**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549-1004**

 

**Form 10-Q**

 

**(Mark One)**

 

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

 

**FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003**

 

**or**

 

**o****  Transition report pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934**

 

**For the transition period from                 to                 **

 

**Commission File Number 0-21681**

 

**EFJ, INC.**

(Exactname of registrant as specified in its charter)

** **

| **DELAWARE**                                                                                                                |   | **47-0801192**                       |
|-----------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                                                             |   | (I.R.S. Employer Identification No.) |
|                                                                                                                        |   |                                 |
| **4800 N.W. 1st STREET**                                                                                                    |
| **LINCOLN, NEBRASKA 68521**                                                                                                 |
| **(402) 474-4800**                                                                                                          |
| (Address, including zip code, and telephone number,  including area code, of registrant’s  principal executive office) |

 

Indicate by checkmark whether the Registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

 

YES  ý          NO o

 

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

 

YES  o          NO ý

 

As of July 23, 2003, 17,577,315 shares of the Registrant’s Common Stockwere outstanding.

 

 

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**PARTI.  FINANCIAL INFORMATION**

 

**ITEM1.  FINANCIAL STATEMENTS**

 

#### **EFJ,INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

June 30, 2003 andDecember 31, 2002

(in thousands, exceptshare data)

 
|                                                                                                                                                                                                                        |   | **JUNE 30,  2003** |       | **DECEMBER 31,  2002** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|------------------------|------------|
|                                                                                                                                                                                                                        |   | **(unaudited)**    |       |                   |       |
| **ASSETS**                                                                                                                                                                                                                  |   |               |       |                   |       |
| Current assets:                                                                                                                                                                                                             |   |               |       |                   |       |
| Cash and cash equivalents                                                                                                                                                                                                   |   | $                  | 3,941      |                   | $          | 11,333 |   |
| Accounts receivable, net of allowance for returns and doubtful accounts  of $176 and $236, respectively                                                                                                                     |   | 7,410              |       | 6,568                  |       |
| Receivables – other                                                                                                                                                                                                    |   | 182                |       | 252                    |       |
| Cost in excess of billings on uncompleted contracts                                                                                                                                                                         |   | 1,927              |       | 1,686                  |       |
| Inventories, net                                                                                                                                                                                                            |   | 10,355             |       | 11,671                 |       |
| Deferred income taxes                                                                                                                                                                                                       |   | 1,000              |       | 1,000                  |       |
| Prepaid expenses                                                                                                                                                                                                            |   | 996                |       | 487                    |       |
| Total current assets                                                                                                                                                                                                        |   | 25,811             |       | 32,997                 |       |
|                                                                                                                                                                                                                        |   |               |       |                   |       |
| Property, plant and equipment, net                                                                                                                                                                                          |   | 2,843              |       | 2,601                  |       |
| Deferred income taxes                                                                                                                                                                                                       |   | 2,000              |       | 2,000                  |       |
| Intangible assets, net of accumulated amortization                                                                                                                                                                          |   | 6,756              |       | 6,760                  |       |
| Other assets                                                                                                                                                                                                                |   | 748                |       | 898                    |       |
| **TOTAL ASSETS**                                                                                                                                                                                                            |   | $                  | 38,158     |                   | $          | 45,256 |   |
|                                                                                                                                                                                                                        |   |               | ** ** |                   | ** ** |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                              |   |               | ** ** |                   | ** ** |
| Current liabilities:                                                                                                                                                                                                        |   |               |       |                   |       |
| Revolving line of credit                                                                                                                                                                                                    |   | $                  | —     |                   | $          | 5,000 |   |
| Current portion of long-term debt obligations                                                                                                                                                                               |   | 130                |       | 22                     |       |
| Accounts payable                                                                                                                                                                                                            |   | 2,952              |       | 4,007                  |       |
| Billings in excess of cost on uncompleted contracts                                                                                                                                                                         |   | —             |       | 38                     |       |
| Deferred revenue - current                                                                                                                                                                                                  |   | 520                |       | 961                    |       |
| Accrued expenses                                                                                                                                                                                                            |   | 1,854              |       | 2,317                  |       |
| Total current liabilities                                                                                                                                                                                                   |   | 5,456              |       | 12,345                 |       |
|                                                                                                                                                                                                                        |   |               |       |                   |       |
| Long-term debt obligations, net of current portion                                                                                                                                                                          |   | 481                |       | 264                    |       |
| Deferred revenue, net of current portion                                                                                                                                                                                    |   | 139                |       | 160                    |       |
| **TOTAL  LIABILITIES**                                                                                                                                                                                                      |   | 6,076              |       | 12,769                 |       |
|                                                                                                                                                                                                                        |   |               |       |                   |       |
| Stockholders’ equity:                                                                                                                                                                                                  |   |               |       |                   |       |
| Preferred stock ($0.01 par value; 3,000,000 shares authorized; none  issued)                                                                                                                                                |   | —             |       | —                 |       |
| Common stock ($0.01 par value; 25,000,000 voting shares authorized,  17,359,773 issued  and outstanding  as of June 30, 2003 and December 31, 2002; 600,000 non-voting  shares authorized, 217,542 issued and  outstanding) |   | 176                |       | 176                    |       |
| Additional paid-in capital                                                                                                                                                                                                  |   | 97,209             |       | 96,918                 |       |
| Accumulated deficit                                                                                                                                                                                                         |   | (65,303            | )          | (64,607                | )          |
| **TOTAL  STOCKHOLDERS’ EQUITY**                                                                                                                                                                                        |   | 32,082             |       | 32,487                 |       |
| **TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                        |   | $                  | 38,158     |                   | $          | 45,256 |   |

 

Seeaccompanying notes to the condensed consolidated financial statements.

 

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**EFJ, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

Forthe three and six months ended June 30, 2003 and 2002

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

 
|                                          |   | **THREE MONTHS ENDED  JUNE 30,** |   | **SIX MONTHS ENDED  JUNE 30,** |   |
|-----------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                          |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                          |   |                             |   |                           |   |   |   |   |   |
| Revenues                                      |   | $                                | 10,723 |                           | $      | 9,514 |   | $ | 19,724 |   | $ | 19,411 |   |
| Cost of sales                                 |   | 6,079                            |   | 5,364                          |   | 11,121 |   | 10,846 |   |
| Gross profit                                  |   | 4,644                            |   | 4,150                          |   | 8,603 |   | 8,565 |   |
| Operating expenses:                           |   |                             |   |                           |   |   |   |   |   |
| Research and development                      |   | 1,813                            |   | 1,108                          |   | 3,215 |   | 2,328 |   |
| Sales and marketing                           |   | 1,533                            |   | 1,410                          |   | 2,844 |   | 2,667 |   |
| General and administrative                    |   | 1,386                            |   | 1,363                          |   | 3,196 |   | 3,448 |   |
| Total operating expenses                      |   | 4,732                            |   | 3,881                          |   | 9,255 |   | 8,443 |   |
|                                          |   |                             |   |                           |   |   |   |   |   |
| Income (loss) from operations                 |   | (88                              | )      | 269                            |   | (652 | ) | 122 |   |
|                                          |   |                             |   |                           |   |   |   |   |   |
| Other income (expense)                        |   | —                           |   | (91                            | )      | 27 |   | 140 |   |
| Interest income                               |   | 9                                |   | 17                             |   | 21 |   | 46 |   |
| Interest expense                              |   | (53                              | )      | —                         |   | (92 | ) | (15 | ) |
| Income (loss) before income taxes             |   | (132                             | )      | 195                            |   | (696 | ) | 293 |   |
|                                          |   |                             |   |                           |   |   |   |   |   |
| Income tax provision                          |   | —                           |   | —                         |   | — |   | — |   |
|                                          |   |                             |   |                           |   |   |   |   |   |
| Net income (loss)                             |   | $                                | (132   | )                              | $      | 195 |   | $ | (696 | ) | $ | 293 |   |
|                                          |   |                             |   |                           |   |   |   |   |   |
| Net income (loss) per share – Basic      |   | $                                | (0.01  | )                              | $      | 0.01 |   | $ | (0.04 | ) | $ | 0.02 |   |
| Net income (loss) per share – Diluted    |   | $                                | (0.01  | )                              | $      | 0.01 |   | $ | (0.04 | ) | $ | 0.02 |   |
|                                          |   |                             |   |                           |   |   |   |   |   |
| Weighted average common shares – Basic   |   | 17,577,315                       |   | 17,577,315                     |   | 17,577,315 |   | 17,577,315 |   |
| Weighted average common shares – Diluted |   | 17,577,315                       |   | 18,237,162                     |   | 17,577,315 |   | 18,118,101 |   |

 

See accompanying notes to the condensed consolidated financialstatements.

 

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**EFJ, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

Six months ended June 30, 2003 and 2002

(Unaudited and inthousands, except share data)

** **
|                                                                                                |   | **Six months ended June 30,** |   |
|-----------------------------------------------------------------------------------------------------|--------|-------------------------------|--------|
|                                                                                                |   | **2003**                      |   | **2002** |   |
| Cash flows from operating activities:                                                               |   |                          |   |   |   |
| Net income (loss)                                                                                   |   | $                             | (696   | ) | $ | 293 |   |
| Adjustments to reconcile net income (loss) to net cash provided by  (used in) operating activities: |   |                          |   |   |   |
| Depreciation and amortization                                                                       |   | 541                           |   | 595 |   |
| Non-cash compensation – intrinsic value of repriced options                                    |   | 296                           |   | 361 |   |
| Gain on sale of fixed assets                                                                        |   | (14                           | )      | (48 | ) |
| Changes in assets and liabilities:                                                                  |   |                          |   |   |   |
| Accounts receivable                                                                                 |   | (772                          | )      | 1,345 |   |
| Cost in excess of billings on uncompleted contracts                                                 |   | (241                          | )      | (597 | ) |
| Inventories                                                                                         |   | 1,316                         |   | (970 | ) |
| Prepaid expenses                                                                                    |   | (469                          | )      | (589 | ) |
| Accounts payable                                                                                    |   | (1,055                        | )      | (1,050 | ) |
| Billings in excess of cost on uncompleted contracts                                                 |   | (38                           | )      | (147 | ) |
| Deferred revenues                                                                                   |   | (462                          | )      | (324 | ) |
| Accrued and other liabilities                                                                       |   | (463                          | )      | (376 | ) |
| Total adjustments                                                                                   |   | (1,361                        | )      | (1,800 | ) |
| Net cash used in operating activities                                                               |   | (2,057                        | )      | (1,507 | ) |
|                                                                                                |   |                          |   |   |   |
| Cash flows from investing activities:                                                               |   |                          |   |   |   |
| Proceeds from sale of fixed assets                                                                  |   | —                        |   | 6 |   |
| Purchase of property, plant and equipment                                                           |   | (391                          | )      | (494 | ) |
| Other assets                                                                                        |   | 110                           |   | 36 |   |
| Net cash used in investing activities                                                               |   | (281                          | )      | (452 | ) |
|                                                                                                |   |                          |   |   |   |
| Cash flows from financing activities:                                                               |   |                          |   |   |   |
| Proceeds from (payments on) revolving line of credit, net                                           |   | (5,000                        | )      | (5,120 | ) |
| Principal payments on long-term debt                                                                |   | (49                           | )      | (19 | ) |
| Other                                                                                               |   | (5                            | )      | — |   |
| Net cash used in financing activities                                                               |   | (5,054                        | )      | (5,139 | ) |
|                                                                                                |   |                          |   |   |   |
| Net decrease in cash and cash equivalents                                                           |   | (7,392                        | )      | (7,098 | ) |
|                                                                                                |   |                          |   |   |   |
| Cash and cash equivalents, beginning of period                                                      |   | 11,333                        |   | 11,582 |   |
|                                                                                                |   |                          |   |   |   |
| Cash and cash equivalents, end of period                                                            |   | $                             | 3,941  |   | $ | 4,484 |   |

 

**Summaryof non-cash transactions:**

 

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

 

See accompanyingnotes to the condensed consolidatedfinancial statements

 

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**EFJ, INC. AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**Three and six months ended June 30, 2003 and 2002**

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

 

**1.GENERAL**

 

The condensedconsolidated balance sheet of EFJ, Inc. (“EFJ” or the “Company”) at December31, 2002 has been derived from audited consolidated financial statements atthat date.  The condensed consolidatedfinancial statements as of June 30, 2003 and for the three and six months endedJune 30, 2003 and 2002 are unaudited. The condensed consolidated financial statements reflect all normal andrecurring accruals and adjustments that, in the opinion of management, are necessaryfor a fair presentation of the financial position, operating results, and cashflows 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, 2002.  The results of operations and cash flows forthe three and six months ended June 30, 2003 are not necessarily indicative ofthe results for any other period or the entire fiscal year ending December 31,2003.  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 amanufacturer of wireless communications products and systems and informationsecurity products.  Through itswholly-owned subsidiary, E.F. Johnson Company (“EFJohnson”), the Companydesigns, develops, manufactures and markets: (1) mobile and portable landmobile radios (“LMR”); (2) stationary LMR transmitters / receivers (basestations or repeaters); and (3) LMR systems. Through its wholly-owned subsidiary, Transcrypt International, Inc.(“Transcrypt”), the Company designs and manufactures information securityproducts, which prevent unauthorized access to sensitive voice and datacommunications.  These products arebased on a wide range of analog scrambling and digital encryption technologiesand are sold mainly to the LMR markets as an add-on security device for analogradios.  The Company sells its productsto: (1) domestic public safety / public service and other governmentalusers; (2) domestic commercial users; and (3) international customers.

 

The condensed consolidated financial statements include the accounts ofthe Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have beeneliminated in the consolidation.

 

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

 

Basic income(loss) per share (“EPS”) is calculated based upon the weighted average numberof common shares outstanding during the period.  The diluted EPS calculation reflects the potential dilution fromcommon stock equivalents such as stock options.  For the three and six months ended June 30, 2003, the impact ofoutstanding stock options on diluted EPS was anti-dilutive as both the threeand six month periods ended June 30, 2003 had a net loss; as such the basic EPSis used for both basic and diluted EPS for the respective periods.  All outstanding stock options granted as ofsuch dates which had exercise prices lower than the average market price of thecommon stock for the respective periods are considered common stock equivalentsin the calculation of the diluted weighted average common shares.  The Company uses the treasury stock methodto calculate diluted weighted average common shares, as if all such optionswere outstanding for the periods presented.

 

If the Company hadnot incurred a net loss for the three and six months ending June 30, 2003, thediluted weighted average common shares would have been 18,431,294 and18,480,985, respectively.  As a resultof the net loss conditions, the Company used weighted average outstandingcommon shares, or 17,577,315, for both the basic and diluted weighted averagecommon shares for the periods ending June 30, 2003.

 

5

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

 

The Companyapplies the intrinsic value-based method of accounting for stock options issuedto employees.  When both the number ofshares that an individual employee is entitled to receive and the option priceare known at the grant date, total compensation cost for the Company’s grantsof stock options is measured at the grant date (“fixed plan awards”).  However, when either or both of thesefactors are not known at the grant date, the Company estimates totalcompensation cost each accounting period from the date of grant based on theestimated fair value of the Company’s common stock at the end of each period(“variable plan awards”).  Changes,either increases or decreases, in the estimated fair value of the sharesbetween the date of grant and the final exercise or expiration date of theoptions result in a change in the measure of compensation cost for variableplan awards.  Compensation cost isrecognized as expense over the periods in which the employee performs therelated services, which is generally presumed to be the vesting period.

 

If compensation cost for theCompany’s stock option plans had been determined based on the fair value at thegrant date for awards for the three and six months ended June 30, 2003 and2002, the Company’s pro forma net income (loss) and pro forma net income (loss)per share would have been as follows:

 
|                                                                                 |   | **Three months ended****June 30,** |   | **Six months ended  June 30,** |   |
|--------------------------------------------------------------------------------------|--------|------------------------------------|--------|--------------------------------|--------|
|                                                                                 |   | **2003**                           |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                                                                 |   |                               |   |                           |   |   |   |   |   |
| Net income  (loss) - as reported                                                     |   | $                                  | (132   | )                              | $      | 195 |   | $ | (696 | ) | $ | 293 |   |
| General and  administrative expenses for management stock option compensation.... |   | 72                                 |   | 89                             |   | 435 |   | 292 |   |
| Pro forma net  income (loss)                                                         |   | $                                  | (204   | )                              | $      | 106 |   | $ | (1,031 | ) | $ | 1 |   |
|                                                                                 |   |                               |   |                           |   |   |   |   |   |
| Net income  (loss) per share, basic and diluted – as reported                   |   | $                                  | (0.01  | )                              | $      | 0.01 |   | $ | (0.04 | ) | $ | 0.02 |   |
| Pro forma net  income (loss) per share, basic and diluted                            |   | $                                  | (0.01  | )                              | $      | 0.01 |   | $ | (0.06 | ) | $ | 0.00 |   |

 

Theweighted average fair value per option at date of grant during the six months endedJune 30, 2003 and 2002 was $1.47 and $.51, respectively.  The fair value of each option grant isestimated on the date of grant using the Black-Scholes option-pricing modelwith the following weighted-average assumptions for options granted:

 
|                        |   | **Six months ended****June 30,** |   |
|-----------------------------|--------|----------------------------------|--------|
|                        |   | **2003**                         |   | **2002** |   |
| Expected option  life       |   | 10  years                        |   | 10  years |   |
| Expected annual  volatility |   | 88                               | %      | 193 | % |
| Risk-free  interest rate    |   | 3.99                             | %      | 2.93 | % |
| Dividend yield              |   | 0                                | %      | 0 | % |

 

6

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**5.INVENTORIES**

 

During the sixmonths ended June 30, 2003, the Company sold, disposed of, or otherwise wroteoff, $1,500 of obsolete inventory, this disposition was substantially recordedagainst the reserve for obsolescence. The following is a summary of inventory at June 30, 2003 and December31, 2002:

 
|                        |   | **June 30,  2003** |   | **December  31, 2002** |   |
|-----------------------------|--------|--------------------|--------|------------------------|--------|
| Raw materials  and supplies |   | $                  | 5,775  |                   | $      | 7,562 |   |
| Work in progress            |   | 1,679              |   | 1,646                  |   |
| Finished goods              |   | 4,365              |   | 4,931                  |   |
|                        |   | 11,819             |   | 14,139                 |   |
| Reserve for  obsolescence   |   | (1,464             | )      | (2,468                 | )      |
| Total inventories, net      |   | $                  | 10,355 |                   | $      | 11,671 |   |

 

**6.  INTANGIBLE ASSETS**

 

As required byStatement of Financial Accounting Standards (“SFAS”) 142, ***Goodwill and Other Intangible Assets***(“SFAS142”)***,*** the Company doesnot amortize its goodwill, instead reviewing its goodwill for impairment, atleast annually.  The Company performedfair value-based impairment tests, in accordance with SFAS 142, at December 31,2002 and 2001, concluding that no impairment of goodwill had occurred as ofthese dates.  No events occurred duringthe three and six months ended June 30, 2003 and 2002 that would indicate thatan impairment of such assets had taken place. As of January 1, 2002, certain of the Company’s intangible assets(customer base, acquired workforce, and tradename) were reclassed to goodwill,as per SFAS 141, ***Business Combinations,***these assets were not deemed separable from goodwill for purposes ofrecognition.

 

Amortizationexpense, related to intangible assets which are subject to amortization, was $4and $92 for the six months ended June 30, 2003 and 2002.  Amortization expense of intangible assetssubject to amortization is anticipated to be $8 for 2003 and annuallythereafter through 2012.  Intangibleassets consist of the following:

 
|                                        |   | **June 30,  2003** |   | **December  31, 2002** |   |
|---------------------------------------------|--------|--------------------|--------|------------------------|--------|
| Goodwill                                    |   |               |   | $                      | 6,690  |   |   |   | $ | 6,690 |   |
| 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        |   | 47                 |   | 66                     |   | 43 |   | 70 |   |
| Total                                       |   |               |   | $                      | 6,756  |   |   |   | $ | 6,760 |   |

 

**7.  REVOLVING LINE OF CREDIT**

 

InNovember 2002, the Company entered into a $10.0 million secured line of creditagreement with Bank of America.  Theline of credit bears interest at a rate of LIBOR plus 200 basis points, theeffective rate at June 30, 2003, which rate may be increased to LIBOR plus 275basis points dependent upon certain debt ratios. The line of credit iscollateralized by substantially all the Company’s assets.  Borrowings available under the line ofcredit are calculated as a percentage of eligible inventory andreceivables.  The agreement, whichexpires September 30, 2004, includes certain covenants, including financial covenants,with which the Company was in compliance, or for which waivers had beenobtained, as of June 30, 2003 and December 31, 2002.  At June 30, 2003 and December 31, 2002, the Company had $0 and$5,000, respectively, outstanding on its line of credit.  The total available credit under the line ofcredit was $7.8 million as of June 30, 2003.

 

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**8.  REPRICED STOCK 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 thestock options resulted in a new measurement date for accounting purposes andthe reclassification of these options as variable plan awards beginning on thedate of the repricing.  The Company hadpreviously accounted for these option grants as fixed plan awards.  As of June 30, 2003 and 2002, respectively,approximately 872,000 and 1,002,000 of these repriced options, in variousstages of vesting, were outstanding.  AtJune 30, 2003 and 2002, respectively, the market value of the Company’s commonstock was $1.60 and $1.13 per share; this compared to market values of $1.25and $0.52 per share at December 31, 2002 and 2001.  Non-cash compensation charges, therefore, resulted to the extentthat the market value exceeded the repriced exercise price of $0.656 pershare.  In the three and six monthsended June 30, 2003, the amounts of compensation expense (benefit) relating tothese repriced options were $(150) and $296, respectively.  In the three and six months ended June 30,2002, the related amounts of compensation expense (benefit) were $(76) and$361, respectively.  These amounts areincluded in general and administrative expenses.

 

**9.  COMMITMENTS AND CONTINGENCIES**

 

On or aboutFebruary 5, 2001, ASRC Communication (“ASRC”) filed a complaint in UnitedStates District Circuit Court of Alaska, against EFJohnson.  ASRC alleges that EFJohnson engaged inwrongful activities in association with radio products sold 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 against ASRC for damages associated with EFJohnsonmanufactured radios.  At this time, theState of Alaska has not formally prosecuted its administrative claim againstASRC.  The State of Alaska has statedthat it has damages in excess of $800. In May 2003, ASRC and EFJohnson tentatively agreed to dismiss ASRC’scomplaint against the Company. Under the tentative agreement, EFJohnson shalldefend ASRC, at EFJohnson’s expense, against any State’s claim allegingnon-performance of the EFJohnson radios. In addition, the parties would resolve any issue or dispute throughmediation and bidding arbitration.  TheCompany is unable to predict the likelihood of the outcome or potentialliability that may arise from this action.

 

The Company is involved in certainother legal proceedings incidental to the normal conduct of its business.  The Company does not believe that anyliabilities relating to such other legal proceedings are likely to be,individually or in the aggregate, material to the Company’s business, financialcondition, results of 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 on various dates in 2003,have a total undrawn balance of $317 at June 30, 2003.  Bonds, which expire on various dates,totaled $7,700 on June 30, 2003.  As ofthat date, no bonds have been drawn upon.

 

**10.  RELATED PARTY TRANSACTION**

 

In April 2002, theCompany extended a loan to its Chief Executive Officer, Michael E. Jalbert, inthe principal amount of $75.  This noteis due on demand and bears interest at the annual rate of 6%.  Any tax obligations associated with the loanare the sole responsibility of Mr. Jalbert.

 

8

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**11.  SEGMENT AND RELATED INFORMATION**

 

The Company operates in the following two industry segments:

•                  the wireless communication industry (EFJohnson), whichis comprised of the design, development, manufacture and sale of stationaryland mobile radio transmitters/receivers, mobile and portable radios andcomplete radio communication systems; and

•                  the information security industry (Transcrypt), whichis comprised of the design, manufacture and sale of devices that prevent theunauthorized interception of sensitive voice and data communication.

 

The Company evaluates segment results based on gross margin and incomefrom operations.  Corporate expenses areallocated to the operating segments based upon estimated usage of corporateresources.  The following table is asummary of the unaudited operating results for the three and six months endedJune 30, 2003 and 2002.

** **
|                                  |   | **Three  Months Ended  June 30,** |       | **Six Months  Ended  June 30,** |       |
|---------------------------------------|--------|-----------------------------------|------------|---------------------------------|------------|
| **In thousands**                      |   | **2003**                          |       | **2002**                        |       | **2003** |   | **2002** |   |
| **Revenues:**                         |   |                              | ** ** |                            | ** ** |   | ** ** |   | ** ** |
| Wireless Communication                |   | $                                 | 9,031      |                            | $          | 7,912 |   | $ | 16,157 |   | $ | 16,217 |   |
| Information Security                  |   | 1,692                             |       | 1,602                           |       | 3,567 |   | 3,194 |   |
|                                  |   | $                                 | 10,723     |                            | $          | 9,514 |   | $ | 19,724 |   | $ | 19,411 |   |
| **Gross Profit:**                     |   |                              |       |                            |       |   |   |   |   |
| Wireless Communication                |   | $                                 | 3,369      |                            | $          | 3,034 |   | $ | 5,990 |   | $ | 6,421 |   |
| Information Security                  |   | 1,275                             |       | 1,116                           |       | 2,613 |   | 2,144 |   |
|                                  |   | $                                 | 4,644      |                            | $          | 4,150 |   | $ | 8,603 |   | $ | 8,565 |   |
| **Operating  Profit (Loss):**         |   |                              |       |                            |       |   |   |   |   |
| Wireless Communication                |   | $                                 | (574       | )                               | $          | 50 |   | $ | (1,574 | ) | $ | (234 | ) |
| Information Security                  |   | 486                               |       | 219                             |       | 922 |   | 356 |   |
| **Income (Loss)  from Operations**    |   | (88                               | )          | 269                             |       | (652 | ) | 122 |   |
|                                  |   |                              |       |                            |       |   |   |   |   |
| **Other Income  (Expense), net**      |   | (44                               | )          | (74                             | )          | (44 | ) | 171 |   |
|                                  |   |                              |       |                            |       |   |   |   |   |
| **Income (Loss)  before Taxes**       |   | $                                 | (132       | )                               | $          | 195 |   | $ | (696 | ) | $ | 293 |   |
|                                  |   |                              |       |                            |       |   |   |   |   |
| **Depreciation  & Amortization:** |   |                              |       |                            |       |   |   |   |   |
| Wireless Communication                |   | $                                 | 260        |                            | $          | 253 |   | $ | 478 |   | $ | 502 |   |
| Information Security                  |   | 30                                |       | 44                              |       | 63 |   | 93 |   |
|                                  |   | $                                 | 290        |                            | $          | 297 |   | $ | 541 |   | $ | 595 |   |
|                                  |   |                              |       |                            |       |   |   |   |   |
| **Assets:**                           |   |                              |       |                            |       |   |   |   |   |
| Wireless Communication                |   | $                                 | 28,764     |                            |       |   |   |   |   |   |
| Information Security                  |   | 5,651                             |       |                            |       |   |   |   |   |
| Corporate                             |   | 3,743                             |       |                            |       |   |   |   |   |
|                                  |   | $                                 | 38,158     |                            |       |   |   |   |   |   |

 

9

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**ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS****OF OPERATIONS**

 

The following table presents certain Consolidated Statements ofOperations information as a percentage of revenues during the periodsindicated:

 
|                                 |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|--------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                 |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                 |   |                             |   |                           |   |   |   |   |   |
| Revenues                             |   | 100.0                            | %      | 100.0                          | %      | 100.0 | % | 100.0 | % |
| Cost of sales                        |   | 56.7                             | %      | 56.4                           | %      | 56.4 | % | 55.9 | % |
| Gross profit                         |   | 43.3                             | %      | 43.6                           | %      | 43.6 | % | 44.1 | % |
| Operating expenses:                  |   |                             |   |                           |   |   |   |   |   |
| Research and development             |   | 16.9                             | %      | 11.6                           | %      | 16.3 | % | 12.0 | % |
| Sales and marketing                  |   | 14.3                             | %      | 14.8                           | %      | 14.4 | % | 13.7 | % |
| General and administrative           |   | 12.9                             | %      | 14.4                           | %      | 16.2 | % | 17.8 | % |
| Total operating expenses             |   | 44.1                             | %      | 40.8                           | %      | 46.9 | % | 43.5 | % |
| Income (loss) from operations        |   | (0.8                             | )%     | 2.8                            | %      | (3.3 | )% | 0.6 | % |
| Interest income (expense) – net |   | (0.4                             | )%     | 0.2                            | %      | (0.3 | )% | 0.2 | % |
| Other income (expense)               |   | —                           |   | (1.0                           | )%     | 0.1 | % | 0.7 | % |
| Income (loss) before income taxes    |   | (1.2                             | )%     | 2.0                            | %      | (3.5 | )% | 1.5 | % |
| Provision for income taxes           |   | —                           |   | —                         |   | — |   | — |   |
| Net income (loss)                    |   | (1.2                             | )%     | 2.0                            | %      | (3.5 | )% | 1.5 | % |

 

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, 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“ITEM 1. BUSINESS — Summary of Business Considerations and Certain Factors ThatMay Affect Future Results of Operations and/or Stock Price” contained in theCompany’s Annual Report on Form 10-K for the year ended December 31, 2002.

 

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 Consolidated Financial Statements and Notesthereto.

 

Revenues

 

Revenues increased13% to $10.7 million in the second quarter of 2003, as compared to $9.5 millionduring the same period in 2002.  Oftotal revenues in the second quarter of 2003, the wireless communicationsegment comprised $9.0 million, which represents an increase of 14% as comparedto revenues of $7.9 million during the same period in 2002.  Information security segment revenues of$1.7 million in the second quarter of 2003 represent a 6% increase as comparedto revenues of $1.6 million during the same period in 2002.

 

10

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Revenues increasedby 2%, to $19.7 million during the six months ended June 30, 2003, as comparedto $19.4 million during the same period in 2002.  Of total revenues in the six months ended June 30, 2003, thewireless communication segment comprised $16.2 million compared to $16.2million during the same period in 2002. Information security segment revenues of $3.6 million during the sixmonths ended June 30, 2003 represent a 12% increase as compared to revenues of$3.2 million during the same period in 2002.

 

AlthoughEFJohnson’s revenues for the first six months of 2003 are relatively flatcompared to the prior year, the increase in domestic public safety / publicservice revenues (as shown below) is consistent with EFJohnson’s marketstrategy to emphasize federal, state and local governmental customers and,correspondingly, to de-emphasize commercial and international sales.  Although 2003 year-to-date revenues atEFJohnson are similar to the prior year, the Company expects EFJohnson’srevenues for 2003 to be 13% to 20% higher than its 2002 revenues.  To this end, the Company’s backlog,comprised substantially of EFJohnson orders, increased to $14.4 million as ofJuly 27, 2003.  However, most of theseorders will be delivered in the fourth quarter of 2003; as such, the Companyexpects third quarter revenues for this segment to be similar to the secondquarter.

 

The increase in revenues of the information securitysegment during the six months ended June 30, 2003, as compared to the prioryear, was primarily the result of timing issues associated with finalizingcertain sales agreements.  The Companybelieves that revenues for its information security segment for the year endedDecember 31, 2003 will approximate the segment’s revenues in 2002.  Accordingly, the Company anticipates thatTranscrypt’s aggregate third and fourth quarter revenues will only be slightlyless than the $3.6 million recognized during the six months ended June 30,2003.

 

The Company made the decision in thefourth quarter of 2000 to substantially exit the commercial LMR markets andfocus its LMR sales on the domestic public safety / public service sector.  Consequently, the Company’s sales to thedomestic public safety / public service sector have steadily increased, and theCompany’s sales to commercial users have decreased.  Although the Company would expect the trend of increasingdomestic public safety / public service sector sales to continue, the Company’ssales to commercial users would be expected to remain relatively flat through2003.  Federal sales in 2003 havecontinued to increase as a percentage of public safety / public servicerevenues, as compared to 2002; the Company expects this trend to continuethrough the remainder of 2003.

 

International sales relatesubstantially to Transcrypt, as EFJohnson’s international sales were only $1.3million and $0.5 million for the six month periods ending June 30, 2003 and2002, respectively.  The Companyanticipates that its international sales will remain at a similar levelthroughout 2003.

 

The Company’s sales, as per itsdefined customer markets, are shown below for the three and six months endedJune 30, 2003 and 2002:

 
| **Revenues  (in thousands):**            |   | **For the three months ended****June 30,** |   | **For the six months ended****June 30,** |   |
|------------------------------------------|--------|--------------------------------------------|--------|------------------------------------------|--------|
|                                     |   | **2003**                                   |   | **2002**                                 |   | **2003** |   | **2002** |   |
|                                     |   | **Sales**                                  |   | **%**                                    |   | **Sales** |   | **%** |   | **Sales** |   | **%** |   | **Sales** |   | **%** |   |
| Domestic public  safety / public service |   | $                                          | 8,476  |                                     | 79     | % | $ | 7,620 |   | 80 | % | $ | 14,918 |   | 76 | % | $ | 13,749 |   | 71 | % |
| Domestic commercial                      |   | 641                                        |   | 6                                        |   | 771 |   | 8 |   | 1,099 |   | 6 |   | 2,777 |   | 14 |   |
| International                            |   | 1,606                                      |   | 15                                       |   | 1,123 |   | 12 |   | 3,707 |   | 18 |   | 2,885 |   | 15 |   |
|                                     |   | $                                          | 10,723 |                                     |   |   | $ | 9,514 |   |   |   | $ | 19,724 |   |   |   | $ | 19,411 |   |   |   |

 

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 $4.6 million (43% grossmargin) for the second quarter of 2003, as compared to $4.2 million (44% grossmargin) for the same period in 2002. Gross margin for the wirelesscommunication segment was 37% in the second quarter of 2003 versus 38% for thesame period in 2002. Gross margin for the

 

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information securitysegment was 75% in the second quarter of 2003 versus 70% for the same period in2002.

 

Consolidated gross profit was $8.6 million (44% grossmargin) for the six months ended June 30, 2003, as compared to $8.6 million(44% gross margin) for the same period in 2002.  Gross margin for the wireless communication segment was 37% forthe six month period ended June 30, 2003 versus 40% for the same period in2002.  Gross margin for the informationsecurity segment was 73% during the six months ended June 30, 2003 as comparedto 67% for the same period in 2002.

 

In the wireless communication segment, the decrease inthe gross margin percentage from 2002 to 2003 was due primarily tomanufacturing inefficiencies resulting from variable sales levels during thesix months ended June 30, 2003. EFJohnson’s gross margin percentage for 2003 is expected to be 38% to42%, as compared to the 37% margin realized during 2002.  Transcrypt’s increase in gross marginpercentage in the second quarter of 2003, as compared to the prior year, wasprimarily the result of sales mix considerations.  The information security segment’s gross margin percentage for2003 is expected to only slightly improve from the 70% margin realized during2002.  Gross margins for both industrysegments are likely to vary in the future, based primarily upon the mix ofproducts and the amount of revenues recognized in the respective periods.

 

Research and Development

 

Research anddevelopment expenses consist primarily of the costs associated with researchand development personnel, third-party technology development, materials, andthe depreciation of equipment and facilities.

 

Research anddevelopment expenses increased to $1.8 million in the second quarter of 2003(17% of revenues) from $1.1 million in the second quarter of 2002 (12% ofrevenues).  Further, research anddevelopment expenses increased to $3.2 million during the six months ended June30, 2003 (16% of revenues), as compared to $2.3 million in the same period in2002 (12% of revenues).  The increaserelated primarily to Project 25 LMR infrastructure development at EFJohnson.  Current research and development efforts areconcentrated primarily on design, development, enhancement, and addition to theCompany’s Project 25 digital LMR infrastructure products, as well as to itsline of digital radios.

 

The Company’s research and development costs willcontinue to increase in the second half of 2003.  The aggregate expenses in the third and fourth quarters areanticipated to be 15% to 25% higher than the research and development expensesincurred during the first half of 2003. Certain of the Company’s anticipated sales at EFJohnson are dependentupon successful and timely completion of its on-going research and developmentprojects.

 

Sales and Marketing

 

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

 

Sales and marketing expenses in 2003 have beensubstantially similar to amounts incurred in 2002, in terms of a percentage ofrevenues.  Sales and marketing expensesincreased slightly to $1.5 million in the second quarter of 2003 (14% ofrevenues) from $1.4 million in the second quarter of 2002 (15% of revenues).  Further, sales and marketing expensesincreased slightly to $2.8 million for the six months ended June 30, 2003 (14%of revenues), as compared to $2.7 million for the same period in 2002 (14% ofrevenues).

 

The Company anticipates that its sales and marketingexpenses for 2003 will be incurred at a percentage of revenues substantiallysimilar to the levels realized during 2002 and for the six months ended June30, 2003, that is, 14% to 15%.

 

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General and Administrative

 

General andadministrative expenses consist primarily of salaries and other expensesassociated with the Company’s management, finance, accounting, andadministration.

 

General andadministrative expenses of $1.4 million in the second quarter of 2003 (13% ofrevenues) were substantially similar to the $1.4 million amount incurred forthe same period in 2002 (14% of revenues). General and administrative expenses for the six months ended June 30,2003 were $3.2 million (16% of revenues); this was a decrease from the $3.4million incurred during the same period in 2002 (18% of revenues).  This decrease for the six months ended June30, 2003 relates to: 1) a decrease in intangible amortization of $0.1 million;and 2) a $0.2 million decrease in bad debt expense in 2003 resulting fromrecovery of accounts that were written off or otherwise fully reserved.

 

As described in Note 8 of the Notesto Condensed Consolidated Financial Statements (“Notes”), for the three monthsended June 30, 2003 and 2002, the Company incurred similar non-cashcompensation expense (benefit), relating to the repricing of its stock options,of $(150,000) and $(76,000), respectively. This compensation expense (benefit) amounts incurred for the six monthsended June 30, 2003 and 2002 were $296,000 and $361,000.  The compensation expense relating to therepriced options varies according to the market value of the Company’s commonstock; presently, each increase of $0.01 per share in the Company’s stockprice, over the closing market on June 30, 2003, of $1.60 per share, will causethe Company to incur approximately $8,300 in future compensation expense.

 

The Companyanticipates future general and administrative expenses for 2003, excludingnon-cash compensation relating to the repriced options, to be similar to thelevel experienced during the first half of 2003.

 

Other Income, net

 

Net other income /(expense) for the six months ended June 30, 2003 was minimal, $27,000, as wouldbe anticipated.  Net other income /(expense), of $140,000, for the six months ended June 30, 2002 relatedsubstantially to insurance proceeds received in relation to a claim for stolenproperty.  The Company would expectother income / (expense) in the future to remain at an insignificant level.

 

Interest Income / InterestExpense

 

Interest income consists of interestincome earned on cash and invested funds. Interest expense consists of interest amounts payable on the Company’sloans and bank line of credit.  Interestincome and interest expense were $21,000 and $92,000, respectively, for the sixmonths ended June 30, 2003, as compared to $46,000 and $15,000 in the sameperiod in 2002.  The Company expectsinterest income for the remainder of the fiscal year to remain similar to thelevel experienced in the first half of 2003. The Company’s interest expense in 2003, which includes monthlyamortization of approximately $10,000 in line of credit fees, is also expectedto remain similar to the level experienced in the first half of 2003.  However, interest income and expense willvary according to the Company’s use of cash, interest rates, debt balances, andoperating results over the remainder of 2003.

 

Provision / Benefit for IncomeTaxes

 

The Company didnot record a tax provision or benefit in either of the first two quarters of2003 or 2002.  As of December 31, 2002,the Company has $24.8 million in deferred tax assets primarily comprised of netoperating loss carryforwards; this asset is reduced by a valuation allowance of$21.8 million.  This reserve is basedupon management’s expectation as to the extent its tax assets will actually berealized, such expectation based upon management’s estimates of futureoperating results and other factors. Accordingly, depending upon such future estimates, all or some portion ofthe reserved deferred tax asset may be restored or, conversely, it may benecessary to write off all or part of the $3.0 million deferred tax assetrecorded on the balance sheet at June 30, 2003 and December 31, 2002.

 

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Net Income (Loss)

 

The Company had a net loss of $0.7 million during thesix months ended June 30, 2003, as compared to a net income of $0.3 millionduring the same period in 2002. Operating results for either period do not include any tax provision orbenefit.  However, in both the sixmonths ending June 30, 2003 and 2002, the Company’s operating results wereadversely affected by non-cash compensation resulting from variable accountingtreatment required for certain of the Company’s stock options repriced in thefourth quarter of 2000 and the first quarter of 2001.  The amounts of such non-cash compensation expense, included ingeneral and administrative expenses, were $296,000 and $361,000 for the sixmonths ending June 30, 2003 and 2002, respectively.

 

The Company expects its net operating results for thethird quarter of 2003 to be substantially similar to the first two quarters of2003, prior to the effect of non-cash compensation expense relating to theCompany’s repriced options.  However,the Company anticipates that net operating results for the fourth quarter of2003 will be profitable to the extent to permit net income in 2003 to be $0.13to $0.16 per share prior to the effect of the aforementioned non-cashcompensation expense.

 

Liquidity and Capital Resources

 

Since January 1,1997, the Company has financed its operations and met its capital requirementsprimarily through short-term borrowings, long-term debt, and stock offeringscompleted on January 22, 1997 and October 15, 1997.  However, the Company’s operations provided positive cash for 2001and 2002, and the Company expects its operations to provide positive cash foryear ended December 31, 2003.

 

The Company’s operating activities used cash of $2.1 million and $1.5million in the six months ended June 30, 2003 and 2002, respectively.  In 2003 depreciation and amortization,non-cash compensation and gain on sale add-backs approximated the Company’s netloss for the six-month period; as such, the cash used in operations substantiallycame from changes in working capital. Primary changes in working capital which used cash in the six monthsended June 30, 2003 related to decreases in accounts payable ($1.1 million) andincreases in receivables ($0.8 million). The difference of $0.6 million of cash used in operating activities, sixmonths ended June 30, 2003 as compared to the same period in 2002, generallyrelates to the difference between the net loss of $0.7 million in 2003 and thenet income of $0.3 million in 2002.  TheCompany expects net cash to be provided by operations in 2003, the cashanticipated to be provided primarily by profits and continued decreases ininventory balances.

 

Cash used byinvesting activities was $0.3 million for the six months ended June 30, 2003;this compared to cash used by investing activities of $0.5 million for the sameperiod in 2002.  The difference, between2003 and 2002, related primarily to cash flows used in the purchase ofproperty.  However, total capitalexpenditures were actually higher in 2003 as $0.4 million of such expenditureswere acquired through the exchange of debt and are, thus, excluded from theStatement of Cash Flows.

 

Cash used byfinancing activities, $5.1 million, in the six months ended June 30, 2003primarily related to paying off the December 31, 2002 line of credit balance of$5.0 million.  Similarly, in the sixmonths ended June 30, 2002, financing activities used net cash of $5.1 millionprimarily related to the pay off and termination of the Company’s previous lineof credit in February 2002.

 

In early 2000, the Company obtained a commitment froma major insurance company that provides for up to $20.0 million in new bondingarrangements at favorable rates and terms. Because of the Company’s performance in 2000, the bonding insurerindicated that any future bonding arrangements must be partially supported bycollateral, either with an irrevocable letter of credit or with cash.  As such, in 2003, the Company secured abonding arrangement with an alternative provider.  This recently negotiated agreement calls for zero-collateralbonding up to $7.0 million; however, no single bond may exceed $2.0million.  The Company believes itsbonding arrangements provide it with sufficient bonding availability through2003; however, the Company continues to seek improved bonding alternatives withincreased limits.

 

As of June 30, 2003, the Company hadno outstanding balance on its current revolving line of credit with Bank ofAmerica, described in Note 7 of the Notes herein.  At such date, after deducting $0.3 million of certificates ofdeposit which collateralize $0.3 million of outstanding letters, the Companyhad unrestricted cash of $3.6 million

 

14

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and approximately $7.8 million of available credit under thisline.  This current line of creditreplaced the Company’s previous line of credit with U.S. Bank, which theCompany elected to pay off and terminate in February 2002.  Management believed that the prior facilitywith U.S. Bank, as structured, did not provide the operational flexibility theCompany required; conversely, the Company believes its present line of creditprovides such flexibility.

 

The Company’sbacklog of unfilled orders at June 30, 2003 was $5.6 million, compared to abacklog of $8.0 million at December 31, 2002. Due to the unpredictable timing of major domestic governmental orders,the Company does not believe that its backlog figures, and variations fromperiod to period therein, are necessarily indicative of sales of products infuture periods.

 

The Company does not anticipate paying cash dividendsin the foreseeable future.

 

Critical Accounting Policies

 

The preparation ofthe Company’s consolidated financial statements in conformity with “generallyaccepted accounting principles” (“GAAP”) requires management to make judgments,estimates and assumptions in certain circumstances that affect the amountsreported in the consolidated financial statements and related footnotes.  The Company regularly evaluates the accountingpolicies and estimates used to prepare its financial statements.  Estimates are used for, but not limited to,the accounting for allowance for doubtful accounts and sales returns, estimatesinvolved in applying percentage of completion accounting for long-term contractrevenues, inventory reserves, and contingencies.  These estimates are based on historical experience and variousassumptions that the Company believes to be reasonable under the particularapplicable facts and circumstances. Actual results could differ from those estimates.

 

The Companyconsiders its critical accounting policies to be those that (i) involvesignificant judgments and uncertainties, (ii) require estimates that are moredifficult for management to determine, and (iii) have the potential to resultin materially different outcomes under varying assumptions and conditions.  The application of GAAP may requiremanagement to make estimates and assumptions that affect the amounts reportedin the financial statements and accompanying results.  Listed below are those policies the Company believes are criticaland require the use of complex judgment in their application.

* *

*Revenue*

 

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

 

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

 

Deferred revenueincludes unearned services provided under systems maintenance contracts andunearned warranty fees on extended product warranty contracts sold tocustomers.  The Company recognizes thefees based upon a straight-line method over the life of the contract.

 

The Companyperiodically reviews its revenue recognition procedures to assure that suchprocedures are in accordance with the provisions of Staff Accounting Bulletin101.

 

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*Goodwill*

 

In July 2002, the Financial Accounting Standards Boardissued SFAS No. 142***. ***SFAS 142 requires thatgoodwill no longer be amortized to earnings, but instead be reviewed forimpairment, on at least an annual basis, by applying a fair value-basedtest.  The Company adopted theprovisions SFAS 142 effective January 1, 2002. At least annually, the Company assesses goodwill, using a fairvalue-based test, consistent with SFAS 142. If the carrying amount exceeds the fair value, goodwill is considered tobe impaired.  In evaluating impairment,the Company estimates the sum of the expected future cash flows derived fromsuch goodwill.  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 governmental entities for wirelesscommunications products.  The Companycontinually evaluates whether events and circumstances have occurred thatindicate the remaining balance of goodwill may not be recoverable.  If the Company fails to deliver newproducts, if the products fail to gain expected market acceptance, or if theCompany fails to achieve assumed revenue growth rates or assumed gross margin,the Company may incur charges for impairment of goodwill 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.  Valuationallowances are provided to the extent that recoverability of tax assets is notconsidered likely.  In determiningwhether a tax asset is recoverable, the Company considers estimates of futurerevenues, costs and expenses and other factors.  If the Company fails to achieve revenue growth rates or grossmargins assumed in the calculation of the deferred tax asset, the Company maybe required to reduce its deferred tax assets in the future.

 

**ITEM3.  QUANTITATIVE AND QUALITATIVEDISCLOSURE 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 monetary exchange values hascaused, and may in the future cause, some foreign customers to delay new ordersor delay payment for existing orders. Additionally, troubled economic conditions, such as that recentlyexperienced in Asia and in Latin America, could result in lower revenues forthe Company.  While much of theCompany’s international sales are supported by letters of credit, the purchaseof Company products by international customers presents increased risks, whichinclude:

•                  unexpectedchanges in regulatory requirements;

•                  tariffs andother trade barriers;

•                  political andeconomic instability in foreign markets;

•                  difficulties inestablishing foreign distribution channels;

•                  longer paymentcycles;

•                  uncertainty inthe collection of accounts receivable;

•                  increased costsassociated with maintaining international marketing efforts;

•                  difficulties inprotecting intellectual property; and

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

 

Some of the Company’s information security productsare subject to export controls under U.S. law, which in most cases requires theapproval of the Department of Commerce in order to ship internationally. TheCompany cannot assure that such approvals will be available to it or itsproducts in the future in a timely manner or at all or that the federalgovernment will not revise its export policies or the list of products andcountries for which export approval is required. The Company’s inability toobtain required export approvals would adversely affect the Company’sinternational sales, which would have a material adverse effect on the Company.In addition, foreign companies not subject to United States export restrictionsmay have a competitive advantage in the international

 

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information securitymarket. The Company cannot predict the impact of these factors on theinternational market for its products.

 

**ITEM 4.CONTROLS AND PROCEDURES**

 

*Evaluation of Disclosure Controlsand 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 (“DisclosureControls”) as of the quarter ended June 30, 2003.  This evaluation (the “Controls Evaluation”) was done under thesupervision and with the participation of management, including our ChiefExecutive Officer (“CEO”) and Chief Financial Officer (“CFO”).  The effectiveness of the Company’sDisclosure Controls, as determined by this evaluation, is disclosed in theChief Executive Officer’s Certification of Report on Form 10-Q for theQuarterly Period Ending June 30, 2003 and the Chief Financial Officer’sCertification of Report on Form 10-Q for the Quarterly Period Ending June 30,2003 (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’s (“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 and operated,can provide only reasonable, not absolute, assurance that the objectives of thecontrol system are met.  Further, thedesign of a control system must reflect the fact that there are resourceconstraints, and the benefits of controls must be considered relative to theircosts.  Because of the inherentlimitations in all control systems, no evaluation of controls can provideabsolute assurance that all control issues and instances of fraud, if any,within the Company have been detected. These inherent limitations include the realities that judgments indecision-making can be faulty, and that breakdowns can occur because of simpleerror or mistake.  Additionally,controls can be circumvented by the individual acts of some persons, bycollusion of two or more people, or by management override of the control.  The design of any system of controls also isbased in part upon certain assumptions about the likelihood of future events,and there can be no assurance that any design will succeed in achieving itsstated goals under all potential future conditions; over time, control maybecome inadequate because of changes in conditions, or the degree of compliancewith the policies or procedures may deteriorate.  Because of the inherent limitations in a cost-effective controlsystem, misstatements due to error or fraud may occur and not be detected, and,thus, the Company’s management cannot provide absolute assurance that theCompany’s Disclosure Controls will prevent all 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 evaluation activities are tomonitor the Company’s Disclosure Controls and to make modifications asnecessary.  The Company’s intent in thisregard is that the Disclosure Controls will be maintained as dynamic systemsthat change (including with improvements and corrections) as conditionswarrant.

 

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 end of the quarter endedJune 30, 2003 to ensure that material information relating to the Company andits consolidated subsidiaries was made known to management, including the CEOand CFO, particularly during the period when periodic reports are beingprepared, and that the Company’s Internal Controls are effective to providereasonable assurance that its financial statements are fairly presented inconformity with GAAP.

 

*Changes in Internal Controls overFinancial Reporting*

 

During the quarter ended June 30, 2003, there havebeen no significant changes in the Company’s internal control over financialreporting that has materially affected, or reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

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**PARTII.  OTHER INFORMATION**

 

**ITEM1.  LEGAL PROCEEDINGS**

 

On or about February 5, 2001, ASRC Communication(“ASRC”) filed a complaint in United States District Circuit Court of Alaska,against EFJohnson.  ASRC alleges thatEFJohnson engaged in wrongful activities in association with radio productssold to ASRC.  ASRC purchased, andresold to the State of Alaska, approximately $500 of products from EFJohnsonsince 1999.  ASRC’s claims againstEFJohnson include breach of contract, breach of express warranty, breach ofimplied warranty of merchantability, breach of implied warranty of fitness for aparticular purpose, breach of duty of good faith and fair dealing, equitableestoppel, misrepresentation, and violations of the racketeer influenced andcorrupt organizations act.  Thecomplaint anticipated that the State of Alaska would formally prosecute itsadministrative claim against ASRC for damages associated with EFJohnsonmanufactured radios.  At this time, theState of Alaska has not formally prosecuted its administrative claim againstASRC.  The State of Alaska has statedthat it has damages in excess of $800.

 

In May 2003, ASRC and EFJohnson tentatively agreed todismiss ASRC’s complaint against the Company. Under the tentative agreement,EFJohnson shall defend ASRC, at EFJohnson’s expense, against any State’s claimalleging non-performance of the EFJohnson radios.  In addition, the parties would resolve any issue or disputethrough mediation and bidding arbitration. The Company is unable to predict the likelihood of the outcome orpotential liability that may arise from this action.

 

**ITEMS 2– 3.**

 

**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

The Company held its Annual Meeting of Shareholders on May 29,2003.  The directors elected at themeeting were Edward H. Bersoff and Winston J. Wade.  Mr. Bersoff received 15,499,118 votes for and 137,590 voteswithheld.  Mr. Wade received 15,499,319votes for and 137,389 votes withheld. The other directors, whose terms of office continued after the meeting,were Michael E. Jalbert, Massoud Safavi, and Thomas R. Thomsen.  Additionally, in June 2003, the Companyappointed Veronica A. Haggart to its Board of Directors.

 

**ITEM 5.**

 

**ITEM6.  EXHIBITS AND REPORTS ON FORM 8-K**

 

(a)  Exhibits – The following exhibits are filedherewith:

 
| **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 Quarterly Period Ending June 30, 2003.                               |
|             |   |                                                                                                                                     |
| 31.2             |   | Chief Financial Officer's Certification of Report on  Form 10-Q for Quarterly Period Ending June 30, 2003.                               |
|             |   |                                                                                                                                     |
| 32               |   | Written Certification of Chief Executive Officer and  Chief Financial Officer, dated July 29, 2003, pursuant to 18 U.S.C. Section  1350. |

 

(b)  Reports on Form 8-K:

 

The Company filed its earnings press release for thequarter ending March 31, 2003 as a report on Form 8-K, under Items 5, 7, and 9,on May 05, 2003.

 

The Company filed its Chairman’s speech to itsshareholders at the Company’s annual shareholder meeting as a report on Form8-K, under Items 5, 7, and 9 on May 29, 2003.

 

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**SIGNATURE**

 

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

 
|   |          | EFJ, INC. |
|--------|---------------|-----------|
|   |          |      |   |
|   |          |      |   |
| Date:  | July 29, 2003 | By:  | /s/ Massoud Safavi |   |
|   |          |      | Massoud Safavi |
|   |          |      | Senior Vice President and |
|   |          |      | Chief Financial Officer |
|   |          |      | (Principal Financial and Accounting  Officer) |

 

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