**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549-1004**

 

**Form10-Q**

 

**(Mark One)**

 

**ý****Quarterly report pursuant to Section 13 or 15(d)of the Securities Exchange Act of 1934**

 

**FOR THE QUARTERLY PERIOD ENDEDSEPTEMBER 30, 2004**

 

**or**

 

**o****Transition report pursuant to Section 13 or 15(d)of the SecuritiesExchange Act of 1934**

 

**For the transition period from                       to                       **

 

**Commission File Number 0-21681**

 

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

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

 

YES  ý               NO o

 

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

 

YES o                NO ý

 

As of October 18, 2004, 18,066,962 shares of theRegistrant’s Common Stock were outstanding.

 

 

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**PART I. FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

#### **EFJ,INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS**

September 30, 2004and December 31, 2003

(in thousands, exceptshare data)

 
| ** **                                                                                                                                                                                                                                                                                                                | ** ** | **SEPTEMBER 30,  2004** | ** ** | **DECEMBER 31,  2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                | ** ** | **(unaudited)**         | ** ** | ** **             | ** ** |
| ** **                                                                                                                                                                                                                                                                                                                | ** ** | ** **              | ** ** | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                                                |       |                    |       |                   |       |
| Current assets:                                                                                                                                                                                                                                                                                                           |       |                    |       |                   |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                                                                 |       | $                       | 7,967      |                   | $          | 4,644 |   |
| Accounts receivable, net of allowance for returns and doubtful accounts  of $142 and $104, respectively                                                                                                                                                                                                                   |       | 9,863                   |       | 19,754                 |       |
| Receivables – other                                                                                                                                                                                                                                                                                                  |       | 178                     |       | 157                    |       |
| Cost in excess of billings on uncompleted contracts                                                                                                                                                                                                                                                                       |       | 1,371                   |       | 869                    |       |
| Inventories                                                                                                                                                                                                                                                                                                               |       | 14,531                  |       | 18,040                 |       |
| Deferred income taxes                                                                                                                                                                                                                                                                                                     |       | 2,000                   |       | 1,500                  |       |
| Prepaid expenses                                                                                                                                                                                                                                                                                                          |       | 3,262                   |       | 587                    |       |
| Total current assets                                                                                                                                                                                                                                                                                                      |       | 39,172                  |       | 45,551                 |       |
|                                                                                                                                                                                                                                                                                                                      |       |                    |       |                   |       |
| Property, plant and equipment, net                                                                                                                                                                                                                                                                                        |       | 3,546                   |       | 2,779                  |       |
| Deferred income taxes                                                                                                                                                                                                                                                                                                     |       | 6,000                   |       | 6,500                  |       |
| Intangible assets, net of accumulated amortization                                                                                                                                                                                                                                                                        |       | 6,748                   |       | 6,753                  |       |
| Other assets                                                                                                                                                                                                                                                                                                              |       | 542                     |       | 686                    |       |
| **TOTAL ASSETS**                                                                                                                                                                                                                                                                                                          |       | $                       | 56,008     |                   | $          | 62,269 |   |
|                                                                                                                                                                                                                                                                                                                      |       |                    |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                             | ** ** | ** **              | ** ** | ** **             | ** ** |
| Current liabilities:                                                                                                                                                                                                                                                                                                      |       |                    |       |                   |       |
| Revolving line of credit                                                                                                                                                                                                                                                                                                  |       | $                       | —     |                   | $          | 7,500 |   |
| Current portion of long-term debt obligations                                                                                                                                                                                                                                                                             |       | 131                     |       | 127                    |       |
| Accounts payable                                                                                                                                                                                                                                                                                                          |       | 6,719                   |       | 8,582                  |       |
| Billings in excess of cost on uncompleted contracts                                                                                                                                                                                                                                                                       |       | 25                      |       | 30                     |       |
| Deferred revenue – current                                                                                                                                                                                                                                                                                           |       | 277                     |       | 1,191                  |       |
| Accrued expenses                                                                                                                                                                                                                                                                                                          |       | 3,867                   |       | 3,406                  |       |
| Total current liabilities                                                                                                                                                                                                                                                                                                 |       | 11,019                  |       | 20,836                 |       |
|                                                                                                                                                                                                                                                                                                                      |       |                    |       |                   |       |
| Long-term debt obligations, net of current portion                                                                                                                                                                                                                                                                        |       | 323                     |       | 426                    |       |
| Deferred revenue, net of current portion                                                                                                                                                                                                                                                                                  |       | 737                     |       | 601                    |       |
| **TOTAL LIABILITIES**                                                                                                                                                                                                                                                                                                     |       | 12,079                  |       | 21,863                 |       |
|                                                                                                                                                                                                                                                                                                                      |       |                    |       |                   |       |
| Stockholders’ equity:                                                                                                                                                                                                                                                                                                |       |                    |       |                   |       |
| Preferred stock ($0.01 par value; 3,000,000 shares authorized; none issued)                                                                                                                                                                                                                                               |       | —                  |       | —                 |       |
| Common stock ($0.01 par value; 50,000,000 voting shares authorized,  17,972,432 and 17,359,973 issued and outstanding as of September 30, 2004 and  December 31, 2003; 600,000 non-voting shares authorized, 217,542 issued and  outstanding at December 31, 2003, which shares were converted to voting  shares in 2004) |       | 180                     |       | 176                    |       |
| Additional paid-in capital                                                                                                                                                                                                                                                                                                |       | 102,046                 |       | 100,845                |       |
| Accumulated deficit                                                                                                                                                                                                                                                                                                       |       | (58,297                 | )          | (60,615                | )          |
| TOTAL  STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                                                                                          |       | 43,929                  |       | 40,406                 |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                                                                          |       | $                       | 56,008     |                   | $          | 62,269 |   |

 

 

Seeaccompanying notes to the condensed consolidated financial statements.

 

2

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**EFJ, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

Forthe three and nine months ended September 30, 2004 and 2003(Unaudited and in thousands, except share and per share data)

 
| ** **                                                                                                                                                                                                                                                                       | ** ** | **THREE MONTHS ENDED  SEPTEMBER 30,** | ** ** | **NINE MONTHS ENDED  SEPTEMBER 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                       | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                                                                                                                                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Revenues                                                                                                                                                                                                                                                                         |       | $                                     | 15,430     |                                 | $          | 13,089 |   | $ | 55,245 |   | $ | 32,803 |   |
| Cost of sales                                                                                                                                                                                                                                                                    |       | 8,161                                 |       | 7,853                                |       | 30,401 |   | 18,974 |   |
| Gross profit                                                                                                                                                                                                                                                                     |       | 7,269                                 |       | 5,236                                |       | 24,844 |   | 13,829 |   |
|                                                                                                                                                                                                                                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Operating expenses:                                                                                                                                                                                                                                                              |       |                                  |       |                                 |       |   |   |   |   |
| Research and development                                                                                                                                                                                                                                                         |       | 2,572                                 |       | 1,939                                |       | 7,842 |   | 5,154 |   |
| Sales and marketing                                                                                                                                                                                                                                                              |       | 2,709                                 |       | 1,756                                |       | 7,045 |   | 4,590 |   |
| General and administrative, inclusive of non-cash  stock option repricing (benefit) expense  adjustment  of $(1,425) and $886  for the three and nine months  ended  September 30, 2004 and $1,890 and $2,186  for the same periods ended September 30, 2003 |       | 1,221                                 |       | 3,327                                |       | 7,580 |   | 6,523 |   |
| Total operating expenses                                                                                                                                                                                                                                                         |       | 6,502                                 |       | 7,022                                |       | 22,467 |   | 16,267 |   |
|                                                                                                                                                                                                                                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Income (loss) from operations                                                                                                                                                                                                                                                    |       | 767                                   |       | (1,786                               | )          | 2,377 |   | (2,438 | ) |
|                                                                                                                                                                                                                                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Other income (expense)                                                                                                                                                                                                                                                           |       | 34                                    |       | 35                                   |       | 29 |   | 62 |   |
| Interest income                                                                                                                                                                                                                                                                  |       | 11                                    |       | 5                                    |       | 31 |   | 26 |   |
| Interest expense                                                                                                                                                                                                                                                                 |       | (28                                   | )          | (41                                  | )          | (119 | ) | (133 | ) |
|                                                                                                                                                                                                                                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Income (loss) before income taxes                                                                                                                                                                                                                                                |       | 784                                   |       | (1,787                               | )          | 2,318 |   | (2,483 | ) |
|                                                                                                                                                                                                                                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Income tax provision                                                                                                                                                                                                                                                             |       | —                                |       | —                               |       | — |   | — |   |
|                                                                                                                                                                                                                                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Net income (loss)                                                                                                                                                                                                                                                                |       | $                                     | 784        |                                 | $          | (1,787 | ) | $ | 2,318 |   | $ | (2,483 | ) |
|                                                                                                                                                                                                                                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Net income (loss) per share – Basic                                                                                                                                                                                                                                         |       | $                                     | 0.04       |                                 | $          | (0.10 | ) | $ | 0.13 |   | $ | (0.14 | ) |
| Net income (loss) per share – Diluted                                                                                                                                                                                                                                       |       | $                                     | 0.04       |                                 | $          | (0.10 | ) | $ | 0.12 |   | $ | (0.14 | ) |
|                                                                                                                                                                                                                                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Weighted average common shares – Basic                                                                                                                                                                                                                                      |       | 17,887,457                            |       | 17,577,315                           |       | 17,779,443 |   | 17,577,315 |   |
| Weighted average common shares – Diluted                                                                                                                                                                                                                                    |       | 18,672,301                            |       | 17,577,315                           |       | 18,784,281 |   | 17,577,315 |   |

 

Seeaccompanying notes to the condensed consolidated financial statements.

 

 

3

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**EFJ, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

Ninemonths ended September 30, 2004 and 2003

(Unaudited and inthousands, except share data)

** **
| ** **                                                                                | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| Cash flows from operating activities:                                                     |       |                                |       |   |   |
| Net income (loss)                                                                         |       | $                                   | 2,318      |   | $ | (2,483 | ) |
| Adjustments to reconcile net income (loss) to net cash provided by  operating activities: |       |                                |       |   |   |
| Depreciation and amortization                                                             |       | 1,041                               |       | 827 |   |
| Non-cash compensation expense – intrinsic value of repriced options                  |       | 886                                 |       | 2,186 |   |
| Gain on sale of fixed assets                                                              |       | (76                                 | )          | (58 | ) |
| Changes in assets and liabilities:                                                        |       |                                |       |   |   |
| Accounts receivable                                                                       |       | 9,870                               |       | (3,623 | ) |
| Cost in excess of billings on uncompleted contracts                                       |       | (502                                | )          | 829 |   |
| Inventories                                                                               |       | 3,509                               |       | (1,778 | ) |
| Prepaid expenses                                                                          |       | (2,675                              | )          | (318 | ) |
| Accounts payable                                                                          |       | (1,863                              | )          | 1,445 |   |
| Billings in excess of cost on uncompleted contracts                                       |       | 461                                 |       | (26 | ) |
| Deferred revenues                                                                         |       | (5                                  | )          | (480 | ) |
| Accrued and other liabilities                                                             |       | (778                                | )          | (126 | ) |
| Total adjustments                                                                         |       | 9,868                               |       | (1,122 | ) |
| Net cash provided by (used in) operating activities                                       |       | 12,186                              |       | (3,605 | ) |
|                                                                                      |       |                                |       |   |   |
| Cash flows from investing activities:                                                     |       |                                |       |   |   |
| Proceeds from sale of fixed assets                                                        |       | 79                                  |       | 53 |   |
| Purchase of property, plant and equipment                                                 |       | (1,806                              | )          | (553 | ) |
| Other assets                                                                              |       | 144                                 |       | 167 |   |
| Net cash used in investing activities                                                     |       | (1,583                              | )          | (333 | ) |
|                                                                                      |       |                                |       |   |   |
| Cash flows from financing activities:                                                     |       |                                |       |   |   |
| Payments on revolving line of credit, net                                                 |       | (7,500                              | )          | (5,000 | ) |
| Principal payments on long-term debt                                                      |       | (99                                 | )          | (82 | ) |
| Other                                                                                     |       | 319                                 |       | (5 | ) |
| Net cash used in financing activities                                                     |       | (7,280                              | )          | (5,087 | ) |
|                                                                                      |       |                                |       |   |   |
| Net increase (decrease) in cash and cash equivalents                                      |       | 3,323                               |       | (9,025 | ) |
|                                                                                      |       |                                |       |   |   |
| Cash and cash equivalents, beginning of period                                            |       | 4,644                               |       | 11,333 |   |
|                                                                                      |       |                                |       |   |   |
| Cash and cash equivalents, end of period                                                  |       | $                                   | 7,967      |   | $ | 2,308 |   |

 

**Summary of non-cash transactions:**

 

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

 

See accompanying notes tothe condensed consolidated financialstatements

 

4

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**EFJ, INC. AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Three and nine months ended September30, 2004 and 2003**

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

 

**1. GENERAL**

 

The condensedconsolidated balance sheet of EFJ, Inc. (“EFJ” or the “Company”) at December31, 2003, presented within this Report on Form 10-Q filing, has been derivedfrom audited consolidated financial statements at that date.  The condensed consolidated financialstatements as of September 30, 2004 and for the three and nine months endedSeptember 30, 2004 and 2003 are unaudited. The condensed consolidated financial statements reflect all normal andrecurring 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.  The condensed consolidated financialstatements should be read in conjunction with the consolidated financialstatements and notes thereto, together with management’s discussion andanalysis of financial condition and results of operations, contained in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2003.  The results of operations and cash flows forthe nine months ended September 30, 2004 are not necessarily indicative of theresults for any other period or the entire fiscal year ending December 31,2004.  Where appropriate, items withinthe condensed consolidated financial statements have been reclassified from theprevious period’s presentation to conform to the current presentation.

 

**2. ORGANIZATION AND CONSOLIDATION**

 

The Company is a providerof land mobile radio (“LMR”) wireless communications products and systems,which are sold to: (1) domestic public safety / public service and othergovernmental users; (2) domestic commercial users; and (3) internationalcustomers.  Through its wholly-ownedsubsidiaries, E.F. Johnson Company (“EFJohnson”) and Transcrypt International,Inc. (“Transcrypt”), the Company designs, develops, manufactures and / or markets:

•                  mobileand portable LMR radios (“subscriber units”);

•                  stationaryLMR transmitters / receivers (base stations or repeaters);

•                  LMRsystems;

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

•                  LMRservices.

 

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

 

**3.  NETINCOME (LOSS) PER SHARE**

 

Basic income (loss) per share (“EPS”) is calculatedbased upon the weighted average number of common shares outstanding during theperiod.  The diluted EPS calculationreflects the potential dilution from common stock equivalents such as stockoptions.  For the three and nine monthsended September 30, 2004 and 2003, substantially all outstanding stock optionsgranted as of such dates had exercise prices lower than the average marketprice of the common stock for the respective periods and are, thereby,considered common stock equivalents in the calculation of the diluted weightedaverage common shares.  The Company usesthe treasury stock method to calculate diluted weighted average common shares,as if all such options were outstanding for the periods presented.

 

For the three and nine months ended September 30, 2003,the impact of outstanding stock options on diluted EPS was anti-dilutive as theCompany incurred net losses during these periods.  Accordingly, basic EPS is used for both basicand diluted EPS for the respective periods. If the Company had not incurred net losses for these periods, thediluted weighted average common shares would have been: 18,779,341 and18,580,437, respectively, for the three andnine months ended September 30, 2003.

** **

5

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

 

The Company applies the intrinsic value-based methodof accounting for stock options issued to employees.   When both the number of shares that anindividual employee is entitled to receive and the option price are known atthe grant date, total compensation cost for the Company’s grants of stock optionsis measured at the grant date (“fixed plan awards”).  However, when either or both of these factorsare not known at the grant date, the Company estimates total compensation costeach accounting period from the date of grant based on the estimated fair valueof the Company’s common stock at the end of each period (“variable plan awards”).  Changes, either increases or decreases, inthe estimated fair value of the shares between the date of grant and the finalexercise or expiration of the options result in a change in the measure ofcompensation cost for variable plan awards. Compensation cost is recognized as expense over the periods in which theemployee performs the related services, which is generally presumed to be thevesting period.

 

If compensation cost for the Company’sstock option plans had been determined based on the fair value at the grantdate for awards for the three and nine months ended September 30, 2004 and2003, the Company’s pro forma net income (loss) and pro forma net income (loss)per share would have been as follows:

** **
| ** **                                                                    | ** ** | **Three months ended   September 30,** | ** ** | **Nine months ended   September 30,** | ** ** |
|-------------------------------------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                    | ** ** | **2004**                               | ** ** | **2003**                              | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                          |       |                                   |       |                                  |       |   |   |   |   |
| Net income  (loss) — as reported                                         |       | $                                      | 784        |                                  | $          | (1,787 | ) | $ | 2,318 |   | $ | (2,483 | ) |
| General and  administrative expenses for management stock option compensation |       | 122                                    |       | (115                                  | )          | 1,932 |   | 320 |   |
| Pro forma net  income (loss)                                                  |       | $                                      | 662        |                                  | $          | (1,672 | ) | $ | 386 |   | $ | (2,803 | ) |
|                                                                          |       |                                   |       |                                  |       |   |   |   |   |
| Net income  (loss) per share, basic — as reported                        |       | $                                      | 0.04       |                                  | $          | (0.10 | ) | $ | 0.13 |   | $ | (0.14 | ) |
| Net income  (loss) per share, diluted — as reported                      |       | 0.04                                   |       | (0.10                                 | )          | 0.12 |   | (0.14 | ) |
| Pro forma net  income (loss) per share, basic                                 |       | 0.04                                   |       | (0.10                                 | )          | 0.11 |   | (0.16 | ) |
| Pro forma net  income (loss) per share, diluted                               |       | 0.03                                   |       | (0.10                                 | )          | 0.10 |   | (0.16 | ) |

 

The weighted average fair value peroption at date of grant during the three months ended September 30, 2004 and 2003was $1.55 and $1.47.  The fair value ofeach option grant is estimated on the date of grant using the Black-Scholesoption-pricing model with the following weighted-average assumptions foroptions granted:

 
| ** **                  | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------|------------|-------------------------------------|------------|
| ** **                  | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| Expected option  life       |       | 10  years                           |       | 10  years |   |
| Expected annual  volatility |       | 75                                  | %          | 92 | % |
| Risk-free  interest rate    |       | 4.40                                | %          | 3.99 | % |
| Dividend yield              |       | 0                                   | %          | 0 | % |

 

**5. INVENTORIES**

 

The following is asummary of inventories:

 

| ** **                  | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|-----------------------------|------------|------------------------|------------|-----------------------|------------|
| Raw materials  and supplies |       | $                      | 8,164      |                  | $          | 8,069 |   |
| Work in progress            |       | 1,487                  |       | 1,350                 |       |
| Finished goods              |       | 6,245                  |       | 9,250                 |       |
|                        |       | 15,896                 |       | 18,669                |       |
| Reserve for  obsolescence   |       | 1,365                  |       | 629                   |       |
| Total  inventories          |       | $                      | 14,531     |                  | $          | 18,040 |   |

 

6

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**6. INTANGIBLE ASSETS**

 

As required by Statement of Financial AccountingStandards (“SFAS”) No. 142, ***Goodwill and OtherIntangible Assets,*** the Company does not amortize its goodwilland tradename, both of which relate solely to the Company’s EFJohnson segment,but instead reviews such assets for impairment, at least annually.  The Company performed fair value-basedimpairment tests, in accordance with SFAS No. 142, at December 31, 2003 and2002, concluding that no impairment of goodwill or tradename had occurred as ofthese dates.  No events occurred duringthe three and nine months ended September 30, 2004 and 2003 that would indicatethat an impairment of such assets had taken place as of such dates.  As of January 1, 2002, certain of the Company’sintangible assets (primarily acquired workforce) were reclassified to goodwill,as these assets, per SFAS No. 141, ***Business Combinations,***were not deemed separable from goodwill.

 

Amortization expense, related to intangible assetswhich are subject to amortization, was $2 and $4 for the three and nine monthsended September 30, 2004 and 2003. Amortization expense of intangible assets subject to amortization isanticipated to be $7 for 2004 and annually thereafter through 2012.  Intangible assets consist of the following asof the dates indicated:

 
| ** **                                      | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|-------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| Intangible  assets not subject to amortization: |       |                   |       |                  |       |   |   |   |   |
| Goodwill                                        |       |                   |       | $                     | 5,126      |   |   |   | $ | 5,126 |   |
| Tradename                                       |       |                   |       | 1,564                 |       |   |   | 1,564 |   |
|                                            |       |                   |       |                  |       |   |   |   |   |
| Intangible  assets subject to amortization:     |       |                   |       |                  |       |   |   |   |   |
| Proprietary and  core technology                |       | 1,290                  |       |                  |       | 1,290 |   |   |   |
| Less:  accumulated amortization                 |       | 1,290                  |       | —                |       | 1,290 |   | — |   |
| Patents                                         |       | 113                    |       |                  |       | 113 |   |   |   |
| Less:  accumulated amortization                 |       | 55                     |       | 58                    |       | 50 |   | 63 |   |
| Total                                           |       |                   |       | $                     | 6,748      |   |   |   | $ | 6,753 |   |

 

**7. REVOLVING LINE OF CREDIT**

 

The Company renewed it line of creditagreement with Bank of America in September 2004.  The secured $15,000 line of credit bears interestat a rate of LIBOR plus 150 basis points, which rate may be increased to LIBORplus 225 basis points dependent upon certain debt ratios.  The effective rate at September 30, 2004 was 3.2%.  The line of credit is collateralized by substantiallyall of the Company’s assets, and borrowings available under the line of creditare calculated as a percentage of eligible inventory and receivables.  The agreement, which expires September 30,2007, includes certain covenants, including financial covenants, with which theCompany was in compliance as of September 30, 2004 and December 31, 2003.  At September 30, 2004 and December 31, 2003,the Company had zero and $7,500, respectively, outstanding on its line ofcredit.  The total available credit underthe line of credit was $8,160 as of September 30, 2004.

 

7

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**8.  WARRANTYCOSTS**

 

**       **TheCompany substantially provides a one-to-two year warranty on its product sales,dependent upon certain terms and conditions of the sale, and estimates futurewarranty claims based on historical experience and anticipated costs to beincurred over the life of the warranty. 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 both extraordinary and determinable.  A reconciliation of changes in the Company’saccrued warranty as of September 30, 2004 is as follows:

 
| ** **                      | ** ** | **Balance at  December 31, 2003** | ** ** | **Charged to   Expenses** | ** ** | **Deduction /  Expenditures** | ** ** | **Balance at  September 30, 2004** | ** ** |
|---------------------------------|------------|-----------------------------------|------------|---------------------------|------------|-------------------------------|------------|------------------------------------|------------|
| ** **                      | ** ** | ** **                        | ** ** | ** **                | ** ** | ** **                    | ** ** | ** **                         | ** ** |
| Allowance for  Warranty Reserve |       | $                                 | 727        |                      | 1,883      |                          | 825        |                               | $          | 1,785 |   |
|                                 |            |                                   |            |                           |            |                               |            |                                    |            |  |  |

 

**9.  REPRICEDSTOCK OPTIONS**

 

In 2000 and 2001, the Companyeffectively cancelled and reissued stock options in order to lower the exerciseprice of those options to $0.656 per share, an amount approximating 150% of thethen prevailing market value of the Company’s common stock (the “repricing”).  The repricing of the stock options resultedin a new measurement date for accounting purposes and the reclassification ofthese options as variable plan awards beginning on the date of therepricing.  The Company had previouslyaccounted for these option grants as fixed plan awards.  The market value of the Company’s commonstock was $6.71 and $3.90 per share at September 30, 2004 and 2003,respectively; this compared to market values of $5.90 and $1.25 per share atDecember 31, 2003 and 2002, respectively. Aggregate non-cash compensation charges, therefore, resulted to theextent that the market value at the respective period ending date exceeded therepriced exercise price of $0.656 per share. In the three and nine months ended September 30, 2004, the amounts of compensation(benefit) expense relating to these repriced options were $(1,425) and $886.  In the three and nine months ended September30, 2003, the amounts of compensation expense relating to these repricedoptions were $1,890 and $2,186.  Theseamounts are included in general and administrative expenses.

 

As of September 30, 2004,approximately 555,000 of these repriced options, in various stages of vesting,were outstanding, of which approximately 492,000 related to options issued tothe Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”).  In the first quarter of 2004, the CEO and CFOadopted pre-arranged stock selling plans, pursuant to Rule 10b5-1 of theSecurities and Exchange Act of 1934, in regards to the repriced option shares heldby them which are subject to variable accounting treatment.  Under the pre-arranged stock selling plans,stock options will be exercised contemporaneously with the sales of theresulting shares.  The respective sellingof the stock commenced in the second quarter of 2004 and will continue over aperiod at least through the second quarter of 2005.  Any non-cash compensation related to theseoptions will become fixed at the time the options are exercised; prior toexercise, the options will continue to be subject to variable accountingtreatment.  The CEO and CFO, inaggregate, exercised approximately 308,000 options during the nine months endedSeptember 30, 2004.

 

**10. COMMITMENTS AND CONTINGENCIES**

 

On or about February 5, 2001,ASRC Communication (“ASRC”) filed a complaint in United States District Courtfor the District of Alaska, against EFJohnson seeking damages against EFJohnsonon claims arising out of EFJohnson’s sale of radio products to ASRC.  ASRC purchased, and resold to the State ofAlaska, approximately $500 of products from EFJohnson since 1999.  ASRC’s claims against EFJohnson includebreach of contract, breach of express warranty, breach of implied warranty ofmerchantability, breach of implied warranty of fitness for a particularpurpose, breach of duty of good faith and fair dealing, equitable estoppel,misrepresentation, and violations of the Racketeer Influenced and CorruptOrganizations Act.  The complaintanticipated that the State of Alaska would formally prosecute itsadministrative claim under the Alaska State Procurement Code against ASRC fordamages associated with alleged malfunctions of EFJohnson manufactured radios.Under the May 21, 2003

 

8

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agreement between ASRC and EFJohnson (the “ASRCAgreement”), EFJohnson agreed to defend ASRC, at EFJohnson’s expense, againstany State’s claim alleging non-performance of the EFJohnson radios.  In the event the State prevailed in its claimEFJohnson and ASRC agreed to allocate any award in favor of the State inaccordance with formula in the ASRC Agreement. In addition, the parties agreed to resolve any issue or disputeremaining between them after the conclusion of the State administrativeproceeding through mediation and binding arbitration.  Based upon the ASRC Agreement, ASRC andEFJohnson dismissed the claims against each other.  On or about April 6, 2004, the State ofAlaska’s Department of Administration, Information Technology Group filed anadministrative claim under the State Procurement Code against ASRC for damagesassociated with the EFJohnson radios.  The State of Alaska claim alleges damages inexcess of $900.  Subsequently, ASRC hastendered, and EFJohnson has accepted, the State’s administrative claim inaccordance with the ASRC Agreement. EFJohnson will undertake to defend ASRCunder the terms and conditions of the ASRC Agreement.  The Company is unable to predict thelikelihood of the outcome or potential liability that may arise from thisaction.

 

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

 

The Company is presently disputing certain state taxliabilities totaling approximately $350. The Company believes the basis for the states’ assessment of the amountsowed is incorrect and intends to vigorously contest such assessments.  At September 30, 2004, the Company hasrecorded a liability related to these assessments, which amount reflects theCompany’s evaluation of the eventual conclusion of these matters.

 

The Company is presently involved in a disputeregarding the computation of certain royalty liabilities.  The Company believes the basis for itsroyalty computation is correct and consistent with the terms of the royaltyagreement.  However, if the Company’smethod of computation proves to be wrong, accrued royalties could beunderstated at September 30, 2004 by approximately $400.  The Company is presently unable to predictthe outcome and eventual liability related to this matter.

 

The Company is involved in certainother legal proceedings incidental to the normal conduct of its business.  The Company does not believe that any liabilitiesrelating to such other legal proceedings are likely to be, individually or inthe aggregate, material to the Company’s business, financial condition, resultsof operations, or cash flows.

 

In the normal course of its businessactivities, the Company is required under a contract with various governmentalauthorities to provide letters of credit and bonds that may be drawn upon ifthe Company fails to perform under its contracts.  The letters of credit, which expire onvarious dates in 2004, have a total undrawn balance of $250 at September 30,2004.  Bonds, which expire on variousdates, totaled $7,300 on September 30, 2004. As of that date, no bonds have been drawn upon.

 

At September 30, 2004, the Company had posted a $2,559cash deposit in regards to an LMR statewide system bid.  The cash deposit was made in lieu of a bidbond.  The deposit was returned inOctober 2004.  The amount is included inprepaid expenses on the balance sheet as of September 30, 2004.

 

9

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**11.  SEGMENTAND RELATED INFORMATION**

 

                The Company operatesin the following two reporting segments, both of which operate in the LMRindustry.  These segments are the Company’stwo operating subsidiaries: EFJohnson and Transcrypt.  Although both segments have product offeringswhich have some market similarity, EFJohnson’s operations primarily entail thedesign, development, manufacture and sale of LMR transmitters/receivers, mobileand portable LMR radios, and LMR communication systems, while Transcrypt’soperations primarily entail the design, manufacture and sale of devices thatprevent the unauthorized interception of sensitive voice and datacommunication.  The Company evaluatessegment results based on gross margin and income from operations.  Corporate expenses, exclusive of charges orbenefits associated with variable accounting for repriced stock options, areallocated to the operating segments based upon estimated usage of corporateresources.  The following table is asummary of the unaudited operating results for the three and nine months endedSeptember 30, 2004 and 2003.

 
| ** **                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| **In thousands**                       | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Revenues:**                          | ** ** | ** **                            | ** ** | ** **                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Wireless Communication                 |       | $                                     | 11,300     |                                 | $          | 11,992 |   | $ | 44,418 |   | $ | 28,139 |   |
| Information Security                   |       | 4,130                                 |       | 1,097                                |       | 10,827 |   | 4,664 |   |
|                                   |       | $                                     | 15,430     |                                 | $          | 13,089 |   | $ | 55,245 |   | $ | 32,803 |   |
| **Gross Profit:**                      |       |                                  |       |                                 |       |   |   |   |   |
| Wireless Communication                 |       | $                                     | 3,914      |                                 | $          | 4,448 |   | $ | 16,125 |   | $ | 10,428 |   |
| Information Security                   |       | 3,355                                 |       | 788                                  |       | 8,719 |   | 3,401 |   |
|                                   |       | $                                     | 7,269      |                                 | $          | 5,236 |   | $ | 24,844 |   | $ | 13,829 |   |
| **Operating Profit (Loss):**           |       |                                  |       |                                 |       |   |   |   |   |
| Wireless Communication                 |       | $                                     | (2,647     | )                                    | $          | 110 |   | $ | (2,131 | ) | $ | (1,242 | ) |
| Information Security                   |       | 1,989                                 |       | (6                                   | )          | 5,394 |   | 990 |   |
| **Income (Loss) from Operations**      |       | (658                                  | )          | 104                                  |       | 3,263 |   | (252 | ) |
|                                   |       |                                  |       |                                 |       |   |   |   |   |
| Stock Option Repricing Adjustment, net |       | 1,425                                 |       | (1,890                               | )          | (886 | ) | (2,186 | ) |
| Other Expense, net                     |       | 17                                    |       | (1                                   | )          | (59 | ) | (45 | ) |
|                                   |       |                                  |       |                                 |       |   |   |   |   |
| **Income (Loss) before Income Taxes**  |       | $                                     | 784        |                                 | $          | (1,787 | ) | $ | 2,318 |   | $ | (2,483 | ) |
|                                   |       |                                  |       |                                 |       |   |   |   |   |
| **Depreciation & Amortization:**   |       |                                  |       |                                 |       |   |   |   |   |
| Wireless Communication                 |       | $                                     | 312        |                                 | $          | 252 |   | $ | 940 |   | $ | 730 |   |
| Information Security                   |       | 34                                    |       | 34                                   |       | 101 |   | 97 |   |
|                                   |       | $                                     | 346        |                                 | $          | 286 |   | $ | 1,041 |   | $ | 827 |   |
|                                   |       |                                  |       |                                 |       |   |   |   |   |
| **Assets:**                            |       |                                  |       |                                 |       |   |   |   |   |
| Wireless Communication                 |       | $                                     | 37,042     |                                 |       |   |   |   |   |   |
| Information Security                   |       | 12,951                                |       |                                 |       |   |   |   |   |
| Corporate                              |       | 6,015                                 |       |                                 |       |   |   |   |   |
|                                   |       | $                                     | 56,008     |                                 |       |   |   |   |   |   |

 

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**12.  PLANNEDMOVES OF THE COMPANY’S OPERATING FACILITIES**

 

During the second quarter of 2004, Transcrypt’soperations moved from its previous facility in Lincoln, Nebraska to a similar18,000 square-foot facility located a short distance from its previousoperations.  The Company incurred $45 and$190 in relation to this move for the three and nine months ended September 30,2004.  The new facility was obtainedpursuant to a ten-year lease with anticipated facility costs approximatingthose of the departed facility.  The movewas precipitated by the May 31, 2004 termination of the lease agreement on thesegment’s previous facility and was complete by September 30, 2004.

 

On April 14, 2004, the Companyannounced its decision to move EFJohnson’s operations, to include theoutsourcing of its manufacturing, from its current facility in Waseca, Minnesotato the Dallas, Texas area.  The Company expectsto incur costs of $1,900 in relation to this move of EFJohnson.  The timing of the recognition of costsassociated with this move will be determined in accordance with SFAS No. 146, ***Accounting for Costs Associated with Exit orDisposal Activities,*** and other relevant guidance,******which provide that a liability fora cost associated with an exit or disposal activity shall be recognized at itsfair value in the period in which the liability is incurred.  In particular, employee-related terminationcosts associated with the relocation are generally recognized ratably over theperiod that the employees are required to provide services in order to earn therespective termination benefit.  Thismove is expected to be completed by April 2005 and is not expected to causesignificant disruption of the business; however, a significant portion ofEFJohnson’s workforce may be replaced or otherwise terminated in relation tothis move.

 

**EFJohnson and Transcrypt Operating**

**FacilityRelocation Costs (in 000’s):**

 
| ** **                                | ** ** | **Total amount   expected to be  incurred** | ** ** | **Amount incurred   in the three   months ended  September 30, 2004** | ** ** | **Cumulative amount   incurred as of   September 30,   2004** | ** ** | **Remaining amount   to be incurred** | ** ** |
|-------------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------|------------|
| Description of  Costs                     |       |                                        |       |                                                                  |       |                                                          |       |                                  |       |
| Employee related  costs                   |       | $                                           | 900        |                                                                  | $          | 410                                                           |       | $                                     | 528        |   | $ | 372 |   |
| Furniture and  equipment relocation costs |       | 490                                         |       | 90                                                                    |       | 242                                                           |       | 248                                   |       |
| Manufacturing  outsourcing set-up costs   |       | 400                                         |       | 128                                                                   |       | 246                                                           |       | 154                                   |       |
| Other                                     |       | 300                                         |       | 110                                                                   |       | 123                                                           |       | 177                                   |       |
|                                      |       |                                        |       |                                                                  |       |                                                          |       |                                  |       |
| **Total**                                 |       | $                                           | 2,090      |                                                                  | $          | 738                                                           |       | $                                     | 1,139      |   | $ | 951 |   |

 

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**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**

**AND RESULTS****OFOPERATIONS**

 

Discussions ofcertain matters contained in this Quarterly Report on Form 10-Q may constituteforward-looking statements under Section 27A of the Securities Act of 1933, asamended (the “Securities Act”), and Section 21E of the Securities Exchange Actof 1934, as amended, (the “Exchange Act”). These forward-looking statementsrelate to, among other things, the results of the Company’s product developmentefforts, future sales and expense levels, the Company’s future financialcondition, liquidity and business prospects generally, relocation of operatingfacilities, outsourcing of EFJohnson’s manufacturing, perceived opportunitiesin the marketplace for the Company’s products, and the Company’s other businessplans for 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 detailed in “ITEM1. BUSINESS — Summary of Business Considerations and Certain Factors That MayAffect Future Results of Operations and/or Stock Price” contained in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2003.

 

The followingdiscussion is intended to provide a better understanding of the significantchanges in trends relating to the Company’s financial condition and results ofoperations.  Management’s Discussion andAnalysis of Financial Condition and Results of Operations should be read inconjunction with the accompanying Condensed Consolidated Financial Statementsand Notes thereto.

 

The followingtable presents certain Condensed Consolidated Statements of Operationsinformation as a percentage of revenues during the periods indicated:

 

| ** **                               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                               | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                     |       |                                  |       |                                 |       |   |   |   |   |
| Revenues                                 |       | 100.0                                 | %          | 100.0                                | %          | 100.0 | % | 100.0 | % |
| Cost of sales                            |       | 52.9                                  |       | 60.0                                 |       | 55.0 |   | 57.8 |   |
| Gross profit                             |       | 47.1                                  |       | 40.0                                 |       | 45.0 |   | 42.2 |   |
| Operating expenses:                      |       |                                  |       |                                 |       |   |   |   |   |
| Research and development                 |       | 16.7                                  |       | 14.8                                 |       | 14.2 |   | 15.7 |   |
| Sales and marketing                      |       | 17.5                                  |       | 13.5                                 |       | 12.7 |   | 14.0 |   |
| Facility relocation expenses             |       | 4.8                                   |       | —                               |       | 2.1 |   | — |   |
| Stock option repricing (benefit) expense |       | (9.2                                  | )          | 14.4                                 |       | 1.6 |   | 6.7 |   |
| General and administrative               |       | 12.3                                  |       | 11.0                                 |       | 10.1 |   | 13.3 |   |
| Total operating expenses                 |       | 42.1                                  |       | 53.7                                 |       | 40.7 |   | 49.7 |   |
| Income (loss) from operations            |       | 5.0                                   |       | (13.7                                | )          | 4.3 |   | (7.5 | ) |
| Interest expense - net                   |       | (0.1                                  | )          | (0.3                                 | )          | (0.2 | ) | (0.3 | ) |
| Other expense                            |       | 0.2                                   |       | 0.3                                  |       | 0.1 |   | 0.2 |   |
| Income (loss) before income taxes        |       | 5.1                                   |       | (13.7                                | )          | 4.2 |   | (7.6 | ) |
| Income tax provision                     |       | —                                |       | —                               |       | — |   | — |   |
| Net income (loss)                        |       | 5.1                                   | %          | (13.7                                | )%         | 4.2 | % | (7.6 | )% |

 

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Revenues

 

Revenues increased8% to $15.4 million in the third quarter of 2004, as compared to $13.1 millionduring the same period in 2003.  Of totalrevenues in the third quarter of 2004, the wireless communication segmentcomprised $11.3 million, representing a 6% decrease over revenues of $12.0million during the same period in 2003. Information security segment revenues of $4.1 million in the third quarterof 2004 represent a 276% increase over revenues of $1.1 million during the sameperiod in 2003.

 

Revenues increased 68% to $55.2 million in the ninemonths ended September 30, 2004, as compared to $32.8 million during the sameperiod in 2003.  Of total revenues in thenine months ended September 30, 2004, the wireless communication segment comprised$44.4 million, representing a 58% increase over revenues of $28.1 millionduring the same period in 2003. Information security segment revenues of $10.8 million in the ninemonths ended September 30, 2004 represent a 132% increase over revenues of $4.7million during the same period in 2003.

 

The Company’s sales, as per itscustomer markets, are shown below for the nine months ended September 30, 2004and 2003.

 
| ** **                              | ** ** | **2004**   | ** ** | **2003** | ** ** |
|-----------------------------------------|------------|------------|------------|----------|------------|
| **Revenues (in ‘000’s):**     | ** ** | **Amount** | ** ** | **%**    | ** ** | **Amount** | ** ** | **%** | ** ** |
| Domestic public safety / public service |       | $          | 41,854     |     | 76         | % | $ | 26,078 |   | 80 | % |
| International                           |       | 11,696     |       | 21       |       | 5,085 |   | 16 |   |
| Domestic commercial                     |       | 1,695      |       | 3        |       | 1,640 |   | 4 |   |
|                                    |       |       |       |     |       |   |   |   |   |
| Total Sales                             |       | $          | 55,245     |     |       |   | $ | 32,803 |   |   |   |

 

The increase inEFJohnson’s revenues for the first nine months of 2004 related primarily to asubstantial increase in sales to the domestic government sector.  This is consistent with EFJohnson’s marketstrategy to emphasize federal, state and local governmental customers.

 

The increase in revenues of the information securitysegment primarily results from increased marketing in certain parts of the worldwhere LMR systems are primarily analog and perceived security risks are high.  Transcrypt’s sales are primarily tointernational customers because of the analog nature of its products.

 

Gross Profit

 

Cost of sales includes materials, labor, depreciation,and overhead costs associated with the production of the Company’s products, aswell as shipping, royalty and warranty product costs.

 

Consolidated gross profit was $7.3 million (47% grossmargin) for the third quarter of 2004, as compared to $5.2 million (40% grossmargin) for the same period in 2003. Gross margin for the wireless communication segment was 35% in the thirdquarter of 2004 versus 37% for the same period in 2003.  Gross margin for the information securitysegment was 81% in the third quarter of 2004 versus 72% for the same period in2003.

 

Consolidated gross profit was $25.0 million (45% grossmargin) for the nine months ended September 30, 2004, as compared to $13.8million (42% gross margin) for the same period in 2003.  Gross margin for the wireless communicationsegment was 36% for the nine months ended September 30, 2004, as compared to37% for the same period in 2003.  Grossmargin for the information security segment was 80% in the first nine months of2004 versus 73% for the same period in 2003.

 

The increase in overall gross margin percentage relatesprimarily to Transcrypt being a larger percentage of the overall sales mix, 20%for the nine months ended September 30, 2004, as compared to 14% for the sameperiod in 2003.  Additionally, Transcrypt’smargin has increased in 2004, as compared to 2003, as a result of economies ofscale created by the higher sales volume in 2004.  EFJohnson’s gross margin percentage for the threemonths ended September 30, 2004 was negatively impacted approximately 2% by higherwarranty costs resulting from certain software upgrades to its digital line ofradios.  The Company does not anticipate thishigher warranty rate to recur in the fourth quarter of 2004.  Additionally, $3.6 million of sales in thefirst quarter of 2004 involved proprietary

 

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encryption modules for which the Company charged no mark-up over thecost of procurement due to competitive market reasons.  Excluding the impact of these proprietary modules,gross margin for the wireless communication segment would have been 40% for thenine months ended September 30, 2004.  TheCompany does not anticipate such proprietary encryption module factor to recur duringthe remainder of 2004.

 

Management intends to make adjustments to its productofferings, where deemed appropriate, to include elimination of marginallyprofitable products and product lines. Management is also continuing to review its manufacturing procedures tocreate efficiencies.  While managementcontinues to review pricing and product strategy, gross margins for bothindustry segments are likely to vary in the future, based primarily upon themix of products and the amount of revenues recognized in the respective periods.  Further, as noted in Note 12 to theaccompanying Notes to Condensed Consolidated Financial Statements, the Companyis presently engaged in outsourcing its manufacturing of wireless communicationproducts; the Company does not anticipate that this event will have any significantimpact on future gross margins.

 

Research and Development

 

Research anddevelopment expenses consist primarily of the costs associated with researchand development personnel, materials, and the depreciation of research anddevelopment equipment and facilities.

 

Research anddevelopment expenses increased 33% in the third quarter of 2004, to $2.6million (17% of revenues) as compared to $2.0 million during the same period in2003 (15% of revenues).  Further,research and development expenses increased 52% for the nine months endedSeptember 30, 2004, to $7.8 million (14% of revenues) as compared to $5.2million for the same period in 2003 (16% of revenues).  The increase related primarily to Project 25LMR infrastructure development at EFJohnson, along with the Company’sdevelopment efforts towards new digital subscriber units, upon which theCompany’s 2004 research and development efforts will be substantiallyconcentrated.  Certain of the Company’santicipated future sales are dependent upon successful and timely completion ofits on-going research and development projects.

 

Sales and Marketing

 

Sales andmarketing expenses consist primarily of salaries and related costs of salespersonnel, including sales commissions and travel expenses, and costs of advertising,public relations, and trade show participation.

 

Sales and marketing expenses increased 54% in thethird quarter of 2004, $2.7 million (18% of revenues) as compared to $1.8million during the same period in 2003 (13% of revenues).  Further, sales and marketing expensesincreased 53% for the nine months ended September 30, 2004, to $7.0 million (13%of revenues) as compared to $4.6 million for the same period in 2003 (14% ofrevenues).  The expenditure level, as apercentage of revenues, was higher in the third quarter of 2004 as a result ofthe lower sales volume at EFJohnson and a build-up in fixed sales resources inconcert with management’s anticipation of future sales opportunities in thewireless communication segment.

 

General and Administrative

 

General andadministrative expenses consist primarily of salaries and other expensesassociated with the Company’s management, finance, accounting, andadministration; it also includes (benefit) expense relating to repriced stockoptions, as well as costs incurred in 2004 to move the operations of bothEFJohnson and Transcrypt.

 

Excluding anybenefit or expense resulting from the repriced stock options adjustment and excludingfacility relocation expenses, general and administrative expenses increased 43%in the third quarter of 2004, to $1.9 million (12% of revenues) as compared to$1.4 million in the same period in 2003 (11% of revenues).  Further, excluding the repriced stock optionadjustment and facility relocation expenses, general and administrativeexpenses increased 25% for the nine months ended September 30, 2004, to $5.6million (10% of revenues) as compared to $4.3 million for the same period in2003 (13% of revenues).  See also “NetIncome (Loss) section below.  The

 

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increases result from: 1) increased support requirements related to theCompany’s increased sales; 2) increased investor relations efforts; and 3)efforts associated with ongoing implementation of §404 of the Sarbanes-Oxley Act.

 

The repriced stock option adjustment was a benefit of$1.4 million for the three months ended September 30, 2004, as compared to anexpense of $1.9 million during the same period in 2003.  The repriced stock option adjustment was anexpense of $0.9 million for the nine months ended September 30, 2004, ascompared to an expense of $2.2 million for the same period in 2003.  The amount of (benefit) or expense recordedrelates substantially to the change in the Company’s common stock price, asexplained in Note 9 of the accompanying Notes to the Condensed ConsolidatedFinancial Statements.

 

In relation to the planned move of its operating facilities,as described in Note 12 to the accompanying Notes to Condensed ConsolidatedFinancial Statements, the Company incurred $0.7 million for the third quarterof 2004, as compared to zero during the same period in 2003.  The Company incurred $1.1 million for thenine months ended September 30, 2004, as compared to zero for the same periodin 2003.

 

The Company will bean accelerated filer as of December 31, 2004 as a result of its marketcapitalization at June 30, 2004.  Accordingly,periodic reports due during the fiscal year ended December 31, 2005 will besubject to an accelerated filing schedule.

 

OtherIncome (Expense)

 

Other income(expense), net for the three months ended September 30, 2004 was $34,000, ascompared to $35,000 for the same period in 2003.  Further, other income (expense), net for thenine months ended September 30, 2004 was $29,000, as compared to $62,000 forthe same period in 2003.  The Companywould expect other income (expense) to remain at an insignificant level duringthe remainder of 2004.

 

InterestIncome / Interest Expense

 

Interest income consists of interestincome earned on cash and invested funds; interest expense related to theCompany’s loans and bank line of credit. Interest income and interest expense were $11,000 and $28,000,respectively, for the three months ended September 30, 2004, as compared to $5,000and $41,000 in the same period in 2003. Further, interest income and interest expense were $31,000 and $119,000,respectively, for the nine months ended September 30, 2004, as compared to $26,000and $133,000 in the same period in 2003. Interest income and expense vary based on the relative interest ratesearned or incurred, and the relative cash and loan balances.  The Company’s interest expense includesmonthly expense of $12,000 related to amortization of loan fees and bank lineof credit availability fees.  Future interestincome and expense will vary according to the Company’s use of cash, interestrates, and operating results.

 

Provision/ Benefit for Income Taxes

 

The Company did notrecord a tax benefit or provision for the three and nine months ended,respectively, September 30, 2004 and 2003. As of September 30, 2004, the Company had approximately $25.2 million indeferred tax assets primarily comprised of net operating loss carryforwards (“NOL’s”),which asset was reduced by a valuation allowance of $17.2 million.  The Company’s tax asset is chiefly composedof NOL’s.  These NOL’s total approximately$57.0 million at September 30, 2004 and do not begin to expire until 2011.  The Company’s deferred tax asset of $8.0million at September 30, 2004 and December 31, 2003, respectively, isapproximately comprised of the following components:

 

| *Tax asset components (in millions):* | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|---------------------------------------|------------|------------------------|------------|-----------------------|------------|
| *** ***                          |       |                   |       |                  |       |
| Net operating  loss carryforwards     |       | $                      | 19.9       |                  | $          | 20.4 |   |
| Timing  differences - book to tax     |       | 2.9                    |       | 3.3                   |       |
| General business  tax credits         |       | 2.4                    |       | 2.4                   |       |
|                                  |       | 25.2                   |       | 26.1                  |       |
| Less: valuation  allowance            |       | 17.2                   |       | 18.1                  |       |
|                                  |       | $                      | 8.0        |                  | $          | 8.0 |   |

 

15

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The valuation allowance is based upon management’sconclusions regarding, among other considerations, the Company’s historicaloperating results, management’s estimates of future earnings based oninformation currently available, and certain technological and competitivefactors impacting the Company’s current products.  Current financial accounting standardsrequire that organizations analyze all positive and negative evidence relatingto deferred tax asset realization.

 

The Company cannot presently estimate what changes tothe deferred tax asset valuation allowance may be deemed appropriate, or towhat extent the Company may record a tax benefit (expense), during theremainder of 2004.  If the Companycontinues its recent trend of profitability in 2004, some portion, if not all,of the deferred tax asset valuation allowance may be reduced in 2004 or beyond,and a net tax benefit may subsequently be recorded.  However, if the Company incurs future losses,it may be necessary to provide an additional allowance against some, or all, ofthe $8.0 million deferred tax asset recorded at September 30, 2004.

 

Net Income (Loss)

 

The Company had a net income of $0.8 million duringthe three months ended September 30, 2004, as compared to a net loss of $1.8million during the same period in 2003. Further, the Company had a net income of $2.3 million during the ninemonths ended September 30, 2004, as compared to a net loss of $2.5 millionduring the same period in 2003. Operating results for the three and nine months ended September 30, 2004and 2003 were affected by non-cash compensation resulting from variableaccounting treatment required for certain of the Company’s stock optionsrepriced in the fourth quarter of 2000 and the first quarter of 2001.  Additionally, the operating results for thethree and nine months ended September 30, 2004 were affected by costs incurredto move the operations of both EFJohnson and Transcrypt, as discussed in Note 12to the accompanying Notes to Condensed Consolidated Financial Statements.

 

The table below illustrates the operating results forthe three and nine months ending September 30, 2004 and 2003, adjusting for thenon-cash stock option repricing and for the non-recurring facility relocation effectsdiscussed above.  The Company believesthat such presentation offers a more comparative measurement of the Company’soperating results.

 
| *Operating Results (in thousands)*                               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                                       | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Net income  (loss)                                               |       | $                                     | 784        |                                 | $          | (1,787 | ) | $ | 2,318 |   | $ | (2,483 | ) |
|                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Facility relocation  expenses                                    |       | 738                                   |       | —                               |       | 1,139 |   | — |   |
|                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Stock option  repricing non-cash compensation expense (benefit). |       | (1,425                                | )          | 1,890                                |       | 886 |   | 2,186 |   |
|                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Proforma income  (loss) - comparative basis                      |       | $                                     | 97         |                                 | $          | 103 |   | $ | 4,343 |   | $ | (297 | ) |
|                                                             |       |                                  |       |                                 |       |   |   |   |   |
| Proforma income  (loss) as a percentage of total revenues        |       | 0.6                                   | %          | 0.8                                  | %          | 7.9 | % | (0.9 | )% |

 

Liquidity and Capital Resources

 

Historically, theCompany has financed its operations and met its capital requirements primarilythrough short-term borrowings, long-term debt, and stock offerings completed onJanuary 22, 1997 and October 15, 1997. However, the Company’s operations have consistently provided positivecash since the second quarter of 2001, and operations provided positive cash of$12.6 million for the nine months ended September 30, 2004.

 

The Company’soperating activities provided (used) cash of $12.2 million and $(3.6) millionin the nine months ended September 30, 2004 and 2003, respectively.  Cash provided by operating activities in thefirst three quarters of 2004 consisted primarily of: net income of $2.3million; depreciation and amortization expenses of $1.0 million; non-cashcompensation of $0.9 million; and a net change in the various components ofworking capital of $8.0 (principally $9.9 million and $3.5 million provided bydecreases, respectively, in accounts receivable and inventories, offset by $1.9million decrease in accounts payable and $2.7 million increase in prepaidexpenses). 

 

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Cash used by operatingactivities in the first nine months of 2003 consisted primarily of: net loss of$(2.5) million; depreciation and amortization expenses of $0.8 million; non-cashcompensation of $2.1 million; and a net change in the various components ofworking capital of $(3.2) million.

 

Cash used by investingactivities was $1.6 million for the first nine months of 2004; this compared tocash used by investing activities of $0.3 million for the same period in2003.  The difference between 2004 and2003 related primarily to cash flows used in the purchase of property.  Total capital expenditures in 2004 were $1.8million, as compared to $0.6 million of capital expenditures in 2003.  Additionally, $0.4 million of capitalexpenditures in 2003 were acquired through the exchange of debt and are, thus,excluded from the Statement of Cash Flows.

 

Cash used byfinancing activities was $7.3 million for the first nine months of 2004; thiscompared to cash used by investing activities of $5.1 million for the same periodin 2003.  The line of credit balance of$7.5 million at December 31, 2003 was paid off during the three months ended March31, 2004, and the line of credit balance remained zero throughout the periodended September 30, 2004.  In theprevious year, the December 31, 2002 line balance of $5.0 million was paid offprior to June 30, 2003, at which time the line of credit balance was zero andremained such through September 30, 2003.

 

The Company’s cash availability position and overall working capitalposition were significantly improved as of September 30, 2004, as compared toDecember 31, 2003, primarily as the result of cash collection of December 31,2003 accounts receivable, as well as of revenues recognized in the first ninemonths of 2004.  The Company’s cashbalance, at any given point in time, is substantially dependent uponfluctuations in receivables which increase and decrease commensurate with thetiming and volume of sales orders.  Further,the Company had zero borrowings under its $15.0 million secured line of creditwith Bank of America as of September 30, 2004, as compared to borrowings of$7.5 million at December 31, 2003. Accordingly, at September 30, 2004, the Company had unrestricted cash of$8.0 million, an additional $8.2 million available credit under its line ofcredit, and a $2.5 million cash deposit which was returned to the Company inOctober 2004.

 

In the normal course of its business activities, theCompany is required under contracts with various government authorities toprovide letters of credit or bonds that may be drawn upon if the Company failsto perform under its contracts.  TheCompany’s current bonding arrangement calls for zero-collateral bonding, with asingle bond limitation of $2.0 million. The Company has approximately $6.2 million of bonding availability underits current bonding agreement.  TheCompany believes its present bonding arrangements provide it with sufficientbonding availability through 2004; however, the Company continues to seekimproved bonding alternatives with increased limits.

 

The Company’sbacklog of unfilled orders at September 30, 2004 was $14.6 million, compared toa backlog of $22.2 million at December 31, 2003 and $32.0 million at September30, 2003.  Due to the unpredictabletiming of major domestic governmental orders, the Company does not believe thatits backlog figures, and variations from period to period therein, arenecessarily indicative of sales of products in future periods.

 

The Company does not anticipate paying cash dividends inthe foreseeable future.

 

**Critical Accounting Policies**

 

Thepreparation of the Company’s consolidated financial statements in conformitywith accounting principles generally accepted in the United States (“USGAAP”)requires management to make judgments, estimates and assumptions in certaincircumstances that affect the amounts reported in the consolidated financialstatements and related footnotes.  TheCompany regularly evaluates the accounting policies and estimates used toprepare its financial statements. Estimates are used for, but not limited to: the accounting for allowancefor doubtful accounts and sales returns; application of the percentage ofcompletion accounting for long-term contract revenues, inventory reserves,income taxes, long-lived assets, and contingencies.  These estimates are based on historicalexperience and various assumptions that the Company believes to be reasonableunder the particular applicable facts and circumstances.  Actual results could differ from thoseestimates.

 

The Company considers its critical accounting policiesto be those that (i) involve significant judgments and

 

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uncertainties, (ii)require estimates that are more difficult for management to determine and (iii)have the potential to result in materially different outcomes under varyingassumptions and conditions.  Theapplication of USGAAP may require management to make estimates and assumptionsthat affect the amounts reported in the financial statements and accompanyingresults.  Listed below are those policiesthe Company believes are critical and require the use of complex judgment intheir application.

 

*Revenue*

 

The Company’s revenue recognition policy is inaccordance with the criteria put forth in Staff Accounting Bulletins 101 and104.  Revenues are recognized when theearnings process is complete, less an estimate for an allowance for returns, ifapplicable, and collection is reasonably assured.  The earnings process is generally completewhen the product is shipped, or received by the customer, depending uponwhether the title to the goods, as well as the risks and benefits of ownership,are transferred to the customer at point of shipment or point of delivery.  For sales where collection is not reasonablyassured, the Company recognizes revenue as cash is received.  If collection is contingent on a futureevent, the Company recognizes revenue when the contingency lapses, generallyupon cash collection.

 

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

 

Deferred revenue includes unearned services providedunder systems maintenance contracts.  TheCompany recognizes the maintenance fees based upon a straight-line method overthe life of the contract.  The Company nolonger defers revenue generated from extended warranties on its digital LMRradio sales, as the Company believes the earnings process is complete at timeof sale, and the Company presently has sufficient history on its digitalproducts to reasonably estimate any future warranty costs related to suchextensions.

 

The Company periodically reviews its revenuerecognition procedures to assure that such procedures are in accordance withthe provisions of Staff Accounting Bulletins 101 and 104.

 

*Inventory*

 

Inventory is recorded at the lower of cost or marketwith cost determined by the first-in, first-out (FIFO) method.  The Company periodically assesses itsinventory for potential obsolescence and lower-of-cost-or-market issues.  The Company makes estimates of inventoryobsolescence, providing reserves when necessary, based on, among other factors,demand for inventory based on backlog, product pricing, the ability toliquidate or sell older inventory, and the impact of introducing newproducts.  Charges associated withproviding for inventory obsolescence, or revisions to related reserves, havehistorically correlated with selling activity and have had a consistent impacton the Company’s gross margins over the last three fiscal years.

 

*Goodwill*

 

SFAS No. 142 requires that goodwill and otherindefinite-lived intangible assets no longer be amortized to earnings, butinstead be reviewed for impairment, on at least an annual basis, by applying afair value-based test.  The Companyadopted the provisions SFAS No. 142 effective January 1, 2002.  At least annually, the Company assesses its goodwilland tradename, using a fair value-based test, consistent with SFAS No.142.  If the carrying amounts exceed the computedfair values, goodwill and/or tradename, as appropriate, is considered to be impaired.  In evaluating impairment, the Companyestimates the sum of the expected future cash flows derived from its goodwilland tradename.  Such evaluations forimpairment are significantly impacted by estimates of future revenues, costsand expenses and other factors.  Theestimates use assumptions about the Company’s market segment share in thefuture and about future expenditures by government entities for wirelesscommunications products.  The

 

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Company continuallyevaluates whether events and circumstances have occurred that indicate theremaining carrying values of goodwill and tradename may not berecoverable.  If the Company fails todeliver new products, if the products fail to gain expected market acceptance,or if the Company fails to achieve assumed revenue growth rates or assumedgross margin, the Company may incur charges for impairment of goodwill and/ortradename in the future.

 

# ***Income Taxes***

 

The Company accounts for income taxes using the assetand 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 tax assets and liabilities aremeasured using current enacted tax rates. The effect on deferred tax assets and liabilities of a change in taxrates is recognized in the results of operations in the period that includesthe enactment date.  Valuation allowancesare provided to the extent that recoverability of tax assets is not consideredlikely.  In determining whether a taxasset is recoverable, the Company considers estimates of future revenues, costsand expenses and other factors.  If theCompany fails to achieve revenue growth rates or gross margins assumed in thecalculation of the deferred tax asset, the Company may be required to reduceits deferred tax assets in the future.

 

*Long-Lived Assets*

 

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

•                  significantdecrease in the market price of the asset;

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

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

•                  currentperiod losses combined with projection of continuing losses associated with theuse of the asset;

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

 

The Company continually evaluates whether events andcircumstances have occurred.  When suchevents or circumstances exist, the recoverability of the asset’s carrying valueshall be determined by estimating the undiscounted future cash flows (cashinflows less associated cash outflows) that are directly associated with andthat are expected to arise as a direct result of the use and eventualdisposition of the asset.  To date, nosuch impairment has occurred.  To theextent such events or circumstances occur that could affect the recoverabilityof the Company’s long-lived assets, the Company may incur charges forimpairment in the future.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Although all of the Company’s sales are denominated inU.S. dollars, fluctuations in the value of international currencies relative tothe U.S. dollar may affect the price, competitiveness and profitability of theCompany’s products sold in international markets.  Furthermore, the uncertainty of monetaryexchange values has caused, and may in the future cause, some foreign customersto delay new orders or delay payment for existing orders.  Additionally, troubled economic conditions,such as that recently experienced in Asia and in Latin America, could result inlower revenues for the Company.  Whilemost international sales are supported by letters of credit, the purchase ofCompany products by international customers presents increased risks, whichinclude:

•                  unexpectedchanges in regulatory requirements;

•                  tariffsand other trade barriers;

•                  politicaland economic instability in foreign markets;

•                  difficultiesin establishing foreign distribution channels;

•                  longerpayment cycles;

•                  uncertaintyin the collection of accounts receivable;

 

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•                  increasedcosts associated with maintaining international marketing efforts;

•                  difficultiesin protecting intellectual property; and

•                  susceptibilityto orders being cancelled as a result of foreign currency fluctuations (sinceall the Company quotations and invoices are denominated in U.S. dollars).

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

In accordance with Rule 13a-15(b) of the SecuritiesExchange Act of 1934 (“Exchange Act”), the Company evaluated the effectivenessof the design and operation of its disclosure controls and procedures asdefined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act (“Disclosure Controls”)as of the quarter ended September 30, 2004. This evaluation (the “Controls Evaluation”) was done under thesupervision and with the participation of management, including the Company’sChief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”).  The effectiveness of the Company’s DisclosureControls, as determined by this evaluation, is disclosed in the Chief ExecutiveOfficer’s Certification of Report on Form 10-Q for the Quarter Ending September30, 2004 and the Chief Financial Officer’s Certification of Report on Form 10-Qfor the Quarter Ending September 30, 2004 (together, “Certifications”).

 

Disclosure Controls are procedures that are designedwith the objective of ensuring that information required to be disclosed in theCompany’s reports filed under the Exchange Act, such as this Quarterly Report,is recorded, processed, summarized and reported within the time periodsspecified in the Securities and Exchange Commission (“SEC”) rules andforms.  Disclosure Controls are alsodesigned with the objective of ensuring that such information is accumulatedand communicated to management, including the CEO and CFO, as appropriate toallow timely decisions regarding required disclosure.

 

A control system, no matter how well conceived andoperated, can provide only reasonable, not absolute, assurance that theobjectives of the control system are met. Further, the design of a controlsystem must reflect the fact that there are resource constraints, and thebenefits of controls must be considered relative to their costs.  Because of the inherent limitations in allcontrol systems, no evaluation of controls can provide absolute assurance thatall control issues and instances of fraud, if any, within the Company have beendetected.  These inherent limitationsinclude the realities that judgments in decision-making can be faulty, and thatbreakdowns can occur because of simple error or mistake.  Additionally, controls can be circumvented bythe individual acts of some persons, by collusion of two or more people, or bymanagement override of the control.  Thedesign of any system of controls also is based in part upon certain assumptionsabout the likelihood of future events, and there can be no assurance that anydesign will succeed in achieving its stated goals under all potential futureconditions; over time, control may become inadequate because of changes inconditions, or the degree of compliance with the policies or procedures maydeteriorate.  Because of the inherentlimitations in a cost-effective control system, misstatements due to error orfraud may occur and not be detected, and, thus, the Company’s management cannotprovide absolute assurance that the Company’s Disclosure Controls will preventall errors and all fraud.

 

The Company’s Disclosure Controls are also evaluatedon an ongoing basis by its Finance organization.  The overall goals of these various evaluationactivities are to monitor the Company’s Disclosure Controls and to makemodifications as necessary.  The Company’sintent in this regard is that the Disclosure Controls will be maintained asdynamic systems that change (including with improvements and corrections) asconditions warrant.

 

Based upon the Controls Evaluation, the Company’s CEOand CFO have concluded that, subject to the limitations noted above, theCompany’s Disclosure Controls are effective as of the quarter ended September30, 2004 to ensure that material information relating to the Company and itsconsolidated subsidiaries was made known to management, including the CEO andCFO, particularly during the period when periodic reports are being prepared,and that the Company’s Disclosure Controls are effective to provide reasonableassurance that its financial statements are fairly presented in conformity withUSGAAP.

 

Due to the Company’s market capitalization at June 30,2004, the Company will be required to comply with §404 of the Sarbanes-OxleyAct (internal control over financial reporting) as of December 31, 2004, asexplained in Item 2 above, in management’s General and Administrativediscussion.

 

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**PART II. OTHER INFORMATION**

 

 

**ITEMS 1 – 5.**

 

 

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

 

(a)  Exhibits

 

The following exhibits are filed herewith:

 
| **Exhibit No.** |   | **Description**                                                                                                                             |
|-----------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                                        |
| 11.1            |   | Computation of income (loss) per share                                                                                                      |
|            |   |                                                                                                                                        |
| 31.1            |   | Chief Executive Officer’s Certification of Report on  Form 10-Q  For the Quarter Ending September 30, 2004                             |
|            |   |                                                                                                                                        |
| 31.2            |   | Chief Financial Officer’s Certification of Report on  Form 10-Q  For the Quarter Ending September 30, 2004                             |
|            |   |                                                                                                                                        |
| 32.0            |   | Written certification of Chief Executive Officer and  Chief Financial Officer, dated October 28, 2004, pursuant to 18 U.S.C.  Section 1350. |

 

(b)  Reports onForm 8-K:

 

On August 03, 2004, the Company filed its pressrelease announcing financial results for the quarter ended June 30, 2004 as areport on Form 8-K, under Items 7 and 12.

 

On September 16, 2004,the Company filed its press release announcing that the Company had enteredinto an amendment of its line of credit agreement with Bank of America, as a report on Form 8-K, underItem 2.02, Entry into Material Definitive Agreements.

 

On September 16, 2004, theCompany filed its press release announcing an update of previousforward-looking earnings guidance, as a report on Form 8-K, underItem 2.02, Results of Operations and Financial Condition.

 

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**SIGNATURE**

 

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

 
|   |             | EFJ, INC. |
|--------|------------------|-----------|
|   |             |      |   |
|   |             |      |   |
| Date:  | October 28, 2004 | By:       | /s/ Massoud Safavi |   |
|   |             |      |   |
|   |             |      | Massoud Safavi |
|   |             |      | Senior Vice President and |
|   |             |      | Chief Financial Officer |
|   |             |      | (Principal Financial and Accounting Officer) |

 

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