Tableof 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 THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|--------------------------------------------------------------------------------------------------------|

** **

**For the quarterly period ended****June 30, 2009**

** **

**or**

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

 

**For the transition period from               to               **

** **

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

 

**EMRISECORPORATION**

(Exact name of registrantas specified in its charter)

 

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

 

**611 Industrial Way**

**Eatontown, New Jersey 07224**

(Address of principal executive offices) (Zip code)

 

**(732) 389-0355**

(Registrant’stelephone number, including area code)

 

**Not applicable**

(Formername, former address and former fiscal year, if changed since last report)

 

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

 

Indicate by check mark whether the registrantsubmitted electronically and posted on its corporate website, if any, everyinteractive data file required to be submitted and posted pursuant to Rule 405of Regulation S-T (section 232.405 of this chapter) during the preceding 12months (or for such shorter period that registrant was required to submit andpost such files).  Yes o  No o

 

Indicate by check mark whether the registrant is a largeaccelerated filer, an accelerated filer, a non-accelerated filer or a smallerreporting company. See the definitions of “large accelerated filer”, “acceleratedfiler” and “smaller reporting company” in Rule 12b-2 of the ExchangeAct.  (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 mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

The number of shares outstanding of the Registrant’scommon stock, $0.0033 par value, as of August 13, 2009 was 10,213,412.

 

 

 

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Table ofContents

 

**EMRISE CORPORATION**

**TABLE OF CONTENTS**

**FORM 10-Q**

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

 
| **PART I.  FINANCIAL INFORMATION**                                                                                      |
|------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                   | ** ** | ** ** |   |
| **ITEM 1.**                                                                                                                  | ** ** | **FINANCIAL  STATEMENTS** |   |
|                                                                                                                         |   |   |   |
| Condensed  Consolidated Balance Sheets as of June 30, 2009 (unaudited) and  December 31, 2008                      | 1 |
|                                                                                                                         |   |
| Condensed  Consolidated Statements of Operations for the Three and Six Months Ended  June 30, 2009 and 2008 (unaudited) | 2 |
|                                                                                                                         |   |
| Condensed  Consolidated Statements of Stockholders’ Equity for the Six Months Ended  June 30, 2009(unaudited)      | 3 |
|                                                                                                                         |   |
| Condensed  Consolidated Statements of Cash Flows for the Six Months Ended June 30,  2009 and 2008 (unaudited)           | 4 |
|                                                                                                                         |   |
| Notes to  Condensed Consolidated Financial Statements (unaudited)                                                            | 5 |
|                                                                                                                         |   |   |   |
| **ITEM 2.**                                                                                                                  | ** ** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** | 23 |
|                                                                                                                         |   |   |   |
| **ITEM 3.**                                                                                                                  | ** ** | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK** | 41 |
|                                                                                                                         |   |   |   |
| **ITEM 4.**                                                                                                                  | ** ** | **CONTROLS AND  PROCEDURES** | 41 |
|                                                                                                                         |   |   |   |
| **ITEM 4T.**                                                                                                                 | ** ** | **CONTROLS AND  PROCEDURES** | 41 |
|                                                                                                                         |   |   |   |
| **PART II  OTHER INFORMATION**                                                                                          |
|                                                                                                                         |
| **ITEM 1.**                                                                                                                  | ** ** | **LEGAL PROCEEDINGS** | 45 |
|                                                                                                                         |   |   |   |
| **ITEM 1A.**                                                                                                                 | ** ** | **RISK FACTORS** | 45 |
|                                                                                                                         |   |   |   |
| **ITEM 2.**                                                                                                                  | ** ** | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS** | 45 |
|                                                                                                                         |   |   |   |
| **ITEM 3.**                                                                                                                  | ** ** | **DEFAULTS UPON  SENIOR SECURITIES** | 45 |
|                                                                                                                         |   |   |   |
| **ITEM 4.**                                                                                                                  | ** ** | **SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS** | 46 |
|                                                                                                                         |   |   |   |
| **ITEM 5.**                                                                                                                  | ** ** | **OTHER INFORMATION** | 46 |
|                                                                                                                         |   |   |   |
| **ITEM 6.**                                                                                                                  | ** ** | **EXHIBITS** | 47 |
|                                                                                                                         |   |   |   |
| **SIGNATURES**                                                                                                               | **48** |

 

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Table of Contents

 

**PART I — FINANCIALINFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**EMRISE CORPORATION**

**Condensed ConsolidatedBalance Sheets**

(in thousands, except share and per share amounts)

 
| ** **                                                                                                                                                                              | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                              | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                                                              | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                              |       |              |       |                  |       |
| Current assets:                                                                                                                                                                         |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                               |       | $                 | 4,832      |                  | $          | 3,242 |   |
| Accounts receivable, net of allowances for doubtful  accounts of $221 at June 30, 2009 and $501 at December 31, 2008                                                          |       | 9,373             |       | 10,333                |       |
| Inventories, net                                                                                                                                                                        |       | 12,916            |       | 12,501                |       |
| Current deferred tax assets                                                                                                                                                             |       | 323               |       | 271                   |       |
| Prepaid and other current assets                                                                                                                                                        |       | 1,429             |       | 1,283                 |       |
| Current assets of discontinued operations                                                                                                                                               |       | —            |       | 2,724                 |       |
| Total current assets                                                                                                                                                                    |       | 28,873            |       | 30,354                |       |
|                                                                                                                                                                                    |       |              |       |                  |       |
| Property, plant and equipment, net                                                                                                                                                      |       | 2,761             |       | 2,990                 |       |
| Goodwill                                                                                                                                                                                |       | 13,368            |       | 9,657                 |       |
| Intangible assets other than goodwill, net                                                                                                                                              |       | 6,070             |       | 6,618                 |       |
| Deferred tax assets                                                                                                                                                                     |       | 1,798             |       | 2,191                 |       |
| Other assets                                                                                                                                                                            |       | 415               |       | 683                   |       |
| Noncurrent assets of discontinued operations                                                                                                                                            |       | —            |       | 1,130                 |       |
| Total assets                                                                                                                                                                            |       | $                 | 53,285     |                  | $          | 53,623 |   |
|                                                                                                                                                                                    |       |              |       |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                          |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                                    |       |              |       |                  |       |
| Accounts payable                                                                                                                                                                        |       | $                 | 5,042      |                  | $          | 4,625 |   |
| Accrued expenses                                                                                                                                                                        |       | 6,511             |       | 6,939                 |       |
| Line of credit                                                                                                                                                                          |       | 5,612             |       | 4,084                 |       |
| Current portion of long-term debt                                                                                                                                                       |       | 1,974             |       | 5,121                 |       |
| Notes payable to stockholders, current portion                                                                                                                                          |       | 802               |       | 542                   |       |
| Income taxes payable                                                                                                                                                                    |       | 891               |       | 451                   |       |
| Other current liabilities                                                                                                                                                               |       | 649               |       | 357                   |       |
| Current liabilities of discontinued operations                                                                                                                                          |       | —            |       | 664                   |       |
| Total current liabilities                                                                                                                                                               |       | 21,481            |       | 22,783                |       |
|                                                                                                                                                                                    |       |              |       |                  |       |
| Long-term debt, net of discount of $725 and $980,  respectively                                                                                                                         |       | 6,672             |       | 13,479                |       |
| Notes payable to stockholders, less current portion                                                                                                                                     |       | 2,959             |       | 250                   |       |
| Deferred income taxes                                                                                                                                                                   |       | 1,927             |       | 2,203                 |       |
| Warrant liability                                                                                                                                                                       |       | 587               |       | —                |       |
| Other liabilities                                                                                                                                                                       |       | 449               |       | 503                   |       |
| Noncurrent liabilities of discontinued operations                                                                                                                                       |       | —            |       | 401                   |       |
| Total liabilities                                                                                                                                                                       |       | 34,075            |       | 39,619                |       |
| Commitments and contingencies                                                                                                                                                           |       |              |       |                  |       |
| Stockholders’ equity:                                                                                                                                                              |       |              |       |                  |       |
| Preferred stock,$0.01 par value. Authorized  10,000,000 shares, zero shares issued and outstanding                                                                                      |       | —            |       | —                |       |
| Common stock,$0.0033 par value. Authorized  150,000,000 shares; 10,213,412 and 10,204,079 shares issued and outstanding  at June 30, 2009 and December 31, 2008, respectively |       | 126               |       | 126                   |       |
| Additional paid-in capital                                                                                                                                                              |       | 43,407            |       | 44,806                |       |
| Accumulated deficit                                                                                                                                                                     |       | (22,869           | )          | (28,101               | )          |
| Accumulated other comprehensive loss                                                                                                                                                    |       | (1,454            | )          | (2,827                | )          |
| Total stockholders’ equity                                                                                                                                                         |       | 19,210            |       | 14,004                |       |
| Total liabilities and stockholders’ equity                                                                                                                                         |       | $                 | 53,285     |                  | $          | 53,623 |   |

 

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

 

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**EMRISE CORPORATION**

**CondensedConsolidated Statements of Operations**

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

 
| ** **                                                                       | ** ** | **Three  Months Ended** | ** ** | **Six Months  Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                                                       | ** ** | **June 30,**       | ** ** | **June 30,**     | ** ** |
| ** **                                                                       | ** ** | **2009**                | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                             |       |                    |       |                  |       |   |   |   |   |
| Net Sales                                                                        |       | $                       | 14,270     |                  | $          | 12,022 |   | $ | 28,483 |   | $ | 22,665 |   |
| Cost of Sales                                                                    |       | 8,811                   |       | 8,309                 |       | 18,067 |   | 15,512 |   |
| Gross profit                                                                     |       | 5,459                   |       | 3,713                 |       | 10,416 |   | 7,153 |   |
|                                                                             |       |                    |       |                  |       |   |   |   |   |
| Operating expenses:                                                              |       |                    |       |                  |       |   |   |   |   |
| Selling, general and administrative                                              |       | 4,347                   |       | 3,529                 |       | 8,894 |   | 7,067 |   |
| Engineering and product development                                              |       | 716                     |       | 608                   |       | 1,238 |   | 1,111 |   |
| Total operating expenses                                                         |       | 5,063                   |       | 4,137                 |       | 10,132 |   | 8,178 |   |
| Income (loss) from operations                                                    |       | 396                     |       | (424                  | )          | 284 |   | (1,025 | ) |
|                                                                             |       |                    |       |                  |       |   |   |   |   |
| Other income (expense):                                                          |       |                    |       |                  |       |   |   |   |   |
| Interest income                                                                  |       | 23                      |       | 23                    |       | 69 |   | 41 |   |
| Interest expense                                                                 |       | (923                    | )          | (604                  | )          | (1,938 | ) | (1,188 | ) |
| Other, net                                                                       |       | 210                     |       | 120                   |       | 168 |   | 103 |   |
| Total other expense, net                                                         |       | (690                    | )          | (461                  | )          | (1,701 | ) | (1,044 | ) |
|                                                                             |       |                    |       |                  |       |   |   |   |   |
| Loss before income taxes                                                         |       | (294                    | )          | (885                  | )          | (1,417 | ) | (2,069 | ) |
| Income tax provision (benefit)                                                   |       | 117                     |       | (4                    | )          | (233 | ) | 80 |   |
| Loss from continuing operations                                                  |       | (411                    | )          | (881                  | )          | (1,184 | ) | (2,149 | ) |
| Discontinued operations:                                                         |       |                    |       |                  |       |   |   |   |   |
| Income (loss) from discontinued operations including  gain on sale of $7,109 YTD |       | (114                    | )          | 625                   |       | 7,288 |   | 996 |   |
| Tax provision (benefit) on discontinued operations                               |       | (11                     | )          | —                |       | 1,345 |   | — |   |
| Net gain (loss) on discontinued operations                                       |       | (103                    | )          | 625                   |       | 5,943 |   | 996 |   |
|                                                                             |       |                    |       |                  |       |   |   |   |   |
| Net Income (loss)                                                                |       | $                       | (514       | )                     | $          | (256 | ) | $ | 4,759 |   | $ | (1,153 | ) |
|                                                                             |       |                    |       |                  |       |   |   |   |   |
| Earnings (loss) per share:                                                       |       |                    |       |                  |       |   |   |   |   |
| Basic                                                                            |       | $                       | (0.05      | )                     | $          | (0.03 | ) | $ | 0.47 |   | $ | (0.11 | ) |
| Diluted                                                                          |       | $                       | (0.05      | )                     | $          | (0.03 | ) | $ | 0.47 |   | $ | (0.11 | ) |
|                                                                             |       |                    |       |                  |       |   |   |   |   |
| Weighted average shares outstanding                                              |       |                    |       |                  |       |   |   |   |   |
| Basic                                                                            |       | 10,205                  |       | 10,204                |       | 10,205 |   | 10,204 |   |
| Diluted                                                                          |       | 10,205                  |       | 10,204                |       | 10,205 |   | 10,204 |   |

 

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

 

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** **

**EMRISE CORPORATION**

**CondensedConsolidated Statements of Stockholders’ Equity**

(Unaudited)****(in thousands)

 
| ** **                                                                        | ** ** | ** **       | ** ** | ** **  | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------|------------|-------------|------------|-----------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                        | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **        | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                                                                        | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                                                                        | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**       | ** ** | **Loss**        | ** ** | **Total**  | ** ** |
|                                                                              |       |             |       |        |       |            |       |              |       |            |       |       |       |
| Balance at December 31, 2008                                                 |       | 10,204           |       | $           | 126        |            | $          | 44,806            |       | $               | (28,101    | )          | $          | (2,827 | ) | $ | 14,004 |   |
| Cumulative effect of change in accounting principle  due to adoption of EITF 07-5 |       | —           |       | —      |       | (1,483          | )          | 473               |       | —          |       | (1,010     | )          |
| Stock option exercises                                                            |       | 9                |       | —      |       | 7               |       | —            |       | —          |       | 7          |       |
| Stock-based compensation                                                          |       | —           |       | —      |       | 75              |       | —            |       | —          |       | 75         |       |
| Warrants issued for services                                                      |       | —           |       | —      |       | 2               |       | —            |       | —          |       | 2          |       |
| Net income and comprehensive income                                               |       | —           |       | —      |       | —          |       | 4,759             |       | 1,373           |       | 6,132      |       |
| Balance at June 30, 2009                                                     |       | 10,213           |       | $           | 126        |            | $          | 43,407            |       | $               | (22,869    | )          | $          | (1,454 | ) | $ | 19,210 |   |

 

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

 

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**EMRISE CORPORATION**

**CondensedConsolidated Statements of Cash Flows**

(Unaudited)****(in thousands)

 
| ** **                                                                                                                                | ** ** | **Six Months  Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                | ** ** | **June 30,**     | ** ** |
| ** **                                                                                                                                | ** ** | **2009**              | ** ** | **2008** | ** ** |
|                                                                                                                                      |       |                  |       |   |   |
| **CASH FLOWS FROM OPERATING  ACTIVITIES**                                                                                                 |       |                  |       |   |   |
| Net Income (loss)                                                                                                                         |       | $                     | 4,759      |   | $ | (1,153 | ) |
| Adjustments to arrive at net loss from continuing  operations                                                                             |       | (5,943                | )          | (996 | ) |
| Net loss from continuing operations                                                                                                       |       | (1,184                | )          | (2,149 | ) |
| Reconciliation to net cash used in operating  activities:                                                                                 |       |                  |       |   |   |
| Depreciation and amortization                                                                                                             |       | 980                   |       | 506 |   |
| Provision for doubtful accounts                                                                                                           |       | 69                    |       | (46 | ) |
| Provision for inventory obsolescence                                                                                                      |       | 258                   |       | 522 |   |
| Provision for warranty reserve                                                                                                            |       | (48                   | )          | 8 |   |
| Deferred taxes                                                                                                                            |       | (292                  | )          | (113 | ) |
| Amortization of deferred issuance costs                                                                                                   |       | 279                   |       | 216 |   |
| Amortization of debt discount                                                                                                             |       | 255                   |       | 216 |   |
| Stock-based compensation expense                                                                                                          |       | 77                    |       | 33 |   |
| Change in common stock warrant value                                                                                                      |       | (423                  | )          | — |   |
| Changes in assets and liabilities:                                                                                                        |       |                  |       |   |   |
| Accounts receivable                                                                                                                       |       | 936                   |       | 559 |   |
| Inventories                                                                                                                               |       | (975                  | )          | (734 | ) |
| Prepaid and other assets                                                                                                                  |       | (156                  | )          | (54 | ) |
| Accounts payable and accrued expenses                                                                                                     |       | (978                  | )          | (527 | ) |
| Operating cash flow used in continuing operations                                                                                         |       | (1,202                | )          | (1,563 | ) |
| Operating cash flow provided by discontinued  operations                                                                                  |       | 693                   |       | 928 |   |
| Net cash used in operating activities                                                                                                     |       | (509                  | )          | (635 | ) |
|                                                                                                                                      |       |                  |       |   |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                                                                 |       |                  |       |   |   |
| Purchases of property, plant and equipment                                                                                                |       | (14                   | )          | (50 | ) |
| ACC purchase price adjustment                                                                                                             |       | (3,116                | )          | — |   |
| Investing cash flow used in continuing operations                                                                                         |       | (3,130                | )          | (50 | ) |
| Investing cash flow provided by (used in)  discontinued operations including proceeds from sale of subsidiary  operations, net of cash    |       | 10,050                |       | (37 | ) |
| Net cash provided by (used in) investing activities                                                                                       |       | 6,920                 |       | (87 | ) |
|                                                                                                                                      |       |                  |       |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                                                                                |       |                  |       |   |   |
| Proceeds from issuance of debt                                                                                                            |       | 3,261                 |       | — |   |
| Net repayments of lines of credit                                                                                                         |       | 1,528                 |       | (1,950 | ) |
| Repayments of long-term debt                                                                                                              |       | (10,288               | )          | (143 | ) |
| Payments of notes to stockholders                                                                                                         |       | (293                  | )          | (271 | ) |
| Proceeds from exercise of stock options and warrants                                                                                      |       | 7                     |       | — |   |
| Net cash used in financing activities                                                                                                     |       | (5,785                | )          | (2,364 | ) |
| Effect of exchange rate changes on cash                                                                                                   |       | 785                   |       | 264 |   |
| Net increase (decrease) in cash and cash equivalents                                                                                      |       | 1,411                 |       | (2,822 | ) |
| Cash and cash equivalents at beginning of period                                                                                          |       | 3,421                 |       | 4,764 |   |
| Cash and cash equivalents at end of period                                                                                                |       | $                     | 4,832      |   | $ | 1,942 |   |
|                                                                                                                                      |       |                  |       |   |   |
| **SUPPLEMENTAL DISCLOSURES OF  NON-CASH INVESTING AND****FINANCING ACTIVITIES:**                                                          |       |                  |       |   |   |
| Acquisition of equipment through capital lease                                                                                            |       | $                     | 74         |   | $ | 453 |   |
| Cumulative effect of change in accounting principle  - reclassification of common stock warrants to liability upon adoption of  EITF 07-5 |       | $                     | 473        |   | $ | — |   |

 

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

 

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

 

*Basis of Presentation*

 

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

 

*Comprehensive Income (Loss)*

 

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

 
| ** **                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                               | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                               | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                     |       |                   |       |                 |       |   |   |   |   |
| Net income (loss)                        |       | $                      | (514       | )                    | $          | (256 | ) | $ | 4,759 |   | $ | (1,153 | ) |
| Other comprehensive  income (loss):      |       |                   |       |                 |       |   |   |   |   |
| Foreign currency  translation adjustment |       | 1,791                  |       | (3                   | )          | 1,373 |   | 223 |   |
| Comprehensive income  (loss)             |       | $                      | 1,277      |                 | $          | (259 | ) | $ | 6,132 |   | $ | (930 | ) |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Revenue Recognition*

 

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

 

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

 

Revenue recognition forproducts and services provided by the Company’s subsidiaries in England and itsU.S. subsidiary, ACC, depends upon the type of contract involved.  Engineering/design services contractsgenerally entail design and production of a prototype over a term of up toseveral years, with revenue deferred until each milestone defined in thecontract is reached.  Productioncontracts provide for a specific quantity of products to be produced over aspecific period of time.  Customers issuebinding purchase orders or enter into binding agreements for the products to beproduced.  The Company recognizesrevenues on these orders as the products are shipped.  Returns are infrequent and permitted onlywith prior authorization because these products are custom made to order basedon binding purchase orders and are quality tested prior to shipment.  An estimate of warranty cost is recorded atthe time revenue is recognized.

 

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

 

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

 

*Reverse Stock Split*

 

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

 

6

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Income (Loss) Per Share*

 

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

 
| ** **                                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                          | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                          | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                |       |                   |       |                 |       |   |   |   |   |
| NUMERATOR:                                          |       |                   |       |                 |       |   |   |   |   |
| Net income (loss)                                   |       | $                      | (514       | )                    | $          | (256 | ) | $ | 4,759 |   | $ | (1,153 | ) |
|                                                |       |                   |       |                 |       |   |   |   |   |
| DENOMINATOR:                                        |       |                   |       |                 |       |   |   |   |   |
| Basic weighted average  common shares outstanding   |       | 10,205                 |       | 10,204               |       | 10,205 |   | 10,204 |   |
| Effect of dilutive  securities:                     |       |                   |       |                 |       |   |   |   |   |
| Dilutive stock options  and warrants                |       | —                 |       | —               |       | — |   | — |   |
| Diluted weighted  average common shares outstanding |       | 10,205                 |       | 10,204               |       | 10,205 |   | 10,204 |   |
|                                                |       |                   |       |                 |       |   |   |   |   |
| Basic income (loss) per  share                      |       | $                      | (0.05      | )                    | $          | (0.03 | ) | $ | 0.47 |   | $ | (0.11 | ) |
|                                                |       |                   |       |                 |       |   |   |   |   |
| Diluted income (loss)  per share                    |       | $                      | (0.05      | )                    | $          | (0.03 | ) | $ | 0.47 |   | $ | (0.11 | ) |

 

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

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Recent Accounting Pronouncements*

 

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

 

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

 

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

 

In March 2008, the FASB issued SFAS No. 161,“Disclosures about Derivative Instruments and Hedging Activities.” The newstandard amends SFAS No. 133 and seeks to enhance disclosure about how andwhy a company uses derivative and hedging activities, how derivative instrumentsand related hedged items are accounted for under SFAS No. 133 (and theinterpretations of that standard) and how derivatives and hedging activitiesaffect a company’s financial position, financial performance and cashflows.  SFAS No. 161 is effectivefor financial statements issued for fiscal years and interim periods beginningafter November 15, 2008.  Theadoption of SFAS No. 161 is not expected to have a material effect on theCompany’s consolidated financial statements.

 

In April 2008, the FASB issued FASB StaffPosition (“FSP”) No. FAS 142-3, “Determination of the Useful Life ofIntangible Assets,” (“FSP 142-3”). FSP 142-3 amends the factors that should beconsidered in developing renewal or extension assumptions used to determine theuseful life of a recognized intangible asset under SFAS No. 142, “Goodwilland Other Intangible Assets” and also requires expanded disclosure related tothe determination of intangible asset useful lives. FSP 142-3 is effective forfiscal years beginning after December 15, 2008. Early adoption isprohibited. The Company is currently evaluating the impact the adoption of FSP142-3 will have on its consolidated financial statements.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

In June 2008, the FASB ratified the consensusreached on EITF Issue No. 07-5, “Determining Whether an Instrument (orEmbedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5clarifies the determination of whether an instrument (or an embedded feature)is indexed to an entity’s own stock, which would qualify as a scope exceptionunder SFAS No. 133, Accounting for Derivative Instruments and HedgingActivities. EITF 07-5 is effective for financial statements issued for fiscalyears beginning after December 15, 2008. Early adoption for an existinginstrument is not permitted. The Company adopted EITF 07-5 on January 1,2009. See Note 12 **—**Warrants belowfor discussion of the impact of the adoption of EITF 07-5 on the Company’soutstanding stock warrants and its consolidated financial statements.

 

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

 

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

 

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

 

**NOTE 2 — LIQUIDITY**

 

TheCompany reported a net loss for the quarter ended June 30, 2009 of $0.5million and net income for the six months ended June 30, 2009 of $4.8million.  Included in net income for thesix month period was a $5.9 million gain (net of tax of $1.3 million) on thedisposition of the Company’s Digitran Operations (see Note 4).  Absent this gain, the Company would haveincurred a $1.1 million net loss for the six months ended June 30,2009.  If the Company’s net losses continue, it mayexperience negative cash flow, which may hamper current operations and mayprevent the Company from expanding its business.  Additionally, such losses may result in a defaulton the Company’s debt covenants associated with its credit facility.  The Company may be unable to attain, sustainor increase profitability on a quarterly or annual basis in the future. If theCompany does not achieve, sustain or increase profitability, its stock pricemay decline.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

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

 

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

 

If the Company cannotmeet or successfully renegotiate its obligations to (i) raise $3.0 millionin equity capital by December 31, 2009, (ii) make monthly principaland interest payments, and/or (iii) achieve certain other financialcovenants, or if the lender does not waive these obligations, then the Companywould be in default under the terms of its credit facility.

 

In the event of a defaultand continuation of a default, the lender may limit future availability underthe Revolver (as defined in Note 10) and/or accelerate the payment of allprincipal balances and accrued interest requiring the Company to pay the entireindebtedness under the credit facility outstanding on that date.  Upon theoccurrence and during the continuation of an event of default, the lender mayalso elect to increase the interest rate applicable to the outstanding balanceof the Term Loans A and B (as defined in Note 10) by four percentage pointsabove the per annum interest rate that would otherwise be applicable.  Anyof these conditions could have a material adverse effect on the Company’soperations and/or ability to conduct business after thatdate.  Additionally, if the lender terminates the credit facilityduring a default period or if the Company prepays the Revolver or the TermLoans prior to November 30, 2009, then the Company is subject to a penaltyequal to 2% of the outstanding principal balance of the Revolver and the TermLoans.

 

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

 

If the Company issuccessful in raising $3.0 million in equity capital by December 31, 2009as required by the Company’s lender under the terms of the credit facility andis able to continue to borrow funds under the terms of the Revolver, managementof the Company believes that current and future capital resources, revenues generatedfrom operations and other existing sources of liquidity will be adequate tomeet its anticipated short term, working capital and capital expenditures needsfor the next 12 months.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

**NOTE 3 — ACQUISITION OF ADVANCEDCONTROL COMPONENTS**

 

OnMay 23, 2008, the Company and its wholly-owned subsidiary, EEC, enteredinto a Stock Purchase Agreement (the “Stock Purchase Agreement”) pursuant towhich EEC agreed to acquire Custom Components, Inc. (“CCI”) and itsoperating subsidiary, Advanced Control Components, Inc. (“ACC”).  On August 20,2008, the Stock Purchase Agreement was amended pursuant to Amendment No. 1to Stock Purchase Agreement (the “Amendment to Purchase Agreement,” andcollectively with the Stock Purchase Agreement, the “ACC Purchase Agreement”)to, among other things, reduce the initial purchase price for all of thecapital stock of both CCI and ACC to $12,400,000, subject to adjustments forworking capital and net cash.  Additionally, pursuant to the terms of theAmendment to Purchase Agreement, the Company is obligated to pay interest on aprincipal amount of $600,000 at a rate equal to the prime rate as reportedin *The Wall Street Journal *onAugust 20, 2008 plus 1% for the period commencing on August 20, 2008and ending on the later of November 18, 2008 or the actual date suchinterest payment is made.

 

Theclosing of the ACC Purchase Agreement occurred on August 20, 2008. Under the terms of the ACC Purchase Agreement, EEC acquired all of the issuedand outstanding shares of common stock of CCI and all of the issued andoutstanding shares of common stock of ACC not owned by CCI (the “Acquisition”). In addition to the purchase price, the Company is obligated to pay up to anadditional $3,000,000 in cash if ACC meets certain operating income targets forone or both of the two 12 month periods following the closing. Additionally, EEC issued Subordinated Secured Contingent Promissory Notes (the “Notes”)to each of the Sellers in the aggregate principal amount of $2,000,000. The Notes become payable if ACC meets certain operating income thresholdsduring the first and second 12 month periods after August 20, 2008. The Notes bear interest at a rate per annum equal to the prime rate asreported in *The Wall StreetJournal *plus 1%.  As of June 30,2009, ACC had met its operating income targets associated with the Notes and assuch the Company recorded a note payable of $2,000,000, which resulted in anadjustment to the net assets acquired. Additionally, the Company recorded $1.2 million in notes payablerepresenting an adjustment to working capital and net cash.  The Company expects to record additionalpurchase price adjustments associated with the contingent cash obligation whensuch obligation is earned or August 20, 2010, whichever is earlier.

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

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

 

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

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

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

 

**NOTE 4 — DISCONTINUED OPERATIONS**

 

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

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

TheDigitran Purchase Agreement contains five year noncompetition and non-solicitationprovisions covering the Company, EEC and each of their respectiveaffiliates.  In addition, the Company and EEC provided customaryindemnification rights to the Buyer and Stock Buyer in connection with theDisposition.

 

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

 

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

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**NOTE 5 — STOCK-BASED COMPENSATION**

 

The Company has five stockoption plans:

 

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

·                  1993 Stock Option Plan;

·                  1997 Stock Incentive Plan;

·                  Amended and Restated 2000 Stock Option Plan; and

·                  2007 Stock Incentive Plan.

 

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

 

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

 

**NOTE 6 — INVENTORIES**

 

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

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

 

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

 

**NOTE 7 — OPERATING SEGMENTS**

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

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

 

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

 

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

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

 
| ** **                | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Total assets              |       |              |       |                  |       |
| Electronic devices        |       | $                 | 35,925     |                  | $          | 34,853 |   |
| Communications  equipment |       | 8,952             |       | 10,260                |       |
| Discontinued Operations   |       | —            |       | 3,600                 |       |
| Corporate and other       |       | 8,408             |       | 4,910                 |       |
| Total                     |       | $                 | 53,285     |                  | $          | 53,623 |   |

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**NOTE 8 — GOODWILL**

 

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

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

 

**NOTE 9 — INCOME TAXES**

 

The effective taxrate for the three month period ended June 30, 2009 was different than the34% U.S. statutory rate primarily because the Company’s foreign entitiesgenerate a tax obligation and related tax expense as a result of their netincome, which cannot be offset by U.S. tax loss carryforwards.

 

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

 

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

 

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

 

**NOTE 10 — LINE OF CREDIT**

 

The Company and itsdirect subsidiaries, EEC, CXR Larus Corporation and RO Associates Incorporated(collectively, the “Borrowers”), are parties to a Credit Agreement (as amendedfrom time to time the “Credit Agreement”) with GVEC Resource IV Inc. (the “Lender”)providing for a credit facility which includes term loans and a revolvingcredit facility and is secured by accounts receivable, other rights to paymentand general intangibles, inventories and equipment. The credit facilityincludes a one year revolving credit facility for up to $7,000,000 that may berenewed up to two times, each for a period of one year, at the Company’soption, provided that certain conditions precedent are met (the “Revolver”).  The credit facility also includes two termloans (see Note 11).

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

Interest on the Revolveris payable monthly.  The interest rate isvariable and is adjusted monthly based on the prime rate as published in the “MoneyRates” column of *The Wall Street Journal* (the “BaseRate”) plus 1.25%, subject to a minimum rate of 9.5% per annum.  The interest rate in effect as of June 30,2009 was the minimum rate of 9.5%.  TheRevolver is subject to various financial covenants on a consolidated basis,including the following: EBITDA, measured on a fiscal quarter-end basis, mustnot be less than the scheduled amount for each specified period; the debtservice coverage ratio, measured quarterly, must be greater than the lesser ofthe scheduled amount for each specific period or 1.10:1.00; the leverage ratio,measured quarterly, must not be greater than the scheduled amount for eachspecified period, and liquidity, measured quarterly, must not be less than thescheduled amount for each specified period. Additionally, the Revolver is subject to the Borrowers not incurringcapital expenditures (a) in excess of $600,000 for the fiscal year ending December 31,2009, and (b) in excess of $1,800,000 for the fiscal year ending December 31,2010.  Additionally, the Revolver is subject to the Borrowersnot incurring unfinanced capital expenditures in excess of $62,500 in anyfiscal quarter. However, if the borrowers incur unfinanced capital expendituresof less than $62,500 in any fiscal quarter, the difference between the amountincurred in a certain fiscal quarter and $62,500 maybe incurred in the twofiscal quarters immediately following such fiscal quarter. The Company was incompliance with all covenants at June 30, 2009.

 

Asof June 30, 2009, the Company had outstanding borrowings of $5.6 millionunder the Revolver with remaining availability under the formula-basedcalculation of $1.4 million.

 

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

 

See related Note 3 “Liquidity” and Note 11 “Long Term Debt” regardingadditional terms and conditions associated with the overall credit facility andrisks associated with this credit facility.

 

**NOTE 11 — LONG-TERM DEBT**

 

On August 20, 2008, in connection with theacquisition of ACC and CCI as discussed in Note 3, the Borrowers and the Lenderamended the credit facility to, among other things, include ACC and CCI asBorrowers and to provide for another term loan in the principal amount of $3million (the “Term Loan C”).  The creditfacility, as so amended, provided for borrowings in the aggregate amount of $26million, including the $7 million revolving facility described in Note 10.

 

The credit facilityconsists of (i) the Revolver, (ii) a term loan in the principalamount of $6 million which is due November 30, 2010 (“Term Loan A”), (iii) aterm loan in the original principal amount of $10 million, which is due on November 30,2010 (“Term Loan B”), and (iv) Term Loan C.  Term Loan A was fully funded on November 30,2007 while Term Loans B and C were fully funded on August 20, 2008 inconnection with the acquisition of ACC. Term Loan A and Term Loan B requirescheduled principal and interest payments commencing September 2009 and afinal balloon payment of principal upon maturity on November 30,2010.  Term Loan C was repaid in full on March 20,2009.  At June 30, 2009, theoutstanding principle balance on Term Loan A was $5.8 million and theoutstanding principle balance on Term Loan B was $3.0 million.

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

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

 

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

 

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

 

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

 

See Note 3 and Note 10 regarding additional terms and conditionsassociated with the Company’s credit facility and risks associated with this creditfacility.

 

**NOTE12 — WARRANTS**

 

In connection with entering into the credit facility (discussed inNote11), the Company issued a seven year warrant to Private Equity ManagementGroup, Inc., an affiliate of the Lender, to purchase up to 775,758 sharesof the Company’s common stock on a cash or cashless basis at an exercise priceof $4.13 per share.  The estimated fairvalue of the warrants was $1.5 million, which was calculated using theBlack-Scholes pricing model.  Thewarrants were originally accounted for as debt discount and the adjustmentresulting from the repricing of the warrants increased the debt discount, whichis being amortized over the remaining life of the credit facility.  The warrants were previously recorded instockholder’s equity.

 

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).

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

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. In June 2008,the FASB ratified the consensus reached on EITF Issue No. 07-5, “DeterminingWhether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock”(“EITF 07-5”). EITF 07-5 clarifies the determination of whether an instrument(or an embedded feature) is indexed to an entity’s own stock, which wouldqualify as a scope exception under SFAS No. 133, Accounting for DerivativeInstruments and Hedging Activities. EITF 07-5 was effective for financialstatements issued for fiscal years beginning after December 15, 2008.  The adoption of EITF 07-5 on January 1,2009, resulted in the reclassification of certain of the Company’s outstandingwarrants from stockholders’ equity to liabilities, which requires the warrantsto be fair valued at each reporting period, with the changes in fair valuerecognized in the Company’s consolidated statement of operations.

 

At January 1, 2009 and June 30, 2009, theCompany had warrants subject to mark to market outstanding to purchase 775,758shares of common stock.  The Companycomputed the fair value of the warrants using a Black-Scholes valuationmodel.  The fair value of these warrantson the date of adoption of January 1, 2009 and on June 30, 2009 wasdetermined using the following assumptions:

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

 

On January 1, 2009, the Company recorded acumulative effect of change in accounting principle adjustment to itsaccumulated deficit of $473,000 and a corresponding reclassification of theseoutstanding warrants from stockholders’ equity to warrant liability.  As of and for the three and six month periodsended June 30, 2009, the change in fair value of the warrants resulted ina $293,000 and $423,000 positive adjustment, respectively, to other income(expense) in the consolidated statement of operations and a correspondingdecrease to the warrant liability.

 

**NOTE 13 — FAIR VALUE MEASUREMENTS**

 

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

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

 

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

 

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

 

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

 

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

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

 

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

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

 

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**(Unaudited)**

 

**NOTE 14 — SUBSEQUENT EVENTS**

 

Inconnection with the preparation of the Company’s financial statements at June 30,2009, subsequent events through August 12, 2009, the date the financialstatements were available for issuance, have been evaluated and the followingsubsequent events were identified:

 

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

 

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

 

**Cautionary Statement**

 

The followingdiscussion should be read in conjunction with our unaudited condensedconsolidated financial statements and the related notes thereto contained in PartI, Item 1 of this Quarterly Report on Form 10-Q. The information contained inthis report is not a complete description of our business or the risksassociated with an investment in our common stock. We urge you to carefullyreview and consider the various disclosures made by us in this report and inour other reports filed with the Securities and Exchange Commission, orCommission, including our Annual Report on Form 10-K for the year ended December31, 2008 and subsequent reports on Forms 10-Q and 8-K, which discuss ourbusiness in greater detail.  This reportand the following discussion contain forward-looking statements within the meaningof Section 21E of the Securities Exchange Act of 1934, as amended, whichgenerally include the plans and objectives of management for future operations,including plans and objectives relating to our future economic performance andour current beliefs regarding revenues we might generate and profits we mightearn if we are successful in implementing our business and growth strategies.The forward-looking statements and associated risks may include, relate to orbe qualified by other important factors, including, without limitation:

 
|   | · | our ability to continue  to borrow funds under the terms of our credit facility in light of certain  actions recently taken against Private Equity Management Group, Inc., an  affiliate of our lender by the Commission (see “ — Liquidity and Capital  Resources”);                                                                        |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | · | exposure to and impacts  of various international risks including legal, business, political and  economic risks associated with our international operations, including risks  associated with foreign currency translation (see “-Foreign Currency  Translation”).                                                                              |
|   | · | the projected growth or  contraction in the electronic devices and communications equipment markets in  which we operate;                                                                                                                                                                                                                                   |
|   | · | our strategies for  expanding, maintaining or contracting our presence in these markets;                                                                                                                                                                                                                                                                    |
|   | · | anticipated trends in  our financial condition and results of operations;                                                                                                                                                                                                                                                                                   |
|   | · | our ability to  distinguish ourselves from our current and future competitors;                                                                                                                                                                                                                                                                              |
|   | · | 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 our customers;                                                                                                                                                                                                                                                                         |
|   | · | failure to comply with  existing or future government or industry standards and regulations;                                                                                                                                                                                                                                                                |
|   | · | our ability to  successfully locate, acquire and integrate any possible future acquisitions;                                                                                                                                                                                                                                                                |
|   | · | our ability to  successfully support the working capital needs of our company;                                                                                                                                                                                                                                                                              |
|   | · | the impact of current  and/or future economic conditions, including but not limited to the overall  condition of the stock market, the overall credit market, political, economic  and/or other constraints which are or may negatively impact the industries in  which we participate and/or the ability for us to market the products which  we sell; and |
|   | · | our ability to successfully compete against  competitors that in many cases are larger than us, have access to  significantly more working capital than us and have significant resources in  comparison to us.                                                                                                                                             |

 

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

 

Any of the factorsdescribed above or in the “Risk Factors” sections contained in our AnnualReport on Form 10-K for the year ended December 31, 2008, our Quarterly Reporton Form 10-Q for the quarterly period ended March 31, 2009, and in this reportcould cause our financial results, including our net income or loss or growthin net income or loss to differ materially from prior results, which in turncould, among other things, cause the price of our common stock to fluctuatesubstantially.

 

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**Recent Transactions**

 

On March 20, 2009, we completed the sale of substantially all theassets of the Digitran division of our wholly-owned subsidiary, EMRISEElectronics Corporation, or EEC, and all the capital stock of ECC’swholly-owned subsidiary, XCEL Japan Ltd., which primarily acted as a salesoffice for the Digitran division, to Electro Switch Corp.  In this report we refer to the businesses ofthe Digitran Division and XCEL Japan, Ltd. as the “Digitran Operations,” and werefer to the sale of the Digitran division and XCEL Japan, Ltd. as the “DigitranTransaction.”  Within our Digitrandivision we manufactured, marketed and sold electro-mechanical digital and newpatented technology very low profileTM rotaryswitches for the worldwide aerospace, defense and industrial markets.  Tokyo-based XCEL Japan Ltd. primarily soldDigitran’s switch product lines in Japan and other countries in Asia. Thesebusinesses were part of our electronic devices business segment.  For purposes of the following discussion andanalysis, the Digitran Operations have been removed from the prior period comparisonsand the quarterly results of the Digitran Operations are reported in ourConsolidated Statements of Operations for all periods presented as adiscontinued operation.

 

**Business Description**

 

We design, manufacture and market proprietary electronic devices andcommunications equipment for aerospace, defense, industrial, and communicationsapplications. We have operations in the U.S., England, and France.  We organize our business in two operating segments:electronic devices and communications equipment. In the first quarter of 2009,our electronic devices segment contributed approximately 82% of overall netsales while the communications segment contributed approximately 18% of overallnet sales. Our subsidiaries within our electronic devices segment design, develop, manufacture and market powersupplies, radio frequency, or RF, and microwave devices for defense, aerospaceand industrial markets.  Oursubsidiaries within our communications equipment segment design, develop,manufacture and market network access equipment, including network timing andsynchronization products, for communications applications in defense, publicand private networks and industrial markets.

 

Within our electronic devices segment, we produce a range of power systemsand RF and microwavedevices. This segment is primarily “project” driven with the majority ofrevenues being derived from custom products with long life cycles and highbarriers to entry.  The majority ofmanufacturing and testing is performed in-house or through sub-contract manufacturers.  Our electronic devices are used in a widerange of military airborne, seaborne and land-based systems, and in-flightentertainment systems, including the latest next generation in-flightentertainment and communications, or IFE&C, systems, such as applications formobile phone, e-mail and internet communications and real time, on-boardsatellite and broadcast TV, which are being installed in new commercialaircraft as well as being retrofitted into existing commercial aircraft.

 

Within our communications equipment segment, we produce a range ofnetwork access equipment, including network timing and synchronizationproducts, 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 network applicationsprimarily for private communications networks, public communications carriers,and also for utility companies and military applications, including homelandsecurity.

 

**Critical Accounting Policies**

 

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

 

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

 

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

 

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

 

Revenue recognition forproducts and services provided by our U.S. subsidiary, Advanced ControlComponents, Inc., or ACC, and our subsidiaries in England depends upon the typeof contract 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.  We recognize revenues on theseorders as the products are shipped. Returns are infrequent and permitted only with prior authorizationbecause these products are custom made to order based on binding purchaseorders and are quality tested prior to shipment.  An estimate of warranty cost is recorded atthe time revenue is recognized.

 

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

 

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

 

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***Product Warranty Liabilities***

 

Generally, our products carry a standardone-year, limited parts and labor warranty. In certain circumstances, we provide a two-year limited parts and laborwarranty.  We offer extended warrantiesbeyond two years for an additional cost to our customers.  Products returned under warranty typicallyare tested and repaired or replaced at our option.  Historically, we have not experiencedsignificant warranty costs or returns.

 

We record a liability for estimated costs thatwe expect to incur under our basic limited warranties when product revenue isrecognized.  Factors affecting ourwarranty liability include the number of units sold, the types of productsinvolved, historical and anticipated rates of claim and historical andanticipated costs per claim.  Weperiodically assess the adequacy of our warranty liability accrual based onchanges in these factors.

 

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

 

Our electronicdevices segment finished goods inventories generally are built to order.  Our communications equipment inventoriesgenerally are built to forecast, which requires us to produce a larger amountof finished goods in our communications equipment business so that ourcustomers can be served promptly.  Ourproducts consist of numerous electronic and other materials, which necessitatethat we exercise detailed inventory management. We value our inventory at the lower of the actual cost to purchase ormanufacture the inventory (first-in, first-out) or the current estimated marketvalue of the inventory (net realizable value). We perform cycle counts ofinventories using an ABC inventory methodology, which groups inventory itemsinto prioritized cycle counting categories, or we conduct physical inventoriesat least once a year.  We regularlyreview inventory quantities on hand and record a provision for excess andobsolete inventory based primarily on our estimated forecast of product demandand production requirements for the next 12 to 24 months. Additionally, todetermine inventory write-down provisions, we review product line inventorylevels and individual items as necessary and periodically review assumptionsabout forecasted demand and market conditions. Any inventory that we determine to be obsolete, either in connectionwith the physical count or at other times of observation, are reserved for andsubsequently written-off.  As of June 30,2009, our total inventory reserves amounted to $5.6 million, of which $3.9million, or 21.0% of total inventory, related to our electronic devices segmentand $1.7 million, or 9% of total inventory, related to our communicationsequipment segment.

 

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

 

***Foreign Currency Translation***

 

We have foreign subsidiaries that together accounted for approximately50.4% and 69.7% of our net revenues, 34.8% and 58.6% of our assets and 24.2%and 53.9% of our total liabilities as of and for the six months ended June 30,2009 and 2008, respectively.  In preparing our consolidated financialstatements, we are required to translate the financial statements of ourforeign subsidiaries from the functional currencies in which they keep theiraccounting records into U.S. dollars. This process results in exchange gainsand losses which, under relevant accounting guidance, are included eitherwithin our statement of operations under the caption “other income (expense)”or as a separate part of our net equity under the caption “accumulated othercomprehensive income (loss).”

 

Under relevantaccounting guidance, the treatment of these translation gains or losses dependsupon management’s determination of the functional currency of each subsidiary.This determination involves consideration of relevant economic facts andcircumstances affecting the subsidiary. Generally, the currency in which thesubsidiary transacts a majority of its transactions, including billings,financing, payroll and other expenditures, would be considered the functionalcurrency. However, management must also consider any dependency of thesubsidiary upon the parent and the nature of the subsidiary’s operations.

 

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

 

If we dispose ofany of our subsidiaries, any cumulative translation gains or losses would berealized into our statement of operations. If we determine that there has beena change in the functional currency of a subsidiary to U.S. dollars, then anytranslation gains or losses arising after the date of the change would beincluded within our statement of operations.

 

Based on ourassessment of the factors discussed above, we consider the functional currencyof each of our international subsidiaries to be each subsidiary’s localcurrency. Accordingly, we had cumulative translation losses of $1.5 million and$2.8 million that were included as part of accumulated other comprehensiveincome within our balance sheets at June 30, 2009 and December 31, 2008,respectively. During the three months ended June 30, 2009 and 2008, we includedtranslation gains of $1.8 million and losses of $3,000, respectively, underaccumulated other comprehensive income and during the six months ended June 30,2009 and 2008, we included translation gains of $1.4 million and $223,000,respectively, under accumulated other comprehensive income.

 

The magnitude of these gains or losses depends upon movements in theexchange rates of the foreign currencies in which we transact business ascompared to the value of the U.S. dollar. During the second quarter of 2009,these currencies include the euro and the British pound sterling. Any futuretranslation gains or losses could be significantly higher or lower than thosewe recorded for these periods.

 

A 2.5 millionBritish pound sterling loan payable from one of our subsidiaries in England to EMRISE was outstanding as ofJune 30, 2009 ($4.1 million based on the exchange rate at June 30, 2009).  Exchange rate losses and gains on thelong-term portion of this loan are recorded in cumulative translation gains orlosses in the equity section of the balance sheet.

 

***Intangibles, Including Goodwill***

 

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

 

In assessing potential impairment of goodwill, we consider these factors aswell as forecasted financial performance of the acquired businesses.  If forecasts are not met, we may have torecord additional impairment charges not previously recognized. In assessingthe recoverability of our goodwill and other intangibles, we must makeassumptions regarding estimated future cash flows and other factors todetermine the fair value of those respective assets. If these estimates ortheir related assumptions change in the future, we may be required to recordimpairment charges for these assets that were not previously recorded.  If that were the case, we would have torecord an expense in order to reduce the carrying value of our goodwill.  Under SFAS No. 142, “Goodwilland Other Intangible Assets”, we are required to analyze our goodwill forimpairment issues at least annually or more frequently if an event occurs orcircumstances change that would more likely than not reduce the fair value of areporting unit below its carrying amount. At June 30, 2009, our reported goodwill totaled $13.4 million.  In assessing the potential impairment ofgoodwill, we consider forecasted financial performance of the acquiredbusinesses to determine the fair value of the respective assets.

 

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**Resultsof Operations**

 

**Overview**

 

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

 

Overall sales fromcontinuing operations increased 19% in the first quarter of 2009 as compared tothe first quarter of 2008.  Our overall netsales of $14.3 million for the second quarter of 2009 reflected $5.4 million ofnet sales contributed by ACC, which we acquired on August 20, 2008, anddeclines in net sales at all of our electronic devices subsidiaries and both ofour communications equipment subsidiaries. With the exception of our French communication subsidiary, whichexperienced a decline in sales largely due to the impact of the global economiccrisis, the declines at our foreign units were largely due to the impact ofexchange rates between the U.S. dollar and the British pound sterling and theeuro.

 

Overall grossprofit as a percentage of sales increased to 38.3% in the second quarter of2009 from 30.8% in the first quarter of 2008. The increase in gross profit as a percentage of sales was due primarilyto the inclusion of ACC sales in 2009 and associated gross margins in ourresults partially offset by a decrease in gross profit as a percentage of saleswithin our communication segment as a result of lower sales volumes within thatsegment.

 

The following is adetailed discussion of our results of operations by business segment.  As a result of the sale of our DigitranOperations in March 2009, for purposes of the following discussion andanalysis, the Digitran Operations have been removed from the prior periodcomparisons and the quarterly results of the Digitran Operations are reportedas a discontinued operation for all periods presented.

 

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***Comparison of the Three Months Ended June 30, 2009 to the Three MonthsEnded June 30, 2008***

 

**Net Sales**

 
| ** **                                  | ** ** | **Three  Months Ended** | ** ** | **Variance**                 | ** ** |
|---------------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | **June  30,**           | ** ** | **Favorable  (Unfavorable)** | ** ** |
| **(in  thousands)**                         | ** ** | **2009**                | ** ** | **2008**                     | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                        |       |                    |       |                         |       |   |   |   |   |
| Electronic devices                          |       | $                       | 11,649     |                         | $          | 8,160 |   | $ | 3,489 |   | 42.8 | % |
| *as %  of net sales*                        | * *   | *81.6*                  | *%*        | *67.9*                       | *%*        | * * | * * | * * | * * |
| Communications  equipment                   |       | 2,621                   |       | 3,862                        |       | (1,241 | ) | (32.1 | )% |
| *as %  of net sales*                        | * *   | *18.4*                  | *%*        | *32.1*                       | *%*        | * * | * * | * * | * * |
| Total net sales from  continuing operations |       | 14,270                  |       | 12,022                       |       | 2,248 |   | 18.7 | % |
| Discontinued operations                     |       | —                  |       | 2,027                        |       |   |   |   |   |
| Total net sales                             |       | $                       | 14,270     |                         | $          | 14,049 |   | $ | 2,248 |   |   |   |

 

*Electronic Devices Segment*

 

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

 

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

 

*Communications Equipment Segment*

 

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

 

Net sales in ourcommunications equipment segment have been, and are likely to continue to be,negatively impacted by the recent economic conditions as many of ourcommunications equipment products are deemed to be discretionary expendituresby our customers and many companies in this industry have announced plans toreduce capital expenditures and/or to defer discretionary spending due tocurrent economic conditions.  Once globaleconomic conditions improve, we believe this segment will benefit more so thanour electronic devices segment, which has not been impacted as severely due tothe defense related nature of that segment. Exchange rates remain an uncertainty and could impact our salespositively or negatively throughout the remainder of 2009 as compared to2008.  The relationship between the euroas compared to the U.S. dollar can have a significant impact on the results ofour European communication segment operations as those results are translatedinto U.S. dollars. Despite the economic impacts in our communications equipmentsegment, we had an unusually high backlog of orders in this segment at June 30,2009 of $0.9 million for our telecommunications test equipment primarily forthe Federal Aviation Administration and the U.S. Navy.  We expect that these orders will be deliveredin the second half of 2009.

 

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**Gross Profit**

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

 

*Electronic Devices Segment*

 

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

 

We expect that during2009, overall gross margins in our electronic devices segment will remainconsistent with those gross margins reported for the second quarter of2009.  During 2009 we may experiencequarter to quarter variability due to product mix differences and resultingdifferentials associated with lower gross margins on our electronic devicesused in commercial applications as compared to gross margins on our electronicdevices used in military applications. We expect ACC to contribute positively to our gross profit throughout2009.  Exchange rates remain anuncertainty and could impact our gross profit positively or negativelythroughout the remainder of 2009.  The relationshipbetween the British pound sterling and the U.S. dollar can have a significantimpact on the results of our European electronic device operations as thoseresults are translated into U.S. dollars.

 

*Communications Equipment Segment*

 

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

 

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

 

**Operating Expenses**

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

 

*Selling, general andadministrative expenses*

 

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

 

During 2009, weexpect SG&A expense to be higher on a quarterly basis in each quarter of2009 as compared to each quarter in 2008. The anticipated increases in 2009 over 2008 quarterly expenses isprimarily due to the inclusion of ACC’s expenses in 2009 as compared to onlyincluding such expense during the last four months of 2008, as well as higheranticipated costs relating to Sarbanes-Oxley compliance due to the fact that weare now subject to the Sarbanes-Oxley Act Section 404 external auditrequirements.  SG&A expense for thirdquarter of 2009 may be higher than the SG&A expenses incurred during thesecond quarter of 2009due to the inclusion of severance costs associated withour ongoing restructuring plan and anticipated Sarbanes-Oxley managementassessment related costs.  However, oversubsequent quarters, we expect SG&A expense to trend lower as compared tosecond quarter 2009 due to significant restructuring efforts at both ourbusiness units and at our corporate office.

 

*Engineering and productdevelopment*

 

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

 

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

 

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**Interestexpense**

 

Interestexpense was $0.9 million for the three months ended June 30, 2009 compared to$0.6 million for the three months ended June 30, 2008 due to higher outstandingloan and line of credit balances and higher interest rates on portions of thoseloan balances in the second quarter of 2009 as compared to the second quarterof 2008.  Included in interest expense inthe second quarter of 2009 were $0.3 million of non-cash amortization ofdeferred financing costs and non-cash amortization of debt discount compared to$0.2 million in the second quarter of 2008.

 

**Otherincome (expense)**

 

Werecorded other income of $211,000 for the three months ended June 30, 2009compared to $120,000 for the same period of 2008.  Other income (expense) consists primarily of (1)short-term exchange rate gains and losses associated with the volatility of theU.S. dollar to the British pound sterling and euro on the current portion ofcertain assets and liabilities and, (2) fair value adjustments on warrantsduring the second quarter of 2009.  Thechange in the fair value of warrants during the second quarter of 2009 resultedin income of $293,000, which was not present in 2008.  The remaining expense of $82,000 for thesecond quarter of 2009 was predominantly related to short-term exchange ratelosses.

 

**Incometax expense**

 

Incometax expense amounted to $117,000 for the three months ended June 30, 2009compared to income tax benefit of $4,000 for the same period of 2008.  We recorded income tax expense primarily asthe result of foreign income tax on foreign earned profits in Europe and NewJersey state income taxes on income generated by ACC.

 

**Netgain on discontinued operations**

 

Inconnection with the sale of our Digitran Operations on March 20, 2009, wereported income from our discontinued Digitran Operations of $6.0 million (netof tax of $1.4 million) during the first quarter of 2009, which included a $7.2million gain on the sale of assets.  Inthe second quarter of 2009, we recorded a decreasing adjustment to the gain onthe sale of Digitran of $0.1 million (including a tax adjustment) associatedwith certain purchase price adjustments associated with the transaction.  In the second quarter of 2008, theseoperations contributed comparative income of $0.6 million.

 

**Netloss**

 

Wereported a net loss of $0.5 million in the second quarter of 2009 and a netloss of $0.3 million in the second quarter of 2008.  Included in our net loss for the secondquarter of 2009 is $0.3 million of severance costs associated with therestructuring of personnel at several of our facilities, and approximately $0.1million in expense associated with the sale of Digitran Operations.  We anticipate net loss to improve in futurequarters, due in large part to the recent restructuring efforts beingcompleted.

 

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***Comparison of the Six Months Ended June 30, 2009 to the Six MonthsEnded June 30, 2008***

 

**NetSales**

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

 

*ElectronicDevices Segment*

 

Theincrease in sales of our electronic devices in the first half of 2009 ascompared to the first half of 2008 was primarily the result of the inclusion of$10.5 million in net sales from ACC, which was acquired in August 2008.  This increase was partially offset by adecrease in sales at all of our other electronic devices subsidiaries, which inthe case of our U.S. power supply division is due to the current globaleconomic crisis and in the case of our foreign subsidiaries, the decrease isdue primarily to the impact of exchange rates.

 

*CommunicationsEquipment Segment*

 

Thedecrease in sales of our communications equipment in the first half of 2009 as comparedto the first half of 2008 is due to an overall decrease in orders and shipmentsfor network access and timing products, especially at our French subsidiarywhere net sales were down $1.7 million in the first half of 2009 compared tothe first half of 2008 due largely to the impacts of the global economic crisisand spending reductions by the French Defense Ministry.  Net sales at our French subsidiary were alsoimpacted by the unfavorable effects of exchange rates in 2009 as compared to2008 between the U.S. dollar and the euro on the translation of the financialresults of our European operations into U.S. dollars.  Sales for network access and timing productsat our U.S. subsidiary also decreased but were partially offset by strongersales of telecommunications test equipment.

 

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**GrossProfit**

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

 

*ElectronicDevices Segment*

 

Theincrease in gross profit, as a percentage of net sales, for our electronicdevices segment from 26.8% in the first half of 2008 to 37.2% in the first halfof 2009 is primarily the result of the inclusion of higher margin products atACC and an increase in gross profit as a percentage of sales at our Europeanoperations due primarily to the effects of exchange rates between the Britishpound sterling and the U.S. dollar.  Thisincrease was partially offset by a reduction in gross margin at our U.S. powersupply division due to a write down of approximately $0.3 million of certaininventories to the lower of cost or market during the first quarter of 2009 andapproximately $0.1 million of severance costs incurred in the second quarterof2009 associated with our restructuring plan.

 

*CommunicationsEquipment Segment*

 

Thedecrease in gross margin for our communications equipment segment from 41.7% inthe first half of 2008 to 33.3% in the first half of 2009 is primarily theresult of decreased sales of both network access products and timing andsynchronization products due to a slow-down of purchases being made by ourcustomers of these products.  Grossprofit, both as a percentage of net sales and on an actual dollar basis, was unfavorablyimpacted as a result of the changes in foreign currency exchange rates betweenthe U.S. dollar and the euro in the first half of 2009 as compared to the firsthalf of 2008.

 

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**OperatingExpenses**

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

 

*Selling,general and administrative expenses*

 

Theincrease in SG&A is primarily the result of approximately $2.5 million ofadditional expenses relating to ACC, which were absent in the results ofoperations for the first half of 2008. These increases were partially offset by decreases in SG&A at someof our business units, including our corporate office.

 

*Engineeringand product development*

 

Theslight increase in engineering and product development costs is primarily dueto the added engineering costs at ACC offset by a slight reduction inengineering costs at some of our business units as compared to the prior year.

 

**Interestexpense**

 

Interestexpense was $1.9 million for the six months ended June 30, 2009 compared to$1.2 million for the six months ended June 30, 2008 due to higher outstandingloan and line of credit balances and higher interest rates on portions of thoseloan balances in the first half of 2009 as compared to the first half of2008.  Included in interest expense inthe first half of 2009 were $0.1 million in fees associated with a waiverreceived from our lender in the first quarter of 2009, and $0.6 million ofnon-cash amortization of deferred financing costs and non-cash amortization ofdebt discount compared to $0.4 million in the first half of 2008.

 

**Otherincome (expense)**

 

Werecorded other income of $168,000 for the six months ended June 30, 2009compared to $103,000 for the same period of 2008.  Other income (expense) consists primarily of (i)short-term exchange rate gains and losses associated with the volatility of theU.S. dollar to the British pound sterling and euro on the current portion ofcertain assets and liabilities and (ii) fair value adjustments onwarrants.  The change in the fair valueof warrants during the first half of 2009 resulted in income of $423,000, whichwas not present in 2008.  The remainingexpenses of $254,000 for the second quarter of 2009 were predominantly relatedto short-term exchange rate losses.

 

**Incometax expense**

 

Incometax benefit amounted to $233,000 for the six months ended June 30, 2009compared to income tax expense of $80,000 for the same period of 2008.  We recorded an income tax benefit as theresult of losses incurred in the first half of 2009 relating to continuingoperations.  This benefit was partiallyoffset by income tax expense incurred primarily as the result of foreign incometax on foreign earned profits in Europe and New Jersey state income taxes onincome generated by ACC.

 

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**Netgain on discontinued operations**

 

Inconnection with the sale of our Digitran Operations on March 20, 2009, wereported income from our discontinued Digitran Operations of $5.9 million (netof $1.3 million in taxes) during the first half of 2009, which includes a $7.1million gain on the sale of assets.  Inthe first half of 2008, these operations contributed comparative income of $1.0million.

 

**Netincome (loss)**

 

Wereported net income of $4.8 million in the first half of 2009 and a net loss of$1.2 million in the first half of 2008. Included in net income in the first half of 2009 was a $5.9 million (netof $1.3 million in taxes) gain on the sale of our Digitran Operations,approximately $0.3 million in inventory write downs, $0.3 million of severancecosts associated with the restructuring of personnel at several of ourfacilities and $0.1 million in fees associated with a waiver received from ourlender in the first quarter of 2009.

 

**Liquidity andCapital Resources**

** **

In making anassessment of our liquidity, we believe that the items in our financialstatements that are most relevant to our ongoing operations are workingcapital, cash generated from operating activities and cash available fromfinancing activities.  During the firsthalf of 2009, we funded our daily cash flow requirements through funds providedby operations and through borrowings under our credit facility with GVECResource IV Inc. (“GVEC” or the “Lender”). Working capital was $7.4 million at June 30, 2009 as compared to $7.6million at December 31, 2008. Significant items that positively impactedworking capital from December 31, 2008 until June 30, 2009 are (i) a reductionof $3.1 million in the current portion of long term debt which was associatedwith the sale of our Digitran Operations in March 2009 and the subsequentrepayment of long term acquisition related debt by approximately $10 million;and (ii) an increase in cash of approximately $1.6 million. Significant itemsthat negatively impacted working capital from December 31, 2008 until June 30,2009 are (i) the sale of our Digitran Operations in March 2009, which at December31, 2008, had net current assets of $2.1 million; (ii) an increase in our lineof credit by $1.5 million; (iii) a decrease in accounts receivable fromcontinuing operations of $0.9 million due to improved collections; and (iv) anincrease of $0.4 million in income taxes payable primarily as a result of thetaxes we paid on the gain on sale of our Digitran Operations.  At June 30, 2009 and December31, 2008, we had accumulated deficits of$22.9 million and $28.1 million, respectively, andcash and cash equivalents of $4.8 million and $3.4 million, respectively. Our cash balances are oftensignificantly higher at the end of the month than at other times throughout theremainder of the month as a result of borrowings under our credit facilitygenerally occurring toward the end of the month and timing of payments tovendors in the form of accounts payable, payroll and interest paymentsgenerally occurring at the beginning of the month.

 

Net cash used inoperating activities during the first half of 2009 totaled $0.5 million.  Our reported net income of $4.8 millionincluded a gain on the sale of the Digitran Operations of $7.1 million.  Significant non-cash adjustments to our netincome for the six months ended June 30, 2009 include (i) the amortization ofdebt discount and amortization of deferred financing cost which, on a combinedbasis, totaled $0.5 million, both of which are non-cash components of interestexpense associated with our credit facility, (ii) depreciation and amortizationexpense which totaled $1.0 million, and (iii) change in fair value of commonstock warrants which contributed $0.4 million as non-cash component of netincome.  Significant uses of cashassociated with operating activities during the six month period ended June 30,2009 included (a) an increase in inventory balances of $1.0 million in order toaccommodate future shipments of backlog, and (b) a decrease in accounts payableand accrued liabilities by approximately $1.0 million, in part due to paymentsmade on previously accrued amounts related to the sale of the DigitranOperations and timing of vendor payments. The primary source of cash associated with operating activities duringthe six month period was a decrease in accounts receivable, which decreased byapproximately $0.9 million, due primarily to increased efforts to collectoutstanding balances on a more timely basis.

 

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Cash generated from our investing activities during the first half of 2009totaled $6.9 million. This amount consisted primarily of net cash proceedsgenerated by the March 2009 sale of our Digitran Operations, all of which was used to partiallyrepay the $13 million in term debt that we incurred in connection with ourpurchase of ACC in August 2008.  Theseproceeds were partially offset by the recording of $3.1 million notes payablerelated to a portion of the contingent component of the purchase price of ACC.

 

Cash used in financing activities during the first quarter of 2009 totaled$5.8 million, which consisted of $10.6 million in repayments of principal owedon long term debt andnotes to stockholders, offset by $1.5 million in net borrowings on ourrevolving credit facility and $3.1 million of notes payable related to theacquisition of ACC.

 

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

 

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

 

Our backlog decreased to $27.8 million as of June 30, 2009 ascompared to $34.7 million as of December31, 2008. The decrease is, in part, due to the sale of the Digitran Operations,which represented $1.5 million in backlog at December 31, 2008, and thereduction of backlog at all of our electronic devices business units as wesatisfied existing contracts during the first half of 2009.  We experienced a slight increase in backlogat our U.S. communications equipment business unit associated with new ordersfor telecommunications test equipment. The amount of backlog orders represents revenue that we anticipaterecognizing in the future, as evidenced by purchase orders and other purchasecommitments received from customers, but on which work has not yet beeninitiated or with respect to which work is currently in progress. Our backlogas of June 30, 2009 was approximately 95% related to our electronic devicesbusiness, which business tends to provide us with long lead-times for ourmanufacturing processes due to the custom nature of the products, andapproximately 5% related to our communications equipment business, whichbusiness tends to deliver standard or modified standard products from stock asorders are received. We believe that the majority of our current backlog willbe shipped within the next 12 months. However, there can be no assurance that we will be successful in fulfillingsuch orders and commitments in a timely manner or that we will ultimatelyrecognize as revenue the amounts reflected as backlog.

 

On November 30,2007, we and our direct subsidiaries, EEC, CXR Larus and RO Associates enteredinto a Credit Agreement with the Lender, providing for a credit facility in theaggregate amount of $23,000,000.  On August20, 2008, in connection with the acquisition of ACC and CCI, we entered into anamendment to the credit facility to include ACC and CCI as borrowers and to,among other things, include an additional term loan in the principal amount of$3,000,000 (the “Term Loan C”).  Inconnection with Digitran Transaction we repaid approximately $10million of term debt in March 2009, including the Term Loan C. As of June 30, 2009, we owed a total of $14.4 million under the terms ofthe credit facility.

 

Thecredit facility currently consists of (i) a one year revolving loan for up to$7 million that may be renewed on November 30, 2009 for a period of one year(the “Revolver”), and (ii) two term loans (Term Loan A and Term Loan B) with anaggregate net outstanding principal amount of $8.8 million. The term loansrequire scheduled principal and interest payments commencing September 1, 2009and a final balloon payment of principal upon maturity on November 30, 2010.  Total aggregate principal payments on TermLoan A and Term Loan B are $1.1 million in 2009 and $7.9 million in 2010.

 

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The Revolver is formula-based and generally provides that theoutstanding borrowings under the line of credit may not exceed an aggregate of85% of eligible accounts receivable, plus 10% of the value of eligible rawmaterials not to exceed $600,000, plus 50% of the value of eligible finishedgoods inventory not to exceed $1,500,000, minus the aggregate amount ofreserves that may be established by the Lender. The Revolver has a maturity date of November 30, 2009, unless it isrenewed by the Lender in which case the maturity date will be extended to November30, 2010.

 

Intereston the Revolver is payable monthly.  Theinterest rate is variable and is adjusted monthly based on the prime rate aspublished in the “Money Rates” column of*TheWall Street Journal* (the “Base Rate”) plus 1.25%, subject to aminimum rate of 9.5% per annum.  TheRevolver is subject to various financial covenants on a consolidated basis,including EBITDA, measured on a fiscal quarter-end basis, must not be less thanthe scheduled amount for each specified period; the debt service coverageratio, measured quarterly, must be greater than the lesser of the scheduledamount for each specific period or 1.10:1.00; minimum liquidity above thescheduled amount, unfinanced capital expenditures not in excess of $62,500 perquarter, and the leverage ratio, measured quarterly, must not be greater thanthe scheduled amount for each specified period.  Additionally, the Revolver is subject to theborrowers not incurring purchase money commitments in excess of $2 million.  As of June 30, 2009, we were in compliancewith all of these debt covenants.

 

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

 

Uponthe sale or disposition by the borrowers or any of their subsidiaries ofproperty or assets, the borrowers may be obligated to prepay the Revolver andthe term loans with the net cash proceeds received in connection with suchsales or dispositions to the extent that the aggregate amount of net cashproceeds received, and not paid to the Lender as a prepayment, for all suchsales or dispositions exceed $150,000 in any fiscal year.  However, to the extent we sell assets after August14, 2009 and prior to January 1, 2010, only 75% of the net cash proceeds ofsuch sale must be used to prepay our outstanding obligations to the Lender.

 

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

 

Wehave agreed with our Lender to raise at least $3 million in net proceedsthrough the sale of stock of the borrowers by no later than December 31,2009.  Under the terms of the creditfacility, we are obligated to remit to our Lender 50% of the first $3 millionof net cash proceeds received in connection with the sale of stock and 30% ofthe net cash proceeds in excess of the first $3 million received. Given currenteconomic and financial market conditions, an equity raise could prove difficult.  Accordingly, no assurances can be made that we will be successfulin this regard.  If we aresuccessful in structuring an equity raise acceptable to us and our Lender, theissuance of equity securities may result in substantial dilution to ourstockholders.

 

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

 

Weare obligated to make monthly principal payments to our Lender of (i) $75,000on September 1. 2009 and October 1, 2009, (ii) $100,000 on November 1, 2009, (iii)$150,000 on December 1, 2009 and (iv) approximately $287,000 commencing on January1, 2010 and continuing on the first day of each of the 10 consecutive monthsthereafter.

 

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

 

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Inthe event of a default and continuation of a default, our Lender may limitfuture availability under our revolving line of credit and/or accelerate thepayment of all principal balances and accrued interest requiring us to pay theentire indebtedness under the credit facility outstanding on that date.  Upon the occurrence and during the continuationof an event of default, the Lender may also elect to increase the interest rateapplicable to the outstanding balance of the Term Loans A and B by fourpercentage points above the per annum interest rate that would otherwise beapplicable.  Any of these conditionscould have a material adverse effect on our operations and/or ability toconduct business after that date.  Additionally,if our Lender terminates the credit facility during a default period or if weprepay the Revolver or the Term Loans prior to November 30, 2009, then we aresubject to a penalty equal to 2% of the outstanding principal balance of theRevolver and the Term Loans.

 

Recentactions taken by the Commission against Private Equity Management Group, Inc.,an affiliate of our Lender, including an order granted in April 2009 by afederal court freezing all assets of Private Equity Management Group, Inc. andits affiliates, including our Lender, may adversely affect our Lender’s abilityto continue to provide us funds under the terms of the Revolver.  At the request of the Commission, the federalcourt also appointed a temporary receiver of our Lender’s agent and of ourLender.  Although we currently believethat the receiver will allow us to continue to borrow funds under the terms ofthe Revolver, no assurances can be made that the receiver will allow our Lenderto continue to make funds available to us.  If, for any reason, the receiver were to limitor terminate our ability to continue to borrow funds under the Revolver, ourcash position and our ability to continue day to day operations would beadversely affected, almost immediately.  If that were to occur, we would be required toseek additional and/or replacement financing immediately.  If we are unable to do so, we may be forcedto drastically curtail or cease operations and possibly seek protection fromour creditors under the U.S. Bankruptcy Code.

 

Ifwe are successful in raising $3.0 million in equity capital by December 31,2009, as required by our Lender, and we are able to continue to borrow fundsunder the terms of the Revolver, management believes that current and futurecapital resources, revenues generated from operations and other existingsources of liquidity will be adequate to meet our anticipated short term, workingcapital and capital expenditures needs for the next 12 months.  If, however, for any reason including thereasons described above, we are unsuccessful in raising additional equitycapital as required by the terms of our credit facility thereby resulting in anevent of default under the credit facility or if we are unable to continue toborrow funds under the terms of the Revolver, we do not believe that currentand future capital resources, revenues generated from operations and otherexisting sources of liquidity will be adequate to meet our anticipated shortterm, working capital and capital expenditures needs for the next 12 months.  Further, if for any reason, including thereasons described above, we are unable to continue to borrow funds under the termsof the Revolver or if we experience a significant loss of revenue or increasein costs, then our cash flow would be negatively impacted resulting in a cashflow deficit which, in turn, will require us to obtain additional or alternatefinancing, with little or no notice.  These potential financing needs could be metin the form of a revised debt structure with our Lender, additional or newfinancing with another lender or lenders, the sale of assets to generate cashor the sale of additional equity to raise capital.  Our failure to secure additional or alternatefinancing, if and when needed, would have an adverse effect on our operationsand/or ability to do business after that date or could restrict our growth,limit our development of new products, or hinder our ability to fulfillexisting or future orders; we may be forced to drastically curtail or ceaseoperations and possibly seek protection from our creditors under the U. S.Bankruptcy Code

 

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

 

**Effects of Inflation**

** **

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

 

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**Impacts of NewAccounting Pronouncements**

 

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

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements”. This statementprovides a single definition of fair value, together with a framework formeasuring it, and requires additional disclosure about the use of fair value tomeasure assets and liabilities. SFAS No. 157 also emphasizes that fair value isa market-based measurement, not an entity-specific measurement, and sets out afair value hierarchy, with the highest priority being quoted prices in activemarkets. The required effective date of SFAS No. 157 was the first quarter of2008. The adoption of SFAS No. 157 for financial assets and liabilities did nothave a material effect on our consolidated financial statements, but resultedin additional disclosures.  In February 2008,the FASB issued Staff Position No. 157-2, which delayed by one year theeffective date of SFAS No. 157 for all non-financial assets and liabilities,except those that are recognized or disclosed at fair value in the financialstatements on a recurring basis.  Theadoption of SFAS No. 157 for non-financial assets and liabilities did not havea material effect on our consolidated financial statements.

 

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

 

In March 2008, theFASB issued SFAS No. 161, “Disclosures about Derivative Instruments and HedgingActivities.” The new standard amends SFAS No. 133 and seeks to enhancedisclosure about how and why a company uses derivative and hedging activities,how derivative instruments and related hedged items are accounted for underSFAS No. 133 (and the interpretations of that standard) and how derivatives andhedging activities affect a company’s financial position, financial performanceand cash flows.  SFAS No. 161 is effectivefor financial statements issued for fiscal years and interim periods beginningafter November 15, 2008.  We areevaluating the effect this statement may have on our consolidated financialstatements.

 

In April 2008, theFASB issued FASB Staff Position (“FSP”) No. FAS 142-3, “Determination of theUseful Life of Intangible Assets,” (“FSP 142-3”). FSP 142-3 amends the factorsthat should be considered in developing renewal or extension assumptions usedto determine the useful life of a recognized intangible asset under SFAS No. 142,“Goodwill and Other Intangible Assets” and also requires expanded disclosurerelated to the determination of intangible asset useful lives. FSP 142-3 iseffective for fiscal years beginning after December 15, 2008. Early adoption isprohibited. We are currently evaluating the impact the adoption of FSP 142-3will have on our consolidated financial statements.

 

In June 2008, the FASBratified the consensus reached on EITF Issue No. 07-5, “Determining Whether anInstrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF07-5”). EITF 07-5 clarifies the determination of whether an instrument (or anembedded feature) is indexed to an entity’s own stock, which would qualify as ascope exception under SFAS No. 133, Accounting for Derivative Instruments andHedging Activities. EITF 07-5 is effective for financial statements issued forfiscal years beginning after December 15, 2008. Early adoption for an existinginstrument is not permitted. We adopted EITF 07-5 on January 1, 2009. See Note12 **—**Warrants in the accompanynotes to condensed consolidated financial statements in this report fordiscussion of the impact of the adoption of EITF 07-5 on our outstanding stockwarrants and our consolidated financial statements.

 

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

 

In May 2009, the FASB issuedSFAS No. 165, “Subsequent Events” (“SFAS No. 165”), effective for interim orannual financial periods ending after June 15, 2009.  For calendar year entities, SFAS No. 165became effective for the three months ended June 30, 2009.  The objective of SFAS No. 165 is to establishgeneral standards of accounting for and disclosure of events that occur afterthe balance sheet date but before financial statements are issued or areavailable to be issued.  In particular,SFAS No. 165 sets forth (1) the period after the balance sheet date duringwhich management of a reporting entity should evaluate events or transactionsthat may occur for potential recognition or disclosure in the financialstatements: (2) the circumstances under which an entity should recognize eventsor transactions occurring after the balance sheet date in its financialsstatements; and (3) the disclosures that an entity should make about events ortransactions that occurred after the balance sheet date.  The adoption of SFAS No. 165 did not have amaterial impact on our financial position, results of operations or cash flows.

 

In June 2009, theFASB issued SFAS No. 168, “The FASB Accounting Standards CodificationTM and theHierarchy of Generally Accepted Accounting Principles — a replacement of FASBStatement No. 162” (“SFAS No. 168”) to formally establish the FASB AccountingStandards CodificationTM (the “Codification”) as the single source ofauthoritative, nongovernmental U.S. GAAP. All existing accounting standards documents are superseded as describedin SFAS No. 168.  All other accountingliterature not included in the Codification is nonauthoritative.  The Codification is effective for interim andannual periods ending after September 15, 2009. We believe the adoption of SFAS No. 168 will not have a material impacton our financial position, results of operations or cash flows.

 
| **ITEM 3.** | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.** |
|-------------|------------------------------------------------------------------|

 

Not applicable.

 
| **ITEM 4.** | **CONTROLS AND PROCEDURES.** |
|-------------|------------------------------|

 

Not applicable.

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

 

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

 

We conducted an evaluation under the supervision and with the participationof our management, including our Chief Executive Officer and Chief FinancialOfficer, our principal accounting officer, of the effectiveness of the designand operation of our disclosure controls and procedures.  The term “disclosure controls and procedures,”as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Actof 1934, as amended (“Exchange Act”), means controls and other procedures of acompany that are designed to ensure that information required to be disclosedby the company in the reports it files or submits under the Exchange Act isrecorded, processed, summarized and reported, within the time periods specifiedin the Commission’s rules and forms. Disclosure controls and procedures also include, without limitation,controls and procedures designed to ensure that information required to bedisclosed by a company in the reports that it files or submits under theExchange Act is accumulated and communicated to the company’s management,including its principal executive and principal financial officers, or personsperforming similar functions, as appropriate, to allow timely decisionsregarding required disclosure.  Based onthis evaluation, our Chief Executive Officer and Chief Financial Officerconcluded as of June 30, 2009 that our disclosure controls and procedures werenot effective at the reasonable assurance level due to the material weaknessesdiscussed below.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

These inherent limitations include the realities that judgments indecision-making can be faulty and that breakdowns can occur because of a simpleerror or mistake. Controls can also be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management override ofthe controls. The design of any system of controls is based in part on certainassumptions about the likelihood of future events, and there can be no assurancethat any design will succeed in achieving its stated goals under all potentialfuture conditions. Projections of any evaluation of controls effectiveness tofuture periods are subject to risks. Over time, controls may become inadequatebecause of changes in conditions or deterioration in the degree of compliancewith policies or procedures.

 

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

 

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

 

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(1)           Wedid not effectively implement comprehensive entity—level internalcontrols, as evidencedby the following control deficiencies:

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

 

(2)           We did not maintain effective controls over changes tocritical financial reporting applications and over access to these applicationsand related data, as evidenced by the fact that certain of our personnel hadunrestricted access to various financial application programs and data beyondthe requirements of their individual job responsibilities. This controldeficiency could result in a material misstatement of significant accounts ordisclosures, including those described above, that could result in a materialmisstatement of our interim or annual consolidated financial statements thatwould not be prevented or detected.

 

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

 

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

 

The above materialweaknesses did not result in adjustments to our consolidated financialstatements for the quarter ended June 30, 2009, however, it is reasonablypossible that, if not remediated, one or more of the material weaknessesdescribed above could result in a material misstatement in our reportedfinancial statements that might result in a material misstatement in a futureannual or interim period.

 

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

 

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

 

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

 

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

 

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

 

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**PART II – OTHERINFORMATION**

 
| **ITEM 1.** | **LEGAL PROCEEDINGS.** |
|-------------|------------------------|

 

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

 
| **ITEM 1A.** | **RISK FACTORS.** |
|--------------|-------------------|

 

Item 1A of Part Iof our Form 10-K for the year ended December 31, 2008 summarizes variousmaterial risks that investors should carefully consider before deciding to buyor maintain an investment in our common stock. Any of those risks and the additional risk factor described below, ifthey actually occur, would likely harm our business, financial condition andresults of operations and could cause the trading price of our common stock todecline.

 

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

 

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

 
| **ITEM 2.** | **UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.** |
|-------------|------------------------------------------------------------------|

 

**Unregistered Sales of Equity Securities**

 

None.

 

**Dividends**

 

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

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

 

None.

 

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

 

On June 25, 2009, we held our 2008 annual meeting of stockholders.  The total number of outstanding votableshares was 10,204,079.  Our stockholderswere asked to consider and vote upon the following two proposals:

 

1)              Re-electionof Otis W. Baskin as a Class I director to serve a three-year term.

 

2)              Ratificationof the selection of our independent registered public accounting firm to auditour consolidated financial statements for 2009.

 

Results of the vote were as follows:

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

 

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

 

**ITEM 5.****                                                 ****OTHERINFORMATION.**

 

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

 

On August 14,2009, we entered into Amendment Number 5 to Loan Documents with our Lender(“Amendment Number 5”).  Pursuant toAmendment Number 5, we agreed to raise no less than $3 million in net proceedsthrough the sale of stock of the borrowers by no later than December 31, 2009.  Under to the terms of Amendment Number 5, weare obligated to remit to our Lender 50% of the first $3,000,000 of net cashproceeds received in connection with the sale of stock and 30% of the net cashproceeds in excess of the first $3,000,000 received.

 

Pursuant to theterms of Amendment Number 5, we are now obligated to make monthly principalpayments to our Lender of (i) $75,000 on September 1. 2009 and October 1, 2009,(ii) $100,000 on November 1, 2009, (iii) $150,000 on December 1, 2009 and (iv) approximately$287,000 commencing on January 1, 2010 and continuing on the first day of eachof the 10 consecutive months thereafter. In addition, the Lender revised the minimum liquidity financial covenantto provide no such covenant for the fiscal quarter ending September 30, 2009and agreed that to the extent we sell assets after the date of Amendment Number5 and prior to January 1, 2010, 75% of the net cash proceeds of such sale mustbe used to prepay our outstanding obligations to the Lender.  Any sales after that date would require us touse all net cash proceeds to prepay our outstanding obligations to the Lender.

 

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

 

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

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                                                                                             |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                                        |
| 10.1       |       | Amendment  to Forbearance Agreement and Amendment Number 3 to Loan Documents, dated  April 9, 2009, by and among EMRISE Corporation, EMRISE Electronics  Corporation, CXR Larus Corporation, RO Associates Incorporated, Advanced  Control Components, Inc., Custom Control Components, Inc. and GVEC Resource  IV Inc. (1) |
|       |       |                                                                                                                                                                                                                                                                                                                        |
| 10.2       |       | Letter  Agreement, dated May 14, 2009, by and among EMRISE Corporation, EMRISE  Electronics Corporation, CXR Larus Corporation, RO Associates Incorporated,  Advanced Control Components, Inc., Custom Control Components, Inc. and GVEC  Resource IV Inc. (2)                                                              |
|       |       |                                                                                                                                                                                                                                                                                                                        |
| 10.3       |       | Amendment  Number 5 to Loan Documents, dated August 14, 2009, by and among EMRISE  Corporation, EMRISE Electronics Corporation, CXR Larus Corporation, RO  Associates Incorporated, Advanced Control Components, Inc., Custom Control  Components, Inc. and GVEC Resource IV Inc.                                           |
|       |       |                                                                                                                                                                                                                                                                                                                        |
| 16.1       |       | Letter  on Change in Certifying Accountant (3)                                                                                                                                                                                                                                                                              |
|       |       |                                                                                                                                                                                                                                                                                                                        |
| 31.1       |       | Certification  of Principal Executive Officer required by Rule 13a-14(a) of the Securities  Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                         |
|       |       |                                                                                                                                                                                                                                                                                                                        |
| 31.2       |       | Certification  of Principal Financial Officer required by Rule 13a-14(a) of the Securities  Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                         |
|       |       |                                                                                                                                                                                                                                                                                                                        |
| 32.1       |       | Certification  of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.  Section 350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002                                                                                                                                             |

 

----

(1) Filed as an exhibit to the Registrant’scurrent report on Form 8-K for April 9, 2009 and incorporated herein byreference.

 

(2) Filed as an exhibit to the Registrant’scurrent report on Form 8-K for May 14, 2009 and incorporated herein byreference.

 

(3)  Filed as an exhibit to theRegistrant’s current report on Form 8-K for April 30, 2009 and incorporatedherein by reference

 

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**SIGNATURES**

 

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

 
|                   | EMRISE CORPORATION |
|------------------------|--------------------|
|                   |               |   |
| Dated: August 14, 2009 | By:                | /S/ CARMINE T. OLIVA |
|                   |               | Carmine T. Oliva, |
|                   |               | Chief Executive Officer |
|                   |               |   |
|                   |               |   |
| Dated: August 14, 2009 | By:                | /S/ D. JOHN DONOVAN |
|                   |               | D. John Donovan, Chief Financial Officer (principal |
|                   |               | financial  and accounting officer) |

 

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**INDEX TO EXHIBITS ATTACHED TOTHIS REPORT**

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                                                                                   |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                        |
| 10.3       |       | Amendment  Number 5 to Loan Documents, dated August 14, 2009, by and among EMRISE  Corporation, EMRISE Electronics Corporation, CXR Larus Corporation, RO  Associates Incorporated, Advanced Control Components, Inc., Custom Control  Components, Inc. and GVEC Resource IV Inc. |
|       |       |                                                                                                                                                                                                                                                                              |
| 31.1       |       | Certification  of Principal Executive Officer required by Rule 13a-14(a) of the Securities  Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                               |
|       |       |                                                                                                                                                                                                                                                                              |
| 31.2       |       | Certification  of Principal Financial Officer required by Rule 13a-14(a) of the Securities  Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                               |
|       |       |                                                                                                                                                                                                                                                                              |
| 32.1       |       | Certification  of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.  Section 350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of  2002                                                                                                   |

 

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