**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 reportpursuant to Section 13 or 15(d) of the Securities Exchange Act of1934**

 

**FOR THE QUARTERLY PERIOD ENDED September 30, 2008**

 

**or**

 

**o****                  Transitionreport pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934**

 

**For the transition period from             to**

 

**CommissionFile Number 0-21681**

 

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**EF JOHNSON TECHNOLOGIES, INC.**

(Exact name ofregistrant 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.) |

 

**1440CORPORATE DRIVE**

**IRVING,TEXAS 75038**

**(972)819-0700**

(Address, includingzip code, and telephone number,

including area code,of registrant’s

principal executiveoffice)

 

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

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (check one)

 

Large Accelerated Filer o    AcceleratedFiler  o    Non-acceleratedFiler  x Smaller Reporting Company o

 

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

 

As of October 27,2008, 26,186,735 shares of the Registrant’s Common Stock were outstanding.

 

 

 

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**PART I. FINANCIAL INFORMATION**

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

 

**EFJOHNSON TECHNOLOGIES, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

September 30, 2008 and December 31, 2007

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

 
| ** **                                                                                                                                                                                     | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                                                     |       |                         |       |                        |       |
| Current assets:                                                                                                                                                                                |       |                         |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                      |       | $                            | 6,241      |                        | $          | 15,636 |   |
| Accounts receivable, net of allowance  for returns and doubtful accounts of $1,890 and $1,642, respectively                                                                                    |       | 32,097                       |       | 21,345                      |       |
| Receivables - other                                                                                                                                                                            |       | 5,218                        |       | 6,944                       |       |
| Cost in excess of billings on  uncompleted contracts                                                                                                                                           |       | 3,241                        |       | 3,275                       |       |
| Inventories                                                                                                                                                                                    |       | 33,663                       |       | 33,871                      |       |
| Prepaid expenses                                                                                                                                                                               |       | 1,171                        |       | 1,109                       |       |
| Total current assets                                                                                                                                                                           |       | 81,631                       |       | 82,180                      |       |
| Property, plant and equipment, net                                                                                                                                                             |       | 6,397                        |       | 7,096                       |       |
| Restricted cash                                                                                                                                                                                |       | 2,012                        |       | —                      |       |
| Goodwill                                                                                                                                                                                       |       | 20,040                       |       | 20,040                      |       |
| Other intangible assets, net of  accumulated amortization                                                                                                                                      |       | 12,651                       |       | 13,821                      |       |
| Other assets                                                                                                                                                                                   |       | 215                          |       | 352                         |       |
| **TOTAL ASSETS**                                                                                                                                                                               |       | $                            | 122,946    |                        | $          | 123,489 |   |
| ** **                                                                                                                                                                                     |       |                         |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                  | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                                                                                           |       |                         |       |                        |       |
| Revolving line of credit                                                                                                                                                                       |       | $                            | 2,000      |                        | $          | — |   |
| Current portion of long-term debt  obligations                                                                                                                                                 |       | 9                            |       | 8                           |       |
| Accounts payable                                                                                                                                                                               |       | 11,476                       |       | 13,411                      |       |
| Accrued expenses                                                                                                                                                                               |       | 9,636                        |       | 11,232                      |       |
| Billings in excess of cost on  uncompleted contracts                                                                                                                                           |       | 289                          |       | 221                         |       |
| Deferred revenues                                                                                                                                                                              |       | 817                          |       | 1,010                       |       |
| Total current liabilities                                                                                                                                                                      |       | 24,227                       |       | 25,882                      |       |
| Long-term debt obligations, net of  current portion                                                                                                                                            |       | 15,008                       |       | 15,015                      |       |
| Deferred income taxes                                                                                                                                                                          |       | 1,489                        |       | 1,489                       |       |
| Other liabilities                                                                                                                                                                              |       | 675                          |       | 737                         |       |
| **TOTAL LIABILITIES**                                                                                                                                                                          |       | 41,399                       |       | 43,123                      |       |
|                                                                                                                                                                                           |       |                         |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                     |       |                         |       |                        |       |
| Preferred stock ($0.01 par value;  3,000,000 shares authorized; none issued)                                                                                                                   |       | —                       |       | —                      |       |
| Common stock ($0.01 par value;  50,000,000 voting shares authorized, 26,273,240 and 26,210,232 issued and  outstanding as of September 30, 2008 and December 31, 2007, respectively) |       | 262                          |       | 262                         |       |
| Additional paid-in capital                                                                                                                                                                     |       | 155,162                      |       | 153,356                     |       |
| Accumulated other comprehensive loss                                                                                                                                                           |       | (657                         | )          | (710                        | )          |
| Accumulated deficit                                                                                                                                                                            |       | (73,220                      | )          | (72,542                     | )          |
| **TOTAL STOCKHOLDERS’ EQUITY**                                                                                                                                                            |       | 81,547                       |       | 80,366                      |       |
| **TOTAL LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                                           |       | $                            | 122,946    |                        | $          | 123,489 |   |

 

See accompanying notes to the condensed consolidated financialstatements.

 

2

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**EFJOHNSON TECHNOLOGIES, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

For the three and nine months ended September 30, 2008 and 2007

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

 

 
| ** **                                       | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|--------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                       | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                       | ** ** | **2008**               | ** ** | **2007**               | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenues                                         |       | $                      | 34,500     |                   | $          | 33,715 |   | $ | 100,969 |   | $ | 129,959 |   |
| Cost of sales                                    |       | 21,872                 |       | 24,065                 |       | 66,284 |   | 89,305 |   |
| Gross profit                                     |       | 12,628                 |       | 9,650                  |       | 34,685 |   | 40,654 |   |
|                                             |       |                   |       |                   |       |   |   |   |   |
| Operating expenses:                              |       |                   |       |                   |       |   |   |   |   |
| Research and development, net of  reimbursements |       | 3,559                  |       | 3,929                  |       | 6,935 |   | 11,504 |   |
| Sales and marketing                              |       | 3,275                  |       | 3,163                  |       | 9,689 |   | 10,288 |   |
| General and administrative                       |       | 4,756                  |       | 5,699                  |       | 16,862 |   | 17,537 |   |
| Amortization of intangibles                      |       | 357                    |       | 407                    |       | 1,170 |   | 1,202 |   |
| Total operating expenses                         |       | 11,947                 |       | 13,198                 |       | 34,656 |   | 40,531 |   |
| Income (loss) from operations                    |       | 681                    |       | (3,548                 | )          | 29 |   | 123 |   |
|                                             |       |                   |       |                   |       |   |   |   |   |
| Interest income (expense), net                   |       | (259                   | )          | 33                     |       | (707 | ) | 12 |   |
| Income (loss) before income taxes                |       | 422                    |       | (3,515                 | )          | (678 | ) | 135 |   |
|                                             |       |                   |       |                   |       |   |   |   |   |
| Income tax benefit (expense)                     |       | —                 |       | 137                    |       | — |   | (22 | ) |
| Net income (loss)                                |       | $                      | 422        |                   | $          | (3,378 | ) | $ | (678 | ) | $ | 113 |   |
|                                             |       |                   |       |                   |       |   |   |   |   |
| Net income (loss) per share — Basic         |       | $                      | 0.02       |                   | $          | (0.13 | ) | $ | (0.03 | ) | $ | — |   |
| Net income (loss) per share — Diluted       |       | $                      | 0.02       |                   | $          | (0.13 | ) | $ | (0.03 | ) | $ | — |   |
|                                             |       |                   |       |                   |       |   |   |   |   |
| Weighted average common shares — Basic      |       | 26,121,544             |       | 26,035,933             |       | 26,088,648 |   | 26,032,312 |   |
| Weighted average common shares — Diluted    |       | 26,687,013             |       | 26,035,933             |       | 26,088,648 |   | 26,397,343 |   |

 

See accompanying notes to the condensed consolidated financialstatements.

 

3

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**EFJOHNSON TECHNOLOGIES, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

Nine months ended September 30, 2008 and 2007

(Unaudited and in thousands)

 

 
| ** **                                                                            | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows from operating activities:                                                 |       |     |       |     |       |
| Net income (loss)                                                                     |       | $        | (678       | )        | $          | 113 |   |
| Adjustments to reconcile net income  (loss) to net cash used in operating activities: |       |     |       |     |       |
| Provision for returns and doubtful  accounts                                          |       | 248      |       | 214      |       |
| Depreciation and amortization                                                         |       | 3,433    |       | 3,320    |       |
| Recognition of deferred gain                                                          |       | (71      | )          | (71      | )          |
| Deferred taxes                                                                        |       | —   |       | 3        |       |
| Stock-based compensation                                                              |       | 1,742    |       | 1,726    |       |
| Changes in operating assets and  liabilities:                                         |       |     |       |     |       |
| Accounts receivable                                                                   |       | (11,000  | )          | (2,029   | )          |
| Receivables - other                                                                   |       | 1,726    |       | 2,228    |       |
| Cost in excess of billings on  uncompleted contracts                                  |       | 34       |       | 566      |       |
| Inventories                                                                           |       | 208      |       | (8,295   | )          |
| Prepaid expenses                                                                      |       | (62      | )          | (107     | )          |
| Accounts payable                                                                      |       | (1,935   | )          | 2,469    |       |
| Accrued and other liabilities                                                         |       | (1,525   | )          | 968      |       |
| Billings in excess of cost on  uncompleted contracts                                  |       | 68       |       | (191     | )          |
| Deferred revenues                                                                     |       | (202     | )          | (356     | )          |
| Total adjustments                                                                     |       | (7,336   | )          | 445      |       |
| Net cash (used in) provided by operating  activities                                  |       | (8,014   | )          | 558      |       |
|                                                                                  |       |     |       |     |       |
| Cash flows from investing activities:                                                 |       |     |       |     |       |
| Increase in restricted cash                                                           |       | (2,012   | )          | —   |       |
| Purchase of property, plant and  equipment                                            |       | (1,564   | )          | (2,112   | )          |
| Purchase of intangibles                                                               |       | —   |       | (2       | )          |
| Other assets                                                                          |       | 137      |       | (54      | )          |
| Net cash used in investing activities                                                 |       | (3,439   | )          | (2,168   | )          |
|                                                                                  |       |     |       |     |       |
| Cash flows from financing activities:                                                 |       |     |       |     |       |
| Proceeds on revolving lines of credits                                                |       | 11,600   |       | —   |       |
| Principal payments on revolving lines of  credits                                     |       | (9,600   | )          | —   |       |
| Proceeds from capitalized lease                                                       |       | —   |       | 25       |       |
| Principal payments on long-term debt                                                  |       | (6       | )          | (5       | )          |
| Proceeds from issuances of common stock                                               |       | 18       |       | 16       |       |
| Proceeds from exercise of stock options                                               |       | 46       |       | 58       |       |
| Net cash provided by financing  activities                                            |       | 2,058    |       | 94       |       |
| Net decrease in cash and cash  equivalents                                            |       | (9,395   | )          | (1,516   | )          |
| Cash and cash equivalents, beginning of  period                                       |       | 15,636   |       | 22,885   |       |
| Cash and cash equivalents, end of period                                              |       | $        | 6,241      |     | $          | 21,369 |   |

 

 

**Supplemental Disclosure of Cash Flow Information:**

The Company paid interestof $920 and $794 during nine months ended September 30, 2008 and 2007,respectively.

The Company paid incometaxes of $235 and $184 during nine months ended September 30, 2008 and2007, respectively.

 

See accompanying notes to the condensed consolidated financialstatements.

 

4

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**EFJOHNSON TECHNOLOGIES, INC. AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**Threeand nine months ended September 30, 2008 and 2007**

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

 

**1. GENERAL**

 

Thecondensed consolidated balance sheet of EF Johnson Technologies, Inc.,formerly EFJ, Inc., at December 31, 2007, presented within thisReport on Form 10-Q, has been derived from audited consolidated financialstatements at that date. The condensed consolidated financial statements as of September 30,2008 and for the three months ended September 30, 2008 and 2007 areunaudited. The condensed consolidated financial statements reflect all normaland recurring accruals and adjustments that, in the opinion of management, arenecessary for a fair presentation of the financial position, operating results,and cash flows for the interim periods presented in this quarterly report. Thecondensed consolidated financial statements should be read in conjunction withthe consolidated financial statements and notes thereto, together withmanagement’s discussion and analysis of financial condition and results ofoperations, contained in our Annual Report on Form 10-K for the year endedDecember 31, 2007. The results of operations and cash flows for the threeand nine months ended September 30, 2008 are not necessarily indicative ofthe results for any other period or the entire fiscal year ended December 31,2008.

 

At theCompany’s May 28, 2008 Annual Meeting of Stockholders, the Stockholders approvedan amendment of the Company’s Certificate of Incorporation to change thecorporate name from EFJ, Inc. to EF Johnson Technologies, Inc. TheCompany’s stock is quoted on the NASDAQ Global Market under the symbol “EFJI”,and its ticker symbol did not change.

 

Unlessthe context otherwise provides, all references to “the Company”, “we,” “us,”and “our” include EF Johnson Technologies, Inc., its predecessor entityand its subsidiaries, including E.F. Johnson Company, Transcrypt International, Inc.,and 3e Technologies International, Inc. on a consolidated basis. Allreferences to “EF Johnson” 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.

 

**2. ORGANIZATION AND CONSOLIDATION**

 

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

 

·                  mobile and portable wireless radios;

 

·                  stationary transmitters / receivers (base stations orrepeaters);

 

·                  infrastructure equipment and systems;

 

·                  secure encryption technologies for proprietarywireless radios;

 

·                  customized wireless network centric products andsystems to the federal government primarily under government funded SmallBusiness Innovative Research (SBIR) programs; and

 

·                  niche hardware and secure software technologies forthe WLAN markets primarily in the government sector.

 

Thecondensed consolidated financial statements include the accounts of EF JohnsonTechnologies, Inc. and our wholly-owned subsidiaries. All inter-companyaccounts and transactions have been eliminated in the consolidation.

 

Previouslythe Company was organized, and reported its financial results, as a parentcompany with two segments, Private Wireless Communications and SecuredCommunications.  Having recognized that the public safety/public servicemarket is moving towards convergent telecommunications solutions, the continueddemand for interoperability and the transition from analog to digitalplatforms, we reorganized the Company in January 2008 into a singlecentralized corporate structure in order to be competitive in this market. Weexpect the centralized corporate structure to improve efficiencies in ouroperations and reduce our infrastructure costs. In light of these changes, theCompany has reassessed its segment reporting, and beginning with the firstquarter of 2008, we are no longer reporting the two segments of PrivateWireless Communications and Secured Communications.

 

5

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**EF JOHNSONTECHNOLOGIES, INC. AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**Threeand nine months ended September 30, 2008 and 2007**

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

 

**3. NET INCOME PER SHARE**

 

Basic income (loss) per share (“EPS”) is calculatedbased upon the weighted average number of common shares outstanding during theperiod. The diluted EPS calculation reflects the potential dilution from commonstock equivalents such as stock options, stock satisfied stock appreciationrights (“SSAR’s”), restricted stock grants and restricted stock units(collectively “Incentive Shares”). For the three months ended September 30,2008, outstanding incentive shares with exercise prices lower than the averagemarket price of the common stock for the respective periods were consideredcommon stock equivalents and were dilutive in the calculation of the dilutedweighted average common shares. For the nine months ended September 30,2008, all outstanding incentive shares were considered anti-dilutive due to thenet loss for the period end.

 

For the three months ended September 30, 2007,all outstanding incentive shares were considered anti-dilutive due to the netloss for the period end. For the nine months ended September 30, 2007,outstanding incentive shares with exercise prices lower than the average marketprice of the common stock for the respective periods were considered commonstock equivalents and were dilutive in the calculation of the diluted weightedaverage common shares.

 

Outstanding incentive shares that had exercise priceshigher than the average market price of the common stock for the periods wereconsidered anti-dilutive and excluded from the calculation of diluted weightedaverage common shares. The outstanding incentive shares that are considereddilutive and anti-dilutive are as follows:

 

| ** **                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|---------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                  | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                  | ** ** | **2008**               | ** ** | **2007**               | ** ** | **2008** | ** ** | **2007** | ** ** |
| Incentive shares with dilutive effect       |       | 565,469                |       | —                 |       | — |   | 518,782 |   |
| Incentive shares with anti-dilutive  effect |       | 1,088,810              |       | 1,629,422              |       | 1,457,856 |   | 1,110,640 |   |
| Outstanding incentive shares                |       | 1,654,279              |       | 1,629,422              |       | 1,457,856 |   | 1,629,422 |   |

 

We usethe 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 usethe Black-Scholes option pricing model to determine the fair value of all stockoption grants and stock satisfied stock appreciation rights (“SSAR’s”)(collectively “Options”). For the three and nine months ended September 30,2008, we recognized compensation expense of $0.4 million and $1.2 million,respectively, related to options and $0.2 million and $0.6 million,respectively, related to restricted stock grants and restricted stock units. Forthe three and nine months ended September 30, 2007, we recognizedcompensation expense of $0.4 million and $1.2 million, respectively, related tooptions and $0.2 million and $0.5 million, respectively, related to restrictedstock grants and restricted stock units.

 

In July 2007,the Compensation Committee of the Board of Directors of the Company deemed itis in the best interest of the Company to approve the use of Restricted StockUnits (“RSU’s) and Stock Satisfied Stock Appreciation Rights (“SSAR’s”) as theequity instruments for grants to certain key employees of the Company pursuantto the 2005 Omnibus Incentive Compensation Plan. Grants of RSU’s and SSAR’svest over a four year period and expire in five years.

 

At theCompany’s May 28, 2008 Annual Meeting of Stockholders, the Stockholdersapproved an amendment to the EFJ, Inc. 2005 Omnibus Incentive CompensationPlan to increase the number of shares available for issuance pursuant to theplan by 1,500,000 shares.

 

**5. INTEREST RATE SWAP AGREEMENT AND COMPREHENSIVE LOSS**

 

On July 19,2006, we entered into an interest rate swap agreement to manage interest costsand risks associated with changing interest rates, not for speculative ortrading purposes. The interest rate swap has been designated as a cash flowhedge and is recorded in the consolidated financial statements at fair value.Changes in the fair value of the swap have been recorded in AccumulatedComprehensive Loss in the balance sheet as the derivative is assessed aseffectively hedged at September 30, 2008.

 

Theinterest rate swap agreement effectively converts the variable LIBOR componentof 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, the Company will pay 5.64%

 

6

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**EFJOHNSON TECHNOLOGIES, INC. AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**Threeand nine months ended September 30, 2008 and 2007**

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

 

and the counterparty willpay 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 losswas $0.7 million and is included with other long-term liabilities andaccumulated other comprehensive loss in the consolidated balance sheet at September 30,2008. The following is a summary of the components of comprehensive loss:

 

| ** **                                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                    | ** ** | **2008**               | ** ** | **2007**               | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net income / (loss)                           |       | $                      | 422        |                   | $          | (3,378 | ) | $ | (678 | ) | $ | 113 |   |
| Fair value adjustment for interest rate  swap |       | 48                     |       | (264                   | )          | 53 |   | (99 | ) |
| Total comprehensive income/(loss)             |       | $                      | 470        |                   | $          | (3,642 | ) | $ | (625 | ) | $ | 14 |   |

 

**6.INVENTORIES**

 

The following is a summary of inventories:

 

|                       | ** ** | **September 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|----------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| Raw materials and supplies |       | $                                | 11,178     |                            | $          | 16,263 |   |
| Work in progress           |       | 1,131                            |       | 1,334                           |       |
| Finished goods             |       | 21,266                           |       | 15,728                          |       |
| Service inventories        |       | 3,769                            |       | 3,517                           |       |
|                       |       | 37,344                           |       | 36,842                          |       |
| Reserve for obsolescence   |       | (3,681                           | )          | (2,971                          | )          |
| Total inventories          |       | $                                | 33,663     |                            | $          | 33,871 |   |

 

**7. GOODWILL AND INTANGIBLE ASSETS**

 

Ourgoodwill and intangible assets are tested for impairment annually as of December 31of each year unless events or circumstances would require an immediate review.Goodwill and intangible asset amounts are allocated to the reporting unitsbased upon amounts allocated at the time of their respective acquisition.Intangible assets, consisting of existingtechnology, customer relationships, license and covenants not-to-compete areamortized over their useful life on a straight-line basis. Intangible assetsconsisting of trademark, trade name and certifications are not subject toamortization.

 

Weperformed fair value-based impairment tests at December 31, 2007. Uponcompletion of the impairment test, we concluded that the fair value was lowerthan the carrying value of the associated goodwill and trade name. Therefore,we reported an impairment charge of $5.5 million related to goodwill and $0.3million related to the trade name in the fourth quarter ended December 31,2007.

 

Noevents occurred during the nine months ended September 30, 2008 and 2007,respectively, which would indicate that an impairment of such assets had takenplace as of such dates.

 

7

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**EFJOHNSON TECHNOLOGIES, INC. AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**Threeand nine months ended September 30, 2008 and 2007**

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

 

Amortization expense, related to intangible assetswhich are subject to amortization, was $1.2 million for the nine months ended September 30,2008 and September 30, 2007, respectively. Intangible assets consist ofthe following as of the dates indicated:

 
| ** **                                      | ** ** | **September 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **                                      | ** ** | **Gross**                   | ** ** | ** **                 | ** ** | **Accumulated** | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | **Net** | ** ** |
| ** **                                      | ** ** | **Amount**                  | ** ** | **Impairment**             | ** ** | **Amortization** | ** ** | **Amount** | ** ** | **Amount** | ** ** | **Impairment** | ** ** | **Amortization** | ** ** | **Amount** | ** ** |
|                                            |       |                        |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Intangible assets not subject to  amortization: |       |                        |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Goodwill                                        |       | $                           | 20,040     |                       | $          | — |   | $ | — |   | $ | 20,040 |   | $ | 25,515 |   | $ | (5,475 | ) | $ | — |   | $ | 20,040 |   |
| Trademarks                                      |       | 4,364                       |       | —                     |       | — |   | 4,364 |   | 4,664 |   | (300 | ) | — |   | 4,364 |   |
| Certifications                                  |       | 1,230                       |       | —                     |       | — |   | 1,230 |   | 1,230 |   | — |   | — |   | 1,230 |   |
|                                            |       | 25,634                      |       | —                     |       | — |   | 25,634 |   | 31,409 |   | (5,775 | ) | — |   | 25,634 |   |
|                                            |       |                        |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Intangible assets subject to  amortization:     |       |                        |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Existing technology                             |       | 6,190                       |       | —                     |       | (2,529 | ) | 3,661 |   | 6,190 |   | — |   | (2,116 | ) | 4,074 |   |
| Customer relationships                          |       | 4,800                       |       | —                     |       | (1,707 | ) | 3,093 |   | 4,800 |   | — |   | (1,103 | ) | 3,697 |   |
| License                                         |       | 320                         |       | —                     |       | (143 | ) | 177 |   | 320 |   | — |   | (95 | ) | 225 |   |
| Covenant not-to-compete                         |       | 400                         |       | —                     |       | (400 | ) | — |   | 400 |   | — |   | (301 | ) | 99 |   |
| Trademarks/Patents                              |       | 209                         |       | —                     |       | (83 | ) | 126 |   | 209 |   | — |   | (77 | ) | 132 |   |
|                                            |       | 11,919                      |       | —                     |       | (4,862 | ) | 7,057 |   | 11,919 |   | — |   | (3,692 | ) | 8,227 |   |
|                                            |       |                        |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total                                           |       | $                           | 37,553     |                       | $          | — |   | $ | (4,862 | ) | $ | 32,691 |   | $ | 43,328 |   | $ | (5,775 | ) | $ | (3,692 | ) | $ | 33,861 |   |

 

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

 

Weamended our secured line of credit agreement with Bank of America in July 2006to include a revolving line of credit of up to $15.0 million and a term loan of$15.0 million (the “Loan Agreement”). Both borrowings bear interest at avariable rate based on the London Interbank Offered Rate (“LIBOR”) plus amargin (“LIBOR Margin”) determined by our ratio of debt to earnings beforeinterest, taxes, depreciation, and amortization (“EBITDA”). The Loan Agreementexpires June 30, 2010. The $15.0 million term loan was fully funded andused to finance the July 10, 2006 acquisition of 3eTI.

 

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

 

Asnoted in our Form 10-K for the period ended December 31, 2007, wewere not in compliance with the financial covenants of the Loan Agreement forthe quarter ended December 31, 2007. As a result, effective March 10,2008 we executed an Amendment to the Loan Agreement whereby Bank of Americawaived such financial covenant defaults on a one time basis, subject to furthermodification of the Loan Agreement to revise such financial covenants thateffectively eliminated the ratio of funded debt to EBITDA and a fixed chargecoverage ratio for 2008, to modify the advance and borrowing revisions underthe Loan Agreement and for certain other purposes more fully set out in theAmendment. The Loan Agreement, as amended, contains a new covenant to maintaina minimum liquidity of $3.0 million in unrestricted cash, unencumberedmarketable securities, cash and cash equivalents through March 31, 2009.Additionally, a covenant for a minimum EBITDA was established for (i) breakevenfor the fiscal quarter ended June 30, 2008, (ii) $1.0 million for thefiscal quarter ended September 30, 2008 and $3.0 million for the fiscalquarter ended December 31, 2008. Pursuant to the Loan Agreement, asfurther amended, the interest rate is equal to LIBOR plus 2.00% through March 31,2009, and thereafter to LIBOR plus a rate between 1.00% and 1.75% depending onour ratio of debt to EBITDA.

 

At September 30,2008, $2.0 million of borrowings were outstanding on the revolving line ofcredit. At December 31, 2007, no borrowings had been made on the revolvingline of credit. There were $0.8 million of letters of credit outstanding,

 

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**EFJOHNSON TECHNOLOGIES, INC. AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**Threeand nine months ended September 30, 2008 and 2007**

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

 

under our line of creditas of September 30, 2008, and there were $0.3 million outstanding as of December 31,2007. The total available remaining credit under the line of credit was$12.2 million and $13.3 million as of September 30, 2008 and December 31,2007, respectively.

 

Theinterest rate in effect at September 30, 2008 was 4.5 percent.

 

Forthe quarter ended September 30, 2008, we were in compliance with thefinancial covenants of the Loan Agreement as amended.

 

**9. INCOME TAXES**

 

Weadopted the provisions of Financial Standards Accounting Board Interpretation No. 48,*Accounting for Uncertainty in Income Taxes (“FIN48”) an interpretation of FASB Statement No. 109 (“SFAS 109”)*on January 1, 2007. FIN 48 prescribes a recognition threshold that a taxposition is required to meet before being recognized in the financialstatements and provides guidance on recognition, measurement, classification,interest and penalties, accounting in interim periods, disclosure andtransition issues. The Company has unrecognized tax benefits of approximately$0.5 million that did not change significantly during the nine months ended September 30,2008 relating to carry forward of business credits. The adoption of FIN 48 didnot result in the recognition of additional tax liability for unrecognizedincome tax benefits since the tax benefits have not been included in priorincome tax return filings. In addition, future changes in the unrecognized taxbenefit will have no net impact on the effective tax rate due to the existenceof the valuation allowance.

 

As of September 30,2008, we have no accrual requirement for interest or penalties related touncertain tax positions since the tax benefits have not been included in priorincome tax return filings. Accrued interest relating to uncertain tax positionswould be recorded as a component of interest expense and penalties related touncertain tax positions would be recorded as a component of general andadministrative expenses.

 

Thetax years 2003-2007 remain open to examination by the major taxingjurisdictions to which we are subject. Additionally, upon inclusion of the NOLand R&D credit carry forward tax benefits from tax years 1996 to 2002 infuture tax returns, the related tax benefit for the period in which the benefitarose may be subject to examination.

 

**10. WARRANTY COSTS**

 

We provide a one-to-threeyear warranty on substantially all of our product sales, depending upon certainterms and conditions of the sale. We estimate future warranty claims based onhistorical experience and anticipated costs to be incurred over the life of thewarranty. Warranty expense is accrued at the time of sale with an additionalaccrual for specific items after the sale when their existence is known andamounts are determinable. A reconciliation of changes in our accrued warrantyreserve as of September 30, 2008 is as follows:

 
| ** **                     | ** ** | **Balance at**                  | ** ** | **Charged to** | ** ** | **Deduction /** | ** ** | **Balance at**                   | ** ** |
|--------------------------------|------------|---------------------------------|------------|---------------------|------------|----------------------|------------|----------------------------------|------------|
| ** **                     | ** ** | **December 31, 2007** | ** ** | **Expense**         | ** ** | **Expenditures**     | ** ** | **September 30, 2008** | ** ** |
| Allowance for Warranty Reserve |       | $                               | 3,803      |                | 2,902      |                 | 3,543      |                             | $          | 3,162 |   |
|                                |            |                                 |            |                     |            |                      |            |                                  |            |  |  |

 

**11. FAIR VALUE MEASUREMENT**

 

In September 2006, theFASB issued SFAS No. 157, *Fair Value Measurements*,(SFAS 157), which is effective for fiscal years beginning after November 15,2007 and for interim periods within those years. This statement defines fairvalue, establishes a framework for measuring fair value and expands the relateddisclosure requirements. While this statement does not require any new fairvalue measurement, it applies to other accounting pronouncements that requireor permit fair value measurements. The statement indicates, among other things,that a fair value measurement assumes that the transaction to sell an asset ortransfer a liability occurs in the principal market for the asset or liabilityor, in the absence of a principal market, the most advantageous market for theasset or liability. SFAS 157 defines fair value based upon an exit price model.

 

SFAS 157 establishes avaluation hierarchy for disclosure of the inputs to valuation used to measurefair value. This hierarchy prioritizes the inputs into three broad levels asfollows: Level 1 inputs are quoted prices (unadjusted) in active markets foridentical assets or liabilities. Level 2 inputs are quoted prices for similarassets and liabilities in active markets or inputs that are observable for theasset or liability, either directly or indirectly through market corroboration,for substantially the full term of the financial instrument. Level 3 inputs areunobservable inputs based on our own assumptions used to

 

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**EFJOHNSON TECHNOLOGIES, INC. AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**Threeand nine months ended September 30, 2008 and 2007**

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

 

measure assets and liabilities at fair value. Afinancial asset or liability’s classification within the hierarchy isdetermined based on the lowest level input that is significant to the fairvalue measurement.

 

Relative to SFAS 157, theFASB issued FASB Staff Positions (FSP) 157-1, 157-2 and 157-3. FSP 157-1 amendsSFAS 157 to exclude SFAS No. 13, *Accounting for Leases*,(SFAS 13) and its related interpretive accounting pronouncements that addressleasing transactions, while FSP 157-2 delays the effective date of theapplication of SFAS 157 to fiscal years beginning after November 15, 2008for all non-financial assets and non-financial liabilities that are recognizedor disclosed at fair value in the financial statements on a non-recurringbasis. FSP 157-3 amends SFAS 157 to provide guidance regarding the manner inwhich SFAS No. 157 should be applied in determining fair value of afinancial asset when there is no active market for such asset at themeasurement date.

 

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

 

The following table providesthe liabilities carried at fair value measured on a recurring basis as of September 30,2008:

 
| ** **                     | ** ** | ** **                                                     | ** ** | **Fair Value Measurements at September 30, 2008 Using:** | ** ** |
|--------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|
| ** **                     | ** ** | **Total Carrying Value at  September 30, 2008** | ** ** | **Quoted prices in  active markets  (Level 1)**                                   | ** ** | **Significant other  observable inputs  (Level 2)** | ** ** | **Significant  unobservable  inputs(Level 3)** | ** ** |
| Interest rate swap - liability |       | $                                                              | 657        |                                                                                        | $          | — |   | $ | 657 |   | $ | — |   |
|                                |            |                                                                |            |                                                                                             |            |  |  |  |  |  |  |  |  |

 

Interest rate swaps aremeasured at fair value indirectly through market corroboration, forsubstantially the full term of the financial instrument within Level 2 of thevaluation hierarchy.

 

In February 2007, theFASB issued SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities — Including an amendment of FASBStatement No. 115*, (SFAS 159) which is effective for fiscalyears beginning after November 15, 2007. This statement permits entitiesto choose to measure many financial instruments and certain other items at fairvalue. This statement also establishes presentation and disclosure requirementsdesigned to facilitate comparisons between entities that choose differentmeasurement attributes for similar types of assets and liabilities. Unrealizedgains and losses on items for which the fair value option is elected would bereported in earnings. We have adopted SFAS 159 and have elected not to measureany additional financial instruments and other items at fair value.

 

**12. COMMITMENTS AND CONTINGENCIES**

 

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

 

Duringthe nine months ended September 30, 2008, we settled two minor legalclaims for $0.2 million. The total we have accrued in regards to all legalproceedings was negligible as of September 30, 2008 and was $0.2 million asof December 31, 2007.

 

In thenormal course of our business activities, we are required under contracts withvarious government authorities to provide letters of credit and bonds that maybe drawn upon if we fail to perform under these contracts. We had open lettersof credit totaling $0.8 million and $0.3 million as of September 30, 2008and December 31, 2007, respectively. Bonds, which expire on various dates,totaled $2.4 million and $0.5 million as of September 30, 2008 and December 31,2007, respectively. No bonds had been drawn upon at either date. The increase in bonds relate to the contractawarded in May 2008 by the Government of Yukon, Canada.

 

**13.********COSTS ASSOCIATED WITHEXIT OR DISPOSAL ACTIVITIES**

 

On November 15,2007, the Company committed to an organizational plan (the “Plan”) to shiftfrom three divisions to one integrated corporate structure focused on securewireless communications for government and industrial customers. The

 

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**EFJOHNSON TECHNOLOGIES, INC. AND SUBSIDIARIES**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**Threeand nine months ended September 30, 2008 and 2007**

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

 

Plan is expected toimprove efficiencies in our operations, reduce our infrastructure costs and tosupport a new technology roadmap driving toward a streamlined and moreeffective structure. Implementation of the Plan includes senior and middlemanagement changes as well as staff reductions designed to eliminate redundantpositions and reflects the Company’s decision to consolidate operations andmove production from three locations into a centralized operations andoutsourcing program in the Dallas/Fort Worth area.

 

Coststhat are directly associated with the Plan are being recorded as “restructuringcosts” and are included in general and administrative expenses. Other coststhat do not qualify as restructuring costs are being classified as otheroperating expenses or costs of goods sold in the Company’s consolidatedstatements of operations.

 

Thetiming of the recognition of costs associated with this move were determined inaccordance with SFAS No. 146, *Accounting for Costs Associated with Exit or DisposalActivities**,*** and otherrelevant guidance, that provides that a liability for a cost associated with anexit or disposal activity shall be recognized at its fair value in the periodin which the liability is incurred. In particular, employee-related terminationcosts associated with the relocation are generally recognized ratably over theperiod that the employees are required to provide services in order to earn therespective termination benefit.

 

Thefollowing table summarizes the estimates and actual exit costs incurred as of September 30,2008:

 
| ** **                    | ** ** | **Original  amount  expected to  be incurred** | ** ** | **Additional  Costs incurred** | ** ** | **Total  amount  expected to  be incurred** | ** ** | **Amount  incurred as of  December 31,  2007** | ** ** | **Amount  incurred as of  September 30,  2008** | ** ** | **Remaining  amount to  be incurred** | ** ** |
|-------------------------------|------------|------------------------------------------------|------------|--------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------|------------|------------------------------------------------------|------------|---------------------------------------|------------|
| One-time termination benefits |       | $                                              | 951        |                           | $          | —                                      |       | $                                                   | 951        |                                                 | $          | 575                                   |       | $ | 300 |   | $ | 76 |   |
| Other costs                   |       | 139                                            |       | 57                             |       | 196                                         |       | 45                                                  |       | 151                                                  |       | —                                |       |
| Total costs                   |       | $                                              | 1,090      |                           | $          | 57                                          |       | $                                                   | 1,147      |                                                 | $          | 620                                   |       | $ | 451 |   | $ | 76 |   |

 

Thefollowing table summarizes the beginning and ending liability reserve for exitcosts as of September 30, 2008:

 
| ** **                    | ** ** | **Balance at  December 31,  2007** | ** ** | **Cash  Payments** | ** ** | **Balance at  September 30,  2008** | ** ** |
|-------------------------------|------------|-----------------------------------------|------------|--------------------|------------|------------------------------------------|------------|
| One-time termination benefits |       | $                                       | 575        |               | $          | 516                                      |       | $ | 59 |   |
| Other costs                   |       | 3                                       |       | 3                  |       | —                                   |       |
| Total costs                   |       | $                                       | 578        |               | $          | 519                                      |       | $ | 59 |   |

 

**14.****RELATED PARTY TRANSACTIONS**

 

During the three months ended September 30, 2008,DRS Technologies, Inc. (“DRS”) and its related subsidiaries purchasedapproximately $1.7 million of our products. During the nine months ended September 30,2008 and 2007, DRS and its related subsidiaries purchased approximately $15.9million and $0.1 million, respectively, of our products. Included in ouraccount receivable balances as of September 30, 2008 and December 31,2007 were amounts due from DRS for $0.1 million and $0.5 million,respectively. Since August 1995, Mark Newman has been the Chairman,President and Chief Executive Officer of DRS. Mr. Newman was appointed adirector of the Company in 2005. It is anticipated that the Company may engagein similar business with DRS in the future.

 

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**ITEM 2.****                              ****MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

Discussionsof certain matters contained in this Quarterly Report on Form 10-Q mayconstitute forward-looking statements under Section 27A of the SecuritiesAct of 1933, as amended, and Section 21E of the Securities Exchange Act of1934, as amended, (the “Exchange Act”). These forward-looking statements arebased upon our current expectations, estimates and projections about ourbusiness and our industry, and reflect our beliefs and assumptions based uponinformation available to us at the date of this report. In some cases, you canidentify 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 relateto, among other things, the results of our product development efforts, futuresales and expense levels, our future financial condition, liquidity, andbusiness prospects generally, the impact of our relocation of operatingfacilities and outsourcing of manufacturing on our operating results, perceivedopportunities in the marketplace for our products, and our other business plansfor the future.

 

Theseforward-looking statements are subject to certain risks and uncertainties thatcould cause the actual results, performance and outcomes to differ materiallyfrom those expressed or implied in these forward-looking statements due to anumber of risk factors including, but not limited to, the risks discussed inthe 2007 Annual Report on Form 10-K under Item 1A “Risk Factors” andin Part II of this report on Form 10-Q under Item 1A “RiskFactors.” We caution readers not to rely on these forward-looking statements,which reflect management’s analysis only as of the date of this quarterlyreport. We undertake no obligation to revise or update any forward-lookingstatement for any reason except as required by law.

 

Thefollowing discussion is intended to provide a better understanding of thesignificant changes in trends relating to our financial condition and resultsof operations. Management’s Discussion and Analysis of Financial Condition andResults of Operations should be read in conjunction with the accompanyingCondensed Consolidated Financial Statements and Notes thereto.

 

**Overview**

 

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

 

In light of thesechanges, the Company has reassessed its segment reporting, and beginning withthe first quarter of 2008, we are no longer reporting the two segments ofPrivate Wireless Communications and Secured Communications. The operatingstructure of the Company also changed in the first quarter. Under the newstructure, all the Company’s operations report up to the chief executiveofficer and president through the chief operating officer. The chief financialofficer, chief operating officer and general counsel report to the chiefexecutive officer and president. Based on the synergies of our products,customers, and organizational structure, the Company now operates in a singlesegment.

 

Wedesign, develop, market and support wireless radios and wireless communicationsinfrastructure and systems for digital and analog platforms. In addition, weoffer encryption technologies for wireless voice, video and data communicationsand we also design, develop, market and support secure wireless networkingsolutions that include Wi-Fi products, mesh networking, access points, andclient infrastructure products. The Company’s customers include firstresponders in public safety and public service, the federal government, andindustrial organizations.

 

Due tothe timing of orders and seasonality, our quarterly results fluctuate. Weexperience seasonality in our results in part due to governmental customerspending patterns that are influenced by government fiscal year-end budgets andappropriations. The unpredictable sales cycle coupled with launching newproducts and solutions can also cause variations from quarter to quarter.

 

*Our Products and Solutions*

 

Ourwireless radio offerings are primarily digital solutions designed to operate inboth analog and digital system environments. Our products and systems are basedon industry standards designed to enhance interoperability among systems,improve bandwidth efficiency, and integrate voice and data communications.

 

TheLand Mobile Radio (“LMR”) industry utilizes two-way wireless communicationsthrough wireless networks, which include infrastructure components such as basestations, repeaters, transmitters and receivers, network switches and

 

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portable and mobiletwo-way communication radios. Individual users operate portable hand-heldradios and vehicular-mounted radios in their wireless communications system.Utilizing licensed RF spectrum, the customer owns and operates the wirelesscommunication system that is networked by linking together the infrastructurecomponents. We develop customer solutions, which leverage the customer’swireless system and wireless radios with customer specific or enterprise wideapplications.

 

Themajority of revenues are derived from the sale of wireless radio products. Ourfederal, state and local governmental agency customers are increasinglydemanding interoperable, secured communications products and systems. Webelieve this demand has created opportunities for us as we believe we arepositioned to provide these products and systems. As a result, we expect tocontinue to allocate a majority of our on-going research and developmentexpenditures to wireless radio features and enhancements, infrastructurecomponents and system development efforts.

 

Weprovide the domestic and international LMR industry with secure encryptiontechnologies for analog wireless radios. These products are specificallydesigned to prevent unauthorized access to sensitive voice communications inparts of the world where wireless radio systems remain analog and securityneeds are high. These products are sold as aftermarket add-on components orembedded components for existing analog radios and systems.

 

We also design, develop,market and support customized wireless network centric products and systemswhich include secure Wi-Fi products, including mesh networking, access point,bridge, and client infrastructure products, as well as security software. Weprovide sensor network solutions, through our InfoMaticsÒ middleware,which enables sensors and databases to communicate data to pertinent personnelfor command and control applications in near real-time. These products andsolutions utilize FIPS 140-2 validated wireless products, 802.11 wirelessnetworking (WIFI) solutions, mesh networking and conditions based and locationbased telematics solutions.

 

*Our Salesand Distribution Approach*

 

Our products and systemsare sold through multiple channels including a direct sales force, dealers,manufacturing representatives, distributors, and strategic partneringarrangements. We utilize our dealer network to assist in installing, servicing,selling and distributing our products. We also generate revenues through the federalgovernment under government funded research and development Small BusinessInnovative Research (“SBIR”) programs. Additionally, we offer our products tocommercial, non-governmental users.

 

Much of our business isobtained through submission of formal competitive bids. Our governmentcustomers generally can specify the terms, conditions and form of the contract.Our government business is subject to government funding decisions and contracttypes can vary widely, including cost plus, fixed-priced, indefinite-delivery/indefinitequantity (“IDIQ”), and government-wide acquisition contracts with the GeneralServices Administration (“GSA”), that require pre-qualification of vendors andallows government customers to more easily procure our products and systems.Through federal government SBIR programs, business is most typically obtainedthrough the submission of formal bids under cost plus or time and materialagreements.

 

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

 

**Description of Operating Accounts**

 

*Revenues*. Revenues consist of product sales, services, andgovernment funded research and development services and solutions net ofreturns and allowances. Longer-term system and government services revenues arerecognized under the percentage of completion method.

 

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

 

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

 

*Research and Development.* Research and development expenses consist primarilyof costs associated with research and development personnel, materials, and thedepreciation of research and development equipment and facilities. We expenseresearch and development costs as they are incurred, net of any applicable costreimbursements. Research and development expenses relating to our governmentfunded research and development services are included as a component of cost ofsales.

 

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*Sales and Marketing.* Sales and marketing expenses consist primarily ofsalaries and related costs of sales personnel, including sales commissions andtravel expenses, as well as costs of advertising, product and programmanagement, public relations and trade show participation.

 

*General and Administrative*. General and administrative expenses consistprimarily of salaries and other expenses associated with our management,accounting, information systems and administrative functions. This expense alsoincludes the impact of equity-based compensation expense. Accounting for governmentcontracts delineates what is a direct charge allowable to include in contractcosts and what is considered to be an indirect charge reflected as general andadministrative expenses. We consider indirect engineering labor and operatingcosts such as quality, planning, operations, and company fringe benefits,general administrative salaries and other general administrative expenses asgeneral and administrative expense.

 

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

 

*Provision for Income Taxes.* Provision (benefit) for income taxes includes theincrease or decrease in the valuation reserve that is based upon management’sconclusions regarding, among other considerations, our historical operatingresults and forecasted future earnings over a five year period, our current andexpected customer base projections, and technological and competitive factorsimpacting our current products. Current financial accounting standards requirethat organizations analyze all positive and negative evidence relating todeferred tax asset realization, which would include our historical accuracy inforecasting future earnings, as well as our history of losses incurred withinthe past three years. Should factors underlying management’s estimates change,future adjustments, either positive or negative, to our valuation allowance maybe necessary.

 

**Critical Accounting Policies**

 

The preparationof our consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America, or GAAP,requires management to make judgments, estimates and assumptions in certaincircumstances that affect the amounts reported in the consolidated financialstatements and related footnotes. We regularly evaluate the accounting policiesand estimates used to prepare our financial statements. Estimates are used for,but not limited to, the accounting for allowance for doubtful accounts andsales returns, application of percentage of completion accounting for long-termcontract revenues, inventory reserves, warranty reserves, valuation allowancefor deferred income tax assets, impairment charges and contingencies. Theseestimates are based on historical experience and various assumptions that webelieve to be reasonable under the particular applicable facts andcircumstances. Actual results could differ from those estimates.

 

Weconsider our critical accounting policies to be those that involve significantjudgments and uncertainties, require estimates that are difficult formanagement to determine, and have the potential to result in materiallydifferent outcomes under varying assumptions and conditions. The application ofGAAP requires management to make estimates and assumptions that affect theamounts reported in the financial statements and accompanying results. Listedbelow are those policies we believe are critical and require the use of complexjudgment in their application.

 

***Revenues***

 

Productrevenues are recognized when the earnings process is complete, less an estimatefor an allowance for returns, if applicable, and collection is reasonablyassured. The earnings process is generally complete when the product is shippedor received by the customer, depending upon whether the title to the goods, aswell as the risks and benefits of ownership, are transferred to the customer atpoint of shipment or point of delivery, as typically we have no further obligationswith respect to the sale which impact the functionality of the product. Forsales where collection is not reasonably assured, we recognize revenues as cashis received. If collection is contingent on a future event, we recognizerevenues when the contingency lapses, generally upon cash collection.

 

Systemsales under long-term contracts are accounted for under the percentage ofcompletion method. Under this method, revenues are recognized as work on acontract progresses. The recognized revenue is that percentage of estimatedtotal revenues that incurred costs to date bear to estimated total costs tocomplete the contract. Revisions in cost and profit estimates are made whenconditions requiring such revisions become known. Anticipated losses on contractsare recognized in operations as soon as such losses are determined to beprobable and reasonably estimable.

 

Governmentfunded services revenue from cost plus contracts is recognized as costs areincurred on the basis of direct costs plus allowable indirect costs and anallocable portion of the fixed fee. Revenue from fixed-type contracts isrecognized under the percentage of completion method with estimated costs andprofits included in contract revenue as work is performed. Revenue from timeand materials contracts is recognized as costs are incurred at amountsrepresented by the agreed billing amounts.

 

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Deferredrevenues include unearned services provided under systems maintenancecontracts. We recognize the fees based upon a straight-line method over thelife of the contract.

 

Weperiodically review our revenue recognition procedures to assure that suchprocedures are in accordance with the provisions of Staff Accounting Bulletins101 and 104, Statement of Position 81-1 and other interpretations, asapplicable. 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. Customers can upgrade their infrastructure andsystems software via a secure download and we follow the guidance of SOP 97-2as amended by SOP 98-9 for software revenue recognition.

 

***Inventories***

 

Inventoriesare recorded at the lower of cost or market with cost determined utilizing astandard cost method. We periodically assess our inventories for potentialobsolescence and lower-of-cost-or-market issues. We make estimates of inventoryobsolescence, providing reserves when necessary, based on, among other factors,demand for inventories based on backlog, product pricing, the ability toliquidate or sell older inventories, and the impact of introducing newproducts. A significant portion of our inventories is comprised of componentsand parts on hand to support maintenance of products previously sold. As such,we anticipate utilizing such inventories over extended periods of time. Ourobsolescence and lower- of - cost-or-market accounting policies provide for aperiodic adjustment to the carrying value of such inventories. As of September 30,2008 we had a reserve for obsolescence of $3.7 million.

 

***Goodwill and Other Intangible Assets***

 

Atleast annually, we assess goodwill and other indefinite lived intangibleassets, using fair value-based tests. If the respective carrying amount exceedsthe fair value, goodwill or other indefinite lived intangible assets areconsidered to be impaired. In evaluating impairment, we estimate the sum of theexpected future cash flows derived from such reporting unit and present valueimplied by estimates of future revenues, costs and expenses and other factors.The estimates use assumptions about our market segment share in the future andabout future expenditures by government entities. We continually evaluatewhether events and circumstances have occurred that indicate the remainingbalance of goodwill or other indefinite lived intangible assets may not berecoverable. To the extent our assumptions change, we may be required to adjustthe carrying value of the goodwill or other intangible assets. For a furtherdiscussion of goodwill and other intangible assets, see the discussion under *Footnote 7 — Notes to Condensed ConsolidatedFinancial Statement*.

 

***Income Taxes***

 

Weaccount for income taxes using the asset and liability method. Deferred taxassets and liabilities are recognized for the future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases. Deferred taxassets and liabilities are measured using current enacted tax rates. The effecton deferred tax assets and liabilities of a change in tax rates is recognizedin the results of operations in the period that includes the enactment date.

 

Weadopted 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 taxpositions in the amount of $0.4 million. However, these tax benefits have notbeen included in prior year income tax return filings and are included in ourdeferred tax asset pools as of January 1, 2007 (FIN 48 adoption date) witha reasonable valuation reserve. Based on activities through December 31,2007 we increased the estimate for uncertain tax positions to $0.5 million thatare included in our deferred tax pools and fully reserved. Therefore, we haveconcluded that there is no requirement to book a liability for FIN 48 asdiscussed in Note 9 to the condensed consolidated financial statements.

 

***Long-Lived Assets***

 

We review our long-lived assets, including intangibleassets subject to amortization, for recoverability whenever events or changesin circumstances indicate that the carrying amount of such long-lived asset orgroup of long-lived assets may not be recoverable. Such circumstances include,but are not limited to:

 

·                  a significant decrease in the market price of thelong-lived asset;

 

·                  a significant change in the extent or manner in whichthe long-lived asset is being used;

 

·                  a significant change in the business climate thatcould affect the value of the long-lived asset;

 

·                  a current period loss combined with projection ofcontinuing loss associated with use of the long-lived asset; and

 

·                  a current expectation that, more likely than not, thelong-lived asset will be sold or otherwise disposed of before the end of itspreviously estimated useful life.

 

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Wecontinually evaluate whether events and circumstances have occurred which mayindicate that the carrying value may not be recoverable. When such events orcircumstances exist, the recoverability of the long-lived asset’s carryingvalue 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 eventualdisposition of, the long-lived asset. During the fourth quarter ended December 31,2007, we recorded impairment charges for indefinite lived intangible assets. Tothe extent such events or circumstances occur in the future that could affectthe recoverability of our long-lived assets, we may be required to impair theseassets at that time.

 

***Stock-based Compensation***

 

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

 

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**Results of Operations**

 

The following table presents certain CondensedConsolidated Statements of Operations information as a percentage of revenuesduring the periods indicated:

 
| ** **                        | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                        | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                        | ** ** | **2008**               | ** ** | **2007**               | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenues                          |       | 100.0                  | %          | 100.0                  | %          | 100.0 | % | 100.0 | % |
| Cost of sales                     |       | 63.4                   |       | 71.3                   |       | 65.6 |   | 68.7 |   |
| Gross profit                      |       | 36.6                   |       | 28.7                   |       | 34.4 |   | 31.3 |   |
|                              |       |                   |       |                   |       |   |   |   |   |
| Operating expenses:               |       |                   |       |                   |       |   |   |   |   |
| Research and development          |       | 10.3                   |       | 11.7                   |       | 6.9 |   | 8.9 |   |
| Sales and marketing               |       | 9.5                    |       | 9.4                    |       | 9.6 |   | 7.9 |   |
| General and administrative        |       | 13.8                   |       | 16.9                   |       | 16.7 |   | 13.5 |   |
| Amortization of intangibles       |       | 1.0                    |       | 1.2                    |       | 1.2 |   | 0.9 |   |
| Total operating expenses          |       | 34.6                   |       | 39.2                   |       | 34.4 |   | 31.2 |   |
| Income (loss) from operations     |       | 2.0                    |       | (10.5                  | )          | 0.0 |   | 0.1 |   |
|                              |       |                   |       |                   |       |   |   |   |   |
| Interest income (expense), net    |       | (0.8                   | )          | 0.1                    |       | (0.7 | ) | — |   |
| Income (loss) before income taxes |       | 1.2                    |       | (10.4                  | )          | (0.7 | ) | 0.1 |   |
|                              |       |                   |       |                   |       |   |   |   |   |
| Income tax benefit                |       | —                 |       | 0.4                    |       | — |   | — |   |
| Net income (loss)                 |       | 1.2                    | %          | (10.0                  | )%         | (0.7 | )% | 0.1 | % |

 

**Comparison of the Three Months and Nine Months Ended September 30,2008 and 2007**

 

*Revenues.*Our revenues increased $0.8 million, or 2.3%, to $34.5million for the three months ended September 30, 2008 from $33.7 millionfor the same period in 2007. The increase was attributable to large deliveriesagainst state and local orders. Our revenues decreased $29.0 million, or 22.3%,to $101.0 million for the nine months ended September 30, 2008 from $130.0million for the same period in 2007. The decline was attributable to largedeliveries against Department of Defense contracts in 2007 not replicated in2008. Partially offsetting this decline in revenue were increases in revenuesassociated with the FCC rebanding effort and large deliveries against state andlocal orders.

 

*Gross Profit.*Our gross profit increased $3.0 million, or 30.9%, to$12.6 million in the three months ended September 30, 2008 from $9.6million for the same period in 2007. Gross profit, as a percentage of revenues,or gross margin, was 36.6% for the three months ended September 30, 2008,as compared to 28.7% for the same period in 2007. The improved gross margin inthe three months ended September 30, 2008 was primarily attributable tofavorable margins associated with revenues from products delivered in the thirdquarter of 2008 and cost reduction programs as compared to the margins achievedfrom the large deliveries against Department of Defense contracts in 2007 notreplicated in 2008. Our gross profit decreased $6.0 million, or 14.7%, to $34.7million in the nine months ended September 30, 2008 from $40.7 million forthe same period in 2007. The decline in gross profit was primarily attributableto the above noted volume variance in revenue. Gross profit, as a percentage ofrevenues, or gross margin, was 34.4% for the nine months ended September 30,2008, as compared to 31.3% for the same period in 2007. We anticipate changesin the revenue mix could impact the gross margin percentage in the fourthquarter of 2008.

 

*Research and Development.*Research and development expenses decreased $0.3million, or 9.4%, to $3.6 million in the three months ended September 30,2008 from $3.9 million in the same period in 2007. Research and developmentexpenses as a percentage of revenues decreased to 10.3% in the third quarter of2008 versus 11.7% for the same period in

 

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2007. Research anddevelopment expenses decreased $4.6 million, or 39.7%, to $6.9 million in thenine months ended September 30, 2008 from $11.5 million in the same periodin 2007. Research and development expenses as a percentage of revenuesdecreased to 6.9% in the first nine months of 2008 versus 8.9% for the sameperiod in 2007.

 

Thedecrease in research and development expenses is attributable to anon-recurring engineering cost reimbursement of $4.0 million received in thesecond quarter of 2008 from a customer for research and development expensesrelating to the development and re-engineering of our Multinet radio productline associated with the FCC re-banding effort. The development of our Multinetradio has been completed and no further non-recurring engineering costreimbursement will be received. We anticipate research and development expensesfor the fourth quarter of 2008 to be similar to the third quarter of 2008.

 

*Sales and Marketing.*Sales and marketing expenses increased $0.1 million,or 3.5%, to $3.3 million in the three months ended September 30, 2008 from$3.2 million in the same period in 2007. Sales and marketing expenses as apercentage of revenues were 9.5% in the third quarter of 2008 versus 9.4% inthe third quarter of 2007. Sales and marketing expenses decreased $0.6 million,or 5.8%, to $9.7 million in the nine months ended September 30, 2008 from$10.3 million in the same period in 2007. The decrease is mainly attributableto lower sales incentives resulting from the decline in revenue noted above.Sales and marketing expenses as a percentage of revenues was 9.6% for 2008versus 7.9% in 2007.

 

*General and Administrative.*General and administrative expenses decreased $0.9million, or 16.5%, to $4.8 million for the three months ended September 30,2008 from $5.7 million for the same period in 2007. General and administrativeexpenses decreased $0.7 million, or 3.8%, to $16.9 million for the nine monthsended September 30, 2008 from $17.5 million for the same period in 2007.The decrease in expenses is primarily attributable to reduced expensesresulting from the reorganization.

 

*Amortization of Intangibles.*Amortization of intangibles was $0. 4 million for thethree months ended September 30, 2008 and 2007, respectively. Amortizationof intangibles was $1.2 million for the nine months ended September 30,2008 and 2007, respectively. Amortization of intangibles relates tospecifically identifiable intangible assets with a definite life.

 

*Interest Expense, net.*Interest expense, net increased $0.3 million to $0.3million in expense for the three months ended September 30, 2008 from thesame period in 2007. Interest expense, net increased $0.7 million to $0.7million in expense for the nine months ended September 30, 2008 from thesame period in 2007. The increases are attributable to interest on the termloan, short term borrowings and lower interest income earned on cashinvestments.

 

*Provision for Income Taxes.*We did not record a tax benefit or provision for thethree and nine months ended September 30, 2008. For the three months andnine months ended September 30, 2008, our deferred tax assets were fullyreserved requiring no provision for income taxes. The valuation reserve isbased upon management’s conclusions regarding, among other considerations, ouroperating results during each period, our current and expected customer base,technological and competitive factors impacting our current products, andmanagement’s estimates of future earnings based on information currentlyavailable. For the three months ended September 30, 2007, we recorded atax benefit of $0.1 million. The difference between our effective tax rates andthe 34% federal statutory rate resulted primarily from utilization of netoperating loss carryforwards and changes in the valuation reserve during 2007.

 

*Net Income / (Loss).*Net income (loss) was $0.4 million for the threemonths ended September 30, 2008, reflecting an increase of $3.8 million,as compared to a net loss of ($3.4) million for the same period in 2007. Netloss was ($0.7) million for the nine months ended September 30, 2008,reflecting a decrease of $0.8 million, as compared to net income of $0.1million for the same period in 2007.

 

**Liquidity and Capital Resources**

 

The Company’s primarysources of liquidity are its cash and cash equivalents that were $6.2 millionand $15.6 million at September 30, 2008 and December 31, 2007,respectively. Effective with the amended Loan Agreement, we designated $3.0 millionof our invested cash balances for the minimum liquidity requirements. Due tothe net losses in 2007 and 2006, we considered several key factors in assessingthe liquidity requirements of the Company for the next twelve months. Managementmonitors operational cash flow projections which factor in our backlog oforders and our historical collection and payment patterns with customers andvendors. We continue to review and identify potential additional cost savingsmeasures that the Company’s may implement. We analyzed these projectionsagainst our modified bank covenants for 2008 noting that on a proforma basisthe covenants would be met. We noted that we are current and have made timelyinterest payments on our term note. Furthermore, we may utilize our revolvingline of credit to borrow supported by the underlying borrowing base of theCompany. During the third quarter of 2008, significant changes in the financialmarkets have occurred. We have reviewed the credit ratings and stability of ourbank noting a stable outlook and credit rating. Based on these factors, amongothers, we believe that our available cash, financing and cash flow fromoperations will be adequate to meet our anticipated needs for at least the nexttwelve months.

 

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*Net cash from operating activities.*Our operating activities used cash of$8.0 million and provided cash of $0.6 million in the nine months ended September 30,2008 and 2007, respectively. Cash used in or provided by operating activitiesis primarily a reflection of our collections on billed receivables, investmentin inventories and expenditures for operations.

 

During the nine months ended 2008, operatingactivities used $8.0 million in cash flow primarily due to an increase inbilled receivables of $11.0 million and other operating activities of $2.4million partially offset by non-cash items of $5.4 million. Non-cash itemsprimarily relate to depreciation, amortization and stock-based compensationexpense. The increase in accounts receivable reflects delays in cashcollections from certain customers during the quarter ended September 30,2008.

 

During the nine months ended 2007, operatingactivities provided $0.5 million in cash flow primarily due to non cash itemsof $5.2 million and other operating activities of $3.6 million partially offsetby purchases of inventory. Non-cash items primarily relate to depreciation,amortization and stock-based compensation expense. The increases in inventorieswere principally the result of continued product procurement in the thirdquarter of 2007 in anticipation of satisfaction of shipments and sales relatingto the fourth quarter.

 

*Net cash from investing activities.* During the nine months ended September 30,2008 investing activities used $3.4 million primarily attributable toestablishing $2.0 million of restricted cash as collateral for the Government of Yukon, Canada bond andpurchases of property plant and equipment of $1.6 million. During thenine months ended September 30, 2007 investing activities used $2.2 millionprimarily attributable to purchases ofproperty plant and equipment of $2.1 million.

 

*Net cash from financing activities.*During the nine months ended September 30,2008 financing activities provided $2.0 million primarily attributable toborrowings from the revolving credit line. During the nine months ended September 30, 2007, virtually no cashwas provided from financing activities.

 

*Letters of credits and bonds.* In the normal course of our businessactivities related to sales of wireless radio systems to local and stategovernmental entities, we are required under contracts with various governmentauthorities to provide letters of credit or performance or bid bonds that maybe drawn upon if we fail to perform under our contracts. Our open letters ofcredit of $0.8 million and $0.3 million were outstanding as of September 30,2008 and December 31, 2007, respectively. Performance and other suretybonds that expire on various dates, totaled $2.4 million and $0.5 million asof  September 30, 2008 and December 31,2007, respectively. In the second quarter of 2008, we entered into a governmentcontract requiring a $2.0 million performance bond, which bond was obtained bythe Company in July 2008.  The Companywas required to post cash collateral in order to obtain that bond.

 

*Secured line of credit.* We amended our secured line of creditagreement with Bank of America, (the “Loan Agreement”), in July 2006 toinclude a revolving line of credit of up to $15.0 million and a term loan of$15.0 million. Both borrowings bear interest at a variable rate based on theLondon Interbank Offered Rate (“LIBOR”) plus a margin (“LIBOR Margin”)determined by our ratio of debt to earnings before interest, taxes,depreciation, and amortization (“EBITDA”). Following the renegotiation of theLoan Agreement, the $15.0 million term loan was fully funded and used tofinance the acquisition of 3eTI. The LIBOR Margin was 175 basis points at December 31,2007. No borrowings were made on the revolving line of credit during 2007.

 

As noted in our Form 10-K for the period endedDecember, 31, 2007, we were not in compliance with the financial covenants ofthe Loan Agreement for the quarter ended December 31, 2007. As a result,effective March 10, 2008 we executed an Amendment to the Loan Agreementwhereby Bank of America waived such financial covenant defaults on a one timebasis, subject to further modification of the Loan Agreement to revise suchfinancial covenants, to modify the advance and borrowing revisions under theLoan Agreement and for certain other purposes more fully set out in theAmendment.

 

The Loan Agreement, as amended, provides for customaryaffirmative and negative covenants, including maintenance of corporateexistence, rights, property, books and records and insurance, compliance withcontracts and laws, and certain reporting requirements, as well as limitationson debt, liens, fundamental changes, acquisitions, transfers of assets,investments, loans, guarantees, use of proceeds, sale-leaseback transactionsand capital expenditures. In addition, the Loan Agreement, as amended, containscertain financial covenants including a maximum ratio of funded debt to EBITDAand a fixed charge coverage ratio. The Loan Agreement, as amended, alsoprovides for events of default that would permit the Lender to acceleraterepayment of the loans upon their occurrence, including failure to makepayments, breaches of representations and warranties, insolvency events,acceleration of other indebtedness, failure to discharge judgments, materialadverse effects, certain breaches of contracts, casualty losses when no orinsufficient insurance is maintained, changes of control, certain ERISA eventsand failure to observe covenants. As collateral for the obligations under theLoan Agreement, as amended, the Lender has a security interest in substantiallyall assets of the Borrowers, including accounts receivable, inventory,machinery, equipment, real estate, and general intangibles. Pursuant to theLoan Agreement, as further amended, effective March 10, 2008, the amendedLoan Agreement effectively eliminated the ratio of funded debt to EBITDA and afixed charge coverage ratio for 2008 and contains a new covenant to maintain aminimum liquidity of $3.0 million in unrestricted cash, unencumbered marketablesecurities, cash and cash equivalents through March 31, 2009.Additionally, a 

 

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covenantfor a minimum EBITDA was established for (i) breakeven for the fiscalquarter ended June 30, 2008, (ii) $1.0 million for the fiscal quarterended September 30, 2008 and $3.0 million for the fiscal quarter ended December 31,2008. Furthermore, effective March 10, 2008, the interest rate is equal toLIBOR plus 2.00% through March 31, 2009, and thereafter to LIBOR plus arate between 1.00% and 1.75% depending on our ratio of debt to EBITDA.

 

We were in compliance with all financial, affirmativeand negative covenants at September 30, 2008. At September 30, 2008,$2.0 million had been borrowed against the revolving line of credit. The totalavailable remaining credit under the line of credit was $12.2 million and$13.3 million as of September 30, 2008 and December 31, 2007,respectively.

 

*Dividend policy.* Since our initial public offering, wehave not declared or paid any dividends on our common stock. We presentlyintend to retain earnings for use in our operations and to finance ourbusiness. Any change in our dividend policy is within the discretion of ourboard of directors and will depend, among other things, on our earnings, debtservice and capital requirements, restrictions in financing agreements, if any,business conditions and other factors that our board of directors deemsrelevant.

 

*Backlog.* Our backlog as of September 30,2008 was $70.5 million, compared to a backlog of $95.0 million at December 31,2007 and $98.1 million at September 30, 2007. Depending on the size andcomplexity of customer specifications and requirements, the backlog can beconverted to revenues in a relatively short period of time (typically 90 days)or with complex integrations and various delivery dates, orders can spanmultiple years.

 

**Off-Balance Sheet Arrangements**

 

As part of our ongoing business, we do not participatein transactions that generate relationships with unconsolidated entities orfinancial partnerships, such as entities often referred to as structuredfinance or variable interest entities (“VIE”), that would have been establishedfor the purpose of facilitating off-balance sheet arrangements or othercontractually narrow or limited purposes. As of September 30, 2008, we arenot involved in any VIE transactions.

 

**Recently Issued Accounting Standards**

 

In October 2008, the FASB issued Staff PositionNo. 157-3, *Determining the Fair Value of a FinancialAsset When the Market for That Asset Is Not Active* (“FSP157-3”).  FSP 157-3 amends SFAS 157 to provide guidanceregarding the manner in which SFAS No. 157 should be applied indetermining fair value of a financial asset when there is no active market forsuch asset at the measurement date.

 

In April 2008, the FASB issued Staff Position No. 157-1 and 157-2. FSP 157-1 amends SFAS 157 toexclude SFAS No. 13, *Accounting for Leases*,(SFAS 13) and its related interpretive accounting pronouncements that addressleasing transactions. FSP 157-2 delays the effective date of the application ofSFAS 157 to fiscal years beginning after November 15, 2008 for allnon-financial assets and non-financial liabilities that are recognized ordisclosed at fair value in the financial statements on a non-recurring basis.

 

In April 2008,the FASB issued Staff Position No. 142-3, *Determinationof the Useful Life of Intangible Assets* (“FSP 142-3”). FSP 142-3amends the factors that should be considered in developing renewal or extensionassumptions used to determine the useful life of a recognized intangible assetunder SFAS No. 142, *Goodwill and OtherIntangible Assets*. FSP 142-3 is effective for fiscal years beginningafter December 15, 2008 and interim periods within those fiscal years,requiring prospective application to intangible assets acquired after theeffective date. The Company will be required to adopt the principles of FSP142-3 with respect to intangible assets acquired on or after January 1,2009. Due to the prospective application requirement, the Company is unable todetermine what effect, if any, the adoption of FSP 142-3 will have on itsconsolidated statement of financial position, results of operations or cashflows.

 

In March 2008, the FASB issued SFAS No. 161,*Disclosures about Derivative Instruments andHedging Activities, an amendment of FASB Statement No. 133*(SFAS 161). This statement is intended to improve transparency in financialreporting by requiring enhanced disclosures of an entity’s derivativeinstruments and hedging activities and their effects on the entity’s financialposition, financial performance, and cash flows. SFAS 161 applies to allderivative instruments within the scope of SFAS 133, *Accountingfor Derivative Instruments and Hedging Activities* (SFAS 133) as wellas related hedged items, bifurcated derivatives, and nonderivative instrumentsthat are designated and qualify as hedging instruments. Entities withinstruments subject to SFAS 161 must provide more robust qualitativedisclosures and expanded quantitative disclosures. SFAS 161 is effectiveprospectively for financial statements issued for fiscal years and interimperiods beginning after November 15, 2008, with early applicationpermitted. We are currently evaluating the disclosure implications of thisstatement.

 

In December 2007, the FASB issued SFAS No. 141(revised 2007), *Business Combination* (“SFAS 141R”),which replaces FASB Statement No. 141. SFAS 141R establishes principlesand requirements for how an acquirer recognizes and measures in its financial statementsthe identifiable assets acquired, the liabilities assumed, any noncontrollinginterest in the 

 

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acquirerand the goodwill acquired. The Statement also establishes disclosurerequirements which will enable users to evaluate the nature and financialeffects of the business combination. SFAS 141R is to be applied prospectivelyto business combinations for which the acquisition date is on or after anentity’s fiscal year that begins after December 15, 2008. The impact ofour adoption of SFAS 141R will depend upon the nature and terms of businesscombinations, if any, that we consummate on or after January 1, 2009.

 

In December 2007, the FASB issued SFAS No. 160,*Noncontrolling Interests in Consolidated FinancialStatements - an amendment of Accounting Research Bulletin No. 51*(“SFAS 160”), which establishes accounting and reporting standards forownership interests in subsidiaries held by parties other than the parent, theamount of consolidated net income attributable to the parent and to thenoncontrolling interest, changes in a parent’s ownership interest and thevaluation of retained noncontrolling equity investments when a subsidiary isdeconsolidated. The Statement also establishes reporting requirements thatprovide sufficient disclosures that clearly identify and distinguish betweenthe interests of the parent and the interests of the noncontrolling owners.SFAS 160 is effective as of the beginning of an entity’s fiscal year thatbegins after December 15, 2008. The adoption of SFAS 160 currently has noimpact on our Consolidated Financial Statements.

 

In December 2007, the EITF issued Issue No. 07-1,*Accounting for Collaborative Arrangements*.This Issue is effective for financial statements issued for fiscal yearsbeginning after December 15, 2008, and interim periods within those fiscalyears, and shall be applied retrospectively to all prior periods presented forall collaborative arrangements existing as of the effective date. This Issuerequires that transactions with third parties (i.e., revenue generated andcosts incurred by the partners) should be reported in the appropriate line itemin each company’s financial statement pursuant to the guidance in EITF Issue No. 99-19,*Reporting Revenue Gross as a Principal versus Netas an Agent*. This Issue also includes enhanced disclosurerequirements regarding the nature and purpose of the arrangement, rights andobligations under the arrangement, accounting policy, amount and incomestatement classification of collaboration transactions between the parties. Weare currently not impacted by EITF Issue No. 07-1.

 

**ITEM 3.****                              ****QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

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

 

As discussed in Note 5 to the unaudited condensed consolidatedfinancial statements, the Company utilizes an interest rate swap arrangement tomanage interest costs and risks associated with changing interest rates. Thisderivative instrument can expose the Company to credit loss in the event ofnonperformance by the counterparty to the agreement.  To manage credit risk, the companyperiodically reviews the credit rating and stability of the counterparty. TheCompany does not expect the counterparty to fail to meet its obligations.

 

The uncertainty of financial markets and monetaryexchange values has caused, and may in the future cause, some customers todelay new orders or delay payment for existing orders. The purchase of ourproducts by customers presents increased risks, which include:

 

·                  unexpected changes in regulatory requirements;

 

·                  tariffs and other trade barriers;

 

·                  political and economic instability;

 

·                  financial market downturns and fluctuations;

 

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

 

·                  increased costs associated with maintaining international marketingefforts;

 

·                  natural disasters or acts of terrorism;

 

·                  difficulties in protecting intellectual property; and

 

·                  susceptibility to orders being cancelled as a result of economicfluctuations since all our quotations and invoices are denominated in U.S.dollars.

 

Although most of our sales are denominated in U.S.dollars, fluctuations in the value of international currencies relative to theU.S. dollar may affect the price, competitiveness and profitability ofour products sold in international markets. Furthermore, the uncertaintyof monetary exchange values has caused, and may in the future cause, someforeign customers to delay new orders or delay payment for existing orders.

 

Export of our products is subject to the U.S. ExportAdministration regulations and some of our secured communications productsrequire a license or a license exception in order to ship internationally. Wecannot assure that such 

 

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approvalswill be available to us or our products in the future in a timely manner or atall or that the federal government will not revise its export policies or thelist of products and countries for which export approval is required. Ourinability to obtain required export approvals would adversely affect ourinternational sales, which may have a material adverse effect on us. Inaddition, foreign companies not subject to United States export restrictionsmay have a competitive advantage in the international secured communicationsmarket. We cannot predict the impact of these factors on the internationalmarket for our products.

 

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

 

**Disclosure Controls and Procedures**

 

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

 

**Internal Controls Over Financial Reporting**

 

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

 

During the first quarter of 2008, we began the processof consolidating our business units into one and integrating the operations andoutsourced contract manufacturing at the Company. This integration continuedduring the third quarter. During the second quarter of 2008 we began the evaluationof potential changes and modifications to the Company’s internal controlstructure resulting from this ongoing transition. No significant changes in ourinternal controls were made during the third quarter 2008. Additionally, aspart of this integration, we continue to update control procedures associatedwith inventory costing, purchasing, shipping, and receiving with our outsourcemanufacturing providers. We will continue to conduct full physical inventorycounts periodically during 2008.

 

There were no other changes in our internal controlsover financial reporting during the quarter ended September 30, 2008 thathave materially affected, or are reasonably likely to materially affect, ourinternal controls over financial reporting.

 

In preparation of our financial statements as of andfor the period ended September 30, 2008, management believes that ourinternal controls over these processes are operating and effective.

 

**PART II. OTHER INFORMATION**

 

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

 

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

 

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

 

**Risk Factors Related to Our Business**

 

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

 

Current credit and financial market conditions coulddelay, or prevent our customers from obtaining funds, grants, financing orexpected tax base revenues, which would adversely affect their cash flows. Dueto the recent tightening of credit markets and concerns regarding the availabilityof credit, particularly in the United States, our customers may be delayed inobtaining, or may not be able to obtain, necessary cash flows for theirpurchases. Additionally, our suppliers of component parts and finished goodscould be negatively impacted by the current credit and financial marketconditions causing delays in product deliveries.  The delays described above could adverselyaffect our product sales and revenues, and therefore harm our business, financialcondition and results of operations.

 

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We continually evaluate whether events andcircumstances have occurred that indicate the remaining balance of goodwill orother indefinite lived intangible assets may not be recoverable. To the extentprolonged credit risks adversely affect our market capitalization ordetermination of an “exit price” for our reporting units as required by FAS 157(see Note 11 to the unaudited condensed consolidated financial statements), ourassumptions could change and we may be required to adjust the carrying value ofthe goodwill or other intangible assets.

 

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

 

N/A.

 

**ITEM 3.****                             ****DEFAULTS UPON SENIORSECURITIES**

 

N/A.

 

**ITEM 4.****                               ****SUBMISSION OF MATTERS TO A VOTEOF SECURITY HOLDERS.**

 

N/A.

 

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

 

N/A

 

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

 

The followingexhibits are filed herewith:

 
| **Exhibit No.** | ** ** | **Description**                                                                                                          |
|----------------------|------------|--------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                     |
| 10.1* +              |       | Letter agreement dated October 14, 2008, by and  among the Company and Michael E. Jalbert.                          |
|                 |       |                                                                                                                     |
| 11.1*                |       | Computation of income per share                                                                                          |
|                 |       |                                                                                                                     |
| 31.1*                |       | Chief Executive Officer’s Certification of Report on  Form 10-Q for the Quarter Ended September 30, 2008  |
|                 |       |                                                                                                                     |
| 31.2*                |       | Chief Financial Officer’s Certification of Report on  Form 10-Q for the Quarter Ended September 30, 2008  |
|                 |       |                                                                                                                     |
| 32.1*                |       | Written certification of Chief Executive Officer,  dated October 29, 2008, pursuant to 18 U.S.C. Section 1350. |
|                 |       |                                                                                                                     |
| 32.2*                |       | Written certification of Chief Financial Officer,  dated October 29, 2008, pursuant to 18 U.S.C. Section 1350. |

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* Filed with this report.

 

+ Management contract or compensatory plan orarrangement.

 

**SIGNATURE**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, as amended, the registranthas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

 
|                                 | EF JOHNSON TECHNOLOGIES, INC. |
|--------------------------------------|-------------------------------|
|                                 |                          |   |
|                                 |                          |   |
| **Date: October 29, 2008** | By:                           | **/s/ Jana Ahlfinger Bell** |
|                                 |                          | Jana Ahlfinger Bell |
|                                 |                          | Executive Vice President and Chief Financial Officer |
|                                 |                          | (Principal Financial and Accounting Officer) |

 

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