**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

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

 

**For thequarterly period ended****March 31,2008**

 

**or**

 

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

 

**For the transition period from             to             **

 

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

** **

**EMRISECORPORATION**

(Exact name ofregistrant as specified in its charter)

 

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

 

**9485 HavenAvenue, Suite 100**

**RanchoCucamonga, California 91730**

(Address of principalexecutive offices) (Zip code)

 

**(909) 987-9220**

(Registrant’s telephone number, including area code)

 

**Not applicable**

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

 

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

 

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

 

| Large accelerated filer  o                     |   | Accelerated filer o          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer o                        |   | Smaller reporting  company x |
| (Do not check if a  smaller reporting company) |   |                              |

 

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

 

The number of sharesoutstanding of the Registrant’s common stock, $0.0033 par value, as of May 7,2008 was 38,254,250.

 

 

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**EMRISE CORPORATION**

**TABLE OF CONTENTS**

**FORM 10-Q**

**FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2008**

** **

**PART I. FINANCIAL INFORMATION**

 
| **ITEM 1.**           | **FINANCIAL  STATEMENTS**                                                                                                   |   |
|-----------------------|-----------------------------------------------------------------------------------------------------------------------------|--------|
|                  |                                                                                                                        |
|                  | Condensed  Consolidated Balance Sheets as of March 31, 2008 (unaudited) and  December 31, 2007                    | 1      |
|                  |                                                                                                                        |   |
|                  | Condensed  Consolidated Statements of Operations for the Three Months Ended  March 31, 2008 and 2007 (unaudited)       | 2      |
|                  |                                                                                                                        |   |
|                  | Condensed  Consolidated Statements of Stockholders’ Equity for the Three Months Ended  March 31, 2008 (unaudited) | 3      |
|                  |                                                                                                                        |   |
|                  | Condensed  Consolidated Statements of Cash Flows for the Three Months Ended  March 31, 2008 and 2007 (unaudited)       | 4      |
|                  |                                                                                                                        |   |
|                  | Notes to Condensed Consolidated Financial Statements  (unaudited)                                                           | 5      |
|                  |                                                                                                                        |
| **ITEM 2.**           | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**                             | 12     |
|                  |                                                                                                                        |   |
| **ITEM 3.**           | **QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**                                                             | 23     |
|                  |                                                                                                                        |   |
| **ITEM 4.**           | **CONTROLS AND  PROCEDURES**                                                                                                | 23     |
|                  |                                                                                                                        |   |
| **ITEM 4T.**          | **CONTROLS AND  PROCEDURES**                                                                                                | 23     |
|                  |                                                                                                                        |   |
| **PART II**      |
| **OTHER INFORMATION** |
|                  |                                                                                                                        |   |
| **ITEM 1.**           | **LEGAL PROCEEDINGS**                                                                                                       | 26     |
|                  |                                                                                                                        |   |
| **ITEM 1A.**          | **RISK FACTORS**                                                                                                            | 26     |
|                  |                                                                                                                        |   |
| **ITEM 2.**           | **UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**                                                            | 26     |
|                  |                                                                                                                        |   |
| **ITEM 3.**           | **DEFAULTS UPON  SENIOR SECURITIES**                                                                                        | 26     |
|                  |                                                                                                                        |   |
| **ITEM 4.**           | **SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS**                                                                    | 26     |
|                  |                                                                                                                        |   |
| **ITEM 5.**           | **OTHER INFORMATION**                                                                                                       | 26     |
|                  |                                                                                                                        |   |
| **ITEM 6.**           | **EXHIBITS**                                                                                                                | 27     |
|                  |                                                                                                                        |
| **SIGNATURES**        |                                                                                                                        | 28     |
|                       |                                                                                                                             |        |  |  |

 

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**EMRISE CORPORATION**

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

 
| ** **                                                                                                                                                                                 | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                 | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                                                                 | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                 |       |               |       |                  |       |
| Current assets:                                                                                                                                                                            |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                 |       | $                  | 3,454      |                  | $          | 4,764 |   |
| Accounts  receivable, net of allowances for doubtful accounts of $291 at March 31,  2008 and $345 at December 31, 2007                                                           |       | 9,297              |       | 9,406                 |       |
| Inventories                                                                                                                                                                                |       | 12,683             |       | 11,664                |       |
| Current deferred  tax assets                                                                                                                                                               |       | 229                |       | 200                   |       |
| Prepaid and  other current assets                                                                                                                                                          |       | 1,367              |       | 1,617                 |       |
| Total current  assets                                                                                                                                                                      |       | 27,030             |       | 27,651                |       |
|                                                                                                                                                                                       |       |               |       |                  |       |
| Property, plant  and equipment, net                                                                                                                                                        |       | 2,511              |       | 2,227                 |       |
| Goodwill                                                                                                                                                                                   |       | 13,093             |       | 13,129                |       |
| Intangible  assets other than goodwill, net                                                                                                                                                |       | 3,208              |       | 3,269                 |       |
| Deferred tax  assets                                                                                                                                                                       |       | 618                |       | 617                   |       |
| Other assets                                                                                                                                                                               |       | 1,184              |       | 1,287                 |       |
| Total assets                                                                                                                                                                               |       | $                  | 47,644     |                  | $          | 48,180 |   |
|                                                                                                                                                                                       |       |               |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                              |       |               |       |                  |       |
| Current  liabilities:                                                                                                                                                                      |       |               |       |                  |       |
| Accounts payable                                                                                                                                                                           |       | $                  | 4,465      |                  | $          | 4,440 |   |
| Accrued expenses                                                                                                                                                                           |       | 5,811              |       | 5,435                 |       |
| Current portion  of long-term debt                                                                                                                                                         |       | 182                |       | 71                    |       |
| Notes payable to  stockholders, current portion                                                                                                                                            |       | 500                |       | 521                   |       |
| Income taxes  payable                                                                                                                                                                      |       | 296                |       | 712                   |       |
| Other current  liabilities                                                                                                                                                                 |       | 357                |       | 357                   |       |
| Total current  liabilities                                                                                                                                                                 |       | 11,611             |       | 11,536                |       |
|                                                                                                                                                                                       |       |               |       |                  |       |
| Long-term line  of credit                                                                                                                                                                  |       | 3,709              |       | 3,957                 |       |
| Long-term debt,  net of discount of $1,155 and $1,264, respectively                                                                                                                        |       | 5,204              |       | 4,829                 |       |
| Notes payable to  stockholders, less current portion                                                                                                                                       |       | 625                |       | 750                   |       |
| Deferred income  taxes                                                                                                                                                                     |       | 904                |       | 904                   |       |
| Other  liabilities                                                                                                                                                                         |       | 1,196              |       | 1,158                 |       |
| Total  liabilities                                                                                                                                                                         |       | 23,249             |       | 23,134                |       |
|                                                                                                                                                                                       |       |               |       |                  |       |
| Commitments and  contingencies (See Note 7)                                                                                                                                                |       |               |       |                  |       |
|                                                                                                                                                                                       |       |               |       |                  |       |
| 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; 38,254,000 and 38,254,000 shares  issued and outstanding at March 31, 2008 and December 31, 2007,  respectively |       | 126                |       | 126                   |       |
| Additional  paid-in capital                                                                                                                                                                |       | 44,547             |       | 44,527                |       |
| Accumulated  deficit                                                                                                                                                                       |       | (21,558            | )          | (20,661               | )          |
| Accumulated  other comprehensive income                                                                                                                                                    |       | 1,280              |       | 1,054                 |       |
| Total  stockholders’ equity                                                                                                                                                           |       | 24,395             |       | 25,046                |       |
| Total  liabilities and stockholders’ equity                                                                                                                                           |       | $                  | 47,644     |                  | $          | 48,180 |   |

 

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

 

1

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Operations**

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

 
| ** **                           | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **March 31,**               | ** ** |
| ** **                           | ** ** | **2008**                         | ** ** | **2007** | ** ** |
|                                 |       |                             |       |   |   |
| Net Sales                            |       | $                                | 12,247     |   | $ | 11,922 |   |
| Cost of Sales                        |       | 7,838                            |       | 8,074 |   |
| Gross profit                         |       | 4,409                            |       | 3,848 |   |
|                                 |       |                             |       |   |   |
| Operating  expenses:                 |       |                             |       |   |   |
| Selling, general  and administrative |       | 3,975                            |       | 3,736 |   |
| Engineering and  product development |       | 664                              |       | 710 |   |
| Total operating  expenses            |       | 4,639                            |       | 4,446 |   |
| Loss from  operations                |       | (230                             | )          | (598 | ) |
|                                 |       |                             |       |   |   |
| Other income  (expense):             |       |                             |       |   |   |
| Interest income                      |       | 18                               |       | 19 |   |
| Interest expense                     |       | (584                             | )          | (150 | ) |
| Other, net                           |       | (17                              | )          | 65 |   |
| Total other  income (expense), net   |       | (583                             | )          | (66 | ) |
|                                 |       |                             |       |   |   |
| Loss before  income taxes            |       | (813                             | )          | (664 | ) |
| Income tax  provision (benefit)      |       | 84                               |       | 128 |   |
| Net Loss                             |       | $                                | (897       | ) | $ | (792 | ) |
|                                 |       |                             |       |   |   |
| Earnings per  share:                 |       |                             |       |   |   |
| Basic                                |       | $                                | (0.02      | ) | $ | (0.02 | ) |
| Diluted                              |       | $                                | (0.02      | ) | $ | (0.02 | ) |
|                                 |       |                             |       |   |   |
| Weighted average  shares outstanding |       |                             |       |   |   |
| Basic                                |       | 38,254                           |       | 38,110 |   |
| Diluted                              |       | 38,254                           |       | 38,110 |   |

 

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

 

2

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Stockholders’Equity**

(Unaudited)****(in thousands)

* *
| ** **                         | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                         | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **        | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                         | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                         | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**       | ** ** | **Income**      | ** ** | **Total**  | ** ** |
|                               |       |                  |       |        |       |            |       |              |       |            |       |       |       |
| Balance at  December 31, 2007 |       | 38,254                |       | $           | 126        |            | $          | 44,527            |       | $               | (20,661    | )          | $          | 1,054 |   | $ | 25,046 |   |
| Stock-based  compensation          |       | —                |       | —      |       | 18              |       | —            |       | —          |       | 18         |       |
| Warrants issued  for services      |       | —                |       | —      |       | 2               |       | —            |       | —          |       | 2          |       |
| Net loss and  comprehensive income |       | —                |       | —      |       | —          |       | (897              | )          | 226             |       | (671       | )          |
| Balance at  March 31, 2008    |       | 38,254                |       | $           | 126        |            | $          | 44,547            |       | $               | (21,558    | )          | $          | 1,280 |   | $ | 24,395 |   |

 

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

 

3

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Cash Flows**

(Unaudited)****(in thousands)

* *
| ** **                                                                    | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                    | ** ** | **March 31,**               | ** ** |
| ** **                                                                    | ** ** | **2008**                         | ** ** | **2007** | ** ** |
|                                                                          |       |                             |       |   |   |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                     |       |                             |       |   |   |
| Net loss                                                                      |       | $                                | (897       | ) | $ | (792 | ) |
| Reconciliation  to net cash used in operating activities:                     |       |                             |       |   |   |
| Depreciation and  amortization                                                |       | 288                              |       | 277 |   |
| Provision for  doubtful accounts                                              |       | (54                              | )          | 4 |   |
| Provision for  inventory obsolescence                                         |       | 53                               |       | 251 |   |
| Provision for  warranty reserve                                               |       | (103                             | )          | — |   |
| Deferred taxes                                                                |       | (30                              | )          | (4 | ) |
| Amortization of  deferred issuance costs                                      |       | 108                              |       | — |   |
| Amortization of  debt discount                                                |       | 108                              |       | — |   |
| Stock-based  compensation expense                                             |       | 18                               |       | 22 |   |
| Warrants issued  for services                                                 |       | 2                                |       | — |   |
| Changes in  assets and liabilities:                                           |       |                             |       |   |   |
| Accounts  receivable                                                          |       | 163                              |       | 712 |   |
| Inventories                                                                   |       | (1,072                           | )          | (681 | ) |
| Prepaid and  other assets                                                     |       | 245                              |       | (201 | ) |
| Accounts payable  and accrued expenses                                        |       | 126                              |       | 237 |   |
| Total  adjustments                                                            |       | (148                             | )          | 617 |   |
| Net cash used in  operating activities                                        |       | (1,045                           | )          | (175 | ) |
|                                                                          |       |                             |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                                    |       |                             |       |   |   |
| Purchases of  property, plant and equipment                                   |       | (37                              | )          | (135 | ) |
| Additions to  intangible assets                                               |       | (11                              | )          | — |   |
| Net cash used in  investing activities                                        |       | (48                              | )          | (135 | ) |
|                                                                          |       |                             |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                                    |       |                             |       |   |   |
| Net proceeds  (repayments) of lines of credit                                 |       | (248                             | )          | (24 | ) |
| Repayments of  long-term debt                                                 |       | (75                              | )          | (126 | ) |
| Payments of  notes to stockholders                                            |       | (146                             | )          | (125 | ) |
| Proceeds from  exercise of stock options and warrants                         |       | —                           |       | 20 |   |
| Net cash used in  financing activities                                        |       | (469                             | )          | (255 | ) |
|                                                                          |       |                             |       |   |   |
| Effect of  exchange rate changes on cash                                      |       | 252                              |       | 32 |   |
| Net decrease in  cash and cash equivalents                                    |       | (1,310                           | )          | (533 | ) |
| Cash and cash  equivalents at beginning of period                             |       | 4,764                            |       | 3,802 |   |
| Cash and cash  equivalents at end of period                                   |       | $                                | 3,454      |   | $ | 3,269 |   |
| ** **                                                                    |       |                             |       |   |   |
| **SUPPLEMENTAL  DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:** |       |                             |       |   |   |
| Acquisition of  equipment through capital lease                               |       | $                                | 453        |   | $ | — |   |

 

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

 

4

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**EMRISE CORPORATION**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 1 – SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

*Organization and Business*

 

EMRISECorporation (the “Company”) designs, manufactures and markets proprietaryelectronic devices and communications equipment for aerospace, defense,industrial, and communications applications. The Company has operations in theUnited States (“U.S.”), England, France and Japan.  The Company conducts its businessthrough two operating segments: electronic devices and communicationsequipment. The subsidiaries within the electronic devices segment design, develop, manufacture and marketelectronic devices for defense, aerospace and industrial markets and operateout of facilities located in the U.S., England and Japan.  The subsidiaries within thecommunications equipment segment design, develop, manufacture and marketnetwork access equipment and network timing and synchronization products andoperate out of facilities located in the U.S. and France.

 

*Basisof Presentation*

 

The accompanying unaudited condensed consolidatedfinancial statements have been prepared in accordance with the rules andregulations of the Securities and Exchange Commission (“Commission”) andtherefore do not include all information and footnotes necessary for a completepresentation of the financial position, results of operations and cash flows inconformity with accounting principles generally accepted in the U.S. (“GAAP”).  The year end balance sheet was derived from theaudited 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, consistingof only normal recurring adjustments, which are, in the opinion of management,necessary to state fairly the financial position as of March 31, 2008 andthe results of operations and cash flows for the related interim periods ended March 31,2008 and 2007. However, these results are not necessarily indicative of resultsfor any other interim period or for the year. The accompanying unauditedcondensed consolidated financial statements should be read in conjunction withthe Company’s audited consolidated financial statements included in its annualreport on Form 10-K for the year ended December 31, 2007 as filedwith the Commission.

 

*ComprehensiveLoss*

 

Comprehensive loss includes all changes in equityduring a period except those that resulted from investments by or distributionsto the Company’s stockholders.  Othercomprehensive income refers to revenues, expenses, gains and losses that, underGAAP, are included in comprehensive income, but excluded from net loss as theseamounts are recorded directly as an adjustment to stockholders’ equity.  The Company’s other comprehensive incomeconsists of foreign currency translation adjustments.  The following table reflects the componentsof comprehensive loss (in thousands):

 
| ** **                               | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **March 31,**               | ** ** |
| ** **                               | ** ** | **2008**                         | ** ** | **2007** | ** ** |
|                                     |       |                             |       |   |   |
| Net  loss                                |       | $                                | (897       | ) | $ | (792 | ) |
| Other  comprehensive income:             |       |                             |       |   |   |
| Foreign  currency translation adjustment |       | 226                              |       | (23 | ) |
| Comprehensive  loss                      |       | $                                | (671       | ) | $ | (815 | ) |

 

5

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*LossPer Share*

 

Basic loss per share is computed by dividing net lossby the weighted average common shares outstanding during a period.  Diluted loss per share is based on the treasurystock method and includes the dilutive effect of stock options and warrantsoutstanding during the period.  Commonshare equivalents have been excluded where their inclusion would beanti-dilutive.  As a result of the lossincurred by the Company for all periods presented, the potentially dilutivecommon shares have been excluded because their inclusion would have beenanti-dilutive.  The following tableillustrates the computation of basic and diluted loss per share (in thousands,except per share amounts):

 
| ** **                                                          | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                          | ** ** | **March 31,**               | ** ** |
| ** **                                                          | ** ** | **2008**                         |       | **2007** |   |
|                                                                |       |                             |       |   |   |
| NUMERATOR:                                                          |       |                             |       |   |   |
| Net  loss                                                           |       | $                                | (897       | ) | $ | (792 | ) |
|                                                                |       |                             |       |   |   |
| DENOMINATOR:                                                        |       |                             |       |   |   |
| Basic  weighted average common shares outstanding                   |       | 38,254                           |       | 38,110 |   |
| Effect  of dilutive securities: Dilutive stock options and warrants |       | —                           |       | — |   |
| Diluted  weighted average common shares outstanding                 |       | 38,254                           |       | 38,110 |   |
|                                                                |       |                             |       |   |   |
| Basic  loss per share                                               |       | $                                | (0.02      | ) | $ | (0.02 | ) |
|                                                                |       |                             |       |   |   |
| Diluted  loss per share                                             |       | $                                | (0.02      | ) | $ | (0.02 | ) |

 

The following table shows the common stock equivalentsthat were outstanding as of March 31, 2008 and 2007, but were not includedin the computation of diluted earnings per share as a result of the lossincurred by the Company or because the options’ or warrants’ exercise price wasgreater than the average market price of the common shares and, therefore, theeffect would have been anti-dilutive:

 
| ** **                            | ** ** | ** **         | ** ** | **Range of**       | ** ** |
|---------------------------------------|------------|--------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **Number of** | ** ** | **Exercise Price** | ** ** |
| ** **                            | ** ** | **Shares**         | ** ** | **Per Share**      | ** ** |
|                                  |       |               |       |                    |       |
| Anti-dilutive  common stock options:  |       |               |       |                    |       |
| As  of March 31, 2008            |       | 1,101,000          |       | $0.20 – $2.00      |       |
| As  of March 31, 2007            |       | 715,000            |       | $1.35 – $3.13      |       |
|                                  |       |               |       |                    |       |
| Anti-dilutive  common stock warrants: |       |               |       |                    |       |
| As  of March 31, 2008            |       | 6,742,000          |       | $1.10 – $1.73      |       |
| As  of March 31, 2007            |       | 4,061,000          |       | $1.21 – $2.00      |       |

 

6

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

*Recent Accounting Pronouncements*

 

In February 2007, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)No. 159, *The Fair Value Option for Financial Assetsand Financial Liabilities*. SFAS No. 159 permits an entity toirrevocably elect fair value on a contract-by-contract basis as the initial andsubsequent measurement attribute for many financial assets and liabilities andcertain other items including insurance contracts. Entities electing the fairvalue option would be required to recognize changes in fair value in earningsand to expense upfront cost and fees associated with the item for which thefair value option is elected. SFAS No. 159 is effective for fiscal yearsbeginning after November 15, 2007. The adoption of SFAS No. 159 didnot have a material effect on the Company’s financial condition or results ofoperations.

 

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements*. This newstatement provides a single definition of fair value, together with a frameworkfor measuring it, and requires additional disclosure about the use of fairvalue to measure assets and liabilities. SFAS No. 157 also emphasizes thatfair value is a market-based measurement, not an entity-specific measurement,and sets out a fair value hierarchy, with the highest priority being quotedprices in active markets. The required effective date of SFAS No. 157 isthe first quarter of 2008. The adoption of SFAS No. 157 for financialassets and liabilities did not have a material effect on the Company’sconsolidated financial statements, but resulted in additional disclosurescontained 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 is currently evaluating the impact the adoption of SFAS No. 157for non-financial assets and liabilities will have on its consolidatedfinancial statements.

 

In March 2008, the FASB issued SFAS No. 161,*Disclosures about Derivative Instruments andHedging Activities*. The new standard amends SFAS No. 133 andseeks to enhance disclosure about how and why a company uses derivative andhedging activities, how derivative instruments and related hedged items areaccounted for under SFAS No. 133 (and the interpretations of thatstandard) and how derivatives and hedging activities affect a company’sfinancial position, financial performance and cash flows.  SFAS No. 161 is effective for financialstatements issued for fiscal years and interim periods beginning after November 15,2008.  The adoption of SFAS No. 161is not expected to have a material effect on the Company’s consolidatedfinancial statements.

 

**NOTE 2 – STOCK-BASED COMPENSATION**

 

The Company has fivestock option plans:

 

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

·                  1993 StockOption Plan;

·                  1997 StockIncentive Plan;

·                  Amended andRestated 2000 Stock Option Plan; and

·                  2007 StockIncentive 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 $20,000 and $22,000 for the three monthsended March 31, 2008 and 2007, respectively. These compensation expenseswere charged to selling, general and administrative expenses. As of March 31,2008, the Company had $43,000 of total 

 

7

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

unrecognized compensationexpense related to stock option grants, which will be recognized over theremaining weighted average period of two years.

 

**NOTE 3 – INVENTORIES**

 

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

 
| ** **         | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|--------------------|------------|--------------------|------------|-----------------------|------------|
| ** **         | ** ** | **2008**           | ** ** | **2007**              | ** ** |
|               |       |               |       |                  |       |
| Raw  materials     |       | $                  | 10,591     |                  | $          | 9,292 |   |
| Work-in-process    |       | 3,756              |       | 4,540                 |       |
| Finished  goods    |       | 4,513              |       | 3,956                 |       |
| Reserves           |       | (6,177             | )          | (6,124                | )          |
| Total  inventories |       | $                  | 12,683     |                  | $          | 11,664 |   |

 

**NOTE 4 – OPERATING SEGMENTS**

 

The Company has two reportable operating segments:electronic devices and communications equipment. The electronic devices segmentmanufactures and markets digital and rotary switches, electronic powersupplies, radio frequency (“RF”) and microwave devices and subsystemassemblies. The electronic devices segment consists of EMRISE ElectronicsCorporation and its subsidiaries located in the U.S., England and Japan, whichoffer the same or similar products to similar customers.  The communications equipment segment designs,manufactures and distributes network access products and timing andsynchronization products.  Thecommunications equipment segment consists of operating entities CXR LarusCorporation located in the U.S. and CXR Anderson Jacobson located in France,which offer the same or similar products to similar customers.  Both segments operate in the U.S., Europeanand Asian markets, but have distinctly different customers, design andmanufacturing processes and marketing strategies.  Each segment has discrete financialinformation and a separate management structure.

 

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

 

There were no differences in the basis of segmentationor in the basis of measurement of segment operating income or loss from theamounts disclosed in the Company’s audited consolidated financial statementsincluded in its annual report on Form 10-K for the year ended December 31,2007.  Included in the Company’sreconciliation of segment financial data to the consolidated amounts isunallocated corporate expenses.

 

8

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 
| ** **                | ** ** | **Three Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **March 31,**               | ** ** |
| ** **                | ** ** | **2008**                         |       | **2007** |   |
| Net  sales                |       |                             |       |   |   |
| Electronic  devices       |       | $                                | 8,887      |   | $ | 8,528 |   |
| Communications  equipment |       | 3,360                            |       | 3,394 |   |
| Total                     |       | $                                | 12,247     |   | $ | 11,922 |   |

 
| Operating  income (loss)  |   |   |   |   |   |
|---------------------------|--------|--------|--------|--------|--------|
| Electronic  devices       |   | $      | 824    |   | $      | 542 |   |
| Communications  equipment |   | 18     |   | (116   | )      |
| Corporate  and other      |   | (1,072 | )      | (1,024 | )      |
| Total                     |   | $      | (230   | )      | $      | (598 | ) |

 
| ** **                | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Total  assets             |       |               |       |                  |       |
| Electronic  devices       |       | $                  | 30,905     |                  | $          | 29,835 |   |
| Communications  equipment |       | 11,525             |       | 11,851                |       |
| Corporate  and other      |       | 5,214              |       | 6,494                 |       |
| Total                     |       | $                  | 47,644     |                  | $          | 48,180 |   |

 

**NOTE 5 – GOODWILL**

 

The following tablereflects changes in our goodwill balances, by segment, for the three monthsended March 31, 2008 (in thousands):

 
| ** **                         | ** ** | **Electronic** | ** ** | **Communications** | ** ** | ** ** | ** ** |
|------------------------------------|------------|----------------|------------|--------------------|------------|------------|------------|
| ** **                         | ** ** | **Devices**    | ** ** | **Equipment**      | ** ** | **Total**  | ** ** |
|                               |       |           |       |               |       |       |       |
| Balance  at December 31, 2007 |       | $              | 7,295      |               | $          | 5,834      |       | $ | 13,129 |   |
| Foreign  currency translation      |       | (36            | )          | —             |       | (36        | )          |
| Balance  at March 31, 2008    |       | $              | 7,259      |               | $          | 5,834      |       | $ | 13,093 |   |

 

9

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 6 –INCOME TAXES**

 

The effective tax rate for the three month periodended March 31, 2008 was different than the 34% U.S. statutory rateprimarily because the Company’s foreign entities generate a tax obligation andrelated tax expense as a result of their net income, which cannot be offset byU.S. tax loss carryforwards.

 

The Company adopted FIN 48, *Accounting for Uncertainty in Income Taxes – an interpretation of FASBStatement No. 109*, on January 1, 2007. The implementationof FIN 48 did not result in a material adjustment to the Company’s liabilityfor unrecognized income tax benefits. At the time of adoption and as of March 31,2008, 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 the first quarter of 2008. As of March 31, 2008, theCompany had nothing accrued for interest and penalties.

 

The Company files income tax returns in the U.S.federal jurisdiction, the United Kingdom, France and Japan, and in the statejurisdictions of California, Texas, Pennsylvania and New Jersey. The Company isno longer subject to United States federal and state tax examinations for yearsbefore 2004 and 2003, respectively, and is no longer subject to taxexaminations for the United Kingdom and Japan for years prior to 2006, and forFrance for years prior to 2004.

 

**NOTE 7 – LINES OF CREDIT**

 

TheCompany and its direct subsidiaries, EMRISE Electronics Corporation, CXR LarusCorporation and RO Associates Incorporated (collectively, the “Borrowers”) areparties to a Credit Agreement (the “Credit Agreement”) with GVEC Resource IVInc. (the “Lender”) providing for a three year credit facility in the aggregateamount of $23,000,000 (the “Credit Facility”) and is secured by accountsreceivable, other rights to payment and general intangibles, inventories andequipment.

 

TheCredit Facility consists of (i) a one year revolving credit facility forup to $7,000,000 that may be extended, at the Company’s option, for up to threeyears (the “Revolver”), (ii) a three year term loan in an outstandingprincipal amount of $6,000,000 which was fully funded on November 30, 2007(the “Term Loan A”); and (iii) a three year term loan in the amount of$10,000,000 to be used solely for possible acquisitions to be made within 18months of November 30, 2007 (the “Term Loan B,” and together with the TermLoan A, the “Term Loans”).  A portion ofthe proceeds from the Revolver and the Term Loan A were used to repay existinginstitutional debt at the time of the closing of the financing and a portion willbe used to fund the Company’s on-going working capital requirements.

 

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

 

Interest on the Revolveris payable monthly.  The interest rate isvariable and is adjusted monthly based on 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%.  The interest rate in effect as of March 31,2008 was the minimum rate of 9.5%.  TheRevolver is subject to various financial covenants on a consolidated basisincluding 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 1.25:1.00; and the Company mustnot incur capital expenditures in any fiscal year in excess of $500,000.  As of 

 

10

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**EMRISE CORPORATION**

**NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

March 31, 2008, theCompany was in default of the debt service coverage ratio described above;which default has been waived by the Lender.

 

Asof March 31, 2008, the Company had outstanding borrowings of $3.7 millionunder the Revolver with remaining availability under the formula-basedcalculation of $2.5 million.

 

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.

 

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

 

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

 

**NOTE 8 – 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 plans to adopt theremaining provisions of SFAS No. 157 as of January 1, 2009.

 

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

 

Level1–Inputsareunadjustedquotedpricesinactivemarketsforidenticalassetsorliabilitiesavailableatthemeasurementdate.

 

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 March 31, 2008, the Company did not have financial assets andliabilities measured at fair value on a recurring basis that would be subjectto the disclosure provisions of SFAS No. 157.

 

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

 

**CautionaryStatement**

 

The following discussion should be read in conjunctionwith our unaudited condensed consolidated financial statements and the relatednotes thereto contained in Part I, Item 1 of this Report. The informationcontained in this Quarterly Report on Form 10-Q is not a completedescription of our business or the risks associated with an investment in ourcommon stock. We urge you to carefully review and consider the variousdisclosures made by us in this Report and in our other reports filed with SEC,including our Annual Report on Form 10-K for the year ended December 31,2007 and subsequent reports on Forms 10-Q and 8-K, which discuss our businessin greater detail.  This report and thefollowing discussion contain forward-looking statements, which generallyinclude the plans and objectives of management for future operations, includingplans and objectives relating to our future economic performance and ourcurrent beliefs regarding revenues we might generate and profits we might earnif we are successful in implementing our business and growth strategies. Theforward-looking statements and associated risks may include, relate to or bequalified by other important factors, including, without limitation:

 

**·**                  the projected growth orcontraction in the electronic devices and communications equipment markets inwhich we operate;

**·**                  our strategies forexpanding, maintaining or contracting our presence in these markets;

**·**                  anticipated trends in ourfinancial condition and results of operations;

**·**                  our ability to distinguishourselves from our current and future competitors;

**·**                  our ability to secure longterm purchase orders;

**·**                  our ability to deliveragainst existing or future backlog;

**·**                  technical or qualityissues experienced by us, our suppliers and/or our customers;

**·**                  failure to comply withexisting or future government or industry standards and regulations;

**·**                  exposure to and impacts ofvarious international risks including legal, business, political and economicrisks associated with our international operations;

**·**                  our ability tosuccessfully locate, acquire and integrate any possible future acquisitions;

**·**                  our ability tosuccessfully support the working capital needs of our company; and

**·**                  our ability tosuccessfully compete against competitors that in many cases are larger than us,have access to significantly more working capital than us and have significantresources in comparison to us.

** **

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

 

Any of the factors described above or in the “RiskFactors” section contained in our Annual Report on Form 10-K for the yearended December 31, 2007 could cause our financial results, including ournet income or loss or growth in net income or loss to differ materially fromprior results, which in turn could, among other things, cause the price of ourcommon stock to fluctuate substantially.

 

**Business Description**

 

EMRISE designs, manufacturesand markets proprietary electronic devices and communications equipment foraerospace, defense, industrial, and communications applications. We haveoperations in the United States (“U.S.”), England, France and Japan.  We conduct our business through twooperating segments: electronic devices and communications equipment. Oursubsidiaries within our electronic devices segment design, develop, manufacture and market electronic devices for defense,aerospace and industrial markets.  Oursubsidiaries within our communications equipment segment design, develop,manufacture and market network access equipment, including network timing andsynchronization products, for the communications industry.

 

Our electronic devices segmentproduces a range of power systems, RF and microwave devices andelectromechanical switches.  Theelectronic devices segment is “project” driven with the majority of revenues 

 

12

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being derived from customproducts with long life cycles and high barriers to entry.  The majority of manufacturing and testing isperformed in-house or through sub-contract manufacturers.  Our electronic devices are used in a widerange of military airborne, seaborne and land-based systems, in-flightentertainment systems, including the latest next generation in-flight entertainmentand communications (“IFE&C”) systems – such as applications for mobilephone, e-mail and internet communications and real time, on-board satellite andbroadcast television – which are being retrofitted in existing commercialaircraft and installed in today’s growing fleet of new commercial aircraft.

 

Our communications equipment segment produces a rangeof network access products, including network timing and synchronizationproducts, for public and private communications customers.  The communications equipment segment is “enduser product” based with a traditional cycle of internally funded developmentand marketing prior to selling via direct and indirect sales channels.  Manufacturing is primarily outsourced.  Our communications equipment is used in abroad range of applications for military (defense and homeland security),utility companies and regional and national communications carriers.

 

**Critical AccountingPolicies**

** **

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

 

***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 U.S. sales of our electronic devices and communications equipment at thepoint of shipment of those products.  Anestimate of warranty costs are recorded at the time the revenue isrecognized.  Product returns areinfrequent and require prior authorization because our sales are final and wequality test our products prior to shipment to ensure the products meet the specificationsof the binding purchase orders under which those products are shipped.Normally, when a customer requests and receives authorization to return aproduct, the request is accompanied by a purchase order for a repair or for areplacement product.

 

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

 

We recognize revenues forproducts sold by our French subsidiary 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 costs are recorded at the time revenue is recognized.

 

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

 

***Product Warranty Liabilities***

 

Generally, our products carry a standardone-year, limited parts and labor warranty. In certain circumstances, we provide a two-year limited parts and laborwarranty on our communications test instruments and network accessproducts.  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, historical and anticipatedrates of claim and costs per claim.  Weperiodically assess the adequacy of our warranty liability accrual based onchanges in these factors.

 

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

 

Our finished goods electronic devices inventoriesgenerally are built to order.  Ourcommunications equipment inventories generally are built to forecast, whichrequires us to produce a larger amount of finished goods in our communicationsequipment business so that our customers can be served promptly.  Our products consist of numerous electronicand other parts, which necessitates that we exercise detailed inventorymanagement.  We value our inventory atthe lower of the actual cost to purchase or manufacture the inventory(first-in, first-out) or the current estimated market value of the inventory(net realizable value). We perform cycle counts of inventories using an ABCinventory methodology, which groups inventory items into cycle countingcategories, or conduct physical inventories at least once a year.  We regularly review inventory quantities onhand and record a provision for excess and obsolete inventory based primarilyon our estimated forecast of product demand and production requirements for thenext 12 to 24 months. Additionally, to determine inventory write-downprovisions, we review product line inventory levels and individual items asnecessary and periodically review assumptions about forecasted demand andmarket conditions.  Any inventory that wedetermine to be obsolete, either in connection with the physical count or atother times of observation, are reserved for and subsequently written-off.  As of March 31, 2008, our totalinventory reserves amounted to $6.2 million of which $4.3 million, or 22.9% oftotal inventory, related to our electronic devices segment and $1.9 million, or9.9% of total inventory, related to our communications equipment segment.

 

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

 

***Foreign Currency Translation***

 

We have foreign subsidiaries that together accountedfor approximately 70.4% and 69.3% of our net revenues, 42.0% and 58.0% of ourassets and 41.6% and 59.9% of our total liabilities as of and for the threemonths ended March 31, 2008 and 2007, 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).”

 

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Under relevant accounting guidance, the treatment ofthese translation gains or losses depends upon our management’s determinationof the functional currency of each subsidiary. This determination involvesconsideration of relevant economic facts and circumstances affecting thesubsidiary. Generally, the currency in which the subsidiary transacts amajority of its transactions, including billings, financing, payroll and otherexpenditures, would be considered the functional currency. However, managementmust also consider any dependency of the subsidiary upon the parent and thenature of the subsidiary’s operations.

 

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

 

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

 

Based on our assessment of the factors discussedabove, we consider the functional currency of each of our internationalsubsidiaries to be each subsidiary’s local currency. Accordingly, we hadcumulative translation gains of $1.3 million and $1.1 million that wereincluded as part of accumulated other comprehensive income within our balancesheets at March 31, 2008 and December 31, 2007, respectively. Duringthe three months ended March 31, 2008 and 2007, we included translationgains of $229,000 and losses of $23,000, respectively, under accumulated othercomprehensive income.

 

If we had determined that the functional currency ofour subsidiaries was U.S. dollars, these gains or losses would have decreased or increased our net loss for thethree months ended March 31, 2008 and 2007. The magnitude of these gainsor losses depends upon movements in the exchange rates of the foreigncurrencies in which we transact business as compared to the value of the U.S.dollar. These currencies include the euro, the British pounds sterling and, toa lesser extent, the Japanese yen. Any future translation gains or losses couldbe significantly higher or lower than those we recorded for these periods.

 

A 2.5 million British pounds sterling loan payablefrom one of our subsidiaries in Englandto EMRISE was outstanding as of March 31, 2008 ($5.0 million based on theexchange rate at March 31, 2008). Exchange rate losses and gains on the long-term portion of this loan arerecorded in cumulative translation gains or losses in the equity section of thebalance sheet.

 

***Intangibles, Including Goodwill***

 

We periodically evaluate our intangibles, includinggoodwill, for potential impairment. Our judgments regarding the existence ofimpairment are based on legal factors, market conditions and operationalperformance of our acquired businesses.

 

In assessing potential impairment of goodwill, weconsider these factors as well as forecasted financial performance of theacquired businesses.  If forecasts arenot met, we may have to record additional impairment charges not previouslyrecognized. In assessing the recoverability of our goodwill and otherintangibles, we must make assumptions regarding estimated future cash flows andother factors to determine the fair value of those respective assets. If theseestimates or their related assumptions change in the future, we may be requiredto record impairment charges for these assets that were not previouslyrecorded.  If that were the case, wewould have to record an expense in order to reduce the carrying value of ourgoodwill.  Under Statement of FinancialAccounting Standards (“SFAS”) No. 142, “Goodwill and Other IntangibleAssets”, we are required to analyze our goodwill for impairment issues at leastannually or more frequently if an event occurs or circumstances change thatwould more likely than not reduce the fair value of a reporting unit below itscarrying amount.  At March 31, 2008,our reported goodwill totaled $13.1 million. During the three months ended March 31, 2008, we did not record any impairment losses relatedto goodwill and other intangible assets.

 

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**Overview**

 

The majority of our products are customized to theunique specifications of our customers and are subject to variable timing ofdelivery.  Shipments of products can beaccelerated or delayed due to many reasons including, but not limited to,exceeding or not meeting customer contract requirements, a change in customertiming or specifications, technology related issues and production relatedissues.  Comparability of our revenuesand gross profit is difficult from period to period as we typically do not haverecurring contracts.  Exceptions to thisinclude U.S. government stocking orders, foreign military contracts and certainlong-term telecommunications contracts. As an example of this variability in revenues, we had orders that weplanned to ship for approximately $1.1 million of products in the first quarterof 2008 that did not ship due to a combination of customer and productionrelated delays.

 

Overall sales increased 2.7% in the first quarter of2008 as compared to the first quarter of 2007. Sales were positively affected as a result of new contracts for powersupplies and new IFE&C products primarily at our facility in England.  We also experienced a slight increase insales of our U.S. electronics devices subsidiaries offset by a decline in salesat our U.S. communications equipment subsidiary as a result of our fiber modemproducts shipments being delayed to the second quarter.  We expect to experience quarter over quarterincreases in sales for the remainder of 2008 with total 2008 sales approaching$60 million.

 

Overall gross margins increased to 36.0% in the firstquarter of 2008 from 32.3% in the first quarter of 2007.  The improvement in gross margin issubstantially related to product mix, particularly at our U.S. electronicdevices subsidiaries and our French communications equipment subsidiary.  Overall margins were also positively impactedas a result of translating foreign unit financial results from local (foreign)currencies to U.S. dollars due to the favorable change in exchange ratesbetween the U.S. dollar, the British pound sterling and the euro compared toprior year.  We expect gross margins levelsfor the full year of 2008 to be consistent with the first quarter of 2008,excluding the possible impact, favorable or unfavorable, of exchange rates onthe translation of foreign operating unit financial results.

 

As a result of our new credit facility, discussedbelow, we are incurring significantly higher interest expense due to higherdebt balances and higher interest rates. Additionally, included within interest expense during the first quarterof 2008 are unused line fees and the non-cash amortization of certain debtacquisition costs and debt discount.  Aportion of the unused line fees and non-cash amortization of debt acquisitioncosts and debt discount is associated with our $10 million acquisition termloan, which was incurred without the benefit of an acquisition.

 

The following is a more detailed discussion of ourresults of operations by segment.

 

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**Resultsof Operations**

 

***Comparisonof the Three Months Ended March 31, 2008 to the Three Months Ended March 31,2007***

 

**Net Sales**

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Variance**                     | ** ** |
|---------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **March 31,**               | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**   | ** ** | **2008**                         | ** ** | **2007**                         | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                      |       |                             |       |                             |       |   |   |   |   |
| Electronic  devices       |       | $                                | 8,887      |                             | $          | 8,528 |   | $ | 359 |   | 4.2 | % |
| *as % of net sales*       | * *   | *72.6*                           | *%*        | *71.5*                           | *%*        | * * | * * | * * | * * |
| Communications  equipment |       | 3,360                            |       | 3,394                            |       | (34 | ) | (1.0 | )% |
| *as % of net sales*       | * *   | *27.4*                           | *%*        | *28.5*                           | *%*        | * * | * * | * * | * * |
| Total  net sales          |       | $                                | 12,247     |                             | $          | 11,922 |   | $ | 325 |   | 2.7 | % |

 

*Electronic Devices Segment*

 

The increase in sales ofour electronic devices in the first quarter of 2008 as compared to the firstquarter of 2007 was primarily the result of a $0.5 million, or 14%, increase insales at our Pascall Electronics Ltd. (“Pascall”) subsidiary in England dueprimarily to shipments of our new IFE&C products.  Also contributing to the increase in saleswas a $0.1 million, or 10%, increase in sales at our U.S. subsidiaries as aresult of the resumption of higher levels of shipments of U.S. governmentorders for digital switches to satisfy our existing backlog for the Defense LogisticsAgency (“DLA”).  These increases werepartially offset by a decline in sales of $0.2 million, or 9%, at our XcelPower Systems Ltd. (“XPS”) subsidiary in England as a result of the timing ofshipment of contracts.

 

We had orders forapproximately $0.4 million of additional products that we expected to ship inthe first quarter of 2008.  However,these products did not ship due to a combination of temporary customer andproduction related delays.  We expect themajority, if not all, of these products to ship in the second quarter of 2008.

 

*Communications Equipment Segment*

 

The slight decrease insales of our communications equipment in the first quarter of 2008 as comparedto the first quarter of 2007 is due to a $0.2 million decrease at our U.S. communicationscompany, primarily due to a year over year decrease in sales of our fiber modemproducts.  Subsequent to the firstquarter of 2007, certain components for our fiber modem products becameobsolete forcing us to reengineer the product. We have completed the reengineering of this product and we expect salesof these delayed fiber modem product shipments to resume during the secondquarter of 2008.  This decrease wassubstantially offset by improved sales of our network transmission products atour French subsidiary.

 

We had orders forapproximately $0.7 million of products, which were planned for delivery in thefirst quarter of 2008, but did not ship primarily due to temporary delays inproduct shipments caused primarily by customer related delays and also due todelayed shipments of fiber modem products as discussed above.  We expect the majority of these products toship in the second quarter of 2008.

 

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**Gross Profit**

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Variance**                     | ** ** |
|---------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **March 31,**               | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**   | ** ** | **2008**                         | ** ** | **2007**                         | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                      |       |                             |       |                             |       |   |   |   |   |
| Electronic  devices       |       | $                                | 2,927      |                             | $          | 2,628 |   | $ | 299 |   | 11.4 | % |
| *as a % of net sales*     | * *   | *32.9*                           | *%*        | *30.8*                           | *%*        | * * | * * | * * | * * |
| Communications  equipment |       | 1,482                            |       | 1,220                            |       | 262 |   | 21.5 | % |
| *as a % of net sales*     | * *   | *44.1*                           | *%*        | *35.9*                           | *%*        | * * | * * | * * | * * |
| Total  gross profit       |       | $                                | 4,409      |                             | $          | 3,848 |   | $ | 561 |   | 14.6 | % |
| *Total gross margin*      | * *   | *36.0*                           | *%*        | *32.3*                           | %          |   |   |   |   |

 

*Electronic Devices Segment*

 

The increase in grossprofit, as a percentage of net sales, for our electronic devices segment from30.8% in the first quarter of 2007 to 32.9% in the first quarter of 2008 isprimarily the result of shipments of high margin digital switches at our U.S.Digitran division, revised product pricing strategy and improved productionefficiency at our RO Associates subsidiary. We expect that during 2008, overall gross margins will approximate thosegross margins reported for the first quarter of 2008.  However, during 2008 we may experiencequarter to quarter variability due to product mix differences and resultingdifferentials associated with lower commercial versus higher militaryelectronic devices gross margins.

 

*Communications Equipment Segment*

 

The increase in grossmargin for our communications equipment segment from 35.9% in the first quarterof 2007 to 44.1% in the first quarter of 2008 is primarily the result ofincreased sales of higher margin internally manufactured network accessproducts at our French subsidiary and sales of our higher margin TiemPoTMproduct.  Gross margins were alsofavorably impacted by approximately $0.1 million as a result of the changes inforeign currency exchange rates between the U.S. dollar and the euro in thefirst quarter of 2008 compared to the first quarter of 2007.  We expect the trend of quarter over quarterimprovement in gross profit (both in dollars and as a percentage of sales) forour communications equipment segment to continue throughout 2008, although aspreviously discussed, we do experience volatility quarter to quarter due tochanges in product mix and timing of shipments.

 

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**Operating Expenses**

 
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Variance**                     | ** ** |
|--------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **March 31,**               | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**              | ** ** | **2008**                         | ** ** | **2007**                         | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                 |       |                             |       |                             |       |   |   |   |   |
| Selling,  general and administrative |       | $                                | 3,975      |                             | $          | 3,736 |   | $ | (239 | ) | (6.4 | )% |
| *as % of net sales*                  | * *   | *32.5*                           | *%*        | *31.3*                           | *%*        | * * | * * | * * | * * |
| Engineering  and product development |       | 664                              |       | 710                              |       | 46 |   | 6.5 | % |
| *as % of net sales*                  | * *   | *5.4*                            | *%*        | *6.0*                            | *%*        | * * | * * | * * | * * |
| Total  operating expenses            |       | $                                | 4,639      |                             | $          | 4,446 |   | $ | (193 | ) | (4.3 | )% |

 

*Selling, general andadministrative expenses*

 

The increase in selling,general and administrative expenses is primarily the result of approximately$0.1 million of increased sales and marketing expenses associated withincreased commissions as a result of higher sales levels.  During the first quarter of 2008, we incurredone-time redundancy costs of approximately $0.1 million associated with therestructuring of personnel at two of our facilities and approximately $0.2million of costs in connection with our Sarbanes-Oxley Act of 2002 (“SOX”)management assessment in 2007, which contributed to the increase in general andadministrative expenses as compared to 2007. These costs were offset, in part, by cost savings being realized as aresult of the consolidation of our RO and CXR Larus facilities in San Jose,California, which was completed during the latter half of 2007.

 

During the second quarterof 2008, we expect one-time redundancy costs associated with additionalrestructurings of approximately $0.2 million. In addition, during the remainder of the year, we will likely incuradditional costs in connection with the remediation of certain internal controldeficiencies, which were identified as a result of our 2007 SOX managementassessment.  We are currently in theprocess of developing specific action plans in that regard.  We are uncertain at this time of theadditional costs to remediate all of the control deficiencies and materialweaknesses, however, we anticipate the cost to be in the range of $200,000 to$400,000, most of which we expect to incur in 2008.  We cannot guarantee that the actual costs toremediate these deficiencies will not exceed this amount.  See “Controls and Procedures.”

 

*Engineering and productdevelopment*

 

The $46,000 decrease inengineering and product development costs is primarily due to approximately$50,000 in costs for our TiemPoTM product line that were incurred inthe first quarter of 2007, which were absent in the first quarter of 2008.  We are continuing the evolution of theTiemPoTM family of products and expect to incur additional product developmentcosts throughout 2008.

 

**Interest expense**

 

Interest expense was $0.6 million for the three monthsended March 31, 2008 compared to $0.2 million for the three months ended March 31,2007 due to higher outstanding loan and line of credit balances and higherinterest rates.  Included in interestexpense in the first quarter of 2008 were $0.2 million of unused line fees,non-cash amortization of deferred financing costs and related to non-cashamortization of debt discount. Approximately $0.1 million of this amount was associated with our $10million acquisition term loan, which was incurred without the benefit of anacquisition.  We expect quarterlyinterest expense for the remainder of 2008 to be consistent with that recordedin the first quarter of 2008.

 

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**Other income (expense)**

 

We recorded other expenseof $47,000 for the three months ended March 31, 2008 compared to generatingother income of approximately $65,000 for the same period of 2007, resulting ina variance of approximately $0.1 million. Other income (expense) consisted primarily of short-term exchange rategains and losses associated with the volatility of the U.S. dollar to theBritish pound sterling and euro on the current portion of certain assets andliabilities.

 

**Income tax expense**

 

Income tax expenseamounted to $0.1 million for the three months ended March 31, 2008compared to $0.1 million for the same period of 2007.  Income tax expense is the result of foreignincome tax on foreign earned profits.

 

**Net Loss**

 

We generated a net lossof $0.9 million and $0.8 million for the three months ended March 31, 2008and 2007, respectively.  The primaryfactors that contributed to our $0.9 million net loss in the first quarter of2008 are as follows:

 

·                  Adelayed revenue shortfall of approximately $1.1 million due to a combination oftemporary customer and production related delays;

 

·                  one-timeredundancy costs of approximately $0.1 million associated with restructuring attwo of our operating units;

 

·                  SOXrelated compliance costs of approximately $0.2 million incurred in connectionwith our 2007 management assessment; and

 

·                  approximately$0.1 million of interest expense (unused line fees and the amortization ofcertain non-cash debt acquisition costs) associated with our $10 millionacquisition term loan, which was incurred without the benefit of anacquisition.

 

**Liquidity and CapitalResources**

 

In making an assessment of our liquidity, we believethat the items in our financial statements that are most relevant are ourworking capital, cash generated from our operating activities and cashavailable from our financing activities. During the first quarter of 2008, we funded our daily cash flowrequirements through funds provided by operations and through borrowings fromour credit facility with GVEC Resource IV Inc. (“GVEC”), an affiliate ofPrivate Equity Management Group LLC (“PEM Group”).  Working capital was $15.4 million at March 31,2008 as compared to $16.1 million at December 31, 2007. The decrease inworking capital is primarily the result of decreases in cash balances relatedto higher inventory purchases to support higher anticipated sales in the secondquarter of 2008 and an increase in debt entered into in the first quarter of2008 for equipment to support our new IFE&C products.  At March 31, 2008 and December 31,2007, we had accumulated deficits of $21.2 million and $20.7 million,respectively, and cash and cash equivalents of $3.5 million and $4.8 million,respectively.

 

Net cash used in operating activities during the threemonths ended March 31, 2008 totaled $1.0 million as compared to $0.2million in the three months ended March 31, 2007.  In addition to the net loss of $0.9 million,the primary significant use of cash from operations during the first quarter of2008 was an increase in inventory of $1.1 million primarily at our U.S.communications equipment subsidiary and our subsidiaries in England, which wasin anticipation of shipments for backlog orders scheduled to ship primarily inthe second quarter of 2008.  Our backlogwas $25.3 million at March 31, 2008. Significant sources of cash associated with operating activities duringthe first quarter of 2007 included (i) a reduction in accounts payable andaccrued expenses of $0.1 million as a result of the timing of payments tovendors for normal payables, (ii) a decrease in accounts receivable 

 

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balances of $0.2 milliondue to collections on aged customer accounts and (iii) a decrease inprepaid and other assets as a result of amortization of amounts paid inprevious periods, not incurred in the current quarter.

 

Other significant uses of cash include $0.5 millionrelated to net repayments on our revolving line of credit and other long-termdebt.

 

As of March 31,2008, we had outstanding borrowings of $3.7 million under the GVEC Creditfacility, remaining actual availability under a formula-based calculation of$2.5 million and contractual availability of $3.3 million under the samefacility.  Actual remainingavailability represents the additional amount we were eligible to borrow as of March 31,2008. Maximum contractual availability represents the maximum amount ofavailability provided under the contract as of that date and includes theactual remaining availability.

 

In addition to the revolving line of credit, at March 31,2008, we had long-term loans and capitalized lease and equipment loan obligationstotaling $6.5 million, the current portion of which loans and obligationstotaled $0.7 million.

 

Our backlog increased to $25.3 million as of March 31,2008 as compared to $23.4 million as of March 31, 2007. The amount ofbacklog orders represents revenue that we anticipate recognizing in the future,as evidenced by purchase orders and other purchase commitments received fromcustomers, but on which work has not yet been initiated or with respect towhich work is currently in progress. Our backlog as of March 31, 2008 wasapproximately 96% related to our electronic devices business, which businesstends to provide us with long lead-times for our manufacturing processes due tothe custom nature of the products, and approximately 4% related to our communicationsequipment business, which business tends to deliver standard or modifiedstandard products from stock as orders are received. We believe that themajority of our current backlog is shippable within the next 12 months.  However, there can be no assurance that wewill be successful in fulfilling such orders and commitments in a timely manneror that we will ultimately recognize as revenue the amounts reflected asbacklog.

 

*Credit Facility*

 

On November 30, 2007, EMRISE Corporation and itsdirect subsidiaries, EMRISE Electronics Corporation, CXR Larus Corporation andRO (collectively, the “Borrowers”) entered into a Credit Agreement with GVEC,providing for a three-year credit facility in the aggregate amount of$23,000,000 and issecured by accounts receivable, other rights to payment and generalintangibles, inventories and equipment.

 

The GVEC credit facilityconsists of (i) a one year revolving credit facility for up to $7,000,000that may be extended for up to three years (the “Revolver”), (ii) a threeyear term loan in an outstanding principal amount of $6,000,000 which was fullyfunded on November 30, 2007, and (iii) a three year term loan in theamount of $10,000,000 to be used solely for possible acquisitions to be madewithin 18 months of November 30, 2007.

 

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

 

Interest on the Revolver is payable monthly.  The interest rate is variable and is adjustedmonthly based on prime rate as published in the “Money Rates” column of *The Wall Street Journal* (the “Base Rate”) plus 1.25%,subject to a minimum rate of 9.5%.  TheRevolver is subject to various financial covenants on a consolidated basis,including the following:  EBITDA,measured on a fiscal quarter-end basis, must not be less than the scheduledamount for each specified period; the debt service coverage ratio, measuredquarterly, must be greater than the lesser of the scheduled amount for eachspecific period or 1.10:1.00; the leverage ratio, measured quarterly, must notbe greater than 1.25:1.00; and we must not incur capital expenditures in anyfiscal year in excess of $500,000.  As ofMarch 31, 2008, we were in default of our the debt service coverage ratiodescribed above, which default has been waived by our Lender.

 

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The term loans bear interestat the Base Rate plus 4.25%, subject to a minimum rate of 12.5%, and requireinterest only payments in the first year, scheduled principal plus interestpayments in years two and three, and a final balloon payment at the end of yearthree.  Interest on the term loans ispayable monthly.  The Borrowersmay make full or partial prepayment of the term loans provided that any suchprepayment is accompanied by the applicable prepayment premium discussed below.

 

Upon the sale or disposition by Borrowers or any oftheir subsidiaries of property or assets, we may be obligated to prepay theRevolver and the term loans with the net cash proceeds received in connectionwith such sales or dispositions to the extent that the aggregate amount of netcash proceeds received and not paid to GVEC as a prepayment, for all such salesor dispositions exceed $150,000 in any fiscal year.

 

In the event of a defaultand continuation of a default, GVEC may accelerate the payment of the principal balance requiring us to paythe entire indebtedness outstanding on that date.  Upon the occurrence and during thecontinuation of an event of default, GVEC may also elect to increase theinterest rate applicable to the outstanding balance by four percentage points abovethe per annum interest rate that would otherwise be applicable.

 

To securepayment of the indebtedness of Borrowers under the GVEC credit facility, the Borrowers irrevocablypledged and assigned to, and granted to GVEC a continuing security interest inall the personal property of the Borrowers including the Borrowers’ interest inany deposit accounts, the stock of each of the Borrowers’ subsidiaries, theintellectual property owned by each of the Borrowers, and the proceeds of theintellectual property owned by each of the Borrowers.  If an event of default, GVEC may, at itsoption, exercise any or all remedies available to it with respect to thecollateral.  In addition, certainof the Borrowers’ foreign subsidiaries have agreed to guaranty the Borrowers’performance under the GVEC credit facility.

 

Overall, we believe thatcurrent and future capital resources, revenues generated from operations andother existing sources of liquidity, including our GVEC credit facility, willbe adequate to meet our anticipated short term, working capital and capitalexpenditures needs for at least the next 12 months.  However, if we experience significant loss ofrevenue or increase in costs, our cash flow could be negatively impactedresulting in a cash flow deficit.  As aresult, we may require additional financing. This financing could be in the form of a revised debt structure with ourexisting lender, new financing with another lender or lenders, the sale ofadditional equity to raise capital, or the sale of certain assets to generatecash.  Our failure to raise capital, ifneeded, ability to sell assets when needed and/or ability to secure additionalfinancing could restrict our growth, limit our development of new products orhinder our ability to compete.

 

**Effects of Inflation**

 

The impact of inflation and changing prices has notbeen significant on the financial condition or results of operations of eitherour company or our operating subsidiaries.

 

**Impacts of New AccountingPronouncements**

 

In February 2007, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)No. 159, *The Fair Value Option for Financial Assetsand Financial Liabilities*. SFAS No. 159 permits an entity toirrevocably elect fair value on a contract-by-contract basis as the initial andsubsequent measurement attribute for many financial assets and liabilities andcertain other items including insurance contracts. Entities electing the fairvalue option would be required to recognize changes in fair value in earningsand to expense upfront cost and fees associated with the item for which thefair value option is elected. SFAS No. 159 is effective for fiscal yearsbeginning 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 newstatement provides a single definition of fair value, together with a frameworkfor measuring it, and requires additional disclosure about the use of fairvalue to measure assets and liabilities. SFAS No. 157 also emphasizes thatfair value is a market-based measurement, not an entity-specific measurement,and sets out a fair value hierarchy, with the highest priority being quotedprices in active markets. The required effective date of SFAS No. 157 isthe first

 

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quarter of 2008. Theadoption of SFAS No. 157 for financial assets and liabilities did not havea material effect on our consolidated financial statements, but resulted inadditional 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.  We arecurrently evaluating the impact the adoption of SFAS No. 157 fornon-financial assets and liabilities will have on our consolidated financialstatements.

 

In March 2008, the FASB issued SFAS No. 161,*Disclosures about Derivative Instruments andHedging Activities*. The new standard amends SFAS No. 133 andseeks to enhance disclosure about how and why a company uses derivative and hedgingactivities, how derivative instruments and related hedged items are accountedfor under SFAS No. 133 (and the interpretations of that standard) and howderivatives and hedging activities affect a company’s financial position,financial performance and cash flows. SFAS No. 161 is effective for financial statements issued forfiscal years and interim periods beginning after November 15, 2008.  We are evaluating the effect this statementmay have on our consolidated financial statements.

 

**ITEM 3.****                                                     QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

** **

Not applicable.

 

**ITEM 4.****                                                     CONTROLSAND PROCEDURES.**

 

Not applicable.

 

**ITEM 4T.****                                             CONTROLSAND PROCEDURES.**

 

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

*** ***

We conducted an evaluationunder the supervision and with the participation of our management, includingour Chief Executive Officer and Vice President Finance and Administration, ourprincipal accounting officer, of the effectiveness of the design and operationof our disclosure controls and procedures. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (“ExchangeAct”), means controls and other procedures of a company that are designed toensure that information required to be disclosed by the company in the reportsit files or submits under the Exchange Act is recorded, processed, summarizedand reported, within the time periods specified in the SEC’s rules andforms.  Disclosure controls andprocedures also include, without limitation, controls and procedures designedto ensure that information required to be disclosed by a company in the reportsthat it files or submits under the Exchange Act is accumulated and communicatedto the company’s management, including its principal executive and principalfinancial officers, or persons performing similar functions, as appropriate, toallow timely decisions regarding required disclosure.  Based on this evaluation, our Chief ExecutiveOfficer and Vice President Finance and Administration concluded as of March 31,2008 that our disclosure controls and procedures were not effective at thereasonable assurance level due to the material weaknesses discussed immediatelybelow.

 

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

 

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

*** ***

Management does not expectthat our disclosure controls and procedures or our internal control overfinancial reporting will prevent or detect all errors and all fraud. A controlsystem, no matter how well conceived and operated, can provide only reasonable,not absolute, assurance that the objectives of the control systems are met.Further, the design of a control system must reflect the fact that there areresource constraints, and the benefits of controls must be considered relativeto their costs. Because of the inherent limitations in a cost-effective

 

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controlsystem, no evaluation of internal control over financial reporting can provideabsolute assurance that misstatements due to error or fraud will not occur orthat all control issues and instances of fraud, if any, have been or will bedetected.

 

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

 

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

*** ***

Set forth below is a summary of the varioussignificant deficiencies which caused management to conclude that we had threematerial weaknesses.  Through the effortsof our Vice President Finance and Administration and our Audit Committee, weare currently in the process of developing specific action plans to remediatethe material weaknesses discussed more fully below.  We expect to complete these various actionplans by June 30, 2008.  If we areable to complete these action plans by that date, we anticipate that allcontrol deficiencies and material weaknesses will be remediated by December 31,2008.

 

(1)                                  Wedid not effectively implementcomprehensive entity-level internal controls, as evidenced by thefollowing control deficiencies:

 

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

 

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

 

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

 

ExternalCommunication.  We lacked formal policiesand procedures regarding how and when matters affecting the achievement offinancial reporting objectives are communicated with outside parties.

 

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

 

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

 

(2)                                  Wedid not maintain effective controls over changes to critical financialreporting applications and over access to these applications and related data,as evidenced by the fact that certain of our personnel had unrestricted accessto various financial application programs and data beyond the requirements oftheir individual job responsibilities. This control deficiency could result ina material misstatement of significant accounts or disclosures, including thosedescribed above, that could result in a material misstatement of our interim orannual consolidated financial statements that would not be prevented ordetected.

 

(3)                                  Wedid not maintain a sufficient level of information technology personnel toexecute general computing controls over our information technology structure,which include the implementation and assessment of information technologypolicies and procedures. This control deficiency did not result in an auditadjustment to

 

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our 2007 interim or annualconsolidated financial statements, but could result in a material misstatementof significant accounts or disclosures, which would not have been prevented ordetected.

 

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

*** ***

The above materialweaknesses did not result in adjustments to our consolidated financialstatements as of March 31, 2008, however, it is reasonably possible that,if not remediated, one or more of the material weaknesses described above couldresult in a material misstatement in our reported financial statements thatmight result in a material misstatement in a future annual or interim period.

 

In addition to thedeveloping specific action plans for each of the above material weaknesses, weare taking steps to unify the financial reporting of all of our divisions.  Accordingly, we are in the initial planningphase of implementing a centralized consolidation software package which webelieve will facilitate this process and will assist in the remediation of manyof the above listed deficiencies.

 

In addition, our auditcommittee has authorized the hiring of additional temporary staff and/or theuse of financial and information technology consultants, as necessary, toensure that we have the depth and experience to remediate the above listedmaterial weaknesses, including the implementation and monitoring of theappropriate level of control procedures related to all of our manufacturinglocations and our corporate offices.  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 2008.  We cannotguarantee that the actual costs to remediate these deficiencies will not exceedthis amount.

 

Through these steps, webelieve that we are addressing the deficiencies that affected our internalcontrol over financial reporting as of March 31, 2008. 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 SEC reporting obligations.

 

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

*** ***

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

 

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**PART II – OTHER INFORMATION**

 

**ITEM 1.****                                                  LEGALPROCEEDINGS.**

 

Various legal actions and claims may arise against usin the ordinary course of business. In the opinion of management, the ultimateresolution of such possible legal actions and claims will not have a materialadverse effect on our consolidated financial position or our results ofoperations.

 

**ITEM 1A.****                                         RISKFACTORS.**

 

Item 1A of Part I of our Form 10-K for theyear ended December 31, 2007 summarizes various material risks thatinvestors should carefully consider before deciding to buy or maintain aninvestment in our common stock.  Any ofthose risks, if they actually occur, would likely harm our business, financialcondition and results of operations and could cause the trading price of ourcommon stock to decline.  There are nomaterial changes to the risk factors set forth in the above-referenced report*.*

 

**ITEM 2.****                                                  UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS.**

 

**UnregisteredSales of Equity Securities**

 

None.

 

**Dividends**

 

We have not declared or paid any cash dividends on ourcapital stock in the past, and we do not anticipate declaring or paying cashdividends on our common stock in the foreseeable future.  We will pay dividends on our common stockonly 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.****                                                  DEFAULTSUPON SENIOR SECURITIES.**

 

None.

 

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

 

None

 

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

 

None.

 

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

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

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                      | EMRISE CORPORATION |
|---------------------------|--------------------|
|                      |               |   |
| Dated: May 15,  2008 | By:                | /S/ CARMINE T. OLIVA |
|                      |               | Carmine T. Oliva, |
|                      |               | Chief  Executive Officer |   |
|                      |               |   |
|                      |               |   |
| Dated: May 15,  2008 | By:                | /S/ D. JOHN DONOVAN |
|                      |               | D. John Donovan, Vice  President Finance and |
|                      |               | Administration  (principal financial and accounting |
|                      |               | officer) |

 

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**INDEX TO EXHIBITS ATTACHED TO THIS REPORT**

 
| **Number** | ** ** | **Description**                                                                                                                                                                                                    |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                               |
| 31.1       |       | Certification of  Principal Executive Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                                                                                                                               |
| 31.2       |       | Certification of  Principal Financial Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                                                                                                                               |
| 32.1       |       | Certification of Chief  Executive Officer and Vice President Finance and Administration 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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