EFJ INC - 10-K Annual Report

PART I

ITEM 1. BUSINESS

Unless the context otherwise provides, all references in this Annual Report on Form 10-K to the “Company” include EFJ, Inc., its predecessor entities, and its subsidiaries, including E.F. Johnson Company and Transcrypt International, Inc., on a combined basis. All references to “EFJohnson” refer to E.F. Johnson Company, and all references to “Transcrypt” refer to Transcrypt International, Inc.

In addition to the historical information contained herein, certain matters discussed in this Annual Report may constitute forward-looking statements under Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements may involve risks and uncertainties and relate, without limitation, to the following:

· the results of the Company’s product development efforts;

· future sales levels and customer confidence;

· the Company’s future financial condition, liquidity and general business prospects;

· perceived opportunities in the marketplace for the Company’s products and its products under development; and

· the Company’s other business plans for the future.

The actual outcomes of the above referenced matters may differ significantly from the outcomes expressed or implied in these forward-looking statements. For a discussion regarding such differences, see “—Summary of Business Considerations and Certain Factors That May Affect Future Results of Operations and/or Stock Price” below.

General

The Company is a manufacturer of wireless communications products and systems and information security products. Through its wholly-owned subsidiary, EFJohnson, which will celebrate its 80^th anniversary in 2003, the Company designs, develops, manufactures, and markets: (1) mobile and portable land mobile radios (“LMR”); (2) stationary LMR transmitters / receivers (base stations or repeaters); and (3) LMR systems. Through its wholly-owned subsidiary, Transcrypt, which will celebrate its 25^th anniversary in 2003, the Company designs and manufactures information security products, which prevent unauthorized access to sensitive voice communications. These products are based on a wide range of analog scrambling and digital encryption technologies and are sold mainly to the LMR markets as an add-on security device for analog radios. The Company primarily sells its products to: (1) domestic public safety / public service and other governmental users; (2) domestic commercial users; and (3) international customers.

At the Company’s June 13, 2002 Annual Meeting of Stockholders, the Stockholders approved an amendment of the Company’s Certificate of Incorporation to change the corporate name to EFJ, Inc. On December 6, 2002, EFJ, Inc. established a new wholly-owned subsidiary, named Transcrypt International, Inc. EFJ, Inc. is in the process of transferring all assets associated with the Transcrypt Secure Technologies division to the new Delaware subsidiary. The Transcrypt Secure Technologies division is solely related to the Company’s information security product line.

The Company’s principal business offices are located at 4800 NW 1st Street, Lincoln, Nebraska 68521, and its phone number is (402) 474-4800.

Industry

Wireless Communications

The mobile wireless communications industry began in the mid-1930s when police departments began using LMR systems to enable immediate communication between headquarters and officers patrolling the community. LMRs consist of hand-held and mobile (vehicle mounted) two-way radios. A typical LMR system consists of one or more base control stations networked with each other and with hand-held and/or mobile radios. Originally designed to transmit information in the analog format, there has been a relatively recent migration of LMR systems to the digital format. Historically, electronic communications were transmitted in analog format. By the late 1980s, accelerating use of wireless communications devices, such as LMRs and cellular telephones, resulted in increased demand for limited radio spectrum. In response to this demand, and enabled by the low-cost availability of digital signal processors (“DSP’s”), electronics manufacturers developed spectrally efficient (i.e., low-bandwidth) digital communications devices. In digital communications, an analog signal is “digitized,” or converted into a series of discrete information “bits” in the form of ones and zeroes prior to transmission.

The following three factors contributed to LMR service expanding beyond its traditional police and fire applications to become an integral means of communications for a variety of governmental and commercial enterprises: (1) recognition of the benefit offered by immediate radio communications with their field personnel; (2) technological advances making LMR systems more affordable; and (3) allocation of increasing amounts of spectrum for LMR use. In addition to dispatch-oriented LMR service, many other forms of mobile wireless communication technologies have emerged and are continuing to be developed to meet the varied communication needs of an increasingly mobile society. These include paging, wireless data, cellular telephone, and personal communication services.

Conventional and trunked are two general types of LMR systems. Both types of systems operate on the specific frequency bands that the Federal Communications Commission (“FCC”) has allocated for such types of systems. Conventional LMR systems use a single channel to transmit and receive information. All users have unrestricted access, and the user must monitor the system and wait until the channel is unoccupied. Trunked systems, including the Company’s logic trunked radio (“LTR®”), LTR-Net®, and Multi-Net® products, combine multiple channels so that an unoccupied channel is automatically selected when a user begins transmitting. Conventional LMR systems are relatively inefficient compared to trunked systems.

The development of trunked LMR systems and the allocation of additional frequency spectrum in the 1970s triggered significant growth in the LMR market. Technological developments by EFJohnson and others have enabled LMR systems to be “networked,” permitting multiple sites to be linked together through a switch to provide extended geographical coverage. In addition, many trunked subscriber units are capable of functioning as mobile telephones through interconnections to the public switched telephone network. More recent technology provides for the interconnection between sites to be accomplished over digital packet based networks using Internet type protocols in a technique called Voice over Internet Protocol (VoIP). The Company’s proprietary implementation has been trademarked as Netelligent®.

Many federal, state and local agencies operate LMR equipment which complies with specifications established by the Association of Public Safety Communications Officials International Inc. (“APCO”). The APCO 16 standard, established in 1979, includes recommendations for 800 MHz transmission, analog voice modulation, and trunking functions for using the frequency spectrum. However, the APCO 16 recommendations permitted development of proprietary systems. As a result, three proprietary APCO 16 technologies evolved: Motorola’s SmartNet®; General Electric’s EDACS®; and EFJohnson’s Multi-Net®. These proprietary systems effectively eliminated competition once the initial technology decision was made, thereby, severely hampering interoperability. Consequently, APCO began efforts on a more comprehensive standard which would stress the importance of interoperability.

In 1995, APCO promulgated a new recommended standard known as Project 25. Project 25 specifies features and signaling for narrow band digital voice and data with conventional and trunking modes of operation. The Telecommunications Industry Association (“TIA”) participated in the development of this suite of standards, following an industry-sanctioned and American National Standards Institute (“ANSI”) accredited process. With TIA’s assistance, Project 25 was structured to specify all details of fundamental LMR communications to allow multi-source procurement and interoperability for the life of Project 25 systems. The Company has provided significant support to both APCO and TIA, to include serving on many of the section and subsection working committees.

The Project 25 standard has been adopted by the National Telecommunications and Information Association (“NTIA”) which controls LMR specifications for the U.S. government. NTIA specified a conversion to narrow band, with Project 25 as the preferred solution, by the year 2005 for the 162-174 MHz bands, and by 2008 for all other bands. Several of the U.S. government agencies (including the Departments of Interior, Justice, and Treasury) have specified a Project 25 requirement for procurements of new LMR Equipment. Although state and local public safety agencies are not currently required by the FCC or APCO to purchase Project 25 compliant LMR systems or otherwise adopt the Project 25 standard, Project 25 compatibility is expected to become one of the key purchasing factors for state and local public safety / public service LMR users. Furthermore, as state and local LMR users upgrade their existing APCO 16 systems to comply with FCC-imposed bandwidth limitations, demand for Project 25 compliant LMR systems is expected to increase, due in part to the fact that Project 25 systems can potentially be configured for compatibility with older APCO 16 mobile and portable radios, allowing adopters of the Project 25 standard to purchase new system equipment without replacing all of their subscriber radios.

Unlike government LMR users, commercial LMR users have only expressed marginal interest in interoperability or compliance with APCO standards. Commercial users, such as utility, transportation, construction and energy companies, require rapid communications among personnel spread out over relatively large geographic areas. Many large commercial LMR users purchase and operate entire systems for their own private use, procuring LMR systems directly from manufacturers or through local distributors that typically provide installation and maintenance services. Smaller commercial users typically utilize specialized mobile radio (“SMR”) operators such as Nextel Corp. and Centennial Communications to provide their radio communication needs.

SMR operators build and lease private LMR systems on a for-profit basis. They sell airtime to end-users whose mobile communication needs can be served by renting or purchasing subscriber units as opposed to purchasing an entire system, or who are unable to obtain a FCC license to operate their own system. Traditionally, end-users of SMR services have included taxi fleets and smaller construction and delivery service companies. Currently, many SMR operators in the larger metropolitan markets, such as Nextel Corp., are also offering more consumer-oriented, cellular-like SMR services.

Competition for domestic commercial users has significantly increased in the last few years. Significant changes include: unavailability of new 800 MHz frequencies; consolidation in the SMR marketplaces; and conversion of certain SMR systems from analog to digital. This has resulted in increased availability of used analog radios and repeaters in the marketplace and decreased prices and contributed to a general commercial market demand for low margin products. Competitors have been reducing their prices and therefore putting pressure on the Company’s prices and margins in this market.

Information Security

The electronic information security industry is generally comprised of products designed to protect the transmission of sensitive voice and data communications through both wireless and wireline mediums. Without such protection, many forms of electronic communications, such as LMR and telephone conversations and remote data communications, are vulnerable to interception and theft. Not surprisingly,

the information security industry originated from the need to secure sensitive wireless military communications.

By the late 1970s, the availability, quality and cost of LMR information security devices had improved so that the use of these devices became economically and functionally feasible for non-military governmental users (such as law enforcement, fire, emergency medical, and other public safety personnel) and large commercial users (such as transportation, construction, and oil companies). The use of scrambling and encryption equipment, such as one of the Company’s modules, is required on both the transmitting and receiving sides of communications in order to operate in secure mode. However, most LMR encryption products, including all of Transcrypt’s products, can be used in the clear, non-scrambled mode with equipment that does not contain a security device.

Analog transmissions typically consist of a voice or other signal modulated directly onto a continuous radio “carrier” wave. An analog transmission can be made secure by “scrambling,” or manipulating the original signal at the point of transmission, and reconstituting the original signal at the receiving end. Digital transmissions can be made secure by a process known as “encryption,” which involves the use of a mathematical algorithm to rearrange the bit-stream prior to transmission and a decoding algorithm to reconstitute the transmitted information back into its original form at the receiving end. The core technologies currently available, and used by companies such as Transcrypt, include the following methods, which are listed in increasing order of sophistication of security technique:

· frequency inversion (inverting or otherwise adjusting the spectrum of a signal based on a consistent method);

· rolling code transmission (incrementally stepping codes used to modify a signal);

· hopping code transmission (changing broadcast frequencies multiple times per second based upon an algorithm);

· digital encryption (encoding a digital bit-stream based upon a mathematical encryption algorithm).

Manufacturers of information security products, such as the Company, typically charge higher prices for devices featuring more advanced levels of security. Therefore, the types of end-users at each level of security tend to vary based upon the importance of the information that the end-user wants to secure. Typical users of the most basic form of scrambler, the frequency inversion scrambler, include taxi dispatchers, other types of consumer businesses, and transportation companies. High-level scrambling and encryption devices are used primarily by public safety agencies, U.S. government personnel, and international customers. For example, domestic and international police forces typically have a medium to high need for security, while military users, who are often faced with hostile and determined threats, typically have a very high need for security.

Markets and Products

Purchasers of the Company’s wireless communications and information security products include domestic public safety / public service agencies and other governmental units, foreign governments, LMR manufacturers, and business and corporate users in finance, manufacturing, public utilities, and energy, among other industries. Significant customers accounting for more than 10% of the Company’s revenues, as a combination of both wireless communications and encryption products, included: State of South Dakota, which represented approximately 12% of sales in both 2002 and 2001; Chester County of Pennsylvania, which represented approximately 14% of sales in 2001; and Motorola, which represented approximately 17% of sales in 2000.

The Company’s basic marketing strategy is founded on the premise that “quality, value, and service equals choice for the customer” (or “QVS=C”). The strategy is to increase market awareness, to convey

the Company’s technical capabilities, support, and overall value of its products so that the customer understands the Company represents a viable choice in fulfilling LMR requirements. To this end, the Company’s marketing staff conducts promotions through a mix of print advertising, trade shows, direct mail campaigns, press releases, presentation material, and distribution of demonstration and loaner equipment. The goal is to make the market aware that the Company is an LMR communications solution provider that offers quality choice in the marketplace.

The Company sells its products domestically through a direct sales force of account executives and sales managers, dealers, and manufacturer representatives. The Company also uses telemarketing personnel who sell primarily to smaller dealers and SMR operators. The Company provides comprehensive support to its LMR dealers, who re-sell the Company’s product to end-users. This support includes cooperative advertising programs, advertising materials, sales and service training, and technical support. The Company’s international sales are primarily made through a specialized international direct sales force in conjunction with Company-authorized distributors, which typically provide a local contact and arrange for technical training in foreign countries. See “—Summary of Business Considerations and Certain Factors That May Affect Future Results of Operations and/or Stock Price—Business, political, regulatory, or economic changes in foreign countries in which the Company markets its products or services could adversely affect the Company’s revenues.”

Wireless Communications

EFJohnson primarily sells its products to: (1) domestic public safety / public service and other governmental users; (2) domestic commercial users; and (3) international customers. In November 2000, the Company made the decision to focus on the domestic public safety / public service sector, de-emphasizing the commercial market and eliminating many of its commercial product offerings. As such, EFJohnson’s sales to domestic commercial entities have steadily declined over the last two years, as evidenced by sales in the amount of $2.3 million in 2002, $4.9 million in 2001, and $12.4 million in 2000. Comparatively, EFJohnson’s sales to domestic public safety / public service and other governmental agencies have increased, as evidenced by sales in the amount of $30.1 million in 2002, $26.9 million in 2001, and $20.9 million in 2000. EFJohnson’s products consist of radios (or “subscriber units”), LMR systems (to include infrastructure equipment, system design, and installation of infrastructure equipment), and service (technical support, maintenance contracts, service parts, and training). Most of these products are sold under the “EFJohnson” brand name.

EFJohnson’s radio offerings include both analog (Multi-Net®, Motorola’s SmartNet® and SmartZone®, LTR-Net®, LTR® and conventional) and digital (Project 25, Motorola’s SmartNet® and SmartZone®) radios. EFJohnson’s Project 25 radios, both hand-held portable and mobile radios, can contain voice scrambling and/or digital encryption technology, Over-the-Air-Reprogramming (“OTAR”), and Project 25 trunking. To further increase its LMR offering, EFJohnson has incorporated its DES-OFB, DES-XL, and AES encryption technology into its radio products. Additionally, the Company’s Project 25 radios can be used on most Motorola APCO 16 systems using the SmartNet® protocol, which EFJohnson licensed from Motorola, and are being developed for use, as well, on the Multi-Net® protocol developed by EFJohnson.

EFJohnson’s current LMR system sales are predominantly Multi-Net® systems. However, EFJohnson also offers Project 25 and LTR-Net® systems. The Multi-Net® and LTR-Net® product line incorporates the EFJohnson trunking protocols and includes: (1) sub-audible signaling, which automatically selects a clear or unoccupied channel; (2) open architecture that is compatible with other analog products; and (3) transmission trunking which provides efficient use of the channels. The Project 25 system offerings are presently conventional only. The majority of system sales, whether for high-end commercial or governmental purchasers, involve soliciting and responding to requests for proposals (“RFP’s”). The RFP process for system sales has a relatively long cycle time, typically taking as much time as one year, and, depending on the size of the system, taking multiple years to complete installation of a project. During 2000 and 2001, the Company focused on the completion of systems contracts for certain EFJohnson projects begun prior to 1999. The Company substantially completed these systems as of December 31, 2001. As of December 31, 2002, the only systems in progress represent projects initiated in 2002. LMR system end-users often require the supplier of the LMR system to supply a bond from an approved surety company at the time that the bid is submitted and at the time that the contract is awarded. See “—Summary of Business Considerations and Certain Factors That May Affect Future Results of Operations and/or Stock Price—The Company’s inability to secure satisfactory bonding arrangements would adversely affect revenues.”

For the EFJohnson product line, the Company’s customer service group provides after-sales service and support, including technical support through a toll-free telephone number, on-site technical personnel for repairs and applications issues, 24-hour turnaround for spare parts, extended maintenance coverage, and product training. Product training includes classes and seminars to provide the end-user assistance in the use, operation and application of LMR products and systems. Training is available at both the customer’s site and the Company’s Waseca, Minnesota facility. LMR products and systems are generally sold with a one-year warranty, which covers parts and labor in North America and parts internationally. Broader warranty and service coverage is provided in certain instances, on a contractual basis, usually for an additional charge.

During 1999, the Company signed a Memorandum of Understanding with Motorola for the exploration of joint development projects and the license of EFJohnson technology. There are currently no significant joint development projects in process. During 2000, the Company signed a licensing agreement allowing Motorola the right to develop and sell mobile and portable radio products incorporating the EFJohnson developed LTR-Net® protocol. To the Company’s knowledge, Motorola has not yet developed any such products.

Domestic public safety / public service

The Company serves domestic public safety / public service and other governmental users primarily with its Netelligent® Project 25 digital product lines and its APCO 16 Multi-Net® analog product lines. The Company believes that its Multi-Net® system, which links together multiple sites for wide-area coverage using a proprietary architecture, is a high-quality, cost-effective alternative to comparable APCO 16 systems produced by other manufacturers. The Company’s system offers many features specifically designed for public safety / public service users, such as:

· emergency queuing;

· over 8,000 unique identification codes;

· automatic subscriber identification;

· five levels of priority access;

· simulcast; and

· wide area system configurations.

The Company provides a broad line of Multi-Net® products, including repeaters, radio network terminals, system management modules, dispatcher consoles, audio and data link and related accessories.

The Company’s primary market focus is in the areas of Project 25 compliant systems and interoperability. The Company’s Netelligent® Project 25 compliant analog/digital radios are compatible and interoperable with older analog radio systems, as well as with Motorola’s proprietary analog APCO 16 trunking technology (SmartNet® and SmartZone®) and proprietary digital encryption algorithms. The Company believes that such backward compatibility with most of Motorola’s APCO 16 trunking technology will provide early adopters of the Project 25 standard, such as the federal, state and local government agencies, with the ability to purchase new equipment without replacing entire older systems. In 2002, EFJohnson introduced Project 25 system infrastructure, beginning with the Model 2600 Repeater.

The Project 25 market has developed slowly, primarily due to the cost of replacing existing systems with Project 25 compliant system infrastructure and radios. However, since September 11, 2001, development and implementation of Project 25 compliant systems has accelerated due to a higher emphasis on the need for interoperability between various local, state and federal governmental entities. The Company expects this movement towards Project 25 to continue at an accelerated rate, particularly among federal agencies and state and local public safety and first-time responders.

The Company believes it has positioned itself to participate in this Project 25 marketplace, particularly as a result of its established presence as a vendor to the Departments of Interior, Justice, Treasury and Defense. With the Company’s continued emphasis on the federal market, this trend of increasing federal sales, as a percentage of the overall sales mix, should continue. The Company also markets its Project 25 capabilities to the state and local governmental units seeking interoperability.

Commercial Users

Nearly two-thirds of the EFJohnson’s LMR sales to commercial entities relate to a branded radio product produced for one certain entity in accordance with given specifications. The remainder of the Company’s commercial LMR sales primarily relate to its LTR-Net® and other analog LMR product lines. Competition for domestic commercial users reached the point where price reductions in the market had put such unacceptable pressure on margins that, in late 2000, the Company altered its market focus to concentrate on non-commercial markets. Nonetheless, management believes that niche markets, such as large public utilities, will desire Project 25 interoperability. In these instances, the demand will be for LMR system and subscriber unit products similar to those that EFJohnson markets to its state, local and federal governments. Given the opportunity, the Company intends to market to such commercial users.

International

EFJohnson serves its international users primarily with its Multi-Net®, LTR-Net®, and LTR® product lines. The Company’s international focus is generally on Latin American countries, notably Brazil, Argentina, Venezuela, and Chile. To date, there has been little international demand for the Company’s digital products, and sales to international customers has become a smaller part of EFJohnson’s overall sales as a result of the decision to focus its marketing and development resources on the domestic public safety / public service markets in general, and the digital Project 25 area in particular. EFJohnson’s international sales represented 4% of its total sales in 2002, as compared to 17% and 8% in 2001 and 2000, respectively.

Information Security

Transcrypt first entered the information security market in 1978 with simple, transistor-based add-on scrambling modules for use in analog LMRs using basic single-inversion scrambling techniques. Transcrypt marketed these products primarily to domestic public safety / public service agencies and international

governments. Since that time, the Company has further developed and improved upon its core information security technologies, which have, at various times, been implemented into the Company’s scrambler modules and other products within its major information security product families.

The Company’s customers use information security products in a variety of situations involving differing security needs. The Company offers a variety of add-on LMR scrambling products featuring its core technologies at varying levels of security. Add-on scramblers are available in two packages, which include: (1) a modular package consisting of a circuit board that is designed to be permanently soldered into existing circuitry; and (2) a plug-in package designed for installation using connectors with standard pin configurations which original equipment manufacturers (“OEM”) may install. The Company also produces modules that add signaling features to radios, including “man-down” (emergency signal broadcast if radio position becomes horizontal), “stun-kill” (disables lost or stolen radios remotely), “ANI” (automatic number identification of radios) and OTAR (changes encryption and scrambling codes remotely). In December 1997, the Company introduced an LMR encryption module, for use as an add-on or in OEM equipment, that uses the U.S. digital encryption standard known as “DES.” This module uses the widely recognized DES algorithm for encoding transmissions. The Company also produces low-cost tactical interoperability products which allow simple cross-band radio communications and range extension using portable or mobile radios. Transcrypt’s TransPeater® product provides interoperability for radios with different frequencies and communication protocols, linking as many as three UHF, VHF, or 800 MHz radio systems using portable or mobile radios to establish rapid development for inter-agency communications.

Transcrypt’s analog products are compatible with a number of OEM manufacturers, including Motorola, EFJohnson, Kenwood U.S.A. Corp. (“Kenwood”), ICOM America, Inc., Relm Corporation (“Relm”), Tait Electronics (“Tait”), and Midland International Corp (“Midland”). However, substantial portions of the analog encryption modules sold by Transcrypt are for use in radios manufactured by Motorola. During 2001, the Company entered into a Professional Radio Application Partner Contract with Motorola which certifies the Company as an Authorized Application Partner of its plug-in information security modules for the Motorola Professional series radios in Europe, the Middle East, and Africa. Presently, the Company is pursuing similar certification for other global regions.

For the Transcrypt product line, the Company provides toll-free telephone access for customers with technical or other problems. The Company will also customize product training for its customers using a classroom approach or seminars at either or both the customer’s site and the Company’s Lincoln facility. The Company offers a standard warranty on all products, which covers parts and labor for a period of one year from purchase. The Company documents installation instructions for its products in OEM devices and has developed instruction for more than 2,600 OEM products, including almost all commercially available two-way radio models sold worldwide.

Transcrypt’s current information security products are designed solely for the encryption of analog transmissions. As the LMR encryption customers migrate from analog to digital transmission systems, the overall market for the Company’s analog encryption products may decrease. This migration from analog to digital is expected to occur more rapidly in North America and Europe than elsewhere in the world. Due to the much higher cost of digital products, the Company anticipates that the overall global demand for analog products will decrease at a fairly slow pace over the next few years. During such period, this decrease is only expected to have a marginal impact upon the Company’s information security product sales.

Products Under Development / Research and Development

Consistent with the Company’s development efforts for its existing products, the Company designs new products around common wireless technologies using common signal processing platforms and circuitry. Using this approach, the Company has generally been able to incorporate improvements in core

technologies into its new products more quickly and with relatively lower development costs compared to developing entire products separately.

The Company’s research and development organization has expertise in: radio frequency technology, computer architecture, switch architecture, networking, cryptography, object-oriented software, and analog and digital hardware designs. Ongoing engineering efforts are focused on adding additional features to existing product lines and developing new and innovative platforms. The Company’s research and development efforts encompass:

· upgrading and supporting existing product lines;

· digital signal processing;

· voice coding (including improved multi-band excitation);

· encryption;

· spectral manipulation and rotation;

· systems simulation;

· mixed signal scrambling;

· digital LMR system infrastructure; and

· design of new mobile and portable radios.

Cross-disciplinary groups, involving marketing, customer service, manufacturing and engineering are used for product planning, definition, and testing.

At December 31, 2002, the Company had a staff of 47 engineers, 36 of whom work primarily in research and development. The Company organizes research and development efforts along its two main product lines: wireless communications; and information security. While engineering staffs will combine efforts when appropriate, the Company believes that this more focused environment fosters a more efficient approach to new product development.

Wireless Communications

The Company continues to develop products in 2003 that include feature enhancements and additions to its line of digital radios, and which will continue to comply with the Project 25 standard. The Company is undertaking the development of Project 25 infrastructure equipment, including Project 25 trunking infrastructure, such as repeaters, base stations, network switching equipments, consoles, and voters. The Company believes that Project 25 trunking systems will be more widely implemented as costs come down and additional competitively priced equipment becomes available. In addition, the Company is analyzing the potential of applying standard Internet Protocol switching techniques for voice and data interconnectivity between wireless sites. To that end, the Company has submitted a VoIP fixed station interface for APCO/TIA standards consideration, and the Project 25 compliant infrastructure under development will include this interface.

Information Security

The LMR security products under development include new versions of the Company’s 460 series modules for deployment in different models of radios, including plug-in modules for certain new model Motorola radios introduced from time to time in different regions of the world. The Company has also undertaken development of the following: 1) software embeddable versions of its current analog product line intended to work with DSP’s, eliminating the need for a separate hardware module in many new

models of analog radios; and 2) feature enhancements to its tactical interoperability products, in order to expand its functional capabilities.

Additionally, Transcrypt is currently assisting EFJohnson in its development of a FIPS-140 certification of its digital radios. This requires isolating the encryption software on the radio’s primary circuit board. At this time Transcrypt is not otherwise involved in development efforts related to digital radio encryption. Encryption for digital radios is accomplished through software embedded in the radio, which has, to date, been accomplished by the manufacturer of the radio. Consequently, development in this area has not been deemed economically beneficial.

Intellectual Property

The Company currently holds or has been assigned 46 U.S. patents. These patents cover a broad range of technologies, including trunking protocols, high-end scrambling and encryption techniques, methods of integrating after-market devices, and a high-speed data interface for LMR communications. Furthermore, the Company holds registered copyrights that cover software containing algorithms for frequency hopping, scrambling and LMR signaling technologies, as well as numerous registered trademarks related to the “EFJohnson” and “Transcrypt” names and product names. In addition to patent, trademark, and copyright laws, the Company relies on trade secret law and employee and third party non-disclosure agreements to protect its proprietary intellectual property rights.

Manufacturing, Materials, and Suppliers

The Company’s manufacturing operations generally consist of the procurement of commercially available subassemblies, parts, and components (such as integrated circuits, printed circuit boards and plastic and metal parts), in addition to the assembly of these various parts and components into finished products. The Company produces many of its wireless communications products, including all of its Project 25 compliant products, at its Waseca, Minnesota facility. The Company assembles its information security products at its facility in Lincoln, Nebraska.

Vendors manufacture certain components and subassemblies in accordance with the Company’s specific design criteria. Certain components and subassemblies used in the Company’s products are presently available only from a single supplier or a limited group of suppliers. With respect to other electronic parts, components and subassemblies, the Company believes that alternative sources could be obtained to supply these products, if necessary. To date, the Company has been able to obtain adequate supplies of key components and subassemblies in a timely manner from existing sources, with the exception of a temporary disruption in the aftermath of September 11, 2001. Nevertheless, a prolonged inability to obtain certain components and subassemblies could impair customer relationships and could have an adverse effect on the Company’s operating results. See “—Summary of Business Considerations and Certain Factors That May Affect Future Results of Operations and/or Stock Price—The Company’s revenues and gross margins are dependent upon the timely and consistent delivery of components by third party suppliers.”

Motorola is often the sole manufacturer of electronic components used by the Company; these components include microprocessors and components used in the Company’s digital encryption and LMRs. The Company has obtained from Motorola a royalty-bearing, irrevocable, non-exclusive, worldwide license (“IPR License”) to manufacture products containing certain proprietary LMR and digital encryption technology. The Company believes this technology will be important to the success of certain of its existing and proposed Project 25 compliant LMR products. The IPR License includes rights to use Motorola’s proprietary analog APCO 16 trunking technology (SmartNet®), Project 25 required products, and certain Motorola digital encryption algorithms in the Company’s LMR products. The digital encryption technology may also be incorporated into certain other information security products. In addition, the Company obtained a license to utilize certain proprietary technology from Motorola relating

to the development of Project 25 compliant digital LMRs. This license covers infrastructure and other Project 25 technology. See “—Summary of Business Considerations and Certain Factors That May Affect Future Results of Operations and/or Stock Price—Reduction in Motorola’s provision of products, components or technology to the Company could harm the Company’s business and operations.”

Some of the Company’s analog LMR products, primarily for commercial and international users, are manufactured by Icom Japan (“ICOM”), Unimo of Korea (formerly, Kukjae), and Tokyo Wireless of Japan under contract by the Company. Products produced by these companies have included repeaters, and mobile and hand-held portable radios that operate in both conventional and trunked mode. In general, the Company and the vendors jointly developed the radio products produced by these vendors. These products, in aggregate, represented approximately 9% of EFJohnson’s revenues in 2002.

Competition

Wireless Communications

In North America, Motorola and M/A-Com are the leading providers of LMR equipment to the public safety / public service sectors. Notwithstanding the fragmented international wireless communications market, the Company believes Motorola and M/A-Com to be the dominant competitors in the Latin American countries where the EFJohnson predominantly sells its LMR products outside the United States. Other LMR providers besides EFJohnson, who tend to focus on particular segments of the market, include Thales Communications (“Thales”), Uniden America Corporation (“Uniden”), Kenwood, ICOM America, Inc., Relm, Datron, Tait, and Midland. EFJohnson’s focus is on the domestic public safety / public service sector, where it competes primarily on the basis of price, technology and the flexibility, support, and responsiveness provided by the Company and its dealers. See—“Summary of Business Considerations and Certain Factors That May Affect Future Results of Operations and/or Stock Price—The Company faces competitive pressures that could adversely affect revenues, gross margins and profitability.”

Motorola and M/A-Com possess entrenched market positions in the domestic public safety / public service sectors. Both companies have substantial financial, marketing and operational resources, other intellectual property rights, and substantial technological capabilities. As such, these competitors have advantages in various aspects of the LMR market, particularly in regards to bidding on LMR systems that will have a cost greater than $10.0 million. As such, the Company’s strategy, as regards large LMR systems bids, is to partner with general contractors and integrators who have substantial financial, marketing, and operational resources; in this regard, the Company can piggy-back its LMR design and product expertise with the larger company’s greater overall resources.

Other than EFJohnson, the Company believes that Motorola, Thales, and Kenwood are currently the principal suppliers of Project 25 LMR products. Motorola is presently the only Project 25 supplier offering trunked infrastructure, as well as trunked mobile and portable radios. The Company supplies trunked mobile and portable radios; however, it only offers conventional Project 25 infrastructure. The Company is continuing its development of Project 25 infrastructure with shipment of trunked infrastructure scheduled to begin in 2004. Certain companies have announced or are anticipated to announce future entry into the Project 25 compliant product market which include, without limitation: M/A-Com, Relm, Westel, Tait, Datron, and Daniels Communications.

Information Security

The markets for analog LMR information security products are highly competitive. A number of companies currently offer add-on scramblers for LMRs that compete with the Company’s add-on information security products, including Future Telecom (d.b.a. “Daxon”), Kavit Electronics Industries, Midian Electronics Inc., and MX-COM Inc. Significant competitive factors in these markets include product quality and performance features, including:

· effectiveness of security features;

· quality of the resulting voice or data signal;

· development of new products and features;

· price;

· name recognition; and

· quality and experience of sales, marketing, and service personnel.

Government Regulation and Export Controls

Wireless Communications

The Company’s wireless products are subject to regulation by the FCC under the Communications Act of 1934, as amended, and the FCC’s rules and policies as well as the regulations of the telecommunications regulatory authority in each country where the Company sells its products. These regulations are in the form of general approval to sell products within a given country for operation in a given frequency band, one-time equipment certification, and, at times, local approval for installation. Additionally, the FCC and foreign regulatory authorities regulate the spectrum used to provide LMR communication, as well as the construction, operation, and acquisition of wireless communications systems, and certain aspects of the performance of mobile communications products. Further, LMR communications of the U.S. government are controlled by the NTIA which regulates technical specifications of the product and spectrum used by the U.S. government and other users. Many of these governmental regulations are highly technical and subject to change. The Company believes that it and its products are in material compliance with all governmental rules and policies in the jurisdictions where the Company sells its products.

In the United States, all of the Company’s wireless products are subject to FCC rules. In those countries that have accepted certain worldwide standards, such as the FCC rulings or those from the European Telecommunications Standards Institute, the Company has not experienced significant regulatory barriers in bringing its products to market. Approval in these markets involves retaining local testing agencies to verify specific product compliance. However, many developing countries, including certain markets in Asia, have not fully developed or have no frequency allocation, equipment certification, or telecommunications regulatory standards.

The majority of the systems operated by EFJohnson’s customers must comply with the rules and regulations governing what has traditionally been characterized as “private radio” or private carrier communications systems. Licenses are issued to use frequencies on either a shared or exclusive basis, depending upon the frequency band in which the system operates. Some of the channels designated for exclusive use are employed on a for-profit basis; and other channels are used to satisfy internal communications requirements. Most SMR systems in operation today use 800 MHz channels. Within the top 50 metropolitan markets, 900 MHz frequencies, licensed for exclusive use systems, have been made available to both SMR and non-SMR licensees. Additional channels designated for exclusive use were made available in the 220 MHz band for both commercial and non-commercial systems.

EFJohnson also offers products in bands below 800 MHz where multiple users in the same geographic area share channels. In this “shared” or conventional spectrum, there is no requirement for loading the channel to any particular level in order to retain use of the frequencies. These channels are generally used by entities satisfying traditional dispatch requirements in, among others, the transportation and services industries. In addition, some customers are applying trunking capabilities to their channels in the UHF (primarily 450-470 MHz) frequency band.

The FCC is considering a number of regulatory changes that could affect the wireless communications industry and the Company’s business, including, but not limited to, various proposals to re-band and reallocate spectrum at 700 MHz and 900 MHz. Therefore, the regulatory environment is inherently uncertain and changes in the regulatory structure and laws and regulations, both in the United States and internationally, can adversely affect the Company and its customers. Such changes could make existing or planned products of the Company obsolete or unusable in one or more markets, which could have a material adverse effect on the Company.

The FCC, through the Public Safety Wireless Advisory Committee, is considering regulatory measures to facilitate a transition by public safety agencies to a more competitive, innovative environment so that the agencies may gain access to higher-quality transmission, emerging technologies, and broader services, including interoperability. In August 1998, the FCC adopted rules for licensing the largest block of spectrum ever allocated at one time for public safety. The FCC established rules for licensing 24 megahertz in the 700 MHz band and established a band plan for use of this spectrum. In accordance with this rule, in January 1999 the FCC established a Public Safety National Coordination Committee (“NCC”) to advise it on issues relating to the use of the 700 MHz public safety spectrum. The Committee is responsible for formulating a national interoperability plan, recommending technical standards to achieve interoperability spectrum, and providing policy recommendations on an advisory basis to the regional planning committees in order to facilitate the development of coordinated plans. The NCC recommended that Project 25 be established as the interim interoperability mode for digital voice communications in this new band. During January of 2001, the FCC released their Fourth Report and Order in which Project 25 was chosen as the interoperability standard. The Committee’s recommendations and the FCC’s rulings and orders could affect products manufactured by the Company. Management cannot predict the outcome of the FCC review or any specific changes in FCC spectrum policies, or any potential effect on the Company’s sales.

Information Security

The Company’s information security products have been subject to export restrictions administered by the Department of Commerce, which permit the export of encryption products only with the required level of export license. U.S. export laws also prohibit the export of encryption products to a number of specified hostile countries. Although to date the Company has been able to secure most required U.S. export licenses, including licenses for export to approximately 120 countries since 1978, there can be no assurance that the Company will continue to be able to secure such licenses in a timely manner in the future or at all. Additionally, in certain foreign countries, the Company’s distributors are required to secure licenses or formal permission before encryption products can be imported.

Management cannot predict whether any new legislation regarding export controls will be enacted, what form such legislation will take or how any such legislation will impact international sales of the Company’s products.

Backlog

The Company presently ships a small amount of information security products against backlog, due to the typically short manufacturing cycle of these products. Because of generally longer manufacturing cycle times required for the production of complete wireless communication products, the Company’s backlog for wireless communication products has been larger than for its security products. At December 31, 2002,

the Company had a total backlog of approximately $8.0 million, substantially related to EFJohnson sales. However, the Company does not believe that its backlog figures, and variations from year to year therein, are indicative of sales of products in future periods.

Employees

At December 31, 2002, the Company had 206 full-time equivalent employees, including 42 at its Lincoln, Nebraska facility, 140 at its Waseca, Minnesota facility, 6 at its Washington, DC facility, and 18 field sales people, sales managers or staff located in the sales territories in which they serve. The Company also uses temporary employees, independent contractors and consultants when necessary to manage fluctuations in demand. None of the Company’s employees are covered by a collective bargaining agreement.

Summary of Business Considerations and Certain Factors That May Affect Future Results of Operations and/or Stock Price

Certain matters discussed in this Annual Report may constitute forward-looking statements under Section 27A of the Securities Act and Section 21E of the Exchange Act. These statements may involve risks and uncertainties and relate, without limitation, to the following:

· the results of the Company’s product development efforts;

· future sales levels and customer confidence;

· the Company’s future financial condition, liquidity and general business prospects;

· perceived opportunities in the marketplace for the Company’s products and its products under development; and

· the Company’s other business plans for the future.

The actual outcomes of the above referenced matters may differ significantly from the outcomes expressed or implied in these forward-looking statements. The following is a summary of some of the important factors that could affect the Company’s future results of operations and its stock price, and should be considered carefully.

If the APCO Project 25 standard is supplanted by some other recommended protocol or is otherwise not supported by the federal, state and local government agencies, it would adversely affect the Company’s operations, cash flows, and financial condition.

The Company’s wireless communications marketing and research and development efforts are substantially focused on Project 25 compliant equipment. The Company believes that sales of its Project 25 digital LMR products have been, and will continue in the foreseeable future to be, substantially dependent upon Motorola’s dominant position as a market leader in the Project 25 marketplace. Motorola is the largest manufacturer of Project 25 compliant LMR products and has been the principal public supporter of the Project 25 digital transmission standard for the LMR market. If Motorola does not maintain this dominant position, or if the Project 25 standard is otherwise abandoned by industry and the governmental public safety / public service users, it would adversely affect the Company’ operations, cash flows, and financial credit.

If the Company does not continue to implement its strategic plan, it will adversely affect the Company’s operations, cash flows, and financial condition.

In response to the substantial losses incurred in each of the three years prior to 2001, the Company implemented a plan that included significant transitions in product strategy and reductions in operating

expenses. The extent to which the Company continues to successfully implement its plan to exit low margin products and markets and expand sales in higher margin products and markets will significantly impact the Company’s future operations and cash flows. The Company’s failure to achieve its future revenue and profitability goals, and other factors beyond the Company’s control, could result in losses, liquidity problems, additional impairment charges, and possible insolvency.

Failure to comply with financial covenants in the Company’s credit facility could result in termination of the credit facility, which would severely strain the Company’s liquidity position.

In November 2002, the Company finalized a new revolving credit facility, which expires September 30, 2004. The credit facility has certain financial covenants with which the Company was in compliance, or for which the Company had obtained waivers, as of December 31, 2002. However, there can be no assurance that the Company will remain in compliance with certain financial covenants or be successful in renewing such facility. Without the benefit of a revolving credit facility, a substantial decline in revenues or gross margins or a material increase in costs or expenses would severely strain the Company’s liquidity position. Further, without a revolving credit facility, the Company’s ability to grow, either internally or through acquisition, would be severely restricted.

A reduction in Motorola’s provision of products, components, or technology to the Company could harm the Company’s business and operations.

The Company is dependent on continuing access to certain Motorola products, electrical components and proprietary intellectual property. Although the Company believes that its relationship with Motorola is good, the Company cannot assure that Motorola will continue to supply products, electrical components and proprietary intellectual property to the Company on the scale or at the price that it now does. In addition, Motorola’s perception of the Company as a competitor could impact Motorola’s continued willingness to do business with the Company. Although the Company has certain contractual relationships with Motorola as a customer, most of these agreements are subject to termination in certain circumstances and expire by their terms within one to ten years. Any reduction of the Company’s contractual relations with Motorola or a decision by Motorola to reduce or eliminate the provision of products, components and technology to the Company could harm the Company’s business and operations.

An unfavorable outcome in pending litigation could adversely affect the Company’s cash flow, financial condition and results of operations.

On or about February 5, 2001, ASRC Communication (“ASRC”) filed a complaint in United States District Circuit Court of Alaska, against EFJohnson. ASRC alleges that EFJohnson engaged in wrongful activities in association with radio products sold to ASRC. ASRC purchased approximately $0.5 million of products from EFJohnson since 1999. ASRC’s claims against EFJohnson include breach of contract, breach of express warranty, breach of implied warranty of merchantability, breach of implied warranty of fitness for a particular purpose, breach of duty of good faith and fair dealing, equitable estoppel, misrepresentation, and violations of the Racketeer Influenced and Corrupt Organization Act. Plaintiff seeks compensatory damages in excess of $0.5 million, attorneys’ fees and costs, and punitive damages in an unspecified amount. The Company vigorously contests ASRC’s allegations. However, the Company is unable to predict the likelihood of the outcome or potential liability that may arise from this legal action.

The Company’s inability to secure satisfactory bonding arrangements would adversely affect revenues.

In the normal course of its business activities, the Company is required under a contract with various governmental authorities to provide letters of credit and bonds that may be drawn upon if the Company fails to perform under its contracts. A number of factors can limit the availability of such bonds, including the applicant’s financial condition and operating results, the applicant’s record for completing similar

systems contracts in the past and the extent to which the applicant has bonds in place for other projects. Bonds, which expire on various dates, totaled $4.3 million at December 31, 2002, and, as of such date, no bonds have been drawn upon. However, if a customer for a systems contract declares an event of default under the outstanding bond related to the system contract, the issuer of the Company’s bonds could reduce the maximum amount of bond coverage available to the Company, or impose additional restrictions with respect to the issuance of bonds on behalf of the Company. The Company’s inability to secure bonding arrangements when needed would adversely affect the Company’s ability to be awarded new systems installation contracts, which would adversely affect its revenues.

The Company’s operating results historically fluctuate from period to period.

The Company’s operating results may fluctuate from period to period due to a number of factors, as follows:

· timing of customer orders;

· timing of the introduction of new products;

· timing and mix of product sales;

· general economic conditions, both in the United States and overseas; and

· specific economic conditions in the information security and wireless communications industries.

These factors make it difficult to utilize the Company’s quarterly results as a predictor of future operations. Historically, more than half of each quarter’s revenues result from orders booked and shipped during the third month of a quarter, and disproportionately in the latter half of that month. These factors make the forecasting of revenue inherently uncertain. Because the Company plans its operating expenses, many of which are relatively fixed in the short term, on expected revenue, a relatively small revenue shortfall may cause a period’s results to be substantially below expectations. Such a revenue shortfall could arise from any number of factors, including lower than expected demand, supply constraints, transit interruptions, overall economic conditions, or natural disasters.

The Company faces competitive pressures that could adversely affect revenues, gross margins, and profitability.

The wireless communications and information security equipment industries, and the LMR market segment in particular, are highly competitive. Competition in the sale of stand-alone and digital products is more intense than for add-on and analog products. In addition, other wireless communication technologies, including cellular telephone, paging, SMR, satellite communications and PCS currently compete and are expected to compete in the future with certain of the Company’s stand-alone products. Furthermore, other manufacturers have announced or are anticipated to announce the availability of APCO Project 25 compliant products or digital land mobile radios.

Motorola and M/A-Com hold dominant and entrenched market positions in the domestic public safety / public service market for wireless communication products. In addition, these competitors have financial, technical, marketing, sales, manufacturing, distribution and other resources substantially greater than those of the Company. Finally, these competitors have established trade names, trademarks, patents and other intellectual property rights and substantial technological capabilities. These advantages allow such competitors to: respond more quickly to new or emerging technologies; manage more extensive research and development programs; undertake more far-reaching marketing campaigns; engage in more aggressive merger and acquisition strategies; and adopt more aggressive pricing policies. Accordingly, the Company cannot make assurances that it will be able to continue to compete effectively in its markets, that competition will not intensify, or that future competition will not have a material adverse effect on the

Company’s revenues, gross margins, or profitability. In addition, the Company cannot assure that new competitors will not begin to compete in the markets for the Company’s products.

If the Company does not effectively manage the transition from analog to digital products, its revenues would be adversely affected.

The LMR markets are migrating from analog to digital equipment. This migration is primarily due to bandwidth capacity constraints, availability of additional features, and the perception that digital transmissions are more secure than analog transmissions. As a result, the Company is seeking to upgrade many of EFJohnson’s LMR products to be compatible with digital LMR communications standards, including APCO Project 25. However, the Company cannot assure that it will be able to effect this transition on a timely basis or that its digital products will compete successfully in the LMR marketplace. The failure of its products to compete successfully in the marketplace would have a material adverse effect on the Company’s revenues. Furthermore, the transition from analog to digital communications is likely to continue to result in a decrease in demand for the Company’s add-on security devices.

The Company’s sales to foreign customers are subject to various export regulations; and the inability to obtain, or the delay in obtaining, any required export approvals would harm revenues.

The Company’s sales to foreign customers are subject to export regulations. Sales of many of the Company’s encryption products require clearance and export licenses from the U.S. Department of Commerce under these regulations. The Company cannot assure that such approvals will be available to it or its products in the future in a timely manner, or at all, or that the federal government will not revise its export policies or the list of products and countries for which export approval is required. The Company’s inability to obtain, or a delay in obtaining, required export approvals would harm the Company’s international sales. In addition, foreign companies not subject to United States export restrictions may have a competitive advantage in the international market. The Company cannot predict the impact of these factors on the international market for its products.

The Company’s future success will depend upon its ability and the resources available to respond to the rapidly evolving technology and customer requirements in the markets in which the Company operates.

The wireless communications and information security markets, in which the Company competes, are rapidly evolving and can be expected to further evolve in the future as a result of changing technology, industry standards and customer requirements. The Company’s ability to compete effectively will depend upon its ability to anticipate and react to these changes in a timely manner. The Company may not have, either currently or in the future, adequate capital or human resources to respond to these changes.

Technological developments in the digital LMR industry include the use of digital trunking, digital simulcast, and digital voting technologies. These technologies have led a number of manufacturers to change the architectures and methodologies used in designing, developing, and implementing large LMR systems. In order for the Company to develop and integrate these new technologies into its products, the Company has made a substantial investment in capital and human resources. However, there can be no assurance that such resources will be readily available to the Company in the future.

The failure of the Company to incorporate these technologies into its LMR products could, in the future, place the Company’s LMR products at a competitive disadvantage to those offered by other manufacturers. This situation could possibly make the Company’s hand-held and mobile LMRs incompatible with systems developed by other manufacturers, which would have a material adverse effect on the Company.

Business, political, regulatory, or economic changes in foreign countries in which the Company markets its products or services could adversely affect the Company’s revenues.

Although all of the Company’s sales are denominated in U.S. dollars, fluctuations in the value of international currencies relative to the U.S. dollar may affect the price, competitiveness and profitability of the Company’s products sold in international markets. Furthermore, the uncertainty of monetary exchange values has caused, and may in the future cause, some foreign customers to delay new orders or delay payment for existing orders. Additionally, troubled economic conditions, such as that recently experienced in Asia and in Latin America, could result in lower revenues for the Company.

In 2002, 2001 and 2000, international sales constituted approximately 15%, 24%, and 17% of revenues, respectively. While substantially all international sales are supported by letters of credit, the purchase of Company products by international customers presents increased risks, which include:

· unexpected changes in regulatory requirements;

· tariffs and other trade barriers;

· political and economic instability in foreign markets;

· difficulties in establishing foreign distribution channels;

· longer payment cycles;

· uncertainty in the collection of accounts receivable;

· increased costs associated with maintaining international marketing efforts;

· difficulties in protecting intellectual property; and

· susceptibility to orders being cancelled as a result of foreign currency fluctuations (since all the Company quotations and invoices are denominated in U.S. dollars).

The Company’s sales are substantially concentrated in public sector markets that inherently possess additional risks that could harm revenues and gross margins.

A significant portion of the Company’s revenue is derived from sales to the federal, state and local governments, both directly or through system integrators and other resellers. Sales to these governmental entities present risks in addition to those involved in sales to commercial customers, including potential disruptions due to appropriation and spending patterns, changes in governmental personnel, political factors, and the government’s reservation of the right to cancel contracts for its convenience. The RFP bidding cycle and contract award stage can take six months to two years before a contract is awarded and the governmental customers funding process for these systems can delay the bidding cycle as well. The Company’s sales to domestic public safety / public service entities accounted for approximately 74%, 61%, and 50% of the Company’s total sales in 2002, 2001, and 2000, respectively. The Company expects that sales to governmental entities will increasingly be subject to competitive bidding requirements. This intensified competition can be expected to result in lower prices, longer sales cycles, and lower margins.

The Company’s future success is dependent upon its ability to motivate and maintain key personnel.

The Company believes that its future success will depend in part on its ability to attract, motivate and retain highly skilled engineering, technical, managerial and marketing personnel. Competition for such personnel is intense, and the Company competes in the market for such personnel against numerous companies, including larger, more established companies with significantly greater financial resources than the Company. The Company currently has openings for engineers and other personnel, and it cannot assure that it will be successful in attracting, motivating or retaining such personnel.

Delaware		47-0801192
(State or other jurisdiction		(I.R.S. Employee
of incorporation or organization)		Identification No.)