Tableof Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q/A**

 

**(Mark One)**

 

| **x**                                                      | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
|                                                       |       |                                                                                                     |
| **For the  quarterly period ended****June 30,  2009** |
|                                                       |
| **or**                                                     |
|                                                       |
| **o**                                                      | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**For the transition period from                 to                **

 

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

 

**EMRISECORPORATION**

(Exact name ofregistrant as specified in its charter)

 

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

 

**611Industrial Way**

**Eatontown,New Jersey 07224**

(Address of principalexecutive offices) (Zip code)

** **

**(732) 389-0355**

(Registrant’s telephone number, including area code)

 

**Not applicable**

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

 

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

 

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

 

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

 

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

 

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

 

The number of sharesoutstanding of the Registrant’s common stock, $0.0033 par value, as of August 13,2009 was 10,213,412.

 

 

 

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Table ofContents

 

**EMRISE CORPORATION**

**TABLE OF CONTENTS**

**FORM 10-Q/A**

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

 
| **PART I.  FINANCIAL INFORMATION**                                                                                                 |                                                                                            |
|-----------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|
|                                                                                                                                    |                                                                                            |
| **EXPLANATORY NOTE**                                                                                                                    |                                                                                            |
|                                                                                                                                    |                                                                                            |   |
| **ITEM 1.**                                                                                                                             | **FINANCIAL STATEMENTS**                                                                        |   |
|                                                                                                                                    |                                                                                            |   |
| Condensed Consolidated  Balance Sheets as of June 30, 2009 (restated) (unaudited) and  December 31, 2008                      | 1                                                                                               |
|                                                                                                                                    |                                                                                            |
| Condensed Consolidated  Statements of Operations for the Three and Six Months Ended June 30,  2009 and 2008 (restated) (unaudited) | 2                                                                                               |
|                                                                                                                                    |                                                                                            |
| Condensed Consolidated  Statements of Stockholders’ Equity for the Six Months Ended June 30,  2009 (restated) (unaudited)     | 3                                                                                               |
|                                                                                                                                    |                                                                                            |
| Condensed Consolidated  Statements of Cash Flows for the Six Months Ended June 30, 2009 and 2008  (restated) (unaudited)           | 4                                                                                               |
|                                                                                                                                    |                                                                                            |
| Notes to Condensed Consolidated Financial Statements  (unaudited)                                                                       | 5                                                                                               |
|                                                                                                                                    |                                                                                            |   |
| **ITEM 2.**                                                                                                                             | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** | 24 |
|                                                                                                                                    |                                                                                            |   |
| **ITEM 3.**                                                                                                                             | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                 | 42 |
|                                                                                                                                    |                                                                                            |   |
| **ITEM 4.**                                                                                                                             | **CONTROLS AND  PROCEDURES**                                                                    | 42 |
|                                                                                                                                    |                                                                                            |   |
| **ITEM 4T.**                                                                                                                            | **CONTROLS AND  PROCEDURES**                                                                    | 43 |
|                                                                                                                                    |                                                                                            |   |
| **PART II  OTHER INFORMATION**                                                                                                     |                                                                                            |
|                                                                                                                                    |                                                                                            |   |
| **ITEM 1.**                                                                                                                             | **LEGAL PROCEEDINGS**                                                                           | 47 |
|                                                                                                                                    |                                                                                            |   |
| **ITEM 1A.**                                                                                                                            | **RISK FACTORS**                                                                                | 47 |
|                                                                                                                                    |                                                                                            |   |
| **ITEM 2.**                                                                                                                             | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                | 48 |
|                                                                                                                                    |                                                                                            |   |
| **ITEM 3.**                                                                                                                             | **DEFAULTS UPON  SENIOR SECURITIES**                                                            | 48 |
|                                                                                                                                    |                                                                                            |   |
| **ITEM 4.**                                                                                                                             | **SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS**                                        | 48 |
|                                                                                                                                    |                                                                                            |   |
| **ITEM 5.**                                                                                                                             | **OTHER INFORMATION**                                                                           | 49 |
|                                                                                                                                    |                                                                                            |   |
| **ITEM  6.**                                                                                                                            | **EXHIBITS**                                                                                    | 50 |
|                                                                                                                                    |                                                                                            |   |
| **SIGNATURES**                                                                                                                          | 51                                                                                              |

 

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**EXPLANATORY NOTE**

 

The purpose ofthis Amendment No. 1 to Form 10-Q (“Amendment”) is to amend ourinitial filing of a Quarterly Report on Form 10-Q for the quarterly periodended June 30, 2009, filed with the Securities and Exchange Commission (“SEC”)on August 14, 2009 (the “Initial Filing”).

 

On September 30,2009, we filed a Current Report on Form 8-K with the SEC disclosing thatour management concluded that an accounting error had been made in ourhistorical financial statements in relation to (i) the erroneousclassification of the issuance of a note relating to a purchase priceadjustment as a cash item in its financial statements rather than asupplemental disclosure item and (ii) updating the impact of certainrecent accounting pronouncements.  Additionally, we did not properlyrecord the acceleration of the pro-rata portion of deferred financing costs anddebt discount as a result of the partial repayment of our Term Loan B on March 20,2009 (as described in Note 2).   As aresult, our financial statements for the quarterly period ended June 30,2009 must be restated (the “Restatement”). In light of the Restatement, the financial statements and otherfinancial information included in the Initial Filing are being restated in thisAmendment.

 

The Company’s Form 10-Qfor the period ended June 30, 2009 is amended and restated in its entiretyas set forth below.

 

Unless specified,the disclosures provided in this document have not been updated for morecurrent information.  Therefore, thisAmendment should be read in conjunction with our other filings made with theSEC subsequent to the date of the Initial Filing.

 

1

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Table of Contents

 

**PART I— FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**EMRISE CORPORATION**

**Condensed Consolidated Balance Sheets**

(in thousands,except share and per share amounts)

 
| ** **                                                                                                                                                                               | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                               | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                                                               | ** ** | **(Restated)**    | ** ** | ** **            | ** ** |
| ** **                                                                                                                                                                               | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                               |       |              |       |                  |       |
|                                                                                                                                                                                     |       |              |       |                  |       |
| Current assets:                                                                                                                                                                          |       |              |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                               |       | $                 | 4,832      |                  | $          | 3,242 |   |
| Accounts receivable,  net of allowances for doubtful accounts of $221 at June 30, 2009 and  $501 at December 31, 2008                                                          |       | 9,373             |       | 10,333                |       |
| Inventories, net                                                                                                                                                                         |       | 12,916            |       | 12,501                |       |
| Current deferred tax assets                                                                                                                                                              |       | 323               |       | 271                   |       |
| Prepaid and other  current assets                                                                                                                                                        |       | 1,302             |       | 1,283                 |       |
| Current assets of  discontinued operations                                                                                                                                               |       | —            |       | 2,724                 |       |
| Total current assets                                                                                                                                                                     |       | 28,746            |       | 30,354                |       |
|                                                                                                                                                                                     |       |              |       |                  |       |
| Property, plant and  equipment, net                                                                                                                                                      |       | 2,761             |       | 2,990                 |       |
| Goodwill                                                                                                                                                                                 |       | 13,368            |       | 9,657                 |       |
| Intangible assets other  than goodwill, net                                                                                                                                              |       | 6,070             |       | 6,618                 |       |
| Deferred tax assets                                                                                                                                                                      |       | 1,798             |       | 2,191                 |       |
| Other assets                                                                                                                                                                             |       | 302               |       | 683                   |       |
| Noncurrent assets of  discontinued operations                                                                                                                                            |       | —            |       | 1,130                 |       |
| Total assets                                                                                                                                                                             |       | $                 | 53,045     |                  | $          | 53,623 |   |
|                                                                                                                                                                                     |       |              |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                            |       |              |       |                  |       |
|                                                                                                                                                                                     |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                                     |       |              |       |                  |       |
| Accounts payable                                                                                                                                                                         |       | $                 | 5,042      |                  | $          | 4,625 |   |
| Accrued expenses                                                                                                                                                                         |       | 6,511             |       | 6,939                 |       |
| Line of credit                                                                                                                                                                           |       | 5,612             |       | 4,084                 |       |
| Current portion of  long-term debt                                                                                                                                                       |       | 1,974             |       | 5,121                 |       |
| Notes payable to  stockholders, current portion                                                                                                                                          |       | 802               |       | 542                   |       |
| Income taxes payable                                                                                                                                                                     |       | 766               |       | 451                   |       |
| Other current  liabilities                                                                                                                                                               |       | 649               |       | 357                   |       |
| Current liabilities of  discontinued operations                                                                                                                                          |       | —            |       | 664                   |       |
| Total current  liabilities                                                                                                                                                               |       | 21,356            |       | 22,783                |       |
|                                                                                                                                                                                     |       |              |       |                  |       |
| Long-term debt, net of  discount of $505 and $980, respectively                                                                                                                          |       | 6,892             |       | 13,479                |       |
| Notes payable to  stockholders, less current portion                                                                                                                                     |       | 2,959             |       | 250                   |       |
| Deferred income taxes                                                                                                                                                                    |       | 1,927             |       | 2,203                 |       |
| Warrant liability                                                                                                                                                                        |       | 587               |       | —                |       |
| Other liabilities                                                                                                                                                                        |       | 449               |       | 503                   |       |
| Noncurrent liabilities  of discontinued operations                                                                                                                                       |       | —            |       | 401                   |       |
| Total liabilities                                                                                                                                                                        |       | 34,170            |       | 39,619                |       |
|                                                                                                                                                                                     |       |              |       |                  |       |
| Commitments and  contingencies                                                                                                                                                           |       |              |       |                  |       |
| Stockholders’ equity:                                                                                                                                                               |       |              |       |                  |       |
| Preferred stock,$0.01  par value. Authorized 10,000,000 shares, zero shares issued and outstanding                                                                                       |       | —            |       | —                |       |
| Common stock,$0.0033  par value. Authorized 150,000,000 shares; 10,213,412 and 10,204,079 shares  issued and outstanding at June 30, 2009 and December 31, 2008,  respectively |       | 126               |       | 126                   |       |
| Additional paid-in  capital                                                                                                                                                              |       | 43,407            |       | 44,806                |       |
| Accumulated deficit                                                                                                                                                                      |       | (23,204           | )          | (28,101               | )          |
| Accumulated other  comprehensive loss                                                                                                                                                    |       | (1,454            | )          | (2,827                | )          |
| Total stockholders’  equity                                                                                                                                                         |       | 18,875            |       | 14,004                |       |
| Total liabilities and  stockholders’ equity                                                                                                                                         |       | $                 | 53,045     |                  | $          | 53,623 |   |

 

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

 

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Operations**

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

 
| ** **                                                                       | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                       | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                                       | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                       | ** ** | **(Restated)**         | ** ** | ** **           | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
| Net Sales                                                                        |       | $                      | 14,270     |                 | $          | 12,022 |   | $ | 28,483 |   | $ | 22,665 |   |
| Cost of Sales                                                                    |       | 8,811                  |       | 8,309                |       | 18,067 |   | 15,512 |   |
| Gross profit                                                                     |       | 5,459                  |       | 3,713                |       | 10,416 |   | 7,153 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Operating expenses:                                                              |       |                   |       |                 |       |   |   |   |   |
| Selling, general and  administrative                                             |       | 4,347                  |       | 3,529                |       | 8,894 |   | 7,067 |   |
| Engineering and product  development                                             |       | 716                    |       | 608                  |       | 1,238 |   | 1,111 |   |
| Total operating  expenses                                                        |       | 5,063                  |       | 4,137                |       | 10,132 |   | 8,178 |   |
| Income (loss) from  operations                                                   |       | 396                    |       | (424                 | )          | 284 |   | (1,025 | ) |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Other income (expense):                                                          |       |                   |       |                 |       |   |   |   |   |
| Interest income                                                                  |       | 23                     |       | 23                   |       | 69 |   | 41 |   |
| Interest expense                                                                 |       | (842                   | )          | (604                 | )          | (2,398 | ) | (1,188 | ) |
| Other, net                                                                       |       | 210                    |       | 120                  |       | 168 |   | 103 |   |
| Total other expense,  net                                                        |       | (609                   | )          | (461                 | )          | (2,161 | ) | (1,044 | ) |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Loss before income  taxes                                                        |       | (213                   | )          | (885                 | )          | (1,877 | ) | (2,069 | ) |
| Income tax provision  (benefit)                                                  |       | 145                    |       | (4                   | )          | (358 | ) | 80 |   |
| Loss from continuing  operations                                                 |       | (358                   | )          | (881                 | )          | (1,519 | ) | (2,149 | ) |
| Discontinued  operations:                                                        |       |                   |       |                 |       |   |   |   |   |
| Income (loss) from  discontinued operations including gain on sale of $7,109 YTD |       | (114                   | )          | 625                  |       | 7,288 |   | 996 |   |
| Tax provision (benefit)  on discontinued operations                              |       | (11                    | )          | —               |       | 1,345 |   | — |   |
| Net gain (loss) on  discontinued operations                                      |       | (103                   | )          | 625                  |       | 5,943 |   | 996 |   |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Net Income (loss)                                                                |       | $                      | (461       | )                    | $          | (256 | ) | $ | 4,424 |   | $ | (1,153 | ) |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Earnings (loss) per  share:                                                      |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                            |       | $                      | (0.05      | )                    | $          | (0.03 | ) | $ | 0.43 |   | $ | (0.11 | ) |
| Diluted                                                                          |       | $                      | (0.05      | )                    | $          | (0.03 | ) | $ | 0.43 |   | $ | (0.11 | ) |
|                                                                             |       |                   |       |                 |       |   |   |   |   |
| Weighted average shares  outstanding                                             |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                            |       | 10,205                 |       | 10,204               |       | 10,205 |   | 10,204 |   |
| Diluted                                                                          |       | 10,205                 |       | 10,204               |       | 10,205 |   | 10,204 |   |

 

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

 

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Stockholders’Equity**

**(Restated)**

(Unaudited)****(in thousands)

* *
| ** **                                                                        | ** ** | ** **        | ** ** | ** **  | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------|------------|-------------------|------------|-------------|------------|-----------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                        | ** ** | ** **        | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **        | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                                                                        | ** ** | **Common  Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                                                                        | ** ** | **Shares**        | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**       | ** ** | **Loss**        | ** ** | **Total**  | ** ** |
|                                                                              |       |              |       |        |       |            |       |              |       |            |       |       |       |
| Balance at  December 31, 2008                                                |       | 10,204            |       | $           | 126        |            | $          | 44,806            |       | $               | (28,101    | )          | $          | (2,827 | ) | $ | 14,004 |   |
| Cumulative effect of  change in accounting principle due to adoption of EITF 07-5 |       | —            |       | —      |       | (1,483          | )          | 473               |       | —          |       | (1,010     | )          |
| Stock option exercises                                                            |       | 9                 |       | —      |       | 7               |       | —            |       | —          |       | 7          |       |
| Stock-based  compensation                                                         |       | —            |       | —      |       | 75              |       | —            |       | —          |       | 75         |       |
| Warrants issued for  services                                                     |       | —            |       | —      |       | 2               |       | —            |       | —          |       | 2          |       |
| Net income and  comprehensive income                                              |       | —            |       | —      |       | —          |       | 4,424             |       | 1,373           |       | 5,797      |       |
| Balance at  June 30, 2009                                                    |       | 10,213            |       | $           | 126        |            | $          | 43,407            |       | $               | (23,204    | )          | $          | (1,454 | ) | $ | 18,875 |   |

 

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

 

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Cash Flows**

(Unaudited)****(in thousands)

 
| ** **                                                                                                                                | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                                                | ** ** | **June 30,**    | ** ** |
| ** **                                                                                                                                | ** ** | **2009**             | ** ** | **2008** | ** ** |
| ** **                                                                                                                                | ** ** | **(Restated)**       | ** ** | ** ** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES**                                                                                                  |       |                 |       |   |   |
| Net  Income (loss)                                                                                                                        |       | $                    | 4,424      |   | $ | (1,153 | ) |
| Adjustments  to arrive at net loss from continuing operations                                                                             |       | (5,943               | )          | (996 | ) |
| Net  loss from continuing operations                                                                                                      |       | (1,519               | )          | (2,149 | ) |
| Reconciliation  to net cash used in operating activities:                                                                                 |       |                 |       |   |   |
| Depreciation  and amortization                                                                                                            |       | 980                  |       | 506 |   |
| Provision  for doubtful accounts                                                                                                          |       | 69                   |       | (46 | ) |
| Provision  for inventory obsolescence                                                                                                     |       | 258                  |       | 522 |   |
| Provision  for warranty reserve                                                                                                           |       | (48                  | )          | 8 |   |
| Deferred  taxes                                                                                                                           |       | (292                 | )          | (113 | ) |
| Amortization  of deferred issuance costs                                                                                                  |       | 519                  |       | 216 |   |
| Amortization  of debt discount                                                                                                            |       | 475                  |       | 216 |   |
| Stock-based  compensation expense                                                                                                         |       | 77                   |       | 33 |   |
| Change  in common stock warrant value                                                                                                     |       | (423                 | )          | — |   |
| Changes  in assets and liabilities:                                                                                                       |       |                 |       |   |   |
| Accounts  receivable                                                                                                                      |       | 936                  |       | 559 |   |
| Inventories                                                                                                                               |       | (975                 | )          | (734 | ) |
| Prepaid  and other assets                                                                                                                 |       | (156                 | )          | (54 | ) |
| Accounts  payable and accrued expenses                                                                                                    |       | (1,103               | )          | (527 | ) |
| Operating  cash flow used in continuing operations                                                                                        |       | (1,202               | )          | (1,563 | ) |
| Operating  cash flow provided by discontinued operations                                                                                  |       | 693                  |       | 928 |   |
| Net  cash used in operating activities                                                                                                    |       | (509                 | )          | (635 | ) |
|                                                                                                                                      |       |                 |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                                                                 |       |                 |       |   |   |
| Purchases  of property, plant and equipment                                                                                               |       | (14                  | )          | (50 | ) |
| ACC  purchase price adjustment                                                                                                            |       | 145                  |       | — |   |
| Investing  cash flow provided by (used in) continuing operations                                                                          |       | 131                  |       | (50 | ) |
| Investing  cash flow provided by (used in) discontinued operations including proceeds  from sale of subsidiary operations, net of cash    |       | 10,050               |       | (37 | ) |
| Net  cash provided by (used in) investing activities                                                                                      |       | 10,181               |       | (87 | ) |
|                                                                                                                                      |       |                 |       |   |   |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                                                                 |       |                 |       |   |   |
| Net  repayments of lines of credit                                                                                                        |       | 1,528                |       | (1,950 | ) |
| Repayments  of long-term debt                                                                                                             |       | (10,288              | )          | (143 | ) |
| Payments  of notes to stockholders                                                                                                        |       | (293                 | )          | (271 | ) |
| Proceeds  from exercise of stock options and warrants                                                                                     |       | 7                    |       | — |   |
| Net  cash used in financing activities                                                                                                    |       | (9,046               | )          | (2,364 | ) |
| Effect  of exchange rate changes on cash                                                                                                  |       | 785                  |       | 264 |   |
| Net  increase (decrease) in cash and cash equivalents                                                                                     |       | 1,411                |       | (2,822 | ) |
| Cash  and cash equivalents at beginning of period                                                                                         |       | 3,421                |       | 4,764 |   |
| Cash  and cash equivalents at end of period                                                                                               |       | $                    | 4,832      |   | $ | 1,942 |   |
|                                                                                                                                      |       |                 |       |   |   |
| **SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND****FINANCING  ACTIVITIES:**                                                          |       |                 |       |   |   |
| Acquisition  of equipment through capital lease                                                                                           |       | $                    | 74         |   | $ | 453 |   |
| 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 an integral part ofthese Condensed Consolidated Financial Statements*

 

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**EMRISE CORPORATION**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

*Organizationand Business*

 

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

 

In March of 2009, the Company sold substantially all the assetsrelated to the Digitran division of the Company’s wholly-owned subsidiary,EMRISE Electronics Corporation’s (“EEC”), and all of the issued and outstandingequity interests of EEC’s wholly-owned subsidiary, XCEL Japan, Ltd.(collectively the “Digitran Operations”).  Theaccompanying financial statements include the Digitran Operations as adiscontinued operation.

 

*Basis of Presentation*

 

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

 

*Comprehensive Income (Loss)*

 

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

 
| ** **                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                               | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                               | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                               | ** ** | **(Restated)**         | ** ** | ** **           | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
| Net  income (loss)                       |       | $                      | (461       | )                    | $          | (256 | ) | $ | 4,424 |   | $ | (1,153 | ) |
| Other  comprehensive income (loss):      |       |                   |       |                 |       |   |   |   |   |
| Foreign  currency translation adjustment |       | 1,791                  |       | (3                   | )          | 1,373 |   | 223 |   |
| Comprehensive  income (loss)             |       | $                      | 1,330      |                 | $          | (259 | ) | $ | 5,797 |   | $ | (930 | ) |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

*Revenue Recognition*

 

The Company derivesrevenues from sales of electronic devices and communications equipment productsand services.  The Company’s sales arebased upon written agreements or purchase orders that identify the type andquantity of the item and/or services being purchased and the purchaseprice.  The Company recognizes revenueswhen shipment of products has occurred or services have been rendered, no significantobligations remain on the part of the Company, and collectability is reasonablyassured based on the Company’s credit and collections practices and policies.

 

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

 

Revenue recognition forproducts and services provided by the Company’s subsidiaries in England and itsU.S. subsidiary, ACC, depends upon the type of contract involved.  Engineering/design services contractsgenerally entail design and production of a prototype over a term of up toseveral years, with revenue deferred until each milestone defined in 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.

 

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

 

Revenues from services such as repairs and modifications are recognizedwhen the service is completed and invoiced. For repairs that involve shipment of a repaired product, the Companyrecognizes repair revenues when the product is shipped back to the customer.Service revenues contribute less than 5% of total revenue and, therefore, areconsidered to be immaterial to overall financial results.

 

*Reverse Stock Split*

 

On November 19, 2008, the Companycompleted a 1-for-3.75 reverse split of its common stock.  All common stock, stock options and warrantsto purchase common stock and earnings per share amounts have been retroactivelyrestated as if the reverse stock split occurred at the beginning of the periodspresented.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

*Income (Loss) Per Share*

 

Basic income (loss) per share is computed by dividingnet loss by the weighted average common shares outstanding during aperiod.  Diluted income (loss) per shareis based on the treasury stock method and includes the dilutive effect of stockoptions and warrants outstanding during the period.  Common share equivalents have been excludedwhere their inclusion would be anti-dilutive. As a result of the loss incurred by the Company for the three monthperiods ended June 30, 2009 and 2008, and for the six month period ended June 30,2008, the potentially dilutive common shares have been excluded from the lossper share computation because their inclusion would have beenanti-dilutive.  The following tableillustrates the computation of basic and diluted income (loss) per share (inthousands, except per share amounts):

 
| ** **                                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                          | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                          | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                          | ** ** | **(Restated)**         | ** ** | ** **           | ** ** | **(Restated)** | ** ** | ** ** | ** ** |
| NUMERATOR:                                          |       |                   |       |                 |       |   |   |   |   |
| Net  income (loss)                                  |       | $                      | (461       | )                    | $          | (256 | ) | $ | 4,424 |   | $ | (1,153 | ) |
|                                                |       |                   |       |                 |       |   |   |   |   |
| DENOMINATOR:                                        |       |                   |       |                 |       |   |   |   |   |
| Basic  weighted average common shares outstanding   |       | 10,205                 |       | 10,204               |       | 10,205 |   | 10,204 |   |
| Effect  of dilutive securities:                     |       |                   |       |                 |       |   |   |   |   |
| Dilutive  stock options and warrants                |       | —                 |       | —               |       | — |   | — |   |
| Diluted  weighted average common shares outstanding |       | 10,205                 |       | 10,204               |       | 10,205 |   | 10,204 |   |
|                                                |       |                   |       |                 |       |   |   |   |   |
| Basic  income (loss) per share                      |       | $                      | (0.05      | )                    | $          | (0.03 | ) | $ | 0.43 |   | $ | (0.11 | ) |
|                                                |       |                   |       |                 |       |   |   |   |   |
| Diluted  income (loss) per share                    |       | $                      | (0.05      | )                    | $          | (0.03 | ) | $ | 0.43 |   | $ | (0.11 | ) |

 

The following table shows the common stock equivalentsthat were outstanding as of June 30, 2009 and 2008, but were not includedin the computation of diluted earnings per share as a result of the lossincurred by the Company in the three month periods ended June 30, 2009 and2008, and for the six month period ended June 30, 2008 or because theoptions’ or warrants’ exercise price was greater than the average market priceof the common shares and, therefore, the effect would have been anti-dilutive:

 
| ** **                            | ** ** | ** **    | ** ** | **Range of**       | ** ** |
|---------------------------------------|------------|---------------|------------|--------------------|------------|
| ** **                            | ** ** | **Number of** | ** ** | **Exercise Price** | ** ** |
| ** **                            | ** ** | **Shares**    | ** ** | **Per Share**      | ** ** |
|                                  |       |          |       |               |       |
| Anti-dilutive  common stock options:  |       |          |       |               |       |
| As  of June 30, 2009             |       | 651,000       |       | $1.53 – $7.50 |       |
| As  of June 30, 2008             |       | 282,000       |       | $0.75 – $7.50 |       |
|                                  |       |          |       |               |       |
| Anti-dilutive  common stock warrants: |       |          |       |               |       |
| As  of June 30, 2009             |       | 1,804,000     |       | $4.31 – $6.49 |       |
| As  of June 30, 2008             |       | 1,798,000     |       | $4.13 – $6.49 |       |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

*Recent Accounting Pronouncements*

 

In February 2007, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)No. 159, “The Fair Value Option for Financial Assets and FinancialLiabilities.” SFAS No. 159 permits an entity to irrevocably elect fairvalue on a contract-by-contract basis as the initial and subsequent measurementattribute for many financial assets and liabilities and certain other itemsincluding insurance contracts. Entities electing the fair value option would berequired to recognize changes in fair value in earnings and to expense upfrontcost and fees associated with the item for which the fair value option iselected. SFAS No. 159 is effective for fiscal years beginning after November 15,2007. The adoption of SFAS No. 159 did not have a material effect on theCompany’s financial condition or results of operations.

 

In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements.” This statement provides a single definition of fairvalue, together with a framework for measuring it, and requires additionaldisclosure about the use of fair value to measure assets and liabilities. SFAS No. 157also emphasizes that fair value is a market-based measurement, not anentity-specific measurement, and sets out a fair value hierarchy, with thehighest priority being quoted prices in active markets. The required effectivedate of SFAS No. 157 was the first quarter of 2008. The adoption of SFAS No. 157for financial assets and liabilities did not have a material effect on theCompany’s consolidated financial statements, but resulted in additionaldisclosures contained herein.  In February 2008,the FASB issued Staff Position No. 157-2, which delayed by one year theeffective date of SFAS No. 157 for all non-financial assets andliabilities, except those that are recognized or disclosed at fair value in thefinancial statements on a recurring basis. The Company has evaluated the impact of the adoption of SFAS No. 157for non-financial assets and liabilities and has determined that the adoptionof SFAS No. 157-2 did not have a material effect on its consolidatedfinancial statements.

 

In December 2007, the FASB issued SFAS No. 141R,“Business Combinations,” which replaced SFAS No. 141, “BusinessCombinations.”  SFAS No. 141Restablishes principles and requirements for determining how an enterpriserecognizes and measures the fair value of certain assets and liabilitiesacquired in a business combination, including noncontrolling interests,contingent consideration and certain acquired contingencies.  SFAS No. 141R also requiresacquisition-related transaction expenses and restructuring costs be expensed asincurred rather than capitalized as a component of the businesscombination.  SFAS No. 141R iseffective for fiscal years beginning after December 15, 2008.  SFAS No. 141R will be applicableprospectively to business combinations for which the acquisition date is on orafter January 1, 2009.  SFAS No. 141Rwill have an impact on accounting for any business acquired after the effectivedate of this pronouncement.

 

In March 2008, the FASB issued SFAS No. 161,“Disclosures about Derivative Instruments and Hedging Activities.” The newstandard amends SFAS No. 133 and seeks to enhance disclosure about how andwhy a company uses derivative and hedging activities, how derivativeinstruments and related hedged items are accounted for under SFAS No. 133(and the interpretations of that standard) and how derivatives and hedgingactivities affect a company’s financial position, financial performance andcash flows.  SFAS No. 161 iseffective for financial statements issued for fiscal years and interim periodsbeginning after November 15, 2008. The adoption of SFAS No. 161 did not have a material effect on theCompany’s consolidated financial statements.

 

In April 2008, the FASB issued FASB StaffPosition (“FSP”) No. FAS 142-3, “Determination of the Useful Life ofIntangible Assets,” (“FSP 142-3”). FSP 142-3 amends the factors that should beconsidered in developing renewal or extension assumptions used to determine theuseful life of a recognized intangible asset under SFAS No. 142, “Goodwilland Other Intangible Assets” and also requires expanded disclosure related tothe determination of intangible asset useful lives. FSP 142-3 is effective forfiscal years beginning after December 15, 2008. Early adoption isprohibited. The adoption of FSP 142-3 did not have a material effect on theCompany’s consolidated financial statements.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

In June 2008, the FASB ratified the consensusreached on EITF Issue No. 07-5, “Determining Whether an Instrument (orEmbedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5clarifies the determination of whether an instrument (or an embedded feature)is indexed to an entity’s own stock, which would qualify as a scope exceptionunder SFAS No. 133, Accounting for Derivative Instruments and HedgingActivities. EITF 07-5 is effective for financial statements issued for fiscalyears beginning after December 15, 2008. Early adoption for an existinginstrument is not permitted. The Company adopted EITF 07-5 on January 1,2009. See Note 13 **—**Warrants belowfor discussion of the impact of the adoption of EITF 07-5 on the Company’soutstanding stock warrants and its consolidated financial statements.

 

In April 2009, the FASB issued FSP No FAS 107-1and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSPFAS 107-1 and APB 28-1”), which amends SFAS No. 107, “Disclosures aboutFair Value of Financial Instruments,” to require disclosures about fair valueof financial instruments in interim as well as in annual financialstatements.  FSP No. FAS 107-1 andAPB 28-1 also amends APB Opinion No. 28, “Interim Financial Reporting,” torequire those disclosures in all interim financial results, financial positionand financial statement disclosures.  FSPFAS 107-1 and APB 28-1 is effective for periods ending after June 15,2009.  The Company has adopted FSP FAS107-1 and APB 28-1 and believes it has all of the required disclosures withinthis report.

 

In May 2009, the FASB issued SFAS No. 165, “SubsequentEvents” (“SFAS No. 165”) effective for interim or annual financial periodsending after June 15, 2009.  Forcalendar year entities, SFAS No. 165 became effective for the three monthsended June 30, 2009.  The objectiveof SFAS No. 165 is to establish general standards of accounting for anddisclosure of events that occur after the balance sheet date but beforefinancial statements are issued or are available to be issued.  In particular, SFAS No. 165 sets forth (1) theperiod after the balance sheet date during which management of a reportingentity should evaluate events or transactions that may occur for potentialrecognition or disclosure in the financial statements: (2) thecircumstances under which an entity should recognize events or transactionsoccurring after the balance sheet date in its financials statements; and (3) thedisclosures that an entity should make about events or transactions thatoccurred after the balance sheet date. The adoption of SFAS No. 165 did not have a material impact on theCompany’s financial position, results of operations or cash flows.

 

In June 2009, the FASB issued SFAS No. 168, “TheFASB Accounting Standards CodificationTM and the Hierarchy of Generally AcceptedAccounting Principles — a replacement of FASB Statement No. 162” (“SFAS No. 168”)to formally establish the FASB Accounting Standards CodificationTM (the “Codification”)as the single source of authoritative, nongovernmental U.S. GAAP.  All existing accounting standards documentsare superseded as described in SFAS No. 168.  All other accounting literature not includedin the Codification is nonauthoritative. The Codification is effective for interim and annual periods endingafter September 15, 2009.  TheCompany believes the adoption of SFAS No. 168 will not have a materialimpact on its financial position, results of operations or cash flows.

 

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

 

Thefinancials statements for the period ended June 30, 2009 have beenrestated to correct an error in accounting treatment for certaintransactions.  The Company used a $7.0million of the proceeds of the sale of the Digitran Operations on March 20, 2009 to repay aportion of the Term Loan B (as defined in Note 12 below), and did notproperly accelerate the pro-rata portion of the deferred financing costs anddebt discount associated with its credit facility related to the repayment. As a result of the partial repayment onTerm Loan B, a pro-rata portion of the balance of deferred financing costs anddebt discount were accelerated and are reflected as a decrease of $81,000 andan increase of $460,000 to interest expense in the accompanying CondensedConsolidated Statements of Operations for the three and six months ended June 30,2009, 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

respectively.  The adjustment also impacted the net carryingvalue of long term debt by $259,000 and other various balance sheet items.  Additionally, the Company incorrectlyclassified the issuance of a note relating to a purchase price adjustment on June 30,2009 as a cash item in its financial statements rather than a supplementaldisclosure item.  As a result, the Company is restating its financialstatements for the interim periods ended March 31, 2009 and June 30,2009.

 

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

 

***Balance Sheet***

 
| ** **                                       | ** ** | **June 30, 2009** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|
| ** **                                       | ** ** | **As reported**        | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                             |       |                   |       |   |   |   |   |
| Other  current assets                            |       | $                      | 1,429      |   | $ | (127 | ) | $ | 1,302 |   |
|                                             |       |                   |       |   |   |   |   |
| Total  current assets                            |       | $                      | 28,873     |   | $ | (127 | ) | $ | 28,746 |   |
|                                             |       |                   |       |   |   |   |   |
| Other  assets                                    |       | $                      | 415        |   | $ | (113 | ) | $ | 302 |   |
|                                             |       |                   |       |   |   |   |   |
| Total  assets                                    |       | $                      | 53,285     |   | $ | (240 | ) | $ | 53,045 |   |
|                                             |       |                   |       |   |   |   |   |
| Income  taxes payable                            |       | $                      | 891        |   | $ | (125 | ) | $ | 766 |   |
|                                             |       |                   |       |   |   |   |   |
| Total  current liabilities                       |       | $                      | 21,481     |   | $ | (125 | ) | $ | 21,356 |   |
|                                             |       |                   |       |   |   |   |   |
| Long-term  debt                                  |       | $                      | 6,672      |   | $ | 220 |   | $ | 6,892 |   |
|                                             |       |                   |       |   |   |   |   |
| Total  liabilities                               |       | $                      | 34,075     |   | $ | 95 |   | $ | 34,170 |   |
|                                             |       |                   |       |   |   |   |   |
| Accumulated  deficit                             |       | $                      | (22,869    | ) | $ | (335 | ) | $ | (23,204 | ) |
|                                             |       |                   |       |   |   |   |   |
| Total  stockholder’s equity                 |       | $                      | 19,210     |   | $ | (335 | ) | $ | 18,875 |   |
|                                             |       |                   |       |   |   |   |   |
| Total  liabilities and stockholder’s equity |       | $                      | 53,285     |   | $ | (240 | ) | $ | 53,045 |   |

 

***Statement ofOperations***

 
| ** **                            | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**   | ** ** |
|---------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                            | ** ** | **June 30, 2009** | ** ** | **June 30, 2009** | ** ** |
| ** **                            | ** ** | **As reported**        | ** ** | **Adjustment**         | ** ** | **Restated** | ** ** | **As reported** | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                  |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Interest  expense                     |       | $                      | (923       | )                      | $          | 81 |   | $ | (842 | ) | $ | (1,938 | ) | $ | (460 | ) | $ | (2,398 | ) |
|                                  |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Pre-tax  income                       |       | $                      | (294       | )                      | $          | 81 |   | $ | (213 | ) | $ | (1,417 | ) | $ | (460 | ) | $ | (1,877 | ) |
|                                  |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Provision  (benefit) for income taxes |       | 117                    |       | 28                     |       | 145 |   | (233 | ) | (125 | ) | (358 | ) |
|                                  |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Net  income                           |       | $                      | (514       | )                      | $          | 53 |   | $ | (461 | ) | $ | 4,759 |   | $ | (335 | ) | $ | 4,424 |   |
|                                  |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Earnings  (loss) per share:           |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Basic                                 |       | $                      | (0.05      | )                      | $          | — |   | $ | (0.05 | ) | $ | 0.47 |   | $ | (0.04 | ) | $ | 0.43 |   |
| Diluted                               |       | $                      | (0.05      | )                      | $          | — |   | $ | (0.05 | ) | $ | 0.47 |   | $ | (0.04 | ) | $ | 0.43 |   |
|                                  |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Weighted  average shares outstanding  |       |                   |       |                   |       |   |   |   |   |   |   |   |   |
| Basic                                 |       | 10,205                 |       | 10,205                 |       | 10,205 |   | 10,205 |   | 10,205 |   | 10,205 |   |
| Diluted                               |       | 10,205                 |       | 10,205                 |       | 10,205 |   | 10,205 |   | 10,205 |   | 10,205 |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

***Statement of CashFlows***

 
| ** **                                               | ** ** | **Six Months Ended**   | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|
| ** **                                               | ** ** | **June 30, 2009** | ** ** |
| ** **                                               | ** ** | **As reported**        | ** ** | **Adjustment** | ** ** | **Restated** | ** ** |
|                                                     |       |                   |       |   |   |   |   |
| Net  income (loss)                                       |       | $                      | 4,759      |   | $ | (335 | ) | $ | 4,424 |   |
|                                                     |       |                   |       |   |   |   |   |
| Net  loss from continuing operations                     |       | $                      | (1,184     | ) | $ | (335 | ) | $ | (1,519 | ) |
|                                                     |       |                   |       |   |   |   |   |
| Reconciliation  to net cash used in operating activities |       |                   |       |   |   |   |   |
| Amortization  of deferred issuance costs                 |       | $                      | 279        |   | $ | 240 |   | $ | 519 |   |
| Amortization  of debt discount                           |       | $                      | 255        |   | $ | 220 |   | $ | 475 |   |
|                                                     |       |                   |       |   |   |   |   |
| Changes  in assets and liabilities                       |       |                   |       |   |   |   |   |
| Accounts  payable and accrued expenses                   |       | $                      | (978       | ) | $ | (125 | ) | $ | (1,103 | ) |

 

**NOTE 3 — LIQUIDITY, AS RESTATED**

 

TheCompany reported a net loss for the quarter ended June 30, 2009 of $0.5million and net income for the six months ended June 30, 2009 of $4.4million.  Included in net income for thesix month period was a $5.9 million gain (net of tax of $1.3 million) on thedisposition of the Digitran Operations (see Note 5).  Absent this gain, the Company would haveincurred a $1.5 million net loss for the six months ended June 30,2009.  If the Company’s net losses continue, it mayexperience negative cash flow, which may hamper current operations and mayprevent the Company from expanding its business.  Additionally, such losses may result in adefault on the Company’s debt covenants associated with its creditfacility.  The Company may be unable toattain, sustain or increase profitability on a quarterly or annual basis in thefuture. If the Company does not achieve, sustain or increase profitability, itsstock price may decline.

 

The Company has agreedwith its lender to raise at least $3 million in net cash proceeds through thesale of stock of the Company or its subsidiaries by no later than December 31,2009.  Under the terms of the Company’scredit facility, the Company is obligated to remit to its lender 50% of thefirst $3 million of net cash proceeds received and 30% of the net cash proceedsreceived in excess of the first $3 million.   Given current economic and financial market conditions, an equityraise could prove difficult.  Accordingly, no assurances can be made that the Company will besuccessful in raising the required amount of equity capital by December 31,2009.  If the Company is successful in structuringan equity raise acceptable to the Company and its lender, the issuance ofequity securities may result in substantial dilution to the Company’sstockholders.

 

Currently,the Company is in the process of seeking alternate financing from a number ofpossible lenders, including traditional lenders, private equity and mezzaninelenders.  Although the Company remainshopeful that it will be able to successfully secure replacement financing on atimely basis, no assurances can be made that the Company will be successful inthis regard.

 

The Company is obligatedto make principal payments to its lender of (i) $75,000 on September 1.2009 and October 1, 2009, (ii) $100,000 on November 1, 2009, (iii) $150,000 on December 1, 2009 and (iv) approximately $287,000  commencing on January 1, 2010 andcontinuing on the first day of each of the 10 consecutive months thereafter.

 

If the Company cannotmeet or successfully renegotiate its obligations to (i) raise $3.0 millionin equity capital by December 31, 2009, (ii) make monthly principaland interest payments, and/or  (iii) achievecertain other financial covenants, or if the lender does not waive theseobligations, then the Company would be in default under the terms of its creditfacility.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

In the event of a defaultand continuation of a default, the lender may limit future availability underthe Revolver (as defined in Note 11) and/or accelerate the payment of allprincipal balances and accrued interest requiring the Company to pay the entireindebtedness under the  credit facilityoutstanding on that date.  Upon the occurrence and during the continuationof an event of default, the lender may also elect to increase the interest rateapplicable to the outstanding balance of the Term Loans A and B (as defined inNote 10) by four percentage points above the per annum interest rate that wouldotherwise be applicable.  Any of these conditions could have a materialadverse effect on the Company’s operations and/or ability to conduct businessafter that date.  Additionally, if the lender terminates the creditfacility during a default period or if the Company prepays the Revolver or theTerm Loans prior to November 30, 2009, then the Company is subject to apenalty equal to 2% of the outstanding principal balance of the Revolver andthe Term Loans.

 

Recent actions taken bythe Commission against Private Equity Management Group, Inc., an affiliateof the Company’s lender, including an order granted in April 2009 by afederal court freezing all assets of Private Equity Management Group, Inc.and its affiliates, including the Company’s lender, may adversely affect theCompany’s lender’s ability to continue to provide the Company funds under theterms of the Revolver.  At the request of the Commission, the federalcourt also appointed a temporary receiver of Private Equity Management Group, Inc.and the Company’s lender.  Although the Company currently believes thatthe receiver will allow the Company to continue to borrow funds under the termsof the Revolver, no assurances can be made that the receiver will allow theCompany’s lender to continue to make funds available to the Company.  If,for any reason, the receiver were to limit or terminate the Company’s abilityto continue to borrow funds under the Revolver, the Company’s cash position andits ability to continue day to day operations would be adversely affected,almost immediately.  If that were to occur, the Company would be requiredto seek additional and/or replacement financing immediately.  If the Company were unable to do so, theCompany may be forced to drastically curtail or cease operations and possiblyseek protection from its creditors under the U.S. Bankruptcy Code.

 

If the Company issuccessful in raising $3.0 million in equity capital by December 31, 2009as required by the Company’s lender under the terms of the credit facility andis able to continue to borrow funds under the terms of the Revolver, managementof the Company believes that current and future capital resources, revenuesgenerated from operations and other existing sources of liquidity will beadequate to meet its anticipated short term, working capital and capitalexpenditures needs for the next 12 months.

 

If, however, for anyreason including the reasons described above, the Company is unsuccessful inraising additional equity capital as required under the terms of the creditfacility thereby resulting in an event of default under the credit facility oris unable to continue to borrow funds under the terms of the Revolver, theCompany does not believe that current and future capital resources, revenuesgenerated from operations and other existing sources of liquidity will beadequate to meet its anticipated short term, working capital and capitalexpenditures needs for the next 12 months.  Further, if for any reason,the Company is not able to continue to borrow funds under the terms of theRevolver or if it experiences a significant loss of revenue or increase incosts, then its cash flow would be negatively impacted resulting in a cash flowdeficit which, in turn, will require it to obtain additional or alternatefinancing, with little or no notice.  These potential financing needscould be met in the form of a revised debt structure with the Company’s currentlender, additional or new financing with another lender or lenders, the sale ofassets to generate cash or the sale of additional equity to raise capital. Failure to secure additional or alternate financing, if and when needed,would have an adverse effect on the Company’s operations and/or ability to dobusiness after that date or could restrict the Company’s growth, limit itsdevelopment of new products, or hinder its ability to fulfill existing orfuture orders.

 

**NOTE 4 — ACQUISITION OF ADVANCEDCONTROL COMPONENTS**

 

OnMay 23, 2008, the Company and its wholly-owned subsidiary, EEC, enteredinto a Stock Purchase Agreement (the “Stock Purchase Agreement”) pursuant towhich EEC agreed to acquire Custom Components, Inc. (“CCI”) and itsoperating subsidiary, Advanced Control Components, Inc. (“ACC”).  On August 20,2008, 

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

theStock Purchase Agreement was amended pursuant to Amendment No. 1 to StockPurchase Agreement (the “Amendment to Purchase Agreement,” and collectivelywith the Stock Purchase Agreement, the “ACC Purchase Agreement”) to, amongother things, reduce the initial purchase price for all of the capital stock ofboth CCI and ACC to $12,400,000, subject to adjustments for working capital andnet cash.  Additionally, pursuant to the terms of the Amendment toPurchase Agreement, the Company is obligated to pay interest on a principalamount of $600,000 at a rate equal to the prime rate as reported in *The Wall Street Journal *on August 20,2008 plus 1% for the period commencing on August 20, 2008 and ending onthe later of November 18, 2008 or the actual date such interest payment ismade.

 

Theclosing of the ACC Purchase Agreement occurred on August 20, 2008. Under the terms of the ACC Purchase Agreement, EEC acquired all of the issuedand outstanding shares of common stock of CCI and all of the issued and outstandingshares of common stock of ACC not owned by CCI (the “Acquisition”).  Inaddition to the purchase price, the Company is obligated to pay up to anadditional $3,000,000 in cash if ACC meets certain operating income targets forone or both of the two 12 month periods following the closing. Additionally, EEC issued Subordinated Secured Contingent Promissory Notes (the “Notes”)to each of the Sellers in the aggregate principal amount of $2,000,000. The Notes become payable if ACC meets certain operating income thresholdsduring the first and second 12 month periods after August 20, 2008. The Notes bear interest at a rate per annum equal to the prime rate asreported in *The Wall StreetJournal *plus 1%.  As of June 30,2009, ACC had met its operating income targets associated with the Notes and assuch the Company recorded a note payable of $2,000,000, which resulted in anadjustment to the net assets acquired. Additionally, the Company recorded $1.2 million in notes payablerepresenting an adjustment to working capital and net cash.  The Company expects to record additionalpurchase price adjustments associated with the contingent cash obligation whensuch obligation is earned.

 

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

 

Inconnection with the Acquisition, the Company commissioned a valuation firm toassist it in determining the fair value of ACC’s tangible assets and theportion of the purchase price that should be allocated to identifiableintangible assets.  The Companyconsidered whether the Acquisition included various types of identifiableintangible assets, including trade names, trademarks, patents, covenants not tocompete, customers, backlog, workforce, technology and software.  As a result of the procedures performed bythe valuation firm and the evaluation of management, the Company determined andrecorded the value of the tangible and intangible assets in its CondensedConsolidated Balance Sheets in accordance with the purchase priceallocation.  The Company has estimatedand recorded the identified intangible assets as follows:  trade name of $1,570,000; covenant not tocompete of $60,000; backlog of $570,000; and customer relationships of$2,550,000.

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

| Accounts receivable                      |   | $      | 2,330  |   |
|------------------------------------------|--------|--------|--------|--------|
| Inventories                              |   | 1,848  |   |
| Property and equipment                   |   | 1,545  |   |
| Intangible assets, net                   |   | 4,750  |   |
| Goodwill                                 |   | 3,928  |   |
| Other assets                             |   | 244    |   |
| Total assets acquired                    |   | 14,645 |   |
| Accounts payable and accrued liabilities |   | (1,678 | )      |
| Other liabilities                        |   | (611   | )      |
| Total liabilities assumed                |   | (2,289 | )      |
| Net assets acquired                      |   | $      | 12,356 |   |

 

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

 

| ** **                            | ** ** | **For the Three** | ** ** | **For the Six**   | ** ** |
|---------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                            | ** ** | **Months Ended**  | ** ** | **Months Ended**  | ** ** |
| ** **                            | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
| ** **                            | ** ** | **2008**          | ** ** | **2008**          | ** ** |
|                                  |       |              |       |              |       |
| Net  sales                            |       | $                 | 17,256     |              | $          | 32,053 |   |
|                                  |       |              |       |              |       |
| Net  loss                             |       | $                 | (1,241     | )                 | $          | (3,224 | ) |
|                                  |       |              |       |              |       |
| Loss  per share:                      |       |              |       |              |       |
| Basic                                 |       | $                 | (0.12      | )                 | $          | (0.32 | ) |
| Diluted                               |       | $                 | (0.12      | )                 | $          | (0.32 | ) |
|                                  |       |              |       |              |       |
| Weighted  average shares outstanding: |       |              |       |              |       |
| Basic                                 |       | 10,204            |       | 10,204            |       |
| Diluted                               |       | 10,204            |       | 10,204            |       |

 

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**EMRISECORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 5 — DISCONTINUED OPERATIONS**

 

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

 

TheBuyer acquired all of the intellectual property, cash, accounts receivable,inventory, customer support and relationships, software and 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 noncompetition andnon-solicitation provisions covering the Company, EEC and each of theirrespective affiliates.  In addition, the Company and EEC providedcustomary indemnification rights to the Buyer and Stock Buyer in connectionwith the Disposition.

 

In connection with theCompany’s divestiture of its Digitran division, which comprised a portion ofthe Company’s electronic devices segment, the Company incurred approximately$900,000 in cash charges that were paid at closing.  The charges paid atclosing included approximately $100,000 in employee terminationcosts. Subsequent to closing, the Company paid $280,000 of previouslyaccrued costs, including a portion of the federal and state income taxliabilities, employee termination costs and transaction related employeebonuses and legal fees.  At June 30,2009, the Company estimates future cash expenditures related to the sale to beapproximately $280,000, which were accrued within “Accrued liabilities” exceptfor income taxes, which were accrued within “Income taxes payable” in theaccompanying condensed consolidated balance sheets.   In addition, the Company has accrued $308,000related to a purchase price adjustment owed to the Buyer in connection with thetransaction.

 

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**EMRISECORPORATION**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 
| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                         | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                         | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                               |       |                   |       |                 |       |   |   |   |   |
| Net Sales                                                          |       | $                      | —     |                 | $          | 2,027 |   | $ | 1,478 |   | $ | 3,631 |   |
| Income from continuing  operations                                 |       | $                      | —     |                 | $          | 625 |   | $ | 178 |   | $ | 996 |   |
| Gain (loss) on sale of  Digitran Operations (net of tax of $1,345) |       | (103                   | )          | —               |       | 5,943 |   | — |   |
| Net (loss) Income                                                  |       | $                      | (103       | )                    | $          | 625 |   | $ | 6,121 |   | $ | 996 |   |
|                                                               |       |                   |       |                 |       |   |   |   |   |
| (Loss) earnings per  share:                                        |       |                   |       |                 |       |   |   |   |   |
| Basic                                                              |       | $                      | (0.01      | )                    | $          | 0.06 |   | $ | 0.60 |   | $ | 0.10 |   |
| Diluted                                                            |       | $                      | (0.01      | )                    | $          | 0.06 |   | $ | 0.60 |   | $ | 0.10 |   |
|                                                               |       |                   |       |                 |       |   |   |   |   |
| Weighted average shares  outstanding                               |       |                   |       |                 |       |   |   |   |   |
| Basic                                                              |       | 10,205                 |       | 10,204               |       | 10,205 |   | 10,204 |   |
| Diluted                                                            |       | 10,205                 |       | 10,204               |       | 10,205 |   | 10,204 |   |

 

**NOTE 6 — STOCK-BASED COMPENSATION**

 

The Company has fivestock option plans:

 

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

·      1993 Stock Option Plan;

·      1997 Stock Incentive Plan;

·      Amended and Restated 2000 Stock Option Plan; and

·      2007 Stock Incentive Plan.

 

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

 

Total stock-based compensation expense included inwages, salaries and related costs was $41,000 and $11,000 for the three monthsended June 30, 2009 and 2008, respectively and $75,000 and $29,000 for thesix months ended June 30, 2009 and 2008, respectively.  These compensation expenses were charged toselling, general and administrative expenses. As of June 30, 2009, theCompany had $307,000 of total unrecognized compensation expense related tostock option grants, which will be recognized over the remaining weightedaverage period of two years.

 

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**EMRISECORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 7 — INVENTORIES**

 

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

 
| ** **        | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|-------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2009**          | ** ** | **2008**              | ** ** |
|              |       |              |       |                  |       |
| Raw materials     |       | $                 | 10,776     |                  | $          | 10,093 |   |
| Work-in-process   |       | 3,405             |       | 3,319                 |       |
| Finished goods    |       | 4,385             |       | 4,311                 |       |
| Reserves          |       | (5,650            | )          | (5,222                | )          |
| Total inventories |       | $                 | 12,916     |                  | $          | 12,501 |   |

 

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

 

**NOTE 8 — OPERATING SEGMENTS, ASRESTATED**

 

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

 

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

 

During the first quarter of 2009, the Company sold itsDigitran Operations (see Note 5), which were part of its electronic devicessegment.  This transaction resulted indifferences in the basis of segmentation from the amounts disclosed in theCompany’s audited consolidated financial statements included in its annual reporton Form 10-K for the year ended December 31, 2008.  In this report, the Digitran Operations arereported as a discontinued operation and are excluded from the electronicsdevices segment.  Therefore, prior periodamounts have been adjusted to conform with this presentation.  Included in the Company’s reconciliation ofsegment financial data to the consolidated amounts is unallocated corporateexpenses.

 

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**EMRISECORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Selected financial data for each of the Company’soperating segments reconciled to the consolidated totals is shown below (inthousands):

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net sales                 |       |                   |       |                 |       |   |   |   |   |
| Electronic devices        |       | $                      | 11,649     |                 | $          | 8,160 |   | $ | 23,244 |   | $ | 15,443 |   |
| Communications  equipment |       | 2,621                  |       | 3,862                |       | 5,239 |   | 7,222 |   |
| Discontinued Operations   |       | —                 |       | 2,027                |       | — |   | 3,631 |   |
| Total                     |       | $                      | 14,270     |                 | $          | 14,049 |   | $ | 28,483 |   | $ | 26,296 |   |
|                      |       |                   |       |                 |       |   |   |   |   |
| Operating income (loss)   |       |                   |       |                 |       |   |   |   |   |
| Electronic devices        |       | $                      | 1,932      |                 | $          | 663 |   | $ | 3,494 |   | $ | 1,116 |   |
| Communications  equipment |       | (466                   | )          | (90                  | )          | (917 | ) | (72 | ) |
| Discontinued Operations   |       | —                 |       | 625                  |       | — |   | 996 |   |
| Corporate and other       |       | (1,070                 | )          | (997                 | )          | (2,293 | ) | (2,069 | ) |
| Total                     |       | $                      | 396        |                 | $          | 201 |   | $ | 284 |   | $ | (29 | ) |

 
| ** **                | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------|------------|-------------------|------------|-----------------------|------------|------------|------------|------------|------------|
| ** **                | ** ** | **2009**          | ** ** | **2008**              | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                | ** ** | **(Restated)**    | ** ** | ** **            | ** ** |       |       |       |       |
| Total assets              |       |              |       |                  |       |       |       |       |       |
| Electronic devices        |       | $                 | 35,925     |                  | $          | 34,853     |       |       |       |   |   |
| Communications  equipment |       | 8,952             |       | 10,260                |       |       |       |       |       |
| Discontinued Operations   |       | —            |       | 3,600                 |       |       |       |       |       |
| Corporate and other       |       | 8,168             |       | 4,910                 |       |       |       |       |       |
| Total                     |       | $                 | 53,045     |                  | $          | 53,623     |       |       |       |   |   |

 

**NOTE 9 — GOODWILL**

 

The following tablereflects changes in the Company’s goodwill balances, by segment, for the sixmonths ended June 30, 2009 (in thousands):

 
| ** **                                      | ** ** | **Electronic** | ** ** | **Communications** | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|----------------|------------|--------------------|------------|------------|------------|
| ** **                                      | ** ** | **Devices**    | ** ** | **Equipment**      | ** ** | **Total**  | ** ** |
|                                            |       |           |       |               |       |       |       |
| Balance at  December 31, 2008              |       | $              | 9,657      |               | $          | —     |       | $ | 9,657 |   |
| Purchase price  adjustment for ACC (see Note 3) |       | 3,116          |       | —             |       | 3,116      |       |
| Foreign currency  translation                   |       | 595            |       | —             |       | 595        |       |
| Balance at  June 30, 2009                  |       | $              | 13,368     |               | $          | —     |       | $ | 13,368 |   |

 

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**EMRISECORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 10 —INCOME TAXES**

 

The effective tax rate for the three month periodended June 30, 2009 was different than the 34% U.S. statutory rateprimarily because the Company’s foreign entities generate a tax obligation andrelated tax expense as a result of their net income, which cannot be offset byU.S. tax loss carryforwards.

 

The Company adopted FIN 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASBStatement No. 109,” on January 1, 2007. The implementation ofFIN 48 did not result in a material adjustment to the Company’s liability forunrecognized income tax benefits. At the time of adoption, and as of June 30,2009, the Company had recorded no net unrecognized tax benefits.

 

The Company recognizes interest and penalties relatedto uncertain tax positions in interest expense and selling, general andadministrative expense, respectively, in the condensed consolidated statementsof operations and comprehensive income. No interest or penalties wererecognized during 2008. As of June 30, 2009, the Company had nothingaccrued for interest and penalties.

 

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

 

**NOTE 11 — LINE OF CREDIT**

 

The Company and itsdirect subsidiaries, EEC, CXR Larus Corporation and RO Associates Incorporated(collectively, the “Borrowers”), are parties to a Credit Agreement (as amendedfrom time to time the “Credit Agreement”) with GVEC Resource IV Inc. (the “Lender”)providing for a credit facility which includes term loans and a revolvingcredit facility and is secured by accounts receivable, other rights to paymentand general intangibles, inventories and equipment. The credit facilityincludes a one year revolving credit facility for up to $7,000,000 that may berenewed up to two times, each for a period of one year, at the Company’s option,provided that certain conditions precedent are met (the “Revolver”).  The credit facility also includes two termloans (see Note 12).

 

The Revolver isformula-based and which generally provides that the outstanding borrowingsunder the line of credit may not exceed an aggregate of 85% of eligibleaccounts receivable, plus 10% of the value of eligible raw materials not toexceed $600,000, plus 50% of the value of eligible finished goods inventory notto exceed $1,500,000, minus the aggregate amount of reserves that may beestablished by the Lender.  The Revolverhas a maturity date of November 30, 2009 unless it is renewed, in whichcase the maturity date will be extended to November 30, 2010.

 

Interest on the Revolveris payable monthly.  The interest rate isvariable and is adjusted monthly based on the prime rate as published in the “MoneyRates” column of *The Wall Street Journal* (the “BaseRate”) plus 1.25%, subject to a minimum rate of 9.5% per annum.  The interest rate in effect as of June 30,2009 was the minimum rate of 9.5%.  TheRevolver is subject to various financial covenants on a consolidated basis,including the following: EBITDA, measured on a fiscal quarter-end basis, mustnot be less than the scheduled amount for each specified period; the debtservice coverage ratio, measured quarterly, must be greater than the lesser ofthe scheduled amount for each specific period or 1.10:1.00; the leverage ratio,measured quarterly, must not be greater than the scheduled amount for eachspecified period, and liquidity, measured quarterly, must not be less than thescheduled amount for each specified period. Additionally, the Revolver is subject to the Borrowers not incurringcapital expenditures (a) in excess of $600,000 for the fiscal year ending December 31,2009, and (b) in excess of $1,800,000 for the fiscal year ending December 31,2010.  Additionally, the Revolver is subject to the 

 

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**EMRISECORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Borrowers not incurringunfinanced capital expenditures in excess of $62,500 in any fiscal quarter.However, if the borrowers incur unfinanced capital expenditures of less than$62,500 in any fiscal quarter, the difference between the amount incurred in acertain fiscal quarter and $62,500 maybe incurred in the two fiscal quartersimmediately following such fiscal quarter. The Company was in compliance withall covenants at June 30, 2009.

 

Asof June 30, 2009, the Company had outstanding borrowings of $5.6 millionunder the Revolver with remaining availability under the formula-basedcalculation of $1.4 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 Note3 “Liquidity” and Note 12 “Long Term Debt” regarding additional terms andconditions associated with the overall credit facility and risks associatedwith this credit facility.

 

**NOTE 12 — LONG-TERM DEBT, ASRESTATED**

 

On August 20, 2008, in connection with the acquisitionof ACC and CCI as discussed in Note 4, the Borrowers and the Lender amended thecredit facility to, among other things, include ACC and CCI as Borrowers and toprovide for another term loan in the principal amount of $3 million (the “TermLoan C”).  The credit facility, as soamended, provided for borrowings in the aggregate amount of $26 million,including the $7 million revolving facility described in Note 11.

 

The credit facilityconsists of (i) the Revolver, (ii) a term loan in the principal amountof $6 million which is due November 30, 2010 (“Term Loan A”), (iii) aterm loan in the original principal amount of $10 million, which is due on November 30,2010 (“Term Loan B”), and (iv) Term Loan C.  Term Loan A was fully funded on November 30,2007 while Term Loans B and C were fully funded on August 20, 2008 inconnection with the acquisition of ACC. Term Loan A and Term Loan B requirescheduled principal and interest payments commencing September 2009 and afinal balloon payment of principal upon maturity on November 30,2010.  Term Loan C was repaid in full on March 20,2009.  At June 30, 2009, theoutstanding principle balance on Term Loan A was $5.8 million and theoutstanding principle balance on Term Loan B was $3.0 million.  As a result of the partial repayment on TermLoan B, a pro-rata portion of the balance of deferred financing costs and debtdiscount were accelerated and are reflected as an adjustment to interestexpense in the accompanying Condensed Consolidated Statements of Operations.

 

The Term Loans A and B bearinterest at the Base Rate plus 4.25%, subject to a minimum rate of 12.5% perannum, and require interest only payments in the first year, scheduledprincipal plus interest payments in years two and three, and a final balloon paymentat the end of year three.  Interest onthe Term Loans is payable monthly.  The Borrowers may make full or partialprepayment of the Term Loans provided that any such prepayment is accompaniedby the applicable prepayment premium.

 

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

 

Uponthe sale or disposition by the Borrowers or any of their subsidiaries ofproperty or assets, the Borrowers may be obligated to prepay the Revolver andthe term loans with the net cash proceeds received in connection with suchsales or dispositions to the extent that the aggregate amount of net cashproceeds received, and not paid to the Lender as a prepayment, for all suchsales or dispositions exceed $150,000 in any fiscal year.  However, to the extent the Company sells assets after August 14,2009 and prior to January 1, 2010, 75% of the net cash proceeds of suchsale must be used to prepay the Company’s outstanding obligations to theLender.

 

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**EMRISECORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

If the Lender terminates the credit facility during adefault period or if the Company prepays the Revolver or the Term Loans priorto November 30, 2009, then the Company is subject to a penalty equal to 2%of the outstanding principal balance of the Revolver and the Term Loans. The Revolver is subject to an unused line fee of 0.5% per annum, payable monthly,on any unused portion of the revolving credit facility.

 

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

 

The Borrowers have agreed with the Lender to raise atleast $3 million in net cash proceeds through the sale of stock of theBorrowers by no later than December 31, 2009.  Under the terms of the credit facility, theBorrower’s are obligated to remit to the Lender 50% of the first $3 million ofnet cash proceeds received and 30% of the net cash proceeds received in excessof the first $3 million.  See Note 3.

 

See Note 3 andNote 11 regarding additional terms and conditions associated with the Company’scredit facility and risks associated with this credit facility.

 

**NOTE 13 — WARRANTS**

 

In connection withentering into the credit facility (discussed in Note11), the Company issued aseven year warrant to Private Equity Management Group, Inc., an affiliateof the Lender, to purchase up to 775,758 shares of the Company’s common stockon a cash or cashless basis at an exercise price of $4.13 per share.  The estimated fair value of the warrants was$1.5 million, which was calculated using the Black-Scholes pricing model.  The warrants were originally accounted for asdebt discount and the adjustment resulting from the repricing of the warrantsincreased the debt discount, which is being amortized over the remaining lifeof the credit facility.  The warrantswere previously recorded in stockholder’s equity.

 

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

 

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**EMRISECORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The exercise price and/ornumber of shares of common stock issuable upon exercise of the warrants may beadjusted in certain circumstances, including certain issuances of securities ata price equal to less than the then current exercise price, subdivisions andstock splits, stock dividends, combinations, reorganizations,reclassifications, consolidations, mergers or sales of properties and assetsand upon issuance of certain assets or securities to holders of the Company’scommon stock, as applicable. In June 2008, the FASB ratified the consensusreached on EITF Issue No. 07-5, “Determining Whether an Instrument (orEmbedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5clarifies the determination of whether an instrument (or an embedded feature)is indexed to an entity’s own stock, which would qualify as a scope exceptionunder SFAS No. 133, Accounting for Derivative Instruments and HedgingActivities. EITF 07-5 was effective for financial statements issued for fiscalyears beginning after December 15, 2008. The adoption of EITF 07-5 on January 1, 2009, resulted in thereclassification of certain of the Company’s outstanding warrants fromstockholders’ equity to liabilities, which requires the warrants to be fairvalued at each reporting period, with the changes in fair value recognized inthe Company’s consolidated statement of operations.

 

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

 
| ** **               | ** ** | **January 1,  2009** | ** ** | **June 30,  2009** | ** ** |
|--------------------------|------------|---------------------------|------------|-------------------------|------------|
| Dividend  yield          |       | None                      |       | None                    |       |
| Expected  volatility     |       | 105                       | %          | 71                      | %          |
| Risk-free  interest rate |       | 0.88                      | %          | 1.11                    | %          |
| Expected  term           |       | 7  years                  |       | 7  years                |       |
| Stock  price             |       | $                         | 1.58       |                    | $          | 1.27 |   |
|                          |            |                           |            |                         |            |  |  |

 

On January 1, 2009,the Company recorded a cumulative effect of change in accounting principleadjustment to its accumulated deficit of $473,000 and a correspondingreclassification of these outstanding warrants from stockholders’ equity towarrant liability.  As of and for thethree and six month periods ended June 30, 2009, the change in fair valueof the warrants resulted in a $293,000 and $423,000 positive adjustment,respectively, to other income (expense) in the consolidated statement ofoperations and a corresponding decrease to the warrant liability.

 

**NOTE 14 — FAIR VALUE MEASUREMENTS**

 

InSeptember 2006, the FASB issued SFAS No. 157, which defines fairvalue, establishes a framework for measuring fair value in generally acceptedaccounting principles and expands disclosures about fair value measurements.  The effective date of the statement is forall entities with fiscal years beginning after November 15, 2007.  In February 2008, the FASB issued FASBStaff Position No. 157-2, which delays the effective date of SFAS No. 157for non-financial assets and liabilities to fiscal years beginning after November 15,2008.  The delay pertains to itemsincluding, but not limited to, goodwill and other intangible assets.  The Company adopted the provisions of thestandard that were effective as of January 1, 2008.  The Company adopted the remaining provisionsof SFAS No. 157 as of January 1, 2009.

 

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

 

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**EMRISECORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

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

 

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

 

Asof June 30, 2009, the Company was required to apply SFAS No. 157provisions to the derivative that is within the warrant that was issued asconsideration for the Company’s credit facility, which is discussed in Note 12and included as a discount on the Company’s long-term debt.  The derivative was valued using theBlack-Scholes model.  The key inputs inthe model are as follows:

 
| ** **               | ** ** | **June 30,  2009** | ** ** |
|--------------------------|------------|-------------------------|------------|
| Dividend  yield          |       | None                    |       |
| Expected  volatility     |       | 71                      | %          |
| Risk-free  interest rate |       | 1.11                    | %          |
| Expected  term           |       | 7  years                |       |
| Stock  price             |       | $                       | 1.27       |   |
|                          |            |                         |            |  |

 

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

 
| ** **                                 | ** ** | **Warrant  Liability** | ** ** |
|--------------------------------------------|------------|------------------------|------------|
| Beginning  balance at January 1, 2009 |       | $                      | 1,010      |   |
| Total  gain realized in earnings           |       | (423                   | )          |
| Ending  balance at June 30, 2009      |       | $                      | 587        |   |

 

**NOTE 15 — SUBSEQUENT EVENTS, AS RESTATED**

 

Inconnection with the preparation of the Company’s financial statements at June 30,2009, subsequent events through September 30, 2009, the date the financialstatements were available for issuance, have been evaluated and the followingsubsequent events were identified:

 

On August 14, 2009, the Borrowers and the Lenderentered into an Amendment Number 5 to Loan Documents (“Amendment Number 5”)pursuant to which, among other things, (i) the Lender revised the principalrepayment schedule for the remainder of 2009, (ii) the Lender deferred the need to comply withthe liquidity financial covenant until December 31, 2009, (iii) theLender agreed that to the extent the Company sells assets after the date ofAmendment Number 5 and prior to January 1, 2010, only 75% of the net cashproceeds of such sale must be used to prepay the Company’s outstandingobligations to the Lender and (iv) the Lender replaced the Company’srequirement to raise a minimum of $2 million in equity capital on or before September 30,2009 with a new requirement to raise a minimum of $3 million in equity capitalon or before December 31, 2009. Under to the terms of Amendment Number 5, the Company is obligated toremit to the Lender 50% of the first $3 million of net cash proceeds receivedin connection with the sale of stock and 30% of the net cash proceeds in excessof the first $3 million received.

 

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**ITEM 2.****        ****MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

**CautionaryStatement**

 

The following discussion should be read in conjunctionwith our unaudited condensed consolidated financial statements and the relatednotes thereto contained in Part I, Item 1 of this Amendment No, 1 to ourQuarterly Report on Form 10-Q. The information contained in this report isnot a complete description of our business or the risks associated with aninvestment in our common stock. We urge you to carefully review and considerthe various disclosures made by us in this report and in our other reportsfiled with the Securities and Exchange Commission, or Commission, including ourAnnual Report on Form 10-K for the year ended December 31, 2008 andsubsequent reports on Forms 10-Q and 8-K, which discuss our business in greaterdetail.  This report and the followingdiscussion contain forward-looking statements within the meaning of Section 21Eof the Securities Exchange Act of 1934, as amended, which generally include theplans and objectives of management for future operations, including plans andobjectives relating to our future economic performance and our current beliefsregarding revenues we might generate and profits we might earn if we aresuccessful in implementing our business and growth strategies. Theforward-looking statements and associated risks may include, relate to or bequalified by other important factors, including, without limitation:

 

**·**      ourability to continue to borrow funds under the terms of our credit facility inlight of certain actions recently taken against Private Equity Management Group, Inc.,an affiliate of our lender by the Commission (see “ — Liquidity and CapitalResources”);

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

**·**      theprojected growth or contraction in the electronic devices and communicationsequipment markets in which we operate;

**·**      ourstrategies for expanding, maintaining or contracting our presence in thesemarkets;

**·**      anticipatedtrends in our financial condition and results of operations;

**·**      ourability to distinguish ourselves from our current and future competitors;

**·**      ourability to secure long term purchase orders;

**·**      ourability to deliver against existing or future backlog;

**·**      technicalor quality issues experienced by us, our suppliers and/or our customers;

**·**      failureto comply with existing or future government or industry standards andregulations;

**·**      ourability to successfully locate, acquire and integrate any possible futureacquisitions;

**·**      our abilityto successfully support the working capital needs of our company;

**·**      theimpact of current and/or future economic conditions, including but not limitedto the overall condition of the stock market, the overall credit market,political, economic and/or other constraints which are or may negatively impactthe industries in which we participate and/or the ability for us to market theproducts which we sell; and

**·**      ourability to successfully compete against competitors that in many cases arelarger than us, have access to significantly more working capital than us andhave significant resources in comparison to us.

 

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

 

Any of the factors described above or in the “RiskFactors” sections contained in our Annual Report on Form 10-K for the yearended December 31, 2008, our Quarterly Report on Form 10-Q for thequarterly period ended March 31, 2009, and in this report could cause ourfinancial results, including our net income or loss or growth in net income orloss to differ materially from prior results, which in turn could, among otherthings, cause the price of our common stock to fluctuate substantially.

 

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**Recent Transactions**

 

On March 20, 2009, wecompleted the sale of substantially all the assets of the Digitran division ofour wholly-owned subsidiary, EMRISE Electronics Corporation, or EEC, and allthe capital stock of ECC’s wholly-owned subsidiary, XCEL Japan Ltd., whichprimarily acted as a sales office for the Digitran division, to Electro SwitchCorp.  In this report we refer to thebusinesses of the Digitran Division and XCEL Japan, Ltd. as the “DigitranOperations,” and we refer to the sale of the Digitran division and XCEL Japan,Ltd. as the “Digitran Transaction.” Within our Digitran division we manufactured, marketed and soldelectro-mechanical digital and new patented technology very low profileTM rotary switches for the worldwide aerospace,defense and industrial markets. Tokyo-based XCEL Japan Ltd. primarily sold Digitran’s switch productlines in Japan and other countries in Asia. These businesses were part of ourelectronic devices business segment.  Forpurposes of the following discussion and analysis, the Digitran Operations havebeen removed from the prior period comparisons and the quarterly results of theDigitran Operations are reported in our Consolidated Statements of Operationsfor all periods presented as a discontinued operation.

 

**Business Description**

 

We design, manufacture andmarket proprietary electronic devices and communications equipment foraerospace, defense, industrial, and communications applications. We haveoperations in the U.S., England, and France. We organizeour business in two operating segments: electronic devices and communicationsequipment. In the first quarter of 2009, our electronic devices segmentcontributed approximately 82% of overall net sales while the communicationssegment contributed approximately 18% of overall net sales. Our subsidiarieswithin our electronic devices segment design,develop, manufacture and market power supplies, radio frequency, or RF, andmicrowave devices for defense, aerospace and industrial markets.  Our subsidiaries within ourcommunications equipment segment design, develop, manufacture and marketnetwork access equipment, including network timing and synchronizationproducts, for communications applications in defense, public and privatenetworks and industrial markets.

 

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

 

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

 

**Critical Accounting Policies**

** **

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

 

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important to theportrayal of our financial condition and results of operations and that requiremanagement’s most difficult, subjective or complex judgments, often as a resultof the need to make estimates about the effects of matters that are inherentlyuncertain.

 

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

 

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

 

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

 

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

 

We recognize revenues forproducts sold by our subsidiary in France at the point of shipment.  Customer discounts are included in theproduct price list provided to the customer. Returns are infrequent and permitted only with prior authorization becausethese products are shipped based on binding purchase orders and are qualitytested prior to shipment.  An estimate ofwarranty cost is recorded at the time revenue is recognized.

 

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

 

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***Product Warranty Liabilities***

 

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

 

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

 

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

 

Our electronic devices segment finished goodsinventories generally are built to order. Our communications equipment inventories generally are built toforecast, which requires us to produce a larger amount of finished goods in ourcommunications equipment business so that our customers can be servedpromptly.  Our products consist ofnumerous electronic and other materials, which necessitate that we exercisedetailed inventory management.  We valueour inventory at the lower of the actual cost to purchase or manufacture theinventory (first-in, first-out) or the current estimated market value of theinventory (net realizable value). We perform cycle counts of inventories usingan ABC inventory methodology, which groups inventory items into prioritizedcycle counting categories, or we conduct physical inventories at least once ayear.  We regularly review inventory quantitieson hand and record a provision for excess and obsolete inventory basedprimarily on our estimated forecast of product demand and productionrequirements for the next 12 to 24 months. Additionally, to determine inventorywrite-down provisions, we review product line inventory levels and individualitems as necessary and periodically review assumptions about forecasted demandand market conditions.  Any inventorythat we determine to be obsolete, either in connection with the physical countor at other times of observation, are reserved for and subsequentlywritten-off.  As of June 30, 2009,our total inventory reserves amounted to $5.6 million, of which $3.9 million,or 21.0% of total inventory, related to our electronic devices segment and $1.7million, or 9% of total inventory, related to our communications equipmentsegment.

 

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

 

***Foreign Currency Translation***

 

We have foreign subsidiaries thattogether accounted for approximately 50.4% and 69.7% of our net revenues, 34.8%and 58.6% of our assets and 24.2% and 53.9% of our total liabilities as of andfor the six months ended June 30, 2009 and 2008, respectively.  In preparing our consolidated financial statements, weare required to translate the financial statements of our foreign subsidiariesfrom the functional currencies in which they keep their accounting records intoU.S. dollars. This process results in exchange gains and losses which, underrelevant accounting guidance, are included either within our statement ofoperations under the caption “other income (expense)” or as a separate part ofour net equity under the caption “accumulated other comprehensive income(loss).”

 

Under relevant accounting guidance, the treatment ofthese translation gains or losses depends upon management’s determination ofthe functional currency of each subsidiary. This determination involvesconsideration of relevant economic facts and circumstances affecting thesubsidiary. Generally, the currency in 

 

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which the subsidiarytransacts a majority of its transactions, including billings, financing,payroll and other expenditures, would be considered the functional currency.However, management must also consider any dependency of the subsidiary uponthe parent and the nature of the subsidiary’s operations.

 

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

 

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

 

Based on our assessment of the factors discussedabove, we consider the functional currency of each of our internationalsubsidiaries to be each subsidiary’s local currency. Accordingly, we hadcumulative translation losses of $1.5 million and $2.8 million that wereincluded as part of accumulated other comprehensive income within our balancesheets at June 30, 2009 and December 31, 2008, respectively. Duringthe three months ended June 30, 2009 and 2008, we included translationgains of $1.8 million and losses of $3,000, respectively, under accumulatedother comprehensive income and during the six months ended June 30, 2009and 2008, we included translation gains of $1.4 million and $223,000,respectively, under accumulated other comprehensive income.

 

The magnitude of these gainsor losses depends upon movements in the exchange rates of the foreigncurrencies in which we transact business as compared to the value of the U.S.dollar. During the second quarter of 2009, these currencies include the euroand the British pound sterling. Any future translation gains or losses could besignificantly higher or lower than those we recorded for these periods.

 

A 2.5 million British pound sterling loan payable fromone of our subsidiaries in Englandto EMRISE was outstanding as of June 30, 2009 ($4.1 million based on theexchange rate at June 30, 2009). Exchange rate losses and gains on the long-term portion of this loan arerecorded in cumulative translation gains or losses in the equity section of thebalance sheet.

 

***Intangibles, Including Goodwill***

 

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

 

In assessing potential impairment ofgoodwill, we consider these factors as well as forecasted financial performanceof the acquired businesses.  If forecastsare not met, we may have to record additional impairment charges not previouslyrecognized. In assessing the recoverability of our goodwill and other intangibles,we must make assumptions regarding estimated future cash flows and otherfactors to determine the fair value of those respective assets. If theseestimates or their related assumptions change in the future, we may be requiredto record impairment charges for these assets that were not previouslyrecorded.  If that were the case, wewould have to record an expense in order to reduce the carrying value of ourgoodwill.  Under SFAS No. 142,“Goodwill and Other Intangible Assets”, we are required to analyze our goodwillfor impairment issues at least annually or more frequently if an event occursor circumstances change that would more likely than not reduce the fair valueof a reporting unit below its carrying amount. At June 30, 2009, our reported goodwill totaled $13.4 million.  In assessing the potential impairment ofgoodwill, we consider forecasted financial performance of the acquiredbusinesses to determine the fair value of the respective assets.

 

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**Results of Operations**

 

**Overview**

** **

The majority of our products are customized to theunique specifications of our customers and are subject to variable timing ofdelivery.  Shipments of products can beaccelerated or delayed due to many reasons including, but not limited to,exceeding or not meeting customer contract requirements, a change in customertiming or specifications, technology related issues and production relatedissues.  Comparability of our revenuesand gross profit is difficult from period to period as most of our sales arefor custom products and we typically do not have recurring orders for standardproducts.  Exceptions to this includecertain long-term military contracts and certain long-term telecommunicationscontracts.

 

Overall sales from continuing operations increased 19%in the first quarter of 2009 as compared to the first quarter of 2008.  Our overall net sales of $14.3 million for thesecond quarter of 2009 reflected $5.4 million of net sales contributed by ACC,which we acquired on August 20, 2008, and declines in net sales at all ofour electronic devices subsidiaries and both of our communications equipmentsubsidiaries.  With the exception of ourFrench communication subsidiary, which experienced a decline in sales largelydue to the impact of the global economic crisis, the declines at our foreignunits were largely due to the impact of exchange rates between the U.S. dollarand the British pound sterling and the euro.

 

Overall gross profit as a percentage of salesincreased to 38.3% in the second quarter of 2009 from 30.8% in the firstquarter of 2008.  The increase in grossprofit as a percentage of sales was due primarily to the inclusion of ACC salesin 2009 and associated gross margins in our results partially offset by adecrease in gross profit as a percentage of sales within our communicationsegment as a result of lower sales volumes within that segment.

 

The following is a detailed discussion of our resultsof operations by business segment.  As aresult of the sale of our Digitran Operations in March 2009, for purposes ofthe following discussion and analysis, the Digitran Operations have beenremoved from the prior period comparisons and the quarterly results of theDigitran Operations are reported as a discontinued operation for all periodspresented.

 

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

 

**Net Sales**

 

*Electronic Devices Segment*

 

The increase in sales ofour electronic devices in the second quarter of 2009 as compared to the secondquarter of 2008 was primarily the result of the inclusion of $5.4 million innet sales from ACC, which we acquired in August 2008.  This increase was partially offset by adecrease in sales at all of our other electronic devices subsidiaries, which inthe case of our U.S. power supply division is due to economic conditions, andin the case of our foreign subsidiaries, is due primarily to the impact ofexchange rates.  On a local currencybasis, net sales at our foreign electronic device companies were slightlyhigher in the second quarter of 2009 as compared to 2008.  However, exchange rates between the U.S.dollar and the British pound sterling negatively impacted the consolidatedresults of our U.K. subsidiaries when translated into U.S. dollars.

 

Throughout the remainderof 2009, we expect quarterly net sales within our electronic devices segment toincrease as compared to each comparable quarter in 2008.  This reflects the expected favorable impactof including ACC’s net sales in each quarter of 2009 as compared to only thelatter four months in 2008. Exchange rates remain an uncertainty and couldimpact our sales positively or negatively throughout the remainder of 2009 ascompared to 2008.  The relationship betweenthe British pound sterling and the U.S. dollar can have a significant impact onthe results of our European electronic device operations as those results aretranslated into U.S. dollars.

 

*Communications Equipment Segment*

 

The decrease in sales ofour communications equipment in the second quarter of 2009 as compared to thesecond quarter of 2008 is due to an overall decrease in orders and shipmentsfor network access and timing products, especially at our French subsidiarywhere quarterly net sales were down $1.1 million due largely to generaleconomic conditions and spending reductions by the French DefenseMinistry.  Net sales at our Frenchsubsidiary were also impacted by the unfavorable effects of exchange rates in2009 as compared to 2008 between the U.S. dollar and the euro on the translationof the financial results of our European operations into U.S. dollars.  Sales for network access and timing productsat our U.S. subsidiary also decreased but were partially offset by strongersales of telecommunications test equipment.

 

Net sales in ourcommunications equipment segment have been, and are likely to continue to be,negatively impacted by the recent economic conditions as many of ourcommunications equipment products are deemed to be discretionary expendituresby our customers and many companies in this industry have announced plans toreduce capital expenditures and/or to defer discretionary spending due tocurrent economic conditions.  Once globaleconomic conditions improve, we believe this segment will benefit more so thanour electronic devices segment, which has not been impacted as severely due tothe defense related nature of that segment. Exchange rates remain an uncertainty and could impact our salespositively or negatively throughout the remainder of 2009 as compared to 2008.  The relationship between the euro as comparedto the U.S. dollar can have a significant impact on the results of our Europeancommunication segment operations as those results are translated into U.S.dollars. Despite the economic impacts in our communications equipment segment,we had an unusually high backlog of orders in this segment at June 30,2009 of $0.9 million for our telecommunications test equipment primarily forthe Federal Aviation Administration and the U.S. Navy.  We expect that these orders will be deliveredin the second half of 2009.

 

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**Gross Profit**

** **
| ** **                                       | ** ** | **Three  Months Ended** | ** ** | **Variance**                 | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                       | ** ** | **June 30,**       | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in  thousands)**                              | ** ** | **2009**                | ** ** | **2008**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                             |       |                    |       |                         |       |   |   |   |   |
| Electronic devices                               |       | $                       | 4,593      |                         | $          | 2,182 |   | $ | 2,411 |   | 110.5 | % |
| *as a  % of net sales*                           | * *   | *39.4*                  | *%*        | *26.7*                       | *%*        | * * | * * | * * | * * |
| Communications  equipment                        |       | 866                     |       | 1,531                        |       | (665 | ) | (43.4 | )% |
| *as a  % of net sales*                           | * *   | *33.0*                  | *%*        | *39.6*                       | *%*        | * * | * * | * * | * * |
| Total gross profit from  continuing operations   |       | 5,459                   |       | 3,713                        |       | 1,746 |   | 47.0 | % |
| *Total  gross margin from continuing operations* | * *   | *38.3*                  | *%*        | *30.9*                       | *%*        |   |   |   |   |
| Discontinued operations                          |       | —                  |       | 1,276                        |       |   |   |   |   |
| Total gross profit                               |       | $                       | 5,459      |                         | $          | 4,989 |   |   |   |   |   |
|                                                  |            |                         |            |                              |            |  |  |  |  |  |  |  |

 

*Electronic Devices Segment*

 

The increase in grossprofit, as a percentage of net sales, for our electronic devices segment from26.7% in the second quarter of 2008 to 39.4% in the second quarter of 2009 isprimarily the result of the inclusion of higher margin products at ACC and anincrease in gross profit as a percentage of sales at one of our Europeanoperations primarily due to the impact of currency exchange rates.  Included within cost of sales for the sixmonth period ended June 30, 2009 is approximately $0.1 million ofseverance costs associated with our restructuring plan which includesreductions in headcount, outsourcing certain centralized services and areduction in facility costs and which we expect will be substantially completedby December 31, 2009.

 

We expect that during2009, overall gross margins in our electronic devices segment will remainconsistent with those gross margins reported for the second quarter of2009.  During 2009 we may experiencequarter to quarter variability due to product mix differences and resultingdifferentials associated with lower gross margins on our electronic devicesused in commercial applications as compared to gross margins on our electronicdevices used in military applications.  Weexpect ACC to contribute positively to our gross profit throughout 2009.  Exchange rates remain an uncertainty andcould impact our gross profit positively or negatively throughout the remainderof 2009.  The relationship between theBritish pound sterling and the U.S. dollar can have a significant impact on theresults of our European electronic device operations as those results aretranslated into U.S. dollars.

 

*Communications Equipment Segment*

 

The decrease in grossmargin as a percentage of net sales for our communications equipment segmentfrom 39.6% in the second quarter of 2008 to 33.0% in the second quarter of 2009is primarily the result of decreased sales volume of both network accessproducts and timing and synchronization products due to a slow-down ofpurchases being made by our customers of these products.  The most significant impact was experiencedat our French subsidiary as a result of declining sales discussed above.  Gross profit, both as a percentage of salesand on an actual dollar basis, were unfavorably impacted as a result of thechanges in foreign currency exchange rates between the U.S. dollar and the euroin the second quarter of 2009 as compared to the second quarter of 2008.

 

We are hopeful during2009 that this segment will be able to return to higher gross margins, such asthose achieved throughout the latter part of 2008.  However, due to current economic conditionsand the impact such conditions are having on this segment’s sales, we areuncertain as to exactly when this segment will return to higher gross marginslevels.  Further, we expect that we willcontinue to experience volatility on a quarter to quarter basis due to changesin product mix and timing of shipments.

 

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**Operating Expenses**

 
| ** **                                           | ** ** | **Three  Months Ended** | ** ** | **Variance**                 | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                           | ** ** | **June 30,**       | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in  thousands)**                                  | ** ** | **2009**                | ** ** | **2008**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                                 |       |                    |       |                         |       |   |   |   |   |
| Selling, general and  administrative                 |       | $                       | 4,346      |                         | $          | 3,529 |   | $ | (817 | ) | (23.2 | )% |
| *as %  of net sales*                                 | * *   | *30.5*                  | *%*        | *29.4*                       | *%*        | * * | * * | * * | * * |
| Engineering and product  development                 |       | 716                     |       | 608                          |       | (108 | ) | (17.8 | )% |
| *as %  of net sales*                                 | * *   | *5.0*                   | *%*        | *5.1*                        | *%*        | * * | * * | * * | * * |
| Total operating  expenses from continuing operations |       | 5,062                   |       | 4,137                        |       | (925 | ) | (22.4 | )% |
| Discontinued operations                              |       | —                  |       | 651                          |       |   |   |   |   |
| Total operating  expenses                            |       | $                       | 5,062      |                         | $          | 4,788 |   |   |   |   |   |
|                                                      |            |                         |            |                              |            |  |  |  |  |  |  |  |

* *

*Selling, general andadministrative expenses*

 

The increase in selling,general and administrative (“SG&A”) expenses is primarily the result ofapproximately $1.2 million of additional expenses relating to ACC, which wereabsent in the results of operations for the second quarter of 2008.  Additionally, we incurred approximately $0.1million of severance costs in the second quarter of 2009 associated with therestructuring of personnel at several of our facilities.  These increases were partially offset bydecreases in selling, general and administrative expenses at nearly all of ourbusiness units, including our corporate office due primarily to reduction inwork force at nearly all of our locations.

 

During 2009, we expect SG&A expense to be higheron a quarterly basis in each quarter of 2009 as compared to each quarter in2008.  The anticipated increases in 2009over 2008 quarterly expenses is primarily due to the inclusion of ACC’s expensesin 2009 as compared to only including such expense during the last four monthsof 2008, as well as higher anticipated costs relating to Sarbanes-Oxleycompliance due to the fact that we are now subject to the Sarbanes-Oxley Act Section 404external audit requirements.  SG&Aexpense for third quarter of 2009 may be higher than the SG&A expensesincurred during the second quarter of 2009due to the inclusion of severancecosts associated with our ongoing restructuring plan and anticipatedSarbanes-Oxley management assessment related costs.  However, over subsequent quarters, we expectSG&A expense to trend lower as compared to second quarter 2009 due tosignificant restructuring efforts at both our business units and at ourcorporate office.

 

*Engineering and productdevelopment*

 

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

 

During the remainder of2009, engineering and product development expenses are expected to be higherthan comparable quarters of 2008 due to the inclusion of ACC.  Amounts are expected to vary by quarterdepending on particular needs within each segment, including ongoingdevelopment efforts for our TiemPoTM product line.

 

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**Interest expense**

 

Interest expense was $0.8million for the three months ended June 30, 2009 compared to $0.6 millionfor the three months ended June 30, 2008 due to higher outstanding loanand line of credit balances and higher interest rates on portions of those loanbalances in the second quarter of 2009 as compared to the second quarter of2008.  Included in interest expense inthe second quarter of 2009 were $0.2 million of non-cash amortization ofdeferred financing costs and non-cash amortization of debt discount compared to$0.2 million in the second quarter of 2008.

 

**Other income (expense)**

 

We recorded other incomeof $211,000 for the three months ended June 30, 2009 compared to $120,000for the same period of 2008.  Otherincome (expense) consists primarily of (1) short-term exchange rate gainsand losses associated with the volatility of the U.S. dollar to the Britishpound sterling and euro on the current portion of certain assets andliabilities and, (2) fair value adjustments on warrants during the secondquarter of 2009.  The change in the fairvalue of warrants during the second quarter of 2009 resulted in income of$293,000, which was not present in 2008. The remaining expense of $82,000 for the second quarter of 2009 waspredominantly related to short-term exchange rate losses.

 

**Income tax expense**

 

Income tax expenseamounted to $145,000 for the three months ended June 30, 2009 compared toincome tax benefit of $4,000 for the same period of 2008.  We recorded income tax expense primarily asthe result of foreign income tax on foreign earned profits in Europe and NewJersey state income taxes on income generated by ACC.

 

**Net gain on discontinuedoperations**

 

In connection with thesale of our Digitran Operations on March 20, 2009, we reported income fromour discontinued Digitran Operations of $6.0 million (net of tax of $1.4million) during the first quarter of 2009, which included a $7.2 million gainon the sale of assets.  In the secondquarter of 2009, we recorded a decreasing adjustment to the gain on the sale ofDigitran of $0.1 million (including a tax adjustment) associated with certainpurchase price adjustments associated with the transaction.  In the second quarter of 2008, theseoperations contributed comparative income of $0.6 million.

 

**Net loss**

 

We reported a net loss of$0.5 million in the second quarter of 2009 and a net loss of $0.3 million inthe second quarter of 2008.  Included inour net loss for the second quarter of 2009 is $0.3 million of severance costsassociated with the restructuring of personnel at several of our facilities,and approximately $0.1 million in expense associated with the sale of DigitranOperations.  We anticipate net loss toimprove in future quarters, due in large part to the recent restructuringefforts being completed.

 

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***Comparisonof the Six Months Ended June 30, 2009 to the Six Months Ended June 30,2008***

 

**Net Sales**

** **
| ** **                                  | ** ** | **Six  Months Ended** | ** ** | **Variance**                 | ** ** |
|---------------------------------------------|------------|-----------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | **June 30,**     | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in  thousands)**                         | ** ** | **2009**              | ** ** | **2008**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                        |       |                  |       |                         |       |   |   |   |   |
| Electronic devices                          |       | $                     | 23,244     |                         | $          | 15,443 |   | $ | 7,801 |   | 50.5 | % |
| *as %  of net sales*                        | * *   | *81.6*                | *%*        | *68.1*                       | *%*        | * * | * * | * * | * * |
| Communications  equipment                   |       | 5,239                 |       | 7,222                        |       | (1,983 | ) | (27.5 | )% |
| *as %  of net sales*                        | * *   | *18.4*                | *%*        | *31.9*                       | *%*        | * * | * * | * * | * * |
| Total net sales from  continuing operations |       | 28,483                |       | 22,665                       |       | 5,818 |   | 25.7 | % |
| Discontinued operations                     |       | —                |       | 3,631                        |       |   |   |   |   |
| Total net sales                             |       | $                     | 28,483     |                         | $          | 26,296 |   | $ | 5,818 |   |   |   |

 

*Electronic Devices Segment*

 

The increase in sales ofour electronic devices in the first half of 2009 as compared to the first halfof 2008 was primarily the result of the inclusion of $10.5 million in net salesfrom ACC, which was acquired in August 2008.  This increase was partially offset by adecrease in sales at all of our other electronic devices subsidiaries, which inthe case of our U.S. power supply division is due to the current globaleconomic crisis  and in the case of ourforeign subsidiaries, the decrease is due primarily to the impact of exchangerates.

 

*Communications Equipment Segment*

 

The decrease in sales ofour communications equipment in the first half of 2009 as compared to the firsthalf of 2008 is due to an overall decrease in orders and shipments for networkaccess and timing products, especially at our French subsidiary where net saleswere down $1.7 million in the first half of 2009 compared to the first half of2008 due largely to the impacts of the global economic crisis and spendingreductions by the French Defense Ministry. Net sales at our French subsidiary were also impacted by the unfavorableeffects of exchange rates in 2009 as compared to 2008 between the U.S. dollarand the euro on the translation of the financial results of our Europeanoperations into U.S. dollars.  Sales fornetwork access and timing products at our U.S. subsidiary also decreased butwere partially offset by stronger sales of telecommunications test equipment.

 

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**Gross Profit**

** **
| ** **                                       | ** ** | **Six  Months Ended** | ** ** | **Variance**                 | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|------------------------------|------------|
| ** **                                       | ** ** | **June 30,**     | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in  thousands)**                              | ** ** | **2009**              | ** ** | **2008**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                             |       |                  |       |                         |       |   |   |   |   |
| Electronic devices                               |       | $                     | 8,670      |                         | $          | 4,140 |   | $ | 4,530 |   | 109.4 | % |
| *as a  % of net sales*                           | * *   | *37.3*                | *%*        | *26.8*                       | *%*        | * * | * * | * * | * * |
| Communications  equipment                        |       | 1,746                 |       | 3,013                        |       | (1,267 | ) | (42.1 | )% |
| *as a  % of net sales*                           | * *   | *33.3*                | *%*        | *41.7*                       | *%*        | * * | * * | * * | * * |
| Total gross profit from  continuing operations   |       | 10,416                |       | 7,153                        |       | 3,263 |   | 45.6 | % |
| *Total  gross margin from continuing operations* | * *   | *36.6*                | *%*        | *31.6*                       | *%*        |   |   |   |   |
| Discontinued operations                          |       | —                |       | 2,245                        |       |   |   |   |   |
| Total gross profit                               |       | $                     | 10,416     |                         | $          | 9,398 |   |   |   |   |   |
|                                                  |            |                       |            |                              |            |  |  |  |  |  |  |  |

 

*Electronic Devices Segment*

 

The increase in grossprofit, as a percentage of net sales, for our electronic devices segment from 26.8%in the first half of 2008 to 37.2% in the first half of 2009 is primarily theresult of the inclusion of higher margin products at ACC and an increase ingross profit as a percentage of sales at our European operations due primarily tothe effects of exchange rates between the British pound sterling and the U.S.dollar.  This increase was partiallyoffset by a reduction in gross margin at our U.S. power supply division due toa write down of approximately $0.3 million of certain inventories to the lowerof cost or market during the first quarter of 2009 and approximately $0.1million of severance costs incurred in the second quarter of2009 associatedwith our restructuring plan.

 

*Communications Equipment Segment*

 

The decrease in gross marginfor our communications equipment segment from 41.7% in the first half of 2008to 33.3% in the first half of 2009 is primarily the result of decreased sales ofboth network access products and timing and synchronization products due to aslow-down of purchases being made by our customers of these products.    Grossprofit, both as a percentage of net sales and on an actual dollar basis, was  unfavorably impacted as a result of thechanges in foreign currency exchange rates between the U.S. dollar and the euroin the first half of 2009 as compared to the first half of 2008.

 

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**Operating Expenses**

** **
| ** **                                           | ** ** | **Six  Months Ended** | ** ** | **Variance**                 | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|------------------------------|------------|
| ** **                                           | ** ** | **June 30,**     | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in  thousands)**                                  | ** ** | **2009**              | ** ** | **2008**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                                 |       |                  |       |                         |       |   |   |   |   |
| Selling, general and  administrative                 |       | $                     | 8,894      |                         | $          | 7,067 |   | $ | (1,827 | ) | (25.9 | )% |
| *as %  of net sales*                                 | * *   | *31.2*                | *%*        | *31.2*                       | *%*        | * * | * * | * * | * * |
| Engineering and product  development                 |       | 1,238                 |       | 1,111                        |       | (127 | ) | (11.4 | )% |
| *as %  of net sales*                                 | * *   | *4.3*                 | *%*        | *4.9*                        | *%*        | * * | * * | * * | * * |
| Total operating  expenses from continuing operations |       | 10,132                |       | 8,178                        |       | (1,954 | ) | (23.9 | )% |
| Discontinued operations                              |       | —                |       | 1,249                        |       |   |   |   |   |
| Total operating  expenses                            |       | $                     | 10,132     |                         | $          | 9,427 |   |   |   |   |   |
|                                                      |            |                       |            |                              |            |  |  |  |  |  |  |  |

 

*Selling, general andadministrative expenses*

 

The increase in SG&Ais primarily the result of approximately $2.5 million of additional expensesrelating to ACC, which were absent in the results of operations for the first halfof 2008.  These increases were partiallyoffset by decreases in SG&A at some of our business units, including ourcorporate office.

 

*Engineering and productdevelopment*

 

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

 

**Interest expense**

 

Interest expense was $2.4million for the six months ended June 30, 2009 compared to $1.2 millionfor the six months ended June 30, 2008. Also affecting the increase in interest expense were higher outstandingloan and line of credit balances and higher interest rates on portions of thoseloan balances in the first half of 2009 as compared to the first half of2008.  Included in interest expense inthe first half of 2009 were $0.1 million in fees associated with a waiverreceived from our lender in the first quarter of 2009, and $0.9 million ofnon-cash amortization of deferred financing costs and non-cash amortization ofdebt discount, including $0.5 million due to the acceleration of deferredfinancing costs and debt discount amortization associated with the partialrepayment of our Term Loan B, compared to $0.4 million in the first half of2008.

 

**Other income (expense)**

 

We recorded other incomeof $168,000 for the six months ended June 30, 2009 compared to $103,000for the same period of 2008.  Otherincome (expense) consists primarily of (i) short-term exchange rate gainsand losses associated with the volatility of the U.S. dollar to the Britishpound sterling and euro on the current portion of certain assets andliabilities and (ii) fair value adjustments on warrants.  The change in the fair value of warrantsduring the first half of 2009 resulted in income of $423,000, which was notpresent in 2008.  The remaining expensesof $254,000 for the second quarter of 2009 were predominantly related toshort-term exchange rate losses.

 

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**Income tax expense**

 

Income tax benefitamounted to $358,000 for the six months ended June 30, 2009 compared toincome tax expense of $80,000 for the same period of 2008.  We recorded an income tax benefit as theresult of losses incurred in the first half of 2009 relating to continuingoperations.  This benefit was partiallyoffset by income tax expense incurred primarily as the result of foreign incometax on foreign earned profits in Europe and New Jersey state income taxes onincome generated by ACC.

 

**Net gain on discontinuedoperations**

 

In connection with thesale of our Digitran Operations on March 20, 2009, we reported income fromour discontinued Digitran Operations of $5.9 million (net of $1.3 million intaxes) during the first half of 2009, which includes a $7.1 million gain on thesale of assets.  In the first half of2008, these operations contributed comparative income of $1.0 million.

 

**Net income (loss)**

 

We reported net income of$4.4 million in the first half of 2009 and a net loss of $1.2 million in thefirst half of 2008.  Included in netincome in the first half of 2009 was a $5.9 million (net of $1.3 million intaxes) gain on the sale of our Digitran Operations, approximately $0.3 millionin inventory write downs, $0.5 million in accelerated amortization of deferredfinancing costs and debt discount associated with the partial repayment of ourTerm Loan B in March 2009, $0.3 million of severance costs associated withthe restructuring of personnel at several of our facilities and $0.1 million infees associated with a waiver received from our lender in the first quarter of2009.

 

**Liquidity andCapital Resources**

** **

In making anassessment of our liquidity, we believe that the items in our financial statementsthat are most relevant to our ongoing operations are working capital, cashgenerated from operating activities and cash available from financingactivities.  During the first half of2009, we funded our daily cash flow requirements through funds provided byoperations and through borrowings under our credit facility with GVECResource IV Inc. (“GVEC” or the “Lender”). Working capital was $7.4 million at June 30, 2009 as compared to$7.6 million at December 31, 2008. Significant items that positivelyimpacted working capital from December 31, 2008 until June 30, 2009are (i) a reduction of $3.1 million in the current portion of long termdebt which was associated with the sale of our Digitran Operations in March 2009and the subsequent repayment of long term acquisition related debt byapproximately $10 million; and (ii) an increase in cash of approximately$1.6 million. Significant items that negatively impacted working capital from December 31,2008 until June 30, 2009 are (i) the sale of our Digitran Operationsin March 2009, which at December 31, 2008, had net current assets of$2.1 million; (ii) an increase in our line of credit by $1.5 million; (iii) adecrease in accounts receivable from continuing operations of $0.9 million dueto improved collections; and (iv) an increase of $0.4 million in incometaxes payable primarily as a result of the taxes we paid on  the gain on sale of our Digitran Operations.  At June 30, 2009 and December 31,2008, we had accumulated deficits of $22.9million and $28.1 million, respectively, andcash and cash equivalents of $4.8 million and $3.4 million, respectively.  Our cash balances are often significantlyhigher at the end of the month than at other times throughout the remainder ofthe month as a result of borrowings under our credit facility generallyoccurring toward the end of the month and timing of payments to vendors in theform of accounts payable, payroll and interest payments generally occurring atthe beginning of the month.

 

Net cash used inoperating activities during the first half of 2009 totaled $0.5 million.  Our reported net income of $4.4 millionincluded a gain on the sale of the Digitran Operations of $7.1 million.  Significant non-cash adjustments to our netincome for the six months ended June 30, 2009 include (i) theamortization of debt discount and amortization of deferred financing costwhich, on a combined basis, totaled $1.0 million, both of which are non-cashcomponents of interest expense associated with our credit facility, (ii) depreciationand amortization expense which totaled $1.0 million, and (iii) change in fairvalue of common stock warrants which 

 

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contributed $0.4 million as non-cash component of net income.  Significant uses of cash associated withoperating activities during the six month period ended June 30, 2009included (a) an increase in inventory balances of $1.0 million in order toaccommodate future shipments of backlog, and (b) a decrease in accountspayable and accrued liabilities by approximately $1.1 million, in part due topayments made on previously accrued amounts related to the sale of the DigitranOperations and timing of vendor payments. The primary source of cash associated with operating activities duringthe six month period was a decrease in accounts receivable, which decreased byapproximately $0.9 million, due primarily to increased efforts to collectoutstanding balances on a more timely basis.

 

Cash generated from our investing activities during the first half of 2009totaled $10.2 million. This amount consisted primarily of net cash proceedsgenerated by the March 2009 sale of our Digitran Operations, all of which was used to partiallyrepay the $13 million in term debt that we incurred in connection with ourpurchase of ACC in August 2008.

 

Cash used in financing activities during the first half of 2009 totaled $9.0million, which consisted of $10.6 million in repayments of principal owed on long term debt and notes to stockholders,offset by $1.5 million in net borrowings on our revolving credit facility.

 

As of June 30, 2009, we had outstanding borrowings of $5.6million under the revolving loan portion of our credit facility.  At June 30, 2009, we had remainingactual availability under a formula-based calculation of $1.4 million under thecredit facility.  Actual remaining availability representsthe additional amount we were eligible to borrow as of June 30, 2009.  The full $7 million available under ourrevolving line of credit fluctuates periodically throughout each monthdepending on timing of borrowings and repayments.

 

In addition to therevolving lines of credit, at June 30, 2009, we had long-term loans andcapitalized lease and equipment loan obligations totaling $14.3 million, thecurrent portion of which loans and obligations totaled $2.8 million.

 

Our backlog decreased to $27.8 million as of June 30, 2009as compared to $34.7 million as of December 31,2008. The decrease is, in part, due to the sale of the Digitran Operations,which represented $1.5 million in backlog at December 31, 2008, and thereduction of backlog at all of our electronic devices business units as wesatisfied existing contracts during the first half of 2009.  We experienced a slight increase in backlogat our U.S. communications equipment business unit associated with new ordersfor telecommunications test equipment. The amount of backlog orders represents revenue that we anticipaterecognizing in the future, as evidenced by purchase orders and other purchasecommitments received from customers, but on which work has not yet beeninitiated or with respect to which work is currently in progress. Our backlogas of June 30, 2009 was approximately 95% related to our electronicdevices business, which business tends to provide us with long lead-times forour manufacturing processes due to the custom nature of the products, andapproximately 5% related to our communications equipment business, whichbusiness tends to deliver standard or modified standard products from stock asorders are received. We believe that the majority of our current backlog 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.

 

On November 30,2007, we and our direct subsidiaries, EEC, CXR Larus and RO Associates enteredinto a Credit Agreement with the Lender, providing for a credit facility in theaggregate amount of $23,000,000.  On August 20,2008, in connection with the acquisition of ACC and CCI, we entered into anamendment to the credit facility to include ACC and CCI as borrowers and to,among other things, include an additional term loan in the principal amount of$3,000,000 (the “Term Loan C”).  In connection with DigitranTransaction we repaid approximately $10 million of term debt in March 2009,including the Term Loan C.  As of June 30, 2009, weowed a total of $14.4 million under the terms of the credit facility.

 

The credit facilitycurrently consists of (i) a one year revolving loan for up to $7 millionthat may be renewed on November 30, 2009 for a period of one year (the “Revolver”),and (ii) two term loans (Term Loan A and Term Loan B) with an aggregatenet outstanding principal amount of $8.8 million. The term loans require 

 

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scheduled principal andinterest payments commencing September 1, 2009 and a final balloon paymentof principal upon maturity on November 30, 2010.  Total aggregateprincipal payments on Term Loan A and Term Loan B are $1.1 million in 2009 and$7.9 million in 2010.

 

The Revolver is formula-based and generally provides that theoutstanding borrowings under the line of credit may not exceed an aggregate of85% of eligible accounts receivable, plus 10% of the value of eligible rawmaterials not to exceed $600,000, plus 50% of the value of eligible finishedgoods inventory not to exceed $1,500,000, minus the aggregate amount ofreserves that may be established by the Lender. The Revolver has a maturity date of November 30, 2009, unless it isrenewed by the Lender in which case the maturity date will be extended to November 30,2010.

 

Interest on the Revolveris payable monthly.  The interest rate is variable and is adjusted monthlybased on the prime rate as published in the “Money Rates” column of*The Wall Street Journal* (the “Base Rate”)plus 1.25%, subject to a minimum rate of 9.5% per annum.  The Revolver issubject to various financial covenants on a consolidated basis, includingEBITDA, measured on a fiscal quarter-end basis, must not be less than thescheduled amount for each specified period; the debt service coverage ratio,measured quarterly, must be greater than the lesser of the scheduled amount foreach specific period or 1.10:1.00; minimum liquidity above the scheduledamount, unfinanced capital expenditures not in excess of $62,500 per quarter,and the leverage ratio, measured quarterly, must not be greater than thescheduled amount for each specified period.  Additionally, the Revolver issubject to the borrowers not incurring purchase money commitments in excess of$2 million.  As of June 30, 2009, we were in compliance with all ofthese debt covenants.

 

The term loans bear interest at the Base Rate plus 4.25%, subject to aminimum rate of 12.5% per annum.  The borrowers under the credit facilitymay make full or partial prepayment of the term loans provided that any suchprepayment is accompanied by the applicable prepayment premium discussed below.

 

Uponthe sale or disposition by the borrowers or any of their subsidiaries ofproperty or assets, the borrowers may be obligated to prepay the Revolver andthe term loans with the net cash proceeds received in connection with suchsales or dispositions to the extent that the aggregate amount of net cashproceeds received, and not paid to the Lender as a prepayment, for all suchsales or dispositions exceed $150,000 in any fiscal year.  However, to the extent we sell assets after August 14,2009 and prior to January 1, 2010, only 75% of the net cash proceeds ofsuch sale must be used to prepay our outstanding obligations to the Lender.

 

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

 

We have agreed with ourLender to raise at least $3 million in net proceeds through the sale of stockof the borrowers by no later than December 31, 2009.  Under the terms of the credit facility, weare obligated to remit to our Lender 50% of the first $3 million of net cashproceeds received in connection with the sale of stock and 30% of the net cashproceeds in excess of the first $3 million received. Given current economic andfinancial market conditions, an equity raise could prove difficult.  Accordingly, no assurances can be made that we will be successfulin this regard.  If we are successful in structuring an equityraise acceptable to us and our Lender, the issuance of equity securities mayresult in substantial dilution to our stockholders.

 

We are obligated to makemonthly principal payments to our Lender of (i) $75,000 on September 1.2009 and October 1, 2009, (ii) $100,000 on November 1, 2009, (iii) $150,000on December 1, 2009 and (iv) approximately $287,000 commencing on January 1,2010 and continuing on the first day of each of the 10 consecutive monthsthereafter.

 

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Currently,we are in the process of seeking alternate financing from a number of possiblelenders, including traditional lenders, private equity and mezzaninelenders.  Although we remain hopeful thatwe will be able to successfully secure replacement financing on a timely basis,no assurances can be made that we will be successful in this regard.

 

If we cannot meet orsuccessfully fulfill our obligations to (i) raise $3.0 million in equitycapital by December 31, 2009, (ii) make monthly principal andinterest payments, and/or (iii) achieve certain other financial covenants,or if our Lender does not waive these obligations, then we would be in defaultunder the terms of our credit facility.

 

In the event of a defaultand continuation of a default, our Lender may limit future availability underour revolving line of credit and/or accelerate the payment of all principalbalances and accrued interest requiring us to pay the entire indebtedness underthe credit facility outstanding on that date.  Upon the occurrence andduring the continuation of an event of default, the Lender may also elect toincrease the interest rate applicable to the outstanding balance of the TermLoans A and B by four percentage points above the per annum interest rate thatwould otherwise be applicable.  Any of these conditions could have amaterial adverse effect on our operations and/or ability to conduct businessafter that date.  Additionally, if our Lender terminates the creditfacility during a default period or if we prepay the Revolver or the Term Loansprior to November 30, 2009, then we are subject to a penalty equal to 2%of the outstanding principal balance of the Revolver and the Term Loans.

 

Recent actions taken bythe Commission against Private Equity Management Group, Inc., an affiliateof our Lender, including an order granted in April 2009 by a federal courtfreezing all assets of Private Equity Management Group, Inc. and itsaffiliates, including our Lender, may adversely affect our Lender’s ability tocontinue to provide us funds under the terms of the Revolver.  At therequest of the Commission, the federal court also appointed a temporaryreceiver of our Lender’s agent and of our Lender.  Although we currentlybelieve that the receiver will allow us to continue to borrow funds under theterms of the Revolver, no assurances can be made that the receiver will allowour Lender to continue to make funds available to us.  If, for any reason,the receiver were to limit or terminate our ability to continue to borrow fundsunder the Revolver, our cash position and our ability to continue day to dayoperations would be adversely affected, almost immediately.  If that wereto occur, we would be required to seek additional and/or replacement financingimmediately.  If we are unable to do so,we may be forced to drastically curtail or cease operations and possibly seekprotection from our creditors under the U.S. Bankruptcy Code.

 

If we are successful inraising $3.0 million in equity capital by December 31, 2009, as requiredby our Lender, and we are able to continue to borrow funds under the terms ofthe Revolver, management believes 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 capitalexpenditures needs for the next 12 months.  If, however, for any reason including thereasons described above, we are unsuccessful in raising additional equity capitalas required by the terms of our credit facility thereby resulting in an eventof default under the credit facility or if we are unable to continue to borrowfunds under the terms of the Revolver, we do not believe that current andfuture capital resources, revenues generated from operations and other existingsources of liquidity will be adequate to meet our anticipated short term,working capital and capital expenditures needs for the next 12 months. Further, if for any reason, including the reasons described above, we areunable to continue to borrow funds under the terms of the Revolver or if weexperience a significant loss of revenue or increase in costs, then our cashflow would be negatively impacted resulting in a cash flow deficit which, inturn, will require us to obtain additional or alternate financing, with littleor no notice.  These potential financing needs could be met in the form ofa revised debt structure with our Lender, additional or new financing withanother lender or lenders, the sale of assets to generate cash or the sale ofadditional equity to raise capital.  Our failure to secure additional oralternate financing, if and when needed, would have an adverse effect on ouroperations and/or ability to do business after that date or could restrict ourgrowth, limit our development of new products, or hinder our ability to fulfillexisting or future orders; we may be forced to drastically curtail or ceaseoperations and possibly seek protection from our creditors under the U. S. BankruptcyCode

 

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Currently,we are in the process of seeking alternate financing from a number of possiblelenders, including traditional lenders, private equity and mezzaninelenders.  Although we remain hopeful thatwe will be able to successfully secure replacement financing in a timelymanner, we cannot assure you that we will be successful in this regard.

 

**Effects of Inflation**

** **

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

 

**Impacts of NewAccounting Pronouncements**

** **

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

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements”. This statementprovides a single definition of fair value, together with a framework formeasuring it, and requires additional disclosure about the use of fair value tomeasure assets and liabilities. SFAS No. 157 also emphasizes that fairvalue is a market-based measurement, not an entity-specific measurement, andsets out a fair value hierarchy, with the highest priority being quoted pricesin active markets. The required effective date of SFAS No. 157 was thefirst quarter of 2008. The adoption of SFAS No. 157 for financial assetsand liabilities did not have a material effect on our consolidated financialstatements, but resulted in additional disclosures.  In February 2008, the FASB issued StaffPosition No. 157-2, which delayed by one year the effective date of SFAS No. 157for all non-financial assets and liabilities, except those that are recognizedor disclosed at fair value in the financial statements on a recurringbasis.  The adoption of SFAS No. 157for non-financial assets and liabilities did not have a material effect on ourconsolidated financial statements.

 

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

 

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

 

In April 2008,the FASB issued FASB Staff Position (“FSP”) No. FAS 142-3, “Determinationof the Useful Life of Intangible Assets,” (“FSP 142-3”). FSP 142-3 amends thefactors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible asset 

 

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under SFAS No. 142, “Goodwill and Other Intangible Assets” andalso requires expanded disclosure related to the determination of intangibleasset useful lives. FSP 142-3 is effective for fiscal years beginning after December 15,2008. Early adoption is prohibited. The adoption of FSP 142-3 did not have amaterial effect on our consolidated financial statements.

 

In June 2008, the FASB ratified the consensusreached on EITF Issue No. 07-5, “Determining Whether an Instrument (orEmbedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5clarifies the determination of whether an instrument (or an embedded feature)is indexed to an entity’s own stock, which would qualify as a scope exceptionunder SFAS No. 133, Accounting for Derivative Instruments and HedgingActivities. EITF 07-5 is effective for financial statements issued for fiscalyears beginning after December 15, 2008. Early adoption for an existinginstrument is not permitted. We adopted EITF 07-5 on January 1, 2009. See Note12 **—**Warrants in the accompanynotes to condensed consolidated financial statements in this report fordiscussion of the impact of the adoption of EITF 07-5 on our outstanding stockwarrants and our consolidated financial statements.

 

In April 2009, the FASB issued FSP No FAS 107-1and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSPFAS 107-1 and APB 28-1”), which amends SFAS No. 107, “Disclosures aboutFair Value of Financial Instruments,” to require disclosures about fair valueof financial instruments in interim as well as in annual financialstatements.  FSP No. FAS 107-1 andAPB 28-1 also amends APB Opinion No. 28, “Interim Financial Reporting,” torequire those disclosures in all interim financial results, financial positionand financial statement disclosures.  FSPFAS 107-1 and APB 28-1 is effective for periods ending after June 15,2009.  We have adopted FSP FAS 107-1 andAPB 28-1 and believe we have all of the required disclosures within thisQuarterly report on Form 10-Q.

 

In May 2009, the FASB issued SFAS No. 165, “SubsequentEvents” (“SFAS No. 165”), effective for interim or annual financialperiods ending after June 15, 2009. For calendar year entities, SFAS No. 165 became effective for thethree months ended June 30, 2009. The objective of SFAS No. 165 is to establish general standards ofaccounting for and disclosure of events that occur after the balance sheet datebut before financial statements are issued or are available to be issued.  In particular, SFAS No. 165 sets forth (1) theperiod after the balance sheet date during which management of a reportingentity should evaluate events or transactions that may occur for potentialrecognition or disclosure in the financial statements: (2) thecircumstances under which an entity should recognize events or transactionsoccurring after the balance sheet date in its financials statements; and (3) thedisclosures that an entity should make about events or transactions thatoccurred after the balance sheet date.  The adoption of SFAS No. 165 did not havea material impact on our financial position, results of operations or cashflows.

 

In June 2009,the FASB issued SFAS No. 168, “The FASB Accounting Standards CodificationTMand the Hierarchy of Generally Accepted Accounting Principles — a replacementof FASB Statement No. 162” (“SFAS No. 168”) to formally establish theFASB Accounting Standards CodificationTM (the “Codification”) as the singlesource of authoritative, nongovernmental U.S. GAAP.  All existing accounting standards documentsare superseded as described in SFAS No. 168.  All other accounting literature not includedin the Codification is nonauthoritative. The Codification is effective for interim and annual periods endingafter September 15, 2009.  Webelieve the adoption of SFAS No. 168 will not have a material impact onour financial position, results of operations or cash flows.

 

**ITEM 3.                QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK.**

** **

Not applicable.

 

**ITEM 4.                CONTROLSAND PROCEDURES.**

 

Not applicable.

 

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**ITEM 4T.             CONTROLS ANDPROCEDURES.**

 

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

*** ***

We conducted an evaluation under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, our principal accounting officer, of the effectivenessof the design and operation of our disclosure controls and procedures.  The term “disclosure controls and procedures,”as defined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended (“Exchange Act”), means controls and otherprocedures of a company that are designed to ensure that information requiredto be disclosed by the company in the reports it files or submits under theExchange Act is recorded, processed, summarized and reported, within the timeperiods specified in the Commission’s rules and forms.  Disclosure controls and procedures alsoinclude, without limitation, controls and procedures designed to ensure thatinformation required to be disclosed by a company in the reports that it filesor submits under the Exchange Act is accumulated and communicated to thecompany’s management, including its principal executive and principal financialofficers, or persons performing similar functions, as appropriate, to allowtimely decisions regarding required disclosure. Based on this evaluation, our Chief Executive Officer and ChiefFinancial Officer concluded as of June 30, 2009 that our disclosurecontrols and procedures were not effective at the reasonable assurance leveldue to the material weaknesses discussed below.

 

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

 

Our Chief Executive Officer and Chief Financial Officer concluded thatas of June 30, 2009 the following four material weaknesses existed:

 
| (1)    |   | We  did not effectively implement comprehensive entity-level internal controls.                                                                                                                                                |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                           |
| (2)    |   | We did not maintain  effective controls over changes to critical financial reporting applications  and over access to these applications and related data.                                                                     |
|   |   |                                                                                                                                                                                                                           |
| (3)    |   | We did not maintain a  sufficient level of information technology personnel to execute general  computing controls over our information technology structure.                                                                  |
|   |   |                                                                                                                                                                                                                           |
| (4)    |   | We did not maintain effective controls over  recording and reporting the acceleration of certain components of our credit  facility and the classification of the issuance of a note relating to a  purchase price adjustment. |

 

If not remediated, thesematerial weaknesses could result in one or more material misstatements in ourreported financial statements in a future annual or interim period.

 

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

*** ***

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

 

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

 

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

*** ***

Set forth below isa summary of the various significant deficiencies which caused management toconclude that we had the four material weaknesses identified above.  Through the efforts of management, externalconsultants and our Audit Committee, we are currently in the process ofexecuting specific action plans to remediate the material weaknesses identifiedabove and discussed more fully below.  Weexpect to complete these various action plans by December 31, 2009.  If we are able to complete these actions bythat date, we anticipate that all control deficiencies and material weaknesseswill be remediated by March 31, 2010.

 

(1)           Wedid not effectively implement comprehensive entity-level internalcontrols, asevidenced by the following control deficiencies:

 
| · |   | Entity Level Internal Control  Evaluation. We did not formally consider entity-wide controls that are  pervasive across our company when considering whether control activities are  sufficient to address identified risks.                                    |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                            |
| · |   | Fraud Considerations. We did not  conduct regular formalized assessments to consider risk factors that  influence the likelihood of someone committing a fraud and the impact of a  fraud on our financial reporting.                                           |
|   |   |                                                                                                                                                                                                                                                            |
| · |   | Objective Evaluation of Internal  Controls. We did not use an internal audit function or other objective party  to provide an objective perspective on key elements of the internal control  system.                                                            |
|   |   |                                                                                                                                                                                                                                                            |
| · |   | External Communication. We lacked  formal policies and procedures regarding how and when matters affecting the  achievement of financial reporting objectives are communicated with outside  parties.                                                           |
|   |   |                                                                                                                                                                                                                                                            |
| · |   | Assessment of Information  Technology. We did not formally evaluate the extent of the needed information  technology controls in relation to our assessment of processes and systems  supporting financial reporting.                                           |
|   |   |                                                                                                                                                                                                                                                            |
| · |   | Information Technology. We did  not have sufficient information technology controls, where applicable,  designed and implemented to support the achievement of financial reporting  objectives.                                                                 |
|   |   |                                                                                                                                                                                                                                                            |
| · |   | Ongoing and Separate Evaluations.  We did not effectively create and maintain effective evaluations on the  progress of our remediation efforts nor the constant evaluations of the  operating effectiveness of our internal controls over financial reporting. |
|   |   |                                                                                                                                                                                                                                                            |
| · |   | Reporting Deficiencies. We did not perform timely and  sufficient internal or external reporting of our progress and evaluation of  prior year material weaknesses or the current fiscal year internal control  deficiencies.                                   |

 

(2)           We did not maintain effective controls over changes tocritical financial reporting applications and over access to these applicationsand related data, as evidenced by the fact that certain of our personnel hadunrestricted access to various financial application programs and data beyondthe requirements of their individual

 

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jobresponsibilities. This control deficiency could result in a materialmisstatement of significant accounts or disclosures, including those describedabove, that could result in a material misstatement of our interim or annualconsolidated financial statements that would not be prevented or detected.

 

(3)           We did not maintain a sufficient level of informationtechnology personnel to execute general computing controls over our informationtechnology structure, which include the implementation and assessment ofinformation technology policies and procedures. This control deficiency did notresult in an audit adjustment to our 2008 interim or annual consolidated financialstatements, but could result in a material misstatement of significant accountsor disclosures, which would not have been prevented or detected.

 

(4)           We did not maintain effective controls overrecording and reporting the acceleration of certain components of our creditfacility and the classification of the issuance of a note relating to apurchase price adjustment.  As a result of a review ofour historical financial statements, management concluded that our controlsover (a) recording the acceleration of certain components of our creditfacility and (b) classifying the issuance of a note relating to a purchaseprice adjustment were not in accordance with generally accepted accountingprinciples.  Based upon this conclusion,our Audit Committee and senior management decided, in the third quarter of2009, to restate our historical financial statements for each of the quarterlyperiods ended March 31, 2009 and June 30, 2009.  Management evaluated the impact of thisrestatement on our assessment of our disclosure controls and procedures andconcluded that the control deficiency that resulted in the incorrect (a) recordingof the acceleration of certain components of our credit facility and (b) classificationof the issuance of a note relating to a purchase price adjustment represented amaterial weakness.

 

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

*** ***

The above materialweaknesses resulted in adjustments to our consolidated financial statements forthe quarter ended June 30, 2009.  Inaddition,, it is reasonably possible that, if not remediated, one or more ofthe material weaknesses described above could result in a material misstatementin our reported financial statements that might result in a materialmisstatement in a future annual or interim period.

 

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

 

In addition, ouraudit committee has authorized the hiring of additional temporary staff and/orthe use of financial and information technology consultants, as necessary, toensure that we have the depth and experience to remediate the above listedmaterial weaknesses, including the implementation and monitoring of theappropriate level of control procedures related to all of our manufacturinglocations and our corporate offices.  Theaudit committee will also work directly with management and outsideconsultants, as necessary to ensure that board level deficiencies are addressed.  We are uncertain at this time of the costs toremediate all of the above listed material weaknesses, however, we anticipatethe cost to be in the range of $200,000 to $400,000 (including the cost of theconsolidation software described above), most of which costs we expect to incurin late 2009 or early 2010.  We cannotguarantee that the actual costs to remediate these deficiencies will not exceedthis amount.

 

Through thesesteps, we believe that we are addressing the deficiencies that affected ourinternal control over financial reporting as of June 30, 2009. Because theremedial actions require hiring of additional personnel, upgrading certain ofour information technology systems, and relying extensively on manual reviewand approval, the successful operation of these controls for at least severalquarters may be required before management may be able to conclude that thematerial weakness has been remediated. We intend to continue to evaluate and strengthen our internal controlover financial reporting systems. These efforts require significant time andresources.  If we are unable to establishadequate internal control over financial reporting systems, we may encounterdifficulties in the audit or review of our financial statements by our independentregistered public accounting firm, which in turn may have a material adverseeffect on our ability to prepare financial statements in accordance with GAAPand to comply with our Commission reporting obligations.

 

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

*** ***

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

 

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**PART II — OTHER INFORMATION**

 

**ITEM 1.               LEGAL PROCEEDINGS.**

 

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

 

**ITEM 1A.            RISK FACTORS.**

 

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

 

***Recentactions taken by the Commission against an affiliate of our lender mayadversely affect our ability to continue to borrow funds under the terms of ourrevolving credit facility with our lender. If our lender limits or terminates our ability to borrow funds under therevolving credit facility, our cash position and our ability to continue day tooperations would be adversely affected, almost immediately.***

 

Recent actions taken by the Commission against Private Equity Management Group, Inc., an affiliateof our lender and our lender, including an order granted in April 2009 bya federal court freezing all assets of Private Equity Management Group, Inc. and itsaffiliates, including our lender, may adversely affect our lender’s ability tocontinue to provide us funds under the terms of our revolving creditfacility.  At the request of theCommission, the federal court also appointed a temporary receiver of our lender’sagent and of our lender.  If, for anyreason, the receiver were to limit or terminate our ability to continue toborrow funds under our revolving credit facility, our cash position and ourability to continue day to day operations would be adversely affected, almostimmediately.  If that were to occur, wewould be required to seek additional and/or replacement financingimmediately.  If we are unable to do so,we may be forced to drastically curtail or cease operations and possibly seekprotection from our creditors under the U. S. Bankruptcy Code.

 

***Wehave material weaknesses in our internal control over financial reportingstructure which has resulted in the restatement of our financial statements forthe quarterly periods ended March 31, 2009 and June 30, 2009, andwhich, until remedied, may cause errors in our financial statements that couldrequire restatements of our financial statements and investors may loseconfidence in our reported financial information, which could lead to a declinein our stock price.***

 

We have identified four material weaknesses****inour internal control over financial reporting and cannot assure you thatadditional material weaknesses will not be identified in the future.  Management has concluded that (i) we did noteffectively implement comprehensive entity-level internal controls; (ii) we did not maintain effective controlsover changes to critical financial reporting applications and over access tothese applications and related data; (iii) we did not maintain asufficient level of information technology personnel to execute generalcomputing controls over our information technology structure; and (iv) we did notmaintain effective controls over recording and reporting the acceleration ofcertain components of our credit facility and the classification of theissuance of a note relating to a purchase price adjustment represented materialweaknesses in our internal control over financial reporting.  As a result of these material weaknesses, werestated our financial statements for the quarterly periods ended March 31,2009 and June 30, 2009.  If ourinternal control over financial reporting or disclosure controls and proceduresare not effective, there may be errors in our financial statements that couldrequire additional restatements and investors may lose confidence in ourreported financial information, which could lead to a decline in our stockprice.

 

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Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluatethe effectiveness of our internal control over financial reporting as of theend of each year, and to include a management report assessing theeffectiveness of our internal control over financial reporting in each AnnualReport on Form 10-K.

 

Our management, including our Chief Executive Officer and Chief FinancialOfficer, does not expect that our internal control over financial reportingwill prevent all error and all fraud. A control system, no matter how welldesigned and operated, can provide only reasonable, not absolute, assurancethat the control system’s objectives will be met. Further, the design of acontrol system must reflect the fact that there are resource constraints, andthe benefits of controls must be considered relative to their costs. Controlscan be circumvented by the individual acts of some persons, by collusion of twoor more people, or by management override of the controls. Over time, controlsmay become inadequate because changes in conditions or deterioration in thedegree of compliance with policies or procedures may occur. Because of theinherent limitations in a cost-effective control system, misstatements due toerror or fraud may occur and not be detected.

 

As a result, we cannot assure you that significant deficiencies or materialweaknesses in our internal control over financial reporting will not beidentified in the future. Any failure to maintain or implement required new orimproved controls, or any difficulties we encounter in their implementation,could result in significant deficiencies or material weaknesses, cause us tofail to timely meet our periodic reporting obligations, or result in materialmisstatements in our financial statements. Any such failure could alsoadversely affect the results of periodic management evaluations regardingdisclosure controls and the effectiveness of our internal control overfinancial reporting required under Section 404 of the Sarbanes-Oxley Actof 2002 and the rules promulgated thereunder. The existence of a materialweakness could result in errors in our financial statements that could resultin a restatement of financial statements, cause us to fail to timely meet ourreporting obligations and cause investors to lose confidence in our reportedfinancial information, leading to a decline in our stock price.

 

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

 

**Unregistered Sales of Equity Securities**

 

None.

 

**Dividends**

 

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

 

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

 

None.

 

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

 

On June 25, 2009, we held our 2008 annual meeting ofstockholders.  The total number ofoutstanding votable shares was 10,204,079. Our stockholders were asked to consider and vote upon the following twoproposals:

 

1)     Re-election of Otis W. Baskin as a Class Idirector to serve a three-year term.

 

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2)     Ratification of the selection of our independentregistered public accounting firm to audit our consolidated financialstatements for 2009.

 

Results of the vote were as follows:

 
| **Proposal** | ** ** | **For**   | ** ** | **Against** | ** ** | **Withheld** | ** ** | **Abstain** | ** ** | **Broker Non-Votes** | ** ** |
|--------------|------------|-----------|------------|-------------|------------|--------------|------------|-------------|------------|----------------------|------------|
| ** **   |       |      |       |        |       |         |       |        |       |                 |       |
| **(1)**      |       | 7,607,559 |       | —      |       | 897,684      |       | —      |       | None                 |       |
| ** **   |       |      |       |        |       |         |       |        |       |                 |       |
| **(2)**      |       | 8,309,902 |       | 178,797     |       | —       |       | 16,543      |       | None                 |       |

 

As a result, Mr. Baskin wasre-elected to serve as a Class I member of our board of directors.  Carmine T. Oliva, Laurence P. Finnegan, Jr.and Richard E. Mahmarian continued to serve on our board of directors followingthe meeting.  The selection of ourindependent registered public accounting firm to audit our consolidatedfinancial statements for 2009 was ratified.

 

**ITEM 5.               OTHER INFORMATION.**

 

***Amendment Number 4 to Loan Documents***

*** ***

On August 14,2009, we entered into Amendment Number 5 to Loan Documents with our Lender (“AmendmentNumber 5”).  Pursuant to Amendment Number 5, we agreed to raise no lessthan $3 million in net proceeds through the sale of stock of the borrowers byno later than December 31, 2009.  Under to the terms of AmendmentNumber 5, we are obligated to remit to our Lender 50% of the first $3,000,000of net cash proceeds received in connection with the sale of stock and 30% ofthe net cash proceeds in excess of the first $3,000,000 received.

 

Pursuant to theterms of Amendment Number 5, we are now obligated to make monthly principalpayments to our Lender of (i) $75,000 on September 1. 2009 and October 1,2009, (ii) $100,000 on November 1, 2009, (iii) $150,000 on December 1,2009 and (iv) approximately $287,000 commencing on January 1, 2010and continuing on the first day of each of the 10 consecutive monthsthereafter.  In addition, the Lenderrevised the minimum liquidity financial covenant to provide no such covenantfor the fiscal quarter ending September 30, 2009 and agreed that to theextent we sell assets after the date of Amendment Number 5 and prior to January 1,2010, 75% of the net cash proceeds of such sale must be used to prepay ouroutstanding obligations to the Lender. Any sales after that date would require us to use all net cash proceedsto prepay our outstanding obligations to the Lender.

 

In connection with entering into Amendment Number5, we paid the Lender a fee equal to $100,000.

 

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**ITEM 6.                EXHIBITS.**

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

 

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**SIGNATURES**

 

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

 
|                        | EMRISE CORPORATION |
|-----------------------------|--------------------|
|                        |               |   |
| Dated: October 2, 2009 | By:                | /S/  CARMINE T. OLIVA |
|                        |               | Carmine  T. Oliva, |
|                        |               | Chief  Executive Officer |
|                        |               |   |
|                        |               |   |
| Dated: October 2, 2009 | By:                | /S/  D. JOHN DONOVAN |
|                        |               | D.  John Donovan, Chief Financial Officer (principal financial and accounting  officer) |

 

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**INDEX TO EXHIBITS ATTACHED TOTHIS REPORT**

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

 

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