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**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-K**

 

**(Mark One)**
| **x**      | **ANNUAL REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                        |
|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                                                                       |
| ** ** | **For the  fiscal year ended****December 31, 2008****.**                                                                                                                                                                                                                                                                              |
|       |                                                                                                                                                                                                                                                                                                                                       |
| **OR**     |
|       |                                                                                                                                                                                                                                                                                                                                       |
| **o**      | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                    |
|       |                                                                                                                                                                                                                                                                                                                                       |
| ** ** | **For the  transition period from                            to                         ** |

 

**Commission file number:****1-10346**

 

**EMRISE CORPORATION**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                                                        | ** ** | **77-0226211**                       |
|---------------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of incorporation  or organization)     | ** ** | (I.R.S. Employer Identification No.) |
| ** **                                                          | ** ** | ** **                           |
| **9485 Haven Avenue, Suite 100, Rancho Cucamonga, California** | ** ** | **91730**                            |
| (Address of principal executive offices)                            | ** ** | (Zip Code)                           |

 

Registrant’s telephone number,including area code: **(909) 987-9220**

 

Securities registered pursuant to Section 12(b) ofthe Act:

 
| **Title of Each Class** | ** ** | **Name of Each Exchange on Which Registered** |
|----------------------------------------|------------|-----------------------------------------------------------------------------|
| **Common Stock,  $0.0033 par value**   | ** ** | **NYSE Arca**                                                               |

 

Securities registered pursuant to Section 12(g) ofthe Act:

** **

**None**

(Title of class)

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act. Yes o   No x

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act.

Yes o   No x

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes x   No o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. x

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer or a smaller reporting company. Seethe definitions of “large accelerated filer”, “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

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

 

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

 

Theaggregate market value of the voting common equity held by nonaffiliates of theregistrant, computed by reference to the $2.44 closing sale price of such stockon June 30, 2008, the last business day of the registrant’s most recentlycompleted second fiscal quarter, was approximately $25,000,000.  The registrant has no non-voting commonequity.

 

Thenumber of shares outstanding of the Registrant’s common stock, $0.0033 parvalue, as of April 6, 2009 was 10,204,000.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Part III incorporates by reference certaininformation from the registrant’s definitive proxy statement for the 2008Annual Meeting of Stockholders to be filed no later than April 30, 2009.

 

 

 

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**EMRISE CORPORATION**

**ANNUAL REPORT ON**

**FORM 10-K**

**FOR THE YEAR ENDED DECEMBER 31, 2008**

 

**TABLE OF CONTENTS**

 
| ** **                       | ** **                                                                                                         | ** ** | **Page**   |
|----------------------------------|--------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **                       | **PART I**                                                                                                    | ** ** | ** ** |
| Item 1.                          | Business                                                                                                           | ** ** | 1          |
| Item 1A.                         | Risk Factors                                                                                                       | ** ** | 10         |
| Item 1B.                         | Unresolved Staff Comments                                                                                          |       | 18         |
| Item 2.                          | Properties                                                                                                         |       | 18         |
| Item 3.                          | Legal Proceedings                                                                                                  |       | 19         |
| Item 4.                          | Submission of Matters to a Vote of Security  Holders                                                               |       | 19         |
| ** **                       | ** **                                                                                                         | ** ** | ** ** |
| ** **                       | **PART II**                                                                                                   | ** ** | ** ** |
| ** **                       | ** **                                                                                                         | ** ** | ** ** |
| Item 5.                          | Market for Registrant’s Common Equity,  Related Stockholder Matters and Issuer Purchases of Equity Securities |       | 20         |
| Item 6.                          | Selected Financial Data                                                                                            |       | 21         |
| Item 7.                          | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                        |       | 22         |
| Item 7A.                         | Quantitative and Qualitative Disclosures  About Market Risk                                                        |       | 32         |
| Item 8.                          | Financial Statements and Supplementary Data                                                                        |       | 32         |
| Item 9.                          | Changes in and Disagreements With  Accountants on Accounting and Financial Disclosure                              |       | 32         |
| Item 9A.                         | Controls and Procedures                                                                                            |       | 32         |
| Item 9A (T).                     | Controls and Procedures                                                                                            |       | 32         |
| Item 9B.                         | Other Information                                                                                                  |       | 35         |
| ** **                       | ** **                                                                                                         | ** ** | ** ** |
| ** **                       | **PART III**                                                                                                  | ** ** | ** ** |
| ** **                       | ** **                                                                                                         | ** ** | ** ** |
| Item 10.                         | Directors, Executive Officers and Corporate  Governance                                                            |       | 36         |
| Item 11.                         | Executive Compensation                                                                                             |       | 36         |
| Item 12.                         | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters                    |       | 36         |
| Item 13.                         | Certain Relationships and Related  Transactions, and Director Independence                                         |       | 36         |
| Item 14.                         | Principal Accounting Fees and Services                                                                             |       | 36         |
| ** **                       | ** **                                                                                                         | ** ** | ** ** |
| ** **                       | **PART IV**                                                                                                   | ** ** | ** ** |
| ** **                       | ** **                                                                                                         | ** ** | ** ** |
| Item 15.                         | Exhibits, Financial Statement Schedules                                                                            |       | 37         |
| Index to Financial Statements    |                                                                                                               | F-1        |
| Signatures                       |                                                                                                               | 41         |
| Exhibits Attached to This Report |                                                                                                               | 42         |

 

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**CAUTIONARYSTATEMENT**

 

*All statementsincluded or incorporated by reference in this Annual Report on Form 10-K,other than statements or characterizations of historical fact, areforward-looking statements.  Examples offorward-looking statements include, but are not limited to, statementsconcerning projected net sales, costs and expenses and gross margins; ouraccounting estimates, assumptions and judgments; the demand for our products;the competitive nature of and anticipated growth in our industries; our abilityto identify and consummate acquisitions and integrate their operationssuccessfully; and our prospective needs for additional capital. Theseforward-looking statements are based on our current expectations, estimates,approximations and projections about our industries and business, management’sbeliefs, and certain assumptions made by us, all of which are subject tochange. Forward-looking statements can often be identified by words such as “anticipates,”“expects,” “intends,” “plans,” “predicts,” “believes,” “seeks,” “estimates,” “may,”“will,” “should,” “would,” “could,” “potential,” “continue,” “ongoing,” similarexpressions, and variations or negatives of these words. These statements arenot guarantees of future performance and are subject to risks, uncertaintiesand assumptions that are difficult to predict. Therefore, our actual resultscould differ materially and adversely from those expressed in anyforward-looking statements as a result of various factors, some of which arelisted under “Risk Factors” in 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.*

 

**PART I**

 

**Item 1.**                       Business.

 

EMRISECorporation (including our subsidiaries, referred to collectively in thisReport as “EMRISE,” the “Company,” “we,” “us” or “our”) is a Delawarecorporation that was formed in 1989.  Our principal executive offices are located at 9485Haven Avenue, Suite 100, Rancho Cucamonga, California, 91730.  Our internet website address iswww.emrise.com.  We do not intend ourwebsite address to be an active link or to otherwise incorporate by referencethe contents of the website into this Report. The public may read and copy any materials that we file with the UnitedStates Securities and Exchange Commission (“SEC”) at the SEC’s Public ReferenceRoom at 100 F Street, NE, Washington, DC 20549, on official business daysduring the hours of 10:00 am to 3:00 pm, or electronically through the SECwebsite (www.sec.gov).  The public mayobtain information on the operation of the Public Reference Room bycalling the SEC at 1-800-SEC-0330. Within the Corporate Governance section of our website, we provideinformation concerning corporate governance, including our Board of Directorscommittee charters, Codes of Conduct and other information.

 

**Recent Business Highlights**

 

**On August 20, 2008, EMRISEand its wholly owned subsidiary, EMRISE Electronics Corporation (“EEC”),completed the acquisition of all of the capital stock of Custom Components, Inc.(“CCI”) and, its subsidiary, Advanced Control Components, Inc. (“ACC”)based in Eatontown, New Jersey. **ACC isa supplier of high performance radio frequency (RF) and microwave devices andsubsystems that for more than 26 years has been serving the military,aerospace, commercial and instrumentation markets.  We believe that the acquisition of ACC willstrengthen our geographic presence, resources and new products to allow us togrow domestically and internationally and to increase sales to United States(U.S.) military and other government and commercial organizations.  For purposes of the Business and IndustryDescription provided below ACC is classified within the electronic devicesbusiness segment of EMRISE.

** **

**On March 20, 2009, EMRISEcompleted the sale of**substantially all the assets ofECC’s Digitran division and all the capital stock of ECC’s Tokyo basedwholly-owned subsidiary, XCEL Japan Ltd., which primarily acted as a salesoffice for the Digitran division in Japan and other countries in Asia, toWeymouth, MA-based Electro Switch Corp. In this Report we refer to the businesses of the Digitran Division andXCEL Japan, Ltd. as the “Digitran Operations,” and we refer to the sale of theDigitran division and XCEL 

 

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**Japan, Ltd. as the “Digitran Transaction.”  Our Digitran division, located in RanchoCucamonga, CA, manufactured, marketed and sold electro-mechanical digital andnew patented technology very low profile**TM rotaryswitches for the worldwide aerospace, defense and industrial markets.  The Digitran division was classified withinout electronic devices business segment and is included in the Business andIndustry Description provided below.  TheDigitran Transaction is a milestone in our previously announced strategy todivest non-core businesses and increase our focus on our core competencies.

** **

**Business and Industry Description**

** **

EMRISEdesigns, manufactures and markets proprietary electronic devices andcommunications equipment for aerospace, defense, industrial, and communicationsapplications. We currently have operations in the U.S., England, andFrance.  We organize our business in two operating segments:electronic devices and communications equipment. In 2008, our electronicdevices segment contributed approximately 75% of overall net sales while thecommunications segment contributed approximately 25% of overall net sales. Oursubsidiaries within our electronic devices segment design, develop, manufacture and market electronic, RF and microwavedevices for defense, aerospace and industrial markets.  Our subsidiaries within ourcommunications equipment segment design, develop, manufacture and marketnetwork access equipment and network timing and synchronization products, forcommunications applications in defense, public and private networks andindustrial markets.

 

***Electronic Devices***

 

Within our electronic devicessegment we produce a range of power systems, RF and microwave devices.  The following is a description of the majorproduct categories within this segment:

 

·                  *Power Systems*.  Our powersystems product category is comprised of high and low voltage, highspecification, high reliability custom and standard power conversion productsdesigned for hostile environments.  Theseproducts are used predominately in the defense, commercial aerospace,industrial and communications markets.

 

·                  *RF and Microwave Devices*.  Our RF andmicrowave devices product category is comprised of microwave and RF devices,including switch matrices, frequency control products, limiters and detectorstogether with custom integrated assemblies and sub-systems. These products areused in applications which include communications, air traffic control,navigation and location equipment, radar and signal jamming devices, andweather radar, among others.

 

Prior to March 20, 2009, ourelectronic devices segment also included the Digitran Operations that were soldin connection with the Digitran Transaction.

 

The electronic devices segment isprimarily “project” driven with the majority of revenues being derived fromcustom products with long life cycles and high barriers to entry.  The majority of manufacturing and testing isperformed in-house or through sub-contract manufacturers.  Our electronic devices are used in a widerange of military airborne, seaborne and land-based systems, and in-flightentertainment systems, including the latest next generation in-flightentertainment and communications (“IFE&C”) systems — such as applicationsfor mobile phone, e-mail and internet communications and real time, on-boardsatellite and broadcast TV — which are being installed in new commercialaircraft as well as being retrofitted into existing commercial aircraft.

 

The electronic device industry iscomprised predominantly of military and commercial aerospace applications.  Large military programs, such as theEurofighter Typhoon aircraft and other land and seaborne military platforms,are high revenue generating opportunities, but are few in number and often morelikely to be affected by budgetary constraints.  As a result, we also focus on multiple smallerdefense projects.

 

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***Communications Equipment***

 

Within our communications equipmentsegment we produce a range of network access products and network timing andsynchronization products, for public and private communications networks.  The following is a description of the majorproduct categories within this segment:

 

·                  *Network Access*.  Our networkaccess product category is comprised of a wide range of LAN/WAN interconnectionequipment and systems over copper, fiber or wireless networks, covering variousspeeds as required by our customers.  Weprovide a combination of proprietary products and third party products to meetcustomer requirements.  Products aretargeted to key markets such as the military, utilities, governmentadministration, and point of sale and service providers primarily in Europe andNorth Africa.

 

·                  *Timing and Synchronization*. Our timing and synchronization product category iscomprised of a range of timing products primarily for the outer edges ofservice provider networks, which we refer to as an “Edge Network”.  Products are targeted to key markets such astelephone companies, military, government administration, and utilitycompanies, primarily in the U.S., but also, to a lessor extent, in Europe andNorth Africa.

 

The communications equipmentsegment is “end user product” based with a traditional cycle of internallyfunded development and marketing prior to selling via direct and indirect saleschannels.  Manufacturing is primarilyoutsourced.  Our communications equipmentis used in a broad range of applications for the military (defense and homelandsecurity), utility companies and independent and national telecommunicationscarriers.

 

The communications equipmentindustry is extremely competitive, with the primary growth expected to be inNext Generation Network (“NGN”) applications. The NGN merges the transmission of data, voice, video and other mediaonto a single network.  We believe thatthis will be the standard network infrastructure for the next 10 to 20years.  As competition to deliver contentover the NGN grows, so does the need for precise timing andsynchronization.  To be competitive inthis market, service providers must focus on performance.  We believe that quality of transmission willbe a significant competitive differentiator. Precise time synchronization is an essential component for the reliabletransport and switching necessary to deliver smooth transmission of voice,video and data, as well as a new generation of services and applications thatwill emerge.  We are highly focused on thismarket.  Our latest generation timing andsynchronization products provide significant cost, space saving and capacityadvantages, particular for Edge Network applications, as well as providing theplatform with which to address central office requirements.

 

Growth in our communication segmenthas been and is likely to continue to be impacted by the recent economicconditions as many of our communication products are deemed to be capitalexpenditures by our customers and many companies in this industry have publiclyannounced, plans to reduce capital expenditures and/or to defer significantpurchases due to current economic conditions. We continue to sell and ship products on a regular basis to most of ourexisting customers in this segment, but we have experienced a decline in neworders and we do not expect growth rates in 2009 to be as robust as we hadexpected.  When the economy does recover,we expect the communications equipment segment to benefit from an expectedincrease in customer needs to enhance and improve their networks and timingsystems, especially in response to the proliferation of video traffic overpublic and private networks.

 

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** **

**Business Strategy**

** **

We pursue a product and geographicdiversification strategy, balancing the risks of each of our business segments.We accomplish this by operating international business units to maximize thereturn on our international presence in the U.S. and Europe and also byidentifying markets where we have specific expertise. Our strategy is toincrease revenue and earnings, while continuing to focus on refining our corebusinesses which are (i) electronic devices including RF and microwavedevices and custom power supplies and (ii) communications equipmentincluding network access systems and network timing and synchronizationequipment.  In order to do so, EMRISE isimplementing the following three-point growth strategy:

 

·                  Focus on the continueddevelopment of our core electronic devices business within the defense andcommercial aerospace market through the introduction of new, unique and marketleading products, the development of our existing customer base and theexpansion of geographical markets.

 

·                  Focus on the developmentof an expanded range of synchronization and timing systems for the U.S. andinternational markets while supplementing our line of transmission and networkaccess products with higher bandwidth technologies and building on our knowledgeand experience of secure encryption to address new markets and broaden productapplication through added features.

 

·                  Expand through mergersand/or acquisitions which provide synergistic opportunities to leverage ourexisting product and customer base while at the same time selling or disposingof non-core businesses or product lines that are inconsistent with our highergrowth core businesses.

 

Ouroverall business strategy is to provide high quality service to our customers,to provide timely products that solve the needs of our customers, and topromptly react to changes in the marketplace. We believe that our relatively small size (as compared to many of ourcompetitors), our relatively quick time from development to production, and ourunique technology and product offerings provide us with a strategic advantagein this regard.  Additionally, we arefocusing our product offerings within high growth markets such as high volumemilitary programs, IFE&C, Edge Network communications timing and synchronizationand other network access applications. We have built a worldwide base of customers, including many of theFortune 100 companies in North America and many similar companies in Europe andAsia, which conduct business in markets served by EMRISE.

 

We planto continue to expand our military and defense business, which has formed alarge and stable platform for our electronic devices business.  In particular, we plan to focus on highgrowth, high volume programs in the RF and microwave device areas, such asradar and signal jamming applications. In addition, we plan to continue to seek opportunities for synergisticand accretive acquisitions.

 

We expectto continue to increase our sales in the IFE&C market.  This increase is expected to be driven by bothnew commercial aircraft being fitted with the latest IFE&C technology aswell as by ongoing retrofitting of existing commercial aircraft with the newerIFE&C systems.  Virgin America, Deltaand Continental, among others, now offer customers a wide range of in-flightentertainment features including movies, live satellite television, games, mapsand a large selection of music through an interactive entertainment system ateach seatback on the majority of long-haul domestic U.S. flights.  Most domestic and international carriers haveannounced plans to upgrade their fleets with some form of new IFE&Csystems, including new features such as broadband, email and internetespecially for long-haul domestic and/or international routes.

 

Growthrates in our Edge Network timing and synchronization product lines have been,and are likely to continue to be, negatively impacted by recent economicconditions.  We expect to continue togrow our presence within this market, although at a lower growth rate in 2009than originally anticipated.  Growth inthis market is being driven, in part, by the need to provide greater networksecurity and redundancy in 

 

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public and private communications networks, the increasingpenetration of major cable companies into the local and long distance servicesmarket and by the proliferation of mobile phone video traffic requiring moreaccurate timing.  When the economy does recover, we expect our timingand synchronization product line to benefit from an increase in customer needsto enhance and improve the timing systems within their existing networks.

 

**Customers**

** **

We sell our commercial and militaryelectronic devices primarily to original equipment manufacturers (“OEMs”),including manufacturers of aerospace and defense systems and industrialinstruments.  During 2008, our top fiveelectronics devices customers in terms of revenues were Panasonic, RockwellCollins, Inc., Selex Airborne Systems, ITT and Essential Components.  We sell our communications equipment topublic, private and corporate telecommunications service providers and endusers, including telephone companies, cable service providers, utilitycompanies and numerous other communications service providers.  During 2008, our top five communicationsequipment customers, in terms of revenues, were Power & Telephone,Harris Corporation, Cherry & White and Siemens.

 

We have a well diversified customerbase for both our electronic device products and our communications equipmentproducts.  During 2008 and 2007, nocustomer accounted for 10% or more of our total net sales during those periods.

 

**Sales, Marketing and Customer Support**

** **

We marketand sell our products through our operating subsidiaries within both of ouroperating segments.  Our sales forceconsists primarily of engineers and technical professionals supplemented by asmall direct sales force and, in some cases, a network of independent salesrepresentatives or distributors.  Oursales professionals in each country within which we operate are highlyknowledgeable about their respective markets, customer operations andstrategies and regulatory environments. We provide training and ongoing professional development and educationto our employees, which we believe significantly enhances the ability of oursales and marketing staff to build long-standing customer relationships as theyare more consultative in nature and can communicate back to us valuable inputon systems and features that our customers desire in future products.

 

Ourelectronic devices products are sold through a combination of direct sales andthird-party distributors.  We sell ourelectronic devices primarily to OEMs and system integrators in the military andcommercial aerospace and industrial electronics industries.  We typically have long-term relationshipswith our customers within our electronic devices segment and projects andprograms often span multiple years, with military programs sometimes in excessof 5 years.  We obtain revenues throughlong-term purchase orders and repeat business from our existing customers, bymarketing subsystem assemblies that incorporate our own and third partyproducts to our existing customers, and by entering new product markets, suchas the IFE&C market, the signal jamming market for military applicationsand new geographic markets.

 

Militaryand defense customers generally require our products to be formally qualifiedfor their application.  The total systemwill then typically undergo flight qualification or the equivalent on a land orsea based system.  A further developmentor prototyping phase may follow to meet additional requirements.  This can lead to lengthy development and approvalcycles and very long prototype phases, sometimes spanning several years, priorto the product entering production.  As aresult of these long development and approval cycles, the overall program issubject to external political and economic constraints over which we havelittle control and which makes sales forecasting difficult.  Further, delays associated withpotential customers’ internal approval and contracting procedures, procurementpractices may cause potential sales of our electronic devices products to bedelayed or foregone.  After a customer hasapproved our product for purchase, there are considerable barriers to entry dueto the need to re-qualify the application for any new prospective supplier. Asa result, once qualified, our products typically enjoy a long production life.

 

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Ourcommunications equipment products are sold primarily through a combination ofour local in-house sales force and third-party distributors.  We sell our communications equipment primarily toprivate network operations and to large communication service providers as wellas resellers and value added resellers and, in Europe, to military customers.  Communications service providers generally commitsignificant resources to an evaluation of our and our competitors’ products andrequire each vendor to expend substantial time, effort and money educating themabout the value of the vendor’s solutions and, in many cases, to qualifyproducts for their networks. Consequently, sales to this type of customer generally require anextensive sales effort throughout the prospective customer’s organization andfinal approval by an executive officer or other senior level employee.  The result is lengthy sales and approvalcycles, which make sales forecasting difficult. In addition, even after a customer has approved our product forpurchase, future purchases are uncertain because while we generally enter intolong-term supply agreements with our customers, these agreements do not requirespecific levels of purchases.

 

Delaysassociated with potential customers’ internal approval and contractingprocedures, procurement practices, testing and acceptance processes are commonand may cause potential sales of our communications products to be delayed orforegone.  As a result of these andrelated factors, the sales cycle of new products for large customers typicallyranges from six to twelve months or more. In addition, we have some distribution channels that generally are boxstocking distributors with significant independent sales forces selling ourproducts to final customers, integrators and other resellers on a regional andnationwide basis.  We perform periodicproduct applications training for our distributor and reseller workforce andfunnel many of the leads we generate to the distribution channels for theirfollow-up and closure.

 

**Competition**

 

Webelieve that our competitive advantage is founded on the application of leadingedge technology, the quality of our products, our ability to quickly addressand adapt to individual customer requirements and to the overall marketplace,the strength of our distribution channels, and our compliance with governmentand industry standards.

 

Theelectronic devices market is highly fragmented and is comprised of a diversegroup of OEMs.  Nonetheless, we believe that our significant experience inthe industry and the customized nature of our products have acted and willcontinue to act as barriers to entry for potential competitors.  This is particularly true in the military anddefense markets which have high barriers to entry after a product has beenqualified.  Competition for developmentprograms includes multinational and local engineering and manufacturingcompanies including customer in-house capabilities.  Competitors in this segment include Herely,Aeroflex, Cobham, Vicor and Interpoint, among others.  Our RF devices and power supplies aresimilarly positioned in the IFE&C markets. Competitors in this market include Panasonic, Thales and a number ofsmaller niche specialists.

 

Thecommunications equipment market is intensely competitive and subject to rapidtechnological change, evolving industry standards and regulatorydevelopments.  Our principal competitorswithin this segment include Symmetricom, Frequency Electronics andOscilloquartz for timing and synchronization products and RAD, Zhone/Paradyne,Adtran and Patton Electronics Corporation, among others, for other networkaccess products.  The design of many of our network access productsenables us to offer numerous product combinations to our customers and to serveboth central site data communications needs and remote access sites on both theenterprise-wide and single location level. We believe that this design flexibility helps us to excel at many of theabove competitive factors by enabling us to offer quality products that meetand are adaptable to evolving customer requirements, technologies andgovernment and industry standards.

 

Most of our competitors havegreater sales, marketing, technological, research and financial resources thanwe do.  Our competitors’ advantage withregard to these resources may reduce our ability to obtain or maintain marketshare for our products in cases where our competitors are better able than weare to satisfy customer needs.

 

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**Backlog**

** **

**At December 31, 2008, our backlog of firm, unshipped orders wasapproximately $34.7 million, up from $25.3 million a year ago, largely due tothe additional backlog associated with ACC, which was not included in the prioryear backlog amount.  This backlog wasrelated approximately 97% to our electronic devices business, which tends toprovide us with long lead-times for our manufacturing processes due to thecustom nature of the products, and approximately 3% to our communicationsequipment business.  Of these backlogorders, we anticipate fulfilling approximately 75% of our electronic devicesorders and 100% of our communications equipment orders in 2009.  However, we cannot provide assurance that wewill be successful in fulfilling these orders in a timely manner or that wewill ultimately recognize as revenue the amounts reflected as backlog.**

** **

**Warranties**

** **

Generally, our products carry a standard one-year, limited parts andlabor warranty.  In certaincircumstances, we provide a two-year limited parts and labor warranty.  We offer extended warranties beyond thestandard one or two year warranty, as may be applicable, for an additional costto our customers.  Products returnedunder warranty typically are tested and repaired or replaced at ouroption.  Historically, we have notexperienced significant warranty costs or returns.  However, we cannot provide assurance thatthis will continue to be the case or that disputes over specifications,materials or workmanship will not arise in the future.

 

**Product Development and Engineering**

** **

Ourproduct development and engineering activities during 2008 and 2007 primarilyrelated to new product development for network access and timing andsynchronization products, our recently divested rotary switch product line, RFfrequency control products and power conversion devices.  We expended $3.1 million in 2008 and $2.8million in 2007 in conducting our product development and engineeringactivities.  The investments we aremaking in product development and engineering are designed to increase ourrange of product offerings to our customers, keep up with the technological andregulatory changes in our industry and anticipate and satisfy our customers’preferences and requirements on existing and/or future anticipated orders.  We continually review and evaluatetechnological and regulatory changes that may affect our products and seek tooffer products and capabilities that solve our customers’ operationalchallenges and improve their efficiency.

 

**Manufacturing, Assembly and Quality Assurance**

** **

Our communications equipmentincluding network access products and communication timing and synchronizationproducts generally are assembled from outsourced subassemblies, with finalassembly, configuration and quality testing typically performed in house.  We believe that outsourcing certain aspectsof manufacturing, especially full assemblies, lowers our manufacturing costs,in particular our components and labor costs, provides us with more flexibilityto scale our operations to meet changing demand, and allows us to focus ourengineering resources on new product development and product enhancements.

 

We manufacture our electronicdevices through a combination of in-house and external outsource manufacturingprocesses depending on the product, application and volume.  We maintain broad mechanical and electronicassembly capabilities such as fabrication, machining and surface mount technology,all of which are utilized to maintain our flexibility to produce small volumebatch products and prototypes.  Many ofthe remaining portions of manufacturing, including assembly of our morestandardized and/or large volume production orders is outsourced.  Although many of our electronic devicesincorporate standard designs and specifications, products are neverthelessbuilt to customer order.  This approach,which avoids the need to maintain a large finished goods inventory, is possiblebecause of the custom nature of the products. Our electronic devices segment produces products in one-piece to severalhundred-piece batches, with a typical lead time between 6 and 30 weeks.  The lead-time is predominantly to sourcesub-component 

 

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pieceparts such as electronic components, mechanical components and services.  Typical build time is six to eight weeks fromreceipt of external components, but can, at times, extend to 26 weeks or more.

 

We operatefive manufacturing and assembly facilities worldwide.  All of these operations, except theoperations of our subsidiary, RO Associates (“RO”), are certified as ISO 9001 or9002 compliant.  Our RO operationsmaintain a formally documented quality system.

 

The purchased components we use tobuild our products are generally available from a number of suppliers.  We rely on a number of limited-sourcesuppliers for specific components and parts. We do not have long-term supply agreements with these vendors.  In general, we make advance purchases of somecomponents to ensure an adequate supply, particularly for products that requirelead-times of up to 36 weeks to manufacture.  If we were required to locate new suppliers oradditional sources of supply, we could experience a disruption in ouroperations or incur additional costs in procuring required materials.

 

**Intellectual Property**

** **

We regard our software, hardwareand manufacturing processes as proprietary and rely on a combination of patent,copyright and trademark laws, trade secrets, confidentiality procedures andcontractual provisions to protect our proprietary rights.  We have historically secured U.S. and foreignpatents for various products , primarily related to our former DigitranOperations, with the U.S. Patent and Trademark Office and in the EuropeanUnion, Japan, Canada and Brazil, when we deemed it advantageous to do so.  We seek to protect our software, documentationand other written materials under trade secret and copyright laws, which affordsome limited protection.  The laws ofsome foreign countries do not protect our proprietary rights to the same extentas do the laws of the U.S.  Our research and developmentand manufacturing process typically involves the use and development of avariety of forms of intellectual property and proprietary technology.  In addition, we incorporate technology andsoftware that we license from third party sources into our products.  These licenses generally involve a one-timefee and no time limit, but in some cases may involve ongoing licensing fees orroyalties based on future sales.  Webelieve that alternative technologies for this licensed technology areavailable both domestically and internationally and we intend to expand theselicensing opportunities in the future. In addition, we believe that some opportunities may exist to license ourown technology or products to other parties in the future.  We intend to pursue these opportunities tothe extent they benefit us.

 

We may receive, in the future,notices from holders of patents that raise issues as to possible infringementby our products.  Questions ofinfringement and the validity of patents in the fields of communications andinformation technology involve highly technical and subjective analyses.  These kinds of proceedings are time consumingand expensive to defend or resolve, result in substantial diversion ofmanagement resources, cause product shipment delays or could force us to enterinto royalty or license agreements rather than dispute the merits of theproceeding initiated against us.  At thistime, we are not aware of any infringement notices.

 

**Government Regulation and Industry Standards and Protocols**

** **

We design our products to complywith a significant number of industry standards and regulations, some of whichare evolving as new technologies are deployed. In the U.S., our products must comply with various regulations definedby the U.S. Federal Communications Commission, or FCC, and UnderwritersLaboratories as well as industry standards such as the Network Electronic BuildStandards, or NEBS, established by Telcordia Technologies, Inc., formerlyBellcore, and those developed by the American National StandardsInstitute.  Internationally, our productsmust comply with standards established by the European Committee forElectrotechnical Standardization, the European Committee for Standardization,the European Telecommunications Standards Institute and telecommunicationsauthorities in various countries, as well as with recommendations of theInternational Telecommunications Union. The failure of our products to comply, or delays in compliance, with thevarious existing and evolving standards could negatively affect our ability tosell our products.  Our products for themilitary markets are typically type tested and require the production of afirst article and other prototypes, which are subject to testing to meet 

 

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specificcustomer and government regulations governing operating environment,performance and operational capability.

 

Our product lines are subject to statutesgoverning safety and environmental protection. We believe that we are in substantial compliance with these statutes andare not aware of any proposed or pending safety or environmental rule orregulation that, if adopted, would have a material effect on our business orfinancial condition.

 

**Seasonality**

** **

There are no significant seasonalaspects to our business, except that purchases of our communications equipmentby public communications carriers tend to be higher than average at the end ofthe year and lower than average during the first quarter of each year becausetheir capital equipment budgets typically are not approved until late in thefirst quarter.

 

**Employees**

** **

As of April 6, 2009, weemployed approximately 360 persons in our various divisions andsubsidiaries.  None of our employees arerepresented by labor unions, and there have not been any work stoppages atany of our facilities.  We believe thatour relationship with our employees is good.

 

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**Item 1A.**              Risk Factors.

 

*The followingsummarizes material risks that investors should carefully consider beforedeciding to buy or maintain an investment in our common stock.  Any of the following risks, if they actuallyoccur, would likely harm our business, financial condition and results ofoperations.  As a result, the trading priceof our common stock could decline, and investors could lose the money they paidto buy our common stock.*

 

**Risks Related to Our Business**

 

***Weincurred a net loss in 2008 and 2007 and may incur losses in the future. If wecontinue to incur losses, we will experience negative cash flow, which mayhamper our operations, may prevent us from expanding our business and may causeour stock price to decline.***

*** ***

Weincurred a $7.4 million net loss for 2008, including a write off of intangibleand goodwill assets of $6.6 million, and a $1.9 million net loss for 2007. We expect to rely on cash on hand, cash generatedfrom our operations and existing and future financing activities to fund thecash requirements of our business. If our net losses continue, we willexperience negative cash flow, which may hamper current operations and mayprevent us from expanding our business. We may be unable to attain, sustain orincrease profitability on a quarterly or annual basis in the future. If we donot achieve, sustain or increase profitability, our stock price may decline.

 

***The current global financial crisis******and uncertaintyin global economic conditions******may have significant negativeeffects on our customers and our suppliers and may therefore******affect ourbusiness, results of operations, and financial condition.***

 

The current global financial crisis - which has included, among otherthings, significant reductions in available capital and liquidity from banksand other providers of credit, substantial reductions and/or fluctuations inequity and currency values worldwide, and concerns that the worldwide economymay enter into a prolonged recessionary period - may have a significantnegative effect on our business andoperating results.* *The potential effects ofthe current global financial crisis are difficult to forecast and mitigate. Asa consequence, our operating results for a particular period are difficult topredict, and, therefore, prior results are not necessarily indicative ofresults to be expected in future periods.

 

The current economic crisis may affect our direct and indirectcustomers’ access to capital or willingness to spend capital on our products,and/or their levels of cash liquidity with which or willingness to pay forproducts that they will order or have already ordered from us.  The effect of the current economic conditionson our customers may therefore lead to decreased demand, including order delaysor cancellations, which in turn may result in lower revenue and adverselyaffect our business, results of operations and financial condition.

 

Likewise, the current global financial crisis may negatively affect oursuppliers’ access to capital and liquidity with which to maintain theirinventories and production levels and could cause them to raise prices or lowerproduction levels, or result in their ceasing operations.  The challenges that our suppliers’ may facein selling their products or otherwise in operating their businesses may leadto our inability to obtain the materials we use to manufacture our products.These actions could cause reductions in our revenue, increased price competitionand increased operating costs, which could adversely affect our business,results of operations and financial condition.

 

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***The current global financial crisis******and uncertaintyin global economic conditions******may have significant negativeeffects on our access to credit and our ability to raise capital. In addition,if our existing credit facility is terminated in 2009 we would incursignificant cash and non-cash expenses relating to such termination.***

 

If the current global financial crisis adversely affects our lender,our lender may not have the ability to provide us with access to the fundsavailable under our credit facility, resulting in our access to cash and ourability to operate our business being negatively affected.  Additionally, the financial market disruptionmay make it difficult for us to raise additional capital or obtain additionalcredit, when needed, on acceptable terms or at all.  If our existing credit facility is terminatedin 2009 for any reason we would incur cash and non-cash expenses in connectionwith such termination including early termination fees and a write off of allunamortized debt acquisition costs and unamortized debt discount.

 

***The current global financial crisis******and uncertaintyin global economic conditions could prevent us from accurately forecastingdemand for our products which could adversely affect our operating results or marketshare.***

 

The current market instability makes it increasingly difficult for us,our customers and our suppliers to accurately forecast future product demandtrends, particularly in our communications equipment segment.  If, as a result, we produce excess productsour inventory carrying costs will increase and result in obsoleteinventory.  Alternatively, due to theforecasting difficulty caused by the unstable economic conditions, we may beunable to satisfy demand for our products which may in turn result in a loss ofmarket share.

 

***The current global financial crisis******and uncertaintyin global economic conditions increase the risk that we could sufferunrecoverable losses on our customers’ accounts receivable which wouldadversely affect our financial results****.*

 

We finance a portion of our sales through trade credit. While weperform ongoing credit evaluations of our customers’ financial condition, wecould suffer significant losses if our customers are unable or unwilling to payus. As global economic conditions worsen, there is an increasing risk ofsignificant losses of accounts receivable that may have a negative impact onour financial results.

 

***The new federal administration may reduce and/or redirect certaindefense and aerospace programs, which could adversely affect our business.***

 

We sellour commercial and military electronic devices primarily to OEMs, includingmanufacturers of aerospace and defense systems and industrial instruments.  In January 2009, a new federaladministration took office, and it is widely expected that the newadministration may reduce and/or redirect defense spending.  If defense spending is reduced or redirected,it may affect our current contracts as well as our ability to procurer additionaldefense contracts, which could have a negative effect on our business, resultsof operations and financial condition.

 

***We have a significant amount of debtoutstanding under our credit facility with our senior lender which could havenegative consequences for us.  In theevent of a default under our credit facility, our lender may limit futureavailability under our revolving line of credit and/or may accelerate paymentof all principal balances under this facility. Any of these conditions couldhave a material adverse effect on our operation and /or our ability to conductbusiness after that date.***

 

We currently use asignificant portion of our operating income for debt service. Our leveragecould make us vulnerable to an increase in interest rates or a downturn in theoperating performance of our business or a decline in general economicconditions. We have approximately $13.1 million in secured debtoutstanding as of April 6, 2009.

 

This amount of indebtednesscould have negative consequences for us, including:

 

·      limitations on our ability to obtainfinancing in the future;

 

·      much of our cash flow will be dedicated todebt service obligations and unavailable for other purposes;

 

·      this level of indebtedness may limit ourflexibility to deal with changing economic, business and competitiveconditions; and

 

·      this level of indebtedness could make usmore vulnerable to an increase in interest rates, a downturn in our operatingperformance or decline in general economic conditions.

 

In addition, failure tocomply with the covenants in the agreements governing the terms of our creditfacility could result in an event of default. In the event of a default and continuation of a default, our lender maylimit future availability under our revolving line of credit and/or acceleratethe payment of all principal balances and accrued interest requiring us to paythe entire indebtedness under our credit facility outstanding on thatdate.  Upon the occurrence and during the continuation of an event ofdefault, our lender may also elect to increase the interest rate applicable tothe outstanding balance of our term loans by four percentage points above theper annum interest rate that would otherwise be applicable.  Any of theseconditions could have a material adverse effect on our operations and/orability to conduct business after that date.

 

***The agent of our lender and itspresident are the subject of a recent article in the Wall Street Journal which,among other things, raises issues surrounding the business practices of the presidentof our lender’s agent which, in turn, may have an effect on our lender’sability to continue to provide us with debt financing.***

 

On April 15, 2009, the *Wall Street Journal* published an article which, among otherthings, raises issues surrounding the business practices of the president ofour lender’s agent.  The statements madein the article, whether or not true, may have an effect on our lender’s abilityto continue to provide us funds under our revolving line of credit.  Such an event would have a material adverseeffect on our operations and/or our ability to conduct business in the future.

 

***Ourlack of long-term purchase orders or commitments may adversely affect ourbusiness if demand is reduced.***

*** ***

During 2008, the sale of electronicdevices accounted for approximately 75% of our total net sales, and the sale ofcommunications equipment and related services accounted for approximately 25%of our total net sales.  In some cases wehave long-term contracts with our electronic devices and communicationsequipment customers that cover the general terms and conditions of ourrelationships with them and can include long-term purchase orders orcommitments.  However, typically ourcustomers issue purchase orders requesting the quantities of products theydesire to purchase from us, and if we are able and willing to fill thoseorders, then we fill them under the terms of the contracts.  Accordingly, we cannot rely on long-termpurchase orders or commitments to protect us from the negative financial effectsof reduced demand for our products that could result from a general economicdownturn, from changes in the electronic devices and communications equipmentindustries, including the entry of new competitors into these markets, from theintroduction by others of new or improved technology, from an unanticipatedshift in the needs of our customers, or from other causes.

 

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*** ***

***Wehave material weaknesses in our internal control over financial reportingstructure which until remedied,***may cause errors in our financial statementsthat could require a restatement or our filings may not be timely and investorsmay lose confidence in our reported financial information, which could lead toa decline in our stock price.

*** ***

***We have identified three material weaknesses in our internalcontrol over financial reporting and cannot assure you that additional materialweaknesses will not be identified in the future. If our internal control overfinancial reporting or disclosure controls and procedures are not effective,there may be errors in our financial statements that could require arestatement or our filings may not be timely and investors may lose confidencein our reported financial information, which could lead to a decline in ourstock price.***

*** ***

Section 404 of theSarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of ourinternal control over financial reporting as of the end of each year, and toinclude a management report assessing the effectiveness of our internal controlover financial reporting in each Annual Report on Form 10-K.

 

We have identified the followingthree material weaknesses in our internal control over financialreporting:  (i) we did noteffectively implement comprehensive entity-level internal controls, (ii) wedid not maintain effective controls over changes to critical financialreporting applications and over security access to these applications andrelated data, and (iii) we did not maintain a sufficient level ofinformation technology personnel to execute general computing controls over ourinformation technology structure.See “Item 9A(T) Controls and Procedures.”

 

Our management, including our ChiefExecutive Officer and Vice President Finance and Administration, does notexpect that our internal control over financial reporting will prevent allerror and all fraud. A control system, no matter how well designed andoperated, can provide only reasonable, not absolute, assurance that the controlsystem’s objectives will be met. Further, the design of a control system mustreflect the fact that there are resource constraints, and the benefits ofcontrols must be considered relative to their costs. Controls can becircumvented by the individual acts of some persons, by collusion of two ormore people, or by management override of the controls. Over time, controls maybecome inadequate because changes in conditions or deterioration in the degreeof compliance with policies or procedures may occur. Because of the inherentlimitations in a cost-effective control system, misstatements due to error orfraud may occur and not be detected.

 

As a result, we cannot assure youthat significant deficiencies or material weaknesses in our internal controlover financial reporting will not be identified in the future. Any failure tomaintain or implement required new or improved controls, or any difficulties weencounter in their implementation, could result in significant deficiencies ormaterial weaknesses, cause us to fail to timely meet our periodic reportingobligations, or result in material misstatements in our financial statements.Any such failure could also adversely affect the results of periodic managementevaluations regarding disclosure controls and the effectiveness of our internalcontrol over financial reporting required under Section 404 of theSarbanes-Oxley Act of 2002 and the rules promulgated thereunder. Theexistence of a material weakness could result in errors in our financialstatements that could result in a restatement of financial statements, cause usto fail to timely meet our reporting obligations and cause investors to loseconfidence in our reported financial information, leading to a decline in ourstock price.

 

***The unpredictability of our quarterly operating results may cause theprice of our common stock to fluctuate or decline.***

** **

Our quarterly operating resultshave varied significantly in the past and will likely continue to do so in thefuture due to a variety of factors, many of which are not within ourcontrol.  Our operating results from ourcommunications equipment segment tend to be less stable and predictable thanour operating results from our electronic devices segment.

 

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The cyclical nature of thecommunications equipment business due to the budgetary cycle of telephonecompanies has had and will likely continue to have, for the foreseeable future,an effect on our quarterly operating results. Telephone companies generally obtain approval for their annual budgetsduring the first quarter of each calendar year. If a telephone company’s annual budget is not approved early in thecalendar year or is insufficient to cover its desired purchases for the entirecalendar year, we are unable to sell products to the telephone company duringthe period of the delay or shortfall.  Inaddition, these budgets historically tend to vary significantly year by yeardepending on a variety of factors, including overall economic conditions.  A significant reduction in any one customer’sor group of customer’s budgets could severely reduce our overall sales, profitsand cash flows in the future.

 

Our electronic devices sales areoften made in conjunction with military contracts.  The timing of required deliveries under thesecontracts can be delayed based on issues related to the overall militarycontract, which can cause delays in our shipment schedules, revenuerecognition, profits and cash flows.

 

Quarter-to-quarter fluctuations mayalso result from the uneven pace of technological innovation, the developmentof products responding to these technological innovations by us and ourcompetitors, our customers’ acceptance of these products and innovations, thevaried degree of price, product and technological competition and our customers’and competitors’ responses to these changes.

 

Due to these factors and otherfactors, including changes in general economic conditions, we believe thatperiod-to-period comparisons of our operating results will not necessarily bemeaningful in predicting future performance. If our operating results do not meet the expectations of investors, ourstock price may fluctuate or decline.

 

***The sales cycles of some of our products are lengthy, exposing us tothe risks of delays, foregone orders and fluctuations in operating results.***

 

Sales of some of our productsdepend upon potential customers’ internal approval and contracting procedures,procurement practices, and testing and acceptance processes, all of whichinvolve require a significant amount of time. As a result of these and related factors, the sales cycle of many of ourproducts, especially for large customers, typically ranges from six to twelvemonths or more.  Lengthy sales cyclessubject us to risks of delays, foregone orders and fluctuations in operatingresults.

 

***Most of our competitors have greater resources than us.  In order to compete successfully, we mustkeep pace with our competitors in anticipating and responding to the rapidchanges involving the electronic devices and communications equipmentindustries.***

** **

Our future success depends, inpart, upon our ability to enhance our current products and services and todevelop and introduce new products and services that keep pace withtechnological developments, respond to the growth in the electronic devices andcommunications equipment markets in which we compete, encompass evolvingcustomer requirements, and to provide a broad range of products and achievemarket acceptance of our products.  Most of our existing andpotential competitors have larger technical staffs, more established and largermarketing and sales organizations and significantly greater financial resourcesthan we do.  Our lack of resourcesrelative to our competitors may cause us to fail to anticipate or respond adequately to technologicaldevelopments and customer requirements or to experience significant delays indeveloping or introducing new products and services.  These failures or delays could reduce ourcompetitiveness, revenues, profit margins or market share, cash flow and stockprice.

 

***We rely heavily on our management, and the loss of their services couldadversely affect our business.***

** **

Our success is highly dependentupon the continued services of key members of our management, including CarmineT. Oliva, our Chairman of the Board, President, and Chief Executive Officer,Graham Jefferies, our Executive Vice President and Chief Operating Officer andJohn Donovan, our Vice President Finance and Administration.  Mr. Oliva co-founded EEC and hasdeveloped personal contacts and other skills that we rely upon in connectionwith our financing, acquisition and general business strategies.  

 

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Mr. Jefferiesis a long-time employee of EMRISE who we have relied upon in connection withour acquisitions in England and who fulfills significant operationalresponsibilities in connection with our foreign and domestic operations.  Mr. Donovan provides us with extensiveexperience in financial reporting and compliance matters.  The loss of Mr. Oliva, Mr. Jefferiesor Mr. Donovan, or one or more other key members of management couldadversely affect us.  Although we haveentered into employment agreements with each of our executive officers, thoseagreements do not guarantee continued employment of these individuals.  We maintain key-man life insurance on Mr. Olivaand Mr. Jefferies.  However, wecannot provide any assurance that we will be able to maintain this insurance ineffect or that the coverage will be sufficient to compensate us for the loss ofthe services of Mr. Oliva or Mr. Jefferies.

 

***Our results ofoperations could be adversely affected as a result of impairments of goodwilland other intangible assets which may cause the price of our common stock tofluctuate or decline.***

 

When we acquire a business, we assign estimated values to certainintangible assets and we also record an asset called “goodwill” equal to theexcess amount we pay for the business, including liabilities assumed, over thefair value of the tangible and intangible assets of the business we acquire.For example, in connection with the acquisition of ACC and CCI, we recordedapproximately $4.1 million in goodwill and $4.8 million of intangible assetsbased on the application of purchase accounting.  Statement of Financial Accounting Standards (“SFAS”)No. 142 provides that goodwill and other intangible assets that haveindefinite useful lives not be amortized, but instead be tested at leastannually for impairment, and intangible assets that have finite useful livescontinue to be amortized over their useful lives. SFAS No. 142provides specific guidance for testing goodwill and other non-amortizedintangible assets for impairment. SFAS No. 142 requires management tomake certain estimates and assumptions when allocating goodwill to reportingunits and determining the fair value of reporting unit net assets andliabilities, including, among other things, an assessment of market conditions,projected cash flows, investment rates, cost of capital and growth rates, whichcould significantly impact the reported value of goodwill and other intangibleassets. Fair value is determined using a combination of the discounted cashflow, market multiple and market capitalization valuation approaches. Absent anyimpairment indicators, we perform our impairment tests annually during thefourth quarter. As part of our 2008 annual test for impairments to goodwill andother intangible assets, we recorded a non-cash charge for the impairment ofgoodwill and indefinite lived intangible assets of $6.6 million in the fourthquarter of 2008, which reflects the write downof substantially all of the carrying value of the goodwill and other intangibleassets for our communications equipment segment. Any future impairments,including impairments of the goodwill or intangible assets recorded inconnection with the acquisition of ACC and CCI, or any other acquisition we maymake in the future, would negatively impact our results of operations for theperiod in which the impairment is recognized which, in turn, may cause ourstock price to fluctuate or decline.

 

***Our acquisition strategy may result in unanticipated accounting chargesor otherwise adversely affect our results of operations, and result indifficulties in assimilating and integrating the operations, personnel,technologies, products and information systems of acquired companies orbusinesses, or be dilutive to existing shareholders.***

** **

A key element of our businessstrategy involves expansion through the acquisition of businesses, assets,products or technologies that allow us to complement our existing productofferings or expand our market coverage. We continually evaluate and explorestrategic opportunities as they arise, including business combinationtransactions, strategic partnerships, and the purchase or sale of assets.

 

Acquisitions may requiresignificant capital infusions, typically entail many risks, and could result indifficulties in assimilating and integrating the operations, personnel,technologies, products and information systems of acquired companies orbusinesses. We have in the past and may in the future experience delays in thetiming and successful integration of an acquired company’s technologies andproduct development through volume production, unanticipated costs andexpenditures, changing relationships with customers, suppliers and strategicpartners, or contractual, intellectual property or employment issues. Inaddition, key personnel of an acquired company may decide not to work for us. 

 

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Thesechallenges could disrupt our ongoing business, distract our management andemployees, harm our reputation and increase our expenses. These challenges aremagnified as the size of the acquisition increases. Furthermore, thesechallenges would be even greater if we acquired a business or entered into abusiness combination transaction with a company that was larger and moredifficult to integrate than the companies we have historically acquired.

 

Acquisitions may require largeone-time charges and can result in increased debt or contingent liabilities,adverse tax consequences, additional stock-based compensation expense, and therecording and later amortization of amounts related to certain purchasedintangible assets, any of which items could negatively impact our results ofoperations. Any of these charges could cause the price of our common stock todecline.

 

Acquisitions or asset purchasesmade entirely or partially for cash may reduce our cash reserves.  Depending on the circumstances, we may seekto obtain additional cash to fund an acquisition by selling equity or debt securities.Any issuance of equity or convertible debt securities may be dilutive to ourexisting stockholders. In addition, the equity or debt securities that we mayissue could have rights, preferences or privileges senior to those of ourcommon stock.

 

We cannot assure you that we willbe able to consummate any pending or future acquisitions or that we willrealize any anticipated benefits from these acquisitions. We may not be able tofind suitable acquisition opportunities that are available at attractivevaluations, if at all. Even if we do find suitable acquisition opportunities,we may not be able to consummate the acquisitions on commercially acceptableterms, and any decline in the price of our common stock may make itsignificantly more difficult and expensive to initiate or consummate additionalacquisitions.

 

***As our international business expands, we are increasingly exposed tovarious legal, business, political and economic risks associated with ourinternational operations.***

** **

International sales accounted for62.0% and 56.7% of our net sales in 2008 and 2007, respectively. We undertakevarious sales and marketing activities through our facilities in England,France and Japan.  We intend to continueto expand our international business activities. Heightened security fromterrorist attacks in the U.S. and abroad and the increasing risk of extendedinternational military conflicts may adversely impact our international salesand could make our international operations more expensive. Internationaloperations are subject to many other inherent risks, including but not limitedto:

 

·                  political,social and economic instability;

·                  exposure todifferent business practices and legal standards, particularly with respect tointellectual property;

·                  naturaldisasters and public health emergencies;

·                  nationalizationof business and blocking of cash flows;

·                  trade and travelrestrictions;

·                  the impositionof governmental controls and restrictions;

·                  burdens ofcomplying with a variety of foreign laws;

·                  import andexport license requirements and restrictions of the U.S. and each other countryin which we operate;

·                  unexpectedchanges in regulatory requirements;

·                  foreigntechnical standards;

·                  changes intaxation and tariffs;

·                  difficulties instaffing and managing international operations;

·                  fluctuations incurrency exchange rates;

·                  difficulties incollecting receivables from foreign entities or delayed revenue recognition;and

·                  potentiallyadverse tax consequences.

 

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Any of the factors described abovemay have a material adverse effect on our ability to increase or maintain ourforeign sales.

 

***If we are unable to fulfill backlog orders due to circumstances involvingus or one or more of our suppliers or customers, our anticipated results ofoperations will suffer***.

** **

As of December 31, 2008, wehad $34.7 million in backlog orders forour products, which amount includes $1.5 million of backlog related to our priorDigitran Operations.  Backlog ordersrepresent revenue that we anticipate recognizing in the future, as evidenced bypurchase orders and other purchase commitments received from customers, but onwhich work has not yet been initiated or with respect to which work iscurrently in progress.  Our backlogorders are due, in large part, to the long lead-times associated with ourelectronic device products, which products generally are custom built to order.  We cannot provide assurance that we will besuccessful in fulfilling orders and commitments in a timely manner or that wewill ultimately recognize as revenue the amounts reflected as backlog.  Factors that could affect our ability tofulfill backlog orders include difficulty we may experience in obtaining rawmaterials or sub-assemblies from suppliers, whether due to obsolescence,production difficulties on the part of suppliers or other causes, orcustomer-induced delays and product holds. Our anticipated results of operations and cash flows will suffer to theextent we are unable to fulfill backlog orders within the timeframes weestablish, particularly if delays in fulfilling backlog orders cause ourcustomers to reduce or cancel their orders.

 

***If our products fail to comply with evolving government and industrystandards and regulations, we may have difficulty selling our products.***

** **

We design our products to complywith a significant number of industry standards and regulations, some of whichare evolving as new technologies are deployed. Our products must comply with various regulations defined by the FCC andUnderwriters Laboratories, the American National Standards Institute, amongothers as well as industry standards such as those established by TelcordiaTechnologies, Inc. (communications), Federal Aviation Authority(aerospace) and Boeing.  Internationally,our products must comply with standards established by the European Committeefor Electrotechnical Standardization, the European Committee for Standardization,the European Telecommunications Standards Institute, and telecommunicationsauthorities in various countries as well as with recommendations of theInternational Telecommunications Union, Airbus and various civil aviationauthorities, among others.  The failureof our products to comply, or delays in compliance, with the various existingand evolving standards could negatively affect our ability to manufactureand/or sell our products in the future.

 

***Financial statements of our foreign subsidiaries are prepared using therelevant foreign currency that must be converted into U.S. dollars forinclusion in our consolidated financial statements.  As a result, exchange rate fluctuations mayadversely affect our reported results of operations.***

** **

Our subsidiaries in England andFrance prepare their financial statements in the relevant local foreigncurrency.  In order to be included in ourconsolidated financial statements, the balance sheets are converted, at thethen current exchange rate, into U.S. dollars, and the statements of operationsare converted using weighted average exchange rates for the applicableperiod.  Accordingly, fluctuations of theforeign currencies relative to the U.S. dollar could affect our consolidatedfinancial statements.  Our exposure tofluctuations in currency exchange rates has increased as a result of the growthof our international subsidiaries.  Salesof our products and services to customers located outside of the U.S. accountedfor approximately 62.0% and 56.7% of our net sales for 2008 and 2007,respectively.  We use derivatives tomanage foreign currency rate risk for certain sales shipped from England.  Our ultimate realized gain or loss withrespect to currency fluctuations will depend on the currency exchange rates andother factors in effect as the contracts mature.  Net foreignexchange translation gains andlosses included in other income and expense in our consolidated statements ofoperations resulted in a $269,000 loss for 2008 and a $83,000 gain for 2007.

 

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** **

***Because we believe thatproprietary rights are material to our success, misappropriation of theserights could adversely affect our financial condition.***

** **

Our future success will be highlydependent on proprietary technology, particularly in our communicationsequipment business.  However, we do nothold any patents and we currently rely on a combination of contractual rights,copyrights, trademarks and trade secrets to protect our proprietary rights inthis area.  Our management believes thatbecause of the rapid pace of technological change in the industries in which weoperate, the legal intellectual property protection for our products is a lesssignificant factor in our success than the knowledge, abilities and experienceof our employees, the frequency of our product enhancements, the effectivenessof our marketing activities and the timeliness and quality of our supportservices.  Consequently, we rely to a greatextent on trade secret protection for much of our technology.  However, there can be no assurance that ourmeans of protecting our proprietary rights will be adequate or that ourcompetitors or customers will not independently develop comparable or superiortechnologies or obtain unauthorized access to our proprietary technology.  Our financial condition would be adverselyaffected if we were to lose our competitive position due to our inability toadequately protect our proprietary rights as our technology evolves.

 

**RisksRelated to Our Common Stock**

** **

***Our common stock price has beenvolatile, which could result in substantial losses for investors purchasingshares of our common stock and in litigation against us.***

** **

The market prices of securities oftechnology-based companies have been and will likely continue to be highlyvolatile.  The market price of our commonstock has fluctuated significantly in the past. During 2008, the high and low closing sale prices of a share of ourcommon stock were $3.41 and $1.05, respectively, which amount reflects a 1 for3.75 reverse split of our common stock that we completed in November 2008.  Our stock price since the reverse split hasexhibited such volatility and may continue to do in the future.  In addition, market price of our common stockmay continue to fluctuate in response to the following factors, many of whichare beyond our control:

 

·                  changes in market valuations of similar companiesand stock market price and volume fluctuations generally;

·                  general global economic weakness;

·                  economic conditions specific to the electronicdevices or communications equipment industries;

·                  announcements by us or our competitors of new orenhanced products, technologies or services or significant contracts,acquisitions, strategic relationships, joint ventures or capital commitments;

·                  delays in our introduction of new products ortechnological innovations or problems in the functioning of these new productsor innovations;

·                  third parties’ infringement of our intellectualproperty rights;

·                  changes in our pricing policies or the pricingpolicies of our competitors;

·                  foreign currency translations gains or losses;

·                  regulatory developments;

·                  fluctuations in our quarterly or annual operatingresults;

·                  additions or departures of key personnel;

·                  future sales of our common stock or othersecurities; and

·                  perception and confidence of investors regarding futureprospects for EMRISE.

 

The price at which you purchaseshares of common stock may not be indicative of the price of our stock thatwill prevail in the trading market.  Youmay be unable to sell your shares of common stock at or above your purchase price,which may result in substantial losses to you. Moreover, in the past, securities class action litigation has often beenbrought against a company following periods of volatility in the market priceof its securities.  We may in the futurebe the target of similar litigation. Securities litigation could result in substantial costs and divertmanagement’s attention and resources and could have a significant impact onprofitability, future cash flows and stock price.

 

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***Future sales of shares of ourcommon stock by our stockholders could cause our stock price to decline.***

** **

We cannot predict the effect, ifany, that market sales of shares of our common stock or the availability ofshares of common stock for sale will have on the market price prevailing fromtime to time.  As of April 6, 2009,we had outstanding 10.2 millionshares of common stock and options and warrants to purchase an aggregate of 2.5million shares of common stock.  Asubstantial number of these shares are eligible for public resale.  Sales of shares of our common stock in thepublic market, or the perception that those sales may occur, could cause thetrading price of our common stock to decrease or to be lower than it might bein the absence of those sales or perceptions.

 

**Item 1B.**              UnresolvedStaff Comments.

 

None.

 

**Item 2.**                       Properties.

 

As of April 6,2009, we leased or owned approximately 153,000 square feet of administrative,engineering, production, storage and shipping space.  All of this space was leased from thirdparties other than our facility located in Abondant, France, which is owned byus.  The following table represents theCompany’s leased properties as of April 6, 2009:

 
| **Business Unit**                                     | ** ** | **Location**                 | ** ** | **Segment**                                      | ** ** | **Use**                                                 | ** ** | **Approximate  Size** |
|-------------------------------------------------------|------------|------------------------------|------------|--------------------------------------------------|------------|---------------------------------------------------------|------------|-----------------------|
|                                                  |       |                         |       |                                             |       |                                                    |       |                  |
| EMRISE Corporation                                    |       | Rancho Cucamonga, CA, U.S.   |       | corporate headquarters                           |       | Administration                                          |       | 5,400 sq. feet        |
|                                                  |       |                         |       |                                             |       |                                                    |       |                  |
| Advanced Control  Components, Inc.               |       | Eatontown, NJ, U.S.          |       | electronic devices                               |       | Administration, Engineering and  Manufacturing          |       | 30,000sq. feet        |
|                                                  |       |                         |       |                                             |       |                                                    |       |                  |
| EMRISE Electronics Corporation  (Circuits Division)   |       | Monrovia, CA, U.S.           |       | electronic devices                               |       | Administration, Engineering and  Manufacturing          |       | 10,500 sq. feet       |
|                                                  |       |                         |       |                                             |       |                                                    |       |                  |
| XCEL Power Systems, Ltd.  and EMRISE Electronics Ltd. |       | Ashford, Kent, England       |       | electronic devices                               |       | Administration, Engineering and  Manufacturing          |       | 28,000 sq. feet       |
|                                                  |       |                         |       |                                             |       |                                                    |       |                  |
| CXR Larus Corporation and  RO Associates              |       | San Jose, CA, U.S.           |       | electronic devices and  communications equipment |       | Administration, Engineering,  Manufacturing and Testing |       | 30,000 sq. feet       |
|                                                  |       |                         |       |                                             |       |                                                    |       |                  |
| Pascall Electronics Limited                           |       | Ryde, Isle of Wight, England |       | electronic devices                               |       | Administration, Engineering and  Manufacturing          |       | 35,000 sq. feet       |
|                                                  |       |                         |       |                                             |       |                                                    |       |                  |
| CXR Anderson Jacobson                                 |       | Antony, France               |       | communications equipment                         |       | Administration                                          |       | 753 sq. feet          |

 

Webelieve that these facilities are suitable for the purposes for which we usethem.  We believe that we have sufficientfacilities to conduct and grow our operations during 2009.  However, we will continue to evaluate thepurchase or lease of additional properties, as our business requires.

 

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**Item 3.**                       Legal Proceedings.

 

We are not a party to any material pending legal proceedings.

 

**Item 4.**                       Submission of Matters to a Vote of Security Holders.

 

None

 

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**PART II**

** **

**Item 5.**                       Market for Registrant’s Common Equity, Related Stockholder Matters andIssuer Purchases of Equity Securities.

 

**Market Price and Holders**

 

Our common stock has traded on NYSEArca since March 8, 2006, under the symbol “ERI.”  On November 19, 2008, we completed a 1for 3.75 reverse split of our common stock. The table below shows, for each fiscal quarter presented, the high andlow closing prices on NYSE Arca for shares of our common stock.  The prices for periods prior to November 19,2008 have been retroactively restated as if the reverse stock split hadoccurred as of January 1, 2007.  Theprices shown reflect inter-dealer prices, without retail mark-up, mark-down orcommission, and may not necessarily represent actual transactions.

 
| ** **                               | ** ** | **High** | ** ** | **Low** | ** ** |
|------------------------------------------|------------|----------|------------|---------|------------|
| ***Year  ended December 31, 2008*** |       |     |       |    |       |
| First                                    |       | $        | 3.41       |    | $          | 1.73 |   |
| Second                                   |       | $        | 3.04       |    | $          | 1.76 |   |
| Third                                    |       | $        | 2.29       |    | $          | 1.35 |   |
| Fourth                                   |       | $        | 2.50       |    | $          | 1.05 |   |
|                                     |       |     |       |    |       |
| ***Year  ended December 31, 2007*** |       |     |       |    |       |
| First                                    |       | $        | 4.91       |    | $          | 3.98 |   |
| Second                                   |       | $        | 4.69       |    | $          | 4.05 |   |
| Third                                    |       | $        | 4.61       |    | $          | 3.11 |   |
| Fourth                                   |       | $        | 3.45       |    | $          | 2.29 |   |

 

As of April 6, 2009, we hadoutstanding 10,204,079****shares of common stock outstandingheld of record by approximately 3,000stockholders.  These holders of recordinclude depositories that hold shares of stock for brokerage firmswhich, in turn, hold shares of stock for numerous beneficial owners.  On April 6, 2009, the closing sale priceof our common stock on NYSE Arca was $1.45 per share.

 

**Dividend Policy**

 

We have not declared or paid anycash dividends on our capital stock in the past, and we do not anticipatedeclaring or paying cash dividends on our common stock in the foreseeablefuture.  We will pay dividends on ourcommon stock only if and when declared by our board of directors.  Our board of directors’ ability to declare adividend is subject to restrictions imposed by Delaware law and by our lender, GVEC Resource IV, Inc.  In determining whether to declare dividends, the board of directors will considerthese restrictions as well as our financial condition, results of operations,working capital requirements, future prospects and other factors it considersrelevant.

 

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**Recent Salesof Unregistered Securities**

 

The following table gives information about ourcommon stock that may be issued upon the exercise of options, warrants andrights under all of our existing equity compensation plans as of December 31,2008.

 
| **Plan category**                                      | ** ** | **Number of securities to  be issued upon exercise  of outstanding options,  warrants and rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a))** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **(a)**                                                                                                                                              | ** ** | **(b)**                                                                                                     | ** ** | **(c)**                                                                                                                                                                                                      | ** ** |
| Equity  compensation plans approved by security holders     |       | 2,493,444                                                                                                                                            | (1)        | $                                                                                                           | 3.47       |                                                                                                                                                                                                         | 8,544,302  | (2) |
| Equity  compensation plans not approved by security holders |       | —                                                                                                                                               |       | —                                                                                                      |       | —                                                                                                                                                                                                       |       |
| Total                                                       |       | 2,493,444                                                                                                                                            |       |                                                                                                        |       | 8,544,302                                                                                                                                                                                                    |       |
|                                                             |            |                                                                                                                                                      |            |                                                                                                             |            |                                                                                                                                                                                                              |            |  |

 

----

(1)               Represents shares ofcommon stock underlying options that are outstanding under our 1993 StockOption Plan, our Employee Stock and Stock Option Plan, our 1997 Stock IncentivePlan, our Amended and Restated 2000 Stock Option Plan and our 2007 StockIncentive Plan. The material features of these plans are described in Note 11to our consolidated financial statements for the years ended December 31,2008 and 2007.

(2)               Represents shares ofcommon stock available for issuance under options that may be issued under ourAmended and Restated 2000 Stock Option Plan and our 2007 Stock Incentive Plan.

 

**Item 6.**                       Selected Financial Data.

 

Notapplicable.

 

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**Item 7.**                       Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following discussion should beread in conjunction with our consolidated financial statements and the relatednotes and the other financial information included elsewhere in thisreport.  This report and the followingdiscussion contain forward-looking statements, which generally include theplans and objectives of management for future operations, including plans andobjectives relating to our future economic performance and our current beliefsregarding revenues we might generate and profits we might earn if we aresuccessful in implementing our business and growth strategies. Theforward-looking statements and associated risks may include, relate to or bequalified by other important factors, including, without limitation:

 

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

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

·                  anticipatedtrends in our financial condition and results of operations;

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

·                  ourability to secure long term purchase orders;

·                  ourability to deliver against existing or future backlog;

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

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

·                  exposureto and impacts of various international risks including legal, business,political and economic risks associated with our international operations;

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

·                  ourability to successfully support the working capital needs of our company;

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

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

 

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

 

Any of the factors described aboveor in the “Risk Factors” section above could cause our financial results,including our net income or loss or growth in net income or loss to differmaterially from prior results, which in turn could, among other things, causethe price of our common stock to fluctuate substantially.

 

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**Recent Transactions**

 

**On August 20,2008, EMRISE and EEC completed the acquisition of all of the capital stock ofCCI and, its subsidiary, ACC. **ACC,based in Eatontown, New Jersey, is a supplier of high performance RF andmicrowave devices and subsystems that for more than 26 years has been servingthe military, aerospace, commercial and instrumentation markets.  We believe that the acquisition of ACC willstrengthen our geographic presence, resources and new products to allow us togrow domestically and internationally and to increase sales to U.S. militaryand other government and commercial organizations.  ACC operates within the electronic devicesbusiness segment of EMRISE.  Theresults of operations of ACC since August 20, 2008 are included in our ConsolidatedStatement of Operations for the year ended December 31, 2008.

** **

**On March 20,2009, EMRISE completed the sale of**substantially all the assetsof ECC’s Digitran division and all the capital stock of ECC’s wholly-ownedsubsidiary, XCEL Japan Ltd., which primarily acted as a sales office for theDigitran division, to Weymouth, MA-based Electro Switch Corp.  In this report we refer to the businesses ofthe Digitran Division and XCEL Japan, Ltd. as the “Digitran Operations,” and werefer to the sale of the Digitran division and XCEL Japan, Ltd. as the “DigitranTransaction.”  Within our Digitrandivision we manufactured, marketed and sold electro-mechanical digital and newpatented technology very low profileTM rotary switches for the worldwide aerospace,defense and industrial markets. Tokyo-based XCEL Japan Ltd. primarily sold Digitran’s switch productlines in Japan and other countries in Asia. These businesses were part of ourelectronic devices business segment.  TheDigitran Transaction is a milestone in ‘our previously announced strategy todivest non-core businesses and increase our focus on our core competencies. Forpurposes of the following discussion and analysis, the Digitran Operations havebeen classified within the electronic devices business segment of EMRISE.  Because the Digitran Transaction occurredafter December 31, 2008, the full year results of the DigitranOperations are included in our Consolidated Statement ofOperations for the year ended December 31, 2008 and the DigitranOperations are reflected in our Consolidated Balance Sheet, ConsolidatedStatement of Stockholders’ Equity and Consolidated Statement of Cash Flows asof December 31, 2008.

** **

**BusinessDescription**

 

EMRISEdesigns, manufactures and markets proprietary electronic devices and communicationsequipment for aerospace, defense, industrial, and communications applications.We have operations in the U.S., England, and France.  We organize our business in two operating segments: electronic devices andcommunications equipment. In 2008, our electronic devices segment contributedapproximately 75% of overall net sales while the communications segmentcontributed approximately 25% of overall net sales. Our subsidiaries within ourelectronic devices segment design,develop, manufacture and market electronic, RF and microwave devices fordefense, aerospace and industrial markets. Our subsidiaries within our communications equipment segmentdesign, develop, manufacture and market network access equipment and networktiming and synchronization products, for communications applications indefense, public and private networks and industrial markets.

 

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

 

 Within our communications equipment segment,we produce a range of network access products, including network timing andsynchronization products, for public and private communications networks.  This segment is “end user product” based witha traditional cycle of internally funded development and marketing prior toselling via direct and indirect sales channels. Manufacturing is primarily outsourced. Our communications equipment is used in a broad range of applicationsfor military (defense and homeland security), utility companies and independentand national telecommunications carriers.

 

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**Critical Accounting Policies**

 

Our discussion and analysis of ourfinancial condition and results of operations is based upon our consolidatedfinancial statements, which have been prepared in accordance with accountingprinciples generally accepted in the U.S. The preparation of these financialstatements requires us to make estimates and judgments that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amount ofnet sales and expenses for each period. The following represents a summary ofour critical accounting policies, defined as those policies that we believe arethe most important to the portrayal of our financial condition and results ofoperations and that require management’s most difficult, subjective or complexjudgments, often as a result of the need to make estimates about the effects ofmatters that are inherently uncertain.

 

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

 

Wederive revenues from sales of electronic devices and communications equipmentproducts and services.  Our sales arebased upon written agreements or purchase orders that identify the type andquantity of the item and/or services being purchased and the purchaseprice.  We recognize revenues whenshipment of products has occurred or services have been rendered, nosignificant obligations remain on our part, and collectability is reasonablyassured based on our credit and collections practices and policies.

 

Werecognize revenues from domestic sales of our electronic devices andcommunications equipment at the point of shipment of those products.  An estimate of warranty cost is recorded atthe time the revenue is recognized. Product returns are infrequent and require prior authorization becauseour sales are final and we quality test our products prior to shipment toensure the products meet the specifications of the binding purchase ordersunder which those products are shipped. Normally, when a customer requests andreceives authorization to return a product, the request is accompanied by apurchase order for a repair or for a replacement product.

 

Revenuerecognition for products and services provided by ACC and our subsidiaries inEngland depends upon the type of contract involved.  Engineering/design services contractsgenerally entail design and production of a prototype over a term of up toseveral years, with revenue deferred until each milestone defined in thecontract is reached.  Productioncontracts provide for a specific quantity of products to be produced over aspecific period of time.  Customers issuebinding purchase orders or enter into binding agreements for the products to beproduced.  We recognize revenues on theseorders as the products are shipped. Returns are infrequent and permitted only with prior authorizationbecause these products are custom made to order based on binding purchaseorders and are quality tested prior to shipment.  An estimate of warranty cost is recorded atthe time revenue is recognized.

 

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

 

Revenuesfrom services such as repairs and modifications are recognized when the serviceis completed and invoiced.  For repairsthat involve shipment of a repaired product, we recognize repair revenues whenthe product is shipped back to the customer. Service revenues contribute lessthan 5% of total revenue and, therefore, are considered to be immaterial tooverall financial results.

 

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***Product Warranty Liabilities***

 

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

 

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

 

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

 

Our finished goods electronicdevices inventories generally are built to order.  Our communications equipment inventoriesgenerally are built to forecast, which requires us to produce a larger amountof finished goods in our communications equipment business so that ourcustomers can be served promptly.  Ourproducts consist of numerous electronic and other materials, which necessitatethat we exercise detailed inventory management. We value our inventory at the lower of the actual cost to purchase ormanufacture the inventory (first-in, first-out) or the current estimated marketvalue of the inventory (net realizable value). We perform cycle counts ofinventories using an ABC inventory methodology, which groups inventory itemsinto prioritized cycle counting categories, or we conduct physical inventoriesat least once a year.  We regularlyreview inventory quantities on hand and record a provision for excess andobsolete inventory based primarily on our estimated forecast of product demandand production requirements for the next 12 to 24 months. Additionally, todetermine inventory write-down provisions, we review product line inventorylevels and individual items as necessary and periodically review assumptionsabout forecasted demand and market conditions. Any inventory that we determine to be obsolete, either in connectionwith the physical count or at other times of observation, are reserved for andsubsequently written-off.  As of December 31,2008, our total inventory reserves amounted to $5.6 million of which $4.0million, or 21.0% of total inventory, related to our electronic devices segmentand $1.6 million, or 8% of total inventory, related to our communicationsequipment segment.

 

The electronic devices andcommunications equipment industries are characterized by rapid technologicalchange, frequent new product development, and rapid product obsolescence thatcould result in an increase in the amount of obsolete inventory quantities onhand. Also, our estimates of future product demand may prove to be inaccurate,in which case we may have understated or overstated the provision required forexcess and obsolete inventory. Although we make every effort to ensure theaccuracy of our forecasts of future product demand, any significantunanticipated changes in demand or technological developments could have asignificant impact on the value of our inventory and our reported operatingresults.

 

***Foreign Currency Translation***

 

We have foreignsubsidiaries that together accounted for approximately 62.0% and 73.2% of ournet revenues, 32.7% and 39.5% of our assets and 22.7% and 37.0% of our totalliabilities as of and for the years ended December 31, 2008 and 2007,respectively.  In preparing our consolidated financial statements,we are required to translate the financial statements of our foreign subsidiariesfrom the functional currencies in which they keep their accounting records intoU.S. dollars. This process results in exchange gains and losses which, underrelevant accounting guidance, are included either within our statement ofoperations under the caption “other income (expense)” or as a separate part ofour net equity under the caption “accumulated other comprehensive income(loss).”

 

Under relevant accounting guidance,the treatment of these translation gains or losses depends upon management’s determinationof the functional currency of each subsidiary. This determination involvesconsideration of relevant economic facts and circumstances affecting thesubsidiary. Generally, the currency in which the subsidiary transacts amajority of its transactions, including billings, financing, payroll and other 

 

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expenditures,would be considered the functional currency. However, management must alsoconsider any dependency of the subsidiary upon the parent and the nature of thesubsidiary’s operations.

 

If management deems any subsidiary’sfunctional currency to be its local currency, then any gain or loss associatedwith the translation of that subsidiary’s financial statements is included as aseparate component of stockholders’ equity in accumulated other comprehensiveincome (loss).  However, if managementdeems the functional currency to be U.S. dollars, then any gain or lossassociated with the translation of these financial statements would be includedin other income (expense) within our statement of operations.

 

If we dispose of any of oursubsidiaries, any cumulative translation gains or losses would be realized intoour statement of operations. If we determine that there has been a change inthe functional currency of a subsidiary to U.S. dollars, then any translationgains or losses arising after the date of the change would be included withinour statement of operations.

 

Based on our assessment of thefactors discussed above, we consider the functional currency of each of ourinternational subsidiaries to be each subsidiary’s local currency. Accordingly,we had cumulative translation losses of $2.8 million and gains of $1.1 millionthat were included as part of accumulated other comprehensive income (loss)within our balance sheets at December 31, 2008 and December 31, 2007,respectively. During the year ended December 31, 2008 and 2007, weincluded translation losses of $3.9 million and gains of $0.4 million,respectively, under accumulated other comprehensive income.

 

Themagnitude of these gains or losses depends upon movements in the exchange ratesof the foreign currencies in which we transact business as compared to thevalue of the U.S. dollar. During 2008, these currencies include the euro, theBritish pound 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.

 

A 2.5 million British poundsterling loan payable from one of oursubsidiaries in England to EMRISE was outstanding as of December 31,2008 ($3.6 million based on the exchange rate at December 31, 2008).  Exchange rate losses and gains on thelong-term portion of this loan are recorded in cumulative translation gains orlosses in the equity section of the balance sheet.

 

***Intangibles, Including Goodwill***

 

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

 

In assessingpotential impairment of goodwill, we consider these factors as well asforecasted financial performance of the acquired businesses.  If forecasts are not met, we may have torecord additional impairment charges not previously recognized. In assessingthe recoverability of our goodwill and other intangibles, we must makeassumptions regarding estimated future cash flows and other factors todetermine the fair value of those respective assets. If these estimates ortheir related assumptions change in the future, we may be required to record impairmentcharges for these assets that were not previously recorded.  If that were the case, we would have torecord an expense in order to reduce the carrying value of our goodwill.  Under SFAS No. 142, “Goodwill and OtherIntangible Assets”, we are required to analyze our goodwill for impairmentissues at least annually or more frequently if an event occurs or circumstanceschange that would more likely than not reduce the fair value of a reportingunit below its carrying amount.  At December 31,2008, our reported goodwill totaled $9.7 million.  During the year ended December 31, 2008,we recorded a non-cash impairment lossrelated to goodwill and other intangible assets of $6.6 million, which isreflected as a component of operations in the accompanying ConsolidatedStatement of Operations.  Inassessing the potential impairment of goodwill, we consider forecastedfinancial performance of the acquired businesses to determine the fair value ofthe respective assets. Due to a decline in the forecasted financial performanceof our communications segment, the estimated fair market value of that segment’sintangible assets declined as compared to the carrying value of such assets onour balance sheet.  As a result, theimpairment charge reflects the write down of substantially all of the carryingvalue of the goodwill and other intangible assets for our communicationssegment.

 

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**Overview**

 

Themajority of our products are customized to the unique specifications of ourcustomers and are subject to variable timing of delivery.  Shipments of products can be accelerated ordelayed due to many reasons including, but not limited to, exceeding or notmeeting customer contract requirements, a change in customer timing orspecifications, technology related issues and production related issues.  Comparability of our revenues and grossprofit is difficult from period to period as we typically do not have recurringorders.  Exceptions to this includecertain long-term military contracts and certain long-term telecommunicationscontracts.

 

Overallsales increased 15.9% in 2008 as compared to 2007.  Included in our net sales results for 2008 is$5.8 million of net sales contributed by ACC, which we acquired on August 20,2008.  ACC product sales accounted for71% of our overall increase in sales. The remaining increase in net sales is primarily due to an increase insales of our other electronic devices subsidiaries, partially offset byexchange translation and lower sales of communication equipment.

 

Overallgross margin increased to 38.9% in 2008 from 33.8% in 2007.  The increase in overall gross margin wasprimarily due to improved sales prices of our products, improved efficiency inmanufacturing and favorable changes in product mix, particularly at our U.S.electronic devices subsidiaries and strong gross margins related to ACCproducts.

 

Thefollowing is a detailed discussion of our results of operations by businesssegment.

 

**Results ofOperations**

 

***Comparison of the Year Ended December 31, 2008 to the Year Ended December 31,2007***

 

**Net Sales**

 
| ** **                | ** ** | **Year Ended**   | ** ** | **Variance**                     | ** ** |
|---------------------------|------------|-----------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **December 31,** | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**   | ** ** | **2008**              | ** ** | **2007**                         | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                      |       |                  |       |                             |       |   |   |   |   |
| Electronic  devices       |       | $                     | 44,739     |                             | $          | 36,471 |   | $ | 8,268 |   | 22.7 | % |
| *as % of net sales*       | * *   | *75.2*                | *%*        | *71.0*                           | *%*        | * * | * * | * * | * * |
| Communications  equipment |       | 14,768                |       | 14,874                           |       | (106 | ) | (0.7 | )% |
| *as % of net sales*       | * *   | *24.8*                | *%*        | *29.0*                           | *%*        | * * | * * | * * | * * |
| Total  net sales          |       | $                     | 59,507     |                             | $          | 51,345 |   | $ | 8,162 |   | 15.9 | % |

 

*Electronic Devices*

 

Theincrease in sales within our electronic devices segment in 2008 as compared to2007 is primarily due to the inclusion of $5.8 million of sales generated byACC, which was acquired in August 2008. Also contributing to the improvement was a $2.3 million increase insales of digital switches.  One of ourEuropean subsidiaries also experienced increased sales, especially due tohigher shipments of IFE&C products for commercial aircraftapplications.  However, the effect ofexchange rates between the U.S. dollar and the British pound sterling on thetranslation of our European operations into U.S. dollars had an unfavorableimpact on all of our European operations’ net sales as compared to the prioryear.  The translation impact of exchangerates remains an uncertainty and could negatively or positively impact ouroverall results in future periods.

 

In 2009, we expect net sales within our electronic devicessegment to increase slightly as compared to 2008.  This reflects the expected favorable impactof including 12 months of ACC’s net sales in 2009 as compared to a little over4 months in 2008, the loss of the net sales relating to our Digitran Operationsafter March 2009 and the anticipated unfavorable effect of exchange ratesexpected in 2009 as compared to 2008 between the U.S. dollar and the Britishpound sterling on the translation of our European operations into U.S. dollars.

 

*Communications Equipment*

 

Theslight decrease in sales within our communications equipment segment in 2008 ascompared to 2007 is primarily due to a $0.5 million decrease in sales at ourFrench subsidiary as the result of a temporary spending reduction by the FrenchDefense Ministry, which resulted in a short-term reduction in orders andshipments for communication networking products.  This decrease was partially offset by a $0.3million increase in our domestic communications equipment operations as aresult of increases in test equipment sales associated with new governmentcontracts.

 

Weexpect net sales in our communications equipment segment to increase slightlyin 2009 as compared to 2008.  Growth inour communication segment has been, and is likely to continue to be, impactedby the recent economic conditions as many of our communication products aredeemed to be discretionary expenditures by our customers and many companies inthis industry have announced publicly plans to reduce capital expendituresand/or to defer discretionary spending due to current economic conditions.  Once global economic conditions improve, webelieve this segment will benefit more so than our electronic devices segment.  We also anticipate an unfavorable effect of exchangerates expected in 2009 as compared to 2008 between the U.S. dollar and the euroon the translation of our European operations into U.S. dollars.

 

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**Gross Profit**

 
| ** **                | ** ** | **Year Ended**        | ** ** | **Variance**                | ** ** |
|---------------------------|------------|-----------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **December 31,** | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**        | ** ** | **2008**              | ** ** | **2007**                    | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                      |       |                  |       |                        |       |   |   |   |   |
| Electronic  devices       |       | $                     | 17,145     |                        | $          | 11,602 |   | $ | 5,543 |   | 47.8 | % |
| *as % of net sales*       |       | *38.3*                | *%*        | *31.8*                      | *%*        |   |   |   |   |
| Communications  equipment |       | 5,977                 |       | 5,748                       |       | 229 |   | 4.0 | % |
| *as % of net sales*       |       | *40.5*                | *%*        | *38.6*                      | *%*        |   |   |   |   |
| Total  gross profit       |       | $                     | 23,122     |                        | $          | 17,350 |   | $ | 5,772 |   | 33.3 | % |
| *Total gross margin*      |       | *38.9*                | *%*        | *33.8*                      | *%*        |   |   |   |   |

 

*Electronic Devices*

 

The improvementin gross profit within our electronic devices segment is primarily due tosubstantial gross margin improvements within all of our electronic devicesubsidiaries due to a combination of improved selling prices, improvedefficiency in manufacturing and/or favorable changes in product mix. Includedin our overall gross profit for 2008 is $2.3 million contributed by ACC,representing approximately four months of gross profit contribution for thatsubsidiary.

 

During2009, we expect gross profit expressed in dollars and gross profit expressed asa percent of net sales within our electronic devices segment to remainconsistent with 2008 results.  Thisreflects the favorable impact of including ACC’s net sales for 12 months in2009 as compared to a little over four months in 2008, offset by the loss ofthe net sales from our Digitran Operations after March 2009 and theanticipated unfavorable effect of exchange rates expected in 2009 as comparedto 2008 between the U.S. dollar and the British pound sterling on thetranslation of our European operations into U.S. dollars.

 

*Communications Equipment*

 

The increase in gross margin is primarily due to increasedsales of higher margin TiemPoTM products. During 2009, we expect gross profit expressed in dollars and grossprofit expressed as a percent of net sales within our communications equipmentsegment to improve slightly as compared to 2008 due in large part to ourexpected results for the communications equipment segment discussed under theheading “Net Sales” above.

 

**Operating Expenses**

 
| ** **                           | ** ** | **Year Ended**   | ** ** | **Variance**                     | ** ** |
|--------------------------------------|------------|-----------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **December 31,** | ** ** | **Favorable (Unfavorable)** | ** ** |
| **(in thousands)**              | ** ** | **2008**              | ** ** | **2007**                         | ** ** | **Dollar** | ** ** | **Percent** | ** ** |
|                                 |       |                  |       |                             |       |   |   |   |   |
| Selling,  general and administrative |       | $                     | 16,975     |                             | $          | 15,392 |   | $ | (1,583 | ) | (10.3 | )% |
| *as % of net sales*                  | * *   | *28.4*                | *%*        | *30.0*                           | *%*        | * * | * * | * * | * * |
| Engineering  and product development |       | 3,053                 |       | 2,792                            |       | (261 | ) | (9.3 | )% |
| *as % of net sales*                  | * *   | *5.1*                 | *%*        | *5.4*                            | *%*        | * * | * * | * * | * * |
| Total  operating expenses            |       | $                     | 20,028     |                             | $          | 18,184 |   | $ | (1,844 | ) | (10.1 | )% |

 

*Selling, General and Administrative*

 

The increase in selling, general and administrativeexpenses is primarily the result of $1.5 million of additional expensesrelating to approximately four months of operations of ACC.

 

During2009, we expect selling, general and administrative expense to increase by atleast $1 million.  This anticipatedincrease reflects the unfavorable impact of including a full 12 months of ACC’sexpenses in 2009 as compared to approximately 4 months during 2008, as well ashigher anticipated costs relating to Sarbanes-Oxley compliance due to the factthat we will be subject to the Sarbanes-Oxley Act Section 404 externalaudit requirements beginning January 1, 2009.  These increases are expected to be partiallyoffset by decreases in selling general and administrative expenses relating tothe sale of our Digitran Operations in March 2009 and significantrestructuring efforts which we expect to complete in the first half of 2009,which include reduction in headcount, outsourcing certain centralized servicesand a reduction in facility costs.

 

*Engineering and Product Development*

 

The increase in engineering and product development costsin 2008 was primarily due to $0.2 million of engineering and productdevelopment costs attributable to ACC.

 

During 2009, engineering and product development expensesare expected to remain at or slightly below 2008 levels.  This reflects the impact of including ACC’sexpenses for the full 12 months in 2009 as compared to approximately 4 monthsduring 2008 offset by the favorable impact of reduced expenses due to the saleof our Digitran Operations in March 2009.

 

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**Loss on Asset Impairment**

 

In 2008, we incurred a loss on the impairment of ourgoodwill and indefinite lived intangible assets of $6.6 million.  In assessingthe potential impairment of goodwill, we consider forecasted financialperformance of the acquired businesses to determine the fair value of therespective assets. Due to a decline in the forecasted financial performance ofour communications segment, the estimated fair market value of that segment’sintangible assets declined as compared to the carrying value of such assets onour balance sheet.  As a result, the 2008impairment charge reflects the write down of substantially all of the carryingvalue of the goodwill and other intangible assets for our communicationssegment.

 

**Interest Expense**

 

Interestexpense was $3.2 million for 2008 as compared to $0.9 million for 2007 due tohigher outstanding loan and line of credit balances, higher interest ratesassociated with our credit facility entered into in November 2007 and theadditional debt incurred in connection with the acquisition of ACC in August 2008.  Included in interest expense in 2008 areapproximately $1.0 million of unused line fees, non-cash amortization ofdeferred financing costs and non-cash amortization of debt discount related toissuance costs for the credit facility.

 

Weexpect interest expense in 2009 to remain relatively consistent with 2008levels, although we expect the ratio of non cash to cash component of interestexpense to increase slightly in 2009 as compared to 2008.  This reflects the fact that we had higherdebt levels for approximately the last four months of 2008 and the first threemonths of 2009 due to borrowings made in connection with the acquisition of ACCand through the closing of the sale of our Digitran Operations in March 2009,which permitted us to pay down our acquisition debt in the amount of $10million.

 

**Other Income (Expense)**

 

Weincurred other expenses of $0.5 million for 2008 and generated other income of$0.5 million for 2007.  Other expense for2008 consisted primarily of short-term exchange rate losses associated with thevolatility of the U.S. dollar to the British pound sterling and euro on thecurrent portion of certain assets and liabilities.  Other income for 2007 included a one-timeaccrual reversal related to the satisfactory resolution of an employee relatedlegal dispute at our French subsidiary.

 

**Loss On Early Extinguishment of Debt**

 

Losson early extinguishment of debt was $0.2 million for 2007 relating to the exitcosts associated with the early termination of our previous credit facilitiesand term loans.  We did not incur such aloss in 2008.  If we were to terminateour existing credit facility during 2009, we would incur significant cash andnon-cash expenses in connection with such a termination including earlytermination fees and a write off of all unamortized debt acquisition costs andunamortized debt discount.

 

**Income Tax Expense**

 

Income tax expense amounted to $0.3 million for 2008compared to $0.7 million for 2007.  2008income tax expense is primarily the result of foreign income tax on foreignearned profits in Europe and Japan and New Jersey state income taxes on incomegenerated by ACC.  We expect asignificant increase in income tax expense in 2009, primarily due to income taxobligations associated with an anticipated gain on the Digitran Transaction,which we completed in March 2009.

 

**Net Loss**

 

We reported a net loss of $7.4 million in 2008 and a netloss of $1.9 million in 2007.  Includedin the net loss in 2008 was a $6.6 million non-cash loss associated with theimpairment of goodwill and indefinite-lived intangible assets.

 

*** ***Liquidity and Capital Resources

 

Inmaking an assessment of our liquidity, we believe that the items in ourfinancial statements that are most relevant to our ongoing operations are ourworking capital, cash generated from our operating activities and cashavailable from our financing activities. During 2008, we funded our daily cash flow requirements through fundsprovided by operations and through borrowings under our credit facility withGVEC Resource IV Inc. (“GVEC” or the “Lender”), an affiliate of PrivateEquity Management Group LLC (“PEM Group”). Working capital was $7.6 million at December 31, 2008 as comparedto $16.1 million at December 31, 2007. The decrease in working capital isprimarily due to the current portion of our long term debt ($5.2 million as of December 31,2008) and our revolving line of credit ($4.1 million as of December 31,2008) being classified as a current liability at December 31, 2008 ascompared to being classified as long term debt at December 31, 2007.  The current portion of long term debtincreased due to higher scheduled principal payments in 2009 as compared to2008.  At December 31, 2008 and 2007, we had accumulated deficits of $28.1 millionand $20.7 million, respectively, and cash and cash equivalents of $3.4 million and $4.8 million, respectively.

 

Netcash generated in operating activities during 2008 totaled $1.9 million ascompared to $1.5 million of net cash used in operating activities in 2007.  Our reported net loss of $7.4 million in2008, included a non-cash loss on impairment of intangible assets of $6.6million.  Additional non-cash adjustmentsto our 2008 net loss include (i) the amortization of debt discount andamortization of deferred financing cost which, on a combined basis, totaled$0.9 million in 2008 compared to a combined total of $0.1 million in 2007, bothof which are non-cash expenses associated with our GVEC credit facility and (ii) depreciationand amortization expense which totaled $1.4 million and $1.2 million,respectively during 2008 and 2007, also a non-cash expense.  Significant sources and uses of cashassociated with operating activities during 2008 included an increase inaccrued expenses of $0.2 million related to timing of payments and an increasein inventory of $0.8 million primarily associated with the addition of ACCinventories in 2008  that were absent in2007, partially offset by a decrease in inventory reserves as a result ofscrapping of inventory during the year and the effect of currency exchangerates between the British pound sterling and the U.S. dollar.

 

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Cash used in our investing activities totaled $12.5 millionin 2008 as compared to $0.8 million in 2007. The $0.8 million of expendituresin 2007 consisted entirely of net increases to property, plant and equipmentcompared to $0.1 million of investment in property, plant and equipment in2008.  The remaining $12.5 million ofexpenditures in 2008 were associated with our purchase of ACC in August 2008.  In connection with the purchase of ACC, we are obligated to pay up to anadditional $3,000,000 in cash if ACC meets certain operating income targets forone or both of the two 12-month periods following the closing.  Additionally, EEC issued Subordinated SecuredContingent Promissory Notes (the “Notes”) to each of the Sellers of ACC in theaggregate principal amount of up to $2,000,000. The Notes only become payable if ACC meets certain operating incomethresholds during the first and second 12 month periods after August 20,2008.

 

Cash provided by our financing activities totaled $12.3million in 2008 as compared to $3.1 million in 2007.  In August 2008, we borrowed $13 millionfrom our lender in connection with the purchase of ACC.  During 2008 we paid approximately $0.8 million towards the repayment oflong term debt and/or notes to stockholders as compared to $1.4 million in2007.

 

For the year ended December 31, 2008, ourcash balances decreased by approximately $2.1 million due to the unfavorableeffects of exchange rates on our cash balances (primarily due to decreases in the exchange rate of the British poundsterling and the euro as compared to the U.S. dollar).  This compares to a $0.2 million increase incash as a result of the effects of exchange rates on our cash balances during2007.

 

As of December 31, 2008, we hadoutstanding borrowings of $4.1 million under the revolving loan portion of ourGVEC credit facility.  At December 31,2008, we had remaining actual availability under a formula-based calculation of$2.9 million under the credit facility.  Actual remaining availability represents theadditional amount we were eligible to borrow as of December 31, 2008.Maximum contractual availability represents the maximum amount of availabilityprovided under the contract as of that date and includes the actual remainingavailability.

 

Inaddition to the revolving lines of credit, at December 31, 2008, we hadlong-term loans and capitalized lease and equipment loan obligations totaling$13.8 million, the current portion of which loans and obligations totaled $5.7million.

 

Our backlog increased to $34.7 million as of December 31,2008 as compared to $25.3 million as of December 31,2007. The increase is primarily due to the addition of incremental backlog inconnection with the acquisition of ACC. The amount of backlog orders represents revenue that we anticipaterecognizing in the future, as evidenced by purchase orders and other purchasecommitments received from customers, but on which work has not yet beeninitiated or with respect to which work is currently in progress. Our backlogas of December 31, 2008 was approximately 97% 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 3% related to our communications equipment business, which businesstends to deliver standard or modified standard products from stock as ordersare received. We believe that the majority of our current backlog is shippablewithin the next 12 months.  However,there can be no assurance that we will be successful in fulfilling such ordersand commitments in a timely manner or that we will ultimately recognize asrevenue the amounts reflected as backlog.

 

*Credit Facility*

* *

On November 30,2007, we and our direct subsidiaries, EEC, CXR Larus and RO Associates enteredinto a Credit Agreement with the Lender, providing for a credit facility in theaggregate amount of $23,000,000.  On August 20,2008, in connection with the acquisition of ACC and CCI, we amended the creditfacility to include ACC and CCI as borrowers and to, among other things,include a term loan in the principal amount of $3,000,000 (the “Term Loan C”).  As of December 31, 2008, we owed a totalof $23.1 million under the credit facility. In connection with Digitran Transaction we repaid approximately $10 million inMarch 2009.

 

The credit facility consists of (i) a one yearrevolving loan for up to $7 million that may be renewed two times, each for aperiod of one year (the “Revolver”), and (ii) term loans in netoutstanding principal amount of $9 million. The term loans require scheduled payments commencing September 2009and regular payments thereafter until the loans are paid in full on November 30,2010.  Total principal payments on TermLoans A and B are $1.1 million in 2009 and $7.9 million in 2010.

 

The Revolver is formula-based and generally provides thatthe outstanding borrowings under the line of credit may not exceed an aggregateof 85% of eligible accounts receivable, plus 10% of the value of eligible rawmaterials not to exceed $600,000, plus 50% of the value of eligible finishedgoods inventory not to exceed $1,500,000, minus the aggregate amount ofreserves that may be established by the Lender. The Revolver has a maturity date of November 30, 2009, unless it isrenewed by the Lender in which case the maturity date will be extended to November 30,2010.

 

Interest on the Revolver is payable monthly.  The interest rate is variable and is adjustedmonthly based on prime rate as published in the “Money Rates” column of*The Wall Street Journal* (the “Base Rate”)plus 1.25%, subject to a minimum rate of 9.5%. The Revolver is subject to various financial covenants on a consolidatedbasis, including EBITDA, measured on a fiscal quarter-end basis, must not beless than the scheduled amount for each specified period; the debt servicecoverage ratio, measured quarterly, must be greater than the lesser of thescheduled amount for each specific period or 1.10:1.00; minimum liquidity abovethe scheduled amount, unfinanced capital expenditures not in excess of $62,500per quarter, and the leverage ratio, measured quarterly, must not be greaterthan the scheduled amount for each specified period.  Additionally, the Revolver is subject to theborrowers not incurring purchase money commitments in excess of $2 million.

 

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The term loans bear interest at the Base Rate plus 4.25%,subject to a minimum rate of 12.5%, and require interest only payments in thefirst year, scheduled principal plus interest payments in years two and three,and a final balloon payment at the end of year three.  Interest on the term loans is payablemonthly.  The borrowers under the credit facility may make fullor partial prepayment of the term loans provided that any such prepayment isaccompanied by the applicable prepayment premium discussed below.

 

Uponthe sale or disposition by borrowers or any of their subsidiaries of propertyor assets, we may be obligated to prepay the Revolver and the term loans withthe net cash proceeds received in connection with such sales or dispositions tothe extent that the aggregate amount of net cash proceeds received and not paidto GVEC as a prepayment for all such sales or disposition exceed $150,000 inany fiscal year.

 

If theLender terminates the credit facility during a default period or if we prepaythe Revolver or the Term Loans prior to the scheduled maturity dates, then weare subject to penalties as follows: if the termination or prepayment occursduring the one year period after November 30, 2007, the penalty is equalto 3% of the outstanding principal balance of the Revolver and the Term Loans;if the termination or prepayment occurs during second year after November 30,2007, the penalty is equal to 2% of the outstanding principal balance of theRevolver and the Term Loans.  TheRevolver is subject to an unused line fee of 0.5% per annum, payable monthly,on any unused portion of the revolving credit facility.

 

Tosecure payment of the indebtedness of borrowers under the credit facility, theborrowers irrevocably pledged and assigned to, and granted to the Lender acontinuing security interest in all the personal property of the borrowersincluding the borrowers’ interest in any deposit accounts, the stock of each ofthe borrowers’ subsidiaries, the intellectual property owned by each of theborrowers, and the proceeds of the intellectual property owned by each of theborrowers.  In an event of default, theLender may, at its option, exercise any or all remedies available to it withrespect to the collateral.  In addition,certain of the borrowers’ foreign subsidiaries have agreed to guaranty theborrowers’ performance under the credit facility.

 

We have agreed with our Lender to raise at least $2 millionin net proceeds through the sale of stock of the borrowers by no later than September 30,2009.  Under to the terms of AmendmentNumber 4 to the credit facility, we are obligated to remit to our Lender$500,000 with respect to the first $2,000,000 of net cash proceeds received inconnection with the sale of stock, 50% of the next $1,000,000 of net cashproceeds received in connection with the sale of stock, and 30% of the net cashproceeds in excess of the first $3,000,000 received in connection with the saleof stock.  In that case, $500,000 wouldbe used to pay down debt and $1,500,000 would remain within EMRISE to supportongoing working capital needs.

 

We are currently evaluating a number of options to meetthis obligation under our credit facility. Given current economic and financial market conditions even a smallequity raise could prove difficult.  Ifwe are successful in structuring an equity raise acceptable to us and ourLender, it may result in substantial dilution to our stockholders.

 

If we are unsuccessful in meeting our Lender’s requirementfor additional capital by the required due dates and/or if we breach any of ouragreed upon financial covenants under the credit facility, then we will be indefault under the terms of our credit facility. In the event of a default and continuation of a default, whether as aresult of our inability to raise additional capital or for some other reason,the Lender may limit future availability under our revolving line of creditand/or accelerate the payment of all principal balances and accrued interestrequiring us to pay the entire indebtedness under our credit facilityoutstanding on that date.  Upon theoccurrence and during the continuation of an event of default, the Lender mayalso elect to increase the interest rate applicable to the outstanding balanceof the Term Loans A and B by four percentage points above the per annuminterest rate that would otherwise be applicable.  Any of these conditions could have a materialadverse effect on our operations and/or ability to conduct business after thatdate.

 

Variousfactors, including the adverse effects of the global market crisis, couldimpact our Lender’s ability to provide us with access to the funds available underour credit facility, resulting in our access to cash and our ability to operateour business being negatively affected.  In addition to the effects of thecurrent global financial crisis, statements in an article published in the *Wall Street Journal* raising issuessurrounding the business practices of our the president of our Lender’s agent,whether or not true, may have an effect on our Lender’s ability to continue toprovide us funds under our revolving line of credit.  Any of theseconditions would have a material adverse effect on our operations and/orability to conduct business after that date.

 

Webelieve that current and future capital resources, revenues generated fromoperations and other existing sources of liquidity, including amounts availableunder the credit facility, will be adequate to meet our anticipated short term,working capital and capital expenditures needs for at least the next 12 months. However, if we experience a significantloss of revenue or increase in costs, our cash flow could be negativelyimpacted resulting in a cash flow deficit which, in turn, may require us toobtain additional or alternate financing. These potential financing needs could be met in the form of a reviseddebt structure with our Lender, new financing with another lender or lenders,the sale of certain assets to generate cash or the sale of additional equity toraise capital.  Our failure to secureadditional or alternate financing, if needed, could have an adverse affect onour operations and/or ability to do business after that date or could restrictour growth, limit our development of new products, or hinder our ability tofulfill existing or future orders.

 

**Effects of 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.

 

**Impacts of New Accounting Pronouncements**

** **

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

 

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In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements”. This newstatement provides a single definition of fair value, together with a frameworkfor measuring it, and requires additional disclosure about the use of fairvalue to measure assets and liabilities. SFAS No. 157 also emphasizes thatfair value is a market-based measurement, not an entity-specific measurement,and sets out a fair value hierarchy, with the highest priority being quotedprices in active markets. The required effective date of SFAS No. 157 isthe first quarter of 2008. The adoption of SFAS No. 157 for financialassets and liabilities did not have a material effect on our consolidatedfinancial statements, but resulted in additional disclosures.  In February 2008, the FASB issued StaffPosition No. 157-2, which delayed by one year the effective date of SFAS No. 157for all non-financial assets and liabilities, except those that are recognizedor disclosed at fair value in the financial statements on a recurringbasis.  We believe the adoption of SFAS No. 157for non-financial assets and liabilities will not have a material effect on ourconsolidated financial statements.

 

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

 

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

 

In April 2008,the FASB issued FASB Staff Position (“FSP”) No. FAS 142-3, “Determinationof the Useful Life of Intangible Assets,” (“FSP 142-3”). FSP 142-3 amends thefactors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible assetunder SFAS No. 142, “Goodwill and Other Intangible Assets” and alsorequires expanded disclosure related to the determination of intangible assetuseful lives. FSP 142-3 is effective for fiscal years beginning after December 15,2008. Early adoption is prohibited. We are currently evaluating the impact theadoption of FSP 142-3 will have on our consolidated financial statements.

 

**Item 7A.     Quantitative and Qualitative DisclosuresAbout Market Risk.**

 

Not applicable.

 

**Item 8.**                       Financial Statements and Supplementary Data.

 

Reference is made to the financial statements included in this Report,which begin at page F-1.

 

**Item** 9.                       Changes in andDisagreements With Accountants on Accounting and Financial Disclosure.

 

None.

 

**Item 9A.**              Controls and Procedures.

 

Not applicable.

 

**Item 9A(T).**                                  Controls and Procedures.

 

**Evaluationof Disclosure Controls and Procedures**

 

We conducted an evaluation under the supervision and withthe participation of our management, including our Chief Executive Officer andVice President Finance and Administration, our principal accounting officer, ofthe effectiveness of the design and operation of our disclosure controls andprocedures.  The term “disclosurecontrols and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (“Exchange Act”), meanscontrols and other procedures of a company that are designed to ensure thatinformation required to be disclosed by the company in the reports it files orsubmits under the Exchange Act is recorded, processed, summarized and reported,within the time periods specified in the SEC’s rules and forms.  Disclosure controls and procedures alsoinclude, without limitation, controls and procedures designed to ensure thatinformation required to be disclosed by a company in the reports that it filesor submits under the Exchange Act is accumulated and communicated to thecompany’s management, including its principal executive and principal financialofficers, or persons performing similar functions, as appropriate, to allowtimely decisions regarding required disclosure. Based on this evaluation, our Chief Executive Officer and Vice PresidentFinance and Administration concluded as of December 31, 2008 that ourdisclosure controls and procedures were not effective at the reasonableassurance level due to the material weaknesses discussed immediately below.

 

In light of thethree material weaknesses described below, we performed additional analysis andother post-closing procedures to ensure that our consolidated financialstatements were prepared in accordance with generally accepted accountingprinciples.  Accordingly, we believe thatthe consolidated financial statements included in this report fairly present,in all material respects, our financial condition, results of operations andcash flows for the periods presented.

 

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**Management’sReport on Internal Control Over Financial Reporting**

 

Our management is responsible for establishing andmaintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act. Our internal control over financialreporting is designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. Ourinternal control over financial reporting includes those policies andprocedures that:

 

(i)                                     pertain to the maintenanceof records that, in reasonable detail, accurately and fairly reflect the transactionsand dispositions of our assets;

 

(ii)                                provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that our receipts and expenditures are being made only inaccordance with authorizations of our management and directors; and

 

(iii)                             provide reasonableassurance regarding prevention or timely detection of unauthorized acquisition,use or disposition of our assets that could have a material affect on ourfinancial statements.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

Amaterial weakness in internal control over financial reporting is defined bythe Public Company Accounting Oversight Board’s Audit Standard No. 5 asbeing a deficiency, or a combination of deficiencies, in internal control overfinancial reporting, such that there is a reasonable possibility that amaterial misstatement of the company’s annual or interim financial statementswill not be prevented or detected on a timely basis.

 

Managementassessed and evaluated the effectiveness of our internal control over financialreporting as of December 31, 2008. Based on the results of management’sassessment and evaluation, our Chief Executive Officer and Vice PresidentFinance and Administration concluded that as of December 31, 2008 thefollowing three material weaknesses in our internal control over financialreporting existed:

 

(1)                                We did not effectively implementcomprehensive entity-level internal controls.

 

(2)                                We did not maintain effective controls over changes tocritical financial reporting applications and over access to these applicationsand related data.

 

(3)                                We did not maintain a sufficient level of informationtechnology personnel to execute general computing controls over our informationtechnology structure.

 

Theforegoing material weaknesses are described in detail below under the caption“Material Weaknesses and Related Remediation Initiatives.”**As a result of these material weaknesses,our Chief Executive Officer and Vice President Finance and Administrationconcluded that we did not maintain effective internal control over financialreporting as of December 31, 2008. If notremediated, these material weaknesses could result in one or more materialmisstatements in our reported financial statements in a future annual orinterim period.

 

In makingits assessment of our internal control over financial reporting, managementused criteria issued by the Committee of Sponsoring Organizations of theTreadway Commission (“COSO”) in its *InternalControl-Integrated Framework*. Because of the material weaknessesdescribed above, management believes that, as of December 31, 2008, we didnot maintain effective internal control over financial reporting.

 

Anindependent consulting firm assisted management with its assessment of theeffectiveness of our internal control over financial reporting, including scopedetermination, planning, staffing, documentation, portions of testing, portionsof remediation and portions of overall program management of the assessmentproject.

 

ThisReport does not include an attestation report of our independent registeredpublic accounting firm regarding internal control over financialreporting.  Management’s report was notsubject to attestation by our independent registered public accounting firmpursuant to temporary rules of the SEC that permit us to provide onlymanagement’s report in this Report.

 

**Inherent Limitations on the Effectiveness ofControls**

** **

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 reflectthe fact that there are resource constraints, and the benefits of controls mustbe considered 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.

 

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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, controlsmay become inadequate because of changes in conditions or deterioration in thedegree of compliance with policies or procedures.

 

**MaterialWeaknesses and Related Remediation Initiatives**

** **

Setforth below is a summary of the various significant deficiencies which causedmanagement to conclude that we had the three material weaknesses identifiedabove.  Through the efforts ofmanagement, external consultants and our Audit Committee, we are currently inthe process of developing specific action plans to remediate the materialweaknesses identified above and discussed more fully below.  We expect to complete these various actionplans by June 30, 2009.  If we areable to complete these action plans by that date, we anticipate that allcontrol deficiencies and material weaknesses will be remediated by December 31,2009.

 

(1)                                We did not effectively implement comprehensive entity-levelinternal controls, as evidenced by the following controldeficiencies:

 

·                  *Entity Level Internal Control Evaluation*.  We did not formallyconsider entity-wide controls that are pervasive across our company whenconsidering whether control activities are sufficient to address identifiedrisks.

 

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

 

·                  *Objective Evaluation of Internal Controls*.  We did not use aninternal audit function or other objective party to provide an objectiveperspective on key elements of the internal control system.

 

·                  *External Communication*.  We lacked formalpolicies and procedures regarding how and when matters affecting theachievement of financial reporting objectives are communicated with outside parties.

 

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

 

·                  *Information Technology*.  We did not havesufficient information technology controls, where applicable, designed andimplemented to support the achievement of financial reporting objectives.

 

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

 

·                  *Reporting Deficiencies*.  We did not performtimely and sufficient internal or external reporting of our progress andevaluation of prior year material weaknesses or the current fiscal yearinternal control deficiencies.

 

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

 

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

 

**Remediationof Internal Control Deficiencies and Expenditures**

** **

The above material weaknesses did not result in adjustmentsto our 2008 consolidated financial statements, however, it is reasonablypossible that, if not remediated, one or more of the material weaknessesdescribed above could result in a material misstatement in our reportedfinancial statements that might result in a material misstatement in a futureannual or interim period.

 

In addition to the developing specific action plans foreach of the above material weaknesses, we are taking steps to unify thefinancial reporting of all of our divisions. Accordingly, we are planning to implement a centralized consolidationsoftware package which we believe will facilitate this process and will assistin the remediation of many of the above listed deficiencies.

 

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In addition, our audit committee has authorized the hiringof additional temporary staff and/or the use of financial and informationtechnology consultants, as necessary, to ensure that we have the depth andexperience to remediate the above listed material weaknesses, including theimplementation and monitoring of the appropriate level of control proceduresrelated to all of our manufacturing locations and our corporate offices.  The audit committee will also work directlywith management and outside consultants, as necessary to ensure that boardlevel deficiencies are addressed.  We areuncertain at this time of the costs to remediate all of the above listedmaterial weaknesses, however, we anticipate the cost to be in the range of$200,000 to $400,000 (including the cost of the consolidation softwaredescribed above), most of which costs we expect to incur in 2009.  We cannot guarantee that the actual costs toremediate these deficiencies will not exceed this amount.

 

Through these steps, we believe that we are addressing thedeficiencies that affected our internal control over financial reporting as of December 31,2008. Because the remedial actions require hiring of additional personnel,upgrading certain of our information technology systems, and relyingextensively on manual review and approval, the successful operation of thesecontrols for at least several quarters may be required before management may beable to conclude that the material weakness has been remediated.  We intend to continue to evaluate andstrengthen our internal control over financial reporting systems. These effortsrequire significant time and resources. If we are unable to establish adequate internal control over financialreporting systems, we may encounter difficulties in the audit or review of ourfinancial statements by our independent registered public accounting firm,which in turn may have a material adverse effect on our ability to preparefinancial statements in accordance with GAAP and to comply with our SECreporting obligations.

 

**Changesin Internal Control over Financial Reporting**

** **

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

 

**Item 9B.**              Other Information.

 

**AmendmentNumber 4 to Loan Documents**

** **

On April 14,2009, we entered into Amendment Number 4 to Loan Documents with our Lender (“AmendmentNumber 4”).  Pursuant to Amendment Number4, we agreed to raise no less than $2 million in net proceeds through the saleof stock of the borrowers by no later than September 30, 2009.  Under to the terms of Amendment Number 4, weare obligated to remit to our Lender $500,000 with respect to the first$2,000,000 of net cash proceeds received in connection with the sale of stock,50% of the next $1,000,000 of net cash proceeds received in connection with thesale of stock, and 30% of the net cash proceeds in excess of the first$3,000,000 received in connection with the sale of stock.

 

Pursuantto the terms of Amendment Number 4, the Lender waived any claims of breach ordefault arising out of or relating to the breach of certain of the financialcovenants under the credit facility through April 14, 2009.  Additionally, several of the financialcovenants related to the $7,000,000 revolving credit facility available under our creditfacility were amended.  Pursuant to the terms of credit facility, theRevolver is subject to various financial covenants on a consolidated basis,including the following: EBITDA, measured on a fiscal quarter-end basis, mustnot be less than the scheduled amount for each specified period; the debtservice coverage ratio, measured quarterly, must be greater than the lesser ofthe scheduled amount for each specific period or 1.10:1.00; the leverage ratio,measured quarterly, must not be greater than the scheduled amount for eachspecified period, and liquidity, measured quarterly, must not be less than thescheduled amount for each specified period. Additionally, the Revolver is subject to the Borrowers not incurringcapital expenditures (a) in excess of $600,000 for the fiscal year ending December 31, 2009,and (b) in excess of $1,800,000 for the fiscal year ending December 31,2010.  Additionally, the Revolver is subject to the borrowers not incurringunfinanced capital expenditures in excess of $62,500 in any fiscal quarter,****provided however that if the borrowers incur unfinancedcapital expenditures of less than $62,500 in any fiscal quarter, the differencebetween the amount incurred in a certain fiscal quarter and $62,500 maybeincurred in the two fiscal quarters immediately following such fiscal quarter.

 

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**PART III**

** **

**Item 10.**                Directors, Executive Officers and CorporateGovernance.

 

**Directors**

 

Theinformation under the captions “Directors, Director Nominee and ExecutiveOfficers” and “Information About our Board of Directors, Board Committees andRelated Matters”, appearing in our definitive proxy statement, to be filedpursuant to Regulation 14A, related to our 2009 Annual Meeting of Stockholders (our“2009 Proxy Statement”), is hereby incorporated by reference.

 

**Executive Officers**

 

Theinformation under the captions “Directors, Director Nominee and ExecutiveOfficers” and “Section 16(a) Beneficial Ownership ReportingCompliance”, appearing in the 2009 Proxy Statement, is hereby incorporated byreference.

 

**Item 11.**                Executive Compensation.

 

The information under the caption “Executive Compensationand Related Information”, appearing in the 2009 Proxy Statement, is herebyincorporated by reference.

 

**Item 12.**                Security Ownership of Certain Beneficial Owners andManagement and Related Stockholder Matters.

 

The information under the captions “Security Ownership ofCertain Beneficial Owners and Management”, appearing in the 2009 ProxyStatement, is hereby incorporated by reference.

 

**Item 13.**                Certain Relationships and Related Transactions, andDirector Independence.

 

The information under the caption “Certain Relationshipsand Related Transactions”, appearing in the 2009 Proxy Statement, is herebyincorporated by reference.

 

**Item 14.**                Principal Accounting Fees and Services.

 

The information under the captions “Principal AccountantFees and Services,” appearing in the 2009 Proxy Statement, is herebyincorporated by reference.

 

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**PART IV**

** **

**Item 15.**              Exhibits and Financial Statement Schedules.

 

**(a)(1)**  Financial Statements.

 

**Reference is made to thefinancial statements listed on and attached following the Index to FinancialStatements contained at page F-1 of this report.**

 

**(a)(2) and(c) Financial Statement Schedules.**

 

**Not applicable.**

 

(a)(3) and (b) Exhibits.

* *
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                       |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                                                                                                                                                                  |
| 2.1              |       | Stock Purchase Agreement dated July 13, 2004 between MicroTel  International Inc.; Noel C. McDermott; Warren P. Yost; Noel C. McDermott, as  Trustee of the Noel C. McDermott Revocable Living Trust dated  December 19, 1995; and Warren P. Yost and Gail A. Yost, as Co-Trustees  Under Declaration of Trust dated March 9, 1988 (1) |
|             |       |                                                                                                                                                                                                                                                                                                                                                  |
| 2.2              |       | Agreement dated March 1, 2005 among Intelek Properties Limited,  XCEL Corporation Limited, Intelek PLC and EMRISE Corporation relating to the  sale and purchase of the outstanding capital shares of Pascall Electronic  (Holdings) Limited (10)                                                                                                |
|             |       |                                                                                                                                                                                                                                                                                                                                                  |
| 2.3              |       | Supplemental Agreement dated March 18, 2005 among Intelek  Properties Limited, XCEL Corporation Limited, Intelek PLC and EMRISE  Corporation (10)                                                                                                                                                                                                |
|             |       |                                                                                                                                                                                                                                                                                                                                                  |
| 2.4              |       | Loan Agreement dated March 18, 2005 among XCEL Corporation Limited,  Pascall Electronics Limited and Pascall Electronic (Holdings) Limited (10)                                                                                                                                                                                                  |
|             |       |                                                                                                                                                                                                                                                                                                                                                  |
| 2.5              |       | Stock Purchase Agreement dated September 2, 2005 between EMRISE  Electronics Corporation, a New Jersey corporation, Robert H. Okada, as  Trustee of the Robert H. Okada Trust Agreement dated February 11, 1992,  and Sharon Vavro, an individual (13)                                                                                      |
|             |       |                                                                                                                                                                                                                                                                                                                                                  |
| 2.6              |       | Amendment No. 1 dated effective as of September 28, 2005 to  Stock Purchase Agreement dated September 2, 2005 between EMRISE  Electronics Corporation, a New Jersey corporation, Robert H. Okada, as  Trustee of the Robert H. Okada Trust Agreement dated February 11, 1992,  and Sharon Vavro, an individual (14)               |
|             |       |                                                                                                                                                                                                                                                                                                                                                  |
| 2.7              |       | Stock Purchase Agreement dated May 23, 2008 by and among EMRISE  Electronics Corporation, EMRISE Corporation, Charles S. Brand, Advanced  Control Components, Inc., Thomas P. M. Couse, Joanne Couse, Michael  Gaffney and Custom Components, Inc.(20)                                                                                 |
|             |       |                                                                                                                                                                                                                                                                                                                                                  |
| 2.8              |       | Amendment No. 1 to Stock Purchase Agreement dated August 20,  2008 by and among EMRISE Electronics Corporation, EMRISE Corporation, Charles  S. Brand, Advanced Control Components, Inc., Thomas P. M. Couse, Joanne  Couse, Michael Gaffney and Custom Components, Inc.(20)                                                      |
|             |       |                                                                                                                                                                                                                                                                                                                                                  |
| 2.9              |       | Asset and Stock Purchase Agreement, dated March 20, 2009, by and among  EMRISE Corporation, EMRISE Electronics Corporation, Electro Switch Corp., and  ESC Worldwide, Inc. (23)                                                                                                                                                                       |
|             |       |                                                                                                                                                                                                                                                                                                                                                  |
| 3.1              |       | Amended and Restated Certificate of Incorporation of EMRISE Corporation filed  with the Secretary of State of Delaware on May 9, 2005 (21)                                                                                                                                                                                                            |
|             |       |                                                                                                                                                                                                                                                                                                                                                  |
| 3.2              |       | Amended and Restated Bylaws adopted by the Board of Directors of the  Corporation on July 23, 2008 (3)                                                                                                                                                                                                                                           |
|             |       |                                                                                                                                                                                                                                                                                                                                                  |
| 3.3              |       | Certificate of Amendment to Certificate of  Incorporation of EMRISE Corporation, filed on November 19, 2008 (11)                                                                                                                                                                                                                                 |
|             |       |                                                                                                                                                                                                                                                                                                                                                  |
| 10.1             |       | 1993 Stock Option Plan (#) (4)                                                                                                                                                                                                                                                                                                                        |
|             |       |                                                                                                                                                                                                                                                                                                                                                  |
| 10.2             |       | Employee Stock and Stock Option Plan (#) (5)                                                                                                                                                                                                                                                                                                          |
|             |       |                                                                                                                                                                                                                                                                                                                                                  |
| 10.3             |       | 1997 Stock Incentive Plan (#) (6)                                                                                                                                                                                                                                                                                                                     |

 

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| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                 |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.4             |       | Amended and Restated 2000 Stock Option Plan (#) (8)                                                                                                                                                                                                                                                                                                             |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.5             |       | Form of Executive Officer and Director Indemnification Agreement  entered into between the Registrant and each of Carmine T. Oliva, Laurence P.  Finnegan, Jr., Otis W. Baskin, Richard E. Mahmarian, D. John Donovan and  Graham Jefferies (2)                                                                                                       |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.6             |       | Description of Compensation of Directors (#) (16)                                                                                                                                                                                                                                                                                                               |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.9             |       | Subordinated Secured Promissory Note dated July 13, 2004 in the  principal amount of $1,681,318.68 made by MicroTel International Inc. in  favor of Noel C. McDermott Revocable Living Trust dated December 19,  1995 (9)                                                                                                                             |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.10            |       | Subordinated Secured Promissory Note dated July 13, 2004 in the  principal amount of $1,318,681.32 made by MicroTel International Inc. in  favor of Warren P. Yost and Gail A. Yost, as Co-Trustees Under Declaration of  Trust dated March 9, 1988 (9)                                                                                               |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.11            |       | Pledge and Security Agreement dated July 13, 2004 between MicroTel  International Inc.; Noel C. McDermott, as Collateral Agent; Noel C.  McDermott, as Trustee of the Noel C. McDermott Revocable Living Trust dated  December 19, 1995; and Warren P. Yost and Gail A. Yost, as Co-Trustees  Under Declaration of Trust dated March 9, 1988 (9) |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.12            |       | Intercreditor Agreement dated July 13, 2004 between MicroTel  International Inc.; Noel C. McDermott, as Trustee of the Noel C. McDermott  Revocable Living Trust dated December 19, 1995; and Warren P. Yost and  Gail A. Yost, as Co-Trustees Under Declaration of Trust dated March 9,  1988 (9)                                               |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.13            |       | Continuing Guarantee dated July 13, 2004 made by Larus Corporation  in favor of Noel C. McDermott, as Trustee of the Noel C. McDermott Revocable  Living Trust dated December 19, 1995, and Warren P. Yost and Gail A.  Yost, as Co-Trustees Under Declaration of Trust dated March 9, 1988 (9)                                                  |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.14            |       | Continuing Guarantee dated July 13, 2004 made by Vista Labs  Incorporated in favor of Noel C. McDermott, as Trustee of the Noel C.  McDermott Revocable Living Trust dated December 19, 1995, and Warren P.  Yost and Gail A. Yost, as Co-Trustees Under Declaration of Trust dated  March 9, 1988 (9)                                           |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.15            |       | Continuing Guarantee dated July 13, 2004 made by CXR Telcom in  favor of Noel C. McDermott, as Trustee of the Noel C. McDermott Revocable  Living Trust dated December 19, 1995, and Warren P. Yost and Gail A.  Yost, as Co-Trustees Under Declaration of Trust dated March 9, 1988 (9)                                                         |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.16            |       | Security Agreement dated July 13, 2004 made by Larus Corporation in  favor of Noel C. McDermott, as Trustee of the Noel C. McDermott Revocable  Living Trust dated December 19, 1995, and Warren P. Yost and Gail A.  Yost, as Co-Trustees Under Declaration of Trust dated March 9, 1988 (9)                                                    |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.17            |       | Security Agreement dated July 13, 2004 made by Vista Labs  Incorporated in favor of Noel C. McDermott, as Trustee of the Noel C.  McDermott Revocable Living Trust dated December 19, 1995, and Warren P.  Yost and Gail A. Yost, as Co-Trustees Under Declaration of Trust dated  March 9, 1988 (9)                                             |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.18            |       | Security Agreement dated July 13, 2004 made by CXR Telcom in favor  of Noel C. McDermott, as Trustee of the Noel C. McDermott Revocable Living  Trust dated December 19, 1995, and Warren P. Yost and Gail A. Yost, as  Co-Trustees Under Declaration of Trust dated March 9, 1988 (9)                                                           |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.19            |       | Lease agreement between the Registrant and Property Reserve Inc. dated  September 16, 1999 (7)                                                                                                                                                                                                                                                        |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.20            |       | Lease agreement between XET, Inc. and Rancho Cucamonga Development  dated August 30, 1999 (7)                                                                                                                                                                                                                                                         |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.21            |       | Commercial Lease dated July 13, 2004 between the Registrant, as  Tenant, and Noel C. McDermott and Warren P. Yost, as Landlord, for the  premises located at 894 Faulstich Court, San Jose, California (9)                                                                                                                                                 |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.22            |       | Executive Employment Agreement dated November 1, 2007 by and  between the Registrant and Carmine T. Oliva (#) (15)                                                                                                                                                                                                                                         |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.23            |       | Executive Employment Agreement dated November 1, 2007 by and  between the Company and Graham Jefferies (#) (15)                                                                                                                                                                                                                                            |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.24            |       | Executive Employment Agreement dated November 1, 2007 by and  between the Company and D. John Donovan (#) (15)                                                                                                                                                                                                                                             |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.27            |       | Loan Agreement dated March 18, 2005 among XCEL Corporation Limited,  Pascall Electronics Limited and Pascall Electronic (Holdings) Limited (10)                                                                                                                                                                                                            |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.28            |       | Form of Incentive Stock Option Agreement Under Amended and Restated  2000 Stock Option Plan (#) (12)                                                                                                                                                                                                                                                       |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.29            |       | Form of Non-Qualified Stock Option Agreement Under Amended and  Restated 2000 Stock Option Plan (#) (12)                                                                                                                                                                                                                                                   |
|             |       |                                                                                                                                                                                                                                                                                                                                                            |
| 10.30            |       | 2007 Stock Incentive Plan (#) (18)                                                                                                                                                                                                                                                                                                                              |

 

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| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                          |
|------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.31            |       | Credit Agreement by and among EMRISE Corporation, EMRISE Electronics  Corporation, CXR Larus Corporation and RO Associates and GVEC Resource IV Inc  dated November 30, 2007(19)                                                                                                                    |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.32            |       | Security Agreement between EMRISE Corporation, Emrise Electronics  Corporation, CXR Larus Corporation and RO Associates Incorporated and GVEC  Resource IV Inc dated November 30, 2007(19)                                                                                                          |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.33            |       | Patent Security Agreement between EMRISE Corporation, RO Associates  Incorporated and GVEC Resource IV Inc dated November 30, 2007(19)                                                                                                                                                              |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.34            |       | Trademark Security Agreement between EMRISE Corporation, EMRISE  Electronics Corporation and RO Associates Incorporated and GVEC Resource IV  Inc dated November 30, 2007(19)                                                                                                                       |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.35            |       | Revolver Loan Note dated November 30, 2007 executed by EMRISE  Corporation, Emrise Electronics Corporation, CXR Larus Corporation and RO  Associates Incorporated in favor of GVEC Resource IV Inc.(19)                                                                                             |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.36            |       | Term Loan A Note dated November 30, 2007 executed by EMRISE  Corporation, Emrise Electronics Corporation, CXR Larus Corporation and RO  Associates Incorporated in favor of GVEC Resource IV Inc.(19)                                                                                               |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.37            |       | Term Loan B Note dated November 30, 2007 executed by EMRISE Corporation,  Emrise Electronics Corporation, CXR Larus Corporation and RO Associates  Incorporated in favor of GVEC Resource IV Inc.(19)                                                                                               |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.38            |       | Warrant issued to Private Equity Management Group LLC dated  November 30, 2007(19)                                                                                                                                                                                                                  |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.39            |       | Guaranty dated November 30, 2007 by and between XCEL Japan Ltd. and  GVEC Resource IV Inc.(19)                                                                                                                                                                                                      |
|             |       |                                                                                                                                                                                                                                                                                                     |
|  10.40      |       | Guaranty dated November 30, 2007 by and among Emrise Electronics  Ltd., XCEL Power Systems, Ltd. Pascall Electronic (Holdings) Limited, Pascall  Electronics Limited, Belix Would Components Ltd. and The Belix Company Ltd.  and GVEC Resource IV Inc.(19)                                         |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.41            |       | Composite Debenture dated November 30, 2007 by and among Emrise  Electronics Ltd., XCEL Power Systems, Ltd. Pascall Electronic (Holdings)  Limited, Pascall Electronics Limited, Belix Would Components Ltd. and The  Belix Company Ltd. and GVEC Resource IV Inc.(19)                              |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.42            |       | Share Charge dated November 30, 2007 by and between Emrise  Electronics Corporation and GVEC Resource IV Inc.(19)                                                                                                                                                                                   |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.43            |       | Guaranty dated November 30, 2007 by and between CXR Anderson  Jacobson, SAS and GVEC Resource IV Inc.(19)                                                                                                                                                                                           |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.45            |       | Agreement For The Pledge Of Account Of Financial Instruments Relating To  Shares Of CXR Anderson Jacobson SAS dated November 30, 2007 by and  between Emrise Corporation and GVEC Resource IV Inc.(19)                                                                                              |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.46            |       | Convention de Nantissement de fonds de commerce dated November 30,  2007 by and between CXR Anderson Jacobson, SAS and GVEC Resource IV Inc.(19)                                                                                                                                                    |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.47            |       | Going Concern Pledge (English Translation of Convention de Nantissement  de fonds de commerce dated November 30, 2007 by and between CXR Anderson  Jacobson, SAS and GVEC Resource IV Inc. filed as Exhibit 10.16 to  this Report.)(19)                                                   |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.48            |       | Form of Subordinated Secured Contingent Promissory Notes issued by  the Company to Charles S. Brand, Thomas P. M. Couse, Joanne Couse, and  Michael Gaffney(20)                                                                                                                                     |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.49            |       | Security Agreement, dated August 20, 2008, by and among EMRISE  Electronics Corporation, Charles S. Brand, Advanced Control  Components, Inc., Thomas P. M. Couse, Joanne Couse, and Michael  Gaffney(20)                                                                                      |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.50            |       | Continuing Guaranty, dated August 20, 2008, by and among EMRISE  Corporation, Charles S. Brand, Advanced Control Components, Inc., Thomas  P. M. Couse, Joanne Couse, and Michael Gaffney(20)                                                                                                  |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.51            |       | Credit Agreement, dated November 30, 2007, by and among EMRISE  Corporation, EMRISE Electronics Corporation, CXR Larus Corporation, and RO  Associates Incorporated and GVEC Resource IV Inc. (20)                                                                                                  |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.52            |       | Amendment Number 1 to Loan Documents, dated August 20, 2008, by and  among EMRISE Corporation, EMRISE Electronics Corporation, CXR Larus  Corporation, RO Associates Incorporated, Advanced Control  Components, Inc. and Custom Control Components, Inc. and GVEC  Resource IV Inc. (20) |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.53            |       | Term Loan C Note dated August 20, 2008 executed by EMRISE  Corporation, Emrise Electronics Corporation, CXR Larus Corporation and RO  Associates Incorporated in favor of GVEC Resource IV Inc. (20)                                                                                                |
|             |       |                                                                                                                                                                                                                                                                                                     |
| 10.54            |       | Collateral Assignment of Rights under Purchase Agreement, dated  August 20, 2008, by and among EMRISE Corporation, Emrise Electronics  Corporation and GVEC Resource IV Inc. (20)                                                                                                                   |

 

39

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Tableof Contents

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                             |
|------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                                                                                                                                                                        |
| 10.55            |       | Amended and Restated Warrant issued to Private Equity Management Group  LLC, dated November 30, 2007(20)                                                                                                                                                                                                               |
|             |       |                                                                                                                                                                                                                                                                                                                        |
| 10.56            |       | Form of Stock Option Agreement issued to EMRISE Corporation’s  directors and executive officers under 2007 Stock Incentive Plan(#)(20)                                                                                                                                                                            |
|             |       |                                                                                                                                                                                                                                                                                                                        |
| 10.57            |       | Amendment to Forbearance Agreement and Amendment Number 3 to Loan  Documents, dated April 9, 2009, by and among EMRISE Corporation, EMRISE  Electronics Corporation, CXR Larus Corporation, RO Associates Incorporated,  Advanced Control Components, Inc., Custom Control Components, Inc. and GVEC  Resource IV Inc. (22) |
|             |       |                                                                                                                                                                                                                                                                                                                        |
| 10.58            |       | Amendment Number 4 to Loan Documents dated April 14, 2009, by and among  EMRISE Corporation, EMRISE Electronics Corporation, CXR Larus Corporation, RO  Associates Incorporated, Advanced Control Components, Inc. and Custom Control  Components, Inc. and GVEC Resource IV Inc.                                           |
|             |       |                                                                                                                                                                                                                                                                                                                        |
| 10.59            |       | Amendment Number 2 to Loan Documents dated February 12, 2009 by and  among EMRISE Corporation, EMRISE Electronics Corporation, CXR Larus  Corporation, RO Associates Incorporated, Advanced Control Components, Inc.,  Custom Components, Inc. and GVEC Resource IV Inc.(24)                                                |
|             |       |                                                                                                                                                                                                                                                                                                                        |
| 10.61            |       | Second Amended and Restated Warrant dated February 12, 2009 issued to  Private Equity Management Group, LLC (24)                                                                                                                                                                                                            |
|             |       |                                                                                                                                                                                                                                                                                                                        |
| 10.62            |       | Second Amended and Restated Warrant dated February 12, 2009 issued to  Private Equity Management Group, LLC (24)                                                                                                                                                                                                            |
|             |       |                                                                                                                                                                                                                                                                                                                        |
| 14.1             |       | Amended and Restated Code of Business Conduct and Ethics (16)                                                                                                                                                                                                                                                               |
|             |       |                                                                                                                                                                                                                                                                                                                        |
| 14.2             |       | Code of Business Ethics for CEO and Senior Financial Officers (16)                                                                                                                                                                                                                                                          |
|             |       |                                                                                                                                                                                                                                                                                                                        |
| 16               |       | Letter dated April 19, 2006 from Grant Thornton LLP regarding  change in certifying accountant (17)                                                                                                                                                                                                               |
|             |       |                                                                                                                                                                                                                                                                                                                        |
| 21               |       | Subsidiaries of the Registrant                                                                                                                                                                                                                                                                                              |
|             |       |                                                                                                                                                                                                                                                                                                                        |
| 23               |       | Consent of Hein & Associates LLP Independent Registered Public  Accounting Firm *                                                                                                                                                                                                                                  |
|             |       |                                                                                                                                                                                                                                                                                                                        |
| 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               |       | Certification of Chief Executive Officer and Vice President Finance and  Administration Pursuant to 18 U.S.C. Section 350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *                                                                                                           |

 

----

*                            Filed herewith.

(#)                    Management contract or compensatory plan, contractor arrangement required to be filed as an exhibit.

(1)                     Filed as an exhibit to the Registrant’s currentreport on Form 8-K for July 13, 2004 and incorporated herein byreference.

(2)                     Filed as an exhibit to the Registrant’s currentreport on Form 8-K for December 8, 2004 and incorporated herein byreference.

(3)                     Filed as  anexhibit to the Registrant’s current report on Form 8-K for July 23,2008 and incorporated herein by reference.

(4)                     Filed as an exhibit to the Registrant’s annualreport on Form 10-K for the year ended December 31, 2000 andincorporated herein by reference.

(5)                     Filed as an exhibit to the Registrant’s definitiveproxy statement for the Registrant’s annual meeting of stockholders held June 11,1998 and incorporated herein by reference.

(6)                     Filed as an exhibit to the Registrant’s definitiveproxy statement for the special meeting of stockholders held January 16,2001 and incorporated herein by reference.

(7)                     Filed as an exhibit to the Registrant’s interimreport on Form 10-Q for September 30, 1999 and incorporated herein byreference.

(8)                     Filed as an exhibit to the Registrant’s quarterlyreport on Form 10-Q for September 30, 2001 and incorporated herein byreference.

(9)                     Filed as an exhibit to the Registrant’s quarterlyreport on Form 10-Q for June 30, 2004 and incorporated herein byreference.

(10)               Filed as an exhibit to the Registrant’s currentreport on Form 8-K for March 18, 2005 and incorporated herein byreference.

(11)               Filed as an exhibit to the Registrant’s currentreport on Form 8-K for November 19, 2008 and incorporated herein byreference.

(12)               Filed as an exhibit to the Registrant’s annualreport on Form 10-K for the year ended December 31, 2004 andincorporated herein by reference.

(13)               Filed as an exhibit to the Registrant’s currentreport on Form 8-K for September 2, 2005 and incorporated herein byreference.

(14)               Filed as an exhibit to amendment no. 1 to theRegistrant’s current report on Form 8-K for September 2, 2005 andincorporated herein by reference.

(15)               Filed as an exhibit to the Registrant’s Form 10-Qfor September 30, 2007 and incorporated herein by reference.

(16)               Filed as an exhibit to the Registrant’s annualreport on Form 10-K for the year ended December 31, 2005.

(17)               Filed as an exhibit to the Registrant’s Form 8-Kfor April 13, 2006 and incorporated herein by reference.

(18)               Filed as an exhibit to the Registrant’s definitiveproxy statement for the Registrant’s annual meeting of stockholders held December 12,2007 and incorporated herein by reference.

(19)               Filed as an exhibit to the Registrant’s currentreport on Form 8-K for November 30, 2007 and incorporated herein byreference.

(20)               Filed as an exhibit to the Registrant’s currentreport on Form 8-K for August 20, 2008 and incorporated herein byreference.

(21)               Filed on May 19, 2005 as an exhibit to the Registrant’scurrent report on Form 8-K for May 6, 2005 and incorporated herein byreference.

(22)               Filed as an exhibit to the Registrant’s currentreport on Form 8-K for April 9, 2009 and incorporated herein by reference.

(23)               Filed as an exhibit to the Registrant’s currentreport on Form 8-K for March 20, 2009 and incorporated herein by reference.

(24)               Filed as an exhibit to the Registrant’s currentreport on Form 8-K for February 12, 2009 and incorporated herein by reference.

 

40

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Tableof Contents

 

**EMRISE CORPORATION AND SUBSIDIARIES**

** **

**Index to Financial Statements**

** **
| ** **                                                                                                | **Page** |
|-----------------------------------------------------------------------------------------------------------|----------|
|                                                                                                      |     |
| Financial  Statements                                                                                     |     |
|                                                                                                      |     |
| Report  of Independent Registered Public Accounting Firm                                                  | F-2      |
|                                                                                                      |     |
| Consolidated  Balance Sheets as of December 31, 2008 and 2007                                        | F-3      |
|                                                                                                      |     |
| Consolidated  Statements of Operations for the Years Ended December 31, 2008 and 2007                | F-4      |
|                                                                                                      |     |
| Consolidated Statements of Stockholders’ Equity for  the Years Ended December 31, 2008 and 2007 | F-5      |
|                                                                                                      |     |
| Consolidated Statements of Cash Flows for the Years  Ended December 31, 2008 and 2007                | F-6      |
|                                                                                                      |     |
| Notes to Consolidated Financial Statements                                                                | F-8      |

 

F-1

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Table ofContents

 

**Report of Independent Registered Public AccountingFirm**

 

Board of Directors

and Stockholders ofEMRISE Corporation

 

Wehave audited the accompanying consolidated balance sheets of EMRISECorporation, a Delaware corporation, as of December 31, 2008 and 2007, andthe related consolidated statements of operations, stockholders’ equity, andcash flows for each of the two years in the period ended December 31,2008. These consolidated financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on theseconsolidated financial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit also includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of EMRISE Corporationas of December 31, 2008 and 2007, and the results of its operations andits cash flows for each of the two years in the period ended December 31,2008 in conformity with accounting principles generally accepted in the UnitedStates of America.

 

Wewere not engaged to examine management’s assertion about the effectiveness ofEmrise Corporation’s internal control over financial reporting as of December 31,2008 included in the accompanying *Management’sReport on Internal Control Over Financial Reporting* and,accordingly, we do not express an opinion thereon.

 

/S/HEIN & ASSOCIATES LLP

 

Irvine,California

April 15, 2009

 

F-2

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Table of Contents

 

**EMRISECORPORATION**

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

 
| ** **                                                                                                                                                                                   | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                   | ** ** | **2008**              | ** ** | **2007**              | ** ** |
| **ASSETS**                                                                                                                                                                                   |       |                  |       |                  |       |
| Current assets:                                                                                                                                                                              |       |                  |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                   |       | $                     | 3,421      |                  | $          | 4,764 |   |
| Accounts  receivable, net of allowances for doubtful accounts of $501 at  December 31, 2008 and $345 at December 31, 2007                                                          |       | 11,520                |       | 9,406                 |       |
| Inventories, net                                                                                                                                                                             |       | 13,716                |       | 11,664                |       |
| Current deferred  tax assets                                                                                                                                                                 |       | 365                   |       | 200                   |       |
| Prepaid and  other current assets                                                                                                                                                            |       | 1,332                 |       | 1,617                 |       |
| Total current  assets                                                                                                                                                                        |       | 30,354                |       | 27,651                |       |
|                                                                                                                                                                                         |       |                  |       |                  |       |
| Property, plant  and equipment, net                                                                                                                                                          |       | 3,190                 |       | 2,227                 |       |
| Goodwill                                                                                                                                                                                     |       | 9,657                 |       | 13,129                |       |
| Intangible  assets other than goodwill, net                                                                                                                                                  |       | 6,787                 |       | 3,269                 |       |
| Deferred tax  assets                                                                                                                                                                         |       | 2,335                 |       | 617                   |       |
| Other assets                                                                                                                                                                                 |       | 1,300                 |       | 1,287                 |       |
| Total assets                                                                                                                                                                                 |       | $                     | 53,623     |                  | $          | 48,180 |   |
|                                                                                                                                                                                         |       |                  |       |                  |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                |       |                  |       |                  |       |
| Current  liabilities:                                                                                                                                                                        |       |                  |       |                  |       |
| Accounts payable                                                                                                                                                                             |       | $                     | 5,063      |                  | $          | 4,440 |   |
| Accrued expenses                                                                                                                                                                             |       | 7,094                 |       | 5,435                 |       |
| Line of credit                                                                                                                                                                               |       | 4,084                 |       | —                |       |
| Current portion  of long-term debt                                                                                                                                                           |       | 5,164                 |       | 71                    |       |
| Notes payable to  stockholders, current portion                                                                                                                                              |       | 542                   |       | 521                   |       |
| Income taxes  payable                                                                                                                                                                        |       | 479                   |       | 712                   |       |
| Other current  liabilities                                                                                                                                                                   |       | 357                   |       | 357                   |       |
| Total current  liabilities                                                                                                                                                                   |       | 22,783                |       | 11,536                |       |
|                                                                                                                                                                                         |       |                  |       |                  |       |
| Long-term line  of credit                                                                                                                                                                    |       | —                |       | 3,957                 |       |
| Long-term debt,  net of discount of $980 and $1,246, respectively                                                                                                                            |       | 13,502                |       | 4,829                 |       |
| Notes payable to  stockholders, less current portion                                                                                                                                         |       | 250                   |       | 750                   |       |
| Deferred income  taxes                                                                                                                                                                       |       | 2,203                 |       | 904                   |       |
| Other  liabilities                                                                                                                                                                           |       | 881                   |       | 1,158                 |       |
| Total  liabilities                                                                                                                                                                           |       | 39,619                |       | 23,134                |       |
|                                                                                                                                                                                         |       |                  |       |                  |       |
| Commitments and  contingencies (See Note 17 and Note 18)                                                                                                                                     |       |                  |       |                  |       |
|                                                                                                                                                                                         |       |                  |       |                  |       |
| Stockholders’  equity:                                                                                                                                                                  |       |                  |       |                  |       |
| Preferred  stock,$0.01 par value. Authorized 10,000,000 shares, zero shares issued and  outstanding                                                                                          |       | —                |       | —                |       |
| Common  stock,$0.0033 par value. Authorized 150,000,000 shares; 10,204,000 and 10,155,000  shares issued and outstanding at December 31, 2008 and December 31,  2007, respectively |       | 126                   |       | 126                   |       |
| Additional  paid-in capital                                                                                                                                                                  |       | 44,806                |       | 44,527                |       |
| Accumulated  deficit                                                                                                                                                                         |       | (28,101               | )          | (20,661               | )          |
| Accumulated  other comprehensive income                                                                                                                                                      |       | (2,827                | )          | 1,054                 |       |
| Total  stockholders’ equity                                                                                                                                                             |       | 14,004                |       | 25,046                |       |
| Total  liabilities and stockholders’ equity                                                                                                                                             |       | $                     | 53,623     |                  | $          | 48,180 |   |

 

*The accompanying Notes are an integral part of these ConsolidatedFinancial Statements*

 

F-3

----

Table of Contents

 

**EMRISECORPORATION**

**Consolidated Statements ofOperations**

(in thousands, except per share amounts)

 
| ** **                           | ** ** | **Years Ended**  | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **December 31,** | ** ** |
| ** **                           | ** ** | **2008**              | ** ** | **2007** | ** ** |
|                                 |       |                  |       |   |   |
| Net sales                            |       | $                     | 59,507     |   | $ | 51,345 |   |
| Cost of sales                        |       | 36,385                |       | 33,995 |   |
| Gross profit                         |       | 23,122                |       | 17,350 |   |
|                                 |       |                  |       |   |   |
| Operating  expenses:                 |       |                  |       |   |   |
| Selling, general  and administrative |       | 16,975                |       | 15,392 |   |
| Engineering and  product development |       | 3,053                 |       | 2,792 |   |
| Loss on asset  impairment            |       | 6,584                 |       | — |   |
| Total operating  expenses            |       | 26,612                |       | 18,184 |   |
| Loss from  operations                |       | (3,490                | )          | (834 | ) |
|                                 |       |                  |       |   |   |
| Other income  (expense):             |       |                  |       |   |   |
| Interest income                      |       | 117                   |       | 155 |   |
| Interest expense                     |       | (3,224                | )          | (848 | ) |
| Loss on early  extinguisment of debt |       | —                |       | (196 | ) |
| Other, net                           |       | (523                  | )          | 529 |   |
| Total other  income (expense), net   |       | (3,630                | )          | (360 | ) |
|                                 |       |                  |       |   |   |
| Loss before  income taxes            |       | (7,120                | )          | (1,194 | ) |
| Income tax  provision (benefit)      |       | 320                   |       | 734 |   |
| Net loss                             |       | $                     | (7,440     | ) | $ | (1,928 | ) |
|                                 |       |                  |       |   |   |
| Loss per share:                      |       |                  |       |   |   |
| Basic                                |       | $                     | (0.73      | ) | $ | (0.19 | ) |
| Diluted                              |       | $                     | (0.73      | ) | $ | (0.19 | ) |
|                                 |       |                  |       |   |   |
| Weighted average  shares outstanding |       |                  |       |   |   |
| Basic                                |       | 10,204                |       | 10,180 |   |
| Diluted                              |       | 10,204                |       | 10,180 |   |

 

*The accompanying Notes are an integral part of these ConsolidatedFinancial Statements*

 

F-4

----

Table of Contents

 

**EMRISECORPORATION**

**Consolidated Statements ofStockholders’ Equity**

(in thousands)

* *
| ** **                                 | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                                 | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **        | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                                 | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**       | ** ** | **Income**      | ** ** | **Total**  | ** ** |
|                                       |       |                  |       |        |       |            |       |              |       |            |       |       |       |
| Balance at  December 31, 2006         |       | 10,155                |       | $           | 125        |            | $          | 43,083            |       | $               | (18,733    | )          | $          | 698 |   | $ | 25,173 |   |
| Stock option  exercises                    |       | 49                    |       | 1           |       | 69              |       | —            |       | —          |       | 70         |       |
| Cost of issuing  common stock              |       | —                |       | —      |       | —          |       | —            |       | —          |       | —     |       |
| Stock-based  compensation expense          |       | —                |       | —      |       | 69              |       | —            |       | —          |       | 69         |       |
| Warrants issued  related to debt financing |       | —                |       | —      |       | 1,300           |       | —            |       | —          |       | 1,300      |       |
| Warrants issued  for services              |       | —                |       | —      |       | 6               |       | —            |       | —          |       | 6          |       |
| Net loss and  comprehensive income         |       | —                |       | —      |       | —          |       | (1,928            | )          | 356             |       | (1,572     | )          |
|                                       |       |                  |       |        |       |            |       |              |       |            |       |       |       |
| Balance at  December 31, 2007         |       | 10,204                |       | 126         |       | 44,527          |       | (20,661           | )          | 1,054           |       | 25,046     |       |
| Stock option  exercises                    |       | —                |       | —      |       | —          |       | —            |       | —          |       | —     |       |
| Stock-based  compensation expense          |       | —                |       | —      |       | 88              |       | —            |       | —          |       | 88         |       |
| Warrants issued  related to debt financing |       | —                |       | —      |       | 183             |       | —            |       | —          |       | 183        |       |
| Warrants issued  for services              |       | —                |       | —      |       | 8               |       | —            |       | —          |       | 8          |       |
| Net loss and  comprehensive income         |       | —                |       | —      |       | —          |       | (7,440            | )          | (3,881          | )          | (11,321    | )          |
| Balance at  December 31, 2008         |       | 10,204                |       | $           | 126        |            | $          | 44,806            |       | $               | (28,101    | )          | $          | (2,827 | ) | $ | 14,004 |   |

 

*The accompanying Notes are an integral part of these ConsolidatedFinancial Statements*

 

F-5

----

Tableof Contents

 

**EMRISECORPORATION**

**Consolidated Statements ofCash Flows**

(in thousands)

* *
| ** **                                                               | ** ** | **Year Ended**   | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                               | ** ** | **December 31,** | ** ** |
| ** **                                                               | ** ** | **2008**              | ** ** | **2007** | ** ** |
| **CASH  FLOWS FROM OPERATING ACTIVITIES**                                |       |                  |       |   |   |
| Net loss                                                                 |       | $                     | (7,440     | ) | $ | (1,928 | ) |
| Reconciliation  to net cash provided by (used in) operating activities:  |       |                  |       |   |   |
| Depreciation and  amortization                                           |       | 1,374                 |       | 1,154 |   |
| Stock-based  compensation expense                                        |       | 88                    |       | 69 |   |
| Warrants issued  for services                                            |       | 8                     |       | 6 |   |
| Deferred taxes                                                           |       | 30                    |       | 56 |   |
| Provision for  inventory obsolescence                                    |       | (52                   | )          | 467 |   |
| Provision for  warranty reserves                                         |       | (84                   | )          | 64 |   |
| Provision for  doubtful accounts                                         |       | 156                   |       | (46 | ) |
| Amortization of  deferred issuance costs                                 |       | 462                   |       | 35 |   |
| Amortization of  debt discount                                           |       | 466                   |       | 36 |   |
| Loss on asset  impairment                                                |       | 6,584                 |       | — |   |
| Loss on sale of  facility                                                |       | 10                    |       | — |   |
| Loss on  disposition of assets                                           |       | 31                    |       | 9 |   |
| Changes in  assets and liabilities, net of effects from purchase of ACC: |       |                  |       |   |   |
| Accounts  receivable                                                     |       | 35                    |       | (140 | ) |
| Inventories                                                              |       | 837                   |       | (1,556 | ) |
| Prepaid and  other assets                                                |       | (1,860                | )          | 23 |   |
| Accounts payable  and accrued expenses                                   |       | 1,059                 |       | 293 |   |
| Total  adjustments                                                       |       | 9,144                 |       | 470 |   |
| Net cash  provided by (used in) operating activities                     |       | 1,704                 |       | (1,458 | ) |
|                                                                     |       |                  |       |   |   |
| **CASH  FLOWS FROM INVESTING ACTIVITIES:**                               |       |                  |       |   |   |
| Purchases of  property, plant and equipment                              |       | (124                  | )          | (837 | ) |
| Additions to  intangible assets                                          |       | (48                   | )          | — |   |
| Payments  received on note receivable                                    |       | 40                    |       | — |   |
| Payment for  purchase of ACC net of cash acquired                        |       | (12,356               | )          | — |   |
| Net cash used in  investing activities                                   |       | (12,488               | )          | (837 | ) |
|                                                                     |       |                  |       |   |   |
| **CASH  FLOWS FROM FINANCING ACTIVITIES:**                               |       |                  |       |   |   |
| Proceeds from  issuance of debt                                          |       | 13,000                |       | 6,000 |   |
| Debt issuance  costs                                                     |       | —                |       | (1,286 | ) |
| Net repayments  of previous lines of credit                              |       | —                |       | (4,310 | ) |
| Net proceeds of  existing line of credit                                 |       | 127                   |       | 3,957 |   |
| Principal  payments on long-term debt                                    |       | (322                  | )          | (907 | ) |
| Payments of  notes to stockholders                                       |       | (479                  | )          | (458 | ) |
| Proceeds from  exercise of stock options and warrants                    |       | —                |       | 70 |   |
| Net cash  provided by financing activities                               |       | 12,326                |       | 3,066 |   |
|                                                                     |       |                  |       |   |   |
| Effect of  exchange rate changes on cash                                 |       | (2,885                | )          | 191 |   |
| Net increase (decrease)  in cash and cash equivalents                    |       | (1,343                | )          | 962 |   |
| Cash and cash  equivalents at beginning of period                        |       | 4,764                 |       | 3,802 |   |
| Cash and cash  equivalents at end of period                              |       | $                     | 3,421      |   | $ | 4,764 |   |

 

*Theaccompanying Notes are an integral part of these Consolidated FinancialStatements*

 

F-6

----

Tableof Contents

 

**EMRISECORPORATION**

**Consolidated Statements ofCash Flows (Continued)**

(in thousands)

 
| ** **                                                                    | ** ** | **Year Ended**   |
|-------------------------------------------------------------------------------|------------|-----------------------|
| ** **                                                                    | ** ** | **December 31,** |
| ** **                                                                    | ** ** | **2008**              | ** ** | **2007** |
| **SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:**                       |       |                  |   |   |
| Cash paid during  the year for:                                               |       |                  |   |   |
|                                                                          |       |                  |   |   |
| Interest                                                                      |       | $                     | 1,602 |   | $ | 635 |
|                                                                          |       |                  |   |   |
| Income taxes                                                                  |       | $                     | 706 |   | $ | 519 |
|                                                                          |       |                  |   |   |
| **SUPPLEMENTAL  DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:** |       |                  |   |   |
| ** **                                                                    |       |                  |   |   |
| Fair value of  warrants issued                                                |       | $                     | 183 |   | $ | 1,300 |
|                                                                          |       |                  |   |   |
| Acquisition of  equipment through capital lease                               |       | $                     | 511 |   | $ | — |

 

*Theaccompanying Notes are an integral part of these Consolidated FinancialStatements*

 

F-7

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Table of Contents

 

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

**NOTE 1 —SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

*Organization and Business*

 

EMRISECorporation (the “Company”) designs, manufactures and markets proprietaryelectronic devices and communications equipment for aerospace, defense,industrial, and communications applications. The Company has operations in theUnited States (“U.S.”), England, France and Japan.  The Company conducts its business through two operating segments:electronic devices and communications equipment. The subsidiaries within theelectronic devices segment design,develop, manufacture and market electronic devices for defense, aerospace andindustrial markets and operate out of facilities located in the U.S., Englandand Japan.  The subsidiarieswithin the communications equipment segment design, develop, manufacture andmarket network access equipment and network timing and synchronization productsand operate out of facilities located in the U.S. and France.

 

*Basis of Presentation*

 

The accompanying consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”) andinclude the accounts of the Company and each of its subsidiaries, afterelimination of intercompany accounts and transactions.  Certain prior years’ amounts have beenreclassified to conform to the current year presentation.

 

***Use of Estimates***

** **

The preparation of financialstatements in conformity with GAAP requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could materially differ from those estimates.

 

***Cash and Cash Equivalents***

** **

The Company considers cash and cashequivalents to include cash in banks, commercial paper and deposits withfinancial institutions that can be liquidated without prior notice orpenalty.  The Company considers allhighly liquid investments with an original maturity of three months or less tobe cash equivalents.

 

***Fair Value of Financial Instruments***

** **

The carrying amount of cash andcash equivalents, accounts receivable, accounts payable and accrued expenses arereasonable estimates of their fair value because of the short maturity of theseitems. The Company believes the carrying amounts of its notes payable andlong-term debt approximate fair value because the interest rates on theseinstruments are subject to change with, or approximate, market interest rates.

 

***Inventories***

** **

The Company’s finished goodselectronic devices inventories generally are built to order.  The Company’s communications equipmentinventories generally are built to forecast, which requires production of alarger amount of finished goods in the communications equipment business sothat customers can be served promptly. The Company’s products consist of numerous electronic parts and other materials,which necessitates the exercise of detailed inventory management.  The Company values its inventory at the lowerof the actual cost to purchase or manufacture the inventory (first-in,first-out) or the current estimated market value of the inventory (net realizablevalue). The Company performs cycle counts of inventories using an ABC inventorymethodology, which groups inventory into cycle counting categories, or conductsphysical inventories at least once a year. The Company regularly reviews inventory quantities on hand and records aprovision for excess and obsolete inventory based primarily on its estimatedforecast of product demand and production requirements for the next 12 to 24months. Additionally, to determine inventory write-down provisions, the Companyreviews product line inventory levels and 

 

F-8

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Table of Contents

 

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

individualitems as necessary and periodically reviews assumptions about forecasted demandand market conditions.  Any inventorythat the Company determines to be obsolete, either in connection with thephysical count or at other times of observation, are reserved for andsubsequently written-off.  As of December 31,2008, total inventory reserves amounted to $5.6 million of which $4.0 million,or 21% of total inventory, related to the electronic devices segment and $1.6million, or 8% of total inventory, related to the communications equipmentsegment.

 

The electronics devices andcommunications equipment industries are characterized by rapid technologicalchange, frequent new product development, and rapid product obsolescence thatcould result in an increase in the amount of obsolete inventory quantities onhand. Also, estimates of future product demand may prove to be inaccurate, inwhich case the Company may have understated or overstated the provisionrequired for excess and obsolete inventory. Although the Company makes everyeffort to ensure the accuracy of its forecasts of future product demand, anysignificant unanticipated changes in demand or technological developments couldhave a significant impact on the value of the Company’s inventory and itsreported operating results.

 

***Property, Plant and Equipment***

** **

Property, plant and equipment arestated at cost, less accumulated depreciation and amortization. Depreciationand amortization are computed principally using the straight-line method overthe useful lives of the assets (or lease term, if shorter) as follows:

 
| Buildings                          |   |   | 50 years  |   |
|------------------------------------|--------|--------|-----------|--------|
| Machinery,  equipment and fixtures |   |   | 3-7 years |   |
| Leasehold  improvements            |   |   | 5 years   |   |

 

Maintenance and repairs areexpensed as incurred, while renewals and betterments are capitalized.  Research and development costs are expensedas incurred.

 

***Deferred Financing Costs***

** **

Deferred financing costs, which areincluded in other assets, are costs incurred to obtain debt financing,including all related fees, and are included in the accompanying consolidatedbalance sheets and are amortized as interest expense over the term of therelated financing using the straight-line method which approximates theinterest rate method.

 

***Long-Lived Assets***

** **

The Company reviews the carryingamount of its long-lived assets for possible impairment whenever events orchanges in circumstances indicate that the carrying amount of the assets maynot be recoverable. Recoverability of assets to be held and used is measured bya comparison of the carrying amount of an asset to future undiscounted net cashflows expected to be generated by the asset. If such assets are considered tobe impaired, the impairment to be recognized is measured by the amount by whichthe carrying amount of the assets exceeds the fair value of the assets. Assets tobe disposed of are reported at the lower of the carrying amount or fair valueless costs to sell.

 

***Goodwill and Other Intangible Assets***

** **

Statement of Financial AccountingStandards (“SFAS”) No. 142, “Goodwilland Other Intangible Assets,” disallows the amortization of goodwill andprovides for impairment testing of goodwill carrying values on an annual basisor more frequently if an event occurs or circumstances change that would morelikely than not reduce the fair value of a reporting unit below its carryingamount.  The Company’s reporting unitshave been identified as electronic devices and communications equipment.  The Company performed its annual requiredtests of impairment as of December 31, 2008 and 2007 for goodwill in theelectronic devices and the communications equipment reporting units.  As a result of this annual test, in 2008 theCompany incurred a loss on the impairment of goodwill and indefinite livedintangible assets of $6.6 million within the Company’s communications equipmentsegment.  In 

 

F-9

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Table of Contents

 

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

assessing the potential impairment of goodwill, the Companyconsiders forecasted financial performance of the acquired businesses todetermine the fair value of the respective assets. Due to a decline in theforecasted financial performance of the communications equipment segment, theestimated fair market value of that segment’s intangible assets declined ascompared to the carrying value of such assets on the Company’s balancesheet.  As a result, the 2008 impairmentcharge reflects the write down of substantially all of the carrying value ofthe goodwill and other intangible assets for the communications equipmentsegment.

 

Intangible assets with identifiableuseful lives are amortized using the straight-line method over their usefullives.  Definite-lived intangible assetsare stated at cost, less accumulated amortization, and are amortized on thestraight-line method over their estimated useful lives ranging from two totwenty years.  The Company periodicallyreviews the original estimated useful lives of long-lived assets and makesadjustments when appropriate.  Intangibleassets with finite useful lives are tested for impairment whenever events orchanges in circumstances indicate that an asset’s carrying amount may not berecoverable.  The Company evaluates itsintangible assets for impairment by comparing the future undiscounted cashflows of the underlying assets to their respective carrying amounts.

 

***Product Warranty Liabilities***

** **

Generally, theCompany’s products carry a standard one-year, limited parts and laborwarranty.  In certain circumstances, theCompany provides a two-year limited parts and labor warranty on communicationstest instruments and network access products. The Company offers extended warranties beyond two years for anadditional cost to its customers. Products returned under warranty typically are tested and repaired orreplaced at the Company’s option. Historically, the Company has not experienced significant warranty costsor returns.

 

The Companyrecords a liability for estimated costs that it expects to incur under thebasic limited warranties when product revenue is recognized.  Factors affecting the warranty liabilityinclude the number of units sold, historical and anticipated rates of claim andcosts per claim.  The Companyperiodically assesses the adequacy of its warranty liability accrual based onchanges in these factors.

 

***Reverse Stock Split***

** **

**On November 19, 2008, the Company completed a board of directorsapproved 1-for-3.75 reverse split of its common stock.  All common stock, stock options and warrants topurchase common stock and earnings per share amounts have been retroactivelyrestated as if the reverse stock split occurred at the beginning of the periodspresented.**

** **

***Stock-Based Compensation***

** **

Effective January 1, 2006, the Companyadopted the modified prospective method of SFAS No. 123R, which requiresthe measurement and recognition of compensation expense for all stock-basedcompensation awards made to employees and directors based on estimated fairvalues.

 

The Company estimates the fair value of itsstock option plans using the Black-Scholes option pricing model (the “OptionModel”).  The Option Model requires theuse of subjective and complex assumptions, including the option’s expected termand the estimated future price volatility of the underlying stock, whichdetermine the fair value of the stock-based awards.  In accordance with the provisions of SFAS No. 123R,stock-based compensation expense recognized during a period is based on thevalue of the portion of the stock-based awards that are expected to vest withemployees.  Accordingly, the recognitionof stock-based compensation expense has been reduced for estimated futureforfeitures.  SFAS No. 123R requiresforfeitures to be estimated at the time of grant with adjustments recorded insubsequent period compensation expense if actual forfeitures differ from thoseestimates.

 

The following weighted average assumptionswere used for stock options granted during the year ended December 31:

 

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Tableof Contents

 

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 
| ** **                                           | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
| Dividend yield                                       |       | None     |       | None     |       |
| Expected  volatility                                 |       | 63       | %          | 83       | %          |
| Risk-free  interest rate                             |       | 2.53     | %          | 4.71     | %          |
| Expected term                                        |       | 6 years  |       | 7 years  |       |
| Weighted average  fair value per share at grant date |       | $        | 1.25       |     | $          | 0.90 |   |
|                                                      |            |          |            |          |            |  |  |

 

***Loss Per Share***

** **

Loss per share is calculatedaccording to SFAS No. 128, “EarningsPer Share.” Basic loss per share includes no dilution and is computed bydividing net income available to common stockholders by the weighted averagenumber of shares outstanding during the year. Diluted loss per share reflectsthe potential dilution of securities that could share in the earnings of the Company.

 

***Foreign Currency Translation***

** **

The accounts of foreignsubsidiaries have been translated using the local currency as the functionalcurrency. Accordingly, foreign currency denominated assets and liabilities havebeen translated to U.S. dollars at the current rate of exchange on the balancesheet date and at the average for the period reported for the statement ofoperations. The effects of translation are recorded either within our statementof operations under the caption “other income (expense)” or as a separate partof our net equity under the caption “accumulated other comprehensive income(loss).”  Exchange gains and lossesarising from transactions denominated in foreign currencies are translated atthe exchange rates applicable on the dates of the transactions and are includedin operations.

 

***Concentration of Credit Risk***

** **

Financial instruments, whichpotentially expose the Company to concentration of credit risk, consistprimarily of cash and accounts receivable. The Company places its cash withhigh quality financial institutions. At times, cash balances may be in excessof the amounts insured by the Federal Deposit Insurance Corporation.

 

The Company’s accounts receivableresult from sales to a broad customer base. The Company extends credit to itscustomers based upon an evaluation of the customer’s financial condition andcredit history and generally does not require collateral. Accounts receivableare generally due within 30 days in the Company’s U.S., England and Franceoperations and are stated net of an allowance for doubtful accounts. Accountsoutstanding for longer than the contractual payment terms are considered pastdue. Provisions for uncollectible accounts are made based on the Company’sspecific assessment of the collectibility of all past due accounts. Creditlosses are provided for in the financial statements and consistently have beenwithin management’s expectations.  No customer represented 10%or more of the Company’s total net sales during 2008 or 2007.

 

*Revenue**Recognition*

 

TheCompany derives revenues from sales of electronic devices and communicationsequipment products and services.  TheCompany’s sales are based upon written agreements or purchase orders thatidentify the type and quantity of the item and/or services being purchased andthe purchase price.  The Companyrecognizes revenues when shipment of products has occurred or services havebeen rendered, no significant obligations remain on the part of the Company,and collectability is reasonably assured based on the Company’s credit andcollections practices and policies.

 

TheCompany recognizes revenues from U.S. sales of RO Associates Incorporated and allof its U.S. communications equipment business units at the point of shipment ofthose products.  An estimate of warrantycost is recorded at the time the revenue is recognized.  Product returns are infrequent and requireprior authorization because sales are final and the Company quality tests itsproducts prior to shipment to ensure products meet the specifications of thebinding purchase orders 

 

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** **

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

underwhich those products are shipped. Normally, when a customer requests andreceives authorization to return a product, the request is accompanied by apurchase order for a repair or for a replacement product.

 

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

 

TheCompany recognizes revenues for products sold by its subsidiary in France atthe point of shipment.  Customerdiscounts are included in the product price list provided to the customer.  Returns are infrequent and permitted onlywith prior authorization because these products are shipped based on bindingpurchase orders and are quality tested prior to shipment.  An estimate of warranty cost is recorded atthe time revenue is recognized.

 

Revenuesfrom services such as repairs and modifications are recognized when the serviceis completed and invoiced.  For repairsthat involve shipment of a repaired product, the Company recognizes repairrevenues when the product is shipped back to the customer. Service revenuescontribute less than 5% of total revenue and, therefore, are considered to beimmaterial to overall financial results.

 

*Shipping and Handling Costs*

 

The Company records shipping andhandling costs in cost of goods sold. Shipping and handling costs were $160,000 and $320,000 in 2008 and 2007,respectively.

 

*Advertising Costs*

 

Advertisingcosts are charged to expense as incurred. Advertising costs for 2008 and 2007 were immaterial.

 

*Income Taxes*

 

Income taxes are accounted forusing an asset and liability approach that requires the recognition of deferredtax assets and liabilities for the expected future tax consequences oftemporary differences between the financial statement and tax bases of assetsand liabilities at the applicable tax rates. A valuation allowance is providedwhen it is more likely than not that some portion or all of the deferred taxassets will not be realized.  The Companyevaluates the realizability of its deferred tax assets by assessing itsvaluation allowance and by adjusting the amount of such allowance, ifnecessary.  The factors used to assessthe likelihood of realization are the Company’s forecast of future taxableincome and available tax planning strategies that could be implemented torealize the net deferred tax assets. Failure to achieve forecasted taxable income in applicable taxjurisdictions could affect the ultimate realization of deferred tax assets andcould result in an increase in the Company’s effective tax rate on futureearnings. The provision for income taxes represents the tax payable for theyear and the change during the year in deferred tax assets and liabilities.

 

The Company adopted FIN 48, “Accounting for Uncertainty in Income Taxes —an interpretation of FASB Statement No. 109”, on January 1,2007. The implementation of FIN 48 did not result in a material adjustment tothe Company’s liability for unrecognized income tax benefits. At the time ofadoption and as of December 31, 2008, the Company had recorded no netunrecognized tax benefits.

 

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Table of Contents

 

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

*Comprehensive Loss*

 

Comprehensive loss includes allchanges in equity during a period except those that resulted from investmentsby 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):

 
| ** **                               | ** ** | **Year Ended**   | ** ** |
|------------------------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **December 31,** | ** ** |
| ** **                               | ** ** | **2008**              | ** ** | **2007** | ** ** |
|                                     |       |                  |       |   |   |
| Net loss                                 |       | $                     | (7,440     | ) | $ | (1,928 | ) |
| Other  comprehensive income (loss):      |       |                  |       |   |   |
| Foreign currency  translation adjustment |       | (3,881                | )          | 356 |   |
| Comprehensive  loss                      |       | $                     | (11,321    | ) | $ | (1,572 | ) |

 

**NOTE 2 —LIQUIDITY**

 

The Company incurred a $7.4 million net loss for2008, including a write off of intangible and goodwill assets of $6.6 million,and a $1.9 million net loss for 2007.  If the Company’s net losses continue, it mayexperience negative cash flow, which may hamper current operations and mayprevent the Company from expanding its business.  Additionally, such losses may result in adefault on the Company’s debt covenants associated with its creditfacility.  The Company may be unable toattain, sustain or increase profitability on a quarterly or annual basis in thefuture. If the Company does not achieve, sustain or increase profitability, itsstock price may decline.  Additionally,the Company has agreed with its Lender to raise at least $2 million in netproceeds through the sale of EMRISE Corporation stock by no later than September 30,2009.  Under the terms of AmendmentNumber 4, we are obligated to remit to our Lender  $500,000 with respect to the first $2,000,000of net cash proceeds received in connection with the sale of stock, 50% of thenext $1,000,000 of net cash proceeds received in connection with the sale ofstock, and 30% of the net cash proceeds in excess of the first $3,000,000received in connection with the sale of stock. The Company is currently evaluating a number of options to meet thisobligation under its credit facility.  Given current economic andfinancial market conditions even a small equity raise could prove difficult.

 

TheCompany believes that currentand future capital resources, revenues generated from operations and otherexisting sources of liquidity, including its existing credit facility, will beadequate to meet its anticipated short term, working capital and capitalexpenditures needs for at least the next 12 months.  However, if the Company experiences asignificant loss of revenue or increase in costs, its cash flow could benegatively impacted resulting in a cash flow deficit.

 

**NOTE 3 —ACQUISITION OF ADVANCED CONTROL COMPONENTS**

 

On May 23, 2008, the Company and its wholly-ownedsubsidiary, EMRISE Electronics Corporation (“EEC”) entered into a StockPurchase Agreement (the “Stock Purchase Agreement”) pursuant to which EECagreed to acquire Custom Components, Inc. (“CCI”) and its operatingsubsidiary, Advanced Control Components, Inc. (“ACC”).  On August 20,2008, the Stock Purchase Agreement was amended pursuant to Amendment No. 1to Stock Purchase Agreement (the “Amendment to Purchase Agreement,” andcollectively with the Stock Purchase Agreement, the “Purchase Agreement”) to,among other things, reduce the initial purchase price for all of the capitalstock of both CCI and ACC to $12,400,000, subject to adjustments for workingcapital and net cash.  Additionally, pursuant to the terms of theAmendment to Purchase Agreement, the Company is obligated to pay interest on aprincipal amount of $600,000 at a rate equal to the prime rate as reportedin *The Wall Street Journal *onAugust 20, 

 

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Table of Contents

 

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

2008 plus 1% for the period commencing on August 20,2008 and ending on the later of November 18, 2008 or the actual date suchinterest payment is made.

 

The closing of the Purchase Agreement occurred on August 20,2008.  Under the terms of the Purchase Agreement, EEC acquired all of the issuedand outstanding shares of common stock of CCI and all of the issued andoutstanding shares of common stock of ACC not owned by CCI (the “Acquisition”). In addition to the purchase price, the Company is obligated to pay up to anadditional $3,000,000 in cash if ACC meets certain operating income targets forone or both of the two 12 month periods following the closing. Additionally, EEC issued Subordinated Secured Contingent Promissory Notes (the “Notes”)to each of the Sellers in the aggregate principal amount of $2,000,000. The Notes become payable if ACC meets certain operating income thresholdsduring the first and second 12 month periods after August 20, 2008. The Notes bear interest at a rate per annum equal to the prime rate asreported in *The Wall StreetJournal *plus 1%.

 

In determining the purchase price for the Acquisition, theCompany took into account the historical and expected earnings and cash flow ofACC, as well as the value of companies of a size and in an industry similar toACC, comparable transactions and the market for such companies generally.  The purchase price represented a premium ofapproximately $4.1 million over the recorded net worth of ACC’s assets.

 

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

 

Thefollowing table summarizes the assets and liabilities assumed in connectionwith the Acquisition (in thousands):

 

| Accounts receivable                       |   | $      | 2,185  |   |
|-------------------------------------------|--------|--------|--------|--------|
| Inventories                               |   | 1,848  |   |
| Property and  equipment                   |   | 1,545  |   |
| Intangible  assets, net                   |   | 4,750  |   |
| Goodwill                                  |   | 4,073  |   |
| Other assets                              |   | 244    |   |
| Total assets  acquired                    |   | 14,645 |   |
| Accounts payable  and accrued liabilities |   | (1,678 | )      |
| Other  liabilities                        |   | (611   | )      |
| Total  liabilities assumed                |   | (2,289 | )      |
| Net assets  acquired                      |   | $      | 12,356 |   |

 

Thefollowing table summarizes, on a pro forma basis, the unaudited combinedresults of operations of the Company and ACC as though the Acquisition occurredas of January 1, 2007.  The pro formaadjustments are based upon available information and assumptions thatmanagement believes reasonably reflect the transaction.  The Company presents the pro forma results ofoperations for informational purposes only. The pro forma results of operations are not necessarily indicative ofwhat the Company’s results of operations would have been had the Companycompleted the Acquisition as of the dates indicated.  In addition, the pro forma financialstatements do not purport to project the future financial position or operatingresults of the combined company.

 

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Tableof Contents

 

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

| ** **                            | ** ** | **For the Years Ended** | ** ** |
|---------------------------------------|------------|----------------------------------------|------------|
| ** **                            | ** ** | **December 31,**                  | ** ** |
| ** **                            | ** ** | **unaudited**                          | ** ** |
| ** **                            | ** ** | **2008**                               | ** ** | **2007** | ** ** |
|                                  |       |                                   |       |   |   |
| Net sales                             |       | $                                      | 67,840     |   | $ | 65,344 |   |
|                                  |       |                                   |       |   |   |
| Net loss                              |       | $                                      | (2,617     | ) | $ | (1,277 | ) |
|                                  |       |                                   |       |   |   |
| Loss per share:                       |       |                                   |       |   |   |
| Basic                                 |       | $                                      | (0.26      | ) | $ | (0.13 | ) |
| Diluted                               |       | $                                      | (0.26      | ) | $ | (0.13 | ) |
|                                  |       |                                   |       |   |   |
| Weighted average  shares outstanding: |       |                                   |       |   |   |
| Basic                                 |       | 10,204                                 |       | 10,204 |   |
| Diluted                               |       | 10,204                                 |       | 10,204 |   |

 

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Tableof Contents

 

**EMRISE CORPORATION**

**Notes to Consolidated FinancialStatements**

 

**NOTE 4 —INVENTORIES**

 

Inventories are stated at the lowerof cost (first-in, first-out method) or market (net realizable value) andconsisted of the following at December 31 (in thousands):

 
| ** **              | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|
|                    |       |     |       |     |       |
| Raw materials           |       | $        | 10,897     |     | $          | 9,292 |   |
| Work-in-process         |       | 3,513    |       | 4,540    |       |
| Finished goods          |       | 4,915    |       | 3,956    |       |
| Reserves                |       | (5,609   | )          | (6,124   | )          |
| Total  inventories, net |       | $        | 13,716     |     | $          | 11,664 |   |

 

**NOTE 5 —PROPERTY, PLANT AND EQUIPMENT**

 

Property, plant and equipmentconsisted of the following as of December 31 (in thousands):

 
| ** **                           | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |
| Land and  buildings                  |       | $        | 403        |     | $          | 419 |   |
| Machinery,  equipment and fixtures   |       | 5,579    |       | 4,582    |       |
| Leasehold  improvements              |       | 741      |       | 944      |       |
| Capital leases                       |       | 270      |       | 270      |       |
|                                 |       | 6,993    |       | 6,215    |       |
| Accumulated  depreciation            |       | (3,803   | )          | (3,988   | )          |
| Total property,  plant and equipment |       | $        | 3,190      |     | $          | 2,227 |   |

 

The Company recorded depreciationexpense associated with its property, plant and equipment of $0.8 million and$0.8 million for the years ended December 31, 2008 and 2007, respectively.

 

**NOTE 6 — DEBTISSUANCE COSTS**

 

On November 30,2007, the Company and its direct subsidiaries, EEC, CXR Larus Corporation andRO Associates Incorporated (collectively, the “Borrowers”) entered into acredit facility (see Note 9 and 10).  Inconnection with the credit facility, the Company incurred $1.3 million of debtissuance costs, which in included in “Other assets” in the accompanyingconsolidated balance sheets and is being amortized over three years, the termof the related financing, using the straight-line method, which approximatesthe interest rate method.  Deferred debtissuance costs amortized to interest expense were $462,000 and $35,000 in 2008and 2007, respectively.  Assuming noadditions or adjustments in debt issuance costs, annual amortization of debtissuance costs to interest expense is estimated to be approximately $558,000 in2009 and $511,000 in 2010.

 

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Tableof Contents

 

**EMRISE CORPORATION**

**Notes to Consolidated Financial Statements**

 

**NOTE 7 —GOODWILL AND INTANGIBLE ASSETS**

 

Goodwill for the Company’sreporting units consisted of the following at December 31 (in thousands):

 
| ** **                | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|
| Electronic  Devices       |       | $        | 9,657      |     | $          | 7,295 |   |
| Communications  Equipment |       | —   |       | 5,834    |       |
|                      |       | $        | 9,657      |     | $          | 13,129 |   |

 

The Company performed its annualrequired tests of impairment in accordance with SFAS No. 142, “Goodwilland Other Intangible Assets,” as of December 31, 2008 and 2007 for each ofits reporting units.  No additions,disposals or impairment adjustments were made to goodwill balances during2007.  During 2008, the Company acquiredACC, which added $4.1 million in goodwill to its balance sheet.  Additionally, the Company’s SFAS No. 142annual test reflected an impairment of goodwill for its communicationsequipment reporting unit of $5.8 million and indefinite-lived intangible assetsof $0.8 million.  The Company incurred atotal impairment charge of $6.6 million associated with this valuation.

 

Thefollowing table reflects changes in our goodwill balances, by segment, for theyear ended December 31, 2008 (in thousands):

 
| ** **                         | ** ** | **Electronic** | ** ** | **Communications** | ** ** | ** ** | ** ** |
|------------------------------------|------------|----------------|------------|--------------------|------------|------------|------------|
| ** **                         | ** ** | **Devices**    | ** ** | **Equipment**      | ** ** | **Total**  | ** ** |
|                               |       |           |       |               |       |       |       |
| Balance at  December 31, 2006 |       | $              | 7,161      |               | $          | 5,834      |       | $ | 12,995 |   |
| Foreign currency  translation      |       | 134            |       | —             |       | 134        |       |
| Balance at  December 31, 2007 |       | 7,295          |       | 5,834              |       | 13,129     |       |
| Acquisition of  ACC                |       | 4,073          |       | —             |       | 4,073      |       |
| Impairment of  goodwill            |       | —         |       | (5,834             | )          | (5,834     | )          |
| Foreign currency  translation      |       | (1,711         | )          | —             |       | (1,711     | )          |
| Balance at  December 31, 2007 |       | $              | 9,657      |               | $          | —     |       | $ | 9,657 |   |

 

Otherchanges to goodwill balances were related to foreign currency translationadjustments on foreign goodwill amounts.

 

F-17

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Tableof Contents

 

**EMRISE CORPORATION**

**Notes to Consolidated FinancialStatements**

 

Other intangible assets consistprimarily of trademarks, trade names and technology acquired.  The original cost and accumulatedamortization of these intangible assets consisted of the following at December 31(in thousands):

 
| ** **                              | ** ** | **2008**       | ** ** | **2007**           | ** ** |
|-----------------------------------------|------------|----------------|------------|--------------------|------------|
| ** **                              | ** ** | **Electronic** | ** ** | **Communications** | ** ** | ** ** | ** ** | **Electronic** | ** ** | **Communications** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Devices**    | ** ** | **Equipment**      | ** ** | **Total** | ** ** | **Devices** | ** ** | **Equipment** | ** ** | **Total** | ** ** |
|                                    |       |           |       |               |       |   |   |   |   |   |   |   |   |
| **Intangibles  with definite lives:**   |       |           |       |               |       |   |   |   |   |   |   |   |   |
| Technology  acquired                    |       | $              | 500        |               | $          | 1,150 |   | $ | 1,650 |   | $ | 500 |   | $ | 1,150 |   | $ | 1,650 |   |
| Customer  relationships                 |       | 2,900          |       | 200                |       | 3,100 |   | 350 |   | 200 |   | 550 |   |
| Trade name                              |       | 1,570          |       | —             |       | 1,570 |   | — |   | — |   | — |   |
| Covenant-not-to-compete                 |       | 260            |       | —             |       | 260 |   | 200 |   | — |   | 200 |   |
| Patents                                 |       | 29             |       | —             |       | 29 |   | 29 |   | — |   | 29 |   |
| Patents-in-progress                     |       | 144            |       | —             |       | 144 |   | 96 |   | — |   | 96 |   |
| Backlog                                 |       | 770            |       | —             |       | 770 |   | 200 |   | — |   | 200 |   |
|                                    |       | 6,173          |       | 1,350              |       | 7,523 |   | 1,375 |   | 1,350 |   | 2,725 |   |
| Accumulated  amortization               |       | (978           | )          | (608               | )          | (1,586 | ) | (584 | ) | (472 | ) | (1,056 | ) |
| Carrying Value                          |       | 5,195          |       | 742                |       | 5,937 |   | 791 |   | 878 |   | 1,669 |   |
|                                    |       |           |       |               |       |   |   |   |   |   |   |   |   |
| **Intangibles  with indefinite lives:** |       |           |       |               |       |   |   |   |   |   |   |   |   |
| Trademarks and  trade names             |       | 850            |       | —             |       | 850 |   | 850 |   | 750 |   | 1,600 |   |
| Total intangible  assets, net           |       | $              | 6,045      |               | $          | 742 |   | $ | 6,787 |   | $ | 1,641 |   | $ | 1,628 |   | $ | 3,269 |   |

 

In accordance with SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets,” the Companyreevaluates the carrying value of identifiable intangible and long-lived assetsfor impairment whenever events or changes in circumstances indicate that thecarrying value may not be recoverable. No events or changes in circumstances occurred during 2008 that wouldhave required an impairment analysis to be performed.

 

Assuming no additions, disposals oradjustments are made to the carrying values and/or useful lives of the assets,annual amortization expense on intangible assets is estimated to beapproximately $906,000 in 2009, $516,000 in 2010 and $496,000 in 2011, 2012 and2013.  The Company’s current intangibleassets have a weighted average remaining useful life of approximately 9 years.

 

**NOTE 8 —ACCRUED LIABILITIES**

 

Accrued expenses as of December 31consisted of the following (in thousands):

 
| ** **                           | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
| Accrued payroll  and benefits        |       | $        | 1,951      |     | $          | 1,142 |   |
| Advance payments  from customers     |       | 1,364    |       | 1,712    |       |
| Warranty reserve                     |       | 268      |       | 352      |       |
| Bank overdrafts                      |       | 685      |       | 711      |       |
| Foreign currency  exposure provision |       | 870      |       | —   |       |
| Accrued interest                     |       | 500      |       | 119      |       |
| Other accrued  expenses              |       | 1,455    |       | 1,399    |       |
| Total accrued expenses               |       | $        | 7,093      |     | $          | 5,435 |   |

 

No other individual itemrepresented more than 5% of total current liabilities.

 

F-18

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Tableof Contents

 

**EMRISE CORPORATION**

**Notes to Consolidated FinancialStatements**

 

**NOTE 9 — LINESOF CREDIT**

 

TheCompany and its direct subsidiaries, EEC, CXR Larus Corporation and ROAssociates Incorporated (collectively, the “Borrowers”) are parties to a CreditAgreement (as amended from time to time the “Credit Agreement”), as amended,with GVEC Resource IV Inc. (the “Lender”) providing for a credit facility inthe original aggregate amount of $23,000,000 and is secured by accountsreceivable, other rights to payment and general intangibles, inventories andequipment. The credit facility includes a one year revolving credit facilityfor up to $7,000,000 that may be renewed up to two times, each for a period ofone year,, at the Company’s option, provided that certain conditions precedentare met (the “Revolver”).  The creditfacility also includes two term loans (see Note 10).

 

TheRevolver is formula-based and which generally provides that the outstandingborrowings under the line of credit may not exceed an aggregate of 85% ofeligible accounts receivable, plus 10% of the value of eligible raw materialsnot to exceed $600,000, plus 50% of the value of eligible finished goodsinventory not to exceed $1,500,000, minus the aggregate amount of reserves thatmay be established by the Lender.  TheRevolver has a maturity date of November 30, 2009 unless it is renewed, inwhich case the maturity date will be extended to November 30, 2010.

 

Intereston the Revolver is payable monthly.  Theinterest rate is variable and is adjusted monthly based on prime rate aspublished in the “Money Rates” column of *The Wall Street Journal*(the “Base Rate”) plus 1.25%, subject to a minimum rate of 9.5%.  The interest rate in effect as of December 31,2008 was the minimum rate of 9.5%.  TheRevolver is subject to various financial covenants on a consolidated basisincluding the following: EBITDA, measured on a fiscal quarter-end basis, mustnot be less than the scheduled amount for each specified period; the debtservice coverage ratio, measured quarterly, must be greater than the lesser ofthe scheduled amount for each specific period or 1.10:1.00; the leverage ratio,measured quarterly, must not be greater than 1.25:1.00; and the Company mustnot incur capital expenditures in any fiscal year in excess of $500,000.  As of December 31, 2008, the Company wasin default of the minimum EBITDA measure described above; which default hasbeen waived by the Lender.  The CreditFacility was amended subsequent to December 31, 2008 and includes revisedfinancial covenants (see Note 21).

 

As of December 31, 2008, the Company had outstandingborrowings of $4.1 million under the Revolver with remaining availability underthe formula-based calculation of $2.9 million.

 

Upon the sale or disposition by the Borrowers or any oftheir subsidiaries of property or assets, the Borrowers may be obligated toprepay the Revolver and the term loans with the net cash proceeds received inconnection with such sales or dispositions to the extent that the aggregateamount of net cash proceeds received, and not paid to the Lender as aprepayment, for all such sales or dispositions exceed $150,000 in any fiscalyear.

 

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

 

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

 

F-19

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Table of Contents

 

**EMRISE CORPORATION**

**Notes to Consolidated FinancialStatements**

 

**NOTE 10 —LONG-TERM DEBT**

 

On August 20, 2008, inconnection with the acquisition of ACC and CCI as discussed in Note 2, theBorrowers and the Lender entered into a Amendment Number 1 to Loan Documents (“Amendmentto Loan Documents”), pursuant to which certain terms of the Credit Facilitywere amended to, among other things, include ACC and CCI as Borrowers and toprovide for another term loan in the principal amount of $3,000,000 (the “TermLoan C).  The credit facility, as soamended, provides for a credit facility in the aggregate amount of $26,000,000(the “Credit Facility”).

 

TheCredit Facility consists of (i) the Revolver, (ii) a three year termloan in the principal amount of $6,000,000 which was fully funded on November 30,2007 (“Term Loan A”), (iii) a term loan in the principal amount of$10,000,000 (“Term Loan B”), and (iv)  Term Loan C.  Term Loans B and C were fully funded on August 20,2008 in connection with the acquisition of ACC. Term Loan B requires scheduled payments commencing June 2009 andregular payments thereafter until the loan is paid in full in November 2010.  Term Loan C was required to be paid in fullby February 15, 2009.

 

Inorder to facilitate the repayment of the Term Loan C, the Company also agreedwith the Lender to raise at least $5 million in net proceeds through either thesale of assets of the Company or any of its subsidiaries or through the sale ofequity of the Company by no later than February 15, 2009.  The Credit Facility was amended subsequent toDecember 31, 2008 (see Note 21).

 

The TermLoans A and B bear interest at the Base Rate plus 4.25%, subject to a minimumrate of 12.5%, and require interest only payments in the first year, scheduledprincipal plus interest payments in years two and three, and a final balloonpayment at the end of year three.  TermLoan C bears interest at the rate of 14% per annum.  Interest on the Term Loans is payablemonthly.  The Borrowers may make full or partial prepayment ofthe Term Loans provided that any such prepayment is accompanied by theapplicable prepayment premium as discussed in Note 7.

 

As part of the consideration forentering into the Credit Agreement, the Company issued warrants to purchase 2.9million shares of the Company’s common stock (see Note 11) with a fair value of$1.3 million, which was accounted for as a discount to the Credit Facility andis amortized over the term of the Credit Agreement.  On August 20, 2008, the warrants wererepriced resulting in an increase of fair value of $0.2 million for a totaladjusted debt discount of $1.5 million, which is amortized over the remainingterm of the Amended Credit Facility.

 

The Company has capital leasesrelating to capital equipment.  Theleases generally contain bargain purchase options and expire at various datesthrough December 31, 2017. Capitalized lease obligations are calculated using interest ratesappropriate at the inception of the lease and range from 6% to 18%.  Leases are amortized over the lease termusing the effective interest method.

 

The following table is a summary oflong-term debt, excluding loans from stockholders, as of December 31 (inthousands):

 

F-20

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Tableof Contents

 

**EMRISE CORPORATION**

**Notes to Consolidated FinancialStatements**

 
| ** **                                     | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|
| Term Loan A                                    |       | $        | 5,950      |     | $          | 6,000 |   |
| Term Loan B                                    |       | 10,000   |       | —   |       |
| Term Loan C                                    |       | 3,000    |       | —   |       |
| Term notes  payable to U.S. commercial lenders |       | 66       |       | 112      |       |
| Capitalized  lease obligations                 |       | 630      |       | 52       |       |
|                                           |       | 19,646   |       | 6,164    |       |
| Unamortized  discount on debt                  |       | (980     | )          | (1,264   | )          |
|                                           |       | 18,666   |       | 4,900    |       |
| Current portion  of long-term debt             |       | (5,164   | )          | (71      | )          |
| Long-term debt                                 |       | $        | 13,502     |     | $          | 4,829 |   |

 

Principal maturities related tolong-term debt, including loans from stockholders (see Note 15), as of December 31,2008, were as follows (in thousands):

 
| ** **                     | ** ** | **Term  Loan A** | ** ** | **Term  Loan B** | ** ** | **Term  Loan C** | ** ** | **Term notes  payable to  U.S.  commercial  lender** | ** ** | **Capitalized  Lease  Obligations** | ** ** | **Stockholder  Notes (Note  18)** | ** ** |
|--------------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|----------------------------------------------------------------|------------|-------------------------------------|------------|----------------------------------------|------------|
| Year ending  December 31, |       |                  |       |                  |       |                  |       |                                                           |       |                                |       |                                   |       |
| 2009                           |       | $                     | 670        |                  | $          | 1,167                 |       | $                                                              | 3,000      |                                | $          | 43                                     |       | $ | 284 |   | $ | 542 |   |
| 2010                           |       | 5,280                 |       | 8,833                 |       | —                |       | 12                                                             |       | 176                                 |       | 250                                    |       |
| 2011                           |       | —                |       | —                |       | —                |       | 11                                                             |       | 170                                 |       | —                                 |       |
| 2012                           |       | —                |       | —                |       | —                |       | —                                                         |       | —                              |       | —                                 |       |
| Thereafter                     |       | —                |       | —                |       | —                |       | —                                                         |       | —                              |       | —                                 |       |
|                           |       | $                     | 5,950      |                  | $          | 10,000                |       | $                                                              | 3,000      |                                | $          | 66                                     |       | $ | 630 |   | $ | 792 |   |

 

**NOTE 11 —STOCK-BASED COMPENSATION**

 

At December 31, 2008, avariety of the Company’s stock-based compensation grants or awards wereoutstanding for employees (including executive officers) and members of theboard of directors. All stock-based compensation plans were approved by theCompany’s board of directors.

 

***Description of Stock Option Plans***

** **

The Company has five stock optionplans:

 

·                  Employee Stock and Stock Option Plan, effective July 1,1994, provides for non-qualified stock options as well as restricted andnon-restricted stock awards to both employees and outside consultants. Up to520,000 shares were authorized for issuance under this plan. Terms of relatedgrants under the plan are at the discretion of the board of directors. Theboard of directors does not intend to issue any additional options or make anyadditional stock grants under this plan.

 

·                  1993 Stock Option Plan, provides for the grant of upto 300,000 incentive and non-qualified stock options to purchase stock at notless than the current market value on the date of grant. Options granted underthis plan vest ratably over three years and expire 10 years after date of grant.The board of directors does not intend to issue any additional options underthis plan.

 

F-21

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Tableof Contents

 

**EMRISE CORPORATION**

**Notes to Consolidated FinancialStatements**

 

·                  The 1997 Stock Incentive Plan (the “1997 Plan”)provides that options granted may be either qualified or nonqualified stockoptions and are required to be granted at fair market value on the date ofgrant. Subject to termination of employment, options may expire up to ten yearsfrom the date of grant and are nontransferable other than in the event ofdeath, disability or certain other transfers that the committee of the board ofdirectors administering the 1997 Plan may permit. Up to 1,600,000 stock optionswere authorized to be granted under the 1997 Plan. The board of directors doesnot intend to issue any additional options under this plan.

 

·                  The 2000 Stock Option Plan was adopted by the boardof directors in November 2000 and approved by the stockholders on January 16,2001. The board of directors adopted the Amended and Restated 2000 Stock OptionPlan (the “2000 Plan”) effective as of August 3, 2001. Under the 2000Plan, options granted may be either incentive or nonqualified options.Incentive options must have an exercise price of not less than the fair marketvalue of a share of common stock on the date of grant. Nonqualified optionsmust have an exercise price of not less than 85% of the fair market value of ashare of common stock on the date of grant. Up to 2,000,000 options may begranted under the 2000 Plan. No option may be exercised more than ten yearsafter the date of grant.  The board ofdirectors does not intend to issue any additional options under this plan.

 

·                  The 2007 Stock Incentive Plan (the “2007 Plan”) wasadopted by the board of directors in November 2007 and approved by thestockholders on December 12, 2007. Under the 2007 Plan, the administratormay grant or issue stock options (incentive or nonqualified), stockappreciation rights (“SARs”), restricted stock, restricted stock units,performance awards and stock payments, or any combination thereof..  Up to 5,000,000 shares of common stock may begranted pursuant to awards under the 2007 Plan. Incentive and nonqualified options must have an exercise price of notless than the fair market value of a share of common stock on the date of grantand may not be exercised more than ten years after the date of grant.  However, incentive options granted to anindividual who owns (or is deemed to own) more than 10% of the total combinedvoting power of all class of EMRISE stock must have an exercise price of notless than 110% of the fair market value of a share of common stock on the dateof grant and may not be exercised more than five years after the date ofgrant.  The base price of any SAR grantedunder the 2007 Plan must be at least 100% of the fair market value of a shareof common stock on the date of grant. SARs will be settled in shares of common stock.  Restricted stock may have a price asdetermined by the administrator. Restricted stock units entitle the holder to receive vested shares ofcommon stock.  Neither restricted stockor restricted stock units may be sold or otherwise hypothecated ortransferred.  Performance awards will bepaid in shares of common stock and may be granted to employees, consultants orindependent directors based on specific performance criteria.  Stock payments may be issued to employees,independent directors or consultants in the form of common stock or an optionor other right to purchase common stock and may be issued as part of a deferredcompensation arrangement that would otherwise be paid in cash.

 

F-22

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Tableof Contents

 

**EMRISE CORPORATION**

**Notes to Consolidated FinancialStatements**

 

On November 19,2008, the Company completed a board of directors approved 1-for-3.75 reversesplit of its common stock.  All commonstock, stock options and warrants to purchase common stock and earnings pershare amounts have been retroactively restated as if the reverse stock splitoccurred at the beginning of the periods presented.

 

Stockoption activity for the years ended December 31, 2008 and 2007 was asfollows:

 
| ** **                         | ** ** | **2008**                 | ** ** | **2007**     | ** ** |
|------------------------------------|------------|--------------------------|------------|--------------|------------|
| ** **                         | ** ** | ** **               | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                         | ** ** | ** **               | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                         | ** ** | **Shares**               | ** ** | **Exercise** | ** ** | **Shares** | ** ** | **Exercise** | ** ** |
| ** **                         | ** ** | **(in 000’s)** | ** ** | **Price**    | ** ** | **(in 000’s)** | ** ** | **Price** | ** ** |
| Outstanding,  beginning of year    |       | 482                      |       | $            | 4.20       |   | 524 |   | $ | 4.05 |   |
| Granted                            |       | 265                      |       | $            | 2.58       |   | 20 |   | $ | 4.35 |   |
| Exercised(1)                       |       | —                   |       | $            | —     |   | (46 | ) | $ | 1.50 |   |
| Forfeited  (including expirations) |       | (52                      | )          | $            | 4.71       |   | (16 | ) | $ | 7.50 |   |
| Outstanding, end  of year          |       | 695                      |       | $            | 3.47       |   | 482 |   | $ | 4.20 |   |
| Exercisable, end  of year          |       | 432                      |       | $            | 4.01       |   | 462 |   | $ | 4.20 |   |

 

----

(1) Exercised at option pricesranging from $0.75 to $3.75 during 2007.

 

The total fair value of optionsthat vested during the years ended December 31, 2008 and 2007, wasapproximately $71,000 and $72,000, respectively. As of December 31, 2008,the Company had 432,000 million fully-vested stock options, with a weightedaverage exercise price of $4.01 and remaining term of 4.9 years. The Companyexpects that 263,000 stock options (after forfeitures), with a weighted-averageexercise price of $2.58 and remaining term of 9.6 years, will vest in thefuture. The aggregate intrinsic value is approximately $1.5 million forunvested and vested options at December 31, 2008 based on the Company’saverage common stock closing price in 2008.

 

The Company received $68,000 fromthe exercise of stock options in 2007. The tax benefit realized was de minimis. For options exercised duringthe year ended December 31, 2007, the difference between the fair value ofthe common shares issued and their respective exercise price was approximately$134,000.  There were no exercises ofstock options during 2008.

 

The following table summarizesinformation about stock options outstanding at December 31, 2008:

 
| ** **                                  | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|---------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | ** **                   | ** ** | **Weighted**                 | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                  | ** ** | ** **                   | ** ** | **Average**                  | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                  | ** ** | **Options**                  | ** ** | **Remaining**                | ** ** | **Exercise** | ** ** | **Options** | ** ** | **Exercise** | ** ** |
| **Range of Exercise Prices** | ** ** | **(in 000’s)**     | ** ** | **Life in Years**  | ** ** | **Price** | ** ** | **(in 000’s)** | ** ** | **Price** | ** ** |
| $0.75 to $1.00                              |       | 46                           |       | 0.9                          |       | $ | 0.75 |   | 46 |   | $ | 0.75 |   |
| $1.01 to $3.00                              |       | 264                          |       | 6.7                          |       | $ | 1.91 |   | 120 |   | $ | 1.58 |   |
| $3.01 to $5.00                              |       | 241                          |       | 7.8                          |       | $ | 3.39 |   | 122 |   | $ | 3.72 |   |
| $5.01 to $7.50                              |       | 144                          |       | 6.9                          |       | $ | 7.34 |   | 144 |   | $ | 7.34 |   |
| Total options                               |       | 695                          |       |                         |       |   |   | 432 |   |   |   |

 

F-23

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Tableof Contents

 

**EMRISE CORPORATION**

**Notes to Consolidated FinancialStatements**

 

Total stock-based compensationexpense included in wages, salaries and related costs was $88,000 and $69,000for the year ended December 31, 2008 and 2007, respectively. Thesecompensation expenses were charged to selling, general and administrativeexpenses. As of December 31, 2008, the Company had $286,000 of totalunrecognized compensation expense related to stock option grants, which will berecognized over the remaining weighted average period of 2.4 years.

 

**NOTE 12 —WARRANTS**

 

During 2007, theCompany issued to a financial advisor a five-year warrant to purchase up to8,334 shares of the Company’s common stock on a cash or cashless basis at anexercise price equal to $4.31 per share. The estimated fair valueof the warrants was $17,000, which was calculated using the Black-Scholespricing model with the following assumptions: risk free interest rate of 4.5%, expected life of 2.5 years, no dividendyield and an expected volatility of 75%.

 

In connection with entering intothe Credit Facility (discussed in Notes 9 and 10), the Company issued a sevenyear warrant to Private Equity Management Group LLC (“PEM”) to purchase up toapproximately 776,000 shares of the Company’s common stock on a cash orcashless basis at an exercise price of $4.13 per share.  The estimated fair value of the warrants was$1.3 million, which was calculated using the Black-Scholes pricing model withthe following assumptions:  risk freeinterest rate of 3.1%, expected life of 7 years, no dividend yield and anexpected volatility of 59%.  On August 20,2008, in connection with the acquisition of ACC, the Company repriced thesewarrants.  The repricing allows PEM topurchase up to approximately 388,000 shares of the Company’s common stock on acash or cashless basis at an exercise price of $1.99 per share and 388,000shares at an exercise price of $3.06 per share. The repricing increased the estimated fair value of the warrants by $0.2million, which was calculated using the Black Scholes pricing model with thefollowing assumptions: risk free interest rate of 2.51%, expected life of 2.5years, no dividend yield and an expected volatility of 65%.  The warrants were originally accounted for asdebt discount and the adjustment resulting from the repricing of the warrantsincreased the debt discount, which is being amortized over the remaining lifeof the Credit Facility.

 

The followingtable reflects warrants outstanding and related activity for warrantsauthorized for issuance by the board of directors to certain officers,directors, stockholders, key employees and other parties:

 
| ** **                                     | ** ** | ** **               | ** ** | ** **   | ** ** | ** **                  | ** ** | **Average**        | ** ** |
|------------------------------------------------|------------|--------------------------|------------|--------------|------------|-----------------------------|------------|--------------------|------------|
| ** **                                     | ** ** | ** **               | ** ** | **Weighted** | ** ** | **Weighted**                | ** ** | **Intrinsic**      | ** ** |
| ** **                                     | ** ** | **Number**               | ** ** | **Average**  | ** ** | **Average**                 | ** ** | **Value**          | ** ** |
| ** **                                     | ** ** | **of Shares**       | ** ** | **Exercise** | ** ** | **Remaining**               | ** ** | **(in-the-money)** | ** ** |
| ** **                                     | ** ** | **(in 000’s)** | ** ** | **Price**    | ** ** | **Life in Years** | ** ** | **Warrants**       | ** ** |
|                                           |       |                     |       |         |       |                        |       |               |       |
| Balance  outstanding at December 31, 2006 |       | 1,110                    |       | $            | 6.41       |                        |       |               |       |   |
| Warrants issued                                |       | 784                      |       | $            | 4.13       |                        |       |               |       |   |
| Warrants  cancelled                            |       | (60                      | )          | $            | 4.99       |                        |       |               |       |   |
| Balance  outstanding at December 31, 2007 |       | 1,834                    |       | $            | 6.41       |                        |       |               |       |   |
|                                           |       |                     |       |         |       |                        |       |               |       |
| Warrants issued                                |       | —                   |       | $            | —     |                        |       |               |       |   |
| Warrants  exercised                            |       | —                   |       | $            | —     |                        |       |               |       |   |
| Warrants  cancelled                            |       | (36                      | )          | $            | 6.58       |                        |       |               |       |   |
|                                           |       |                     |       |         |       |                        |       |               |       |
| Balance  outstanding at December 31, 2008 |       | 1,798                    |       | $            | 4.76       |                        | 3.2        |               | $          | 46 |   |
|                                                |            |                          |            |              |            |                             |            |                    |            |  |  |

 

There were approximately 388,000warrants outstanding at December 31, 2008 where the exercise price wasbelow the market price for the Company’s shares (in-the-money).

 

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Tableof Contents

 

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

**NOTE 13 — LOSSPER SHARE**

 

Basic loss per share is computed bydividing net loss by the weighted average common shares outstanding during aperiod.  Diluted loss per share is basedon the treasury stock method and includes the dilutive effect of stock optionsand warrants outstanding during the period. Common share equivalents have been excluded where their inclusion wouldbe anti-dilutive.  As a result of theloss incurred by the Company for all periods presented, the potentiallydilutive common shares have been excluded because their inclusion would havebeen anti-dilutive.  The following tableillustrates the computation of basic and diluted loss per share for the yearsended December 31, 2008 and 2007 (in thousands, except per share amounts):

 
| ** **                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|
|                                                |       |     |       |     |       |
| NUMERATOR:                                          |       |     |       |     |       |
| Net loss                                            |       | $        | (7,440     | )        | $          | (1,928 | ) |
|                                                |       |     |       |     |       |
| DENOMINATOR:                                        |       |     |       |     |       |
| Basic weighted  average common shares outstanding   |       | 10,204   |       | 10,180   |       |
| Effect of  dilutive securities:                     |       |     |       |     |       |
| Dilutive stock  options and warrants                |       | —   |       | —   |       |
| Diluted weighted  average common shares outstanding |       | 10,204   |       | 10,180   |       |
|                                                |       |     |       |     |       |
| Basic loss per  share                               |       | $        | (0.73      | )        | $          | (0.19 | ) |
|                                                |       |     |       |     |       |
| Diluted loss per  share                             |       | $        | (0.73      | )        | $          | (0.19 | ) |

 

The following table shows thecommon stock equivalents that were outstanding as of December 31, 2008 and2007, but were not included in the computation of diluted earnings per share asa result of the loss incurred by the Company or because the options’ orwarrants’ exercise price was greater than the average market price of thecommon shares and, therefore, the effect would have been anti-dilutive:

 
| ** **                            | ** ** | ** **         | ** ** | **Range of**       | ** ** |
|---------------------------------------|------------|--------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **Number of** | ** ** | **Exercise Price** | ** ** |
| ** **                            | ** ** | **Shares**         | ** ** | **Per Share**      | ** ** |
|                                  |       |               |       |                    |       |
| Anti-dilutive  common stock options:  |       |               |       |                    |       |
| As of  December 31, 2008         |       | 531,000            |       | $2.18 – $7.50      |       |
| As of  December 31, 2007         |       | 212,000            |       | $4.24 – $7.50      |       |
|                                  |       |               |       |                    |       |
| Anti-dilutive  common stock warrants: |       |               |       |                    |       |
| As of  December 31, 2008         |       | 1,410,000          |       | $4.31 – $6.49      |       |
| As of  December 31, 2007         |       | 1,834,000          |       | $4.13 – $7.50      |       |

 

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Table of Contents

 

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

**NOTE 14 —INCOME TAXES**

 

The Company files a consolidatedU.S. federal income tax return. This return includes all domestic companies 80%or more owned by the Company. State tax returns are filed on a consolidated,combined or separate basis depending on the applicable laws relating to theCompany and its domestic subsidiaries.

 

The Company’s income beforeprovision for income taxes was generated from the U.S. and foreign operationsfor the years ended December 31 as follows (in thousands):

 
| ** **                            | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|
|                                  |       |     |       |     |       |
| Earnings (loss)  before income taxes: |       |     |       |     |       |
| U.S.                                  |       | $        | (9,649     | )        | $          | (5,365 | ) |
| Foreign                               |       | 2,529    |       | 4,171    |       |
| Earnings (loss)  before income taxes  |       | $        | (7,120     | )        | $          | (1,194 | ) |

 

The Company’s provision for incometaxes consisted of the following for the years ended December 31 (inthousands):

 
| ** **                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
| Current                           |       |     |       |     |       |
| Federal                           |       | $        | —     |     | $          | — |   |
| State                             |       | 98       |       | 12       |       |
| Foreign                           |       | 806      |       | 666      |       |
| Total current                     |       | 904      |       | 678      |       |
|                              |       |     |       |     |       |
| Deferred                          |       |     |       |     |       |
| Federal                           |       | (277     | )          | —   |       |
| State                             |       | —   |       | —   |       |
| Foreign                           |       | (307     | )     | 56       |       |
| Total deferred                    |       | (584     | )     | 56       |       |
| Total provision  for income taxes |       | $        | 320        |     | $          | 734 |   |

 

Income tax expense (benefit)differed from the amount obtained by applying the statutory federal income taxrate of 34% to income before income taxes as follows for the years ended December 31(in thousands):

 
| ** **                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|
| Federal income  tax at statutory rates      |       | $        | (3,281     | )        | $          | (1,498 | ) |
| State income  taxes, net of federal benefit |       | (287     | )          | (131     | )          |
| Foreign income  taxes                       |       | (362     | )          | 226      |       |
| Changes in  valuation allowances            |       | 2,057    |       | 2,139    |       |
| Permanent  differences                      |       | 2,193    |       | (2       | )          |
|                                        |       | $        | 320        |     | $          | 734 |   |

 

F-26

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Table of Contents

 

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

Deferred income taxes reflect thenet tax effects of temporary differences between the carrying amounts of assetsand liabilities for financial reporting purposes and the amounts used forincome tax purposes. Significant components of the Company’s deferred taxassets and liabilities were as follows as of December 31 (in thousands):

 
| ** **                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------------------------------------|------------|----------|------------|----------|------------|
| **Current  deferred tax assets:**                     |       |     |       |     |       |
| Allowance for  doubtful accounts                      |       | $        | 125        |     | $          | 72 |   |
| Inventory  reserves and uniform capitalization        |       | 1,200    |       | 1,081    |       |
| Other accrued  liabilities                            |       | 848      |       | 621      |       |
|                                                  |       | 2,173    |       | 1,774    |       |
| Valuation  allowance-current deferred tax assets      |       | (1,808   | )          | (1,574   | )          |
| Total current  deferred tax assets                    |       | 365      |       | 200      |       |
|                                                  |       |     |       |     |       |
| **Long-term  deferred tax assets:**                   |       |     |       |     |       |
| Depreciation on  property, plant & equipment |       | 58       |       | 370      |       |
| Deferred  compensation                                |       | 366      |       | 218      |       |
| Alternative  minimum tax credit carryforwards         |       | 142      |       | 142      |       |
| Capital loss  carryforwards                           |       | —   |       | 136      |       |
| Net operating  loss carryforwards                     |       | 8,692    |       | 7,988    |       |
|                                                  |       | 9,258    |       | 8,854    |       |
| Valuation allowance-long-term  deferred tax assets    |       | (6,923   | )          | (8,237   | )          |
| Total long-term  deferred tax assets                  |       | 2,335    |       | 617      |       |
|                                                  |       |     |       |     |       |
| **Deferred  tax liabilities:**                        |       |     |       |     |       |
| Intangible  assets other than goodwill                |       | (2,203   | )          | (904     | )          |
| Total deferred  tax liabilities (long-term)           |       | (2,203   | )          | (904     | )          |
| Net deferred tax  asets (liabilities)                 |       | $        | 497        |     | $          | (87 | ) |

 

The Company had federal and statenet operating loss carryforwards of approximately $28.4 million and $26.4million as of December 31, 2008 and 2007, respectively, that expire atvarious dates through 2028. As of December 31, 2008 and 2007, the Companyrecorded a valuation allowance on the deferred tax asset. Management believessufficient uncertainty exists regarding the realizability of the deferred taxasset items and that a valuation allowance is required. Management considersprojected future taxable income and tax planning strategies in making thisassessment. For the years ended December 31, 2008 and 2007, managementrecorded a decrease in its valuation allowances of $1.1 million and an increaseof $2.7 million, respectively, based on the domestic book income in 2008 and2007 and projections for future taxable income over periods that the deferredassets are deductible. The amount of the deferred tax assets consideredrealizable, however, could materially change in the near future if estimates offuture taxable income during the carryforward period are changed.

 

Utilization of the Company’s netoperating loss and tax credit carryforwards may be subject to a substantialannual limitation due to the ownership change limitations provided by theInternal Revenue Code and similar state provisions. Such an annual limitationcould result in the expiration or elimination of the net operating loss and taxcredit carryforwards before utilization. As a result of a merger in 1997 theCompany experienced a more than 50% ownership change for federal income taxpurposes. Of the pre-1997 net operating loss carryforwards subject tolimitation, approximately $276,000 per year is available to offset future federaltaxable income.

 

The Company adopted FIN 48, “Accounting for Uncertainty in Income Taxes —an interpretation of FASB Statement No. 109,” on January 1,2007. The implementation of FIN 48 did not result in a material adjustment tothe 

 

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Table of Contents

 

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

Company’s liability for unrecognized income tax benefits. At the time ofadoption and as of December 31, 2008, the Company had recorded no netunrecognized tax benefits.

 

The Company recognizes interest andpenalties related to uncertain tax positions in interest expense and selling,general and administrative expense, respectively, in the condensed consolidatedstatements of operations and comprehensive income. No interest or penaltieswere recognized during 2008. As of December 31, 2008, the Company hadnothing accrued for interest and penalties.

 

The Company files income taxreturns in the United States federal jurisdiction, the United Kingdom, Franceand Japan, and in the state jurisdictions of California, Texas, Pennsylvaniaand New Jersey. The Company is no longer subject to United States federal andstate tax examinations for years before 2005 and 2004, respectively, and is nolonger subject to tax examinations for the United Kingdom and Japan for yearsprior to 2007, and for France for years prior to 2005.

 

**NOTE 15 —OPERATING SEGMENTS**

 

The Company has two reportableoperating segments: electronic devices and communications equipment. Theelectronic devices segment manufactures and markets digital and rotaryswitches, electronic power supplies, radio frequency (“RF”) and microwavedevices and subsystem assemblies. The electronic devices segment consists ofEEC and its subsidiaries, which offer the same or similar products to similarcustomers. The communications equipment segment designs, manufactures anddistributes network access products and timing and synchronization products. Thecommunications equipment segment consists of operating entities CXR LarusCorporation and CXR Anderson Jacobson, which offer the same or similar productsto similar customers. Both segments operate in the U.S., European and Asian markets,but have distinctly different customers, design and manufacturing processes andmarketing strategies. Each segment has discrete financial information and aseparate management structure. The Company evaluates performance based uponprofit or loss from operations before income taxes exclusive of nonrecurringgains and losses. The Company accounts for intersegment sales at pre-determinedprices negotiated between the individual segments.

 

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Table of Contents

 

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

Includedin the Company’s reconciliation of segment financial data to the consolidatedamounts is unallocated corporate expenses. Selected financial data for each ofthe Company’s operating segments reconciled to the consolidated totals is shownbelow (in thousands):

 
| ** **                     | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------|------------|--------------------------------------------|------------|
| ** **                     | ** ** | **2008**                                   | ** ** | **2007** | ** ** |
| Net sales                      |       |                                       |       |   |   |
| Electronic  devices            |       | $                                          | 44,739     |   | $ | 36,471 |   |
| Communications  equipment      |       | 14,768                                     |       | 14,874 |   |
| Total                          |       | $                                          | 59,507     |   | $ | 51,345 |   |
|                           |       |                                       |       |   |   |
| Gross profit                   |       |                                       |       |   |   |
| Electronic  devices            |       | $                                          | 17,145     |   | $ | 11,602 |   |
| Communications  equipment      |       | 5,977                                      |       | 5,748 |   |
| Total                          |       | $                                          | 23,122     |   | $ | 17,350 |   |
|                           |       |                                       |       |   |   |
| Depreciation and  amortization |       |                                       |       |   |   |
| Electronic  devices            |       | $                                          | 1,049      |   | $ | 895 |   |
| Communications  equipment      |       | 311                                        |       | 236 |   |
| All other                      |       | 14                                         |       | 23 |   |
| Total                          |       | $                                          | 1,374      |   | $ | 1,154 |   |
|                           |       |                                       |       |   |   |
| Operating income  (loss)       |       |                                       |       |   |   |
| Electronic  devices            |       | $                                          | 7,078      |   | $ | 2,845 |   |
| Communications  equipment      |       | (6,563                                     | )          | 188 |   |
| Corporate and  other           |       | (4,005                                     | )          | (3,867 | ) |
| Total                          |       | $                                          | (3,490     | ) | $ | (834 | ) |

 
| ** **                | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|---------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                | ** ** | **2008**              | ** ** | **2007**              | ** ** |
| Total assets              |       |                  |       |                  |       |
| Electronic  devices       |       | $                     | 45,744     |                  | $          | 29,835 |   |
| Communications  equipment |       | 4,338                 |       | 11,851                |       |
| Corporate and  other      |       | 3,541                 |       | 6,494                 |       |
| Total                     |       | $                     | 53,623     |                  | $          | 48,180 |   |

 

No customer in either segmentaccounted for 10% or more of net sales during 2008 or 2007.

 

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**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

The Company’s segments operate indifferent geographic areas. The following table is a summary of the Company’snet sales by geographic area for the year ended December 31 (inthousands):

 
| ** **      | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------|------------|----------|------------|----------|------------|
| United States   |       | $        | 22,443     |     | $          | 13,786 |   |
| England         |       | 26,620   |       | 26,484   |       |
| France          |       | 9,169    |       | 9,645    |       |
| Japan           |       | 1,275    |       | 1,430    |       |
| Total net sales |       | $        | 59,507     |     | $          | 51,345 |   |

 

Salesand purchases between geographic areas have been accounted for on the basis ofprices set between the geographic areas, general at cost plus 40%. Net sales bygeographic area have been determined based upon the country from which theproduct was shipped.

 

**NOTE 16 —RETIREMENT PLANS**

 

The Company maintains certaindefined contribution retirement plans covering substantially all U.S. domesticemployees. The Company’s contributions to these retirement plans were $38,000and $33,000 in the years ended December 31, 2008 and 2007, respectively.

 

TheCompany’s subsidiary in France has a defined benefit pension plan. The planis an unfunded plan. As such, no contributions were made in either of theperiods presented. The plan does not have plan assets. Employee benefits arebased on years of service and the employees’ compensation during theiremployment. The actuarially computed components of net periodic benefit costincluded the following components for the years ended December 31, (inthousands):

 
| ** **                         | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
| Service Costs                      |       | $        | 14         |     | $          | 14 |   |
| Interest Costs                     |       | 14       |       | 10       |       |
| Amortization of  unrecognized loss |       | —   |       | —   |       |
| Expected return  on plan assets    |       | —   |       | —   |       |
| Net periodic  pension expense      |       | $        | 28         |     | $          | 24 |   |

 

F-30

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Tableof Contents

 

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

The following table sets forth the funded status andamounts recognized in the Company’s consolidated statement of operations forthe years ended December 31, (in thousands):

 
| ** **                                       | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Change in  benefit obligation:                   |       |     |       |     |       |
| Projected  benefit obligation, beginning of year |       | $        | 261        |     | $          | 208 |   |
| Service cost                                     |       | 14       |       | 14       |       |
| Interest cost                                    |       | 14       |       | 10       |       |
| Benefits paid                                    |       | —   |       | —   |       |
| Actuarial  loss/(gain)                           |       | 17       |       | 4        |       |
| Effect of  foreign currency translation          |       | (1       | )          | 25       |       |
| Projected  benefit obligation, end of year       |       | $        | 305        |     | $          | 261 |   |
|                                             |       |     |       |     |       |
| Change in plan  assets:                          |       |     |       |     |       |
| Plan assets,  beginning of year                  |       | $        | —     |     | $          | — |   |
| Actual return on  plan assets                    |       | —   |       | —   |       |
| Employer  contribution                           |       | —   |       | —   |       |
| Benefits paid                                    |       | —   |       | —   |       |
| Plan assets, end  of year                        |       | $        | —     |     | $          | — |   |
| Unfunded Status                                  |       | $        | 305        |     | $          | 261 |   |
| Unrecognized  (gain)/loss                        |       | (5       | )          | (22      | )          |
| Net amount  recognized                           |       | $        | 300        |     | $          | 239 |   |

 

The weighted average assumptions used to determinepension benefit obligations at December 31, were as follows:

 
| ** **                     | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
|                           |       |     |       |     |       |
| Discount rate                  |       | 5.00     | %          | 5.00     | %          |
| Rate of  compensation increase |       | 2.00     | %          | 2.00     | %          |

 

**NOTE 17 —COMMITMENTS AND CONTINGENCIES**

 

***Leases***

** **

The Company conducts most of itsoperations from leased facilities under operating leases that expire at variousdates through 2016. The leases generally require the Company to pay allmaintenance, insurance and property tax costs and contain provisions for rentincreases. Total rent expense, net of sublease income, for 2008 and 2007 wasapproximately $1.4 million and $1.7 million, respectively.

 

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Table of Contents

 

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

The future minimum rental paymentsrequired under operating leases that have initial or remaining noncancelablelease terms in excess of one year are as follows:

 
| **Year ending December 31,** | ** ** | **Amount** | ** ** |
|---------------------------------------------|------------|------------|------------|
| 2009                                        |       | $          | 1,108      |   |
| 2010                                        |       | 747        |       |
| 2011                                        |       | 453        |       |
| 2012                                        |       | 28         |       |
| 2013                                        |       | 7          |       |
| Thereafter                                  |       | —     |       |
| Total                                       |       | $          | 2,343      |   |

 

***Litigation***

** **

The Company is not currently aparty to any material legal proceedings. However, the Company and itssubsidiaries are, from time to time, involved in legal proceedings, claims andlitigation arising in the ordinary course of business. While the amountsclaimed may be substantial, the ultimate liability cannot presently bedetermined because of considerable uncertainties that exist. Therefore, it ispossible the outcome of such legal proceedings, claims and litigation couldhave a material effect on quarterly or annual operating results or cash flowswhen resolved in a future period. However, based on facts currently available,management believes such matters will not have a material adverse effect on theCompany’s consolidated financial position, results of operations or cash flows.

 

**NOTE 18 —RELATED PARTIES**

 

The Company issued promissorynotes, dated July 13, 2004, to two former stockholders of CXR LarusCorporation (formerly Larus Corporation) totaling $3.0 million. These notes aresubordinated to the Company’s bank debt and are payable in 72 equal monthlypayments of principal plus interest at the 30-day LIBOR plus 5% with a maximuminterest rate of 7% during the first two years of the term of the notes, 8%during the third and fourth years, and 9% thereafter. At December 31,2008, the 30-day LIBOR was 1.08%. Future maturities of notes payable tostockholders are $542,000 in 2009 and $250,000 in 2010. Interest paid on thesenotes was $84,000 and $127,000 for the year ended December 31, 2008 and2007, respectively.

 

Additionally, the Company enteredinto an above-market real property lease with the two former stockholders ofCXR Larus Corporation. The lease represented an obligation that exceeded thefair market value by approximately $756,000. The lease term is for 7 years andexpires on June 30, 2011. It is renewable for a 5-year term priced undermarket conditions. The base rent is based on a minimum rent of $.90 per squarefoot per month, which is $27,000 monthly or $324,000 per year, subject tomonthly adjustments of the interest rate based on the Federal Reserve DiscountRate that match the lessor’s variable interest rate mortgage payments on thebuilding. The maximum increase in any year is 1.5%, with a cumulative maximumincrease of 8% over the life of the lease. The increases apply to that portionof the rent that corresponds to the interest portion of the lessor’s mortgage. Leasepayments paid to the related parties during 2008 and 2007 totaled $390,000 and$439,000, respectively. Future minimum lease payments under the operating leasepayable to the stockholders are included in Note 10.

 

TheCompany obtains consulting services from Jason Oliva, a related party. Paymentsmade to Mr. Oliva for these services were $58,000 and $31,000 during theyear ended December 31, 2008 and 2007, respectively.

 

Thereare no guarantees by officers or fees paid to officers or loans to or fromofficers of the Company.

 

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**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

**NOTE 19 — FAIR VALUEMEASUREMENTS**

 

In September 2006,the FASB issued SFAS No. 157, which defines fair value, establishes aframework for measuring fair value in generally accepted accounting principlesand expands disclosures about fair value measurements. The effective date ofthe statement is for all entities with fiscal years beginning after November 15,2007. In February 2008, the FASB issued FSP No. 157-2, which delaysthe effective date of SFAS No. 157 for non-financial assets andliabilities to fiscal years beginning after November 15, 2008. The delaypertains to items including, but not limited to, goodwill and other intangibleassets. The Company adopted the provisions of the standard that were effectiveas of January 1, 2008. The Company plans to adopt the remaining provisionsof SFAS No. 157 as of January 1, 2009.

 

SFAS No. 157defines fair value as the price that would be received to sell an asset or paidto transfer a liability (an exit price) in an orderly transaction betweenmarket participants and also establishes a fair value hierarchy which requiresan entity to maximize the use of observable inputs and minimize the use ofunobservable inputs when measuring fair value. The fair value hierarchydistinguishes between three levels of inputs that may be utilized whenmeasuring fair value as follows:

 

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

 

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

 

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

 

As of December 31,2008, the Company did not have financial assets and liabilities measured atfair value on a recurring basis that would be subject to the disclosureprovisions of SFAS No. 157.

 

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Table of Contents

 

**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

**NOTE 20 —RECENT ACCOUNTING PRONOUNCEMENTS**

 

In February 2007, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 159, “The Fair Value Option for FinancialAssets 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 upfront cost and fees associated with the item for which thefair value option is elected. SFAS No. 159 is effective for fiscal yearsbeginning after November 15, 2007. The adoption of SFAS No. 159 didnot have a material effect on the Company’s financial condition or results ofoperations.

 

In September 2006, the FASBissued 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 thefirst quarter of 2008. The adoption of SFAS No. 157 for financial assetsand liabilities did not have a material effect on the Company’s consolidatedfinancial statements, but resulted in additional disclosures contained herein. InFebruary 2008, the FASB issued Staff Position No. 157-2, which delayedby one year the effective date of SFAS No. 157 for all non-financialassets and liabilities, except those that are recognized or disclosed at fairvalue in the financial statements on a recurring basis. The Company hasevaluated the impact the adoption of SFAS No. 157 for non-financial assetsand liabilities have determined that the adoption of SFAS No. 157-2 willnot have a material effect on its consolidated financial statements.

 

In December 2007, the FASBissued SFAS No. 141R, “Business Combinations,” which replaces SAFS No. 141,“Business Combinations.” SFAS No. 141R establishes principles andrequirements for determining how an enterprise recognizes and measures the fairvalue of certain assets and liabilities acquired in a business combination,including noncontrolling interests, contingent consideration and certainacquired contingencies. SFAS No. 141R also requires acquisition-relatedtransaction expenses and restructuring costs be expensed as incurred ratherthan capitalized as a component of the business combination. SFAS No. 141Rwill be applicable prospectively to business combinations for which theacquisition date is on or after January 1, 2009. SFAS No. 141R wouldhave an impact on accounting for any business acquired after the effective dateof this pronouncement.

 

In March 2008, the FASB issuedSFAS No. 161, “Disclosures about Derivative Instruments and HedgingActivities.” The new standard amends SFAS No. 133 and seeks to enhancedisclosure about how and why a company uses derivative and hedging activities,how derivative instruments and related hedged items are accounted for underSFAS No. 133 (and the interpretations of that standard) and howderivatives and hedging activities affect a company’s financial position,financial performance and cash flows. SFAS No. 161 is effective forfinancial statements issued for fiscal years and interim periods beginningafter November 15, 2008. The adoption of SFAS No. 161 is not expectedto have a material effect on the Company’s consolidated financial statements.

 

In April 2008, the FASB issuedFASB Staff Position (“FSP”) No. FAS 142-3, “Determination of the UsefulLife of Intangible Assets,” (“FSP 142-3”). FSP 142-3 amends the factors thatshould be considered in developing renewal or extension assumptions used todetermine the useful life of a recognized intangible asset under SFAS No. 142,“Goodwill and Other Intangible Assets” and also requires expanded disclosurerelated to the determination of intangible asset useful lives. FSP 142-3 iseffective for fiscal years beginning after December 15, 2008. Earlyadoption is prohibited. The Company is currently evaluating the impact theadoption of FSP 142-3 will have on its consolidated financial statements.

 

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**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

**NOTE 21 —SUBSEQUENT EVENTS**

 

*Disposition ofAssets*

 

On March 20, 2009, the Company and its wholly-ownedsubsidiary, EEC, entered into an Asset and Stock Purchase Agreement (the “PurchaseAgreement”) with  Electro Switch Corp., aDelaware corporation (the “Buyer”) and ESC Worldwide, Inc., aMassachusetts corporation and subsidiary of Buyer (the “Stock Buyer”).  Atthe closing of the Purchase Agreement on March 20, 2009, (i) theBuyer purchased from the Company and EEC substantially all the assets relatedto EEC’s Digitran division, and (ii) the Stock Buyer purchased from EECall of the issued and outstanding equity interests of its wholly-ownedsubsidiary, XCEL Japan, Ltd., for an aggregate purchase price of approximately$11,561,101 (the “Disposition”).  Under the terms of the PurchaseAgreement, the Buyer is obligated to pay up to an additional $500,000 in cashto EEC if net sales for the fiscal year ending December 31, 2009 relatedto the businesses that were sold pursuant to the Purchase Agreement exceeds$6,835,120.

 

The Buyer acquired all of the intellectual property, cash,accounts receivable, inventory, customer support and relationships, softwareand product development, and real property lease related to the Digitrandivision, which, prior to its acquisition, was in the business of manufacturinga line of electromechanical switches comprised of digital and rotary switchesused for routing electronic signals.  The Stock Buyer acquired XCEL Japan,Ltd., which, prior to its acquisition, was engaged in the business of sellingand distributing Digitran division products in the Asia Pacific market. EEC retained all accounts payable and certain other assets and liabilitiesrelated to the Digitran division.  The Company will continue to operateits communications equipment segment and the power systems RF and microwavedevices product lines in its electronic devices segment.

 

The Purchase Agreement contains five year noncompetitionand non-solicitation provisions covering the Company, EEC and each of theirrespective affiliates.  In addition, the Company and EEC providedcustomary indemnification rights to the Buyer and Stock Buyer in connectionwith the Disposition.

 

Inconnection with the Company’s divestiture of its Digitran division, whichcomprised a portion of the Company’s electronic devices segment, the Companyincurred approximately $990,000 in cash charges that were paid atclosing.  The charges paid at closing included approximately $180,000 inemployee termination costs.  In addition, the Company estimates futurecash expenditures related to the sale to be approximately $1,300,000.  TheCompany anticipates the charges will be comprised of (i) approximately$990,000 in costs related to federal and state income liabilities, (ii) approximately$260,000 in employee termination costs and transaction related employeeincentive bonuses, and (iii) other costs and fees, including additionallegal and accounting fees.  Substantially all of the charges are expectedto be incurred within 12 months of the closing of the sale.

 

*Amendment toCredit Facility*

 

On February 12,2009, the Borrowers entered into Amendment Number 2 to Loan Documents (the“Second Amendment to Loan Documents”) with Lender, an affiliate of PEM Group.The Amendment Number 2 to Loan Documents amends certain terms of theCredit Facility.

 

Pursuantto the terms of the Second Amendment to Loan Documents, the maturity date ofthe $3,000,000 Term Loan C and the date by which the Borrowers must raiseat least $5,000,000 from either (i) the sale of equity or assets of asignificant subsidiary or division of Borrowers, or (ii) the sale ofBorrowers’ equity, have each been extended from February 15, 2009 to March 20,2009.  In addition, the Second Amendment to Loan Documents amends theCredit Facility to make clear that proceeds from the sale of equity or assetsmay be used by Borrowers to repay the Term Loan C.

 

Inconnection with entering into the Second Amendment to Loan Documents, and inconsideration of the services performed by the PEM Group, the Company amendedthe exercise price of a warrant previously issued to Private Equity ManagementGroup, LLC an affiliate of PEM Group, on November 30, 2007.  Adescription of the 

 

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**EMRISE CORPORATION**

**Notes toConsolidated Financial Statements**

 

warrant,prior to this most recent amendment, is included in Note 11.  Pursuant tothe Second Amendment to Loan Documents, the original warrant was divided intotwo warrants (each, a “Second Amended and Restated Warrant” and collectively,the “Second Amended and Restated Warrants”).  Each Second Amended andRestated Warrant covers 387,879 shares of the Company’s common stock (whichamount reflects the Company’s 1-for-3.75 reverse split of its common stockeffective November 18, 2008).  One of the Second Amended and RestatedWarrants provides for an exercise price of $1.99 per share (which amountreflects the Company’s 1-for-3.75 reverse split of its common stock effective November 18,2008).  The other Second Amended and Restated Warrant provides for anexercise price of $1.80 per share (which amount reflects the Company’s1-for-3.75 reverse split of its common stock effective November 18, 2008and a reduction from a post-split exercise price of $3.06 per share).

 

On March 20, 2009, the Borrowers and the Lenderentered into a Forbearance Agreement and Amendment Number 3 to LoanDocuments  (“Amendment Number 3 to LoanDocuments”) pursuant to which, among other things, (i) certain terms ofthe Credit Agreement were amended, (ii) the Lender released its liens onthe assets and stock sold pursuant to the Purchase Agreement and (iii) theLender agreed to waive and forbear on its rights with respect to certain eventsof default under the Credit Agreement.

 

In connection with the Purchase Agreement, and pursuant tothe terms of Amendment Number 3 to Loan Documents, the Lender consented to theCompany and EEC entering into and consummating the transactions contemplated bythe Purchase Agreement and agreed to release its security interest in theassets and stock sold pursuant to the Purchase Agreement.  In addition,the Borrowers used $10,000,000 of the proceeds from the Disposition to pay infull the entire outstanding principal balance and accrued and unpaid intereston the Term Loan C (as defined in the Credit Agreement) and to prepay a portionof the Borrowers’ remaining outstanding obligations under the CreditAgreement.  In consummating the transactions contemplated by the PurchaseAgreement, the Borrowers met their obligation under the Credit Agreement toraise no less than $5,000,000 in net proceeds from the sale of assets or, inthe absence of a sale of assets, a sale of stock on or prior to March 20,2009.

 

Under the terms of Amendment Number 3 to Loan Documents,the Lenders waived any claims of breach or default arising out of or relatingto the breach of certain of the financial covenants under the Credit Agreementthrough March 20, 2009.  In addition, the Lender agreed to forbearfrom exercising certain of its default-related rights and remedies againstBorrowers with respect to the breach of these certain financial covenants from March 20,2009 until the date that the parties enter into a further amendment to theCredit Agreement.

 

On April 14, 2009, theBorrowers and the Lender entered into an Amendment Number 4 to Loan Documents (“AmendmentNumber 4”) pursuant to which, among other things, (i) the Lenders waived any claims of breach or default arising out of or relatingto the breach of certain of the financial covenants under the Credit Agreementthrough April 14, 2009, (ii) the financial covenants for the Revolverwere amended to account for the sale of the Digitran Operations and (iii) theCompany agreed to raise a minimum of $2 million on or prior to September 30,2009.  Under to the terms of AmendmentNumber 4, the Company is obligated to remit to the Lender  $500,000 with respect to the first $2,000,000of net cash proceeds received in connection with the sale of stock, 50% of thenext $1,000,000 of net cash proceeds received in connection with the sale ofstock, and 30% of the net cash proceeds in excess of the first $3,000,000received in connection with the sale of stock.

 

Pursuant to the terms of AmendmentNumber 4, the Lender waived any claims of breach or default arising out of orrelating to the breach of certain of the financial covenants under the creditfacility through April 14, 2009. Additionally, several of the financial covenants related to the$7,000,000 revolving credit facility available under the credit facility wereamended.  Pursuant to the terms of creditfacility, the Revolver is subject to various financial covenants on aconsolidated basis, including the following: EBITDA, measured on a fiscalquarter-end basis, must not be less than the scheduled amount for eachspecified period; the debt service coverage ratio, measured quarterly, must begreater than the lesser of the scheduled amount for each specific period or1.10:1.00; the leverage ratio, measured quarterly, must not be greater than thescheduled amount for each specified period, and liquidity, measured quarterly,must not be less than the scheduled amount for each specified period.  Additionally, the Revolver is subject to theBorrowers not incurring capital expenditures (a) in excess of $600,000 for thefiscal year ending December 31, 2009, and (b) in excess of $1,800,000 for thefiscal year ending December 31, 2010. Additionally, the Revolver is subject to the borrowers not incurringunfinanced capital expenditures in excess of $62,500 in any fiscal quarter,provided however that if the borrowers incur unfinanced capital expenditures ofless than $62,500 in any fiscal quarter, the difference between the amountincurred in a certain fiscal quarter and $62,500 maybe incurred in the twofiscal quarters immediately following such fiscal quarter.

 

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**SIGNATURES**

 

Pursuant to the requirements of Section 13or 15(d) the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized on this 31st day of March,2008.

 
|   | EMRISE CORPORATION |
|--------|--------------------|
|   |               |
|   | By:                | /S/  CARMINE T. OLIVA |
|   |               | Carmine  T. Oliva, |
|   |               | Chairman  of the Board, President and |
|   |               | Chief  Executive Officer (principal executive officer) |
|   |               |   |
|   |               |   |
|   | By:                | /S/  D. JOHN DONOVAN |
|   |               | D.  John Donovan, |
|   |               | Vice  President of Finance and Administration (principal |
|   |               | financial  officer) and Secretary |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned by the following persons on behalf of the registrant and in thecapacities and on the dates indicated.

** **
| **Signature**                       | ** ** | **Capacity**                                                    | ** ** | **Date**             |
|-------------------------------------|------------|-----------------------------------------------------------------|------------|----------------------|
| ** **                          | ** ** | ** **                                                      | ** ** | ** **           |
|                                |       |                                                            |       |                 |
| /s/  Carmine T. Oliva               |       | Chairman  of the Board, President, Chief Executive Officer      |       | April 15,  2009 |
| Carmine  T. Oliva                   |       | (principal  executive officer) and Director                     |       |                 |
|                                |       |                                                            |       |                 |
|                                |       |                                                            |       |                 |
| /s/  D. John Donovan                |       | Vice  President Finance and Administration (principal financial |       | April 15,  2009 |
| D.  John Donovan                    |       | officer)                                                        |       |                 |
|                                |       |                                                            |       |                 |
|                                |       |                                                            |       |                 |
| /s/  Laurence P. Finnegan, Jr. |       | Director                                                        |       | April 15,  2009 |
| Laurence  P. Finnegan, Jr.     |       |                                                            |       |                 |
|                                |       |                                                            |       |                 |
|                                |       |                                                            |       |                 |
| /s/  Otis W. Baskin                 |       | Director                                                        |       | April 15,  2009 |
| Otis  W. Baskin                     |       |                                                            |       |                 |
|                                |       |                                                            |       |                 |
|                                |       |                                                            |       |                 |
| /s/  Richard E. Mahmarian           |       | Director                                                        |       | April 15,  2009 |
| Richard  E. Mahmarian               |       |                                                            |       |                 |

 

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**EMRISE CORPORATION**

**EXHIBITS ATTACHED TO THIS REPORT**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                                                                                                   |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                                                                                                                                                                                        |
| 10.58               |       | Amendment Number 4 to Loan Documents dated April 14,  2009, by and among EMRISE Corporation, EMRISE Electronics Corporation, CXR  Larus Corporation, RO Associates Incorporated, Advanced Control Components, Inc.  and Custom Control Components, Inc. and GVEC Resource IV Inc. |
|                |       |                                                                                                                                                                                                                                                                              |
| 21                  |       | Subsidiaries of the Registrant                                                                                                                                                                                                                                                    |
|                |       |                                                                                                                                                                                                                                                                              |
| 23                  |       | Consent of Hein and Associates LLP, Independent  Registered Public Accounting Firm                                                                                                                                                                                                |
|                |       |                                                                                                                                                                                                                                                                              |
| 31.1                |       | Certification  of Principal Executive Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                |
|                |       |                                                                                                                                                                                                                                                                              |
| 31.2                |       | Certification  of Principal Financial Officer required by Rule 13a-14(a) of the  Securities Exchange Act of 1934, as amended, as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                |
|                |       |                                                                                                                                                                                                                                                                              |
| 32.1                |       | Certification  of Chief Executive Officer and Vice President Finance and Administration  Pursuant to 18 U.S.C. Section 350, as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002                                                                  |

 

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