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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

(Mark One)

Commission file number: 1-10346

EMRISE CORPORATION

(Exact name of registrant as specified in its charter)

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

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

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 x

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 x

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 x   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. x

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):

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

The aggregate market value of the voting common equity held by nonaffiliates of the registrant, computed by reference to the $2.44 closing sale price of such stock on June 30, 2008, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $25,000,000.  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 April 6, 2009 was 10,204,000.

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 30, 2009.

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EMRISE CORPORATION

ANNUAL REPORT ON

FORM 10-K

FOR THE YEAR ENDED DECEMBER 31, 2008

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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 is www.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.

Recent Business Highlights

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

On March 20, 2009, EMRISE completed the sale of substantially all the assets of ECC’s Digitran division and all the capital stock of ECC’s Tokyo based wholly-owned subsidiary, XCEL Japan Ltd., which primarily acted as a sales office for the Digitran division in Japan and other countries in Asia, to Weymouth, MA-based Electro Switch Corp.  In this Report we refer to the businesses of the Digitran Division and XCEL Japan, Ltd. as the “Digitran Operations,” and we refer to the sale of the Digitran division and XCEL

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Japan, Ltd. as the “Digitran Transaction.”  Our Digitran division, located in Rancho Cucamonga, CA, manufactured, marketed and sold electro-mechanical digital and new patented technology very low profileTM rotary switches for the worldwide aerospace, defense and industrial markets.  The Digitran division was classified within out electronic devices business segment and is included in the Business and Industry Description provided below.  The Digitran Transaction is a milestone in our previously announced strategy to divest non-core businesses and increase our focus on our core competencies.

Business and Industry Description

EMRISE designs, manufactures and markets proprietary electronic devices and communications equipment for aerospace, defense, industrial, and communications applications. We currently have operations in the U.S., England, and France.  We organize our business in two operating segments: electronic devices and communications equipment. In 2008, our electronic devices segment contributed approximately 75% of overall net sales while the communications segment contributed approximately 25% of overall net sales. Our subsidiaries within our electronic devices segment design, develop, manufacture and market electronic, RF and microwave devices for defense, aerospace and industrial markets.  Our subsidiaries within our communications equipment segment design, develop, manufacture and market network access equipment and network timing and synchronization products, for communications applications in defense, public and private networks and industrial markets.

Electronic Devices

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

·                  Power Systems.  Our power systems product category is comprised of high and low voltage, high specification, high reliability custom and standard power conversion products designed for hostile environments.  These products are used predominately in the defense, commercial aerospace, industrial and communications markets.

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

Prior to March 20, 2009, our electronic devices segment also included the Digitran Operations that were sold in connection with the Digitran Transaction.

The electronic devices segment is primarily “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, and 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 installed in new commercial aircraft as well as being retrofitted into existing commercial aircraft.

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

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Communications Equipment

Within our communications equipment segment we produce 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 this segment:

·                  Network Access.  Our network access product category is comprised of a wide range of LAN/WAN interconnection equipment and systems over copper, fiber or wireless networks, covering various speeds as required by our customers.  We provide a combination of proprietary products and third party products to meet customer requirements.  Products are targeted to key markets such as the military, utilities, government administration, and point of sale and service providers primarily in Europe and North Africa.

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

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 the 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.

Growth in our communication segment has been and is likely to continue to be impacted by the recent economic conditions as many of our communication products are deemed to be capital expenditures by our customers and many companies in this industry have publicly announced, plans to reduce capital expenditures and/or to defer significant purchases due to current economic conditions.  We continue to sell and ship products on a regular basis to most of our existing customers in this segment, but we have experienced a decline in new orders and we do not expect growth rates in 2009 to be as robust as we had expected.  When the economy does recover, we expect the communications equipment segment to benefit from an expected increase in customer needs to enhance and improve their networks and timing systems, especially in response to the proliferation of video traffic over public and private networks.

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Business Strategy

We pursue a product and geographic diversification strategy, balancing the risks of each of our business segments. We accomplish this by operating international business units to maximize the return on our international presence in the U.S. and Europe and also by identifying markets where we have specific expertise. Our strategy is to increase revenue and earnings, while continuing to focus on refining our core businesses which are (i) electronic devices including RF and microwave devices and custom power supplies and (ii) communications equipment including network access systems and network timing and synchronization equipment.  In order to do so, EMRISE is implementing the following three-point growth strategy:

·                  Focus on the continued development of our core electronic devices business within the defense and commercial aerospace market through the introduction of new, unique and market leading products, the development of our existing customer base and the expansion of geographical markets.

·                  Focus on the development of an expanded range of synchronization and timing systems for the U.S. and international markets while supplementing our line of transmission and network access products with higher bandwidth technologies and building on our knowledge and experience of secure encryption to address new markets and broaden product application through added features.

·                  Expand through mergers and/or acquisitions which provide synergistic opportunities to leverage our existing product and customer base while at the same time selling or disposing of non-core businesses or product lines that are inconsistent with our higher growth core businesses.

Our overall business strategy is to provide high quality service to our customers, to provide timely products that solve the needs of our customers, and to promptly react to changes in the marketplace.  We believe that our relatively small size (as compared to many of our competitors), our relatively quick time from development to production, and our unique technology and product offerings provide us with a strategic advantage in this regard.  Additionally, we are focusing our product offerings within high growth markets such as high volume military programs, 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 plan to continue to expand our military and defense business, which has formed a large and stable platform for our electronic devices business.  In particular, we plan to focus on high growth, high volume programs in the RF and microwave device areas, such as radar and signal jamming applications.  In addition, we plan to continue to seek opportunities for synergistic and accretive acquisitions.

We expect to continue to increase our sales in the IFE&C market.  This increase is expected to be driven by both new commercial aircraft being fitted with the latest IFE&C technology as well as by ongoing retrofitting of existing commercial aircraft with the newer IFE&C systems.  Virgin America, Delta and Continental, among others, now offer customers a wide range of in-flight entertainment features 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 long-haul domestic U.S. flights.  Most domestic and international carriers have announced plans to upgrade their fleets with some form of new IFE&C systems, including new features such as broadband, email and internet especially for long-haul domestic and/or international routes.

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

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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.  When the economy does recover, we expect our timing and synchronization product line to benefit from an increase in customer needs to enhance and improve the timing systems within their existing networks.

Customers

We sell our commercial and military electronic devices primarily to original equipment manufacturers (“OEMs”), including manufacturers of aerospace and defense systems and industrial instruments.  During 2008, our top five electronics devices customers in terms of revenues were Panasonic, Rockwell Collins, Inc., Selex Airborne Systems, ITT and Essential Components.  We sell our communications equipment to public, private and corporate telecommunications service providers and end users, including telephone companies, cable service providers, utility companies and numerous other communications service providers.  During 2008, our top five communications equipment customers, in terms of revenues, were Power & Telephone, Harris Corporation, Cherry & White and Siemens.

We have a well diversified customer base for both our electronic device products and our communications equipment products.  During 2008 and 2007, 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 supplemented by a small direct sales force and, in some cases, a network of independent sales representatives or distributors.  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 training and ongoing professional development and education to our employees, which we believe significantly enhances the ability of our sales and marketing staff to build long-standing customer relationships as they are more consultative in nature and can communicate back to us valuable input on systems and features that 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 OEMs and system integrators in the military and commercial aerospace and 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 5 years.  We obtain revenues through long-term purchase orders and repeat business from our existing customers, by marketing 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, the signal jamming market for military applications and new geographic markets.

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 the equivalent on a land or sea based system.  A further development or prototyping phase may follow to meet additional requirements.  This can lead to lengthy development and approval cycles and very long prototype phases, sometimes spanning several years, prior to the product entering production.  As a result of these long development and 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.  Further, delays associated with potential customers’ internal approval and contracting procedures, procurement practices may cause potential sales of our electronic devices products to be delayed or foregone.  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. As a result, once qualified, our products typically enjoy a long production life.

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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 equipment primarily to private network operations and 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 periodic 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, the quality of our products, our ability to quickly address and adapt to individual customer requirements and to the overall marketplace, the strength of our distribution channels, and our compliance with government and industry standards.

The electronic devices market is highly fragmented and is comprised 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 and will continue to act as barriers to entry for potential competitors.  This is particularly true in the military and defense markets which have high barriers to entry after a product has been qualified.  Competition for development programs includes multinational and local engineering and manufacturing companies including customer in-house capabilities.  Competitors in this segment include Herely, Aeroflex, Cobham, Vicor and Interpoint, 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 products and RAD, Zhone/Paradyne, Adtran 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 customer needs.

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Backlog

At December 31, 2008, our backlog of firm, unshipped orders was approximately $34.7 million, up from $25.3 million a year ago, largely due to the additional backlog associated with ACC, which was not included in the prior year backlog amount.  This backlog was related approximately 97% 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 3% to our communications equipment business.  Of these backlog orders, we anticipate fulfilling approximately 75% of our electronic devices orders and 100% of our communications equipment orders in 2009.  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.  We offer extended warranties beyond the standard one or two year warranty, as may be applicable, 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 specifications, materials or workmanship will not arise in the future.

Product Development and Engineering

Our product development and engineering activities during 2008 and 2007 primarily related to new product development for network access and timing and synchronization products, our recently divested rotary switch product line, RF frequency control products and power conversion devices.  We expended $3.1 million in 2008 and $2.8 million in 2007 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 on existing and/or future anticipated orders.  We continually review and evaluate technological and regulatory changes that may 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 communications equipment including network access products and communication timing and synchronization products generally are assembled from outsourced subassemblies, with final assembly, configuration and quality testing typically performed in house.  We believe that outsourcing certain aspects of manufacturing, especially full assemblies, lowers our 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 outsource manufacturing processes depending on the product, application and volume.  We maintain broad mechanical and electronic assembly capabilities such as fabrication, machining and surface mount technology, all of 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 and/or large volume production orders 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

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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 five 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 historically secured U.S. and foreign patents for various products , primarily related to our former Digitran Operations, with the U.S. Patent and Trademark Office and in the European Union, Japan, Canada and Brazil, when we deemed it advantageous to do so.  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 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

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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 April 6, 2009, we employed approximately 360 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 2008 and 2007 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 $7.4 million net loss for 2008, including a write off of intangible and goodwill assets of $6.6 million, and a $1.9 million net loss for 2007. 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.

The current global financial crisis and uncertainty in global economic conditions may have significant negative effects on our customers and our suppliers and may therefore affect our business, results of operations, and financial condition.

The current global financial crisis - which has included, among other things, significant reductions in available capital and liquidity from banks and other providers of credit, substantial reductions and/or fluctuations in equity and currency values worldwide, and concerns that the worldwide economy may enter into a prolonged recessionary period - may have a significant negative effect on our business and operating results.  The potential effects of the current global financial crisis are difficult to forecast and mitigate. As a consequence, our operating results for a particular period are difficult to predict, and, therefore, prior results are not necessarily indicative of results to be expected in future periods.

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

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

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

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

The current global financial crisis and uncertainty in global economic conditions could prevent us from accurately forecasting demand for our products which could adversely affect our operating results or market share.

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

The current global financial crisis and uncertainty in global economic conditions increase the risk that we could suffer unrecoverable losses on our customers’ accounts receivable which would adversely affect our financial results.

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

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

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

We have a significant amount of debt outstanding under our credit facility with our senior lender which could have negative consequences for us.  In the event of a default under our credit facility, our lender may limit future availability under our revolving line of credit and/or may accelerate payment of all principal balances under this facility. Any of these conditions could have a material adverse effect on our operation and /or our ability to conduct business after that date.

We currently use a significant portion of our operating income for debt service. Our leverage could make us vulnerable to an increase in interest rates or a downturn in the operating performance of our business or a decline in general economic conditions. We have approximately $13.1 million in secured debt outstanding as of April 6, 2009.

This amount of indebtedness could have negative consequences for us, including:

·      limitations on our ability to obtain financing in the future;

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

·      this level of indebtedness may limit our flexibility to deal with changing economic, business and competitive conditions; and

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

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

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

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

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

During 2008, the sale of electronic devices accounted for approximately 75% of our total net sales, and the sale of communications equipment and related services accounted for approximately 25% 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 and can include long-term purchase orders or commitments.  However, typically 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.

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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.

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 security 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 “Item 9A(T) 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.

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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, 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 EEC and has developed personal contacts and other skills that we rely upon in connection with our financing, acquisition and general business strategies. 

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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 provides us with extensive experience in financial reporting and compliance matters.  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.

Our results of operations could be adversely affected as a result of impairments of goodwill and other intangible assets which may cause the price of our common stock to fluctuate or decline.

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

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 acquisition 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.

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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. 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.  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 stockholders. 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 62.0% and 56.7% of our net sales in 2008 and 2007, 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. Heightened security from terrorist attacks in the U.S. and abroad and the increasing risk of extended international military conflicts may adversely impact our international sales and could make our international operations more expensive. International operations are subject to many other inherent risks, including but not limited to:

·                  political, social and economic instability;

·                  exposure to different business practices and legal standards, particularly with respect to intellectual property;

·                  natural disasters and public health emergencies;

·                  nationalization of business and blocking of cash flows;

·                  trade and travel restrictions;

·                  the imposition of governmental controls and restrictions;

·                  burdens of complying with a variety of foreign laws;

·                  import and export license requirements and restrictions of the U.S. and each other country in which we operate;

·                  unexpected changes in regulatory requirements;

·                  foreign technical standards;

·                  changes in taxation and tariffs;

·                  difficulties in staffing and managing international operations;

·                  fluctuations in currency exchange rates;

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

·                  potentially adverse tax consequences.

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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, 2008, we had $34.7 million in backlog orders for our products, which amount includes $1.5 million of backlog related to our prior Digitran Operations.  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 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.

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.

Our subsidiaries in England and France prepare their financial statements in the relevant local foreign currency.  In order to be included in our consolidated financial statements, the 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 62.0% and 56.7% of our net sales for 2008 and 2007, respectively.  We use derivatives to manage foreign currency rate risk for 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 a $269,000 loss for 2008 and a $83,000 gain for 2007.

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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 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 2008, the high and low closing sale prices of a share of our common stock were $3.41 and $1.05, respectively, which amount reflects a 1 for 3.75 reverse split of our common stock that we completed in November 2008.  Our stock price since the reverse split has exhibited such volatility and may continue to do in the future.  In addition, market price of our common stock may continue to fluctuate in response to the following factors, many of which are beyond our control:

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

·                  general global economic weakness;

·                  economic conditions specific to the electronic devices or communications equipment industries;

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

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

·                  third parties’ infringement of our intellectual property rights;

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

·                  foreign currency translations gains or losses;

·                  regulatory developments;

·                  fluctuations in our quarterly or annual operating results;

·                  additions or departures of key personnel;

·                  future sales of our common stock or other securities; and

·                  perception and confidence of investors regarding future prospects for EMRISE.

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.

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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 April 6, 2009, we had outstanding 10.2 million shares of common stock and options and warrants to purchase an aggregate of 2.5 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.

Item 2.                       Properties.

As of April 6, 2009, we leased or owned approximately 153,000 square feet of administrative, engineering, production, storage and shipping space.  All of this space was leased from 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 April 6, 2009:

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 2009.  However, we will continue to evaluate the purchase or lease of additional properties, as our business requires.

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Item 3.                       Legal Proceedings.

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

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

None

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PART II

Item 5.                       Market for Registrant’s Common Equity, Related Stockholder Matters 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.”  On November 19, 2008, we completed a 1 for 3.75 reverse split of our common stock.  The table below shows, for each fiscal quarter presented, the high and low closing prices on NYSE Arca for shares of our common stock.  The prices for periods prior to November 19, 2008 have been retroactively restated as if the reverse stock split had occurred as of January 1, 2007.  The prices shown reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions.

As of April 6, 2009, we had outstanding 10,204,079 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 April 6, 2009, the closing sale price of our common stock on NYSE Arca was $1.45 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 and by our lender, GVEC Resource IV, Inc.  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.

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Recent Sales of Unregistered Securities

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

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

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

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:

·                  the projected growth or contraction in the electronic devices and communications equipment markets in which we operate;

·                  our strategies for expanding, maintaining or contracting our presence in these markets;

·                  anticipated trends in our financial condition and results of operations;

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

·                  our ability to secure long term purchase orders;

·                  our ability to deliver against existing or future backlog;

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

·                  failure to comply with existing or future government or industry standards and regulations;

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

·                  our ability to successfully locate, acquire and integrate any possible future acquisitions;

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

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

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

We do 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.

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Recent Transactions

On August 20, 2008, EMRISE and EEC completed the acquisition of all of the capital stock of CCI and, its subsidiary, ACC.  ACC, based in Eatontown, New Jersey, is a supplier of high performance RF and microwave devices and subsystems that for more than 26 years has been serving the military, aerospace, commercial and instrumentation markets.  We believe that the acquisition of ACC will strengthen our geographic presence, resources and new products to allow us to grow domestically and internationally and to increase sales to U.S. military and other government and commercial organizations.  ACC operates within the electronic devices business segment of EMRISE.  The results of operations of ACC since August 20, 2008 are included in our Consolidated Statement of Operations for the year ended December 31, 2008.

On March 20, 2009, EMRISE completed the sale of substantially all the assets of ECC’s Digitran division and all the capital stock of ECC’s wholly-owned subsidiary, XCEL Japan Ltd., which primarily acted as a sales office for the Digitran division, to Weymouth, MA-based Electro Switch Corp.  In this report we refer to the businesses of the Digitran Division and XCEL Japan, Ltd. as the “Digitran Operations,” and we refer to the sale of the Digitran division and XCEL Japan, Ltd. as the “Digitran Transaction.”  Within our Digitran division we manufactured, marketed and sold electro-mechanical digital and new patented technology very low profileTM rotary switches for the worldwide aerospace, defense and industrial markets.  Tokyo-based XCEL Japan Ltd. primarily sold Digitran’s switch product lines in Japan and other countries in Asia. These businesses were part of our electronic devices business segment.  The Digitran Transaction is a milestone in ‘our previously announced strategy to divest non-core businesses and increase our focus on our core competencies. For purposes of the following discussion and analysis, the Digitran Operations have been classified within the electronic devices business segment of EMRISE.  Because the Digitran Transaction occurred after December 31, 2008, the full year results of the Digitran Operations are included in our Consolidated Statement of Operations for the year ended December 31, 2008 and the Digitran Operations are reflected in our Consolidated Balance Sheet, Consolidated Statement of Stockholders’ Equity and Consolidated Statement of Cash Flows as of December 31, 2008.

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, and France.  We organize our business in two operating segments: electronic devices and communications equipment. In 2008, our electronic devices segment contributed approximately 75% of overall net sales while the communications segment contributed approximately 25% of overall net sales. Our subsidiaries within our electronic devices segment design, develop, manufacture and market electronic, RF and microwave devices for defense, aerospace and industrial markets.  Our subsidiaries within our communications equipment segment design, develop, manufacture and market network access equipment and network timing and synchronization products, for communications applications in defense, public and private networks and industrial markets.

Within our electronic devices segment, we produce a range of power systems, RF and microwave devices.  This segment is primarily “project” driven with the majority of revenues being derived from custom products 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, and 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 TV – which are being installed in new commercial aircraft as well as being retrofitted into existing commercial aircraft.

 Within our communications equipment segment, we produce a range of network access products, including network timing and synchronization products, for public and private communications networks.  This 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.

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

We recognize revenues for products sold by our subsidiary in France 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 cost is 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.

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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.  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, the types of products involved, historical and anticipated rates of claim and historical and anticipated 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 materials, which necessitate 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 prioritized cycle counting categories, or we 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, 2008, our total inventory reserves amounted to $5.6 million of which $4.0 million, or 21.0% of total inventory, related to our electronic devices segment and $1.6 million, or 8% of total inventory, related to our communications equipment segment.

The electronic 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 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 62.0% and 73.2% of our net revenues, 32.7% and 39.5% of our assets and 22.7% and 37.0% of our total liabilities as of and for the years ended December 31, 2008 and 2007, respectively.  In preparing our consolidated financial statements, we are required to translate the financial statements of our foreign 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 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

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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 losses of $2.8 million and gains of $1.1 million that were included as part of accumulated other comprehensive income (loss) within our balance sheets at December 31, 2008 and December 31, 2007, respectively. During the year ended December 31, 2008 and 2007, we included translation losses of $3.9 million and gains of $0.4 million, respectively, under accumulated other comprehensive income.

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. During 2008, these currencies include the euro, the British pound 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 pound sterling loan payable from one of our subsidiaries in England to EMRISE was outstanding as of December 31, 2008 ($3.6 million based on the exchange rate at December 31, 2008).  Exchange rate losses and gains on the long-term portion of this loan are recorded in cumulative translation gains or losses in the equity section of the balance sheet.

Intangibles, Including Goodwill

We periodically evaluate our intangibles, including goodwill, for potential impairment. Our judgments regarding the existence of impairment are based on many factors including 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 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, 2008, our reported goodwill totaled $9.7 million.  During the year ended December 31, 2008, we recorded a non-cash impairment loss related to goodwill and other intangible assets of $6.6 million, which is reflected as a component of operations in the accompanying Consolidated Statement of Operations.  In assessing the potential impairment of goodwill, we consider forecasted financial performance of the acquired businesses to determine the fair value of the respective assets. Due to a decline in the forecasted financial performance of our communications segment, the estimated fair market value of that segment’s intangible assets declined as compared to the carrying value of such assets on our balance sheet.  As a result, the impairment charge reflects the write down of substantially all of the carrying value of the goodwill and other intangible assets for our communications segment.

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Overview

The majority of our products are customized to the unique specifications of our customers and are subject to variable timing of delivery.  Shipments of products can be accelerated or delayed due to many reasons including, but not limited to, exceeding or not meeting customer contract requirements, a change in customer timing or specifications, technology related issues and production related issues.  Comparability of our revenues and gross profit is difficult from period to period as we typically do not have recurring orders.  Exceptions to this include certain long-term military contracts and certain long-term telecommunications contracts.

Overall sales increased 15.9% in 2008 as compared to 2007.  Included in our net sales results for 2008 is $5.8 million of net sales contributed by ACC, which we acquired on August 20, 2008.  ACC product sales accounted for 71% of our overall increase in sales.  The remaining increase in net sales is primarily due to an increase in sales of our other electronic devices subsidiaries, partially offset by exchange translation and lower sales of communication equipment.

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

The following is a detailed discussion of our results of operations by business segment.

Results of Operations

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

Net Sales

Electronic Devices

The increase in sales within our electronic devices segment in 2008 as compared to 2007 is primarily due to the inclusion of $5.8 million of sales generated by ACC, which was acquired in August 2008.  Also contributing to the improvement was a $2.3 million increase in sales of digital switches.  One of our European subsidiaries also experienced increased sales, especially due to higher shipments of IFE&C products for commercial aircraft applications.  However, the effect of exchange rates between the U.S. dollar and the British pound sterling on the translation of our European operations into U.S. dollars had an unfavorable impact on all of our European operations’ net sales as compared to the prior year.  The translation impact of exchange rates remains an uncertainty and could negatively or positively impact our overall results in future periods.

In 2009, we expect net sales within our electronic devices segment to increase slightly as compared to 2008.  This reflects the expected favorable impact of including 12 months of ACC’s net sales in 2009 as compared to a little over 4 months in 2008, the loss of the net sales relating to our Digitran Operations after March 2009 and the anticipated unfavorable effect of exchange rates expected in 2009 as compared to 2008 between the U.S. dollar and the British pound sterling on the translation of our European operations into U.S. dollars.

Communications Equipment

The slight decrease in sales within our communications equipment segment in 2008 as compared to 2007 is primarily due to a $0.5 million decrease in sales at our French subsidiary as the result of a temporary spending reduction by the French Defense Ministry, which resulted in a short-term reduction in orders and shipments for communication networking products.  This decrease was partially offset by a $0.3 million increase in our domestic communications equipment operations as a result of increases in test equipment sales associated with new government contracts.

We expect net sales in our communications equipment segment to increase slightly in 2009 as compared to 2008.  Growth in our communication segment has been, and is likely to continue to be, impacted by the recent economic conditions as many of our communication products are deemed to be discretionary expenditures by our customers and many companies in this industry have announced publicly plans to reduce capital expenditures and/or to defer discretionary spending due to current economic conditions.  Once global economic conditions improve, we believe this segment will benefit more so than our electronic devices segment.  We also anticipate an unfavorable effect of exchange rates expected in 2009 as compared to 2008 between the U.S. dollar and the euro on the translation of our European operations into U.S. dollars.

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Gross Profit

Electronic Devices

The improvement in gross profit within our electronic devices segment is primarily due to substantial gross margin improvements within all of our electronic device subsidiaries due to a combination of improved selling prices, improved efficiency in manufacturing and/or favorable changes in product mix. Included in our overall gross profit for 2008 is $2.3 million contributed by ACC, representing approximately four months of gross profit contribution for that subsidiary.

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

Communications Equipment

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

Operating Expenses

Selling, General and Administrative

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

During 2009, we expect selling, general and administrative expense to increase by at least $1 million.  This anticipated increase reflects the unfavorable impact of including a full 12 months of ACC’s expenses in 2009 as compared to approximately 4 months during 2008, as well as higher anticipated costs relating to Sarbanes-Oxley compliance due to the fact that we will be subject to the Sarbanes-Oxley Act Section 404 external audit requirements beginning January 1, 2009.  These increases are expected to be partially offset by decreases in selling general and administrative expenses relating to the sale of our Digitran Operations in March 2009 and significant restructuring efforts which we expect to complete in the first half of 2009, which include reduction in headcount, outsourcing certain centralized services and a reduction in facility costs.

Engineering and Product Development

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

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

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Loss on Asset Impairment

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

Interest Expense

Interest expense was $3.2 million for 2008 as compared to $0.9 million for 2007 due to higher outstanding loan and line of credit balances, higher interest rates associated with our credit facility entered into in November 2007 and the additional debt incurred in connection with the acquisition of ACC in August 2008.  Included in interest expense in 2008 are approximately $1.0 million of unused line fees, non-cash amortization of deferred financing costs and non-cash amortization of debt discount related to issuance costs for the credit facility.

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

Other Income (Expense)

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

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 previous credit facilities and term loans.  We did not incur such a loss in 2008.  If we were to terminate our existing credit facility during 2009, we would incur significant cash and non-cash expenses in connection with such a termination including early termination fees and a write off of all unamortized debt acquisition costs and unamortized debt discount.

Income Tax Expense

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

Net Loss

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

 Liquidity and Capital Resources

In making an assessment of our liquidity, we believe that the items in our financial statements that are most relevant to our ongoing operations are our working capital, cash generated from our operating activities and cash available from our financing activities.  During 2008, we funded our daily cash flow requirements through funds provided by operations and through borrowings under our credit facility with GVEC Resource IV Inc. (“GVEC” or the “Lender”), an affiliate of Private Equity Management Group LLC (“PEM Group”).  Working capital was $7.6 million at December 31, 2008 as compared to $16.1 million at December 31, 2007. The decrease in working capital is primarily due to the current portion of our long term debt ($5.2 million as of December 31, 2008) and our revolving line of credit ($4.1 million as of December 31, 2008) being classified as a current liability at December 31, 2008 as compared to being classified as long term debt at December 31, 2007.  The current portion of long term debt increased due to higher scheduled principal payments in 2009 as compared to 2008.  At December 31, 2008 and 2007, we had accumulated deficits of $28.1 million and $20.7 million, respectively, and cash and cash equivalents of $3.4 million and $4.8 million, respectively.

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

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

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

For the year ended December 31, 2008, our cash balances decreased by approximately $2.1 million due to the unfavorable effects of exchange rates on our cash balances (primarily due to decreases in the exchange rate of the British pound sterling and the euro as compared to the U.S. dollar).  This compares to a $0.2 million increase in cash as a result of the effects of exchange rates on our cash balances during 2007.

As of December 31, 2008, we had outstanding borrowings of $4.1 million under the revolving loan portion of our GVEC credit facility.  At December 31, 2008, we had remaining actual availability under a formula-based calculation of $2.9 million under the credit facility.  Actual remaining availability represents the additional amount we were eligible to borrow as of December 31, 2008. 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, 2008, we had long-term loans and capitalized lease and equipment loan obligations totaling $13.8 million, the current portion of which loans and obligations totaled $5.7 million.

Our backlog increased to $34.7 million as of December 31, 2008 as compared to $25.3 million as of December 31, 2007. The increase is primarily due to the addition of incremental backlog in connection with the acquisition of ACC.  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, 2008 was approximately 97% 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 3% 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.

Credit Facility

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

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

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 the Lender.  The Revolver has a maturity date of November 30, 2009, unless it is renewed by the Lender in which case the maturity date will be extended to November 30, 2010.

Interest on the Revolver is payable monthly.  The interest rate is variable and is 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 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; minimum liquidity above the scheduled amount, unfinanced capital expenditures not in excess of $62,500 per quarter, and the leverage ratio, measured quarterly, must not be greater than the scheduled amount for each specified period.  Additionally, the Revolver is subject to the borrowers not incurring purchase money commitments in excess of $2 million.

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The term loans bear interest at the Base Rate plus 4.25%, subject to a minimum rate of 12.5%, and require interest only payments in 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 under the credit facility 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 disposition exceed $150,000 in any fiscal year.

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

To secure payment of the indebtedness of borrowers under the credit facility, the borrowers irrevocably pledged and assigned to, and granted to the Lender 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.  In an event of default, the Lender 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 credit facility.

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

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

If we are unsuccessful in meeting our Lender’s requirement for additional capital by the required due dates and/or if we breach any of our agreed upon financial covenants under the credit facility, then we will be in default under the terms of our credit facility.  In the event of a default and continuation of a default, whether as a result of our inability to raise additional capital or for some other reason, the Lender may limit future availability under our revolving line of credit and/or accelerate the payment of all principal balances and accrued interest requiring us to pay the entire indebtedness under our credit facility 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 of the Term Loans A and B by four percentage points above the per annum interest rate that would otherwise be applicable.  Any of these conditions could have a material adverse effect on our operations and/or ability to conduct business after that date.

Various factors, including the adverse effects of the global market crisis, could impact our Lender’s ability to provide us with access to the funds available under our credit facility, resulting in our access to cash and our ability to operate our business being negatively affected.  In addition to the effects of the current global financial crisis, statements in an article published in the Wall Street Journal raising issues surrounding the business practices of our the president of our Lender’s agent, whether or not true, may have an effect on our Lender’s ability to continue to provide us funds under our revolving line of credit.  Any of these conditions would have a material adverse effect on our operations and/or ability to conduct business after that date.

We believe that current and future capital resources, revenues generated from operations and other existing sources of liquidity, including amounts available under the credit facility, will be adequate to meet our anticipated short term, working capital and capital expenditures needs for at least the next 12 months.  However, if we experience a significant loss of revenue or increase in costs, our cash flow could be negatively impacted resulting in a cash flow deficit which, in turn, may require us to obtain additional or alternate financing.  These potential financing needs could be met in the form of a revised debt structure with our Lender, new financing with another lender or lenders, the sale of certain assets to generate cash or the sale of additional equity to raise capital.  Our failure to secure additional or alternate financing, if needed, could have an adverse affect on our operations and/or ability to do business after that date or could restrict our growth, limit our development of new products, or hinder our ability to fulfill existing or future orders.

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

In February 2007, the Financial Accounting Standards Board (“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 adoption of SFAS No. 159 did not have a material effect on our financial condition or results of operations.

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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 for financial assets and liabilities did not have a material effect on our consolidated financial statements, but resulted in additional disclosures.  In February 2008, the FASB issued Staff Position No. 157-2, which delayed by one year the effective date of SFAS No. 157 for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis.  We believe the adoption of SFAS No. 157 for non-financial assets and liabilities will not have a material effect on our consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141R, “Business Combinations,” which replaces SAFS No. 141, “Business Combinations.”  SFAS No. 141R establishes principles and requirements for determining how an enterprise recognizes and measures the fair value of certain assets and liabilities acquired in a business combination, including noncontrolling interests, contingent consideration and certain acquired contingencies.  SFAS No. 141R also requires acquisition-related transaction expenses and restructuring costs be expensed as incurred rather than capitalized as a component of the business combination.  SFAS No. 141R will be applicable prospectively to business combinations for which the acquisition date is on or after January 1, 2009.  SFAS No. 141R would have an impact on accounting for any business acquired after the effective date of this pronouncement.

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.

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

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

Not applicable.

Item 8.                       Financial Statements and Supplementary Data.

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

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

None.

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 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, 2008 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.

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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:

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

(ii)                                provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and

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

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, 2008. Based on the results of management’s assessment and evaluation, our Chief Executive Officer and Vice President Finance and Administration concluded that as of December 31, 2008 the following three material weaknesses in our internal control over financial reporting existed:

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

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

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

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, 2008. 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 its Internal Control-Integrated Framework. Because of the material weaknesses described above, management believes that, as of December 31, 2008, we did not maintain effective internal control over financial reporting.

An independent consulting firm assisted management with its assessment of the effectiveness of our internal control over financial reporting, including scope determination, planning, staffing, documentation, portions of testing, portions of remediation and portions of 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.

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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.

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 management, external consultants 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, 2009.  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, 2009.

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

·                  Entity Level Internal Control Evaluation.  We did not formally consider entity-wide controls that are pervasive across our company when considering whether control activities are sufficient to address identified risks.

·                  Fraud Considerations.  We did not conduct regular formalized assessments to consider risk factors that influence the likelihood of someone committing a fraud and the impact of a fraud on our financial reporting.

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

·                  External Communication.  We lacked formal policies and procedures regarding how and when matters affecting the achievement of financial reporting objectives are communicated with outside parties.

·                  Assessment of Information Technology.  We did not formally evaluate the extent of the needed information technology controls in relation to our assessment of processes and systems supporting financial reporting.

·                  Information Technology.  We did not have sufficient information technology controls, where applicable, designed and implemented to support the achievement of financial reporting objectives.

·                  Ongoing and Separate Evaluations.  We did not effectively create and maintain effective evaluations on the progress of our remediation efforts nor the constant evaluations of the operating effectiveness of our internal controls over financial reporting.

·                  Reporting Deficiencies.  We did not perform timely and sufficient internal or external reporting of our progress and evaluation of prior year material weaknesses or the current fiscal year internal control deficiencies.

(2)                                We did not maintain effective controls over changes 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 2008 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 2008 consolidated financial statements, however, it is reasonably possible that, if not remediated, one or more of the material 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 planning to implement 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.

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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 2009.  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, 2008. 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.

Amendment Number 4 to Loan Documents

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

Pursuant to the terms of Amendment Number 4, the Lender waived any claims of breach or default arising out of or relating to the breach of certain of the financial covenants under the credit facility through April 14, 2009.  Additionally, several of the financial covenants related to the $7,000,000 revolving credit facility available under our credit facility were amended.  Pursuant to the terms of credit facility, 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 the scheduled amount for each specified period, and liquidity, measured quarterly, must not be less than the scheduled amount for each specified period.  Additionally, the Revolver is subject to the Borrowers not incurring capital expenditures (a) in excess of $600,000 for the fiscal year ending December 31, 2009, and (b) in excess of $1,800,000 for the fiscal year ending December 31, 2010.  Additionally, the Revolver is subject to the borrowers not incurring unfinanced capital expenditures in excess of $62,500 in any fiscal quarter, provided however that if the borrowers incur unfinanced capital expenditures of less than $62,500 in any fiscal quarter, the difference between the amount incurred in a certain fiscal quarter and $62,500 maybe incurred in the two fiscal quarters immediately following such fiscal quarter.

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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 2009 Annual Meeting of Stockholders (our “2009 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 2009 Proxy Statement, is hereby incorporated by reference.

Item 11.                Executive Compensation.

The information under the caption “Executive Compensation and Related Information”, appearing in the 2009 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 2009 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 2009 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 2009 Proxy Statement, is hereby incorporated by reference.

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PART IV

Item 15.              Exhibits and Financial Statement Schedules.

(a)(1)   Financial Statements.

Reference is made to the financial statements listed on and attached following the Index to Financial Statements contained at page F-1 of this report.

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

Not applicable.

(a)(3) and (b) Exhibits.

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*                            Filed herewith.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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EMRISE CORPORATION AND SUBSIDIARIES

Index to Financial Statements

F-1

Table of Contents

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, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2008. 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, 2008 and 2007, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2008 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, 2008 included in the accompanying Management’s Report on Internal Control Over Financial Reporting and, accordingly, we do not express an opinion thereon.

/S/ HEIN & ASSOCIATES LLP

Irvine, California

April 15, 2009

F-2

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EMRISE CORPORATION

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