UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549

FORM 10-K

|(Mark One) |                                                                                         
|---------- | ----------------------------------------------------------------------------------------
|ý          | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|           | For the fiscal year endedDecember 31, 2007.                                             
|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 as specified in its charter)

|Delaware(State or other jurisdiction of
incorporation or organization)                             |  | 77-0226211(I.R.S. Employer
Identification No.)
|-------------------------------------------------------------------------------------------------- |  | ----------------------------------------------
|9485 Haven Avenue, Suite 100,
Rancho Cucamonga, California(Address of principal executive offices) |  | 91730(Zip Code)                               
|Registrant's telephone number, including area code:(909) 987-9220                                 

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class

Name of Each Exchange on Which RegisteredCommon Stock, $0.0033 par value

NYSE Arca


Securities
registered pursuant to Section 12(g) of the Act: None(Title of class)

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

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o    No ý

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not
be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. ý

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

Large accelerated filer o

Accelerated filer oNon-accelerated filer o(do not check if a Smaller Reporting Company)

Smaller Reporting Company ý


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

The aggregate market value of the voting common equity held by nonaffiliates of the registrant, computed by reference to the $1.21 closing sale price of such
stock on June 29, 2007, the last business day of the registrant's most recently completed second fiscal quarter, was approximately $46,000,000. The registrant has no non-voting
common equity.

The
number of shares outstanding of the Registrant's common stock, $0.0033 par value, as of March 14, 2008 was 38,254,250.

DOCUMENTS INCORPORATED BY REFERENCE

Part III incorporates by reference certain information from the registrant's definitive proxy statement for the 2008 Annual Meeting of Stockholders to be
filed no later than April 29, 2008.



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EMRISE CORPORATION  ANNUAL REPORT ON  FORM 10-K  FOR THE YEAR ENDED DECEMBER 31, 2007

TABLE OF CONTENTS

|                                 |  |                                                                                                              |  | Page
|-------------------------------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|PART I                          
|Item 1.                          |  | Business.                                                                                                    |  | 1   
|Item 1A.                         |  | Risk Factors                                                                                                 |  | 9   
|Item 1B.                         |  | Unresolved Staff Comments                                                                                    |  | 16  
|Item 2.                          |  | Properties                                                                                                   |  | 17  
|Item 3.                          |  | Legal Proceedings                                                                                            |  | 17  
|Item 4.                          |  | Submission of Matters to a Vote of Security Holders                                                          |  | 17  
|PART II                         
|Item 5.                          |  | Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 19  
|Item 6.                          |  | Selected Financial Data                                                                                      |  | 19  
|Item 7.                          |  | Management's Discussion and Analysis of Financial Condition and Results of Operations                        |  | 20  
|Item 7A.                         |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 35  
|Item 8.                          |  | Financial Statements and Supplementary Data                                                                  |  | 36  
|Item 9.                          |  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure                         |  | 36  
|Item 9A.                         |  | Controls and Procedures                                                                                      |  | 37  
|Item 9A(T).                      |  | Controls and Procedures                                                                                      |  | 37  
|Item 9B.                         |  | Other Information                                                                                            |  | 41  
|PART III                        
|Item 10.                         |  | Directors, Executive Officers and Corporate Governance                                                       |  | 44  
|Item 11.                         |  | Executive Compensation                                                                                       |  | 44  
|Item 12.                         |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |  | 44  
|Item 13.                         |  | Certain Relationships and Related Transactions, and Director Independence                                    |  | 44  
|Item 14.                         |  | Principal Accounting Fees and Services                                                                       |  | 44  
|PART IV                         
|Item 15.                         |  | Exhibits, Financial Statement Schedules                                                                      |  | 45  
|Index to Financial Statements    |  | F-1                                                                                                         
|Signatures                       |  | 49                                                                                                          
|Exhibits Attached to This Report |  | 50                                                                                                          

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CAUTIONARY STATEMENT

All statements included or incorporated by reference in this Annual Report on Form 10-K, other than statements or
characterizations of historical fact, are forward-looking statements. Examples of forward-looking statements include, but are not limited to, statements concerning projected net sales, costs and
expenses and gross margins; our accounting estimates, assumptions and judgments; the demand for our products; the competitive nature of and anticipated growth in our industries; our ability to
identify and consummate acquisitions and integrate their operations successfully; and our prospective needs for additional capital. These forward-looking statements are based on our current
expectations, estimates, approximations and projections about our industries and business, management's beliefs, and certain assumptions made by us, all of which are subject to change. 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," similar expressions, and variations or negatives of these words. These statements are not guarantees of future performance and are subject to risks, uncertainties and
assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors,
some of which are listed under "Risk Factors" in Item 1A of this Report. These forward-looking statements speak only as of the date of this Report. We undertake no obligation to revise or
update publicly any forward-looking statement for any reason, except as otherwise required by law.

PART I

Item 1.    Business.

EMRISE Corporation (including our subsidiaries, referred to collectively in this Report as "EMRISE," the "Company," "we," "us" or "our") is a Delaware corporation
that was formed in 1989. Our principal executive offices are located at 9485 Haven Avenue, Suite 100, Rancho Cucamonga, California,
91730. Our internet website address iswww.emrise.com. We do not intend our website address to be an active link or to otherwise incorporate by
reference the contents of the website into this Report. The public may read and copy any materials that we file with the United States Securities and Exchange Commission ("SEC") at the SEC's Public
Reference Room at 100 F Street, NE, Washington, DC 20549, on official business days during the hours of 10:00 am to 3:00 pm, or electronically through the SEC website
(www.sec.gov). The public may obtain information on the operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. Within the Corporate Governance section of our website, we provide information concerning corporate governance, including our Board of Directors
committee charters, Codes of Conduct and other information.

Business and Industry Description

EMRISE designs, manufactures and markets proprietary electronic devices and communications equipment for aerospace, defense, industrial, and communications
applications. We have operations in the United States ("U.S."), England, France and Japan. We conduct our business through two operating segments: electronic devices and communications equipment. Our
subsidiaries within our electronic devices segment design, develop, manufacture and market electronic devices for defense, aerospace and industrial markets. Our subsidiaries within our communications
equipment segment design, develop, manufacture and market network access equipment, including network timing and synchronization products, for the communications industry.

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Electronic Devices

The electronic devices segment produces a range of power systems, radio frequency ("RF") and microwave devices and electromechanical switches. The following is a
description of the major product categories within the electronic devices segment:



The
electronic devices segment is "project" driven with the majority of revenues being derived from custom products with long life cycles and high barriers to entry. The majority of
manufacturing and testing is performed in-house or through sub-contract manufacturers. Our electronic devices are used in a wide range of military airborne, seaborne and
land-based systems, in-flight entertainment systems, including the latest next generation in-flight entertainment and communications ("IFE&C")
systemssuch as applications for mobile phone, e-mail and internet communications and real time, on-board satellite and broadcast TVwhich are being
retrofitted into existing commercial aircraft and are being installed in today's growing fleet of new commercial aircraft.

The
electronic devices industry is comprised predominantly of military and commercial aerospace applications. Large volume military programs, such as Eurofighter Typhoon, are high
revenue generating opportunities, but are few in number and extend over several years. Therefore, it is important for us to also focus on multiple, low volume projects. The IFE&C market is
experiencing significant growth, primarily driven by the rapid increase in airline fleets and the retrofitting of existing aircraft.

Communications Equipment

The communications equipment segment produces a range of network access products and network timing and synchronization products, for public and private
communications networks. The following is a description of the major product categories within the electronic devices segment:



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The
communications equipment segment is "end user product" based with a traditional cycle of internally funded development and marketing prior to selling via direct and indirect sales
channels. Manufacturing is primarily outsourced. Our communications equipment is used in a broad range of applications for military (defense and homeland security), utility companies and independent
and national telecommunications carriers.

The
communications equipment industry is extremely competitive, with the primary growth expected to be in Next Generation Network ("NGN") applications. The NGN merges the transmission of
data, voice, video and other media onto a single network. We believe that this will be the standard network infrastructure for the next 10 to 20 years. As competition to deliver content over
the NGN grows, so does the need for precise timing and synchronization. To be competitive in this market, service providers must focus on performance. We believe that quality of transmission will be a
significant competitive differentiator. Precise time synchronization is an essential component for the reliable transport and switching necessary to deliver smooth transmission of voice, video and
data, as well as a new generation of services and applications that will emerge. We are highly focused on this market. Our latest generation timing and synchronization products provide significant
cost, space saving and capacity advantages, particular for Edge Network applications, as well as providing the platform with which to address central office requirements.

Business Strategy

We pursue a product and geographic diversification strategy, balancing the risks of each of our business groups. We accomplish this by identifying markets where
we have specific expertise. The strategy is to increase revenue and earnings, while continuing to focus on reinforcing core business and operating as
international business units to maximize the return on our worldwide presence. In order to do so, EMRISE is implementing a three-point strategy for growth:.



Our
business strategy is to promptly react to changes in the marketplace and we believe that the potential of our newest data, voice and video products places us in this strategic
position. Additionally, we are focusing our product offerings within high growth markets such as IFE&C, Edge Network communications timing and synchronization and other network access applications. We
have built a worldwide base of customers, including many of the Fortune 100 companies in North America and many similar companies in Europe and Asia, which conduct business in markets served by
EMRISE.

We
expect to significantly increase our sales in the IFE&C market over the next five years. This increase is expected to be driven, in large part, by what we believe to be a rapid
increase in aircraft fleets and by an increase in the number of aircraft to be retrofitted with newer IFE&C systems. Virgin America and Delta, among others, now offer customers a wide range of
in-flight entertainment features

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including
movies, live satellite television, games, maps and a large selection of music through an interactive entertainment system at each seatback on the majority of domestic U.S. flights. Other
U.S. carriers are also testing and installing IFE&C systems. Further, in nearly all cases, domestic and international carriers have announced plans to upgrade their fleets with some form of new IFE&C
systems, especially for long-haul domestic and/or international routes.

We
also believe that the market for Edge Network timing and synchronization products will increase rapidly over the next five years. This growth trend is being driven, in part, by the
need to provide greater network security and redundancy in public and private communications networks, the increasing penetration of major cable companies into the local and long distance services
market and by the proliferation of mobile phone video traffic requiring more accurate timing.

In
addition to our primary focus on the IFE&C and Edge Network markets, we plan to continue to expand our military and defense business, which has formed a large and stable platform for
our electronic devices business. In addition, we plan to continue to seek out opportunities for synergistic and accretive acquisitions, particularly for this segment.

Customers

We sell our commercial and military electronic devices primarily to OEMs, including manufacturers of aerospace and defense systems and industrial instruments.
During 2007, our top five electronics devices customers in terms of revenues were Panasonic, Rockwell Collins, Inc., Selex Airborne Systems, Thales, and BAE Systems. We sell our communications
equipment to public, private and corporate telecommunications service providers and end users, including telephone companies, internet service providers, cable service providers and numerous other
communications service providers. During 2007, our top five communications equipment customers, in terms of revenues, were Power & Telephone, Harris Corporation, Graybar, Motorola and
Cherry & White.

We
have a well diversified customer base for both our electronic device products and our communications equipment products. During 2007 and 2006, no customer accounted for 10% or more of
our total net sales during those periods.

Sales, Marketing and Customer Support

We market and sell our products through our operating subsidiaries within both of our operating segments. Our sales force consists primarily of engineers and
technical professionals. Our sales professionals in each country within which we operate are highly knowledgeable about their respective markets, customer operations and strategies and regulatory
environments. We provide extensive training and ongoing professional development and education, which we believe significantly enhances the ability for our sales and marketing staff to build
long-standing customer relationships as they are more consultant in nature and can communicate back to us valuable input on systems and features our customers desire in future products.

Our
electronic devices products are sold through a combination of direct sales and third-party distributors. We sell our electronic devices primarily to original equipment manufacturers
("OEM") and system integrators in the military and commercial aerospace, industrial electronics industries. We typically have long-term relationships with our customers within our
electronic devices segment and projects and programs often span multiple years, with military programs sometimes in excess of 10 years. We obtain revenues through long-term orders
and repeat business from our existing customers, marketing of subsystem assemblies that incorporate our own and third party products to our existing customers, and by entering new product markets,
such as the IFE&C market and new geographic markets. Through our Japanese subsidiary, we are able to market our digital and rotary switches into the Japanese market and other highly industrialized
Asian countries.

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Military
and defense customers generally require our products to be formally qualified for their application. The total system will then typically undergo flight qualification or
equivalent. A further development or prototyping phase may follow to meet additional requirements. This can lead to lengthy approval cycles and very long prototype phases, sometimes of several years
prior to the unit entering production. As a result of these long approval cycles, the overall program is subject to external political and economic constraints over which we have little control and
which makes sales forecasting difficult. After a customer has approved our product for purchase, there are considerable barriers to entry due to the need to re-qualify the application for
any new prospective supplier. Therefore, once qualified, our products typically enjoy a long production life.

Our
communications equipment products are sold primarily through a combination of our local in-house sales force and third-party distributors. We sell our communications
devices primarily to large communication service providers as well as resellers and value added resellers and, in Europe, to military customers. Communications service providers generally commit
significant resources to an evaluation of our and our competitors' products and require each vendor to expend substantial time, effort and money educating them about the value of the vendor's
solutions and, in many cases, to qualify products for their networks. Consequently, sales to this type of customer generally require an extensive sales effort throughout the prospective customer's
organization and final approval by an executive officer or other senior level employee. The result is lengthy sales and approval cycles, which make sales forecasting difficult. In addition, even after
a customer has approved our product for purchase, future purchases are uncertain because while we generally enter into long-term supply agreements with our customers, these agreements do
not require specific levels of purchases.

Delays
associated with potential customers' internal approval and contracting procedures, procurement practices, testing and acceptance processes are common and may cause potential sales
of our communications products to be delayed or foregone. As a result of these and related factors, the sales cycle of new products for large customers typically ranges from six to twelve months or
more. In addition, we have some distribution channels that generally are box stocking distributors with significant independent sales forces selling our products to final customers, integrators and
other resellers on a regional and nationwide basis. We perform product applications training for our distributor and reseller
workforce and funnel many of the leads we generate to the distribution channels for their follow-up and closure.

Competition

We believe that our competitive advantage is founded on the application of leading edge technology and quality of our products, our ability to quickly address and
adapt to individual customer requirements, the strength of our distribution channels, and our compliance with government and industry standards. The electronic devices market is highly fragmented and
composed of a diverse group of OEMs. Nonetheless, we believe that our significant experience in the industry and the customized nature of our products have acted as barriers to entry for other
potential competitors and have assisted us in establishing ourselves as a sole source supplier on existing production programs for many of the digital and rotary switches that we sell. Our RF devices
and power supplies enjoy a similar position in the military and defense markets with high barriers to entry after the product has been qualified. Competition for development programs includes
multinational and local engineering and manufacturing companies including customer in-house facilities. Competitors in this segment include Esterline/Janco, AML, Vicor and
Interpoint/Grenson, among others. Our RF devices and power supplies are similarly positioned in the IFE&C markets. Competitors in this market include Panasonic, Thales and a number of smaller niche
specialists.

The
communications equipment market is intensely competitive and subject to rapid technological change, evolving industry standards and regulatory developments. Our principal competitors
within this segment include Symmetricom, Frequency Electronics and Oscilloquartz for timing and synchronization

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products
and RAD, Zhone/Paradyne and Patton Electronics Corporation, among others, for other network access products. The design of many of our network access products enables us to offer numerous
product combinations to our customers and to serve both central site data communications needs and remote access sites on both the enterprise-wide and single location level. We believe
that this design flexibility helps us to excel at many of the above competitive factors by enabling us to offer quality products that meet and are adaptable to evolving customer requirements,
technologies and government and industry standards.

Most
of our competitors have greater sales, marketing, technological, research and financial resources than we do. Our competitors' advantage with regard to these resources may reduce
our ability to obtain or maintain market share for our products in cases where our competitors are better able than we are to satisfy the above competitive factors.

Backlog

At December 31, 2007, our backlog of firm, unshipped orders was approximately $25.3 million. This backlog was related approximately 94% to our
electronic devices business, which tends to provide us with long lead-times for our manufacturing processes due to the custom nature of the products, and approximately 6% to our
communications equipment business, the majority of which portion relates to our network access and communications timing and synchronization and test equipment products. Of these backlog orders, we
anticipate fulfilling approximately 75% of our electronic devices orders and 100% of our communications equipment orders in 2008. However, we cannot provide assurance that we will be successful in
fulfilling these orders in a timely manner or that we will ultimately recognize as revenue the amounts reflected as backlog.

Warranties

Generally, our products carry a standard one-year, limited parts and labor warranty. In certain circumstances, we provide a two-year
limited parts and labor warranty on our network access products. We offer extended warranties beyond two years for an additional cost to our customers. Products returned under warranty typically are
tested and repaired or replaced at our option. Historically, we have not experienced significant warranty costs or returns. However, we cannot provide assurance that this will continue to be the case
or that disputes over devices or other materials or workmanship will not arise in the future.

Product Development and Engineering

Our product development and engineering activities during 2007 and 2006 primarily related to new product development for communication network access and timing
and synchronization products, our new rotary switch product line, and RF and power conversion devices, including our IFE&C product line. We expended $2.3 million in 2007 and $3.1 million
in 2006 in conducting our product development and engineering activities. The investments we are making in product development and engineering are designed to increase our range of product offerings
to our customers, keep up with the technological and regulatory changes in our industry and anticipate and satisfy our customers' preferences and requirements. We continually review and evaluate
technological and regulatory changes that will affect our products and seek to offer products and capabilities that solve our customers' operational challenges and improve their efficiency.

Manufacturing, Assembly and Quality Assurance

Our network access products, communication timing and synchronization products and communications test instruments generally are assembled from outsourced
subassemblies, with final assembly, configuration and quality testing performed in house. We believe that outsourcing lowers our

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manufacturing
costs, in particular our components and labor costs, provides us with more flexibility to scale our operations to meet changing demand, and allows us to focus our engineering resources
on new product development and product enhancements.

We
manufacture our electronic devices through a combination of in-house and external processes depending on the product, application and volume. We maintain broad mechanical
and electronic assembly capabilities such as injection molding, fabrication, machining and surface mount technology, which are utilized to maintain our flexibility to produce small volume batch
products and prototypes. Many of the remaining portions of manufacturing, including assembly of our more standardized power supplies is outsourced. Although many of our electronic devices incorporate
standard designs and specifications, products are nevertheless built to customer order. This approach, which avoids the need to maintain a large finished goods inventory, is possible because of the
custom nature of the products. Our electronic devices segment produces products in one-piece to several hundred-piece batches, with a typical lead time between 6 and 30 weeks. The
lead-time is predominantly to source sub-component piece parts such as electronic components, mechanical components and services. Typical build time is six to eight weeks from
receipt of external components, but can, at times, extend to 26 weeks or more.

We
operate seven manufacturing and assembly facilities worldwide. All of these operations, except the operations of our subsidiary, RO Associates ("RO"), are certified as ISO 9001
or 9002 compliant. Our RO operations maintain a formally documented quality system.

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

Intellectual Property

We regard our software, hardware and manufacturing processes as proprietary and rely on a combination of patent, copyright and trademark laws, trade secrets,
confidentiality procedures and contractual provisions to protect our proprietary rights. We have secured a U.S. and foreign patent for a low profile rotary switch product and we have filed patent
applications, and intend to file additional patent applications in the future, for various other products with the U.S. Patent and Trademark Office and in the European Union, Japan, Canada and Brazil.
We seek to protect our software, documentation and other written materials under trade secret and copyright laws, which afford some limited protection. The laws of some foreign countries do not
protect our proprietary rights to the same extent as do the laws of the U.S. Our research and development and manufacturing process typically involves the use and development of a variety of forms of
intellectual property and proprietary technology. In addition, we incorporate technology and software that we license from third party sources into our products. These licenses generally involve a
one-time fee and no time limit, but in some cases may involve ongoing licensing fees or royalties based on future sales. We believe that alternative technologies for this licensed
technology are available both domestically and internationally and we intend to expand these licensing opportunities in the future. In addition, we believe that some opportunities may exist to license
our own technology or products to other parties in the future. We intend to pursue these opportunities to the extent they benefit us.

We
may receive in the future notices from holders of patents that raise issues as to possible infringement by our products. Questions of infringement and the validity of patents in the
fields of communications and information technology involve highly technical and subjective analyses. These kinds of proceedings are time consuming and expensive to defend or resolve, result in
substantial

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diversion
of management resources, cause product shipment delays or could force us to enter into royalty or license agreements rather than dispute the merits of the proceeding initiated against us. At
this time, we are not aware of any infringement notices.

Government Regulation and Industry Standards and Protocols

We design our products to comply with a significant number of industry standards and regulations, some of which are evolving as new technologies are deployed. In
the U.S., our products must comply with various regulations defined by the U.S. Federal Communications Commission, or FCC, and Underwriters Laboratories as well as industry standards such as the
Network Electronic Build Standards, or NEBS, established by Telcordia Technologies, Inc., formerly Bellcore, and those developed by the American National Standards Institute. Internationally,
our products must comply with standards established by the European Committee for Electrotechnical Standardization, the European Committee for Standardization, the European Telecommunications
Standards Institute and telecommunications authorities in various countries, as well as with recommendations of the International Telecommunications Union. The failure of our products to comply, or
delays in compliance, with the
various existing and evolving standards could negatively affect our ability to sell our products. Our products for the military markets are typically type tested and require the production of a first
article and other prototypes, which are subject to testing to meet specific customer and government regulations governing operating environment, performance and operational capability.

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

Seasonality

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

Employees

As of March 14, 2008, we employed approximately 300 persons in our various divisions and subsidiaries. None of our employees are represented by labor
unions, and there have not been any work stoppages at any of our facilities. We believe that our relationship with our employees is good.

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Item 1A.    Risk Factors.

The following summarizes material risks that investors should carefully consider before deciding to buy or maintain an investment in our
common stock. Any of the following risks, if they actually occur, would likely harm our business, financial condition and results of operations. As a result, the trading price of our common stock
could decline, and investors could lose the money they paid to buy our common stock.

Risks Related to Our Business

We incurred a net loss in 2007 and 2006 and may incur losses in the future. If we continue to incur losses, we will experience negative cash flow, which may hamper our
operations, may prevent us from expanding our business and may cause our stock price to decline.

We incurred a $1.9 million net loss for 2007 and a $3.6 million net loss for 2006. We expect to rely on cash on hand, cash generated from our
operations and existing and future financing activities to fund the cash requirements of our business. If our net losses continue, we will experience negative cash flow, which may hamper current
operations and may prevent us from expanding our business. We may be unable to attain, sustain or increase profitability on a quarterly or annual basis in the future. If we do not achieve, sustain or
increase profitability, our stock price may decline.

Our lack of long-term purchase orders or commitments may adversely affect our business if demand is reduced.

During 2007, the sale of electronic devices accounted for approximately 71% of our total net sales, and the sale of communications equipment and related services
accounted for approximately 29% of our total net sales. In some cases we have long-term contracts with our electronic devices and communications equipment customers that cover the general
terms and conditions of our relationships with them but that do not include long-term purchase orders or commitments. Rather, our customers issue purchase orders requesting the quantities
of products they desire to purchase from us, and if we are able and willing to fill those orders, then we fill them under the terms of the contracts. Accordingly, we cannot rely on
long-term purchase orders or commitments to protect us from the negative financial effects of reduced demand for our products that could result from a general economic downturn, from
changes in the electronic devices and communications equipment industries, including the entry of new competitors into these markets, from the introduction by others of new or improved technology,
from an unanticipated shift in the needs of our customers, or from other causes.

We have material weaknesses in our internal control over financial reporting structure which until remedied, may cause errors in our financial statements that could require a
restatement or our filings may not be timely and investors may lose confidence in our reported financial information, which could lead to a decline in our stock price.

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

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

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We
have identified the following three material weaknesses in our internal control over financial reporting: (i) we did not effectively implement comprehensive entity-level
internal controls, (ii) we did
not maintain effective controls over changes to critical financial reporting applications and over access to these applications and related data, and (iii) we did not maintain a sufficient
level of information technology personnel to execute general computing controls over our information technology structure. See "Controls and Procedures."

Our
management, including our Chief Executive Officer and Vice President Finance and Administration, does not expect that our internal control over financial reporting will prevent all
error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the
design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Controls can be circumvented by the
individual acts of some persons, by collusion of two or more people, or by management override of the controls. Over time, controls may become inadequate because changes in conditions or deterioration
in the degree of compliance with policies or procedures may occur. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and
not be detected.

As
a result, we cannot assure you that significant deficiencies or material weaknesses in our internal control over financial reporting will not be identified in the future. Any failure
to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in significant deficiencies or material weaknesses, cause us to fail
to timely meet our periodic reporting obligations, or result in material misstatements in our financial statements. Any such failure could also adversely affect the results of periodic management
evaluations regarding disclosure controls and the effectiveness of our internal control over financial reporting required under Section 404 of the Sarbanes-Oxley Act of 2002 and the rules
promulgated thereunder. The existence of a material weakness could result in errors in our financial statements that could result in a restatement of financial statements, cause us to fail to timely
meet our reporting obligations and cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.

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

Our quarterly operating results have varied significantly in the past and will likely continue to do so in the future due to a variety of factors, many of which
are not within our control. Our operating results from our communications equipment segment tend to be less stable and predictable than our operating results from our electronic devices segment.

The
cyclical nature of the communications equipment business due to the budgetary cycle of telephone companies 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 budgets during the first quarter of each calendar year. If a telephone company's annual budget
is not approved early in the calendar year or is insufficient to cover its desired purchases for the entire calendar year, we are unable to sell products to the telephone company during the period of
the delay or shortfall. In
addition, these budgets historically tend to vary significantly year by year depending on a variety of factors, including overall economic conditions. A significant reduction in any one customer's or
group of customer's budgets could severely reduce our overall sales, profits and cash flows in the future.

Our
electronic devices sales are often made in conjunction with military contracts. The timing of required deliveries under these contracts can be delayed based on issues related to the
overall military contract, which can cause delays in our shipment schedules, revenue recognition, profits and cash flows.

Quarter-to-quarter
fluctuations may also result from the uneven pace of technological innovation, the development of products responding to these technological
innovations by us and our competitors,

10

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our
customers' acceptance of these products and innovations, the varied degree of price, product and technological competition and our customers' and competitors' responses to these changes.

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

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

Sales of some of our products depend upon potential customers' internal approval and contracting procedures, procurement practices, and testing and acceptance
processes, all of which involve require a significant amount of time. As a result of these and related factors, the sales cycle of many of our products, especially for large customers, typically
ranges from six to twelve months or more. Lengthy sales cycles subject us to risks of delays, foregone orders and fluctuations in operating results.

Most of our competitors have greater resources than us. In order to compete successfully, we must keep pace with our competitors in anticipating and responding to the rapid
changes involving the electronic devices and communications equipment industries.

Our future success depends, in part, upon our ability to enhance our current products and services and to develop and introduce new products and services that
keep pace with technological developments,
respond to the growth in the electronic devices and communications equipment markets in which we compete, encompass evolving customer requirements, and to provide a broad range of products and achieve
market acceptance of our products. Most of our existing and potential competitors have larger technical staffs, more established and larger marketing and sales organizations and significantly greater
financial resources than we do. Our lack of resources relative to our competitors may cause us to fail to anticipate or respond adequately to technological developments and customer requirements or to
experience significant delays in developing or introducing new products and services. These failures or delays could reduce our competitiveness, revenues, profit margins or market share, cash flow and
stock price.

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

Our success is highly dependent upon the continued services of key members of our management, including Carmine T. Oliva, our Chairman of the Board, President,
and Chief Executive Officer, Graham Jefferies, our Executive Vice President and Chief Operating Officer and John Donovan, our Vice President Finance and Administration. Mr. Oliva
co-founded EMRISE Electronics and has developed personal contacts and other skills that we rely upon in connection with our financing, acquisition and general business strategies.
Mr. Jefferies is a long-time employee of EMRISE who we have relied upon in connection with our acquisitions in England and who fulfills significant operational responsibilities in
connection with our foreign and domestic operations. Mr. Donovan was hired during 2007 to provide us with his extensive experience in financial reporting and compliance. The loss of
Mr. Oliva, Mr. Jefferies or Mr. Donovan, or one or more other key members of management could adversely affect us. Although we have entered into employment agreements with each of
our executive officers, those agreements do not guarantee continued employment of these individuals. We maintain key-man life insurance on Mr. Oliva and Mr. Jefferies.
However, we cannot provide any assurance that we will be able to maintain this insurance in effect or that the coverage will be sufficient to compensate us for the loss of the services of
Mr. Oliva or Mr. Jefferies.

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

A key element of our business strategy involves expansion through the acquisitions of businesses, assets, products or technologies that allow us to complement our
existing product offerings or expand our market coverage. We continually evaluate and explore strategic opportunities as they arise, including business combination transactions, strategic
partnerships, and the purchase or sale of assets.

Acquisitions
may require significant capital infusions, typically entail many risks, and could result in difficulties in assimilating and integrating the operations, personnel,
technologies, products and information systems of acquired companies or businesses. We have in the past and may in the future experience delays in the timing and successful integration of an acquired
company's technologies and product development through volume production, unanticipated costs and expenditures, changing relationships with customers, suppliers and strategic partners, or contractual,
intellectual property or employment issues. In addition, key personnel of an acquired company may decide not to work for us. These challenges could disrupt our ongoing business, distract our
management and employees, harm our reputation and increase our expenses. These challenges are magnified as the size of the acquisition increases. Furthermore, these challenges would be even greater if
we acquired a business or entered into a business combination transaction with a company that was larger and more difficult to integrate than the companies we have historically acquired.

Acquisitions
may require large one-time charges and can result in increased debt or contingent liabilities, adverse tax consequences, additional stock-based compensation
expense, and the recording and later amortization of amounts related to certain purchased intangible assets, any of which items could negatively impact our results of operations. In addition, we may
record goodwill in connection with an acquisition and incur goodwill impairment charges in the future. Any of these charges could cause the price of our common stock to decline.

Acquisitions
or asset purchases made entirely or partially for cash may reduce our cash reserves or require us borrow additional amounts under our credit facility. Depending on the
circumstances, we may seek to 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 our existing
shareholders. In addition, the equity or debt securities that we may issue could have rights, preferences or privileges senior to those of our common stock.

We
cannot assure you that we will be able to consummate any pending or future acquisitions or that we will realize any anticipated benefits from these acquisitions. We may not be able to
find suitable acquisition opportunities that are available at attractive valuations, if at all. Even if we do find suitable acquisition opportunities, we may not be able to consummate the acquisitions
on commercially acceptable terms, and any decline in the price of our common stock may make it significantly more difficult and expensive to initiate or consummate additional acquisitions.

As our international business expands, we are increasingly exposed to various legal, business, political and economic risks associated with our international operations.

International sales accounted for 56.7% and 50.2% of our net sales in 2007 and 2006, respectively. We undertake various sales and marketing activities through our
facilities in England, France and Japan. We intend to continue to expand our international business activities. The continuing effects of the war in Iraq and terrorist attacks in the U.S. and abroad,
the resulting heightened security, and the increasing risk of extended international military conflicts may adversely impact our international sales

12

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and
could make our international operations more expensive. International operations are subject to many other inherent risks, including but not limited to:



Any
of the factors described above may have a material adverse effect on our ability to increase or maintain our foreign sales.

If we are unable to fulfill backlog orders due to circumstances involving us or one or more of our suppliers or customers, our anticipated results of operations will suffer.

As of December 31, 2007, we had $25.3 million in backlog orders for our products. Backlog orders represent revenue that we anticipate recognizing in
the future, as evidenced by purchase orders and other purchase commitments received from customers, but on which work has not yet been initiated or with respect to which work is currently in progress.
Our backlog orders are due, in large part, to the long lead-times associated with our electronic device products, which products generally are custom built to order. We cannot provide
assurance that we will be successful in fulfilling orders and commitments in a timely manner or that we will ultimately recognize as revenue the amounts reflected as backlog. Factors that could affect
our ability to fulfill backlog orders include difficulty we may experience in obtaining raw materials or sub-assemblies from suppliers, whether due to obsolescence, production difficulties
on the part of suppliers or other causes, or customer-induced delays and product holds. Our anticipated results of operations and cash flows will suffer to the extent we are unable to fulfill backlog
orders within the timeframes we establish, particularly if delays in fulfilling backlog orders cause our customers to reduce or cancel their orders.

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

We design our products to comply with a significant number of industry standards and regulations, some of which are evolving as new technologies are deployed. Our
products must comply with various

13

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regulations
defined by the FCC and Underwriters Laboratories, the American National Standards Institute, among others as well as industry standards such as those established by Telcordia
Technologies, Inc. (communications), Federal Aviation Authority (aerospace) and Boeing. Internationally, our products must comply with standards established by the European Committee for
Electrotechnical Standardization, the European Committee for Standardization, the European Telecommunications Standards Institute, and telecommunications authorities in various countries as well as
with recommendations of the International Telecommunications Union, Airbus and various Civil Aviation Authorities, among others. The failure of our products to comply, or delays in compliance, with
the various existing and evolving standards could negatively affect our ability to manufacture and/or sell our products in the future.

Our business could suffer if we are unable to obtain components of our products from outside suppliers.

The major components of our products include circuit boards, microprocessors, chipsets and memory components. Most of these components are available from multiple
sources. However, we currently obtain some components used in our products from single or limited sources. Some modem chipsets used in our data communications equipment products have been in short
supply and are frequently on allocation by semiconductor manufacturers and some military components are specified to extreme and harsh environment and special packaging. We have, from time to time,
experienced difficulty in obtaining some components. We do not have guaranteed supply arrangements with any of our suppliers, and there can be no assurance that our suppliers will continue to meet our
requirements. Further, disruption in transportation services as a result of threatened or actual terrorist attacks, weather related delays, labor issues or other causes could result in increased costs
and/or delays in both our receipt of components and shipment of products to our customers. If our existing suppliers are unable to meet our requirements, we could be required to alter product designs
to use alternative components or, if alterations are not feasible, we could be required to eliminate products from our product line.

Shortages
of components could not only limit our product line and production capacity but also could result in higher costs due to the higher costs of components in short supply or the
need to use higher cost substitute components. Significant increases in the prices of components could adversely affect our results of operations because our products compete on price and, therefore,
we may not be able to adjust product pricing to reflect the increases in component costs. Also, an extended interruption in the supply of components or a reduction in their quality or reliability
would adversely affect our financial condition, results of operations and cash flows by impairing our ability to timely deliver quality products to our customers. Delays in deliveries due to shortages
of components or other factors may result in cancellation by our customers of all or part of their orders.

Financial statements of our foreign subsidiaries are prepared using the relevant foreign currency that must be converted into U.S. dollars for inclusion in our consolidated
financial statements. As a result, exchange rate fluctuations may adversely affect our reported results of operations.

We have established and acquired international subsidiaries in England, France and Japan that prepare their balance sheets in the relevant local foreign currency.
In order to be included in our consolidated financial statements, these balance sheets are converted, at the then current exchange rate, into U.S. dollars, and the statements of operations are
converted using weighted average exchange rates for the applicable period. Accordingly, fluctuations of the foreign currencies relative to the U.S. dollar could affect our consolidated financial
statements. Our exposure to fluctuations in currency exchange rates has increased as a result of the growth of our international subsidiaries. Sales of our products and services to customers located
outside of the U.S. accounted for approximately 56.7% and 50.2% of our net sales for 2007 and 2006, respectively. We use derivatives to manage foreign currency rate risk for

14

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certain
sales shipped from England. Our ultimate realized gain or loss with respect to currency fluctuations will depend on the currency exchange rates and other factors in effect as the contracts
mature. Net foreign exchange translation gains and losses included in other income and expense in our consolidated statements of operations resulted in an $83,000 gain for 2007 and a $343,000 loss for
2006.

Because we believe that proprietary rights are material to our success, misappropriation of these rights could adversely affect our financial condition.

Our future success will be highly dependent on proprietary technology, particularly in our communications equipment business. However, we do not hold any patents
and we currently rely on a combination of contractual rights, copyrights, trademarks and trade secrets to protect our proprietary rights in this area. Our management believes that because of the rapid
pace of technological change in the industries in which we operate, the legal intellectual property protection for our products is a less significant factor in our success than the knowledge,
abilities and experience of our employees, the frequency of our product enhancements, the effectiveness of our marketing activities and the timeliness and quality of our support services.
Consequently, we rely to a great extent on trade secret protection for much of our technology. However, there can be no assurance that our means of protecting our proprietary rights will be adequate
or that our competitors or customers will not independently develop comparable or superior technologies or obtain unauthorized access to our proprietary technology. Our financial condition would be
adversely affected if we were to lose our competitive position due to our inability to adequately protect our proprietary rights as our technology evolves.

Risks Related to Our Common Stock

Our common stock may be delisted from NYSE Arca, which could decrease the market price of our common stock and make it more difficult to dispose of or obtain quotations for our
common stock.

On November 13, 2007, NYSE Arca Equities, Inc. advised us that our common stock had failed to maintain the required minimum price of $1.00 per share
as required by NYSE Arca Equities Rule 5.5(h)(4). On December 21, 2007, NYSE Arca Equities, Inc. advised us that they had approved a six-month cure period commencing
on November 13, 2007. By the end of this six-month cure period on May 13, 2008, we must have achieved a minimum $1.00 share price and a $1.00 average share price over the 30
trading days immediately preceding May 13, 2008 in order to maintain our listing. If we fail to achieve these minimum requirements, our common stock will be delisted from trading by the NYSE
Arca. If delisting occurs, shares of our common stock will trade on the OTC Bulletin Board and, as a result, trading in shares of our common stock could decrease substantially, the market price of our
common stock could decline further, and our shareholders could lose some or all of their investment.

Our common stock price has been volatile, which could result in substantial losses for investors purchasing shares of our common stock and in litigation against us.

The market prices of securities of technology-based companies have been and will likely continue to be highly volatile. The market price of our common stock has
fluctuated significantly in the past. During 2007, the high and low closing sale prices of a share of our common stock were $1.31 and $0.61, respectively. Between January 1, 2007 and
March 14, 2008, the high and low closing sale prices of a share of our common stock were $1.31 and $0.49, respectively. The market price of our common stock may continue to fluctuate in
response to the following factors, many of which are beyond our control:



15

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The
price at which you purchase shares of common stock may not be indicative of the price of our stock that will prevail in the trading market. You may 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 been brought against a company
following periods of volatility in the market price of its securities. We may in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert
management's attention and resources and could have a significant impact on profitability, future cash flows and stock price.

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

We cannot predict the effect, if any, that market sales of shares of our common stock or the availability of shares of common stock for sale will have on the
market price prevailing from time to time. As of March 14, 2008, we had outstanding 38.3 million shares of common stock and options and warrants to purchase an aggregate of
8.7 million shares of common stock. A substantial number of these shares are eligible for public resale. Sales of shares of our common stock in the public market, or the perception that those
sales may occur, could cause the trading price of our common stock to decrease or to be lower than it might be in the absence of those sales or perceptions.

Item 1B.    Unresolved Staff Comments.

None.

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Item 2.    Properties.

As of March 14, 2008, we leased or owned approximately 173,000 square feet of administrative, engineering, production, storage and shipping space. All of
this space was leased from third parties other than our facility located in Abondant, France, which is owned by us. The following table represents the Company's leased properties as of
December 31, 2007:

|Business Unit                                        |  | Location                     |  | Segment                                         |  | Use                                                    |  | Approximate
Size
|---------------------------------------------------- |  | ---------------------------- |  | ----------------------------------------------- |  | ------------------------------------------------------ |  | ----------------
|EMRISE Corporation                                   |  | Rancho Cucamonga,
CA, U.S.   |  | corporate headquarters                          |  | Administration                                         |  | 5,400 sq. feet  
|EMRISE Electronics Corporation                       |  | Rancho Cucamonga,
CA, U.S.   |  | electronic devices                              |  | Administration, Engineering and Manufacturing          |  | 15,745 sq. 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 
|XCEL Japan, Ltd.                                     |  | Tokyo, Japan                 |  | electronic devices                              |  | Sales                                                  |  | 1,433 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                                         |  | 743 sq. feet    

We believe that these facilities are suitable for the purposes for which we use them. We believe that we have sufficient facilities to conduct and
grow our operations during 2008. However, we will continue to evaluate the purchase or lease of additional properties, as our business requires.

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.

On December 12, 2007, we held our 2007 Annual Stockholder's Meeting. The total number of outstanding votable shares was 38,254,250. Our stockholders were
asked to consider and vote upon the following three proposals:



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Results
of the vote were as follows:

Proposal

For

Against

Withheld(1)

31,129,466



502,781(2)

11,558,728

4,753,606

303,702(3)

31,328,050

79,744

224,453


As
a result, Mr. Finnegan was re-elected to serve as a Class II member of our board of directors. Carmine T. Oliva, Otis W. Baskin, and Richard E. Mahmarian
continued to serve on our board of directors following the meeting. Additionally, the adoption of the EMRISE Corporation 2007 Stock Incentive Plan was ratified and the selection of our independent
registered public accounting firm to audit our consolidated financial statements for 2007 was ratified.

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PART II

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Price and Holders

Our common stock has traded on NYSE Arca since March 8, 2006, under the symbol "ERI." For the period from August 10, 2005 through March 7,
2006, our common stock traded on the Archipelago Exchange(SM) (ArcaEx®), a facility of the Pacific Exchange®, under the symbol "ERI." The table below shows, for each fiscal
quarter indicated, the high and low closing prices on NYSE Arca and the Pacific Exchange, as the case may be, for shares of our common stock. The prices shown reflect inter-dealer prices, without
retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.

High

LowYear ended December 31, 2007First

$
1.31

$
1.06Second

$
1.25

$
1.08Third

$
1.23

$
0.83Fourth

$
0.92

$
0.61Year ended December 31, 2006First

$
1.55

$
0.94Second

$
1.14

$
0.74Third

$
1.15

$
0.66Fourth

$
1.10

$
0.89


As
of March 14, 2008, we had outstanding 38,254,250 shares of common stock outstanding held of record by approximately 3,000 stockholders. These holders of record include
depositories that hold shares of stock for brokerage firms which, in turn, hold shares of stock for numerous beneficial owners. On March 14, 2008, the closing sale price of our common stock on
NYSE Arca was $0.80 per share.

Dividend Policy

We have not declared or paid any cash dividends on our capital stock in the past, and we do not anticipate declaring or paying cash dividends on our common stock
in the foreseeable future. We will
pay dividends on our common stock only if and when declared by our board of directors. Our board of directors' ability to declare a dividend is subject to restrictions imposed by Delaware law. In
determining whether to declare dividends, the board of directors will consider these restrictions as well as our financial condition, results of operations, working capital requirements, future
prospects and other factors it considers relevant.

Recent Sales of Unregistered Securities

On November 30, 2007, we issued a warrant to purchase 2,909,090 shares of our common stock to Private Equity Management Group, Inc., an affiliate of
our primary lender, in connection with our entry into a new credit facility. The warrant has an exercise price of $1.10 per share and will expire 7 years after the date of issuance.

Exemption
from the registration provisions of the Securities Act for the transaction described above is claimed under Section 4(2) of the Securities Act, among others, on the
basis that such transaction did not involve any public offering and the purchaser was accredited or sophisticated with access to the kind of information registration would provide. Appropriate
investment representations were obtained, a warrant certificate was issued with restricted stock legends, and/or stop transfer orders were placed with our transfer agent.

Item 6.    Selected Financial Data.

Not applicable.

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

The following discussion should be read in conjunction with our consolidated financial statements and the related notes and the other financial information
included elsewhere in this report. This report and the following discussion contain forward-looking statements, which generally include the plans and objectives of management for future operations,
including plans and objectives relating to our future economic performance and our current beliefs regarding revenues we might generate and profits we might earn if we are successful in implementing
our business and growth strategies. The forward-looking statements and associated risks may include, relate to or be qualified by other important factors, including, without limitation:



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

Any
of the factors described above or 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 differ
materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially.

Business Description

EMRISE designs, manufactures and markets proprietary electronic devices and communications equipment for aerospace, defense, industrial, and communications
applications. We have operations in the U.S., England, France and Japan. We conduct our business through two operating segments: electronic devices and communications equipment. Our subsidiaries
within our electronic devices segment design, develop, manufacture and market electronic devices for defense, aerospace and industrial markets. Our subsidiaries within our communications equipment
segment design, develop, manufacture and market network access equipment, including network timing and synchronization products, for the communications industry.

Our
electronic devices segment produces a range of power systems, RF and microwave devices and electromechanical switches. The electronic devices segment is "project" driven with the
majority of

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revenues
being derived from custom products with long life cycles and high barriers to entry. The majority of manufacturing and testing is performed in-house or through
sub-contract manufacturers. Our electronic devices are used in a wide range of military airborne, seaborne and land-based systems, in-flight entertainment systems,
including the latest next generation IFE&C systemssuch as applications for mobile phone, e-mail and internet communications and real time, on-board satellite and
broadcast televisionwhich are being retrofitted in existing commercial aircraft and installed in today's growing fleet of new commercial aircraft.

Our
communications equipment segment produces a range of network access products, including network timing and synchronization products, for public and private communications companies.
The communications equipment segment is "end user product" based with a traditional cycle of internally funded development and marketing prior to selling via direct and indirect sales channels.
Manufacturing is primarily outsourced. Our communications equipment is used in a broad range of applications for military (defense and homeland security), utility companies and independent and
national telecommunications carriers.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the U.S. The preparation of those financial statements requires us to make estimates and judgments that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of net sales and expenses for each period. The following
represents a summary of our critical accounting policies, defined as those policies that we believe are the most important to the portrayal of our financial condition and results of operations and
that require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.

Revenue Recognition

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

We
recognize revenues from domestic sales of our electronic devices and communications equipment at the point of shipment of those products. An estimate of warranty costs are recorded at
the time the revenue is recognized. Product returns are infrequent and require prior authorization because our sales are final and we quality test our products prior to shipment to ensure the products
meet the specifications of the binding purchase orders under which those products are shipped. Normally, when a customer requests and receives authorization to return a product, the request is
accompanied by a purchase order for a repair or for a replacement product.

Revenue
recognition for products and services provided by our subsidiaries in England depends upon the type of contract involved. Engineering/design services contracts generally entail
design and production of a prototype over a term of up to several years, with revenue deferred until each milestone defined in the contract is reached. Production contracts provide for a specific
quantity of products to be produced over a specific period of time. Customers issue binding purchase orders or enter into binding agreements for the products to be produced. We recognize revenues on
these orders as the products are shipped. Returns are infrequent and permitted only with prior authorization

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because
these products are custom made to order based on binding purchase orders and are quality tested prior to shipment. An estimate of warranty costs are recorded at the time revenue is recognized.

We
recognize revenues for products sold by our French subsidiary at the point of shipment. Customer discounts are included in the product price list provided to the customer. Returns are
infrequent and permitted only with prior authorization because these products are shipped based on binding purchase orders and are quality tested prior to shipment. An estimate of warranty costs are
recorded at the time revenue is recognized.

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

Product Warranty Liabilities

Generally, our products carry a standard one-year, limited parts and labor warranty. In certain circumstances, we provide a two-year
limited parts and labor warranty on our communications test instruments and network access products. We offer extended warranties beyond
two years for an additional cost to our customers. Products returned under warranty typically are tested and repaired or replaced at our option. Historically, we have not experienced significant
warranty costs or returns.

We
record a liability for estimated costs that we expect to incur under our basic limited warranties when product revenue is recognized. Factors affecting our warranty liability include
the number of units sold, historical and anticipated rates of claim and costs per claim. We periodically assess the adequacy of our warranty liability accrual based on changes in these factors.

Inventory Valuation

Our finished goods electronic devices inventories generally are built to order. Our communications equipment inventories generally are built to forecast, which
requires us to produce a larger amount of finished goods in our communications equipment business so that our customers can be served promptly. Our products consist of numerous electronic and other
parts, which necessitates that we exercise detailed inventory management. We value our inventory at the lower of the actual cost to purchase or manufacture the inventory (first-in,
first-out) or the current estimated market value of the inventory (net realizable value). We perform cycle counts of inventories using an ABC inventory methodology, which groups inventory
items into cycle counting categories, or conduct physical inventories at least once a year. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory
based primarily on our estimated forecast of product demand and production requirements for the next 12 to 24 months. Additionally, to determine inventory write-down provisions, we
review product line inventory levels and individual items as necessary and periodically review assumptions about forecasted demand and market conditions. Any inventory that we determine to be
obsolete, either in connection with the physical count or at other times of observation, are reserved for and subsequently written-off. As of December 31, 2007, our total inventory
reserves amounted to $6.1 million of which $4.4 million, or 24.6% of total inventory, related to our electronic devices segment and $1.7 million, or 9.8% of total inventory,
related to our communications equipment segment.

The
electronics devices and communications equipment industries are characterized by rapid technological change, frequent new product development, and rapid product obsolescence that
could result in an increase in the amount of obsolete inventory quantities on hand. Also, our estimates of future product demand may prove to be inaccurate, in which case we may have understated or
overstated the provision required for excess and obsolete inventory. Although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated
changes in

22

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demand
or technological developments could have a significant impact on the value of our inventory and our reported operating results.

Foreign Currency Translation

We have foreign subsidiaries that together accounted for approximately 73.2% and 63.5% of our net revenues, 39.5% and 56.4% of our assets and 37.0% and 56.9% of
our total liabilities as of and for the years ended December 31, 2007 and 2006, respectively. In preparing our consolidated financial statements, we are required to translate the financial
statements of our foreign subsidiaries from the functional currencies in which they keep their accounting records into U.S. dollars. This process results in exchange gains and losses which, under
relevant accounting guidance, are included either within our statement of operations under the caption "other income (expense)" or as a separate part of our net equity under the caption "accumulated
other comprehensive income (loss)."

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

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

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

Based
on our assessment of the factors discussed above, we consider the functional currency of each of our international subsidiaries to be each subsidiary's local currency. Accordingly,
we had cumulative translation gains of $1.1 million and $0.7 million that were included as part of accumulated other comprehensive income within our balance sheets at December 31,
2007 and December 31, 2006, respectively. During the year ended December 31, 2007 and 2006, we included translation gains of $0.4 million and $1.6 million, respectively,
under accumulated other comprehensive income.

If
we had determined that the functional currency of our subsidiaries was U.S. dollars, these gains would have decreased our net loss for the year ended December 31, 2007 and
2006. The magnitude of
these gains or losses depends upon movements in the exchange rates of the foreign currencies in which we transact business as compared to the value of the U.S. dollar. These currencies include the
euro, the British pounds sterling and, to a lesser extent, the Japanese yen. Any future translation gains or losses could be significantly higher or lower than those we recorded for these periods.

A
2.5 million British pounds sterling loan payable from one of our subsidiaries in England to EMRISE was outstanding as of December 31, 2007 ($4.9 million based on
the exchange rate at December 31, 2007). Exchange rate losses and gains on the long-term portion of this loan are recorded in cumulative translation gains or losses in the equity
section of the balance sheet.

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Intangibles, Including Goodwill

We periodically evaluate our intangibles, including goodwill, for potential impairment. Our judgments regarding the existence of impairment are based on legal
factors, market conditions and operational performance of our acquired businesses.

In
assessing potential impairment of goodwill, we consider these factors as well as forecasted financial performance of the acquired businesses. If forecasts are not met, we may have to
record additional impairment charges not previously recognized. In assessing the recoverability of our goodwill and other intangibles, we must make assumptions regarding estimated future cash flows
and other factors to determine the fair value of those respective assets. If these estimates or their related assumptions change in the future, we may be required to record impairment charges for
these assets that were not previously recorded. If that were the case, we would have to record an expense in order to reduce the carrying value of our goodwill. Under Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets", we are required to analyze our goodwill for impairment issues at least annually or more frequently if an event occurs or
circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. At December 31, 2007, our reported goodwill totaled
$13.1 million. During the year ended December 31, 2007, we did not record any impairment losses related to goodwill and other intangible assets.

Overview

Overall sales increased 10.7% in 2007 as compared to 2006. Sales were positively affected at our foreign subsidiaries in both of our operating segments,
electronics devices and communications
equipment, as a result of new contracts for power supplies, new IFE&C products, and network access products. The sales increases experienced by our foreign subsidiaries were partially offset by sales
declines experienced by our domestic subsidiaries. While we continue to experience year-over-year decreases in our domestic sales, during the early part of 2008 we have
experienced improvements in domestic sales of our power supplies for military customers and new TiemPo Edge Network timing products due, in part, to new orders by a national
communications carrier. We expect continued growth in our foreign markets and we believe that our new TiemPo product, new power supply products and our patented Very Low Profile, or
VLP®, rotary switches will bring improved sales to our domestic operations as well.

Overall
gross margins decreased from 36.6% in 2006 to 33.8% in 2007. The declines in overall gross margins were primarily due to the remaining effects of transitioning the manufacturing
of our domestic RO power supply products to a contract manufacturer, which commenced in the second quarter of 2007 and resulted in lower sales and higher initial production costs; the temporary higher
costs associated with engineering and prototyping of our new IFE&C products at our subsidiaries in England; and changes in product mix as we are experiencing the impact of shifting from traditional
higher margin, low growth products to lower-margin, long-term growth products. We have made a conscious effort to develop and pursue product lines in areas where we expect substantial
growth potential. In some cases, these opportunities, such as existing products sold in the commercial IFE&C market, have lower margins as compared to our traditional higher margin military market
resulting in lower overall average margins. Similarly, our rotary switch product line is comprised of lower margin products as compared to our traditional digital switch products, but with a
substantial future growth potential. In all cases, however, we expect that the overall higher anticipated sales volumes in these high growth areas will result in improved gross margin and overall
improved profitability. In contrast, our new TiemPo products have both high growth potential and higher margin potential. We expect our overall margins to increase slightly in 2008 as
compared to 2007.

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

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Results of Operations

Comparison of the Year Ended December 31, 2007 to the Year Ended December 31, 2006

Net Sales

|                         |                   | Year Ended
December 31, |        | Variance
Favorable (Unfavorable) |  
|------------------------ | ----------------- | ----------------------- | ------ | -------------------------------- | -
|
|Electronic devices       |                   | $                       | 36,471 |                                  | $
|                         | as % of net sales |                         |        | 71.0                             | %
|Communications equipment |                   |                         | 14,874 |                                  |  
|                         | as % of net sales |                         |        | 29.0                             | %
|                         |                   |                         |        |                                  |  
|Total net sales          |                   | $                       | 51,345 |                                  | $
|                         |                   |                         |        |                                  |  

Electronic Devices

The increase in sales of our electronic devices in 2007 as compared to 2006 is primarily due to a $5.3 million (25%) increase in sales by our foreign
subsidiaries. This was primarily the result of significant military power supply sales by our subsidiary in England resulting from new contracts and also a result of increased sales of existing and
new IFE&C products by our foreign subsidiaries. This overall increase was partially offset by a $1.6 million (14%) decline in sales at our domestic operations, primarily due to the impact of
the transition of the manufacturing operations of our subsidiary, RO, to a contract manufacturer, which transition occurred during the second and third quarters of 2007 and during which time, we
experienced temporary shipping delays in certain products. The transition of RO to contract manufacturing was completed during the third quarter of 2007. Shipments since then have stabilized and we
expect RO shipments during 2008 to exceed 2007 shipment levels. Our domestic electronic device sales were also affected by reductions in U.S. government stocking orders by the Defense Supply Agency
("DSA") for our digital switches.

Sales
of electronic devices are also expected to rise in 2008, including sales of EMRISE's patented VLP® rotary switches and ongoing sales growth of IFE&C equipment and
systems. New orders for the products during the 2008 first quarter have continued to show reason for optimism and shipments through March of this year have been higher compared to the same period last
year.

Communications Equipment

The increase in sales of our communications equipment in 2007 as compared to 2006 is primarily due to a $2.5 million (35%) increase in network access
equipment sales at our French subsidiary as a result of new domestic military and commercial business in Europe as well as larger international orders. This increase was partially offset by a
$1.3 million (20%) decline in our domestic operations as a result of decreases in sales of our central office timing products. Sales of our central office timing products have decreased year
over year, in part, as a result of a market shift from central office products to Edge Network products and also due to our intentional effort to focus on Edge Network opportunities where we believe
our TiemPo product gives us a competitive advantage over competitors due to its cost, next generation capabilities, and other value added features. We believe that our French subsidiary
will continue to experience strong sales in 2008 of network access equipment to both military and commercial customers. We also expect improved sales in 2008 at both our domestic and foreign
operations as a result of anticipated increased shipments of our new TiemPo product.

Going
forward, EMRISE expects continued growth in sales in foreign communications markets. Domestic sales are also expected to increase due to growing demand for Edge Network products,

25

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primarily
TiemPo, especially from anticipated opportunities with public communications carriers and other large-scale customers, as evidenced by our recently announced orders from a
national communications carrier in the U.S.

Gross Profit

|                         |                    | Year Ended
December 31, |        | Variance
Favorable (Unfavorable) |  
|------------------------ | ------------------ | ----------------------- | ------ | -------------------------------- | -
|
|Electronic devices       |                    | $                       | 11,602 |                                  | $
|                         | as % of net sales  |                         |        | 31.8                             | %
|Communications equipment |                    |                         | 5,748  |                                  |  
|                         | as % of net sales  |                         |        | 38.6                             | %
|                         |                    |                         |        |                                  |  
|Total gross profit       |                    | $                       | 17,350 |                                  | $
|                         |                    |                         |        |                                  |  
|                         | Total gross margin |                         |        | 33.8                             | %

Electronic Devices

The decline in gross margin, as a percentage of net sales, for our electronic devices from 35.9% in 2006 to 31.8% in 2007 is primarily the result of a reduction
in gross profit at RO of $0.7 million (67%), which occurred during the transition of RO's manufacturing operations to a contract manufacturer commencing in the second quarter of 2007 and which
resulted in higher initial production costs throughout the transition period. The transition of RO to contract manufacturing was completed during the third quarter of 2007 and gross margins stabilized
during the 4th quarter of 2007. During 2008, we expect RO operating income to significantly improve as compared to 2007 as the result of improved gross margins, lower operating
costs, and higher order entry levels.

In
addition, during 2007, our gross profit was negatively impacted by temporary engineering and prototyping costs associated with our new IFE&C products and reductions in DSA stocking
orders for higher margin digital switch products. Additionally, we are making a conscious effort to penetrate the lower margin commercial in-flight entertainment market as we see
substantial growth potential as compared to our traditional higher margin military market resulting in lower average margins for those products. Over time, we expect this strategy to result in higher
operating profits as we believe that we will be able to increase sales at a higher rate than our operations costs.

Communications Equipment

The slight increase in gross margin, as a percentage of net sales, for our communications equipment from 38.2% in 2006 to 38.6% in 2007 was the result of
increased sales of higher margin military network access products at our French subsidiary resulting in a $1.2 million (3%) increase in gross profit, offset in part by a $0.7 million
(28%) decrease in gross profit at our domestic subsidiaries due primarily to lower sales of our central office timing products. During 2008, we expect gross margins to remain constant at our French
subsidiary and we expect gross margins to improve at our domestic subsidiary as a result of a significant increase in shipments of our new TiemPo timing and synchronization product, which
is manufactured for us by a contract manufacture and therefore,
generally carries higher margins than traditional in house built central office and other network access products.

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Operating Expenses

|                                    |                   | Year Ended
December 31, |        | Variance
Favorable (Unfavorable) |  
|----------------------------------- | ----------------- | ----------------------- | ------ | -------------------------------- | -
|
|Selling, general and administrative |                   | $                       | 15,392 |                                  | $
|                                    | as % of net sales |                         |        | 30.0                             | %
|Engineering and product development |                   |                         | 2,792  |                                  |  
|                                    | as % of net sales |                         |        | 5.4                              | %
|                                    |                   |                         |        |                                  |  
|Total operating expenses            |                   | $                       | 18,184 |                                  | $
|                                    |                   |                         |        |                                  |  

Selling, General and Administrative

The decrease in selling, general and administrative expenses is primarily the result of $1.5 million of costs for the restatement and reaudit of our 2004
and 2005 financial statements which were incurred in 2006 as compared to $0.3 million which were incurred in 2007. These decreases were partially offset by $0.2 million of
non-recurring costs relating to the consolidation of the operations of RO into our CXR Larus Corporation facility, $0.3 million of additional sales and marketing costs associated
with higher sales in our foreign electronic devices subsidiaries, and $0.3 million related to an increase in compensation and other related expenses.

Beginning
the first quarter of 2008 and continuing throughout 2008, we expect to incur significant expenses in connection with our efforts to comply with the requirements of the
Sarbanes-Oxley Act of 2002 ("SOX"). In particular, we expect to incur approximately $100,000 to $200,000 during the first quarter of 2008 in connection with our 2007 SOX management assessment, which
pursuant to SEC guidelines for non-accelerated filers, we are required to complete for the first time in connection with our 2007 financial statements. Further, during the remainder of the
year, we will likely incur additional costs in connection with the remediation of certain internal control deficiencies which were identified as a result of our 2007 management assessment. We are
currently in the process of developing specific action plans in that regard, which we expect to complete by June 30, 2007. If we are able to complete these action plans by that date, we
anticipate that all control deficiencies and material weaknesses will be remediated by December 31, 2008. We are uncertain at this time of the additional costs to remediate all of the control
deficiencies and material weaknesses, however, we anticipate the cost to be in the range of $200,000 to $400,000, most of which costs we expect to incur in 2008. We cannot guarantee that the actual
costs to remediate these deficiencies will not exceed this amount.

Engineering and Product Development

The decrease in engineering and product development costs is primarily due to reduced expenses for the development of our new TiemPoTM product line for which most
of the costs were incurred in 2006. We expect engineering and development costs to be higher in 2008 as a result of additional TiemPo engineering costs and IFE&C development activities.

Interest Expense

Interest expense was $0.9 million for 2007 as compared to $0.5 million for 2006 due to increased loan balances for our U.S., England and French
operations and increased interest rates. As a result of our recently completed debt financing in November 2007, we expect interest expense to increase in 2008 by approximately $0.4 million over
2007 expenses based on both higher outstanding balances and higher interest rates, which include the amortization of certain debt issuance costs.

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Loss on Early Extinguishment of Debt

Loss on early extinguishment of debt was $0.2 million for 2007 relating to the exit costs associated with the early termination of our existing credit
facilities and term loans. We did not incur such a loss in 2006.

Other Income (Expense)

We generated other income of $0.5 million for 2007 compared to other expense of approximately $0.4 million for 2006. Other income for 2007 included
a one-time accrual reversal related to the satisfactory resolution of a employee related legal dispute at our French subsidiary. Other expense for 2006 consisted primarily of
short-term exchange rate gains and losses associated with the volatility of the U.S. dollar to the British pounds sterling and euro on the current portion of certain assets and
liabilities.

Income Tax Expense

Income tax expense amounted to $0.8 million for 2007 compared to $0.6 million for 2006. Income tax expense is the result of foreign income tax on
foreign earned profits in Europe and Japan.

Net Loss

We reported a net loss of $1.9 million in 2007 and a net loss of $3.6 million in 2006. This reduction in net loss for 2007 was primarily a result of
the inclusions of $1.5 million in restatement related costs in 2006 as compared to only $0.3 million of such costs in 2007. Additional factors that contributed to the current year net
loss were as follows:



The
above factors were partially offset by a $1.1 million improvement in operating profit at our French subsidiary during 2007 as compared to 2006, due to higher sales of network
access equipment.

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Comparison of the Year Ended December 31, 2006 to the Year Ended December 31, 2005

Net Sales

|                         |                   | Year Ended
December 31, |        | Variance
Favorable (Unfavorable) |  
|------------------------ | ----------------- | ----------------------- | ------ | -------------------------------- | -
|
|Electronic devices       |                   | $                       | 32,702 |                                  | $
|                         | as % of net sales |                         |        | 70.5                             | %
|Communications equipment |                   |                         | 13,682 |                                  |  
|                         | as % of net sales |                         |        | 29.5                             | %
|                         |                   |                         |        |                                  |  
|Total net sales          |                   | $                       | 46,384 |                                  | $
|                         |                   |                         |        |                                  |  

Electronic Devices

The increase in sales of our electronic devices was primarily due to a $6.9 million (48.8%) increase in sales of power supplies in 2006 compared to 2005.
Contributing to this increase was a $3.3 million increase in sales of power supplies due to inclusion of a full year sales in 2006 as compared to only four months of sales included in 2005, due
to the acquisition of RO on August 31, 2005. Our subsidiary, Pascall Electronics Limited ("Pascall"), increased it sales of power supplies by $1.9 million (23.0%) to $9.9 million
in 2006. However, because we acquired Pascall on March 18, 2005, only nine and one-half months of sales for Pascall were included in our 2005 sales. The remainder of the
$1.8 million increase in sales of power supplies was due to an increase in sales volume of our subsidiary, XCEL Power Systems, Ltd., ("XPS"). Sales of RF devices by Pascall increased by
$0.6 million (19.9%) to $3.7 million in 2006 as compared to $3.1 million in 2005 due to increased sales volume. Sales of switches were $6.6 million, which approximated
sales of switches in the prior year.

Communications Equipment

The majority of the decrease in sales of our communications equipment was due to a $1.4 million (48.6%) decrease in sales of test equipment in 2007 as
compared to 2006. This decrease was mainly due to a lower volume of sales caused by the erosion of the communications industry customer base for our test instruments as a result of our decision to
cease investing in this product line. This decision resulted in us selling primarily to customers providing upgrades for a Federal Aviation Administration modernization project. Sales of our network
access and transmission products decreased $0.6 million (6.4%) to $8.3 million in 2006 as compared to $8.8 million in 2005. This decrease resulted from a $1.0 million
decrease in our CXR Larus U.S.-based sales primarily due to decreased sales volume as a result of reductions in sales of central office network equipment, offset by a $0.4 million increase in
our French-based sales due to increased sales volume. Partially offsetting these decreases was a modest increase in the sales of our timing systems by CXR Larus.

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Gross Profit

|                         |                    | Year Ended
December 31, |        | Variance
Favorable (Unfavorable) |  
|------------------------ | ------------------ | ----------------------- | ------ | -------------------------------- | -
|
|Electronic devices       |                    | $                       | 11,747 |                                  | $
|                         | as% of net sales   |                         |        | 35.9                             | %
|Communications equipment |                    |                         | 5,224  |                                  |  
|                         | as% of net sales   |                         |        | 38.2                             | %
|                         |                    |                         |        |                                  |  
|Total gross profit       |                    | $                       | 16,971 |                                  | $
|                         |                    |                         |        |                                  |  
|                         | Total gross margin |                         |        | 36.6                             | %

Electronic Devices

The increase in gross profit of our electronic devices was primarily due to a $1.3 million (32.6%) increase in our power supply operations in England. Of
this increase, Pascall provided $0.9 million due to an increase in sales volume and inclusion of a full year of operations in 2006 and XPS contributed $0.4 million due to increased sales
volume. Also contributing to the increase in gross profit was the addition of a full year of gross profit for RO. Gross profit for switches produced by our Digitran division remained constant.

Communications Equipment

The reduction in gross profit of our communications equipment was primarily due to a $1.2 million decrease in test equipment gross profit due to decreased
sales volume. In addition, gross profit for our CXR Larus communication timing and network access products declined $0.9 million due to a decrease in sales volume and a decrease in inventory
carrying values for certain items deemed to be slow moving. The gross profit at our French subsidiary declined $0.1 million due to a decrease in sales volume and a change in accounting policy
necessitating an inventory write-down.

Operating Expenses

|                                    |                   | Year Ended
December 31, |        | Variance
Favorable (Unfavorable) |  
|----------------------------------- | ----------------- | ----------------------- | ------ | -------------------------------- | -
|
|Selling, general and administrative |                   | $                       | 16,117 |                                  | $
|                                    | as % of net sales |                         |        | 34.7                             | %
|Engineering and product development |                   |                         | 3,085  |                                  |  
|                                    | as % of net sales |                         |        | 6.7                              | %
|                                    |                   |                         |        |                                  |  
|Total operating expenses            |                   | $                       | 19,202 |                                  | $
|                                    |                   |                         |        |                                  |  

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Selling, General and Administrative

Selling, general and administrative expenses increased as a result of the following:



Engineering and Product Development

Engineering and product development expenses consist primarily of new product development engineering activities. The increase in these expenses resulted
primarily from the increase of $0.4 million in expenses attributable to our decision to accelerate the introduction of our TiemPo 6400, a new Edge Network timing and
synchronization product, and a $0.2 million increase in engineering expenses attributable to ROA. The increase in engineering expense for the TiemPo product was mainly due to
$0.6 million of contract engineering expenses we incurred in 2006 to accelerate product development of this new Edge Network timing and synchronization product. These increases were partially
offset by a $0.2 million reduction of engineering expenses for switches and power supplies.

Interest Expense and Income

Interest expense was approximately $0.5 million for 2006 and 2005. The slight increase in interest expense in 2006 was a result of larger loan balances. We
recorded $0.2 million in interest income in 2005, which we earned primarily on the proceeds of our January 2005 private placement of equity securities.

Other Income (Expense)

Other expense in 2006 of $0.4 million was primarily due to currency exchange losses. Other income of $0.2 million in 2005 primarily resulted from a
$0.1 million gain due to the sale of our T-Com product line and a $0.1 million net currency exchange gain. The T-Com technology and tangible assets had no
carrying value.

Income Tax

The $0.6 million in income tax expense in 2006 includes $0.5 million of foreign taxes and $0.1 million of domestic taxes. We recorded a
provision for federal tax in 2006 to reduce our deferred tax assets for federal purposes and to reduce the amount of operating loss carryforwards recognized. An income tax benefit of
$0.3 million was recorded in 2005 primarily because we reduced our tax asset valuation allowance by $0.5 million and recorded a federal tax benefit of $0.2 million that was offset
by a foreign tax provision of $0.4 million.

Net Loss

Net loss for 2006 was $3.6 million as compared to net income of $1.4 million for 2005. Major contributors to this $5.1 million difference
were as follows:



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These
negative amounts were partially offset by a $1.6 million increase in gross profit related to sales of our electronic devices which, in turn, was primarily due to a
$7.0 million increase in net sales of these products.

Liquidity and Capital Resources

In making an assessment of our liquidity, we believe that the items in our financial statements that are most relevant are our working capital, cash generated
from our operating activities and cash available from our financing activities. During 2007, we funded our daily cash flow requirements through funds provided by operations and through borrowings from
our new credit facility with GVEC Resource IV Inc. ("GVEC"), an affiliate of Private Equity Management Group LLC ("PEM Group"), our prior domestic revolving credit facilities with Wells
Fargo Bank acting through its Wells Fargo Business Credit operating division ("WFBC"), and credit facilities with various foreign banks. Working capital was $16.1 million at December 31,
2007 as compared to $9.1 million at December 31, 2006. The increase in working capital is primarily the result of the increase in cash balances related to our new debt financing.
Additionally, the current structure of the new line of credit is such that it is classified as long term where the previous lines of credit were classified short-term. At
December 31, 2007
and 2006, we had accumulated deficits of $20.7 million and $18.7 million, respectively, and cash and cash equivalents of $4.7 million and $3.8 million, respectively.

Net
cash used in operating activities during 2007 totaled $1.5 million as compared to $1.1 million in 2006. Other than the 2007 net loss of $1.9 million, the only
other significant use of cash in operations during 2007 was an increase in inventory of $1.6 million, which was primarily due to increases in sales at our foreign subsidiaries. During 2007, we
experienced a $5.3 million, or 25%, increase in sales at our foreign electronic devices subsidiaries and a $2.5 million, or 35%, increase in sales at our foreign communication equipment
subsidiary. Significant sources of cash associated with operating activities during 2007 included (i) a reduction in accounts payable and accrued expenses of $0.6 million as a result of
more timely payments to vendors for aged payables and (ii) depreciation and amortization expense which totaled $1.2 million during both 2007 and 2006, but which is a non-cash
expense.

Cash
used in our investing activities totaled $0.8 million for 2007 as compared to $0.9 million in 2006. The 2007 amount consists of net increases to property, plant and
equipment. We have guaranteed obligations of EMRISE Electronics in connection with the Pascall acquisition and have agreed to indemnify Pascall's former parent in connection with obligations under
Pascall's facilities lease.

Cash
provided by our financing activities totaled $3.1 million in 2007. During 2007, we retired revolving bank debt of $5.7 million and borrowed $10 million under
our new credit facility with GVEC. During the year, we also borrowed approximately $1.4 million under prior revolving lines of credit, which amounts were subsequently paid off, and paid
approximately $1.4 million towards the repayment of long term debt and/or notes to stockholders. In connection with entering into our new GVEC credit facility, we paid $1.3 million in
issuance costs, and issued a seven year warrant to PEM Group to purchase 2,909,091 shares of EMRISE restricted common stock, at an exercise price of $1.10 per share.

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As
of December 31, 2007, we had outstanding borrowings of $4.0 million under GVEC Credit facility, remaining actual availability under a formula-based calculation of
$2.3 million and contractual availability of $3.0 million under the same facility. Actual remaining availability represents the additional amount we were eligible to borrow as of
December 31, 2007. Maximum contractual availability represents the maximum amount of availability provided under the contract as of that date and includes the actual remaining availability.

In
addition to the revolving lines of credit, at December 31, 2007, we had long-term loans and capitalized lease and equipment loan obligations totaling
$6.2 million, the current portion of which loans and obligations totaled $0.6 million.

Our
backlog decreased slightly to $25.3 million as of December 31, 2007 as compared to $25.8 million as of December 31, 2006. The amount of backlog orders
represents revenue that we anticipate recognizing in the future, as evidenced by purchase orders and other purchase commitments received from customers, but on which work has not yet been initiated or
with respect to which work is currently in progress. Our backlog as of December 31, 2007 was approximately 94% related to our electronic devices business, which business tends to provide us
with long lead-times for our manufacturing processes due to the custom nature of the products, and approximately 6% related to our communications equipment business, which business tends
to deliver standard or modified standard products from stock as orders are received. We believe that the majority of our current backlog is shippable within the next 12 months. However, there
can be no assurance that we will be successful in fulfilling such orders and commitments in a timely manner or that we will ultimately recognize as revenue the amounts reflected as backlog.

Existing Credit Facility

On November 30, 2007, EMRISE Corporation and its direct subsidiaries, EMRISE Electronics Corporation, CXR Larus Corporation and RO (collectively, the
"Borrowers") entered into a Credit Agreement with GVEC, providing for a three-year credit facility in the aggregate amount of $23,000,000 and is secured by accounts receivable, other
rights to payment and general intangibles, inventories and equipment.

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

The
Revolver is formula-based and generally provides that the outstanding borrowings under the line of credit may not exceed an aggregate of 85% of eligible accounts receivable, plus 10%
of the value of eligible raw materials not to exceed $600,000, plus 50% of the value of eligible finished goods inventory not to exceed $1,500,000, minus the aggregate amount of reserves that may be
established by GVEC.

Interest
on the Revolver is payable monthly. The interest rate is variable and is adjusted monthly 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
consolidated basis, including the following: EBITDA, measured on a fiscal quarter-end basis, must not be less than the scheduled amount for each specified period; the debt service coverage
ratio, measured quarterly, must be greater than the lesser of the 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 we must not incur capital expenditures in any fiscal year in excess of $500,000.

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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 the first 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 payable monthly. The Borrowers may make full or partial prepayment of the term
loans provided that any such prepayment is accompanied by the applicable prepayment premium discussed below.

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

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

To
secure payment of the indebtedness of Borrowers under the GVEC credit facility, the Borrowers irrevocably pledged and assigned to, and granted to GVEC a continuing security interest
in all the personal property of the Borrowers including the Borrowers' interest in any deposit accounts, the stock of each of the Borrowers' subsidiaries, the intellectual property owned by each of
the Borrowers, and the proceeds of the intellectual property owned by each of the Borrowers. If an event of default, GVEC may, at its option, exercise any or all remedies available to it with respect
to the collateral. In addition, certain of the Borrowers' foreign subsidiaries have agreed to guaranty the Borrowers' performance under the GVEC credit facility.

Previous Credit Facilities

Our prior credit facility with WFBC provided for a $5,000,000 revolving line of credit that expired on December 1, 2009 and was secured by accounts
receivable, other rights to payment and general intangibles, inventories and equipment. The line of credit was formula-based and generally provided that the outstanding borrowings under the line of
credit may not exceed an aggregate of 85% of eligible accounts receivable plus 10% of the value of eligible finished goods inventory. Interest was payable monthly. The interest rate was variable and
adjusted monthly based on the prime rate plus 1%.
On November 30, 2007, in connection with entering into the new credit facility with GVEC, we terminated the WFBC credit facility.

As
of December 31, 2006, we had balances of $1,978,000 outstanding on the WFBC revolving line of credit and $200,000 outstanding on the term loan. Availability on the WFBC
revolving line of credit was $102,000. As of December 31, 2006, we were not in compliance with the loan's financial covenants for net worth and net losses. We obtained a waiver from WFBC for
those covenant violations.

As
of December 31, 2006, our foreign subsidiaries had credit facilities, including lines of credit and term loans, with Lloyds TSB Bank PLC and Lloyds TSB Commercial
Finance Limited in England, IFN Finance, Banc National de Paris, and Société Générale in France, and Sogelease and Johnan Shinkin Bank in
Japan. At December 31, 2006, the balances outstanding under our credit facilities in England, France and Japan were $1,762,000, $1,156,000 and $15,000, respectively. On November 30,
2007, in connection with entering into the new GVEC credit facility, we terminated these foreign subsidaries' credit facilities.

Overall,
we believe that current and future capital resources, revenues generated from operations and other existing sources of liquidity, including our GVEC credit facility, will be
adequate to meet our anticipated short term, working capital and capital expenditures needs for at least the next 12 months.

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However,
if we experience significant loss of revenue or increase in costs, our cash flow could be negatively impacted resulting in a cash flow deficit. As a result, we may require additional
financing. This financing could be in the form of a revised debt structure with our existing lender, new financing with another lender or lenders, the sale of additional equity to raise capital, or
the sale of certain assets to generate cash. Our failure to raise capital, if needed, ability to sell assets when needed and/or ability to secure additional financing could restrict our growth, limit
our development of new products or hinder our ability to compete.

Effects of Inflation

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

Impacts of New Accounting Pronouncements

On January 1, 2007, we adopted Financial Accounting Standards Board ("FASB") Financial Interpretation ("FIN") 48,Accounting for
Uncertainty in Income Taxesan interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for the uncertainty in recognizing income
taxes in an organization in accordance with FASB Statement No. 109 by providing detailed guidance for financial statement recognition, measurement and disclosure involving uncertain tax
positions. FIN 48 requires an uncertain tax position to meet a more-likely-than-not recognition threshold at the effective date to be recognized both upon
the adoption of FIN 48 and in subsequent periods. The implementation of FIN 48 did not have a material effect on our financial statements.

In
February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities. SFAS
No. 159 permits an entity to irrevocably elect fair value on a contract-by-contract basis as the initial and subsequent measurement attribute for many financial assets
and liabilities and certain other items including insurance contracts. Entities electing the fair value option would be required to recognize changes in fair value in earnings and to expense upfront
cost and fees associated with the item for which the fair value option is elected. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We are evaluating the
effect of the adoption of SFAS No. 159 would have on our financial condition or results of operations.

In
September 2006, the FASB issued SFAS No. 157,Fair Value Measurements. This new statement provides a single definition of fair
value, together with a framework for measuring it, and requires additional disclosure about the use of fair value to measure assets and liabilities. SFAS No. 157 also emphasizes that fair value
is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy, with the highest priority being quoted prices in active markets. The required effective date of
SFAS No. 157 is the first quarter of 2008. We are evaluating the effect this statement may have on our consolidated financial statements.

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

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

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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 and Disagreements With Accountants on Accounting and Financial Disclosure.

On April 13, 2006, we notified Grant Thornton LLP ("GT"), the independent registered public accounting firm that was engaged as our principal
accountant to audit our consolidated financial statements, that we intended to engage new certifying accountants and thereby were terminating our relationship with GT. Our decision to change
accountants was approved by our audit committee and board of directors. The reason for the change was to allow us to engage an alternative firm that we believed had adequate resources and experience
to provide us with the auditing and tax services we require, on a more cost-effective basis.

The
audit reports of GT on our consolidated financial statements and consolidated financial statement schedules as of and for the years ended December 31, 2005 and 2004 did not
contain any adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles. During the years ended December 31, 2005 and
2004 and the subsequent interim period through April 13, 2006, there were no disagreements with GT on any matter of accounting principles or practices, financial statement disclosure, or
auditing scope or procedures which disagreements, if not resolved to GT's satisfaction, would have caused GT to make reference to the subject matter of the disagreement in connection with its opinion.
During the years ended December 31, 2005 and 2004 and the subsequent interim period through April 13, 2006, there were no reportable events as described in Item 304(a)(1)(v) of
Regulation S-K under the Securities Act of 1933, as amended, except as described below.

On
April 5, 2005, in connection with its audit of our consolidated financial statements for the year ended December 31, 2004, GT advised our audit committee and management
of two matters that GT considered to be "material weaknesses" as that term is defined under standards established by the Public Company Accounting Oversight Board (United States), or PCAOB. A material
weakness is a control deficiency or combination of control deficiencies that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will
not be prevented or detected. The first matter related to our need for additional staff with expertise in preparing required disclosures in the notes to the financial statements, and our need to
develop greater internal resources for researching and evaluating the appropriateness of complex accounting principles and for evaluating the effects of new accounting pronouncements on us. Our growth
during and since 2004 as a result of our acquisitions of Larus Corporation, Pascall and RO and the increased complexity surrounding our financing arrangements are major contributors to the need for
additional resources in financial reporting. The second matter related to segregation of duties relating to cash disbursements. Both our assistant controller and accounts payable clerk had access to
initiate the payment of invoices and print electronically signed checks. Both individuals had the ability to record transactions in the accounting system. The lack of segregation of these two
functionscheck-writing ability and the recording of disbursement transactions in our accounting systemrepresented a material weakness in the cash disbursements cycle. We
considered these matters in connection with the preparation of the December 31, 2004 consolidated financial statements and also determined that no prior period financial statements were
materially affected by such matters. In response to the observations made by GT, on April 7, 2005, we engaged financial consultants who are certified public accountants with the requisite
background and experience to prepare required disclosures in the notes to our financial statements and to provide greater internal resources for researching and evaluating the appropriateness of
complex accounting principles and for evaluating the effects that new accounting pronouncements may have on us. In addition, we recognize that the risk of an unauthorized disbursement exists without
proper segregation of duties between check-writing and record keeping. However, every month we review the listing of checks produced and research any check number that is missing or questionable. We
believe

36

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this
type of detective control would identify unauthorized disbursements. Additionally, on May 6, 2005, we limited the system access for those individuals performing this review such that there
are appropriate mitigating controls over the incompatible duties with regard to our disbursements. We believe these steps addressed the matters GT raised.

On
August 15, 2005, in connection with its review of our condensed consolidated financial statements for the quarter ended June 30, 2005, GT advised our management of a
matter that GT considered to be a material weakness. GT noted that we recorded revenue in our Pascall division for certain items previously recorded as "bill and hold" inventory. We had shipped the
items to the customer on June 30, 2005, and the customer took title to the items and paid for the items. However, the customer requested that Pascall modify the items and returned the items to
Pascall on July 7, 2005 under a separate contract. The return of the items by the customer subsequent to June 30, 2005 resulted in the transaction not meeting the revenue recognition
criteria under SAB No. 104. The recording of these items as sales in the quarter ended June 30, 2005 resulted in an adjusting journal entry to reduce revenue by $841,000 and to reduce
net income by $314,000 ($0.01 per share). GT met with our audit committee on August 18, 2005 and recommended that we review the control procedures over bill and hold arrangements to determine
adherence to SAB No. 104. Our audit committee and management have undertaken an extensive review of SAB No. 104. We have sought and plan to continue to seek
guidance from our financial consultants, who are certified public accountants with the requisite background and experience, to assist us in our future compliance with SAB No. 104 as it relates
to control procedures over bill and hold matters and believe we have therefore remediated the material weakness.

On
March 28, 2006, in connection with its audit of our consolidated financial statements for the year ended December 31, 2005, GT advised our management and audit committee
of two matters that GT considered material weaknesses. GT indicated that in the area of accounting and financial reporting, it believed we had insufficient accounting resources to enable us to
identify and evaluate complex accounting and reporting matters. In addition, GT recommended that we establish procedures to ensure that our Chief Financial Officer can more closely monitor information
submitted to our corporate headquarters by our subsidiary controllers and oversee accounting for reserves and other areas that involving significant judgment at all company locations. GT also
recommended that we establish procedures to ensure that personnel familiar with accounting principles generally accepted in the United States and with Commission disclosure requirements thoroughly
evaluate activities and transactions at all company locations in order to determine that we are timely making all required disclosures.

On
April 17, 2006, we engaged Hein & Associates LLP as our new certifying accountants. We had not consulted with Hein in the past regarding the application of
accounting principles to a specified transaction or the type of audit opinion that might be rendered on our financial statements or as to any disagreement or reportable event as described in
Item 304(a)(1)(iv) and Item 304(a)(1)(v) of Regulation S-K.

Item 9A.    Controls and Procedures.

Not applicable.

Item 9A(T).    Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

We conducted an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Vice President Finance
and Administration, our principal accounting officer, of the effectiveness of the design and operation of our disclosure controls and procedures. The term "disclosure controls and procedures," as
defined in Rules 13a-15(e) and

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15d-15(e)
under the Securities Exchange Act of 1934, as amended ("Exchange Act"), means controls and other procedures of a company that are designed to ensure that information required to
be disclosed by the company in the reports it files or submits 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 also include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or
submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, or persons performing similar functions,
as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our Chief Executive Officer and Vice President Finance and Administration concluded as of
December 31, 2007 that our disclosure controls and procedures were not effective at the reasonable assurance level due to the material weaknesses discussed immediately below.

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

Management's Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f)
and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and
procedures that:



Because
of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

A
material weakness in internal control over financial reporting is defined by the Public Company Accounting Oversight Board's Audit Standard No. 5 as being a deficiency, or a
combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company's annual or interim financial
statements will not be prevented or detected on a timely basis.

Management
assessed and evaluated the effectiveness of our internal control over financial reporting as of December 31, 2007. Based on the results of management's assessment and
evaluation, our Chief Executive Officer and Vice President Finance and Administration concluded that as of

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December 31,
2007 the following three material weaknesses in our internal control over financial reporting existed:



The
foregoing 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 Administration concluded that we did not maintain effective internal control over financial reporting as of December 31, 2007. If not
remediated, these material weaknesses could result in one or more material misstatements in our reported financial statements in a future annual or interim period.

In
making its assessment of our internal control over financial reporting, management used criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission
("COSO") in itsInternal ControlIntegrated Framework. Because of the material weaknesses described above, management believes that, as of
December 31, 2007, we did not maintain effective internal control over financial reporting.

A
nationally-recognized independent consulting firm assisted management with its assessment of the effectiveness of our internal control over financial reporting, including scope
determination, planning, staffing, documentation, testing, remediation and retesting and overall program management of the assessment project.

This
Report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management's report was not
subject to attestation by our independent registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management's report in this Report.

Inherent Limitations on the Effectiveness of Controls

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

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

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Material Weaknesses and Related Remediation Initiatives

Set forth below is a summary of the various significant deficiencies which caused management to conclude that we had the three material weaknesses identified
above. Through the efforts of our Vice President Finance and Administration and our Audit Committee, we are currently in the process of developing specific action plans to remediate the material
weaknesses identified above and discussed more fully below. We expect to complete these various action plans by June 30, 2008. If we are able to complete these action plans by that date, we
anticipate that all control deficiencies and material weaknesses will be remediated by December 31, 2008.

(1)   We
did not effectively implement comprehensive entity-level internal controls, as evidenced by the following control deficiencies:



(2)   We
did not maintain effective controls over changes to critical financial reporting applications and over access to these applications and related data, as evidenced by
the fact that certain of our personnel had unrestricted access to various financial application programs and data beyond the requirements of their individual job responsibilities. This control
deficiency could result in a material misstatement of significant accounts or disclosures, including those described above, that could result in a material misstatement of our interim or annual
consolidated financial statements that would not be prevented or detected.

(3)   We
did not maintain a sufficient level of information technology personnel to execute general computing controls over our information technology structure, which include
the implementation and assessment of information technology policies and procedures. This control deficiency did not result in an audit adjustment to our 2007 interim or annual consolidated financial
statements, but could result in a material misstatement of significant accounts or disclosures, which would not have been prevented or detected.

Remediation of Internal Control Deficiencies and Expenditures

The above material weaknesses did not result in adjustments to our 2007 consolidated financial statements, however, it is reasonably possible that, if not
remediated, one or more of the material

40

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weaknesses
described above could result in a material misstatement in our reported financial statements that might result in a material misstatement in a future annual or interim period.

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

In
addition, our audit committee has authorized the hiring of additional temporary staff and/or the use of financial and information technology consultants, as necessary, to ensure that
we have the depth and experience to remediate the above listed material weaknesses, including the implementation and monitoring of the appropriate level of control procedures related to all of our
manufacturing locations and our corporate offices. The audit committee will also work directly with management and outside consultants, as necessary to ensure that board level deficiencies are
addressed. We are uncertain at this time of the costs to remediate all of the above listed material weaknesses, however, we anticipate the cost to be in the range of $200,000 to $400,000 (including
the cost of the consolidation software described above), most of which costs we expect to incur in 2008. We cannot guarantee that the actual costs to remediate these deficiencies will not exceed this
amount.

Through
these steps, we believe that we are addressing the deficiencies that affected our internal control over financial reporting as of December 31, 2007. Because the remedial
actions require hiring of additional personnel, upgrading certain of our information technology systems, and relying extensively on manual review and approval, the successful operation of these
controls for at least several quarters may be required before management may be able to conclude that the material weakness has been remediated. We intend to continue to evaluate and strengthen our
internal control over financial reporting systems. These efforts require significant time and resources. If we are unable to establish adequate internal control over financial reporting systems, we
may encounter difficulties in the audit or review of our financial statements by our independent registered public accounting firm, which in turn may have a material adverse effect on our ability to
prepare financial statements in accordance with GAAP and to comply with our SEC reporting obligations.

Changes in Internal Control over Financial Reporting

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

Item 9B.    Other Information.

The Emrise Corporation 2007 Stock Incentive Plan

Effective November 1, 2007, our board of directors unanimously approved and adopted the EMRISE Corporation 2007 Stock Incentive Plan (the "2007 Plan"),
subject to stockholder approval. Our stockholders approved the 2007 Plan on December 12, 2007. As of the date of this Report, no awards have been made under the 2007 Plan.

The
principal features of the 2007 Plan are summarized below. This summary does not purport to be a complete description of the 2007 Plan and is qualified in its entirety by reference to
the 2007 Plan, a copy of which was filed as an exhibit to our proxy statement for our 2007 Annual Meeting of Stockholders and is incorporated into this Report by reference.

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Purpose of the 2007 Plan

The purpose of the 2007 Plan is to promote the success and enhance the value of our company by linking the personal interests of the members of our board,
employees, and consultants to those of our
stockholders and by providing those individuals with an incentive for outstanding performance to generate superior returns to our stockholders. The 2007 Plan is further intended to provide flexibility
in our efforts to motivate, attract and retain the services of members of our board, employees and consultants upon whose judgment, interest, and special effort the successful conduct of our
operations is largely dependent.

Administration of 2007 Plan

With respect to awards granted to our independent directors, the administrator of the 2007 Plan is our board of directors. The compensation committee of our board
of directors is the administrator of the 2007 Plan for all other persons, unless our board of directors assumes authority for administration. The compensation committee may delegate to a committee
consisting of one or more members of the compensation committee and/or of one or more officers of our company its authority to grant awards under the 2007 Plan to persons other than individuals who
are executive officers or directors of our company.

Eligibility

Our employees, consultants and directors are eligible to receive awards under the 2007 Plan. Awards may also be granted under the 2007 Plan to employees,
consultants and directors of our subsidiaries. The administrator determines which of our employees, consultants and directors will be granted awards, except that in the case of the granting of options
and restricted stock to independent directors, such determinations will be made by our board of directors.

Securities Subject to the 2007 Plan

Pursuant to the 2007 Plan, the maximum aggregate number of shares of common stock that may be issued or transferred pursuant to awards is 5,000,000. In the event
of any dividend or other distribution, recapitalization, reclassification, stock split, reverse stock split, reorganization, merger, consolidation, split-up, spin off or other transaction
that affects our common stock in a manner that would, in the administrator's discretion, require adjustment to such limit in order to prevent the dilution or enlargement of the potential benefits
intended to be made available under the 2007 Plan, the administrator of the 2007 Plan has the authority in its sole discretion to appropriately adjust any or all of: (i) the number and kind of
shares of common stock (or other securities or property) with respect to which awards may be granted or awarded under the 2007 Plan (including, but not limited to, adjusting the limitation on the
maximum number and kind of shares that may be issued to any one individual during any calendar year and the maximum number and kind of shares that may be issued pursuant to various types of awards);
(ii) the number and kind of shares of common stock (or other
securities or property) subject to outstanding awards under the 2007 Plan; and (iii) the grant or exercise price with respect to any outstanding award.

To
the extent that an award terminates, expires or lapses for any reason, any shares subject to the award at such time will be available for future grants under the 2007 Plan.
Additionally, shares tendered or withheld to satisfy the grant or exercise price or tax withholding obligation with respect to any award under the 2007 Plan will be available for future grants under
the 2007 Plan. If any shares of restricted stock are surrendered by a participant or repurchased by us pursuant to the terms of the 2007 Plan, those shares also will be available for future grants
under the 2007 Plan. To the extent permitted by applicable law or any exchange rule, shares issued in assumption of, or in substitution for, any outstanding awards of any entity acquired in any form
of combination by us or any of our

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subsidiaries
will not be counted against the shares available for issuance under the 2007 Plan. The shares of common stock covered by the 2007 Plan may be treasury shares, authorized but unissued
shares, or shares purchased in the open market.

Awards Under the 2007 Plan

The 2007 Plan provides that the administrator may grant or issue incentive or nonqualified stock options, stock appreciation rights, restricted stock, restricted
stock units, performance awards and stock payments, or any combination thereof. Each award will be set forth in a separate agreement with the person receiving the award and will indicate the type,
terms and conditions of the award.

Amendment and Termination of 2007 Plan

The administrator may amend the 2007 Plan at any time, subject to stockholder approval to the extent required by applicable law or regulation or the listing
standards of any market or stock exchange on which our common stock is at the time primarily traded. Additionally, stockholder approval will be specifically required to (i) increase the number
of shares available for issuance under the 2007 Plan, (ii) expand the classes of persons to whom awards may be granted under the 2007 Plan, or (iii) decrease the exercise price of any
outstanding option or stock appreciation right granted under the 2007 Plan.

The
administrator may terminate the 2007 Plan at any time. However, in no event may an award be granted pursuant to the 2007 Plan on or after November 1, 2017.

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PART III

Item 10.    Directors, Executive Officers and Corporate Governance.

Directors

The information under the captions "Directors, Director Nominee and Executive Officers" and "Information About our Board of Directors, Board Committees and
Related Matters", appearing in our definitive proxy statement, to be filed pursuant to Regulation 14A, related to our 2008 Annual Meeting of Stockholders (our "2008 Proxy Statement"), is hereby
incorporated by reference.

Executive Officers

The information under the captions "Directors, Director Nominee and Executive Officers" and "Section 16(a) Beneficial Ownership Reporting Compliance",
appearing in the 2008 Proxy Statement, is hereby incorporated by reference.

Item 11.    Executive Compensation.

The information under the caption "Executive Compensation and Related Information", appearing in the 2008 Proxy Statement, is hereby incorporated by reference.

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

The information under the captions "Security Ownership of Certain Beneficial Owners and Management", appearing in the 2008 Proxy Statement, is hereby incorporated
by reference.

Item 13.    Certain Relationships and Related Transactions, and Director Independence.

The information under the caption "Certain Relationships and Related Transactions", appearing in the 2008 Proxy Statement, is hereby incorporated by reference.

Item 14.    Principal Accounting Fees and Services.

The information under the captions "Principal Accountant Fees and Services," appearing in the 2008 Proxy Statement, is hereby incorporated by reference.

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PART IV

Item 15.    Exhibits and Financial Statement Schedules.



|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)                   
|3.1         |  | Amended and Restated Certificate of Incorporation of EMRISE Corporation filed with the Secretary of State of Delaware on May 9, 2005(11)                                                                                                                                                                                         
|3.2         |  | Amended and Restated Bylaws adopted by the Board of Directors of the Corporation on September 1, 2004(3)                                                                                                                                                                                                                         
|10.1        |  | 1993 Stock Option Plan(#)(4)                                                                                                                                                                                                                                                                                                     
|10.2        |  | Employee Stock and Stock Option Plan(#)(5)                                                                                                                                                                                                                                                                                       
|10.3        |  | 1997 Stock Incentive Plan(#)(6)                                                                                                                                                                                                                                                                                                  
|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, Randolph D. Foote 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)                                                                                                            

45

---



|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 February 24, 2006 by and between the Registrant and Carmine T. Oliva(#)(15)                                                                                                                                                                                                                           
|10.23 |  | Executive Employment Agreement dated February 24, 2006 by and between the Company and Graham Jefferies(#)(15)                                                                                                                                                                                                                              

46

---



|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)                                                                                                                                                                 
|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(16)                                                                                                                                                               
|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*  

---

47

---



48

---





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, 2007 and 2006                                   |  | F-3 
|Consolidated Statements of Operations for the Years Ended December 31, 2007 and 2006           |  | F-4 
|Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2007 and 2006 |  | F-5 
|Consolidated Statements of Cash Flows for the Years Ended December 31, 2007 and 2006           |  | F-6 
|Notes to Consolidated Financial Statements                                                     |  | F-7 

F-1

---





Report of Independent Registered Public Accounting Firm

Board
of Directors
and Stockholders of EMRISE Corporation

We
have audited the accompanying consolidated balance sheets of EMRISE Corporation, a Delaware corporation, as of December 31, 2007 and 2006, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the two years in the period ended December 31, 2007. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of EMRISE Corporation as of December 31,
2007 and 2006, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2007 in conformity with accounting principles generally accepted
in the United States of America.

We
were not engaged to examine management's assertion about the effectiveness of Emrise Corporation's internal control over financial reporting as of December 31, 2007 included in
the
accompanyingManagement's Report on Internal Control Over Financial Reportingand, accordingly, we do not express an opinion thereon.

As
discussed in Note 12 to the Consolidated Financial Statements, EMRISE Corporation changed its method of accounting for uncertain income tax positions in accordance with
Financial Accounting Standards Board Interpretation No. 48 on January 1, 2007.

/s/
HEIN & ASSOCIATES LLP

Irvine,
California
March 28, 2008

F-2

---





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

|                                                               |                                                                                                                                                                                  | December 31,
2007                          |        | December 31,
2006 |       
|-------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | ----------------- | ------
|ASSETS                                                         |                                                                                                                                                                                  |                                            |        |                   |       
|Current assets:                                                |                                                                                                                                                                                  |                                            |        |                   |       
|                                                               | Cash and cash equivalents                                                                                                                                                        |                                            | $      | 4,764             |       
|                                                               | Accounts receivable, net of allowances for doubtful accounts of $345 at December 31, 2007 and $391 at December 31, 2006                                                          |                                            |        | 9,406             |       
|                                                               | Inventories                                                                                                                                                                      |                                            |        | 11,664            |       
|                                                               | Current deferred tax assets                                                                                                                                                      |                                            |        | 200               |       
|                                                               | Prepaid and other current assets                                                                                                                                                 |                                            |        | 1,617             |       
|                                                               |                                                                                                                                                                                  |                                            |        |                   |       
|                                                               |                                                                                                                                                                                  | Total current assets                       |        |                   | 27,651
|Property, plant and equipment, net                             |                                                                                                                                                                                  |                                            | 2,227  |                   |       
|Goodwill                                                       |                                                                                                                                                                                  |                                            | 13,129 |                   |       
|Intangible assets other than goodwill, net                     |                                                                                                                                                                                  |                                            | 3,269  |                   |       
|Deferred tax assets                                            |                                                                                                                                                                                  |                                            | 617    |                   |       
|Other assets                                                   |                                                                                                                                                                                  |                                            | 1,287  |                   |       
|                                                               |                                                                                                                                                                                  |                                            |        |                   |       
|                                                               |                                                                                                                                                                                  | Total assets                               |        | $                 | 48,180
|                                                               |                                                                                                                                                                                  |                                            |        |                   |       
|LIABILITIES AND STOCKHOLDERS' EQUITY                           |                                                                                                                                                                                  |                                            |        |                   |       
|Current liabilities:                                           |                                                                                                                                                                                  |                                            |        |                   |       
|                                                               | Accounts payable                                                                                                                                                                 |                                            | $      | 4,440             |       
|                                                               | Accrued expenses                                                                                                                                                                 |                                            |        | 5,435             |       
|                                                               | Lines of credit                                                                                                                                                                  |                                            |        |                  |       
|                                                               | Current portion of long-term debt                                                                                                                                                |                                            |        | 71                |       
|                                                               | Notes payable to stockholders, current portion                                                                                                                                   |                                            |        | 521               |       
|                                                               | Income taxes payable                                                                                                                                                             |                                            |        | 712               |       
|                                                               | Other current liabilities                                                                                                                                                        |                                            |        | 357               |       
|                                                               |                                                                                                                                                                                  |                                            |        |                   |       
|                                                               |                                                                                                                                                                                  | Total current liabilities                  |        |                   | 11,536
|Long-term line of credit                                       |                                                                                                                                                                                  |                                            | 3,957  |                   |       
|Long-term debt, net of discount of $1,264 and $0, respectively |                                                                                                                                                                                  |                                            | 4,829  |                   |       
|Notes payable to stockholders, less current portion            |                                                                                                                                                                                  |                                            | 750    |                   |       
|Deferred income taxes                                          |                                                                                                                                                                                  |                                            | 904    |                   |       
|Other liabilities                                              |                                                                                                                                                                                  |                                            | 1,158  |                   |       
|                                                               |                                                                                                                                                                                  |                                            |        |                   |       
|                                                               |                                                                                                                                                                                  | Total liabilities                          |        |                   | 23,134
|Commitments and contingencies (See Note 15)                    |                                                                                                                                                                                  |                                            |        |                   |       
|Stockholders' equity:                                          |                                                                                                                                                                                  |                                            |        |                   |       
|                                                               | Preferred stock, $0.01 par value. Authorized 10,000,000 shares, zero shares issued and outstanding                                                                               |                                            |        |                  |       
|                                                               | Common stock, $0.0033 par value. Authorized 150,000,000 shares; 38,254,000 and 38,082,000 shares issued and outstanding at December 31, 2007 and December 31, 2006, respectively |                                            |        | 126               |       
|                                                               | Additional paid-in capital                                                                                                                                                       |                                            |        | 44,527            |       
|                                                               | Accumulated deficit                                                                                                                                                              |                                            |        | (20,661           | )     
|                                                               | Accumulated other comprehensive income                                                                                                                                           |                                            |        | 1,054             |       
|                                                               |                                                                                                                                                                                  |                                            |        |                   |       
|                                                               |                                                                                                                                                                                  | Total stockholders' equity                 |        |                   | 25,046
|                                                               |                                                                                                                                                                                  |                                            |        |                   |       
|                                                               |                                                                                                                                                                                  | Total liabilities and stockholders' equity |        | $                 | 48,180
|                                                               |                                                                                                                                                                                  |                                            |        |                   |       

The accompanying Notes are an integral part of these Consolidated Financial Statements

F-3

---





EMRISE CORPORATION        Consolidated Statements of Operations(in thousands, except per share amounts)

|                                    |                                     | Years Ended December 31,          |       
|----------------------------------- | ----------------------------------- | --------------------------------- | ------
|
|Net sales                           |                                     | $                                 | 51,345
|Cost of sales                       |                                     |                                   | 33,995
|                                    |                                     |                                   |       
|Gross profit                        |                                     |                                   | 17,350
|Operating expenses:                 |                                     |                                   |       
|                                    | Selling, general and administrative |                                   |       
|                                    | Engineering and product development |                                   |       
|                                    |                                     |                                   |       
|                                    |                                     | Total operating expenses          |       
|                                    |                                     |                                   |       
|Loss from operations                |                                     |                                   | (834  
|Other income (expense):             |                                     |                                   |       
|                                    | Interest income                     |                                   |       
|                                    | Interest expense                    |                                   |       
|                                    | Loss on early extinguisment of debt |                                   |       
|                                    | Other, net                          |                                   |       
|                                    |                                     |                                   |       
|                                    |                                     | Total other income (expense), net |       
|                                    |                                     |                                   |       
|Loss before income taxes            |                                     |                                   | (1,194
|Income tax provision (benefit)      |                                     |                                   | 734   
|                                    |                                     |                                   |       
|Net loss                            |                                     | $                                 | (1,928
|                                    |                                     |                                   |       
|Loss per share:                     |                                     |                                   |       
|                                    | Basic                               |                                   | $     
|                                    |                                     |                                   |       
|                                    | Diluted                             |                                   | $     
|                                    |                                     |                                   |       
|Weighted average shares outstanding |                                     |                                   |       
|                                    | Basic                               |                                   |       
|                                    |                                     |                                   |       
|                                    | Diluted                             |                                   |       
|                                    |                                     |                                   |       

The accompanying Notes are an integral part of these Consolidated Financial Statements

F-4

---





EMRISE CORPORATION
Consolidated Statements of Stockholders' Equity(in thousands)

|                                          |  | Common Stock |  |   |     |  |   | Accumulated
Other
Comprehensive
Income |   |   |        
|----------------------------------------- |  | ------------ |  | - | --- |  | - | -------------------------------------- | - | - | -------
|
|
|Balance at December 31, 2005              |  | 37,550       |  | $ | 124 |  | $ | 42,877                                 |   | $ | (15,118
|Stock option exercises                    |  | 181          |  |   |    |  |   | 97                                     |   |   |       
|Warrant exercises                         |  | 351          |  |   | 1   |  |   | 286                                    |   |   |       
|Cost of issuing common stock              |  |             |  |   |    |  |   | (323                                   | ) |   |       
|Stock-based compensation expense          |  |             |  |   |    |  |   | 131                                    |   |   |       
|Warrants issued for services              |  |             |  |   |    |  |   | 15                                     |   |   |       
|Net loss and comprehensive income         |  |             |  |   |    |  |   |                                       |   |   | (3,615 
|                                          |  |              |  |   |     |  |   |                                        |   |   |        
|Balance at December 31, 2006              |  | 38,082       |  |   | 125 |  |   | 43,083                                 |   |   | (18,733
|Stock option exercises                    |  | 172          |  |   | 1   |  |   | 69                                     |   |   |       
|Cost of issuing common stock              |  |             |  |   |    |  |   |                                       |   |   |       
|Stock-based compensation expense          |  |             |  |   |    |  |   | 69                                     |   |   |       
|Warrants issued related to debt financing |  |             |  |   |    |  |   | 1,300                                  |   |   |       
|Warrants issued for services              |  |             |  |   |    |  |   | 6                                      |   |   |       
|Net loss and comprehensive income         |  |             |  |   |    |  |   |                                       |   |   | (1,928 
|                                          |  |              |  |   |     |  |   |                                        |   |   |        
|Balance at December 31, 2007              |  | 38,254       |  | $ | 126 |  | $ | 44,527                                 |   | $ | (20,661
|                                          |  |              |  |   |     |  |   |                                        |   |   |        

The accompanying Notes are an integral part of these Consolidated Financial Statements

F-5

---





EMRISE CORPORATION        Consolidated Statements of Cash Flows(in thousands)

|                                                                         |                                         | Year Ended December 31, |       
|------------------------------------------------------------------------ | --------------------------------------- | ----------------------- | ------
|
|CASH FLOWS FROM OPERATING ACTIVITIES                                     |                                         |                         |       
|Net loss                                                                 |                                         | $                       | (1,928
|Reconciliation to net cash (used in) operating activities:               |                                         |                         |       
|                                                                         | Depreciation and amortization           |                         |       
|                                                                         | Stock-based compensation expense        |                         |       
|                                                                         | Warrants issued for services            |                         |       
|                                                                         | Deferred taxes                          |                         |       
|                                                                         | Provision for inventory obsolescence    |                         |       
|                                                                         | Provision for warranty reserves         |                         |       
|                                                                         | Provision for doubtful accounts         |                         |       
|                                                                         | Amortization of deferred issuance costs |                         |       
|                                                                         | Amortization of debt discount           |                         |       
|                                                                         | (Gain) loss on disposition of assets    |                         |       
|Changes in assets and liabilities:                                       |                                         |                         |       
|                                                                         | Accounts receivable                     |                         |       
|                                                                         | Inventories                             |                         |       
|                                                                         | Prepaid and other assets                |                         |       
|                                                                         | Accounts payable and accrued expenses   |                         |       
|                                                                         |                                         |                         |       
|                                                                         |                                         | Total adjustments       |       
|                                                                         |                                         |                         |       
|Net cash used in operating activities                                    |                                         |                         | (1,458
|                                                                         |                                         |                         |       
|CASH FLOWS FROM INVESTING ACTIVITIES:                                    |                                         |                         |       
|Purchases of property, plant and equipment                               |                                         |                         | (837  
|Disposal of property, plant and equipment                                |                                         |                         |      
|                                                                         |                                         |                         |       
|Net cash used in investing activities                                    |                                         |                         | (837  
|                                                                         |                                         |                         |       
|CASH FLOWS FROM FINANCING ACTIVITIES:                                    |                                         |                         |       
|Proceeds from issuance of debt                                           |                                         |                         | 6,000 
|Debt issuance costs                                                      |                                         |                         | (1,286
|Net proceeds (repayments) of previous lines of credit                    |                                         |                         | (4,310
|Net proceeds (repayments) of existing line of credit                     |                                         |                         | 3,957 
|Principal payments on long-term debt                                     |                                         |                         | (907  
|Payments of notes to stockholders                                        |                                         |                         | (458  
|Proceeds from exercise of stock options and warrants                     |                                         |                         | 70    
|                                                                         |                                         |                         |       
|Net cash provided by financing activities                                |                                         |                         | 3,066 
|                                                                         |                                         |                         |       
|Effect of exchange rate changes on cash                                  |                                         |                         | 191   
|                                                                         |                                         |                         |       
|Net decrease in cash and cash equivalents                                |                                         |                         | 962   
|Cash and cash equivalents at beginning of period                         |                                         |                         | 3,802 
|                                                                         |                                         |                         |       
|Cash and cash equivalents at end of period                               |                                         | $                       | 4,764 
|                                                                         |                                         |                         |       
|SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:                       |                                         |                         |       
|Cash paid during the year for:                                           |                                         |                         |       
|                                                                         | Interest                                |                         | $     
|                                                                         |                                         |                         |       
|                                                                         | Income taxes                            |                         | $     
|                                                                         |                                         |                         |       
|SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES: |                                         |                         |       
|                                                                         | Fair value of warrants issued           |                         | $     
|                                                                         |                                         |                         |       

The accompanying Notes are an integral part of these Consolidated Financial Statements

F-6

---





EMRISE CORPORATION        Notes to Consolidated Financial Statements

NOTE 1SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Business

EMRISE Corporation (the "Company") designs, manufactures and markets proprietary electronic devices and communications equipment for aerospace, defense,
industrial, and communications applications. The Company has operations in the United States ("U.S."), England, France and Japan. The Company conducts its business through two operating segments:
electronic devices and communications equipment. The subsidiaries within the electronic devices segment design, develop, manufacture and market electronic devices for defense, aerospace and industrial
markets and operate out of facilities located in the U.S., England and Japan. The subsidiaries within the communications equipment segment design, develop, manufacture and market network access
equipment and network timing and synchronization products and operate out of facilities located in the U.S. and France.

Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America
("GAAP") and include the accounts of the Company and each of its subsidiaries, after elimination of intercompany accounts and transactions. Certain prior years' amounts have been reclassified to
conform to the current year presentation.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual
results could materially differ from those estimates.

Cash and Cash Equivalents

The Company considers cash and cash equivalents to include cash in banks, commercial paper and deposits with financial institutions that can be liquidated without
prior notice or penalty. The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.

Fair Value of Financial Instruments

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

Inventories

The Company's finished goods electronic devices inventories generally are built to order. The Company's communications equipment inventories generally are built
to forecast, which requires production of a larger amount of finished goods in the communications equipment business so that customers can be served promptly. The Company's products consist of
numerous electronic and other

F-7

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

parts,
which necessitates the exercise of detailed inventory management. The Company values its inventory at the lower of the actual cost to purchase or manufacture the inventory
(first-in, first-out) or the current estimated market value of the inventory (net realizable value). The Company performs cycle counts of inventories using an ABC inventory
methodology, which groups inventory into cycle counting categories, or conducts physical inventories at least once a year. The Company regularly reviews inventory quantities on hand and records a
provision for excess and obsolete inventory based primarily on its estimated forecast of product demand and production requirements for the next 12 to 24 months. Additionally, to determine
inventory write-down provisions, the Company reviews product line inventory levels and individual items as necessary and periodically review assumptions about forecasted demand and market
conditions. Any inventory that the Company determines to be obsolete, either in connection with the physical count or at other times of observation, are reserved for and subsequently
written-off. As of December 31, 2007, total inventory reserves amounted to $6.1 million of which $4.4 million, or 24.6% of total inventory, related to the electronic
devices segment and $1.7 million, or 9.8% of total inventory, related to the communications equipment segment.

The
electronics devices and communications equipment industries are characterized by rapid technological change, frequent new product development, and rapid product obsolescence that
could result in an increase in the amount of obsolete inventory quantities on hand. Also, estimates of future product demand may prove to be inaccurate, in which case the Company may have understated
or overstated the provision required for excess and obsolete inventory. Although the Company makes every effort to ensure the accuracy of its forecasts of future product demand, any significant
unanticipated changes in demand or technological developments could have a significant impact on the value of the Company's inventory and its reported operating results.

Property, Plant and Equipment

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

Buildings

50 yearsMachinery, equipment and fixtures

3-7 yearsLeasehold improvements

5 years


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

Deferred Financing Costs

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

Long-Lived Assets

The Company reviews the carrying amount of its long-lived assets for possible impairment whenever events or changes in circumstances indicate that the
carrying amount of the assets may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows
expected to be generated by the asset. If such

F-8

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

assets
are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to sell.

Goodwill and Other Intangible Assets

Statement of Financial Accounting Standards ("SFAS") No. 142,Goodwill and Other Intangible Assets,
disallows the amortization of goodwill and provides for impairment testing of goodwill carrying values on an annual basis or more frequently if an event occurs or circumstances change that would more
likely than not reduce the fair value of a reporting unit below its carrying amount. The Company's reporting units have been identified as electronic devices and communications equipment. The Company
performed its annual required tests of impairment as of December 31, 2007 and 2006 for goodwill in the electronic devices and the communications equipment reporting units. No events or changes
in circumstances occurred between annual tests that would have required an interim goodwill impairment test. Intangible assets with identifiable useful lives are amortized using the
straight-line method over their useful lives.

Definite-lived
intangible assets are stated at cost, less accumulated amortization, and are amortized on the straight-line method over their estimated useful lives ranging
from two to twenty years. The Company periodically reviews the original estimated useful lives of long-lived assets and makes adjustments when appropriate. Intangible assets with finite
useful lives are tested for impairment whenever events or changes in circumstances indicate that an asset's carrying amount may not be recoverable. The Company evaluates its intangible assets for
impairment by comparing the future undiscounted cash flows of the underlying assets to their respective carrying amounts.

Product Warranty Liabilities

Generally, the Company's products carry a standard one-year, limited parts and labor warranty. In certain circumstances, the Company provides a
two-year limited parts and labor warranty on communications test instruments and network access products. The Company offers extended warranties beyond two years for an additional cost to
its customers. Products returned under warranty typically are tested and repaired or replaced at the Company's option. Historically, the Company has not experienced significant warranty costs or
returns.

The
Company records a liability for estimated costs that it expects to incur under the basic limited warranties when product revenue is recognized. Factors affecting the warranty
liability include the number of units sold, historical and anticipated rates of claim and costs per claim. The Company periodically assesses the adequacy of its warranty liability accrual based on
changes in these factors.

Stock-Based Compensation

Effective January 1, 2006, the Company adopted the modified prospective method of SFAS No. 123R, which requires the measurement and recognition of
compensation expense for all stock-based compensation awards made to employees and directors based on estimated fair values.

The
Company estimates the fair value of its stock option plans using the Black-Scholes option pricing model (the "Option Model"). The Option Model requires the use of subjective and
complex assumptions, including the option's expected term and the estimated future price volatility of the underlying stock, which determine 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 the value of the portion of the stock-based awards that are expected to vest with
employees.

F-9

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

Accordingly,
the recognition of stock-based compensation expense beginning January 1, 2006 has been reduced for estimated future forfeitures. SFAS No. 123R requires forfeitures to be
estimated at the time of grant with adjustments recorded in subsequent period compensation expense if actual forfeitures differ from those estimates.

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

2007

2006Dividend yield


None


NoneExpected volatility


83
%

86
%Risk-free interest rate


4.71
%

4.75
%Expected term


7 years


7 yearsWeighted average fair value per share at grant date

$
0.90

$
0.79


Loss Per Share

Loss per share is calculated according to SFAS No. 128,Earnings Per Share. Basic loss per share includes
no dilution and is computed by dividing net income available to common stockholders by the weighted average number of shares outstanding during the year. Diluted loss per share reflects the potential
dilution of securities that could share in the earnings of the Company.

Foreign Currency Translation

The accounts of foreign subsidiaries have been translated using the local currency as the functional currency. Accordingly, foreign currency denominated assets
and liabilities have been translated to United States dollars at the current rate of exchange on the balance sheet date and at the average for the period reported for the statement of operations. The
effects of translation are recorded either within our statement of operations under the caption "other income (expense)" or as a separate part of our net equity under the caption "accumulated other
comprehensive income (loss)." Exchange gains and losses arising from transactions denominated in foreign currencies are translated at the exchange rates applicable on the dates of the transactions and
are included in operations.

Concentration of Credit Risk

Financial instruments, which potentially expose the Company to concentration of credit risk, consist primarily of cash and accounts receivable. The Company places
its cash with high quality financial institutions. At times, cash balances may be in excess of the amounts insured by the Federal Deposit Insurance Corporation.

The
Company's accounts receivable result from sales to a broad customer base. The Company extends credit to its customers based upon an evaluation of the customer's financial condition
and credit history and generally does not require collateral. Accounts receivable are generally due within 30 days in the Company's U.S., England and France operations and are stated net of an
allowance for doubtful accounts. Accounts outstanding for longer than the contractual payment terms are considered past due.
Provisions for uncollectible accounts are made based on the Company's specific assessment of the collectibility of all past due accounts. Credit losses are provided for in the financial statements and
consistently have been within management's expectations. No customer represented 10% or more of the Company's total net sales during 2007 or 2006.

F-10

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

Revenue Recognition

The Company derives revenues from sales of electronic devices and communications equipment products and services. The Company's sales are based upon written
agreements or purchase orders that identify the type and quantity of the item and/or services being purchased and the purchase price. The Company recognizes revenues when shipment of products has
occurred or services have been rendered, no significant obligations remain on the part of the Company, and collectability is reasonably assured based on the Company's credit and collections practices
and policies.

The
Company recognizes revenues from U.S. sales of its electronic devices and communications equipment at the point of shipment of those products. An estimate of warranty costs are
recorded at the time the revenue is recognized. Product returns are infrequent and require prior authorization because sales are final and the Company quality tests its products prior to shipment to
ensure products meet the specifications of the binding purchase orders under which those products are shipped. Normally, when a customer requests and receives authorization to return a product, the
request is accompanied by a purchase order for a repair or for a replacement product.

Revenue
recognition for products and services provided by the Company's subsidiaries in England depends upon the type of contract involved. Engineering/design services contracts
generally entail design and production of a prototype over a term of up to several years, with revenue deferred until each milestone defined in the contract is reached. Production contracts provide
for a specific quantity of products to be produced over a specific period of time. Customers issue binding purchase orders or enter into binding agreements for the products to be produced. The Company
recognizes revenues on these orders as the products are shipped. Returns are infrequent and permitted only with prior authorization because these products are custom made to order based on binding
purchase orders and are quality tested prior to shipment. An estimate of warranty costs are recorded at the time revenue is recognized.

The
Company recognizes revenues for products sold by its French subsidiary at the point of shipment. Customer discounts are included in the product price list provided to the customer.
Returns are infrequent and permitted only with prior authorization because these products are shipped based on
binding purchase orders and are quality tested prior to shipment. An estimate of warranty costs are recorded at the time revenue is recognized.

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

Shipping and Handling Costs

The Company records shipping and handling costs in cost of goods sold. Shipping and handling costs were $320,000 and $163,000 in 2007 and 2006, respectively.

Advertising Costs

Advertising costs are charged to expense as incurred. Advertising costs for 2007 and 2006 were immaterial.

F-11

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

Income Taxes

Income taxes are accounted for using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future
tax consequences of temporary differences between the financial statement and tax bases of assets and liabilities at the applicable tax rates. A valuation allowance is provided when it is more likely
than not that some portion or all of the deferred tax assets will not be realized. The Company evaluates the realizability of its deferred tax assets by assessing its valuation allowance and by
adjusting the amount of such allowance, if necessary. The factors used to assess the likelihood of realization are the Company's forecast of future taxable income and available tax planning strategies
that could be implemented to realize the net deferred tax assets. Failure to achieve forecasted taxable income in applicable tax jurisdictions could affect the ultimate realization of deferred tax
assets and could result in an increase in the Company's effective tax rate on
future earnings. The provision for income taxes represents the tax payable for the year and the change during the year in deferred tax assets and liabilities.

Comprehensive Loss

Comprehensive loss includes all changes in equity during a period except those that resulted from investments by or distributions to the Company's stockholders.
Other comprehensive income refers to revenues, expenses, gains and losses that, under GAAP, are included in comprehensive income, but excluded from net loss as these amounts are recorded directly as
an adjustment to stockholders' equity. The Company's other comprehensive income consists of foreign currency translation adjustments. The following table reflects the components of comprehensive loss
(in thousands):

Year Ended
December 31,2007

2006Net loss

$
(1,928
)
$
(3,615
)Other comprehensive income:Foreign currency translation adjustment


356


1,568Comprehensive loss

$
(1,572
)
$
(2,047
)


NOTE 2INVENTORIES

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

2007

2006Raw materials

$
9,292

$
8,771Work-in-process


4,540


3,588Finished goods


3,956


3,873Reserves


(6,124
)

(5,657
)Total inventories, net

$
11,664

$
10,575


F-12

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

NOTE 3PROPERTY, PLANT AND EQUIPMENT

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

2007

2006Land and buildings

$
419

$
379Machinery, equipment and fixtures


4,582


4,263Leasehold improvements


944


729Capital leases


270


2706,215


5,641Accumulated depreciation


(3,988
)

(3,396
)Total property, plant and equipment

$
2,227

$
2,245


NOTE 4DEBT ISSUANCE COSTS

On November 30, 2007, EMRISE Corporation and its direct subsidiaries, EMRISE Electronics Corporation, CXR Larus Corporation and RO Associates
(collectively, the "Borrowers") entered into a new Credit Facility (see Note 7 and 8). In connection with the new Credit Facility, the company incurred $1.3 million of debt issuance
costs, which in included in "Other assets" in the accompanying consolidated balance sheets and is being amortized over three years, the term of the related financing, using the
straight-line method, which approximates the interest rate method. For 2007, $35,000 of deferred debt issuance costs was amortized to interest expense. Assuming no additions or adjustments
in debt issuance costs, annual amortization of debt issuance costs to interest expense is estimated to be approximately $429,000 in 2008 and 2009 and $393,000 in 2010.

NOTE 5GOODWILL AND INTANGIBLE ASSETS

Goodwill for the Company's reporting units consisted of the following at December 31 (in thousands):

2007

2006Electronic Devices

$
7,295

$
7,161Communications Equipment


5,834


5,834$
13,129

$
12,995


The
Company performed its annual required tests of impairment in accordance with SFAS No. 142,Goodwill and Other Intangible
Assets, as of December 31, 2007 and 2006 for each of its reporting units. No events or changes in circumstances occurred between annual tests that would have required an
interim goodwill impairment test. No additions, disposals or impairment adjustments were made to goodwill balances during 2007.

F-13

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

The
following table reflects changes in our goodwill balances, by segment, for the year ended December 31, 2007 (in thousands):

Electronic
Devices

Communications
Equipment

TotalBalance at December 31, 2006

$
7,161

$
5,834

$
12,995Foreign currency translation


134





134Balance at December 31, 2007

$
7,295

$
5,834

$
13,129


Changes
to goodwill balances were related to foreign currency translation adjustments on foreign goodwill amounts.

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

|                                   |                              | 2007 |       | 2006  |  
|---------------------------------- | ---------------------------- | ---- | ----- | ----- | -
|
|Intangibles with definite lives:   |                              |      |       |       |  
|                                   | Technology acquired          |      | $     | 500   |  
|                                   | Customer relationships       |      |       | 350   |  
|                                   | Covenant-not-to-compete      |      |       | 200   |  
|                                   | Patents                      |      |       | 29    |  
|                                   | Patents-in-progress          |      |       | 96    |  
|                                   | Backlog                      |      |       | 200   |  
|                                   |                              |      |       |       |  
|                                   |                              |      | 1,375 |       |  
|                                   | Accumulated amortization     |      |       | (584  | )
|                                   |                              |      |       |       |  
|                                   | Carrying Value               |      |       | 791   |  
|Intangibles with indefinite lives: |                              |      |       |       |  
|                                   | Trademarks and trade names   |      |       | 850   |  
|                                   |                              |      |       |       |  
|                                   | Total intangible assets, net |      | $     | 1,641 |  
|                                   |                              |      |       |       |  

In
accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets, the Company
reevaluates the carrying value of identifiable intangible and long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be
recoverable. No events or changes in circumstances occurred during 2007 that would have required an impairment analysis to be performed.

Assuming
no additions, disposals or adjustments are made to the carrying values and/or useful lives of the assets, annual amortization expense on intangible assets is estimated to be
approximately $238,000 in 2008 and $221,000 in 2009, 2010, 2011 and 2012. The Company's current intangible assets have a weighted average remaining useful life of approximately 9 years.

F-14

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

NOTE 6ACCRUED LIABILITIES

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

2007

2006Accrued payroll and benefits

$
1,142

$
1,547Advance payments from customers


1,712


1,840Warranty reserve


352


288Other accrued expenses


2,229


1,384Total accrued expenses

$
5,435

$
5,059


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

NOTE 7LINES OF CREDIT

Existing Line of Credit

On November 30, 2007, the Company and its direct subsidiaries, EMRISE Electronics Corporation, CXR Larus Corporation and RO Associates Incorporated
(collectively, the "Borrowers") entered into a Credit Agreement (the "Credit Agreement") with GVEC Resource IV Inc. (the "Lender") providing for a three year credit facility in the aggregate
amount of $23,000,000 (the "Credit Facility") and is secured by accounts receivable, other rights to payment and general intangibles, inventories and equipment.

The
Credit Facility consists of (i) a one year revolving credit facility for up to $7,000,000 that may be extended, at the Company's option, for up to three years (the
"Revolver"), (ii) a three year term loan in an outstanding principal amount of $6,000,000 which was fully funded on November 30, 2007 (the "Term Loan A"); and (iii) a three year
term loan in the amount of $10,000,000 to be used solely for possible acquisitions to be made within 18 months of November 30, 2007 (the "Term Loan B," and together with the Term Loan A,
the "Term Loans"). A portion of the proceeds from the Revolver and the Term Loan A were used to repay existing institutional debt at the time of the closing of the financing and a portion will be used
to fund the Company's on-going working capital requirements.

The
Revolver is formula-based and which generally provides that the outstanding borrowings under the line of credit may not exceed an aggregate of 85% of eligible accounts receivable,
plus 10% of the value of eligible raw materials not to exceed $600,000, plus 50% of the value of eligible finished goods inventory not to exceed $1,500,000, minus the aggregate amount of reserves that
may be established by the Lender.

Interest
on the Revolver is payable monthly. The interest rate is variable and is adjusted monthly 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
consolidated basis including the following: EBITDA, measured on a fiscal quarter-end basis, must not be less than the scheduled amount for each specified period; the debt service coverage
ratio, measured quarterly, must be greater than the lesser of the 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 must not incur capital expenditures in any fiscal year in excess of $500,000. As of December 31, 2007, the Company was in compliance with all of its covenants under the
Revolver.

F-15

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

As
of December 31, 2007, the Company had outstanding borrowings of $4.0 million under the Revolver with remaining availability under the formula-based calculation of
$2.3 million.

Upon
the sale or disposition by the Borrowers or any of their subsidiaries of property or assets, the Borrowers may be obligated to prepay the Revolver and the Term Loans with the net
cash proceeds received in connection with such sales or dispositions to the extent that the aggregate amount of net cash proceeds received, and not paid to the Lender as a prepayment, for all such
sales or dispositions exceed $150,000 in any fiscal year.

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

In
connection with entering into the Credit Agreement, 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 is governed by the terms of the Credit Agreement.

Previous Lines of Credit

On December 1, 2006, EMRISE Corporation, EMRISE Electronics, CXR Larus, RO and Wells Fargo Bank acting through its Wells Fargo Business Credit operating
division ("WFBC") entered into a Credit and Security Agreement ("WFBC credit facility") providing for a revolving line of credit and term loan. The WFBC credit facility provided for a $5,000,000
revolving line of credit that expired on December 1, 2009 and was secured by accounts receivable, other rights to payment and general intangibles, inventories and equipment. The line of credit
was formula-based and generally provided that the outstanding borrowings under the line of credit may not exceed an aggregate of 85% of eligible accounts receivable plus 10% of the value of eligible
finished goods inventory. Interest was payable monthly. The interest rate was variable and adjusted monthly based on the prime rate plus 1%. On November 30, 2007, in connection with entering
into the new Credit Facility, the Company terminated the WFBC credit facility.

As
of December 31, 2006, the Company had balances of $1,978,000 outstanding on the WFBC revolving line of credit and $200,000 outstanding on the term loan. Availability on the
WFBC revolving line of credit was $102,000. As of December 31, 2006, the Company was not in compliance with the loan's financial covenants for net worth and net losses. The Company obtained a
waiver from WFBC for those covenant violations.

As
of December 31, 2006, the Company's foreign subsidiaries had credit facilities, including lines of credit and term loans, with Lloyds TSB Bank PLC and Lloyds TSB
Commercial Finance Limited in England, IFN Finance, Banc National de Paris and Société Générale in France, and Sogelease and Johnan Shinkin
Bank in Japan. At December 31, 2006, the balances outstanding under the Company's England, France and Japan credit facilities were $1,762,000, $1,156,000 and $15,000, respectively. On
November 30, 2007, in connection with entering into the new Credit Facility, the Company terminated these foreign subsidaries' credit facilities.

NOTE 8LONG-TERM DEBT

In connection with entering into the Credit Agreement discussed in Note 7, the Borrowers issued to the Lender a Term Loan A Note dated November 30,
2007 in the principal amount of $6,000,000,

F-16

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

which
was fully funded on November 30, 2007, and a Term Loan B Note dated November 30, 2007 in the principal amount of $10,000,000, to be used solely for possible acquisitions to be made
within 18 months of November 30, 2007, which remained unfunded at December 31, 2007 (collectively, the "Term Notes"). The Term Notes are governed by the terms of the Credit
Agreement. As part of the consideration for issuance of the Credit Agreement, the Company issued warrants to purchase 2.9 million shares of EMRISE common stock (see Note 10) with a fair
value of $1.3 million, which was accounted for as a discount to the Credit Facility and is amortized over the term of the Credit Agreement.

The
Term Notes bear interest at the Base Rate plus 4.25%, subject to a minimum rate of 12.5%, and require interest only payments in the first 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 Notes is payable monthly. The Borrowers may make full or partial prepayment of the Term
Notes provided that any such prepayment is accompanied by the applicable prepayment premium.

At
December 31, 2006, the Company had agreements with several foreign banks that included term borrowings that matured at various dates through 2008. Interest rates on these
borrowings ranged from 3.25% to 7%. On November 30, 2007, in connection with entering into the Credit Facility, the Company terminated these foreign subsidaries' term loans.

The
Company has capital leases relating to capital equipment. The leases all contain bargain purchase options and expire at various dates through December 31, 2017. Capitalized
lease obligations are calculated using interest rates appropriate at the inception of the lease and range from 6% to 18%. Leases are amortized over the lease term using the effective interest method.

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

2007

2006Term Loan A

$
6,000

$
Term Loan B





Term notes payable to U.S. commercial lender


112


200Term notes payable to foreign banks





601Capitalized lease obligations


52


2486,164


1,049Unamortized discount on debt


(1,264
)

4,900


1,049Current portion of long-term debt


(71
)

(516
)Long-term debt

$
4,829

$
533


F-17

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

Principal
maturities related to long-term debt, including loans from stockholders (see Note 15), as of December 31, 2007, were as follows (in thousands):

Year ending December 31,

Term
Loan A

Term notes
payable to
U.S.
commercial
lender

Capitalized
Lease
Obligations

Stockholder
Notes
(Note 15)2008





36

$
35


5212009


600


55


14


5002010


1,080


16


3


2502011


4,320


5





Thereafter











$
6,000

$
112

$
52

$
1,271


NOTE 9STOCK-BASED COMPENSATION

On January 1, 2006, the Company adopted the provisions of SFAS No. 123R under the modified prospective method (see Note 1), which requires
the measurement and recognition of compensation expense for all stock-based compensation awards made to employees and directors based on estimated fair values. A summary of the Company's stock-based
compensation plans is presented below.

At
December 31, 2007, a variety of the Company's stock-based compensation grants or awards were outstanding for employees (including executive officers) and members of the board
of directors. All stock-based compensation plans were approved by the Company's board of directors.

Description of Stock Option Plans

The Company has five stock option plans:



F-18

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)



F-19

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)



Stock
option activity for the years ended December 31, 2007 and 2006 was as follows:

2007

2006Shares
(in 000's)

Weighted
Average
Exercise
Price

Shares
(in 000's)

Weighted
Average
Exercise
PriceOutstanding, beginning of year

1,965

$
1.08

2,108

$
1.05Granted

75

$
1.16

50

$
1.00Exercised(1)

(172
)
$
0.40

(181
)
$
0.54Forfeited (including expirations)

(60
)
$
2.00

(12
)
$
3.13Outstanding, end of year

1,808

$
1.12

1,965

$
1.08Exercisable, end of year

1,733

$
1.12

1,860

$
1.08


---

The
total fair value of options that vested during the years ended December 31, 2007 and 2006, was approximately $72,000 and $213,000, respectively. As of December 31,
2007, the Company had 1.7 million fully-vested stock options, with a weighted average exercise price of $1.12 and remaining term of 5.7 years. The Company expects that 87,000 stock
options (after forfeitures), with a weighted-average exercise price of $1.16 and remaining term of 9.4 years, will vest in the future. The aggregate intrinsic value is approximately
$0.4 million for unvested and vested options at December 31, 2007 based on the Company's average common stock closing price in 2007.

The
Company received $68,000 and $97,000 from the exercise of stock options in 2007 and 2006, respectively. The tax benefit realized was de minimis. For options exercised during the
years ended December 31, 2007 and 2006, the differences between the fair value of the common shares issued and their respective exercise price were approximately $134,000 and $141,000,
respectively.

The
following table summarizes information about stock options outstanding at December 31, 2007:

Options Outstanding

Options ExercisableRange of Exercise Prices

Options
(in 000's)

Weighted
Average
Remaining
Life in Years

Weighted
Average
Exercise
Price

Options
(in 000's)

Weighted
Average
Exercise
Price$0.20 to $1.00

1,013

4.6

$
0.59

720

$
0.83$1.01 to $2.00

795

7.5

$
1.79

1,013

$
1.32Total options

1,808






1,733


Total
stock-based compensation expense included in wages, salaries and related costs was $69,000 and $131,000 for the year ended December 31, 2007 and 2006, respectively. These
compensation expenses were charged to selling, general and administrative expenses. As of December 31, 2007, the Company had $41,000 of total unrecognized compensation expense related to stock
option grants, which will be recognized over the remaining weighted average period of two years.

F-20

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

NOTE 10WARRANTS

During 2006, the Company issued warrants to purchase up to 25,000 shares of common stock at an exercise price of $1.21 per share for services rendered or to be
rendered. The estimated value of the warrants was $15,000 and was calculated using the Black-Scholes pricing model with the following assumptions: risk-free interest rate of 4.25%,
expected life of 3 years, no dividend yield and an expected volatility of 80%.

During
2007, the Company issued to a financial advisor a five-year warrant to purchase up to 31,250 shares of the Company's common stock on a cash or cashless basis at an
exercise price equal to $1.15 per share. The estimated fair value of the warrants was $17,000, which was calculated
using the Black-Scholes pricing model with the following assumptions: risk free interest rate of 4.5%, expected life of 2.5 years, no dividend yield and an expected volatility of 75%.

In
connection with entering into the Credit Facility (discussed in note 7), the Company issued a seven year warrant to Private Equity Management Group LLC to purchase up to
2.9 million shares of the Company's common stock on a cash or cashless basis at an exercise price of $1.10 per share. The estimated fair value of the warrants was $1.3 million, which was
calculated using the Black-Scholes pricing model with the following assumptions: risk free interest rate of 3.1%, expected life of 7 years, no dividend yield and an expected volatility of 59%.

The
following table reflects warrants outstanding and related activity for warrants authorized for issuance by the Board of Directors to certain officers, directors, stockholders, key
employees and other parties:

|                                         |  | Number
of Shares
(in 000's) |   | Weighted
Average
Exercise
Price |      | Weighted
Average
Remaining
Life in Years |     | Average
Intrinsic
Value
(in-the-money)
Warrants
|---------------------------------------- |  | --------------------------- | - | ------------------------------- | ---- | ---------------------------------------- | --- | -----------------------------------------------
|Balance outstanding at December 31, 2005 |  | 4,487                       |   | $                               | 1.63 |                                          |     |                                                
|Warrants issued                          |  | 25                          |   | $                               | 1.21 |                                          |     |                                                
|Warrants exercised                       |  | (351                        | ) | $                               | 0.82 |                                          |     |                                                
|                                         |  |                             |   |                                 |      |                                          |     |                                                
|Balance outstanding at December 31, 2006 |  | 4,161                       |   | $                               | 1.71 |                                          |     |                                                
|Warrants issued                          |  | 2,941                       |   | $                               | 1.10 |                                          |     |                                                
|Warrants exercised                       |  |                            |   |                                 |      |                                          |     |                                                
|Warrants cancelled                       |  | (225                        | ) | $                               | 1.33 |                                          |     |                                                
|                                         |  |                             |   |                                 |      |                                          |     |                                                
|Balance outstanding at December 31, 2007 |  | 6,877                       |   | $                               | 1.46 |                                          | 4.1 |                                                
|                                         |  |                             |   |                                 |      |                                          |     |                                                

There
were no warrants outstanding at December 31, 2007 where the exercise price was below the market price for the Company's shares (in-the-money).

F-21

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

NOTE 11LOSS PER SHARE

Basic loss per share is computed by dividing net loss by the weighted average common shares outstanding during a period. Diluted loss per share is based on the
treasury stock method and includes the dilutive effect of stock options and warrants outstanding during the period. Common share equivalents have been excluded where their inclusion would be
anti-dilutive. As a result of the loss incurred by the Company for all periods presented, the potentially dilutive common shares have been excluded because their inclusion would have been
anti-dilutive. The following table illustrates the computation of basic and diluted loss per share for the years ended December 31, 2007 and 2006 (in thousands, except per share
amounts):

2007

2006NUMERATOR:Net loss

$
(1,928
)
$
(3,615
)DENOMINATOR:Basic weighted average common shares outstanding


38,176


37,981Effect of dilutive securities:Dilutive stock options and warrants





Diluted weighted average common shares outstanding


38,176


37,981Basic loss per share

$
(0.05
)
$
(0.10
)Diluted loss per share

$
(0.05
)
$
(0.10
)


The
following table shows the common stock equivalents that were outstanding as of December 31, 2007 and 2006, but were not included in the computation of diluted earnings per
share as a result of the loss incurred by the Company or because the options' or warrants' exercise price was greater than the average market price of the common shares and, therefore, the effect
would have been anti-dilutive:

Number of
Shares

Range of
Exercise Price
Per ShareAnti-dilutive common stock options:As of December 31, 2007

795,000

$0.20 - $2.00As of December 31, 2006

780,000

$1.13 - $2.00Anti-dilutive common stock warrants:As of December 31, 2007

6,877,000

$0.85 - $2.00As of December 31, 2006

4,111,000

$1.30 - $2.00


NOTE 12INCOME TAXES

The Company files a consolidated U.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 the Company and its domestic subsidiaries.

F-22

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

The
Company's income before provision for income taxes was generated from the U.S. and foreign operations for the years ended December 31 as follows (in thousands):

2007

2006Earnings (loss) before income taxes:U.S.

$
(5,365
)
$
(4,689
)Foreign


4,171


1,693Earnings (loss) before income taxes

$
(1,194
)
$
(2,996
)


The
Company's provision for income taxes consisted of the following for the years ended December 31 (in thousands):

2007

2006CurrentFederal

$


$
State


12


36Foreign


666


548Total current


678


584DeferredFederal





109State





Foreign


56


(74
)Total deferred


56


35Total provision for income taxes

$
734

$
619


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

2007

2006Federal income tax at statutory rates

$
(1,498
)
$
(1,128
)State income taxes, net of federal benefit


(131
)

(143
)Foreign income taxes


226


(101
)Changes in valuation allowances


2,139


2,024Permanent differences


(2
)

(33
)$
734

$
619


Deferred
income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used
for income tax

F-23

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

purposes.
Significant components of the Company's deferred tax assets and liabilities were as follows as of December 31 (in thousands):

2007

2006Current deferred tax assets:Allowance for doubtful accounts

$
72

$
38Inventory reserves and uniform capitalization


1,081


1,065Other accrued liabilities


621


3191,774


1,422Valuation allowancecurrent deferred tax assets


(1,574
)

(1,251
)Total current deferred tax assets


200


171Long-term deferred tax assets:Depreciation on property, plant & equipment


370


59Deferred compensation


218


218Alternative minimum tax credit carryforwards


142


142Capital loss carryforwards


136


136Net operating loss carryforwards


7,988


5,8358,854


6,390Valuation allowancelong-term deferred tax assets


(8,237
)

(5,835
)Total long-term deferred tax assets


617


555Deferred tax liabilities:Intangible assets other than goodwill


(904
)

(1,053
)Total deferred tax liabilities (long-term)


(904
)

(1,053
)Net deferred tax asets (liabilities)

$
(87
)
$
(327
)


The
Company had federal and state net operating loss carryforwards of approximately $26.4 million and $15.5 million as of December 31, 2007 and 2006, respectively,
that expire at various dates through 2028. As of December 31, 2007 and 2006, the Company recorded a valuation allowance on the deferred tax asset. Management believes sufficient uncertainty
exists regarding the realizability of the deferred tax asset items and that a valuation allowance is required. Management considers projected future taxable income and tax planning strategies in
making this assessment. For the years ended December 31, 2007 and 2006, management recorded increases in its valuation allowances of $2.7 million and $1.9 million, respectively,
based on the domestic book income in 2007 and 2006 and projections for future taxable income over periods that the deferred assets are deductible. The amount of the deferred tax assets considered
realizable, however, could materially change in the near future if estimates of future taxable income during the carryforward period are changed.

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

F-24

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

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 to the Company's liability for unrecognized income tax
benefits. At the time of adoption and as of December 31, 2007, the Company had recorded no net unrecognized tax benefits.

The
Company recognizes interest and penalties related to uncertain tax positions in interest expense and selling, general and administrative expense, respectively, in the condensed
consolidated statements of operations and comprehensive income. No interest or penalties were recognized during 2007. As of December 31, 2007, the Company had nothing accrued for interest and
penalties.

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

NOTE 13OPERATING SEGMENTS

The Company has two reportable operating segments: electronic devices and communications equipment. The electronic devices segment manufactures and markets
digital and rotary switches, electronic power supplies, radio frequency ("RF") and microwave devices and subsystem assemblies. The electronic devices segment consists of EMRISE Electronics Corporation
and its subsidiaries, which offer the same or similar products to similar customers. The communications equipment segment designs, manufactures and distributes network access products and timing and
synchronization products. The communications equipment segment consists of operating entities CXR Larus Corporation and CXR Anderson Jacobson, which offer the same or similar products to similar
customers. Both segments operate in the U.S., European and Asian markets, but have distinctly different customers, design and manufacturing processes and marketing strategies. Each segment has
discrete financial information and a separate management structure. The Company evaluates performance based upon profit or loss from operations before income taxes exclusive of nonrecurring gains and
losses. The Company accounts for intersegment sales at pre-determined prices negotiated between the individual segments.

F-25

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

Included
in the Company's reconciliation of segment financial data to the consolidated amounts is unallocated corporate expenses. Selected financial data for each of the Company's
operating segments reconciled to the consolidated totals is shown below (in thousands):

Year ended December 31,2007

2006Net salesElectronic devices

$
36,471

$
32,702Communications equipment


14,874


13,682Total

$
51,345

$
46,384Gross profitElectronic devices

$
11,602

$
11,747Communications equipment


5,748


5,224Total

$
17,350

$
16,971Depreciation and amortizationElectronic devices

$
895

$
922Communications equipment


236


232All other


23


36Total

$
1,154

$
1,190Operating income (loss)Electronic devices

$
2,845

$
3,635Communications equipment


188


(1,031
)Corporate and other


(3,867
)

(4,835
)Total

$
(834
)
$
(2,231
)


|
|

December 31, 2007

December 31, 2006Total assetsElectronic devices

$
29,835

$
27,514Communications equipment


11,851


15,912Corporate and other


6,642


1,359Total

$
48,328

$
44,785


No
customer in either segment accounted for 10% or more of net sales during 2007 or 2006.

F-26

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

The
Company's segments operate in different geographic areas. The following table is a summary of the Company's net sales by geographic area for the year ended December 31 (in
thousands):

2007

2006United States

$
13,786

$
16,952England


26,484


21,126France


9,645


7,120Japan


1,430


1,186Total net sales

$
51,345

$
46,384


Sales
and purchases between geographic areas have been accounted for on the basis of prices set between the geographic areas, general at cost plus 40%. Net sales by geographic area have
been determined based upon the country from which the product was shipped.

NOTE 14RETIREMENT PLANS

The Company maintains certain defined contribution retirement plans covering substantially all U.S. domestic employees. The Company's contributions to these
retirement plans were $33,000 and $34,000 in the years ended December 31, 2007 and 2006, respectively.

The
Company's subsidiary in France has a defined benefit pension plan. The plan is an unfunded plan. As such, no contributions were made in either of the periods presented. The plan does
not have plan assets. Employee benefits are based on years of service and the employees' compensation during their employment. The actuarially computed components of net periodic benefit cost included
the following components for the years ended December 31, (in thousands):

2007

2006Service Costs

$
14

$
11Interest Costs


10


7Amortization of unrecognized loss





Expected return on plan assets





Net periodic pension expense

$
24

$
18


F-27

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

The
following table sets forth the funded status and amounts recognized in the Company's consolidated statement of operations for the years ended December 31, (in thousands):

2007

2006Change in benefit obligation:Projected benefit obligation, beginning of year

$
208

$
163Service cost


14


11Interest cost


10


7Benefits paid





Actuarial loss/(gain)


4


Effect of foreign currency translation


25


27Projected benefit obligation, end of year

$
261

$
208Change in plan assets:Plan assets, beginning of year

$


$
Actual return on plan assets





Employer contribution





Benefits paid





Plan assets, end of year

$


$
Unfunded Status

$
261

$
208Unrecognized (gain)/loss


(22
)

(16
)Net amount recognized

$
239

$
192


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

2007

2006Discount rate

5.00
%
4.00
%Rate of compensation increase

2.00
%
2.00
%


NOTE 15COMMITMENTS AND CONTINGENCIES

Leases

The Company conducts most of its operations from leased facilities under operating leases that expire at various dates through 2016. The leases generally require
the Company to pay all maintenance,
insurance and property tax costs and contain provisions for rent increases. Total rent expense, net of sublease income, for 2007 and 2006 was approximately $1.7 million and $1.5 million,
respectively.

F-28

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

The
future minimum rental payments required under operating leases that have initial or remaining noncancelable lease terms in excess of one year are as follows:

Year ending December 31,

Amount2008

$
1,5292009


1,2412010


1,0832011


8282012


83Thereafter


$
4,764


Litigation

The Company is not currently a party to any material legal proceedings. However, the Company and its subsidiaries are, from time to time, involved in legal
proceedings, claims and litigation arising in the ordinary course of business. While the amounts claimed may be substantial, the ultimate liability cannot
presently be determined because of considerable uncertainties that exist. Therefore, it is possible the outcome of such legal proceedings, claims and litigation could have a material effect on
quarterly or annual operating results or cash flows when resolved in a future period. However, based on facts currently available, management believes such matters will not have a material adverse
effect on the Company's consolidated financial position, results of operations or cash flows.

NOTE 16RELATED PARTIES

The Company issued promissory notes, dated July 13, 2004, to two former stockholders of CXR Larus Corporation (formerly Larus Corporation) totaling
$3.0 million. These notes are subordinated to the Company's bank debt and are payable in 72 equal monthly payments of principal plus interest at the 30-day LIBOR plus 5% with a
maximum interest 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, 2007, the 30-day LIBOR was
5.02%. Future maturities of notes payable to stockholders are $521,000 in 2008, $500,000 in 2009 and $250,000 in 2010. Interest paid on these notes was $127,000 and $152,000 for the year ended
December 31, 2007 and 2006, respectively.

Additionally,
the Company entered into an above-market real property lease with the two former stockholders of CXR Larus Corporation. The lease represented an obligation that exceeded
the fair market value by approximately $756,000. The lease term is for 7 years and expires on June 30, 2011. It is renewable for a 5-year term priced under market conditions.
The base rent is based on a minimum rent of $.90 per square foot per month, which is $27,000 monthly or $324,000 per year, subject to monthly adjustments of the interest rate based on the
Federal Reserve Discount Rate that match the lessor's variable interest rate mortgage payments on the building. The maximum increase in any year is 1.5%, with a cumulative maximum increase of 8% over
the life of the lease. The increases apply to that portion of the rent that corresponds to the interest portion of the lessor's mortgage. Lease payments paid to the related parties during 2007 and
2006 totaled $439,000 and $456,000, respectively. Future minimum lease payments under the operating lease payable to the stockholders are included in Note 14.

F-29

---



EMRISE CORPORATION

Notes to Consolidated Financial Statements (Continued)

The
Company obtains consulting services from Jason Oliva, a related party. Payments made to Mr. Oliva for these services were $31,000 during the year ended December 31,
2007. No payments were made to Mr. Oliva for the year ended December 31, 2006.

There
are no guarantees by officers or fees paid to officers or loans to or from officers of the Company.

NOTE 17RECENT ACCOUNTING PRONOUNCEMENTS

On January 1, 2007, the Company adopted Financial Accounting Standards Board ("FASB") Financial Interpretation No. ("FIN") 48, Accounting for Uncertainty in
Income Taxesan interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting for
the uncertainty in recognizing income taxes in an organization in accordance with FASB Statement No. 109 by providing detailed guidance for financial statement recognition, measurement and
disclosure involving uncertain tax positions. FIN 48 requires an uncertain tax position to meet a more-likely-than-not recognition threshold at the effective
date to be recognized both upon the adoption of FIN 48 and in subsequent periods. The implementation of FIN 48 did not have a material effect on the Company's financial statements.

In
February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities. SFAS
No. 159 permits an entity to irrevocably elect fair value on a contract-by-contract basis as the initial and subsequent measurement attribute for many financial assets
and liabilities and certain other items including insurance contracts. Entities electing the fair value option would be required to recognize changes in fair value in earnings and to expense upfront
cost and fees associated with the item for which the fair value option is elected. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is evaluating
the effect that adoption of SFAS No. 159 would have on its financial condition or results of operations.

In
September 2006, the FASB issued SFAS No. 157,Fair Value Measurements. This new statement provides a single definition of fair
value, together with a framework for measuring it, and requires additional disclosure about the use of fair value to measure assets and liabilities. SFAS No. 157 also emphasizes that fair value
is a market-based measurement, not an entity-specific measurement, and sets out a fair value hierarchy, with the highest priority being quoted prices in active markets. The required effective date of
SFAS No. 157 is the first quarter of 2008. The adoption of SFAS No. 157 is not expected to have a material effect on the Company's consolidated financial statements.

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

F-30

---





SIGNATURES

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

| |  | EMRISE CORPORATION
| |  | ------------------
| |  | By:               
| |  | By:               

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the
dates indicated.

|Signature                                             |  | Capacity                                                                                             |  | Date          
|----------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------- |  | --------------
|                                                      |  |                                                                                                      |  |               
|/s/CARMINE T. OLIVACarmine T. Oliva                   |  | Chairman of the Board, President, Chief Executive Officer (principal executive officer) and Director |  | March 31, 2008
|/s/D. JOHN DONOVAND. John Donovan                     |  | Vice President Finance and Administration (principal financial officer)                              |  | March 31, 2008
|/s/LAURENCE P. FINNEGAN, JR.Laurence P. Finnegan, Jr. |  | Director                                                                                             |  | March 31, 2008
|/s/OTIS W. BASKINOtis W. Baskin                       |  | Director                                                                                             |  | March 31, 2008
|/s/RICHARD E. MAHMARIANRichard E. Mahmarian           |  | Director                                                                                             |  | March 31, 2008

49

---





EMRISE CORPORATION  EXHIBITS ATTACHED TO THIS REPORT

|Exhibit
Number |  | Description                                                                                                                                                                                     
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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  

50

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