**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

 

**FORM10-Q**

| **(Mark  One)**                                        | ** ** | ** **                                                                                    |
|--------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
| **x**                                                  | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
| ** **                                             | ** ** | ** **                                                                                    |
| **For the  quarterly period ended September 30, 2007** |
| ** **                                             | ** ** | ** **                                                                                    |
| **or**                                                 |
| ** **                                             | ** ** | ** **                                                                                    |
| **o**                                                  | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

For the transitionperiod from                      to                      

 

Commission File Number **1-10346**

 

**EMRISECORPORATION**

(Exact name of registrantas specified in its charter)

 

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

**9485 HavenAvenue, Suite 100**

**Rancho Cucamonga, California 91730**

(Address of principal executive offices) (Zip code)

**(909) 987-9220**

(Registrant’stelephone number, including area code)

**Not applicable**

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

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat registrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x  No o

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act.  (Check one):

                   Large Accelerated Filer o               AcceleratedFiler o             Non-AcceleratedFiled x

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o   No x

The number of shares outstanding of the Registrant’s commonstock, $0.0033 par value, as of November 9, 2007 was 38,254,250.

 

 

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**EMRISE CORPORATION**

**TABLE OF CONTENTS**

**FORM 10-Q**

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007**

 

 
| **PART  I. FINANCIAL INFORMATION** |                                                                                                                                |
|------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------|
| ** **                         | ** **                                                                                                                          |   |
| **ITEM 1.**                        | **FINANCIAL STATEMENTS**                                                                                                            |   |
| ** **                         | ** **                                                                                                                          |   |
|                               | Condensed  Consolidated Balance Sheets as of September 30, 2007 (unaudited)   and December 31, 2006                       | 1 |
|                               |                                                                                                                                |   |
|                               | Condensed  Consolidated Statements of Operations for the Three and Nine Months   Ended September 30, 2007 and 2006 (unaudited) | 2 |
|                               |                                                                                                                                |   |
|                               | Condensed  Consolidated Statements of Stockholders’ Equity for the   Nine Months Ended September 30, 2007 (unaudited)          | 3 |
|                               |                                                                                                                                |   |
|                               | Condensed  Consolidated Statements of Cash Flows for the Nine Months Ended   September 30, 2007 and 2006 (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**                                                                   | 26 |
| ** **                         | ** **                                                                                                                          |   |
| **ITEM 4T.**                       | **CONTROLS AND  PROCEDURES**                                                                                                        | 27 |
|                               |                                                                                                                                |   |
| **PART II**                        |                                                                                                                                |
| **OTHER  INFORMATION**             |                                                                                                                                |
| ** **                         |                                                                                                                                |
| **ITEM 1.**                        | **LEGAL PROCEEDINGS**                                                                                                               | 30 |
| ** **                         | ** **                                                                                                                          |   |
| **ITEM 1A.**                       | **RISK FACTORS**                                                                                                                    | 30 |
| ** **                         | ** **                                                                                                                          |   |
| **ITEM 2.**                        | **UNREGISTERED  SALES OF EQUITY SECURITIES ANDUSE OF PROCEEDS**                                                                     | 30 |
| ** **                         | ** **                                                                                                                          |   |
| **ITEM 3.**                        | **DEFAULTS UPON  SENIOR SECURITIES**                                                                                                | 30 |
| ** **                         | ** **                                                                                                                          |   |
| **ITEM 4.**                        | **SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS**                                                                            | 30 |
| ** **                         | ** **                                                                                                                          |   |
| **ITEM 5.**                        | **OTHER INFORMATION**                                                                                                               | 31 |
| ** **                         | ** **                                                                                                                          |   |
| **ITEM 6.**                        | **EXHIBITS**                                                                                                                        | 36 |
| ** **                         | ** **                                                                                                                          |   |
| **SIGNATURES**                     | 37                                                                                                                                  |
|                                    |                                                                                                                                     |  |  |

 

 

----

 

 

**PART I —FINANCIAL INFORMATION**

**ITEM1.**                             FINANCIALSTATEMENTS

 

**EMRISE CORPORATION**

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

 
| ** **                                                                                                                                                                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **2007**          | ** ** | **2006**         | ** ** |
| ** **                                                                                                                                                                          | ** ** | **(Unaudited)**   | ** ** | ** **       | ** ** |
| **ASSETS**                                                                                                                                                                          | ** ** | ** **        | ** ** | ** **       | ** ** |
| Current assets:                                                                                                                                                                     |       |              |       |             |       |
| Cash and cash  equivalents                                                                                                                                                          |       | $                 | 2,018      |             | $          | 3,802 |   |
| Accounts  receivable, net of allowances for doubtful accounts of $291 at September 30,  2007 and $391 at December 31, 2006                                                          |       | 9,158             |       | 9,220            |       |
| Inventories                                                                                                                                                                         |       | 11,507            |       | 10,575           |       |
| Deferred income  taxes                                                                                                                                                              |       | 723               |       | 726              |       |
| Prepaid and  other current assets                                                                                                                                                   |       | 1,118             |       | 1,082            |       |
| Total current  assets                                                                                                                                                               |       | 24,524            |       | 25,405           |       |
|                                                                                                                                                                                |       |              |       |             |       |
| Property, plant  and equipment, net                                                                                                                                                 |       | 2,298             |       | 2,245            |       |
| Goodwill                                                                                                                                                                            |       | 13,115            |       | 12,995           |       |
| Intangible  assets other than goodwill, net                                                                                                                                         |       | 3,313             |       | 3,546            |       |
| Other assets                                                                                                                                                                        |       | 798               |       | 594              |       |
| Total assets                                                                                                                                                                        |       | $                 | 44,048     |             | $          | 44,785 |   |
|                                                                                                                                                                                |       |              |       |             |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                       | ** ** | ** **        | ** ** | ** **       | ** ** |
| Current  liabilities:                                                                                                                                                               |       |              |       |             |       |
| Accounts payable                                                                                                                                                                    |       | $                 | 5,435      |             | $          | 4,640 |   |
| Accrued expenses                                                                                                                                                                    |       | 4,978             |       | 5,309            |       |
| Borrowings under  lines of credit                                                                                                                                                   |       | 5,148             |       | 4,310            |       |
| Current portion  of long-term debt                                                                                                                                                  |       | 471               |       | 516              |       |
| Notes payable to  stockholders, current portion                                                                                                                                     |       | 500               |       | 500              |       |
| Income taxes  payable                                                                                                                                                               |       | 442               |       | 519              |       |
| Total current  liabilities                                                                                                                                                          |       | 16,974            |       | 15,794           |       |
|                                                                                                                                                                                |       |              |       |             |       |
| Long-term debt                                                                                                                                                                      |       | 219               |       | 533              |       |
| Notes payable to  stockholders, less current portion                                                                                                                                |       | 938               |       | 1,250            |       |
| Deferred income  taxes                                                                                                                                                              |       | 1,053             |       | 1,053            |       |
| Other  liabilities                                                                                                                                                                  |       | 1,127             |       | 982              |       |
| Total  liabilities                                                                                                                                                                  |       | 20,311            |       | 19,612           |       |
|                                                                                                                                                                                |       |              |       |             |       |
| 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  38,082,000 shares issued and outstanding at September 30, 2007 and December  31, 2006, respectively |       | 126               |       | 125              |       |
| Additional  paid-in capital                                                                                                                                                         |       | 43,211            |       | 43,083           |       |
| Accumulated  deficit                                                                                                                                                                |       | (20,634           | )          | (18,733          | )          |
| Accumulated  other comprehensive income                                                                                                                                             |       | 1,034             |       | 698              |       |
| Total  stockholders’ equity                                                                                                                                                    |       | 23,737            |       | 25,173           |       |
| Total liabilities  and stockholders’ equity                                                                                                                                    |       | $                 | 44,048     |             | $          | 44,785 |   |

 

 

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

 

1

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Operations**

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

 
| ** **                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                           | ** ** | **2007**                              | ** ** | **2006**                             | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                 |       |                                  |       |                                 |       |   |   |   |   |
| Net sales                            |       | $                                     | 12,809     |                                 | $          | 12,177 |   | $ | 36,798 |   | $ | 33,728 |   |
| Cost of sales                        |       | 8,798                                 |       | 7,499                                |       | 24,863 |   | 20,874 |   |
| Gross profit                         |       | 4,011                                 |       | 4,678                                |       | 11,935 |   | 12,854 |   |
|                                 |       |                                  |       |                                 |       |   |   |   |   |
| Operating  expenses:                 |       |                                  |       |                                 |       |   |   |   |   |
| Selling, general  and administrative |       | 3,796                                 |       | 4,180                                |       | 11,381 |   | 11,645 |   |
| Engineering and  product development |       | 692                                   |       | 796                                  |       | 2,067 |   | 2,410 |   |
| Total operating  expenses            |       | 4,488                                 |       | 4,976                                |       | 13,448 |   | 14,055 |   |
| Loss from  operations                |       | (477                                  | )          | (298                                 | )          | (1,513 | ) | (1,201 | ) |
|                                 |       |                                  |       |                                 |       |   |   |   |   |
| Other income  (expense):             |       |                                  |       |                                 |       |   |   |   |   |
| Interest income                      |       | 40                                    |       | 13                                   |       | 95 |   | 59 |   |
| Interest expense                     |       | (190                                  | )          | (124                                 | )          | (510 | ) | (341 | ) |
| Other, net                           |       | 314                                   |       | (158                                 | )          | 479 |   | (194 | ) |
| Total other  income (expense), net   |       | 164                                   |       | (269                                 | )          | 64 |   | (476 | ) |
|                                 |       |                                  |       |                                 |       |   |   |   |   |
| Loss before  income taxes            |       | (313                                  | )          | (567                                 | )          | (1,449 | ) | (1,677 | ) |
| Income tax  provision (benefit)      |       | 173                                   |       | 149                                  |       | 452 |   | 371 |   |
| Net loss                             |       | $                                     | (486       | )                                    | $          | (716 | ) | $ | (1,901 | ) | $ | (2,048 | ) |
|                                 |       |                                  |       |                                 |       |   |   |   |   |
| Loss per share:                      |       |                                  |       |                                 |       |   |   |   |   |
| Basic                                |       | $                                     | (0.01      | )                                    | $          | (0.02 | ) | $ | (0.05 | ) | $ | (0.05 | ) |
| Diluted                              |       | $                                     | (0.01      | )                                    | $          | (0.02 | ) | $ | (0.05 | ) | $ | (0.05 | ) |
|                                 |       |                                  |       |                                 |       |   |   |   |   |
| Weighted average  shares outstanding |       |                                  |       |                                 |       |   |   |   |   |
| Basic                                |       | 38,193                                |       | 38,082                               |       | 38,163 |   | 37,947 |   |
| Diluted                              |       | 38,193                                |       | 38,082                               |       | 38,163 |   | 37,947 |   |
|                                      |            |                                       |            |                                      |            |  |  |  |  |  |  |  |  |  |  |

 

 

*The accompanying Notes are anintegral part of these Condensed Consolidated Financial 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, 2006      |       | 38,082           |       | $           | 125        |            | $          | 43,083            |       | $               | (18,733    | )          | $          | 698 |   | $ | 25,173 |   |
| Stock option  exercises            |       | 172              |       | 1           |       | 68              |       | —            |       | —          |       | 69         |       |
| Stock-based  compensation          |       | —           |       | —      |       | 60              |       | —            |       | —          |       | 60         |       |
| Net loss and  comprehensive income |       | —           |       | —      |       | —          |       | (1,901            | )          | 336             |       | (1,565     | )          |
| Balance at  September 30, 2007     |       | 38,254           |       | $           | 126        |            | $          | 43,211            |       | $               | (20,634    | )          | $          | 1,034 |   | $ | 23,737 |   |
|                                    |            |                  |            |             |            |                 |            |                   |            |                 |            |            |            |  |  |  |  |  |  |  |  |

 

 

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

 

3

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**EMRISE CORPORATION**

**Condensed Consolidated Statements of Cash Flows**

(Unaudited)****(in thousands)

* *
| ** **                                                              | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                              | ** ** | **September 30,**     | ** ** |
| ** **                                                              | ** ** | **2007**              | ** ** | **2006** | ** ** |
|                                                                    |       |                  |       |   |   |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                               | ** ** | ** **            | ** ** | ** ** | ** ** |
| Net loss                                                                |       | $                     | (1,901     | ) | $ | (2,048 | ) |
| Reconciliation  to net cash provided by (used in) operating activities: |       |                  |       |   |   |
| Depreciation and  amortization                                          |       | 818                   |       | 878 |   |
| Provision for  inventory obsolescence                                   |       | 664                   |       | 1,163 |   |
| Deferred taxes                                                          |       | 3                     |       | (87 | ) |
| Stock-based  compensation expense                                       |       | 60                    |       | 110 |   |
| Provision for doubtful  accounts                                        |       | (100                  | )          | — |   |
| Changes in  assets and liabilities:                                     |       |                  |       |   |   |
| Accounts  receivable                                                    |       | 162                   |       | 820 |   |
| Inventories                                                             |       | (1,596                | )          | (2,313 | ) |
| Prepaid and  other assets                                               |       | (240                  | )          | (144 | ) |
| Accounts payable  and accrued expenses                                  |       | 532                   |       | 686 |   |
| Total  adjustments                                                      |       | 303                   |       | 1,113 |   |
| Net cash used in  operating activities                                  |       | (1,598                | )          | (935 | ) |
|                                                                    |       |                  |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                              | ** ** | ** **            | ** ** | ** ** | ** ** |
| Purchases of  property, plant and equipment                             |       | (613                  | )          | (413 | ) |
| Disposal of  property, plant and equipment                              |       | —                |       | 52 |   |
| Net cash used in  investing activities                                  |       | (613                  | )          | (361 | ) |
|                                                                    |       |                  |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                              | ** ** | ** **            | ** ** | ** ** | ** ** |
| Net proceeds  (repayments) of lines of credit                           |       | 838                   |       | (658 | ) |
| Repayments of  long-term debt                                           |       | (421                  | )          | (256 | ) |
| Payments of  notes to stockholders                                      |       | (250                  | )          | (375 | ) |
| Proceeds from exercise  of stock options and warrants                   |       | 69                    |       | 385 |   |
| Net cash  provided by (used in) financing activities                    |       | 236                   |       | (904 | ) |
|                                                                    |       |                  |       |   |   |
| Effect of  exchange rate changes on cash                                |       | 191                   |       | 575 |   |
| Net decrease in  cash and cash equivalents                              |       | (1,784                | )          | (1,625 | ) |
| Cash and cash  equivalents at beginning of period                       |       | 3,802                 |       | 4,371 |   |
| Cash and cash  equivalents at end of period                             |       | $                     | 2,018      |   | $ | 2,746 |   |

 

 

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

 

4

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**NOTE 1 — SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

*Organization and Business*

EMRISECorporation (the “Company”) operates through two operating segments: electronicdevices and communications equipment. The Company’s subsidiaries within itselectronic devices segment design,develop, manufacture and market electronic devices for defense, aerospace andindustrial markets.  The Company’ssubsidiaries within its communications equipment segment design, develop,manufacture and market network access equipment and network timing andsynchronization products.  The Companyconducts its operations out of various facilities in the United States (“U.S.”),France, the United Kingdom (“U.K.”) and Japan. The following reflects the Company’s direct subsidiaries, as indicated,and indirect subsidiaries and the locations of operation:

***Electronic Devices Segment***

EMRISE ElectronicsCorporation (“EEC”), a subsidiary of the Company — U.S.

EMRISE ElectronicsLimited (“EEL”) — U.K.

Pascall ElectronicsLimited (“Pascall”) — U.K.

XCEL Power Systems, Ltd.(“XPS”) — U.K.

RO AssociatesIncorporated (“RO”) — U.S.

EMRISE Japan Ltd. (“EJL”)— Japan

***Communications Equipment Segment***

        CXR Larus Corporation (“CXR Larus”), a subsidiary of theCompany — U.S.

        CXR Anderson Jacobson (“CXR-AJ”), a subsidiary of the Company— France

*Basis of Presentation*

Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with the rules and regulations of the Securities andExchange Commission (“Commission”) and therefore do not include all informationand footnotes necessary for a complete presentation of the financial position,results of operations and cash flows in conformity with accounting principlesgenerally accepted in the U.S. (“GAAP”). The year end balance sheet was derived from the audited financialstatements at that date, but does not include all of the information andfootnotes required by GAAP for complete financial statements.  The unaudited condensed consolidatedfinancial statements do, however, reflect all adjustments, consisting of onlynormal recurring adjustments, which are, in the opinion of management,necessary to state fairly the financial position as of September 30, 2007 andthe results of operations and cash flows for the related interim periods endedSeptember 30, 2007 and 2006. However, these results are not necessarilyindicative of results for any other interim period or for the year. Theaccompanying unaudited condensed consolidated financial statements should beread in conjunction with the Company’s audited consolidated financialstatements included in its amended annual report on Form 10-K for the yearended December 31, 2006 as filed with the Commission.

 

5

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*ComprehensiveLoss*

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

 

| ** **                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                               | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                     |       |                   |       |                  |       |   |   |   |   |
| Net loss                                 |       | $                      | (486       | )                     | $          | (716 | ) | $ | (1,901 | ) | $ | (2,048 | ) |
| Other  comprehensive income:             |       |                   |       |                  |       |   |   |   |   |
| Foreign currency  translation adjustment |       | 162                    |       | 310                   |       | 336 |   | 992 |   |
| Comprehensive  loss                      |       | $                      | (324       | )                     | $          | (406 | ) | $ | (1,565 | ) | $ | (1,056 | ) |
|                                          |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |

 

*Loss Per Share*

Basicloss per share is computed by dividing net loss by the weighted average commonshares outstanding during a period. Diluted loss per share is based on the treasury stock method andincludes the dilutive effect of stock options and warrants outstanding duringthe period.  Common share equivalentshave been excluded where their inclusion would be anti-dilutive.  As a result of the loss incurred by theCompany for all periods presented, the potentially dilutive common shares havebeen excluded because their inclusion would have been anti-dilutive.  The following table illustrates the computationof basic and diluted loss per share (in thousands, except per share amounts):

 

| ** **                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                          | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                                          | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                          | ** ** | ** **             | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| NUMERATOR:                                          |       |                   |       |                  |       |   |   |   |   |
| Net loss                                            |       | $                      | (486       | )                     | $          | (716 | ) | $ | (1,901 | ) | $ | (2,048 | ) |
|                                                |       |                   |       |                  |       |   |   |   |   |
| DENOMINATOR:                                        |       |                   |       |                  |       |   |   |   |   |
| Basic weighted  average common shares outstanding   |       | 38,193                 |       | 38,082                |       | 38,163 |   | 37,947 |   |
| Effect of  dilutive securities:                     |       |                   |       |                  |       |   |   |   |   |
| Dilutive stock  options and warrants                |       | —                 |       | —                |       | — |   | — |   |
| Diluted weighted  average common shares outstanding |       | 38,193                 |       | 38,082                |       | 38,163 |   | 37,947 |   |
|                                                |       |                   |       |                  |       |   |   |   |   |
| Basic loss per  share                               |       | $                      | (0.01      | )                     | $          | (0.02 | ) | $ | (0.05 | ) | $ | (0.05 | ) |
|                                                |       |                   |       |                  |       |   |   |   |   |
| Diluted loss per  share                             |       | $                      | (0.01      | )                     | $          | (0.02 | ) | $ | (0.05 | ) | $ | (0.05 | ) |
|                                                     |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |

 

6

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The following table shows the common stock equivalentsthat were outstanding as of September 30, 2007 and 2006, 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 September  30, 2007             |       | 1,808,000     |       | $0.20 — $2.00 |       |
| As of September  30, 2006             |       | 1,200,000     |       | $1.00 — $2.00 |       |
|                                  |       |          |       |               |       |
| Anti-dilutive  common stock warrants: |       |          |       |               |       |
| As of September  30, 2007             |       | 4,042,000     |       | $0.85 — $2.00 |       |
| As of September  30, 2006             |       | 4,161,000     |       | $1.30 — $2.00 |       |

 

*Recent Accounting Pronouncements*

OnJanuary 1, 2007, the Company adopted Financial Accounting Standards Board (“FASB”)Financial Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASBStatement No. 109.” FIN 48 clarifies the accounting for theuncertainty in recognizing income taxes in an organization in accordance withFASB Statement No. 109 by providing detailed guidance for financial statementrecognition, measurement and disclosure involving uncertain taxpositions.  FIN 48 requires an uncertain tax position to meet amore-likely-than-not recognition threshold at the effective date to berecognized both upon the adoption of FIN 48 and in subsequent periods.  The implementation of FIN 48 didnot have a material effect on the Company’s financial statements.  See Note 6 — Income Taxes.

InFebruary 2007, the FASB issued SFAS No. 159, “The Fair Value Option forFinancial Assets and 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 up front 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 Company is evaluating the effect thatadoption of SFAS No. 159 would have on its financial condition or resultsof operations.

InSeptember 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” Thisnew statement provides a single definition of fair value, together with aframework for measuring it, and requires additional disclosure about the use offair value 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 is thefirst quarter of 2008. The Company is evaluating the effect this statement mayhave on its consolidated financial statements.

 

 

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**NOTE 2 — STOCK-BASED COMPENSATION**

 

The Company has four stock option plans:

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

•                  1993 Stock Option Plan;

•                  1997 Stock Incentive Plan; and

•                  Amended and Restated 2000 Stock Option Plan.

Asa result of the Company’s adoption of SFAS No. 123 (revised 2004), “Share-BasedPayment,” as of January 1, 2006, total stock-based compensation expenseincluded in wages, salaries and related costs was $15,000 and $36,000 for thethree months ended September 30, 2007 and 2006, respectively, and $60,000 and $110,000for the nine months ended September 30, 2007 and 2006, respectively. Thesecompensation expenses were charged to selling, general and administrativeexpenses. As of September 30, 2007, the Company had $43,000 of totalunrecognized compensation expense related to stock option grants, which will berecognized over the remaining weighted average period of two years.

 

**NOTE 3 — INVENTORIES**

 

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

 

| ** **         | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------|------------|-------------------|------------|------------------|------------|
| ** **         | ** ** | **2007**          | ** ** | **2006**         | ** ** |
|               |       |              |       |             |       |
| Raw materials      |       | $                 | 9,790      |             | $          | 8,771 |   |
| Work-in-process    |       | 4,485             |       | 3,588            |       |
| Finished goods     |       | 3,553             |       | 3,873            |       |
| Reserves           |       | (6,321            | )          | (5,657           | )          |
| Total  inventories |       | $                 | 11,507     |             | $          | 10,575 |   |

 

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**NOTE 4 — OPERATING SEGMENTS**

TheCompany has two reportable operating segments: electronic devices andcommunications equipment. The electronic devices segment manufactures andmarkets digital and rotary switches, electronic power supplies, radio frequency(“RF”) and microwave devices and subsystem assemblies. The electronic devicessegment consists of EEC and its subsidiaries, which offer the same or similarproducts to similar customers.  Thecommunications equipment segment designs, manufactures and distributes networkaccess products and timing and synchronization products.  The communications equipment segment consistsof operating entities CXR Larus and CXR-AJ, which offer the same or similarproducts to similar customers.  Bothsegments operate in the U.S., European and Asian markets, but have distinctlydifferent customers, design and manufacturing processes and marketingstrategies.  Each segment has discretefinancial information and a separate management structure.

TheCompany evaluates performance based upon profit or loss from operations beforeincome taxes exclusive of nonrecurring gains and losses. The Company accountsfor intersegment sales at pre-determined prices negotiated between theindividual 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 31,2006.  Included in the Company’sreconciliation of segment financial data to the consolidated amounts isunallocated corporate expenses.  Selectedfinancial data for each of the Company’s operating segments reconciled to theconsolidated totals is shown below (in thousands):

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **                | ** ** | **2007**               | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net sales                 |       |                   |       |                  |       |   |   |   |   |
| Electronic  devices       |       | $                      | 8,872      |                  | $          | 8,552 |   | $ | 25,839 |   | $ | 24,325 |   |
| Communications  equipment |       | 3,937                  |       | 3,625                 |       | 10,959 |   | 9,403 |   |
| Total                     |       | $                      | 12,809     |                  | $          | 12,177 |   | $ | 36,798 |   | $ | 33,728 |   |
|                      |       |                   |       |                  |       |   |   |   |   |
| Operating income  (loss)  |       |                   |       |                  |       |   |   |   |   |
| Electronic  devices       |       | $                      | 287        |                  | $          | 1,068 |   | $ | 1,363 |   | $ | 2,911 |   |
| Communications  equipment |       | 189                    |       | 30                    |       | (9 | ) | (703 | ) |
| Corporate and  other      |       | (953                   | )          | (1,396                | )          | (2,867 | ) | (3,409 | ) |
| Total                     |       | $                      | (477       | )                     | $          | (298 | ) | $ | (1,513 | ) | $ | (1,201 | ) |
|                           |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|---------------------------|------------|-------------------|------------|------------------|------------|
| ** **                | ** ** | **2007**          | ** ** | **2006**         | ** ** |
| Total assets              |       |              |       |             |       |
| Electronic  devices       |       | $                 | 27,033     |             | $          | 27,514 |   |
| Communications  equipment |       | 15,886            |       | 15,912           |       |
| Corporate and  other      |       | 1,129             |       | 1,359            |       |
| Total                     |       | $                 | 44,048     |             | $          | 44,785 |   |
|                           |            |                   |            |                  |            |  |  |  |

 

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**NOTE 5 — GOODWILL**

 

                The followingtable reflects changes in our goodwill balances, by segment, for the ninemonths ended September 30, 2007 (in thousands):

 

| ** **                     | ** ** | **Electronic** | ** ** | **Communications** | ** ** | ** ** | ** ** |
|--------------------------------|------------|----------------|------------|--------------------|------------|------------|------------|
| ** **                     | ** ** | **Devices**    | ** ** | **Equipment**      | ** ** | **Total**  | ** ** |
|                           |       |           |       |               |       |       |       |
| Balance at  December 31, 2006  |       | $              | 7,161      |               | $          | 5,834      |       | $ | 12,995 |   |
| Foreign currency  translation  |       | 120            |       | —             |       | 120        |       |
| Balance at  September 30, 2007 |       | $              | 7,281      |               | $          | 5,834      |       | $ | 13,115 |   |
|                                |            |                |            |                    |            |            |            |  |  |  |  |  |

 

**NOTE 6 — INCOME TAXES**

The effective taxrate for the three and nine month periods ended September 30, 2007 wasdifferent than the 34% U.S. statutory rate primarily because of foreign taxeson foreign source income that cannot be offset by domestic tax losscarryforwards.

OnJanuary 1, 2007, the Company adopted FIN 48. The implementation of FIN 48 didnot result in a material adjustment to the Company’s liability for unrecognizedincome tax benefits. At the time of adoption and as of the end of the secondquarter of 2007, the Company had recorded no net unrecognized tax benefits. TheCompany does not believe that it will record unrecognized tax benefits for2007.

TheCompany recognizes interest and penalties related to uncertain tax positions ininterest expense and selling, general and administrative expense, respectively,in the condensed consolidated statements of operations and comprehensiveincome. No interest or penalties were recognized during the first half of 2007.As of September 30, 2007, the Company had nothing accrued for interest andpenalties in this regard.

TheCompany files income tax returns in the U.S. federal jurisdiction, the U.K.,France and Japan, and in the state jurisdictions of California, Texas and NewJersey. The Company is no longer subject to U.S. federal and state taxexaminations for years before 2003 and 2002, respectively, and is no longersubject to tax examinations for the U.K. and Japan for years prior to 2005, andfor France for years prior to 2003.

 

**NOTE7 — LINES OF CREDIT**

Outstanding borrowings under the Company’s revolvinglines of credit described below were as follows:

 

| ** **                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                    | ** ** | **2007**          | ** ** | **2006**         | ** ** |
|                                          |       |              |       |             |       |
| Line of credit  with a U.S. commercial lender |       | $                 | 1,478      |             | $          | 1,978 |   |
| Lines of credit  with foreign banks           |       | 3,670             |       | 2,332            |       |
|                                          |       | $                 | 5,148      |             | $          | 4,310 |   |

 

 

 

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EMRISE Corporation, EEC, CXR Larus, RO and Wells FargoBank, acting through its Wells Fargo Business Credit operating division (“WFBC”),are parties to a Credit and Security Agreement (“WFBC credit facility”).  The WFBC credit facility provides for a $5.0million revolving line of credit that expires on December 1, 2009 and issecured by accounts receivable, other rights to payment and generalintangibles, inventories and equipment. The Company is subject to certain financial covenants associated with theWFBC credit facility, including minimum net worth, minimum net income (loss),and minimum debt service coverage ratio. In August 2007, the Company amended the WFBC credit facility to resetthese covenants.  On October 5, 2007, theCompany entered into a Forbearance Agreement and Second Amendment withWFBC.  Under the terms of this secondamendment, WFBC agreed to forbear its rights with regard to the July 31, 2007covenant violations through December 31, 2007 provided that the Company meetscertain temporary financial covenants (collectively, the “Financial Tests”),during the forbearance period including minimum book net worth and minimum netincome.  As of September 30, 2007, theCompany was in compliance with the Financial Tests as required by the ForbearanceAgreement and Second Amendment.  WFBC iscurrently in the process of resetting the covenants for 2008.

TheCompany’s indirect subsidiaries, Pascall and XPS, are parties to a creditfacility with Lloyds TSB Commercial Finance Limited (“Lloyds”) that provides arevolving loan secured by receivables, with a maximum availability of 2.1million British pounds sterling (approximately $4.2 million based on theexchange rate in effect on September 30, 2007). The Company is subject to certain financial covenants associated withthe Lloyd’s credit facility.  As ofSeptember 30, 2007, the Company was in compliance with all such covenants.

CXR-AJis party to a credit facility with IFN Finance, a subsidiary of ABN AMRON.V.  This credit facility is for amaximum of $1.3 million based on the exchange rate in effect at September 30,2007 for the conversion of euros into U.S. dollars.  The IFN credit facility is secured byaccounts receivable.  The IFN creditfacility has no financial performance covenants.

 

                During the quarterended September 30, 2007, the Company entered into a note with one of itsvendors, the amount of which may not exceed $300,000, relating to tradepayables for raw materials recieved during 2007.  Pursuant to the terms of the note, theCompany pledged 500,000 shares of restricted common stock as collateral tosupport the note.  As of September 30,2007 the balance on the note was $165,000.

 

**NOTE8 — SUBSEQUENT EVENTS**

 

                On November 7,2007, the Company secured a commitment letter from GVEC Resource IV, Inc., anaffiliate of Private Equity Management Group (“PEM Group”), to provide a threeyear global debt facility (the “Financing Transaction”).  The facility totals $23 million comprised ofa $7 million formula-based revolving credit facility, a $6 million term loan,which funds entirely at the time of closing, and a $10 million line of creditto be used exclusively for purposes of acquisitions.  Proceeds from the credit facility and theterm loan will be used to repay existing institutional debt and to fund workingcapital.  The interest rate on therevolving credit facility is variable at the prime rate as published in the “MoneyRates” column of the Wall Street Journal plus 1.25% subject to a minimum of9.5%.  The interest rate on the term loanand acquisition line is variable at the prime rate plus 4.25% subject to aminimum of 12.5%.  The term loan and, ifused, the acquisition line require interest only payments in the first year andscheduled principal and interest payments in years two and three with theremaining principal balance due upon maturity of the term loan.  The Financing Transaction is expected toclose on or before December 7, 2007.  Inconnection with the Financing Transaction, the Company will issue to PEM Group a warrant to purchase 2,909,091shares of the Company’s common stock at an exercise price of $1.10 pershare.  The warrants will expire in sevenyears.  The closing of the FinancingTransaction is subject to acceptable final documentation and customary closingconditions.

 

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

**Cautionary Statement**

Youshould read the following discussion and analysis in conjunction with ourunaudited condensed consolidated financial statements and the related notesthereto contained in Part I, Item 1 of this Report. The information containedin this Quarterly Report on Form 10-Q is not a complete description of ourbusiness or the risks associated with an investment in our common stock. Weurge you to carefully review and consider the various disclosures made by us inthis Report and in our other reports filed with SEC, including our AnnualReport on Form 10-K for the year ended December 31, 2006 and subsequent reportson Forms 10-Q and 8-K, which discuss our business in greater detail.

Thesection entitled “Risk Factors” set forth below, and similar discussions in ourother SEC filings, describe some of the important risk factors that may affectour business, financial condition, results of operations and/or liquidity. Youshould carefully consider those risks, in addition to the other information inthis Report and in our other filings with the SEC, before deciding to purchase,hold or sell our common stock.

Allstatements included or incorporated by reference in this Report, other thanstatements or characterizations of historical fact, are forward-lookingstatements. Examples of forward-looking statements include, but are not limitedto, statements concerning projected net revenue, costs and expenses and grossmargin; our accounting estimates, assumptions and judgments; the impact of theJanuary 2007 restatement of our financial statements for prior periods;estimates related to the amount and/or timing of the expensing of unearnedstock-based compensation expense; our success in pending litigation; the demandfor our products; the effect that seasonality and volume fluctuations in thedemand for our customers’ consumer-oriented products will have on our quarterlyoperating results; our dependence on a few key customers for a substantialportion of our revenue; our ability to scale operations in response to changesin demand for existing products and services or the demand for new productsrequested by our customers; the competitive nature of and anticipated growth inour markets; our ability to migrate to smaller process geometries;manufacturing, assembly and test capacity; our ability to consummateacquisitions and integrate their operations successfully; our potential needsfor additional capital and inventory and accounts receivable levels. Theseforward-looking statements are based on our current expectations, estimates andprojections about our industry and business, management’s beliefs, and certainassumptions made by us, all of which are subject to change. Forward-lookingstatements can often be identified by words such as “anticipates,” “expects,” “intends,”“plans,” “predicts,” “believes,” “seeks,” “estimates,” “may,” “will,” “should,”“would,” “could,” “potential,” “continue,” “ongoing,” similar expressions, andvariations or negatives of these words. These statements are not guarantees offuture performance and are subject to risks, uncertainties and assumptions thatare difficult to predict. Therefore, our actual results could differ materiallyand adversely from those expressed in any forward-looking statements as aresult of various factors, some of which are listed under the section “RiskFactors” contained in Part II, Item 1A of this Report. These forward-lookingstatements speak only as of the date of this Report. We undertake no obligationto revise or update publicly any forward-looking statement for any reason,except as otherwise required by law.

**General**

Weare a Delaware corporation that was formed July 14, 1989 and operates throughsubsidiaries in two operating segments: electronic devices and communicationsequipment. Our subsidiaries within our electronic devices segment design, develop, manufacture and marketelectronic devices for defense, aerospace and industrial markets, includingdigital and rotary switches, electronic power supplies and radio frequency (“RF”)device systems and subsystem assemblies. Our subsidiaries within our communications equipment segmentdesign, develop, manufacture and market network access equipment, includingnetwork timing and synchronization products for communications serviceproviders.  We are a multinationalcompany operating out of facilities located in the United States (“U.S.”),United Kingdom (“U.K.”), France and Japan. The following reflects our direct subsidiaries, as indicated andindirect subsidiaries and their locations of operation:

 

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***Electronic Devices Segment***

        EMRISE Electronics Corporation (“EEC”), a subsidiary ofEMRISE — U.S.

EMRISE ElectronicsLimited (“EEL”) — U.K.

Pascall ElectronicsLimited (“Pascall”) — U.K.

XCEL Power Systems, Ltd.(“XPS”) — U.K.

RO AssociatesIncorporated (“RO”) — U.S.

EMRISE Japan Ltd. (“EJL”)— Japan

***Communications Equipment Segment***

        CXR Larus Corporation (“CXR Larus”), a subsidiary of EMRISE —U.S.

        CXR Anderson Jacobson (“CXR-AJ”), a subsidiary of EMRISE —France

**Critical Accounting Policies**

Ourdiscussion and analysis of our financial condition and results of operations isbased upon our consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the U.S. Thepreparation of those financial statements requires us to make estimates andjudgments that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amount of net sales and expenses for each period.The following represents a summary of our critical accounting policies, definedas those policies that we believe are the most important to the portrayal ofour financial condition and results of operations and that require management’smost difficult, subjective or complex judgments, often as a result of the needto make estimates about the effects of matters that are inherently uncertain.

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

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

We recognize revenuesfrom domestic sales of our electronic devices and communications equipment atthe point of shipment of those products. Product returns are infrequent and require prior authorization becauseour sales are final and we quality test our products prior to shipment toensure they meet the specifications of the binding purchase orders under whichthey are shipped. Normally, when a customer requests and receives authorizationto return a product, the request is accompanied by a purchase order for areplacement product.

Revenue recognition forproducts and services provided by our U.K. subsidiaries depends upon the typeof contract involved.  Engineering/designservices contracts generally entail design and production of a prototype over aterm of up to several years, with revenue deferred until each milestone definedin the contract is reached.  Productioncontracts provide for a specific quantity of products to be produced over aspecific period of time.  Customers issuebinding purchase orders 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.  Generally,these products carry a one-year limited parts and labor warranty.

 

 

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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. Generally, these products carry a two-year limited parts and laborwarranty.

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 electronic devices, network accessand transmission products and communication timing and synchronization productscarry a one-year, limited parts and labor warranty and our communications testinstruments and European network access and transmission products carry atwo-year limited parts and labor warranty. Products returned under warranty typically are tested and repaired orreplaced at our option.  Historically, wehave not experienced significant warranty costs or returns.

We record a liability for estimated costs that weexpect 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***

Ourfinished goods electronic devices inventories generally are built toorder.  Our communications equipmentinventories generally are built to forecast, which requires us to produce alarger amount of finished goods in our communications equipment business so thatour customers can promptly be served. Our products consist of numerous electronic and other parts, whichnecessitates that we exercise detailed inventory management.  We value our inventory at the lower of theactual cost to purchase or manufacture the inventory (first-in, first-out) orthe current estimated market value of the inventory (net realizable value). Weperform cycle counts of inventories using the ABC inventory methodology orconduct 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 twelve months. Additionally, to determine inventory write-down provisions,we review product line inventory levels and individual items as necessary andperiodically review assumptions about forecasted demand and marketconditions.  Any parts or finished goodsthat we determine are obsolete, either in connection with the physical count orat other times of observation, are reserved for and subsequently discarded andwritten-off.  As of September 30, 2007,our total inventory reserves amounted to $6.3 million of which $4.5 million, or25.0% of total inventory, related to our electronic devices segment and $1.9million, or 10.5% of total inventory, related to our communications equipmentsegment.

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

***Foreign Currency Translation***

We have foreign subsidiaries that together accounted forapproximately 71.4% and 62.7% of our net revenues, 59.4% and 52.3% of ourassets and 57.4% and 49.6% of our total liabilities as of and for the ninemonths ended September 30, 2007 and 2006, respectively.  In preparing our consolidated financial statements, weare required to translate the financial statements of our foreign subsidiariesfrom the currencies in which they keep their accounting records into U.S.dollars. This process results in exchange gains and losses which, underrelevant accounting guidance, are included either within our statement ofoperations under the caption “other income (expense)” or as a separate part ofour net equity under the caption “accumulated other comprehensive income(loss).”

 

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Underrelevant accounting guidance, the treatment of these translation gains orlosses depends upon our management’s determination of the functional currencyof each subsidiary. This determination involves consideration of relevanteconomic facts and circumstances affecting the subsidiary. Generally, thecurrency in which the subsidiary transacts a majority of its transactions,including billings, financing, payroll and other expenditures, would beconsidered the functional currency. However, management must also consider anydependency of the subsidiary upon the parent and the nature of the subsidiary’soperations.

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

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

Basedon our assessment of the factors discussed above, we consider the functionalcurrency of each of our international subsidiaries to be each subsidiary’slocal currency. Accordingly, we had cumulative translation gains of $1.0million and $0.7 million that were included as part of accumulated othercomprehensive income within our balance sheets at September 30, 2007 andDecember 31, 2006, respectively. During the nine months ended September30, 2007 and 2006, we included translation gains of $0.3 million and $1.0million, respectively, under accumulated other comprehensive income.

Ifwe had determined that the functional currency of our subsidiaries was U.S.dollars, these gains would havedecreased our net loss for the nine months ended September 30, 2007 and 2006.The magnitude of these gains or losses depends upon movements in the exchangerates of the foreign currencies in which we transact business as compared tothe value of the U.S. dollar. These currencies include the euro, the Britishpound sterling and, to a lesser extent, the Japanese yen. Any futuretranslation gains or losses could be significantly higher or lower than thosewe recorded for these periods.

A2.5 million British pound sterling loan payable from EEL to EMRISE was outstanding as of September 30, 2007 ($5.5million based on the exchange rate at September 30, 2007).  Exchange rate losses and gains on thelong-term portion of this loan are recorded in cumulative translation gains orlosses in the equity section of the balance sheet.

***Intangibles, Including Goodwill***

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

In assessing potential impairment of goodwill, we considerthese factors as well as forecasted financial performance of the acquiredbusinesses.  If forecasts are not met, wemay have to record additional impairment charges not previously recognized. Inassessing the recoverability of our goodwill and other intangibles, we must makeassumptions regarding estimated future cash flows and other factors todetermine the fair value of those respective assets. If these estimates ortheir related assumptions change in the future, we may be required to recordimpairment charges for these assets that were not previously recorded.  If that were the case, we would have torecord an expense in order to reduce the carrying value of our goodwill.  Under Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets”, weare required to analyze our goodwill for impairment issues at least annually ormore frequently if an event occurs or circumstances change that would morelikely than not reduce the fair value of a reporting unit below its carryingamount.  At September 30, 2007, ourreported goodwill totaled $13.1 million. During the nine months ended September 30, 2007, we did not record any impairment losses relatedto goodwill and other intangible assets.

 

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**Overview**

Overallsales increased 5.2% and 9.1% in the three months and nine months endedSeptember 30, 2007, respectively, from the same periods in 2006.  Sales were positively affected at our foreignsubsidiaries in both of our operating segments, electronics devices andcommunications equipment, as a result of new contracts for power supplies, newin-flight entertainment and communication products, or IFE&C, and networkaccess products.  The sales increases forour foreign subsidiaries were partially offset by sales declines for ourdomestic subsidiaries.  While we continueto experience year-over-year decreases in our domestic sales, we have alreadyseen improvements in domestic sales of our rotary switches and new TiemPoTM edge networktiming product, or TiemPoTM, due,inpart, to new orders for TiemPoTM by a national communications carrier.  We expect continued growth in our foreignmarkets and we believe that our new TiemPoTM product and our patented Very LowProfile, or VLP, rotary switches will bring improved sales to our domesticoperations as well.

Overallgross margins decreased 7.1 and 5.7 percentage points for the third quarter andyear-to-date periods in 2007, respectively, from the same periods in 2006.  The declines in gross margins were primarilydue to the remaining effects of transitioning the manufacturing of our ROproducts to a contract manufacturer, which commenced in the second quarter of2007 and resulted in lower sales and higher initial production costs; thetemporary higher costs associated with engineering and prototyping of our newIFE&C products at our U.K. subsidiaries; and changes in product mix as weare experiencing the impact of shifting from higher margin legacy products tolower-margin, long-term growth products. We have made a conscious effort to develop and pursue product lines inareas where we expect substantial growth potential.  In some cases, these opportunities, such asexisting products sold in the IFE&C market, have lower margins as comparedto our traditional higher margin military market resulting in lower overallaverage margins.  Similarly, our rotaryswitch product line is a lower margin product than our traditional legacydigital switch products, but with a substantial future growth potential.  In all cases, however, we expect that theoverall higher anticipated sales volumes in these high growth areas will resultin improved gross profit and overall improved profitability.  In contrast, our new TiemPoTM products haveboth high growth potential and higher margin potential.  Therefore, we are particularly excited aboutthe growth of this product.  We expectour margins throughout the remainder of 2007 to remain relatively consistentwith the margins we experienced during the third quarter of 2007.

Weare encouraged by our continued sales growth reflecting the market interest inour new products.  Our strategy is tocontinue to generate market acceptance of these products, manage general andadministrative costs and seek acquisition opportunities that will complimentour existing product lines and customer base.

 

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The following is a further, more detailed discussionof our results of operations by segment.

 

**Results of Operations**

 

***Comparison of the Three Months Ended September 30, 2007 to the ThreeMonths Ended September 30, 2006***

 

**Net Sales**

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Variance**                | ** ** |
|---------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **September 30,**      | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**        | ** ** | **2007**               | ** ** | **2006**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| Electronic  devices       |       | $                      | 8,872      |                        | $          | 8,552 |   | $ | 320 |   | 3.7 | % |
| *as % of  net sales*      | * *   | *69.3*                 | *%*        | *70.2*                      | *%*        | * * | * * | * * | * * |
| Communications  equipment |       | 3,937                  |       | 3,625                       |       | 312 |   | 8.6 | % |
| *as % of  net sales*      | * *   | *30.7*                 | *%*        | *29.8*                      | *%*        | * * | * * | * * | * * |
| Total net sales           |       | $                      | 12,809     |                        | $          | 12,177 |   | $ | 632 |   | 5.2 | % |
|                           |            |                        |            |                             |            |  |  |  |  |  |  |  |  |  |  |

 

*Electronic Devices Segment*

 

The increase in sales of electronic devices in thethird quarter of 2007 as compared to the third quarter of 2006 is primarily dueto a $1.0 million increase in sales at our foreign subsidiaries.  This was primarily the result of militarypower supply sales in our U.K. subsidiary due to new contracts and also due toincreased revenues from both existing and new IFE&C products.  This increase was partially offset by $0.7million in sales declines at our domestic operations primarily due to delays inU.S. government stocking orders by the Defense Supply Center Columbus (“DSCC”)for our digital switches and the remaining impact of the transition of themanufacturing operations of our RO products to a contract manufacturer, whichoccurred during the second quarter of 2007. Approximately $0.4 million of sales were delayed as a result of lowproduction rates at the new contract manufacturer associated with the set upand execution of the assembly process. We expect our electronic devices segment sales to improve in the fourthquarter of 2007 as compared to the third quarter of 2007, primarily due to thefollowing:

 

•                  higher IFE&C shipments anticipated inthe fourth quarter of 2007;

•                  improved shipments at RO as a result ofongoing efforts to improve manufacturing efficiencies with contractmanufacturer and as they continue to satisfy existing backlog of $0.9 million;and

•                  the possible release in the fourthquarter of 2007 of high gross margin switch shipments at our Digitran divisionas a result of ongoing efforts to work with DSCC to release orders that havebeen requested, but not released throughout 2007, which total $0.9 million asof September 30, 2007.

 

*Communications Equipment Segment*

 

The increase in sales of communications equipment inthe third quarter of 2007 as compared to the third quarter of 2006 is primarilydue to a $0.7 million increase in sales of network access equipment at ourFrench subsidiary as a result of new contracts and larger international ordersand an increase of $0.2 million in domestic network access equipment sales,primarily the result of FAA upgrades to North American airports.  The increase was partially offset by declinesin our domestic operations as a result of decreases in sales of our centraloffice timing products.  Sales of ourcentral office timing products have been slower than in 2006 as a result of amarket shift from central office to edge network products.  We expect to experience strong sales from ourFrench subsidiary for the remainder of the year as evidenced by an increase inbacklog to $1.1 million at September 30, 2007 as compared to $0.8 million atSeptember 30, 2006.  We also expectimproved sales in both our domestic and foreign operations increased shipmentsof our new TiemPoTM product in both the U.S. and Europe due, inpart, to new orders for TiemPoTM by a national communications carrier customer,which will begin shipping in the fourth quarter of 2007.

 

17

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**Gross Profit**

 
| ** **                | ** ** | **Three Months Ended** | ** ** | **Variance**                | ** ** |
|---------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **September 30,**      | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**        | ** ** | **2007**               | ** ** | **2006**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| Electronic  devices       |       | $                      | 2,538      |                        | $          | 3,223 |   | $ | (685 | ) | (21.3 | )% |
| *gross  margin*           | * *   | *28.6*                 | *%*        | *37.7*                      | *%*        | * * | * * | * * | * * |
| Communications  equipment |       | 1,473                  |       | 1,455                       |       | 18 |   | 1.2 | % |
| *gross  margin*           | * *   | *37.4*                 | *%*        | *40.1*                      | *%*        | * * | * * | * * | * * |
| Total gross  profit       |       | $                      | 4,011      |                        | $          | 4,678 |   | $ | (667 | ) | (14.3 | )% |
| *Total  gross margin*     | * *   | *31.3*                 | *%*        | *38.4*                      | *%*        | * * | * * | * * | * * |

 

*Electronic Devices Segment*

 

The decline in gross margin for our electronic devicessegment from 37.7% in the third quarter of 2006 to 28.6% in the third quarterof 2007 is primarily the result of the continued effect of the transition of ROmanufacturing to a contract manufacturer, which commenced in the second quarterof 2007 and resulted in higher initial production costs; temporary engineeringand prototyping costs associated with new IFE&C products; changes inproduct mix from higher margin products with limited life spans to lowermargin, high growth rotary switch products; and the ongoing delayed release ofDSCC stocking orders for high margin digital switch products, which totaled$0.9 million as of September 30, 2007. Additionally, we are making a conscious effort to penetrate the lowermargin commercial in-flight entertainment market as we see substantial growthpotential as compared to our traditional higher margin military marketresulting in lower average margins for those products.  We expect to see these margins improve in thefourth quarter due to:

 

•                  anticipated IFE&C product shipmentsthat will generate higher margins than currently being generated as engineeringand prototype activities are replaced by higher margin product shipments;

•                  improved manufacturing efficiencies withthe RO contract manufacturer and increased shipments of products to satisfyexisting backlog of $0.9 million; and

•                  the expected release in the fourthquarter of 2007 of high gross margin switch shipments at our Digitran divisionas a result of ongoing efforts to work with DSCC to release orders that havebeen requested, but not released as of September 30, 2007.

 

*Communications Equipment Segment*

 

The decline in gross margin for our communicationsequipment segment from 40.1% in the third quarter of 2006 to 37.4% in the thirdquarter of 2007 is primarily the result of a decrease in margins at ourdomestic subsidiaries due to lower sales of our central office timing productsas the market shifts to edge network products, offset in part by increased salesof higher margin military network access products at our Frenchsubsidiary.  Margins have increasedslightly over second quarter 2007 primarily as a result of the launch of ournew TiemPoTM product which carries a higher margin and which weexpect will help our margins in the fourth quarter of 2007 remain relativelyconsistent with the third quarter of 2007.

 

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**Operating Expenses**

 
| ** **                           | ** ** | **Three Months Ended** | ** ** | **Variance**                | ** ** |
|--------------------------------------|------------|------------------------|------------|-----------------------------|------------|
| ** **                           | ** ** | **September 30,**      | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**                   | ** ** | **2007**               | ** ** | **2006**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| Selling, general  and administrative |       | $                      | 3,796      |                        | $          | 4,180 |   | $ | 384 |   | 9.2 | % |
| *as % of  net sales*                 | * *   | *29.6*                 | *%*        | *34.3*                      | *%*        | * * | * * | * * | * * |
| Engineering and  product development |       | 692                    |       | 796                         |       | 104 |   | 13.1 | % |
| *as % of  net sales*                 | * *   | *5.4*                  | *%*        | *6.5*                       | *%*        | * * | * * | * * | * * |
| Total operating  expenses            |       | $                      | 4,488      |                        | $          | 4,976 |   | $ | 488 |   | 9.8 | % |
|                                      |            |                        |            |                             |            |  |  |  |  |  |  |  |  |  |  |

 

*Selling, general and administrative expenses*

 

The decrease in selling, general and administrativeexpenses is primarily the result of $0.7 million of costs for the restatementand reaudit of our 2004 and 2005 financial statements, which were incurred inthe third quarter of 2006 and were absent in the third quarter of 2007.  Additionally, the volatility of the U.S.dollar to the British pound sterling and euro contributed to the favorable variance.

 

*Engineering and product development*

 

The decrease in engineering and product developmentcosts is primarily due to reduced expenses for the development of the newTiemPoTM product line for which most of the costs wereincurred in 2006.  Development costsincurred for this new product were $0.1 million in the third quarter of 2007compared to $0.2 million in the third quarter of 2006.

 

*Interest expense*

 

Interest expense was $0.2 million for the three monthsended September 30, 2007 compared to $0.1 million for the three months endedSeptember 30, 2006 due to increased loan balances for our U.S., U.K. and Frenchoperations and increased interest rates.

 

*Other income (expense)*

 

We generated other income of $0.3 million for thethree months ended September 30, 2007 compared to other expense ofapproximately $0.2 million for the same period of 2006.  Other income for the third quarter of 2007included a one-time accrual reversal related to the satisfactory resolution ofa legal dispute at our French subsidiary, CXR AJ.  Other expense for the third quarter of 2006consisted primarily of short-term exchange rate gains and losses associatedwith the volatility of the U.S. dollar to the British pound sterling and euroon the current portion of certain assets and liabilities.

 

*Income tax expense*

 

Income tax expense amounted to $0.2 million for thethree months ended September 30, 2007 compared to $0.1 million for the sameperiod of 2006.  Income tax expense isthe result of foreign income tax on foreign earned profits.

 

*Net Loss*

 

We generated a net loss of $0.5 million and $0.7million for the three months ended September 30, 2007 and 2006,respectively.  Our third quarter 2007 netloss position improved over the net loss for the prior year third quarter.  Factors that contributed to the currentquarter net loss were the disruption in sales at RO as a result of theconversion of the manufacturing of RO products to contract manufacturing,delayed DSCC orders and the lower margins generated from our change in productmix to commercial from military markets offset by a one-time accrual reversalrelated to the satisfactory resolution of a legal dispute at our Frenchsubsidiary, CXRAJ.

 

19

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***Comparison of the Nine months Ended September 30, 2007 to the Ninemonths Ended September 30, 2006***

 

**Net Sales**

 
| ** **                | ** ** | **Nine Months Ended** | ** ** | **Variance**                | ** ** |
|---------------------------|------------|-----------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **September 30,**     | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**        | ** ** | **2007**              | ** ** | **2006**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| Electronic  devices       |       | $                     | 25,839     |                        | $          | 24,326 |   | $ | 1,513 |   | 6.2 | % |
| *as % of  net sales*      | * *   | *70.2*                | *%*        | *72.1*                      | *%*        | * * | * * | * * | * * |
| Communications  equipment |       | 10,959                |       | 9,402                       |       | 1,557 |   | 16.6 | % |
| *as % of  net sales*      | * *   | *29.8*                | *%*        | *27.9*                      | *%*        | * * | * * | * * | * * |
| Total net sales           |       | $                     | 36,798     |                        | $          | 33,728 |   | $ | 3,070 |   | 9.1 | % |
|                           |            |                       |            |                             |            |  |  |  |  |  |  |  |  |  |

 

*Electronic Devices Segment*

 

The increase in sales of electronic devices in thenine months ended September 30, 2007 as compared to the same period of 2006 isprimarily due to an increase in sales of $3.1 million at our foreignsubsidiaries.  This was primarily theresult of military power supply sales and increased revenues from existing andnew IFE&C products by our U.K. subsidiaries.  This increase was partially offset by salesdeclines in our domestic operations of $1.6 million primarily due to delays inU.S. government DSCC stocking orders for our digital switches, which totaled$0.9 million as of September 30, 2007 and the remaining impact of thetransition of the manufacturing operations of our RO products to a contractmanufacturer, which commenced during the second quarter. We expect year-to-datenet sales of electronic devices in 2007 to continue to compare favorably toyear-to-date results of 2006 based on anticipated shipments in the fourthquarter.

 

*Communications Equipment Segment*

 

The increase in sales of communications equipment inthe nine months ended September 30, 2007 as compared to the same period of 2006is primarily due to a $2.1 million increase at our French subsidiary of salesof network access equipment as a result of new contracts and largerinternational orders and an increase of $0.6 million in domestic network accessequipment sales primarily as a result of FAA upgrades to North Americanairports.  The increase was partiallyoffset by declines in our domestic operations as a result of decreases in salesof our central office timing products. Sales of our central office timing products have been slower than in2006 as a result of a market shift from central office to edge network products.  We expect to experience strong sales from ourFrench subsidiary for the remainder of the year as evidenced by increasedbacklog of $1.1 million at September 30, 2007 as compared to $0.8 million atSeptember 30, 2006.  We also expectimproved sales in both our domestic and foreign operations increased shipmentsof our new TiemPoTM product in both the U.S. and Europe.

 

20

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**Gross Profit**

 
| ** **                | ** ** | **Nine Months Ended** | ** ** | **Variance**                | ** ** |
|---------------------------|------------|-----------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **September 30,**     | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**        | ** ** | **2007**              | ** ** | **2006**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| Electronic  devices       |       | $                     | 7,961      |                        | $          | 9,002 |   | $ | (1,041 | ) | (11.6 | )% |
| *gross  margin*           | * *   | *30.8*                | *%*        | *37.0*                      | *%*        | * * | * * | * * | * * |
| Communications  equipment |       | 3,974                 |       | 3,852                       |       | 122 |   | 3.2 | % |
| *gross  margin*           | * *   | *36.3*                | *%*        | *41.0*                      | *%*        | * * | * * | * * | * * |
| Total gross  profit       |       | $                     | 11,935     |                        | $          | 12,854 |   | $ | (919 | ) | (7.1 | )% |
| *Total  gross margin*     | * *   | *32.4*                | *%*        | *38.1*                      | *%*        | * * | * * | * * | * * |

 

*Electronic Devices Segment*

 

The decline in gross margin for our electronic devicessegment from 37.0% in the nine months ended September 30, 2006 to 30.8% in thesame period of 2007 is primarily the result of the effect of the transition ofRO manufacturing to a contract manufacturer, which commenced in the secondquarter of 2007 and resulted in higher initial production costs; engineeringand prototyping costs associated with new IFE&C products; changes inproduct mix from higher margin products with limited life spans to lowermargin, high growth rotary switch products; and the ongoing delayed release ofDSCC stocking orders for high margin digital switch products, which totaled$0.9 million as of September 30, 2007. We expect overall segment margins for the full year to remain consistentwith the nine month margins.

 

*Communications Equipment Segment*

 

The decline in gross margin for our communicationsequipment segment from 41.0% in the nine months ended September 30, 2006 to36.3% in the same period of 2007 is primarily the result of a decrease inmargins at our domestic subsidiaries due to lower sales of our central officetiming products as the market shifts to edge network products, offset in partby increased sales for higher margin military network access products at ourFrench subsidiary.  We expect the highermargins of our TiemPoTM product will help our margins to remain consistent forthe remainder of the year.

 

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**Operating Expenses**

 
| ** **                           | ** ** | **Nine Months Ended** | ** ** | **Variance**                | ** ** |
|--------------------------------------|------------|-----------------------|------------|-----------------------------|------------|
| ** **                           | ** ** | **September 30,**     | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**                   | ** ** | **2007**              | ** ** | **2006**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
| Selling, general  and administrative |       | $                     | 11,381     |                        | $          | 11,645 |   | $ | 264 |   | 2.3 | % |
| *as % of  net sales*                 | * *   | *30.9*                | *%*        | *34.5*                      | *%*        | * * | * * | * * | * * |
| Engineering and  product development |       | 2,067                 |       | 2,410                       |       | 343 |   | 14.2 | % |
| *as % of  net sales*                 | * *   | *5.6*                 | *%*        | *7.1*                       | *%*        | * * | * * | * * | * * |
| Total operating  expenses            |       | $                     | 13,448     |                        | $          | 14,055 |   | $ | 607 |   | 4.3 | % |

 

*Selling, general and administrative expenses*

 

The decrease in selling, general and administrativeexpenses is primarily the result of $0.8 million of costs for the restatementand reaudit of our 2004 and 2005 financial statements, which were incurred inthe nine months ended September 30, 2006 compared to $0.3 million incurred inthe same period of 2007.  Additionally,the volatility of the U.S. dollar to the British pound sterling and eurocontributed to the favorable variance. These favorable variances were offset, in part, by $0.2 million ofnon-recurring costs related to the consolidation of RO into our CXR Larusfacility and the costs of exiting the old premises.

 

*Engineering and product development*

 

The decrease in engineering and product developmentcosts is primarily due to reduced expenses for the development of the newTiemPoTM product line for which most of the costs were incurred in 2006.  Development costs incurred for this newproduct were $0.3 million for the nine months ended September 30, 2007 comparedto $0.5 million for the same period of 2006.

 

*Interest expense*

 

Interest expense was $0.5 million for the nine monthsended September 30, 2007 compared to $0.3 million for the nine months endedSeptember 30, 2006 due to increased loan balances for our U.S., U.K. and Frenchoperations and increased interest rates.

 

*Other income (expense)*

 

We generated other income of $0.5 million for the ninemonths ended September 30, 2007 compared to other expense of approximately $0.2million for the same period of 2006. Other income for the third quarter of 2007 included a one-time accrualreversal related to the satisfactory resolution of a legal dispute at ourFrench subsidiary, CXR AJ.  Other expensefor the third quarter of 2006 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 expense amounted to $0.5 million for thenine months ended September 30, 2007 compared to $0.4 million for the sameperiod of 2006.  Income tax expense isthe result of foreign income tax on foreign earned profits.

 

 

22

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*Net Loss*

 

We generated a net loss of $1.9 million and $2.0million for the nine months ended September 30, 2007 and 2006,respectively.  Our 2007 net loss positionhas remained relatively consistent with the net loss incurred for the prioryear.  Factors that contributed to the2007 net loss were the audit and legal costs incurred related to the re-auditand restatement of our 2003, 2004 and 2005 earnings, the costs incurred to movethe RO operations and exit the existing premises, the delays in stocking ordersfrom DSCC for our digital switches and the disruption in sales at RO as aresult of the consolidation of our RO and CXR Larus facilities and theconversion of the manufacturing of products to contract manufacturing offset bya one-time accrual reversal related to the satisfactory resolution of a legaldispute at our French subsidiary, CXRAJ.

**Liquidity and Capital Resources**

 

In making an assessment ofour liquidity, we believe that the items in our financial statements that aremost relevant are our working capital, cash generated from our operatingactivities and cash available from our financing activities.  We fund our daily cash flow requirementsthrough funds provided by operations and through borrowings from short-termrevolving credit facilities, both foreign and domestic. Working capital at September 30, 2007 was $7.6 million compared to $9.6million at December 31, 2006. The decrease in working capital is primarily theresult of decreases in our cash and accounts receivable balances and increasesin our inventory, accounts payable and accrued expenses balances.

 

Net cash used in operating activities for the ninemonths ended September 30, 2007 amounted to $1.6 million compared to $0.9million for the nine months ended September 30, 2006.  Significant sources of cash from operationswere a decrease in accounts receivable related to collections from customersand an increase in accounts payable as a result of slower timing of payment todomestic vendors related to a temporary cash deficit at our U.S.operations.  The most significant use ofcash from operations was related to increases in inventory primarily inanticipation of DSCC orders for switches, the build up of IFE&C product andTiemPoTM products expected to be shipped in the fourthquarter of 2007.

 

Other significant uses of cash during the nine monthsended September 30, 2007 include $0.6 million for investment in property, plantand equipment and repayment of loans.

Our backlog decreased to $24.9 million as ofSeptember 30, 2007 compared to $27.6 million as of September 30, 2006. The amount of backlog orders represents revenuethat we anticipate recognizing in the future, as evidenced by purchase ordersand other purchase commitments received from customers, but on which work hasnot yet been initiated or with respect to which work is currently in progress.Our backlog as of September 30, 2007 was approximately 94% related to our electronicdevices business, which business tends to provide us with long lead-times forour manufacturing processes due to the custom nature of the products, andapproximately 6% related to our communications equipment business, whichbusiness tends to deliver standard or modified standard products from stock asorders are received. We expect the majority of our current backlog is shippablewithin the next twelve months. However, there can be no assurance that we willbe successful in fulfilling such orders and commitments in a timely manner orthat we will ultimately recognize as revenue the amounts reflected as backlog.

 

*Contractual Obligations*

 

                We included in ourannual report on Form 10-K for the year ended December 31, 2006 a contractualobligations table that outlines payments due from us or our subsidiaries underour lines of credit, term loans and other significant contractual obligations through2011, exclusive of interest.  During thenine months ended September 30, 2007, no material changes in this informationoccurred outside the ordinary course of business.

 

As of September 30, 2007, outstanding borrowings andavailability under our revolving lines of credit were as follows (inthousands):

 

| ** **                                    | ** ** | **Outstanding** | ** ** | **Remaining**    | ** ** |
|-----------------------------------------------|------------|-----------------|------------|------------------|------------|
| ** **                                    | ** ** | **Borrowings**  | ** ** | **Availability** | ** ** |
|                                          |       |            |       |             |       |
| Line of credit  with a U.S. commercial lender |       | $               | 1,478      |             | $          | 584 |   |
| Lines of credit  with foreign banks           |       | 3,670           |       | 1,845            |       |
|                                          |       | $               | 5,148      |             | $          | 2,429 |   |

 

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Remaining availability is presented as of September30, 2007 and is affected by timing of advances, payments, collections andshipments.  In addition to the revolvinglines of credit, at September 30, 2007 we had term loans and capitalized leaseand equipment loan obligations of $2.1 million, the current portion of whichloans and obligations was $1.0 million.

 

                During the quarterended September 30, 2007, we entered into a note with one of our vendors, theamount of which may not exceed $300,000, relating to trade payables for rawmaterials recieved during 2007.  Pursuantto the terms of the note, we pledged 500,000 shares of restricted common stockas collateral to support the note.  As ofSeptember 30, 2007 the balance on the note was $165,000.

 

*Credit Facilities*

OnDecember 1, 2006, EMRISE Corporation, EEC, CXR Larus, RO and Wells Fargo Bank,acting through its Wells Fargo Business Credit operating division (“WFBC”),entered into to a Credit and Security Agreement (“WFBC credit facility”).  The WFBC credit facility provides for a $5.0million revolving line of credit that expires on December 1, 2009 and issecured by accounts receivable, other rights to payment and generalintangibles, inventories and equipment. The line of credit is formula-based and generally provides that theoutstanding borrowings under the line of credit may not exceed an aggregate of85% of eligible accounts receivable plus 10% of the value of eligible finishedgoods inventory.  Interest is payablemonthly.  The interest rate is variableand is adjusted monthly based on the prime rate plus 1%.  The prime rate at September 30, 2007 was7.75%.

TheWFBC credit facility is subject to an unused line fee equal to 0.25% per annum,payable monthly based on the average daily unused amount of the line of credit.The WFBC credit facility is also subject to a minimum monthly interest chargeof $8,500 with respect to the revolving line of credit.

IfWFBC terminates the WFBC credit facility during a default period, or if weterminate or reduce the WFBC credit facility prior to the maturity date, or ifwe prepay the term loan portion of the facility, we will be subject topenalties as follows: if the termination or prepayment occurs during the oneyear period after the initial funding date, the penalty is equal to 3% of themaximum line amount and/or prepayment amount; if the termination or prepaymentoccurs during second year after the initial funding date, the penalty is equalto 2% of the maximum line amount and/or prepayment amount; and if the terminationor prepayment occurs at any time after the second anniversary of the initialfunding date and prior to the maturity date, the penalty is equal to 1% of themaximum line amount and/or prepayment amount.

Inthe event of a default and continuation of a default, Wells Fargo mayaccelerate the payment of the principal balance, requiring us to pay the entireindebtedness outstanding on that date. From and after the maturity date of theWFBC credit facility, or any earlier date that all principal owing under theWFBC credit facility becomes due and payable by acceleration or otherwise, theoutstanding principal balance will bear interest until paid in full at anincreased rate per annum equal to 3% above the rate of interest in effect fromtime to time under the WFBC credit facility.

Weare subject to certain financial covenants associated with the WFBC creditfacility on a consolidated basis, including minimum net worth, minimum netincome (loss), and minimum debt service coverage ratio.  In August 2007, we amended the WFBC creditfacility to reset these covenants.  OnOctober 5, 2007, we entered into a Forbearance Agreement and Second Amendmentwith WFBC.  Under the terms of this secondamendment, WFBC agreed to forbear its rights with regard to the July 31, 2007covenant violations through December 31, 2007, provided that we meet certaintemporary financial covenants (collectively, the “Financial Tests”) during theforbearance period including minimum book net worth and minimum netincome.  The Financial Tests during theforbearance period are as follows:  thebook net worth, determined on a consolidated basis as of the end of eachcalendar month, commencing August 31, 2007 and continuing each calendar monththereafter, must be greater than $22,500,000 and for the quarter endingDecember 31, 2007, our net income must not be less than $125,000.  As of September 30, 2007, we were incompliance with the Financial Tests. WFBC is currently in the process of resetting the covenants for 2008.

OnJuly 8, 2005, XPS and Pascall obtained a credit facility with Lloyds TSBCommercial Finance Limited (“Lloyds”) that provides a revolving loan secured byreceivables, with a maximum availability of 2.1 million British pounds sterling(approximately $4.2 million based on the exchange rate in effect on September30, 2007).

 

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The annual interest rate on the revolving loan is 1.5%above the Lloyds TSB base rate. The Lloyds TSB base rate was 5.75% at September30, 2007.  The financial covenantsinclude a 50% cap on combined export gross sales of XPS and Pascall and dayssales outstanding of less than 65 days, and the funding balance is capped at125% of XPS and Pascall combined gross sales. This facility can be terminated by either party with 90 days’notice.  We are not aware of anytermination notice or expected termination notice by either party.

InApril 2003, CXR-AJ obtained a credit facility from IFN Finance, a subsidiary ofABN AMRO N.V. This credit facility is for a maximum of $1.2 million based onthe exchange rate in effect at September 30, 2007 for the conversion of eurosinto U.S. dollars. CXR-AJ also had approximately $21,000 of term loans withanother French bank outstanding as of September 30, 2007. The IFN Finance facilityis secured by accounts receivable and carries an annual interest rate of 1.6%above the French “T4M” rate. At September 30, 2007, the French T4M rate was4.4%, and this facility in addition to small loans with other banks had abalance of $1.3 million. This facility has no financial performance covenants.Availability on the IFN Finance credit line was $0.6 million as of September30, 2007, in addition to approximately $37,000 availability with several otherbanks.

OnNovember 7, 2007, we secured a commitment letter from GVEC Resource IV, Inc.,an affiliate of Private Equity Management Group (“PEM Group”), to provide athree year global debt facility (the “Financing Transaction”).  The facility totals $23 million comprised ofa $7 million formula-based revolving credit facility, a $6 million term loan,which funds entirely at the time of closing, and a $10 million line of creditto be used exclusively for purposes of acquisitions.  Proceeds from the credit facility and theterm loan will be used to repay existing institutional debt and to fund workingcapital.  The interest rate on the revolvingcredit facility is variable at the prime rate as published in the “Money Rates”column of the Wall Street Journal plus 1.25% subject to a minimum of 9.5%.  The interest rate on the term loan andacquisition line is variable at the prime rate plus 4.25% subject to a minimumof 12.5%.  The term loan and, if used,the acquisition line require interest only payments in the first year andscheduled principal and interest payments in years two and three with theremaining principal balance due upon maturity of the term loan.  The Financing Transaction is expected toclose on or before December 7, 2007.  Inconnection with the Financing Transaction, we will issue to PEM Group a warrantto purchase 2,909,091 shares of our common stock at an exercise price of $1.10per share.  The warrants will expire inseven years.  The closing of the FinancingTransaction is subject to acceptable final documentation and customary closingconditions.  No assurances can be giventhat we will be successful in completing the Financing Transaction.

Weintend to grow our business through both internal growth and furtheracquisitions or mergers. Any additional acquisitions would likely be fundedprimarily through the use of cash and/or a combination of cash, seller providednotes, and additional third-party debt. Although these acquisitions may also include an equity component; ourintent is to minimize the use of equity in any such transactions.  In any case, our focus would be onacquisitions or mergers that we identify as being potentially both synergisticand accretive of our earnings.

 

Due to the significant accounting, legal fees andother costs incurred in 2006 and 2007 associated with our 2005/2006 re-auditand restatement and the losses incurred throughout 2007 in our domesticoperations, we experienced a cash flow deficit at our U.S. operations beginningin the second quarter of 2007 and continuing through the third quarter of 2007.   As of September 30, 2007, the combined U.S.operations were cash flow neutral.  Weanticipate that the combined U.S. operations will be cash flow neutralthroughout the remainder of 2007.  Ourdomestic operations are past due with some of our key vendors in the U.S.  We have negotiated extended payment termswith certain key vendors.  In most cases,we have continued to receive products in a timely manner from all key vendors,however some disruptions in sales have occurred as a result of the domesticU.S. cash flow situation, particularly at RO and our CXR Larus operations. As aresult of the pending PEM Group financing discussed above, we expect the cashflow situation in the U.S. to significantly improve in the fourth quarter of2007 and we expect to pay all past due bills invoices with our domestic vendorswhich should minimize the risk of ongoing or future disruptions due to cashflow constraints.

 

Throughout 2006 and continuing in 2007, we haveutilized the positive cash flow from our foreign subsidiaries and leveragedexisting lending relationships with Lloyds and other foreign-based banks tohelp fund the cash flow deficit in the U.S. Due to the pending PEM Group financing transaction discussed above, wedo not expect to continue to need this level of support from our foreignsubsidiaries in the future.

 

 

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Overall, we believe that the new pending financestructure to be provided by PEM Group will be adequate to meet our anticipatedshort term and working capital needs for at least the next 24 months. If,however, the PEM Group financing is delayed or does not conclude for anyreason, then our working capital situation in the U.S. will likely continue tobe a challenge and could result in the continued and/or ongoing disruptions ofsales, particularly at our RO and our CXR Larus operations.  Our failure to secure the PEM Group or otheralternative credit facility could restrict our growth, limit our development ofnew products, limit our ability to secure acquisitions, or hinder our abilityto compete.

** **

**Effectsof Inflation**

The impact of inflation and changing prices has not beensignificant on the financial condition or results of operations of either ourcompany or our operating subsidiaries.

** **

**Impactsof New Accounting Pronouncements**

OnJanuary 1, 2007, we adopted Financial Accounting Standards Board (“FASB”)Financial Interpretation No. (“FIN”) 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASBStatement No. 109.” FIN 48 clarifies the accounting for theuncertainty in recognizing income taxes in an organization in accordance withFASB Statement No. 109 by providing detailed guidance for financial statementrecognition, measurement and disclosure involving uncertain tax positions. FIN 48 requires an uncertain tax position to meet a more-likely-than-notrecognition threshold at the effective date to be recognized both upon theadoption of FIN 48 and in subsequent periods.  The implementation of FIN 48 did not result ina material effect on our financial statements. See Note 6 — Income Taxes in the Notes to Consolidated FinancialStatements in this Form 10-Q.

InSeptember 2006, the FASB issued SFAS No. 157, “**Fair Value Measurements**.” This new statementprovides a single definition of fair value, together with a framework formeasuring it, and requires additional disclosure about the use of fair value tomeasure assets and liabilities. SFAS No. 157 also emphasizes that fairvalue is a market-based measurement, not an entity-specific measurement, andsets out a fair value hierarchy, with the highest priority being quoted pricesin active markets. The required effective date of SFAS No. 157 is the firstquarter of 2008. We currently are evaluating the effect this statement may haveon our consolidated financial statements.

InFebruary 2007, the FASB issued SFAS No. 159, “**The Fair Value Option for Financial Assets and Financial Liabilities”***.*SFAS No. 159 permits an entity to irrevocably elect fairvalue on a contract-by-contract basis as the initial and subsequent measurementattribute for many financial assets and liabilities and certain other items including insurance contracts.Entities electing the fair value option would be required to recognize changesin fair value in earnings and to expense up front cost and fees associated withthe item for which the fair value option is elected. SFAS No. 159 is effectivefor fiscal years beginning after November 15, 2007. We currently are evaluatingthe effect that adoption of SFAS No. 159 would have on our financial conditionor results of operations.

 

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

Foreign Currency Exchange Risk

We have international subsidiariesthat prepare their balance sheets in the relevant foreign currency. In order tobe included in our consolidated financial statements, these balance sheets areconverted, at the then current exchange rate, into U.S. dollars, and thestatements of operations are converted using weighted average exchange ratesfor the applicable period.  Foreigncurrency fluctuations also affect our foreign currency cash flows related tothird party purchases, intercompany loans, and product shipments. We are alsoexposed to the translation of foreign currency earnings to the U.S. dollar. Ourprincipal exposures are to British pound sterling, Euro, and to a lesserextent, the Japanese yen.

 

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SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities,” as amended,establishes accounting and reporting standards requiring that every derivativeinstrument be recorded in the balance sheet as either an asset or a liabilitymeasured at its fair value. SFAS No. 133 also requires that changes in thederivative’s fair value be recognized currently in earnings unless specifichedge accounting criteria are met, and that a company must formally document,designate and assess the effectiveness of transactions that receive hedgeaccounting. We currently use derivatives to manage foreign currency rate risk.

In particular, one of our U.K. subsidiaries, whosefunctional currency is the British pound sterling, conducts business in Britishpounds sterling, U.S. dollar and Euro, which creates foreign currency exchangerisk.  This subsidiary has a programwhereby they utilize forward currency contracts denominated in U.S. dollars tooffset the risk associated with the effects of currency exposure for sales inU.S. dollars.  Under this program,increases or decreases in the subsidiary’s foreign currency exposure are offsetby gains or losses on the forward contracts, to mitigate the possibility offoreign currency translationgains or losses.  These forward contractsgenerally have terms of 180 days or less. We do not use these forward contracts for trading or speculativepurposes.  All outstanding foreigncurrency forward contracts used in this program are marked to market at the endof each reporting period with unrealized gains and losses included in otherincome and expense.

Our ultimate realized gain or loss with respect to currencyfluctuations will depend on the currency exchange rates and other factors ineffect as the contracts mature.  Netforeign exchange translationgains and losses included in other income and expense in the accompanying condensedconsolidated statements of operations were gains of approximately $119,000 andlosses of approximately $142,000 for the nine months ended September 30, 2007and 2006, respectively.

***Interest Rate Sensitivity***

A substantial portion of our notes payableand long-term debt have variable interest rates based on the prime interestrate and/or the lender’s base rate, which exposes us to risk of earnings lossdue to changes in such interest rates.  Our amended annualreport on Form 10-K for the year ended December 31, 2006 contains informationabout our debt obligations that are sensitive to changes in interest ratesunder “Item 7A. Quantitative and Qualitative Disclosures About Market Risk.”There were no material changes in those market risks during the nine monthsended September 30, 2007.

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

***Evaluationof Disclosure Controls and Procedures***

Weconducted an evaluation under the supervision and with the participation of ourChief Executive Officer, who is our principal executive officer, and VicePresident of Finance and Administration, who is our principal financialofficer, of the effectiveness of the design and operation of our disclosurecontrols and procedures.  The term “disclosurecontrols and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended (“Exchange Act”), means controlsand other procedures of a company that are designed to ensure that informationrequired to be disclosed by the company in the reports filed or submitted by itunder the Exchange Act is recorded, processed, summarized and reported, withinthe time periods specified in the Securities and Exchange Commission’s rulesand forms.  Disclosure controls andprocedures also include, without limitation, controls and procedures designedto ensure that information required to be disclosed by a company in the reportsfiled or submitted by it 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 our Vice President of Finance and Administration have concluded asof September 30, 2007 that our disclosure controls and procedures wereeffective at a reasonable assurance level.

 

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* Changes in InternalControl Over Financial Reporting*

Management concluded as of December31, 2006 in our Annual Report on Form 10-K (“Annual Report”), for the year thenended, that our internal control over financial reporting was noteffective.  You should refer tomanagement’s discussion under “Item 9A—Controls and Procedures” in our AnnualReport for a complete description of the criteria applied by management and thefactors based upon which management concluded that our internal control overfinancial reporting was not then effective.

Inour Annual Report, management identified the following two material weaknessesin our internal control over financial reporting:

1.             We didnot have a sufficient complement of personnel with appropriate training andexperience in accounting principles generally accepted in the United States ofAmerican (“GAAP”) and with Securities and Exchange Commission disclosurerequirements.

2.             Welacked procedures to ensure that our principal accounting and financial officercan closely monitor information submitted to our corporate headquarters by oursubsidiaries and oversee accounting for reserves and other areas that involvesignificant judgment at all of our locations. We also lacked procedures to ensure that personnel familiar with GAAPand with Securities and Exchange Commission disclosure requirements canthoroughly evaluate activities and transactions at all of our locations inorder to make all required disclosures in a timely manner.

During the third quarter of 2007, we implemented a varietyof changes to our internal control over financial reporting intended toremediate these material weaknesses. Based on management’s evaluation of the effectiveness of the design andoperation of our disclosure controls and procedures, our Chief ExecutiveOfficer and Vice President of Finance and Administration concluded that, as ofSeptember 30, 2007, all material weakness identified above had been fullyremediated.

Because of thepossibility of changed circumstances between now and year-end, and because theevaluation of our internal control over financial reporting that will berequired under Section 404 of the Sarbanes-Oxley Act of 2002 in connection withour annual audit is more comprehensive and rigorous than the evaluation weperformed for the quarterly period ended September 30, 2007, we cannot assure youthat management will not identify material weaknesses in our internal controlover financial reporting and conclude that our disclosure controls andprocedures were not effective at a reasonable assurance level and that we didnot maintain effective internal control over financial reporting as of December31, 2007.

Following is a summary description of the changes inour internal control over financial reporting implemented during the quarterended September 30, 2007 and, in one case, prior to commencement of the quarterended September 30, 2007.

With respect to the firstmaterial weakness identified above, effective May 16, 2007, D. John Donovan wasappointed as our Vice President of Finance and Administration.  Mr. Donovan assumed the role of principal financialand accounting officer on that date. Also in May 2007, we established the position of and appointed a newCorporate Controller for our U.S. operations. Mr. Donovan and the new Corporate Controller each have expertise inpublic company financial reporting compliance. We believe we now have a sufficient complement of personnel withappropriate training and experience in GAAP and Securities and ExchangeCommission disclosure requirements.

 

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With respect to thesecond material weakness identified above, through the efforts of our VicePresident of Finance and Administration and Corporate Controller we developedpolicies and procedures, including an adequate supervisory structure, necessaryto ensure that our principal accounting and financial officer can closelymonitor financial information throughout our company and oversee all accountingthat involves significant judgment on the part of personnel located at ouroperating subsidiaries, within the U.S., Europe and Asia.  In addition, our Vice President of Financeand Administration and Corporate Controller established policies and proceduresnecessary to ensure that personnel familiar with GAAP and with Securities andExchange Commission disclosure requirements are capable of evaluatingactivities and transactions at all of our operating subsidiaries in order tomake all required disclosures in a timely manner. Our Vice President of Financeand Administration and Corporate Controller work closely with our Director ofFinancial Controls for Europe, whom we hired in late 2005 to oversee our threeEuropean Controllers and who reports to our Vice President of Finance andAdministration, on these matters.

The changes noted above are theonly changes during our most recently completed fiscal quarter that havematerially affected or are reasonably likely to materially affect, our internalcontrol over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f)under the Exchange Act.

***InherentLimitations on the Effectiveness of Controls***

Managementdoes not expect that our disclosure controls and procedures or our internalcontrol over financial reporting will prevent or detect all errors and allfraud. A control system, no matter how well conceived and operated, can provideonly reasonable, not absolute, assurance that the objectives of the controlsystems are met. Further, the design of a control system must reflect the factthat there are resource constraints, and the benefits of controls must beconsidered relative to their costs. Because of the inherent limitations in acost-effective control system, no evaluation of internal control over financialreporting can provide absolute assurance that misstatements due to error orfraud will not occur or that all control issues and instances of fraud, if any,have been or will be detected.

These inherent limitations include the realities thatjudgments in decision-making can be faulty and that breakdowns can occurbecause of a simple error or mistake. Controls can also be circumvented by theindividual acts of some persons, by collusion of two or more people, or bymanagement override of the controls. The design of any system of controls isbased in part on certain assumptions about the likelihood of future events, andthere can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions. Projections of any evaluation ofcontrols effectiveness to future periods are subject to risks. Over time,controls may become inadequate because of changes in conditions ordeterioration in the degree of compliance with policies or procedures.

 

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**PART II — OTHER INFORMATION**

**ITEM 1.      LEGAL PROCEEDINGS.**

Variouslegal actions and claims may arise against us in the ordinary course ofbusiness. In the opinion of management, the ultimate resolution of suchpossible legal actions and claims will not have a material adverse effect onour consolidated financial position or our results of operations.

**ITEM 1A.   RISK FACTORS.**

Item1A of Part I of our Form 10-K for the year ended December 31, 2006 summarizesvarious material risks that investors should carefully consider before decidingto buy or maintain an investment in our common stock.  Any of those risks, if they actually occur,would likely harm our business, financial condition and results of operationsand could cause the trading price of our common stock to decline.  There are no material changes to the riskfactors set forth in the above-referenced report*.*

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

** **

**Recent Sales of Unregistered 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.  In addition, our credit facility with WFBC,described in “Management’s Discussion and Analysis of Financial Condition andResults of Operations — Liquidity and Capital Resources,” restricts the paymentof dividends without the bank’s consent.

We will pay dividends on our common stock only if and whendeclared by our board of directors.  Ourboard of directors’ ability to declare a dividend is subject to restrictionsimposed by Delaware law.  In determiningwhether to declare dividends, the board of directors will consider theserestrictions as well as our financial condition, results of operations, workingcapital requirements, future prospects and other factors it considers relevant.

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

None.

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

None

 

 

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

Effectiveas of November 1, 2007, the Company entered into new employment agreements withCarmine T. Oliva, Graham Jeffries, and D. John Donovan.  The new employment agreements replaced theMay 16, 2007 agreement with Mr. Donovan and the February 24, 2006 agreementswith Mr. Oliva and Mr. Jeffries, and are described generally below.

Carmine T. Oliva

Underthe November 1, 2007 executive employment agreement with Mr. Oliva, Mr.Oliva has agreed to serve as our Chairman of the Board, President and ChiefExecutive Officer on an at-will basis. The agreement provides for a base salaryof $350,000, paid vacation of at least four weeks per year, a monthlyautomobile allowance of at least $750, and non-exclusive use of our corporateresidence. Mr. Oliva is eligible to receive increases and annual cash incentivebonuses at the discretion of our compensation committee and to participate inbenefit and incentive programs we may offer. We have agreed to nominate Mr.Oliva as a Class III member of our board and to seek stockholder approval ofthe nomination at our 2008 annual meeting of stockholders.  We have also agreed to maintain in effect adirectors’ and officers’ liability insurance policy with a minimum limit ofliability of $10 million and that we would enter into an indemnificationagreement with Mr. Oliva upon terms mutually acceptable to us and Mr. Oliva.

Theagreement contains non-competition provisions that prohibit Mr. Oliva fromengaging or participating in a competitive business or soliciting our customeror employees during his employment with us and for two years afterward. Theagreement also contains provisions that restrict disclosure by Mr. Oliva of ourconfidential information and assign ownership to us of inventions related toour business that are created by him during his employment and for two yearsafterward.

Wemay terminate the agreement at any time, with or without due cause. “Due cause”includes any intentional misapplication of our funds or other material assets,or any other act of dishonesty injurious to us, or conviction of a felony or acrime involving moral turpitude. “Due cause” also includes abuse of controlledsubstances or alcohol and breach, nonperformance or nonobservance of any of theterms of the agreement, provided that Mr. Oliva fails to satisfactorilyremedy the performance problem following 30 days’ written notice.

Mr.Oliva may terminate the agreement at any time, with or without good reason.However, termination for good reason must occur within 90 days of theoccurrence of an event constituting good reason, and Mr. Oliva must furnish uswith written notice of the event within 30 days after the initial existence ofthe event and provide us with at least a 30-day cure period. “Good reason”includes: a material diminution in his authority, duties, responsibilities,titles or offices; a purported reduction in Mr. Oliva’s base salaryamounting to a material diminution in his salary to an amount less than thegreater of $350,000 or 10% below the base salary in effect at the time of thereduction; our failure to timely cure or diligently initiate a cure of anymaterial breach within 30 days after Mr. Oliva gives us written notice ofthe breach.

Ifwe terminate Mr. Oliva’s employment for due cause or due to Mr. Oliva’sbreach of his employment agreement by refusing to continue his employment, orif Mr. Oliva terminates his employment without good reason, then allcompensation and benefits for Mr. Oliva will cease, other than amounts underretirement and benefit plans and programs that were earned and vested by thedate of termination, pro rata annual salary through the date of termination,any stock options that were vested as of the date of termination, and accruedvacation as required by California law.

IfMr. Oliva becomes incapacitated, we may terminate his employment under theagreement upon 30 days’ prior written notice. Upon Mr. Oliva’s death, the agreement terminates immediately. IfMr. Oliva’s employment terminates due to his incapacity or death, Mr. Olivaor his estate or legal representative will be entitled to receive benefitsunder our retirement and benefits plans and programs that were earned andvested at the date of termination, a pro rated incentive bonus for the fiscalyear in which incapacity or death occurred (to

 

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the extent he wouldotherwise be eligible), and a lump sum cash payment in an amount equal to oneyear of his then current annual salary, grossed up to cover applicable taxesthat are deducted from such amount.

IfMr. Oliva’s employment terminates for good reason or other than as a result ofdue cause, incapacity, death or retirement, Mr. Oliva will be entitled to hissalary through the end of the month in which termination occurs plus credit foraccrued vacation, and a pro rated incentive bonus, if eligible, for the fiscalyear during which termination occurred. In addition, under those circumstances,if Mr. Oliva enters into a separation and release agreement with us, then he willbe entitled to receive (i) a severance payment equal to three times his thencurrent annual salary (grossed up to cover applicable taxes that are deductedfrom such amount), (ii) all medical insurance benefits to which he wasentitled immediately prior to the date of termination for a period of eighteenmonths or the date that Mr. Oliva’s continued participation in our medicalinsurance plan was not possible under the plan, whichever was earlier,(iii) a lump-sum cash payment equal to eighteen times the estimatedmonthly COBRA premiums at the time of termination (taking into account allknown or anticipated premiume increases) to be used by Mr. Oliva to maintainhis medical insurance coverage for an additional eighteen months, and(iv) a lump-sum cash payment equal to thirty-six times the estimatedmonthly life insurance premiums at the time of termination (taking into accountall known or anticipated premium increases) to be used by Mr. Oliva tomaintain his existing group life insurance coverage and the $1,000,000 lifeinsurance policy on his life for three years. If our medical insurance plan did not allow Mr. Oliva’s continuedparticipation, then we will be required to pay to Mr. Oliva, in monthlyinstallments, the monthly premium or premiums for COBRA coverage, covering theeighteen month period described in clause (ii) in the preceding sentence.

Immediatelypreceding the occurrence of a change in control, and regardless of whetherMr. Oliva’s employment terminates and/or he receives severance payments asa result of the change in control, Mr. Oliva will be entitled to receive apayment equal to three times his then current annual salary (grossed up tocover applicable taxes that are deducted from such amount). A “change incontrol” includes the following circumstances:

(a)                                 the acquisition by any person or group ofbeneficial ownership of securities entitled to vote generally in the electionof our directors (“voting securities”) that represent 40% or more of thecombined voting power of our then outstanding voting securities or 50% or moreof the combined fair market value of our then outstanding stock, other than:

(i)                          an acquisition by a trustee or otherfiduciary holding securities under any employee benefit plan (or related trust)sponsored or maintained by us or any person controlled by us or by any employeebenefit plan (or related trust) sponsored or maintained by us or any personcontrolled by us, or

(ii)                       an acquisition of voting securities by usor a corporation owned, directly or indirectly, by our stockholders insubstantially the same proportions as their ownership of our stock;

Notwithstandingcircumstance (a) above, however, if we make an acquisition of our securitiesthat (x) causes our voting securities beneficially owned by a person or groupto represent 40% or more of the combined voting power of our then outstandingvoting securities or (y) causes our stock beneficially owned by a person orgroup to represent 50% or more of the combined fair market value of our thenoutstanding stock, the acquisition will not be considered an acquisition by anyperson or group for purposes of circumstance (a) unless the person or groupsubsequently becomes the beneficial owner of additional securities of ours.

(b)                                a majority of members of our board isreplaced during any 12-month period by directors whose appointment or electionis not endorsed by a majority of members of our board before the date of theappointment or election, excluding any individual whose initial assumption ofoffice occurs as a result of an actual or threatened election contest withrespect to the election or removal of directors or other actual or threatenedsolicitation of proxies or consents by or on behalf of a person other than ourboard;

(c)                                 the acquisition by any person or group, orcombined acquisitions during the 12-month period ending on the date of the mostrecent acquisition by such person or group, of ownership of assets

                                               from us that have a total gross fairmarket value equal to or more than 40% of the total gross fair market value ofall of our assets immediately before such acquisition; and

 

 

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(d)                                stockholder approval of a completeliquidation or dissolution of our company.

Forpurposes of circumstance (a) above, the calculation of voting power will bemade as if the date of the acquisition were a record date for a vote of ourstockholders, and for purposes of circumstance (c) above, the calculation ofvoting power will be made as if the date of the consummation of the transactionwere a record date for a vote of our stockholders.

Notwithstandingthe above, there will be no change in control event when there is a transfer toan entity that is controlled by our stockholders immediately after thetransfer.  A transfer of assets by us isnot treated as a change in control if the assets are transferred to: astockholder of ours (immediately before the asset transfer) in exchange for orwith respect to the stockholders’ stock; an entity, 50% or more of the totalvalue or voting power of which is owned, directly or indirectly, by us; aperson or group that owns, directly or indirectly, 50% or more of the totalvalue or voting power of all of our outstanding stock; or an entity, at least50% of the total value or voting power of which is owned, directly orindirectly, by a person or group described in the immediately preceding clause.

Graham Jefferies

Underthe November 1, 2007 executive employment agreement with Mr. Jefferies,Mr. Jefferies has agreed to serve as our Executive Vice President and ChiefOperating Officer on an at-will basis. The agreement provides for a base salary of 152,800 British poundssterling per year (approximately $316,600 as of November 1, 2007), whichamount is to be paid by our subsidiary, EMRISE Electronics Ltd., paid vacationof 25 working days per year and public holidays in the United Kingdom, and amonthly automobile allowance of at least 460 British pounds sterling.  Mr. Jefferies is eligible to receiveincreases and annual cash incentive bonuses at the discretion of ourcompensation committee and to participate in benefit and incentive programs wemay offer. We have also agreed to maintain in effect a directors’ and officers’liability insurance policy with a minimum limit of liability of $10 million andthat we would enter into an indemnification agreement with Mr. Jefferies uponterms mutually acceptable to us and Mr. Jefferies.

Theagreement contains non-competition provisions that prohibit Mr. Jefferies fromengaging or participating in a competitive business or soliciting our customeror employees during his employment with us and for two years afterward. Theagreement also contains provisions that restrict disclosure by Mr. Jefferies ofour confidential information and assign ownership to us of inventions relatedto our business that are created by Mr. Jefferies in connection with hisemployment and for two years afterward.

Mr.Jefferies may terminate the agreement at any time, with or without good reason.However, termination for good reason must occur within 30 days of theoccurrence of an event constituting good reason. The term “good reason” has thesame meaning as in Mr. Oliva’s employment agreement described above, exceptthat Mr. Jefferies’ base salary is 152,800 British pounds sterling per year.

Wemay terminate the agreement at any time, immediately upon written notice, withor without due cause. The term “due cause” has the same meaning as in Mr. Oliva’semployment agreement described above, except that Mr. Jefferies maysatisfactorily remedy the performance problem following 90 days’ writtennotice. If we terminate Mr. Jefferies’ employment for due cause or due toMr. Jefferies’ breach of his employment agreement by refusing to continue hisemployment, or if Mr. Jefferies terminates his employment without good reason,then all compensation and benefits for Mr. Jefferies will cease, other thanamounts under retirement and benefit plans and programs that were earned andvested by the date of termination, pro rata annual salary through the date oftermination, and any stock options that were vested as of the date oftermination, and accrued vacation as required by applicable law.

 

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IfMr. Jefferies becomes mentally or physically incapable of performing theservices required under the agreement for a period of 180 consecutive days, theagreement terminates; provided, however, that Mr. Jefferies will remain anemployee of EMRISE Electronics Ltd. and be entitled to remuneration in anamount equal to the amount paid under EMRISE Electronics Ltd.’s permanenthealth insurance scheme, subject to the paragraph immediately below. Upon Mr.Jefferies’ death, the agreement terminates immediately.

IfMr. Jefferies’ employment terminates due to his incapacity or death, Mr.Jefferies or his estate or legal representative will be entitled to receivebenefits under our retirement and benefits plans and programs that were earnedand vested at the date of termination, a pro rated incentive bonus for thefiscal year in which incapacity or death occurred (to the extent he wouldotherwise be eligible), and a lump sum cash payment in an amount equal to oneyear of his then current annual salary, grossed up to cover applicable taxesthat are deducted from such amount.

IfMr. Jefferies’ employment terminates for good reason or other than as a resultof due cause, incapacity, death or retirement, Mr. Jefferies will be entitledto his salary through the end of the month in which termination occurs pluscredit for accrued vacation, and a pro rated incentive bonus, if eligible, forthe fiscal year during which termination occurred. In addition, under thosecircumstances, if Mr. Jefferies enters into a separation and release agreementwith us, then he will be entitled to receive a severance payment equal to twotimes his then current annual salary (grossed up to cover applicable taxes thatare deducted from such amount), to receive all medical and life insurance benefits to which he was entitledimmediately prior to the date of termination (or at the election ofMr. Jefferies in the eventof a change in control, immediately prior to the date of the change in control)for a period of two years or the date or dates that Mr. Jefferies’ continued participation in our medical and/orlife insurance plans was not possible under the plans, whichever wasearlier.  If our medical and/or lifeinsurance plans did not allow Mr. Jefferies’ continued participation, then wewill be required to pay to Mr. Jefferies, in monthly installments, the monthly premiumor premiums that had been payable by us covering the two-year period.

Immediatelypreceding the occurrence of a change in control, and regardless of whetherMr. Jefferies’ employment terminates and/or he receives severance paymentsas a result of the change in control, Mr. Jefferies will be entitled to receivea payment equal to two times his then current annual salary (grossed up tocover applicable taxes that are deducted from such amount). The term “change incontrol” has the same meaning as in Mr. Oliva’s employment agreementdescribed above.

D. John Donovan

Underthe November 1, 2007 executive employment agreement with Mr. Donovan, Mr.Donovan has agreed to serve as our Vice President Finance and Administration,Secretary and Treasurer on an at-will basis. The agreement provides for aninitial base salary of $223,000 during the first six months of employmentfollowed by a 10% increase to his base salary to $245,300, an objective-basedadditional cash compensation for up to $20,000 during the first seven months ofemployment to be awarded based solely on the CEO’s determination (and payableas to one-half of this amount, if at all, on November 30, 2007 and May 1,2008), reimbursement for up to $5,000 per year for Certified Public Accountantcontinuing professional education programs, paid vacation of at least threeweeks per year, and a monthly automobile allowance of at least $600. Mr.Donovan is eligible to receive increases and annual cash incentive bonuses atthe discretion of our compensation committee and to participate in benefit andincentive programs we may offer.  We havealso agreed to maintain in effect a directors’ and officers’ liabilityinsurance policy with a minimum limit of liability of $10 million and that wewould enter into an indemnification agreement with Mr. Donovan upon termsmutually acceptable to us and Mr. Donovan.

Theagreement contains non-competition provisions that prohibit Mr. Donovan fromengaging or participating in a competitive business or soliciting our customeror employees during his employment with us and for two years afterward. Theagreement also contains provisions that restrict disclosure by Mr. Donovan ofour confidential information and assign ownership to us of inventions relatedto our business that are created by him during his employment and for two yearsafterward.

Mr.Donovan may terminate the agreement at any time, with or without good reason.However, termination for good reason must occur within 90 days of theoccurrence of an event constituting good reason, and Mr. Donovan must furnishus with written notice of the event within 30 days after the initial existenceof the event and provide us with at least a 30-day cure period. The term “goodreason” has the same meaning as in Mr. Oliva’s employment agreement describedabove, except that Mr. Donovan’s initial base salary is $223,000 during thefirst six months of employment, and $245,300 thereafter per year.

 

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Ifwe terminate Mr. Donovan’s employment for due cause or due to Mr. Donovan’sbreach of his employment agreement by refusing to continue his employment, orif Mr. Donovan terminates his employment without good reason, then allcompensation and benefits for Mr. Donovan will cease, other than amounts underretirement and benefit plans and programs that were earned and vested by thedate of termination, pro rata annual salary through the date of termination,any stock options that were vested as of the date of termination, and accruedvacation as required by California law.

IfMr. Donovan becomes incapacitated, we may terminate his employment under theagreement upon 30 days’ prior written notice. Upon Mr. Donovan’s death, the agreement terminates immediately. IfMr. Donovan’s employment terminates due to his incapacity or death, Mr.Donovan or his estate or legal representative will be entitled to receivebenefits under our retirement and benefits plans and programs that were earnedand vested at the date of termination, a pro rated incentive bonus for thefiscal year in which incapacity or death occurred (to the extent he wouldotherwise be eligible), and a lump sum cash payment in an amount equal to oneyear of his then current annual salary, grossed up to cover applicable taxesthat are deducted from such amount.

IfMr. Donovan’s employment terminates for good reason or other than as a resultof due cause, incapacity, death or retirement, Mr. Donovan will be entitled tohis salary through the end of the month in which termination occurs plus creditfor accrued vacation, and a pro rated incentive bonus, if eligible, for thefiscal year during which termination occurred. In addition, under thosecircumstances, if Mr. Donovan enters into a separation and release agreementwith us, then he will be entitled to receive (i) a severance payment equal tohis then current annual salary (grossed up to cover applicable taxes that arededucted from such amount), (ii) all medical insurance benefits to whichhe was entitled immediately prior to the date of termination for a period ofeighteen months or the date that Mr. Donovan’s continued participation in ourmedical insurance plan was not possible under the plan, whichever was earlier,and (iii) a lump-sum cash payment equal to $1,650 to be used byMr. Donovan to maintain his existing life insurance coverage for a period of eighteen months.  If our medical insurance plan did not allowMr. Donovan’s continued participation, then we will be required to pay to Mr.Donovan, in monthly installments, the monthly premium or premiums for COBRAcoverage, covering the eighteen month period described in clause (ii) in thepreceding sentence.

Immediatelypreceding the occurrence of a change in control, and regardless of whetherMr. Donovan’s employment terminates and/or he receives severance paymentsas a result of the change in control, Mr. Donovan will be entitled to receive apayment equal to his then current annual salary (grossed up to cover applicabletaxes that are deducted from such amount).

Theterms “due cause” and “change in control” have the same meaning as inMr. Oliva’s employment agreement described above.

The newemployment agreements are included as exhibits to this Quarterly Report on Form10-Q.

 

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

 
| **Number** | ** ** | **Description**                                                                                                                                                                                          |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                     |
| 10.1       |       | Executive  Employment Agreement effective as of November 1, 2007 by and between the  Registrant and Carmine T. Oliva                                                                                     |
|       |       |                                                                                                                                                                                                     |
| 10.2       |       | Executive Employment  Agreement effective as of November 1, 2007 by and between the  Registrant and Graham Jeffries                                                                                      |
|       |       |                                                                                                                                                                                                     |
| 10.3       |       | Executive Employment  Agreement effective as of November 1, 2007 by and between the  Registrant and D. John Donovan                                                                                      |
|       |       |                                                                                                                                                                                                     |
| 31.1       |       | Certification of  Principal Executive Officer Required by Rule 13a-14(a) of the Securities  Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                                                                                                                     |
| 31.2       |       | Certification of  Principal Financial Officer Required by Rule 13a-14(a) of the Securities  Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                                                                                                                     |
| 32.1       |       | Certification of  Principal Executive Officer and Principal Financial Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002            |

 

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**SIGNATURES**

Pursuant to the requirements of the Securities Exchange Actof 1934, the registrant has duly caused this report to be signed on its behalfby the undersigned thereunto duly authorized.

 
|                     | EMRISE  CORPORATION |
|--------------------------|---------------------|
|                     |                |   |
| Dated: November 12, 2007 | By:                 | /S/ CARMINE T. OLIVA |
|                     |                | Carmine T. Oliva, |
|                     |                | Chief Executive Officer, (duly  authorized officer) |
|                     |                |   |
|                     |                |   |
| Dated: November 12, 2007 | By:                 | /S/ D. JOHN DONOVAN |
|                     |                | D. John Donovan, Vice President of  Finance and |
|                     |                | Administration (principal  financial officer) |

 

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**INDEX TO EXHIBITS ATTACHED TOTHIS REPORT**

 
| **Number** | ** ** | **Description**                                                                                                                                                                                          |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                     |
| 10.1       |       | Executive Employment  Agreement effective as of November 1, 2007 by and between the  Registrant and Carmine T. Oliva                                                                                     |
|       |       |                                                                                                                                                                                                     |
| 10.2       |       | Executive Employment  Agreement effective as of November 1, 2007 by and between the  Registrant and Graham Jeffries                                                                                      |
|       |       |                                                                                                                                                                                                     |
| 10.3       |       | Executive Employment  Agreement effective as of November 1, 2007 by and between the  Registrant and D. John Donovan                                                                                      |
|       |       |                                                                                                                                                                                                     |
| 31.1       |       | Certification of  Principal Executive Officer Required by Rule 13a-14(a) of the Securities  Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                                                                                                                     |
| 31.2       |       | Certification of  Principal Financial Officer Required by Rule 13a-14(a) of the Securities  Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                                                                                                                     |
| 32.1       |       | Certification of  Principal Executive Officer and Principal Financial Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002            |

 

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