UNITED STATES
 SECURITIES AND
EXCHANGE COMMISSION Washington, D.C. 20549  
 FORM 10-K FOR
ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 xANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the fiscal year
ended December 31, 2002 OR oTRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the transition
period from 
to . Commission file
number: 0-21681  
 EFJ, INC. (Exact name of Registrant as specified in its charter) Delaware
  
  47-0801192(State or other jurisdiction
  
  (I.R.S. Employeeof incorporation or organization)
  
  Identification No.)
  4800 NW 1st Street Lincoln, Nebraska 68521 (Address of principal executive offices) (Zip Code) Registrants telephone number, including area code:
(402) 474-4800 Securities registered pursuant to Section 12(b) of
the Act: None Securities registered pursuant to Section 12(g) of
the Act: Common Stock, par value $0.01 per share (Title of Class) 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 the Registrant was required to file such
reports), and (2) has been subject to such filing requirements for the
past 90 days. Yesx   No
o Indicate by check mark
whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yeso   No
x 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.o The aggregate market value
of the voting and non-voting Common Stock held by non-affiliates of the
Registrant, based upon the last sale price of the Common Stock on February 17,
2003, as reported in the Over the Counter Bulletin Board market was
approximately $31,500,000. Shares of Common Stock held by each executive
officer and director and each person owning more than 5% of the outstanding
Common Stock of the Registrant have been excluded in that such persons may be
deemed to be affiliates of the Registrant. This determination of affiliate
status is not necessarily a conclusive determination for other purposes. Number
of shares outstanding of the Registrants Common Stock, as of February 17,
2003: 17,577,315. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive Proxy Statement for the
Registrants 2002 Annual Meeting of Stockholders to be filed within 120 days of
the fiscal year ended December 31, 2002 are incorporated by reference in
Items 10, 11, 12 and 13 of Part III of this Annual Report on Form 10-K.


---

PART I ITEM 1. BUSINESS Unless the context otherwise provides, all references
in this Annual Report on Form 10-K to the Company include EFJ, Inc.,
its predecessor entities, and its subsidiaries, including E.F. Johnson Company
and Transcrypt International, Inc., on a combined basis. All references to
EFJohnson refer to E.F. Johnson Company, and all references to Transcrypt
refer to Transcrypt International, Inc. In addition to the historical information contained
herein, certain matters discussed in this Annual Report may constitute
forward-looking statements under Section 27A of the Securities Act of
1933, as amended (the Securities Act), and Section 21E of the Securities
Exchange Act of 1934, as amended (the Exchange Act). These statements may involve
risks and uncertainties and relate, without limitation, to the following: ·the results of the Companys
product development efforts; ·future sales levels and
customer confidence; ·the Companys future
financial condition, liquidity and general business prospects; ·perceived opportunities in
the marketplace for the Companys products and its products under development;
and ·the Companys other
business plans for the future. The actual outcomes of the above referenced matters
may differ significantly from the outcomes expressed or implied in these
forward-looking statements. For a discussion regarding such differences, see Summary
of Business Considerations and Certain Factors That May Affect Future
Results of Operations and/or Stock Price below. General The Company is a manufacturer of wireless
communications products and systems and information security products. Through
its wholly-owned subsidiary, EFJohnson, which will celebrate its 80th
anniversary in 2003, the Company designs, develops, manufactures, and markets: (1) mobile
and portable land mobile radios (LMR); (2) stationary LMR transmitters /
receivers (base stations or repeaters); and (3) LMR systems. Through its
wholly-owned subsidiary, Transcrypt, which will celebrate its 25th
anniversary in 2003, the Company designs and manufactures information security
products, which prevent unauthorized access to sensitive voice communications. These
products are based on a wide range of analog scrambling and digital encryption
technologies and are sold mainly to the LMR markets as an add-on security
device for analog radios. The Company primarily sells its products to: (1) domestic
public safety / public service and other governmental users;  (2) domestic commercial users; and (3) international
customers. At the Companys June 13, 2002 Annual Meeting of
Stockholders, the Stockholders approved an amendment of the Companys
Certificate of Incorporation to change the corporate name to EFJ, Inc. On December 6, 2002, EFJ, Inc. established
a new wholly-owned subsidiary, named Transcrypt International, Inc. EFJ, Inc.
is in the process of transferring all assets associated with the Transcrypt
Secure Technologies division to the new Delaware subsidiary.  The Transcrypt Secure Technologies division is
solely related to the Companys information security product line. The Companys principal business offices are located
at 4800 NW 1st Street, Lincoln, Nebraska 68521, and its phone number is (402)
474-4800. 2 Industry Wireless Communications The mobile wireless communications industry began in
the mid-1930s when police departments began using LMR systems to enable
immediate communication between headquarters and officers patrolling the
community. LMRs consist of hand-held and mobile (vehicle mounted) two-way
radios. A typical LMR system consists of one or more base control stations
networked with each other and with hand-held and/or mobile radios. Originally
designed to transmit information in the analog format, there has been a
relatively recent migration of LMR systems to the digital format. Historically,
electronic communications were transmitted in analog format. By the late 1980s,
accelerating use of wireless communications devices, such as LMRs and cellular
telephones, resulted in increased demand for limited radio spectrum. In
response to this demand, and enabled by the low-cost availability of digital
signal processors (DSPs), electronics manufacturers developed spectrally
efficient (i.e., low-bandwidth) digital
communications devices. In digital communications, an analog signal is digitized,
or converted into a series of discrete information bits in the form of ones
and zeroes prior to transmission. The following three factors contributed to LMR service
expanding beyond its traditional police and fire applications to become an
integral means of communications for a variety of governmental and commercial
enterprises: (1) recognition of the benefit offered by immediate radio
communications with their field personnel; (2) technological advances
making LMR systems more affordable; and (3) allocation of increasing
amounts of spectrum for LMR use. In addition to dispatch-oriented LMR service,
many other forms of mobile wireless communication technologies have emerged and
are continuing to be developed to meet the varied communication needs of an
increasingly mobile society. These include paging, wireless data, cellular
telephone, and personal communication services. Conventional and trunked are two general types of LMR
systems. Both types of systems operate on the specific frequency bands that the
Federal Communications Commission (FCC) has allocated for such types of
systems. Conventional LMR systems use a single channel to transmit and receive
information. All users have unrestricted access, and the user must monitor the
system and wait until the channel is unoccupied. Trunked systems, including the
Companys logic trunked radio (LTR®), LTR-Net®, and Multi-Net® products,
combine multiple channels so that an unoccupied channel is automatically
selected when a user begins transmitting. Conventional LMR systems are
relatively inefficient compared to trunked systems. The development of trunked LMR systems and the
allocation of additional frequency spectrum in the 1970s triggered significant
growth in the LMR market. Technological developments by EFJohnson and others
have enabled LMR systems to be networked, permitting multiple sites to be
linked together through a switch to provide extended geographical coverage. In
addition, many trunked subscriber units are capable of functioning as mobile
telephones through interconnections to the public switched telephone network. More
recent technology provides for the interconnection between sites to be
accomplished over digital packet based networks using Internet type protocols
in a technique called Voice over Internet Protocol (VoIP). The Companys proprietary
implementation has been trademarked as Netelligent®. Many federal, state and local agencies operate LMR
equipment which complies with specifications established by the Association of
Public Safety Communications Officials International Inc. (APCO). The APCO 16
standard, established in 1979, includes recommendations for 800 MHz
transmission, analog voice modulation, and trunking functions for using the
frequency spectrum. However, the APCO 16 recommendations permitted development
of proprietary systems. As a result, three proprietary APCO 16 technologies
evolved: Motorolas SmartNet®; General Electrics EDACS®; and EFJohnsons
Multi-Net®. These proprietary systems effectively eliminated competition once
the initial technology decision was made, thereby, severely hampering
interoperability. Consequently, APCO began efforts on a more comprehensive
standard which would stress the importance of interoperability. 3 In 1995, APCO promulgated a new recommended standard
known as Project 25. Project 25 specifies features and signaling for narrow
band digital voice and data with conventional and trunking modes of operation. The
Telecommunications Industry Association (TIA) participated in the development
of this suite of standards, following an industry-sanctioned and American
National Standards Institute (ANSI) accredited process. With TIAs
assistance, Project 25 was structured to specify all details of fundamental LMR
communications to allow multi-source procurement and interoperability for the
life of Project 25 systems. The Company has provided significant support to
both APCO and TIA, to include serving on many of the section and subsection
working committees. The Project 25 standard has been adopted by the
National Telecommunications and Information Association (NTIA) which controls
LMR specifications for the U.S. government. NTIA specified a conversion to
narrow band, with Project 25 as the preferred solution, by the year 2005 for
the 162-174 MHz bands, and by 2008 for all other bands. Several of the U.S.
government agencies (including the Departments of Interior, Justice, and
Treasury) have specified a Project 25 requirement for procurements of new LMR
Equipment. Although state and local public safety agencies are not currently
required by the FCC or APCO to purchase Project 25 compliant LMR systems or
otherwise adopt the Project 25 standard, Project 25 compatibility is expected
to become one of the key purchasing factors for state and local public safety /
public service LMR users. Furthermore, as state and local LMR users upgrade
their existing APCO 16 systems to comply with FCC-imposed bandwidth
limitations, demand for Project 25 compliant LMR systems is expected to
increase, due in part to the fact that Project 25 systems can potentially be
configured for compatibility with older APCO 16 mobile and portable radios,
allowing adopters of the Project 25 standard to purchase new system equipment
without replacing all of their subscriber radios. Unlike government LMR users, commercial LMR users have
only expressed marginal interest in interoperability or compliance with APCO
standards. Commercial users, such as utility, transportation, construction and
energy companies, require rapid communications among personnel spread out over
relatively large geographic areas. Many large commercial LMR users purchase and
operate entire systems for their own private use, procuring LMR systems
directly from manufacturers or through local distributors that typically
provide installation and maintenance services. Smaller commercial users
typically utilize specialized mobile radio (SMR) operators such as Nextel
Corp. and Centennial Communications to provide their radio communication needs. SMR operators build and lease private LMR systems on a
for-profit basis. They sell airtime to end-users whose mobile communication
needs can be served by renting or purchasing subscriber units as opposed to
purchasing an entire system, or who are unable to obtain a FCC license to
operate their own system. Traditionally, end-users of SMR services have
included taxi fleets and smaller construction and delivery service companies.
Currently, many SMR operators in the larger metropolitan markets, such as
Nextel Corp., are also offering more consumer-oriented, cellular-like SMR
services. Competition for domestic commercial users has
significantly increased in the last few years. Significant changes include:
unavailability of new 800 MHz frequencies; consolidation in the SMR
marketplaces; and conversion of certain SMR systems from analog to digital. This
has resulted in increased availability of used analog radios and repeaters in
the marketplace and decreased prices and contributed to a general commercial
market demand for low margin products. Competitors have been reducing their
prices and therefore putting pressure on the Companys prices and margins in
this market. Information Security The electronic information security industry is
generally comprised of products designed to protect the transmission of
sensitive voice and data communications through both wireless and wireline
mediums. Without such protection, many forms of electronic communications, such
as LMR and telephone conversations and remote data communications, are
vulnerable to interception and theft. Not surprisingly, 4 the information security
industry originated from the need to secure sensitive wireless military
communications. By the late 1970s, the availability, quality and cost
of LMR information security devices had improved so that the use of these
devices became economically and functionally feasible for non-military
governmental users (such as law enforcement, fire, emergency medical, and other
public safety personnel) and large commercial users (such as transportation,
construction, and oil companies). The use of scrambling and encryption
equipment, such as one of the Companys modules, is required on both the
transmitting and receiving sides of communications in order to operate in
secure mode. However, most LMR encryption products, including all of Transcrypts
products, can be used in the clear, non-scrambled mode with equipment that does
not contain a security device. Analog transmissions typically consist of a voice or
other signal modulated directly onto a continuous radio carrier wave. An
analog transmission can be made secure by scrambling, or manipulating the
original signal at the point of transmission, and reconstituting the original
signal at the receiving end. Digital transmissions can be made secure by a
process known as encryption, which involves the use of a mathematical
algorithm to rearrange the bit-stream prior to transmission and a decoding
algorithm to reconstitute the transmitted information back into its original
form at the receiving end. The core technologies currently available, and used
by companies such as Transcrypt, include the following methods, which are
listed in increasing order of sophistication of security technique: ·frequency inversion
(inverting or otherwise adjusting the spectrum of a signal based on a
consistent method); ·rolling code transmission
(incrementally stepping codes used to modify a signal); ·hopping code transmission
(changing broadcast frequencies multiple times per second based upon an
algorithm); ·digital encryption
(encoding a digital bit-stream based upon a mathematical encryption algorithm). Manufacturers of information security products, such
as the Company, typically charge higher prices for devices featuring more
advanced levels of security. Therefore, the types of end-users at each level of
security tend to vary based upon the importance of the information that the
end-user wants to secure. Typical users of the most basic form of scrambler,
the frequency inversion scrambler, include taxi dispatchers, other types of
consumer businesses, and transportation companies. High-level scrambling and
encryption devices are used primarily by public safety agencies, U.S.
government personnel, and international customers. For example, domestic and
international police forces typically have a medium to high need for security,
while military users, who are often faced with hostile and determined threats,
typically have a very high need for security. Markets and Products Purchasers of the Companys wireless communications
and information security products include domestic public safety / public
service agencies and other governmental units, foreign governments, LMR
manufacturers, and business and corporate users in finance, manufacturing,
public utilities, and energy, among other industries. Significant customers
accounting for more than 10% of the Companys revenues, as a combination of
both wireless communications and encryption products, included: State of South
Dakota, which represented approximately 12% of sales in both 2002 and 2001;
Chester County of Pennsylvania, which represented approximately 14% of sales in
2001; and Motorola, which represented approximately 17% of sales in 2000. The Companys basic marketing strategy is founded on
the premise that quality, value, and service equals choice for the customer
(or QVS=C). The strategy is to increase market awareness, to convey 5 the Companys technical
capabilities, support, and overall value of its products so that the customer
understands the Company represents a viable choice in fulfilling LMR
requirements. To this end, the Companys marketing staff conducts promotions
through a mix of print advertising, trade shows, direct mail campaigns, press
releases, presentation material, and distribution of demonstration and loaner
equipment. The goal is to make the market aware that the Company is an LMR
communications solution provider that offers quality choice in the marketplace. The Company sells its products domestically through a
direct sales force of account executives and sales managers, dealers, and
manufacturer representatives. The Company also uses telemarketing personnel who
sell primarily to smaller dealers and SMR operators. The Company provides
comprehensive support to its LMR dealers, who re-sell the Companys product to
end-users. This support includes cooperative advertising programs, advertising
materials, sales and service training, and technical support. The Companys
international sales are primarily made through a specialized international
direct sales force in conjunction with Company-authorized distributors, which
typically provide a local contact and arrange for technical training in foreign
countries. See Summary of Business Considerations and Certain Factors That May Affect
Future Results of Operations and/or Stock PriceBusiness, political,
regulatory, or economic changes in foreign countries in which the Company
markets its products or services could adversely affect the Companys revenues. Wireless Communications EFJohnson primarily sells its products to: (1) domestic
public safety / public service and other governmental users; (2) domestic
commercial users; and (3) international customers. In November 2000,
the Company made the decision to focus on the domestic public safety / public
service sector, de-emphasizing the commercial market and eliminating many of
its commercial product offerings. As such, EFJohnsons sales to domestic
commercial entities have steadily declined over the last two years, as
evidenced by sales in the amount of $2.3 million in 2002, $4.9 million in 2001,
and $12.4 million in 2000. Comparatively, EFJohnsons sales to domestic public
safety / public service and other governmental agencies have increased, as
evidenced by sales in the amount of $30.1 million in 2002, $26.9 million in
2001, and $20.9 million in 2000. EFJohnsons products consist of radios (or subscriber
units), LMR systems (to include infrastructure equipment, system design, and
installation of infrastructure equipment), and service (technical support,
maintenance contracts, service parts, and training). Most of these products are
sold under the EFJohnson brand name. EFJohnsons radio offerings include both analog
(Multi-Net®, Motorolas SmartNet® and SmartZone®, LTR-Net®, LTR® and
conventional) and digital (Project 25, Motorolas SmartNet® and SmartZone®)
radios. EFJohnsons  Project 25 radios,
both hand-held portable and mobile radios, can contain voice scrambling and/or
digital encryption technology, Over-the-Air-Reprogramming (OTAR), and Project
25 trunking. To further increase its LMR offering, EFJohnson has incorporated
its DES-OFB, DES-XL, and AES encryption technology into its radio products.
Additionally, the Companys Project 25 radios can be used on most Motorola APCO
16 systems using the SmartNet® protocol, which EFJohnson licensed from Motorola,
and are being developed for use, as well, on the Multi-Net® protocol developed
by EFJohnson. 6


---

EFJohnsons current LMR system sales are predominantly
Multi-Net® systems. However, EFJohnson also offers Project 25 and LTR-Net®
systems. The Multi-Net® and LTR-Net® product line incorporates the EFJohnson
trunking protocols and includes: (1) sub-audible signaling, which
automatically selects a clear or unoccupied channel; (2) open architecture
that is compatible with other analog products; and (3) transmission
trunking which provides efficient use of the channels. The Project 25 system
offerings are presently conventional only. The majority of system sales,
whether for high-end commercial or governmental purchasers, involve soliciting
and responding to requests for proposals (RFPs). The RFP process for system
sales has a relatively long cycle time, typically taking as much time as one
year, and, depending on the size of the system, taking multiple years to
complete installation of a project. During 2000 and 2001, the Company focused
on the completion of systems contracts for certain EFJohnson projects begun
prior to 1999. The Company substantially completed these systems as of December 31,
2001. As of December 31, 2002, the only systems in progress represent
projects initiated in 2002. LMR system end-users often require the
supplier of the LMR system to supply a bond from an approved surety company
at the time that the bid is submitted and at the time that the contract is
awarded. See Summary of Business Considerations and Certain
Factors That May Affect Future Results of Operations and/or Stock PriceThe
Companys inability to secure satisfactory bonding arrangements would adversely
affect revenues. For the EFJohnson product line, the Companys customer
service group provides after-sales service and support, including technical
support through a toll-free telephone number, on-site technical personnel for
repairs and applications issues, 24-hour turnaround for spare parts, extended
maintenance coverage, and product training. Product training includes classes
and seminars to provide the end-user assistance in the use, operation and
application of LMR products and systems. Training is available at both the
customers site and the Companys Waseca, Minnesota facility. LMR products and
systems are generally sold with a one-year warranty, which covers parts and
labor in North America and parts internationally. Broader warranty and service
coverage is provided in certain instances, on a contractual basis, usually for
an additional charge. During 1999, the Company signed a Memorandum of
Understanding with Motorola for the exploration of joint development projects
and the license of EFJohnson technology. There are currently no significant
joint development projects in process. During 2000, the Company signed a
licensing agreement allowing Motorola the right to develop and sell mobile and
portable radio products incorporating the EFJohnson developed LTR-Net® protocol.
To the Companys knowledge, Motorola has not yet developed any such products. Domestic public
safety / public service The Company serves
domestic public safety / public service and other governmental users primarily
with its Netelligent® Project 25 digital product lines and its APCO 16
Multi-Net® analog product lines. The Company believes that its Multi-Net®
system, which links together multiple sites for wide-area coverage using a
proprietary architecture, is a high-quality, cost-effective alternative to
comparable APCO 16 systems produced by other manufacturers. The Companys
system offers many features specifically designed for public safety / public service
users, such as: ·emergency
queuing; ·over
8,000 unique identification codes; ·automatic
subscriber identification; ·five
levels of priority access; ·simulcast;
and ·wide
area system configurations. 7 The Company provides a broad line of Multi-Net®
products, including repeaters, radio network terminals, system management
modules, dispatcher consoles, audio and data link and related accessories. The Companys primary market focus is in the areas of
Project 25 compliant systems and interoperability. The Companys Netelligent®
Project 25 compliant analog/digital radios are compatible and interoperable
with older analog radio systems, as well as with Motorolas proprietary analog
APCO 16 trunking technology (SmartNet® and SmartZone®) and proprietary digital
encryption algorithms. The Company believes that such backward compatibility
with most of Motorolas APCO 16 trunking technology will provide early adopters
of the Project 25 standard, such as the federal, state and local government
agencies, with the ability to purchase new equipment without replacing entire
older systems. In 2002, EFJohnson introduced Project 25 system infrastructure,
beginning with the Model 2600 Repeater. The Project 25 market has developed slowly, primarily
due to the cost of replacing existing systems with Project 25 compliant system
infrastructure and radios. However, since September 11, 2001, development
and implementation of Project 25 compliant systems has accelerated due to a
higher emphasis on the need for interoperability between various local, state
and federal governmental entities. The Company expects this movement towards
Project 25 to continue at an accelerated rate, particularly among federal
agencies and state and local public safety and first-time responders. The Company believes it has positioned itself to
participate in this Project 25 marketplace, particularly as a result of its
established presence as a vendor to the Departments of Interior, Justice,
Treasury and Defense. With the Companys continued emphasis on the federal
market, this trend of increasing federal sales, as a percentage of the overall
sales mix, should continue. The Company also markets its Project 25
capabilities to the state and local governmental units seeking
interoperability. Commercial Users Nearly two-thirds of the EFJohnsons LMR sales to
commercial entities relate to a branded radio product produced for one certain
entity in accordance with given specifications. The remainder of the Companys
commercial LMR sales primarily relate to its LTR-Net® and other analog LMR
product lines. Competition for domestic commercial users reached the point
where price reductions in the market had put such unacceptable pressure on
margins that, in late 2000, the Company altered its market focus to concentrate
on non-commercial markets. Nonetheless, management believes that niche markets,
such as large public utilities, will desire Project 25 interoperability. In
these instances, the demand will be for LMR system and subscriber unit products
similar to those that EFJohnson markets to its state, local and federal
governments. Given the opportunity, the Company intends to market to such
commercial users. International EFJohnson serves its international users primarily
with its Multi-Net®, LTR-Net®, and LTR® product lines. The Companys
international focus is generally on Latin American countries, notably Brazil,
Argentina, Venezuela, and Chile. To date, there has been little international
demand for the Companys digital products, and sales to international customers
has become a smaller part of EFJohnsons overall sales as a result of the
decision to focus its marketing and development resources on the domestic
public safety / public service markets in general, and the digital Project 25
area in particular. EFJohnsons international sales represented 4% of its total
sales in 2002, as compared to 17% and 8% in 2001 and 2000, respectively. Information Security Transcrypt first entered the information security
market in 1978 with simple, transistor-based add-on scrambling modules for use
in analog LMRs using basic single-inversion scrambling techniques. Transcrypt
marketed these products primarily to domestic public safety / public service
agencies and international 8 governments. Since that
time, the Company has further developed and improved upon its core information
security technologies, which have, at various times, been implemented into the
Companys scrambler modules and other products within its major information
security product families. The Companys customers use information security
products in a variety of situations involving differing security needs. The
Company offers a variety of add-on LMR scrambling products featuring its core
technologies at varying levels of security. Add-on scramblers are available in
two packages, which include: (1) a modular package consisting of a circuit
board that is designed to be permanently soldered into existing circuitry; and (2) a
plug-in package designed for installation using connectors with standard pin
configurations which original equipment manufacturers (OEM) may install. The
Company also produces modules that add signaling features to radios, including man-down
(emergency signal broadcast if radio position becomes horizontal), stun-kill
(disables lost or stolen radios remotely), ANI (automatic number
identification of radios) and OTAR (changes encryption and scrambling codes
remotely). In December 1997, the Company introduced an LMR encryption
module, for use as an add-on or in OEM equipment, that uses the U.S. digital
encryption standard known as DES.  This
module uses the widely recognized DES algorithm for encoding transmissions. The
Company also produces low-cost tactical interoperability products which allow
simple cross-band radio communications and range extension using portable or
mobile radios. Transcrypts TransPeater® product provides interoperability for
radios with different frequencies and communication protocols, linking as many
as three UHF, VHF, or 800 MHz radio systems using portable or mobile radios to
establish rapid development for inter-agency communications. Transcrypts analog products are compatible with a
number of OEM manufacturers, including Motorola, EFJohnson, Kenwood U.S.A.
Corp. (Kenwood), ICOM America, Inc., Relm Corporation (Relm), Tait
Electronics (Tait), and Midland International Corp (Midland). However,
substantial portions of the analog encryption modules sold by Transcrypt are
for use in radios manufactured by Motorola. During 2001, the Company entered
into a Professional Radio Application Partner Contract with Motorola which certifies
the Company as an Authorized Application Partner of its plug-in information
security modules for the Motorola Professional series radios in Europe, the
Middle East, and Africa. Presently, the Company is pursuing similar
certification for other global regions. For the Transcrypt product line, the Company provides
toll-free telephone access for customers with technical or other problems. The
Company will also customize product training for its customers using a
classroom approach or seminars at either or both the customers site and the
Companys Lincoln facility. The Company offers a standard warranty on all
products, which covers parts and labor for a period of one year from purchase. The
Company documents installation instructions for its products in OEM devices and
has developed instruction for more than 2,600 OEM products, including almost
all commercially available two-way radio models sold worldwide. Transcrypts current information security products are
designed solely for the encryption of analog transmissions. As the LMR
encryption customers migrate from analog to digital transmission systems, the
overall market for the Companys analog encryption products may decrease. This
migration from analog to digital is expected to occur more rapidly in North
America and Europe than elsewhere in the world. Due to the much higher cost of
digital products, the Company anticipates that the overall global demand for
analog products will decrease at a fairly slow pace over the next few years. During
such period, this decrease is only expected to have a marginal impact upon the
Companys information security product sales. Products Under Development
/ Research and Development Consistent with the Companys development efforts for
its existing products, the Company designs new products around common wireless
technologies using common signal processing platforms and circuitry. Using this
approach, the Company has generally been able to incorporate improvements in
core 9 technologies into its new
products more quickly and with relatively lower development costs compared to
developing entire products separately. The Companys research and development organization
has expertise in: radio frequency technology, computer architecture, switch
architecture, networking, cryptography, object-oriented software, and analog
and digital hardware designs. Ongoing engineering efforts are focused on adding
additional features to existing product lines and developing new and innovative
platforms. The Companys research and development efforts encompass: ·upgrading and supporting
existing product lines; ·digital signal processing; ·voice coding (including
improved multi-band excitation); ·encryption; ·spectral manipulation and
rotation; ·systems simulation; ·mixed signal scrambling; ·digital LMR system
infrastructure; and ·design of new mobile and
portable radios. Cross-disciplinary groups, involving marketing,
customer service, manufacturing and engineering are used for product planning,
definition, and testing. At December 31, 2002, the Company had a staff of
47 engineers, 36 of whom work primarily in research and development. The
Company organizes research and development efforts along its two main product
lines: wireless communications; and information security. While engineering
staffs will combine efforts when appropriate, the Company believes that this
more focused environment fosters a more efficient approach to new product
development. Wireless Communications The Company continues to develop products in 2003 that
include feature enhancements and additions to its line of digital radios, and
which will continue to comply with the Project 25 standard. The Company is
undertaking the development of Project 25 infrastructure equipment, including
Project 25 trunking infrastructure, such as repeaters, base stations, network
switching equipments, consoles, and voters. The Company believes that Project
25 trunking systems will be more widely implemented as costs come down and
additional competitively priced equipment becomes available. In addition, the
Company is analyzing the potential of applying standard Internet Protocol
switching techniques for voice and data interconnectivity between wireless
sites. To that end, the Company has submitted a VoIP fixed station interface
for APCO/TIA standards consideration, and the Project 25 compliant
infrastructure under development will include this interface. Information Security The LMR security products under development include
new versions of the Companys 460 series modules for deployment in different
models of radios, including plug-in modules for certain new model Motorola
radios introduced from time to time in different regions of the world. The
Company has also undertaken development of the following: 1) software
embeddable versions of its current analog product line intended to work with
DSPs, eliminating the need for a separate hardware module in many new 10 models of analog radios;
and 2) feature enhancements to its tactical interoperability products, in order
to expand its functional capabilities. Additionally, Transcrypt is currently assisting
EFJohnson in its development of a FIPS-140 certification of its digital radios.
This requires isolating the encryption software on the radios primary circuit
board. At this time Transcrypt is not otherwise involved in development efforts
related to digital radio encryption. Encryption for digital radios is
accomplished through software embedded in the radio, which has, to date, been
accomplished by the manufacturer of the radio. Consequently, development in
this area has not been deemed economically beneficial. Intellectual Property The Company currently holds or has been assigned 46
U.S. patents. These patents cover a broad range of technologies, including
trunking protocols, high-end scrambling and encryption techniques, methods of
integrating after-market devices, and a high-speed data interface for LMR
communications. Furthermore, the Company holds registered copyrights that cover
software containing algorithms for frequency hopping, scrambling and LMR
signaling technologies, as well as numerous registered trademarks related to
the EFJohnson and Transcrypt names and product names. In addition to
patent, trademark, and copyright laws, the Company relies on trade secret law
and employee and third party non-disclosure agreements to protect its
proprietary intellectual property rights. Manufacturing, Materials,
and Suppliers The Companys manufacturing operations generally
consist of the procurement of commercially available subassemblies, parts, and
components (such as integrated circuits, printed circuit boards and plastic and
metal parts), in addition to the assembly of these various parts and components
into finished products. The Company produces many of its wireless
communications products, including all of its Project 25 compliant products, at
its Waseca, Minnesota facility. The Company assembles its information security
products at its facility in Lincoln, Nebraska. Vendors manufacture certain components and
subassemblies in accordance with the Companys specific design criteria. Certain
components and subassemblies used in the Companys products are presently
available only from a single supplier or a limited group of suppliers. With
respect to other electronic parts, components and subassemblies, the Company
believes that alternative sources could be obtained to supply these products,
if necessary. To date, the Company has been able to obtain adequate supplies of
key components and subassemblies in a timely manner from existing sources, with
the exception of a temporary disruption in the aftermath of September 11,
2001. Nevertheless, a prolonged inability to obtain certain components and
subassemblies could impair customer relationships and could have an adverse
effect on the Companys operating results. See Summary of Business
Considerations and Certain Factors That May Affect Future Results of
Operations and/or Stock PriceThe Companys revenues and gross margins are
dependent upon the timely and consistent delivery of components by third party
suppliers. Motorola is often the sole manufacturer of electronic
components used by the Company; these components include microprocessors and
components used in the Companys digital encryption and LMRs. The Company has
obtained from Motorola a royalty-bearing, irrevocable, non-exclusive, worldwide
license (IPR License) to manufacture products containing certain proprietary
LMR and digital encryption technology. The Company believes this technology
will be important to the success of certain of its existing and proposed
Project 25 compliant LMR products. The IPR License includes rights to use
Motorolas proprietary analog APCO 16 trunking technology (SmartNet®), Project
25 required products, and certain Motorola digital encryption algorithms in the
Companys LMR products. The digital encryption technology may also be
incorporated into certain other information security products. In addition, the
Company obtained a license to utilize certain proprietary technology from
Motorola relating 11 to the development of
Project 25 compliant digital LMRs. This license covers infrastructure and other
Project 25 technology. See Summary of Business Considerations and Certain
Factors That May Affect Future Results of Operations and/or Stock PriceReduction
in Motorolas provision of products, components or technology to the Company
could harm the Companys business and operations. Some of the Companys analog LMR products, primarily
for commercial and international users, are manufactured by Icom Japan (ICOM),
Unimo of Korea (formerly, Kukjae), and Tokyo Wireless of Japan under contract
by the Company. Products produced by these companies have included repeaters,
and mobile and hand-held portable radios that operate in both conventional and
trunked mode. In general, the Company and the vendors jointly developed the
radio products produced by these vendors. These products, in aggregate,
represented approximately 9% of EFJohnsons revenues in 2002. Competition Wireless Communications In North America, Motorola and M/A-Com are the leading
providers of LMR equipment to the public safety / public service sectors. Notwithstanding
the fragmented international wireless communications market, the Company
believes Motorola and M/A-Com to be the dominant competitors in the Latin
American countries where the EFJohnson predominantly sells its LMR products
outside the United States. Other LMR providers besides EFJohnson, who tend to
focus on particular segments of the market, include Thales Communications (Thales),
Uniden America Corporation (Uniden), Kenwood, ICOM America, Inc., Relm,
Datron, Tait, and Midland. EFJohnsons focus is on the domestic public safety /
public service sector, where it competes primarily on the basis of price,
technology and the flexibility, support, and responsiveness provided by the
Company and its dealers. SeeSummary of Business Considerations and Certain
Factors That May Affect Future Results of Operations and/or Stock PriceThe
Company faces competitive pressures that could adversely affect revenues, gross
margins and profitability. Motorola and M/A-Com possess entrenched market
positions in the domestic public safety / public service sectors. Both
companies have substantial financial, marketing and operational resources,
other intellectual property rights, and substantial technological capabilities.
As such, these competitors have advantages in various aspects of the LMR
market, particularly in regards to bidding on LMR systems that will have a cost
greater than $10.0 million. As such, the Companys strategy, as regards large
LMR systems bids, is to partner with general contractors and integrators who
have substantial financial, marketing, and operational resources; in this
regard, the Company can piggy-back its LMR design and product expertise with
the larger companys greater overall resources. Other than EFJohnson, the Company believes that
Motorola, Thales, and Kenwood are currently the principal suppliers of Project
25 LMR products. Motorola is presently the only Project 25 supplier offering trunked
infrastructure, as well as trunked mobile and 
portable radios. The Company supplies trunked mobile and portable
radios; however, it only offers conventional Project 25 infrastructure. The
Company is continuing its development of Project 25 infrastructure with
shipment of trunked infrastructure scheduled to begin in 2004. Certain
companies have announced or are anticipated to announce future entry into the
Project 25 compliant product market which include, without limitation: M/A-Com,
Relm, Westel, Tait, Datron, and Daniels Communications. 12


---

Information Security The markets for analog LMR information security
products are highly competitive. A number of companies currently offer add-on
scramblers for LMRs that compete with the Companys add-on information security
products, including Future Telecom (d.b.a. Daxon), Kavit Electronics
Industries, Midian Electronics Inc., and MX-COM Inc. Significant competitive
factors in these markets include product quality and performance features,
including: ·effectiveness of security
features; ·quality of the resulting
voice or data signal; ·development of new products
and features; ·price; ·name recognition; and ·quality and experience of
sales, marketing, and service personnel. Government Regulation and
Export Controls Wireless Communications The Companys wireless products are subject to
regulation by the FCC under the Communications Act of 1934, as amended, and the
FCCs rules and policies as well as the regulations of the
telecommunications regulatory authority in each country where the Company sells
its products. These regulations are in the form of general approval to sell
products within a given country for operation in a given frequency band,
one-time equipment certification, and, at times, local approval for
installation. Additionally, the FCC and foreign regulatory authorities regulate
the spectrum used to provide LMR communication, as well as the construction,
operation, and acquisition of wireless communications systems, and certain
aspects of the performance of mobile communications products. Further, LMR
communications of the U.S. government are controlled by the NTIA which
regulates technical specifications of the product and spectrum used by the U.S.
government and other users. Many of these governmental regulations are highly
technical and subject to change. The Company believes that it and its products
are in material compliance with all governmental rules and policies in the
jurisdictions where the Company sells its products. In the United States, all of the Companys wireless
products are subject to FCC rules. In those countries that have accepted
certain worldwide standards, such as the FCC rulings or those from the European
Telecommunications Standards Institute, the Company has not experienced
significant regulatory barriers in bringing its products to market. Approval in
these markets involves retaining local testing agencies to verify specific
product compliance. However, many developing countries, including certain
markets in Asia, have not fully developed or have no frequency allocation,
equipment certification, or telecommunications regulatory standards. The majority of the systems operated by EFJohnsons
customers must comply with the rules and regulations governing what has
traditionally been characterized as private radio or private carrier
communications systems. Licenses are issued to use frequencies on either a
shared or exclusive basis, depending upon the frequency band in which the
system operates. Some of the channels designated for exclusive use are employed
on a for-profit basis; and other channels are used to satisfy internal
communications requirements. Most SMR systems in operation today use 800 MHz
channels. Within the top 50 metropolitan markets, 900 MHz frequencies, licensed
for exclusive use systems, have been made available to both SMR and non-SMR
licensees. Additional channels designated for exclusive use were made available
in the 220 MHz band for both commercial and non-commercial systems. 13 EFJohnson also offers products in bands below 800 MHz
where multiple users in the same geographic area share channels. In this shared
or conventional spectrum, there is no requirement for loading the channel to
any particular level in order to retain use of the frequencies. These channels
are generally used by entities satisfying traditional dispatch requirements in,
among others, the transportation and services industries. In addition, some
customers are applying trunking capabilities to their channels in the UHF
(primarily 450-470 MHz) frequency band. The FCC is considering a number of regulatory changes
that could affect the wireless communications industry and the Companys
business, including, but not limited to, various proposals to re-band and
reallocate spectrum at 700 MHz and 900 MHz. Therefore, the regulatory
environment is inherently uncertain and changes in the regulatory structure and
laws and regulations, both in the United States and internationally, can
adversely affect the Company and its customers. Such changes could make
existing or planned products of the Company obsolete or unusable in one or more
markets, which could have a material adverse effect on the Company. The FCC, through the Public Safety Wireless Advisory
Committee, is considering regulatory measures to facilitate a transition by
public safety agencies to a more competitive, innovative environment so that
the agencies may gain access to higher-quality transmission, emerging
technologies, and broader services, including interoperability. In August 1998,
the FCC adopted rules for licensing the largest block of spectrum ever
allocated at one time for public safety. The FCC established rules for
licensing 24 megahertz in the 700 MHz band and established a band plan for use
of this spectrum. In accordance with this rule, in January 1999 the FCC
established a Public Safety National Coordination Committee (NCC) to advise
it on issues relating to the use of the 700 MHz public safety spectrum. The
Committee is responsible for formulating a national interoperability plan,
recommending technical standards to achieve interoperability spectrum, and
providing policy recommendations on an advisory basis to the regional planning
committees in order to facilitate the development of coordinated plans. The NCC
recommended that Project 25 be established as the interim interoperability mode
for digital voice communications in this new band. During January of 2001,
the FCC released their Fourth Report and Order in which Project 25 was chosen
as the interoperability standard. The Committees recommendations and the FCCs
rulings and orders could affect products manufactured by the Company.  Management cannot predict the outcome of the
FCC review or any specific changes in FCC spectrum policies, or any potential
effect on the Companys sales. Information Security The Companys information security products have been
subject to export restrictions administered by the Department of Commerce,
which permit the export of encryption products only with the required level of
export license. U.S. export laws also prohibit the export of encryption
products to a number of specified hostile countries. Although to date the
Company has been able to secure most required U.S. export licenses, including
licenses for export to approximately 120 countries since 1978, there can be no
assurance that the Company will continue to be able to secure such licenses in
a timely manner in the future or at all. Additionally, in certain foreign
countries, the Companys distributors are required to secure licenses or formal
permission before encryption products can be imported. Management cannot predict whether any new legislation
regarding export controls will be enacted, what form such legislation will take
or how any such legislation will impact international sales of the Companys
products. Backlog The Company presently ships a small amount of
information security products against backlog, due to the typically short
manufacturing cycle of these products. Because of generally longer
manufacturing cycle times required for the production of complete wireless
communication products, the Companys backlog for wireless communication
products has been larger than for its security products. At December 31,
2002, 14 the Company had a
total backlog of approximately $8.0 million, substantially related to EFJohnson
sales. However, the Company does not believe that its backlog figures, and
variations from year to year therein, are indicative of sales of products in
future periods. Employees At December 31, 2002, the Company had 206
full-time equivalent employees, including 42 at its Lincoln, Nebraska facility,
140 at its Waseca, Minnesota facility, 6 at its Washington, DC facility, and 18
field sales people, sales managers or staff located in the sales territories in
which they serve. The Company also uses temporary employees, independent
contractors and consultants when necessary to manage fluctuations in demand.
None of the Companys employees are covered by a collective bargaining
agreement. Summary of Business
Considerations and Certain Factors That May Affect Future Results of
Operations and/or Stock Price Certain matters discussed in this Annual Report may
constitute forward-looking statements under Section 27A of the Securities
Act and Section 21E of the Exchange Act. These statements may involve
risks and uncertainties and relate, without limitation, to the following: ·the results of the Companys
product development efforts; ·future sales levels and
customer confidence; ·the Companys future
financial condition, liquidity and general business prospects; ·perceived opportunities in
the marketplace for the Companys products and its products under development;
and ·the Companys other
business plans for the future. The actual outcomes of the above referenced matters may
differ significantly from the outcomes expressed or implied in these
forward-looking statements. The following is a summary of some of the important
factors that could affect the Companys future results of operations and its
stock price, and should be considered carefully. If the APCO Project
25 standard is supplanted by some other recommended protocol or is otherwise
not supported by the federal, state and local government agencies, it would
adversely affect the Companys operations, cash flows, and financial condition. The Companys wireless communications marketing and
research and development efforts are substantially focused on Project 25
compliant equipment. The Company believes that sales of its Project 25 digital
LMR products have been, and will continue in the foreseeable future to be,
substantially dependent upon Motorolas dominant position as a market leader in
the Project 25 marketplace. Motorola is the largest manufacturer of Project 25
compliant LMR products and has been the principal public supporter of the
Project 25 digital transmission standard for the LMR market. If Motorola does
not maintain this dominant position, or if the Project 25 standard is otherwise
abandoned by industry and the governmental public safety / public service
users, it would adversely affect the Company operations, cash flows, and
financial credit. If the Company does
not continue to implement its strategic plan, it will adversely affect the
Companys operations, cash flows, and financial condition. In response to the substantial losses incurred in each
of the three years prior to 2001, the Company implemented a plan that included
significant transitions in product strategy and reductions in operating 15 expenses. The
extent to which the Company continues to successfully implement its plan to
exit low margin products and markets and expand sales in higher margin products
and markets will significantly impact the Companys future operations and cash
flows. The Companys failure to achieve its future revenue and profitability
goals, and other factors beyond the Companys control, could result in losses,
liquidity problems, additional impairment charges, and possible insolvency. Failure to comply
with financial covenants in the Companys credit facility could result in termination
of the credit facility, which would severely strain the Companys liquidity
position. In November 2002, the Company finalized a new
revolving credit facility, which expires September 30, 2004. The credit
facility has certain financial covenants with which the Company was in
compliance, or for which the Company had obtained waivers, as of December 31,
2002. However, there can be no assurance that the Company will remain in
compliance with certain financial covenants or be successful in renewing such facility.
Without the benefit of a revolving credit facility, a substantial decline in
revenues or gross margins or a material increase in costs or expenses would
severely strain the Companys liquidity position. Further, without a revolving
credit facility, the Companys ability to grow, either internally or through
acquisition, would be severely restricted. A reduction in
Motorolas provision of products, components, or technology to the Company
could harm the Companys business and operations. The Company is dependent on continuing access to
certain Motorola products, electrical components and proprietary intellectual
property. Although the Company believes that its relationship with Motorola is
good, the Company cannot assure that Motorola will continue to supply products,
electrical components and proprietary intellectual property to the Company on
the scale or at the price that it now does. In addition, Motorolas perception
of the Company as a competitor could impact Motorolas continued willingness to
do business with the Company. Although the Company has certain contractual
relationships with Motorola as a customer, most of these agreements are subject
to termination in certain circumstances and expire by their terms within one to
ten years. Any reduction of the Companys contractual relations with Motorola
or a decision by Motorola to reduce or eliminate the provision of products,
components and technology to the Company could harm the Companys business and
operations. An unfavorable
outcome in pending litigation could adversely affect the Companys cash flow,
financial condition and results of operations. On or about February 5, 2001, ASRC Communication
(ASRC) filed a complaint in United States District Circuit Court of Alaska,
against EFJohnson. ASRC alleges that EFJohnson engaged in wrongful activities
in association with radio products sold to ASRC. ASRC purchased approximately
$0.5 million of products from EFJohnson since 1999. ASRCs claims against
EFJohnson include breach of contract, breach of express warranty, breach of
implied warranty of merchantability, breach of implied warranty of fitness for
a particular purpose, breach of duty of good faith and fair dealing, equitable
estoppel, misrepresentation, and violations of the Racketeer Influenced and
Corrupt Organization Act. Plaintiff seeks compensatory damages in excess of
$0.5 million, attorneys fees and costs, and punitive damages in an unspecified
amount. The Company vigorously contests ASRCs allegations. However, the
Company is unable to predict the likelihood of the outcome or potential
liability that may arise from this legal action. The Companys
inability to secure satisfactory bonding arrangements would adversely affect
revenues. In the normal course of its business activities, the Company
is required under a contract with various governmental authorities to provide
letters of credit and bonds that may be drawn upon if the Company fails to
perform under its contracts. A number of factors can limit the availability of
such bonds, including the applicants financial condition and operating
results, the applicants record for completing similar 16 systems contracts
in the past and the extent to which the applicant has bonds in place for other
projects. Bonds, which expire on various dates, totaled $4.3 million at December 31,
2002, and, as of such date, no bonds have been drawn upon. However, if a
customer for a systems contract declares an event of default under the
outstanding bond related to the system contract, the issuer of the Companys
bonds could reduce the maximum amount of bond coverage available to the
Company, or impose additional restrictions with respect to the issuance of
bonds on behalf of the Company. The Companys inability to secure bonding
arrangements when needed would adversely affect the Companys ability to be
awarded new systems installation contracts, which would adversely affect its
revenues. The Companys
operating results historically fluctuate from period to period. The Companys operating results may fluctuate from
period to period due to a number of factors, as follows: ·timing of customer orders; ·timing of the introduction
of new products; ·timing and mix of product
sales; ·general economic
conditions, both in the United States and overseas; and ·specific economic
conditions in the information security and wireless communications industries. These factors make it difficult to utilize the Companys
quarterly results as a predictor of future operations. Historically, more than
half of each quarters revenues result from orders booked and shipped during
the third month of a quarter, and disproportionately in the latter half of that
month. These factors make the forecasting of revenue inherently uncertain. Because
the Company plans its operating expenses, many of which are relatively fixed in
the short term, on expected revenue, a relatively small revenue shortfall may
cause a periods results to be substantially below expectations. Such a revenue
shortfall could arise from any number of factors, including lower than expected
demand, supply constraints, transit interruptions, overall economic conditions,
or natural disasters. The Company faces
competitive pressures that could adversely affect revenues, gross margins, and
profitability. The wireless communications and information security
equipment industries, and the LMR market segment in particular, are highly
competitive. Competition in the sale of stand-alone and digital products is
more intense than for add-on and analog products. In addition, other wireless
communication technologies, including cellular telephone, paging, SMR,
satellite communications and PCS currently compete and are expected to compete
in the future with certain of the Companys stand-alone products. Furthermore,
other manufacturers have announced or are anticipated to announce the
availability of APCO Project 25 compliant products or digital land mobile
radios. Motorola and M/A-Com hold dominant and entrenched
market positions in the domestic public safety / public service market for
wireless communication products. In addition, these competitors have financial,
technical, marketing, sales, manufacturing, distribution and other resources
substantially greater than those of the Company. Finally, these competitors
have established trade names, trademarks, patents and other intellectual
property rights and substantial technological capabilities. These advantages
allow such competitors to: respond more quickly to new or emerging
technologies; manage more extensive research and development programs;
undertake more far-reaching marketing campaigns; engage in more aggressive
merger and acquisition strategies; and adopt more aggressive pricing policies. Accordingly,
the Company cannot make assurances that it will be able to continue to compete
effectively in its markets, that competition will not intensify, or that future
competition will not have a material adverse effect on the 17 Companys revenues,
gross margins, or profitability. In addition, the Company cannot assure that
new competitors will not begin to compete in the markets for the Companys
products. If the Company does
not effectively manage the transition from analog to digital products, its
revenues would be adversely affected. The LMR markets are migrating from analog to digital
equipment. This migration is primarily due to bandwidth capacity constraints,
availability of additional features, and the perception that digital
transmissions are more secure than analog transmissions. As a result, the
Company is seeking to upgrade many of EFJohnsons LMR products to be compatible
with digital LMR communications standards, including APCO Project 25. However,
the Company cannot assure that it will be able to effect this transition on a
timely basis or that its digital products will compete successfully in the LMR
marketplace. The failure of its products to compete successfully in the
marketplace would have a material adverse effect on the Companys revenues. Furthermore,
the transition from analog to digital communications is likely to continue to
result in a decrease in demand for the Companys add-on security devices. The Companys sales
to foreign customers are subject to various export regulations; and the
inability to obtain, or the delay in obtaining, any required export approvals
would harm revenues. The Companys sales to foreign customers are subject
to export regulations. Sales of many of the Companys encryption products
require clearance and export licenses from the U.S. Department of Commerce
under these regulations. The Company cannot assure that such approvals will be
available to it or its products in the future in a timely manner, or at all, or
that the federal government will not revise its export policies or the list of
products and countries for which export approval is required. The Companys
inability to obtain, or a delay in obtaining, required export approvals would
harm the Companys international sales. In addition, foreign companies not
subject to United States export restrictions may have a competitive advantage
in the international market. The Company cannot predict the impact of these factors
on the international market for its products. The Companys
future success will depend upon its ability and the resources available to
respond to the rapidly evolving technology and customer requirements in the
markets in which the Company operates. The wireless communications and information security
markets, in which the Company competes, are rapidly evolving and can be
expected to further evolve in the future as a result of changing technology,
industry standards and customer requirements. The Companys ability to compete
effectively will depend upon its ability to anticipate and react to these
changes in a timely manner. The Company may not have, either currently or in
the future, adequate capital or human resources to respond to these changes. Technological developments in the digital LMR industry
include the use of digital trunking, digital simulcast, and digital voting
technologies. These technologies have led a number of manufacturers to change
the architectures and methodologies used in designing, developing, and
implementing large LMR systems. In order for the Company to develop and
integrate these new technologies into its products, the Company has made a
substantial investment in capital and human resources. However, there can be no
assurance that such resources will be readily available to the Company in the
future. The failure of the Company to incorporate these
technologies into its LMR products could, in the future, place the Companys
LMR products at a competitive disadvantage to those offered by other
manufacturers. This situation could possibly make the Companys hand-held and
mobile LMRs incompatible with systems developed by other manufacturers, which
would have a material adverse effect on the Company. 18 Business,
political, regulatory, or economic changes in foreign countries in which the
Company markets its products or services could adversely affect the Companys
revenues. Although all of the Companys sales are denominated in
U.S. dollars, fluctuations in the value of international currencies relative to
the U.S. dollar may affect the price, competitiveness and profitability of the
Companys products sold in international markets. Furthermore, the uncertainty
of monetary exchange values has caused, and may in the future cause, some foreign
customers to delay new orders or delay payment for existing orders. Additionally,
troubled economic conditions, such as that recently experienced in Asia and in
Latin America, could result in lower revenues for the Company. In 2002, 2001 and 2000, international sales
constituted approximately 15%, 24%, and 17% of revenues, respectively. While
substantially all international sales are supported by letters of credit, the
purchase of Company products by international customers presents increased
risks, which include: ·unexpected changes in
regulatory requirements; ·tariffs and other trade
barriers; ·political and economic
instability in foreign markets; ·difficulties in
establishing foreign distribution channels; ·longer payment cycles; ·uncertainty in the
collection of accounts receivable; ·increased costs associated
with maintaining international marketing efforts; ·difficulties in protecting
intellectual property; and ·susceptibility
to orders being cancelled as a result of foreign currency fluctuations (since
all the Company quotations and invoices are denominated in U.S. dollars). The Companys sales
are substantially concentrated in public sector markets that inherently possess
additional risks that could harm revenues and gross margins. A significant portion of the Companys revenue is
derived from sales to the federal, state and local governments, both directly
or through system integrators and other resellers. Sales to these governmental
entities present risks in addition to those involved in sales to commercial
customers, including potential disruptions due to appropriation and spending
patterns, changes in governmental personnel, political factors, and the
governments reservation of the right to cancel contracts for its convenience. The
RFP bidding cycle and contract award stage can take six months to two years
before a contract is awarded and the governmental customers funding process for
these systems can delay the bidding cycle as well. The Companys sales to
domestic public safety / public service entities accounted for approximately
74%, 61%, and 50% of the Companys total sales in 2002, 2001, and 2000,
respectively. The Company expects that sales to governmental entities will
increasingly be subject to competitive bidding requirements. This intensified
competition can be expected to result in lower prices, longer sales cycles, and
lower margins. The Companys
future success is dependent upon its ability to motivate and maintain key
personnel. The Company believes that its future success will
depend in part on its ability to attract, motivate and retain highly skilled
engineering, technical, managerial and marketing personnel. Competition for
such personnel is intense, and the Company competes in the market for such
personnel against numerous companies, including larger, more established
companies with significantly greater financial resources than the Company. The
Company currently has openings for engineers and other personnel, and it cannot
assure that it will be successful in attracting, motivating or retaining such
personnel. 19


---

The Companys
revenues and gross margins are dependent upon the timely and consistent
delivery of components by third party suppliers. Most of the Companys current and proposed products
require essential electronic components supplied by outside vendors. Certain
components may be available from only one supplier and may occasionally be in
short supply. For example, in the aftermath of September 11, 2001, the
Company experienced a temporary disruption in its vendor supply chain. Any
significant delay in the Companys ability to obtain key components could
result in lost sales, the need to maintain excessive inventory levels, higher
component costs, or the need to redesign certain affected electronic
sub-assemblies. In addition, the Companys dependence on limited and sole
source suppliers of components involves additional risks of inadequate supply,
late deliveries, and poor component quality. Significant lead time and costs
may be required to secure secondary sources for key components. Any material
disruption in the supply of essential components would increase the cost of
producing the Companys products and would have a material adverse effect on
the Companys ability to meet the demand for its products. Unforeseen
environmental costs could adversely impact the Companys profitability. The Company is subject to various federal, state and
local environmental statutes, ordinances and regulations relating to the use,
storage, handling and disposal of certain toxic, volatile or otherwise
hazardous substances and wastes used or generated in the manufacturing and
assembly of the Companys products. Under these laws, the Company may become
liable for the costs of removal or remediation of certain hazardous substances
or wastes that have been or are being released at the Companys facilities, or
have been or are being disposed of offsite as wastes. Such laws may impose
liability without regard as to whether the Company knew of, or caused, the
release of such hazardous substances or wastes. The Company cannot assure that any environmental
assessments the Company has undertaken with respect to its facilities have
revealed all potential environmental liabilities, that any prior owner or
operator of the Companys properties did not create any material environmental
condition not known to the Company, or that an environmental condition that
could result in penalties, expenses, or liability to the Company does not
otherwise exist in any one or more of the Companys facilities. In addition,
the amount of hazardous substances or wastes produced or generated by the
Company may increase in the future depending on changes in the Companys
operations. Any failure by the Company to comply with present or future
environmental laws could subject it to the imposition of substantial fines,
suspension of production, alteration of manufacturing processes, or cessation
of operations, any of which could have a material adverse effect on the
Company. Compliance with such environmental laws could require the Company to
acquire expensive remediation equipment or to incur substantial expenses. Furthermore,
the presence of hazardous substances on a property or at certain offsite
locations could result in the Company incurring substantial liabilities as a
result of a claim by a private third-party for personal injury or a claim by an
adjacent property owner for property damage. The imposition of any of the
foregoing liabilities could materially adversely affect the Company. The Companys
revenues are dependent upon the Companys continued ability to enforce or
license intellectual property rights. The Company currently holds a number of patents and
has on file applications for additional patents. Although the Company assesses
the advisability of patenting any technological development, the Company has
historically relied on copyright and trade secret law, as well as employee and
third-party non-disclosure agreements, to protect its proprietary intellectual
property and rights. The protection afforded by such means may not be as
complete as patent protection. In addition, the laws of some countries do not
protect trade secrets. There are limitations on the availability of patent
protection as a means to protect the Companys products. Even when patent
protection can be obtained, there are often limitations on the 20 enforceability of such
patent rights. The Companys inability to preserve all of its proprietary
intellectual property and rights could have a material adverse effect on the
Company. In addition, much of the Companys business and many
of its products rely on key technologies developed by third parties, and the
Company may not be able to obtain or renew licenses or technologies from these
third parties on reasonable terms or at all. Further, third parties may claim
that the Company is infringing on their intellectual property rights. Even if
the Company does not believe that its products are infringing on third parties
intellectual property rights, the claims can be time consuming and costly to
defend and could, thereby, divert managements attention and resources away
from the Companys business. Terrorist acts and
acts of war may adversely affect the Companys business, its revenues, costs of
operations, or overall financial condition. Terrorist acts or acts of war (wherever located around
the world) may cause damage or disruption to the Company, its employees,
suppliers, distributors and resellers, or customers, which could significantly
impact the Companys revenues, costs of operations, or financial condition. The
terrorist attacks that took place in the United States on September 11,
2001 created many economic and political uncertainties. The long-term effects
on the Company of the September 11, 2001 attacks are unknown. The
potential for future terrorist attacks, the national and international
responses to terrorist attacks, and other acts of war or hostility could
adversely affect the business and results of operations of the Company in ways
that cannot presently be predicted. The Companys
failure to comply with or changes in governmental regulation could adversely
affect the Companys business and operations. The Companys wireless communications and encryption
products, and the spectrum within which these products are used, are subject to
regulation by domestic and foreign laws and international treaties, as are the
Companys customers. In particular, the Companys LMR products are regulated by
the FCC. The Company believes itself to be in substantial compliance with all
applicable regulations governing its products and operations. However, the
regulatory environment is uncertain. Changes in the regulatory structure, laws
or regulations, or in the use and/or allocation of spectrum, could adversely
affect the Company and / or its customers. Such changes could make the Companys
existing or planned products obsolete or not sellable in one or more markets,
which could have a material adverse effect on the Company. Further, the Companys
failure to comply in the future with applicable regulations could result in
penalties on the Company, such as fines, operational restrictions, or a
temporary or permanent closure of the Companys facilities. Significant
increases in the Companys stock price could cause the Company to incur net
losses as a result of the variable accounting used for certain repriced stock
options. During 2001 and 2000, the Company effectively
decreased the exercise price on options for 1,186,000 shares, lowering the
exercise price of those options to an amount approximately 150% of the
prevailing market value of the Companys common stock (the repricing), that
is $0.656 per share. The repricing of the stock options resulted in a new
measurement date for accounting purposes and the reclassification of these
options as variable plan awards beginning on the date of the repricing. The Company
previously accounted for these option grants as fixed plan awards. The Company
recorded $483,000 in non-cash compensation expense in 2002 for the cumulative
effects of the repricings as a result of the Companys stock price being $1.25
at December 31, 2002. To the extent the Companys stock price exceeds
$1.25 at the end of future reporting periods, the Company could incur
additional non-cash compensation expense. In the event of substantial increases
in the Companys stock price, the Companys results of operations could be
adversely effected, and the Company could incur net losses as a consequence. 21 ITEM 2. PROPERTIES The Company occupies a portion of a 76,500 square foot
multi-story administrative and manufacturing facility located at 4800 NW 1st Street,
Suite 100, Lincoln, Nebraska, 68521, which is located in the University of
Nebraska Technology Park. The Company sold this facility and approximately 10
acres of surrounding land during August 1999 for approximately $5.2
million. In conjunction with the sale, the Company leased approximately 23,000
square feet of the facility for five years, and for which the Company will pay
approximately $285,000 during 2003. On January 28, 1998, the Company purchased the
250,000 square-foot manufacturing facility located on a 20-acre site in Waseca,
Minnesota. During December 1999, the Company sold the Waseca facility for
approximately $2.7 million. In conjunction with the sale, the Company leased
back 136,000 square feet of the facility for five years, and for which the
Company will pay approximately $840,000 during 2003. The Company also leases additional sales and service
facilities in Miami, Florida, and Washington, D.C. and owns a residential
property in Waseca, Minnesota. ITEM 3. LEGAL PROCEEDINGS On or about February 5, 2001, ASRC filed a
complaint in United States District Circuit Court of Alaska, against EFJohnson.
ASRC alleges that EFJohnson engaged in wrongful activities in association with
radio products sold to ASRC. ASRC purchased approximately $0.5 million of
products from EFJohnson since 1999. ASRCs claims against EFJohnson include
breach of contract, breach of express warranty, breach of implied warranty of
merchantability, breach of implied warranty of fitness for a particular
purpose, breach of duty of good faith and fair dealing, equitable estoppel,
misrepresentation, and violations of the Racketeer Influenced and Corrupt
Organizations Act. Plaintiff seeks compensatory damages in excess of $0.5
million, attorneys fees and costs, and punitive damages in an unspecified
amount. The Company vigorously contests ASRCs allegations. However, the
Company is unable to predict the likelihood of the outcome or potential
liability that may arise from this legal action. The Company is involved in certain other legal
proceedings incidental to the normal conduct of its business. The Company does
not believe that any liabilities relating to such other legal proceedings are
likely to be, individually or in the aggregate, material to the Companys
business, financial condition, results of operations or cash flows. ITEM 4. SUBMISSION OF
MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to the stockholders during
the fourth quarter of 2002. 22 PART II ITEM 5. MARKET FOR
REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Companys Common Stock trades on the Over the
Counter (OTC) Bulletin Board under the symbol EFJI.  It has traded on the OTC Bulletin Board since
August 1998, following the delisting of the Common Stock from the NASDAQ
Stock Market in May 1998. The following table sets forth, in the periods
indicated, the high and low sales prices per share of the Common Stock, as
reported by the OTC Bulletin Board for the periods presented. OTC Bulletin
Board quotations reflect inter-dealer prices, without retail mark-up,
mark-down, or commission and may not necessarily represent actual transactions. High
  
  Low2001First Quarter
  
  $
  0.88
  
  $
  0.16Second Quarter
  
  $
  0.39
  
  $
  0.17Third Quarter
  
  $
  0.70
  
  $
  0.16Fourth Quarter
  
  $
  0.72
  
  $
  0.432002First Quarter
  
  $
  1.50
  
  $
  0.45Second Quarter
  
  $
  1.40
  
  $
  0.79Third Quarter
  
  $
  1.08
  
  $
  0.58Fourth
  Quarter
  
  $
  1.30
  
  $
  0.65  The last sale price of the Common Stock on December 31,
2002, as reported in the OTC Bulletin Board was $1.25. As of February 17,
2003, the Company had approximately 2,200 shareholders of record. Dividends The Company has never declared or paid any cash
dividends on its shares of Common Stock. Further, the Companys revolving line
of credit agreement imposes restrictions upon the Companys ability to pay
dividends. The Company currently intends to retain any future earnings to
finance the growth and development of its business. Any determination in the
future to pay dividends would depend on the Companys financial condition,
capital requirements, results of operations, contractual limitations and any
other factors deemed relevant by the Companys Board of Directors. 23


---

ITEM 6. SELECTED FINANCIAL
DATA The following selected consolidated financial data of
the Company is qualified by reference to, and should be read together with the Consolidated Financial Statements, with
related notes and the independent auditors reports thereon, and Managements
Discussion and Analysis of Financial Condition and Results of Operations,
included elsewhere in this Annual Report on Form 10-K. The Consolidated
Statement of Operations data for the years ended December 31, 2002, 2001
and 2000 and the Consolidated Balance Sheet data as of December 31, 2002
and 2001 are derived from the Consolidated Financial Statements of the Company
included elsewhere in this Annual Report on Form 10-K. The Consolidated
Statement of Operations data for the years ended December 31, 1999 and
1998 and the Consolidated Balance Sheet data as of December 31, 2000,
1999, and 1998 are derived from financial statements not included herein. Year ended December 31,1998
  
  1999
  
  2000
  
  2001
  
  2002(in thousands, except share and per share data)Consolidated Statement of
  Operations Data:Revenues
  
  $
  62,041
  
  $
  53,520
  
  $
  42,192
  
  $
  44,168
  
  $
  40,787Cost of sales
  
  44,905
  
  36,059
  
  33,613
  
  26,610
  
  23,216Gross profit
  
  17,136
  
  17,461
  
  8,579
  
  17,558
  
  17,571Operating expenses:Research and development
  
  8,812
  
  5,724
  
  5,763
  
  4,972
  
  4,573Sales and marketing
  
  11,476
  
  8,282
  
  7,263
  
  5,093
  
  5,920General and administrative(1)(5)
  
  12,529
  
  9,601
  
  10,196
  
  7,332
  
  5,915Restructuring charge(2)
  
  1,230
  
  523
  
  358
  
  
  
  Provision for litigation settlement(3)
  
  10,000
  
  (2,221
  )
  (924
  )
  
  
  Total operating expenses
  
  44,047
  
  21,909
  
  22,656
  
  17,397
  
  16,408Income (loss) from
  operations
  
  (26,911
  )
  (4,448
  )
  (14,077
  )
  161
  
  1,163Interest income,
  net of interest expense
  
  655
  
  386
  
  292
  
  20
  
  43Other income, net
  of other expenses
  
  46
  
  235
  
  775
  
  363
  
  204Income tax expense
  (benefit)(4)
  
  (3,916
  )
  
  
  12,376
  
  
  
  Net income (loss)
  
  $
  (22,294
  )
  $
  (3,827
  )
  $
  (25,386
  )
  $
  544
  
  $
  1,410Net income (loss) per shareBasic(6)
  
  $
  (1.72
  )
  $
  (0.30
  )
  $
  (1.88
  )
  $
  0.03
  
  $
  0.08Net income (loss)
  per shareDiluted(6)
  
  $
  (1.72
  )
  $
  (0.30
  )
  $
  (1.88
  )
  $
  0.03
  
  $
  0.08Weighted average common sharesBasic(6)
  
  12,946,624
  
  12,947,795
  
  13,511,489
  
  16,617,426
  
  17,577,315Weighted average
  common sharesDiluted(6)
  
  12,946,624
  
  12,947,795
  
  13,511,489
  
  16,617,426
  
  18,008,496Consolidated
  Balance Sheet Data:Working capital
  
  $
  17,426
  
  $
  26,793
  
  $
  16,091
  
  $
  18,645
  
  $
  20,652Total assets
  
  $
  87,212
  
  $
  85,521
  
  $
  46,994
  
  $
  44,120
  
  $
  45,256Long-term debt and
  capitalized lease obligations, net of current portion
  
  $
  6
  
  $
  197
  
  $
  19
  
  $
  
  
  $
  264Stockholders equity
  
  $
  53,096
  
  $
  49,286
  
  $
  25,770
  
  $
  30,594
  
  $
  32,487  
 (1)Includes amortization and impairment
charges for intangible assets. Amortization of intangible assets related to the
acquisition of EFJohnson commenced in August 1997. In 2000, the Company
recorded an impairment charge of $2.3 million related to the acquired work
force, customer base, and trade name. As of January 1, 2002, the company
adopted Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets; accordingly, the
Company no longer amortizes certain intangibles, including goodwill. This
resulted in a reduction of amortization expense of approximately $1.0 million
in 2002, as compared to previous years. See Note 5 of Notes to Consolidated
Financial Statements for a more detailed explanation. (2)Represents a charge for reductions in
workforce taken in the third quarter of 1998, the second quarter of 1999, and
the fourth quarter of 2000. (3)Represents a special provision taken in
the fourth quarter of 1998 for potential class action litigation settlement, and
the reversals of a portion of that reserve in the second quarter of 1999 and
the second and fourth quarters of 2000. See Note 11 of Notes to Consolidated
Financial Statements for a more detailed explanation. (4)Includes a $12.4 million increase in the
valuation allowance for Deferred Tax Assets during the fourth quarter of 2000. See
Note 9 of Notes to Consolidated Financial Statements for a more detailed
explanation. 24 (5)Includes $0.5 million of non-cash
compensation expense in 2002 resulting from the variable accounting treatment
applied to certain repriced stock options. See Note 12 of Notes to Consolidated
Financial Statements for a more detailed explanation. (6)See Note 1 of Notes to Consolidated
Financial Statements for an explanation of the method used to determine the
number of shares used to compute net income (loss) per share. ITEM 7. MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Annual Report on Form 10-K, including the
following Managements Discussion and Analysis of Financial Condition and
Results of Operations, contains forward-looking statements that may involve
risks and uncertainties. The Companys actual results may differ significantly
from those discussed herein. Factors that might cause such differences include,
but are not limited to, those discussed under ITEM 1. BUSINESSSummary
of Business Considerations and Certain Factors That May Affect Future
Results of Operations and/or Stock Price. The following discussion should be
read together with the Companys Consolidated Financial Statements and Notes
thereto appearing elsewhere in this Annual Report on Form 10-K. Overview The Company is engaged in the design, manufacture, and
marketing of wireless communications products and systems and information
security products. Through EFJohnson, the Company designs, develops,
manufactures, and markets: (1) stationary LMR transmitters/receivers (base
stations or repeaters); (2) mobile and portable radios; and (3) LMR
systems. Through Transcrypt, the Company designs and manufactures information
security products that prevent unauthorized access to sensitive voice
communications. These products are based on a wide range of analog scrambling
and digital encryption technologies and are sold mainly to the LMR security
markets. The Company primarily sells its products to: (1)  domestic public
safety / public service and other governmental users; (2) commercial
users; and (3) international customers. Since implementation of a new strategic plan in 2000,
the Company has been focused on restoring growth and profitability via
significant transitions in product mix and strategy and reduction in operating
expenses. The Companys product strategy has been to exit certain lower margin
product lines and to focus EFJohnsons resources on the Multi-Net®,
SmartNet®/SmartZone®, APCO 25 and LTR-Net® product lines. This product strategy
entailed a substantial exit from the commercial market, and an emphasis on the
domestic public safety / public service sector, thereby allowing the Company to
focus its resources on the markets and products which the Company believes have
the most potential for sustained profitability. The Company plans to continue
this product strategy in 2003. The Company also initiated programs to reduce operating
expenses in order to keep costs in line with revenues. These initiatives
included workforce reductions in the fourth quarter of 2000, and the first
quarter of 2001. These initiatives resulted in a reduction in the minimum level
of revenues necessary to support the organization. The amount of revenues
required to provide adequate cash flow to support the Company depends in part
upon the mix of products and services sold by the Company. The Company
recognized net income of $1.4 million in 2002 and $0.5 million in 2001 and
generated cash from operations of $1.2 million in 2002 and $3.9 million in
2001. The extent to which the Company continues to
successfully implement its plan to exit low margin products and markets and
expand sales in higher margin products and markets will have a significant
impact on the Companys future operations and cash flows. Although the Company
was successful in the formulation and implementation of such plans in 2002 and
2001, the Company cannot guarantee that these strategies will continue to allow
the Company to remain profitable in the future. Management anticipates that the
Company will be able to achieve a sufficient level of revenues in the future to
continue operations. However, the Companys failure to achieve its future
revenue and profitability goals, and other factors 25 beyond the Companys
control, could result in losses, liquidity problems, additional impairment
charges, and possible insolvency. Results of Operations The following table
sets forth certain Consolidated Statement of Operations information as a
percentage of revenues during the periods indicated. Year Ended December 31,2000
  
  2001
  
  2002Revenues
  
  100.0
  %
  100.0
  %
  100.0
  %Cost of sales
  
  79.7
  
  60.3
  
  56.9Gross profit
  
  20.3
  
  39.7
  
  43.1Operating expenses:Research and development
  
  13.7
  
  11.3
  
  11.2Sales and marketing
  
  17.2
  
  11.5
  
  14.5General and administrative
  
  24.2
  
  16.6
  
  14.5Restructuring charge
  
  0.8
  
  
  
  Provision for litigation settlement
  
  (2.2
  )
  
  
  Total operating expenses
  
  53.7
  
  39.4
  
  40.2Income (loss)
  from operations
  
  (33.4
  )
  0.3
  
  2.9Interest income
  (expense), net
  
  0.7
  
  
  
  0.1Other income
  
  1.8
  
  0.9
  
  0.5Income tax
  expense
  
  (29.3
  )
  
  
  Net income (loss)
  
  (60.2
  )%
  1.2
  %
  3.5
  %  Revenues If collection is reasonably assured, revenues are
recognized when product is shipped, less an estimate for an allowance for
returns or doubtful accounts, if applicable. For shipments where collection is
not reasonably assured, the Company recognizes revenue as cash is received. If
collection is contingent on a future event, such as a reseller of product
selling the product to the end user, the Company recognizes revenue when the
contingency lapses, generally upon cash collection. System sales under long-term contracts are accounted
for using the percentage of completion method. Under this method, revenues are
recognized as work on a contract progresses. The recognized revenue is that
percentage of estimated total revenue that incurred costs to date bears to
estimated total costs to complete the contract. Revisions in cost and profit
estimates are made when conditions requiring such revisions become known.
Anticipated losses on contracts are recognized as soon as such losses are
determined to be probable and can be reasonably estimated. Deferred revenue includes unearned warranty fees on
extended product warranty contracts sold to customers. The Company recognizes
the fees based on the expected warranty repairs to be incurred over the life of
the contract, generally on a straight-line basis. 2002 vs. 2001 Revenues decreased by 8% in 2002, to $40.8 million, as
compared to $44.2 million in 2001. Of the total revenues for 2002, the wireless
communication segment revenues comprised $33.8 million, or 83% of total revenues;
and the information security segment revenues comprised $7.0 million, or 17% of
total revenues. 26


---

Wireless communication revenues decreased to $33.8 million
in 2002, as compared to $38.4 million in 2001. This 12% decrease was
primarily the result of the decreased international and commercial / OEM sales
as EFJohnson continued to focus its efforts on the domestic public safety /
public service and governmental user segment of the market. Although sales to
the domestic public safety / public service sector increased by $3.2 million
during 2002 (from $26.9 million in 2001 to $30.1 million in 2002),
predominantly resulting from increased emphasis on sales to U.S. government
agencies, international sales declined from $6.6 million in 2001 to $1.3 million
in 2002, and commercial / OEM sales declined from $4.9 million in 2001 to
$2.3 million in 2002. Management does not expect international or
commercial / OEM sales to vary significantly from the amounts realized in 2002
in either the short or long term. The Companys digital, Project 25 and
SmartNet®/SmartZone® product offerings, in particular, became a more significant
part of the Companys revenue mix in 2002, and management anticipates
increasing revenues from these product offerings, as well as system expansion
contracts, in 2003, primarily to the domestic public safety / public service
sector. Information security revenues increased to $7.0 million
in 2002, as compared to $5.8 million in 2001. This 21% increase primarily
related to increased market demand in Asia for analog encryption products. As
the LMR market continues to move towards digital products, demand for analog
encryption radio products will decrease. To ameliorate the adverse effects of
this trend, Transcrypt intends to increase its marketing efforts in those parts
of the world where any movement to digital LMR products is expected to be
delayed for several years. The Company anticipates an immaterial decline in its
information security revenues in 2003 as compared to 2002. 2001 vs. 2000 Revenues increased by 5% in 2001, to $44.2 million,
as compared to $42.2 million in 2000. Of the total revenues for 2001, the
wireless communication segment revenues comprised $38.4 million, or 87%,
and the information security segment revenues comprised $5.8 million, or
13%. The increase in wireless communication revenues to
$38.4 million in 2001, versus $36.1 million in 2000, was primarily
the result of the Company focusing its efforts on the domestic public safety /
public service and governmental user segment of the market, as well as
improvement in its respective LMR products. The Companys SmartNet®/SmartZone®
product offerings, in particular, became a more significant part of the Companys
revenue mix in the third and fourth quarters of 2001, and the Companys sales
to Federal governmental users also significantly increased in the fourth
quarter of 2001. These increases offset the substantial decrease in commercial
and OEM manufacturing sales, from $12.4 million in 2000 to $4.9 million
in 2001. Information security revenues decreased to $5.8 million
in 2001 from $6.1 million in 2000. In 2001, the Company exited from the
telephony security market due to the increased deployment of digital cellular
services. Revenues derived from the Companys telephony security products were
$0.2 million in 2001, as compared to $0.7 million in 2000. International International sales were $6.1 million, or 15% of
revenues, in 2002, as compared to $10.5 million, or 24% of revenues, in
2001, and $7.2 million, or 17% of revenues, in 2000. In 2002, the
information security segment accounted for 78% of the Companys total
international sales. The Company experienced a 78% decrease in revenues
from the Central and Latin America regions in 2002 as compared to 2001, $1.3 million
versus $5.8 million. Virtually all of this decrease is attributable to
decreases in wireless communication sales to this area, which was primarily
impacted by economic problems in Brazil and Argentina. During 2001, revenues
from this region increased 115% as compared to 27 2000, $5.8 million
versus $2.7 million. This increase primarily resulted from LMR product
sales to a certain Brazilian governmental agency. Sales to the Middle East and Asia regions were $4.1 million
in 2002 as compared to $3.0 million in 2001, reflecting an increase of 37%.
This increase related substantially to increased encryption products to the Asian
market. International sales from the Middle East and Asian regions were $3.0 million
in 2001, as compared to $3.7 million in 2000. The Company anticipates that revenues derived from
both the Latin American region and the Middle East and Asian regions to
slightly increase in 2003 as the Company continues to increase its encryption
marketing efforts in these areas. The Companys sales to the European market
were $0.7 million in 2002, $1.7 million in 2001, and $0.8 million
in 2000; and the Company would not expect any material changes in 2003 sales to
this area. Gross Profit Cost of sales includes materials, labor, depreciation
and overhead costs associated with the production of the Companys products, as
well as shipping, royalty, and warranty product costs. Gross profit was $17.6 million (43% gross margin) in
2002, as compared to $17.6 million (40% gross margin) in 2001, and $8.6 million
(20% gross margin) in 2000. Gross margins for the wireless communications
segment were 37% in 2002, 36% in 2001, and 10% in 2000. Gross margins for the
information security segment were 70% in 2002, 67% in 2001, and 72% in 2000. The increase in overall gross margins from 2001 to
2002 is the result of improved manufacturing techniques, more efficient
outsourcing decisions, the continued movement away from low margin commercial
and international wireless communication markets, and general sales mix. Further,
new product offerings, using cost-effective common platforms, became a larger
portion of sales in 2002. The increase in overall gross margins from 2000 to
2001 is the result of several factors, which include: 1) the reduction of the
Companys workforce in the fourth quarter of 2000 and the first quarter of 2001
eliminating approximately 30% of the Companys workforce and decreasing the
Companys production cost burden; 2) the Companys decision in the fourth
quarter of 2000 to exit certain low margin commercial products; 3) the Companys
efforts to reduce manufacturing costs through outsourcing and other
efficiencies; and 4) the Companys focus in 2000 on the completion of several
large systems installation contracts which, due to delays, had significantly
reduced profit margins. Management is continuing to review pricing strategies
and product line profitability at both segments. Management intends to make
adjustments to its product offerings, where deemed appropriate, to include
elimination of marginally profitable products and product lines. Management is
also continuing to review its manufacturing procedures in search of further
efficiencies. Based upon the foregoing, management expects the Companys gross
margin levels achieved in 2002 to continue at such levels in the future. Research and Development Research and development expenses consist primarily of
costs associated with research and development personnel, materials, and the
depreciation of research and development equipment and facilities. The Company
expenses all research and development costs as they are incurred. Research and development expenses were $4.6 million in
2002, as compared to $5.0 million in 2001 and $5.8 million in 2000. As a
percentage of sales, research and development expenses were 11% of revenues in
2002, as compared to 11% in 2001 and 14% in 2000. During 2002 and 2001, the Companys research and development
costs were substantially focused on the Companys new line of digital radios. Research
and development costs in 2000, on the other hand, were 28 significantly impacted by
issues associated with completing certain systems installation contracts and significant
maintenance of line work involving the resolution of problems associated with
existing products. Additionally, the Companys research and development
workforce was reduced in the fourth quarter of 2000 as a result of the Companys
decision to exit certain commercial product lines. Current research and development efforts are
concentrated on enhancements and additions to the Companys line of digital
radios that will continue to comply with Project 25 standards. The Company is
also developing Project 25 system infrastructure such as repeaters, voters, and
base stations. The Company would anticipate that 2003 research and development
costs, as a percentage of sales, would remain at, or slightly above, the
percentages experienced in 2002 and 2001. Sales and Marketing Sales and marketing expenses consist primarily of
salaries and related costs of sales personnel, including sales commissions and
travel expenses, as well as costs of advertising, public relations and trade
show participation. Sales and marketing expenses were $5.9 million in
2002, as compared to $5.1 million in 2001, and $7.3 million in 2000. As
a percentage of sales, sales and marketing expenses were 15% of revenues in
2002, as compared to 12% in 2001 and 17% in 2000. The increase in 2002 was substantially due to
unusually higher external commissions (to non-employee dealers and
representatives) incurred on sales at both segments. The decrease in 2001 was a
result of workforce reductions in the fourth quarter of 2000 and the first
quarter of 2001, as well as a result of the Companys decision to de-emphasize
the commercial products. The Company would anticipate its sales and marketing
expenses to decrease only slightly as a percentage of sales in 2003, as
compared to the rate experienced in 2002, as the Company continues to increase
its marketing efforts in the domestic public safety / public service sectors. General and Administrative General and administrative expenses consist primarily
of salaries and other expenses associated with the Companys management,
accounting, finance and administrative functions, and amortization of
intangible assets. General and administrative expenses were $5.9 million
in 2002, as compared to $7.3 million in 2001 and $10.2 million in 2000. As a
percent of revenues, general and administrative expenses were 15% of revenues
in 2002, as compared to 17% of revenues in 2001, and 24% of revenues in 2000. In connection with the Companys purchase of all of
the outstanding shares of capital stock of EFJohnson, the Company recorded
$18.0 million of goodwill and other intangibles at the closing of this
acquisition. The Company amortized these amounts on a straight-line basis over
periods of 3 to 15 years from August 1997 through December 2001. During
2000, management determined that, due to the Companys recent performance and
product development strategy, certain facets of the Companys intangible assets
associated with the purchase of EFJohnson in 1997 had become impaired. Consequently,
impairment charges totaling $2.3 million, relating to acquired work force,
customer base, and trade name, were taken during the fourth quarter of 2000. The
impairment loss measurement was based upon managements estimate of the fair
value of the intangible assets. Specifically, the Company reduced the carrying
value of the EFJohnson trade name by $0.8 million, the carrying value of the
EFJohnson customer base by $0.9 million, and the carrying value of the
EFJohnson workforce by $0.5 million. As of January 1, 2002, in accordance
with its adoption of SFAS No. 142, Goodwill and Other
Intangible Assets, the Company no longer amortizes certain
intangibles, including goodwill; alternatively, the Company reviews such assets
for impairment at the reporting dates. This change in accounting for intangible
assets resulted in a 29 decrease in amortization
expense of approximately $1.0 million per year in 2002, as compared to 2001 and
2000. In addition, no impairment of the Companys goodwill was deemed to exist
at December 31, 2002 and 2001. General and administrative expenses in 2002 were less
than 2001 materially as a result of the following factors: (1) the
aforementioned adoption of SFAS No. 142 resulting in a decrease of $1.0
million as to the amortization of intangible assets; (2) decreased
expenses in 2002 related to reduced staffing levels resulting from a reduction
in workforce in the first quarter of 2001. The lower general and administrative expenses in 2001,
as compared to 2000, are primarily the result of $2.3 million in impairment
losses on intangible assets in 2000, as well as the aforementioned workforce
reductions in the fourth quarter of 2000 and the first quarter of 2001. The Company anticipates general and administrative
expenses for 2003 to be at a similar level as experienced in 2002, excluding
non-cash compensation expense relating to the repriced options. These repriced
options have an exercise price of $0.656 per share. Required variable
accounting treatment of these repriced options is such that each $0.01 change
in the market price of the Companys common stock from the $1.25 price per
share as of December 31, 2002 will cause, as applicable, a non-cash
benefit (for decreases below $1.25 per share, limited to the exercise price of
the options) or expense (for increases above $1.25 per share) of approximately
$8,500. Restructuring Charges The Company incurred negligible expenses in connection
with its workforce reduction in the first quarter of 2001. However, in 2000, in
connection with its fourth quarter reduction in workforce, the Company incurred
a restructuring charge of approximately $0.4 million. Provision for Litigation
Settlement In December 1998, the Company recorded a special
provision of $10.0 million relating to the federal and state class action
lawsuits then pending in Nebraska against the Company and certain of its
current and former officers. During June 1999, the Company revised its
estimated costs related to the settlement of actions against it. The result was
a $2.2 million reduction of the special provision to $7.8 million. During 2000,
the Company further reduced the special provision by $0.9 million due to the
settlements of litigation between the Company and PricewaterhouseCoopers and
between the Company and Physicians Mutual and adjustment to the reserve for
legal fees. Net Interest Income or
Expense Net interest income consists of interest income earned
on cash and invested funds, net of interest expense related to amounts payable
on its term and installment loans and bank lines of credit.  Net interest income was less than $0.1 million
in 2002 and 2001, as compared to $0.3 million in 2000. The decrease in net
interest income in both 2002 and 2001 is due primarily to the decrease in the
average cash balance in 2002 and 2001, as well as the reduced investment rates,
as compared to 2000. The Company expects net interest income to increase
slightly in 2003, assuming that investment rates remain relatively unchanged. Provision for Income Taxes The Companys expense (benefit) for income taxes was
zero in both 2002 and 2001, as compared to $12.4 million in 2000. As of December 31,
2002, the Company has $24.8 million in deferred tax assets before valuation
allowance, primarily comprised of net operating loss carryforwards (NOLs). The
NOLs do not begin to expire until 2010, and 86% of the NOLs have at least 10
years remaining before expiration. Current financial accounting standards
require that organizations analyze all positive and 30 negative evidence relating
to deferred tax asset realization. As the Company has a recent history of
losses prior to 2001, the Company has substantially reserved for its deferred
tax assets at December 31, 2002. In 2000, as a result of the fourth quarters operating
loss creating uncertainty about the recoverability of the deferred tax assets, the
Company increased its valuation allowance so to reduce its deferred income tax
assets from $12.4 million to zero as of December 31, 2000; this increase
in the Companys deferred tax asset valuation allowance was recorded as income
tax expense. In the fourth quarters of 2002 and 2001, the Company reduced its
deferred tax asset valuation allowance, effectively recognizing a deferred tax
asset of $3.0 million and $0.5 million at December 31, 2002 and 2001,
respectively. The decisions to decrease the valuation allowance were based upon
the Companys expectations of future earnings in light of earnings in each of
the four quarters of 2002 and the third and fourth quarters of 2001. In both
2002 and 2001, these  increases in the
deferred tax asset were recognized by decreasing the Companys goodwill
balance, rather than as income tax benefits, as management concluded that the
aforementioned increase related to the original $3.0 million valuation
allowance against deferred tax assets established at the time of the Companys
acquisition of EFJohnson, relating to acquired NOLs and recorded as part of
goodwill. Since the Company now has reversed the entire valuation allowance
recorded against deferred tax assets originally recorded as part of goodwill,
any further decreases in the Companys deferred tax asset allowance, and
corresponding increases in the Companys deferred tax asset, will be recorded
as income tax benefits in the Companys consolidated statement of operations. Management anticipates that if the Company continues
its recent trend of profitability, all or some portion of the deferred tax
asset valuation allowance may continue to be reduced. Conversely, if the
Company incurs future losses, it may be necessary to write off some or all of
the $3.0 million deferred tax asset recorded at December 31, 2002. The
Companys deferred tax asset valuation allowance is $21.8 million as of December 31,
2002. The Company cannot presently estimate what changes to the deferred tax
asset valuation allowance may be deemed appropriate in 2003. Net Income (Loss) The Company had a net income of $1.4 million during
2002. This amount does not include any tax benefit or provision; as such,
income before taxes in 2002 was $1.4 million. Net income was adversely affected
by $0.4 million of non-cash compensation resulting from variable accounting
treatment required for certain of the Companys stock options repriced in the
fourth quarter of 2000 and the first quarter of 2001. No similar expense was
recorded prior to 2002. In addition, net income was also positively impacted by
the aforementioned adoption of SFAS No. 142 which resulted in a decrease
in amortization expense associated with goodwill of approximately $1.0 million
as compared to the prior year. The Company had a net income of $0.5 million during
2001. This amount does not include any tax benefit or provision; as such,
income before taxes in 2001 was $0.5 million. The Company had a net loss of $25.4 million during
2000. This amount includes a $2.3 million impairment loss on intangible
assets, as well as a $12.4 million reduction of its deferred income tax asset. Before
these adjustments, the Company incurred a net loss of $10.7 million.  31


---

Quarterly
Results of Operations The following table
sets forth certain unaudited financial information in dollars and as a
percentage of revenues for the Company for the eight quarters ended December 31,
2002. In the opinion of the Companys management, this information has been
prepared on the same basis as the audited Consolidated Financial Statements
appearing elsewhere in this Annual Report on Form 10-K and includes all
adjustments, consisting only of normal recurring adjustments, necessary to
present fairly the unaudited results set forth herein. The operating results
for any quarter are not necessarily indicative of results for subsequent
periods or for the entire fiscal year. Quarter Ended(in thousands, except per share data)
  
  
  
  March 31,
  2001
  
  June 30,
  2001
  
  Sept. 30,
  2001(3)
  
  Dec. 31,
  2001(3)
  
  March 31,
  2002
  
  June 30,
  2002
  
  Sept. 30,
  2002
  
  Dec. 31,
  2002Revenues
  
  
  $
  9,551
  
  
  $
  10,660
  
  $
  10,292
  
  $
  13,665
  
  
  $
  9,897
  
  
  $
  9,514
  
  $
  10,136
  
  $
  11,240Cost of sales
  
  
  5,878
  
  
  6,483
  
  5,919
  
  8,330
  
  
  5,482
  
  
  5,364
  
  5,800
  
  6,570Gross profit
  
  
  3,673
  
  
  4,177
  
  4,373
  
  5,335
  
  
  4,415
  
  
  4,150
  
  4,336
  
  4,670Operating
  expenses:Research and development
  
  
  1,136
  
  
  1,297
  
  1,288
  
  1,251
  
  
  1,220
  
  
  1,109
  
  1,128
  
  1,116Sales and marketing
  
  
  1,407
  
  
  1,324
  
  1,248
  
  1,114
  
  
  1,257
  
  
  1,409
  
  1,577
  
  1,677General and administrative(1)(2)
  
  
  2,002
  
  
  1,846
  
  1,785
  
  1,699
  
  
  2,085
  
  
  1,363
  
  1,194
  
  1,273Total operating expenses
  
  
  4,545
  
  
  4,467
  
  4,321
  
  4,064
  
  
  4,562
  
  
  3,881
  
  3,899
  
  4,066Income (loss) from operations
  
  
  (872
  )
  
  (290
  )
  52
  
  1,271
  
  
  (147
  )
  
  269
  
  437
  
  604Interest (expense) income and other income(expense), net
  
  
  74
  
  
  30
  
  12
  
  267
  
  
  245
  
  
  (74
  )
  54
  
  22Net income (loss) before income taxes
  
  
  (798
  )
  
  (260
  )
  64
  
  1,538
  
  
  98
  
  
  195
  
  491
  
  626Provision for income taxes
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  Net income (loss)
  
  
  $
  (798
  )
  
  $
  (260
  )
  $
  64
  
  $
  1,538
  
  
  $
  98
  
  
  $
  195
  
  $
  491
  
  $
  626Net income (loss) per share-basic
  
  
  $
  (0.06
  )
  
  $
  (0.02
  )
  $
  0.00
  
  $
  0.09
  
  
  $
  0.01
  
  
  $
  0.01
  
  $
  0.03
  
  $
  0.04Net income (loss) per share-diluted
  
  
  $
  (0.06
  )
  
  $
  (0.02
  )
  $
  0.00
  
  $
  0.09
  
  
  $
  0.01
  
  
  $
  0.01
  
  $
  0.03
  
  $
  0.04Weighted average common shares-basic and diluted
  
  
  14,424
  
  
  16,891
  
  17,577
  
  17,577
  
  
  17,577
  
  
  17,577
  
  17,577
  
  17,577Weighted average common shares-basic and diluted
  
  
  14,424
  
  
  16,891
  
  17,577
  
  17,577
  
  
  17,856
  
  
  18,237
  
  17,838
  
  18,103As
  a Percentage of Revenues:Revenues
  
  
  100.0
  %
  
  100.0
  %
  100.0
  %
  100.0
  %
  
  100.0
  %
  
  100.0
  %
  100.0
  %
  100.0
  %Cost of sales
  
  
  62.5
  
  
  62.2
  
  58.7
  
  60.6
  
  
  55.4
  
  
  56.4
  
  57.2
  
  58.5Gross profit
  
  
  37.5
  
  
  37.8
  
  41.3
  
  39.4
  
  
  44.6
  
  
  43.6
  
  42.8
  
  41.5Operating
  expenses:Research and development
  
  
  11.9
  
  
  12.2
  
  12.6
  
  9.1
  
  
  12.3
  
  
  11.7
  
  11.1
  
  9.9Sales and marketing
  
  
  13.7
  
  
  10.8
  
  10.8
  
  8.8
  
  
  12.7
  
  
  14.8
  
  15.6
  
  14.9General and administrative(1)(2)
  
  
  21.0
  
  
  17.5
  
  17.4
  
  12.3
  
  
  21.1
  
  
  14.3
  
  11.8
  
  11.3Total operating expenses
  
  
  46.6
  
  
  40.5
  
  40.8
  
  30.2
  
  
  46.1
  
  
  40.8
  
  38.5
  
  36.1Income (loss) from operations
  
  
  (9.1
  )
  
  (2.7
  )
  0.5
  
  9.2
  
  
  (1.5
  )
  
  2.8
  
  4.3
  
  5.4Interest (expense) income and other income(expense), net
  
  
  0.7
  
  
  0.2
  
  0.1
  
  1.9
  
  
  2.5
  
  
  (0.8
  )
  0.5
  
  0.2Provision for income taxes
  
  
  0.0
  
  
  0.0
  
  0.0
  
  0.0
  
  
  0.0
  
  
  0.0
  
  0.0
  
  0.0Net
  income (loss)
  
  
  (8.4
  )%
  
  (2.5
  )%
  0.6
  %
  11.1
  %
  
  1.0
  %
  
  2.0
  %
  4.8
  %
  5.6
  % 
 (1)Includes $237 of quarterly amortization of goodwill and
certain other intangible assets in each quarter of 2001, which assets are no
longer amortized as of January 1, 2002, in accordance with SFAS 142. (2)Includes $483 of non-cash compensation expense in 2002
resulting from the variable accounting treatment applied to certain repriced
stock options. See Note 11 of Notes to Consolidated Financial Statements. (3)As a result of the September 11, 2001 attacks, the
Company experienced a temporary disruption in its vendor supply chain, this
disruption effectively moving approximately $1.7 million of revenues and $0.5
million in income from operations from the third quarter of 2001 to the fourth
quarter of 2001. 32


---

The Company historically has experienced substantial
variability in its results of operations from quarter to quarter. The level of
revenues in a particular quarter varies primarily based upon the timing of
customer purchase orders, due principally to the seasonal nature of
governmental budgeting processes and the needs of competing budgetary concerns
of the Companys customers during the year. Other factors that affect the
results of operations in a particular quarter include the timing of the
introduction of new products, general economic conditions, the timing and mix
of product sales and specific economic conditions in the wireless
communications and information security industries. The Company believes that
quarterly results are likely to vary for the foreseeable future. Liquidity and Capital
Resources Since January 1, 1997, the Company has financed
its operations and met its capital requirements primarily through short-term
borrowings, long-term debt and stock offerings completed on January 22,
1997 and October 15, 1997. In 2002 and 2001, the Companys operations
provided cash flow sufficient to fund its operational and capital requirements
during the year. The Companys operating activities provided cash of
$1.2 million and $3.9 million in 2002 and 2001, respectively, whereas the
Companys operating activities used $12.3 million in 2000. The decrease of $2.7 million
from 2001 to 2002 related primarily to changes in components of working capital.
As such, the amount of cash provided from operations before changes in
components of working capital were similar in 2002 and 2001, $2.9 million in
both years. During 2002, cash used by changes in components of working capital
was approximately $1.7 million, with $2.9 million being provided by the Companys
net income adjusted for the add-back of non-cash compensation, gain on sale of
assets, and depreciation and amortization expense. During 2001, cash provided
from changes in components of working capital was approximately $1.0 million,
with $2.9 million being provided by the Companys net income adjusted for the
add-back of gain on sale of assets and depreciation and amortization expense. During 2002, the Company used $1.3 million in
investing activities, $1.1 million related to net purchase of fixed assets
and $0.1 million for prepaid royalties. During 2001, the Company used $0.5 million
in investing activities, primarily relating to the purchase of fixed assets. During
2000, $0.1 million in cash was used in investing activities; and the receipt of
approximately $0.4 million from the sale of fixed assets offset approximately
$0.5 million used to purchase fixed assets. During 2002, the Company used $0.1 million in
financing activities, substantially related to a nominal decrease in its line
of credit balance. During 2001, the Company used $3.2 million in financing
activities, substantially relating to net payments made on its line of credit. During
2000, financing activities provided cash of $2.3 million, substantially related
to net borrowings on the Companys line of credit. In the normal course of its business activities, the
Company is required under contracts with various governmental authorities to
provide letters of credit or bonds that may be drawn upon if the Company fails
to perform under its contracts. The letters of credit, which expire on various
dates in 2003, have a total undrawn balance of $2.0 million on December 31,
2002; as of February 17, 2003, the Companys outstanding letters of credit
were $0.3 million.  Bonds, which expire
on various dates through 2002, totaled $4.3 million at December 31, 2002. In
early 2000, the Company obtained a commitment from a major insurance company
that provides for up to $20 million in new bonding arrangements at favorable
rates and terms. As a result of the Companys performance in 2000, the bonding
insurer indicated that, until the Companys financial performance improves,
future bonding arrangements must be partially supported by collateral, either
with an irrevocable letter of credit or cash. Presently, the Company is
attempting to negotiate a decrease in these collateral requirements or a new
bonding relationship. The Company also leases various equipment and
buildings under operating leases. Future minimum rental payments under
non-cancelable operating lease agreements are approximately $1.2 million in
2003, 33 $1.1 million in 2004 and
$0.2 million in 2005. The Company anticipates that, in the normal course of
business, leases will be renewed or replaced as they expire. In November 2002, the Company entered into a
$10.0 million secured line of credit with Bank of America. The line of credit,
bearing interest at a rate of LIBOR plus 200 basis points, is collateralized by
substantially all the Companys assets. Borrowings available under the line of
credit are calculated as a percentage of eligible inventory and receivables. This
new revolving line of credit expires in September 2004 and contains
certain financial covenants with which the Company was in compliance, or for
which waivers had been obtained, at December 31, 2002. This line of credit
replaced the Companys previous line of credit with U.S. Bank, which the
Company elected to pay off and terminate in February 2002, as management
believed that the prior facility, as structured, did not provide the
operational flexibility the Company required. At December 31, 2002, the Company had $5.0
million outstanding on the revolving line of credit. During 2002, the average
borrowings under the Companys line of credits was $0.3 million, and the
weighted average interest rate was 5.0%. At December 31, 2002, the Company
had unrestricted cash of $9.2 million and approximately $2.6 million of
available credit under the above line. The Company currently does not anticipate paying cash
dividends in the foreseeable future. Pending Claims The Companys liquidity and results of operations
could be adversely affected by unfavorable outcomes of pending litigation,
particularly the claims filed against the Company by ASRC. See PART I. ITEM
3LEGAL PROCEEDINGS. Recently Issued Accounting
Standards In June 2002, Financial Accounting Standards
Board (FASB) issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, which addresses
accounting and processing for costs associated with exit or disposal
activities. SFAS No. 146 requires the recognition of a liability for a
cost associated with an exit or disposal activity when the liability is
incurred versus the date the Company commits to an exit plan. In addition, SFAS
No. 146 states the liability should be initially measured at fair value.
The requirements of SFAS No. 146 are effective for exit or disposal
activities that are initiated after December 31, 2002. This pronouncement
is not expected to have a material impact on the Companys financial position
or results of operations. In December 2002 the FASB issued SFAS No. 148,
Accounting for Stock-Based CompensationTransition
and Disclosure. SFAS No. 148 amends the disclosure and
certain transition provisions of SFAS No. 123, Accounting
for Stock-Based Compensation.Its disclosure
provisions, which apply to all entities with employee stock-based compensation,
are effective for fiscal years ending after December 15, 2002. New interim
period disclosures are required in financial statements for interim periods
beginning after December 15, 2002.  Other than the additional disclosure
requirements, this pronouncement is not expected to have a material impact on
the Companys financial position or results of operations. In November 2002, the FASB issued FASB
Interpretation No. 45 (FIN 45), Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. FIN 45 addresses the
disclosure requirements of a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. FIN 45
also requires a guarantor to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The disclosure requirements of FIN 45 are effective for the
Company effective December 31, 2002. The liability recognition
requirements will be applicable prospectively to all guarantees issued or
modified after December 31, 2002.  This pronouncement is not expected to have a
material impact on the Companys financial position or results of operation. 34 Critical Accounting
Policies The preparation of the Companys consolidated
financial statements in conformity with generally accepted accounting
principles (GAAP) requires management to make judgments, estimates and
assumptions in certain circumstances that affect the amounts reported in the
consolidated financial statements and related footnotes. The Company regularly
evaluates the accounting policies and estimates used to prepare its financial
statements. Estimates are used for, but not limited to, the accounting for
allowance for doubtful accounts and sales returns, estimates involved in
applying percentage of completion accounting for long-term contract revenues,
inventory reserves and contingencies. These estimates are based on historical
experience and various assumptions that the Company believes to be reasonable
under the particular applicable facts and circumstances. Actual results could
differ from those estimates. The Company considers its critical accounting policies
to be those that (i) involve significant judgments and uncertainties, (ii) require
estimates that are more difficult for management to determine and (iii) have
the potential to result in materially different outcomes under varying
assumptions and conditions. The application of GAAP may require management to
make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying results. Listed below are those policies
the Company believes are critical and require the use of complex judgment in
their application. Goodwill Effective January 1, 2002, the Company adopted
the provisions of SFAS No. 142, Goodwill and Other
Intangible Assets.Upon the
adoption of SFAS No. 142, goodwill is no longer subject to amortization. Goodwill
is subject to at least an annual assessment for impairment by applying a fair
value-based test. If the carrying amount exceeds the fair value, goodwill is
considered to be impaired. The Company continually evaluates whether events and
circumstances have occurred that indicate the remaining balance of goodwill may
not be recoverable. In evaluating impairment, the Company estimates the sum of
the expected future cash flows derived from such goodwill. Such evaluations for
impairment are significantly impacted by estimates of future revenues, costs
and expenses and other factors. The estimates use assumptions about the Companys
market segment share in the future and about future expenditures by
governmental entities for wireless communications products. If the Company
fails to deliver new products, if the products fail to gain expected market
acceptance, or if the Company fails to achieve assumed revenue growth rates or
assumed gross margin, the Company may incur charges for impairment of goodwill
in the future. Income Taxes The Company accounts for income taxes using the asset
and liability method. Deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
current enacted tax rates. The effect on deferred tax assets and liabilities of
a change in tax rates is recognized in the results of operations in the period
that includes the enactment date. Valuation allowances are provided to the
extent that recoverability of tax assets is not considered likely. In
determining whether a tax asset is recoverable, the Company considers estimates
of future revenues, costs and expenses and other factors. If the Company fails
to achieve our assumed revenue growth rates or assumed gross margin, we may be
required to reduce the Companys deferred tax assets in the future. ITEM 7A. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK Although all of the Companys sales are denominated in
U.S. dollars, fluctuations in the value of international currencies relative to
the U.S. dollar may affect the price, competitiveness and profitability of the
Companys products sold in international markets. Furthermore, the uncertainty
of monetary exchange 35 values has caused, and may
in the future cause, some foreign customers to delay new orders or delay
payment for existing orders. Additionally, troubled economic conditions, such
as that recently experienced in Asia and in Latin America, could result in
lower revenues for the Company. While substantially all international sales are
supported by letters of credit, the purchase of Company products by
international customers presents increased risks, which include: ·unexpected changes in
regulatory requirements; ·tariffs and other trade
barriers; ·political and economic
instability in foreign markets; ·difficulties in
establishing foreign distribution channels; ·longer payment cycles; ·uncertainty in the collection
of accounts receivable; ·increased costs associated
with maintaining international marketing efforts; ·difficulties in protecting
intellectual property; and ·susceptibility to orders
being cancelled as a result of foreign currency fluctuations (since all the
Company quotations and invoices are denominated in U.S. dollars). Some of the Companys information security products
are subject to export controls under U.S. law, which in most cases requires the
approval of the Department of Commerce in order to ship internationally. The
Company cannot assure that such approvals will be available to it or its
products in the future in a timely manner or at all or that the federal
government will not revise its export policies or the list of products and countries
for which export approval is required. The Companys inability to obtain
required export approvals would adversely affect the Companys international
sales, which would have a material adverse effect on the Company. In addition,
foreign companies not subject to United States export restrictions may
have a competitive advantage in the international information security market.
The ompany cannot predict the impact of these factors on the international
market for its products. See Government Regulation and Export Controls. ITEM 8. FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA See Item 15. Exhibits, Financial Statement Schedules
and Reports on Form 8-K for the Companys Consolidated Financial
Statement, and the notes thereto, and the financial statement schedule filed as
part of this report. ITEM 9.CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On October 12, 2001, as reported on its Form 8-K
filed on October 18, 2001, the Company dismissed its independent
accountant, KPMG LLP (KPMG), and selected Grant Thornton LLP (GT) as its
independent accountant to audit its financial statements for the year ending December 31,
2001.  The decisions to dismiss KPMG and select
GT were unanimously recommended by the Companys Audit Committee and
unanimously approved by the Companys Board of Directors. There were no
disagreements between the Company and KPMG on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure. 36


---

PART III Incorporated by reference in Items 10 to 13 below are
certain sections of the Companys definitive proxy statement, to be filed
pursuant to Regulation 14A with the SEC within 120 days after December 31,
2002. ITEM 10. DIRECTORS AND
EXECUTIVE OFFICERS OF REGISTRANT Incorporated by reference in this Annual Report is the
information required by this Item 10 contained in the sections entitled Discussion
of Proposals Recommended by the BoardProposal 1: Elect Two Directors, Information
About Directors and Executive Officers and Information About Transcrypt
Common Stock OwnershipDid Directors, Executive Officers and Greater-Than-10%
Stockholders Comply With Section 16(a) Beneficial Ownership Reporting
in 2002? of the Companys definitive proxy statement, to be filed pursuant to
Regulation 14A with the SEC within 120 days after December 31, 2002. ITEM 11. EXECUTIVE
COMPENSATION Incorporated by reference in this Annual Report is the
information required by this Item 11 contained in the sections entitled Information
About Directors and Executive Officers and Information About Transcrypt
Common Stock OwnershipCompensation Committee Interlocks and Insider
Participation of the Companys definitive proxy statement, to be filed
pursuant to Regulation 14A with the SEC within 120 days after December 31,
2002. ITEM 12. SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated by reference in this Annual Report is the
information required by this Item 12 contained in the section entitled Information
About Transcrypt Common Stock Ownership of the Companys definitive proxy
statement, to be filed pursuant to Regulation 14A with the SEC within 120 days
after December 31, 2002. ITEM 13. CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated by reference in this Annual Report is the
information required by this Item 13 contained in the section entitled Information
About Directors and Executive OfficersCertain Relationships and Related
Transactions of the Companys definitive proxy statement, to be filed pursuant
to Regulation 14A with the SEC within 120 days after December 31,
2002. PART IV ITEM 14. CONTROLS AND
PROCEDURES (a)Evaluation of Disclosure Controls and Procedures Within the 90 days prior to the date of this Annual
Report on Form 10-K, the Company evaluated the effectiveness of the design
and operation of its disclosure controls and procedures (Disclosure Controls),
and its internal controls and procedures for financial reporting (Internal
Controls).  This evaluation (the Controls
Evaluation) was done under the supervision and with the participation of
management, including our Chief Executive Officer (CEO) and Chief Financial
Officer (CFO). The effectiveness of the Companys disclosure controls and
procedures, as determined by this evaluation, is disclosed in the Chief
Executive Officers Certification of Report on Form 10-K for the Year
Ending December 31, 2002 and the Chief Financial Officers Certification
of Report on Form 10-K for the Year Ending December 31, 2002 (together,
Certifications). Disclosure Controls are procedures that are designed
with the objective of ensuring that information required to be disclosed in the
Companys reports filed under the Exchange Act, such as this Annual 37 Report, is recorded, processed,
summarized and reported within the time periods specified in the Securities and
Exchange Commissions (SEC) rules and forms. Disclosure Controls are
also designed with the objective of ensuring that such information is
accumulated and communicated to management, including the CEO and CFO, as
appropriate to allow timely decisions regarding required disclosure. Internal
Controls are procedures which are designed with the objective of permitting the
preparation of our financial statements in conformity with GAAP and of
providing reasonable assurance that: (1) transactions are properly
authorized; (2) assets are safeguarded against unauthorized or improper
use; and (3) transactions are properly recorded and reported. The Companys management, including the CEO and CFO,
does not expect that the Companys Disclosure Controls or Internal Controls
will prevent 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 system 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 all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the control. The design of any system
of controls also is based in part upon 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; over time,
control may become inadequate because of changes in conditions, or the degree
of compliance with the policies or procedures may deteriorate. Because of the
inherent limitations in a cost-effective control system, misstatements due to
error or fraud may occur and not be detected. The Companys Internal Controls are also evaluated on
an ongoing basis by its Finance organization. The overall goals of these
various evaluation activities are to monitor the Companys Disclosure Controls
and Internal Controls and to make modifications as necessary. The Companys
intent in this regard is that the Disclosure Controls and the Internal Controls
will be maintained as dynamic systems that change (including with improvements
and corrections) as conditions warrant. Based upon the Controls Evaluation, the Companys CEO
and CFO have concluded that, subject to the limitations noted above, the
Companys Disclosure Controls are effective to ensure that material information
relating to the Company and its consolidated subsidiaries is made known to
management, including the CEO and CFO, particularly during the period when
periodic reports are being prepared, and that the Companys Internal Controls
are effective to provide reasonable assurance that its financial statements are
fairly presented in conformity with GAAP. (b)Changes in Internal Controls In accord with SEC requirements, and as disclosed in
the Certifications, the CEO and CFO note that, since the date of the Controls
Evaluation to the date of this Annual Report, there have been no significant
changes in Internal Controls or in other factors that could significantly
affect Internal Controls, including any corrective actions with regard to
significant deficiencies and material weaknesses. 38


---

ITEM 15. EXHIBITS,
FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)    The
following documents are included in this report at the page numbers
indicated.  Page No.1.
  
  Financial Statements and
  SchedulesReports
  of Independent Certified Public Accountants
  
  F-1 & F-2Consolidated
  Balance Sheets as of December 31, 2002 and 2001
  
  F-3Consolidated
  Statements of Operations for the Years ended December 31, 2002, 2001 and
  2000
  
  F-4Consolidated Statements of Changes in
  Stockholders Equity for the Years ended December 31, 2002, 2001 and
  2000
  
  F-5Consolidated
  Statements of Cash Flows for the Years ended December 31, 2002, 2001 and
  2000
  
  F-6Notes
  to Consolidated Financial Statements
  
  F-7 to F-232.
  
  Supplemental Financial
  Statement SchedulesSchedule IIValuation and Qualifying Accounts and Reserves
  
  S-1  Schedules not listed above have been omitted because
the information required to be set forth therein is not applicable or is shown
in the financial statements or notes thereto. 3.Exhibits (1)Executive
Compensation Plans and Arrangements: The following is a summary of the Companys executive
compensation plans and arrangements, which are required to be filed as exhibits
to this Annual Report on Form 10-K: 1.Transcrypt
International, Inc. 1999 Non Employee Director Stock Purchase Plan.
Incorporated by reference to Exhibit 10.4 to the Companys Annual Report
on Form 10-K for the year ended December 31, 1999, File No. 0-21681
(hereinafter known as the 1999 Form 10-K). 2.Transcrypt International, Inc.
1999 Executive Officer Stock Purchase Plan. Incorporated herein by reference to
Exhibit 10.2 to the 1999 Form 10-K. 3.Transcrypt
International, Inc. 1996 Stock Incentive Plan, as amended. Incorporated
herein by reference to Exhibit 99.1 to the Companys Registration
Statement on Form S-8, No. 333-48880 (hereinafter known as the S-8
Registration Statement). 4.Form of
Indemnification Agreement between the Company and each executive officer and
director of the Company. Incorporated herein by reference to Exhibit 10.5
to the Companys Registration Statement on Form S-1, No. 333-14351,
declared effective on January 22, 1997 (hereinafter the January 1997
Registration Statement). 5.Consulting
Agreement and Termination of Employment Agreement between the Company and John T.
Connor dated February 23, 1999. Incorporated herein by reference to Exhibit 10.41
to the Companys Annual Report on Form 10-K for the year ended December 31,
1998, File No. 0-21681 (hereinafter known as the 1998 Form 10-K). 6.Employment
Agreement between the Company and Michael E. Jalbert dated October 15,
2002. Included herein at Exhibit 10.42. 39 7.Transcrypt
International, Inc. Michael Jalbert 1999 Stock Option Agreement.
Incorporated by reference to Exhibit 99.1 to the Companys Registration
Statement on Form S-8, No. 333-48836 (hereinafter known as the Jalbert
S-8 Registration Statement). 8.Letter Agreement
dated August 13, 2001 between Transcrypt International, Inc. and
Massoud Safavi, regarding employment rights. Incorporated by reference to Exhibit 10.11
to the Companys Annual Report on Form 10-K for the year ended December 31,
2001, File No. 0-21681 (hereinafter known as the 2001 Form 10-K). 9.Transcrypt
Executive Health Program. Incorporated by reference to Exhibit 10.14 to
the 2001 Form 10-K. (2)Exhibit Index:  Exhibit
  Number
  
  Description3.1
  
  Second Amended and
  Restated Certificate of Incorporation of the Company filed on
  September 30, 1996 with the Secretary of State of the State of Delaware
  (incorporated herein by reference to Exhibit 3.1 to the Companys
  Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1999,
  File No. O-21681).3.2
  
  Amended and Restated
  Bylaws of the Company (incorporated herein by reference to Exhibit 3.2
  to the January 1997 Registration Statement).4.1
  
  Form of Common
  Stock certificate (incorporated herein by reference to Exhibit 4.1 to
  the January 1997 Registration Statement).10.1
  
  Transcrypt
  International, Inc. 1999 Non Employee Director Stock Plan (incorporated
  by reference to Exhibit 10.1 to the 1998 Form 10-K).10.2
  
  Transcrypt
  International, Inc. 1999 Executive Officer Stock Purchase Plan
  (incorporated by reference to Exhibit 10.2 to the 1999 Form 10-K).10.3
  
  RESERVED10.4
  
  Transcrypt
  International, Inc. 1996 Stock Incentive Plan, as amended (incorporated
  by reference to Exhibit 99.1 to the S-8 Registration Statement).10.5
  
  Form of
  Indemnification Agreement between the Company and each executive officer and
  director of the Company (incorporated herein by reference to
  Exhibit 10.5 to the January 1997 Registration Statement).10.6
  
  License Agreement for
  APCO 25 Compliant Product between Motorola, Inc. and the Company dated
  as of August 2, 1994 (incorporated herein by reference to
  Exhibit 10.6 to the January 1997 Registration Statement).10.7*
  
  Amendment, dated as of
  June 28, 1996, to License Agreement for APCO Project 25 Compliant
  Product between Motorola, Inc. and the Company dated as of
  August 2, 1994 (incorporated herein by reference to Exhibit 10.7 to
  the January 1997 Registration Statement).10.8
  
  OEM Agreement between
  Motorola, Inc. and the Company dated as of August 2, 1994
  (incorporated herein by reference to Exhibit 10.8 to the
  January 1997 Registration Statement). 40  Exhibit
  Number
  
  Description10.9*
  
  Amendment, dated as of
  July 15, 1996, to OEM Agreement between Motorola, Inc. and the
  Company dated as of August 2, 1994 (incorporated herein by reference to
  Exhibit 10.9 to the January 1997 Registration Statement).10.10
  
  RESERVED10.11
  
  Letter Agreement dated
  August 13, 2001 between Transcrypt International, Inc. and Massoud
  Safavi, regarding employment rights (incorporated herein by reference to
  Exhibit 10.11 to the 2001 Form 10-K).10.12
  
  License Agreement for
  APCO Fed Project 25 Algorithm between Digital Voice Systems, Inc. and
  the Company, dated as of August 14, 1995 (incorporated herein by
  reference to Exhibit 10.12 to the January 1997 Registration
  Statement).10.13
  
  Consigned Inventory
  Agreement between Arrow/Schwebber Electronics Group and the Company, dated as
  of June 22, 1994 (incorporated herein by reference to Exhibit 10.13
  to the January 1997 Registration Statement).10.14
  
  Transcrypt Executive
  Health Program (incorporated herein by reference to Exhibit 10.14 to the
  2001 Form 10-K).10.15-10.22
  
  RESERVED10.23
  
  Addendum I to License
  Agreement for APCO Fed Project 25 Algorithm between Digital Voice
  Systems, Inc. and the Company, dated as of July 12, 2001
  (incorporated herein by reference to Exhibit 10.23 to the 2001
  Form 10-K [original License Agreement is listed above as
  Exhibit 10.12]).10.24
  
  Form of Adoption
  Agreement for Nonstandardized 401(k) Profit Sharing Plan (incorporated herein
  by reference to Exhibit 10.24 to the January 1997 Registration
  Statement).10.25
  
  Defined Contribution
  Master Plan and Trust Agreement of Norwest Bank Nebraska, NA., Master Plan
  Sponsor (incorporated herein by reference to Exhibit 10.25 to the
  January 1997 Registration Statement).10.26-10.35
  
  RESERVED10.36
  
  License Agreement, dated
  as of January 15, 1997, between E.F. Johnson Company and Johnson Data
  Telemetry Corporation (incorporated herein by reference to Exhibit 10.36
  to the Companys Registration Statement on Form S-1, No. 333-35469,
  declared effective on October 15, 1997).10.37-10.40
  
  RESERVED10.41
  
  Consulting Agreement and
  Termination of Employment Agreement between the Company and John T. Connor
  dated February 23, 1999 (incorporated herein by reference to
  Exhibit 10.41 to the 1998 Form 10-K).10.42
  
  Employment Agreement
  between the Company and Michael E. Jalbert dated October 15, 2002.10.43-10.45
  
  RESERVED10.46
  
  Transcrypt
  International, Inc. Michael Jalbert 1999 Stock Option Agreement
  (incorporated by reference to Exhibit 99.1 to the Jalbert S-8
  Registration Statement). 41  Exhibit
  Number
  
  Description10.47
  
  RESERVED10.48
  
  Revolving Line of Credit
  Loan Agreement and Security Agreement between the Company and Bank of
  America, N.A., dated November 19, 2002.10.49
  
  Lease Agreement between
  the Company and Waseca Properties, LLC dated December 30, 1999
  (incorporated herein by reference to Exhibit 10.49 to the 1999
  Form 10-K).11.1
  
  Statement re.
  Computation of Per Share Earnings.21
  
  Subsidiaries of the
  Registrant (incorporated herein by reference to Exhibit 21 to the
  Companys Annual Report on Form 10-K for the year ended
  December 31, 1997, File No. 0-21681).23.1
  
  Consent of Grant
  Thornton LLP.23.2
  
  Consent of KPMG LLP.99.1
  
  Written Certification of
  Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.
  § 1350.  
 * Confidential treatment has
previously been granted by the SEC as to a portion of this exhibit. (b)Reports on Form 8-K The Company filed a report on Form 8K on November 20,
2001, under Item 5. Other Events to report the November 19, 2002
execution of a $10.0 million, asset-based, line of credit agreement between the
Company and Bank of America, N.A. (c)Exhibits
Required by Item 601 of Regulation S-K See Item 15(a)(3) above. (d)Additional
Financial Statements See Item 15(a)(2) above. 42


---

SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of
the Securities Exchange Act of 1934, the Registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized. Transcrypt International, Inc.By:
  /s/ Michael E. JalbertMichael E.
  Jalbert
  Chairman
  of the Board of Directors
  and
  Chief Executive Officer
  (Principal
  Executive Officer)
  Dated:
  February 28, 2003  Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the following
persons on behalf of the Registrant and in the capacities and on the dates
indicated.  Signature
  
  
  
  Title
  
  
  
  DateChairman of the Board of
  
  February 28,
  2003/s/ MichaelE. Jalbert
  
  Directors, President and
  Chief Executive Officer
  (Principal Executive Officer)Michael E.
  JalbertSenior Vice President of Finance
  
  February 28,
  2003/s/ Massoud Safavi
  
  and Chief Financial
  Officer
  (Principal Financial and
  Accounting Officer)Massoud Safavi/s/ Edward H. Bersoff
  
  Director
  
  February 28,
  2003Edward H. Bersoff/s/ Winston J. Wade
  
  Director
  
  February 28,
  2003Winston J. Wade/s/ Thomas R. Thomsen
  
  Director
  
  February 28,
  2003Thomas R. Thomsen   43


---

Chief
Executive Officers Certification of Report on Form 10-K
For the Year Ending December 31, 2002 I, Michael E. Jalbert, certify that: 1.      I have
reviewed this annual report on Form 10-K of EFJ, Inc; 2.      Based on
my knowledge, this annual report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this annual report; 3.      Based on
my knowledge, the financial statements, and other financial information
included in this annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this annual report; 4.      The
registrants other certifying officers and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14
and 15d-14) for the registrant and we have: a)     designed
such disclosure controls and procedures to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which
this annual report is being prepared; b)     evaluated
the effectiveness of the registrants disclosure controls and procedures as of
a date within 90 days prior to the filing date of this annual report (the Evaluation
Date); and c)     presented
in this annual report our conclusions about the effectiveness of the disclosure
controls and procedures based on our evaluation as of the Evaluation Date; 5.      The
registrants other certifying officers and I have disclosed, based on our most
recent evaluation, to the registrants auditors and the audit committee of
registrants board of directors (or persons performing the equivalent
function): a)     all
significant deficiencies in the design or operation of internal controls which
could adversely affect the registrants ability to record, process, summarize
and report financial data and have identified for the registrants auditors any
material weaknesses in internal controls; and b)     any fraud,
whether or not material, that involves management or other employees who have a
significant role in the registrants internal controls; and 6.    The registrants other certifying officers and I have indicated
in this annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses. Date:   February 28, 2003
  By:
  /s/Michael
  E. JalbertMichael E. JalbertChief
  Executive Officer 44 Chief
Financial Officers Certification of Report on Form 10-K
for the Year Ending December 31, 2002 I, Massoud Safavi, certify that: 1.      I have
reviewed this annual report on Form 10-K of EFJ, Inc; 2.      Based on
my knowledge, this annual report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this annual report; 3.      Based on
my knowledge, the financial statements, and other financial information
included in this annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this annual report; 4.      The
registrants other certifying officers and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14
and 15d-14) for the registrant and we have: a)     designed
such disclosure controls and procedures to ensure that material information
relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in
which this annual report is being prepared; b)     evaluated
the effectiveness of the registrants disclosure controls and procedures as of
a date within 90 days prior to the filing date of this annual report (the Evaluation
Date); and c)     presented
in this annual report our conclusions about the effectiveness of the disclosure
controls and procedures based on our evaluation as of the Evaluation Date; 5.    The
registrants other certifying officers and I have disclosed, based on our most
recent evaluation, to the registrants auditors and the audit committee of
registrants board of directors (or persons performing the equivalent
function): a)     all
significant deficiencies in the design or operation of internal controls which
could adversely affect the registrants ability to record, process, summarize
and report financial data and have identified for the registrants auditors any
material weaknesses in internal controls; and b)     any fraud,
whether or not material, that involves management or other employees who have a
significant role in the registrants internal controls; and 6.    The registrants other certifying officers and I have indicated
in this annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses. Date:   February 28, 2003
  By:
  /s/
  Massoud SafaviMassoud SafaviChief
  Financial Officer  45


---

(This page is left intentionally blank.)


---

INDEPENDENT REPORT OF CERTIFIED PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors
EFJ, Inc. and Subsidiaries We have audited the accompanying consolidated balance
sheets of EFJ, Inc. and Subsidiaries as of December 31, 2002 and 2001
and the related consolidated statements of operations, changes in stockholders
equity, and cash flows for the years then ended. 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 auditing
standards generally accepted in the United States of America. Those standards
require that we plan and perform the audits to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes 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 financial statements referred to
above present fairly, in all material respects, the consolidated financial
position of EFJ, Inc. and Subsidiaries as of December 31, 2002 and
2001 and the consolidated results of their operations and their consolidated
cash flows for the years then ended, in conformity with accounting principles
generally accepted in the United States of America. As discussed in Note 5 to the consolidated financial
statements, the Company adopted Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangible Assets (SFAS 142) on January 1, 2002. We have also audited
Schedule II of EFJ, Inc. and Subsidiaries for the years ended December 31,
2002 and 2001. In our opinion, this schedule presents fairly, in all material
respects, the information required to be set forth therein. /s/ Grant
  Thornton LLP Minneapolis, Minnesota
February 4, 2003 F-1 INDEPENDENT
REPORT OF CERTIFIED PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors
EFJ, Inc.: We have audited the accompanying consolidated
statements of operations, changes in stockholders equity, and cash flows of
EFJ, Inc. (formerly Transcrypt International, Inc.) and subsidiaries
(collectively, the Company) for the year ended December 31, 2000. In
connection with our audit of the consolidated financial statements, we have
also audited the information in the financial statement schedule for the year
ended December 31, 2000 listed in Item 14(a)(2) of this Form 10-K.
These consolidated financial statements and financial statement schedule are
the responsibility of the Companys management. Our responsibility is to
express an opinion on these consolidated financial statements and financial
statement schedule based on our audit. We conducted our audit in accordance with auditing
standards generally accepted in the United States of America. 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
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements
referred to above present fairly, in all material respects, the consolidated
results of the Companys operations and their cash flows for the year ended December 31,
2000, in conformity with accounting principles generally accepted in the United
States of America. Also, in our opinion, the related financial statement
schedule referred to above for the year ended December 31, 2000, when
considered in relation to the basic consolidated financial statements taken as
a whole, presents fairly, in all material respects, the information set forth
therein. The accompanying
consolidated financial statements have been prepared assuming that the Company will
continue as a going concern. As discussed in Note 18 to the consolidated
financial statements, the Company has suffered recurring losses from operations
that raise substantial doubt about its ability to continue as a going concern. Managements
plans in regard to this matter are also described in Note 18. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty. /s/ KPMG LLP Omaha, Nebraska
February 16, 2001 F-2


---

EFJ, INC. AND
SUBSIDIARIES CONSOLIDATED BALANCE
SHEETS December 31, 2002 and
2001 (in thousands, except
share data) ASSETS2002
  
  2001Current assets:Cash
  and cash equivalents
  
  $
  11,333
  
  $
  11,582Accounts
  receivable, net of allowance for returns and doubtful accounts of $236 and
  $284
  
  6,568
  
  6,540Receivablesother
  
  252
  
  493Cost
  in excess of billings on uncompleted contracts
  
  1,686
  
  1,616Inventory,
  net of reserve of $2,468 and $2,160
  
  11,671
  
  11,262Deferred
  income taxes
  
  1,000
  
  Prepaid
  expenses
  
  487
  
  366Total
  current assets
  
  32,997
  
  31,859Property,
  plant and equipment, net
  
  2,601
  
  2,116Deferred
  income taxes, net of current portion
  
  2,000
  
  500Intangible
  assets, net of accumulated amortization
  
  6,760
  
  9,370Other
  assets
  
  898
  
  275TOTAL ASSETS
  
  $
  45,256
  
  $
  44,120LIABILITIES AND STOCKHOLDERS
  EQUITYCurrent liabilities:Revolving
  line of credit
  
  $
  5,000
  
  $
  5,120Current
  portion of long-term debt obligations
  
  22
  
  19Accounts
  payable
  
  4,007
  
  4,409Billings
  in excess of cost on uncompleted contracts
  
  38
  
  147Deferred
  revenue
  
  961
  
  794Accrued
  expenses
  
  2,317
  
  2,725Total
  current liabilities
  
  12,345
  
  13,214Long-term
  debt obligations, net of current portion
  
  264
  
  Deferred
  revenue, net of current portion
  
  160
  
  312TOTAL LIABILITIES
  
  12,769
  
  13,526Stockholders equity:Preferred
  stock ($.01 par value; 3,000,000 shares authorized; none issued)
  
  
  
  Common
  stock ($.01 par value; 25,000,000 voting shares authorized, 17,359,773 issued
  and outstanding; 600,000 non-voting shares authorized, 217,542 issued and
  outstanding)
  
  176
  
  176Additional
  paid-in capital
  
  96,918
  
  96,435Accumulated
  deficit
  
  (64,607
  )
  (66,017
  )TOTAL STOCKHOLDERS EQUITY
  
  32,487
  
  30,594TOTAL LIABILITIES and
  STOCKHOLDERS EQUITY
  
  $
  45,256
  
  $
  44,120  See accompanying notes to the consolidated financial statements. F-3


---

EFJ,
INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2002, 2001, and 2000
(in thousands, except share and per share data) 2002
  
  2001
  
  2000Revenues
  
  $
  40,787
  
  $
  44,168
  
  $
  42,192Cost of sales
  
  23,216
  
  26,610
  
  33,613Gross profit
  
  17,571
  
  17,558
  
  8,579Operating expenses:Research and development
  
  4,573
  
  4,972
  
  5,763Sales and marketing
  
  5,920
  
  5,093
  
  7,263General and administrative
  
  5,915
  
  7,332
  
  10,196Restructuring charge
  
  
  
  
  
  358Provision for litigation
  settlement
  
  
  
  
  
  (924
  )Total operating expenses
  
  16,408
  
  17,397
  
  22,656Income (loss) from operations
  
  1,163
  
  161
  
  (14,077
  )Interest income
  
  71
  
  372
  
  840Interest expense
  
  (28
  )
  (352
  )
  (548
  )Other income
  
  204
  
  363
  
  775Income (loss) before income
  taxes
  
  1,410
  
  544
  
  (13,010
  )Income taxes
  
  
  
  
  
  12,376Net income (loss)
  
  $
  1,410
  
  $
  544
  
  $
  (25,386
  )Net income (loss) per
  sharebasic
  
  $
  .08
  
  $
  .03
  
  $
  (1.88
  )Net income (loss) per sharediluted
  
  $
  .08
  
  $
  .03
  
  $
  (1.88
  )Weighted average common
  sharesbasic
  
  17,577,315
  
  16,617,426
  
  13,511,489Weighted
  average common sharesdiluted
  
  18,008,496
  
  16,617,426
  
  13,511,489  See accompanying notes to
the consolidated financial statements. F-4


---

EFJ, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
Years Ended December 31, 2002, 2001 and 2000
(in thousands, except share data) Common Stock
  
  AdditionalPar
  
  Paid-in
  
  AccumulatedShares
  
  Value
  
  Capital
  
  Deficit
  
  TotalBalance,
  December 31, 1999
  
  12,954,124
  
  $
  130
  
  $
  90,331
  
  
  $
  (41,175
  )
  
  $
  49,286Exercise of stock options
  
  50,000
  
  
  
  72
  
  
  
  
  
  72Issuance of
  common stock for litigation settlement
  
  1,337,999
  
  13
  
  1,785
  
  
  
  
  
  1,798Net loss
  
  
  
  
  
  
  
  
  (25,386
  )
  
  (25,386
  )Balance, December 31, 2000
  
  14,342,123
  
  143
  
  92,188
  
  
  (66,561
  )
  
  25,770Issuance of common stock for litigation settlement
  
  3,197,001
  
  32
  
  4,240
  
  
  
  
  
  4,272Other
  
  38,191
  
  1
  
  7
  
  
  
  
  
  8Net income
  
  
  
  
  
  
  
  
  544
  
  
  544Balance, December 31, 2001
  
  17,577,315
  
  176
  
  96,435
  
  
  (66,017
  )
  
  30,594Expense related to repriced options
  
  
  
  
  
  483
  
  
  
  
  
  483Net income
  
  
  
  
  
  
  
  
  1,410
  
  
  1,410Balance,
  December 31, 2002
  
  17,577,315
  
  $
  176
  
  $
  96,918
  
  
  $
  (64,607
  )
  
  $
  32,487  See accompanying notes to
the consolidated financial statements. F-5


---

EFJ, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2002, 2001, and 2000
(in thousands, except share data) 2002
  
  2001
  
  2000Cash
  flows from operating activities:Net income (loss)
  
  $
  1,410
  
  $
  544
  
  $
  (25,386
  )Adjustments to reconcile net income (loss) to net cash provided by
  (used in)operating activities:Provision for litigation
  settlement
  
  
  
  
  
  (924
  )Depreciation and amortization
  
  1,072
  
  2,460
  
  3,210Impairment charge on intangible
  assets
  
  
  
  
  
  2,255Gain on sale of fixed assets
  
  (107
  )
  (118
  )
  (225
  )Deferred income taxes
  
  
  
  
  
  12,376Non-cash compensationintrinsic
  value of repriced options
  
  483
  
  
  
  Changes in assets and liabilities:Accounts receivable
  
  213
  
  (2,830
  )
  8,838Cost in excess of billings on
  uncompleted contracts
  
  (70
  )
  84
  
  598Inventory
  
  (409
  )
  3,863
  
  1,322Prepaid expenses and other
  assets
  
  (597
  )
  (29
  )
  113Accounts payable
  
  (402
  )
  265
  
  (4,370
  )Billings in excess of cost on
  uncompleted contracts
  
  (109
  )
  (1,231
  )
  (3,738
  )Accrued expenses
  
  (408
  )
  835
  
  (2,162
  )Payments on restructuring
  reserve
  
  
  
  
  
  (705
  )Deferred revenue
  
  99
  
  8
  
  (3,532
  )Total adjustments
  
  (235
  )
  3,307
  
  13,056Net cash provided by (used in)
  operating activities
  
  1,175
  
  3,851
  
  (12,330
  )Cash flows from investing activities:Proceeds from sale of fixed
  assets
  
  41
  
  63
  
  392Purchase of fixed assets
  
  (1,173
  )
  (803
  )
  (536
  )Decrease (increase) in other
  assets
  
  (147
  )
  264
  
  22Net cash used in investing
  activities
  
  (1,279
  )
  (476
  )
  (122
  )Cash flows from financing activities:Proceeds (payments) on
  revolving lines of credit, net
  
  (120
  )
  (3,160
  )
  2,471Principal payments on long-term
  debt
  
  (25
  )
  (42
  )
  (253
  )Proceeds from the exercise of employee
  stock options
  
  
  
  
  
  72Net cash provided by (used in)
  financing activities
  
  (145
  )
  (3,202
  )
  2,290Net increase (decrease) in cash and cash equivalents
  
  (249
  )
  173
  
  (10,162
  )Cash and cash equivalents, beginning of year
  
  11,582
  
  11,409
  
  21,571Cash
  and cash equivalents, end of year
  
  $
  11,333
  
  $
  11,582
  
  $
  11,409  Supplemental
Disclosure of Cash Flow Information: The Company paid interest
of $35, $383, and $536, during the years 2002, 2001 and 2000, respectively. The Company paid $30 of income taxes in 2002; no
payments were made for income taxes in 2001 and 2000. In 2002, the Company
acquired $292 of property, plant and equipment in exchange for long-term debt. In 2002 and 2001,
respectively, the Company decreased its deferred tax valuation allowance,
recognizing a net deferred tax asset of $2,500 and $500, which amounts were
offset against the Companys goodwill. The Company issued
3,197,001 and 1,337,999 shares of common stock in 2001 and 2000, respectively,
as payment of litigation settlements in the amounts of $4,272 and $1,798. The
Company also issued 38,191 shares of common stock in 2001 for certain
liabilities amounting to $8. See accompanying notes to the consolidated financial
statements. F-6


---

EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands except for share and per share data) 1. Significant
Accounting Policies: The following is a summary of significant accounting
policies followed in the preparation of these consolidated financial
statements. Organization EFJ, Inc. (the Company) is a Delaware
corporation engaged in the design, manufacture and marketing of wireless
communication products and systems and information security products. Through
its EFJohnson subsidiary (EFJohnson), the Company designs, develops,
manufactures and markets stationary land mobile radio transmitters/receivers
and mobile and portable radios. Through its Transcrypt International subsidiary
(Transcrypt), the Company designs, develops, manufactures and markets
encryption devices for land mobile radios. The Company operates two industry
segments: the wireless communication industry (EFJohnson), located in Waseca,
Minnesota; and the information security industry (Transcrypt), located in
Lincoln, Nebraska. In both industry segments, the Company primarily markets its
products to: domestic public safety / public service and other governmental
users; domestic commercial users; and international customers. Principles of
Consolidation The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in the
consolidation. Cash and Cash Equivalents The Company considers all highly liquid investments
with original maturities less than 90 days as cash equivalents. The Company
places its temporary cash investments with high credit qualified financial
institutions. Such investments are carried at cost, which approximates fair
value. At December 31, 2002, cash and cash equivalents of $2.0 million
were pledged as security for the Companys outstanding letters of credit and
were unavailable for general operating purposes. Inventory Inventory is recorded at the lower of cost or market
with cost determined by the first-in, first-out (FIFO) method. Management
periodically assesses its inventory for potential obsolescence and
lower-of-cost-or-market issues and establishes reserves accordingly. Property, Plant and
Equipment Property, plant and equipment are recorded at cost. The
Companys policy is to capitalize expenditures for major improvements and to
charge to operating expenses the cost of maintenance and repairs. Depreciation
is computed on the straight-line method over the estimated useful lives of the
assets as follows: land improvements15 years; buildings and improvements15 to
30 years; equipment and furniture and fixtures3 to 7 years. The cost and
related accumulated depreciation of assets retired or otherwise disposed of are
eliminated from the respective accounts at the time of disposition. Any
resulting gain or loss is included in current operating results. F-7 EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 1. Significant Accounting Policies: (Continued) Intangible Assets Goodwill represents the excess of purchase price over
fair value of assets acquired. Effective January 1, 2002, with the Companys
adoption of SFAS No. 142, goodwill and certain other intangible assets are
no longer amortized to earnings, but instead is periodically reviewed for
impairment. The Company assesses the recoverability of goodwill and other
intangible assets by performing a fair value impairment test, at least annually.
If it is determined that impairment has occurred, the goodwill is written down
to its estimated net realizable value. Prior to 2002, the Company amortized
goodwill and certain other assets over the estimated useful lives of such
assets. Income Taxes Deferred tax assets and liabilities are recognized for
the future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards. Deferred
income tax assets and liabilities are measured using enacted tax rates expected
to apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The Company periodically evaluates its
deferred tax asset and assesses the need for a valuation allowance based upon
managements estimate of the recoverability of the future tax benefits
associated with the deferred tax asset. Revenue Recognition If collection is reasonably assured, revenues for
product sales are recognized when product is shipped, less an estimate for an
allowance for returns or doubtful accounts, if applicable. For shipments where
collection is not reasonably assured, the Company recognizes revenue as cash is
received. If collection is contingent on a future event, such as a reseller of
product selling the product to the end user, the Company recognizes revenue
when the contingency lapses, generally upon cash collection. System sales under long-term contracts are accounted
for using the percentage-of-completion method. Under this method, revenues are
recognized as work on a contract progresses. The recognized revenue is that
percentage of estimated total revenues that incurred costs to date bear to
estimated total costs to complete the contract. Revisions in cost and profit
estimates are made when conditions requiring such revisions become known.
Anticipated losses on contracts are recognized as soon as such losses are
determined to be probable and reasonably estimable. Deferred revenue includes unearned warranty fees on
extended product warranty and maintenance contracts sold to customers. The
Company recognizes the fees based on the expected warranty repairs to be
incurred over the life of the contract, generally on a straight-line basis. Deferred
revenue also includes the deferred gain discussed in Note 7. The Company periodically reviews its revenue
recognition procedures to assure that such procedures are in accordance with
the provisions of Staff Accounting Bulletin 101. F-8 EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 1. Significant Accounting
Policies: (Continued) Warranty Costs The Company substantially provides a one-year warranty
on its products. The Company estimates future warranty claims based on
historical experience and anticipated costs to be incurred. Warranty expense is
accrued at the time of sale with an additional accrual for specific items after
the sale when their existence is known and amounts are determinable. The following
represents a reconciliation of changes in the Companys accrued warranty as of December 31,
2002 and 2001: Balance at
  
  Charged to
  
  
  
  Balance atBeginning
  
  Costs and
  
  
  
  Endof Period
  
  Expenses
  
  Deductions
  
  of PeriodYear Ended
  December 31, 2001
  
  
  505
  
  
  
  
  731
  
  
  
  
  
  802
  
  
  
  
  434Year Ended
  December 31, 2002
  
  
  434
  
  
  
  
  869
  
  
  
  
  
  852
  
  
  
  
  451  Income (Loss) Per Share Basic net income (loss) per share is calculated based
upon the weighted average number of common shares outstanding during the period.
The diluted loss per share calculations for 2000 do not reflect the potential
dilution from stock options, as the effect of doing so would be anti-dilutive. Further,
in 2001, the potential dilution from stock options is not material as substantially
all of the outstanding stock options at December 31, 2001 have exercise
prices above the common stocks market value. As such, options to purchase
1,313,413 and 1,483,613 shares of common stock with weighted average exercise
prices of $0.667 and $1.953, respectively, were outstanding at December 31,
2001 and 2000, but such options were excluded from the computation of common
share equivalents because their exercise prices were greater than the average
market price of the common shares. Outstanding options at December 31,
2002, to purchase 1,528,186 shares of common stock with weighted average
exercise price of $0.683, were used in the computation of common share
equivalents for 2002; all outstanding options at December 31, 2002 were
included in the computation at that date as all such options had exercise
prices below the annual average trading price of $0.99 per share. Management
Estimates The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make certain estimates and assumptions that affect
carrying amounts of assets and liabilities and disclosures of contingent assets
and liabilities as of financial statement dates, as well as the reported
revenues and expenses for the years then ended. Actual results may differ from
managements estimates. Stock Option Plan The Company applies the intrinsic value-based method
of accounting for stock options issued to employees.  When both the number of shares that an individual
employee is entitled to receive and the option price are known at the grant
date, total compensation cost for the Companys grants of stock options is
measured at the grant date (fixed plan awards). However, when either or both
of these factors F-9 EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 1. Significant Accounting
Policies: (Continued) are not known at the grant date, the Company estimates
total compensation cost each accounting period from the date of grant based on
the estimated fair value of the Companys common stock at the end of each
period (variable plan awards). Changes, either increases or decreases, in the
estimated fair value of the shares between the date of grant and the final
exercise or expiration of the options result in a change in the measure of
compensation cost for variable plan awards. Compensation cost is recognized as
expense over the periods in which the employee performs the related services,
which is generally presumed to be the vesting period. Had compensation
cost for the Companys stock option plans been determined based on the fair
value at the grant date for awards in 2002, 2001 and 2000, the Companys pro
forma net loss and pro forma income (loss) per share would have been as
follows: 2002
  
  2001
  
  2000Net income
  (loss)as reported
  
  $
  1,410
  
  $
  544
  
  $
  (25,386
  )General and
  administrative expenses for management stock option compensation
  
  357
  
  785
  
  844Pro forma net
  income (loss)
  
  $
  1,053
  
  $
  (241
  )
  $
  (26,230
  )Net income (loss) per share, basic and dilutedas
  reported
  
  $
  0.08
  
  $
  0.03
  
  $
  (1.88
  )Pro forma net income
  (loss) per share, basic and diluted
  
  0.06
  
  (0.01
  )
  (1.94
  )  The weighted
average fair value per option at date of grant during 2002, 2001 and 2000 was
$0.74, $1.11, and $1.39, respectively. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes option-pricing model
with the following weighted-average assumptions for options granted: 2002
  
  2001
  
  2000Expected option
  life
  
  10 years
  
  10 years
  
  10 yearsExpected annual
  volatility
  
  193
  %
  184
  %
  144
  %Risk-free
  interest rate
  
  2.93
  %
  4.39
  %
  5.94
  %Dividend yield
  
  0
  %
  0
  %
  0
  %  Reclassifications Certain amounts in 2001 and 2000 have been
reclassified to conform to current year presentation. The reclassifications did
not affect net income (loss) or stockholders equity as previously reported. Recently Issued Accounting
Standards In June 2002, Financial Accounting Standards
Board (FASB) issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, which addresses
accounting and processing for costs associated with exit or disposal
activities. SFAS No. 146 requires the recognition of a liability for a
cost associated with an exit or disposal activity when the liability is
incurred versus the date the Company commits to an exit plan. In addition, SFAS
No. 146 states the liability should be initially measured at fair value.
The requirements of SFAS No. 146 are effective for exit or disposal
activities that are initiated after F-10


---

EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 1. Significant Accounting
Policies: (Continued) December 31, 2002. This pronouncement is not
expected to have a material impact on the Companys financial position or
results of operations. In December 2002 the FASB issued SFAS No. 148,
Accounting for Stock-Based CompensationTransition
and Disclosure. SFAS No. 148 amends the disclosure and certain
transition provisions of SFAS No. 123, Accounting for Stock-Based
Compensation.Its disclosure provisions, which apply to all entities
with employee stock-based compensation, are effective for fiscal years ending
after December 15, 2002. New interim period disclosures are required in
financial statements for interim periods beginning after December 15, 2002.
 Other than the additional disclosure
requirements, this pronouncement is not expected to have a material impact on
the Companys financial position or results of operations. In November 2002, the FASB issued FASB
Interpretation No. 45 (FIN 45), Guarantors Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. FIN 45 addresses the disclosure
requirements of a guarantor in its interim and annual financial statements
about its obligations under certain guarantees that it has issued. FIN 45
also requires a guarantor to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The disclosure requirements of FIN 45 are effective for the
Company effective December 31, 2002. The liability recognition
requirements will be applicable prospectively to all guarantees issued or
modified after December 31, 2002. This pronouncement is not expected to
have a material impact on the Companys financial position or results of
operation. 2. Inventory: The following is a summary
of inventory at December 31: 2002
  
  2001Raw materials and
  supplies
  
  $
  7,562
  
  $
  6,965Work in process
  
  1,646
  
  2,205Finished goods
  
  4,931
  
  4,25214,139
  
  13,422Less: reserve for
  obsolescence
  
  2,468
  
  2,160$
  11,671
  
  $
  11,262  F-11 EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 3. Contracts in Progress: Costs incurred to date,
estimated earnings and the related progress billings to date on contracts in
progress are as follows as of December 31: 2002
  
  2001Costs on uncompleted contracts
  
  $
  2,716
  
  $
  5,795Profits in uncompleted contracts
  
  2,786
  
  5,1215,502
  
  10,916Less billings
  
  3,854
  
  9,447$
  1,648
  
  $
  1,469The
  above is included in the consolidated balance sheet as follows:Cost in excess of billings on
  uncompleted contracts
  
  $
  1,686
  
  $
  1,616Billings in excess of cost on
  uncompleted contracts
  
  (38
  )
  (147
  )$
  1,648
  
  $
  1,469  Cost in excess of billings
on uncompleted contracts includes direct costs of manufacturing, installation,
project management, engineering, and allocable manufacturing overhead costs and
accrued profits in excess of amounts billed. Billings in excess of costs on
uncompleted contracts include amounts billed and accrued anticipated costs on
open contracts in excess of costs and accrued profits. 4. Property, Plant and
Equipment: Property, plant and
equipment consists of the following at December 31: 2002
  
  2001Land and land
  improvements
  
  $
  158
  
  $
  58Buildings and
  improvements
  
  572
  
  177Equipment
  
  9,068
  
  9,509Furniture and
  fixtures
  
  1,158
  
  1,178Software
  
  1,506
  
  969Construction in
  progress
  
  256
  
  47612,718
  
  12,367Less accumulated depreciation and amortization
  
  10,117
  
  10,251$
  2,601
  
  $
  2,116  As of January 1,
2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 144,
Impairment or Disposal of Long-Lived Assets.SFAS 144 addresses financial accounting and reporting for
long-term assets and supersedes SFAS 121, Accounting for the
Impairment of Long-Lived Assets to be Disposed of. SFAS 144
requires an entity to recognize an impairment loss to the extent that the
carrying value of a long-lived asset or asset group is not recoverable and exceeds its fair value. The
Companys adoption of SFAS 144 did not have a material effect upon the Companys
results of operations in 2002. F-12 EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 5. Intangible Assets: Intangible assets consist
of the following at December 31: 2002
  
  2001Goodwill
  
  $
  9,900
  
  $
  10,401Proprietary and
  core technology; and licensing agreements
  
  1,290
  
  1,290Acquired work
  force, customer base, trade name
  
  
  
  3,979Other
  
  113
  
  11311,303
  
  15,783Less accumulated amortization
  
  4,543
  
  6,413$
  6,760
  
  $
  9,370  As of January 1, 2002, the Company adopted SFAS No. 142,
Goodwill and Other Intangible Assets,which requires that goodwill no longer be amortized to
earnings, but instead be reviewed for impairment. In accordance with SFAS 142,
certain of  the Companys other
intangible assets, identified at December 31, 2002 as acquired workforce,
customer base and trade name,are also not
to be amortized in the future and the net unamortized balances at December 31,
2001 have been reclassified to goodwill as of January 1, 2002. As required
by SFAS 142 the Companyreviews its
intangible assets for impairment, at least annually. The Company performed such
fair value impairment tests at December 31, 2002 and 2001, concluding that
no impairment of goodwill and certain other intangible assets had occurred. The
Company amortized $1,137 of goodwill and certain other intangible assets in
each of 2001 and 2000. Had this amortization expense not been recorded in 2001
and 2000, net income (loss) would have been $1,681 and ($24,249), respectively. In the fourth quarter of 2000, the Company recognized
an impairment charge of $2,255 related to acquired work force, customer base,
and trade name. The impairment loss was measured based upon managements
estimate of fair value of the assets and was necessitated by work force
reductions and managements decision to exit certain customer markets. The
Company also evaluated the fair value of its intangible assets at various dates
in 2001, including year-end, and determined that fair value exceeded the
carrying value; therefore, no further impairment charge was deemed necessary. In the fourth quarters of 2002 and 2001, the Company
decreased its deferred tax asset valuation allowance by $3,400 and $546,
respectively, thereby recognizing a deferred tax asset of $3,000 and $500 at December 31,
2002 and 2001. These amounts were offset against goodwill as it was determined
that the adjusted deferred tax asset valuation allowance related to an amount
established at the time of the purchase of EFJohnson relating to acquired net
operating losses (NOLs). As of December 31, 2002, goodwill includes no
further amounts related to such acquired NOLs. 6. Revolving Line of
Credit: In November 2002, the Company entered into a
$10.0 million secured line of credit agreement with Bank of America. The line
of credit bears interest at a rate of LIBOR plus 200 basis points, the
effective rate at December 31, 2002, which rate may be increased to LIBOR
plus 275 basis points dependent upon certain debt ratios. The line of credit is
collateralized by substantially all the Companys assets. Borrowings available
under the line of credit are calculated as a percentage of eligible inventory
and receivables. The F-13 EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 6. Revolving Line
of Credit: (Continued) agreement, which expires September 30, 2004,
includes certain covenants, including financial covenants, with which the
Company was in compliance, or for which waivers had been obtained, as of December 31,
2002. At December 31, 2001, the Company had a $10.0
million secured line of credit with U.S. Bank. The Company voluntarily chose to
pay off and terminate such line of credit as of February 1, 2002 as management
no longer assessed any operational need for the line of credit as it was
structured. At December 31, 2002 and 2001, respectively, the
Company had $5,000 and $5,120 outstanding on its lines of credit. Average
borrowings under the Companys lines of credit and the weighted average
interest rate were, respectively, $276 and 5.0% during 2002 and $6,700 and 6.0%
during 2001. The total available credit under the line of credit was $2,606 as
of December 31, 2002. 7. Long-Term Debt: Long-term debt at December 31,
2002 includes a mortgage on certain property, as well as notes for financing of
equipment. Future principal payments as of December 31, 2002 are as follows: Year Ending December 312003
  
  $
  222004
  
  252005
  
  152006
  
  122007
  
  12Thereafter
  
  200$
  286  8. Leases: In 1999, the Company entered into sale-leaseback
transactions involving its facilities in Lincoln, Nebraska and Waseca,
Minnesota. Under the terms of the Lincoln agreement, the Company leases a minor
portion of the facility under a five-year operating lease. Under the terms of
the Waseca agreement, the Company leases approximately 60% of the facilities
under a five-year operating lease. The gain on the sale of the Waseca building
was deferred and is being realized on a straight-line basis over the life of
the lease. The remaining deferred gain of $58 is included in deferred revenue
at December 31, 2002. F-14 EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 8. Leases: (Continued) The
Company also leases various equipment and buildings under operating leases.
Rent expense was $1,300, $1,500, and $1,776 for the years 2002, 2001 and 2000,
respectively. The Company anticipates, in 
the normal course of business, that leases will be renewed or replaced
as they expire. Future minimum rental payments under non-cancelable operating
lease agreements as of December 31, 2002 are as follows: Year Ending December 312003
  
  $
  1,2372004
  
  1,1012005
  
  1752006
  
  1522007
  
  103$
  2,768  9. Income Taxes: The components of
the expense (benefit) for income taxes for the years ending December 31,
2002, 2001 and 2000 are as follows: 2002
  
  2001
  
  2000Current:Federal
  
  $
  
  
  $
  
  
  $
  State
  
  
  
  
  
  Deferred:Federal
  
  
  
  
  
  12,376State
  
  
  
  
  
  Total
  
  $
  
  
  $
  
  
  $
  12,376  A reconciliation of
the Companys effective tax rate to the U.S. federal statutory rate is as
follows: 2002
  
  Percent
  
  2001
  
  Percent
  
  2000
  
  PercentU.S. federal tax at statutory tax rate
  
  $
  480
  
  
  34.0
  
  
  $
  185
  
  
  34.0
  
  
  $
  (4,423
  )
  (34.0
  )Increase (decrease) in valuation allowance
  
  
  
  
  
  
  
  
  
  
  
  
  
  15,212
  
  116.9Use of net operating loss (NOL) carryforwards
  
  (550
  )
  
  (39.0
  )
  
  (435
  )
  
  (80.0
  )
  
  
  
  Non deductible amortization and impairment charge
  
  35
  
  
  2.5
  
  
  250
  
  
  46.0
  
  
  1,018
  
  7.8State taxes
  
  17
  
  
  1.2
  
  
  
  
  
  
  
  
  
  
  Other
  
  18
  
  
  1.3
  
  
  
  
  
  
  
  
  569
  
  4.4$
  
  
  
  0.0
  %
  
  $
  
  
  
  0.0
  %
  
  $
  12,376
  
  95.1
  %  F-15


---

EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 9. Income Taxes:
(Continued) Temporary
differences between the financial statement carrying amounts and tax bases of
assets and liabilities that give rise to deferred income taxes at December 31,
2002 and 2001 relate to the following: 2002
  
  2001Special compensation expense
  
  $
  1,045
  
  $
  1,400Allowance for bad debts and returns
  
  35
  
  110Reserve for inventory obsolescence
  
  800
  
  740NOL carryforwards
  
  20,415
  
  21,320Difference between tax and book amortization
  
  1,400
  
  1,550Difference between tax and book depreciation
  
  185
  
  200Difference between tax and book liability accruals and  prepaid assets
  
  920
  
  380Gross deferred tax assets
  
  24,800
  
  25,700Less valuation allowance
  
  21,800
  
  25,200$
  3,000
  
  $
  500  In 2000, the valuation allowance was increased by
$15,212. In 2002 and 2001, the valuation allowance was reduced by $3,400 and
$546, respectively. In assessing the realizability of deferred tax assets,
management considers whether it is more likely than not that some portion or all
of the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is entirely dependent upon the generation of future taxable
income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income, and tax planning strategies in
making this assessment. In order to realize fully its deferred tax asset, the
Company will need to generate future taxable income of at least $74.7 million
prior to expiration of its NOL carryforwards. Taxable income for the year ended
December 31, 2002 was approximately $2.0 million. Taxable losses for the
years ended December 31, 2001 and 2000 were approximately, $5.0 million,
and $9.9 million, respectively. During the fourth quarter of 2000, the Company reduced
the net book value of its deferred income tax assets from $12.4 million to zero
by adjusting the valuation allowance. One of the primary factors in the
conclusion to increase the valuation allowance was the operating loss in the
fourth quarter of 2000, as the fourth quarter results created further
uncertainty about the recoverability of the deferred tax assets. During the
fourth quarters of 2002 and 2001, the Company decreased its valuation allowance
by $3,400 and $546, respectively, increasing its deferred tax asset to $3,000
at December 31, 2002 and $500 at December 31, 2001. The resulting
increases in the Companys deferred tax asset was offset against goodwill as
the amount was determined to relate to the original $3,000 valuation allowance
for deferred tax assets established at the time of the EFJohnson acquisition
(relating to acquired NOL carryforwards). Any subsequently recognized tax
benefits will be recognized as an income tax benefit in the Companys
Consolidated Statement of Operations. The conclusion to decrease the valuation
allowance, and thereby establish a deferred tax asset, was, among other
considerations, a result of the Companys operating results during 2002 and
2001 and managements expectations of future earnings. Taxable net operating loss carryforwards, totaling
$54.4 million at December 31, 2002, originated in 1996 through 2001 and
begin to expire in 2011. The Company has approximately $7,500 in Federal and F-16 EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 9. Income Taxes:
(Continued) state net operating loss
carryforwards attributable to EFJohnson, which expire in 2012. Tax regulations
limit the amount that may be utilized on these acquired net operating losses on
an annual basis to approximately $588. 10. Accrued Expenses: Accrued expenses
consist of the following at December 31, 2002 and 2001: 2002
  
  2001Payroll, bonuses and employee benefits
  
  $
  1,159
  
  $
  1,196Warranty reserve
  
  451
  
  434Commissions
  
  654
  
  314Other expenses
  
  53
  
  781$
  2,317
  
  $
  2,725  11. Commitments and
Contingencies: The Company was named as a defendant in class action
lawsuits that were filed subsequent to the Companys announcement on March 27,
1998 that the filing of its Annual Report on Form 10-K for year ended December 31,
1997 would be delayed, and that adjustments would be made to the Companys
previously announced financial results. The Company has settled the stockholder
class action suits against the Company and certain of its current or former
officers. In accordance with the settlement, the Company issued 1,337,999 shares of common stock of the Company
in the third quarter of 2000 and issued additional 3,122,001 shares in the
second quarter of 2001. Further, in June 2001, the Company issued
75,000 shares resulting from the settlement of litigation with Physicians
Mutual. On or about June 8, 2001, Electronic Engineering
Company (EEC) filed a complaint in the Iowa District Court of Polk County,
against EFJohnson. Plaintiff alleged that EFJohnson engaged in wrongful
activities in connection with a transaction for the installation of an
EFJohnson 900-megahertz trunked radio system. The Company vigorously contested
these allegations. In May 2002, the parties entered into a settlement
whereby (i) EEC returned to the Company certain of EFJohnsons equipment
previously sold to EEC, (ii) EFJohnson forgave a $133 receivable due from
EEC, and (iii) the Company paid EEC $200. Both parties executed and
exchanged general releases. On or about February 5, 2001, ASRC Communication
(ASRC) filed a complaint in United States District Circuit Court of Alaska,
against EFJohnson. ASRC alleges that EFJohnson engaged in wrongful activities
in association with radio products sold to ASRC. ASRC purchased approximately
$0.5 million of products from EFJohnson since 1999. ASRCs claims against
EFJohnson include breach of contract, breach of express warranty, breach of
implied warranty of merchantability, breach of implied warranty of fitness for
a particular purpose, breach of duty of good faith and fair dealing, equitable
estoppel, misrepresentation, and violations of the Racketeer Influenced and
Corrupt Organizations Act. Plaintiff seeks compensatory damages in excess of
$0.5 million, attorneys fees and costs, and punitive damages in an unspecified
amount. The Company vigorously contests ASRCs allegations. However, the
Company is unable to predict the likelihood of the outcome or potential
liability that may arise from this legal action. F-17 EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 11. Commitments and
Contingencies: (Continued) The Company is involved in
certain other legal proceedings incidental to the normal conduct of its
business. The Company does not believe that any liabilities relating to such
other legal proceedings arelikely to be, individually or in the aggregate, material
to the Companys business, financial condition, results of operations or cash
flows. In the normal course of its business activities, the
Company is required under a contract with various governmental authorities to
provide letters of credit and bonds that may be drawn upon if the Company fails
to perform under its contracts. The letters of credit, which expire on various
dates in 2003, have a total undrawn balance of $2.0 million. Bonds, which
expire on various dates, totaled $6.5 million on December 31, 2002. As of
that date, no bonds had been drawn upon. 12. Option Plans: Under the Companys 1996 Stock Incentive Plan (the Plan),
any employee, including any director of the Company and any non-employee
director or independent contractor of the Company, is eligible to be considered
for the issuance of shares of common stock or of any other class of security or
right of the Company which is convertible into common stock. There are
approximately 1,065,000 remaining shares available to be issued under this
Plan. The Plan provides that, unless otherwise provided by the Plan committee,
any stock option granted shall have an exercise price not less than 100% of the
market value of a share of common stock on the date the option is granted and
that the term of such option shall be ten years from date of grant with vesting
of the options at a rate of 20% per year. During 2001 and 2000, the Company cancelled and
reissued 620,000 and 366,000 stock options, respectively, under the Plan to
lower the exercise price of those options to an amount approximately 150% of
the prevailing market value of the Companys common stock (the repricing),
that is $0.656 per share. The repricing of the stock options resulted in a new
measurement date for accounting purposes and the reclassification of these
options as variable plan awards beginning on the date of the repricing.
Further, in 2001, similar to the Companys aforementioned repricing decision,
the Company decreased the exercise price of the 200,000 stock options issued to
its Chief Executive Officer in 1999 (pursuant to the Michael Jalbert 1999 Stock
Option Agreement, hereafter referred to as Mr. Jalberts Option Agreement)
from $1.4375 to $0.656 per share. The Company previously accounted for these
option grants as fixed plan awards. Subsequent to the repricings through December 31,
2001, the quoted value of the Companys common stock was not above the exercise
price of the options by any substantial amount or for any substantial length of
time; as such, no compensation expense was recognized in 2001 or 2000 for the
effects of the repricings. However, in 2002 the market value Companys common
stock generally remained above the exercise price of the repriced options,
closing at December 31, 2002 at $1.25 per share, and the Company recorded
$483 in non-cash compensation expense in 2002 for the cumulative effects of the
repricings. F-18 EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 12. Option Plans:
(Continued) The status of the Companys stock options (excluding
options for 200,000 shares under Mr. Jalberts Option Agreement) are
summarized as follows: Number of
  Shares
  
  Weighted
  Average
  Price Per
  Share
  
  Weighted
  Average
  Options
  ExercisableBalance at
  December 31, 1999
  
  1,602,161
  
  
  3.44
  
  
  
  874,927Granted(1)
  
  789,250
  
  
  1.57
  
  
  
  Exercised
  
  (50,000
  )
  
  1.44
  
  
  
  Forfeited(1)
  
  (857,798
  )
  
  3.97
  
  
  
  Balance at
  December 31, 2000
  
  1,483,613
  
  
  1.95
  
  
  
  775,370Granted(1)
  
  752,556
  
  
  0.63
  
  
  
  Forfeited(1)
  
  (922,756
  )
  
  2.67
  
  
  
  Balance at
  December 31, 2001
  
  1,313,413
  
  
  0.67
  
  
  
  810,632Granted.
  
  529,700
  
  
  0.74
  
  
  
  Forfeited
  
  (514,927
  )
  
  0.69
  
  
  
  Balance at December 31, 2002
  
  1,328,186
  
  
  $
  0.68
  
  
  
  665,021  
 (1)Includes 620,000 and
366,000 options cancelled and reissued during 2001 and 2000, respectively, in connection
with the repricing. The Companys outstanding options, including options
for 200,000 shares under Mr. Jalberts Option Agreement, as of December 31,
2002 are as follows: Range of
  Exercise Price
  
  Number
  Outstanding at
  December 31,
  2002
  
  Weighted
  Average
  Remaining
  Contractual
  Life
  
  Weighted
  Average
  Exercise
  Price
  
  Number
  Exercisable at
  December 31,
  2002
  
  Exercisable
  Weighted
  Average
  Exercise Price$0.390-0.390
  
  
  32,500
  
  
  
  8.3
  
  
  
  $
  0.390
  
  
  
  6,500
  
  
  
  $
  0.3900.510-0.510
  
  
  168,700
  
  
  
  9.1
  
  
  
  0.510
  
  
  
  
  
  
  
  0.656-0.656
  
  
  976,986
  
  
  
  7.7
  
  
  
  0.656
  
  
  
  817,021
  
  
  
  0.6560.734-0.734
  
  
  20,000
  
  
  
  8.1
  
  
  
  0.734
  
  
  
  4,000
  
  
  
  0.7340.820-0.820
  
  
  50,000
  
  
  
  9.6
  
  
  
  0.820
  
  
  
  
  
  
  
  0.890-0.890
  
  
  280,000
  
  
  
  9.6
  
  
  
  0.890
  
  
  
  37,500
  
  
  
  0.8900.390-0.890
  
  
  1,528,186
  
  
  
  8.3
  
  
  
  $
  0.664
  
  
  
  865,021
  
  
  
  $
  0.667  13. Benefit Plans: The Company has a profit sharing plan, which covers
substantially all employees. Contribution levels are determined annually by the
Board of Directors. There were no profit sharing contributions in any of the
three years ended December 31, 2002, 2001 and 2000. The Company also has a 401(k) plan, which covers
substantially all employees. Participants may contribute up to 15% of their
annual compensation and the Company makes matching contributions of 40% for the
first 6% of the amount contributed by participants. Contributions may not
exceed the maximum allowable by law. Company contributions approximated $164,
$160, and $201 for the years ended December 31, 2002, 2001 and 2000,
respectively. F-19 EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 14. Fair Value of
Financial Instruments: The carrying amount of the Companys current assets
and liabilities approximate fair value because of the short maturity of these
instruments. The carrying amount of the revolving line of credit approximates fair
value as calculated by discounting the future cash flows of the instrument at
rates currently offered to the Company for similar debt instruments of
comparable maturities by the Companys bankers. 15. Concentrations: Sales to the State of South Dakota accounted for 12%
of all sales in each of 2002 and 2001. Sales to Chester County of Pennsylvania
accounted for 14% of all sales in 2001. Sales to Motorola accounted for 17% of
all sales in 2000. In addition, a substantial portion of the Companys
revenue is from customers in the governmental sector, both domestic and
foreign. The Companys policy does not require significant collateral or other
security to support such receivables. However, the Company typically requests
collateral on certain foreign sales that carry higher than normal risk
characteristics, and also carries insurance on certain of its accounts
receivable. In addition to being a customer, Motorola is a key
manufacturer of electronic components used by the Company; purchases from
Motorola totaled approximately $3,670, $2,390, and $1,062, in 2002, 2001 and
2000, respectively. 16. Export Sales: A significant
portion of the Companys sales are made to customers outside of the United
States. Export sales are recorded and settled in U.S. dollars. Export sales by
major geographic areas, excluding Canada, were as follows for the years ended December 31,
2002, 2001 and 2000: 2002
  
  2001
  
  2000Europe
  
  $
  685
  
  $
  1,680
  
  $
  797Middle East and
  Asia
  
  4,148
  
  3,030
  
  3,723Central and Latin
  America
  
  1,287
  
  5,760
  
  2,698$
  6,120
  
  $
  10,470
  
  $
  7,218  17. Related Party
Transaction: On January 7, 2000, the Company extended an
interest free loan to the Companys Chief Executive Officer, Michael E.
Jalbert, in the principal amount of $175. In March 2001, the Company
forgave repayment of Mr. Jalberts loan. Accordingly, general and
administrative expense for the first quarter of 2001 includes this charge. In April 2002,
the Company extended another loan to Mr. Jalbert in the principal amount
of $75. This note is due on demand and bears interest at the rate of 6%. F-20


---

EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 18. Financial Condition
and Liquidity: The Company incurred a net loss of $25.4 million and
used cash in operations of $12.3 million for the year ended December 31,
2000. At December 31, 2000, the Company had approximately $1.4 million
available under its existing line of credit and had unrestricted cash of
approximately $1.4 million. The Companys long-term viability, as well as its
ability to meet its existing operating requirements and future capital needs,
depends on its ability to achieve and maintain profitable operations. Consequently,
the Company implemented certain initiatives in the fourth quarter of 2000 to
improve its fiscal performance in both the short and long term. These
initiatives included workforce reductions of 69 and 24 employees in November 2000
and March 2001, respectively. In addition, the Company evaluated its
products and product lines, and adjusted prices and eliminated products and
product lines in order to maximize overall profitability. These and other
infrastructure changes have enabled the organization, in the opinion of
management, to more readily respond to and take advantage of the opportunities
available to the Company. The result of these initiatives is a reduction in the
minimum level of revenues necessary to support the organization, although the
amount of revenues required to provide adequate cash flow to support the
Company depends in part upon the mix of products and services sold by the Company.
The Company recognized net income of $1,410 and $544 for the years ended December 31,
2002 and 2001, respectively; further, cash provided from operating activities
during these two years was $1,175 and $3,851, respectively. The extent to which
the Company continues to successfully implement these initiatives will have a
significant impact on the Companys future operating cash flows. Management
anticipates that the Company will be able to achieve a sufficient level of cash
flows in the future to continue operations. Nevertheless, the Companys failure
to achieve its future revenue and profitability goals, and other factors beyond
the Companys control, could result in losses, liquidity problems, additional
asset impairment charges, and possible insolvency. 19. Segment and Related
Information: The Company
operates in the following two industry segments: ·the wireless communication
industry (EFJohnson), which is comprised of the design, development,
manufacture and sale of stationary land mobile radio transmitters/receivers,
mobile and portable radios and complete radio communication systems; and ·the information security
industry (Transcrypt), which is comprised of the design, manufacture and sale
of devices that prevent the unauthorized interception of sensitive voice and
data communication. F-21 EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 19. Segment and Related
Information: (Continued) The Company evaluates segment results based on gross
margin and income from operations. Corporate expenses are allocated to the
operating segments based upon estimated usage of corporate resources. The
following table is a summary of annual results for the years ended December 31,
2002, 2001 and 2000. 2002
  
  2001
  
  2000(in thousands)Revenues:Wireless Communication
  
  $
  33,785
  
  $
  38,399
  
  $
  36,100Information Security
  
  7,002
  
  5,769
  
  6,092$
  40,787
  
  $
  44,168
  
  $
  42,192Gross
  Profit:Wireless Communication
  
  $
  12,645
  
  $
  13,674
  
  $
  4,164Information Security
  
  4,926
  
  3,884
  
  4,415$
  17,571
  
  $
  17,558
  
  $
  8,579Operating
  Income (Loss):Wireless Communication
  
  $
  (169
  )
  $
  (633
  )
  $
  (14,906
  )Information Security
  
  1,332
  
  794
  
  829Income (Loss) from Operations
  
  1,163
  
  161
  
  (14,077
  )Other Income, net
  
  247
  
  383
  
  1,067Income (Loss) before Taxes
  
  $
  1,410
  
  $
  544
  
  $
  (13,010
  )Depreciation & Amortization:Wireless Communication
  
  $
  911
  
  $
  2,190
  
  $
  2,858Information Security
  
  161
  
  270
  
  352$
  1,072
  
  $
  2,460
  
  $
  3,210Assets:Wireless Communication
  
  $
  28,647
  
  $
  29,142Information Security
  
  4,921
  
  5,023Corporate
  
  11,688
  
  9,955$
  45,256
  
  $
  44,120  The Company made the decision in the fourth quarter of
2000 to substantially exit the commercial LMR markets and focus its LMR sales
on the domestic public safety / public service sector. Consequently, the
Companys sales to the domestic public safety / public service sector have
steadily increased, and the Companys sales to commercial users have decreased.
The Companys sales to these domestic governmental users were $30.2 million in
2002, $26.9 million in 2001, and $21.0 million in 2000, or 74%, 61%, and
50% of total sales, respectively. The Companys sales to commercial users were
$4.5 million in 2002, $6.7 million in 2001, and $14.1 million in 2000, or
11%, 15% and 33% of total sales, respectively. F-22 EFJ, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (in thousands except for share and per share data) 20. Unaudited Quarterly Financial Data: The following table sets forth unaudited condensed operating
results for each of the eight quarters in the two-year period ended December 31,
2002. This information has been prepared on the same basis as the financial
statements appearing elsewhere in this report. The Companys operating results
for any one quarter are not indicative of results for any future period. Earnings
per share for each quarter are computed independently of earnings per share for
the year. The sum of the quarterly earnings per share may not equal the
earnings per share for the year because of: (i) transactions affecting the
weighted average number of common shares outstanding in each quarter; and (ii) the
uneven distribution of earnings during the year. Quarter EndedMarch 31,
  
  June 30,
  
  Sept. 30,
  
  Dec. 31,(in thousands, except per share data)2002Revenues
  
  
  $
  9,897
  
  
  $
  9,514
  
  $
  10,136
  
  $
  11,240Income (loss) from operations
  
  
  (147
  )
  
  269
  
  437
  
  604Interest and other income (expenses), net
  
  
  245
  
  
  (74
  )
  54
  
  22Income before income taxes
  
  
  98
  
  
  195
  
  491
  
  626Provision for income taxes
  
  
  
  
  
  
  
  
  
  Net income
  
  
  $
  98
  
  
  $
  195
  
  $
  491
  
  $
  626Net income (loss) per sharebasic
  
  
  $
  0.01
  
  
  $
  0.01
  
  $
  0.03
  
  $
  0.04Net income (loss) per sharediluted
  
  
  $
  0.01
  
  
  $
  0.01
  
  $
  0.03
  
  $
  0.032001Revenues
  
  
  $
  9,551
  
  
  $
  10,660
  
  $
  10,292
  
  $
  13,665Income (loss) from operations
  
  
  (872
  )
  
  (290
  )
  52
  
  1,271Interest and other income (expense), net
  
  
  74
  
  
  30
  
  12
  
  267Income (loss) before income taxes
  
  
  (798
  )
  
  (260
  )
  64
  
  1,538Provision for income taxes
  
  
  
  
  
  
  
  
  
  Net income (loss)
  
  
  $
  (798
  )
  
  $
  (260
  )
  $
  64
  
  $
  1,538Net
  income (loss) per sharebasic and diluted
  
  
  $
  (0.06
  )
  
  $
  (0.02
  )
  $
  0.00
  
  $
  0.09  As a result of the September 11, 2001 attacks,
the Company experienced a temporary disruption in its vendor supply chain. This
disruption effectively moved approximately $1.7 million of revenues and $0.5
million in income from operations from the third quarter of 2001 to the fourth
quarter of 2001. As explained in Note 12, the Company has repriced
stock options which are accounted for as variable plan awards. As a result of
the prevailing market price of the Companys common stock exceeding the Companys
repriced stock options in 2002, the Company incurred non-cash compensation
expenses of $483 relating to these options. The Company did not incur any
expense in relation to these repriced options in 2001. The amounts of
compensation expense (benefit) recorded in the quarters ended March 31, June 30,
September 30, and December 31, 2002, respectively, were $437, ($76),
($199), and $321. F-23


---

SCHEDULE IIVALUATION AND
QUALIFYING ACCOUNTS AND RESERVES  Balance at
  Beginning
  of Period
  
  Charged to
  Expenses
  (Provisions)
  
  Charged
  to Other
  Accounts
  
  Deductions
  (Write-offs)
  
  Balance at
  End
  of PeriodAllowance for Doubtful Accounts for the:Year Ended December 31, 2000
  
  1,569,612
  
  (564,070
  )
  
  
  182,556
  
  822,986Year Ended December 31, 2001
  
  822,986
  
  (264,653
  )
  
  
  273,973
  
  284,360Year Ended December 31, 2002
  
  284,360
  
  436,782
  
  
  
  485,064
  
  236,078Inventory Obsolescence
  Reserve for the:Year Ended December 31, 2000
  
  3,718,714
  
  776,312
  
  
  
  1,339,143
  
  3,155,883Year Ended December 31, 2001
  
  3,155,883
  
  171,125
  
  
  
  1,167,220
  
  2,159,788Year Ended December 31, 2002
  
  2,159,788
  
  1,020,760
  
  
  
  712,762
  
  2,468,786Valuation Allowance for
  Deferred Tax Asset for the:Year Ended December 31, 2000
  
  9,034,000
  
  15,212,000
  
  
  
  
  
  24,246,000Year Ended December 31, 2001
  
  24,246,000
  
  1,454,000
  
  (500,000
  )
  
  
  25,200,000Year Ended December 31, 2002
  
  25,200,000
  
  (900,000
  )
  (2,500,000
  )
  
  
  21,800,000Allowance for Warranty
  Reserve for the:Year Ended December 31, 2000
  
  502,806
  
  638,128
  
  
  
  636,038
  
  504,896Year Ended December 31, 2001
  
  504,896
  
  731,500
  
  
  
  802,288
  
  434,108Year Ended
  December 31, 2002
  
  434,108
  
  869,223
  
  
  
  852,419
  
  450,912  See independent auditors
reports. S-1


---

Index of Attached
Exhibits The following documents are included in this report. Exhibit
  Number
  
  
  Description10.42
  
  Employment Agreement
  between the Company and Michael E. Jalbert dated October 15, 2002.10.48
  
  Revolving Line of Credit
  Loan Agreement and Security Agreement between the Company and Bank of
  America, N.A., dated November 19, 2002.11.1
  
  Statement re.
  Computation of Per Share Earnings.23.1
  
  Consent of Grant
  Thornton LLP.23.2
  
  Consent of KPMG LLP.99.1
  
  Written Certification of
  Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.
  § 1350.


---