EFJ INC - 10-Q Quarterly Report

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý

As of April 23, 2003, 17,577,315 shares of the Registrant's Common Stock were outstanding.

EFJ, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, 2003 and December 31, 2002
(in thousands, except share data)

EFJ, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
For the three months ended March 31, 2003 and 2002
(Unaudited and in thousands, except share and per share data)

EFJ, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended March 31, 2003 and 2002
(Unaudited and in thousands, except share data)

In the three months ending March 31, 2003, the Company acquired $374 of fixed assets in exchange for long-term debt.

Three months ended March 31, 2003 and 2002
(Unaudited and in thousands, except share and per share data)

The condensed consolidated balance sheet of EFJ, Inc. ("EFJ" or the "Company") at December 31, 2002 has been derived from audited consolidated financial statements at that date. The condensed consolidated financial statements as of March 31, 2003 and for the three months ended March 31, 2003 and 2002 are unaudited. The condensed consolidated financial statements reflect all normal and recurring accruals and adjustments that, in the opinion of management, are necessary for a fair presentation of the financial position, operating results, and cash flows for the interim periods presented in this quarterly report. The condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, together with management's discussion and analysis of financial condition and results of operations, contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2002. The results of operations and cash flows for the three months ended March 31, 2003 are not necessarily indicative of the results for any other period or the entire fiscal year ending December 31, 2003. Where appropriate, items within the condensed consolidated financial statements have been reclassified from the previous period's presentation to conform to the current presentation.

The Company is a manufacturer of wireless communications products and systems and information security products. Through its wholly-owned subsidiary, E.F. Johnson Company ("EFJohnson"), 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 International, Inc. ("Transcrypt"), 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 sells its products to: (1) domestic public safety / public service and other governmental users; (2) domestic commercial users; and (3) international customers.

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

Basic income (loss) per share ("EPS") is calculated based upon the weighted average number of common shares outstanding during the period. The diluted EPS calculation reflects the potential dilution from common stock equivalents such as stock options. For the three months ended March 31, 2003, the impact of outstanding stock options on diluted EPS was anti-dilutive as the period ended March 31, 2003 had a net loss; as such the basic EPS is used for both basic and diluted EPS for the period. For the three months ended March 31, 2003 and 2002, all outstanding stock options granted as of such date had exercise prices lower than the average market price of the common stock for the respective periods and are, thereby, considered common stock equivalents in the calculation of the diluted weighted average common shares. The Company uses the treasury stock method to calculate diluted weighted average common shares, as if all such options were outstanding for the three-month periods presented.

Had the Company not incurred a net loss for the three months ending March 31, 2003, the diluted weighted average common shares would have been 18,761,344. Because of the net loss condition, the Company uses weighted average outstanding common shares for both the basic and diluted weighted average common shares, or 17,577,315 for the period ending March 31, 2003.

The Company applies the intrinsic value-based method of accounting for stock options issued to employees. When both the number of shares that an individual employee is entitled to receive and the option price are

known at the grant date, total compensation cost for the Company's grants of stock options is measured at the grant date ("fixed plan awards"). However, when either or both of these factors are not known at the grant date, the Company estimates total compensation cost each accounting period from the date of grant based on the estimated 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 shares between the date of grant and the final exercise or expiration of the options result in a change in the measure of compensation cost for variable plan awards. Compensation cost is recognized as expense over the periods in which the employee performs the related services, which is generally presumed to be the vesting period.

Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant date for awards for the three months ended March 31, 2003 and 2002, the Company's pro forma net loss and pro forma net loss per share would have been as follows:

	Three months ended March 31,
	2003			2002
Net income (loss)—as reported	$	(564	)	$	98
General and administrative expenses for management stock option compensation		363			203

Pro forma net loss		(927	)		(105	)
Net income (loss) per share, basic and diluted—as reported	$	(0.03	)	$	0.01
Pro forma net loss per share, basic and diluted		(0.06	)		(0.01	)

The weighted average fair value per option at date of grant during the three months ended March 31, 2003 and 2002 was $1.70 and $.51, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for options granted:

	Three months ended March 31,
	2003		2002
Expected option life	10 years		10 years
Expected annual volatility	193	%	193	%
Risk-free interest rate	2.93	%	2.93	%
Dividend yield	0	%	0	%

The following is a summary of inventory at March 31, 2003 and December 31, 2002:

		March 31, 2003			December 31, 2002
Raw materials and supplies		$	6,485		$	7,562
Work in progress			1,732			1,646
Finished goods			5,986			4,931

			14,203			14,139
Reserve for obsolescence			(2,055	)		(2,468	)

	Total inventories, net	$	12,148		$	11,671

As required by Statement of Financial Accounting Standards ("SFAS") 142, Goodwill and Other Intangible Assets ("SFAS 142"), the Company does not amortize its goodwill, instead reviewing its goodwill for impairment, at least annually. The Company performed such fair value-based impairment tests, in accordance with SFAS 142, at December 31, 2002 and 2001, concluding that no impairment of goodwill was deemed necessary as of these dates. No events occurred during the three months ended March 31, 2003 and 2002 that would indicate that an impairment of such assets had occurred. 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 of recognition.

Amortization expense, related to intangible assets which are subject to amortization, was $2 for the three months ended March 31, 2003 and 2002. Amortization expense of intangible assets subject to amortization is anticipated to be $7 for 2003 and annually thereafter through 2012. Intangible assets consist of the following:

				March 31, 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		45		68	43		70

			Total		$	6,758		$	6,760

In November 2002, the Company entered into a $10.0 million secured line of credit agreement with Bank of America. The line of credit bears interest at a rate of LIBOR plus 200 basis points, the effective rate at March 31, 2003, which rate may be increased to LIBOR plus 275 basis points dependent upon certain debt ratios. The line of credit is collateralized by substantially all the Company's assets. Borrowings available under the line of credit are calculated as a percentage of eligible inventory and receivables. The agreement, which expires September 30, 2004, includes certain covenants, including financial covenants, with which the Company was in compliance, or for which waivers had been obtained, as of March 31, 2003 and December 31, 2002. At March 31, 2003 and December 31, 2002, the Company had $5,000 outstanding on its line of credit. The total available credit under the line of credit was $118 as of March 31, 2003.

In 2000 and 2001, the Company effectively cancelled and reissued stock options in order to lower the exercise price of those options to $0.656 per share, an amount approximating 150% of the then prevailing market value of the Company's common stock (the "repricing"). The repricing of the stock options resulted in a new measurement date for accounting purposes and the reclassification of these options as variable plan awards beginning on the date of the repricing. The Company had previously accounted for these option grants as fixed plan awards. As of March 31, 2003 and 2002, respectively, approximately 872,000 and 1,002,000 of these repriced options, in various stages of vesting, were outstanding. At March 31, 2003 and 2002, respectively, the market value of the Company's common stock was $1.80 and $1.23 per share; this compared to market values of $1.25 and $0.52 per share at December 31, 2002 and 2001. Non-cash compensation charges, therefore, resulted to the extent that the market value exceeded the repriced exercise price of $0.656 per share. In the three months ended March 31, 2003 and 2002, the amounts of compensation expense relating to these repriced options were $446 and $437, respectively, and are included in general and administrative expenses.

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 organizations 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 is involved in certain other legal proceedings incidental to the normal conduct of its business. The Company does not believe that any liabilities relating to such other legal proceedings are likely to be, individually or in the aggregate, material to the Company's business, financial condition, results of operations, or cash flows.

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. The letters of credit, which expire on various dates in 2003, have a total undrawn balance of $0.3 million at March 31, 2003. Bonds, which expire on various dates, totaled $7.4 million on March 31, 2003. As of that date, no bonds have been drawn upon.

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

The Company evaluates segment results based on gross margin and income from operations. Corporate expenses are allocated to the operating segments based upon estimated usage of corporate resources. The

following table is a summary of the unaudited operating results for the three months ended March 31, 2003 and 2002.

	Three Months Ended March 31,
	2003			2002
	Unaudited and in thousands
Revenues:
Wireless Communication	$	7,126		$	8,305
Information Security		1,875			1,592

	$	9,001		$	9,897

Gross Profit:
Wireless Communication	$	2,621		$	3,387
Information Security		1,338			1,028

	$	3,959		$	4,415

Operating Profit (Loss):
Wireless Communication	$	(1,000	)	$	(284	)
Information Security		436			137

Loss from Operations		(564	)		(147	)
Other Income, net		—			245

Income (Loss) before Taxes	$	(564	)	$	98

Depreciation & Amortization:
Wireless Communication	$	218		$	249
Information Security		33			49

	$	251		$	298

Assets:
Wireless Communication	$	26,355
Information Security		5,156
Corporate		12,146

	$	43,657

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

			Three Months Ended March 31,
			2003		2002
Revenues			100.0	%	100.0	%
Cost of sales			56.0		55.4

Gross profit			44.0		44.6

Operating expenses:
	Research and development		15.6		12.3
	Sales and marketing		14.6		12.7
	General and administrative		20.1		21.1

		Total operating expenses	50.3		46.1

Loss from operations			(6.3	)	(1.5	)
	Interest income (expense)—net		—		—
	Other income		—		2.5

Income (loss) before income taxes			(6.3	)	1.0
	Provision for income taxes		—		—

Net income (loss)			(6.3	)%	1.0	%

Discussions of certain matters contained in this Quarterly Report on Form 10-Q may constitute forward-looking statements under Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended, (the "Exchange Act"). These forward-looking statements relate to, among other things, the results of the Company's product development efforts, future sales and expense levels, the Company's future financial condition, liquidity and business prospects generally, perceived opportunities in the marketplace for the Company's products, and the Company's other business plans for the future. These forward-looking statements are subject to certain risks and uncertainties that could cause the actual results, performance and outcomes to differ materially from those expressed or implied in these forward-looking statements due to a number of risk factors including, but not limited to, the risks detailed in "ITEM 1. BUSINESS—Summary of Business Considerations and Certain Factors That May Affect Future Results of Operations and/or Stock Price" contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2002.

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

Revenues decreased 9% to $9.0 million in the first quarter of 2003, as compared to $9.9 million during the same period in 2002. Of total revenues in the first quarter of 2003, the wireless communication segment comprised $7.1 million, which represents a decrease of 14% as compared to revenues of $8.3 million during the same period in 2002. Information security segment revenues of $1.9 million, in the first quarter of 2003, represent an 18% increase as compared to revenues of $1.6 million during the same period in 2002.

The decrease in EFJohnson's revenues related primarily to the decrease in commercial sales, consistent with EFJohnson's market strategy to emphasize federal, state and local governmental customers. Additionally, revenues in the first quarter of 2003 were impacted by the deferral of certain domestic governmental orders; management believes that such orders are deferred to a later quarter rather than lost. Notwithstanding EFJohnson's lower revenues in the first quarter of 2003, the Company does not expect this trend to continue, and, presently, the Company expects EFJohnson's revenues for 2003 to be 12% to 17% higher than its 2002 revenues.

The increase in revenues of the information security segment during the three months ended March 31, 2003 was primarily the result of timing issues associated with finalizing certain sales agreements. The Company believes that revenues for its information security segment for the year ended December 31, 2003 will approximate the segment's revenues in 2002.

The Company made the decision in the fourth quarter of 2000 to substantially exit the commercial LMR markets and focus its LMR sales on the domestic public safety / public service sector. Consequently, the Company's sales to the domestic public safety / public service sector have steadily increased, and the Company's sales to commercial users have decreased. Although the Company would expect the trend of increasing domestic public safety / public service sector sales to continue, the Company's sales to commercial users would be expected to remain relatively flat through 2003. International sales relate substantially to Transcrypt, as EFJohnson's international sales were only $0.6 million and $0.4 million for the three months ending March 31, 2003 and 2002, respectively. The Company anticipates that its international sales will remain at a similar level throughout 2003.

The Company's sales, as per its defined customer markets, is shown below for the three months ended March 31, 2003 and 2002:

Revenues (in thousands):	2003				2002
Domestic public safety / public service	$	6,442	72	%	$	6,129	62	%
Domestic commercial		458	5			2,006	20
International		2,101	23			1,762	18

	$	9,001			$	9,897

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

Consolidated gross profit was $4.0 million (44% gross margin) for the first quarter of 2003, as compared to $4.4 million (45% gross margin) for the same period in 2002. Gross margin for the wireless communication segment was 37% in the first quarter of 2003 versus 41% for the same period in 2002. Gross margin for the information security segment was 71% in the first quarter of 2003 versus 65% for the same period in 2002.

In the wireless communication segment, the decrease in the gross margin percentage from 2002 to 2003 was due primarily to manufacturing inefficiencies caused by the lower sales volume. EFJohnson's gross margin percentage for 2003 i

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

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

			March 31, 2003			December 31, 2002
			(unaudited)
ASSETS
Current assets:
	Cash and cash equivalents		$	12,022		$	11,333
	Accounts receivable, net of allowance for returns and doubtful accounts of $135 and $236, respectively			3,460			6,568
	Receivables—other			300			252
	Cost in excess of billings on uncompleted contracts			1,700			1,686
	Inventories, net			12,148			11,671
	Deferred income taxes			1,000			1,000
	Prepaid expenses			675			487

		Total current assets		31,305			32,997
Property, plant and equipment, net				2,809			2,601
Deferred income taxes				2,000			2,000
Intangible assets, net of accumulated amortization				6,758			6,760
Other assets				785			898

		TOTAL ASSETS	$	43,657		$	45,256

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Revolving line of credit		$	5,000		$	5,000
	Current portion of long-term debt obligations			126			22
	Accounts payable			3,121			4,007
	Billings in excess of cost on uncompleted contracts			—			38
	Deferred revenue—current			708			961
	Accrued expenses			1,660			2,317

		Total current liabilities		10,615			12,345
Long-term debt obligations, net of current portion				529			264
Deferred revenue, net of current portion				144			160

		TOTAL LIABILITIES		11,288			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 March 31, 2003 and December 31, 2002; 600,000 non-voting shares authorized, 217,542 issued and outstanding)			176			176
	Additional paid-in capital			97,364			96,918
	Accumulated deficit			(65,171	)		(64,607	)

		TOTAL STOCKHOLDERS' EQUITY		32,369			32,487

		TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	43,657		$	45,256

					Three months ended March 31,
					2003			2002
Cash flows from operating activities:
	Net income (loss)				$	(564	)	$	98

	Adjustments to reconcile net income (loss) to net cash provided by operating activities:
		Depreciation and amortization				251			298
		Non-cash compensation—intrinsic value of repriced options				446			437
		Gain on sale of fixed assets				(8	)		(21	)
		Changes in assets and liabilities:
			Accounts receivable			3,060			2,003
			Cost in excess of billings on uncompleted contracts			(14	)		(91	)
			Inventories			(477	)		(1,070	)
			Prepaid expenses			(149	)		(588	)
			Accounts payable			(886	)		182
			Billings in excess of cost on uncompleted contracts			(38	)		18
			Deferred revenues			(269	)		(217	)
			Accrued and other liabilities			(657	)		(652	)

				Total adjustments		1,259			299

				Net cash provided by operating activities		695			397

Cash flows from investing activities:
	Proceeds from sale of fixed assets					2			3
	Purchase of property, plant and equipment					(79	)		(371	)
	Other assets					76			(2	)

				Net cash provided by (used in) investing activities		(1	)		(370	)

Cash flows from financing activities:
	Payments on revolving line of credit, net					—			(5,120	)
	Principal payments on long-term debt					(5	)		—

				Net cash used in financing activities		(5	)		(5,120	)

Net increase (decrease) in cash and cash equivalents						689			(5,093	)
Cash and cash equivalents, beginning of period						11,333			11,582

Cash and cash equivalents, end of period					$	12,022		$	6,489