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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 JUNE 30, 2007

or



| ̈ | 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 of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|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, including zip code, and telephone number,

including area code, of registrants

principal executive office)



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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (check one)

Large Accelerated Filer ̈Accelerated Filer  x    Non-accelerated Filer ̈

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

As of July 20, 2007, 26,033,627 shares of the Registrants Common Stock were outstanding.



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PART I. FINANCIAL INFORMATION



|ITEM 1. | FINANCIAL STATEMENTS
|------- | --------------------

EFJ, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

June 30, 2007 and December 31, 2006

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



|                                                                                                                                                                              |  |              |         |   |                  |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                                              |  | June 30,2007 |         |   | December 31,2006 |  
|ASSETS                                                                                                                                                                        |  |              |         |   |                  |   |         |  
|Current assets:                                                                                                                                                               |  |              |         |   |                  |   |         |  
|Cash and cash equivalents                                                                                                                                                     |  | $            | 23,028  |   |                  | $ | 22,885  |  
|Accounts receivable, net of allowance for returns and doubtful accounts of $981 and $547, respectively                                                                        |  |              | 31,206  |   |                  |   | 23,427  |  
|Receivablesother                                                                                                                                                             |  |              | 10,273  |   |                  |   | 8,673   |  
|Cost in excess of billings on uncompleted contracts                                                                                                                           |  |              | 3,074   |   |                  |   | 3,940   |  
|Inventories, net                                                                                                                                                              |  |              | 29,911  |   |                  |   | 24,411  |  
|Deferred income taxes                                                                                                                                                         |  |              | 1,565   |   |                  |   | 3,814   |  
|Prepaid expenses                                                                                                                                                              |  |              | 2,505   |   |                  |   | 1,317   |  
|                                                                                                                                                                              |  |              |         |   |                  |   |         |  
|Total current assets                                                                                                                                                          |  |              | 101,562 |   |                  |   | 88,467  |  
|Property, plant and equipment, net                                                                                                                                            |  |              | 6,676   |   |                  |   | 6,744   |  
|Deferred income taxes, net of current portion                                                                                                                                 |  |              | 18,361  |   |                  |   | 16,115  |  
|Goodwill                                                                                                                                                                      |  |              | 25,515  |   |                  |   | 25,513  |  
|Other intangible assets, net of accumulated amortization                                                                                                                      |  |              | 14,843  |   |                  |   | 15,638  |  
|Other assets                                                                                                                                                                  |  |              | 137     |   |                  |   | 86      |  
|                                                                                                                                                                              |  |              |         |   |                  |   |         |  
|TOTAL ASSETS                                                                                                                                                                  |  | $            | 167,094 |   |                  | $ | 152,563 |  
|                                                                                                                                                                              |  |              |         |   |                  |   |         |  
|                                                                                                                                                                              |  |             
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                          |  |              |         |   |                  |   |         |  
|Current liabilities:                                                                                                                                                          |  |              |         |   |                  |   |         |  
|Current portion of long-term debt obligations                                                                                                                                 |  | $            | 1       |   |                  | $ | 5       |  
|Accounts payable                                                                                                                                                              |  |              | 20,534  |   |                  |   | 11,097  |  
|Accrued expenses                                                                                                                                                              |  |              | 9,132   |   |                  |   | 8,111   |  
|Billings in excess of cost on uncompleted contracts                                                                                                                           |  |              | 8       |   |                  |   | 427     |  
|Deferred revenues                                                                                                                                                             |  |              | 714     |   |                  |   | 885     |  
|                                                                                                                                                                              |  |              |         |   |                  |   |         |  
|Total current liabilities                                                                                                                                                     |  |              | 30,389  |   |                  |   | 20,525  |  
|Long-term debt obligations, net of current portion                                                                                                                            |  |              | 15,000  |   |                  |   | 15,000  |  
|Other liabilities                                                                                                                                                             |  |              | 167     |   |                  |   | 332     |  
|                                                                                                                                                                              |  |              |         |   |                  |   |         |  
|TOTAL LIABILITIES                                                                                                                                                             |  |              | 45,556  |   |                  |   | 35,857  |  
|                                                                                                                                                                              |  |              |         |   |                  |   |         |  
|Commitments and contingencies                                                                                                                                                 |  |              |         |   |                  |   |         |  
|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, 26,184,131 and 26,179,707 issued and outstanding as of June 30, 2007
and December 31, 2006, respectively) |  |              | 262     |   |                  |   | 262     |  
|Additional paid-in capital                                                                                                                                                    |  |              | 152,841 |   |                  |   | 151,665 |  
|Accumulated other comprehensive loss                                                                                                                                          |  |              | (167    | ) |                  |   | (332    | )
|Accumulated deficit                                                                                                                                                           |  |              | (31,398 | ) |                  |   | (34,889 | )
|                                                                                                                                                                              |  |              |         |   |                  |   |         |  
|TOTAL STOCKHOLDERS EQUITY                                                                                                                                                    |  |              | 121,538 |   |                  |   | 116,706 |  
|                                                                                                                                                                              |  |              |         |   |                  |   |         |  
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                    |  | $            | 167,094 |   |                  | $ | 152,563 |  
|                                                                                                                                                                              |  |              |         |   |                  |   |         |  

See accompanying notes to the condensed consolidated financial statements.



2



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EFJ, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

For the three and six months
ended June 30, 2007 and 2006

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



|                                         |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|---------------------------------------- |  | --------------------------- | ---------- | - | ------------------------- | - | ---------- | ---- |  | - | ---------- | - |  | - | ---------- | -
|                                         |  | Three Months Ended June 30, |            |   | Six Months Ended June 30, |  
|                                         |  | 2007                        |            |   | 2006                      |   |            | 2007 |  |   | 2006       |  
|Revenues                                 |  | $                           | 57,296     |   |                           | $ | 28,750     |      |  | $ | 96,244     |   |  | $ | 39,313     |  
|Cost of sales                            |  |                             | 38,866     |   |                           |   | 16,249     |      |  |   | 65,240     |   |  |   | 21,263     |  
|                                         |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Gross profit                             |  |                             | 18,430     |   |                           |   | 12,501     |      |  |   | 31,004     |   |  |   | 18,050     |  
|                                         |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Operating expenses:                      |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Research and development                 |  |                             | 4,115      |   |                           |   | 2,994      |      |  |   | 7,574      |   |  |   | 5,736      |  
|Sales and marketing                      |  |                             | 3,720      |   |                           |   | 2,625      |      |  |   | 7,126      |   |  |   | 4,720      |  
|General and administrative               |  |                             | 6,192      |   |                           |   | 3,469      |      |  |   | 11,838     |   |  |   | 7,710      |  
|Amortization of intangibles              |  |                             | 374        |   |                           |   |           |      |  |   | 795        |   |  |   |           |  
|                                         |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Total operating expenses                 |  |                             | 14,401     |   |                           |   | 9,088      |      |  |   | 27,333     |   |  |   | 18,166     |  
|                                         |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Income/(loss) from operations            |  |                             | 4,029      |   |                           |   | 3,413      |      |  |   | 3,671      |   |  |   | (116       | )
|Interest income                          |  |                             | 277        |   |                           |   | 477        |      |  |   | 521        |   |  |   | 920        |  
|Interest expense                         |  |                             | (293       | ) |                           |   | (14        | )    |  |   | (542       | ) |  |   | (29        | )
|                                         |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Income before income taxes               |  |                             | 4,013      |   |                           |   | 3,876      |      |  |   | 3,650      |   |  |   | 775        |  
|Income tax provision                     |  |                             | (159       | ) |                           |   |           |      |  |   | (159       | ) |  |   |           |  
|                                         |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net income                               |  | $                           | 3,854      |   |                           | $ | 3,876      |      |  | $ | 3,491      |   |  | $ | 775        |  
|                                         |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net income per share  Basic             |  | $                           | 0.15       |   |                           | $ | 0.15       |      |  | $ | 0.13       |   |  | $ | 0.03       |  
|                                         |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Net income per share  Diluted           |  | $                           | 0.15       |   |                           | $ | 0.15       |      |  | $ | 0.13       |   |  | $ | 0.03       |  
|                                         |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|                                         |  |                             |            |  
|Weighted average common shares  Basic   |  |                             | 26,031,173 |   |                           |   | 25,795,798 |      |  |   | 26,030,472 |   |  |   | 25,753,471 |  
|                                         |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  
|Weighted average common shares  Diluted |  |                             | 26,408,999 |   |                           |   | 26,195,984 |      |  |   | 26,387,795 |   |  |   | 26,191,963 |  
|                                         |  |                             |            |   |                           |   |            |      |  |   |            |   |  |   |            |  

See accompanying notes to the condensed consolidated financial statements



3



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EFJ, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Six months ended June 30,
2007 and 2006

(Unaudited and in thousands)



|                                                                                  |  |                          |        |   |      |   |        |  
|--------------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ | -
|                                                                                  |  | Six Months EndedJune 30, |       
|                                                                                  |  | 2007                     |        |   | 2006 |  
|Cash flows from operating activities:                                             |  |                          |        |   |      |   |        |  
|Net income                                                                        |  | $                        | 3,491  |   |      | $ | 775    |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                          |        |   |      |   |        |  
|Depreciation and amortization                                                     |  |                          | 2,178  |   |      |   | 1,063  |  
|Recognition of deferred gain                                                      |  |                          | (47    | ) |      |   |       |  
|Deferred taxes                                                                    |  |                          | 2      |   |      |   |       |  
|Stock-based compensation                                                          |  |                          | 1,126  |   |      |   | 817    |  
|Gain on sale of fixed assets                                                      |  |                          |       |   |      |   | (50    | )
|Changes in operating assets and liabilities (net of acquisition):                 |  |                          |        |   |      |   |        |  
|Accounts receivable                                                               |  |                          | (7,779 | ) |      |   | 12,753 |  
|Receivables  other                                                               |  |                          | (1,600 | ) |      |   | (3,506 | )
|Cost in excess of billings on uncompleted contracts                               |  |                          | 866    |   |      |   | (606   | )
|Inventories                                                                       |  |                          | (5,500 | ) |      |   | (7,743 | )
|Prepaid expenses and other                                                        |  |                          | (1,239 | ) |      |   | (260   | )
|Accounts payable                                                                  |  |                          | 9,437  |   |      |   | 5,667  |  
|Accrued and other liabilities                                                     |  |                          | 1,068  |   |      |   | (1,230 | )
|Billings in excess of cost on uncompleted contracts                               |  |                          | (419   | ) |      |   | (5     | )
|Deferred revenues                                                                 |  |                          | (171   | ) |      |   | 106    |  
|                                                                                  |  |                          |        |   |      |   |        |  
|Total adjustments                                                                 |  |                          | (2,078 | ) |      |   | 7,006  |  
|                                                                                  |  |                          |        |   |      |   |        |  
|Net cash provided by operating activities                                         |  |                          | 1,413  |   |      |   | 7,781  |  
|                                                                                  |  |                          |        |   |      |   |        |  
|Cash flows from investing activities:                                             |  |                          |        |   |      |   |        |  
|Proceeds from sale of facility                                                    |  |                          |       |   |      |   | 4,600  |  
|Purchase of facility                                                              |  |                          |       |   |      |   | (3,627 | )
|Purchase of property, plant and equipment                                         |  |                          | (1,314 | ) |      |   | (1,533 | )
|Other assets                                                                      |  |                          | (2     | ) |      |   | (1,134 | )
|                                                                                  |  |                          |        |   |      |   |        |  
|Net cash used in investing activities                                             |  |                          | (1,316 | ) |      |   | (1,694 | )
|                                                                                  |  |                          |        |   |      |   |        |  
|Cash flows from financing activities:                                             |  |                          |        |   |      |   |        |  
|Principal payments on long-term debt                                              |  |                          | (4     | ) |      |   | (62    | )
|Deferred gain on facility purchase/sale/leaseback                                 |  |                          |       |   |      |   | (923   | )
|Proceeds from issuances of common stock                                           |  |                          | 16     |   |      |   |       |  
|Proceeds from exercise of stock options                                           |  |                          | 34     |   |      |   | 117    |  
|                                                                                  |  |                          |        |   |      |   |        |  
|Net cash provided by (used in) financing activities                               |  |                          | 46     |   |      |   | (868   | )
|                                                                                  |  |                          |        |   |      |   |        |  
|Net increase in cash and cash equivalents                                         |  |                          | 143    |   |      |   | 5,219  |  
|Cash and cash equivalents, beginning of period                                    |  |                          | 22,885 |   |      |   | 39,107 |  
|                                                                                  |  |                          |        |   |      |   |        |  
|Cash and cash equivalents, end of period                                          |  | $                        | 23,028 |   |      | $ | 44,326 |  
|                                                                                  |  |                          |        |   |      |   |        |  

Supplemental Disclosure of Cash Flow Information:

The Company paid interest of $505 and $29 during the six months ended June 30, 2007 and 2006, respectively.

The Company paid income taxes of $174 and $70 during the six months ended June 30, 2007 and 2006, respectively.

See accompanying notes to the condensed consolidated financial statements



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EFJ, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three and six months
ended June 30, 2007 and 2006

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

1. GENERAL

The condensed consolidated balance sheet
of EFJ, Inc. at December 31, 2006, presented within this Form 10-Q, has been derived from audited consolidated financial statements at that date. The condensed consolidated financial statements as of June 30, 2007 and for the three and six
months ended June 30, 2007 and 2006 are unaudited. The condensed consolidated financial statements reflect all normal and recurring accruals and adjustments that, in the opinion of management, are necessary for a fair presentation of the
financial position, operating results, and cash flows for the interim periods presented in this quarterly report. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes
thereto, together with managements discussion and analysis of financial condition and results of operations, contained in our Annual Report on Form 10-K for the year ended December 31, 2006. The results of operations and cash flows for
the three and six months ended June 30, 2007 are not necessarily indicative of the results for any other period or the entire fiscal year ending December 31, 2007.

On July 10, 2006, a merger was consummated pursuant to the Agreement and Plan of Merger (the Agreement) by and among EFJ, Inc., a
Delaware corporation (EFJ), Avanti Acquisition Corp., a Maryland corporation and wholly-owned subsidiary of EFJ (the Merger Sub), 3e Technologies International, Inc., a Maryland corporation (3eTI) , Chih-Hsiang
Li, as Stockholders Agent, and Steven Chen, James Whang, Chih-Hsiang Li and AEPCO, Inc., as Principal Stockholders (the Merger). Pursuant to the terms of the Agreement, Merger Sub was merged with and into 3eTI, which is the
surviving corporation (the Surviving Corporation) in the Merger, and the separate existence of Merger Sub thereupon ceased. As a result of the Merger, 3eTI became a wholly-owned subsidiary of EFJ.

Unless the context otherwise provides, all references to we, us, and our include EFJ, Inc., its predecessor entity
and its subsidiaries, including E.F. Johnson Company, Transcrypt International, Inc., and 3e Technologies International, Inc., on a consolidated basis. All references to EFJohnson refer to E.F. Johnson Company, all references to
Transcrypt refer to Transcrypt International, Inc., and all references to 3eTI refer to 3e Technologies International, Inc. Further, all references to the private wireless communications segment refer to EFJohnson, and all
references to the secured communications segment refer to Transcrypt and 3eTI combined.

2. ORGANIZATION AND CONSOLIDATION

We are a provider of secure wireless and private wireless solutions which are sold to: (1) domestic and foreign public safety / public service
entities, (2) federal, state and local governmental agencies, including the Departments of Homeland Security and Defense, and (3) domestic and foreign commercial customers. Through our private wireless communications and secured
communications segments we design, develop, market, and support:



| |  |  | mobile and portable wireless radios;
| | - |  | ------------------------------------



| |  |  | stationary transmitters / receivers (base stations or repeaters);
| | - |  | -----------------------------------------------------------------



| |  |  | infrastructure equipment and systems;
| | - |  | -------------------------------------



| |  |  | secure encryption technologies for wireless radios;
| | - |  | ---------------------------------------------------



| |  |  | customized wireless network centric products and systems to the federal government primarily under government funded Small Business Innovative Research (SBIR)
programs; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | niche hardware and secure software technologies for the WLAN markets primarily in the government sector.
| | - |  | --------------------------------------------------------------------------------------------------------

The condensed consolidated financial statements include the accounts of EFJ, Inc. and our wholly-owned subsidiaries. All inter-company accounts and
transactions have been eliminated in consolidation.



5



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3. NET INCOME PER SHARE

Basic income per share (EPS) is calculated based upon the weighted average number of common shares outstanding during the period. The diluted EPS calculation reflects the potential dilution from common
stock equivalents such as stock options. Outstanding stock options with exercise prices lower than the average market price of the common stock for the respective periods are considered common stock equivalents and are dilutive in the calculation of
the diluted weighted average common shares. Outstanding stock options which had exercise prices higher than the average market price of the common stock for the periods are considered anti-dilutive and excluded from the calculation of diluted
weighted average common shares. The outstanding stock options which are considered dilutive and anti-dilutive are:



|                                  |  |                             |  |                           |  |           |  |          
|--------------------------------- |  | --------------------------- |  | ------------------------- |  | --------- |  | ---------
|                                  |  | Three Months Ended June 30, |  | Six Months Ended June 30,
|                                  |  | 2007                        |  | 2006                      |  | 2007      |  | 2006     
|Options with dilutive effect      |  | 174,462                     |  | 755,412                   |  | 174,462   |  | 1,144,222
|Options with anti-dilutive effect |  | 1,185,920                   |  | 458,960                   |  | 1,185,920 |  | 70,150   
|                                  |  |                             |  |                           |  |           |  |          
|Outstanding stock options         |  | 1,360,382                   |  | 1,214,372                 |  | 1,360,382 |  | 1,214,372
|                                  |  |                             |  |                           |  |           |  |          

We use the treasury stock method to calculate diluted weighted average common shares, as if all such options were
outstanding for the periods presented.

4. ACCOUNTING FOR STOCK-BASED COMPENSATION

We use the Black-Scholes option pricing model to determine the fair value of all option grants. For the three and six months ended June 30, 2007, we
recognized compensation expense of $0.4 million and $0.8 million, respectively, related to stock option grants and $0.2 million and $0.3 million, respectively, related to restricted stock grants. For the three and six months ended June 30,
2006, we recognized compensation expense of $0.3 million and $0.6 million, respectively, related to stock option grants and $0.1 million and $0.2 million, respectively, related to restricted stock grants

5. INTEREST RATE SWAP AGREEMENTS AND COMPREHENSIVE LOSS

We report all derivative instruments as hedging activities in the consolidated financial statements at fair value. Changes in the fair value of the derivatives are recorded each period in Accumulated Other Comprehensive Loss in the balance
sheet as the derivative is designated as effectively hedged at June 30, 2007. We entered into an interest rate swap agreement to manage interest costs and risks associated with changing interest rates not for speculative or trading purposes.

On July 19, 2006, we entered into an interest rate swap agreement which effectively converts the variable LIBOR component of the
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 the counterparty will pay LIBOR on a monthly basis. The interest rate swap agreement terminates on
June 30, 2010, the termination date of the term loan. The cumulative net unrealized loss was $0.2 million and is included with other long-term liabilities and Accumulated Other Comprehensive Loss in the consolidated balance sheet at
June 30, 2007.



6



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The following is a summary of the components of comprehensive income:



|                                             |  |                            |       |                          |   |       |  |      |       |  |   |    
|-------------------------------------------- |  | -------------------------- | ----- | ------------------------ | - | ----- |  | ---- | ----- |  | - | ---
|                                             |  | Three Months EndedJune 30, |       | Six Months EndedJune 30,
|                                             |  | 2007                       |       | 2006                     |   | 2007  |  | 2006
|Net income                                   |  | $                          | 3,854 |                          | $ | 3,876 |  | $    | 3,491 |  | $ | 775
|Fair value adjustment for interest rate swap |  |                            | 210   |                          |   |      |  |      | 165   |  |   |   
|                                             |  |                            |       |                          |   |       |  |      |       |  |   |    
|Total comprehensive income                   |  | $                          | 4,064 |                          | $ | 3,876 |  | $    | 3,656 |  | $ | 775
|                                             |  |                            |       |                          |   |       |  |      |       |  |   |    

6. INVENTORIES

The following is a summary of inventories:



|                          |  |               |        |                   |   |       
|------------------------- |  | ------------- | ------ | ----------------- | - | ------
|                          |  | June 30, 2007 |        | December 31, 2006
|Raw material and supplies |  | $             | 13,994 |                   | $ | 9,350 
|Work in progress          |  |               | 644    |                   |   | 655   
|Finished goods            |  |               | 12,977 |                   |   | 12,240
|Service inventories       |  |               | 3,399  |                   |   | 2,965 
|                          |  |               |        |                   |   |       
|                          |  |               | 31,014 |                   |   | 25,210
|Reserve for obsolescence  |  |               | 1,103  |                   |   | 799   
|                          |  |               |        |                   |   |       
|Total inventories         |  | $             | 29,911 |                   | $ | 24,411
|                          |  |               |        |                   |   |       

The inventory balances have increased at June 30, 2007 mainly due to the increases related to
raw materials and service inventories in the Private Wireless segment.

7. GOODWILL AND INTANGIBLE ASSETS

We do not amortize our goodwill and tradename, but instead review such assets for impairment, at least annually. We performed fair value-based impairment
tests at December 31, 2006 and 2005, relating to the EFJohnson reporting unit and concluded that no impairment of goodwill or tradename had occurred as of such dates. No events occurred during the six months ended June 30, 2007 and 2006,
respectively, which would indicate that an impairment of such assets had taken place as of such dates.

Additional intangible assets were
purchased as part of the acquisition of 3eTI, as discussed in Note 14. Intangible assets, consisting of existing technology, customer relationships, license and covenants not-to-compete, are amortized over their useful life on a straight-line basis.
Intangible assets consisting of trademark and tradename and certifications are not subject to amortization, but will be reviewed for impairment at least annually. No events occurred during the six months ended June 30, 2007 that would indicate
an impairment of such assets had taken place as of such date.



7



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Amortization expense, related to intangible assets which are subject to amortization, was $0.8 million
and zero for the six months ended June 30, 2007 and June 30, 2006, respectively. Intangible assets consist of the following as of the dates indicated:



|                                               |  |               |        |                   |   |        |        |  |        |        |              |   |        |        |   |        |   |  |   |       
|---------------------------------------------- |  | ------------- | ------ | ----------------- | - | ------ | ------ |  | ------ | ------ | ------------ | - | ------ | ------ | - | ------ | - |  | - | ------
|                                               |  | June 30, 2007 |        | December 31, 2006
|                                               |  | Gross         |        | Accumulated       |   |        | Net    |  | Gross  |        | Accumulated  |   |        | Net   
|                                               |  | Amount        |        | Amortization      |   |        | Amount |  | Amount |        | Amortization |   |        | Amount
|Intangible assets not subject to amortization: |  |               |        |                   |   |        |        |  |        |        |              |   |        |        |   |        |   |  |   |       
|Goodwill                                       |  | $             | 25,515 |                   | $ |       |        |  | $      | 25,515 |              | $ | 25,513 |        | $ |       |   |  | $ | 25,513
|Trademarks                                     |  |               | 4,664  |                   |   |       |        |  |        | 4,664  |              |   | 4,664  |        |   |       |   |  |   | 4,664 
|Certifications                                 |  |               | 1,230  |                   |   |       |        |  |        | 1,230  |              |   | 1,230  |        |   |       |   |  |   | 1,230 
|                                               |  |               |        |                   |   |        |        |  |        |        |              |   |        |        |   |        |   |  |   |       
|                                               |  |               | 31,409 |                   |   |       |        |  |        | 31,409 |              |   | 31,407 |        |   |       |   |  |   | 31,407
|Intangible assets subject to amortization:     |  |               |        |                   |   |        |        |  |        |        |              |   |        |        |   |        |   |  |   |       
|Existing technology                            |  |               | 6,190  |                   |   | (1,841 | )      |  |        | 4,349  |              |   | 6,190  |        |   | (1,566 | ) |  |   | 4,624 
|Customer relationships                         |  |               | 4,800  |                   |   | (700   | )      |  |        | 4,100  |              |   | 4,800  |        |   | (297   | ) |  |   | 4,503 
|License                                        |  |               | 320    |                   |   | (64    | )      |  |        | 256    |              |   | 320    |        |   | (32    | ) |  |   | 288   
|Covenant not-to-compete                        |  |               | 400    |                   |   | (200   | )      |  |        | 200    |              |   | 400    |        |   | (117   | ) |  |   | 283   
|Trademarks / patents                           |  |               | 116    |                   |   | (72    | )      |  |        | 44     |              |   | 113    |        |   | (67    | ) |  |   | 46    
|                                               |  |               |        |                   |   |        |        |  |        |        |              |   |        |        |   |        |   |  |   |       
|                                               |  |               | 11,826 |                   |   | (2,877 | )      |  |        | 8,949  |              |   | 11,823 |        |   | (2,079 | ) |  |   | 9,744 
|Total                                          |  | $             | 43,235 |                   | $ | (2,877 | )      |  | $      | 40,358 |              | $ | 43,230 |        | $ | (2,079 | ) |  | $ | 41,151
|                                               |  |               |        |                   |   |        |        |  |        |        |              |   |        |        |   |        |   |  |   |       

The changes in the carrying amounts of goodwill and identified intangibles for the six months ended June 30,
2007 are as follows:



|                                          |  |        |        |              |   |        |        |  |   |        |  
|----------------------------------------- |  | ------ | ------ | ------------ | - | ------ | ------ |  | - | ------ | -
|                                          |  | Gross  |        | Accumulated  |   |        | Net    | 
|                                          |  | Amount |        | Amortization |   |        | Amount | 
|Intangible assets as of December 31, 2006 |  | $      | 43,230 |              | $ | (2,079 | )      |  | $ | 41,151 |  
|Amortization of intangible assets         |  |        |       |              |   | (795   | )      |  |   | (795   | )
|Current year additions                    |  |        | 5      |              |   | (3     | )      |  |   | 2      |  
|                                          |  |        |        |              |   |        |        |  |   |        |  
|Intangible assets as of June 30, 2007     |  | $      | 43,235 |              | $ | (2,877 | )      |  | $ | 40,358 |  
|                                          |  |        |        |              |   |        |        |  |   |        |  

8. NOTE PAYABLE AND LINE OF CREDIT

We amended our secured line of credit agreement with Bank of America in July 2006 to include a revolving line of credit of up to $15.0 million and to
include a term loan of $15.0 million (the Loan Agreement). Both borrowings bear interest at a variable rate based on the London Interbank Offered Rate (LIBOR) plus a margin (LIBOR Margin) determined by our ratio
of debt to earnings before interest, taxes, depreciation, and amortization (EBITDA), as defined. The LIBOR Margin was 175 basis points at June 30, 2007, and the interest rate in effect at June 30, 2007 was 7.07 percent. The
Loan Agreement expires June 30, 2010.

The $15.0 million term loan was fully funded and used to finance the acquisition of 3eTI as
described in Note 14. At June 30, 2007 and December 31, 2006, no borrowings have been made on the revolving line of credit. Letters of credit under our line of credit were $0.3 million as of June 30, 2007 and December 31, 2006.
The total available credit under the line of credit was $14.6 million and $10.9 million as of June 30, 2007 and December 31, 2006, respectively.

The Loan Agreement provides for customary affirmative and negative covenants, including maintenance of corporate existence, rights, property, books and records and insurance, compliance with contracts and laws, and
certain reporting requirements, as well as limitations on debt, liens, fundamental changes, acquisitions, transfers of assets, investments, loans, guarantees, use of proceeds, sale-leaseback transactions and capital expenditures. In addition, the
Loan Agreement contains certain financial covenants including a maximum ratio of funded debt to EBITDA and a fixed charge coverage ratio. The Loan Agreement also provides for events of default that would permit the lender to accelerate the loans
upon their occurrence, including failure to make payments, breaches of representations and warranties, insolvency events, acceleration of other indebtedness, failure to discharge judgments, material adverse effects, certain breaches of contracts,
casualty losses when no or insufficient insurance is maintained, changes of control, certain ERISA events and failure to observe covenants. As collateral for the obligations under the Loan Agreement, the Lender has a security interest in
substantially all assets of the borrowers, including accounts receivable, inventories, machinery, equipment, real estate, and general intangibles.



8



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As noted in our Form 10-K for the period ending December 31, 2006, we were not in compliance with
the financial covenants of the Loan Agreement for the quarter ended December 31, 2006. As a result, on March 5, 2007 we executed an Amendment to the Loan Agreement whereby the Bank of America waived such financial covenant defaults on a
one time basis, subject to further modification of the Loan Agreement to revise such financial covenants, to modify the advance and borrowing revisions under the Loan Agreement and for certain other purposes more fully set out in the amendment. For
the quarter ended June 30, 2007, we were in compliance with the financial covenants of the Loan Agreement as amended.

9. INCOME TAXES

Income taxes have been provided using the asset and liability method and the provision for income taxes reflects our estimate of the
effective rate expected to be applicable for the full fiscal year. Under the asset and liability method, a deferred tax asset or liability is recognized for estimated future tax effects attributable to permanent and temporary differences,
utilization of carryforwards relating to net operating loss and business tax credits. The measurement of deferred income tax assets is adjusted by a valuation allowance, if necessary, to recognize future tax benefits only to the extent that it is
more likely than not such benefits will be realized based on available evidence.

We recorded a tax provision of $0.2 million and $0.2
million for the three and six months ended June 30, 2007, respectively, and no tax provisions for the three and six months ended June 30, 2006, respectively. The difference between our effective tax rates and the 34% federal statutory rate
resulted primarily from utilization of net operating loss carryforwards and changes in the valuation allowance.

We adopted the provisions
of Financial Standards Accounting Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) an interpretation of FASB Statement No. 109 (SFAS 109) on January 1, 2007. FIN 48
prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim
periods, disclosure and transition issues. The Company has unrecognized tax benefits of approximately $0.4 million that did not change significantly during the six months ended June 30, 2007 relating to carry forward of business credits. The
adoption of FIN 48 did not result in the recognition of additional tax liability for unrecognized income tax benefits since the tax benefits have not been included in prior income tax return filings. In addition, future changes in the unrecognized
tax benefit will have no net impact on the effective tax rate due to the existence of the valuation allowance.

As of June 30, 2007,
we have no accrual requirement for interest or penalties related to uncertain tax positions since the tax benefits have not been included in prior income tax return filings. Accrued interest relating to uncertain tax positions would be recorded as a
component of interest expense and penalties related to uncertain tax positions would be recorded as a component of general and administrative expenses.

The tax years 2003-2006 remain open to examination by the major taxing jurisdictions to which we are subject. Additionally, upon inclusion of the NOL and R&D credit carry forward tax benefits from tax years 1996
to 2002 in future tax returns, the related tax benefit for the period in which the benefit arose may be subject to examination.

10. WARRANTY COSTS

We provide a one or two year warranty on substantially all of our products, depending upon certain terms and conditions of the sale, and
estimate future warranty claims based on historical experience 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 for specific items after the sale when
their existence is known. A reconciliation of changes in our accrued warranty reserve as of June 30, 2007 is as follows:



|                               |  |                             |       |                   |   |                         |  |   |                         |   |  |   |      
|------------------------------ |  | --------------------------- | ----- | ----------------- | - | ----------------------- |  | - | ----------------------- | - |  | - | -----
|                               |  | Balance atDecember 31, 2006 |       | Charged toExpense |   | Deduction /Expenditures |  |   | Balance atJune 30, 2007
|Allowance for warranty reserve |  | $                           | 1,412 |                   | $ | 2,899                   |  | $ | (1,580                  | ) |  | $ | 2,731
|                               |  |                             |       |                   |   |                         |  |   |                         |   |  |   |      

11. COMMITMENTS AND CONTINGENCIES

On February 5, 2001, ASRC Communication (ASRC) filed a complaint in United States District Court for the District of Alaska, seeking
damages against EFJohnson on claims arising out of EFJohnsons sale of radio products to ASRC. ASRC purchased, and resold to the State of Alaska, approximately $0.5 million of products from EFJohnson since 1999. ASRCs complaint
anticipated that the State of Alaska would prosecute its claims against ASRC under an administrative procedure provided for under the Alaska State Procurement Code for damages associated with alleged malfunctions of EFJohnson radios. Under a
May 21, 2003 agreement between ASRC and EFJohnson (the ASRC Agreement), EFJohnson



9



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agreed to defend ASRC, at EFJohnsons expense, against any of the State of Alaskas claim alleging non-performance of the EFJohnson radios. In the
event the State of Alaska prevailed in its claim, EFJohnson and ASRC agreed to allocate any award in favor of the State of Alaska in accordance with the formula in the ASRC Agreement. In addition, the parties agreed to resolve any issue or dispute
remaining between them after the conclusion of the State administrative proceeding through mediation and binding arbitration. Based upon the ASRC Agreement, ASRC and EFJohnson dismissed the claims against each other. On or about April 6, 2004,
the State of Alaskas Department of Administration, Information Technology Group filed an administrative claim under the State Procurement Code against ASRC for damages associated with the EFJohnson radios. On June 30, 2005, the presiding
administrative law judge granted the Companys motion to dismiss, and dismissed the administrative claim without prejudice to renewal of the action if the matter is not resolved on the merits in the Superior Court. On January 12, 2007, the
State of Alaska filed a complaint against ASRC in the Superior Court for the State of Alaska claiming damages of at least $0.6 million for breach of contract. Pursuant to the ASRC Agreement, we will defend and indemnify ASRC for any damages they
incur. This matter was settled for $0.2 million in the second quarter of 2007 that was accrued as of December 31, 2006.

We are
involved in certain other legal proceedings incidental to the normal conduct of our business. At this time, we do not believe that any liabilities relating to such other legal proceedings are likely to be, individually or in the aggregate, material
to our business, financial condition, results of operations or cash flows.

The total we have accrued in regards to all legal proceedings
as of June 30, 2007 was $0.05 million.

In the normal course of our business activities, we are required under contracts with various
government authorities to provide letters of credit and bonds that may be drawn upon if we fail to perform under these contracts. At June, 30, 2007 and December 31, 2006 we had open letters of credit totaling $0.3 million. Bonds, which expire
on various dates, totaled $0.5 million on June 30, 2007 and December 31, 2006. No bonds had been drawn upon at either date.



10



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12. SEGMENT AND RELATED INFORMATION

We operate in two reporting segments: Private Wireless Communications and Secured Communications. Our Private Wireless Communications segment is composed of our EFJohnson subsidiary. Our Secured Communications segment
is composed of our Transcrypt and 3eTI subsidiaries. Prior to the acquisition of 3eTI, Transcrypt was the only component of the Secured Communications segment. Each segment is led by a business unit President and we evaluate the results of each
segment based on gross margin and income from operations. Corporate general and administrative expenses are allocated to the operating segments based upon certain criteria, including the estimated usage of corporate resources. The following table is
a summary of the unaudited operating results for our reporting segments for the three and six months ended June 30, 2007 and 2006.



|                                |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|------------------------------- |  | -------------------------- | ------- | ------------------------ | ---- | - | ------- |  | - | ------- | - |  | - | ------- | -
|                                |  | Three Months EndedJune 30, |         | Six Months EndedJune 30, |     
|                                |  | 2007                       |         |                          | 2006 |   | 2007    |  |   | 2006    |  
|Revenue:                        |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|Private Wireless Communications |  | $                          | 51,455  |                          |      | $ | 23,050  |  | $ | 82,713  |   |  | $ | 27,613  |  
|Secured Communications          |  |                            | 5,841   |                          |      |   | 5,700   |  |   | 13,531  |   |  |   | 11,700  |  
|                                |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|                                |  | $                          | 57,296  |                          |      | $ | 28,750  |  | $ | 96,244  |   |  | $ | 39,313  |  
|                                |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|                                |  |                            |         |                         
|Gross Profit:                   |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|Private Wireless Communications |  | $                          | 15,469  |                          |      | $ | 7,688   |  | $ | 24,697  |   |  | $ | 8,220   |  
|Secured Communications          |  |                            | 2,961   |                          |      |   | 4,813   |  |   | 6,307   |   |  |   | 9,830   |  
|                                |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|                                |  | $                          | 18,430  |                          |      | $ | 12,501  |  | $ | 31,004  |   |  | $ | 18,050  |  
|                                |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|                                |  |                            |         |                         
|Operating income (loss):        |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|Private Wireless Communications |  | $                          | 5,462   |                          |      | $ | 143     |  | $ | 5,960   |   |  | $ | (6,280  | )
|Secured Communications          |  |                            | (1,433  | )                        |      |   | 3,270   |  |   | (2,289  | ) |  |   | 6,164   |  
|                                |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|Income from operations          |  |                            | 4,029   |                          |      |   | 3,413   |  |   | 3,671   |   |  |   | (116    | )
|Other income / (expense), net   |  |                            | (16     | )                        |      |   | 463     |  |   | (21     | ) |  |   | 891     |  
|                                |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|Income / (loss) before taxes    |  | $                          | 4,013   |                          |      | $ | 3,876   |  | $ | 3,650   |   |  | $ | 775     |  
|                                |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|                                |  |                            |         |                         
|Depreciation & Amortization:    |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|Private Wireless Communications |  | $                          | 593     |                          |      | $ | 473     |  | $ | 1,139   |   |  | $ | 941     |  
|Secured Communications          |  | $                          | 500     |                          |      | $ | 63      |  | $ | 1,039   |   |  | $ | 122     |  
|                                |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|                                |  | $                          | 1,093   |                          |      | $ | 536     |  | $ | 2,178   |   |  | $ | 1,063   |  
|                                |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|                                |  |                            |         |                         
|Assets:                         |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|Private Wireless Communications |  | $                          | 76,468  |                          |      | $ | 68,209  |  | $ | 76,468  |   |  | $ | 68,209  |  
|Secured Communications          |  |                            | 64,945  |                          |      |   | 46,879  |  |   | 64,945  |   |  |   | 46,879  |  
|Corporate                       |  |                            | 25,681  |                          |      |   | 25,335  |  |   | 25,681  |   |  |   | 25,335  |  
|                                |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  
|                                |  | $                          | 167,094 |                          |      | $ | 140,423 |  | $ | 167,094 |   |  | $ | 140,423 |  
|                                |  |                            |         |                          |      |   |         |  |   |         |   |  |   |         |  

13. SALE/LEASEBACK TRANSACTION

On March 31, 2006, EFJohnson exercised an option under an existing lease agreement to purchase the facility at 1440 Corporate Drive in Irving, Texas
for $3.6 million. Simultaneously, EFJohnson sold the facility to an unrelated party for $4.6 million and EFJ, Inc. executed a 10-year lease for the facility. The aggregate effect of the purchase and sale transactions was a gain of $1.0 million,
which has been deferred and is recorded in accrued liabilities in the accompanying financial statements.

The 10-year lease executed by
EFJ, Inc. covered the entire facility purchased and sold in the previous transactions; therefore, the gain has been deferred and will be amortized over the term of the lease as a reduction of rent expense in general and administrative expenses.



11



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14. ACQUISITION OF 3ETI

On July 10, 2006, we completed a merger resulting in our owning 100% of the equity of 3eTI, which became a wholly-owned subsidiary of EFJ. This merger allows us to increase our product portfolio by adding
wireless data and wireless data security products and solutions that expand the addressable market for our company. 3eTI is a provider of customized wireless network centric products and systems to the federal government primarily under government
funded SBIR programs; and a provider of wireless data hardware for WiFi and mesh networking and secure software technologies that meet federal standards for securing wireless data networks primarily in the government sectors. We also offer products
to commercial, non-governmental users.

The total consideration paid by EFJ in the merger consisted of $36.0 million in cash, which
includes $3.6 million to be held in escrow to indemnify us for any claims under the merger agreement and certain purchase price adjustments. The remaining amount in the escrow account after satisfying indemnification claims and purchase price
adjustments, if any, will be distributed to 3eTIs selling shareholders.

3eTI is included in our secured communications segment.

The following is supplemental pro forma information presented as if the acquisition of 3eTI had occurred at the beginning of each of the
respective periods. The pro forma financial information is not necessarily indicative of our actual results of operations had the 3eTI results been included in our consolidated financial statements for the periods indicated. In addition, the
unaudited pro forma financial results do not attempt to project the future results of operations of the combined company.



|                             |  |                                 |        |                                |   |             |  |           |        |  |   |        |  
|---------------------------- |  | ------------------------------- | ------ | ------------------------------ | - | ----------- |  | --------- | ------ |  | - | ------ | -
|                             |  | Three months endedJune 30, 2006 |        | Six months ended June 30, 2006 |  
|                             |  | As Reported                     |        | Pro Forma                      |   | As Reported |  | Pro Forma |       
|Revenue                      |  | $                               | 28,750 |                                | $ | 34,836      |  | $         | 39,313 |  | $ | 52,380 |  
|Net income (loss)            |  | $                               | 3,876  |                                | $ | 3,412       |  | $         | 775    |  | $ | (550   | )
|Net income (loss) per share: |  |                                 |        |                                |   |             |  |           |        |  |   |        |  
|Basic                        |  |                                 | 0.15   |                                |   | 0.13        |  |           | 0.03   |  |   | (0.02  | )
|Diluted                      |  |                                 | 0.15   |                                |   | 0.13        |  |           | 0.03   |  |   | (0.02  | )



12



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|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

Discussions of certain matters contained in this Quarterly Report on Form 10-Q may constitute forward-looking statements under Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, (the Exchange Act). These forward-looking statements are based upon our current expectations, estimates and projections about
our business and our industry, and reflect our beliefs and assumptions based upon information available to us at the date of this report. 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 of our product development efforts, future sales and expense levels, our future financial condition, liquidity, and business prospects generally, the impact
of our relocation of operating facilities, and outsourcing of EF Johnsons manufacturing on our operating results, perceived opportunities in the marketplace for our products, and our other business plans for the future.

These forward-looking statements are subject to certain risks and uncertainties that could cause the actual results, performance and outcomes to differ
materially from those expressed or implied in these forward-looking statements due to a number of risk factors including, but not limited to, our expectations on profitability, margin improvement for the business, improved costs on our products,
backlog and the risks discussed in the 2006 Annual Report on Form 10-K under Item 1A Risk Factors and in Part II of this report on Form 10-Q under Item 1A Risk Factors. We caution readers not to rely on these
forward-looking statements, which reflect managements analysis only as of the date of this quarterly report. We undertake no obligation to revise or update any forward-looking statement for any reason except as required by law.

The following discussion is intended to provide a better understanding of the significant changes in trends relating to our financial condition and
results of operations. Managements Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and Notes thereto.

Overview

EFJ, Inc. is a provider of secure wireless
technologies primarily for the homeland security marketplace. Through our private wireless segment, we design, develop, market and support private wireless communications, including wireless radios and wireless communications infrastructure and
systems for digital and analog platforms. In addition and through our secured communications segment, we offer encryption technologies for wireless voice, video and data communications and we also design, develop, market and support secure wireless
networking solutions that include Wi-Fi products, mesh networking, access points, and client infrastructure products. We provide our products and services to homeland security, defense, public safety and public service, international markets and
business and industrial customers.

Due to the timing of orders and seasonality, our quarterly results fluctuate. In our private wireless
communications segment, we experience seasonality in our results in part due to governmental customer spending patterns that are influenced by government fiscal year-end budgets and appropriations. The unpredictable sales cycle of our secured
communications products in addition to launching new hardware and secure software for the WLAN market in this segment can also cause variations from quarter to quarter.

Private Wireless Communications

Our private wireless communications segment designs, develops,
markets and supports secure wireless radios, wireless communications infrastructure and systems. Our wireless radio offerings are primarily digital solutions designed to operate in both analog and digital system environments. Our products and
systems are based on industry standards designed to enhance interoperability among systems, improve bandwidth efficiency, and integrate voice and data communications.

The private wireless communications industry provides two-way wireless communications through wireless networks, which include infrastructure components such as base stations, transmitters and receivers, network
switches and portable and mobile two-way communication radios. Individual users operate portable hand-held radios and vehicular-mounted radios in the private wireless communications system. Utilizing free licensed RF spectrum, the customer owns and
operates the private wireless communications system that is networked by linking together the infrastructure components. We develop customer solutions, which leverage the customers private wireless system and wireless radios with customer
specific or enterprise wide applications.

The majority of revenues in our private wireless communications segment are derived from the
sale of wireless radio products. Our federal, state and local governmental agency customers are increasingly demanding interoperable, secured, private wireless communications products and systems. We believe this demand has created opportunities and
we believe we are positioned to provide both of these products and systems. As a result, we expect to continue to allocate a portion of our on-going research and development expenditures to infrastructure components and system development efforts.



13



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Our private wireless communications products and systems are sold domestically through a direct sales
force, dealers and manufacturing representatives. We utilize our dealer network to assist in installing, servicing, selling and distributing our products.

In 2004, we relocated our private wireless communications operations from Waseca, Minnesota to Irving, Texas to benefit from a larger and more experienced engineering and marketing community, and to increase
synergistic opportunities with other local technology providers. Concurrent with this move, we began to outsource the manufacturing of our products.

Secured Communications

Our secured communications segment designs,
develops, markets and supports secured communications products. The company designs and manufactures secure Wi-Fi products, including mesh networking, access point, bridge, and client infrastructure products, as well as security software. We also
provide sensor network solutions, through our InfoMatics®middleware, which enables
sensors and databases to communicate data to pertinent personnel for command and control applications in near real-time. We also provide products with secure encryption technologies for analog wireless radios. These products are specifically
designed to prevent unauthorized access to sensitive voice communications. Our secured communications segment leverages our technology expertise, government relationships and leading market position to gain new customers. In parts of the world where
wireless radio systems remain analog, security needs are high, and the cost to upgrade to a digital secured communications system is usually prohibitive.

Under our 3eTI brand, we provide customized wireless network centric products and systems. To date, most of our sales have been to the federal government, primarily under government funded research and development
SBIR programs. These products and solutions utilize FIPS 140-2 validated wireless products, 802.11 wireless networking (WIFI) solutions, mesh networking and conditions based and location based telematics solutions. We also offer our products to
commercial, non-governmental users.

Under our Transcrypt brand, we offer secure encryption technologies for analog wireless radios. These
products are specifically designed to prevent unauthorized access to sensitive voice communications. We leverage our market position to gain new customers in parts of the world where wireless radio systems remain analog, security needs are high, and
the cost to upgrade to a digital secured communications system is usually prohibitive. These products are sold as aftermarket add-on components or embedded components for existing analog radios and systems. We have also developed an encryption
product that uses digital technology in order to obtain higher levels of security and allows for compatibility with our analog encryption product line.

Sales

Our private wireless communications products and systems are sold domestically through a direct sales force, dealers and
manufacturing representatives. We utilize our dealer network to assist in installing, servicing, selling and distributing our products. To date, most of our secured communications products have been sold to the federal government, primarily through
government funded SBIR programs. We also utilize a select group of dealers, distributors, and strategic partnering arrangements to sell our products and solutions. Several products and solutions utilize FIPS 140-2 validated wireless products, 802.11
wireless networking (WIFI) solutions, mesh networking and conditions based and location based telematics solutions.

Much of our private
wireless business is obtained through submission of formal competitive bids. Our governmental customers generally can specify the terms, conditions and form of the contract. Government business for both segments is subject to government funding
decisions and contract types can vary widely, including cost plus, fixed-priced, indefinite-delivery/indefinite quantity, or IDIQ, and government-wide acquisition contracts with the General Services Administration, or GSA, which requires
pre-qualification of vendors and allows government customers to more easily procure our products and systems.

Depending on the size and
complexity of customer specifications and requirements, products can be shipped to the customer in a relatively short period of time (typically 90 days) or with complex integrations and various delivery dates, orders can span multiple years. For
example, our longer-term system contracts and government services revenues are generated under customer contracts and agreements for which revenue is recorded under the percentage-of-completion method.



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Description of Operating Accounts

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

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

Gross Profit. Gross profit is net revenues less the cost of 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. Un-reimbursed research and development
expenses consist primarily of costs associated with research and development personnel, materials, and the depreciation of research and development equipment and facilities. We expense all un-reimbursed research and development costs as they are
incurred while all research and development expenses that are reimbursed by our government customers are included as a component of cost of sales.

Sales and Marketing. Sales and marketing expenses consist primarily of salaries and related costs of sales personnel, including sales commissions and travel expenses, as well as costs of advertising, product and program management,
public relations and trade show participation.

General and Administrative. General and administrative expenses consist primarily of
salaries and other expenses associated with our management, accounting, information systems and administrative functions. This expense also includes the impact of equity-based compensation expense. For 3eTI, accounting for government contracts
delineates what is a direct charge allowable to include in contract costs and what is considered to be an indirect charge reflected as general and administrative expenses. We consider indirect engineering labor and operating costs such as quality,
planning, operations, and company fringe benefits, general administrative salaries and other general administrative expenses as general and administrative expense.

Net Interest Income or Expense.Net interest income (expense) consists of interest expense on the term note and capital leases net of interest income earned on cash and invested funds.

Provision for Income Taxes. Provision (benefit) for income taxes includes the increase or decrease in the valuation reserve that is based upon
managements conclusions regarding, among other considerations, our historical operating results and forecasted future earnings over a five year period, our current and expected customer base projections, and technological and competitive
factors impacting our current products. Current financial accounting standards require that organizations analyze all positive and negative evidence relating to deferred tax asset realization, which would include our historical accuracy in
forecasting future earnings, as well as our history of losses prior to 2001. Should factors underlying managements estimates change, future adjustments, either positive or negative, to our valuation allowance may be necessary. Our tax asset is
principally composed of net tax benefits associated with net operating loss carryforwards, or NOLs.

Critical Accounting Policies

The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, or
GAAP, requires management to make judgments, estimates and assumptions in certain circumstances that affect the amounts reported in the consolidated financial statements and related footnotes. We regularly evaluate the accounting policies and
estimates used to prepare our financial statements. Estimates are used for, but not limited to, the accounting for allowance for doubtful accounts and sales returns, application of the percentage of completion accounting for long-term contract
revenues, inventory reserves, warranty reserves, valuation allowance for deferred income tax assets, and contingencies. These estimates are based on historical experience and various assumptions that we believe to be reasonable under the particular
applicable facts and circumstances. Actual results could differ from those estimates.

We consider our critical accounting policies to be
those that involve significant judgments and uncertainties, require estimates that are difficult for management to determine, and have the potential to result in materially different outcomes under varying assumptions and conditions. Listed below
are those policies we believe are critical and require the use of complex judgment in their application.

Revenues

Product revenues are recognized when the earnings process is complete, less an estimate for an allowance for returns, if applicable, and collection is
reasonably assured. The earnings process is generally complete when the product is shipped, or received by the customer, depending upon whether the title to the goods, as well as the risks and benefits of ownership, are



15



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transferred to the customer at point of shipment or point of delivery, as typically we have no further obligations with respect to the sale which impact the
functionality of the product. For sales where collection is not reasonably assured, we recognize revenues as cash is received. If collection is contingent on a future event, we recognize revenues when the contingency lapses, generally upon cash
collection.

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

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

Deferred revenues include
unearned services provided under systems maintenance contracts. We recognize the fees based upon a straight-line method over the life of the contract.

We periodically review our revenue recognition procedures to assure that such procedures are in accordance with the provisions of Staff Accounting Bulletins 101 and 104, Statement of Position 88-1 and other
interpretations, as applicable. In addition, while most of our current products contain software, we believe the software is incidental in the overall context of our products features and functionality, therefore, at present we do not use
revenue recognition pronouncements applicable to software sales.

Inventories

Inventories are recorded at the lower of cost or market with cost determined by the first-in, first-out, or FIFO, method. We periodically assess our
inventories for potential obsolescence and lower-of-cost-or-market issues. We make estimates of inventory obsolescence, providing reserves when necessary, based on, among other factors, demand for inventories based on backlog, product pricing, the
ability to liquidate or sell older inventories, and the impact of introducing new products. A significant portion of our inventories is comprised of components and parts on hand to support maintenance of products previously sold. As such, we
anticipate utilizing such inventories over extended periods of time. Our obsolescence and lower of cost-or-market accounting policies provide for a periodic adjustment to the carrying value of such inventories. As of June 30, 2007, we had a
reserve for obsolescence of $1.1 million.

Goodwill and Other Intangible Assets

At least annually, we assess goodwill and other indefinite lived intangible assets, using fair value-based tests. If the respective carrying amount
exceeds the fair value, goodwill or other indefinite lived intangible assets are considered to be impaired. In evaluating impairment, we estimate the sum of the expected future cash flows derived from such reporting unit and present value implied by
estimates of future revenues, costs, expenses and other factors. The estimates use assumptions about our market segment share in the future and about future expenditures by government entities for private wireless communications products. We
continually evaluate whether events and circumstances have occurred that indicate the remaining balance of goodwill or other indefinite lived intangible assets may not be recoverable. To the extent our assumptions change, we may be required to
adjust the carrying value of the goodwill or other intangible assets. For a further discussion of goodwill and other intangible assets, see the discussion under Footnote 7  Notes to Condensed Consolidated Financial Statement.

Income Taxes

We account for
income taxes using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured using current enacted tax rates. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that
includes the enactment date.

We adopted FIN 48 Accounting for Uncertainty in Income Taxes an interpretation of FASB
Statement No. 109 Accounting for Income Taxes. Based on the review of the various tax positions we estimated uncertain tax positions in the amount of $0.4 million. However, these tax benefits have not been included in prior year
income tax return filings and are included in



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our deferred tax asset pools as of January 1, 2007 (FIN 48 adoption date) with a reasonable valuation reserve. Therefore, we have concluded that there
is no requirement to book a liability for FIN 48 as discussed in Note 9 to the condensed consolidated financial statements.

Long-Lived Assets

We review our long-lived assets, including intangible assets subject to amortization, for recoverability whenever events or
changes in circumstances indicate that the carrying amount of such long-lived asset or group of long-lived assets may not 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-lived asset is being used;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | a significant change in the business climate that could affect the value of the long-lived asset;
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | a current period loss combined with projection of continuing loss associated with use of the long-lived asset; and
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | a current expectation that, more likely than not, the long-lived asset will be sold or otherwise disposed of before the end of its previously estimated useful life.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

We continually evaluate whether events and circumstances have occurred which may indicate that the carrying value may
not be recoverable. When such events or circumstances exist, the recoverability of the long-lived assets carrying value shall be determined by estimating the undiscounted future cash flows (cash inflows less associated cash outflows) that are
directly associated with and that are expected to arise as a direct result of the use and eventual disposition of the long-lived asset. To date, no such impairment has occurred. To the extent such events or circumstances occur that could affect the
recoverability of our long-lived assets, we may be required to impair these assets.

Stock-based Compensation

Stock-based compensation cost is estimated at the grant date based on the value of the award and is recognized as expense ratably over the requisite
service period of the award. Determining the appropriate fair value model and calculating the fair value of stock-based awards at the grant date requires judgment, including estimating stock price volatility, forfeiture rates and expected option
life. To the extent our estimates used in calculating fair value are adjusted, the amount of compensation costs we would be required to record could change.



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Results of Operations

The following table presents certain Condensed Consolidated Statements of Operations information as a percentage of revenues during the periods indicated:



|                            |  |                            |   |  |                          |   |  |        |   |  |        |  
|--------------------------- |  | -------------------------- | - |  | ------------------------ | - |  | ------ | - |  | ------ | -
|                            |  | Three Months EndedJune 30, |   |  | Six Months EndedJune 30, |  
|                            |  | 2007                       |   |  | 2006                     |   |  | 2007   |   |  | 2006   |  
|Revenues                    |  | 100.00                     | % |  | 100.00                   | % |  | 100.00 | % |  | 100.00 | %
|Cost of sales               |  | 67.83                      |   |  | 56.52                    |   |  | 67.79  |   |  | 54.09  |  
|                            |  |                            |   |  |                          |   |  |        |   |  |        |  
|Gross profit                |  | 32.17                      |   |  | 43.48                    |   |  | 32.21  |   |  | 45.91  |  
|                            |  |                            |   |  |                          |   |  |        |   |  |        |  
|Operating expenses:         |  |                            |   |  |                          |   |  |        |   |  |        |  
|Research and development    |  | 7.18                       |   |  | 10.41                    |   |  | 7.87   |   |  | 14.59  |  
|Sales and marketing         |  | 6.49                       |   |  | 9.13                     |   |  | 7.40   |   |  | 12.01  |  
|General and administrative  |  | 10.81                      |   |  | 12.07                    |   |  | 12.30  |   |  | 19.61  |  
|Amortization of intangibles |  | 0.65                       |   |  |                         |   |  | 0.83   |   |  |       |  
|                            |  |                            |   |  |                          |   |  |        |   |  |        |  
|Total operating expenses    |  | 25.13                      |   |  | 31.61                    |   |  | 28.40  |   |  | 46.21  |  
|                            |  |                            |   |  |                          |   |  |        |   |  |        |  
|Income from operations      |  | 7.04                       |   |  | 11.87                    |   |  | 3.81   |   |  | (0.30  | )
|Interest income             |  | 0.47                       |   |  | 1.66                     |   |  | 0.54   |   |  | 2.34   |  
|Interest expense            |  | (0.51                      | ) |  | (0.05                    | ) |  | (0.56  | ) |  | (0.07  | )
|                            |  |                            |   |  |                          |   |  |        |   |  |        |  
|Income before income taxes  |  | 7.00                       |   |  | 13.48                    |   |  | 3.79   |   |  | 1.97   |  
|Income tax (expense)        |  | (0.27                      | ) |  |                         |   |  | (0.16  | ) |  |       |  
|                            |  |                            |   |  |                          |   |  |        |   |  |        |  
|Net Income                  |  | 6.73                       | % |  | 13.48                    | % |  | 3.63   | % |  | 1.97   | %
|                            |  |                            |   |  |                          |   |  |        |   |  |        |  

Comparison of the Three and Six Months Ended June 30, 2007 and 2006

Revenues.Our revenues increased $28.5 million, or 99%, to $57.3 million for the three months ended June 30, 2007 from $28.8 million for the
same period in 2006. In the second quarter of 2007, the private wireless communications segment revenues comprised $51.5 million, or 90% of total revenues, as compared to $23.1 million or 80% of total revenues in the second quarter of 2006. Revenues
from the secured communications segment comprised $5.8 million, or 10% of total revenues, as compared to $5.7 million or 20% of total revenues in the second quarter of 2006.

Our revenues increased $56.9 million, or 145%, to $96.2 million for the six months ended June 30, 2007 from $39.3 million for the same period in
2006. In the first six months of 2007, the private wireless communications segment revenues comprised $82.7 million, or 86% of total revenues, as compared to $27.6 million or 70% of total revenues in the first six months of 2006. Revenues from the
secured communications segment comprised $13.5 million, or 14% of total revenues, as compared to $11.7 million or 30% of total revenues in the first six months of 2006.

Private wireless communications revenues increased $28.4 million, or 123%, to $51.5 million for the three months ended June 30, 2007 from $23.1 million for the same period in 2006. For the first six months of
2007, the private wireless communications segment revenues increased $55.1 million to $82.7, or 200%, from $27.6 million in the same period for 2006. These increases are primarily due to deliveries against a large Department of Defense order we
previously announced.

Secured communications revenues increased $0.1 million, or 2%, to $5.8 million for the three months ended
June 30, 2007 from $5.7 million for the same period in 2006. For the first six months of 2007, the secured communications segment revenues increased $1.8 million, or 16%, to $13.5 million from $11.7 million in the same period for 2006. These
increases were attributable to the inclusion of 3eTI revenues of $4.9 million and $11.2 million during the second quarter and six months ended June 30, 2007, partially offset by the anticipated decline in Transcrypts encryption revenues.

Gross Profit.Our gross profit increased $5.9 million, or 47%, to $18.4 million in the three months ended June 30, 2007 from $12.5 million for
the same period in 2006. Gross profit, as a percentage of revenue, or gross margin, was 32% for the three months ended June 30, 2007, as compared to 43% for the same period in 2006. For the six months ended June 30, 2007,



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gross profit increased $13.0 million, to $31.0 million from $18.0 million. Gross margin for the first six months of 2007 decreased to 32% from 46% in the
first six months of 2006. The decline in gross margin is attributable to the anticipated decline in Transcrypts high gross margin revenues.

In the second quarter of 2007, gross profit for the private wireless communications segment was $15.5 million with a gross margin of 30%, compared to $7.7 million with a gross margin of 33% in the same period for 2006. For the first six
months of 2007, gross profit for the private wireless communications segment was $24.7 million with a gross margin of 30%, compared to $8.2 million with a gross margin of 30%, in the same period for 2006. The increase in gross profits in the first
six months of 2007 were primarily due to deliveries against a large Department of Defense order we previously announced.

In the second
quarter of 2007, gross profit for the secured communications segment was $3.0 million with a gross margin of 51%, compared to $4.8 million with a gross margin of 84% in the same period for 2006. For the first six months of 2007, gross profit for the
secured communications segment was $6.3 million with a gross margin of 47%, compared to $9.8 million with a gross margin of 84%, in the same period for 2006. The decline in gross margin is attributable to the anticipated decline in Transcrypts
high gross margin revenues.

Research and DevelopmentResearch and development expenses increased $1.1 million, or 37%, to $4.1
million in the three months ended June 30, 2007 from $3.0 million in the same period in 2006. Research and development expenses were 7% of revenues in the second quarter of 2007, as compared to 10% during the same period in 2006. For the six
months ended June 30, 2007, research and development increased $1.8 million, or 32%, to $7.6 million from $5.7 million. In the first six months of 2007, research and development expenses were 8% of revenues compared to 15% in the same period of
2006.

These increases are attributable to new product deliveries requiring project, prototype and testing together with the inclusion of
3eTI . Additionally we received a non-recurring engineering benefit of $0.6 million in the first quarter of 2006 associated with 800 MHz product line that was not replicated in the first quarter of 2007. We expect research and development expenses
to be approximately 8% to 9% of 2007 revenues.

Sales and Marketing.Sales and marketing expenses increased $1.1 million, or 42%, to
$3.7 million for the three months ended June 30, 2007 from $2.6 million for the same period in 2006. As a percentage of revenue, sales and marketing expenses decreased to 6% of revenues in the second quarter of 2007 from 9% of revenues in the
second quarter of 2006. For the first six months of 2007, sales and marketing expenses increased $2.4 million to $7.1 million from $4.7 million in the same period in 2006. Sales and marketing expenses were 7% of revenues in the first six months of
2007 and 12% of revenues in 2006. These increases are the result of higher commission expense associated with the increased revenues and the inclusion of sales marketing expenses for our 3eTI branded products.

General and Administrative.General and administrative expenses increased $2.7 million, or 78%, to $6.2 million (11% of revenues) for the three
months ended June 30, 2007 from $3.5 million (12% of revenues) for the same period in 2006. For the first six months of 2007, general and administrative expenses increased $4.1 million, or 53%, to $11.8 million (12% of revenues) from $7.7
million (20% of revenues) in 2006. The majority of the increases in expenses were attributable to the inclusion of 3eTI administrative expenses amounting to $1.6 million in the second quarter and $3.1 million for the first six months of 2007.
Included in general and administrative expenses in the three and six months ended June 30, 2007 were $0.6 million and $1.1 million, respectively, related to equity compensation expense. In the three and six month periods ended June 30,
2006, we recorded $0.4 million and $0.8 million in equity compensation expense.

Amortization of Intangibles.Amortization of
intangibles of $0.4 million and $0.8 million for the three and six months ended June 30, 2007 reflects the amortization of specifically identifiable intangible assets resulting from the 3eTI acquisition.

Net Interest Income /(Expense).Net interest income/(expense) decreased to virtually zero for the three months ended June 30, 2007 from $0.5
million for the same period in 2006. Net interest income/(expense) decreased to virtually zero for the six months ended June 30, 2007 from $0.9 million for the same period in 2006. This is attributable to interest on the term loan associated
with the 3eTI acquisition and lower interest income earned on cash balances.

Provision for Income Taxes.We recorded a tax
provision of $0.2 million for the three and six months ended June 30, 2007, respectively, and no tax provisions for the three and six months ended June 30, 2006, respectively. The difference between our effective tax rates and the 34%
federal statutory rate resulted primarily from utilization of net operating loss carryforwards and changes in the valuation allowance.

The
valuation reserve is based upon managements conclusions regarding, among other considerations, our operating results during 2007, our current and expected customer base, technological and competitive factors impacting our current products, and
managements estimates of future earnings based on information currently available.



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Net Income. Net income for the three months ended June 30, 2007 and 2006 was $3.4 million and
$3.9 million, respectively. As a percent of revenues, net income was 7% of revenues in the second quarter of 2007 compared to 13% of revenues in the second quarter of 2006. For the first six months of 2007, net income was $3.5 million (4% of
revenues) as compared to $0.8 million (2% of revenues) for the first six months of 2006.

Liquidity and Capital Resources

Based upon our current level of operations, we expect that our cash flow from operations will be adequate to meet our anticipated needs for at least the
next twelve months.

Net cash from operating activities.Our operating activities provided cash of $1.4 million and $7.8 million in
the six months ended June 30, 2007 and 2006, respectively. Cash provided by or used in operating activities is primarily a reflection of our collections on billed receivables, investment in inventories and expenditures for operations.

During the six months ended 2007, operating activities provided $1.4 million in cash flow primarily due to net income of $3.5 million,
depreciation and amortization of $2.2 million and other operating activities providing $8.9 million in cash. Uses of cash resulted from collections of $88.5 million of billed receivables offset by product billings of $96.2 million that effectively
decreased cash from operating activities by $7.7 million. Additionally, we used $5.5 million to purchase inventories. The increase in accounts receivable reflects the significant increase in revenues in the private wireless communications segment
continuing in the quarter ended June 30, 2007. The increases in inventories were principally the result of continued product procurement in the second quarter of 2007 in anticipation of satisfaction of shipments and sales relating to a large
Department of Defense order we previously announced.

During the first six months of 2006, operating activities provided $7.8 million in
cash flow. We collected $52.2 million of billed receivables that effectively increased cash from operating activities by $12.8 million after product billings of $39.4 million. Additionally, depreciation, amortization and net income provided $1.8
million in operating cash flows. Other operating activities provided $0.9 million. We used $7.7 million of cash to purchase inventories.

Net cash from investing activities. During the six months ended June 30, 2007 and 2006, investing activities used $ 1.3 million and $1.7 million respectively. In the first six months of 2007 we purchased $1.3 million in
equipment. Additionally, we used $1.5 million to purchase equipment in the first six months of 2006.

Net cash from financing
activities.During the six months ended June 30, 2006 financing activities used $0.9 million primarily relating to the deferred gain on the sale and leaseback of the Irving facility.

Letters of credits and bonds. In the normal course of our business activities related to sales of wireless radio systems to local and state
governmental entities, we are required under contracts with various government authorities to provide letters of credit or performance or bid bonds that may be drawn upon if we fail to perform under our contracts. Our outstanding letters of credit
had a total un-drawn balance of $0.3 million as of June 30, 2007. Performance and bid bonds, which expire on various dates, totaled $0.5 million as of June 30, 2007. Our current bonding arrangement calls for zero-collateral bonding up to
$7.0 million; however, no single bond may exceed $2.0 million. We believe our bonding arrangements provide us with sufficient bonding availability through 2007.

Secured line of credit. We amended our secured line of credit agreement with Bank of America in July 2006 to include 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 the London 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 basis points at June 30, 2007. Following the renegotiation of this agreement, the $15.0 million term loan was fully funded and used to finance the acquisition of 3eTI. No borrowings have been made
on the revolving line of credit.

As noted in our Form 10-K for the period ending December, 31, 2006, we were not in compliance with the
financial covenants of the Loan Agreement for the quarter ending December 31, 2006. As a result, on March 5, 2007 we executed an Amendment to the Loan Agreement whereby the Bank of America waived such financial covenant defaults on a one
time basis, subject to further modification of the Loan Agreement to revise such financial covenants, to modify the advance and borrowing revisions under the Loan Agreement and for certain other purposes more fully set out in the amendment.

The Loan Agreement as amended with Bank of America (the Loan Agreement) provides for customary affirmative and negative
covenants, including maintenance of corporate existence, rights, property, books and records and insurance, compliance with contracts and laws, and certain reporting requirements, as well as limitations on debt, liens, fundamental changes,
acquisitions, transfers of assets, investments, loans, guarantees, use of proceeds, sale-leaseback transactions and capital expenditures. In addition, the Loan Agreement as amended contains certain financial covenants including a maximum



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ratio of funded debt to EBITDA and a fixed charge coverage ratio. The Loan Agreement as amended also provides for events of default that would permit the
Lender to accelerate the loans upon their occurrence, including failure to make payments, breaches of representations and warranties, insolvency events, acceleration of other indebtedness, failure to discharge judgments, material adverse effects,
certain breaches of contracts, casualty losses when no or insufficient insurance is maintained, changes of control, certain ERISA events and failure to observe covenants. As collateral for the obligations under the Loan Agreement as amended, the
Lender has a security interest in substantially all assets of the Borrowers, including accounts receivable, inventory, machinery, equipment, real estate, and general intangibles.

We were in compliance with all financial and negative covenants at June 30, 2007. At June 30, 2007, we had no amounts outstanding on the
revolving line of credit, and the total available line of credit was $14.6 million.

Dividend policy. Since our initial public
offering, we have not declared or paid any dividends on our common stock. We presently intend to retain earnings for use in our operations and to finance our business. Any change in our dividend policy is within the discretion of our board of
directors and will depend, among other things, on our earnings, debt service and capital requirements, restrictions in financing agreements, if any, business conditions and other factors that our board of directors deems relevant.

Backlog. Our backlog of unfilled orders at June 30, 2007 was $83.1 million, compared to a backlog of $136.5 million at December 31, 2006
and $65.0 million at June 30, 2006. Depending on the size and complexity of customer specifications and requirements, the backlog can be converted to revenues in a relatively short period of time (typically 90 days) or with complex integrations
and various delivery dates, orders can span multiple years.

Off-Balance Sheet Arrangements

As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships,
such as entities often referred to as structured finance or variable interest entities, or VIEs, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As
of June 30, 2007, we are not involved in any VIE transactions.

Recently Issued Accounting Standards

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157), which provides guidance for
measuring the fair value of assets and liabilities, as well as requires expanded disclosures about fair value measurements. SFAS 157 indicates that fair value should be determined based on the assumptions marketplace participants would use in
pricing the asset or liability, and provides additional guidelines to consider in determining the market-based measurement. The Company will be required to adopt SFAS 157 on January 1, 2008. The Company is currently evaluating the impact of
adopting SFAS 157 on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, The Fair Value
Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 permits all entities to choose to measure eligible items at fair value at specified election dates. SFAS 159 is effective as of the beginning of an
entitys first fiscal year that begins after November 15, 2007. The Company is currently assessing the impact of adopting SFAS 159 on its consolidated financial statements.



|ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|------- | ----------------------------------------------------------

Our financial instruments consist of cash, cash equivalents, short- and long-term investments, trade accounts receivable, accounts payable and long-term obligations. The primary objective of our investment activities is to preserve
principal while at the same time maximizing yields without increasing risk. As of June 30, 2007, we had an investment portfolio of short-term investments in a variety of interest-bearing instruments, consisting of United States government and
agency securities, high-grade United States corporate bonds, municipal bonds, mortgage-backed securities and money market accounts. Due to the short duration of our investment portfolio, a hypothetical 1% change in interest rates would not be
material to our financial condition or results of operations.

Although all of our sales are denominated in U.S. dollars, fluctuations in
the value of international currencies relative to the U.S. dollar may affect the price, competitiveness and profitability of our products sold in international markets. Furthermore, the uncertainty of monetary exchange values has caused, and
may in the future cause, some foreign customers to delay new orders or delay payment for existing orders. Additionally, troubled economic conditions, such as that recently experienced in Asia and in Latin America, could result in lower revenues for
us. While most international sales are supported by letters of credit or cash in advance, the purchase of our products by international customers presents increased risks, which include:



| |  |  | unexpected changes in regulatory requirements;
| | - |  | ----------------------------------------------



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| |  |  | 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 accounts receivable;
| | - |  | ------------------------------------------------------------------------------



| |  |  | increased costs associated with maintaining international marketing efforts;
| | - |  | ----------------------------------------------------------------------------



| |  |  | 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 foreign currency fluctuations since all our quotations and invoices are denominated in U.S. dollars.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------

Export of our products is subject to the U.S. Export Administration regulations and some of our secured communications
products require a license or a license exception in order to ship internationally. We cannot assure that such approvals will be available to us or our products in the future in a timely manner or at all or that the federal government will not
revise its export policies or the list of products and countries for which export approval is required. Our inability to obtain required export approvals would adversely affect our international sales, which would have a material adverse effect on
us. In addition, foreign companies not subject to United States export restrictions may have a competitive advantage in the international secured communications market. We cannot predict the impact of these factors on the international market for
our products.



|ITEM 4. | CONTROLS AND PROCEDURES
|------- | -----------------------

Disclosure Controls and Procedures

Our Chief Executive Officer (CEO) and Chief Financial Officer (CFO) evaluated our disclosure controls and
procedures, as defined in Rule 240.13a-15(e) and 15d-15(e) under the Exchange Act of 1934, as amended (the Exchange Act) as of the end of the period covered by this report. Based on this evaluation, our CEO and CFO have concluded that
our disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms and is accumulated and communicated to our management including our principal executive and principal financial officer, as
appropriate, to allow timely decisions regarding disclosures.

Internal Controls Over Financial Reporting

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

During the quarter ended June 30, 2007, we developed improved controls in our private wireless communications segment associated with access
security of our computer and information system. Additionally, we have begun the integration of 3eTI processes and controls into our existing internal control structure. We will continue this integration effort into the third and fourth quarters and
anticipate completion by the end of our fiscal year.

We will continue to develop and implement new/modified control procedures associated
with inventory costing, purchasing, shipping, and receiving with our outsource manufacturing providers. In response to the increased risk imposed by these changes, we increased the nature and extent of analytical review and analysis of the accounts
impacted by these changes. We will continue to conduct full physical inventory counts periodically during 2007. We anticipate that there will be additional changes in our internal control process during the year as we continue to enhance our
internal control effectiveness in conjunction with these processes.

There were no other changes in our internal controls over financial
reporting during the quarter ending June 30, 2007 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

In preparation of our financial statements as of and for the period ended June 30, 2007, management believes that our internal controls over these
processes are operating and effective.



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PART II. OTHER INFORMATION



|ITEM 1. | LEGAL PROCEEDING
|------- | ----------------

See Note 11 to the Notes to
Condensed Consolidated Financial Statements in Part I, Item 1.



|ITEM 1A. | RISK FACTORS
|-------- | ------------

Risk Factors Related to Our Business

Our operations and financial results are subject to various risks and uncertainties, including those described below, that could
adversely affect our business, financial condition, results of operations and trading price of our common stock. Item 1A of our annual report on Form 10-K for fiscal year 2006 includes a detailed discussion of our risk factors.



|ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
|------- | -----------------------------------------------------------

N/A.



|ITEM 3. | DEFAULTS UPON SENIOR SECURITIES
|------- | -------------------------------

N/A.



|ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Legal update Table
|------- | ----------------------------------------------------------------------



| | (a) | Our 2007 Annual Meeting of Shareholders (the 2007 Annual Meeting) was held June 8, 2007.
| | --- | ------------------------------------------------------------------------------------------



| | (b) | At the 2007 Annual Meeting, the shareholders elected each of the following nominees as directors, to serve on our Board of Directors for a three year term. The vote for each
director was as follows:
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                    |  |            |  |               
|------------------- |  | ---------- |  | --------------
|                    |  | Votes For  |  | Votes Withheld
|Veronica A. Haggart |  | 22,982,503 |  | 1,425,190     
|Thomas R. Thomsen   |  | 22,940,603 |  | 1,467,090     



|ITEM 5. | OTHER INFORMATION
|------- | -----------------

N/A.



|ITEM 6. | EXHIBITS
|------- | --------

The following exhibits are filed
herewith:



|            |  |                                                                                                                                                 
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                     
|11.1        |  | Computation of income per share                                                                                                                 
|            | 
|31.1        |  | Chief Executive Officers Certification of Report on Form 10-Q for the Quarter Ending June 30, 2007                                             
|            | 
|31.2        |  | Chief Financial Officers Certification of Report on Form 10-Q for the Quarter Ending June 30, 2007                                             
|            | 
|32.1        |  | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|            | 
|32.2        |  | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



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SIGNATURE

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



|                     |  |           |  |                                                  
|-------------------- |  | --------- |  | -------------------------------------------------
|                     |  | EFJ, INC.
|                     |  |          
|Date: August 1, 2007 |  | By:       |  | /s/ Jana Ahlfinger Bell                          
|                     |  |           |  | Jana Ahlfinger Bell                              
|                     |  |           |  | Senior Vice President and Chief Financial Officer
|                     |  |           |  | (Principal Financial and Accounting Officer)     



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