**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,DC 20549-1004**

 

**Form 10-Q**

 

**(MarkOne)**

 

**ý****  Quarterly report pursuant to Section 13or 15(d) of the Securities Exchange**

**Act of 1934**

 

**FORTHE QUARTERLY PERIOD ENDED JUNE 30, 2004**

 

**or**

 

**o****  Transition report pursuant toSection 13 or 15(d) of the Securities**

**Exchange Act of 1934**

 

**Forthe transition period from                      to                      **

 

**CommissionFile Number 0-21681**

 

**EFJ, INC.**

(Exact name of registrant asspecified in its charter)

 

| **DELAWARE**                                                                                                                 |   | **47-0801192**                        |
|------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                                                              |   | (I.R.S. Employer Identification  No.) |
|                                                                                                                         |   |                                  |
| **1232 22nd STREET NW, SUITE 600  WASHINGTON, D.C. 20037  (202) 833-7742**                                                   |
| (Address, including zip code,  and telephone number,  including area code, of registrant’s  principal executive office) |

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that theRegistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 
| YES  ý |   | NO  o |
|------------------|--------|------------|

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).

 
| YES  o |   | NO  ý |
|-------------|--------|-----------------|

 

As of July 26, 2004, 17,939,462 shares of theRegistrant’s Common Stock were outstanding.

 

 

----

 

**PART I.  FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIAL STATEMENTS**

 

#### **EFJ, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

June 30, 2004 and December 31, 2003

(in thousands, except share data)

 
|                                                                                                                                                                                                                                                                                                                                 |   | **JUNE 30,  2004** |       | **DECEMBER 31,  2003** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|-----------------------------|------------|
|                                                                                                                                                                                                                                                                                                                                 |   | **(unaudited)**         |       |                        |       |
| **ASSETS**                                                                                                                                                                                                                                                                                                                           |   |                    |       |                        |       |
| Current  assets:                                                                                                                                                                                                                                                                                                                     |   |                    |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                                                                                           |   | $                       | 8,849      |                        | $          | 4,644 |   |
| Accounts  receivable, net of allowance for returns and doubtful accounts  of $166 and $104, respectively                                                                                                                                                                                                                             |   | 13,104                  |       | 19,754                      |       |
| Receivables –  other                                                                                                                                                                                                                                                                                                            |   | 186                     |       | 157                         |       |
| Cost in excess  of billings on uncompleted contracts                                                                                                                                                                                                                                                                                 |   | 1,006                   |       | 869                         |       |
| Inventories                                                                                                                                                                                                                                                                                                                          |   | 12,825                  |       | 18,040                      |       |
| Deferred  income taxes                                                                                                                                                                                                                                                                                                               |   | 2,000                   |       | 1,500                       |       |
| Prepaid  expenses                                                                                                                                                                                                                                                                                                                    |   | 717                     |       | 587                         |       |
| Total current  assets                                                                                                                                                                                                                                                                                                                |   | 38,687                  |       | 45,551                      |       |
|                                                                                                                                                                                                                                                                                                                                 |   |                    |       |                        |       |
| Property,  plant and equipment, net                                                                                                                                                                                                                                                                                                  |   | 3,111                   |       | 2,779                       |       |
| Deferred  income taxes                                                                                                                                                                                                                                                                                                               |   | 6,000                   |       | 6,500                       |       |
| Intangible  assets, net of accumulated amortization                                                                                                                                                                                                                                                                                  |   | 6,749                   |       | 6,753                       |       |
| Other assets                                                                                                                                                                                                                                                                                                                         |   | 590                     |       | 686                         |       |
| **TOTAL ASSETS**                                                                                                                                                                                                                                                                                                                     |   | $                       | 55,137     |                        | $          | 62,269 |   |
|                                                                                                                                                                                                                                                                                                                                 |   |                    | ** ** |                        | ** ** |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                                        |   |                    | ** ** |                        | ** ** |
| Current  liabilities:                                                                                                                                                                                                                                                                                                                |   |                    |       |                        |       |
| Revolving line  of credit                                                                                                                                                                                                                                                                                                            |   | $                       | —     |                        | $          | 7,500 |   |
| Current  portion of long-term debt obligations                                                                                                                                                                                                                                                                                       |   | 130                     |       | 127                         |       |
| Accounts  payable                                                                                                                                                                                                                                                                                                                    |   | 5,150                   |       | 8,582                       |       |
| Billings in  excess of cost on uncompleted contracts                                                                                                                                                                                                                                                                                 |   | —                  |       | 30                          |       |
| Deferred  revenue – current                                                                                                                                                                                                                                                                                                     |   | 893                     |       | 1,191                       |       |
| Accrued  expenses                                                                                                                                                                                                                                                                                                                    |   | 3,309                   |       | 3,406                       |       |
| Total current  liabilities                                                                                                                                                                                                                                                                                                           |   | 9,482                   |       | 20,836                      |       |
|                                                                                                                                                                                                                                                                                                                                 |   |                    |       |                        |       |
| Long-term debt  obligations, net of current portion                                                                                                                                                                                                                                                                                  |   | 356                     |       | 426                         |       |
| Deferred  revenue, net of current portion                                                                                                                                                                                                                                                                                            |   | 951                     |       | 601                         |       |
| **TOTAL LIABILITIES**                                                                                                                                                                                                                                                                                                                |   | 10,789                  |       | 21,863                      |       |
|                                                                                                                                                                                                                                                                                                                                 |   |                    |       |                        |       |
| Stockholders’  equity:                                                                                                                                                                                                                                                                                                          |   |                    |       |                        |       |
| Preferred  stock ($0.01 par value; 3,000,000 shares authorized; none issued)                                                                                                                                                                                                                                                         |   | —                  |       | —                      |       |
| Common stock  ($0.01 par value; 50,000,000 voting shares authorized, 17,784,925 and  17,359,973 issued and outstanding as of June 30, 2004 and  December 31, 2003; 600,000 non-voting shares authorized, 217,542 issued  and outstanding at December 31, 2003, which shares were converted to  voting shares in 2004) |   | 178                     |       | 176                         |       |
| Additional  paid-in capital                                                                                                                                                                                                                                                                                                          |   | 103,251                 |       | 100,845                     |       |
| Accumulated  deficit                                                                                                                                                                                                                                                                                                                 |   | (59,081                 | )          | (60,615                     | )          |
| **TOTAL STOCKHOLDERS’  EQUITY**                                                                                                                                                                                                                                                                                                 |   | 44,348                  |       | 40,406                      |       |
| **TOTAL LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                                 |   | $                       | 55,137     |                        | $          | 62,269 |   |

 

See accompanying notes to thecondensed consolidated financial statements.

 

2

----

 

**EFJ, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

For the three and six monthsended June 30, 2004 and 2003

(Unaudited and in thousands,except share and per share data)

 
|                                                                                                                                                                                                                                                             |   | **THREE MONTHS ENDED  JUNE 30,** |   | **SIX MONTHS ENDED  JUNE 30,** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
|                                                                                                                                                                                                                                                             |   | **2004**                              |   | **2003**                            |   | **2004** |   | **2003** |   |
|                                                                                                                                                                                                                                                             |   |                                  |   |                                |   |   |   |   |   |
| Revenues                                                                                                                                                                                                                                                         |   | $                                     | 17,571 |                                | $      | 10,723 |   | $ | 39,815 |   | $ | 19,724 |   |
| Cost of sales                                                                                                                                                                                                                                                    |   | 8,554                                 |   | 6,079                               |   | 22,240 |   | 11,121 |   |
| Gross profit                                                                                                                                                                                                                                                     |   | 9,017                                 |   | 4,644                               |   | 17,575 |   | 8,603 |   |
|                                                                                                                                                                                                                                                             |   |                                  |   |                                |   |   |   |   |   |
| Operating  expenses:                                                                                                                                                                                                                                             |   |                                  |   |                                |   |   |   |   |   |
| Research and  development                                                                                                                                                                                                                                        |   | 2,694                                 |   | 1,813                               |   | 5,270 |   | 3,215 |   |
| Sales and  marketing                                                                                                                                                                                                                                             |   | 2,090                                 |   | 1,533                               |   | 4,336 |   | 2,844 |   |
| General and administrative,  inclusive of non-cashstock option repricing (benefit) expense adjustment  of $3,398 and  $2,311 for the three and six months  ended June 30, 2004 and $(150) and $296 for  the  three  and six months ended June 30, 2003 |   | 5,672                                 |   | 1,386                               |   | 6,359 |   | 3,196 |   |
| Total  operating expenses                                                                                                                                                                                                                                        |   | 10,456                                |   | 4,732                               |   | 15,965 |   | 9,255 |   |
|                                                                                                                                                                                                                                                             |   |                                  |   |                                |   |   |   |   |   |
| Income (loss)  from operations                                                                                                                                                                                                                                   |   | (1,439                                | )      | (88                                 | )      | 1,610 |   | (652 | ) |
|                                                                                                                                                                                                                                                             |   |                                  |   |                                |   |   |   |   |   |
| Other income  (expense)                                                                                                                                                                                                                                          |   | 4                                     |   | —                              |   | (5 | ) | 27 |   |
| Interest  income                                                                                                                                                                                                                                                 |   | 9                                     |   | 9                                   |   | 20 |   | 21 |   |
| Interest  expense                                                                                                                                                                                                                                                |   | (35                                   | )      | (53                                 | )      | (91 | ) | (92 | ) |
|                                                                                                                                                                                                                                                             |   |                                  |   |                                |   |   |   |   |   |
| Income (loss)  before income taxes                                                                                                                                                                                                                               |   | (1,461                                | )      | (132                                | )      | 1,534 |   | (696 | ) |
|                                                                                                                                                                                                                                                             |   |                                  |   |                                |   |   |   |   |   |
| Income tax  provision                                                                                                                                                                                                                                            |   | —                                |   | —                              |   | — |   | — |   |
|                                                                                                                                                                                                                                                             |   |                                  |   |                                |   |   |   |   |   |
| Net income  (loss)                                                                                                                                                                                                                                               |   | $                                     | (1,461 | )                                   | $      | (132 | ) | $ | 1,534 |   | $ | (696 | ) |
|                                                                                                                                                                                                                                                             |   |                                  |   |                                |   |   |   |   |   |
| Net income  (loss) per share – Basic                                                                                                                                                                                                                        |   | $                                     | (0.08  | )                                   | $      | (0.01 | ) | $ | 0.09 |   | $ | (0.04 | ) |
| Net income  (loss) per share – Diluted                                                                                                                                                                                                                      |   | $                                     | (0.08  | )                                   | $      | (0.01 | ) | $ | 0.08 |   | $ | (0.04 | ) |
|                                                                                                                                                                                                                                                             |   |                                  |   |                                |   |   |   |   |   |
| Weighted  average common shares – Basic                                                                                                                                                                                                                     |   | 17,716,875                            |   | 17,577,315                          |   | 17,650,585 |   | 17,577,315 |   |
| Weighted  average common shares – Diluted                                                                                                                                                                                                                   |   | 17,716,875                            |   | 17,577,315                          |   | 18,840,271 |   | 17,577,315 |   |

 

See accompanying notes to thecondensed consolidated financial statements.

 

3

----

 

**EFJ,INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

Six months ended June 30,2004 and 2003

(Unaudited and in thousands, except sharedata)

 
|                                                                                      |   | **Six months ended June 30,** |   |
|-------------------------------------------------------------------------------------------|--------|------------------------------------|--------|
|                                                                                      |   | **2004**                           |   | **2003** |   |
| Cash flows  from operating activities:                                                    |   |                               |   |   |   |
| Net income  (loss)                                                                        |   | $                                  | 1,534  |   | $ | (696 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |   |                               |   |   |   |
| Depreciation  and amortization                                                            |   | 695                                |   | 541 |   |
| Non-cash  compensation expense – intrinsic value of repriced options                 |   | 2,311                              |   | 296 |   |
| Gain on sale  of fixed assets                                                             |   | (1                                 | )      | (14 | ) |
| Changes in  assets and liabilities:                                                       |   |                               |   |   |   |
| Accounts  receivable                                                                      |   | 6,621                              |   | (772 | ) |
| Cost in excess  of billings on uncompleted contracts                                      |   | (137                               | )      | (241 | ) |
| Inventories                                                                               |   | 5,215                              |   | 1,316 |   |
| Prepaid  expenses                                                                         |   | (130                               | )      | (469 | ) |
| Accounts  payable                                                                         |   | (3,432                             | )      | (1,055 | ) |
| Billings in  excess of cost on uncompleted contracts                                      |   | (30                                | )      | (38 | ) |
| Deferred  revenues                                                                        |   | 52                                 |   | (462 | ) |
| Accrued and  other liabilities                                                            |   | (97                                | )      | (463 | ) |
| Total  adjustments                                                                        |   | 11,067                             |   | (1,361 | ) |
| Net cash  provided by (used in) operating activities                                      |   | 12,601                             |   | (2,057 | ) |
|                                                                                      |   |                               |   |   |   |
| Cash flows  from investing activities:                                                    |   |                               |   |   |   |
| Proceeds from  sale of fixed assets                                                       |   | 1                                  |   | — |   |
| Purchase of  property, plant and equipment                                                |   | (1,023                             | )      | (391 | ) |
| Other assets                                                                              |   | 96                                 |   | 110 |   |
| Net cash used  in investing activities                                                    |   | (926                               | )      | (281 | ) |
|                                                                                      |   |                               |   |   |   |
| Cash flows from  financing activities:                                                    |   |                               |   |   |   |
| Payments on  revolving line of credit, net                                                |   | (7,500                             | )      | (5,000 | ) |
| Principal  payments on long-term debt                                                     |   | (67                                | )      | (49 | ) |
| Other                                                                                     |   | 97                                 |   | (5 | ) |
| Net cash used  in financing activities                                                    |   | (7,470                             | )      | (5,054 | ) |
|                                                                                      |   |                               |   |   |   |
| Net increase  (decrease) in cash and cash equivalents                                     |   | 4,205                              |   | (7,392 | ) |
|                                                                                      |   |                               |   |   |   |
| Cash and cash  equivalents, beginning of period                                           |   | 4,644                              |   | 11,333 |   |
|                                                                                      |   |                               |   |   |   |
| Cash and cash  equivalents, end of period                                                 |   | $                                  | 8,849  |   | $ | 3,941 |   |

 

**Summary of non-cashtransactions:**

 

In the six months ending June 30, 2003, the Company acquired $374of fixed assets in exchange for long-term debt.

 

See accompanying notes to the condensed consolidated financialstatements

 

4

----

 

**EFJ, INC. AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**Three and six months ended June 30, 2004and 2003**

**(Unaudited and in thousands, except share andper share data)**

 

**1. GENERAL**

 

The condensed consolidated balance sheet of EFJ, Inc. (“EFJ” or the“Company”) at December 31, 2003, presented within this Report on Form 10-Qfiling, has been derived from audited consolidated financial statements at thatdate.  The condensed consolidatedfinancial statements as of June 30, 2004 and for the three and six monthsended June 30, 2004 and 2003 are unaudited.  The condensed consolidated financial statements reflect allnormal and recurring accruals and adjustments that, in the opinion ofmanagement, are necessary for a fair presentation of the financial position,operating results, and cash flows for the interim periods presented in thisquarterly report.  The condensedconsolidated financial statements should be read in conjunction with theconsolidated financial statements and notes thereto, together with management’sdiscussion and analysis of financial condition and results of operations,contained in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2003.  The results ofoperations and cash flows for the six months ended June 30, 2004 are notnecessarily indicative of the results for any other period or the entire fiscalyear ending December 31, 2004. Where appropriate, items within the condensed consolidated financialstatements have been reclassified from the previous period’s presentation toconform to the current presentation.

 

**2.  ORGANIZATION AND CONSOLIDATION**

 

The Company is a provider of land mobile radio (“LMR”) wirelesscommunications products and systems, which are sold to: (1) domesticpublic safety / public service and other governmental users; (2) domesticcommercial users; and (3) international customers.  Through its wholly-owned subsidiaries, E.F. Johnson Company(“EFJohnson”) and Transcrypt International, Inc. (“Transcrypt”), the Companydesigns, develops, manufactures and / or markets:

 

•                  mobile andportable LMR radios (“subscriber units”);

•                  stationary LMRtransmitters / receivers (base stations or repeaters);

•                  LMR systems;

•                  informationsecurity products, based on a wide range of analog scrambling and digitalencryption technologies; and

•                  LMR services.

 

The condensed consolidated financial statementsinclude the accounts of the Company and its wholly owned subsidiaries.  All significant intercompany accounts andtransactions have been eliminated in the consolidation.

 

**3.  NET INCOME (LOSS) PER SHARE**

 

Basic income (loss) per share (“EPS”) is calculated based upon theweighted average number of common shares outstanding during the period.  The diluted EPS calculation reflects thepotential dilution from common stock equivalents such as stock options.  For the three and six months endedJune 30, 2004 and 2003, substantially all outstanding stock optionsgranted as of such dates had exercise prices lower than the average marketprice of the common stock for the respective periods and are, thereby,considered common stock equivalents in the calculation of the diluted weightedaverage common shares.  The Company usesthe treasury stock method to calculate diluted weighted average common shares,as if all such options were outstanding for the periods presented.

 

For the three months ended June 30, 2004 and 2003 and for the sixmonths ended June 30, 2003, the impact of outstanding stock options ondiluted EPS was anti-dilutive as the Company incurred net losses during theseperiods.  Accordingly, basic EPS is usedfor both basic and diluted EPS for the respective periods.  If the Company had not incurred net lossesfor these periods, the diluted weighted average common shares would have been: 18,618,425 and 18,431,294, respectively, for thethree months ended June 30, 2004 and 2003; and 18,480,985 for thesix months ended June 30, 2003.

 

5

----

 

**4.  ACCOUNTING FOR STOCK-BASED COMPENSATION**

 

The Company applies the intrinsic value-based method of accounting forstock options issued to employees.  When both the number of shares that an individual employee is entitledto receive and the option price are known at the grant date, total compensationcost for the Company’s grants of stock options is measured at the grant date(“fixed plan awards”).  However, wheneither or both of these factors are not known at the grant date, the Companyestimates total compensation cost each accounting period from the date of grantbased on the estimated fair value of the Company’s common stock at the end ofeach period (“variable plan awards”). Changes, either increases or decreases, in the estimated fair value ofthe shares between the date of grant and the final exercise or expiration of theoptions result in a change in the measure of compensation cost for variableplan awards.  Compensation cost isrecognized as expense over the periods in which the employee performs therelated services, which is generally presumed to be the vesting period.

 

Ifcompensation cost for the Company’s stock option plans had been determinedbased on the fair value at the grant date for awards for the three and sixmonths ended June 30, 2004 and 2003, the Company’s pro forma net income(loss) and pro forma net income (loss) per share would have been as follows:

 
|                                                                          |   | **Three months ended June 30,** |   | **Six months ended June 30,** |   |
|-------------------------------------------------------------------------------|--------|--------------------------------------|--------|------------------------------------|--------|
|                                                                          |   | **2004**                             |   | **2003**                           |   | **2004** |   | **2003** |   |
|                                                                          |   |                                 |   |                               |   |   |   |   |   |
| Net income (loss) — as reported                                          |   | $                                    | (1,461 | )                                  | $      | (132 | ) | $ | 1,534 |   | $ | (696 | ) |
| General and administrative expenses for  management stock option compensation |   | 1,009                                |   | 72                                 |   | 1,810 |   | 435 |   |
| Pro forma net income (loss)                                                   |   | $                                    | (2,470 | )                                  | $      | (204 | ) | $ | (276 | ) | $ | (1,131 | ) |
|                                                                          |   |                                 |   |                               |   |   |   |   |   |
| Net income (loss) per share, basic — as  reported                        |   | $                                    | (0.08  | )                                  | $      | (0.04 | ) | $ | 0.09 |   | $ | (0.01 | ) |
| Net income (loss) per share, diluted — as  reported                      |   | (0.08                                | )      | (0.04                              | )      | 0.08 |   | (0.01 | ) |
| Pro forma net loss per share, basic                                           |   | (0.14                                | )      | (0.06                              | )      | (0.02 | ) | (0.01 | ) |
| Pro forma net loss per share, diluted                                         |   | (0.14                                | )      | (0.06                              | )      | (0.02 | ) | (0.01 | ) |

 

Theweighted average fair value per option at date of grant during the three monthsended June 30, 2004 and 2003 was $5.48 and $1.47, respectively.  The fair value of each option grant isestimated on the date of grant using the Black-Scholes option-pricing modelwith the following weighted-average assumptions for options granted:

 
|                       |   | **Six months ended June 30,** |   |
|----------------------------|--------|------------------------------------|--------|
|                       |   | **2004**                           |   | **2003** |   |
| Expected option life       |   | 10 years                           |   | 10 years |   |
| Expected annual volatility |   | 75                                 | %      | 88 | % |
| Risk-free interest rate    |   | 4.40                               | %      | 3.99 | % |
| Dividend yield             |   | 0                                  | %      | 0 | % |

 

**5. INVENTORIES**

 

The following is a summary of inventories:

 
|                       |   | **June 30,  2004** |   | **December 31,  2003** |   |
|----------------------------|--------|-------------------------|--------|-----------------------------|--------|
| Raw materials and supplies |   | $                       | 7,185  |                        | $      | 8,069 |   |
| Work in progress           |   | 1,010                   |   | 1,350                       |   |
| Finished goods             |   | 5,722                   |   | 9,250                       |   |
|                       |   | 13,917                  |   | 18,669                      |   |
| Reserve for obsolescence   |   | 1,092                   |   | 629                         |   |
| Total inventories          |   | $                       | 12,825 |                        | $      | 18,040 |   |

 

6

----

 

**6.  INTANGIBLE ASSETS**

 

As required by Statement of Financial Accounting Standards (“SFAS”) No.142, ***Goodwill and Other IntangibleAssets,*** the Company does not amortize its goodwill andtradename, both of which relate solely to the Company’s EFJohnson segment, butinstead reviews such assets for impairment, at least annually.  The Company performed fair value-basedimpairment tests, in accordance with SFAS No. 142, at December 31, 2003and 2002, concluding that no impairment of goodwill or tradename had occurredas of these dates.  No events occurredduring the three and six months ended June 30, 2004 and 2003 that wouldindicate that an impairment of such assets had taken place as of suchdates.  As of January 1, 2002,certain of the Company’s intangible assets (primarily acquired workforce) werereclassified to goodwill, as these assets, per SFAS No. 141, ***Business Combinations,***were not deemed separable from goodwill.

 

Amortization expense, related to intangible assets which are subject toamortization, was $2 and $4 for the three and six months ended June 30,2004 and 2003.  Amortization expense ofintangible assets subject to amortization is anticipated to be $7 for 2004 andannually thereafter through 2012. Intangible assets consist of the following as of the dates indicated:

 
|                                            |   | **June 30,  2004** |   | **December 31,  2003** |   |
|-------------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
| Intangible assets not subject to  amortization: |   |                    |   |                        |   |   |   |   |   |
| Goodwill                                        |   |                    |   | $                           | 5,126  |   |   |   | $ | 5,126 |   |
|                                            |   |                    |   |                        |   |   |   |   |   |
| Tradename                                       |   |                    |   | 1,564                       |   |   |   | 1,564 |   |
|                                            |   |                    |   |                        |   |   |   |   |   |
| Intangible assets subject to amortization:      |   |                    |   |                        |   |   |   |   |   |
| Proprietary and core technology                 |   | 1,290                   |   |                        |   | 1,290 |   |   |   |
| Less:   accumulated amortization           |   | 1,290                   |   | —                      |   | 1,290 |   | — |   |
| Patents                                         |   | 113                     |   |                        |   | 113 |   |   |   |
| Less:   accumulated amortization           |   | 54                      |   | 59                          |   | 50 |   | 63 |   |
| Total                                           |   |                    |   | $                           | 6,749  |   |   |   | $ | 6,753 |   |

 

**7.  REVOLVING LINE OF CREDIT**

 

TheCompany has a $10,000 secured line of credit agreement with Bank ofAmerica.  The line of credit bearsinterest at a rate of LIBOR plus 200 basis points (3.4%), the effective rate atJune 30, 2004, which rate may be increased to LIBOR plus 275 basis pointsdependent upon certain debt ratios. The line of credit is collateralized bysubstantially all of the Company’s assets. Borrowings available under the line of credit are calculated as apercentage of eligible inventory and receivables.  The agreement, which expires September 30, 2004, includescertain covenants, including financial covenants, with which the Company was incompliance as of June 30, 2004 and December 31, 2003.  At June 30, 2004 and December 31,2003, the Company had zero and $7,500, respectively, outstanding on its line ofcredit.  The total available creditunder the line of credit was $9,750 as of June 30, 2004.

 

TheCompany is presently in discussions with the Bank to extend this line of creditagreement to September 30, 2007. The Company anticipates such extension to be completed in the thirdquarter of 2004.

 

7

----

 

**8.  WARRANTY COSTS**

 

The Company substantially provides a one-year warranty on its productsand estimates future warranty claims based on historical experience andanticipated costs to be incurred. Warranty expense is accrued at the time of sale with an additional accrualfor specific items after the sale when their existence is known and amounts aredeterminable.  A reconciliation ofchanges in the Company’s accrued warranty as of June 30, 2004 is asfollows:

 
|                           |   | **Balance at  December 31, 2003** |   | **Charged to  Expenses** |   | **Deduction  /  Expenditures** |   | **Balance at  June 30, 2004** |   |
|--------------------------------|--------|----------------------------------------|--------|--------------------------|--------|--------------------------------|--------|------------------------------------|--------|
|                           |   |                                   |   |                     |   |                           |   |                               |   |
| Allowance for Warranty Reserve |   | $                                      | 727    |                     | 1,042  |                           | 578    |                               | $      | 1,191 |   |
|                                |        |                                        |        |                          |        |                                |        |                                    |        |  |  |

 

**9.  REPRICED STOCK OPTIONS**

 

In 2000and 2001, the Company effectively cancelled and reissued stock options in orderto lower the exercise price of those options to $0.656 per share, an amountapproximating 150% of the then prevailing market value of the Company’s commonstock (the “repricing”).  The repricingof the stock options resulted in a new measurement date for accounting purposesand the reclassification of these options as variable plan awards beginning onthe date of the repricing.  The Companyhad previously accounted for these option grants as fixed plan awards.  The market value of the Company’s commonstock was $8.84 and $1.60 per share at June 30, 2004 and 2003,respectively; this compared to market values of $5.90 and $1.25 per share atDecember 31, 2003 and 2002, respectively. Aggregate non-cash compensation charges, therefore, resulted to theextent that the market value at the respective period ending date exceeded therepriced exercise price of $0.656 per share. In the three and six months ended June 30, 2004, the amounts ofcompensation expense relating to these repriced options were $3,398 and $2,311.  In the three and six months endedJune 30, 2003, the amounts of compensation (benefit) expense relating tothese repriced options were $(150) and $296. These amounts are included in general and administrative expenses.

 

As ofJune 30, 2004, approximately 740,000 of these repriced options, in variousstages of vesting, were outstanding, of which approximately 677,000 related tooptions issued to the Company’s Chief Executive Officer (“CEO”) and ChiefFinancial Officer (“CFO”).  In the firstquarter of 2004, the CEO and CFO adopted pre-arranged stock selling plans,pursuant to Rule 10b5-1 of the Securities and Exchange Act of 1934, in regardsto the repriced option shares held by them which are subject to variableaccounting treatment.  Under thepre-arranged stock selling plans, stock options will be exercisedcontemporaneously with the sales of the resulting shares.  The respective selling of the stockcommenced in the second quarter of 2004 and will continue over a period atleast through the second quarter of 2005. Any non-cash compensation related to these options will become fixed atthe time the options are exercised; prior to exercise, the options willcontinue to be subject to variable accounting treatment.  The CEO and CFO, in aggregate, exercisedapproximately 123,000 options during the six months ended June 30, 2004.

 

**10.  RELATED PARTY TRANSACTION**

 

In April 2002, the Company extended a loan to its CEO, Michael E.Jalbert, in the principal amount of $75. This note is due on demand and bears interest at the annual rate of 6%.  Any tax obligations associated with the loanare the sole responsibility of Mr. Jalbert. Mr. Jalbert fully paid off the loan, principal and interest, inJuly 2004.

 

8

----

 

**11.  COMMITMENTS AND CONTINGENCIES**

 

On or about February 5, 2001, ASRCCommunication (“ASRC”) filed a complaint in United States District Court forthe District of Alaska, against EFJohnson seeking damages against EFJohnson onclaims arising out of EFJohnson’s sale of radio products to ASRC.  ASRC purchased, and resold to the State ofAlaska, approximately $500 of products from EFJohnson since 1999.  ASRC’s claims against EFJohnson includebreach of contract, breach of express warranty, breach of implied warranty ofmerchantability, breach of implied warranty of fitness for a particularpurpose, breach of duty of good faith and fair dealing, equitable estoppel,misrepresentation, and violations of the Racketeer Influenced and CorruptOrganizations Act.  The complaint anticipatedthat the State of Alaska would formally prosecute its administrative claimunder the Alaska State Procurement Code against ASRC for damages associatedwith alleged malfunctions of EFJohnson manufactured radios. Under the May 21,2003 agreement between ASRC and EFJohnson (the “ASRC Agreement”), EFJohnsonagreed to defend ASRC, at EFJohnson’s expense, against any State’s claimalleging non-performance of the EFJohnson radios.  In the event the State prevailed in its claim EFJohnson and ASRCagreed to allocate any award in favor of the State in accordance with formulain the ASRC Agreement.  In addition, theparties agreed to resolve any issue or dispute remaining between them after theconclusion of the State administrative proceeding through mediation and bindingarbitration.  Based upon the ASRCAgreement, ASRC and EFJohnson dismissed the claims against each other.  On or about April 6, 2004, the State ofAlaska’s Department of Administration, Information Technology Group filed anadministrative claim under the State Procurement Code against ASRC for damagesassociated with the EFJohnson radios. The State of Alaska claim alleges damages in excess of $900.  Subsequently, ASRC has tendered, andEFJohnson has accepted, the State’s administrative claim in accordance with theASRC Agreement. EFJohnson will undertake to defend ASRC under the terms andconditions of the ASRC Agreement.  TheCompany is unable to predict the likelihood of the outcome or potentialliability that may arise from this action.

 

In June 2004, Mace, Incorporated(“Mace”) filed a complaint in United States District Court for the EasternDistrict of Virginia, against EFJohnson seeking damages against EFJohnson onclaims for third-party commissions allegedly due in conjunctionwith certain product sales to the federal government. Mace has alleged protected damages of $400 and an unspecifiedpercentage of past and future federal government sales.  The Company has provided for its estimatedliability relating to this matter.  TheCompany believes that it has meritorious contractual defenses against suchdemand and intends to vigorously contest such allegation.  Due to the fact that the assertion isundefined, the Company is unable to predict the likelihood of the outcome orpotential liability that may arise from this request for payment.

 

The Company is presently disputing certain state tax liabilitiestotaling approximately $350.  TheCompany believes the basis for the states’ assessment of the amounts owed isincorrect and intends to vigorously contest such assessments.  At June 30, 2004, the Company hasrecorded a liability related to these assessments, which amount reflects theCompany’s evaluation of the eventual conclusion of these matters.

 

The Company is presently involved in a dispute regarding thecomputation of certain royalty liabilities. The Company believes the basis for its royalty computation is correctand consistent with the terms of the royalty agreement.  However, if the Company’s method ofcomputation proves to be wrong, accrued royalties could be understated at June 30,2004 by approximately $400.

 

TheCompany is involved in certain other legal proceedings incidental to the normalconduct of its business.  The Companydoes not believe that any liabilities relating to such other legal proceedingsare likely to be, individually or in the aggregate, material to the Company’sbusiness, financial condition, results of operations, or cash flows.

 

In thenormal course of its business activities, the Company is required under acontract with various governmental authorities to provide letters of credit andbonds that may be drawn upon if the Company fails to perform under itscontracts.  The letters of credit, whichexpire on various dates in 2004, have a total undrawn balance of $250 atJune 30, 2004.  Bonds, which expireon various dates, totaled $7,300 on June 30, 2004.  As of that date, no bonds have been drawnupon.

 

9

----

 

**12.  SEGMENT AND RELATED INFORMATION**

 

The Company operates in the following two reportingsegments, both of which operate in the LMR industry.  These segments are the Company’s two operating subsidiaries:EFJohnson and Transcrypt.  Although bothsegments have product offerings which have some market similarity, EFJohnson’soperations primarily entail the design, development, manufacture and sale ofLMR transmitters/receivers, mobile and portable LMR radios, and LMRcommunication systems, while Transcrypt’s operations primarily entail thedesign, manufacture and sale of devices that prevent the unauthorized interceptionof sensitive voice and data communication. The Company evaluates segment results based on gross margin and incomefrom operations.  Corporate expenses areallocated to the operating segments based upon estimated usage of corporateresources.  The following table is asummary of the unaudited operating results for the three months endedJune 30, 2004 and 2003.

 
|                                    |   | **Three  Months Ended  June 30,** |       | **Six Months  Ended  June 30,** |       |
|-----------------------------------------|--------|----------------------------------------|------------|--------------------------------------|------------|
| **In thousands**                        |   | **2004**                               |       | **2003**                             |       | **2004** |   | **2003** |   |
| **Revenues:**                           |   |                                   | ** ** |                                 | ** ** |   | ** ** |   | ** ** |
| Wireless  Communication                 |   | $                                      | 13,264     |                                 | $          | 9,031 |   | $ | 33,118 |   | $ | 16,157 |   |
| Information  Security                   |   | 4,307                                  |       | 1,692                                |       | 6,697 |   | 3,567 |   |
|                                    |   | $                                      | 17,571     |                                 | $          | 10,723 |   | $ | 39,815 |   | $ | 19,724 |   |
| **Gross Profit:**                       |   |                                   |       |                                 |       |   |   |   |   |
| Wireless  Communication                 |   | $                                      | 5,434      |                                 | $          | 3,369 |   | $ | 12,211 |   | $ | 5,990 |   |
| Information  Security                   |   | 3,583                                  |       | 1,275                                |       | 5,364 |   | 2,613 |   |
|                                    |   | $                                      | 9,017      |                                 | $          | 4,644 |   | $ | 17,575 |   | $ | 8,603 |   |
| **Operating Profit  (Loss):**           |   |                                   |       |                                 |       |   |   |   |   |
| Wireless  Communication                 |   | $                                      | (509       | )                                    | $          | (682 | ) | $ | 516 |   | $ | (1,352 | ) |
| Information  Security                   |   | 2,468                                  |       | 444                                  |       | 3,405 |   | 996 |   |
| **Income (Loss) from  Operations**      |   | 1,959                                  |       | (238                                 | )          | 3,921 |   | (356 | ) |
|                                    |   |                                   |       |                                 |       |   |   |   |   |
| Stock Option  Repricing Adjustment, net |   | (3,398                                 | )          | 150                                  |       | (2,311 | ) | (296 | ) |
| Other Expense,  net                     |   | (22                                    | )          | (44                                  | )          | (76 | ) | (44 | ) |
|                                    |   |                                   |       |                                 |       |   |   |   |   |
| **Income (Loss)  before Income Taxes**  |   | $                                      | (1,461     | )                                    | $          | (132 | ) | $ | 1,534 |   | $ | (696 | ) |
|                                    |   |                                   |       |                                 |       |   |   |   |   |
| **Depreciation &  Amortization:**   |   |                                   |       |                                 |       |   |   |   |   |
| Wireless  Communication                 |   | $                                      | 328        |                                 | $          | 260 |   | $ | 628 |   | $ | 478 |   |
| Information  Security                   |   | 32                                     |       | 30                                   |       | 67 |   | 63 |   |
|                                    |   | $                                      | 360        |                                 | $          | 290 |   | $ | 695 |   | $ | 541 |   |
|                                    |   |                                   |       |                                 |       |   |   |   |   |
| **Assets:**                             |   |                                   |       |                                 |       |   |   |   |   |
| Wireless Communication                  |   | $                                      | 32,778     |                                 |       |   |   |   |   |   |
| Information  Security                   |   | 10,485                                 |       |                                 |       |   |   |   |   |
| Corporate                               |   | 11,874                                 |       |                                 |       |   |   |   |   |
|                                    |   | $                                      | 55,137     |                                 |       |   |   |   |   |   |

 

TheCompany’s sales, as per its customer markets, are shown below for the sixmonths ended June 30, 2004 and 2003.

 
|                                     |   | **2004**   |   | **2003** |   |
|------------------------------------------|--------|------------|--------|----------|--------|
| **Revenues (in ‘000’s):**      |   | **Amount** |   | **%**    |   | **Amount** |   | **%** |   |
| Domestic public safety /  public service |   | $          | 31,021 |     | 78     | % | $ | 14,918 |   | 76 | % |
| Domestic commercial                      |   | 1,162      |   | 3        |   | 1,099 |   | 6 |   |
| International                            |   | 7,632      |   | 19       |   | 3,707 |   | 18 |   |
|                                     |   |       |   |     |   |   |   |   |   |
| Total Sales                              |   | $          | 39,815 |     |   |   | $ | 19,724 |   |   |   |

 

10

----

 

**13.  PLANNED MOVES OF THE COMPANY’S OPERATINGFACILITIES**

 

Duringthe second quarter of 2004, Transcrypt’s operations moved from its previousfacility in Lincoln, Nebraska to a similar 18,000 square-foot facility locateda short distance from its previous operations. The Company incurred approximately $150 in relation to this move for thethree and six months ended June 30, 2004. The new facility was obtained pursuant to a ten-year lease with anticipatedfacility costs approximating those of the departed facility.  The move was precipitated by the May 31,2004 termination of the lease agreement on the segment’s previous facility andwas fully completed by June 30, 2004.

 

OnApril 14, 2004, the Company announced its decision to move EFJohnson’soperations, to include the outsourcing of its manufacturing, from its currentfacility in Waseca, Minnesota to the Dallas, Texas area.  The Company expects to incur costs of $1,900in relation to this move of EFJohnson. The timing of the recognition of costs associated with this move will bedetermined in accordance with SFAS No. 146, ***Accounting for Costs Associated with Exit or DisposalActivities,*** and other relevant guidance,******which provide that a liability for a costassociated with an exit or disposal activity shall be recognized at its fairvalue in the period in which the liability is incurred.  In particular, employee-related terminationcosts associated with the relocation are generally recognized ratably over theperiod that the employees are required to provide services in order to earn therespective termination benefit.  Thismove is expected to be completed by April 2005 and is not expected tocause significant disruption of the business; however, a significant portion ofEFJohnson’s workforce may be replaced or otherwise terminated in relation tothis move.

 

**EFJohnson and Transcrypt Operating**

**Facility Relocation Costs (in 000’s):**

 
|                                     |   | **Total  amount  expected to be  incurred** |   | **Amount  incurred  in the three  months ended  June 30, 2004** |   | **Cumulative  amount  incurred as of  June 30, 2004** |   | **Remaining  amount  to be incurred** |   |
|------------------------------------------|--------|---------------------------------------------|--------|----------------------------------------------------------------------|--------|------------------------------------------------------------|--------|---------------------------------------|--------|
| Description of Costs                     |   |                                        |   |                                                                 |   |                                                       |   |                                  |   |
| Employee related costs                   |   | $                                           | 900    |                                                                 | $      | 118                                                        |   | $                                     | 118    |   | $ | 782 |   |
| Furniture and equipment relocation costs |   | 450                                         |   | 152                                                                  |   | 152                                                        |   | 298                                   |   |
| Manufacturing outsourcing set-up costs   |   | 400                                         |   | 118                                                                  |   | 118                                                        |   | 282                                   |   |
| Other                                    |   | 300                                         |   | 13                                                                   |   | 13                                                         |   | 287                                   |   |
|                                     |   |                                        |   |                                                                 |   |                                                       |   |                                  |   |
| **Total**                                |   | $                                           | 2,050  |                                                                 | $      | 401                                                        |   | $                                     | 401    |   | $ | 1,649 |   |

 

11

----

 

**ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS****OF OPERATIONS**

 

Discussions of certain matters contained in this Quarterly Report onForm 10-Q may constitute forward-looking statements under Section 27A ofthe Securities Act of 1933, as amended (the “Securities Act”), andSection 21E of the Securities Exchange Act of 1934, as amended, (the“Exchange Act”). These forward-looking statements relate to, among otherthings, the results of the Company’s product development efforts, future salesand expense levels, the Company’s future financial condition, liquidity andbusiness prospects generally, relocation of operating facilities, outsourcingof EFJohnson’s manufacturing, perceived opportunities in the marketplace forthe Company’s products, and the Company’s other business plans for thefuture.  These forward-lookingstatements are subject to certain risks and uncertainties that could cause theactual results, performance and outcomes to differ materially from those expressedor implied in these forward-looking statements due to a number of risk factorsincluding, but not limited to, the risks detailed in “ITEM 1. BUSINESS —Summary of Business Considerations and Certain Factors That May Affect FutureResults of Operations and/or Stock Price” contained in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2003.

 

The following discussion is intended to provide a better understandingof the significant changes in trends relating to the Company’s financialcondition and results of operations.  Management’s Discussion and Analysis of Financial Condition andResults of Operations should be read in conjunction with the accompanyingCondensed Consolidated Financial Statements and Notes thereto.

 

The following table presents certain Condensed ConsolidatedStatements of Operations information as a percentage of revenues during theperiods indicated:

 
|                                      |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|-------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
|                                      |   | **2004**                              |   | **2003**                            |   | **2004** |   | **2003** |   |
|                                      |   |                                  |   |                                |   |   |   |   |   |
| Revenues                                  |   | 100.0                                 | %      | 100.0                               | %      | 100.0 | % | 100.0 | % |
| Cost of sales                             |   | 48.7                                  |   | 56.7                                |   | 55.9 |   | 56.4 |   |
| Gross profit                              |   | 51.3                                  |   | 43.3                                |   | 44.1 |   | 43.6 |   |
| Operating  expenses:                      |   |                                  |   |                                |   |   |   |   |   |
| Research and  development                 |   | 15.1                                  |   | 16.9                                |   | 13.2 |   | 16.3 |   |
| Sales and  marketing                      |   | 11.8                                  |   | 14.3                                |   | 10.8 |   | 14.4 |   |
| Facility  relocation expenses             |   | 2.7                                   |   | —                              |   | 1.2 |   | — |   |
| Stock option  repricing (benefit) expense |   | 19.3                                  |   | (1.4                                | )      | 5.7 |   | 1.5 |   |
| General and  administrative               |   | 10.6                                  |   | 14.3                                |   | 9.1 |   | 14.7 |   |
| Total  operating expenses                 |   | 59.5                                  |   | 44.1                                |   | 40.0 |   | 46.9 |   |
| Income (loss)  from operations            |   | (8.2                                  | )      | (0.8                                | )      | 4.1 |   | (3.3 | ) |
| Interest  expense – net              |   | (0.1                                  | )      | (0.4                                | )      | (0.2 | ) | (0.3 | ) |
| Other expense                             |   | —                                |   | —                              |   | — |   | 0.1 |   |
| Income (loss)  before income taxes        |   | (8.3                                  | )      | (1.2                                | )      | 3.9 |   | (3.5 | ) |
| Income tax  provision                     |   | —                                |   | —                              |   | — |   | — |   |
| Net income  (loss)                        |   | (8.3                                  | )%     | (1.2                                | )%     | 3.9 | % | (3.5 | )% |

 

12

----

 

Revenues

 

Revenues increased 64% to $17.6 million in the second quarter of 2004,as compared to $10.7 million during the same period in 2003.  Of total revenues in the second quarter of2004, the wireless communication segment comprised $13.3 million, representinga 48% increase over revenues of $9.0 million during the same period in2003.  Information security segmentrevenues of $4.3 million in the second quarter of 2004 represent a 155%increase over revenues of $1.7 million during the same period in 2003.

 

Revenues increased 102% to $39.8 million in the six months endedJune 30, 2004, as compared to $19.7 million during the same period in2003.  Of total revenues in the sixmonths ended June 30, 2004, the wireless communication segment comprised$33.1 million, representing a 104% increase over revenues of $16.2 millionduring the same period in 2003. Information security segment revenues of $6.7 million in the six monthsended June 30, 2004 represent an 88% increase over revenues of $3.6million during the same period in 2003.

 

The increase in EFJohnson’s revenues for the first six months of 2004related primarily to a substantial increase in sales to the domestic governmentsector, principally federal, $28.2 million in 2004 compared to $12.7 million inthe same period in 2003.  This isconsistent with EFJohnson’s market strategy to emphasize federal, state andlocal governmental customers.

 

The increase in revenues of the information security segment during thesix months ended June 30, 2004 was primarily the result of increasedmarketing in certain parts of the world where LMR systems are primarily analogand perceived security risks are high.

 

Transcrypt’ssales are primarily to international customers because of the analog nature ofits products.  EFJohnson’s internationalsales increased in 2004, to $2.0 million in the six months ended June 30,2004 versus $0.9 million during the same period in 2003.

 

GrossProfit

 

Cost of sales includes materials, labor, depreciation, and overheadcosts associated with the production of the Company’s products, as well asshipping, royalty and warranty product costs.

 

Consolidated gross profit was $9.0 million (51% gross margin) for thesecond quarter of 2004, as compared to $4.6 million (43% gross margin) for thesame period in 2003.  Gross margin forthe wireless communication segment was 41% in the second quarter of 2004 versus37% for the same period in 2003.  Grossmargin for the information security segment was 83% in the second quarter of2004 versus 75% for the same period in 2003.

 

Consolidated gross profit was $17.6 million (44% gross margin) for thesix months ended second quarter of 2004, as compared to $8.6 million (44% grossmargin) for the same period in 2003. Gross margin for the wireless communication segment was 37% for both thesix months ended June 30, 2004 and 2003. Gross margin for the information security segment was 80% in the firstsix months of 2004 versus 73% for the same period in 2003.

 

The increase in overall gross margin percentage at both segmentsrelates primarily to economies of scale created by the higher sales volume in2004.  Although EFJohnson’s margin wassimilar during the first six months of both years, this was a result of $3.6million of sales in the first quarter of 2004 involving a proprietaryencryption module for which the Company charged no mark-up over the cost ofprocurement due to competitive market reasons. Excluding the impact of these proprietary modules, gross margin for thewireless communication segment would have been 41% for the six months endedJune 30, 2004, and the Company’s consolidated gross margin would have been45%.  The Company does not anticipatesuch proprietary encryption module factor to recur during the remainder of 2004.

 

Management intends to make adjustments to its product offerings, wheredeemed appropriate, to include elimination of marginally profitable productsand product lines.  Management is alsocontinuing to review its manufacturing procedures to create efficiencies.  While management continues to review pricingand product strategy, gross margins for both industry segments are likely tovary in the future, based primarily upon the mix of

 

13

----

 

products and the amount of revenues recognized in the respectiveperiods.  Further, as noted in Note 13to the accompanying Notes to Condensed Consolidated Financial Statements, theCompany is presently engaged in outsourcing its manufacturing of wirelesscommunication products; the Company does not anticipate that this event willhave any significant impact on future gross margins.

 

Researchand Development

 

Research and development expenses consist primarily of the costsassociated with research and development personnel, materials, and thedepreciation of research and development equipment and facilities.

 

Research and development expenses increased 49% in the second quarterof 2004, to $2.7 million (15% of revenues) as compared to $1.8 million duringthe same period in 2003 (17% of revenues). Further, research and development expenses increased 62% for the sixmonths ended June 30, 2004, to $5.3 million (13% of revenues) as comparedto $3.2 million for the same period in 2003 (16% of revenues).  The increase related primarily to Project 25LMR infrastructure development at EFJohnson, along with the Company’sdevelopment efforts towards new digital subscriber units, upon which theCompany’s 2004 research and development efforts will be substantiallyconcentrated.  Certain of the Company’santicipated future sales are dependent upon successful and timely completion ofits on-going research and development projects.

 

Salesand Marketing

 

Sales and marketing expenses consist primarily of salaries and relatedcosts of sales personnel, including sales commissions and travel expenses, andcosts of advertising, public relations, and trade show participation.

 

Sales and marketing expenses increased 36% in the second quarter of2004, $2.1 million (11% of revenues) as compared to $1.5 million during thesame period in 2003 (14% of revenues). Further, sales and marketing expenses increased 52% for the six monthsended June 30, 2004, to $4.3 million (11% of revenues) as compared to $2.8million for the same period in 2003 (14% of revenues).  The increase in sales and marketing expensesare relate to certain variable expenses, such as sales commissions, whichcorrelate with changes in the Company’s sales levels; however, the expenditurelevel, as a percentage of revenues, decreased as a result of economies of scaleachieved due to the substantially higher sales volume in 2004.

 

Generaland Administrative

 

General and administrative expenses consist primarily of salaries andother expenses associated with the Company’s management, finance, accounting,and administration.

 

Excluding any benefit or expense resulting from the repriced stockoptions adjustment and excluding facility relocation expenses, general andadministrative expenses increased 22% in the second quarter of 2004, to $1.9million (10% of revenues) as compared to $1.5 million in the second quarter of2003 (13% of revenues).  Further,excluding the repriced stock option adjustment and facility relocationexpenses, general and administrative expenses increased 25% for the six monthsended June 30, 2004, to $3.6 million (9% of revenues) as compared to $2.9million for the same period in 2003 (15% of revenues).  The increases result from increased supportrequirements related to the Company’s increased sales.

 

The expense resulting from the repriced stock option adjustmentincreased to $2.3 million for the six months ended June 30, 2004, from$0.3 million during the same period in 2003. This expense was $3.4 million for the three months ended June 30,2004 as compared to a benefit of $150,000 for the same period in 2003.  The amount of (benefit) or expense recordedrelates substantially to the change in the Company’s common stock price, asexplained in Note 8 of the accompanying Notes to the Condensed ConsolidatedFinancial Statements.

 

The Company incurred $0.4 million for the six months endedJune 30, 2004, as compared to zero during the same period in 2003, inrelation to the planned move of its operating facilities, as described in Note13 to the

 

14

----

 

accompanying Notes to Condensed Consolidated Financial Statements.  The Company anticipates incurringapproximately $1.2 of these relocation costs during 2004, including the amountrecorded during the six months ended June 30, 2004, and an additional $0.8million in 2005.

 

The Company will be an accelerated filer as of December 31, 2004as a result of its market capitalization at June 30, 2004.  Accordingly, periodic reports due during thefiscal year ended December 31, 2005 will be subject to an acceleratedfiling schedule.  Furthermore, inconnection with the Company’s required compliance with §404 of theSarbanes-Oxley Act (internal control over financial reporting), the Companyanticipates an increase in its general and administrative expenses during thethird and fourth quarter of 2004.  TheCompany is not presently able to estimate the cost of compliance.

 

Other Income (Expense)

 

Other income (expense), net for the three months ended June 30,2004 was $4,000, as compared to zero for the same period in 2003.  Further, other income (expense), net for thesix months ended June 30, 2004 was $(5,000), as compared to $27,000 forthe same period in 2003.  The Companywould expect other income (expense) to remain at an insignificant level duringthe remainder of 2004.

 

Interest Income / Interest Expense

 

Interestincome consists of interest income earned on cash and invested funds; interestexpense related to the Company’s loans and bank line of credit.  Interest income and interest expense were $9,000and $35,000, respectively, for the three months ended June 30, 2004, ascompared to $9,000 and $53,000 in the same period in 2003.  Further, interest income and interestexpense were $20,000 and $91,000, respectively, for the six months endedJune 30, 2004, as compared to $21,000 and $92,000 in the same period in2003.  Interest income and expense varybased on the relative interest rates earned or incurred, and the relative cashand loan balances.  The Company’sinterest expense includes monthly expense of $12,000 related to amortization ofloan fees and bank line of credit availability fees.  Future interest income and expense will vary according to theCompany’s use of cash, interest rates, and operating results.

 

Provision / Benefit for Income Taxes

 

The Company did not record a tax benefit or provision for the three andsix months ended, respectively, June 30, 2004 and 2003.  As of June 30, 2004, the Company hadapproximately $24.7 million in deferred tax assets primarily comprised of netoperating loss carryforwards (“NOL’s”), which asset was reduced by a valuationallowance of $16.7 million.  TheCompany’s tax asset is chiefly composed of NOL’s.  These NOL’s total approximately $56.1 million at June 30,2004 and do not begin to expire until 2011. The Company’s deferred tax asset of $8.0 million at June 30, 2004and December 31 2003, respectively, is approximately comprised of thefollowing components:

 
| **Tax asset components (in  millions):** |   | **June 30, 2004** |   | **December 31, 2003** |   |
|------------------------------------------|--------|------------------------|--------|----------------------------|--------|
|                                     |   |                   |   |                       |   |
| Net operating loss carryforwards         |   | $                      | 19.0   |                       | $      | 20.4 |   |
| Timing differences – book to tax    |   | 3.3                    |   | 3.3                        |   |
| General business tax credits             |   | 2.4                    |   | 2.4                        |   |
|                                     |   | 24.7                   |   | 26.1                       |   |
| Less: valuation allowance                |   | 16.7                   |   | 18.1                       |   |
|                                     |   | $                      | 8.0    |                       | $      | 8.0 |   |

 

The valuation allowance is based upon management’s conclusionsregarding, among other considerations, the Company’s historical operatingresults, management’s estimates of future earnings based on informationcurrently available, and certain technological and competitive factorsimpacting the Company’s current products. Current financial accounting standards require that organizationsanalyze all positive and negative evidence relating to deferred tax assetrealization.

 

15

----

 

The Company cannot presently estimate what changes to the deferred taxasset valuation allowance may be deemed appropriate, or to what extent theCompany may record a tax benefit (expense), during the remainder of 2004.  If the Company continues its recent trend ofprofitability in 2004, some portion, if not all, of the deferred tax assetvaluation allowance may be reduced in 2004 or beyond, and a net tax benefit maysubsequently be recorded.  However, ifthe Company incurs future losses or management revises its forecasted incomedownward, it may be necessary to provide an additional allowance against some,or all, of the $8.0 million deferred tax asset recorded at June 30, 2004.

 

Net Income (Loss)

 

The Company had a net loss of $1.5 million during the three monthsended June 30, 2004, as compared to a net loss of $0.1 million during thesame period in 2003.  Further, theCompany had a net income of $1.5 million during the six months endedJune 30, 2004, as compared to a net loss of $0.7 million during the sameperiod in 2003.  Operating results forthe three and six months ended June 30, 2004 and 2003 were affected bynon-cash compensation resulting from variable accounting treatment required forcertain of the Company’s stock options repriced in the fourth quarter of 2000and the first quarter of 2001.  Theamounts of such non-cash compensation expense (benefit), included in generaland administrative expenses, were $3.4 and $2.3 million, respectively, for thethree and six months ended June 30, 2004, as compared to $(150,000) and$0.3 million, respectively, for the three and six months ending June 30,2004 and 2003, respectively.

 

The table below illustrates the operating results for the three and sixmonths ending 2004 and 2003, adjusting for the non-cash stock option repricingeffect discussed above and for the non-recurring expenses related to therelocations of the Company’s operating facilities.  The Company believes that such presentation offers a morecomparative measurement of the Company’s operating results.

 
|                                                            |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|-----------------------------------------------------------------|--------|---------------------------------------|--------|-------------------------------------|--------|
| **Operating Results (in thousands)**                            |   | **2004**                              |   | **2003**                            |   | **2004** |   | **2003** |   |
| Net income (loss)                                               |   | $                                     | (1,461 | )                                   | $      | (132 | ) | $ | 1,534 |   | $ | (696 | ) |
|                                                            |   |                                  |   |                                |   |   |   |   |   |
| Facility relocation expenses                                    |   | 401                                   |   | —                              |   | 401 |   | — |   |
|                                                            |   |                                  |   |                                |   |   |   |   |   |
| Stock option repricing non-cash compensation  expense (benefit) |   | 3,398                                 |   | (150                                | )      | 2,311 |   | 296 |   |
|                                                            |   |                                  |   |                                |   |   |   |   |   |
| Proforma income (loss) – comparative basis                 |   | $                                     | 2,338  |                                | $      | (282 | ) | $ | 4,246 |   | $ | (400 | ) |
|                                                            |   |                                  |   |                                |   |   |   |   |   |
| Proforma income (loss) as a percentage of total  revenues       |   | 13.3                                  | %      | (2.6                                | )%     | 10.8 | % | (2.0 | )% |

 

Liquidityand Capital Resources

 

Since January 1, 1997, the Company has financed its operations andmet its capital requirements primarily through short-term borrowings, long-termdebt, and stock offerings completed on January 22, 1997 andOctober 15, 1997.  However, theCompany’s operations have consistently provided positive cash since the secondquarter of 2001, and operations provided positive cash of $12.6 million for thesix months ended June 30, 2004.

 

The Company’s operating activities provided (used)cash of $12.6 million and $(2.1) million in the six months ended June 30,2004 and 2003, respectively.  Cashprovided by operating activities in the first two quarters of 2004 consisted primarilyof: net income of $1.5 million; depreciation and amortization expenses of $0.7million; non-cash compensation of $2.3 million; and a net change in the variouscomponents of working capital of $8.1 (principally $6.6 million and $5.2million provided by decreases, respectively, in accounts receivable andinventories, offset by $3.4 million decrease in accounts payable).  Cash used by operating activities in thefirst six months of 2003 consisted primarily of: net loss of $(0.7) million;depreciation and amortization expenses of $0.5 million; non-cash compensationof $0.3 million; and a net change in the various components of working capitalof $1.4 million.

 

16

----

 

Cash used by investing activities was $0.9 million for the first sixmonths of 2004; this compared to cash used by investing activities of $0.3million for the same period in 2003. The difference between 2004 and 2003 related primarily to cash flowsused in the purchase of property.  Totalcapital expenditures in 2004 were $1.0 million, as compared to $0.4 million ofcapital expenditures in 2003. Additionally, $0.4 million of capital expenditures in 2003 were acquiredthrough the exchange of debt and are, thus, excluded from the Statement of CashFlows.

 

The line of credit balance of $7.5 million at December 31, 2003was paid off during the three months ended March 31, 2004, and the line ofcredit balance remained zero throughout the three months ended June 30,2004.  In the previous year, theDecember 31, 2003 line balance of $5.0 million was paid off prior toJune 30, 2003, at which time the line of credit balance was zero.

 

The Company’s cash availability position and overall working capitalposition were significantly improved as of June 30, 2004, as compared toDecember 31, 2003.  This was theresult of cash collection of December 31, 2003 accounts receivable, aswell as revenues recognized in the first six months of 2004.  Further, the Company had zero borrowingsunder its $10.0 million secured line of credit with Bank of America as of June 30,2004.  Accordingly, at June 30,2004, the Company had unrestricted cash of $8.8 million and an additional $9.7million available credit under its line of credit.  As discussed in Note 7 of the accompanying Notes to CondensedConsolidated Financial Statements, the Company expects its line of creditagreement with Bank of America to be renewed to September 30, 2007.

 

In the normal course of its business activities, the Company isrequired under contracts with various government authorities to provide lettersof credit or bonds that may be drawn upon if the Company fails to perform underits contracts.  The Company’s currentbonding arrangement calls for zero-collateral bonding, with a single bondlimitation of $2.0 million.  The Companyhas approximately $6.2 million of bonding availability under its currentbonding agreement.  The Company believesits present bonding arrangements provide it with sufficient bondingavailability through 2004; however, the Company continues to seek improvedbonding alternatives with increased limits.

 

The Company’s backlog of unfilled orders at June 30, 2004 was$11.4 million, compared to a backlog of $22.2 million at December 31, 2003and $5.6 million at June 30, 2003. Due to the unpredictable timing of major domestic governmental orders,the Company does not believe that its backlog figures, and variations fromperiod to period therein, are necessarily indicative of sales of products infuture periods.

 

The Company does not anticipate paying cash dividends in the foreseeablefuture.

 

**Critical AccountingPolicies**

 

The preparation of theCompany’s consolidated financial statements in conformity with accountingprinciples generally accepted in the United States (“USGAAP”) requiresmanagement to make judgments, estimates and assumptions in certaincircumstances that affect the amounts reported in the consolidated financialstatements and related footnotes.  TheCompany regularly evaluates the accounting policies and estimates used to prepareits financial statements.  Estimates areused for, but not limited to: the accounting for allowance for doubtfulaccounts and sales returns; application of the percentage of completionaccounting for long-term contract revenues, inventory reserves, income taxes,long-lived assets, and contingencies. These estimates are based on historical experience and variousassumptions that the Company believes to be reasonable under the particularapplicable 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 estimatesthat are more difficult for management to determine and (iii) have thepotential to result in materially different outcomes under varying assumptionsand conditions.  The application ofUSGAAP may require management to make estimates and assumptions that affect theamounts reported in the financial statements and accompanying results.  Listed below are those policies the Companybelieves are critical and require the use of complex judgment in theirapplication.

 

17

----

 

*Revenue*

 

The Company’s revenue recognition policy is in accordance with thecriteria put forth in Staff Accounting Bulletins 101 and 104.  Revenues are recognized when the earningsprocess is complete, less an estimate for an allowance for returns, ifapplicable, and collection is reasonably assured.  The earnings process is generally complete when the product isshipped, or received by the customer, depending upon whether the title to thegoods, as well as the risks and benefits of ownership, are transferred to thecustomer at point of shipment or point of delivery.  For sales where collection is not reasonably assured, the Companyrecognizes revenue as cash is received. If collection is contingent on a future event, the Company recognizesrevenue when the contingency lapses, generally upon cash collection.

 

System sales under long-term contracts are accounted for under thepercentage-of-completion method.  Underthis method, revenues are recognized as work on a contract progresses.  The recognized revenue is that percentage ofestimated total revenue that incurred costs to date bear to estimated totalcosts to complete the contract. Revisions in cost and profit estimates are made when conditionsrequiring such revisions become known. Anticipated losses on contracts are recognized in operations as soon assuch losses are determined to be probable and reasonably estimable.

 

Deferred revenue includes unearned services provided under systemsmaintenance contracts and unearned warranty fees on extended product warrantycontracts sold to customers.  TheCompany recognizes the fees based upon a straight-line method over the life ofthe contract.

 

The Company periodically reviews its revenue recognition procedures toassure that such procedures are in accordance with the provisions of StaffAccounting Bulletins 101 and 104.

 

*Inventory*

 

Inventory is recorded at the lower of cost or market with costdetermined by the first-in, first-out (FIFO) method.  The Company periodically assesses its inventory for potentialobsolescence and lower-of-cost-or-market issues.  The Company makes estimates of inventory obsolescence, providingreserves when necessary, based on, among other factors, demand for inventorybased on backlog, product pricing, the ability to liquidate or sell olderinventory, and the impact of introducing new products.  Charges associated with providing forinventory obsolescence, or revisions to related reserves, have historicallycorrelated with selling activity and have had a consistent impact on theCompany’s gross margins over the last three fiscal years.

 

*Goodwill*

 

SFAS No. 142 requires that goodwill and other indefinite-livedintangible assets no longer be amortized to earnings, but instead be reviewedfor impairment, on at least an annual basis, by applying a fair value-basedtest.  The Company adopted theprovisions SFAS No. 142 effective January 1, 2002.  At least annually, the Company assesses itsgoodwill and tradename, using a fair value-based test, consistent with SFAS No.142.  If the carrying amounts exceed thecomputed fair values, goodwill and/or tradename, as appropriate, is consideredto be impaired.  In evaluatingimpairment, the Company estimates the sum of the expected future cash flowsderived from its goodwill and tradename. Such evaluations for impairment are significantly impacted by estimatesof future revenues, costs and expenses and other factors.  The estimates use assumptions about theCompany’s market segment share in the future and about future expenditures bygovernment entities for wireless communications products.  The Company continually evaluates whetherevents and circumstances have occurred that indicate the remaining carryingvalues of goodwill and tradename may not be recoverable.  If the Company fails to deliver newproducts, if the products fail to gain expected market acceptance, or if theCompany fails to achieve assumed revenue growth rates or assumed gross margin,the Company may incur charges for impairment of goodwill and/or tradename inthe future.

 

18

----

 

# ***Income Taxes***

# ** **

The Company accounts for income taxes using the asset and liabilitymethod.  Deferred tax assets andliabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using currentenacted tax rates.  The effect ondeferred tax assets and liabilities of a change in tax rates is recognized inthe results of operations in the period that includes the enactment date.  Valuation allowances are provided to theextent that recoverability of tax assets is not considered likely.  In determining whether a tax asset isrecoverable, the Company considers estimates of future revenues, costs andexpenses and other factors.  If theCompany fails to achieve revenue growth rates or gross margins assumed in thecalculation of the deferred tax asset, the Company may be required to reduceits deferred tax assets in the future.

 

*Long-Lived Assets*

 

In accordance with SFAS No. 144, ***Accounting for the Impairment or Disposal of Long-Lived Assets****,*theCompany reviews its long-lived assets, to include intangible assets subject toamortization, for recoverability whenever events or changes in circumstancesindicate that the carrying amount of such long-lived asset or group oflong-lived assets (collectively referred to as “the asset”) may not berecoverable.  Such circumstancesinclude, but are not limited to:

 

•                  significantdecrease in the market price of the asset;

•                  significantchange in the extent or manner in which the asset is being used;

•                  significantchange in the business climate that could affect the value of the asset;

•                  current periodlosses combined with projection of continuing losses associated with the use ofthe asset;

•                  currentexpectation that, more likely than not, the asset will be sold or otherwisedisposed of before the end of its previously estimated useful life.

 

The Company continually evaluates whether events and circumstances haveoccurred.  When such events orcircumstances exist, the recoverability of the asset’s carrying value shall bedetermined by estimating the undiscounted future cash flows (cash inflows lessassociated cash outflows) that are directly associated with and that areexpected to arise as a direct result of the use and eventual disposition of theasset.  To date, no such impairment hasoccurred.  To the extent such events orcircumstances occur that could affect the recoverability of the Company’slong-lived assets, the Company may incur charges for impairment in the future.

 

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT 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’sproducts sold in international markets. Furthermore, the uncertainty of monetary exchange values has caused, andmay in the future cause, some foreign customers to delay new orders or delaypayment for existing orders. Additionally, troubled economic conditions, such as that recentlyexperienced in Asia and in Latin America, could result in lower revenues forthe Company.  While most internationalsales are supported by letters of credit, the purchase of Company products byinternational customers presents increased risks, which include:

 

•                  unexpectedchanges in regulatory requirements;

•                  tariffs andother trade barriers;

•                  political andeconomic instability in foreign markets;

•                  difficulties inestablishing foreign distribution channels;

•                  longer paymentcycles;

•                  uncertainty inthe collection of accounts receivable;

•                  increased costsassociated with maintaining international marketing efforts;

•                  difficulties inprotecting intellectual property; and

•                  susceptibility toorders being cancelled as a result of foreign currency fluctuations (since allthe Company quotations and invoices are denominated in U.S. dollars).

 

Some of the Company’s information security products are subject toexport controls under U.S. law, which in most cases requires the approval ofthe Department of Commerce in order to ship internationally. The Company cannotassure that such approvals will be available to it or its products in thefuture in a timely manner or at all or

 

19

----

 

that the federal government will not revise its export policies or thelist of products and countries for which export approval is required. TheCompany’s inability to obtain required export approvals would adversely affectthe Company’s international sales, which would have a material adverse effecton the Company. In addition, foreign companies not subject to United Statesexport restrictions may have a competitive advantage in the internationalinformation security market. The Company cannot predict the impact of thesefactors on the international market for its products.

 

**ITEM 4. CONTROLS ANDPROCEDURES**

 

In accordance with Rule 13a-15(b) of the Securities Exchange Act of1934 (“Exchange Act”), the Company evaluated the effectiveness of the designand operation of its disclosure controls and procedures as defined in Rule13a-15(e) and 15d-15(e) under the Exchange Act (“Disclosure Controls”) as ofthe quarter ended June 30, 2004.  Thisevaluation (the “Controls Evaluation”) was done under the supervision and withthe participation of management, including the Company’s Chief ExecutiveOfficer (“CEO”) and Chief Financial Officer (“CFO”).  The effectiveness of the Company’s Disclosure Controls, asdetermined by this evaluation, is disclosed in the Chief Executive Officer’sCertification of Report on Form 10-Q for the Quarter Ending June 30, 2004and the Chief Financial Officer’s Certification of Report on Form 10-Q for theQuarter Ending June 30, 2004 (together, “Certifications”).

 

Disclosure Controls are procedures that are designed with the objectiveof ensuring that information required to be disclosed in the Company’s reportsfiled under the Exchange Act, such as this Quarterly Report, is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission (“SEC”) rules and forms.  Disclosure Controls are also designed withthe objective of ensuring that such information is accumulated and communicatedto management, including the CEO and CFO, as appropriate to allow timelydecisions regarding required disclosure.

 

A control system, no matter how well conceived and operated, canprovide only reasonable, not absolute, assurance that the objectives of thecontrol system are met. Further, the design of a control system must reflectthe fact that there are resource constraints, and the benefits of controls mustbe considered relative to their costs. Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within the Company have been detected.  These inherent limitations include therealities that judgments in decision-making can be faulty, and that breakdownscan occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management override ofthe control.  The design of any systemof controls also is based in part upon certain assumptions about the likelihoodof future events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions; over time,control may become inadequate because of changes in conditions, or the degreeof compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected, and, thus, the Company’s management cannot provideabsolute assurance that the Company’s Disclosure Controls will prevent allerrors and all fraud.

 

The Company’s Disclosure Controls are also evaluated on an ongoingbasis by its Finance organization.  Theoverall goals of these various evaluation activities are to monitor theCompany’s Disclosure Controls and to make modifications as necessary.  The Company’s intent in this regard is thatthe Disclosure 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 haveconcluded that, subject to the limitations noted above, the Company’sDisclosure Controls are effective as of the quarter ended June 30, 2004 toensure that material information relating to the Company and its consolidatedsubsidiaries was made known to management, including the CEO and CFO,particularly during the period when periodic reports are being prepared, andthat the Company’s Disclosure Controls are effective to provide reasonableassurance that its financial statements are fairly presented in conformity withUSGAAP.

 

Due to the Company’s market capitalization at June 30, 2004, theCompany will be required to comply with §404 of the Sarbanes-Oxley Act(internal control over financial reporting) in 2004, as explained in Item 2above, in management’s General and Administrative discussion.

 

20

----

 

**PART II.  OTHER INFORMATION**

 

**ITEMS 1.  LEGAL PROCEEDINGS**

 

In June 2004, Mace, Incorporated(“Mace”) filed a complaint in United States District Court for the EasternDistrict of Virginia, against EFJohnson seeking damages against EFJohnson onclaims for third-party commissions allegedly due in conjunctionwith certain product sales to the federal government. Mace’s claims against EFJohnson include breach of contract, breach ofexpress warranty, breach of implied warranty of merchantability, breach ofimplied warranty of fitness for a particular purpose, breach of duty of goodfaith and fair dealing, equitable estoppel and misrepresentation. Mace hasalleged protected damages of $400 and an unspecified percentage of pastand future federal government sales. The Company has recorded a liability of $175 at June 30, 2004relating to this matter compared with $80 as of December 31, 2003.  The Company believes that it has meritoriouscontractual defenses against such demand and intends to vigorously contest suchallegation.  However, due to the factthat the assertion is undefined, the Company is unable to predict thelikelihood of the outcome or potential liability that may arise from thisrequest for payment.

 

**ITEMS 2 – 3.**

 

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

The Company held its Annual Meeting of Shareholders on June 03,2004.

 

The directors elected at the meeting were Veronica A. Haggart andThomas R. Thomsen.  Ms. Haggart received16,364,692 votes for and 173,239 votes withheld.  Mr. Thomsen received 15,834,339 votes for and 703,592 voteswithheld.  The other directors, whoseterms of office continued after the meeting, were Michael E. Jalbert, MassoudSafavi, Edward H. Bersoff, and Winston J. Wade.

 

The proposal to amend the Certificate of Incorporationto increase the authorized shares of Common Stock from twenty-five million(25,000,000) to fifty million (50,000,000) was approved with 15,748,054 votesfor and 744,823 votes against and 45,054 votes abstained.  Receiving the required number of votes, thenumber of authorized shares of common stock was increased to fifty million.

 

**ITEM 5.**

 

**ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K**

 

(a)  Exhibits

 

The following exhibits are filed herewith:

 
| **Exhibit No.** |   | **Description** |
|-----------------|--------|-----------------|
|            |   |            |
| 3.1             |   |            | Amendment to the Certificate of Incorporation of the Company |
|            |   |            |   |
| 11.1            |   |            | Computation of income (loss) per share |
|            |   |            |   |
| 31.1            |   |            | Chief Executive Officer’s Certification of Report on Form 10-Q |
|            |   |            | For the Quarter Ending June 30, 2004 |
|            |   |            |   |
| 31.2            |   |            | Chief Financial Officer’s Certification of Report on Form 10-Q |
|            |   |            | For the Quarter Ending June 30, 2004 |

 

21

----

 
| 32.0 |   |   | Written certification of Chief Executive Officer and Chief Financial  Officer, dated August 02, 2004, pursuant to 18 U.S.C. Section 1350. |
|------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------|

 

(b)  Reports on Form 8-K:

 

On May 03, 2004, the Company filed its press release announcingfinancial results for the quarter ended March 31, 2004 as a report on Form8-K, under Items 7 and 12.

 

On June 04, 2004,the Company filed notification that its principal executive and corporate office had beenchanged to its Washington DC facility located at 1232 22nd StreetNW, Suite 600, under Item 5.

 

22

----

 

**SIGNATURE**

 

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

 
|                             | EFJ, INC. |                                |
|----------------------------------|-----------|-------------------------------------|
|                             |      |                                |
|                             |      |                                |
| Date:  August 05, 2004 | By:       | /s/ Massoud Safavi                  |   |
|                             |      |                                |
|                             |      | Massoud Safavi                      |
|                             |      | Senior Vice President and           |
|                             |      | Chief Financial Officer             |
|                             |      | (Principal Financial and Accounting |
|                             |      | Officer)                            |
|                                  |           |                                     |  |

 

23

----