headcount reductions, office closures inFrance and California, and an overall decrease in the corporate budget.  In addition, we expect to further reducecorporate general and administrative costs after the sale of ACC throughfurther corporate headcount reductions.

 

*Engineeringand product development*

 

Theslight decrease in engineering and product development costs is primarily dueto lower investment in engineering and product development at our U.S.communications equipment subsidiary as a result of cash constraints during thequarter.

 

Duringthe remainder of 2010, engineering and product development expenses areexpected to remain at or slightly below 2009 levels.

 

**Interestexpense**

 

Interestexpense was $0.7 million for the three months ended June 30, 2010 comparedto $0.8 million for the three months ended June 30, 2009 due to loweroutstanding loan balances.  Included ininterest expense in the second quarter of 2010 were $0.3 million of non-cashamortization of deferred financing costs and non-cash amortization of debt discountcompared to $0.2 million in the second quarter of 2009.  We expect quarterly interest expense for theremainder of 2010 to decrease significantly from the comparable prior yearperiods as a result of the lower outstanding loan balances and as we makescheduled principal payments and use the proceeds from the sales of assets topay down outstanding loan balances.

 

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**Other incomeand expense**

 

Werecorded other income of $0.1 million in the second quarter of 2010 compared to$0.2 million in the second quarter of 2009. Other income and expense consists primarily of (i) fair valueadjustments on warrants and (ii) short-term exchange rate gains and lossesassociated with the volatility of the U.S. dollar to the British pound sterlingand euro on the current portion of certain assets and liabilities and.  The change in the fair value of warrantsresulted in income of $0.3 million in the second quarter of 2010 and 2009.  The remaining loss of $0.2 million for thesecond quarter of 2010 was predominantly related to short-term exchange ratelosses.

 

**Incometax provision (benefit)**

 

Incometax benefit amounted to $0.3 million for the second quarter of 2010 compared toexpense of $0.1 million for the second quarter of 2009.  We recorded income tax expense in the 2009period primarily as a result of foreign income tax on foreign earned profits inEurope.  The income tax benefit in thesecond quarter of 2010 was related to the losses from continuing operationsthat we incurred during the quarter.

 

TheCompany has exhausted a significant portion of its net operating lossesavailable to be carried forward into future periods and, as a result, anyincome from operations and/or gain on sales of assets could result in taxobligations in 2010.

 

**Incomefrom discontinued and held for sale operations**

 

Asa result of the classification of the ACC Operation as held for sale, wereported income from discontinued and held for sale operations of $0.5 million(net of tax of $0.5 million) during the second quarter of 2010 compared to $0.5million of income during the second quarter of 2009.  Income from discontinued and held for saleoperations in the second quarter of 2009 included losses of $0.3 million fromthe RO Operations and an adjustment to the Digitran Operations as a $0.1million reduction to the gain on the sale.

 

**Net(loss) income**

 

Wereported a net loss of $0.8 million in the second quarter of 2010 compared to$0.5 million in the second quarter of 2009. Included in net loss in the second quarter of 2010 was an overalldecline in net sales and gross profit from continuing operations and costsassociated with the sale activities of $0.4 million.  We plan to make additional headcountreductions after the sale of ACC, as discussed above, and will experience loweranticipated interest expense in future quarters. However, despite theseefforts, we will likely continue to incur net losses from continuing operationsin future quarters.

 

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***Comparison of the Six Months Ended June 30, 2010 to the Six MonthsEnded June 30, 2009***

 

**Net Sales**

 
| ** **                                     | ** ** | **Six Months Ended** | ** ** | **Variance**                | ** ** |
|------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|
| ** **                                     | ** ** | **June 30,**    | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in  thousands)**                            | ** ** | **2010**             | ** ** | **2009**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                           |       |                 |       |                        |       |   |   |   |   |
| Electronic  devices                            |       | $                    | 8,396      |                        | $          | 11,471 |   | $ | (3,075 | ) | (26.8 | )% |
| *as % of net sales from continuing operations* | * *   | *61.9*               | *%*        | *68.6*                      | *%*        | * * | * * | * * | * * |
| Communications  equipment                      |       | 5,170                |       | 5,239                       |       | (69 | ) | (1.3 | )% |
| *as % of net sales from continuing operations* | * *   | *38.1*               | *%*        | *31.4*                      | *%*        | * * | * * | * * | * * |
| Total  net sales from continuing operations    |       | 13,566               |       | 16,710                      |       | (3,144 | ) | (18.8 | )% |
| Discontinued  operations                       |       | 11,140               |       | 11,773                      |       |   |   |   |   |
| Total  net sales                               |       | $                    | 24,706     |                        | $          | 28,483 |   |   |   |   |   |
|                                                |            |                      |            |                             |            |  |  |  |  |  |  |  |

 

*ElectronicDevices Segment*

 

Thedecrease in sales of our electronic devices in the first half of 2010 ascompared to the first half of 2009 was primarily due to lower volume as aresult of the global economic conditions, which delayed In-flight Entertainment(“IFE”) orders, a gap in the production schedule for the European fighteraircraft (Typhoon) and other military power supply projects, and one largecontract at one of our U.K. subsidiaries concluding in the second quarter of2009.  Additionally, a significantportion of our business at U.K. subsidiaries is transacted in U.S. dollars andwas negatively impacted by exchange rate fluctuations, as the subsidiary’slocal currency is the British pound sterling.  The translation impact of exchange ratesremains an uncertainty and could negatively or positively impact our overallresults in future periods.

 

*CommunicationsEquipment Segment*

 

Firsthalf 2010 net sales within our communications equipment segment remainedconsistent with the 2009 second quarter. We experienced an increase in sales of test equipment to the FAA and theU.S. military at our U.S. communications equipment subsidiary offset by adecrease in orders and shipments for network access products at our Frenchsubsidiary due largely to economic impacts and spending reductions by theFrench Defense Ministry.

 

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**GrossProfit**

 
| ** **                                      | ** ** | **Six Months Ended** | ** ** | **Variance**                | ** ** |
|-------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|
| ** **                                      | ** ** | **June 30,**    | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in  thousands)**                             | ** ** | **2010**             | ** ** | **2009**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                            |       |                 |       |                        |       |   |   |   |   |
| Electronic  devices                             |       | $                    | 2,081      |                        | $          | 3,893 |   | $ | (1,812 | ) | (46.5 | )% |
| *as % of net sales from continuing operations*  | * *   | *24.8*               | *%*        | *33.9*                      | *%*        | * * | * * | * * | * * |
| Communications  equipment                       |       | 1,811                |       | 1,746                       |       | 65 |   | 3.7 | % |
| *as % of net sales from continuing operations*  | * *   | *35.0*               | *%*        | *33.3*                      | *%*        | * * | * * | * * | * * |
| Total  gross profit from continuing operations  |       | 3,892                |       | 5,639                       |       | (1,747 | ) | (31.0 | )% |
| *Total gross margin from continuing operations* | * *   | *28.7*               | *%*        | *33.7*                      | *%*        | * * | * * | * * | * * |
| Discontinued  operations                        |       | 5,723                |       | 4,777                       |       |   |   |   |   |
| Total  gross profit                             |       | $                    | 9,615      |                        | $          | 10,416 |   |   |   |   |   |
|                                                 |            |                      |            |                             |            |  |  |  |  |  |  |  |

 

*ElectronicDevices Segment*

 

Thedecrease in gross profit, as a percentage of net sales, for our electronicdevices segment from 33.9% in the first half of 2009 to 24.8% in the first halfof 2010 is primarily due to the decrease in volume of sales as discussed aboveand also due to changes in product mix and the negative impact of exchange ratefluctuations between the U.S. dollar and the British pound sterling.

 

*CommunicationsEquipment Segment*

 

Theincrease in gross profit, as a percentage of sales, for our communicationsequipment segment from 33.3% in the first half of 2009 to 35.0% in the firsthalf of 2010 is primarily the result of increases in gross margins at our U.S.communications equipment subsidiary primarily due to an increase in sale ofhigher margin network access timing products, partially offset by unfavorableimpacts as a result of the changes in foreign currency exchange rates between theU.S. dollar and the euro.

 

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**OperatingExpenses**

 
| ** **                                           | ** ** | **Six Months Ended** | ** ** | **Variance**                | ** ** |
|------------------------------------------------------|------------|----------------------|------------|-----------------------------|------------|
| ** **                                           | ** ** | **June 30,**    | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in  thousands)**                                  | ** ** | **2010**             | ** ** | **2009**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                                 |       |                 |       |                        |       |   |   |   |   |
| Selling,  general and administrative                 |       | $                    | 5,099      |                        | $          | 5,922 |   | $ | 823 |   | 13.9 | % |
| *as % of net sales from continuing operations*       | * *   | *37.6*               | *%*        | *35.4*                      | *%*        | * * | * * | * * | * * |
| Engineering  and product development                 |       | 925                  |       | 839                         |       | (86 | ) | (10.3 | )% |
| *as % of net sales from continuing operations*       | * *   | *6.8*                | *%*        | *5.0*                       | *%*        | * * | * * | * * | * * |
| Total  operating expenses from continuing operations |       | 6,024                |       | 6,761                       |       | 737 |   | 10.9 | % |
| Discontinued  operations                             |       | 3,174                |       | 3,371                       |       |   |   |   |   |
| Total  operating expenses                            |       | $                    | 9,198      |                        | $          | 10,132 |   |   |   |   |   |
|                                                      |            |                      |            |                             |            |  |  |  |  |  |  |  |

 

*Selling,general and administrative expenses*

 

Thedecrease in selling, general and administrative expenses is primarily theresult of the cost reduction activities implemented in 2009, which includedheadcount reductions, office closures in France and California, and an overalldecrease in corporate expenses.  Alsocontributing to the decrease was the impact of the headcount reductions in thefirst half of 2009, which resulted in employee termination costs that were notpresent in the first half of 2010.  Thesedecreases were offset slightly by CXR absorbing all of the facility costs atits location in the second quarter of 2010 where it had previously shared costswith the RO Operations.  The facilitylease at CXR ends in June of 2011, at which time, we anticipate moving toa less expensive facility or negotiating a reduced rate at the currentfacility.

 

*Engineeringand product development*

 

Theslight increase in engineering and product development costs is primarily dueto U.S. communications equipment subsidiary related to development of newproducts and enhancements of existing products, particularly in the firstquarter of 2010.

 

**Interestexpense**

 

Interestexpense was $1.6 million for the six months ended June 30, 2010 comparedto $2.3 million for the six months ended June 30, 2009 due to loweroutstanding loan balances.  Additionally,in the first half of 2009, we accelerated the amortization of deferredfinancing costs and debt discount in the amount of $0.5 million associated withthe partial repayment of our Term Loan B, which was absent in the first half of2010.  Included in interest expense inthe first half of 2010 were $0.6 million of non-cash amortization of deferredfinancing costs and non-cash amortization of debt discount compared to $1.0million in the first half of 2009.

 

**Otherincome and expense**

 

Werecorded other income of $0.3 million in the first half of 2010 compared to$0.2 million in the first half of 2009. Other income and expense consists primarily of (i) fair valueadjustments on warrants and (ii) short-term exchange rate gains and lossesassociated with the volatility of the U.S. dollar to the British pound sterlingand euro on the current portion of certain assets and liabilities.  The change in the fair value of warrantsduring the first half of 2010 resulted in income of $0.1 million compared toincome of $0.4 million in the first half of 2009.  The remaining income of $0.2 million for thefirst half of 2010 was predominantly related to short-term exchange rate gains.

 

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**Incometax provision (benefit)**

 

Incometax benefit amounted to $0.4 million for the second half of 2010 compared toexpense of $0.3 million for the second half of 2009.  We recorded income tax expense in the 2009period primarily as a result of foreign income tax on foreign earned profits inEurope.  The income tax benefit in thesecond quarter of 2010 was related to the losses from continuing operationsthat we incurred during the quarter.

 

**Incomefrom discontinued and held for sale operations**

 

Inconnection with the sale of the RO Operations on March 20, 2010 and theclassification of the ACC Operations as held for sale, we reported income fromdiscontinued and held for sale operations of $1.2 million (net of tax of $0.7million) during the first half of 2010, which includes a $0.5 million loss onthe sale of the RO Operations and related costs associated with those salesactivities of $0.5 million.  We reportedincome from discontinued and held for sale operations of $7.4 million duringthe first half of 2009, which includes a $7.1 million gain on the sale of theDigitran Operations.

 

**Netincome (loss)**

 

Wereported a net loss of $1.7 million in the first half of 2010 and net income of$4.3 million in the first half of 2009. Included in net loss in the first half of 2010 was a $0.5 million losson the sale of RO, additional costs associated with sale activities of $0.5million, and an overall decline in net sales and gross profit from continuingoperations.

 

**Liquidity and CapitalResources**

 

Inmaking an assessment of our liquidity, we believe that the items in ourfinancial statements that are most relevant to our ongoing operations areworking capital, cash generated from operating activities and cash availablefrom financing activities.  We fund ourdaily cash flow requirements through funds provided by operations and throughborrowings under our Credit Agreement with GVEC Resource IV Inc., anaffiliate of Private Equity Management Group LLC (“PEM Group”) (“GVEC” or the “Lender”).  Working capital from continuing operationswas negative $4.8 million at June 30, 2010 as compared to negative $3.5million at December 31, 2009, primarily due to lower cash, accounts receivableand inventory balances at June 30, 2010 as a result of lower sales levelsduring the first half of 2010.  At June 30,2010 and December 31, 2009, we had accumulated deficits of $28.3 millionand $26.6 million, respectively, and cash and cash equivalents of $2.0 millionand $4.0 million, respectively.  Cashbalances fluctuate and are dependent upon timing of advances and repayments onthe Revolver.  Our cash balances are oftensignificantly higher at the end of the month than at other times throughout theremainder of the month as a result of borrowings under our Credit Agreementgenerally occurring toward the end of the month and timing of payments tovendors in the form of accounts payable, payroll and interest paymentsgenerally occurring at the beginning of the month.

 

Netcash provided by operating activities during the first half of 2010 totaled$0.7 million.  Significant non-cashadjustments to our net loss for 2010 include (i) the amortization of debtdiscount and amortization of deferred financing costs which, on a combinedbasis, totaled $0.6 million, both of which are non-cash components of interestexpense associated with our Credit Agreement, and (ii) depreciation andamortization expense which totaled $0.5 million.  The primary significant use of cashassociated with operating activities during the first half of 2010 was adecrease in accounts payable and accrued liabilities by approximately $0.8million, in part due to payments made on previously accrued amounts related tothe sale of the RO Operations and ACC Operations also due to timing of vendorpayments.  The primary sources of cashassociated with operating activities during the second quarter of 2010 includeda decrease in accounts receivable, which decreased by $1.2 million, due primarilyto stable collections on first quarter sales in conjunction with lower sales inthe second quarter of 2010 and a decrease in inventory of $1.0 million as aresult of an effort to more effectively use existing inventory and decreases inorders of inventory due to lower backlog.

 

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Cashgenerated from our investing activities during the second quarter of 2010 totaled$0.8 million. This amount consisted primarily of net cash proceeds generated bythe March 2010 sale of the RO Operations.

 

Cashused in financing activities during the second quarter of 2010 totaled $2.7million, which consisted of $1.1 million in repayments of principal owed onlong term debt and notes to stockholders and $1.6 million in net repayments onour revolving credit facility.

 

As of June 30, 2010, we hadoutstanding borrowings of $3.6 million under the revolving creditfacility.  At June 30, 2010, we hadremaining actual availability under a formula-based calculation of $2.0 millionunder the revolving credit facility.  Actualremaining availability represents the additional amount we were eligible toborrow as of June 30, 2010 pursuant to our $7.0 million revolving line ofcredit.  The availability under ourrevolving line of credit fluctuates periodically throughout each monthdepending on timing of borrowings and repayments.  At July 31, 2010, our eligiblecollateral was $6.1 million (compared to the maximum available under ourrevolving line of credit of $7.0 million) and our outstanding borrowings atthat date were $3.7 million.  Therefore,our actual availability was $2.4 million.

 

Includingthe $3.6 million outstanding under the revolving line of credit, at June 30,2010, we had total debt obligations of $17.9 million, of which $3.7 million wasreported in discontinued and held for sale operations. Total debt includes ourrevolving credit facility, term loans, notes payable to stockholders, capitallease obligations and notes payable to the Former Shareholders, the currentportion of which loans and obligations totaled $15.0 million.  The Company anticipates retainingapproximately $3.8 million in long term debt payable to both its current Lenderand the Former Shareholders upon the close of the ACC Transaction, all of whichhas a maturity of at least two years or longer, of which $1 million iscurrently recorded in current portion of long-term debt and the remaining $2.8million is recorded in long-term debt in the accompanying condensedconsolidated balance sheets.

 

Ourbacklog from continuing operations remained relatively unchanged at $17.0million as of June 30, 2010 as compared to $16.9 million as of December 31,2009. The amount of backlog orders represents revenue that we anticipaterecognizing in the future, as evidenced by purchase orders and other purchasecommitments received from customers, but on which work has not yet beeninitiated or with respect to which work is currently in progress. Our backlogas of June 30, 2010 was approximately 85% related to our electronicdevices business, which business tends to provide us with long lead-times forour manufacturing processes due to the custom nature of the products, andapproximately 15% related to our communications equipment business, whichbusiness tends to deliver standard or modified standard products from stock asorders are received. We believe that the majority of our current backlog willbe shipped within the next 12 months. However, there can be no assurance that we will be successful infulfilling such orders and commitments in a timely manner or that we willultimately recognize as revenue the amounts reflected as backlog.

 

*CreditAgreement*

 

EMRISE(including each of its direct subsidiaries), are parties to a Credit Agreement,as amended, with the Lender, providing for a Credit Agreement in the aggregateamount of $26 million.  As of June 30,2010, we owed a total of $11.1 million under the terms of the credit facility.

 

Allreferences to the Credit Agreement herein refer to the Credit Agreement asamended.  The Credit Agreement requiresthe sale of a significant portion of our assets by August 31, 2010 (the “MaturityDate”).  As discussed further in Note 3in our June 30, 2010 financial statements, these assets contributedapproximately $20 million or 37% of the Company’s net sales from continuingoperations and operating income of approximately $3 million of the Company’stotal operating income from continuing operations of $1.4 million for2009.  The Company is required to achievecertain milestones in connection with these sale activities and the maintenanceof maximum capital expenditure financial covenants.  Failure to achieve these milestones and/orfailure to sell the required assets by the agreed upon dates, all of which areprior to August 31, 2010, can result in a default under the CreditAgreement.  Additionally, pursuant to theCredit Agreement, as amended, a termination of the ACC Purchase Agreement,which became terminable by either party at any time on August 1, 2010, isan event of default.  The Lender has thecurrent right to appoint an outside observer to review our books and recordsand business operations, with certain limitations designed to minimize disruptionto our business operations.  Upon thecompletion of the ACC Transaction, we will retain a percentage of the proceedsfor working capital and are obligated to use the remaining proceeds to pay downa significant portion of the obligations owed to the Lender.  We are also obligated to provide financialinformation and status reports to the Lender on a regular basis.

 

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TheCredit Agreement currently consists of (i) a revolving credit facility forup to $7 million that expires on August 31, 2010 (the “Revolver”), and(ii) two term loans (Term Loan A and Term Loan B) with an aggregate netoutstanding principal amount of $7.4 million as of June 30, 2010. The termloans require remaining combined scheduled principal payments of $75,000bi-weekly, which began on February 1, 2010 and continue throughmaturity.  The Credit Agreement alsorequires monthly interest payments and a final balloon payment of principalupon maturity on August 31, 2010 of approximately $7.2 million in termdebt plus the outstanding balance of the revolver, which at June 30, 2010was $3.6 million.

 

TheRevolver is formula-based and generally provides that the outstandingborrowings under the line of credit may not exceed an aggregate of 85% ofeligible accounts receivable, plus 10% of the value of eligible raw materialsnot to exceed $600,000, plus 50% of the value of eligible finished goods inventorynot to exceed $1,500,000, minus the aggregate amount of reserves that may beestablished by the Lender.

 

Intereston the Revolver is payable monthly.  The interest rate is variable and isadjusted monthly based 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% perannum.  The Revolver contains a capital expenditures covenant, prohibitingany such expenditures in excess of $1,800,000 through June 30, 2010.  Additionally, the Revolver prohibits us fromincurring unfinanced capital expenditures in excess of $62,500 in any fiscalquarter and from incurring purchase money commitments in excess of $2 millionover the life of the facility.  However,if we incur unfinanced capital expenditures of less than $62,500 in any fiscalquarter, the difference between the amount incurred in a certain fiscal quarterand $62,500 may be incurred in the two fiscal quarters immediately followingsuch fiscal quarter. The Company was in compliance with these covenants at June 30,2010.

 

Theterm loans bear interest at the Base Rate plus 4.25%, subject to a minimum rateof 12.5% per annum.  Under the CreditAgreement, we may make full or partial prepayment of the term loans providedthat any such prepayment is accompanied by the applicable prepayment premiumdiscussed below.

 

Tosecure payment of the indebtedness under the Credit Agreement, we irrevocablypledged and assigned to, and granted to the Lender a continuing security interestin, all the personal property of the Company and its direct subsidiaries,including our interest in any deposit accounts, the stock of each of our directand indirect subsidiaries, the intellectual property owned by each of theCompany and its direct subsidiaries, and the proceeds of the intellectualproperty owned by each of these entities.  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 our foreignsubsidiaries have agreed to guarantee our performance under the CreditAgreement.

 

Therecan be no assurance that we will be able to successfully sell the contemplatedassets that we are obligated to sell, pursuant to the Credit Agreement, in theagreed time frames, achieve the related milestones on a timely basis, and/orsell the assets at prices sufficient to satisfy the debt owed to the Lender, ifat all.  Even if we do successfully sellthe contemplated assets and pay the obligations owed to the Lender in full, ourongoing revenues will be substantially reduced, which could have a materialadverse affect on our operations and financial condition.

 

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Ifan event of default were to occur, including the failure to achieve any of themilestones related to asset sales required by the Credit Agreement, the Lendercould accelerate the debt and exercise its rights and remedies under the CreditAgreement.  An acceleration of theprincipal, deferred fees and accrued interest due on the date of a declaredevent of default would be a significant amount that would be due on such date.  If such an acceleration were declared as of August 16,2010, the amount would equal approximately $11 million.  We do not have the ability to pay this amountfrom currently available sources at this time. The rights and remedies available to the Lender under the CreditAgreement in the event of a declared event of default include a foreclosure onour assets before the contemplated asset sales could be completed.  The Lender may also elect to increase theinterest rate applicable to the outstanding balance of the Term Loans A and Bby four percentage points above the per annum interest rate that wouldotherwise be applicable.  Additionally, if the Lender terminates thecredit facility during a default period then we are subject to a penalty equalto 2% of the outstanding principal balance of the Revolver and the Term Loans.

 

*Liquidity*

 

Our current business plan requires additionalfunding beyond our anticipated cash flows from operations.  These and other factors described in moredetail below raise substantial doubt about our ability to continue as a goingconcern.  Our ability to continue as agoing concern is dependent upon our ability to (i) achieve the milestonesrelated to the sale of a significant portion of our assets as required by theCredit Agreement between now and August 31, 2010, including obtainingstockholder approval to consummate the pending sale of ACC, (ii) repay theCredit Agreement on or prior to its maturity on August 31, 2010, (iii) obtainalternate financing to fund operations after August 31, 2010 and (iv) achieveprofitable operations. Further, following the successful sale of ACC,management believes we will, by necessity, be required to sell additional stockor assets, complete a recapitalization, or consummate a merger transaction inorder to continue operations.

 

Inconnection with the obligation to sell certain assets, we are obligated toachieve certain sale-related milestones, the most immediate of which includes obtaining stockholder approval toconsummate the pending sale of ACC by August 31, 2010.  Also, pursuant to the Credit Agreement, asamended, a termination of the ACC Purchase Agreement, which became terminableby either party at any time on August 1, 2010, is an event of default. Asof the date of this filing, we believe we will be able to achieve such milestonesand do not anticipate termination of the ACC Purchase Agreement, but noassurances can be provided in this regard.

 

Ifour net losses from continuing operations continue, we will likely experiencenegative cash flow, which may prevent us from continuing operations.  If we are not able to attain, sustain orincrease profitability on a quarterly or annual basis, we may not be able tocontinue operations.

 

Uponthe occurrence and during the continuation of an event of default, the Lendermay also elect to increase the interest rate applicable to the outstandingbalance of the Term Loans A and B by four percentage points above the per annuminterest rate that would otherwise be applicable.  Additionally, if theLender terminates the Credit Agreement during a default period, then we aresubject to a penalty equal to 2% of the outstanding principal balance of theRevolver and the Term Loans.

 

Ifwe (i) default under the Credit Agreement for any reason, (ii) areunable to timely obtain stockholder approval and complete the sale of ACC inorder to repay our obligations prior to August 31, 2010 as agreed with ourLender, (iii) cannot borrow funds under the terms of our revolving creditfacility, for any reason, through August 31, 2010, or (iv) fail toobtain alternate financing to replace our Credit Agreement prior to August 31,2010 or a new revolving credit facility once the current Credit Agreement isrepaid, then we do not believe that current and future capital resources,revenues generated from operations and other existing sources of liquidity willbe adequate to meet our anticipated short term, working capital and capitalexpenditure needs for the next 12 months.  To address these potentialfinancing needs, we may need to explore a revised debt structure with our Lender;additional or new financing with another lender or lenders; expedite the saleof certain assets to generate cash; complete a recapitalization, or consummatea merger or other transaction. Successfully executing these strategies is uncertain and there are manyrisks associated with attempting to execute each, in addition to the risks anduncertainties of the short and long term impact of executing on any of thesestrategies.   Failure to meet our financingrequirements, if and when needed, would have an adverse effect on ouroperations and/or ability to do business after that date or could restrict ourgrowth, limit the development of new products, hinder our ability to fulfillexisting or future orders or negatively affect our ability to secure newcustomers or product orders.

 

Further,if the sale of ACC is successful,  weexpect to continue to experience losses from our continuing operations andnegative cash flow subsequent to such sale, which may require us to sell additional assets, complete arecapitalization, or consummate a merger transaction. Selling additionalassets, completing a recapitalization or consummating a merger transactionfollowing the successful sale of ACC may prove to be difficult given thecurrent economic conditions and because of our financial condition. Further,even if we are successful in completing the transaction, such transaction mayprove to be dilutive to the existing stockholders.

 

Ifwe are unsuccessful in timely obtaining stockholder approval, completing thesale of ACC, and repaying our obligations as agreed with our Lender by August 31,2010, or if we are unsuccessful in securing the necessary financing to continueoperations by August 31, 2010 or otherwise when needed, then we may be forced to seek protection under the U.S.Bankruptcy Code or be forced into liquidation or substantially restructuring oraltering our business operations and/or debt obligations.

 

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**Effects of Inflation**

 

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

 

**Impacts of New AccountingPronouncements**

 

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

 

InMarch 2010, the FASB ratified accounting guidance on defining a milestoneand determining when it may be appropriate to apply the milestone method ofrevenue recognition for research or development transactions. This guidanceprovides criteria that must be met to recognize consideration that iscontingent upon achievement of a substantive milestone in its entirety in theperiod in which the milestone is achieved. The amendment is effective formilestones achieved in fiscal years beginning on or after June 15, 2010.Early adoption is allowed. We are currently evaluating the impact of theadoption of this amendment on our condensed consolidated financial statements.

 

**ITEM 3.                  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK.**

 

Notapplicable.

 

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

 

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

 

Management is responsiblefor establishing and maintaining adequate internal control over financialreporting. The Company maintains disclosure controls and procedures that are designedto ensure that information required to be disclosed in the Company’s reportspursuant to the Securities Exchange Act of 1934, as amended, is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms, and that such information is accumulated and communicatedto the Company’s management, including its Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure. In designing and evaluating the disclosure controls and procedures,management recognized that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives, and management necessarily was required to applyits judgment in evaluating the cost-benefit relationship of possible controlsand procedures.

 

Based on an evaluation ofour disclosure controls and procedures required by paragraph (b) of Rule 13a-15or Rule 15d-15, as of June 30, 2010, our Principal Executive Officerand Principal Financial Officer have concluded that our disclosure controls andprocedures were not effective, because of the material weaknesses set forthbelow that were identified as part of our evaluation of the effectiveness ofour internal controls over financial reporting at December 31, 2009.

 

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***Summary of Material Weaknesses***

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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***Remediation of Internal Control Deficiencies***

 

Through the efforts ofmanagement, external consultants and our Audit Committee, we are currently inthe process of executing specific action plans to remediate the materialweaknesses identified above. If we are able to complete these actions in atimely manner, we anticipate that all control deficiencies and materialweaknesses will be remediated in 2011.

 

We are developing specificaction plans for each of the above material weaknesses. In addition, our auditcommittee has authorized the hiring of additional temporary staff and/or theuse of financial and information technology consultants, as necessary, toensure that we have the depth and experience to remediate the above listedmaterial weaknesses, including the implementation and monitoring of theappropriate level of control procedures related to all of our manufacturinglocations and our corporate offices. The audit committee will also workdirectly with management and outside consultants, as necessary, to ensure thatboard level deficiencies are addressed.

 

We are uncertain at thistime of the costs to remediate all of the above listed material weaknesses,however, we anticipate the cost to be in the range of $100,000 to $200,000(including the cost of the consolidation software described above), most ofwhich costs we expect to incur during 2011. We cannot guarantee that the actualcosts to remediate these deficiencies will not exceed this amount.

 

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

 

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

 

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

 

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**PART II— OTHER INFORMATION**

 

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

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                 |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                      |
| 10.1       |       | Amendment  Number 10 to Loan Documents dated as of May 3, 2010 by and among EMRISE  Corporation, EMRISE Electronics Corporation, CXR Larus Corporation, Advanced  Control Components, Inc., Custom Control Components, Inc., GVEC  Resources IV Inc. and Private Equity Management Group LLC *   |
|       |       |                                                                                                                                                                                                                                                                                                            |
| 10.2       |       | Amendment  Number 11 to Loan Documents dated as of May 17, 2010 by and among EMRISE  Corporation, EMRISE Electronics Corporation, CXR Larus Corporation, Advanced  Control Components, Inc., Custom Control Components, Inc., GVEC  Resources IV Inc. and Private Equity Management Group LLC *  |
|       |       |                                                                                                                                                                                                                                                                                                            |
| 10.3       |       | Amendment  Number 12 to Loan Documents dated as of June 1, 2010 by and among EMRISE  Corporation, EMRISE Electronics Corporation, CXR Larus Corporation, Advanced  Control Components, Inc., Custom Control Components, Inc., GVEC  Resources IV Inc. and Private Equity Management Group LLC *  |
|       |       |                                                                                                                                                                                                                                                                                                            |
| 10.4       |       | Amendment  Number 13 to Loan Documents dated as of June 17, 2010 by and among  EMRISE Corporation, EMRISE Electronics Corporation, CXR Larus Corporation,  Advanced Control Components, Inc., Custom Control Components, Inc.,  GVEC Resources IV Inc. and Private Equity Management Group LLC * |
|       |       |                                                                                                                                                                                                                                                                                                            |
| 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 Principal Executive Officer Pursuant to 18 U.S.C. Section 1350,  as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*                                                                                                                                         |
|       |       |                                                                                                                                                                                                                                                                                                            |
| 32.2       |       | Certification  of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350,  as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*                                                                                                                                         |

 

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* Filed herewith.

 

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**SIGNATURES**

 

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

 
|                         | EMRISE CORPORATION |
|------------------------------|--------------------|
|                         |               |   |
| Dated:  August 16, 2010 | By:                | /s/  CARMINE T. OLIVA |
|                         |               | Carmine  T. Oliva, |
|                         |               | Chief  Executive Officer (Principal Executive Officer) |
|                         |               |
|                         |               |   |
| Dated:  August 16, 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**                                                                                                                                                                                                                                                                                               |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                    |
| 10.1       |       | Amendment  Number 10 to Loan Documents dated as of May 3, 2010 by and among EMRISE  Corporation, EMRISE Electronics Corporation, CXR Larus Corporation, Advanced  Control Components, Inc., Custom Control Components, Inc., GVEC  Resources IV Inc. and Private Equity Management Group LLC   |
|       |       |                                                                                                                                                                                                                                                                                                          |
| 10.2       |       | Amendment  Number 11 to Loan Documents dated as of May 17, 2010 by and among EMRISE  Corporation, EMRISE Electronics Corporation, CXR Larus Corporation, Advanced  Control Components, Inc., Custom Control Components, Inc., GVEC  Resources IV Inc. and Private Equity Management Group LLC  |
|       |       |                                                                                                                                                                                                                                                                                                          |
| 10.3       |       | Amendment  Number 12 to Loan Documents dated as of June 1, 2010 by and among EMRISE  Corporation, EMRISE Electronics Corporation, CXR Larus Corporation, Advanced  Control Components, Inc., Custom Control Components, Inc., GVEC  Resources IV Inc. and Private Equity Management Group LLC  |
|       |       |                                                                                                                                                                                                                                                                                                          |
| 10.4       |       | Amendment  Number 13 to Loan Documents dated as of June 17, 2010 by and among  EMRISE Corporation, EMRISE Electronics Corporation, CXR Larus Corporation,  Advanced Control Components, Inc., Custom Control Components, Inc.,  GVEC Resources IV Inc. and Private Equity Management Group LLC |
|       |       |                                                                                                                                                                                                                                                                                                          |
| 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 Principal Executive Officer Pursuant to 18 U.S.C. Section 1350,  as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                        |
|       |       |                                                                                                                                                                                                                                                                                                          |
| 32.2       |       | Certification  of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350,  as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                        |

 

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