** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,DC 20549-1004**

 

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**Form 10-Q**

 

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**(Mark One)**
| **x** | ** ** | **Quarterly  report pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934** |
|-------|------------|---------------------------------------------------------------------------------------------------------|

 
| ** ** | ** ** | **FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2008** |
|------------|------------|--------------------------------------------------------|

 

**or**

 
| **o** | ** ** | **Transition  report pursuant to Section 13 or 15(d) of the Securities Exchange  Act of 1934** |
|-------|------------|----------------------------------------------------------------------------------------------------------|

 
|   | **For the transition period from               to** |
|--------|-----------------------------------------------------------------------------------------------------------------|

 

**Commission File Number 0-21681**

 

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**EFJ, INC.**

(Exact name ofregistrant as specified in its charter)

 

| **DELAWARE**                                                      | ** ** | **47-0801192**                          |
|-------------------------------------------------------------------|------------|-----------------------------------------|
| (State  or other jurisdiction of

incorporation  or organization) |       | (I.R.S.  Employer

Identification  No.) |

 

**1440 CORPORATE DRIVE**

**IRVING, TEXAS 75038**

**(972) 819-0700**

(Address, includingzip code, and telephone number,

including area code,of registrant’s

principal executiveoffice)

 

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

 

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

 

Large Accelerated Filer  o    AcceleratedFiler  x    Non-acceleratedFiler  o    Smaller ReportingCompany  o

 

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

 

Asof April 25, 2008, 26,079,342 shares of the Registrant’s Common Stock wereoutstanding.

 

 

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**PART I. FINANCIAL INFORMATION**

 

**ITEM 1.****                             ****FINANCIAL STATEMENTS**

 

**EFJ,INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

March 31, 2008 and December 31,2007

(Unaudited and inthousands, except share and per share data)

 
| ** **                                                                                                                                                                                  | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                                                  |       |                     |       |                        |       |
| Current assets:                                                                                                                                                                             |       |                     |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                  |       | $                        | 8,447      |                        | $          | 15,636 |   |
| Accounts  receivable, net of allowance for returns and doubtful accounts of $1,914 and  $1,642, respectively                                                                                |       | 28,461                   |       | 21,345                      |       |
| Receivables -  other                                                                                                                                                                        |       | 7,163                    |       | 6,944                       |       |
| Cost in excess  of billings on uncompleted contracts                                                                                                                                        |       | 4,762                    |       | 3,275                       |       |
| Inventories, net                                                                                                                                                                            |       | 33,918                   |       | 33,871                      |       |
| Prepaid expenses                                                                                                                                                                            |       | 1,479                    |       | 1,109                       |       |
| Total current  assets                                                                                                                                                                       |       | 84,230                   |       | 82,180                      |       |
| Property, plant  and equipment, net                                                                                                                                                         |       | 6,795                    |       | 7,096                       |       |
| Goodwill                                                                                                                                                                                    |       | 20,040                   |       | 20,040                      |       |
| Other intangible  assets, net of accumulated amortization                                                                                                                                   |       | 13,414                   |       | 13,821                      |       |
| Other assets                                                                                                                                                                                |       | 430                      |       | 352                         |       |
| **TOTAL  ASSETS**                                                                                                                                                                           |       | $                        | 124,909    |                        | $          | 123,489 |   |
|                                                                                                                                                                                        |       |                     |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                               |       |                     |       |                        |       |
| Current  liabilities:                                                                                                                                                                       |       |                     |       |                        |       |
| Revolving line  of credit                                                                                                                                                                   |       | $                        | 6,500      |                        | $          | — |   |
| Current portion  of long-term debt obligations                                                                                                                                              |       | 8                        |       | 8                           |       |
| Accounts payable                                                                                                                                                                            |       | 10,673                   |       | 13,411                      |       |
| Accrued expenses                                                                                                                                                                            |       | 10,321                   |       | 11,232                      |       |
| Billings in  excess of cost on uncompleted contracts                                                                                                                                        |       | 676                      |       | 221                         |       |
| Deferred  revenues                                                                                                                                                                          |       | 588                      |       | 1,010                       |       |
| Total current  liabilities                                                                                                                                                                  |       | 28,766                   |       | 25,882                      |       |
| Long-term debt  obligations, net of current portion                                                                                                                                         |       | 15,013                   |       | 15,015                      |       |
| Deferred income  taxes                                                                                                                                                                      |       | 1,489                    |       | 1,489                       |       |
| Other  liabilities                                                                                                                                                                          |       | 1,134                    |       | 737                         |       |
| **TOTAL  LIABILITIES**                                                                                                                                                                      |       | 46,402                   |       | 43,123                      |       |
| 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, 26,213,128 and  26,210,232 issued and outstanding as of March 31, 2008 and  December 31, 2007, respectively) |       | 262                      |       | 262                         |       |
| Additional  paid-in capital                                                                                                                                                                 |       | 154,006                  |       | 153,356                     |       |
| Accumulated  other comprehensive loss                                                                                                                                                       |       | (1,107                   | )          | (710                        | )          |
| Accumulated  deficit                                                                                                                                                                        |       | (74,654                  | )          | (72,542                     | )          |
|                                                                                                                                                                                        |       |                     |       |                        |       |
| **TOTAL  STOCKHOLDERS’ EQUITY**                                                                                                                                                        |       | 78,507                   |       | 80,366                      |       |
|                                                                                                                                                                                        |       |                     |       |                        |       |
| **TOTAL LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                        |       | $                        | 124,909    |                        | $          | 123,489 |   |

 

See accompanying notes to the condensedconsolidated financial statements.

 

2

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**EFJ, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

For the three months ended March 31,2008 and 2007

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

 
| ** **                                 | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|--------------------------------------------|------------|------------|------------|------------|------------|
| Revenues                                   |       | $          | 33,899     |       | $          | 38,948 |   |
| Cost of sales                              |       | 22,601     |       | 26,374     |       |
| Gross profit                               |       | 11,298     |       | 12,574     |       |
| Operating expenses:                        |       |       |       |       |       |
| Research and  development                  |       | 3,255      |       | 3,459      |       |
| Sales and  marketing                       |       | 3,166      |       | 3,406      |       |
| General and  administrative                |       | 6,401      |       | 5,646      |       |
| Amortization of  intangibles               |       | 407        |       | 421        |       |
| Total operating  expenses                  |       | 13,229     |       | 12,932     |       |
| Loss from  operations                      |       | (1,931     | )          | (358       | )          |
| Interest  expense, net                     |       | (181       | )          | (5         | )          |
| Loss before  income taxes                  |       | (2,112     | )          | (363       | )          |
| Income tax  benefit (expense)              |       | —     |       | —     |       |
| Net loss                                   |       | $          | (2,112     | )          | $          | (363 | ) |
| Net loss per  share—Basic             |       | $          | (0.08      | )          | $          | (0.01 | ) |
| Weighted average  common shares—Basic |       | 26,062,748 |       | 26,030,067 |       |

 

See accompanying notes to the condensedconsolidated financial statements

 

3

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**EFJ, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

Three months ended March 31, 2008 and 2007

(Unaudited and in thousands)

 
| ** **                                                                   | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows from  operating activities:                                       |       |     |       |     |       |
| Net loss                                                                     |       | $        | (2,112     | )        | $          | (363 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |     |       |     |       |
| Provision for  returns and doubtful accounts                                 |       | 272      |       | 170      |       |
| Depreciation and  amortization                                               |       | 1,115    |       | 1,085    |       |
| Recognition of  deferred gain                                                |       | (24      | )          | (24      | )          |
| Stock-based  compensation                                                    |       | 642      |       | 536      |       |
| Changes in  operating assets and liabilities:                                |       |     |       |     |       |
| Accounts  receivable                                                         |       | (7,388   | )          | (4,537   | )          |
| Receivables -  other                                                         |       | (219     | )          | (1,984   | )          |
| Cost in excess  of billings on uncompleted contracts                         |       | (1,487   | )          | 1,083    |       |
| Inventories                                                                  |       | (47      | )          | (4,101   | )          |
| Prepaid expenses  and other                                                  |       | (370     | )          | (1,804   | )          |
| Accounts payable                                                             |       | (2,738   | )          | 11,233   |       |
| Accrued and  other liabilities                                               |       | (887     | )          | (1,708   | )          |
| Billings in  excess of cost on uncompleted contracts                         |       | 455      |       | (421     | )          |
| Deferred  revenues                                                           |       | (422     | )          | (350     | )          |
| Total  adjustments                                                           |       | (11,098  | )          | (822     | )          |
| Net cash used in  operating activities                                       |       | (13,210  | )          | (1,185   | )          |
| Cash flows from  investing activities:                                       |       |     |       |     |       |
| Purchase of  property, plant and equipment                                   |       | (407     | )          | (729     | )          |
| Other assets                                                                 |       | (78      | )          | (1       | )          |
| Net cash used in  investing activities                                       |       | (485     | )          | (730     | )          |
| Cash flows from  financing activities:                                       |       |     |       |     |       |
| Proceeds on  revolving lines of credits, net                                 |       | 6,500    |       | —   |       |
| Principal  payments on long-term debt                                        |       | (2       | )          | (2       | )          |
| Proceeds from  issuances of common stock                                     |       | 8        |       | 8        |       |
| Proceeds from  exercise of stock options                                     |       | —   |       | 2        |       |
| Net cash  provided by financing activities                                   |       | 6,506    |       | 8        |       |
| Net decrease in  cash and cash equivalents                                   |       | (7,189   | )          | (1,907   | )          |
| Cash and cash  equivalents, beginning of period                              |       | 15,636   |       | 22,885   |       |
| Cash and cash  equivalents, end of period                                    |       | $        | 8,447      |     | $          | 20,978 |   |

 

**Supplemental Disclosure of CashFlow Information:**

TheCompany paid interest of $332 and $255 during the three months ended March 31,2008 and 2007, respectively.

TheCompany paid income taxes of $21 and $122 during the three months ended March 31,2008 and 2007, respectively.

 

See accompanying notes to the condensedconsolidated financial statements

 

4

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**EFJ, INC.AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**Threemonths ended March 31, 2008 and 2007**

**(Unauditedand in thousands, except share and per share data)**

 

**1. GENERAL**

 

The condensed consolidated balance sheet of EFJ, Inc.at December 31, 2007, presented within this Report on Form 10-Q, hasbeen derived from audited consolidated financial statements at that date. Thecondensed consolidated financial statements as of March 31, 2008 and forthe three months ended March 31, 2008 and 2007 are unaudited. Thecondensed consolidated financial statements reflect all normal and recurringaccruals and adjustments that, in the opinion of management, are necessary fora fair presentation of the financial position, operating results, and cashflows for the interim periods presented in this quarterly 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 our Annual Report on Form 10-K for the year ended December 31,2007. The results of operations and cash flows for the three months ended March 31,2008 are not necessarily indicative of the results for any other period or theentire fiscal year ending December 31, 2008.

 

Unless the context otherwise provides, allreferences to “we,” “us,” and “our” include EFJ, Inc., its predecessorentity and its subsidiaries, including E.F. Johnson Company, TranscryptInternational, Inc., and 3e Technologies International, Inc. on aconsolidated basis. All references to “EFJohnson” refer to E.F. JohnsonCompany, all references to “Transcrypt” refer to Transcrypt International, Inc.,and all references to 3eTI refer to 3e Technologies International, Inc.

 

**2. ORGANIZATION AND CONSOLIDATION**

 

We are a provider of secure wireless solutions whichare sold to: (1) domestic and foreign public safety / public serviceentities, (2) federal, state and local governmental agencies, includingthe Departments of Homeland Security and Defense, and (3) domestic andforeign commercial customers.  We design,develop, market, and support:

 

•                  mobile and portable wireless radios;

 

•                  stationary transmitters / receivers (basestations or repeaters);

 

•                  infrastructure equipment and systems;

 

•                  secure encryption technologies forproprietary wireless radios;

 

•                  customized wireless network centric productsand systems to the federal government primarily under government funded SmallBusiness Innovative Research (SBIR) programs; and

 

•                  niche hardware and secure softwaretechnologies for the WLAN markets primarily in the government sector.

 

The condensed consolidated financial statementsinclude the accounts of EFJ, Inc. and our wholly-owned subsidiaries. Allinter-company accounts and transactions have been eliminated in theconsolidation. Certain amounts in 2007 have been reclassified to conform tocurrent year presentation. The reclassifications did not affect net income orstockholders’ equity as previously reported.

 

Previously the Company was organized, and reportedits financial results, as a parent company with two segments, Private WirelessCommunications and Secured Communications.  Having recognized that thepublic safety/public service market is moving towards convergenttelecommunications solutions, the continued demand for interoperability and thetransition from analog to digital platforms, we reorganized the Company in January 2008into a single centralized corporate structure in order to be competitive inthis market.  We expect the centralizedcorporate structure to improve efficiencies in our operations and reduce ourinfrastructure costs. In light of these changes, the Company has reassessed itssegment reporting, and beginning with the first quarter of 2008, we are nolonger reporting the two segments of Private Wireless Communications andSecured Communications.

 

5

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**EFJ, INC.AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**Threemonths ended March 31, 2008 and 2007**

**(Unauditedand in thousands, except share and per share data)**

 

**3. NET INCOME PER SHARE**

 

Basic loss per share (“EPS”) is calculated basedupon the weighted average number of common shares outstanding during theperiod. The diluted EPS calculation reflects the potential dilution from commonstock equivalents such as stock options, stock satisfied appreciation rights (“SSAR’s”),restricted stock grants and restricted stock units (collectively “IncentiveShares”). For the three months ended March 31, 2008 and 2007, alloutstanding incentive shares of 1,643,572 and 1,668,472, respectively, wereconsidered anti-dilutive due to the net loss in each quarter. For the threemonths ended March 31, 2008 and 2007, outstanding incentive shares of509,558 and 383,418, respectively, with exercise prices lower than the averagemarket price of the common stock for the respective periods were consideredcommon stock equivalents and were dilutive in the calculation of the dilutedweighted average common shares. Outstanding incentive shares that had exerciseprices higher than the average market price of the common stock for the periodswere considered anti-dilutive and excluded from the calculation of dilutedweighted average common shares.

 

We use the treasury stock method to calculatediluted weighted average common shares, as if all such options were outstandingfor the periods presented.

 

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

 

We use the Black-Scholes option pricing model todetermine the fair value of all stock option grants and stock satisfied stockappreciation rights (“SSAR’s”) (collectively “Options”). For the three monthsended March 31, 2008, we recognized compensation expense of $0.4 millionrelated to options and $0.2 million related to restricted stock grants and restricted stock units.  For the three months ended March 31,2007, we recognized compensation expense of $0.4 million related to options and$0.1 million related to restricted stock grants.

 

In July 2007, the Compensation Committee of theBoard of Directors of the Company deemed it is in the best interests of theCompany to approve the use of Restricted Stock Units (“RSU’s) and StockSatisfied Appreciation Rights (“SSAR’s”) as the equity instruments for grant tocertain key employees of the Company pursuant to the 2005 Omnibus IncentiveCompensation Plan. Grants of RSU’s and SSAR’s vest over a four year period andexpire in five years.

 

**5. INTEREST RATE SWAP AGREEMENTS AND COMPREHENSIVELOSS**

 

We report all derivative instruments as hedgingactivities in the consolidated financial statements at fair value. Changes inthe fair value of the derivatives are recorded each period in the AccumulatedComprehensive Loss in the balance sheet as the derivative is designated aseffectively hedged at March 31, 2008. We entered into an interest rateswap agreement to manage interest costs and risks associated with changinginterest rates not for speculative or trading purposes.

 

On July 19, 2006, we entered into an interestrate swap agreement which effectively converts the variable LIBOR component ofthe interest rate on the $15.0 million term loan to a fixed rate of 5.64%.Under the terms of the interest rate swap agreement, EFJ will pay 5.64% and thecounterparty will pay LIBOR on a monthly basis. The interest rate swapagreement terminates on June 30, 2010, the termination date of the termloan. The cumulative net unrealized loss was $1.1 million and is included withother long-term liabilities and accumulated other comprehensive loss in theconsolidated balance sheet at March 31, 2008. The following is a summaryof the components of comprehensive loss:

 
| ** **                                    | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|
| ** **                                    | ** ** | **March 31,**               | ** ** |
| ** **                                    | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Net loss                                      |       | $                                | (2,112     | ) | $ | (363 | ) |
| Fair value  adjustment for interest rate swap |       | (397                             | )          | (45 | ) |
| Total other  comprehensive loss               |       | $                                | (2,509     | ) | $ | (408 | ) |

 

6

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**EFJ, INC.AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**Threemonths ended March 31, 2008 and 2007**

**(Unauditedand in thousands, except share and per share data)**

 

**6. INVENTORIES**

 

The following is a summary of inventories:

 
| ** **                  | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|-----------------------------|------------|------------------------------|------------|---------------------------------|------------|
| Raw materials  and supplies |       | $                            | 16,819     |                            | $          | 16,263 |   |
| Work in progress            |       | 1,662                        |       | 1,334                           |       |
| Finished goods              |       | 14,012                       |       | 15,728                          |       |
| Service  inventories        |       | 3,743                        |       | 3,517                           |       |
|                        |       | 36,236                       |       | 36,842                          |       |
| Reserve for  obsolescence   |       | (2,318                       | )          | (2,971                          | )          |
| Total  inventories          |       | $                            | 33,918     |                            | $          | 33,871 |   |

 

**7. GOODWILL AND INTANGIBLE ASSETS**

 

Our goodwill and intangible assets are tested forimpairment annually as of December 31 of each year unless events orcircumstances would require an immediate review. Goodwill and intangible assetamounts are allocated to the reporting units based upon amounts allocated atthe time of their respective acquisition.Intangible assets, consisting of existing technology, customerrelationships, license and covenants not-to-compete, are amortized over theiruseful life on a straight-line basis. Intangible assets consisting of trademarkand trade name and certifications are not subject to amortization.

 

We performed fair value-based impairment tests at December 31,2007. Upon completion of the impairment test, we concluded that the fair valuewas lower than the carrying value of the associated goodwill and tradename.  Therefore, we reported animpairment charge of $5.5 million related to goodwill and $0.3 million relatedto the trade name in the fourth quarter ended December 31, 2007.

 

No events occurred during the three months ended March 31,2008 and 2007, respectively, which would indicate that an impairment of suchassets had taken place as of such dates.

 

Amortization expense, related to intangible assetswhich are subject to amortization, was $0.4 million for the three months ended March 31,2008 and March 31, 2007, respectively. Intangible assets consist of thefollowing as of the dates indicated:

 
| ** **                                      | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|-------------------------------------------------|------------|--------------------|------------|---------------------------------|------------|
| ** **                                      | ** ** | **Gross**          | ** ** | ** **                      | ** ** | **Accumulated** | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | **Net** | ** ** |
| ** **                                      | ** ** | **Amount**         | ** ** | **Impairment**                  | ** ** | **Amortization** | ** ** | **Amount** | ** ** | **Amount** | ** ** | **Impairment** | ** ** | **Amortization** | ** ** | **Amount** | ** ** |
|                                            |       |               |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Intangible  assets not subject to amortization: |       |               |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Goodwill                                        |       | $                  | 20,040     |                            | $          | — |   | $ | — |   | $ | 20,040 |   | $ | 25,515 |   | $ | (5,475 | ) | $ | — |   | $ | 20,040 |   |
| Trademarks                                      |       | 4,364              |       | —                          |       | — |   | 4,364 |   | 4,664 |   | (300 | ) | — |   | 4,364 |   |
| Certifications                                  |       | 1,230              |       | —                          |       | — |   | 1,230 |   | 1,230 |   | — |   | — |   | 1,230 |   |
|                                            |       | 25,634             |       | —                          |       | — |   | 25,634 |   | 31,409 |   | (5,775 | ) | — |   | 25,634 |   |
|                                            |       |               |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Intangible  assets subject to amortization:     |       |               |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Existing  technology                            |       | 6,190              |       | —                          |       | (2,254 | ) | 3,936 |   | 6,190 |   | — |   | (2,116 | ) | 4,074 |   |
| Customer  relationships                         |       | 4,800              |       | —                          |       | (1,304 | ) | 3,496 |   | 4,800 |   | — |   | (1,103 | ) | 3,697 |   |
| Licence                                         |       | 320                |       | —                          |       | (111 | ) | 209 |   | 320 |   | — |   | (95 | ) | 225 |   |
| Covenant  not-to-compete                        |       | 400                |       | —                          |       | (351 | ) | 49 |   | 400 |   | — |   | (301 | ) | 99 |   |
| Trademarks/Patents                              |       | 208                |       | —                          |       | (79 | ) | 129 |   | 209 |   | — |   | (77 | ) | 132 |   |
|                                            |       | 11,918             |       | —                          |       | (4,099 | ) | 7,819 |   | 11,919 |   | — |   | (3,692 | ) | 8,227 |   |
|                                            |       |               |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                           |       | $                  | 37,552     |                            | $          | — |   | $ | (4,099 | ) | $ | 33,453 |   | $ | 43,328 |   | $ | (5,775 | ) | $ | (3,692 | ) | $ | 33,861 |   |

 

**8. NOTE PAYABLE AND LINE OF CREDIT**

 

We amended our secured line of credit agreement withBank of America in July 2006 to include a revolving line of credit of upto $15.0 million and a term loan of $15.0 million (the “Loan Agreement”). Bothborrowings bear interest at a variable rate based on the London InterbankOffered Rate (“LIBOR”) plus a margin (“LIBOR Margin”) determined by our ratioof debt to earnings before interest, taxes, depreciation, and amortization (“EBITDA”).The Loan Agreement expires June 30, 2010.

 

The Loan Agreement provides for customaryaffirmative and negative covenants, including maintenance of corporateexistence, rights, property, books and records and insurance, compliance withcontracts and laws, and certain reporting 

 

7

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**EFJ, INC.AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**Threemonths ended March 31, 2008 and 2007**

**(Unauditedand in thousands, except share and per share data)**

 

requirements, as well aslimitations on debt, liens, fundamental changes, acquisitions, transfers ofassets, investments, loans, guarantees, use of proceeds, sale-leasebacktransactions and capital expenditures. In addition, the Loan Agreement containscertain financial covenants including a maximum ratio of funded debt to EBITDAand a fixed charge coverage ratio. The Loan Agreement also provides for eventsof default that would permit the lender to accelerate the loans upon theiroccurrence, including failure to make payments, breaches of representations andwarranties, insolvency events, acceleration of other indebtedness, failure todischarge judgments, material adverse effects, certain breaches of contracts,casualty losses when no or insufficient insurance is maintained, changes ofcontrol, certain ERISA events and failure to observe covenants. As collateralfor the obligations under the Loan Agreement, the Lender has a securityinterest in substantially all assets of the borrowers, including accountsreceivable, inventories, machinery, equipment, real estate, and generalintangibles.

 

As noted in our Form 10-K for the period endingDecember 31, 2007, we were not in compliance with the financial covenantsof the Loan Agreement for the quarter ended December 31, 2007. As aresult, effective March 10, 2008 we executed an Amendment to the LoanAgreement whereby Bank of America waived such financial covenant defaults on aone time basis, subject to further modification of the Loan Agreement to revisesuch financial covenants, to modify the advance and borrowing revisions underthe Loan Agreement and for certain other purposes more fully set out in theAmendment. The Loan Agreement, as amended, contains a new covenant to maintaina minimum liquidity of $3.0 million in unrestricted cash, unencumberedmarketable securities, cash and cash equivalents through March 31, 2009.Pursuant to the Loan Agreement, as further amended, the interest rate is equalto LIBOR plus 2.00% through March 31, 2009, and thereafter to LIBOR plus arate between 1.00% and 1.75% depending on our ratio of debt to EBITDA.

 

The $15.0 million term loan was fully funded andused to finance the acquisition of 3eTI dated July 10, 2006. At December 31,2007, no borrowings had been made on the revolving line of credit. At March 31,2008, $6.5 million of borrowings had been made from the revolving line ofcredit. Letters of credit, under our line of credit were $1.2 million and $0.3million as of March 31, 2008 and December 31, 2007, respectively. Thetotal available remaining credit under the line of credit was $7.3 millionand $13.3 million as of March 31, 2008 and December 31, 2007,respectfully.

 

The interest rate in effect at March 31, 2008was 4.62 percent.

 

For the quarter ended March 31, 2008 we were incompliance with the financial covenants of the Loan Agreement as amended.

 

**9. INCOME TAXES**

 

We adopted the provisions of Financial StandardsAccounting Board Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes (“FIN 48”) an interpretation of FASB Statement No. 109(“SFAS 109”)* on January 1, 2007. FIN 48 prescribes arecognition threshold that a tax position is required to meet before beingrecognized in the financial statements and provides guidance on recognition,measurement, classification, interest and penalties, accounting in interimperiods, disclosure and transition issues. The Company has unrecognized taxbenefits of approximately $0.5 million that did not change significantly duringthe three months ended March 31, 2008 relating to carry forward ofbusiness credits. The adoption of FIN 48, did not result in the recognition ofadditional tax liability for unrecognized income tax benefits since the taxbenefits have not be included in prior income tax return filings. In addition,future changes in the unrecognized tax benefit will have no net impact on theeffective tax rate due to the existence of the valuation allowance.

 

As of March 31, 2008, we have no accrualrequirement for interest or penalties related to uncertain tax positions sincethe tax benefits have not been included in prior income tax return filings.Accrued interest relating to uncertain tax positions would be recorded as acomponent of interest expense and penalties related to uncertain tax positionswould be recorded as a component of general and administrative expenses.

 

The tax years 2003-2007 remain open to examinationby the major taxing jurisdictions to which we are subject. Additionally, uponinclusion of the NOL and R&D credit carry forward tax benefits from taxyears 1996 to 2002 in future tax returns, the related tax benefit for theperiod in which the benefit arose may be subject to examination.

 

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**EFJ, INC.AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**Threemonths ended March 31, 2008 and 2007**

**(Unauditedand in thousands, except share and per share data)**

 

**10. WARRANTY COSTS**

 

We provide a one-to-three year warranty onsubstantially all of our product sales, depending upon certain terms andconditions of the sale, and estimate future warranty claims based on historicalexperience and anticipated costs to be incurred over the life of the warranty.Warranty expense is accrued at the time of sale with an additional accrual forspecific items after the sale when their existence is known and amounts areboth extraordinary and determinable. A reconciliation of changes in our accruedwarranty reserve as of March 31, 2008 is as follows:

 
| ** **                      | ** ** | **Balance at**             | ** ** | **Charged to** | ** ** | **Deduction /** | ** ** | **Balance at**          | ** ** |
|---------------------------------|------------|---------------------------------|------------|---------------------|------------|----------------------|------------|------------------------------|------------|
| ** **                      | ** ** | **December 31, 2007** | ** ** | **Expense**         | ** ** | **Expenditures**     | ** ** | **March 31, 2008** | ** ** |
| Allowance for  Warranty Reserve |       | $                               | 3,803      |                | 1,264      |                 | 929        |                         | $          | 4,138 |   |
|                                 |            |                                 |            |                     |            |                      |            |                              |            |  |  |

 

**11. FAIR VALUE MEASUREMENT**

 

In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements,” (SFAS 157), whichis effective for fiscal years beginning after November 15, 2007 and forinterim periods within those years. This statement defines fair value,establishes a framework for measuring fair value and expands the relateddisclosure requirements. This statement applies under other accountingpronouncements that require or permit fair value measurements. The statementindicates, among other things, that a fair value measurement assumes that thetransaction to sell an asset or transfer a liability occurs in the principalmarket for the asset or liability or, in the absence of a principal market, themost advantageous market for the asset or liability. SFAS 157 defines fairvalue based upon an exit price model.

 

Relative to SFAS 157, theFASB issued FASB Staff Positions (FSP) 157-1 and 157-2. FSP 157-1 amends SFAS157 to exclude SFAS No. 13, “Accounting for Leases,” (SFAS 13) and itsrelated interpretive accounting pronouncements that address leasingtransactions, while FSP 157-2 delays the effective date of the application ofSFAS 157 to fiscal years beginning after November 15, 2008 for allnonfinancial assets and nonfinancial liabilities that are recognized ordisclosed at fair value in the financial statements on a nonrecurring basis.

 

We adopted SFAS 157 as of January 1,2008, with the exception of the application of the statement to non-recurringnonfinancial assets and nonfinancial liabilities. Non-recurring nonfinancialassets and nonfinancial liabilities for which we have not applied theprovisions of SFAS 157 include those measured at fair value in goodwillimpairment testing, indefinite lived intangible assets measured at fair valuefor impairment testing, asset retirement obligations initially measured at fairvalue, and those initially measured at fair value in a business combination.

 

Valuation Hierarchy. SFAS157 establishes a valuation hierarchy for disclosure of the inputs to valuationused to measure fair value. This hierarchy prioritizes the inputs into threebroad levels as follows. Level 1 inputs are quoted prices (unadjusted) inactive markets for identical assets or liabilities. Level 2 inputs are quotedprices for similar assets and liabilities in active markets or inputs that areobservable for the asset or liability, either directly or indirectly throughmarket corroboration, for substantially the full term of the financialinstrument. Level 3 inputs are unobservable inputs based on our own assumptionsused to measure assets and liabilities at fair value. A financial asset orliability’s classification within the hierarchy is determined based on thelowest level input that is significant to the fair value measurement.

 

The following tableprovides the liabilities carried at fair value measured on a recurring basis asof March 31, 2008:

 
| ** **                       | ** ** | ** **                                                       | ** ** | **Fair Value Measurements at March 31, 2008 Using** | ** ** |
|----------------------------------|------------|------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                       | ** ** | **Total Carrying  Value at  March 31, 2008** | ** ** | **Quoted prices  in active markets  (Level 1)**                    | ** ** | **Significant other  observable inputs  (Level 2)** | ** ** | **Significant  unobservable inputs  (Level 3)** | ** ** |
| Interest rate  swaps - liability |       | $                                                                | 1,107      |                                                                                   |       |   | $ | 1,107 |   |   |   |
|                                  |            |                                                                  |            |                                                                                        |            |  |  |  |  |  |  |

 

Valuation Techniques.Interest rate swaps are measured at fair value indirectly through marketcorroboration, for substantially the full term of the financial instrumentwithin Level 2 of the valuation hierarchy.

 

In February 2007, theFASB issued SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities — Including an amendment of FASB Statement No. 115,”(SFAS 159) which is effective for fiscal years beginning after November 15,2007. This statement permits entities to choose to measure many financialinstruments and certain other items at fair value. This statement alsoestablishes presentation and disclosure requirements designed to facilitatecomparisons between entities that choose different measurement attributes forsimilar types of assets and liabilities. 

 

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**EFJ, INC.AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**Threemonths ended March 31, 2008 and 2007**

**(Unauditedand in thousands, except share and per share data)**

 

Unrealizedgains and losses on items for which the fair value option is elected would bereported in earnings. We have adopted SFAS 159 and have elected not to measureany additional financial instruments and other items at fair value.

 

**12. COMMITMENTS AND CONTINGENCIES**

 

We are involved in certain legal proceedingsincidental to the normal conduct of our business. At this time, we do notbelieve that any liabilities relating to such legal proceedings are likely tobe, individually or in the aggregate, material to our business, financialcondition, results of operations or cash flows.

 

The total we have accrued in regards to all legalproceedings as of March 31, 2008 and December 31, 2007 was $0.2million.

 

In the normal course of our business activities, weare required under contracts with various government authorities to provideletters of credit and bonds that may be drawn upon if we fail to perform underthese contracts. At March, 31, 2008 and December 31, 2007 we had openletters of credit totaling $1.2 million and $0.3 million, respectively. Bonds,which expire on various dates, totaled $0.5 million on March, 31, 2008 and December 31,2007, respectively. No bonds had been drawn upon at either date.

 

**13.****COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES**

 

On November 15, 2007, the Company committed toan organizational plan (the “Plan”) to shift from three divisions to oneintegrated corporate structure focused on secure wireless communications forgovernment and industrial customers. The Plan is expected to improveefficiencies in our operations, reduce our infrastructure costs and to supporta new technology roadmap driving towards a streamlined and more effectivestructure. Implementation of the Plan includes senior and middle managementchanges as well as staff reductions designed to eliminate redundant positionsand reflects the Company’s decision to consolidate operations and moveproduction from three locations into a centralized operations and outsourcingprogram in the Dallas/Fort Worth area.

 

Costs that are directly associated with the Plan arebeing recorded as “restructuring costs” and are included in general andadministrative expenses. Other costs that do not qualify as restructuring costsare being classified as other operating expenses or costs of goods sold in theCompany’s consolidated statements of operations.

 

The timing of the recognition of costs associatedwith this move were determined in accordance with SFAS No. 146, *Accounting for CostsAssociated with Exit or Disposal Activities**,***and other relevant guidance, that provides 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 termination costs associated with the relocation are generallyrecognized ratably over the period that the employees are required to provideservices in order to earn the respective termination benefit.

 

The following table summarizes the estimates andactual exit costs incurred as of March 31, 2008:

 
| ** **                     | ** ** | **Original amount  expected to be  incurred** | ** ** | **Amount incurred in  the three months ended  March 31,2008** | ** ** | **Amount incurred  in the year ended  December 31, 2007** | ** ** | **Remaining amount  to be incurred** | ** ** |
|--------------------------------|------------|--------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| One-time  termination benefits |       | $                                                            | 951        |                                                                                        | $          | —                                                                                  |       | $                                                   | 575        |   | $ | 376 |   |
| Other cost                     |       | 139                                                          |       | 78                                                                                          |       | 45                                                                                      |       | 16                                                  |       |
| Total Costs                    |       | $                                                            | 1,090      |                                                                                        | $          | 78                                                                                      |       | $                                                   | 620        |   | $ | 392 |   |

 

14.**RELATED PARTY TRANSACTIONS**

 

During the three months ended March 31, 2008and 2007, DRS Technologies, Inc. (“DRS”) and its’ related subsidiariesacquired approximately $8.1 million and $0.1 million, respectively, of ourproducts. Included in our account receivable balances as of March 31, 2008and December 31, 2007 were amounts due from DRS for $8.2 million and$0.7 million, respectively. Since August 1995, Mark Newman has beenthe Chairman, President and Chief Executive Officer of DRS. Mr. Newman wasappointed a director of EFJI in 2005. It is anticipated that the Company mayengage in similar business with DRS in the future.

 

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**ITEM 2.****         ****MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Discussions of certain matters contained in thisQuarterly Report on Form 10-Q may constitute forward-looking statementsunder Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Theseforward-looking statements are based upon our current expectations, estimatesand projections about our business and our industry, and reflect our beliefsand assumptions based upon information available to us at the date of thisreport. In some cases, you can identify these statements by words such as “if,”“may,” “might,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,”“estimates,” “predicts,” “potential,” “continue,” and other similar terms.These forward-looking statements relate to, among other things, the results ofour product development efforts, future sales and expense levels, our futurefinancial condition, liquidity, and business prospects generally, the impact ofour relocation of operating facilities, and outsourcing of manufacturing on ouroperating results, perceived opportunities in the marketplace for our products,and our other business plans for the future.

 

These forward-looking statements are subject tocertain risks and uncertainties that could cause the actual results,performance and outcomes to differ materially from those expressed or impliedin these forward-looking statements due to a number of risk factors including,but not limited to, the risks discussed in the 2007 Annual Report on Form 10-Kunder Item 1A “Risk Factors” and in Part II of this report on Form 10-Qunder Item 1A “Risk Factors.” We caution readers not to rely on theseforward-looking statements, which reflect management’s analysis only as of thedate of this quarterly report. We undertake no obligation to revise or updateany forward-looking statement for any reason except as required by law.

 

The following discussion is intended to provide abetter understanding of the significant changes in trends relating to ourfinancial condition and results of operations. Management’s Discussion andAnalysis of Financial Condition and Results of Operations should be read inconjunction with the accompanying Condensed Consolidated Financial Statementsand Notes thereto.

 

**Overview**

 

Previously the Companywas organized, and reported its financial results, as a parent company with twosegments, Private Wireless Communications and Secured Communications. Having recognized that the public safety/public service market is movingtowards convergent telecommunications solutions, the continued demand forinteroperability and the transition from analog to digital platforms, wereorganized the Company in January 2008 into a single centralizedcorporate structure that we expect to improve efficiencies in our operationsand reduce our infrastructure costs. Our current products, system solutions,and technology allow us to participate and be competitive in this transitioningmarket and technology trend of convergence.

 

In light of thesechanges, the Company has reassessed its segment reporting, and beginning withthe first quarter of 2008, we are no longer reporting the two segments ofPrivate Wireless Communications and Secured Communications.  The operating structure of the Company alsochanged in the first quarter. Under the new structure, all the Company’soperations report up to the chief executive officer and president through thechief operating officer. The chief financial officer, chief operating officer,general counsel, and chief technology officer report to the chief executiveofficer and president.  Based on thesynergies of our products, customers, and organizational structure, the Companynow operates in a single segment.

 

We design, develop, market and support wirelessradios and wireless communications infrastructure and systems for digital andanalog platforms. In addition, we offer encryption technologies for wirelessvoice, video and data communications and we also design, develop, market andsupport secure wireless networking solutions that include Wi-Fi products, meshnetworking, access points, and client infrastructure products. The Company’scustomers include first responders in public safety and public service, thefederal government, and industrial organizations.

 

Due to the timing of orders and seasonality, ourquarterly results fluctuate. We experience seasonality in our results in partdue to governmental customer spending patterns that are influenced bygovernment fiscal year-end budgets and appropriations. The unpredictable salescycle coupled with launching new products and solutions can also causevariations from quarter to quarter.

 

*Our Products and Solutions*

 

Our wireless radio offerings are primarily digitalsolutions designed to operate in both analog and digital system environments.Our products and systems are based on industry standards designed to enhanceinteroperability among systems, improve bandwidth efficiency, and integrate voiceand data communications.

 

The Land Mobile Radio (“LMR”) industry utilizestwo-way wireless communications through wireless networks, which includeinfrastructure components such as base stations, repeaters, transmitters andreceivers, network switches and 

 

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portable and mobile two-waycommunication radios. Individual users operate portable hand-held radios andvehicular-mounted radios in their wireless communications system. Utilizinglicensed RF spectrum, the customer owns and operates the wireless communicationsystem that is networked by linking together the infrastructure components. Wedevelop customer solutions, which leverage the customer’s wireless system andwireless radios with customer specific or enterprise wide applications.

 

The majority of revenues are derived from the saleof wireless radio products. Our federal, state and local governmental agencycustomers are increasingly demanding interoperable, secured communicationsproducts and systems. We believe this demand has created opportunities for usas we believe we are positioned to provide these products and systems. As aresult, we expect to continue to allocate a majority of our on-going researchand development expenditures to wireless radio features and enhancements,infrastructure components and system development efforts.

 

We provide the domestic and international LMRindustry with secure encryption technologies for analog wireless radios. Theseproducts are specifically designed to prevent unauthorized access to sensitivevoice communications in parts of the world where wireless radio systems remainanalog and security needs are high. These products are sold as aftermarketadd-on components or embedded components for existing analog radios andsystems.

 

We also design, develop,market and support customized wireless network centric products and systemswhich include secure Wi-Fi products, including mesh networking, access point,bridge, and client infrastructure products, as well as security software. Weprovide sensor network solutions, through our InfoMatics® middleware, whichenables sensors and databases to communicate data to pertinent personnel forcommand and control applications in near real-time. These products and solutionsutilize FIPS 140-2 validated wireless products, 802.11 wireless networking(WIFI) solutions, mesh networking and conditions based and location basedtelematics solutions.

 

*Our Sales and Distribution Approach*

 

Our products and systems are sold through multiplechannels including a direct sales force, dealers, manufacturingrepresentatives, distributors, and strategic partnering arrangements. Weutilize our dealer network to assist in installing, servicing, selling anddistributing our products. We also generate revenues through the federalgovernment under government funded research and development Small BusinessInnovative Research programs (“SBIR”). Additionally, we offer our products tocommercial, non-governmental users.

 

Much of our business is obtained through submissionof formal competitive bids. Our governmental customers generally can specifythe terms, conditions and form of the contract. Our government business issubject to government funding decisions and contract types can vary widely, includingcost plus, fixed-priced, indefinite-delivery/indefinite quantity, (“IDIQ”), andgovernment-wide acquisition contracts with the General Services Administration,(“GSA”), that require pre-qualification of vendors and allows governmentcustomers to more easily procure our products and systems. Through the federalgovernment SBIR programs the business is most typically obtained through thesubmission of formal bids under cost plus or time and material agreements.

 

Depending on the size andcomplexity of customer specifications and requirements, products can be shippedto the customer in a relatively short period of time (typically 90 days) orwith complex integrations and various delivery dates, orders can span multipleyears. For example, our longer-term system contracts and government servicesrevenues are generated under customer contracts and agreements for whichrevenue is recorded under the percentage-of-completion method.

 

**Description of Operating Accounts**

 

*Revenues*. Revenues consist of product sales,services, and government funded research and development services and solutionsnet of returns and allowances. Longer-term system and government servicesrevenues are recognized under the percentage of completion method.

 

*Cost of Sales.* Cost of sales includes costs of componentsand materials, labor, depreciation and overhead costs associated with theproduction of our products and services, as well as shipping, royalty,inventory reserves, warranty costs, and incurred cost under sales contracts.

 

*Gross Profit.* Gross profit is net revenues less the costof sales and is affected by a number of factors, including competitive pricing,product mix, business segment mix, and cost of products and services.

 

*Research and Development.* Research and development expenses consistprimarily of costs associated with research and development personnel,materials, and the depreciation of research and development equipment andfacilities. We expense research and development costs as they are incurred.Research and development expenses relating to our government funded researchand development services are included as a component of cost of sales.

 

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*Sales and Marketing.* Sales and marketing expenses consistprimarily of salaries and related costs of sales personnel, including salescommissions and travel expenses, as well as costs of advertising, product andprogram management, public relations and trade show participation.

 

*General and Administrative*. General and administrative expenses consistprimarily of salaries and other expenses associated with our management,accounting, information systems and administrative functions. This expense alsoincludes the impact of equity-based compensation expense. Accounting forgovernment contracts delineates what is a direct charge allowable to include incontract costs and what is considered to be an indirect charge reflected asgeneral and administrative expenses. We consider indirect engineering labor andoperating costs such as quality, planning, operations, and company fringebenefits, general administrative salaries and other general administrativeexpenses as general and administrative expense.

 

*Interest Expense, Net.*Interest expense, net consists of interestexpense on the term note, revolving line of credit and capital leases net ofinterest income earned on cash and cash equivalents.

 

*Provision for Income Taxes.* Provision (benefit) for income taxesincludes the increase or decrease in the valuation reserve that is based uponmanagement’s conclusions regarding, among other considerations, our historicaloperating results and forecasted future earnings over a five year period, ourcurrent and expected customer base projections, and technological andcompetitive factors impacting our current products. Current financialaccounting standards require that organizations analyze all positive andnegative evidence relating to deferred tax asset realization, which wouldinclude our historical accuracy in forecasting future earnings, as well as ourhistory of losses incurred within the past three years. Should factorsunderlying management’s estimates change, future adjustments, either positiveor negative, to our valuation allowance may be necessary.

 

**Critical Accounting Policies**

 

The preparation of our consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States of America, or GAAP, requires management to make judgments,estimates and assumptions in certain circumstances that affect the amountsreported in the consolidated financial statements and related footnotes. Weregularly evaluate the accounting policies and estimates used to prepare ourfinancial statements. Estimates are used for, but not limited to, theaccounting for allowance for doubtful accounts and sales returns, applicationof the percentage of completion accounting for long-term contract revenues,inventory reserves, warranty reserves, valuation allowance for deferred incometax assets, impairment charges and contingencies. These estimates are based onhistorical experience and various assumptions that we believe to be reasonableunder the particular applicable facts and circumstances. Actual results coulddiffer from those estimates.

 

We consider our critical accounting policies to bethose that involve significant judgments and uncertainties, require estimatesthat are difficult for management to determine, and have the potential toresult in materially different outcomes under varying assumptions andconditions. The application of GAAP requires management to make estimates andassumptions that affect the amounts reported in the financial statements andaccompanying results. Listed below are those policies we believe are criticaland require the use of complex judgment in their application.

 

***Revenues***

 

Product 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 isgenerally complete when the product is shipped, or received by the customer,depending upon whether the title to the goods, as well as the risks andbenefits of ownership, are transferred to the customer at point of shipment orpoint of delivery as typically we have no further obligations with respect tothe sale which impact the functionality of the product. For sales wherecollection is not reasonably assured, we recognize revenues as cash isreceived. If collection is contingent on a future event, we recognize revenueswhen the contingency lapses, generally upon cash collection.

 

System sales under long-term contracts are accountedfor under the percentage-of-completion method. Under this method, revenues arerecognized as work on a contract progresses. The recognized revenue is thatpercentage of estimated total revenues that incurred costs to date bear toestimated total costs to complete the contract. Revisions in cost and profitestimates are made when conditions requiring such revisions become known.Anticipated losses on contracts are recognized in operations as soon as suchlosses are determined to be probable and reasonably estimable.

 

Government funded services revenue from cost pluscontracts is recognized as costs are incurred on the basis of direct costs plusallowable indirect costs and an allocable portion of the fixed fee. Revenuefrom fixed-type contracts is recognized under the percentage of completionmethod with estimated costs and profits included in contract revenue as work isperformed. Revenue from time and materials contracts is recognized as costs areincurred at amounts represented by the agreed billing amounts.

 

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Deferred revenues include unearned services providedunder systems maintenance contracts. We recognize the fees based upon astraight-line method over the life of the contract.

 

We periodically review our revenue recognitionprocedures to assure that such procedures are in accordance with the provisionsof Staff Accounting Bulletins 101 and 104, Statement of Position 88-1 and otherinterpretations, as applicable. In addition, while most of our current productscontain software, we believe the software is incidental in the overall contextof our products’ features and functionality, therefore, at present we do notuse revenue recognition pronouncements applicable to software sales.

 

***Inventories***

 

Inventories are recorded at the lower of cost ormarket with cost determined utilizing a standard cost method. We periodicallyassess our inventories for potential obsolescence and lower-of-cost-or-marketissues. We make estimates of inventory obsolescence, providing reserves whennecessary, based on, among other factors, demand for inventories based onbacklog, product pricing, the ability to liquidate or sell older inventories,and the impact of introducing new products. A significant portion of ourinventories is comprised of components and parts on hand to support maintenanceof products previously sold. As such, we anticipate utilizing such inventoriesover extended periods of time. Our obsolescence and lower of cost-or-marketaccounting policies provide for a periodic adjustment to the carrying value ofsuch inventories. As of March 31, 2008 we had a reserve for obsolescenceof $2.3 million.

 

***Goodwill andOther Intangible Assets***

 

At least annually, we assess goodwill and otherindefinite lived intangible assets, using fair value-based tests. If therespective carrying amount exceeds the fair value, goodwill or other indefinitelived intangible assets are considered to be impaired. In evaluatingimpairment, we estimate the sum of the expected future cash flows derived fromsuch reporting unit and present value implied by estimates of future revenues,costs and expenses, other factors. The estimates use assumptions about ourmarket segment share in the future and about future expenditures by governmententities. We continually evaluate whether events and circumstances haveoccurred that indicate the remaining balance of goodwill or other indefinitelived intangible assets may not be recoverable. To the extent our assumptionschange, we may be required to adjust the carrying value of the goodwill orother intangible assets. For a further discussion of goodwill and otherintangible assets, see the discussion under *Footnote7 — Notes to Condensed Consolidated Financial Statement*.

 

***Income Taxes***

 

We account for income taxes using the asset andliability method. Deferred tax assets and liabilities are recognized for thefuture tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective tax bases. Deferred tax assets and liabilities are measured usingcurrent enacted tax rates. The effect on deferred tax assets and liabilities ofa change in tax rates is recognized in the results of operations in the periodthat includes the enactment date.

 

We adopted FIN 48 *“Accountingfor Uncertainty in Income Taxes” an interpretation of FASB Statement No. 109“Accounting for Income Taxes”*. Based on the review of the varioustax positions we estimated uncertain tax positions in the amount of $0.4million.  However, these tax benefitshave not been included in prior year income tax return filings and are includedin our deferred tax asset pools as of January 1, 2007 (FIN 48 adoptiondate) with a reasonable valuation reserve. Based on activities through December 31,2007 we increased the estimate for uncertain tax positions to be $0.5 millionthat are included in our deferred tax pools and fully reserved. Therefore, wehave concluded that there is no requirement to book a liability for FIN 48 asdiscussed in Note 10 to the condensed consolidated financial statements.

 

***Long-Lived Assets***

 

Wereview our long-lived assets, including intangible assets subject to amortization,for recoverability whenever events or changes in circumstances indicate thatthe carrying amount of such long-lived asset or group of long-lived assets maynot be recoverable. Such circumstances include, but are not limited to:

 

•      a significant decrease in the market price of the long-lived asset;

 

•      a significant change in the extent or manner in which the long-livedasset is being used;

 

•      a significant change in the business climate that could affect thevalue of the long-lived asset;

 

•      a current period loss combined with projection of continuing lossassociated with use of the long-lived asset; and

 

•      a current expectation that, more likely than not, the long-lived assetwill be sold or otherwise disposed of before the end of its previously estimateduseful life.

 

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We continually evaluate whether events andcircumstances have occurred which may indicate that the carrying value may notbe recoverable. When such events or circumstances exist, the recoverability ofthe long-lived asset’s carrying value shall be determined by estimating theundiscounted future cash flows (cash inflows less associated cash outflows)that are directly associated with, and that are expected to arise as a directresult of the use and eventual disposition of, the long-lived asset. During thefourth quarter ended December 31, 2007, we recorded impairment charges forindefinite lived intangible assets. To the extent such events or circumstancesoccur in the future that could affect the recoverability of our long-livedassets, we may be required to impair these assets at that time.

 

***Stock-basedCompensation***

 

Stock-based compensation cost is estimated at thegrant date based on the fair value of the award and is recognized as expenseratably over the requisite service period of the award. Determining theappropriate fair value model and calculating the fair value of stock-basedawards at the grant date requires judgment, including estimating stock pricevolatility, forfeiture rates and expected option life. To the extent ourestimates used in calculating fair value are adjusted, the amount ofcompensation costs we would be required to record could change.

 

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**Results of Operations**

 

The following table presentscertain Condensed Consolidated Statements of Operations information as apercentage of revenues during the periods indicated:

 
| ** **                   | ** ** | **Three Months Ended** | ** ** |
|------------------------------|------------|----------------------------------|------------|
| ** **                   | ** ** | **March 31,**               | ** ** |
| ** **                   | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Revenues                     |       | 100.0                            | %          | 100.0 | % |
| Cost of sales                |       | 66.7                             |       | 67.7 |   |
|                         |       |                             |       |   |   |
| Gross profit                 |       | 33.3                             |       | 32.3 |   |
| Operating  expenses:         |       |                             |       |   |   |
| Research and  development    |       | 9.6                              |       | 8.9 |   |
| Sales and  marketing         |       | 9.3                              |       | 8.7 |   |
| General and  administrative  |       | 18.9                             |       | 14.5 |   |
| Amortization of  intangibles |       | 1.2                              |       | 1.1 |   |
| Total operating  expenses    |       | 39.0                             |       | 33.2 |   |
| Loss from  operations        |       | (5.7                             | )          | (0.9 | ) |
| Interest  expense, net       |       | (0.5                             | )          | (0.0 | ) |
| Loss before  income taxes    |       | (6.2                             | )          | (0.9 | ) |
| Income tax  provision        |       | —                           |       | — |   |
| Net loss                     |       | (6.2                             | )%         | (0.9 | )% |

 

**Comparison of the Three MonthsEnded March 31, 2008 and 2007**

 

*Revenues.*Our revenues decreased $5.0 million, or 13%,to $33.9 million for the three months ended March 31, 2008 from $38.9million for the same period in 2007. The decline was attributable to largedeliveries against Department of Defense contracts in the first quarter of 2007not replicated in the first quarter of 2008. Partially offsetting this declinein revenue were increases in revenues associated with the FCC rebanding effort.

 

*Gross Profit.*Our gross profit decreased $1.3 million, or10%, to $11.3 million in the three months ended March 31, 2008 from $12.6million for the same period in 2007. Gross profit, as a percentage of revenues,or gross margin, was 33% for the three months ended March 31, 2008, ascompared to 32% for the same period in 2007.

 

*Research and Development.*Research and development expenses decreased$0.2 million, or 6%, to $3.3 million in the three months ended March 31,2008 from $3.5 million in the same period in 2007. The decrease is mainlyattributable to the reduction of contract labor during the first quarter of2008. Research and development expenses as a percentage of revenues increasedto 10% in the first three months of 2008 versus 9% for the same period in 2007.

 

*Sales and Marketing.*Sales and marketing expenses decreased $0.2million, or 7%, to $3.2 million in the three months ended March 31, 2008from $3.4 million in the same period in 2007. The decrease is mainlyattributable to lower marketing expenses associated with reduced labor andtrade show expenses. Sales and marketing expenses as a percentage of revenues were9% in the first three months of 2008 and 2007, respectively.

 

*General and Administrative.*General and administrative expenses increased$0.8 million, or 13%, to $6.4 million for the three months ended March 31,2008 from $5.6 million for the same period in 2007. The increase in expenses isprimarily attributable to increased legal fees, stock compensation expense,bank amendment fees, bad debt expense and accrued compensation expense.

 

*Amortization of Intangibles.*Amortization of intangibles was $0.4 millionfor the three months ended March 31, 2008 and 2007, respectively,reflecting amortization of specifically identifiable intangible assets with adefinite life.

 

*Interest Expense, net.*Interest expense, net increased $0.2 millionin expense for the three months ended March 31, 2008 from $0.005  million for the same period in 2007. This isattributable to interest on the term loan and lower interest income earned oncash investments.

 

*Provision for Income Taxes.*We did not record a tax benefit or provisionfor either the three months ended March 31, 2008 or 2007. For the threemonths ended March 31, 2008, our deferred tax assets were fully reservedrequiring no provision 

 

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for income taxes. For thethree months ended March 31, 2007, changes in our deferred tax assets wereoffset by changes in the valuation allowance resulting in no provision forincome taxes. The valuation reserve is based upon management’s conclusionsregarding, among other considerations, our operating results during eachperiod, our current and expected customer base, technological and competitivefactors impacting our current products, and management’s estimates of futureearnings based on information currently available.

 

*Net Loss.*Net loss was $2.1 million for the threemonths ended March 31, 2008, reflecting an increase of $1.7 million, ascompared to net loss of $0.4 million for the same period in 2007.

 

**Liquidity and Capital Resources**

 

The Company’s primary sourcesof liquidity are its cash and cash equivalents that were $8.4 million and $15.6million at March 31, 2008 and December 31, 2007.  Effective with the amended Loan Agreement, wedesignated $3.0 million of our invested cash balances for the minimum liquidityrequirements. Due to the net losses in 2007 and 2006, we considered several keyfactors in assessing the liquidity requirements of the Company for the nexttwelve months.  Management monitorsoperational cash flow projections which factor in our backlog of orders, thecost savings of $3 million to $5 million anticipated from the Company’sreorganization, and our historical collection and payment patterns withcustomers and vendors.  We analyzed theseprojections against our modified bank covenants for 2008 noting that on aproforma basis the covenants would be met. We noted that we are current and have made timely interest payments onour term note.  Furthermore, we may utilizeour revolving line of credit to borrow supported by the underlying borrowingbase of the Company.   Based on thisthese factors, among others, we believe that our available cash, financing andcash flow from operations will be adequate to meet our anticipated needs for atleast the next twelve months.

 

*Net cash from operating activities.*Our operatingactivities used cash of $13.2 million and $1.2 million in the three monthsended March 31, 2008 and 2007, respectively. Cash provided by or used inoperating activities is primarily a reflection of our collections on billedreceivables, investment in inventories and expenditures for operations.

 

During the first quarter of 2008, we collected $26.9million of billed receivables offset by product billings of $34.3 million thateffectively decreased cash from operating activities by $7.4 million.Additionally, $3.7 million was used for other operating purchases and expenses.The increase in accounts receivable reflects delays in cash collections fromcertain customers during the quarter ended March 31, 2008.

 

During the first quarter of 2007, we collected $34.6million of billed receivables offset by product billings of $39.0 million thateffectively decreased cash from operating activities by $4.4 million.Additionally, $4.1 million was used to purchase inventories and $7.2 million wasused for other operating expenses. The increase in accounts receivable reflectsthe significant increase in revenues during the quarter ended March 31,2007. The increases in inventories were principally the result of productprocurement in the first quarter of 2007 in anticipation of shipments and salesrelating to a large Department of Defense order.

 

*Net cash from investingactivities.* Duringthe three months ended March 31, 2008 and 2007, investing activities used$0.5 million and $0.7 million, respectively, mainly attributable to thepurchase of property, plant and equipment.

 

*Net cash from financingactivities.*Duringthe three months ended March 31, 2008 and 2007, financing activitiesprovided $6.5 million and $0.008 million, respectively. The increase in thefirst three months of 2008 was attributable to a borrowing from the revolvingline of credit to cover short term cash requirements at the beginning of thesecond quarter due to delays in certain customer collections.

 

*Letters of credits and bonds.* In the normal course of our businessactivities related to sales of wireless radio systems to local and stategovernmental entities, we are required under contracts with various governmentauthorities to provide letters of credit or performance or bid bonds that maybe drawn upon if we fail to perform under our contracts. Our outstandingletters of credit were $1.2 million and $0.3 million on March 31, 2008 and2007, respectively. Performance and bid bonds, that expire on various dates,totaled $0.5 million at March 31, 2008. Our current bonding arrangementcalls for zero-collateral bonding up to $7.0 million; however, no single bondmay exceed $2.0 million.

 

*Secured line of credit.* We amended our secured line of creditagreement with Bank of America, (the “Loan Agreement”), in July 2006 toinclude a revolving line of credit of up to $15.0 million and a term loan of$15.0 million. Both borrowings bear interest at a variable rate based on theLondon Interbank Offered Rate (“LIBOR”) plus a margin (“LIBOR Margin”)determined by our ratio of debt to earnings before interest, taxes,depreciation, and amortization (“EBITDA”). The LIBOR Margin was 175 basispoints at December 31, 2007. Following the renegotiation of the LoanAgreement, the $15.0 million term loan was fully funded and used to finance theacquisition of 3eTI. No borrowings were made on the revolving line of creditduring 2007. As noted in our Form 10-K for the period ending December, 31,2007, we were not in compliance with the financial covenants of the LoanAgreement for the quarter ending December 31, 2007. As a result, effectiveMarch 10, 2008 we executed an Amendment to the Loan Agreement whereby Bankof America waived such financial 

 

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covenant defaults on a onetime basis, subject to further modification of the Loan Agreement to revisesuch financial covenants, to modify the advance and borrowing revisions underthe Loan Agreement and for certain other purposes more fully set out in theAmendment.

 

The Loan Agreement, as amended, provides forcustomary affirmative and negative covenants, including maintenance ofcorporate existence, rights, property, books and records and insurance,compliance with contracts and laws, and certain reporting requirements, as wellas limitations on debt, liens, fundamental changes, acquisitions, transfers ofassets, investments, loans, guarantees, use of proceeds, sale-leasebacktransactions and capital expenditures. In addition, the Loan Agreement, asamended, contains certain financial covenants including a maximum ratio offunded debt to EBITDA and a fixed charge coverage ratio. The Loan Agreement, asamended, also provides for events of default that would permit the Lender toaccelerate the loans upon their occurrence, including failure to make payments,breaches of representations and warranties, insolvency events, acceleration ofother indebtedness, failure to discharge judgments, material adverse effects,certain breaches of contracts, casualty losses when no or insufficientinsurance is maintained, changes of control, certain ERISA events and failureto observe covenants. As collateral for the obligations under the LoanAgreement, as amended, the Lender has a security interest in substantially allassets of the Borrowers, including accounts receivable, inventory, machinery,equipment, real estate, and general intangibles. Pursuant to the LoanAgreement, as further amended, effective March 10, 2008, the interest rateis equal to LIBOR plus 2.00% through March 31, 2009, and thereafter toLIBOR plus a rate between 1.00% and 1.75% depending on our ratio of debt toEBITDA.

 

We were in compliance with all financial andnegative covenants at March 31, 2008. At March 31, 2008, $6.5 millionof borrowings had been made from the revolving line of credit. Letters ofcredit, under our line of credit were $1.2 million and $0.3 million as of March 31,2008 and December 31, 2007, respectively. The total available remainingcredit under the line of credit was $7.3 million and $13.3 million asof March 31, 2008 and December 31, 2007, respectfully.

 

*Dividend policy.* Since our initial public offering, we havenot declared or paid any dividends on our common stock. We presently intend toretain earnings for use in our operations and to finance our business. Anychange in our dividend policy is within the discretion of our board ofdirectors and will depend, among other things, on our earnings, debt serviceand capital requirements, restrictions in financing agreements, if any,business conditions and other factors that our board of directors deemsrelevant.

 

*Backlog.* Our backlog of unfilled orders at March 31,2008 was $74.3 million, compared to a backlog of $95.0 million at December 31,2007 and $121.1 million at March 31, 2007. Depending on the size andcomplexity of customer specifications and requirements, the backlog can beconverted to revenues in a relatively short period of time (typically 90 days)or with complex integrations and various delivery dates, orders can spanmultiple years.

 

**Off-Balance Sheet Arrangements**

 

As part of our ongoing business, we do notparticipate in transactions that generate relationships with unconsolidatedentities or financial partnerships, such as entities often referred to asstructured finance or variable interest entities (“VIE”), that would have beenestablished for the purpose of facilitating off-balance sheet arrangements orother contractually narrow or limited purposes. As of March 31, 2008, weare not involved in any VIE transactions.

 

**Recently Issued AccountingStandards**

 

In December 2007, the FASB issued SFAS No. 141(revised 2007), Business Combination (“SFAS 141R”), which replaces FASBStatement No. 141. SFAS 141R establishes principles and requirements forhow an acquirer recognizes and measures in its financial statements theidentifiable assets acquired, the liabilities assumed, any noncontrollinginterest in the acquire and the goodwill acquired. The Statement alsoestablishes disclosure requirements which will enable users to evaluate thenature and financial effects of the business combination. SFAS 141R is to beapplied prospectively to business combinations for which the acquisition dateis on or after an entity’s fiscal year that begins after December 15,2008. We are currently not impacted by the adoption of SFAS 141R on ourConsolidated Financial Statements.

 

In December 2007, the FASB issued SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements - an amendment ofAccounting Research Bulletin No. 51 (“SFAS 160”), which establishesaccounting and reporting standards for ownership interests in subsidiaries heldby parties other than the parent, the amount of consolidated net incomeattributable to the parent and to the noncontrolling interest, changes in aparent’s ownership interest and the valuation of retained noncontrolling equityinvestments when a subsidiary is deconsolidated. The Statement also establishesreporting requirements that provide sufficient disclosures that clearlyidentify and distinguish between the interests of the parent and the interestsof the noncontrolling owners. SFAS 160 is effective as of the beginning of anentity’s fiscal year that begins after December 15, 2008. We are currentlynot impacted by the adoption of SFAS 141R on our Consolidated FinancialStatements.

 

In December 2007, the EITF issued Issue No. 07-1,“Accounting for Collaborative Arrangements.” This Issue is effective forfinancial statements issued for fiscal years beginning after December 15,2008, and interim periods within those 

 

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fiscal years, and shall beapplied retrospectively to all prior periods presented for all collaborativearrangements existing as of the effective date. This Issue requires thattransactions with third parties (i.e., revenue generated and costs incurred bythe partners) should be reported in the appropriate line item in each company’sfinancial statement pursuant to the guidance in EITF Issue No. 99-19, “ReportingRevenue Gross as a Principal versus Net as an Agent.” This Issue also includesenhanced disclosure requirements regarding the nature and purpose of thearrangement, rights and obligations under the arrangement, accounting policy,amount and income statement classification of collaboration transactionsbetween the parties. We are currently not impacted by EITF Issue No. 07-1.

 

In March 2008, the FASB issued SFAS No. 161,“Disclosures about Derivative Instruments and Hedging Activities, an amendmentof FASB Statement No. 133” (SFAS 161). This statement is intended toimprove transparency in financial reporting by requiring enhanced disclosuresof an entity’s derivative instruments and hedging activities and their effectson the entity’s financial position, financial performance, and cash flows. SFAS161 applies to all derivative instruments within the scope of SFAS 133, “Accountingfor Derivative Instruments and Hedging Activities” (SFAS 133) as well asrelated hedged items, bifurcated derivatives, and nonderivative instrumentsthat are designated and qualify as hedging instruments. Entities withinstruments subject to SFAS 161 must provide more robust qualitativedisclosures and expanded quantitative disclosures. SFAS 161 is effectiveprospectively for financial statements issued for fiscal years and interimperiods beginning after November 15, 2008, with early applicationpermitted. We are currently evaluating the disclosure implications of thisstatement.

 

**ITEM 3.           QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Our financial instruments consist of cash and cashequivalents, trade accounts receivable, accounts payable and long-termobligations. The primary objective of our investment activities is to preserveprincipal while at the same time maximizing yields without increasing risk.

 

Although all of our salesare denominated in U.S. dollars, fluctuations in the value of internationalcurrencies relative to the U.S. dollar may affect the price, competitivenessand profitability of our products sold in international markets. Furthermore,the uncertainty of monetary exchange values has caused, and may in the futurecause, some foreign customers to delay new orders or delay payment for existingorders. While most international sales are supported by letters of credit orcash in advance, the purchase of our products by international customerspresents increased risks, which include:

 

•      unexpected changes in regulatory requirements;

 

•      tariffs and other trade barriers;

 

•      political and economic instability in foreign markets;

 

•      difficulties in establishing foreign distribution channels;

 

•      longer payment cycles or uncertainty in the collection of accountsreceivable;

 

•      increased costs associated with maintaining international marketingefforts;

 

•      cultural differences in the conduct of business;

 

•      natural disasters or acts of terrorism;

 

•      difficulties in protecting intellectual property; and

 

•      susceptibility to orders being cancelled as a result of foreigncurrency fluctuations since all our quotations and invoices are denominated inU.S. dollars.

 

Export of our products is subject to the U.S. ExportAdministration regulations and some of our products require a license or alicense exception in order to ship internationally. We cannot assure that suchapprovals will be available to us or our products in the future in a timelymanner or at all or that the federal government will not revise its exportpolicies or the list of products and countries for which export approval isrequired. Our inability to obtain required export approvals would adverselyaffect our international sales, which would have a material adverse effect onus. In addition, foreign companies not subject to United States exportrestrictions may have a competitive advantage in the international securedcommunications market. We cannot predict the impact of these factors on theinternational market for our products.

 

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**ITEM 4.****         ****CONTROLS AND PROCEDURES**

 

**Disclosure Controls and Procedures**

 

Our Chief Executive Officer (“CEO”) and ChiefFinancial Officer (“CFO”) reviewed and evaluated our disclosure controls andprocedures, as defined in Rule 240.13a-15(e) and 15d-15(e) underthe Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of theperiod covered by this report. Based on this evaluation, our CEO and CFO haveconcluded that our disclosure controls and procedures were effective as of theend of the period covered by this report to ensure that information required tobe disclosed in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms and isaccumulated and communicated to our management including our principal executiveand principal financial officer, as appropriate, to allow timely decisionsregarding disclosures.

 

**Internal Controls Over FinancialReporting**

 

As required by Rule 13a-15(d) under theExchange Act, our CEO and CFO, also conducted an evaluation of our internalcontrol over financial reporting to determine whether any change occurredduring our most recent fiscal quarter that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

During the quarter ended March 31, 2008, webegan the process of consolidating our business units into one and integratingthe operations and outsourced contract manufacturing at the Company. Theinternal control structure was held constant during this transition. During thesecond and third quarters of 2008 we will be evaluating potential changes andmodifications resulting from this on going transition.

 

As part of this integration, we will develop andimplement new/modified control procedures associated with inventory costing,purchasing, shipping, and receiving with our outsource manufacturing providers.We will continue to conduct full physical inventory counts periodically during2008.

 

There were no other changes in our internal controlsover financial reporting during the quarter ending March 31, 2008 thathave materially affected, or are reasonably likely to materially affect, ourinternal controls over financial reporting.

 

In preparation of our financial statements as of andfor the period ended March 31, 2008, management believes that our internalcontrols over these processes are operating and effective.

 

**PART II. OTHER INFORMATION**

 

**ITEM 1.****         ****LEGAL PROCEEDING**

 

See Note 12 to the Notes to Condensed ConsolidatedFinancial Statements in Part I, Item 1.

 

**ITEM 1A.****      ****RISK FACTORS**

 

**Risk Factors Related to OurBusiness**

 

Our operations and financial results are subject tovarious risks and uncertainties, including those described below, that couldadversely affect our business, financial condition, results of operations andtrading price of our common stock. Item 1A of our annual report on Form 10-Kfor fiscal year 2007 includes a detailed discussion of our risk factors.

 

**ITEM 2.****         ****UNREGISTERED SALES OFSECURITIES AND USE OF PROCEEDS**

 

N/A.

 

**ITEM 3.****         ****DEFAULTS UPON SENIOR SECURITIES**

 

N/A.

 

**ITEM 4.****         ****SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

 

N/A.

 

**ITEM 5.****         ****OTHER INFORMATION**

 

N/A

 

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**ITEM 6.****         ****EXHIBITS**

 

The following exhibits arefiled herewith:

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                     | ** ** |
|----------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                |       |
| 10.1                 |       | First Amendment to Term  Note by and among the Company, E. F. Johnson Company, Transcrypt  International, Inc., 3e Technologies International, Inc, and Bank of  America, N.A., dated as of March 10, 2008 (incorporated herein by  reference to Exhibit 10.1 to the Company’s Current Report on  Form 8-K filed with the SEC on April 4, 2008).      |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                |       |
| 10.2                 |       | Third Amendment to  Revolving Note by and among the Company, E. F. Johnson Company, Transcrypt  International, Inc., 3e Technologies International, Inc, and Bank of  America, N.A., dated as of March 10, 2008 (incorporated herein by  reference to Exhibit 10.2 to the Company’s Current Report on  Form 8-K filed with the SEC on April 4, 2008). |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                |       |
| 10.3 +               |       | Employment Agreement  between the Company and Elaine Flud Rodriguez dated March 17, 2008  (incorporated herein by reference to Exhibit 10.1 to the Company’s  Current Report on Form 8-K filed with the SEC on March 18, 2008).                                                                                                                            |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                |       |
| 11.1                 |       | Computation of income  per share                                                                                                                                                                                                                                                                                                                                                    |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                |       |
| 31.1                 |       | Chief Executive  Officer’s Certification of Report on Form 10-Q for the Quarter Ending  March 31, 2008                                                                                                                                                                                                                                                               |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                |       |
| 31.2                 |       | Chief Financial  Officer’s Certification of Report on Form 10-Q for the Quarter Ending  March 31, 2008                                                                                                                                                                                                                                                               |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                |       |
| 32.1                 |       | Written certification  of Chief Executive Officer, dated April 30, 2008, pursuant to 18 U.S.C.  Section 1350.                                                                                                                                                                                                                                                             |       |
|                 |       |                                                                                                                                                                                                                                                                                                                                                                                |       |
| 32.2                 |       | Written certification  of Chief Financial Officer, dated April 30, 2008, pursuant to 18 U.S.C.  Section 1350.                                                                                                                                                                                                                                                             |       |

 

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+ Management contract or compensatory plan orarrangement.

 

**SIGNATURE**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, as amended, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 
|                                | EFJ, INC. |
|-------------------------------------|-----------|
|                                |      |   |
|                                |      |   |
| Date: April 30, 2008 | By:       | /s/ Jana Ahlfinger Bell |
|                                |      | Jana Ahlfinger Bell |
|                                |      | Executive Vice  President and Chief Financial Officer |
|                                |      | (Principal Financial  and Accounting Officer) |

 

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