Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

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

 

**For thequarterly period ended****March 31,2010**

 

**or**

 

**o****        ****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES 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 and postedpursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). Yes oNo 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                    |   | Smaller  Reporting Company x |
| (do not check if Smaller Reporting Company) |   |                         |

 

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

 

The number of sharesoutstanding of the Registrant’s common stock, $0.0033 par value, as of May 12,2010 was 10,213,214.

 

 

 

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Table ofContents

 

**EMRISE CORPORATION**

**TABLE OF CONTENTS**

**FORM 10-Q**

**FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2010**

 

**PART I**

**FINANCIAL INFORMATION**

 
| **ITEM 1.**                         | **FINANCIAL STATEMENTS**                                                                                                   |   |
|-------------------------------------|----------------------------------------------------------------------------------------------------------------------------|--------|
|                                |                                                                                                                       |   |
|                                | Condensed Consolidated Balance Sheets as of  March 31, 2010 (unaudited) and December 31, 2009                    | 1      |
|                                |                                                                                                                       |   |
|                                | Condensed Consolidated Statements of Operations for  the Three Months Ended March 31, 2010 and 2009 (unaudited)       | 2      |
|                                |                                                                                                                       |   |
|                                | Condensed Consolidated Statements of Stockholders’  Equity for the Three Months Ended March 31, 2010 (unaudited) | 3      |
|                                |                                                                                                                       |   |
|                                | Condensed Consolidated Statements of Cash Flows for  the Three Months Ended March 31, 2010 and 2009 (unaudited)       | 4      |
|                                |                                                                                                                       |   |
|                                | Notes to Condensed Consolidated Financial Statements  (unaudited)                                                          | 5      |
|                                |                                                                                                                       |   |
| **ITEM 2.**                         | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**                            | 20     |
|                                |                                                                                                                       |   |
| **ITEM 3.**                         | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                            | 33     |
|                                |                                                                                                                       |   |
| **ITEM 4.**                         | **CONTROLS AND  PROCEDURES**                                                                                               | 33     |
|                                |                                                                                                                       |   |
| **ITEM 4T.**                        | **CONTROLS AND  PROCEDURES**                                                                                               | 33     |
|                                |                                                                                                                       |   |
| **PART II  OTHER INFORMATION** |
|                                |                                                                                                                       |   |
| **ITEM 6.**                         | **EXHIBITS**                                                                                                               | 37     |
|                                |                                                                                                                       |   |
| **SIGNATURES**                      | 38                                                                                                                         |
|                                     |                                                                                                                            |        |  |

 

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Table of Contents

 

**PART I — FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**EMRISE CORPORATION**

**Condensed Consolidated Balance Sheets**

(in thousands,except share and per share amounts)

 
| ** **                                                                                                                                           | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                           | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                           | ** ** | **(unaudited)**    | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                           |       |               |       |                  |       |
| Current assets:                                                                                                                                      |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                                                           |       | $                  | 2,540      |                  | $          | 3,994 |   |
| Accounts receivable,  net of allowances for doubtful accounts of $220 at March 31, 2010 and  $262 at December 31, 2009                     |       | 4,711              |       | 6,059                 |       |
| Inventories, net                                                                                                                                     |       | 7,312              |       | 8,030                 |       |
| Current deferred tax  assets                                                                                                                         |       | 150                |       | 158                   |       |
| Prepaid and other  current assets                                                                                                                    |       | 978                |       | 841                   |       |
| Current assets of  discontinued and held for sale operations                                                                                         |       | 5,599              |       | 6,369                 |       |
| Total current assets                                                                                                                                 |       | 21,290             |       | 25,451                |       |
|                                                                                                                                                 |       |               |       |                  |       |
| Property, plant and  equipment, net                                                                                                                  |       | 882                |       | 987                   |       |
| Goodwill                                                                                                                                             |       | 3,484              |       | 2,878                 |       |
| Intangible assets other  than goodwill, net                                                                                                          |       | 1,073              |       | 1,108                 |       |
| Deferred tax assets                                                                                                                                  |       | 1,623              |       | 1,818                 |       |
| Other assets                                                                                                                                         |       | 93                 |       | 121                   |       |
| Noncurrent assets of  discontinued and held for sale operations                                                                                      |       | 17,034             |       | 17,914                |       |
| Total assets                                                                                                                                         |       | $                  | 45,479     |                  | $          | 50,277 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                        |       |               |       |                  |       |
| Current liabilities:                                                                                                                                 |       |               |       |                  |       |
| Accounts payable                                                                                                                                     |       | $                  | 2,941      |                  | $          | 2,734 |   |
| Accrued expenses                                                                                                                                     |       | 4,170              |       | 5,232                 |       |
| Line of credit                                                                                                                                       |       | 3,655              |       | 5,156                 |       |
| Current portion of  long-term debt, net of discount of $145 and $290                                                                                 |       | 7,873              |       | 8,110                 |       |
| Notes payable to  stockholders, current portion                                                                                                      |       | 300                |       | 348                   |       |
| Income taxes payable                                                                                                                                 |       | 390                |       | 604                   |       |
| Other current  liabilities                                                                                                                           |       | 357                |       | 370                   |       |
| Current liabilities of  discontinued and held for sale operations                                                                                    |       | 9,238              |       | 9,839                 |       |
| Total current  liabilities                                                                                                                           |       | 28,924             |       | 32,393                |       |
|                                                                                                                                                 |       |               |       |                  |       |
| Long-term debt                                                                                                                                       |       | 62                 |       | 92                    |       |
| Deferred income taxes                                                                                                                                |       | 1,469              |       | 1,654                 |       |
| Other liabilities                                                                                                                                    |       | 1,516              |       | 688                   |       |
| Noncurrent liabilities  of discontinued and held for sale operations                                                                                 |       | 35                 |       | 62                    |       |
| Total liabilities                                                                                                                                    |       | 32,006             |       | 34,889                |       |
| Commitments and  contingencies                                                                                                                       |       |               |       |                  |       |
| Stockholders’ equity:                                                                                                                           |       |               |       |                  |       |
| Preferred stock,$0.01  par value. Authorized 10,000,000 shares, no shares issued and outstanding                                                     |       | —             |       | —                |       |
| Common stock,$0.0033  par value. Authorized 150,000,000 shares; 10,213,000 issued and outstanding  at March 31, 2010 and December 31, 2009 |       | 126                |       | 126                   |       |
| Additional paid-in  capital                                                                                                                          |       | 43,516             |       | 43,480                |       |
| Accumulated deficit                                                                                                                                  |       | (27,538            | )          | (26,586               | )          |
| Accumulated other  comprehensive loss                                                                                                                |       | (2,631             | )          | (1,632                | )          |
| Total stockholders’  equity                                                                                                                     |       | 13,473             |       | 15,388                |       |
| Total liabilities and  stockholders’ equity                                                                                                     |       | $                  | 45,479     |                  | $          | 50,277 |   |

 

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

 

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Operations**

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

 
| ** **                                                                            | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                            | ** ** | **March 31,**     | ** ** |
| ** **                                                                            | ** ** | **2010**               | ** ** | **2009** | ** ** |
| ** **                                                                            | ** ** | ** **             | ** ** | **(Restated)** | ** ** |
| Net Sales                                                                             |       | $                      | 7,092      |   | $ | 8,521 |   |
| Cost of Sales                                                                         |       | 5,141                  |       | 5,544 |   |
| Gross profit                                                                          |       | 1,951                  |       | 2,977 |   |
|                                                                                  |       |                   |       |   |   |
| Operating expenses:                                                                   |       |                   |       |   |   |
| Selling, general and  administrative                                                  |       | 2,534                  |       | 3,017 |   |
| Engineering and product  development                                                  |       | 522                    |       | 369 |   |
| Total operating  expenses                                                             |       | 3,056                  |       | 3,386 |   |
| Loss from operations                                                                  |       | (1,105                 | )          | (409 | ) |
|                                                                                  |       |                   |       |   |   |
| Other income (expense):                                                               |       |                   |       |   |   |
| Interest income                                                                       |       | 15                     |       | 46 |   |
| Interest expense                                                                      |       | (824                   | )          | (1,545 | ) |
| Other, net                                                                            |       | 144                    |       | (42 | ) |
| Total other expense,  net                                                             |       | (665                   | )          | (1,541 | ) |
|                                                                                  |       |                   |       |   |   |
| Loss before income  taxes                                                             |       | (1,770                 | )          | (1,950 | ) |
| Income tax (benefit)  provision                                                       |       | (136                   | )          | 150 |   |
| Loss from continuing  operations                                                      |       | (1,634                 | )          | (2,100 | ) |
| Discontinued and held  for sale operations:                                           |       |                   |       |   |   |
| Income from  discontinued and held for sale operations including gain on sale in 2009 |       | 912                    |       | 7,644 |   |
| Tax provision on  discontinued and held for sale operations                           |       | 230                    |       | 707 |   |
| Net income on discontinued  and held for sale operations                              |       | 682                    |       | 6,937 |   |
|                                                                                  |       |                   |       |   |   |
| Net (loss) income                                                                     |       | $                      | (952       | ) | $ | 4,837 |   |
|                                                                                  |       |                   |       |   |   |
| Earnings (loss) per  share from continuing operations:                                |       |                   |       |   |   |
| Basic                                                                                 |       | $                      | (0.16      | ) | $ | (0.21 | ) |
| Diluted                                                                               |       | $                      | (0.16      | ) | $ | (0.21 | ) |
|                                                                                  |       |                   |       |   |   |
| Weighted average shares  outstanding                                                  |       |                   |       |   |   |
| Basic                                                                                 |       | 10,213                 |       | 10,204 |   |
| Diluted                                                                               |       | 10,213                 |       | 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**

(Unaudited) ****(in thousands)

 
| ** **                         | ** ** | ** **        | ** ** | ** **  | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|------------------------------------|------------|-------------------|------------|-------------|------------|-----------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                         | ** ** | ** **        | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **        | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                         | ** ** | **Common  Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                         | ** ** | **Shares**        | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**       | ** ** | **Loss**        | ** ** | **Total**  | ** ** |
|                               |       |              |       |        |       |            |       |              |       |            |       |       |       |
| Balance at  December 31, 2009 |       | 10,213            |       | $           | 126        |            | $          | 43,480            |       | $               | (26,586    | )          | $          | (1,632 | ) | $ | 15,388 |   |
| Stock-based  compensation          |       | —            |       | —      |       | 36              |       | —            |       | —          |       | 36         |       |
| Warrants issued for  services      |       | —            |       | —      |       | —          |       | —            |       | —          |       | —     |       |
| Net loss and  comprehensive loss   |       | —            |       | —      |       | —          |       | (952              | )          | (999            | )          | (1,951     | )          |
| Balance at  March 31, 2010    |       | 10,213            |       | $           | 126        |            | $          | 43,516            |       | $               | (27,538    | )          | $          | (2,631 | ) | $ | 13,473 |   |

 

*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)

 
| ** **                                                                                                                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                                | ** ** | **March 31,**     | ** ** |
| ** **                                                                                                                                | ** ** | **2010**               | ** ** | **2009** | ** ** |
|                                                                                                                                      |       |                   |       | **(restated)** |   |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                                                                                 | ** ** | ** **             | ** ** | ** ** | ** ** |
| Net Income (loss)                                                                                                                         |       | $                      | (952       | ) | $ | 4,837 |   |
| Adjustments to arrive  at net loss from continuing operations                                                                             |       | (682                   | )          | (6,937 | ) |
| Net loss from  continuing operations                                                                                                      |       | (1,634                 | )          | (2,100 | ) |
| Reconciliation to net  cash provided by operating activities:                                                                             |       |                   |       |   |   |
| Depreciation and  amortization                                                                                                            |       | 119                    |       | 133 |   |
| Provision for doubtful  accounts                                                                                                          |       | 10                     |       | 13 |   |
| Provision for inventory  obsolescence                                                                                                     |       | 83                     |       | 145 |   |
| Provision for warranty  reserve                                                                                                           |       | 17                     |       | 7 |   |
| Deferred taxes                                                                                                                            |       | 18                     |       | 14 |   |
| Amortization of  deferred issuance costs                                                                                                  |       | 158                    |       | 405 |   |
| Amortization of debt  discount                                                                                                            |       | 145                    |       | 386 |   |
| Stock-based  compensation expense                                                                                                         |       | 36                     |       | 36 |   |
| Change in fair value of  common stock warrant                                                                                             |       | 208                    |       | (130 | ) |
| Changes in assets and  liabilities:                                                                                                       |       |                   |       |   |   |
| Accounts receivable                                                                                                                       |       | 1,345                  |       | 1,474 |   |
| Inventories                                                                                                                               |       | 823                    |       | (170 | ) |
| Prepaid and other  assets                                                                                                                 |       | (262                   | )          | 118 |   |
| Accounts payable and  accrued expenses                                                                                                    |       | (493                   | )          | 510 |   |
| Operating cash flow  provided by continuing operations                                                                                    |       | 573                    |       | 841 |   |
| Operating cash flow  provided by discontinued operations                                                                                  |       | (20                    | )          | 372 |   |
| Net cash provided by  operating activities                                                                                                |       | 553                    |       | 1,213 |   |
|                                                                                                                                      |       |                   |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                                                                                |       |                   |       |   |   |
| Purchases of property,  plant and equipment                                                                                               |       | (28                    | )          | (4 | ) |
| Investing cash flow  used in continuing operations                                                                                        |       | (28                    | )          | (4 | ) |
| Investing cash flow  provided by discontinued operations including proceeds from sale of  subsidiary operations, net of cash              |       | 850                    |       | 10,050 |   |
| Net cash provided by  investing activities                                                                                                |       | 822                    |       | 10,046 |   |
|                                                                                                                                      |       |                   |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                                                                                |       |                   |       |   |   |
| Borrowings from lines  of credit                                                                                                          |       | 10,622                 |       | 14,269 |   |
| Repayments of lines of  credit                                                                                                            |       | (12,123                | )          | (14,285 | ) |
| Repayments of long-term  debt                                                                                                             |       | (401                   | )          | (10,119 | ) |
| Payments of notes to  stockholders                                                                                                        |       | (48                    | )          | (168 | ) |
| Financing cash flow  used in continuing operations                                                                                        |       | (1,950                 | )          | (10,303 | ) |
| Financing cash flow  used in discontinued operations                                                                                      |       | (39                    | )          | (81 | ) |
| Net cash used in  financing activities                                                                                                    |       | (1,989                 | )          | (10,384 | ) |
| Effect of exchange rate  changes on cash                                                                                                  |       | (892                   | )          | (545 | ) |
| Net (decrease) increase  in cash and cash equivalents                                                                                     |       | (1,506                 | )          | 330 |   |
| Cash and cash  equivalents at beginning of period                                                                                         |       | 4,046                  |       | 3,137 |   |
| Cash and cash  equivalents at end of period                                                                                               |       | $                      | 2,540      |   | $ | 3,467 |   |
|                                                                                                                                      |       |                   |       |   |   |
| **SUPPLEMENTAL  DISCLOSURES OF NON-CASH INVESTING AND****FINANCING  ACTIVITIES:**                                                         |       |                   |       |   |   |
| Acquisition of  equipment through capital lease                                                                                           |       | $                      | —     |   | $ | 22 |   |
| Cumulative effect of  change in accounting principle - reclassification of common stock warrants to  liability upon adoption of EITF 07-5 |       | $                      | —     |   | $ | 473 |   |

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 1 — SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

*Organizationand Business*

 

EMRISE Corporation (the “Company”)designs, manufactures and markets proprietary electronic devices andcommunications equipment for aerospace, defense, industrial, and communicationsapplications. The Company has operations in the United States (“U.S.”), Englandand 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.

 

*Basis of Presentation*

 

The accompanying unaudited condensed consolidatedfinancial statements have been prepared in accordance with the rules andregulations of the U.S. Securities and Exchange Commission (“SEC”) 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 financial statements.  The unaudited condensed consolidatedfinancial statements do, however, reflect all adjustments, consisting of onlynormal recurring adjustments, which are, in the opinion of management,necessary to state fairly the financial position as of March 31, 2010 andthe results of operations and cash flows for the related interim periods ended March 31,2010 and 2009. However, these results are not necessarily indicative of resultsfor any other interim period or for the year. The accompanying unauditedcondensed consolidated financial statements should be read in conjunction withthe Company’s audited consolidated financial statements included in its annualreport on Form 10-K for the year ended December 31, 2009 as filedwith the Commission.

 

In March of 2009, theCompany sold substantially all the assets related to the Digitran division ofthe Company’s wholly-owned subsidiary, EMRISE Electronics Corporation’s (“EEC”),and all of the issued and outstanding equity interests of EEC’s wholly-ownedsubsidiary, XCEL Japan, Ltd. (collectively the “Digitran Operations”). The accompanying financial statements include the Digitran Operations asa discontinued operation for all periods presented.

 

In January of 2010, the Company entered intoAmendment Number 8 to Loan Documents (“Amendment 8”).  In connection with Amendment 8 and theassociated Amendments Number 9 and 10, entered into in April and May,2010, respectively, the Company is required to sell a significant portion ofits assets in order to repay the debt obligations owed to Lender.  The Company has identified certain assets itintends to market for sale.  The assetsidentified represent a substantial portion of the Company’s assets in primarilythe electronic devices segment.  Theaccompanying financial statements include the identified assets as discontinuedoperations and assets held for sale for all periods presented.

 

On March 22, 2010, EMRISE completed the sale ofsubstantially all the assets of EEC’s subsidiary, RO Associates, toMassachusetts based Astrodyne Corporation.  In this Quarterly Report on Form 10-Q, werefer to the businesses of RO Associates as the “RO Operations” or “RO,” and werefer to the sale of the RO Associates’ assets as the “RO Transaction.”  The accompanying financial statements includethe RO Operations as a discontinued operation for all periods presented.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*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** | ** ** |
|------------------------------------------|------------|------------------------|------------|
| ** **                               | ** ** | **March 31,**     | ** ** |
| ** **                               | ** ** | **2010**               | ** ** | **2009** | ** ** |
|                                     | ** ** | ** **             | ** ** | **(Restated)** | ** ** |
| Net (loss) income                        |       | $                      | (952       | ) | $ | 4,837 |   |
| Other comprehensive  loss:               |       |                   |       |   |   |
| Foreign  currency translation adjustment |       | (999                   | )          | (418 | ) |
| Comprehensive (loss)  income             |       | $                      | (1,951     | ) | $ | 4,419 |   |

 

*Revenue**Recognition*

 

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

 

The Company recognizesrevenues from its U.S. communications equipment business unit at the point ofshipment of those products.  An estimateof warranty cost is recorded at the time the revenue is recognized.  Product returns are infrequent and requireprior authorization because sales are final and the Company tests its productsfor quality 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, Advanced Control Components (“ACC”), depends upon the type ofcontract involved.  Engineering/designservices contracts generally entail design and production of a prototype over aterm of up to several years, with revenue deferred until each milestone definedin the contract is reached.  Productioncontracts provide for a specific quantity of products to be produced over aspecific period of time.  Customers issuebinding purchase orders or enter into binding agreements for the products to beproduced.  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.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Revenues from servicessuch as repairs and modifications are recognized when the service is completedand invoiced.  For repairs that involveshipment of a repaired product, the Company recognizes repair revenues when theproduct is shipped back to the customer. Service revenues contribute less than5% of total revenue and, therefore, are considered to be immaterial to overallfinancial results.

 

*Loss Per Share from Continuing Operations*

 

Basic loss per share from continuing operations iscomputed by dividing net loss from continuing operations by the weightedaverage common shares outstanding during a period.  Diluted loss per share from continuingoperations is based on the treasury stock method and includes the dilutiveeffect of stock options and warrants outstanding during the period.  Common share equivalents have been excludedwhere their inclusion would be anti-dilutive. As a result of the losses from continuing operations incurred by theCompany for the first quarter of 2010 and 2009, the potentially dilutive commonshares have been excluded from the loss per share computation because theirinclusion would have been anti-dilutive. The following table illustrates the computation of basic and dilutedloss per share from continuing operations (in thousands, except per shareamounts):

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                   | ** ** | **March 31,**     | ** ** |
| ** **                                                   | ** ** | **2010**               | ** ** | **2009** | ** ** |
|                                                         |       |                   |       | **(Restated)** |   |
| NUMERATOR:                                                   | ** ** | ** **             | ** ** | ** ** | ** ** |
| Net (loss) income                                            |       | $                      | (952       | ) | $ | 4,837 |   |
| Net income from  discontinued and held for sale operations   |       | 682                    |       | 6,937 |   |
| Net loss from  continuing operations                         |       | $                      | (1,634     | ) | $ | (2,100 | ) |
|                                                         |       |                   |       |   |   |
| DENOMINATOR:                                                 |       |                   |       |   |   |
| Basic weighted average  common shares outstanding            |       | 10,213                 |       | 10,204 |   |
| Effect of dilutive  securities:                              |       |                   |       |   |   |
| Dilutive stock options  and warrants                         |       | —                 |       | — |   |
| Diluted weighted  average common shares outstanding          |       | 10,213                 |       | 10,204 |   |
|                                                         |       |                   |       |   |   |
| Basic and diluted loss  per share from continuing operations |       | $                      | (0.16      | ) | $ | (0.21 | ) |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The following table shows the common stock equivalentsthat were outstanding as of March 31, 2010 and 2009, but were not includedin the computation of diluted earnings per share because the options’ orwarrants’ exercise price was greater than the average market price of thecommon shares and, therefore, the effect would have been anti-dilutive:

 
| ** **                            | ** ** | ** **     | ** ** | **Range  of**       | ** ** |
|---------------------------------------|------------|----------------|------------|---------------------|------------|
| ** **                            | ** ** | **Number  of** | ** ** | **Exercise  Price** | ** ** |
| ** **                            | ** ** | **Shares**     | ** ** | **Per  Share**      | ** ** |
|                                  |       |           |       |                |       |
| Anti-dilutive common  stock options:  |       |           |       |                |       |
| As of March 31,  2010            |       | 683,425        |       | $1.31 – $7.50  |       |
| As of March 31,  2009            |       | 584,000        |       | $1.88 – $7.50  |       |
|                                  |       |           |       |                |       |
| Anti-dilutive common  stock warrants: |       |           |       |                |       |
| As of March 31,  2010            |       | 784,092        |       | $4.13 – $4.31  |       |
| As of March 31,  2009            |       | 1,804,000      |       | $4.31 – $6.49  |       |

 

*Recent Accounting Pronouncements*

 

**Adopted**

 

**None.**

 

**Issued, but not adopted**

 

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

 

**NOTE 2 — GOING CONCERN**

 

Theaccompanying condensed consolidated financial statements have been prepared inconformity with GAAP, which contemplate the continuation of the Company as agoing concern.  The Company reported anet loss for the three months ended March 31, 2010 of $1.0 million.  Included in net loss was a $0.5 million lossfrom discontinued operations related to the disposition of the Company’s ROOperations (see Note 3).  Absent thisloss, the Company still would have incurred a $0.5 million net loss for thethree months ended March 31, 2010. Primarily as a result of the reclassification of the majority of itsdebt from long to short term during 2009, the Company also reported negativeworking capital from continuing operations of $4.0 million at March 31,2010 and negative working capital from continuing operations of $3.5 million atDecember 31, 2009.  The Company’scurrent business plan for the next 12 months requires additional funding beyondits anticipated cash flows from operations. These and other factors described in more detail below raise substantialdoubt about the Company’s ability to continue as a going concern.  Theaccompanying consolidated financial statements do not include any adjustmentsthat might result from the outcome of this uncertainty.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Theability of the Company to continue as a going concern is dependent upon itsability to (i) achieve the milestones related tosale of a significant portion of its assets as required by the Credit Agreementbetween now and June 30, 2010, (ii) repay the credit facility in fullon or prior to its maturity on June 30, 2010, (iii) obtain alternatefinancing to fund operations after the credit facility is paid in full and (iv) achieveprofitable operations.

 

The Company is working on an amendment to extend certainof the milestones to have been achieved the week of this filing with anindication from the lender such extension will be acceptable.  The Company expects to sign a formalamendment this week, but there can be no guarantees that such amendment will besuccessfully or timely completed.

 

Ifthe Company’s net losses continue, it may experience negative cash flow, whichmay prevent the Company from continuing operations.  If the Company is not able to attain, sustainor increase profitability on a quarterly or annual basis, it may not be able tocontinue operations.

 

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

 

If the Company (i) defaults under the Credit Facility for any reason, including failing to successfully amend the Credit Agreement to extend sale related milestones or missing a milestone, (ii) is unable to timely sell assets at sufficient prices to repay its obligations in full, (iii) cannot borrow funds under the terms of the Revolver, for any reason, or (iv) fails to obtain alternate financing to replace its credit facility or a new revolving facility once the current credit facility is paid in full, then the Company does not believe that current and future capital resources, revenues generated from operations and other existing sources of liquidity will be adequate to meet its anticipated short term, working capital and capital expenditure needs for the next 12 months.  Further, if any of these occur for any reason, or if the Company experiences a significant loss of revenue or increase in costs, then its cash flow would be negatively impacted resulting in a cash flow deficit.  A cash flow deficit will require the Company to seek additional or alternate financing, with little or no notice which would be difficult to obtain in these economic conditions and the Company’s anticipated financial condition in such circumstances.  To address these potential financing needs the Company may have to explore a revised debt structure with its current lender; additional or new financing with another lender or lenders; expedite the sale of assets to generate cash; or expedite the sale of equity to raise capital.  Successfully executing these strategies is uncertain and there are many risks associated with attempting to execute each, in addition to the risks and uncertainties of the short and long term impact of executing on any of these strategies.   Failure to meet the Company’s financing requirements, if and when needed, would have an adverse effect on the Company’s operations and/or ability to do business after that date or could restrict its growth, limit the development of new products, hinder its ability to fulfill existing or future orders or negatively affect its ability to secure new customers or product orders.

 

Ifthe Company is unsuccessful in securing the necessary financing to continueoperations, when needed, then it may beforced to seek protection under the U.S. Bankruptcy Code or be forced intoliquidation or substantially restructuring or altering its business operationsand/or debt obligations.

 

**NOTE 3 — DISCONTINUED OPERATIONS**

 

*RO Associates*

 

On March 22, 2010,EEC, a wholly-owned subsidiary of the Company, entered into and consummated theclosing under an asset purchase agreement by and among Astrodyne Corporation (“Astrodyne”),RO, and EEC dated March 22, 2010 (the “Purchase Agreement”) pursuant towhich Astrodyne purchased substantially all of the assets, properties, andbusiness as a going concern of RO.  Theassets of RO that were sold and transferred to Astrodyne include, but are notlimited to, the following:  (i) machineryand equipment; (ii) raw materials, work-in-process, and finished goodsrelating to RO; (iii) tangible personal property, such as office furnitureand equipment; (iv) advance payments, rental deposits, and other similarassets; (v) rights to payments from

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

customers; (vi) booksand records; (vii) rights under certain contracts; (viii) intangiblerights and property, such as goodwill and rights in and to the name “ROAssociates,” product names, trade names, trademarks, fictitious names andservice marks; (ix) information and data; (x) unfilled purchase andsale orders; (xi) governmental authorizations relating to RO’s business andpending applications in connection with such authorizations; (xii) RO’s rightsto its business of manufacturing and selling standard, high-density AC to DC,and DC to DC converters (the “Business”); and (xiii) all claims, causes ofaction, and judgments relating to the Business. Such sale and transfer was deemed to be a disposition of aninsignificant amount of assets by the Company and EEC.  RO retained certain rights, as fully describedin the Purchase Agreement, including certain records, rights to benefits plansand insurance policies and proceeds, and certain assets.

 

As part of thetransactions contemplated by the Purchase Agreement, Astrodyne assumed certainspecified liabilities of RO pursuant to an Assignment and Assumption Agreementby and between Astrodyne and RO (the “Assignment and Assumption Agreement”).  Pursuant to the Purchase Agreement, EEC alsoagreed to guarantee the full, complete, and timely compliance with and performanceof all agreements, covenants and obligations of RO in connection with the ROTransaction.

 

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

 

In connection with theCompany’s divestiture of RO, which comprised a portion of the Company’selectronic devices segment, the Company incurred approximately $0.4 million incharges relating to legal, accounting and investment banking fees.  The Company does not expect to incur anyadditional costs associated with this transaction.  The Company incurred a loss on the sale ofthe RO assets of approximately $0.5 million.

 

The Company hasclassified RO, which is a component of its electronic devices segment, asdiscontinued operations in the accompanying consolidated financial statementsfor all periods presented.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The following tablesummarizes the results from discontinued operations for the three months ended March 31,2010 and 2009 (in thousands):

 
| ** **                           | ** ** | **2010**   | ** ** | **2009**       | ** ** |
|--------------------------------------|------------|------------|------------|----------------|------------|
| ** **                           | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
|                                 |       |       |       |           |       |
| Net Sales                            |       | $          | 442        |           | $          | 643 |   |
|                                 |       |       |       |           |       |
| Income (loss) from  operations       |       | $          | 211        |           | $          | (535 | ) |
|                                 |       |       |       |           |       |
| Other income (expense)               |       | —     |       | (1             | )          |
| Loss on sale of RO  Operations       |       | (450       | )          | —         |       |
| Net loss                             |       | $          | (239       | )              | $          | (536 | ) |
|                                 |       |       |       |           |       |
| Loss per share:                      |       |       |       |           |       |
| Basic                                |       | $          | (0.02      | )              | $          | (0.05 | ) |
| Diluted                              |       | $          | (0.02      | )              | $          | (0.05 | ) |
|                                 |       |       |       |           |       |
| Weighted average shares  outstanding |       |       |       |           |       |
| Basic                                |       | 10,213     |       | 10,204         |       |
| Diluted                              |       | 10,213     |       | 10,204         |       |

 

The following tablereflects the major classes of assets and liabilities of the RO Operations atthe balance sheet date for the periods presented (in thousands):

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

 

*Assets Held for Sale*

 

In connection withAmendment 8 and the associated Amendments Number 9 and 10, entered into inApril, 2010 and May, 2010, respectively, as discussed above, the Company isrequired to sell a significant portion of its assets in order to repay the debtobligations owed to Lender.  The Companyhas identified multiple assets it intends to market for sale.  The assets identified as held for salerepresent a substantial portion of the Company’s assets in primarily theelectronic devices segment.  These assetscontributed approximately $20 million of net sales or 37% of the Company’s netsales and operating income of approximately $3 million of the Company’s totaloperating income from continuing operations of $1.4 million for 2009.

 

The Company hasclassified these identified assets, which are a component of its electronicdevices segment, as discontinued and held for sale operations in theaccompanying condensed consolidated financial statements for all periodspresented.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

The following tablesummarizes the results from the identified assets held for sale for the threemonths ended March 31, 2010 and 2009 (in thousands):

 
| ** **                           | ** ** | **2010**   | ** ** | **2009**       | ** ** |
|--------------------------------------|------------|------------|------------|----------------|------------|
| ** **                           | ** ** | ** ** | ** ** | **(restated)** | ** ** |
|                                 |       |       |       |           |       |
| Net Sales                            |       | $          | 5,210      |           | $          | 5,049 |   |
|                                 |       |       |       |           |       |
| Income from operations               |       | $          | 1,259      |           | $          | 832 |   |
|                                 |       |       |       |           |       |
| Other expense                        |       | (108       | )          | (10            | )          |
| Provision for income  taxes          |       | 230        |       | 44             |       |
| Net income                           |       | $          | 921        |           | $          | 778 |   |
|                                 |       |       |       |           |       |
| Earnings per share:                  |       |       |       |           |       |
| Basic                                |       | $          | 0.09       |           | $          | 0.08 |   |
| Diluted                              |       | $          | 0.09       |           | $          | 0.08 |   |
|                                 |       |       |       |           |       |
| Weighted average shares  outstanding |       |       |       |           |       |
| Basic                                |       | 10,213     |       | 10,204         |       |
| Diluted                              |       | 10,213     |       | 10,204         |       |

 

The following tablereflects the major classes of assets and liabilities, by segment, classified asheld for sale  for the periods presented(in thousands):

 
| ** **                                  | ** ** | **Electronic  Devices Segment** | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|
| ** **                                  | ** ** | **March 31,  2010**        | ** ** | **December 31,  2009** | ** ** |
| Cash and cash  equivalents                  |       | $                               | 8          |   | $ | 52 |   |
| Accounts receivable,  net                   |       | 2,961                           |       | 2,189 |   |
| Inventory, net                              |       | 2,501                           |       | 2,495 |   |
| Prepaids and other  current assets          |       | 129                             |       | 136 |   |
| Total current assets                        |       | 5,599                           |       | 4,872 |   |
|                                        |       |                            |       |   |   |
| Property, plant and  equipment, net         |       | 1,256                           |       | 1,326 |   |
| Goodwill                                    |       | 12,020                          |       | 12,755 |   |
| Intangible assets other  than goodwill, net |       | 3,698                           |       | 3,773 |   |
| Other                                       |       | 60                              |       | 60 |   |
| Total assets                                |       | $                               | 22,633     |   | $ | 22,786 |   |
|                                        |       |                            |       |   |   |
| Total current  liabilities                  |       | $                               | 9,238      |   | $ | 9,094 |   |
|                                        |       |                            |       |   |   |
| Total long-term  liabilities                |       | $                               | 35         |   | $ | 62 |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 4 — STOCK-BASED COMPENSATION**

 

The Company has fivestock option plans:

 

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

·                  1993 Stock Option Plan;

·                  1997 Stock Incentive Plan;

·                  Amended and Restated 2000 Stock Option Plan; and

·                  2007 Stock Incentive Plan.

 

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

 

Total stock-based compensation expense included inwages, salaries and related costs was $36,000 and $34,000 for the three monthsended March 31, 2010 and 2009, respectively. These compensation expenseswere charged to selling, general and administrative expenses. As of March 31,2010, the Company had $198,000 of total unrecognized compensation expenserelated to stock option grants, which will be recognized over the remainingweighted average period of two years.

 

**NOTE 5 — 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):

 
| ** **        | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|--------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2009**           | ** ** | **2009**              | ** ** |
|              |       |               |       |                  |       |
| Raw materials     |       | $                  | 6,230      |                  | $          | 6,690 |   |
| Work-in-process   |       | 1,820              |       | 2,121                 |       |
| Finished goods    |       | 3,201              |       | 3,273                 |       |
| Reserves          |       | (3,939             | )          | (4,054                | )          |
| Total inventories |       | $                  | 7,312      |                  | $          | 8,030 |   |

 

**NOTE 6 — OPERATING SEGMENTS**

 

The Company has two reportable operating segments:electronic devices and communications equipment. The electronic devices segmentmanufactures and markets electronic power supplies, RF and microwave devicesand subsystem assemblies. The electronic devices segment consists of theCompany’s three electronic device subsidiaries, one located in the U.S. and twolocated in England, all of which offer the same or similar products to the sameor similar customers.  The communicationsequipment segment designs, manufactures and distributes network access productsand timing and synchronization products. The communications equipment segment consists of operating entities CXRLarus Corporation located in the U.S. and CXR Anderson Jacobson located inFrance, both of which offer the same or similar products to similarcustomers.  Both segments operateprimarily in the U.S. and European markets, but they have distinctly differentcustomers, design and manufacturing processes and marketing strategies.  Each segment has discrete financialinformation and a separate management structure.

 

The Company evaluates performance based uponcontribution margin of the segments and also upon profit or loss fromoperations before income taxes exclusive of nonrecurring gains and losses. TheCompany accounts for intersegment sales at pre-determined prices negotiatedbetween the individual segments.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

During the first quarterof 2010, the Company sold its RO Operations (see Note 3), which were part ofits electronic devices segment.  Thistransaction resulted in differences in the basis of segmentation from theamounts disclosed in the Company’s unaudited condensed consolidated financialstatements included in its quarterly report on Form 10-Q for the threemonths ended March 31, 2009.  The ROOperations were included as discontinued and held for sale operations at December 31,2009.  Additionally, at March 31,2010, the Company had classified certain additional assets within itselectronic devices segment as assets held for sale in the accompanyingconsolidated financial statements.  Inthis report, the RO Operations and the certain identified assets held for saleare reported as discontinued and held for sale operations and are excluded fromthe electronics devices segment. Therefore, prior period amounts have been adjusted to conform to thispresentation.

 

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

 
| ** **                                 | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **March 31,**     | ** ** |
| ** **                                 | ** ** | **2010**               | ** ** | **2009** | ** ** |
| ** **                                 | ** ** | ** **             | ** ** | **(restated)** | ** ** |
| Net sales                                  | ** ** |                   |       |   |   |
| Electronic devices                         |       | $                      | 4,437      |   | $ | 5,903 |   |
| Communications  equipment                  |       | 2,655                  |       | 2,618 |   |
| Net sales from  continuing operations      |       | 7,092                  |       | 8,521 |   |
| Discontinued and held  for sale operations |       | 5,652                  |       | 5,692 |   |
| Total net sales                            |       | $                      | 12,744     |   | $ | 14,213 |   |
|                                       |       |                   |       |   |   |
| Operating income (loss)                    |       |                   |       |   |   |
| Electronic devices                         |       | $                      | 476        |   | $ | 1,265 |   |
| Communications  equipment                  |       | (478                   | )          | (452 | ) |
| Corporate and other                        |       | (1,103                 | )          | (1,222 | ) |
| Operating loss from  continuing operations |       | (1,105                 | )          | (409 | ) |
| Discontinued and held  for sale operations |       | 1,470                  |       | 297 |   |
|                                       |       | $                      | 365        |   | $ | (112 | ) |

 
| ** **                                 | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| Total assets                               | ** ** | ** **         | ** ** | ** **            | ** ** |
| Electronic devices                         |       | $                  | 12,045     |                  | $          | 13,783 |   |
| Communications  equipment                  |       | 7,446              |       | 8,439                 |       |
| Corporate and other                        |       | 3,355              |       | 3,772                 |       |
| Total assets from  continuing operations   |       | 22,846             |       | 25,994                |       |
| Discontinued and held  for sale operations |       | 22,633             |       | 24,283                |       |
| Total assets                               |       | $                  | 45,479     |                  | $          | 50,277 |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 7 — GOODWILL**

 

The following tablereflects changes in our goodwill balances, by segment, for the three monthsended March 31, 2010 (in thousands):

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

 

**NOTE 8 — INCOME TAXES**

 

The effective taxrate for the three month period ended March 31, 2010 was different thanthe 34% U.S. statutory rate primarily because the Company’s foreign entitiesgenerate a tax obligation and related tax expense as a result of their netincome, which cannot be offset by U.S. tax loss carryforwards.

 

The Company’s business is subject to regulation undera wide variety of U.S. federal, state and foreign tax laws, regulations andpolicies.  The majority of the Company’sforeign subsidiaries have earnings and profits that are reinvestedindefinitely.  However, under the creditfacility described in Notes 9 and 10, the foreign subsidiaries have issuedguarantees on the credit facility and, as a result, under IRC §956, have beendeemed to have distributed these earnings to fund U.S. operations.  This has resulted in U.S. federal taxableincome and an increase in U.S. tax liability, which has been reduced throughutilization of available net operating loss carryforwards and foreign taxcredits.

 

The Company adopted FASB guidance for accounting foruncertainty in income taxes on January 1, 2007. The implementation of thisguidance did not result in a material adjustment to the Company’s liability forunrecognized income tax benefits. At the time of adoption and as of December 31,2009, the Company had recorded no net unrecognized tax benefits.  The Company currently has no open matters withtax authorities nor is it engaged in an examination by any tax authority.  The Company recognizes interest and penaltiesrelated to 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 the first quarter of 2010. As of March 31, 2010, theCompany had nothing accrued for interest and penalties.

 

The Company files income tax returns in the UnitedStates federal jurisdiction, the United Kingdom and France, and in the statejurisdictions of California, Texas, Pennsylvania and New Jersey. The Company isno longer subject to United States federal and state tax examinations for yearsbefore 2006 and 2005, respectively, and is no longer subject to taxexaminations for the United Kingdom and Japan for years prior to 2008, and forFrance for years prior to 2006.

 

**NOTE 9 — LINE OF CREDIT**

 

The Company and certainof its subsidiaries, including EEC and CXR Larus Corporation, CCI, ACC andEMRISE Power Systems, Incorporated (collectively, the “Borrowers”), are partiesto a Credit Agreement (as amended from time to time, the “Credit Agreement”)with GVEC Resource IV Inc. (the “Lender”) providing for a credit facility whichincludes term loans and a revolving credit facility and is secured by accountsreceivable, other rights to payment and general intangibles, inventories andequipment. The credit facility includes a revolving credit facility for up to$7,000,000 that expires on June 30, 2010 (the “Revolver”).

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

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 December 31,2009 was the minimum rate of 9.5%.  TheRevolver is subject to the Borrowers not incurring capital expenditures in excess of$1,800,000 for the fiscal year ending December 31, 2010.  Additionally, the Revolver is subject to the Borrowersnot incurring unfinanced capital expenditures in excess of $62,500 in anyfiscal quarter and the Borrowers not incurring purchase money commitments inexcess of $2 million over the life of the facility.  However, if the Borrowers incur unfinancedcapital expenditures of less than $62,500 in any fiscal quarter, the differencebetween the amount incurred in a certain fiscal quarter and $62,500 maybeincurred in the two fiscal quarters immediately following such fiscal quarter.The Company was in compliance with these covenants at March 31, 2010.

 

Asof March 31, 2010, the Company had outstanding borrowings of $3.7 millionunder the Revolver with remaining availability under the formula-basedcalculation of $3.3 million.

 

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

 

See related Note 2 “Going Concern” and Note 10 “Debt” regardingadditional terms and conditions associated with the overall credit facility andrisks associated with this credit facility.

 

**NOTE 10 —DEBT**

 

The credit facility, asdescribed in Note 9, consists of (i) the Revolver (see Note 10 — “Lines ofCredit”), (ii) a term loan in the original principal amount of $6 million,of which $5.4 million was outstanding as of March 31, 2010 and is due June 30,2010 (“Term Loan A”), (iii) a term loan in the original principal amountof $10 million, of which $2.5 million was outstanding as of December 31,2009 and is due on June 30, 2010 (“Term Loan B”), and (iv) Term LoanC, which originally provided for a principal amount of $3 million and has sincebeen retired.  Term Loan A was fullyfunded on November 30, 2007 while Term Loans B and C were fully funded on August 20,2008 in connection with the acquisition of ACC. $6.8 million of Term Loan B andall of Term Loan C was repaid in March 2009, in connection with the saleof the Company’s Digitran Operations. Term Loan A and Term Loan B require an aggregate scheduled principalpayment of $75,000 bi-weekly beginning on February 1, 2010 through thematurity date of June 30, 2010.  Thefacility also requires monthly interest payments and a final balloon payment of$7.4 million upon maturity on June 30, 2010.

 

The Term Loans A and B bearinterest at the Base Rate plus 4.25%, subject to a minimum rate of 12.5% perannum, and required interest only payments in the first year, scheduledprincipal plus interest payments in years two and three, and a final balloonpayment at June 30, 2010.  Intereston the Term Loans is payable monthly.

 

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.  See Note 11.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Uponthe sale or disposition by the Borrowers or any of their subsidiaries ofproperty or assets, the Borrowers may be obligated to prepay the Revolver andthe term loans with the net cash proceeds received in connection with suchsales or dispositions to the extent that the aggregate amount of net cashproceeds received, and not paid to the Lender as a prepayment, for all suchsales or dispositions exceed $150,000 in any fiscal year.  However, in order to repay its obligations,the Borrowers agreedto sell a significant portion of its assets in 2010.  As discussed further in Note 3, these assets contributed approximately $20million of net sales or 37% of the Company’s net sales and operating income ofapproximately $3 million of the Company’s total operating income fromcontinuing operations of $1.4 million for 2009. The Company will retain a percentage of the proceeds of some of suchsales for working capital and pursuant to the agreement, will use the remainingproceeds to pay down the obligations owed to the Lender.

 

If the Lender terminates the credit facility during adefault period, then the Company is subject to a penalty equal to 2% of theoutstanding principal balance of the Revolver and the Term Loans.  TheRevolver 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 thatdate.  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.

 

Pursuant to a January 2010 amendment to the CreditFacility, the Borrowers have agreed with the Lender that it has the right toappoint an outside observer to review the Borrower’s books and records andbusiness operations, with certain limitations designed to minimize disruptionto the business operations of the Borrowers. In addition, pursuant to that amendment, certain fees (including a$200,000 advisory fee arising in connection with that amendment, which isrecorded in accrued expenses in the accompanying consolidated balance sheet)and certain expenses owed by the Borrowers have been deferred until theMaturity Date.  In connection with arecent amendment, and the associated Amendments Number 9 and 10, entered intoin April, 2010 and May, 2010, respectively, the Borrowers agreed to sell asignificant portion of its assets by June 30, 2010 and committed tocertain milestone events associated with the sales process.  Failure to achieve these milestones and/orfailure to sell the required assets by the agreed upon dates, can result in adefault under the Credit Agreement.  TheBorrowers are also obligated to provide financial information and statusreports to the Lender on a regular basis.

 

The Company is working on an amendment to extendcertain of the milestones to have been achieved the week of this filing with anindication from the lender such extension will be acceptable.  The Company expects to sign a formalamendment this week, but there can be no guarantees that such amendment will besuccessfully or timely completed.

 

See Note 2 and Note 9 regarding additional terms andconditions associated with the Company’s credit facility and risks associatedwith this credit facility.

 

**NOTE 11 — WARRANTS**

 

In connection with entering into the credit facility (discussed in Note11), the Company issued a seven year warrant to Private Equity Management Group, Inc.(“PEM Group”), an affiliate of the Lender, to purchase up to 775,758 shares ofthe Company’s common stock on a cash or cashless basis at an original exerciseprice of $4.13 per share, (which amount reflects the Company’s 1-for-3.75reverse split of its common stock effective November 18, 2008).  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.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

The exercise price and/or number of shares of common stock issuableupon exercise of the warrants may be adjusted in certain circumstances,including certain issuances of securities at a price equal to less than thethen current exercise price, subdivisions and stock splits, stock dividends,combinations, reorganizations, reclassifications, consolidations, mergers orsales of properties and assets and upon issuance of certain assets orsecurities to holders of the Company’s common stock, as applicable. On January 1,2009, the Company adopted FASB updates which affected how instruments indexedto an entity’s own stock are accounted for. The adoption of the revised FASB guidance resulted in thereclassification of the PEM Group warrants from stockholders’ equity toliabilities, and now requires that the warrants to be fair valued pursuant to “markto market” provisions at each reporting period, with the changes in fair valuerecognized in the Company’s consolidated statement of operations.

 

At March 31, 2010 and December 31, 2009, theCompany had warrants subject to “mark to market” provisions outstanding topurchase 775,758 shares of common stock. The Company computed the fair value of the warrants using aBlack-Scholes valuation model.  The fairvalue of these warrants on the date of adoption of March 31, 2010 and on December 31,2009 was determined using the following assumptions:

 
| ** **               | ** ** | **March 31,  2010** | ** ** | **December 31,  2009** | ** ** |
|--------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Dividend  yield          |       | None                     |       | None                        |       |
| Expected  volatility     |       | 78                       | %          | 71                          | %          |
| Risk-free  interest rate |       | 1.02                     | %          | 1.14                        | %          |
| Expected  term           |       | 7  years                 |       | 7  years                    |       |
| Stock  price             |       | $                        | 1.05       |                        | $          | 0.76 |   |
|                          |            |                          |            |                             |            |  |  |

 

As of and for the quarter ended March 31, 2010,the change in fair value of the warrants resulted in a $208,000 adjustment toother income (expense) in the condensed consolidated statement of operationsand a corresponding increase to the warrant liability.

 

**NOTE 12 — FAIR VALUE MEASUREMENTS**

 

FASB guidance for fairvalue measurements defines fair value as the price that would be received tosell an asset or paid to transfer a liability (an exit price) in an orderlytransaction between market participants and also establishes a fair valuehierarchy which requires an entity to maximize the use of observable inputs andminimize the use 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:

 

Level 1 — Inputs areunadjusted quoted prices in active markets for identical assets or liabilitiesavailable at the measurement date.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

Level 2 — Inputs areunadjusted quoted prices for similar assets and liabilities in active markets,quoted prices for identical or similar assets and liabilities in markets thatare not active, inputs other than quoted prices that are observable, and inputsderived from or corroborated by observable market data.

 

Level 3 — Inputs that areunobservable inputs which reflect the reporting entity’s own assumptions onwhat assumptions the market participants would use in pricing the asset orliability based on the best available information.

 

Asof January 1, 2009 the Company was required to apply updated FASB guidanceto the derivative that is within the warrant that was issued as considerationfor the Company’s credit facility, which is discussed in Note 10 and includedas a discount on the Company’s long-term debt. The derivative was valued using the Black-Scholes model.  The key inputs in the model at March 31,2010 are as follows:

 
| ** **               | ** ** | **March 31,  2010** | ** ** |
|--------------------------|------------|--------------------------|------------|
| Dividend  yield          |       | None                     |       |
| Expected  volatility     |       | 78                       | %          |
| Risk-free  interest rate |       | 1.02                     | %          |
| Expected  term           |       | 7  years                 |       |
| Stock  price             |       | $                        | 1.05       |   |
|                          |            |                          |            |  |

 

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

 
| ** **                                   | ** ** | **Warrant  Liability** | ** ** |
|----------------------------------------------|------------|------------------------|------------|
|                                         |       |                   |       |
| Beginning  balance at December 31, 2009 |       | $                      | 292        |   |
| Total  loss realized in earnings             |       | 208                    |       |
| Ending  balance at March 31, 2010       |       | $                      | 500        |   |

 

**NOTE 13 — SUBSEQUENT EVENTS**

 

*Amendment to Credit Facility*

 

The Borrowers and the Lender entered into AmendmentNumber 10 to Loan Documents (“Amendment 10”), which amends the Credit Agreementas of May 3, 2010.  Among otherthings, Amendment 10 modifies the schedule for certain milestone events relatedto the process for the sale of certain assets of the Borrowers.

 

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

 

**CautionaryStatement**

 

The following discussion should be read in conjunctionwith our unaudited condensed consolidated financial statements and the relatednotes thereto contained in Part I, Item 1 of this Quarterly Report on Form 10-Q.The information contained in this report is not a complete description of ourbusiness or the risks associated with an investment in our common stock. Weurge you to carefully review and consider the various disclosures made by us inthis Quarterly Report on Form 10-Q and in our other reports filed with theU.S. Securities and Exchange Commission (the “SEC”), including our AnnualReport on Form 10-K for the year ended December 31, 2009 andsubsequent reports on Forms 10-Q and 8-K, which discuss our business in greaterdetail.  This report and the followingdiscussion contain forward-looking statements, which generally include theplans,  objectives and expectations ofmanagement for future operations, including plans, objectives and expectationsrelating to our future economic performance and our current beliefs regardingrevenues we might generate and profits we might earn if we are successful inimplementing our business and growth strategies. The forward-looking statementsand associated risks may include, relate to or be qualified by other importantfactors, including, without limitation:

 

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

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

**·**                  the ongoing revenues and profitability of theCompany will be substantially reduced as a result of our sale of a significantportion of the Company’s assets in order to satisfy our debt obligations.  This could have a material adverse effect onthe Company’s operations, financial condition and ability to continueoperations;

**·**                  our ability to find and secure alternate financing to our current creditfacility on or before June 30, 2010, including a replacement revolver facilityin the event the obligations under the current facility are paid in full;

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

 

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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, 2009 and in this report could cause our financialresults, including our net income or loss or growth in net income or loss todiffer materially from prior results, which in turn could, among other things,cause the price of our common stock to fluctuate substantially.

 

**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 2010, our electronic devices segmentcontributed approximately 63% of overall net sales while the communicationssegment contributed approximately 37% of overall net sales. Our subsidiarieswithin our electronic devices segment design,develop, manufacture and market power supplies, radio frequency, or RF, andmicrowave devices for defense, aerospace and industrial markets.  Our subsidiaries within ourcommunications equipment segment design, develop, manufacture and marketnetwork access equipment, including network timing and synchronizationproducts, for communications applications in defense, public and privatenetworks and industrial markets.

 

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

 

Within our communications equipment segment, weproduce a range of network access equipment, including network timing andsynchronization products, for public and private communications networks.  This segment is “end user product” based witha traditional cycle of internally funded development and marketing prior toselling via direct and indirect sales channels. Manufacturing is primarily outsourced. Our communications equipment is used in a broad range of networkapplications primarily for private communications networks, publiccommunications carriers, and also for utility companies and militaryapplications, 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 GAAP. The preparation of thesefinancial statements requires us to make estimates and judgments that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamount of net sales and expenses for each period. The following represents asummary of our critical accounting policies, defined as those policies that webelieve are the most important to the portrayal of our financial condition andresults of operations and that require management’s most difficult, subjectiveor complex judgments, often as a result of the need to make estimates about theeffects of matters that are inherently uncertain.

 

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

 

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

 

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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 the specificationsof the binding purchase orders under which those products are shipped.Normally, when a customer requests and receives authorization to return aproduct, the request is accompanied by a purchase order for a repair or for areplacement product.

 

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

 

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

 

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

 

***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 inventoryquantities on hand and record a provision for excess and obsolete inventorybased primarily 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 

 

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conditions.  Any inventory that we determine to beobsolete, either in connection with the physical count or at other times ofobservation, are reserved for and subsequently written-off.

 

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 81.8% and 87.1% of our net revenues fromcontinuing operations, 33.1% and 34.7% of our assets and 19.7% and 27.5% of ourtotal liabilities as of and for the three months ended March 31, 2010 and2009, respectively.  In preparing our consolidated financialstatements, we are required to translate the financial statements of ourforeign subsidiaries from the functional currencies in which they keep theiraccounting records into U.S. dollars. This process results in exchange gainsand losses which, under relevant accounting guidance, are included eitherwithin our statement of operations under the caption “other income (expense)”or as a separate part of our net equity under the caption “accumulated othercomprehensive income (loss).”

 

Under relevant 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 which the subsidiary transacts amajority of its transactions, including billings, financing, payroll and otherexpenditures, would be considered the functional currency. However, managementmust also consider any dependency of the subsidiary upon the parent and thenature 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 $2.6 million and $1.6 million that wereincluded as part of accumulated other comprehensive loss within our balancesheets at March 31, 2010 and December 31, 2009, respectively. Duringthe three months ended March 31, 2010 and 2009, we included translationlosses of $1.0 million and $0.4 million, respectively, under accumulated othercomprehensive loss.

 

The magnitude of these gainsor losses depends upon movements in the exchange rates of the foreigncurrencies in which we transact business as compared to the value of the U.S.dollar. During the first quarter of 2010 and 2009, these currencies primarily includedthe euro and the British pound sterling and, to a lesser extent, the Japaneseyen in the period ended March 31, 2009. Any future translation gains orlosses could be significantly higher or lower than those we recorded for theseperiods.

 

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A 2.5 million British pound sterling loan payable fromone of our subsidiaries in Englandto EMRISE was outstanding as of March 31, 2010 ($3.8 million based on theexchange rate at March 31, 2010). Exchange rate losses and gains on the long-term portion of this loan arerecorded in cumulative translation gains or losses in the equity section of thebalance sheet.

 

***Intangibles, Including Goodwill***

 

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

 

In assessing potential impairment ofgoodwill, we consider these factors as well as forecasted financial performanceof the acquired businesses.  If forecastsare not met, we may have to record additional impairment charges not previouslyrecognized. In assessing the recoverability of our goodwill and otherintangibles, we must make assumptions regarding estimated future cash flows andother factors to determine the fair value of those respective assets. If theseestimates or their related assumptions change in the future, we may be requiredto record impairment charges for these assets that were not previouslyrecorded.  If that were the case, wewould have to record an expense in order to reduce the carrying value of ourgoodwill.  Under FASB guidance related to goodwill and other intangible assets, we are requiredto analyze our goodwill for impairment issues at least annually or morefrequently if an event occurs or circumstances change that would more likelythan not reduce the fair value of a reporting unit below its carryingamount.  At March 31, 2010, ourreported goodwill totaled $15.5 million of which $12.0 million had beenallocated to assets held for sale.  Weevaluated the fair value of the electronic devices reporting unit at March 31,2010 and determined that no impairment of goodwill existed at that date.  In assessing the potential impairment ofgoodwill, we consider forecasted financial performance of the 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 of delivery.  Shipments of products can be accelerated ordelayed due to many reasons including, but not limited to, exceeding or notmeeting customer contract requirements, a change in customer timing orspecifications, technology related issues and production related issues.  Comparability of our revenues and grossprofit is difficult from period to period due to this product variability.  Exceptions to this include certain long-termmilitary contracts and certain long-term telecommunications contracts.

 

Overall sales from continuing operations decreased16.8% in the first quarter of 2010 as compared to the first quarter of2009.  Our overall net sales of $7.1million for the first quarter of 2010 reflected declines in net sales at ourelectronic devices subsidiaries, offset slightly by increases in ourcommunications equipment subsidiaries. The declines in our electronic devices subsidiary were further affectedby the negative impact of exchange rates between the U.S. dollar and theBritish pound sterling.

 

Overall gross profit as a percentage of sales fromcontinuing operations decreased to 27.5% in the first quarter of 2010 from34.9% in the first quarter of 2009.  Thedecrease in gross profit as a percentage of sales from continuing operationswas due to the decline in gross margins within our electronic devices segmentand our French communications equipment subsidiary associated with lower salesvolumes, which was partially offset by improvements in gross profit as apercentage of sales within our U.S. communications equipment subsidiary.

 

The following is a detailed discussion of our resultsof operations by business segment.  As aresult of the sale of our RO Operations in March of 2009, for purposes ofthe following discussion and analysis, the RO Operations have been removed fromthe prior period comparisons and the quarterly results of the RO Operations arereported as a discontinued operation for all periods presented.  Additionally, the certain assets identifiedfor sale as a result of Amendment 8 and the associated Amendments Number 9 and 10, enteredinto in April and May, 2010, respectively, of our credit facility havebeen reported as a discontinued and held for sale operation for all periodspresented.

 

As required under the CreditFacility, we plan to sell a significant portion of our total assets during 2010(See Notes 2, 9 and 10 in the accompanying notes to consolidated financialstatements).  We may sell additionalassets for strategic or other reasons (together with the significant assets weagreed to sell under the Credit Facility, the “Future Asset Sales”).  As a result of the Future Asset Sales, we areexpecting overall declines in net sales, gross profit, operating income and netincome within all of our reporting segments and on a consolidated basis as aCompany.  However, the magnitude of suchdeclines will largely depend on which assets we actually sell and the timing ofsuch sales, all of which are uncertain at this time.  Where applicable, we will discuss possiblefuture impacts of Future Assets Sales herein; however, we will not attempt toaddress all potential impacts or to quantify the magnitude of such sales on ourfuture results due to the significant uncertainties associated with doing so.

 

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***Comparisonof the Three Months Ended March 31, 2010 to the Three Months Ended March 31,2009***

 

**Net Sales**

 
| ** **                                  | ** ** | **Three  Months Ended** | ** ** | **Variance**                 | ** ** |
|---------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | **March 31,**      | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in thousands)**                          | ** ** | **2010**                | ** ** | **2009**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                        |       |                    |       |                         |       |   |   |   |   |
| Electronic devices                          |       | $                       | 4,437      |                         | $          | 5,903 |   | $ | (1,466 | ) | (24.8 | )% |
| *as %  of net sales*                        | * *   | *34.8*                  | *%*        | *41.5*                       | *%*        | * * | * * | * * | * * |
| Communications  equipment                   |       | 2,654                   |       | 2,618                        |       | 36 |   | 1.4 | % |
| *as % of net sales*                         | * *   | *20.8*                  | *%*        | *18.4*                       | *%*        | * * | * * | * * | * * |
| Total net sales from  continuing operations |       | 7,091                   |       | 8,521                        |       | (1,430 | ) | (16.8 | )% |
| Discontinued operations                     |       | 5,653                   |       | 5,692                        |       |   |   |   |   |
| Total net sales                             |       | $                       | 12,744     |                         | $          | 14,213 |   |   |   |   |   |
|                                             |            |                         |            |                              |            |  |  |  |  |  |  |  |

 

*Electronic Devices Segment*

 

The decrease in sales ofour electronic devices in the first quarter of 2010 as compared to the firstquarter of 2009 was primarily due to delays in the awarding of foreign militarycontracts as a result of the global economic conditions and one large contractat one of our U.K. subsidiaries concluding in the first quarter of 2009.  Additionally, a significant portion of ourbusiness at U.K. subsidiaries is transacted in U.S. dollars and was negativelyimpacted by exchange rate fluctuations, as the subsidiary’s local currency isthe British pound sterling.  Thetranslation impact of exchange rates remains an uncertainty and couldnegatively or positively impact our overall results in future periods.

 

*Communications Equipment Segment*

 

First quarter 2010 netsales within our communications equipment segment remained consistent with the2009 first quarter.  We experienced anincrease in sales to the Federal Aviation Administration and the U.S. militaryat our U.S. communications equipment subsidiary as a result of a substantialincrease in test equipment sales offset by a decrease in orders and shipmentsfor network access and timing products at our French subsidiary due largely toeconomic impacts and spending reductions by the French Defense Ministry.

 

Net sales in our Frenchcommunications equipment subsidiary have been, and are likely to continue tobe, negatively impacted by the recent economic conditions, as the Frenchgovernment continues to defer discretionary spending due to current economicconditions.

 

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**Gross Profit**

 
| ** **                                       | ** ** | **Three  Months Ended** | ** ** | **Variance**                 | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                       | ** ** | **March 31,**      | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in thousands)**                               | ** ** | **2010**                | ** ** | **2009**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                             |       |                    |       |                         |       |   |   |   |   |
| Electronic devices                               |       | $                       | 1,105      |                         | $          | 2,097 |   | $ | (992 | ) | (47.3 | )% |
| *as %  of net sales*                             | * *   | *24.9*                  | *%*        | *35.5*                       | *%*        | * * | * * | * * | * * |
| Communications  equipment                        |       | 846                     |       | 880                          |       | (34 | ) | (3.9 | )% |
| *as %  of net sales*                             | * *   | *31.9*                  | *%*        | *33.6*                       | *%*        | * * | * * | * * | * * |
| Total gross profit from  continuing operations   |       | 1,951                   |       | 2,977                        |       | (1,026 | ) | (34.5 | )% |
| *Total  gross margin from continuing operations* | * *   | *27.5*                  | *%*        | *34.9*                       | *%*        | * * | * * | * * | * * |
| Discontinued operations                          |       | 2,813                   |       | 1,980                        |       |   |   |   |   |
| Total gross profit                               |       | $                       | 4,764      |                         | $          | 4,957 |   |   |   |   |   |
|                                                  |            |                         |            |                              |            |  |  |  |  |  |  |  |

 

*Electronic Devices Segment*

 

The decrease in grossprofit, as a percentage of net sales, for our electronic devices segment from35.5% in the first quarter of 2009 to 24.9% in the first quarter of 2010 isprimarily due to the decrease in volume of sales as discussed above, whichresulted in a larger portion of fixed production overhead being absorbed, andchanges in product mix.

 

*Communications Equipment Segment*

 

The decrease in grossmargin for our communications equipment segment from 33.6% in the first quarterof 2009 to 31.9% in the first quarter of 2010 is primarily the result ofunfavorable impacts as a result of the changes in foreign currency exchangerates between the U.S. dollar and the euro in the first quarter of 2010 ascompared to the first quarter of 2009 and the lower sales volume at our Frenchsubsidiary, partially offset by increases in gross margins at our U.S.communications equipment subsidiary as a result of changes in pricing strategy.

 

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**Operating Expenses**

 
| ** **                                           | ** ** | **Three  Months Ended** | ** ** | **Variance**                 | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                           | ** ** | **March 31,**      | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in thousands)**                                   | ** ** | **2010**                | ** ** | **2009**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                                 |       |                    |       |                         |       |   |   |   |   |
| Selling, general and  administrative                 |       | $                       | 2,494      |                         | $          | 2,617 |   | $ | 123 |   | 4.7 | % |
| *as %  of net sales*                                 | * *   | *35.2*                  | *%*        | *30.7*                       | *%*        | * * | * * | * * | * * |
| Engineering and product  development                 |       | 522                     |       | 369                          |       | (153 | ) | (41.5 | )% |
| *as %  of net sales*                                 | * *   | *7.4*                   | *%*        | *4.3*                        | *%*        | * * | * * | * * | * * |
| Total operating  expenses from continuing operations |       | 3,016                   |       | 2,986                        |       | (30 | ) | (1.0 | )% |
| Discontinued operations                              |       | 1,383                   |       | 2,083                        |       |   |   |   |   |
| Total operating  expenses                            |       | $                       | 4,399      |                         | $          | 5,069 |   |   |   |   |   |
|                                                      |            |                         |            |                              |            |  |  |  |  |  |  |  |

 

*Selling, general andadministrative expenses*

 

The decrease in selling,general and administrative expenses is primarily the result of the significantdecreases in SG&A, primarily at our corporate headquarters, as a result ofcost reduction activities.

 

During 2010, we expect selling, general andadministrative expense to be lower than the 2009 comparative periods as we seethe affects of the cost reduction actions taken in 2009 and due to the sale ofour RO Operations.

 

*Engineering and product development*

 

The increase inengineering and product development costs is primarily due to U.S.communications equipment subsidiary related to development of new products andenhancements of existing products.

 

During the remainder of2010, engineering and product development expenses are expected to remain at orslightly below 2009 levels.

 

**Interest expense**

 

Interest expense was $0.8million for the three months ended March 31, 2010 compared to $1.5 millionfor the three months ended March 31, 2009 due to lower outstanding loanbalances.  Additionally, in the firstquarter of 2009, we accelerated the amortization of deferred financing costsand debt discount in the amount of $0.5 million associated with the partialrepayment of our Term Loan B, which was absent in the first quarter of2010.  Included in interest expense inthe first quarter of 2010 were $0.3 million of non-cash amortization ofdeferred financing costs and non-cash amortization of debt discount compared to$0.8 million in the first quarter of 2009. We expect quarterly interest expense for the remainder of 2010 todecrease significantly from the comparable prior year periods as a result ofthe lower outstanding loan balances and as we make scheduled principal paymentsand use the proceeds from the sales of assets to pay down outstanding loanbalances.

 

**Other, net**

 

Werecorded other income of $144,000 in the first quarter of 2010 compared toexpense of $42,000 in the first quarter of 2009.  Other, net consists primarily of (i) short-termexchange rate gains and losses associated with the volatility of the U.S.dollar to the British pound sterling and euro on the current portion of certainassets and liabilities and (ii) fair value adjustments on warrants.  The change in the fair value of warrantsduring the first quarter of 2010 resulted in expense of $208,000 compared toincome of $130,000 in the first quarter of 2009.  The remaining income of $352,000 for thefirst quarter of 2010 was predominantly related to short-term exchange rate 

 

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gains.

 

**Income tax expense**

 

Incometax benefit amounted to $0.1 million for the first quarter of 2010 compared toexpense of $0.2 million for the first quarter of 2009.  We recorded income tax expense primarily as aresult of foreign income tax on foreign earned profits in Europe and New Jerseystate income taxes on income generated by ACC. The income tax benefit in the first quarter of 2010 was related to thelosses we incurred during the quarter.

 

FutureAsset Sales may trigger additional income tax obligations in 2010.  The Company has exhausted a significantportion of its net operating losses available to be carried forward into futureperiods and, as a result, any income from operations and/or gain on sales ofassets could result in significant tax obligations in 2010.

 

**Income(Loss) from Discontinued and Held For Sale Operations**

 

Inconnection with the sale of our RO Operations on March 20, 2010 and theclassification of certain of our assets as held for sale, we reported incomefrom discontinued and held for sale operations of $0.7 million (net of $0.2million in taxes) during the first quarter of 2010, which includes a $0.5 millionloss on the sale of our RO Operations. Additionally, in connection with the sale of our Digitran Operations on March 20,2009, we reported income from discontinued and held for sale operations of $6.7million (net of $0.7 million in taxes) during the first quarter of 2009, whichincludes a $7.4 million gain on the sale of our Digitran Operations.

 

**Net income (loss)**

 

We reported a net loss of$1.0 million in the first quarter of 2010 and net income of $4.8 million in thefirst quarter of 2009.  Included in netloss in the first quarter of 2010 was a $0.5 million loss on the sale of RO andan overall decline in net sales and gross profit from continuingoperations.  Excluding any impact fromthe sale of assets in the remaining quarters of 2010, we anticipate net income(loss) to improve in future quarters as compared to prior year quarters, due inlarge part to the cost reduction efforts completed in 2009, and also due tolower anticipated interest expense in future quarters.

 

**Liquidity and CapitalResources**

** **

Inmaking an assessment of our liquidity, we believe that the items in ourfinancial statements that are most relevant to our ongoing operations areworking capital, cash generated from operating activities and cash availablefrom financing activities.  We fund ourdaily cash flow requirements through funds provided by operations and throughborrowings under our credit facility with GVEC Resource IV Inc. (“GVEC” orthe “Lender”).  Working capital fromcontinuing operations was negative $4.0 million at March 31, 2010 ascompared to negative $3.5 million at December 31, 2009, primarily due tolower accounts receivable and inventory balances at March 31, 2010 as aresult of lower sales levels during the first quarter of 2010.  At March 31, 2010 and December 31,2009, we had accumulated deficits of$27.5 million and $26.6 million, respectively, and cash and cash equivalents of $2.5 million and $4.0 million, respectively.  Cash balances fluctuate and are dependentupon timing of advances and repayments on the Revolver.  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.

 

Netcash provided by operating activities during the first quarter of 2010 totaled$0.6 million.  Significant non-cashadjustments to our net income for 2009 include (i) the amortization ofdebt discount and amortization of deferred financing costs which, on a combinedbasis, totaled $0.3 million, both of which are non-cash components of interestexpense associated with our credit facility, (ii) depreciation andamortization expense which totaled $0.3 million, and (iii) a change infair value of common stock warrants which expensed $0.2 million as a non-cashcomponent of net income.  The primarysignificant use of cash associated with operating activities during the first 

 

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quarter of 2010 was a decrease in accounts payable and accruedliabilities by approximately $1.2 million, in part due to payments made onpreviously accrued amounts related to the sale of the RO Operations and alsodue to timing of vendor payments.  Theprimary sources of cash associated with operating activities during the firstquarter of 2010 included a decrease in accounts receivable, which decreased by$0.8 million, due primarily to increased collections on higher sales in thefourth quarter of 2009 and a decrease in inventory of $0.8 million as a resultof an effort to more effectively use existing inventory.

 

Cash generated from our investing activities during thefirst quarter of 2010 totaled $0.8 million. This amount consisted primarily ofnet cash proceeds generated by the March 2010 sale of our RO Operations.

 

Cash used in financing activities during the first quarterof 2010 totaled $2.0 million, which consisted of $0.5 million in repayments ofprincipal owed on long term debt and notes to stockholders and $1.5million in net repayments on our revolving credit facility.

 

As of March 31, 2010, we hadoutstanding borrowings of $3.7 million under the revolving loan portion of ourcredit facility.  At March 31, 2010,we had remaining actual availability under a formula-based calculation of $3.3million under the credit facility.  Actualremaining availability represents the additional amount we were eligible toborrow as of March 31, 2010 pursuant to our $7.0 million revolving line ofcredit.  The availability under ourrevolving line of credit fluctuates periodically throughout each monthdepending on timing of borrowings and repayments.  At May 7, 2010, our eligible collateralwas $5.9 million (compared to the maximum of $7 million) and our outstandingborrowings at that date were $5.2 million. Therefore, our actual availability was $0.6 million.

 

Inaddition to the revolving line of credit, at March 31, 2010, we had debtobligations of $8.2 million, which includes term loans from our Lender,capitalized lease and equipment loan obligations and notes payable toshareholders, the current portion of which loans and obligations totaled $8.1million. We also have debt obligations associated with assets held for sale of$4.3 million that has been classified as current liabilities of discontinuedand held for sale operations in our condensed consolidated balance sheets.  These debt obligations are due in November 2010.

 

Ourbacklog from continuing operations increased to $17.6 million as of March 31, 2010 as compared to $15.9million as of December 31, 2009. The increase from December 31, 2009is primarily due to the increase of additional orders at our U.K. RF devicessubsidiary and our French communications equipment subsidiary offset bydeclines at our other subsidiaries.  Theamount of backlog orders represents revenue that we anticipate recognizing inthe future, as evidenced by purchase orders and other purchase commitmentsreceived from customers, but on which work has not yet been initiated or withrespect to which work is currently in progress. Our backlog as of March 31,2010 was approximately 91% related to our electronic devices business, whichbusiness tends to provide us with long lead-times for our manufacturingprocesses due to the custom nature of the products, and approximately 9%related to our communications equipment business, which business tends todeliver standard or modified standard products from stock as orders arereceived. We believe that the majority of our current backlog will be shippedwithin the next 12 months.  However,there can be no assurance that we will be successful in fulfilling such ordersand commitments in a timely manner or that we will ultimately recognize asrevenue the amounts reflected as backlog.

 

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*CreditFacility*

 

EMRISE (including each ofits direct subsidiaries), are parties to a Credit Agreement, as amended, withthe Lender, providing for a credit facility in the aggregate amount of$26,000,000.  As of March 31, 2010,we owed a total of $11.6 million under the terms of the credit facility.

 

On January 25, 2010,EMRISE and its Lender entered into Amendment Number 8 to Loan Documents, whichamended EMRISE’s Credit Agreement as of December 31, 2009.  All references to the Credit Facility hereinrefer to the Credit Agreement as amended. The Credit Facility requires the sale of a significant portion of ourassets by June 30, 2010 (the “Maturity Date”).  As discussed further in Note3 in our March 31, 2010 financial statements, these assets contributed approximately $20 million or37% of the Company’s net sales from continuing operations and operating incomeof approximately $3 million of the Company’s total operating income from continuingoperations of $1.4 million for 2009.  TheCompany is required to achieve certain milestones in connection with these saleactivities and the maintenance of maximum capital expenditure financialcovenants.  Lender has the current rightto appoint an outside observer to review our books and records and businessoperations, with certain limitations designed to minimize disruption to ourbusiness operations.  Upon the sale ofthe assets we agreed to sell, we will retain a percentage of the proceeds ofsome of such sales for working capital and are obligated to use the remainingproceeds to pay down the obligations owed to the Lender.  We are also obligated to provide financialinformation and status reports to the Lender on a regular basis.  The practical effect of the January 25th amendment wasto provide a forbearance by the Lender through the Maturity Date on the equityraise default and the possible financial covenant defaults that was and mayhave been otherwise triggered under the Credit Agreement as of December 31,2009 and allow us time to sell certain assets in order to pay down theobligations to the Lender.

 

In April, 2010, theBorrowers and the Lender entered into Amendment Number 9 to Loan Documents,which removes the obligation to sell certain assets while retaining theobligation to sell other assets, and provides some clarity that the Lender willnot charge fees for making adjustments to the milestones required to be metbefore the maturity date, provided certain conditions are satisfied. In May 2010,the Borrowers and the Lender entered into Amendment Number 10 to LoanDocuments, which adjusted certain milestones required to be met before thematurity date.

 

We are working on an amendment to extend certain ofthe milestones to have been achieved the week of this filing with an indicationfrom the lender such extension will be acceptable.  We expect to sign a formal amendment thisweek, but there can be no guarantees that such amendment will be successfullyor timely completed. 

 

Thecredit facility currently consists of (i) a revolving loan for up to $7million that expires on June 30, 2010 (the “Revolver”), and (ii) twoterm loans (Term Loan A and Term Loan B) with an aggregate net outstandingprincipal amount of $7.9 million as of March 31, 2010. The term loansrequire remaining combined scheduled principal payments of $75,000 bi-weekly,which began on February 1, 2010 and continue through maturity.  The facility also requires monthly interestpayments and a final balloon payment of principal upon maturity on June 30,2010 of approximately $7.4 million in term debt plus the outstanding balance ofthe revolver, which at March 31, 2010 was $3.7 million.

 

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

 

Interest on the Revolver is payable monthly.  Theinterest rate is variable and is adjusted monthly based on the prime rate aspublished in the “Money Rates” column of*TheWall Street Journal* (the “Base Rate”) plus 1.25%, subject to aminimum rate of 9.5% per annum.  The Revolver contains a capitalexpenditures covenant, prohibiting any such expenditures in excess of$1,800,000 through June 30, 2010. Additionally, the Revolver prohibits us from incurring unfinancedcapital expenditures in excess of $62,500 in any fiscal quarter and fromincurring purchase money commitments in excess of $2 million over the life ofthe facility.  However, if we incurunfinanced capital expenditures of less than $62,500 in any fiscal quarter, thedifference between the amount incurred in a certain fiscal quarter and $62,500may be incurred in the two fiscal quarters immediately following such fiscalquarter. The Company was in compliance with these covenants at March 31,2010.

 

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The term loans bear interestat the Base Rate plus 4.25%, subject to a minimum rate of 12.5% per annum.  Under the credit facility, we may make fullor partial prepayment of the term loans provided that any such prepayment isaccompanied by the applicable prepayment premium discussed below.

 

Tosecure payment of the indebtedness under the credit facility, we irrevocablypledged and assigned to, and granted to the Lender a continuing securityinterest in, all the personal property of the Company and its directsubsidiaries, including our interest in any deposit accounts, the stock of eachof our direct and indirect subsidiaries, the intellectual property owned byeach of the Company and its direct subsidiaries, and the proceeds of theintellectual property owned by each of these entities.  In an event ofdefault, the Lender may, at its option, exercise any or all remedies availableto it with respect to the collateral.  In addition, certain of our foreignsubsidiaries have agreed to guarantee our performance under the creditfacility.

 

There can be no assurance that we will be able tosuccessfully amend the Credit Agreement to extend sale related milestones, wewill be able to successfully sell the contemplated assets that we are obligatedto sell, pursuant to the credit facility, in the agreed time frames, achievethe related milestones on a timely basis, and/or sell the assets at pricessufficient to satisfy the debt owed to the Lender, if at all.  Even if we do successfully amend the CreditAgreement to extend sale related milestones and sell the contemplated assetsand pay the obligations owed to the Lender in full, our ongoing revenues willbe substantially reduced, which could have a material adverse affect on ouroperations and financial condition.

 

If an event of defaultwere to occur, including the failure to successfully amend the Credit Agreementto extend sale related milestones or failure to achieve any of the milestonesrelated to asset sales required by the Credit Facility, the Lender couldaccelerate the debt and exercise its rights and remedies under the CreditAgreement.  An acceleration of theprincipal, deferred fees and accrued interest due on the date of a declaredevent of default would be a significant amount that would be due on suchdate.  If such an acceleration weredeclared as of May 7, 2010, the amount would equal $13.2 million.  We do not have the abilityto pay this amount from currently available sources at this time.  The rights and remedies available to theLender under the Credit Agreement in the event of a declared event of default include a foreclosure on our assetsbefore the contemplated asset sales could be completed.  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.  Additionally, if the lender terminates thecredit facility during a default period then we are subject to a penalty equalto 2% of the outstanding principal balance of the Revolver and the Term Loans.

 

*Liquidity*

 

Our current business plan requires additionalfunding beyond our anticipated cash flows from operations.  These and other factors described in moredetail below raise substantial doubt about our ability to continue as a goingconcern.  Our ability to continue as agoing concern is dependent upon our ability to (i) sell the assets asrequired in the Credit Facility, (ii) repay our credit facility on orprior to its maturity date, (iii) obtain alternate revolver financing tofund operations after the credit facility is paid in full and (iv) achieveprofitable operations.

 

Ifour net losses continue, we may experience negative cash flow, which mayprevent us from continuing operations. If we are not able to attain, sustain or increase profitability on aquarterly or annual basis, we may not be able to continue operations and ourstock price may decline.

 

Ifwe (i) default under the Credit Facility for any reason, including missinga milestone, (ii) are unable to timely sell assets at sufficient prices, (iii) cannotborrow funds under the terms of the Revolver, for any reason, or (iv) failto obtain alternate financing to replace our credit facility or a new revolvingfacility once the current credit facility is paid in full, we do not believethat current and future capital resources, revenues generated from operationsand other existing sources of liquidity will be adequate to meet ouranticipated short term, working capital and capital expenditures needs for thenext 12 months.  Further, if any of these occur for any reason, or if we experiencea significant loss of revenue or increase in costs, then our cash flow would benegatively impacted resulting in a cash flow deficit.  A cash flow deficit will require us to 

 

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seekadditional or alternate financing, with little or no notice, which would bedifficult to obtain in these economic conditions and our anticipated financialcondition in such circumstances.  To address these potential financingneeds, we may have to explore revised debt structure with our current lender,seek additional or new financing with another lender or lenders, selladditional assets to generate cash, or sell equity to raise capital.  Successfully executing these strategies isuncertain and there are many risks associated with attempting to executeeach.   Failure to meet ourfinancing requirements, if and when needed, would have an adverse effect on ouroperations and/or ability to do business after that date or could restrict ourgrowth, limit the development of new products, hinder our ability to fulfillexisting or future orders or negatively affect our ability to secure newcustomers or product orders.

 

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

 

**Effects of Inflation**

** **

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

 

**Impacts of NewAccounting Pronouncements**

** **

None.

** **

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

** **

Not applicable.

 

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

 

Not applicable.

 

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

 

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

*** ***

Management is responsible for establishing andmaintaining adequate internal control over financial reporting.  The Company maintains disclosure controls andprocedures that are designed to ensure that information required to bedisclosed in the Company’s reports pursuant to the Securities aExchange Act of1934, as amended, is recorded, processed, summarized and reported within thetime periods specified in the SEC’s rules and forms, and that suchinformation is accumulated and communicated to the Company’s management,including its Chief Executive Officer and Chief Financial Officer, asappropriate, to allow timely decisions regarding required disclosure. Indesigning and evaluating the disclosure controls and procedures, managementrecognized that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, and management necessarily was required to apply itsjudgment in evaluating the cost-benefit relationship of possible controls andprocedures.

 

Under the supervision and with the participation ofmanagement, including the Company’s Principal Executive Officer and PrincipalFinancial Officer, the Company conducted an evaluation of the effectiveness ofits internal control over financial reporting based on the framework inInternal Control — Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission. This evaluation includedan assessment of the design of the Company’s internal control over financialreporting and testing of the operational effectiveness of its internal controlover financial reporting. Based on this evaluation, our Chief ExecutiveOfficer 

 

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andChief Financial Officer concluded as of March 31, 2010 that our disclosurecontrols and procedures and internal controls over financial reporting were noteffective at the reasonable assurance level due to the material weaknessesdiscussed below.

 

Inlight of the four material weaknesses described below, we performed additionalanalysis and other post-closing procedures to ensure that our consolidatedfinancial statements were prepared in accordance with GAAP.  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 Officerand Chief Financial Officer concluded that as of March 31, 2010, thefollowing four material weaknesses existed:

 

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

 

(2)                                We did notmaintain effective controls over changes to critical financial reportingapplications and over access to these applications and related data.

 

(3)                                We did notmaintain a sufficient level of information technology personnel to executegeneral computing controls over our information technology structure.

 

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

 

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

 

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

*** ***

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

 

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

 

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

*** ***

Set forth below is a summaryof the various significant deficiencies which caused management to concludethat 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 during 2010.  If we are able to complete these actions in atimely manner, we anticipate that all control deficiencies and materialweaknesses will be remediated in 2011.

 

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(1)           We did not effectivelyimplement comprehensive entity-level internal controls, as evidenced by thefollowing control deficiencies:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

(2)           We did not maintain effective controlsover changes to critical financial reporting applications and over access tothese applications and related data, as evidenced by the fact that certain ofour personnel had unrestricted access to various financial application programsand data beyond the requirements of their individual job responsibilities. Thiscontrol deficiency could result in a material misstatement of significantaccounts or disclosures, including those described above, that could result ina material misstatement of our interim or annual consolidated financialstatements that would not be prevented or detected.

 

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

 

(4) We are a relatively complex company with operations conducted in multiplecountries, multiple currencies and multiple languages.  We have divestedfour separate operations in the past 18 months, acquired a large subsidiaryduring the same time, and we are in the process of divesting additional assetsin order to repay our current obligations.  All of these transactions giverise to complex accounting and tax treatments. Most recently, we have beenconcentrating our efforts in securing amendments to our current credit facilityand ensuring adherence to milestones set forth in our most recent creditfacility amendment.  Our finance team isa relatively small but experienced staff. Although we believe the accountingstaff are qualified to perform their functions, due to reasons above, thequantity of staff may be insufficient to deal with the work load andcomplexities created, which could result in material misstatements to ourfinancial statements.

 

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

 

It is reasonably possiblethat, if not remediated, one or more of the material weaknesses described abovecould result in a material misstatement in our reported financial statementsthat might result in a material misstatement in a future annual or interim period.

 

We are developing specificaction plans for each of the above material weaknesses.  In addition, our audit committee hasauthorized the hiring of additional temporary staff and/or the use of financialand information technology consultants, as necessary, to ensure that we havethe depth and experience to remediate the above listed material weaknesses,including the implementation and monitoring of the appropriate level of controlprocedures related to all of our manufacturing locations and our corporateoffices.  The audit committee will alsowork directly with management and outside consultants, as necessary, to ensurethat board level deficiencies are addressed. We are uncertain at this time of the costs to remediate all of the abovelisted material weaknesses, however, we anticipate the cost to be in the rangeof $200,000 to $400,000 (including the cost of the consolidation softwaredescribed above), most of which costs we expect to incur during 2010.  We cannot guarantee that the actual costs toremediate these deficiencies will not exceed this amount.

 

Throughthese steps, we believe that we are addressing the deficiencies that affectedour internal control over financial reporting as of March 31, 2010.Because the remedial actions require hiring of additional personnel, upgradingcertain of our information technology systems, and relying extensively onmanual review and approval, the successful operation of these controls for atleast several quarters may be required before management may be able to concludethat the material weaknesses have been remediated.  We intend to continue to evaluate andstrengthen our internal control over financial reporting systems. These effortsrequire significant time and resources. If we are unable to establish adequate internal control over financialreporting systems, we may encounter difficulties in the audit or review of ourfinancial statements by our independent registered public accounting firm,which in turn may have a material adverse effect on our ability to preparefinancial statements in accordance with GAAP and to comply with our SECreporting obligations.

 

***Changes in Internal Control over FinancialReporting***

 

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

 

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**PART II — OTHER INFORMATION**

 

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

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 2.11       |       | Asset Purchase  Agreement by and among Astrodyne Corporation, RO Associates Incorporated and  EMRISE Electronics Corporation dated March 22, 2010. The schedules to  the Asset Purchase Agreement in this exhibit 2.11 have been omitted pursuant  to Item 601(b) of Regulation S-K. A description of the omitted schedules  is contained within the Asset Purchase Agreement. The Company hereby agrees  to furnish a copy of any omitted schedule to the Commission upon request. (1) |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 31.1       |       | Certification of  Principal Executive Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002*                                                                                                                                                                                                                                                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 31.2       |       | Certification of  Principal Financial Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002*                                                                                                                                                                                                                                                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 32.1       |       | Certification of  Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*                                                                                                                                                                                                                                                                                                                           |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 32.2       |       | Certification of  Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*                                                                                                                                                                                                                                                                                                                           |

 

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* Filed herewith.

 

(1) Filed as an exhibit to the Registrant’s current reporton Form 8-K for March 22, 2010 and incorporated herein by reference.

 

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**SIGNATURES**

 

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

 
|                      | EMRISE CORPORATION |
|---------------------------|--------------------|
|                      |               |
| Dated:  May 17, 2010 | By:                | /S/  CARMINE T. OLIVA |
|                      |               | Carmine  T. Oliva, |
|                      |               | Chief  Executive Officer (Principal Executive Officer) |
|                      |               |   |
|                      |               |   |
| Dated:  May 17, 2010 | By:                | /S/  D. JOHN DONOVAN |
|                      |               | D.  John Donovan, Chief Financial Officer (Principal Financial and Accounting  Officer) |

 

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**INDEX TO EXHIBITS ATTACHED TOTHIS REPORT**

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                    |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                               |
| 31.1       |       | Certification of  Principal Executive Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                                                                                                                               |
| 31.2       |       | Certification of  Principal Financial Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                                                                                                                               |
| 32.1       |       | Certification of  Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                             |
|       |       |                                                                                                                                                                                                               |
| 32.2       |       | Certification of  Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                             |

 

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