Edgar Filing: ESSEX CORPORATION

FORM 10-K
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the fiscal year ended December 28, 2003

Commission File No. 0-10772

ESSEX CORPORATION
(Exact name of registrant as specified in its charter)

Virginia 54-0846569
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

9150 Guilford Road, Columbia, Maryland 21046
(Address of principal executive offices) (Zip Code)

Issuer's telephone number: (301) 939-7000

SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:

TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
------------------- -----------------------------------------
None None

SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT:
COMMON STOCK, NO PAR VALUE PER SHARE
(Title of Each Class)

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 X NO
--- ----

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.

Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). YES NO X
---- ---

State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was last sold, or the average bid and asked prices of such common equity, as of
the last business day of the registrant's most recently completed second
quarter. $23,862,650

CLASS OUTSTANDING AT MARCH 1, 2004
----- ----------------------------
Common Stock, no par value per share 15,471,233

DOCUMENTS INCORPORATED BY REFERENCE
None

================================================================================
A list of the Exhibits and Financial Statement Schedules in this Report on Form
10-K appears on page 56.

Table of Contents
FORM 10-K
Essex Corporation

PART I
Item No. Page

-- INTRODUCTORY STATEMENT................................................. 3
1. BUSINESS............................................................... 3
2. PROPERTIES..............................................................24
3. LEGAL PROCEEDINGS.......................................................24
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.....................24

PART II

5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.................................................................25
6. SELECTED FINANCIAL DATA.................................................27
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS...................................................28
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK..............36
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.............................37
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE....................................................37
9A. CONTROLS AND PROCEDURES.................................................37

PART III

10. DIRECTORS AND EXECUTIVE OFFICERS........................................38
11. EXECUTIVE COMPENSATION..................................................47
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT..........51
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..........................53
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES..................................55

PART IV

15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K........56

PART I

INTRODUCTORY STATEMENT

The information contained in this report pertains to the registrant, Essex
Corporation. References to the "Company", "Essex" or "we", "our" and "us" refer
to Essex Corporation.

FORWARD-LOOKING STATEMENTS

Some of the statements contained, or incorporated by reference, in this
annual report contain "forward-looking statements" within the meaning of the
United States Private Securities Reform Act of 1995. These statements are based
on management's current expectations and are subject to risks, uncertainty and
changes in circumstances, which may cause actual results, performance or
achievements to differ materially from anticipated results, performance or
achievements. All statements contained herein that are not clearly historical in
nature are forward looking. The forward-looking statements in this report
include statements addressing the following subjects: future financial condition
and operating results. Economic, business, competitive and/or regulatory factors
affecting Essex's business are examples of factors, among others, that could
cause actual results to differ materially from those described in the
forward-looking statements.

Important factors that could cause our actual results to be materially
different from the forward-looking statements are disclosed under the heading
"BUSINESS - Risk Factors". Essex is under no obligation to (and expressly
disclaims any such obligation to) update or alter its forward-looking statements
whether as a result of new information, future events or otherwise.

ITEM 1. BUSINESS

GENERAL OVERVIEW

Essex provides advanced optoelectronic and signal processing services and
products for U.S. Government intelligence and defense customers and
communications customers with whom we have established and maintained long
standing and successful relationships. We provide optoelectronic and signal
processing services to classified U.S. Government customers under next
generation research and development contracts. We support the intelligence
community's mission critical voice and video systems infrastructure and provide
systems engineering services to highly classified U.S. Government customers. We
build optical communications and networking system elements and components, as
well as signal and image processing software products. While we have
historically sold our products to the intelligence and defense markets, we
believe our existing products and our patent portfolio position us well to
benefit from spending on next generation technology that decreases the costs and
increases the speed, performance and security of existing communications
networks.

We provide advanced optical and optoelectronic, which involves both optical
and electronic parts, signal processing services and products within the
following four business areas:

o Communications and Networks

o Radar Analysis

o 3-D Imaging

o Critical Information Technology Infrastructure

Our customers include the National Security Agency, or NSA, the National
Reconnaissance Office, or NRO, the National Geospatial - Intelligence Agency, or
NGA, other intelligence agencies, the Defense Advanced Research Project Agency,
or DARPA, the U.S. Army, Navy, and Air Force and other defense elements. Many of
our advanced processing solutions are used in critical national defense
programs, frequently under classified contracts. In these programs we deliver
optical and signal processors for next generation radar, imaging and
communications systems to our core intelligence and defense customers.

Our business is guided by our experienced team of executive officers and
senior managers, who have an average of 20 years of executive level experience
in our industry and in managing optoelectronic and signal processing and
government information technology businesses. We provide our services and
products through our workforce of 118 employees. As of December 28, 2003, 87 of
our 118 employees had government security clearances, with a substantial
majority holding Top Secret/Sensitive Compartmented Information clearances, or
TS/SCI, which are security clearances at the highest levels.

For the fiscal year ended December 29, 2002, we generated revenues of $4.5
million and for the fiscal year ended December 28, 2003 we generated revenues of
$16.3 million. Our total backlog has increased significantly over this past year
from $52.1 million on December 29, 2002 to $112.8 million on December 28, 2003.
The 2003 backlog figure includes $55.7 million from an approximately $57.0
million multi-year contract awarded in October 2003 for software and systems
engineering. For both fiscal years ended December 29, 2002 and December 28,
2003, approximately 94% of our revenues were derived from our customers in the
intelligence and defense communities.

INDUSTRY OVERVIEW

We provide services and products to the U.S. Government intelligence and
defense communities, and to the communications market. Currently, most of our
revenues are from our contracts with intelligence and defense customers, many of
which are classified. We believe we have significant opportunities to expand our
communications sales.

INTELLIGENCE AND DEFENSE MARKET

The U.S. Government is one of the largest purchasers of optoelectronic,
signal processing and other information technology services and products. The
global threat of terrorism, the demands of homeland security, the needs of the
intelligence community and renewed focus on modernizing Department of Defense
infrastructures have led to increased government spending. We believe that
government spending will continue to increase due to a number of trends
including:

o INCREASING U.S. DEPARTMENT OF DEFENSE BUDGETS. Department of Defense
spending for procurement and research and development is projected to
continue increasing through 2007. The Department of Defense Budget
Request for 2003 projected the total defense

budget to grow from $379.0 billion in fiscal year 2003 to $451.4
billion in fiscal year 2007, continuing to reverse the reduction in
defense spending in the early 1990's.

o INTELLIGENCE SPENDING AND THE NEED FOR INFORMATION SUPERIORITY. While
the budget for the intelligence community is classified for national
security reasons, several factors suggest increased demand for signal
processing and refreshed information technology infrastructure
throughout the intelligence community. "Joint Vision 2010", published
by the Joint Chiefs of Staff, notes that, "Information superiority is
the capability to collect, process, and disseminate an uninterrupted
flow of information while exploiting or denying an adversary's
ability to do the same." The message from the Director of the
National Security Agency is that "Our end state is an NSA that -- in
tomorrow's technological environment -- can create decisive U.S.
strategic and tactical advantage by reliably providing otherwise
denied information to U.S. decision makers, in a timely manner, in an
actionable format while at the same time denying access to U.S.
information and information systems by adversaries and competitors."
Achieving information superiority requires technological change,
infrastructure modernization and continual upgrades to technology,
thought process and systems and software.

o INCREASED FOCUS ON MISSILE DEFENSE. The National Missile Defense Act
of 1999 states that it is the policy of the United States to deploy
as soon as is technologically possible an effective National Missile
Defense system capable of defending the United States against limited
ballistic missile attacks. In August 2002, the Bush Administration
proposed an evolutionary path for the deployment of missile defenses.
The capabilities planned for operational use, starting in 2004 and
continuing into 2005, will include ground-based interceptors,
sea-based interceptors, additional Patriot units, and sensors based
on land, at sea and in space. These capabilities will serve as a
starting point for fielding improved and expanded missile defense
capabilities later. The Missile Defense Agency is developing a
layered defense to intercept ballistic missiles of all ranges in all
phases of flight-boost, midcourse and terminal. The hit-to-kill
technology, also known as the challenge of "hitting a bullet with a
bullet," requires several enabling technologies, including
optoelectronic processors, sensors, radars and communication
networks. In order to establish a national missile defense, the
Missile Defense Agency was allocated a budget of $6.7 billion in
fiscal year 2003, with an expectation that budgeted expenditures
would reach $7.2 billion in fiscal year 2004 and continues to grow to
$8.7 billion in fiscal year 2007.

o EMPHASIS ON PHOTONICS. Photonics is the use of light to process and
transport information. In a recent address to Congress (March 27,
2003), Dr. Anthony Tether, the Director of DARPA, noted that
photonics is one of three core technologies for the U.S. military,
"...enabling it to see farther, with greater clarity and better
communicate information in a timely manner." Photonics can be applied
to a number of intelligence and defense requirements, including
signal processing used to analyze high speed communications,
transporting information over fiber optic cable or in free space and
analyzing radar signals and complex image data sets.

COMMUNICATIONS MARKET

The market for next generation optoelectronic and signal processing
services and products is driven by the strong continued demand for bandwidth and
the economic pressure on service

providers to increase revenues and to reduce the cost of their existing network
infrastructure. Although current spending levels have dropped below the peak
levels experienced in 2000, spending on next generation technologies that
address these issues continues. Technologies that offer improved cost
performance, scalability based on demand and improved distribution of high
bandwidth levels to customers are expected to receive strong interest in the
market.

o EXPECTED INCREASED COMMUNICATIONS INDUSTRY SPENDING AND EXPECTED
GROWTH IN BANDWIDTH DEMAND. In June 2003, the Telecommunications
Industry Association forecast that U.S. spending on communications
equipment will increase by 8% in 2003 and stated, "Sectors that will
fare particularly well include enterprise services, wireless services
and broadband. Service provider spending will also increase as strong
demand for bandwidth and new services means carriers will be forced
to upgrade existing networks." IDC forecasted in a recent report that
internet traffic will nearly double each year for the next five
years. The survey data forecast that internet traffic will grow from
180,000 terabits per day in 2003, to 5,175,000 terabits per day in
2007.

o COST PERFORMANCE OF WAVELENGTH SOLUTIONS. Yankee Group, in an April
2003 analysis, concludes that, "wavelengths in their most basic form,
as an unprotected transport service, can be 30 to 60 percent cheaper
than comparable lit bandwidth services." For example, the application
of wavelength division multiplexing, or WDM, systems in existing
optical networks enables service providers to greatly increase
capacity of the existing networks in a cost-effective manner. WDM
systems separate or combine light of different wavelengths or colors,
which increases capacity by enabling simultaneous transmission of
data along numerous wavelengths on the same fiber optic cable. By
transmitting more wavelengths per fiber and using them to distribute
bandwidth to customers, service providers can reduce costs and
increase revenue.

COMPETITIVE STRENGTHS

We possess the following competitive strengths that will allow us to take
advantage of trends in our industry and we are well-positioned to meet our
customers' demands.

o OPTOELECTRONIC AND SIGNAL PROCESSING EXPERTISE. We have provided
signal intelligence and information security services and products to
the intelligence community for over 25 years. Given our expertise and
track record with these customers, we believe we are well-positioned
to take advantage of the heightened awareness and expected increase
in spending for intelligence activities. Led by our Chief Scientist,
Terry Turpin, we have a strong photonics team delivering leading edge
products in communications and 3-D, image and radar processing.

o SKILLED EMPLOYEES WITH HIGH LEVEL SECURITY CLEARANCES. The strict
security clearance requirements for companies and the personnel who
work on classified programs for the intelligence community and
Department of Defense severely limit the number of suppliers that are
allowed to work on such programs. In order for a company to work on
these programs, it must have a sufficient number of employees who
have completed the lengthy process to obtain security clearance. As
of December 28, 2003, 87 of our 118 employees had government security
clearances, with a substantial majority holding Top Secret/Sensitive
Compartmented Information clearances, or TS/SCI, which are security
clearances at the highest levels.

o ESTABLISHED SOLE SOURCE CONTRACT RELATIONSHIPS. In some cases we do
not have to compete for U.S. Government contracts. Sole source
contracts are awarded when an agency's need for the services is of
such an unusual and compelling urgency that the U.S. would be
seriously injured unless the agency is permitted to limit the number
of sources from which it solicits bids or proposals. A contract can
also be awarded to a contractor on a sole source basis when the
services needed by the agency are available from only one responsible
source or only from a limited number of responsible sources and no
other type of services will satisfy the needs of the agency. We
received a substantial amount of our intelligence and defense
communities revenues for 2003 from such contracts. These
relationships provide us with the ability to prepare proactively for
follow-on program opportunities through upgrades, continuing work and
new products.

o EXPERIENCED MANAGEMENT TEAM. Our executives have an average of more
than 20 years of leadership experience in supporting the U.S.
intelligence community and the Department of Defense. Our long-term
relationships in these communities are the result of successful
performance and commitment as directed by our senior executives.

o INTELLECTUAL PROPERTY. Through innovative use of optical processing,
we have produced a number of technologies including our HYPERFINE
WDM, optical devices for noise reduction in cellular and wireless
communications systems through our Optical Processing Enhanced
Receiver Architecture, or OPERATM technology, and 3-D image
synthesis technologies. We have a strong patent portfolio that
includes 11 issued patents covering our core intellectual property.
In 2003 we were awarded a patent for our HYPERFINE WDM technology and
we have 14 additional patent applications in process related to these
technologies. With our team of veteran innovators, we are focused and
experienced in creating and protecting our intellectual property.

o ESTABLISHED INNOVATIVE RESEARCH AND DEVELOPMENT TEAM. We have
participated for many years in the Small Business Innovation
Research, or SBIR, program administered by various agencies within
the Department of Defense and we have received a number of Phase I,
Phase II and Phase III contracts to advance our core optoelectronic
and signal processing technologies. The SBIR program allows us to
leverage government investment in research and development to create
intellectual property while retaining the ownership and the value of
innovations developed under the program, subject to rights retained
by the U.S. Government. We continue to use SBIR contracts to create
value for our customers, employees, and shareholders by combining
corporate and government research and development funds to create a
portfolio of products.

o EXPERT TECHNICAL AND NATIONAL PROGRAMS ADVISORY BOARDS. Our advisory
boards provide us with strategic guidance concerning the application
of our optoelectronic and signal processing technology. Key members
of our advisory boards include:

o U.S. ARMY LIEUTENANT GENERAL CLAUDIA KENNEDY (RETIRED).
General Kennedy served for 32 years in the Army culminating in
her appointment as Deputy Chief of Staff of Intelligence.

o U.S. AIR FORCE LIEUTENANT GENERAL KENNETH MINIHAN (RETIRED).
General Minihan served 33 years in the Air Force in various
capacities including Director of the National Security
Agency/Central Security Service.

o U.S. NAVY ADMIRAL DONALD MCDOWELL (RETIRED). Admiral McDowell
commanded the worldwide 10,000-person Naval Security Group.

o DR. PAUL GREEN. Dr. Green is a co-inventor and co-developer of
key communications technologies in use in optical and cellular
communications.

o SAM GREENHOLTZ. Mr. Greenholtz is a retired senior optical
networking architecture engineer for Verizon where he was
responsible for technical evaluation of optical networking
products. Mr. Greenholtz is currently a senior communications
consultant and founder of Telecom Pragmatics, LLC, an advisory
company to communication and financial services businesses.

o JOE HOUSTON. Mr. Houston is the former President of the
International Society of Optical Engineering and has 39 years
of engineering expertise and technical management experience.

STRATEGY

Our objective is to continue to grow our business as a provider of
optoelectronic and signal processing services and products to U.S. Government
customers and to leverage our intellectual property and assets in this field to
government as well as communications customers. Key elements of our strategy
include:

o LEVERAGE TECHNOLOGY TO EXPAND U.S. GOVERNMENT BUSINESS. We intend to
leverage our high technology services and products to the
intelligence and defense communities to expand our participation in
high growth areas of the U.S. Government.

o BUILD ON RESEARCH AND DEVELOPMENT EFFORTS. We believe that a key to
our continued success is our ongoing research and development efforts
in the areas of optoelectronics and signal processing. We intend to
continue robust research and development efforts in these areas in
conjunction with our ongoing U.S. Government relationships and our
work on HYPERFINE WDM and OPERATM. We intend to utilize company
and customer funded research and development to develop technologies
and products that have the potential for sizable and sustained market
penetration.

o PURSUE STRATEGIC ACQUISITIONS. We intend to pursue strategic
acquisitions that can cost effectively add new customers, specific
federal agency knowledge, or technological expertise to accelerate
our access to existing or new markets.

o ACCELERATE BUSINESS DEVELOPMENT EFFORTS. We intend to accelerate our
business development efforts by hiring additional personnel in select
government and communications areas, and leveraging the relationships
that members of our management and technical teams and our advisory
boards have with government and industry agencies.

o EXPAND INTO COMMUNICATIONS MARKETS. We intend to expand sales of
systems engineering services and our HYPERFINE WDM and OPERA(TM)
products and technologies into the communications market. We believe
we are well positioned to capitalize on communications spending for
low cost products that increase the bandwidth and security of
existing networks.

SERVICES AND PRODUCTS

We provide advanced optoelectronic and signal processing services and
products within the following four business areas:

COMMUNICATIONS AND NETWORKS

SIGNAL PROCESSING AND SYSTEMS ENGINEERING. We provide software and systems
engineering services to the intelligence community. We significantly expanded
our systems engineering capabilities by acquiring Sensys Development
Laboratories, Inc., or SDL, in March 2003. SDL's skill and experience are highly
complementary to our core competencies in image and signal processing
technology. In October 2003, we were awarded a defense related contract for
approximately $57.0 million over four years (a three-month base period plus four
option years) for software and systems engineering and delivery of custom
systems to national priority programs. The knowledge and capability of the SDL
team enabled us to win this large contract.

NETWORKING HARDWARE. We believe that our HYPERFINE WDM technology provides
solutions to carriers who are seeking to upgrade their existing networks,
currently characterized by rigid bandwidth provisioning, significant service
delays, truck rolls for required upgrades and high life cycle costs, to networks
that can provision by wavelength and provide tunable bandwidth, upgrades through
installation of network cards and bandwidth on demand "pay as you go"
infrastructures. The core characteristics of our HYPERFINE WDM technology
include simple and small packaging, high channel density, low insertion loss,
superior filter shape, low sensitivity to temperature changes, and the fact that
it is a passive optical (does not require power to operate) technology.
HYPERFINE WDM enabled networks will have the benefits of being simpler, with
fewer components, less optical loss, and higher bandwidth carrying capacity than
networks without HYPERFINE products.

We have sold 10 HYPERFINE WDM devices including both prototype units for
laboratory test networks and early production (alpha) units, based on advanced
designs of the product. In addition, a number of large communications equipment
companies, including Telcordia Corporation and Agilent have agreed to conduct
field trials of our HYPERFINE WDM prototype and/or work with us on this
technology. We are developing products for the remaining family of HYPERFINE WDM
devices including: laser locker/monitor, optical spectrum analyzer, optical
add/drop multiplexer, optical privacy encoder and optical code division multiple
access, or OCDMA, systems.

In July 2003, we were awarded a contract by a key government agency to
apply HYPERFINE WDM to achieve privacy in an all optical network and a contract
to create a technology roadmap for optical components. We are exploring with
DARPA applying our communications technology to improve processor performance in
next generation supercomputer performance.

In November 2001, we entered into a manufacturing relationship with Harris
Corporation that established Harris as the primary manufacturer of the HYPERFINE
WDM product line. Harris has a well-deserved reputation as a reliable
manufacturer of optical networking products.

OPERATM is a technology that reduces the noise and improves communications
performance in wireless and cellular networks. OPERATM is based on optical
processor technology that we have been designing and deploying in defense
applications for more than ten years. In general for these networks, other
similar signals that interfere with reception are the most important factors
that limit the distance, capacity (number of users) and speed of operation on
the system. OPERATM allows the system to recognize these interfering signals and
cancel their interference thereby significantly improving the performance of the
system. OPERATM development is not scheduled to begin until 2005, based on
current product priorities and available reserach and development funds.

RADAR ANALYSIS

We design, develop, manufacture and support advanced optical processing
products. Advanced optical processors, or AOPs, are high performance radar
signal processors that can be applied to radar signal analysis to provide
advanced ballistic missile defense in a cost-effective, low size, low weight and
low power package. In missile defense, the missile target must be identified,
along with other items that make it harder to identify the missile so that the
missile target can be isolated and "killed." In addition to radar analysis, our
customers use our AOPs for cellular phone signal analysis, wideband electronic
intelligence analysis, and encryption system exploitation.

In May 2002, we were awarded a five-year $25.0 million indefinite delivery,
indefinite quantity, or IDIQ, contract from the Naval Air Warfare Center to use
our signal processing technology to enhance Department of Defense radar
programs. Working for the Missile Defense Agency under this contract, we are
designing and fabricating a prototype AOP. We will test the device at the
Massachusetts Institute of Technology's Lincoln Laboratory facility and plan for
a field demonstration. The laboratory and field tests are among the final steps
prior to production of the AOP for Department of Defense applications.

3-D IMAGING

We design, develop, manufacture and support products that feature
optoelectronic processing and Synthetic Aperture Radar, or SAR, imagery
technology to provide 3-D images. The work in this area revolves around our
Virtual Lens Imaging technology. The Virtual Lens Imaging system, or VLI, is a
patented high-resolution imaging system that leverages our experience in
synthetic aperture imagery and optoelectronic system development. Our VLI
technology incorporates an optoelectronic processor and has the ability to
calculate images in real time. We developed our original optical computer, the
ImSynTM computer, or image synthesis computer, in 1995. ImSynTM computers are
still used to process image data today.

These technologies are primarily used for military imaging that penetrates
clouds, foliage and the ground, change detection, facility inspection, and can
be used in other applications, such as utility monitoring, mineral exploration
and other special purpose inspections. We have received approximately $5.0
million in SBIR contracts and continue to further this technology. We believe

CRITICAL INFORMATION TECHNOLOGY INFRASTRUCTURE SERVICES

we are in position to apply this technology to major government programs for
customers that are increasingly focusing on military imaging.

We provide information technology services that facilitate the
modernization, project management, integration and engineering analysis of the
intelligence community's mission critical voice and video systems and associated
infrastructure. In early 2003, we received a telecommunication services contract
with a total multiyear contract value of over $30.0 million. We believe our
technology infrastructure group has the potential for significant growth as the
intelligence and defense communities focus on upgrading their communications
infrastructure.

CUSTOMERS

Our intelligence and defense customers typically exercise independent
contracting authority. We serve our customers in either a prime contractor or
sub-contractor capacity.

Our intelligence customers include most of the 13 federal agencies that
comprise the intelligence community listed below. Most of our intelligence
customers require that they not be specifically disclosed.

Central Intelligence Agency Defense Intelligence Agency
National Security Agency Army Intelligence
Naval Intelligence Air Force Intelligence
Marine Corps Intelligence Department of State
Department of Energy Department of Treasury
Federal Bureau of Investigation National Reconnaissance Office
National Geospatial - Intelligence Agency

Long-term relationships between intelligence customers and related
contractors develop because of the high level of security clearances required to
work on projects and unique technical requirement of intelligence customers. For
example, we have been working closely with the NSA for over 20 years during
which we have completed numerous projects and have several currently ongoing.

We provide services and products to other customers within the U.S. defense
community including DARPA and the Missile Defense Agency.

The potential communications market for HYPERFINE WDM products includes a
wide range of customers such as communications service providers, supercomputer
vendors and optical networking vendors. In the communications market, we are
positioning ourselves as a provider of HYPERFINE WDM optical components and
subsystems to system vendors. This positioning will allow HYPERFINE WDM to be
integrated into overall system architectures being sold to the communications
service providers, and will leverage rather than attempt to compete with the
established relationships between communications service providers and their
system vendor of choice.

EMPLOYEES

As of February 29, 2004, we have 131 employees. Our technical team has
grown to over 108 with the formation of the Communications Services Division in
late 2002 and the acquisition of SDL in March of 2003. Of our 131 employees, 98
have government security clearances, with a substantial majority holding Top
Secret/Sensitive Compartmented Information clearances, or TS/SCI, which are
security clearances at the highest levels. We believe we are successful in
recruiting and retaining our employees by offering a competitive salary,
benefits, growth prospects and the opportunity to perform mission critical
services in a classified environment.

INTELLECTUAL PROPERTY

We have 11 issued patents and 14 patents pending (U.S. and International)
covering the core intellectual property for our products. Our patent portfolio
is divided into four technology groups: HYPERFINE WDM, OPERATM, ImSynTM and
Virtual Lens Imaging.

HYPERFINE WDM

We filed the first HYPERFINE WDM patent applications in the U.S. and other
countries on October 13, 2000. These patents cover the use of the device as a
receiver and demultiplexer for wavelength division multiplexing fiber optic
networks. On January 22, 2002, we filed U.S. patent applications for use of
HYPERFINE WDM technology as an add drop multiplexer and as an optical-code
division multiple access, or OCDMA, system. In July 2002, we filed U.S. and
international patent applications for several other HYPERFINE WDM optical signal
processing architectures. On November 19, 2003, we filed our latest U.S. and
international patent applications for HYPERFINE WDM as a private and secure
fiber optic transmission system. Our first HYPERFINE WDM U.S. patent issued in
August 2003 (U.S. Patent No. 6,608,721), "Optical Tapped Delay Line" includes 46
claims and expires June 20, 2020.

OPERATM

We filed a patent application for our OPERATM technology in the U.S. and in
certain other countries on January 19, 2001 (U.S. Patent Pending No.
09/766,151). OPERATM is an optoelectronic system for wireless communications
that eliminates interfering signals using optical correlation combined with
multi-user detection algorithms.

IMSYNTM

We hold four U.S. patents on our ImSynTM technology. Three of these patents
cover the optoelectronic architecture and applications including accelerating
image reconstructions for SAR and Magnetic Resonance Imaging, or MRI. The fourth
patent covers the sensing and reconstruction techniques of the Virtual Lens
MicroscopeTM, or VLM, technology which is part of our VLI technology family. The
VLM can be applied to semiconductor inspection, ground penetrating radar,
biomedical imaging, and non-destructive testing.

The first issued ImSynTM patent (U.S. Patent No. 5,079,555), "Sequential
Image Synthesizer," includes 20 claims and expires January 7, 2009. The
corresponding Canadian patent (No. 2,058,209), expires November 25, 2011. The
corresponding European patent for a subset of the claims (No. 0543064) is in
force in the United Kingdom and Germany, and will

expire on November 21, 2011. Our patent in Japan (Patent No. 3113338) for the
same claims as the U.S. patent will expire on October 29, 2011.

The second issued ImSynTM patent (U.S. Patent No. 5,384,573), "Image
Synthesis Using Time Sequential Holography," includes 157 claims and expires on
January 24, 2012. A notification of allowance for a similar patent has been
issued in Canada. In France, the United Kingdom, Germany and Italy, Patent
EP0617797B1 has been awarded for a subset of the claims in the U.S. patent and
this patent expires December 17, 2012.

The third ImSynTM U.S. Patent No. 5,736,958, "Image Synthesis Using Time
Sequential Holography," with 8 claims expires April 7, 2015. The fourth issued
ImSyn(TM) patent (U.S. Patent No. 5,751,243), "Image Synthesis Using Time
Sequential Holography" with 21 claims expires May 11, 2015.

VIRTUAL LENS IMAGING

The ImSynTM U.S. Patent No. 5,751,243 discloses the Virtual Lens
Microscope, a 2-D and 3-D sensing and reconstruction technique called the
Synthetic Aperture Microscope. On January 28, 2004, we received a Notice of
Allowance from the U.S. Patent and Trademark Office for the second Virtual Lens
Imaging patent. This patent, entitled "Efficient Fourier Transform Algorithm For
Non-Uniform Data", discloses a set of techniques for 2-D and 3-D imaging.

COMPETITION

We sell our services and products to the intelligence and defense
communities. The level of security clearances required for this work limits the
range of competitors against whom we compete for both services and products. In
addition, the number of competitors is limited even further by the level of
technical expertise required for both product and service deliveries to our
government customers. We compete either as prime contractor or as a
subcontractor, depending on the requirement and scope of the project. Our larger
competitors for U.S. Government business include Lockheed Martin Corporation and
divisions of large defense contractors such as Boeing Support Services.

Competition in the communications market for network communications
equipment is intense and has historically been dominated by such large companies
as Alcatel, Ciena, Cisco Systems, JDS Uniphase, Lucent Technologies, NEC and
Nortel Networks.

In the communications market, we are still positioning our optical products
and technology. Our communications products will be sold as part of an
integrated solution. We intend to sell our products through well established
channels within the communications industry in order to successfully introduce
our technology and products into the market. Our products are based on patented
technology, available only through us, which we believe have significant
performance advantages over alternative products in the same market space,
including simple and small packaging, high channel density, low insertion loss,
superior filter shape, low sensitivity to temperature changes, and the fact that
it is a passive optical (does not require power to operate) technology.

BACKLOG

As of December 28, 2003, we had a total contract backlog, funded and
unfunded, of approximately $112.8 million as compared with $52.1 million at
December 29, 2002. Of these amounts, funded backlog was $15.0 million and
unfunded backlog was $97.8 million at December 28, 2003 compared to $600,000 and
$51.5 million, respectively, at fiscal year end 2002. Of the unfunded backlog at
December 28, 2003, approximately $19.0 million represents the remaining balance
of a $25.0 million U.S. Government five year Indefinite Delivery Indefinite
Quantity, or IDIQ, contract through 2007 to provide technology to enhance
Department of Defense radar programs. Unfunded backlog as of December 28, 2003
also includes the remaining balance of approximately $22.8 million on our $30.0
million, ten-year contract to provide communications systems support to the
intelligence community. Backlog at December 28, 2003 includes $7.3 million
funded and $48.4 million unfunded, unexpended total of $55.7 million, remaining
of the award of an approximately $57.0 million contract for software and systems
engineering that we received in October 2003. See "Business--Services and
Products". Funded backlog as of December 28, 2003 does not include approximately
$6.3 million of funding received in January 2004.

RISK FACTORS

OUR BUSINESS, RESULTS OF OPERATIONS AND FINANCIAL CONDITION MAY BE
MATERIALLY AND ADVERSELY AFFECTED DUE TO ANY OF THE FOLLOWING RISKS. THE RISKS
DESCRIBED BELOW ARE NOT THE ONLY ONES WE FACE. ADDITIONAL RISKS THAT WE ARE NOT
PRESENTLY AWARE OF OR THAT WE CURRENTLY BELIEVE ARE IMMATERIAL MAY ALSO IMPAIR
OUR BUSINESS OPERATIONS.

RISKS RELATED TO OUR BUSINESS AND FINANCIAL RESULTS

WE CURRENTLY RELY ON SALES TO U.S. GOVERNMENT ENTITIES AND THE LOSS OF CERTAIN
OF OUR CONTRACTS WITH THE U.S. GOVERNMENT COULD HAVE AN ADVERSE IMPACT ON OUR
OPERATING RESULTS.

We are highly dependent on sales to the U.S. Government. Contracts with the
intelligence and defense communities and other departments and agencies of the
Department of Defense, accounted for approximately 98%, or $15.9 million of our
revenues, and 97%, or $4.4 million of our revenues, for the fiscal years ended
December 28, 2003 and December 29, 2002, respectively. For the fiscal year ended
December 29, 2002, our contract with the Missile Defense Agency accounted for
46% of our revenues.

For the fiscal year ended December 28, 2003, our top three customer
programs accounted for approximately 52% of our revenues. The loss or
significant reduction in government funding of a program for which we are the
contractor or in which we participate could reduce our revenue and cash flows
and have an adverse effect on our operating results.

OUR U.S. GOVERNMENT CONTRACTS, UPON WHICH WE DEPEND, ARE ONLY PARTIALLY FUNDED
AND THE U.S. GOVERNMENT HAS NO OBLIGATION TO FULLY FUND OUR CONTRACTS.

Budget decisions made by the U.S. Government are outside of our control and
have significant consequences for our business. The funding of U.S. Government
contracts to which we are party is subject to Congressional appropriations.
Although multi-year contracts may be planned or authorized in connection with
major procurements, Congress generally appropriates funds on a fiscal year basis
even though a program may be expected to continue for several years.
Consequently, contracts often receive only partial funding initially, and
additional funds are committed only as Congress makes further appropriations.
The termination of funding for one of our U.S. Government contracts would result
in a loss of anticipated future revenues attributable to that program which
could have an adverse impact on our operations and increase our overall costs of
doing business.

Our backlog was approximately $112.8 million as of December 28, 2003, of
which approximately $15.0 million was funded. In addition, the award to us in
October 2003 of an approximately $57.0 million contract for software and systems
engineering increased our backlog, of which there remains $7.3 million in funded
and $48.4 million in unfunded backlog. Our backlog includes orders under
contracts that in some cases extend for several years, with the latest expiring
in 2011. The U.S. Government's ability to select multiple winners under multiple
award schedule contracts, government-wide acquisition contracts, blanket
purchase agreements and other indefinite delivery, indefinite quantity, or IDIQ,
contracts, as well as its right to award subsequent task orders among such
multiple winners, means that there is no assurance that unfunded contract
backlog will result in actual orders. The actual receipt of revenues on
engagements included in backlog may never occur or may change because a program
schedule

could change or the program could be canceled, or a contract could be reduced,
modified, or terminated early. Moreover, under IDIQ contracts, the government is
not obligated to order more than a minimum quantity of goods or services.

U.S. GOVERNMENT CONTRACTS ARE SUBJECT TO IMMEDIATE TERMINATION AND ARE HEAVILY
REGULATED AND AUDITED.

Our U.S. Government contracts generally contain provisions permitting
termination, in whole or in part, without prior notice at the U.S. Government's
convenience. In addition, supplying defense-related services and equipment to
U.S. Government agencies subjects our business to risks specific to the defense
industry, including the ability of the U.S. Government to unilaterally:

o suspend us from receiving new contracts pending resolution of alleged
violations of procurement laws or regulations;

o terminate our existing contracts;

o reduce the value of our existing contracts;

o audit our contract-related costs and fees, including allocated indirect
costs; and

o control and prohibit the export of our products.

Any of our U.S. Government contracts can be terminated by the U.S.
Government either for its convenience or if we default by failing to perform
under the contract. If the U.S. Government elects to terminate one of our
contracts, we are only entitled to payment of compensation for work done and
commitments made at the time of termination. If our U.S. Government contracts
are terminated for default, we would be obligated to pay the excess costs
incurred by the U.S. Government in procuring undelivered items from another
source. If any or all of our U.S. Government contracts are terminated under
either of these circumstances, we may be unable to procure new contracts to
offset the lost revenues. Because a significant portion of our revenues are
dependent on our procurement, performance and payment under our U.S. Government
contracts, the loss of one or more large contracts would have an adverse impact
on our financial condition.

WE ENTER INTO FIXED PRICE CONTRACTS THAT COULD SUBJECT US TO LOSSES IN THE EVENT
COSTS EXCEED OUR EXPECTATIONS.

We provide some of our services and products through fixed price contracts.
For the fiscal year ended December 28, 2003, fixed price contracts accounted for
16% of our revenues. Fixed price contracts accounted for 28% and 45% of our
revenues for the years ending December 29, 2002 and December 30, 2001,
respectively. In a fixed price contract, the price is not subject to adjustment
based on cost incurred to perform the required work under the contract.
Therefore, we fully absorb cost overruns on fixed price contracts.

Cost overruns reduce our profit margin on the contract and may result in a
loss. A further risk associated with fixed price contracts is the difficulty of
estimating sales and costs that are related to performance in accordance with
contract specifications and the possibility of obsolescence in connection with
long-term procurements. Failure to anticipate technical problems, estimate costs

accurately or control costs during performance of a fixed price contract may
reduce our profit, result in significant losses or cause a loss on the contract.

WE HAVE A HISTORY OF NET LOSSES AND WE MAY NOT ACHIEVE OR SUSTAIN PROFITABILITY.

Although we had net income of $140,000 for the fiscal year ended December
28, 2003, we incurred a net loss for each of our fiscal years ended December 29,
2002 and December 30, 2001. We also incurred net losses for the fiscal years
ended December 31, 2000 and December 27, 1998. In 1999, we reported a small net
income. As of December 28, 2003, we had an accumulated deficit of approximately
$14.3 million. Our revenues increased from $2.6 million in fiscal 2001 to $4.5
million in fiscal year 2002, primarily as a result of higher revenues on new and
expanding U.S. Government programs. In fiscal 2003, our revenues increased to
approximately $16.3 million, primarily as a result of expansion of government
programs and the inclusion of ten months of results for SDL, which we acquired
effective March 1, 2003. From 2000 through the end of 2002, we funded our
research and development activities primarily from the sale of equity
securities. If we continue to incur significant research and development
expenses, we will need to increase revenues to achieve and sustain consistent
profitability. If revenues do not meet our expectations, or if our expenses
exceed our expectations, we may incur substantial operating losses in the
future, in which case the price of our common stock may decline.

IF WE ARE UNABLE TO MANAGE OUR GROWTH, OUR BUSINESS COULD BE ADVERSELY AFFECTED.

Achieving our plans for growth will place significant demands on our
management, as well as on our administrative, operational and financial
resources. For us to successfully manage our growth, we must continue to improve
our operational, financial and management information systems and expand,
motivate and manage our workforce. If we are unable to successfully manage our
growth without compromising the quality of our services and products, our
business, prospects, financial condition or operating results could be adversely
affected.

A KEY PART OF OUR STRATEGY INVOLVES PURSUING ACQUISITIONS, HOWEVER, SUCH
ACQUISITIONS MAY NOT ACHIEVE ALL INTENDED BENEFITS.

A key part of our strategy is to selectively pursue acquisitions. We
recently acquired SDL, are currently identifying potential acquisition
opportunities, and intend to continue to pursue acquisition opportunities in the
future. If we do identify an appropriate acquisition candidate, we may not be
able to successfully negotiate the terms of the acquisition. We may use all or a
substantial portion of the net proceeds to us from our recent follow-on public
offering in December 2003 on one or more acquisitions. We may incur significant
amortization expenses related to intangible assets. We also may incur
significant write-offs of goodwill associated with companies, businesses or
technologies that we acquire.

Acquisitions and strategic investments involve numerous other risks,
including:

o difficulties in integrating the operations, technologies, and products
of the acquired companies;

o diversion of management's attention from our existing business;

o potential difficulties in completing projects of the acquired company;

o the potential loss of key employees of the acquired company; and

o dependence on unfamiliar or relatively small supply partners.

OUR SUCCESS LARGELY DEPENDS ON OUR ABILITY TO RETAIN KEY PERSONNEL.

Our success has historically depended in large part on our ability to
attract and retain highly-skilled technical, managerial and operational
personnel, particularly those knowledgeable about the U.S. Government
intelligence and defense agencies and skilled in optoelectronics and optical
communications equipment. In addition, the relationships and reputation that
many members of our senior management team have established and maintain with
government personnel contribute to our ability to maintain good customer
relationships and to identify new business opportunities. The loss of key
personnel may impair our ability to obtain new U.S. Government contracts or
adequately perform under our current U.S. Government contracts. We also rely on
the skills and expertise of our senior technical development personnel, the loss
of any of which could prevent us from completing current development and
restrict new development. We do not currently maintain "key man" insurance on
any of our executives or key employees.

OUR QUARTERLY OPERATING RESULTS MAY VARY WIDELY.

Our quarterly revenues and operating results have in the past, and may in
the future, fluctuate significantly. A number of factors cause our revenue, cash
flow and operating results to vary from quarter to quarter, including:

o acquisitions of other businesses;

o commencement, completion or termination of contracts during any
particular quarter;

o variable purchasing patterns under government contracts, blanket
purchase agreements and ndefinite delivery, indefinite quantity
contracts;

o changes in Presidential administrations and senior U.S. Federal
Government officials that affect the timing of technology procurement;
and

o changes in policy or budgetary measures that adversely affect
appropriations for government contracts in general.

Changes in the number of contracts commenced, completed or terminated
during any quarter may cause significant variations in our cash flow from
operations because a relatively large amount of our expenses are fixed. We may
incur significant operating expenses during the start-up and early stages of
contracts and typically do not receive corresponding payments in that same
quarter. We may also incur significant or unanticipated expenses when contracts
expire or are terminated. In addition, payments due to us from government
agencies may be delayed due to billing cycles or as a result of failures of
governmental budgets to gain Congressional and Presidential approval in a timely
manner.

SINCE WE ARE CURRENTLY DEVELOPING OUR OPTICAL AND WIRELESS COMMUNICATIONS
PRODUCTS, IT IS DIFFICULT TO EVALUATE OUR FUTURE BUSINESS AND PROSPECTS.

We have traditionally derived our revenues from contracts with the U.S.
Government. While we intend to enhance and expand our government business, we
are continuing our work to develop new optoelectronics communications products,
including for our HYPERFINE WDM fiber optic communications technology and
OPERA(TM) technology. Since we have not begun significant communications sales
of these products, our communications revenue and profit potential is unproven
and our limited history in the communications field makes it difficult to
evaluate our business and prospects. We cannot accurately forecast our
communications revenue and we have limited historical financial data upon which
to base production budgets. You should consider our business and prospects in
light of the heightened risks and unexpected expenses and problems we may face
as a company developing new communications products for a rapidly changing
industry.

WE FACE INTENSE COMPETITION FROM MANY COMPETITORS THAT HAVE GREATER RESOURCES
THAN WE DO, WHICH COULD RESULT IN PRICE REDUCTIONS, REDUCED PROFITABILITY AND
LOSS OF MARKET SHARE.

We operate in highly competitive markets and may encounter intense
competition to win U.S. Government contracts. If we are unable to successfully
compete for new business, our revenue growth may decline. Many of our
competitors are larger and have greater financial, technical, marketing and
public relations resources than we do. Larger competitors include Lockheed
Martin Corporation and divisions of large defense contractors such as Boeing
Support Services. Our larger competitors may be able to compete more effectively
for very large scale government contracts. Our larger competitors may also be
able to provide customers with different or greater capabilities or benefits
than we can provide in areas such as technical qualification, past performance
on larger scale contracts, geographic presence, price, and the availability of
key professional personnel. Our competitors also have established or may
establish relationships among themselves or with third parties, including
through mergers and acquisitions, to increase their ability to address
customers' needs. Accordingly, it is possible that new competitors or alliances
among competitors may emerge against whom it will be difficult for us to
compete.

In addition, competition in the communications market for network
communications equipment is intense. This market has historically been dominated
by such large companies as Alcatel, Ciena, Cisco Systems, JDS Uniphase, Lucent
Technologies, NEC and Nortel Networks. Some of these companies, as well as
emerging companies, are currently developing products that may compete in the
specialty areas that our technology is designed to address. We may face
competition from other large communications companies who may enter our proposed
markets. Many of these possible competitors have longer operating histories,
greater name recognition, larger customer bases and greater financial, technical
and business development resources than we do and may be able to undertake more
extensive marketing efforts and adopt more aggressive pricing policies than we
can. Due to the rapidly evolving markets in which we compete, additional
competitors with significant market presence and financial resources may enter
our markets, further intensifying competition.

IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY EFFECTIVELY, WE MAY BE
UNABLE TO PREVENT THIRD PARTIES FROM USING OUR TECHNOLOGIES, WHICH WOULD IMPAIR
OUR COMPETITIVE ADVANTAGE.

We rely on a combination of patent, copyright, trademark and trade secret
laws and restrictions on disclosure to protect our intellectual property rights.
We also enter into confidentiality or license agreements with our key employees
and consultants and control access to and distribution of our software,
documentation and other proprietary information. We believe that our patents and
patent applications provide us with a competitive advantage. Accordingly, in the
event our products and technologies under development gain market acceptance,
patent protection would be important to our business. However, obtaining patent
and other intellectual property protection may not adequately protect our rights
or permit us to gain or keep any competitive advantage. For instance,
unauthorized parties may attempt to copy, reverse engineer or otherwise obtain
and use our patented products or technology without our permission, eroding or
eliminating the competitive advantage we hope to gain though the exclusive
rights provided by patent protection. Moreover, our existing patents and patents
we have applied for (if granted) may not protect us against competitors that
independently develop proprietary technologies that are substantially equivalent
or superior to our technologies, or design around our patents. The competitive
advantage provided by patenting our technology may erode if we do not upgrade,
enhance and improve our technology on an ongoing basis to meet competitive
challenges.

In addition, we conduct research and development under contracts with the
U.S. Government. In general, our rights to technologies we develop under those
contracts are subject to the U.S. Government's non-exclusive, non-royalty
bearing, worldwide license to use those technologies. In the case of SBIR
contracts, the U.S. Government has limited rights to the delivered data for five
years after project completion, and unlimited rights after five years.

Monitoring unauthorized use of our technology is difficult, and we cannot
be certain that the steps we have taken will prevent unauthorized use of our
technology, particularly in foreign countries where the laws may not protect our
proprietary rights as fully as in the United States. A description of our
patents and patent applications is contained in this Form 10-K under
"Business--Intellectual Property."

THERE IS A RISK THAT SOME OF OUR PATENT APPLICATIONS WILL NOT BE GRANTED.

Although we have received our first HYPERFINE WDM patent, we have filed
several other applications for U.S. patents relating to our HYPERFINE WDM and
OPERA(TM) technologies, and there is a risk that some or all of the pending
applications will not issue as patents. Although we believe our patent
applications are valid, the failure of our pending applications to issue as
patents would affect the competitive advantage we hope to gain by obtaining
patent protection and could have a material adverse effect upon our business and
results of operations.

WE MAY BECOME INVOLVED IN INTELLECTUAL PROPERTY DISPUTES, WHICH COULD SUBJECT US
TO SIGNIFICANT LIABILITY, DIVERT THE TIME AND ATTENTION OF OUR MANAGEMENT AND
PREVENT US FROM SELLING OUR PRODUCTS.

We or our customers may be a party to litigation in the future to protect
our intellectual property or to respond to allegations that we infringe on
others' intellectual property. We have not performed any patent infringement
clearance searches and are not in a position to assess the likelihood that any
claims would be asserted. If any parties assert that our products infringe upon
their proprietary rights, we would be forced to defend ourselves and possibly
our customers against the alleged infringement. If we are unsuccessful in any
intellectual property litigation, we could be subject to significant liability
for damages and loss of our proprietary rights. Intellectual

property litigation, regardless of its success, would likely be time consuming
and expensive to resolve and would divert management's time and attention. In
addition, we could be forced to do one or more of the following:

o stop selling, incorporating or using our products that include the
challenged intellectual property;

o obtain from the owner of any infringed intellectual property right a
license to sell or use the relevant technology, which license may not
be available on reasonable terms, or at all; or

o re-design those products that use the technology.

If we are forced to take any of these actions, our business could be
seriously harmed.

IF NECESSARY LICENSES OF THIRD-PARTY TECHNOLOGY ARE NOT AVAILABLE TO US OR ARE
VERY EXPENSIVE, OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS WOULD BE
HARMED.

From time to time we may be required to license technology from third
parties to sell or develop our products and product enhancements. These
third-party licenses may not be available to us on commercially reasonable
terms, if at all. Our inability to maintain or obtain any third-party license
required to sell or develop our products and product enhancements could require
us to obtain substitute technology of lower quality or performance standards or
at greater cost. If we were required to use technology with lower performance
standards or quality, customers may stop buying our products and this would
cause our revenues to decline. Similarly, if our costs rise significantly,
customers may choose less expensive alternative products, which would cause our
revenues to decline.

RISKS RELATED TO THE OPTICAL NETWORKING INDUSTRY

OUR ABILITY TO EXPAND INTO THE COMMUNICATIONS OPTICAL NETWORKING MARKET MAY BE
ADVERSELY AFFECTED BY UNFAVORABLE AND UNCERTAIN CONDITIONS IN THE COMMUNICATIONS
INDUSTRY AND THE ECONOMY IN GENERAL.

The market for communications equipment, including optical components, has
suffered a severe and prolonged downturn. Many of our potential customers have
experienced significant financial distress, and some have gone out of business.
This has resulted in a significant consolidation in the communications equipment
industry, combined with a substantial reduction in overall demand. In addition,
most of our potential customers have become more conservative and uncertain
about their future purchases, which have made our communications business slow
to materialize.

We expect the factors described above to continue to affect our business
for an indeterminate period, in several significant ways:

o capital expenditures by many of our potential customers may be flat or
reduced;

o increased competition resulting from reduced demand will put
substantial downward pressures on the pricing of our products,
tending to reduce profit margins;

o increased competition may enable customers to insist on more
favorable terms and conditions for sales, including extended payment
terms or other financing assistance, as a condition of procuring
their business; and

o the bankruptcies or weakened financial condition of several
communications companies may adversely affect the market for our
optical networking products.

The result of any one or a combination of these factors could eliminate or
reduce our ability to penetrate this market.

OUR OPTOELECTRONIC PRODUCTS ARE COMPLEX, OPERATE IN COMPLEX ENVIRONMENTS AND
HAVE NOT YET BEEN WIDELY DEPLOYED. IF OUR PRODUCTS CONTAIN DEFECTS THAT ARE
UNDISCOVERED UNTIL FULL DEPLOYMENT WE MAY INCUR SIGNIFICANT UNEXPECTED EXPENSES,
LOSSES OF SALES AND HARM TO OUR REPUTATION.

Optoelectronic products are complex and are designed to be deployed across
complex networks. Because of the nature of the products, they can only be fully
tested when completely deployed in large networks with high amounts of traffic.
Customers may discover errors or defects in the hardware or the software, or
products we develop may not operate as expected, after they have been fully
deployed. If we are unable to fix defects or other problems that may be
identified in full deployment, we would likely experience:

o loss of, or delay in, revenue and loss of market share;

o loss of existing customers;

o difficulties in attracting new customers or achieving market
acceptance;

o diversion of development resources;

o increased service and warranty costs;

o legal actions by our customers; and

o increased insurance costs.

The occurrence of any of these problems could seriously harm our business,
financial condition and results of operations. Defects, integration issues or
other performance problems could result in financial or other damages to our
customers or could negatively affect market acceptance for the products we
develop. Our customers could also seek damages for losses from us, which, if
they were successful, would seriously harm our business, financial condition and
results of operations. A product liability claim brought against us, even if
unsuccessful, would likely be time consuming and costly and would put a strain
on our management and resources.

RISKS RELATED TO OUR COMPANY

A LIMITED NUMBER OF SHAREHOLDERS ARE ABLE TO EXERT SIGNIFICANT INFLUENCE OVER
MATTERS REQUIRING SHAREHOLDER APPROVAL.

As of January 31, 2004, a few private investors collectively hold
approximately 5.1 million shares, or 34.3%, of our total outstanding shares of
common stock. Accordingly, these investors could seek to exercise significant
control and influence of certain actions requiring the approval of the holders
of shares of our common stock. This concentration of ownership may also delay or
prevent a change in control of us or reduce the price other investors might be
willing to pay for our common stock. In addition, the interests of this limited
number of investors may conflict with the interests of other holders of our
common stock.

THERE IS CURRENTLY ONLY A LIMITED PUBLIC MARKET FOR OUR COMMON STOCK.

Our common stock was included for listing on the American Stock Exchange,
or AMEX, on June 4, 2003. Prior to being listed on AMEX, our common stock was
traded on the OTC Bulletin Board. Historically, there has been only a limited
public market for our common stock and there may be difficulty in selling
shares of our common stock. In addition, in the event our operating results fall
below the expectations of public market analysts and investors, the market price
of our common stock would likely decline.

THE MARKET PRICE OF OUR COMMON STOCK IS SUBJECT TO SIGNIFICANT PRICE
FLUCTUATIONS.

The trading price of our common stock has historically been volatile and
will likely continue to fluctuate significantly in the future. This volatility
has often been unrelated to our operating performance. Volatility in the market
price of our common stock may prevent investors from being able to sell their
common stock at or above the price such investors paid for their shares or at
any price at all.

SALES OF A SIGNIFICANT NUMBER OF SHARES OF OUR COMMON STOCK BY EXISTING
SHAREHOLDERS COULD CAUSE THE MARKET PRICE OR OUR COMMON STOCK TO DECLINE.

If our shareholders sell substantial amounts of our common stock, including
shares issued upon the exercise of outstanding options, the market price of our
common stock may decline. These sales also might make it more difficult for us
to sell equity or equity-related securities in the future at a time and price
that we deem appropriate. We are unable to predict the effect that sales may
have on the then prevailing market price of our common stock.

As of February 27, 2004, there remain registered for resale under the
Securities Act approximately 2.6 million shares of our common stock on behalf of
certain of our shareholders. In addition, 2.0 million common shares issued in
December 2003 upon the conversion of warrants are subject to registration rights
upon demand, and there are approximately 192,307 shares of our common stock
issued in December 2003 upon conversion of a note payable, the holder of which
is entitled to "piggy-back" registration rights. Sales of substantial amounts of
common stock under Rule 144 or pursuant to the holder's registration rights, or
the perception that such sales may occur, could depress the market price of our
common stock. All of these shares will become eligible for public resale at
various times within two years subject to volume limitations and certain
restrictions on sales by affiliates.

CHANGES IN STOCK OPTION ACCOUNTING RULES MAY ADVERSELY IMPACT OUR OPERATING
RESULTS PREPARED IN ACCORDANCE WITH GENERALLY ACCEPTED ACCOUNTING PRINCIPLES.

Technology companies like ours have a history of using broad based employee
stock option programs to hire, incentivize and retain our workforce in a
competitive marketplace. Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation", allows companies the choice of either
using a fair value method of accounting for options which would result in
expense recognition for all options granted, or using an intrinsic value method,
as prescribed by Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" (APB 25), with a pro forma disclosure of the impact
on net income (loss) of using the fair value option expense recognition method.
We have elected to apply APB 25 and accordingly we generally do not recognize
any expense with respect to employee stock options as long as such options are
granted at exercise prices equal to the fair value of our common stock on the
date of grant.

On March 12, 2003, the Financial Accounting Standards Board (FASB)
announced its plans to re-deliberate the appropriate accounting for employee
stock options with a goal to have one standard applicable to all companies. The
FASB expects to have the new standard become effective sometime in 2005. If the
FASB requires expensing of employee stock options by all companies, our results
of operations prepared in accordance with generally accepted accounting
principles would be adversely impacted.

ITEM 2. PROPERTIES

OFFICE FACILITIES

We lease approximately 18,000 square feet of space in our corporate
headquarters and offices at 9150 Guilford Road, Columbia, Maryland. This lease
expires October 2005. We also have approximately 7,421 square feet of lease
space at 135 National Business Parkway, Annapolis Junction, Maryland that
expires December 31, 2007.

The Company is looking to expand its facilities to accommodate the growth
in its operations. The Company believes there is space available to meet its
business needs.

ITEM 3. LEGAL PROCEEDINGS

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.
24

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS

PRICE RANGE OF COMMON STOCK

Our common stock has traded on the AMEX, under the symbol "EYW" since June
4, 2003. Prior to that time, the common stock traded on the OTC Bulletin Board.
The following table sets forth the range of high and low intra-day sales prices
reported for our common stock on those markets for the periods indicated.

HIGH LOW
---- ---
Year Ended December 30, 2001:

First Quarter ..................... $ 5.25 $ 2.22
Second Quarter ..................... $ 4.80 $ 2.88
Third Quarter ..................... $ 6.70 $ 3.30
Fourth Quarter ..................... $ 7.50 $ 5.55
Year Ended December 29, 2002:
First Quarter ..................... $ 8.25 $ 3.60
Second Quarter ..................... $ 6.40 $ 3.15
Third Quarter ..................... $ 4.25 $ 2.15
Fourth Quarter ..................... $ 3.56 $ 1.50
Year Ending December 28, 2003:
First Quarter ..................... $ 3.90 $ 2.55
Second Quarter ..................... $ 5.85 $ 2.85
Third Quarter ..................... $ 6.28 $ 4.31
Fourth Quarter ..................... $ 10.45 $ 5.55

On March 1, 2004, the last reported sale price for our common stock on the
AMEX was $8.35 per share. As of March 1, 2004, there were 326 shareholders of
record of our common stock.

DIVIDEND POLICY

We have never declared or paid any cash dividends on our capital stock. We
currently expect to retain future earnings, if any, to finance the growth and
development of our business and do not anticipate paying any cash dividends in
the foreseeable future.

EQUITY COMPENSATION PLAN INFORMATION

The following table sets forth information as of December 28, 2003 with
respect to compensation plans under which equity securities of the Company are
authorized for issuance.

NUMBER OF SECURITIES TO WEIGHTED AVERAGE NUMBER OF SECURITIES
BE ISSUED UPON EXERCISE EXERCISE PRICE OF REMAINING AVAILABLE
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, FOR FUTURE ISSUANCE
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS (EXCLUDING COLUMN (A))

(A) (B) (C)
------------------------------- -------------------------- ---------------------------- -------------------------

EQUITY COMPENSATION PLANS

APPROVED BY SECURITY HOLDERS 1,537,200 $3.26 272,900

EQUITY COMPENSATION PLANS NOT
APPROVED BY SECURITY HOLDERS (1)(2) 620,673 $2.56 7,550

-------------------------- --------------------------
TOTAL 2,157,873 280,450

(1)Represents shares of common stock underlying non-qualified stock
options issued outside of any formal plan. Generally, options granted
outside equity compensation plans have grant prices equal to or greater
than the fair market value of the underlying stock on the grant date
and have a term of 10 years. The Board will adjust non-plan awards to
make appropriate adjustments in the number of shares underlying options
in the event of a stock split, merger, or other change in capital
structure of the Company. Other specific conditions of the awards, such
as vesting and termination provisions, are individually determined.

(2)Includes remaining 179,173 options issued at below market prices in
exchange for fully vested outstanding options of acquired company.

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth the selected consolidated statement of
operations data, consolidated balance sheet data and other data for each of the
periods indicated. The selected financial data for fiscal years 1999, 2000,
2001, 2002 and 2003 are derived from our audited financial statements and
related notes. Such financial statements include all adjustments, consisting of
normal recurring adjustments, which we consider necessary for a fair
presentation of our financial position and results of operations for these
periods. You should not assume that the results below indicate results that we
will achieve in the future. The selected financial data presented below should
be read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations," the consolidated financial statements and
related notes.

FISCAL YEAR ENDED
(IN THOUSANDS, EXCEPT PER SHARE DATA)

DEC. 26, DEC. 31, DEC. 30, DEC. 29, DEC. 28,
1999 2000 2001 2002 2003
---- ---- ---- ---- ----
STATEMENT OF OPERATIONS DATA:

Revenues $ 4,813 $ 3,255 $ 2,642 $ 4,506 $ 16,286

Costs of goods sold and services
provided (2,524) (1,626) (1,342) (2,594) (10,389)
--------- --------- --------- --------- ---------

Gross margin 2,289 1,629 1,300 1,912 5,897

Selling, general and administrative
expenses (1,693) (2,041) (2,460) (2,667) (4,905)

Research and development (495) (771) (2,417) (1,395) (403)

Amortization of other intangible assets -- -- -- -- (381)
--------- --------- --------- --------- ---------

Operating income (loss) 101 (1,183) (3,577) (2,150) 208

Interest income (expense), net (56) (8) 8 (24) (69)
--------- --------- --------- --------- ---------

Income (loss) before income taxes 45 (1,191) (3,569) (2,174) 139

Benefit (provision) for income taxes -- -- -- -- --
--------- --------- --------- --------- ---------

Net income (loss) 45 (1,191) (3,569) (2,174) 139

Beneficial conversion feature of
convertible preferred stock -- (1,250) (750) -- --
--------- --------- --------- --------- ---------

Net income (loss) attributable to
common shareholders $ 45 $ (2,441) $ (4,319) $ (2,174) $ 139
========= ========= ========= ========= =========

Net income (loss) per share-- basic $ 0.01 $ (0.52) $ (0.67) $ (0.29) $ 0.02

Net income (loss) per share-- diluted $ 0.01 $ (0.52) $ (0.67) $ (0.29) $ 0.01

Shares used in per share calculations
-- basic 4,398 4,717 6,494 7,411 8,706

Shares used in per share calculations
-- diluted 4,398 4,717 6,494 7,411 9,798

AS OF

DEC. 26, DEC. 31, DEC. 30, DEC. 29, DEC. 28,
1999 2000 2001 2002 2003
---- ---- ---- ---- ----
BALANCE SHEET DATA:

Working capital $ 384 $ 736 $ 112 $ 222 $ 32,971

Total assets 1,609 1,619 1,553 2,343 39,726

Total debt 444 23 191 745 104

Shareholders' equity 610 1,091 645 358 36,745

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition and results of
operations should be read together with our consolidated financial statements
and the notes to those statements included elsewhere in this Form 10-K. This
discussion contains forward-looking statements that involve risks and
uncertainties. See "Forward Looking Statements." For additional information
regarding some of the risks and uncertainties that affect our business and the
industry in which we operate, please see "Risk Factors" beginning on page 15.

OVERVIEW

Most of our revenues are derived from contracts with the U.S. Government,
where we are either the prime contractor or a subcontractor, depending on the
contract. Contracts with the U.S. Government, primarily the military services
and other departments and agencies of the Department of Defense, accounted for
approximately 84%, or $2.2 million of our revenues, and 97%, or $4.4 million of
our revenues, for the fiscal years ended December 30, 2001 and December 29,
2002, respectively. For the fiscal year ended December 28, 2003, revenues
derived from U.S. Government programs were $15.9 million, or 98% of our
revenues. We received a substantial amount of our intelligence and defense
community revenues for 2003 from sole source contracts.

Our most significant expense is our cost of goods sold and services
provided, which consists primarily of direct labor and associated costs for
program personnel and direct expenses incurred

to complete contracts, including cost of materials and subcontract efforts. Our
ability to accurately predict personnel requirements, salaries and other costs,
as well as to manage personnel levels and successfully redeploy personnel, can
have a significant impact on our cost of goods sold and services provided.
Selling, general and administrative expenses consist primarily of costs
associated with our management, finance and administrative groups, personnel
training, business development expenses which include bid and proposal efforts,
and occupancy, travel and other corporate costs.

In March 2003, we acquired 100% of the common stock of Sensys Development
Laboratories, Inc., or SDL. The assigned value of the consideration and related
expenses was approximately $4.4 million. SDL provides both system and software
engineering technical support to U.S. Government customers and prime contractors
supporting government programs. SDL has an established workforce with
specialized experience and credentials. For its most recent fiscal year ended
September 30, 2002, SDL had revenues of $3.1 million and operated at an
annualized level of approximately $7.0 million for fiscal 2003.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues and
expenses, and related disclosure of contingent assets and liabilities. On an
ongoing basis, we re-evaluate our estimates, including those related to revenue
recognition, research and development, inventories, intangible assets, income
taxes and contingencies. We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. We believe the following critical accounting policies
affect our more significant judgments and estimates used in the preparation of
our financial statements.

REVENUE RECOGNITION

We enter into three types of U.S. Government contracts: cost plus fixed
fee, fixed price and time and material. We recognize revenue on cost plus fixed
fee contracts to the extent costs are incurred plus a proportionate amount of
fee earned. We must determine that the costs incurred are proper and that the
ultimate costs incurred will not overrun the expected funding on the contract
and still deliver the scope of work proposed. Even though cost plus fixed fee
contracts generally do not require that we expend costs in excess of the
contract value, such expenditures may be required in order to achieve customer
satisfaction and receive additional work. In addition, since the reimbursable
costs include both direct and indirect costs, we must determine that the
indirect costs are properly accounted and allocated in accordance with
government cost accounting requirements. On fixed price contracts, we must
determine that the costs incurred provide a proportionate amount of progress on
the work and that the ultimate costs incurred will not overrun the funding on
the contract and the required hours or work product will be delivered. On fixed
price product orders, revenue is not recorded until we determine that the goods
have been delivered and accepted by the customer. On time and material
contracts, revenue is recognized to the extent of billable rates multiplied by
hours delivered, plus other direct costs. This is generally the most
straightforward revenue computation. We use historical technical performance
experience where applicable to evaluate progress on fixed price and cost plus
fixed

fee jobs. We use historical government audit experience in the indirect cost
area to evaluate the propriety and expected recovery of our indirect costs on
cost plus fixed fee contracts.

The following table sets forth the percentage of revenues under each type
of contract for the fiscal years ended December 30, 2001, December 29, 2002 and
December 28, 2003:

PERCENTAGE OF REVENUES BY
CONTRACT TYPE
FISCAL YEAR ENDED
DEC. 30, DEC. 29, DEC. 28,
2001 2002 2003
---- ---- ----

Cost plus fixed fee ....................... 38.4% 67.5% 27.5%

Time and material ....................... 16.4 4.7 56.9

Fixed price ....................... 45.2 27.8 15.6
------ ------ ------

Total ....................... 100.0% 100.O% 100.0%
====== ====== ======

COSTS OF GOODS SOLD AND SERVICES PROVIDED

Our costs are categorized as either direct or indirect costs. Direct costs
are those that can be identified with and allocated to specific contracts and
tasks. They include labor, fringe (for example, leave time, medical/dental,
retirement plan, payroll taxes, employee welfare, worker's compensation and
other benefits), subcontractor costs, consultant fees, travel expenses,
materials and equipment. Indirect costs are either overhead or general and
administrative expenses. Indirect costs cannot generally be identified with
specific contracts or tasks, and to the extent that they are allowable, they are
allocated to contracts and tasks using appropriate government-approved
methodologies. Costs determined to be unallowable under the Federal Acquisition
Regulations cannot be allocated to projects. Our principal unallowable costs are
interest expense, amortization expense for separately identified intangibles
from acquisitions, certain general and administrative expenses, financing and
merger/acquisition costs.

RESEARCH AND DEVELOPMENT

We have expended significant amounts on research and development of new
products and technologies. In accordance with generally accepted accounting
principles, we expense and do not capitalize and add to inventory our research
and development expenses. When product design and prototypes are finalized and
product marketability and viability have been established, expenditures for
inventory are treated accordingly. There is a judgmental aspect to this decision
which could result in over-expensing in some cases or the early capitalization
in other cases of such expenditures.

GOODWILL AND OTHER INTANGIBLE ASSETS

Business acquisitions typically result in goodwill and other intangible
assets, which affect the amount of future period amortization expense and
possible impairment expense that we will incur. We have adopted Statement of
Financial Accounting Standards, or SFAS, No. 142 "Goodwill and Other Intangible
Assets",which requires that we, on an annual basis, calculate the fair value of
the reporting units that contain the goodwill and compare that to the carrying
value of the reporting unit to determine if impairment exists. Impairment
testing must take place more

often if circumstances or events indicate a change in the impairment status.
Management judgment is required in calculating the fair value of the reporting
units.

BUSINESS COMBINATION

We apply the provisions of SFAS No. 141, Business Combinations, whereby the
net tangible and separately identifiable intangible assets acquired and
liabilities assumed are recognized at their estimated fair market values at the
acquisition date. The purchase price in excess of the estimated fair market
value of the net tangible and separately identifiable intangible assets acquired
represents goodwill. The allocation of the purchase price related to our
business combinations involves significant estimates and management judgment
that may be adjusted during the allocation period, but in no case beyond one
year from the acquisition date. No adjustments to purchase price were made
subsequent to year end 2003 for the acquisition made in 2003. External costs
incurred related to successful business combinations are capitalized as costs of
business combinations, while internal costs incurred by us for acquisition
opportunities are expensed.

OFF BALANCE SHEET ARRANGEMENTS

The Company does not have any off balance sheet arrangements with or
through any unconsolidated entity or which have not been recognized and
disclosed in these financial statements.

RESULTS OF OPERATIONS

The following table sets forth, for each period indicated, the percentage
of items in the statement of operations in relation to revenue.

FISCAL YEAR ENDED
DEC. 30, DEC. 29, DEC. 28,
2001 2002 2003
---- ---- ----

Revenues ............................................... 100.0% 100.0% 100.0%

Costs of goods sold and services provided .............. (50.8) (57.6) (63.8)
------- ------- -------

Gross margin ........................................... 49.2 42.4 36.2

Selling, general and administrative expenses ........... (93.1) (59.2) (30.1)

Research and development ............................... (91.5) (30.9) (2.5)

Amortization of other intangible assets ................ (0.0) (0.0) (2.3)
-------- -------- --------

Operating (loss) income ................................ (135.4) (47.7) 1.3

Interest income (expense), net ......................... 0.3 (0.5) (0.4)
------- -------- --------

(Loss) income before income taxes ...................... (135.1) (48.2) 0.9

Benefit (provision) for income taxes ................... 0.0 0.0 0.0
------- ------- -------

Net (loss) income ...................................... (135.1) (48.2) 0.9

Beneficial conversion feature of convertible
preferred stock ........................................ (28.4) 0.0 0.0
------- ------- -------

Net (loss) income attributable to common shareholders .... (163.5)% (48.2)% 0.9%
======= ======= =======

FISCAL YEAR ENDED DECEMBER 28, 2003 COMPARED TO THE FISCAL YEAR ENDED
DECEMBER 29, 2002

REVENUES. Our revenues were $16.3 million and $4.5 million in fiscal 2003
and 2002, respectively. Revenues in fiscal 2003 include $5.8 million for ten
months of operations from SDL, which we acquired in March 2003. Excluding SDL,
revenues in 2003 were $10.5 million or $6.0 million higher than 2002 due to
several factors. A key factor was the increased activity on the U.S. Government
Missile Defense Agency program for design of a next generation advanced
optoelectronics radar processor, or AOP, demonstration unit. This program
generated revenues of $3.3 million in fiscal 2003 compared to revenues of $2.1
million in 2002 as we did not begin this program until May 2002. Our
communications services contracts contributed $3.5 million of revenues in fiscal
2003 and $32,000 of revenues in fiscal 2002. Additionally, in fiscal 2003 we
sold $1.1 million of products and equipment, including the sale of ten HYPERFINE
WDM family devices, consisting of five prototype demultiplexers and five of the
new flat-top HYPERFINE WDM devices for use in building advanced optical code
division multiple access systems, for $460,000 to several government and
intermediate customers. We had only $107,000 of such products and equipment
sales in fiscal 2002.

COST OF GOODS SOLD AND SERVICES PROVIDED. Our cost of goods sold and
services provided increased by $7.8 million to $10.4 million in fiscal 2003 from
$2.6 million in fiscal 2002. As a percentage of revenues, cost of goods sold and
services provided was approximately 63.8% for fiscal 2003, compared to
approximately 57.6% for fiscal 2002. In fiscal 2003, due to the SDL acquisition
and communications sales referenced previously, there was a significant increase
in the direct labor and associated costs for work performed at our customers'
facilities. We receive a lower markup on work performed at customer facilities.
Overall, the higher volume during 2003 contributed a larger amount of gross
profit, though at a lower gross profit percentage.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased $2.2 million to $4.9 million for fiscal 2003
from $2.7 million for fiscal 2002. The increase was due to increased business
development and higher management costs in the government contracts area, and to
the recurring costs of the acquired company related to its operations.

RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
declined by $992,000 to $403,000 for fiscal 2003 from $1.4 million in fiscal
2002. We incurred the majority of our research and development expenses on
efforts related to development of our optical communications technology.

AMORTIZATION OF OTHER INTANGIBLE ASSETS. During fiscal 2003, amortization
of other intangible assets was $381,000, all of which was related to the SDL
acquisition. We expect the remaining balance of $50,000 of other intangible
assets to be substantially amortized within approximately three months. We had
no amortization cost in fiscal 2002.

NET INTEREST EXPENSE. Net interest expense was $69,000 and $24,000 in
fiscal 2003 and 2002, respectively. The increase in net interest expense
reflects an increase in our debt and costs related to our accounts receivable
facility prior to the completion of our follow-on public offering in mid
December 2003.

NET INCOME (LOSS). Net income was $140,000 and net loss was $2.2 million in
fiscal 2003 and 2002, respectively. We are in a net operating loss carry forward
position for book and tax purposes. We did not recognize any provision for
income taxes in 2003 due to our net operating loss carry forwards.

FISCAL YEAR ENDED DECEMBER 29, 2002 COMPARED TO THE FISCAL YEAR ENDED
DECEMBER 30, 2001

REVENUES. Our revenues increased to $4.5 million in fiscal 2002 from $2.6
million in fiscal 2001. Our revenue growth was primarily due to the $2.1 million
in revenue we derived from the U.S. Government Missile Defense Agency program
for design of a next generation AOP demonstration unit, including procurement of
necessary materials and equipment. This initial phase commenced May 2002 and was
substantially completed by December 2002.

COST OF GOODS SOLD AND SERVICES PROVIDED. Our cost of goods sold and
services provided increased by $1.3 million to $2.6 million for fiscal 2002 from
$1.3 million for fiscal 2001. As a percentage of revenues, cost of goods sold
and services provided was 57.6% in fiscal 2002 compared to 50.8% in fiscal 2001.
In fiscal 2001, the major component of cost of goods sold and services provided
was direct labor and associated costs. In fiscal 2002, due to our new AOP
program, we experienced a significant increase in the direct materials and
equipment component of cost of goods sold and services provided. We receive a
higher markup on direct labor than direct material and equipment costs.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Our selling, general and
administrative expenses increased by $208,000 to $2.7 million in fiscal 2002
from $2.5 million in fiscal 2001. Selling, general and administrative expenses
increased slightly in fiscal 2002, particularly our marketing expenses related
to our new optoelectronics and communications devices. In fiscal 2002, we also
incurred higher expenses related to our efforts to raise additional financing.

RESEARCH AND DEVELOPMENT EXPENSES. Our research and development expenses
decreased in fiscal 2002 to $1.4 million from $2.4 million in fiscal 2001. The
initial HYPERFINE WDM development in 2001 required significant expenditure to
outside vendors for materials and non-recurring engineering services.

AMORTIZATION OF OTHER INTANGIBLE ASSETS. We had no expense associated with
the amortization of intangible assets in either of fiscal 2002 or 2001.

NET INTEREST INCOME (EXPENSE). We had net interest expense of $24,000 in
fiscal 2002 compared to net interest income of $8,000 in fiscal 2001. In fiscal
2001, interest income, primarily from the temporary investment of funds from
private placements of our common stock, offset $18,000 in interest expense. In
2002, we had less cash available for temporary investment.

NET LOSS. Our net loss was $2.2 million and $3.6 million in fiscal 2002 and
2001, respectively. Our fiscal 2002 net loss declined primarily due to the
decline in research and development expenses and increased revenues covering a
greater portion of fixed expenses.

BENEFICIAL CONVERSION EXPENSE. We recognized a $750,000 charge in fiscal
2001 from the beneficial conversion feature of convertible preferred stock. As
proceeds were received from the sale of preferred stock in 2001 and 2000, we
recognized the pro rata beneficial conversion feature

on the convertible preferred stock as a deemed dividend for purposes of
computing net loss attributable to common shareholders and per share amounts.
The total recorded was $750,000 in 2001 and $1.3 million in 2000. This imputed
amount had no effect on our net loss from operations or cash flows. These
expenses resulted in a net loss attributable to common stock of $4.3 million and
$2.4 million in fiscal 2001 and 2000, respectively.

BACKLOG

Funded backlog generally consists of the sum of all contract amounts of
work for which funding has been approved and contracts signed, less the value of
work performed under such contracts. Even though such contracts are fully funded
by appropriations, they are subject to other risks inherent in government and
communications contracts, such as termination for the convenience of the
customer.

NET OPERATING LOSS CARRY FORWARD

We are in a net operating loss ("NOL") carry forward position. The NOL and
other tax credits can be used to offset future taxable income and taxes payable.

LIQUIDITY AND CAPITAL RESOURCES

Our primary liquidity and capital resource needs are to finance the costs
of our operations and to make capital expenditures and acquisitions. Based upon
our current level of operations, we expect that our cash flow from operations
and amounts we are able to borrow under our accounts receivable facility, will
be adequate to meet our anticipated needs for the foreseeable future. A
significant part of our business strategy is to pursue one or more significant
strategic acquisitions, and we may use all or a substantial portion of the net
proceeds from our recent public offering for such acquisitions.

During fiscal year 2003, net cash used in operating activities was
$228,000. Cash provided from net income and non cash depreciation, amortization
and other charges of approximately $880,000 was offset by an increase in
accounts receivable net of the change in billings in excess of costs, accounts
payable and accrued items of $1,108,000. The increase in accounts receivable

during 2003 was due to the increase in sales and does not reflect any change in
payment cycle. The net cash used in operating activities of $1.6 million and
$3.3 million during fiscal 2002 and 2001, respectively, was a result of the
losses we incurred in those periods, primarily due to the research and
development expenditures for our optoelectronics services and products. Our
working capital at December 28, 2003 increased to $33.0 million from $222,000 at
fiscal year end 2002. The increase was primarily the result of our recent
follow-on public offering from which we netted $31.4 million and also as a
result of our acquisition of SDL in early 2003 for predominately common stock
after deducting the $309,000 of cash consideration paid.

During fiscal year 2003, we used net cash of $501,000 in investing
activities. Of this amount, $309,000 represents the cash consideration paid in
our acquisition of SDL. We also spent $194,000 in 2003 for property and
equipment to support our growing work force. The net cash used in investing
activities of $30,000 and $81,000 during fiscal 2002 and 2001, respectively, was
for purchases of equipment.

During fiscal year 2003, net cash provided by financing activities of $31.5
million resulted primarily from our recent follow-on public offering. In fiscal
2002 and 2001, the net cash provided by financing activities was $2.1 million
and $3.0 million, respectively, and primarily resulted from our completion of
private placements of equity or debt securities to private investors. We
received $2.0 million and $3.0 million in fiscal 2002 and fiscal 2001,
respectively, from these private placements. The funds have been used primarily
for the development of the optical communications device technologies.

We currently have a working capital financing agreement with an accounts
receivable factoring organization. Under this agreement, the factoring
organization may purchase certain of our accounts receivable subject to full
recourse against us in the case of nonpayment by our customers. We generally
receive 85%-90% of the invoice amount at the time of purchase and the balance
when the invoice is paid. We are charged an interest fee and other processing
charges, payable at the time each invoice is paid. There were no funds advanced
as of December 28, 2003 and $169,000 as of December 29, 2002.

INFLATION

Because of our substantial activities in professional services and product
development, our business is more labor intensive than firms involved primarily
in industrial activities. To attract and maintain higher caliber professional
staff, we must structure our compensation programs competitively. The wage
demand effect of inflation is felt almost immediately in our costs, however, the
net effect during the years presented is minimal.

The inflation rate in the United States generally has little impact on our
cost-reimbursable type contracts and other short-term contracts. For
longer-term, fixed price type contracts, we endeavor to protect our margins by
including cost escalation provisions or other specific inflation protective
terms in these contracts.

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

CONTRACTUAL CASH OBLIGATIONS

The following table shows our contractual cash obligations due in each of
fiscal 2004 through 2007. We have no contractual cash obligations due after
2007.

2004 2005 2006 2007
---- ---- ---- ----

Operating leases $ 430,151 $ 396,526 $ 200,760 $ 206,783

Capital leases, including interest 5,362 -- -- --

Note payable (1) 100,000 -- -- --

Interest on note payable 8,501 -- -- --
---------- ---------- ---------- ----------

Total $ 544,014 $ 396,526 $ 200,760 $ 206,783
========== ========== ========== ==========

(1) The note was paid in January 2004.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Our exposure to market risk relates to changes in interest rates for
borrowings under our working capital financing agreement. These borrowings bear
interest at variable rates. Based upon our borrowings under this facility in
fiscal 2003, a hypothetical 10% increase in interest rates would have increased
interest expense by about $1,000 and would have decreased our annual cash flow
by a comparable amount.

NEW ACCOUNTING PRONOUNCEMENTS

In December 2002, the Financial Accounting Standards Board, or FASB, issued
SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and
Disclosure -- an Amendment of FASB Statement No. 123", which is effective for
financial statements for fiscal years ending after December 15, 2002, with early
adoption permitted. SFAS No. 148 enables companies that choose to adopt the fair
value based method to report the full effect of employee stock options in their
financial statements immediately upon adoption, and to make available to
investors better and more frequent disclosure about the cost of employee stock
options. We will continue to apply the disclosure-only provisions of both SFAS
No. 123 and SFAS No. 148.

In January 2003, the FASB issued Financial Interpretation No. 46, or FIN
46, "Consolidation Of Variable Interest Entities." FIN 46 requires that if an
entity has a controlling financial interest in a variable interest entity, the
assets, liabilities and results of activities of the variable interest entity
should be included in the consolidated financial statements of the entity. FIN
46 is effective immediately for all new variable interest entities created or
acquired after January 31, 2003. For variable interest entities created or
acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for
the first interim or annual period beginning after

June 15, 2003. Since we are not involved with any variable interest entities,
the adoption of FIN 46 did not have a material impact on our results of
operations or financial position.

In May 2003, the FASB issued SFAS No. 150, "Accounting For Certain
Financial Instruments With Characteristics Of Both Liabilities And Equity." SFAS
No. 150 establishes standards on the classification and measurement of certain
financial instruments with characteristics of both liabilities and equity. The
provisions of SFAS No. 150 are effective for financial instruments entered into
or modified after May 31, 2003 and to all other instruments that exist as of the
beginning of the first interim financial reporting period beginning after June
15, 2003. The adoption of SFAS No. 150 did not have a material impact on our
results of operations or financial position.

In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104,
"Revenue Recognition", which codifies, revises and rescinds certain sections of
SAB No. 101, "Revenue Recognition", in order to make this interpretive guidance
consistent with current authoritative accounting and auditing guidance and SEC
rules and regulations. The changes noted in SAB No. 104 did not have a material
effect on our results of operations, financial position or cash flows.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See Item 15(a)(1) in Part IV of this Form 10-K.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

Based on their most recent evaluation, the Company's Chief Executive
Officer and Chief Financial Officer believe the Company's disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) are
effective as of the end of the period covered by this Form 10-K to ensure that
information required to be disclosed by the Company in this report is
accumulated and communicated to the Company's management, including its
principal executive officer and principal financial officer, as appropriate, to
allow timely decisions regarding required disclosure. There were no significant
changes in the Company's internal controls or other factors that could
significantly affect these controls subsequent to the date of their evaluation
and there were no corrective actions with regard to significant deficiencies and
material weaknesses.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS

Our executive officers and directors, and their respective ages and
positions, are set forth below.

NAME AGE POSITION
Leonard E. Moodispaw 61 President; Chief Executive Officer and Director
Terry M. Turpin 61 Sr. Vice President; Chief Scientist and Director
James J. Devine 64 Executive Vice President and General Manager
Joseph R. Kurry, Jr. 53 Sr. Vice President; Treasurer and Chief Financial
Officer
Matthew S. Bechta 50 Vice President
Kimberly J. DeChello 42 Vice President, Chief Administrative Officer and
Secretary
Edwin M. Jaehne 51 Vice President and Chief Strategy Officer
Rudolf Liskovec 51 Vice President
Caroline S. Pisano 37 Vice President, Finance and General Counsel
Craig H. Price 54 Vice President
H. Jeffrey Leonard 49 Chairman; Director
Frank E. Manning 84 Chairman Emeritus; Director
John G. Hannon 66 Director
Robert W. Hicks 66 Director
Ray M. Keeler 72 Director
Marie S. Minton 42 Director
Arthur L. Money 64 Director

LEONARD E. MOODISPAW, President, Chief Executive Officer and Director of
Essex, rejoined Essex in 1998. He held the office of Chief Operating Officer
until September 2000 when he was elected Chief Executive Officer. Mr. Moodispaw
was an employee and consultant with Essex during 1988 to 1993. From 1988 to
1993, he was President of the former Essex subsidiary, System Engineering and
Development Corporation, or SEDC, and later served as Essex Chief Administrative
Officer and General Counsel. From April 1994 to April 1998, Mr. Moodispaw was
President of ManTech Advanced Systems International, Inc., a subsidiary of
ManTech International Corporation. From 1965 to 1978, Mr. Moodispaw was a senior
manager in the National Security Agency, or NSA. After leaving the NSA he was
engaged in the private practice of law. He is the Founder of the Security
Affairs Support Association that brings government and industry together to
solve problems of mutual interest. He also serves as a member of the board

of directors of Griffin Services, Inc., a subsidiary of Vosper-Thornycroft, a UK
company. He received a Bachelor of Science degree in Business Administration
from the American University in Washington, D.C. in 1965, a Master of Science
degree in Business Administration from George Washington University in
Washington D.C. in 1969 and Juris Doctor in Law from the University of
Baltimore, Maryland in 1977. He enjoys chocolate and Key West, Florida; is
growing older but not up.

TERRY M. TURPIN was elected a Director of Essex in January 1997 and became
our Senior Vice President and Chief Scientist for Essex, positions he has held
since 1996. He joined Essex through merger with SEDC where he was Vice President
and Chief Scientist from September 1984 through June 1989. Currently Mr. Turpin
is the Chairman of the Industrial Advisory Board for the Optoelectronic
Computing Center at the University of Colorado. From December 1983 to September
1984 he was an independent consultant. From 1963 through December 1983, Mr.
Turpin was employed by the NSA. He was Chief of the Advanced Processing
Technologies Division for ten years. He holds patents for optical computers and
adaptive optical components. Mr. Turpin represented NSA on the Tri-Service
Optical Processing Committee organized by the Under Secretary of Defense for
Research and Engineering. He received a Bachelor of Science degree in Electrical
Engineering from the University of Akron in 1966 and a Master of Science degree
in Electrical Engineering from Catholic University in Washington, D.C. in 1970.

JAMES J. DEVINE, Executive Vice President and General Manager for the
Company, joined Essex in February 2004. From November 2000 through January 2004
he was a Principal at Booz Allen Hamilton leading the Corporate Enterprise and
Mission Operations lines of business supporting the Intelligence Community. From
1964 to 2000, Mr. Devine was a senior executive at NSA. He served three overseas
assignments in Europe and Asia and led two of the major NSA Directorates during
his 36 year career. He holds a Bachelor of Science in Engineering from Johns
Hopkins University and a Master of Engineering Administration from George
Washington University. He is a graduate of the National War College. He enjoys
golf (despite never having broken 100), hiking, cross country skiing, and
travel.

JOSEPH R. KURRY, JR. joined Essex Corporation in March 1985. He is
Treasurer and Chief Financial Officer, positions he has held since 1985, and a
Senior Vice President. Mr. Kurry was controller of ManTech International
Corporation from December 1979 to March 1985. Mr. Kurry graduated in 1972 from
Georgetown University, in Washington, D.C. and is a Certified Public Accountant.
Mr. Kurry and his wife spend time with their college-age daughters and son in
supporting various sports and school programs for Lehigh University in
Pennsylvania and the University of Maryland. The family prefers summer vacations
at the shore in Sea Girt, New Jersey.

MATTHEW S. BECHTA was elected Vice President in October 1993. He is
currently the Director of the Processing Systems Group, responsible for
developing radar imaging technology and products for the Intelligence and
Defense Community. Mr. Bechta joined Essex in 1989 with the merger of Essex and
SEDC. Mr. Bechta was one of the founders of SEDC, where he served in various
technical and management capacities since incorporation in 1980. At SEDC he
contributed to the development of several satellite processing systems. From
1975-1980, Mr. Bechta was employed as a project engineer with NSA, where he was
involved in the development of remote collection and satellite communication
systems. Mr. Bechta holds a Master of Science degree from the Johns Hopkins
University and a Bachelor of Science degree in Electrical Engineering from
Spring Garden College, Pennsylvania. In the off-hours, Matt is a

coach with the Columbia Reds Baseball Club, President of the Centennial High
School Boosters and a fan of University of Pennsylvania baseball.

KIMBERLY J. DECHELLO joined Essex in May 1987 and has served in various
administrative and management capacities. She was appointed Chief Administrative
Officer in November 1997 and Corporate Secretary in January 1998. Ms. DeChello
is responsible for administration, human resources, investor relations and
industrial insurance. Ms. DeChello received a Master of Science degree in Human
Resources Management in 2000 from the University of Maryland. Ms. DeChello also
holds an Associate of Arts degree in Accounting and a Bachelor of Science degree
in Criminal Justice/Criminology from the University of Maryland. She enjoys
dancing and bird watching. She teaches West Cost Swing dance classes and has
competed as a ProAm student.

EDWIN M. JAEHNE joined Essex Corporation as Vice President and Chief
Strategy Officer in 2003. He is a veteran entrepreneur with over 20 years of
international experience as an executive of information technology companies. He
is experienced in creating rapid growth companies as well as in the strategic
acquisition and merger of companies to form strong solutions focused companies
in both the communications and government markets. As Chief Strategy Officer,
Mr. Jaehne is focused on the strategic growth of Essex, expanding on existing
technology and capabilities, and creating product and service lines for both the
commercial and government markets. From 1996 until 2003 he served as either
President or Chief Operating Officer of several information technology
companies, where he led several successful mergers and acquisitions. He started
his first company, Jaehne Associates, LTD (an information security consultancy),
in 1983, which he sold in 1988 to ManTech International, Inc. From 1988 until
1996, he served as President of ManTech Strategic Associates, Ltd. Mr. Jaehne
has a diverse educational background. In 1975 he earned two Bachelor of Arts
degrees (Physics and Russian) from the University of Utah. Mr. Jaehne continued
at the University of Utah to earn a Master of Arts degree in Physics (1976). In
1977, he earned a Master of Arts in the History and Philosophy of Science at the
University of Toronto, Toronto, Canada.

RUDOLF (RUDY) LISKOVEC joined Essex in 2003 as Vice President of Essex's
Government Services. Mr. Liskovec provides leadership to Essex technology
professionals that support enterprise-wide, life-cycle engineering and technical
services, application development, systems integration and business process
reengineering to systems of national importance. Mr. Liskovec has 25 years of
international management and engineering experience where he has developed a
track record of excellence in organizational development, operational and
engineering management, business development, and systems engineering. During
2002-2003, Mr. Liskovec was President/CEO of Lisk Technical Services, LLC, a
consulting firm to government contractors, including Essex. From 2001 to 2002,
Mr. Liskovec was a director for the communications and networks group of General
Dynamics and from 1993 to 2001 he was an Executive Vice President for ManTech
International. He holds a Master of Science degree (honors) in Computer
Information Systems from Boston University, a Bachelor of Science degree (Cum
Laude) in Computer Science from the University of Maryland and a Bachelor of
Science degree (Summa Cum Laude) in Business Management from the University of
Maryland.

CAROLINE S. PISANO was a Director of Essex from September 2000 through
January 2003 and now serves as General Counsel and Vice President of Finance.
From April 2000 through December 2002 Ms. Pisano was a member of Networking
Ventures, L.L.C. From August 1996 to March 2000, Ms. Pisano served as General
Counsel and Chief Financial Officer of Pulse Engineering, Inc., an information
security and signal processing company which was sold in

March 2000. From August 1992 to July 1996 Ms. Pisano served as a senior
transactional attorney with the law firm of Wechsler, Selzer, and Gurvitch,
Chartered. From June 1988 to August 1990, Ms. Pisano, a certified public
accountant, practiced public accounting and specialized in high tech and biotech
companies. Ms. Pisano received her Juris Doctor from the Washington College of
Law at the American University in Washington, D.C. Ms. Pisano graduated Magna
Cum Laude with a Bachelor of Science degree in Accounting from the University of
Maryland. Ms. Pisano is the sister-in-law of H. Jeffrey Leonard. Although Ms.
Pisano is an attorney and an accountant she likes to follow Jimmy Buffett's
advice and "say what you mean, mean what you say." Ms. Pisano has four children
and enjoys volunteering at her children's public school.

CRAIG H. PRICE was elected Vice President in October 1993. Dr. Price,
Director of Optical Solutions, is responsible for the development of products
utilizing Essex patented optical technologies. Dr. Price joined Essex in 1989 as
a result of the merger of Essex and SEDC. Dr. Price had joined SEDC in 1985,
with varied assignments in engineering, analysis and advanced technologies.
Previously, he served in numerous technical and project positions in the U.S.
Air Force during the period 1974 through 1985, where he was awarded the
Distinguished Service Medal. Dr. Price holds a Bachelor of Science degree in
Electrical Engineering from Kansas State University, a Master of Science degree
in Electrical Engineering from Purdue University and a Doctor of Philosophy
degree in Electrical Engineering from Stanford University. He enjoys tennis,
family vacations and visiting his daughter in Cambridge, England, with the added
benefit of cheap hops to Europe.

H. JEFFREY LEONARD, was elected a Director of Essex in September 2000 and
Chairman of the Board in December 2000. Dr. Leonard is the President and
founding shareholder of Global Environment Fund, or GEF. Dr. Leonard has served
as Chairman of the Investment Committee for GEF's five investment funds. He has
extensive experience in international private equity and project finance
investments, and advanced technology investments in the energy, environmental,
applications software, intelligent systems engineering, biological and medical
fields. Dr. Leonard also serves as a member of the board of directors of the
National Cooperative Bank, Xymetrex Corporation, Aurora Flight Sciences Corp.,
Athena Technologies, Sorbent Technologies, International Pepsi-Cola Bottlers
Limited and Global Forest Products Company Limited. He has served as an advisor
to the U.S. Office of Technology Assessment and is a member of the board of
directors of the National Council for Science and the Environment. Dr. Leonard
received a Bachelor of Arts degree in 1976 from Harvard College, a Master of
Science degree from the London School of Economics in 1978 and a Doctor of
Philosophy degree from Princeton University in 1984. He is the brother-in-law of
Caroline S. Pisano. Dr. Leonard is the Chairman of the Board of Beacon House, a
not-for-profit community development and education organization assisting
children and their families in Northeast Washington D.C. He is a marathon runner
and was the winner of the 2003 Cleantech Pioneer Award from the Cleantech
Venture Capital Network.

FRANK E. MANNING, Chairman Emeritus, is the founder of Essex. Mr. Manning
has served as a Director of Essex since its organization in 1969. Mr. Manning
has been a special advisor to the CEO for the past six years. Mr. Manning
received a Bachelor of Science degree in Economics from Franklin and Marshall
College in 1942, and a Masters of Letters degree in Industrial Relations from
the University of Pittsburgh in 1946.

JOHN G. HANNON was elected a Director of Essex in September 2000. From
early 2000 to 2002, Mr Hannon was the managing member of Networking Ventures,
L.L.C., a privately held

company that invested in technology companies. From 1979 to March 2000, Mr.
Hannon served as the Chief Executive Officer of Pulse Engineering, Inc. an
information security and signals processing company which was sold in March
2000. Mr. Hannon started his business career in 1963 after serving in the United
States Marine Corps. Since that time, he has been involved in numerous
entrepreneurial ventures. He is a past Director of the Armed Forces
Communications and Electronics Association.

ROBERT W. HICKS was elected a Director of Essex in August 1988. He has been
an independent consultant since 1986. During this period he was engaged for
three and one-half years by the State of Maryland Deposit Insurance Fund
Corporation as Receiver of several savings and loan associations, first as an
Agent and then as a Special Representative (both court-approved positions). He
was a principal officer and shareholder in Asset Management & Recovery, Inc., a
consulting firm which primarily provided services, directly and as a
subcontractor, to the Resolution Trust Corporation and law firms engaged by the
Resolution Trust Corporation. Mr. Hicks is also a Director and the Corporate
Secretary of the Kirby Lithographic Company, Inc. In 1998 he formed Hicks Little
Company, LLC for the purpose of conducting consulting activity.

RAY M. KEELER was elected a Director of Essex in July 1989. Since 1986, he
has been an independent consultant to both industry and government organizations
in areas related to national and tactical intelligence programs. Mr. Keeler
served on the board of directors of SEDC from December 1987 through April 1989.
From 1988 to November 1995, he was President of CRYTEC, Inc., a service company
providing management, business development and technical support to companies
involved in classified cryptologic projects. Since December 1995, he has been a
consultant to companies involved in national technical intelligence programs.
From 1982 to 1986, Mr. Keeler was Director of Program and Budget for the NSA. He
received a Bachelor of Arts degree from the University of Wisconsin-Madison in
1957.

MARIE S. MINTON was elected a Director of Essex in December 2000. In late
2003, Ms. Minton founded Transition Finance Strategies, L.L.C., a holding
company that owns small businesses in the financial reporting and professional
services areas. From 1994 to June 2003, Ms. Minton was a Managing Director and
the Chief Financial Officer of Global Environment Fund, an international private
equity investment management firm. Before joining GEF, Ms. Minton was the Vice
President of Finance for Clean Air Capital Markets Corporation, a boutique
investment banking firm. From 1986 through 1993, Ms. Minton was an Audit Manager
in the Entrepreneurial Services Division of Ernst & Young. Ms. Minton graduated
from the University of Virginia in 1986 with a Bachelor of Science degree in
Commerce. She is a member of the Virginia Society and American Institute of
Certified Public Accountants, the Washington Society of Investment Analysts, or
WSIA, and the Association for Investment Management and Research. She serves as
an officer and Board member of the WSIA and is a faculty member for the WSIA's
CFA Education Program. Ms. Minton is a Certified Public Accountant and a
Chartered Financial Analyst. She teaches accounting for the WSIA CFA education
program, volunteers as a Girl Scout leader and enjoys riding her horse, Abner,
in her free time.

ARTHUR L. MONEY was elected a Director of Essex in January 2003. Mr. Money
served as the Assistant Secretary of Defense for Command, Control, Communication
and Intelligence (C3I) from October 1999 to April 2001. Prior to his Senate
confirmation in that role, he was the Senior Civilian Official, Office of the
ASD (C3I) from February 1998. Mr. Money also served as the Chief Information
Officer for the Department of Defense from 1998 to 2001. From 1996 to 1998, he
served as Assistant Secretary of the Air Force for Research, Development and
Acquisition,

and as CIO for the Air Force. Prior to his government service, Mr. Money held
senior management positions with ESL Inc., a subsidiary of TRW, and the TRW
Avionics and Surveillance Group. Mr. Money serves on numerous United States
Government Panels, Boards and Commissions. He additionally serves on many U.S.
company boards, advisory boards and advisory groups. Mr. Money received a
Bachelor of Science degree in Mechanical Engineering from San Jose State
University in 1965, a Master of Science degree in Mechanical Engineering from
University of Santa Clara in 1970 and attended the Harvard Executive Security
Program in 1985 and the Program for Senior Executives at the Massachusetts
Institute of Technology in 1988.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") requires the Company's officers and directors, and persons who
own more than ten percent of a registered class of the Company's equity
securities (the "Reporting Persons"), to file reports of ownership and changes
in ownership of equity securities of the Company with the Securities and
Exchange Commission ("SEC"). Officers, directors, and greater than ten percent
shareholders are required by SEC regulations to furnish the Company with copies
of all Section 16(a) forms that they file.

Based solely upon a review of Forms 3 and Forms 4 furnished to the Company
pursuant to Rule 16(a)-3 under the Exchange Act during its most recent fiscal
year and Forms 5 with respect to its most recent fiscal year, the Company
believes that all such forms required to be filed pursuant to Section 16(a) of
the Exchange Act were timely filed by the Reporting Persons during the fiscal
year ended December 28, 2003, other than one filing each by Ms. DeChello, Mr.
Kurry, Mr. Leonard, and Mr. Price.

ADVISORY BOARDS

We have two advisory boards, composed of recognized leaders in the
intelligence community, defense industry and communications industry, to assist
us in identifying opportunities to market our services and products.

NATIONAL PROGRAMS ADVISORY BOARD

The National Programs Advisory Board provides us with strategic guidance
concerning the application of our optoelectronic and signal processing
technology for high priority national security projects. Members of this board
routinely meet with our technical and business development teams to assist in
identifying opportunities in the intelligence community. The following
individuals are members of our National Programs Advisory Board:

LIEUTENANT GENERAL CLAUDIA KENNEDY (retired) is the first and only woman to
receive this flag rank in the United States Army. She served in the U.S. Army
with distinction for 32 years, culminating in her appointment as Deputy Chief of
Staff for Intelligence from 1997 to 2000. During her career, General Kennedy
received numerous awards and decorations including the National Intelligence
Distinguished Service Medal, the Legion of Merit (three Oak Leaf Clusters), and
the Women's International Center's 1998 Living Legacy Patriot Award. General
Kennedy has been named to a list of "Best Women Role Models," and Vanity Fair's
"Most Influential." She was also named to the Ladies Home Journal's "100 Most
Important Women's"

list. General Kennedy has been honored for leadership and lifetime achievement
by such organizations as Business and Professional Women (USA), Girl Scout
Council of Hawaii, Women Executives and State Government, National Women's Law
Center, and the National Center for Women and Policy. She has received honorary
degrees from Trinity College in Hartford, Connecticut, Rhodes College in
Memphis, Tennessee, and Gannon University in Erie, Pennsylvania.

LIEUTENANT GENERAL KENNETH MINIHAN retired from the U.S. Air Force in 1999
after more than 33 years of distinguished service. He has served in many
important positions including Director of the National Security Agency/Central
Security Service and Director of the Defense Intelligence Agency. Currently, he
is President of the Security Affairs Support Association, an organization for
industry and government partnership to enhance intelligence business
development. Among his awards and decorations are the National Security Medal,
the Defense Distinguished Service Medal, the Bronze Star and the National
Intelligence Distinguished Service Medal.

REAR ADMIRAL DONALD MCDOWELL retired from the U.S. Navy after more than 32
years of distinguished service. For over three years, he commanded the
worldwide, 10,000 person Naval Security Group responsible for ship, airborne,
and shore cryptologic systems. He also served as the Deputy Director of Naval
Intelligence and Chief of Support to Military Operations at the National
Security Agency. Since retiring from the Navy, he has been an active consultant
to the intelligence industry on cryptologic and intelligence operations and
systems.

TECHNICAL ADVISORY BOARD

Our Technical Advisory Board provides us with valuable advice, experience
and access. By introducing us to key participants in our industry, we are better
able to promote our services and products. The following individuals are members
of our Technical Advisory Board:

DR. PAUL GREEN is a well-known communications expert recognized as the
progenitor of the all-optical network with the publication of his book, FIBER
OPTIC NETWORKS in 1993 by Prentice Hall. His career began at MIT Lincoln Labs
where he developed the first operational spread spectrum system. In 1958 he was
the co-inventor and co-developer of RAKE receivers that are now widely used in
cellular code division multiple access, or CDMA. In 1969, he became a senior
manager at IBM Research Division where he later formed a team to develop the
first wavelength division multiplexing network. He became the Director of the
Optical Networking Technology Group at Tellabs in 1997 where he led a team to
develop one of the first all-optical cross connect. Dr. Green is the past
president of two Institute of Electrical and Electronics Engineers, or IEEE,
professional societies, a member or chairman of several U.S. Government panels
and editor of many IEEE publications. In 1981 he received the IEEE Pioneer Award
and a National Academy of Engineering Award for his spread spectrum work. In
1994, Dr. Green received the Association of Computing Machinery SigComm Annual
Award for data communications theory, protocols, architectures and technology.

SAM GREENHOLTZ is a recently retired senior engineer in long distance
planning for Verizon. He is a 27-year veteran of Verizon with a well-rounded
background in various segments of the communications industry. Mr. Greenholtz is
well known in the optical networking industry and has been selected to write and
present position papers at such national transport network conferences as
Optical Fiber Conference, National Fiber Optic Engineers Conference, Institute

for International Research and COMPForum. Mr. Greenholtz's primary
responsibility for his last six years at Verizon was technical evaluation of
optical networking products including DWDM, OC-192 and optical cross-connects.
In this role, Mr. Greenholtz completed the paper and laboratory evaluations for
new optical networking products and had the responsibility for placing the first
office applications into the interoffice network. Mr. Greenholtz now serves as a
senior communications consultant and is the founder of Telecom Pragmatics, LLC,
an advisory company to communication and financial services businesses.

JOE HOUSTON has 39 years of engineering expertise and technical management
experience. Mr. Houston is a former President of the International Society for
Optical Engineering, and a noted author of numerous articles on optical
processing. He was the Itek Vice President for Advanced Development and Special
Projects where he pioneered work in optical signal processors. He also was the
President of Houston Research Associates, a private consulting firm.

BOARD COMPOSITION

Our board of directors consists of nine individuals. Directors are elected
annually, and each director holds office for a one-year term. The board
generally meets quarterly. Additionally, our bylaws provide for special meetings
and, as also permitted by Virginia law, board action may be taken without a
meeting upon unanimous written consent of all directors.

Our board of directors has adopted a policy providing that any transaction
or series of similar transactions entered into between us (or any of our
subsidiaries) and one or more of our executive officers, directors or greater
than five percent shareholders, an immediate family member of any of the
foregoing persons, or an entity in which any of the foregoing persons has or
have a direct or indirect material interest, must be approved by a majority of
the directors who do not have an interest in such transaction(s), if the amount
involved in the transaction(s) exceeds $60,000.

BOARD COMMITTEES

The board of directors has three standing committees: the audit committee,
the compensation committee and the ethics committee.

AUDIT COMMITTEE. Our audit committee is established in accordance with
Section 3(a)(58)(A) of the Exchange Act of 1934 as amended, and composed of the
following three directors: Messrs. Hicks and Keeler and Ms. Minton. Messrs.
Hicks and Keeler and Ms. Minton are independent directors within the meaning of
current AMEX listing rules. Ms. Minton is a financial expert as defined by Item
401(h) of Regulation S-K of the Securities Act of 1933, as amended.

The primary responsibilities of the audit committee are to:

o Oversee management's conduct of our financial reporting process and
systems of internal accounting and financial control;

o Monitor the independence and performance of our outside auditors;

o Provide an avenue of communication among the outside auditors,
management and our board of directors;

o Make reports and recommendations to our board and our shareholders as
necessary under the rules of the Securities and Exchange Commission or
as otherwise within the scope of its functions; and

o Oversee and, where appropriate, report to our board on our review of
and response to any government audit, inquiry or investigation, as they
determine to be appropriate.

Our audit committee is monitoring the proposed revised listing standards by
American Stock Exchange pertaining to audit committees, including standards
required pursuant to the Sarbanes-Oxley Act of 2002, and will consider any
further changes to its charter and designated responsibilities as it deems
necessary and appropriate.

COMPENSATION COMMITTEE. Our compensation committee is composed of the
following three directors: Messrs. Hannon, Keeler and Manning are members of
this committee, two of whom are independent directors as defined by the rules of
the U.S. Securities and Exchange Commission and the Internal Revenue Code. The
compensation committee has the authority to recommend to the board of directors
compensation, including incentive compensation, for our directors and officers.
We are currently monitoring the development of revised compensation committee
and other corporate governance requirements by the AMEX in order to comply with
the mandates of the Sarbanes-Oxley Act of 2002 and intend to take steps to
comply with any new requirements adopted by the AMEX.

ETHICS COMMITTEE. Our ethics committee is composed of the following two
members: Mr. Leonard E. Moodispaw and Mr. Frank E. Manning. The primary
responsibilities of the ethics committee are to:

o Advise our management and the entire board of directors of means of
ensuring that we adhere to the highest ethical standards in our day
to day operations;

o Ensure that a positive working environment is created and maintained
for all our employees and that those employees are challenged to
meet such a standard;

o Provide a forum for advice to the corporate counsel, our management
and any of our employees to consider ethical issues; and

o Recommend to our management and the entire board of directors means
of training managers and employees.

CODE OF ETHICS

The Company has adopted a Code of Ethics which applies to all directors and
officers, including the Company's Chief Executive Officer, Chief Financial
Officer and Vice President of Finance. The Company has posted a copy of its Code
of Ethics on its website at www.essexcorp.com. Any person may receive a copy of
this Code of Ethics at no charge by contacting the Company's Chief
Administrative Officer, c/o Human Resources Department via mail, email or
1-800-533-7739.

ITEM 11. EXECUTIVE COMPENSATION

The following table sets forth the aggregate cash compensation paid for
services rendered during the last three fiscal years by the Chief Executive
Officer and the four other most highly compensated executive officers who served
as such at the end of the last fiscal year and whose total compensation exceeded
$100,000.

SUMMARY COMPENSATION TABLE

LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
------------------------------------------------------ ------
SECURITIES
OTHER ANNUAL UNDERLYING
NAME AND PRINCIPAL POSITION YEAR SALARY ($)(1) BONUS ($) COMPENSATION($)(2) OPTIONS/SARS(#)
------------------------------------------ ---- ------------- --------- ------------------ ---------------

Leonard E. Moodispaw 2003 192,556 -- 5,777 30,000
President, CEO and Director 2002 175,032 -- 5,251 30,000
2001 175,032 -- 1,616 85,000

Terry M. Turpin 2003 164,706 10,000 5,269 30,000
Senior Vice President, Chief Scientist 2002 155,064 -- 4,652 20,000
and Director 2001 155,064 -- 4,652 70,000

Joseph R. Kurry, Jr. 2003 140,036 10,000 4,509 15,000
Senior Vice President, Treasurer and CFO 2002 134,992 -- 4,050 10,000
2001 134,992 -- 4,050 40,000

Craig H. Price 2003 139,260 5,000 4,335 --
Vice President 2002 134,992 -- 4,050 7,500
2001 134,992 -- 4,050 25,000

Rudolf Liskovec, Jr. 2003 201,845 32,000 9,418 40,000
Vice President (3)

(1) Includes amounts deferred at the election of the named executive officer
pursuant to Section 401(k) of the Internal Revenue Code ("401(k)").

(2) Represents matching 401(k) contributions made on behalf of the respective
named executive officer pursuant to Essex's Retirement Plan and Trust.
Excludes other perquisites and benefits not exceeding the lesser of $50,000
or 10% of the named executive officer's total annual salary and bonus.

(3) Mr. Liskovec was hired on May 5, 2003. Prior to that time, Mr. Liskovec was
a self employed consultant on direct program work for Essex and was paid
$4,620 in the period October - December 2002 and $90,860 in the period
January 2003 - April 2003. The amount paid in 2003 for consulting is
included in salary in the table above. Mr. Liskovec also received a non
qualified stock option for 10,000 shares in November 2002 with an exercise
price at the market price of $2.36. Mr. Liskovec was paid signing and other
bonuses in 2003 of $32,000.

EMPLOYEE BENEFIT PLANS

DEFINED CONTRIBUTION RETIREMENT PLAN. The Essex Corporation Retirement Plan
and Trust is a qualified defined contribution retirement plan which includes a
401(k) salary reduction feature for its employees. This plan calls for an
employer matching contribution of up to 3% of eligible employee compensation
under the salary reduction feature and a discretionary contribution as
determined by the board of directors. We did not make any discretionary
contribution between

2001 and 2003. The total authorized contribution under the matching contribution
feature of this plan was approximately $125,000 in 2003, $78,000 in 2002 and
$64,000 in 2001. All employee contributions are 100% vested at all times and our
contributions vest based on length of service. Vested contributions are
distributable and benefits are payable only upon death, disability, retirement
or break in service. Participants may request that their accrued benefits under
the Section 401(k) portion of the plan be allocated among various investment
options established by the plan administrator.

Our contributions under this plan for the persons referred to in the
Summary Compensation Table are included in that table.

EMPLOYEE INCENTIVE PERFORMANCE AWARD PLAN. We have an Employee Incentive
Performance Award Plan under which bonuses are distributed to employees. All
employees are eligible to receive such awards under flexible criteria designed
to compensate for superior division and individual performance during each
fiscal year. Awards are generally recommended annually by management and
approved by the board of directors. These awards may be constrained by our
overall financial performance. In 2003, we paid approximately $49,000, including
the $25,000 awarded to three of the persons named in the Summary Compensation
Table, under this plan. We did not make any awards under this plan in 2001 or
2002.

RESTRICTED STOCK BONUS PLAN. We have a Restricted Stock Bonus Plan under
which up to 50,000 shares of our common stock may be reserved for issuance to
non-employee members of the board of directors and key employees selected by the
board of directors. Shares of restricted stock may be issued under the Plan
subject to forfeiture during a restriction period, fixed in each instance by the
board of directors, whereby all rights of the grantee to the stock terminate
upon certain conditions such as cessation of continuous employment during the
restriction period. Upon expiration of the restriction period, or earlier upon
the death or substantial disability of the grantee, the restrictions applicable
to all shares of restricted stock of the grantee expire. While this plan also
provides that we may advance loans to a grantee to pay income taxes due on the
taxable value of shares granted under the plan, we have never issued any such
loans. The Board of Directors has prohibited these loans.

STOCK OPTION PLANS

We have established several stock option and stock appreciation rights
plans. These plans provide for the grant of options to purchase shares of our
common stock which qualify as incentive stock options under Section 422 of the
Internal Revenue Code of 1986, as amended, or the Code, to persons who are our
employees, as well as non-qualified options which do not so qualify to be issued
to persons or consultants, including those who are not employees. These plans
also provide for grants of stock appreciation rights, or SARs, in connection
with the grant of options under the plans. The exercise price of an incentive
stock option under the plans may not be less than the "fair market value" of the
shares at the time of grant; the exercise price of non-qualified options and the
appreciation base price of SARs are determined in the discretion of the board of
directors except that the SAR appreciation base price may not be less than 50%
of the fair market value of a share of common stock on the grant date with
respect to awards to persons who are officers or directors of Essex.

We grant non-plan, non-qualified options from time to time directly to
certain parties. In 2003, we issued such options for 30,000 shares to our Chief
Scientist and 10,000 shares to our

Chief Financial Officer/Treasurer. We issued such options for 85,000 shares to
our President and 40,000 to our Chief Financial Officer/Treasurer in 2001. Also
in 2001, we issued such options to purchase 45,000 shares to another one of our
employees. We did not grant any non-plan, non-qualified options in 2002.

The following table shows for the fiscal year ended December 28, 2003 for
the persons named in the Summary Compensation Table, information with respect to
options to purchase common stock granted during 2003.

STOCK OPTION GRANTS
FOR FISCAL YEAR ENDED DECEMBER 28, 2003

POTENTIAL REALIZABLE
VALUE AT ASSUMED
NUMBER OF % OF TOTAL ANNUAL RATES OF STOCK
SECURITIES OPTIONS/SARS PRICE APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OR OPTION TERM
OPTIONS EMPLOYEES IN BASE PRICE EXPIRATION -----------
NAME GRANTED 2003 PER SHARE DATE 5% 10%
---- ------- ---- --------- ---- -- ---

Leonard E. Moodispaw 30,000(2) 6.5 $ 3.61 05-18-13 $ 176,409 $ 280,902

Terry M. Turpin 30,000(2) 6.5 $ 3.61 05-18-13 $ 176,409 $ 280,902

Joseph R. Kurry, Jr. 5,000(1) 1.1 $ 3.34 03-24-13 $ 27,203 $ 46,817
10,000(2) 2.2 $ 3.61 05-18-13 $ 58,803 $ 86,631

Craig H. Price -- -- $ -- -- $ -- $ --

Rudolf Liskovec 30,000(2) 6.5 $ 3.61 05-18-13 $ 176,409 $ 280,902
10,000(3) 2.2 $ 5.71 09-04-13 $ 93,010 $ 148,103

(1) Such options became exercisable beginning March 25, 2003.
(2) Such options became exercisable beginning May 19, 2003.
(3) Such options became exercisable beginning September 5, 2003.

The following table shows for the fiscal year ended December 28, 2003 for
the persons named in the Summary Compensation Table, information with respect to
option/SAR exercises and fiscal year end values for unexercised options/SARs.

AGGREGATED OPTION/SAR EXERCISES AND OPTION/SAR
VALUES FOR FISCAL YEAR ENDED DECEMBER 28, 2003

NUMBER OF SECURITIES VALUE OF UNEXERCISED
SHARES UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT
ACQUIRED OPTIONS AT FY-END # FY-END $ (1)
ON VALUE --------------------------- ---------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- -------- -------- ----------- ------------- ----------- -------------

Leonard E. Moodispaw -- -- 380,000 15,000 $ 2,731,100 $ 90,300

Terry M. Turpin 4,000 $ 20,720 221,450 550 $ 1,470,582 $ 3,999

Joseph R. Kurry, Jr. 5,200 $ 26,780 170,500 7,500 $1,183,980 $ 45,825
2,800 $ 15,120 -- -- -- --

Craig H. Price 3,000 $ 17,580 101,500 0 $ 698,420 $ 0

Rudolf Liskovec -- $ -- 30,000 20,000 $ 182,600 $ 109,900

(1) Market value of underlying securities based on the closing price of Essex's
common stock on December 26, 2003 (last trading day of fiscal 2003) on the AMEX
of $9.63 minus the exercise price.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

None of our executive officers serves on the board of directors or
compensation committee of any entity that has one or more executive officers
serving as a member of our board of directors or compensation committee.

DIRECTOR COMPENSATION

Non-employee members of the board of directors receive a maximum of $1,500
for each board meeting and $750 for each board committee meeting they attend.
Such members are also reimbursed for travel expenses incurred in connection with
their attendance at board and committee meetings. One member of the board of
directors, Arthur L. Money, receives $1,500 per month for serving on an informal
committee of the board with Messrs. Hannon and Leonard. The members of our board
of directors who are affiliated with our significant shareholders, GEF and The
Hannon Family LLC, have waived the right to receive any board fees. Employee
directors do not receive fees for their service on our board of directors.

In addition, non-employee members of the board of directors are eligible to
participate in our Restricted Stock Bonus Plan. Shares of restricted stock may
be issued under this plan subject to forfeiture during a restriction period,
fixed in each instance by the board of directors, whereby all rights of the
grantee to the stock terminate upon certain conditions such as cessation of
continuous membership on our board during the restriction period. Upon
expiration of the restriction period, or earlier upon the death or substantial
disability of the grantee, the restrictions applicable to all shares of
restricted stock of the grantee expire. While this plan also provides that we
may advance loans to a grantee to pay income taxes due on the taxable value of
shares granted under the plan, we have never issued any such loans. The Board of
Directors has prohibited these loans.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT

The following table and accompanying notes set forth as of March 1, 2004,
information with respect to the beneficial ownership of the Company's voting
securities by (i) each person or group who beneficially owns more than 5% of the
voting securities, (ii) each of the directors of the Company, (iii) each of the
officers of the Company named in the Summary Compensation Table, and (iv) all
directors and executive officers of the Company as a group.

Percentage of Outstanding
Outstanding Shares of
Amount and Nature of Common Stock
Name and Address of Beneficial Owner* Beneficial Ownership (1) Beneficially Owned
--------------------------------------------------- ------------------------ -------------------------

H. Jeffrey Leonard (2) 2,344,533 15.6

John G. Hannon (3) 2,049,498 13.6

Caroline S. Pisano (4) 753,000 5.0

Terry M. Turpin (5) 496,643 3.3

Leonard E. Moodispaw (6) 437,950 2.8

Joseph R. Kurry, Jr. (7) 215,814 1.4

Frank E. Manning (8) 124,775 **

Craig H. Price (9) 118,712 **

Rudy Liskovec (10) 30,000 **

Robert W. Hicks (11) 71,700 **

Ray M. Keeler (12) 46,500 **

Marie S. Minton (13) -- --

Arthur L. Money (14) 10,000 **

GEF Management Corporation ("GEFMC") (15) 2,314,758 15.4

Global Environment Capital Co. LLC ("GECC") (15)
2,314,758 15.4

Global Environment Strategic Technology
Partners ("GESTP") (15) 2,314,758 15.4

GEF Technology Managers, Co., LLC
("GEFTM") (15) 2,314,758 15.4

The Hannon Family LLC (16) 1,438,973 9.6

Systematic Financial Management, LP (17) 915,130 6.1

All Directors and Executive Officers
as a Group (16 persons) (18) 6,906,643 42.6

* Except as noted below, all beneficial owners are directors and/or
officers of the Company and can be reached c/o Essex Corporation, 9150
Guilford Road, Columbia, MD 21046.

** Less than 1%.

(1) The shares listed above include options and rights to acquire shares
within sixty (60) days and shares held of record by the Essex Corporation
Retirement Trust as to which shares the respective participant has
disposition and voting rights. The percentage ownership is computed based
upon the number of shares which would be outstanding if such options and
rights were exercised.

(2) H. Jeffrey Leonard is Chairman of the Board of the Company and the
President and a director of GEFMC. Of the shares of Common Stock shown as
beneficially owned, 29,775 are owned directly by Mr. Leonard. In
addition, 2,314,758 shares of Common Stock may be deemed to be
beneficially owned by Mr. Leonard as described in footnotes (15) and (19)
below. Mr. Leonard's address is c/o GEF Management Corporation, 1225 Eye
Street, N.W., Suite 900, Washington, DC 20005. Mr. Leonard is the
brother-in-law of Ms. Pisano.

(3) John G. Hannon is a Director of the Company. Of the shares of Common
Stock shown as beneficially owned, 610,525 are owned directly by Mr.
Hannon. In addition, 1,438,973 shares of Common Stock may be deemed to be
beneficially owned by Mr. Hannon as described in footnote (16) below.

(4) Caroline S. Pisano is Vice President of Finance and General Counsel of
the Company. Ms. Pisano is the sister-in-law of Mr. Leonard.

(5) Terry M. Turpin is a Director, Senior Vice President and Chief Scientist
of the Company. Of the shares shown as beneficially owned, 221,450
represent presently exercisable rights to acquire Common Stock through
stock options.

(6) Leonard E. Moodispaw is President, Chief Executive Officer and a Director
of the Company. Of the shares shown as beneficially owned, 380,000
represent presently exercisable rights to acquire Common Stock through
stock options.

(7) Joseph R. Kurry, Jr. is Senior Vice President, Treasurer and Chief
Financial Officer of the Company. Of the shares shown as beneficially
owned, 165,500 represent presently exercisable rights to acquire Common
Stock through stock options.

(8) Mr. Manning is the Chairman Emeritus and a Director of the Company. Of
the shares shown as beneficially owned, 42,000 represent presently
exercisable rights to acquire Common Stock through stock options. Does
not include 37,500 shares of the Company's Common Stock owned of record
and beneficially by Mrs. Eva L. Manning, wife of Mr. Frank E. Manning.
Also does not include 63,000 shares beneficially owned by separate family
trusts of which Mrs. Manning is the sole trustee and over which trusts
she has exclusive voting and dispositive power.

(9) Craig H. Price is Vice President of the Company. Of the shares shown as
beneficially owned, 101,500 represent presently exercisable rights to
acquire Common Stock through stock options.

(10)Rudy Liskovec is Vice President of the Company. Of the shares shown as
beneficially owned, 30,000 represent presently exercisable rights to
acquire Common Stock through stock options.

(11)Robert W. Hicks is a Director of the Company. Of the shares shown as
beneficially owned, 31,500 represent presently exercisable rights to
acquire Common Stock through stock options.

(12)Ray M. Keeler is a Director of the Company. Of the shares shown as
beneficially owned, 32,500 represent presently exercisable rights to
acquire Common Stock through stock options.

(13)Marie S. Minton is a Director of the Company.

(14)Arthur L. Money is a Director of the Company. Of the shares shown as
beneficially owned, 10,000 represent presently exercisable rights to
acquire Common Stock through stock options.

(15)Consists of 582,473 shares of Common Stock directly owned by GEFMC. Also
consists of (i) 118,200 shares of Common Stock directly owned by GECC, by
virtue of the arrangements described in footnote (19), (ii) 864,166
shares of Common Stock directly owned by GESTP, by virtue of the
arrangements described in footnote (19) and (iii) 749,919 shares of
Common Stock directly owned by GEFTM, by virtue of the arrangements
described in footnote (19) below. GEF is a Delaware limited liability
company with its principal executive offices located at 1225 Eye Street,
N.W., Suite 900, Washington, DC 20005.

(16)Consists of 1,438,973 shares directly held by The Hannon Family LLC. Mr.
John G. Hannon is the managing person of this entity.

(17)Based on a Schedule 13G filed with the SEC on February 12, 2004.
Systematic Financial Management, L.P. address is 300 Frank W. Burr
Boulevard, Glenpointe East, 7th Floor, Teaneck, NJ 07666.

(18)Of the shares shown as beneficially owned, 1,172,100 represent presently
exercisable rights to acquire Common Stock through stock options.

(19)Based on a Schedule 13D/A filed with the SEC on February 24, 2004, each
of GEFMC, GECC, GESTP, GEFTM, and Mr. Leonard may be deemed the
beneficial owner of 2,314,758 shares of Common Stock directly held for
the account of GEF.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

PRIVATE PLACEMENTS WITH INVESTOR GROUPS

GEF OPTICAL INVESTMENT COMPANY, LLC, OR GEF, AND NETWORKING VENTURES,
L.L.C. From September 2000 through October 2002, we sold shares of our
convertible preferred stock and common stock in private placement funding
transactions with GEF and Networking Ventures, L.L.C., or their affiliates,
aggregating $4.4 million:

On September 7, 2000, we sold 500,000 shares of our Series B convertible
preferred stock at a price of $4.00 per share for an aggregate of $2.0 million
and issued warrants to purchase 2.0 million shares of our common stock; 1.0
million each to GEF and Networking Ventures, L.L.C. All of these shares of
Series B convertible preferred stock shares were converted into 2.0 million
shares of common stock in September 2002. Also in February of 2002, GEF Optical
Investment Company, LLC assigned its warrants to purchase 1.0 million shares of
our common stock to two of its affiliates. These warrants became exercisable
upon completion of the follow-on public offering on December 9, 2003. The 1.0
million warrants were exercised for $0.001 per share and converted into
approximately 1.0 million shares of common stock in December 2003.

On December 4, 2000, we sold 80,000 shares of our common stock to each of
GEF and Networking Ventures at a per share price of $2.50 for an aggregate sum
of $400,000.

On March 15, 2001, we sold 250,000 shares of common stock to each of GEF
and Networking Ventures at a per share price of $4.00 for an aggregate sum of
$2.0 million.

The terms of these agreements were fair as determined by our board of
directors. Mr. H. Jeffrey Leonard is our Chairman of the Board and is a managing
member of GEF. Mr. Hannon is one of our directors. Ms. Pisano is our Vice
President of Finance and General Counsel and is the sister-in-law of Mr.
Leonard. Networking Ventures L.L.C. was owned by Mr. Hannon and Ms. Pisano.
Networking Ventures was dissolved in December 2002. Upon dissolution, Mr. Hannon
received 600,000 shares of common stock and warrants to purchase 600,000 shares
and Ms. Pisano received 400,000 shares of common stock and warrants to purchase
400,000 shares. These warrants became exercisable upon completion of the
follow-on public offering on December 9, 2003. The 1.0 million warrants were
exercised for $0.001 per share and converted into approximately 1.0 million
shares of common stock in December 2003.

GLOBAL ENVIRONMENT STRATEGIC TECHNOLOGY PARTNERS AND THE HANNON FAMILY LLC.
In addition to the transactions described above, we entered into the following
private placement funding transactions with Global Environment Strategic
Technology Partners and The Hannon Family LLC, aggregating $1.75 million:

In December 2001, we sold 76,924 shares of common stock for $6.50 per share
for an aggregate of $500,000. In March of 2002, we sold an additional 153,848
for $6.50 per share for an aggregate of 230,772 shares for $1.5 million pursuant
to these agreements. In connection with the October 2002 investment described
below, the price was adjusted to $3.00 per share and an additional 269,228
shares were issued.

In October 2002, we sold 50,000 shares of common stock for $3.00 per share
for an aggregate of $150,000 and issued warrants for 33,332 shares of our common
stock for a $100,000 deposit. In December 2002, 16,666 of these warrants were
converted into common stock at $3.00 per share and in January 2003, another
16,666 of these warrants were converted into common stock at $3.00 per share.

Global Environment Strategic Technology Partners is an affiliate of GEF.
Mr. H. Jeffrey Leonard, our Chairman of the Board, is the managing member of
GEF. Mr. John G. Hannon, one of our directors, is the managing partner of The
Hannon Family LLC. The terms of these agreements were fair as determined by our
board of directors.

NOTE PURCHASE AGREEMENTS TO HANNON FAMILY LLC

In December 2002, we issued a promissory note in the principal amount of
$500,000 bearing interest at a rate of 10% per annum to The Hannon Family LLC.
The note was converted into shares of our common stock at a conversion price
equal to $2.60 in December 2003 and all interest was waived. In February 2003,
we issued an additional non-convertible promissory note in the principal amount
of $100,000 bearing interest at a rate of 10% per annum, to The Hannon Family
LLC. This note and accrued interest was paid off in cash early in January 2004.
Mr. John G. Hannon is a director of Essex and the managing member of The Hannon
Family LLC. The terms of these notes were fair as determined by our board of
directors.

REGISTRATION RIGHTS

In connection with the foregoing transactions, we granted certain
registration rights to the purchasers.

AGREEMENT WITH SENSYS ENGINEERING, INC.

On August 1, 2003 we entered into an agreement with Sensys Engineering,
Inc., as a subcontractor to us for work to be performed by Mr. James A. Katra,
under one of our contracts. The term of the agreement began August 28, 2003 and
is extended on a month to month basis, for consideration of approximately
$15,000 per month. Mr. Katra is the sole owner of Sensys Engineering, Inc. and
was an employee of Essex until August 28, 2003. The terms of this agreement were
fair as determined by our board of directors.

AGREEMENT WITH LISK TECHNICAL SERVICES, LLC

Prior to his employment with Essex, Mr. Rudy Liskovec, Vice President, was
paid $90,860 in the period January - April 2003. Mr. Liskovec was a self
employed consultant on direct program work for Essex. See Item 11 - Executive
Compensation.

POLICY ON FUTURE RELATED PARTY TRANSACTIONS

Our board of directors has adopted a policy that future transactions over
$60,000 between Essex and our officers, directors, principal shareholders and
their affiliates must be (i) approved by a majority of the disinterested
directors and (ii) on terms no less favorable to us than could be obtained from
unaffiliated third parties.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The Company uses Stegman & Company ("Stegman") as its principal accountant.
The following table shows the fees that were billed to the Corporation by
Stegman for professional services rendered for the fiscal years ended December
28, 2003 and December 29, 2002.

FEE CATEGORY 2003 2002
----------------------------------------------- ----------- -----------

Audit Fees..................................... $ 32,000 $ 32,000
Audit-Related Fees............................. 44,000 --
Tax Fees....................................... 8,000 5,500
All Other Fees................................. -- 1,500
----------- -----------

Total Fees................................ $ 84,000 $ 39,000
=========== ===========

AUDIT FEES

This category includes fees for the audit of the Company's annual financial
statements and review of financial statements included in the quarterly reports
on Form 10-Q.

AUDIT-RELATED FEES

This category includes fees for assurance and related services that are
reasonably related to the performance of the audit or review of the
Corporation's financial statements and are not included above under "Audit
Fees". These services include accounting advice and services in connection with
acquisitions, including comfort letters to underwriters.

TAX FEES

This category includes fees for tax return preparation, tax advice and tax
planning.

ALL OTHER FEES

This category includes fees for products and services provided by Stegman
that are not included in the services reported above.

PRE-APPROVAL OF SERVICES

The Audit Committee pre-approves all services, including both audit and
non-audit services, provided by the Company's independent accountants. For audit
services, each year the independent auditor provides the Committee with an
engagement letter outlining the scope of the audit services proposed to be
performed during the year, which must be formally accepted by the Committee
before the audit commences. The independent auditor also submits an audit
services fee proposal, which also must be approved by the Committee before the
audit commences.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) (1) Consolidated Financial Statements

Report of Independent Auditors 59
Consolidated Balance Sheets 60 - 61
Consolidated Statements of Operations 62
Consolidated Statements of Changes in Shareholders' Equity 63
Consolidated Statements of Cash Flows 64
Notes to Consolidated Financial Statements 65 - 79
(2) Exhibits
(i) None.
(ii) Exhibit 3(i) - Articles of Incorporation A
Exhibit 3(i) - Articles of Amendment B
Exhibit 3(ii) - By-Laws, as amended C
(iii) Exhibit 4 - Instruments defining the Rights of Holders
4.3 Specimen of Common Stock Certificate D
(iv) Exhibit 10 - Material Contracts
10.3 Restricted Stock Bonus Plan D
10.4 Option and Stock Appreciation Rights Plan D
10.6 Pension Plan and Trust Agreement D
10.7 Defined Contribution Retirement Plan D
10.8 Incentive Performance Award Plan D
10.11 Option Agreement between the Company and Rumsey Associates D
Limited Partnership
10.13 Registration Rights Agreement D
10.15 1996 Stock Option and Appreciation Rights Plan E
10.22 1998 Stock Option and Appreciation Rights Plan F
10.23 1999 Stock Option and Appreciation Rights Plan G
10.24 2000 Stock Option and Appreciation Rights Plan H
10.25 Flex Lease Agreement Between PHL-OPCO, LP, as Landlord and I
Essex Corporation, As Tenant, Rivers 95 Columbia, MD
10.26 2001 Stock Option and Appreciation Rights Plan J
10.27 2002 Stock Option and Appreciation Rights Plan K
(v) Exhibit 23 - Consent of Experts and Counsel
23.1 Consent of Independent Auditors 80
(vi) Exhibit 31 - Rule 13a-14(a)/15d-14(a) Certifications
31.1 Rule 13a-14(a)/15d-14(a) Certification of the Chief
Executive Officer 82
31.2 Rule 13a-14(a)/15d-14(a) Certification of the Chief
Financial Officer 83
(vii) Exhibit 32 - Section 1350 Certifications
32.1 Section 1350 Certification of the Chief Executive
Officer L
32.2 Section 1350 Certification of the Chief Financial
Officer L
(viii) Exhibit 99
(a) Securities Purchase Agreement dated September 7, 2000 B
(b) Registration Rights Agreement dated September 7, 2000 B
(c) Common Stock Purchase Warrants dated September 12, 2000
B
(3) Financial Statement Schedules
(i) Schedule II - Valuation and Qualifying Accounts 81

(b) Reports on Form 8-K
(1) Form 8-K dated October 29, 2003 which reported third quarter and
nine months ended September 28, 2003 results.
(2) Form 8-K dated November 6, 2003 which reported that a registration
statement for a proposed follow-on public offering of up to
4,000,000 shares of its common stock had been filed with the SEC.
(3 Form 8-K dated December 11, 2003 which reported that it had
priced the follow-on public offering of its common stock at a
price of $8.50 per share.
(4) Form 8-K dated December 16, 2003 which reported filing of
cautionary risk factor statements in connection with the closing
of the public offering.

-----------------------

A Filed as Exhibit 3(i) to Registrant's Registration Statement on Form SB-2
filed October 17, 1994, Registration No. 33-82920
B Filed as Exhibit to Registrant's Form 8-K dated September 20, 2000
C Filed as Exhibit 3(ii) to Registrant's Registration Statement on Form SB-2
filed October 17, 1994, Registration No. 33-82920
D Filed as Exhibit to Registrant's Registration Statement on Form SB-2
filed October 17, 1994, Registration No. 33-82920
E Filed as Exhibit to Registrant's Form 8-K dated November 13, 1996
F Filed as Exhibit to Form Def 14a - Definitive Proxy Statement dated
October 12, 1998
G Filed as Exhibit to Form Def 14a - Definitive Proxy Statement dated
October 11, 1999
H Filed as Exhibit to Form Def 14a - Definitive Proxy Statement dated
November 10, 2000
I Filed as Exhibit to Registrant's Form 8-K dated December 12, 2001
J Filed as Exhibit to Form Def 14a - Definitive Proxy Statement dated May
23, 2001
K Filed as Exhibit to Form Def 14a - Definitive Proxy Statement dated
October 10, 2002
L These exhibits are being "furnished" with this periodic report and are not
deemed "filed" with the Securities and Exchange Commission and are not
incorporated by reference in any filing of the Company under the
Securities Act of 1933 or the Securities Exchange Act of 1934, whether
made before or after the date hereof and irrespective of any general
incorporation by reference language in any such filing.

SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

ESSEX CORPORATION
(Registrant)

By: /S/ LEONARD E. MOODISPAW
--------------------------------------------
Leonard E. Moodispaw
President and Chief Executive Officer;
Principal Executive Officer
March 15, 2004

By: /S/ JOSEPH R. KURRY, JR.
--------------------------------------------
Joseph R. Kurry, Jr.
Senior Vice President, Treasurer and Chief Financial Officer;
Principal Financial and Accounting Officer
March 15, 2004

In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.

/S/ JOHN G. HANNON /S/ MARIE S. MINTON
------------------------ -------------------------
John G. Hannon, Director Marie S. Minton, Director
March 15, 2004 March 15, 2004

/S/ ROBERT W. HICKS /S/ ARHTUR L. MONEY
------------------------- -------------------------
Robert W. Hicks, Director Arthur L. Money, Director
March 15, 2004 March 15, 2004

/S/ RAY M. KEELER /S/ LEONARD E. MOODISPAW
----------------------- ------------------------------
Ray M. Keeler, Director Leonard E. Moodispaw, Director
March 15, 2004 March 15, 2004

/S/ H. JEFFREY LEONARD /S/ TERRY M. TURPIN
---------------------------- -------------------------
H. Jeffrey Leonard, Director Terry M. Turpin, Director
March 15, 2004 March 15, 2004

/S/ FRANK E. MANNING
--------------------------
Frank E. Manning, Director
March 15, 2004

REPORT OF INDEPENDENT AUDITORS

Audit Committee of the Board of Directors and Shareholders of
Essex Corporation and Subsidiary
Columbia, Maryland

We have audited the accompanying consolidated balance sheets of Essex
Corporation (the "Company") and subsidiary as of December 28, 2003 and December
29, 2002 and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for the fiscal years ended December 28,
2003, December 29, 2002 and December 30, 2001. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the Company
as of December 28, 2003 and December 29, 2002 and the results of its operations
and its cash flows for the fiscal years ended December 28, 2003, December 29,
2002 and December 30, 2001, in conformity with accounting principles generally
accepted in the United States of America.

/s/ Stegman & Company

Stegman & Company

Baltimore, Maryland
February 23, 2004

ESSEX CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 28, 2003 AND DECEMBER 29, 2002

December 28, December 29,
2003 2002
------------------ ---------------

ASSETS

Current Assets

Cash and cash equivalents $ 31,835,294 $ 1,030,247
Accounts receivable, net 3,969,601 565,626
Prepayments and other 146,517 106,987
------------------ ------------------
Total Current Assets 35,951,412 1,702,860
------------------ ------------------

Property and Equipment
Computers and special equipment 1,226,349 948,455
Furniture, equipment and other 250,138 219,112
------------------ ------------------
1,476,487 1,167,567
Accumulated depreciation and amortization (1,107,790) (845,360)
------------------ ------------------
Net Property and Equipment 368,697 322,207
------------------ ------------------

Other Assets
Goodwill 2,998,000 --
Patents, net 333,648 296,407
Other intangibles, net 50,141 --
Other 23,764 21,725
------------------ ------------------
Total Other Assets 3,405,553 318,132
------------------ ------------------

TOTAL ASSETS $ 39,725,662 $ 2,343,199
================== ==================

The accompanying notes are an integral part of these statements.

ESSEX CORPORATION AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 28, 2003 AND DECEMBER 29, 2002

December 28, December 29,
2003 2002
---------------- ----------------

LIABILITIES AND SHAREHOLDERS' EQUITY

Current Liabilities

Accounts payable $ 694,434 $ 659,977
Note payable 100,000 --
Accrued wages and vacation 898,498 233,940
Advance from accounts receivable financing -- 169,432
Accrued retirement plans contribution payable 298,551 65,000
Billings in excess of costs 462,000 135,000
Other accrued expenses 522,538 146,041
Capital leases 4,390 71,261
---------------- -----------------
Total Current Liabilities 2,980,411 1,480,651
---------------- -----------------

Long-Term Debt
Convertible note payable -- 500,000
Capital leases, net of current portion -- 4,390
---------------- -----------------
Total Long-Term Debt -- 504,390
---------------- -----------------
Total Liabilities 2,980,411 1,985,041
---------------- -----------------

Shareholders' Equity
Common stock, no par value; 25 million shares
authorized; 15,241,257 and 7,790,398
shares issued and outstanding, respectively 49,004,021 12,706,520
Additional paid-in capital 2,000,000 2,000,000
Prepaid warrant -- 50,000
Accumulated deficit (14,258,770) (14,398,362)
---------------- -----------------
Total Shareholders' Equity 36,745,251 358,158
---------------- -----------------

TOTAL LIABILITIES AND SHAREHOLDERS'
EQUITY $ 39,725,662 $ 2,343,199
================ =================

The accompanying notes are an integral part of these statements.

ESSEX CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE FIFTY-TWO WEEK FISCAL YEARS ENDED
DECEMBER 28, 2003, DECEMBER 29, 2002 AND DECEMBER 30, 2001

2003 2002 2001
----------------- ----------------- -----------------

Revenues $ 16,286,210 $ 4,506,419 $ 2,641,776
Costs of goods sold and services provided (10,388,831) (2,593,677) (1,342,444)
----------------- ----------------- -----------------
Gross Margin 5,897,379 1,912,742 1,299,332

Selling, general and administrative expenses (4,905,475) (2,668,117) (2,459,631)
Research and development expenses (403,051) (1,394,784) (2,416,837)
Amortization of other intangibles (380,608) -- --
----------------- ----------------- -----------------

Operating Income (Loss) 208,245 (2,150,159) (3,577,136)

Interest (expense) income, net (68,653) (23,458) 7,937
----------------- ----------------- -----------------

Income (Loss) Before Income Taxes 139,592 (2,173,617) (3,569,199)

Provision for income taxes -- -- --
----------------- ----------------- -----------------

Net Income (Loss) 139,592 (2,173,617) (3,569,199)

Beneficial conversion feature of convertible
preferred stock
-- -- (750,000)
----------------- ----------------- -----------------

Net Income (Loss) Attributable to Common Stock $ 139,592 $ (2,173,617) $ (4,319,199)
================= ================= =================

Basic Earnings (Loss) Per Common Share $ 0.02 $ (0.29) $ (0.67)
================= ================= =================

Diluted Earnings (Loss) Per Common Share $ 0.01 $ (0.29) $ (0.67)
================= ================= =================

WEIGHTED AVERAGE NUMBER OF SHARES

Basic 8,706,498 7,410,647 6,493,665

Effect of dilution -
Stock options 1,091,456 -- --
----------------- ----------------- -----------------

Diluted 9,797,954 7,410,647 6,493,665
================= ================= =================

The accompanying notes are an integral part of these statements.

ESSEX CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002 AND
DECEMBER 30, 2001

Common Stock Preferred Stock Total
----------------------- --------------------- Additional Share-
Prepaid Paid-In Accumulated Holder's
Shares Amount Shares Amount Warrant Capital Deficit Equity
--------- ----------- ------- ------------ ------- ----------- ------------ -----------

BALANCE, DECEMBER 31, 2000 4,570,361 $ 6,496,320 312,500 $ 1,250,000 $ -- $ 1,250,000 $(7,905,546) $ 1,090,774
Preferred stock issued -- -- 187,500 750,000 -- -- -- 750,000
Beneficial conversion feature
of preferred stock -- -- -- -- -- 750,000 (750,000) --
Common stock issued 538,462 2,250,000 -- -- -- -- -- 2,250,000
Stock options exercised 49,182 91,806 -- -- -- -- -- 91,806
Retired shares/cashless stock
option tender (2,400) (17,082) -- -- -- -- -- (17,082)
Stock compensation -- 49,000 -- -- -- -- -- 49,000
Net loss -- -- -- -- -- -- (3,569,199) (3,569,199)
----------- ----------- -------- ------------ -------- ---------- ------------ ----------
BALANCE, DECEMBER 30, 2001 5,155,605 8,870,044 500,000 2,000,000 -- 2,000,000 (12,224,745) 645,299
Preferred stock converted 2,000,000 2,000,000 (500,000) (2,000,000) -- -- -- --
Common stock issued 511,538 1,400,003 -- -- -- -- -- 1,400,003
Stock options exercised 81,350 143,398 -- -- -- -- -- 143,398
Retired shares/cashless stock
option tender (6,261) (26,250) -- -- -- -- -- (26,250)
Stock compensation 31,500 269,325 -- -- -- -- -- 269,325
Prepaid warrant issued -- -- -- -- 100,000 -- -- 100,000
Prepaid warrant converted 16,666 50,000 -- -- (50,000) -- -- --
Net loss -- -- -- -- -- -- (2,173,617) 2,173,617)
----------- ----------- -------- ------------ -------- ---------- ------------ ----------
BALANCE, DECEMBER 29, 2002 7,790,398 12,706,520 -- -- 50,000 2,000,000 (14,398,362) 358,158
Common stock sold 4,000,000 31,391,242 -- -- -- -- -- 31,391,242
Stock warrants exercised, net 1,999,892 1,000 -- -- -- -- -- 1,000
Conversion of note payable 192,307 551,528 -- -- -- -- -- 551,528
Acquisition of company
(See Note 11) 1,104,907 4,020,361 -- -- -- -- -- 4,020,361
Stock options exercised 141,017 316,369 -- -- -- -- -- 316,369
Retired shares/cashless stock
option tender (3,930) (32,999) -- -- -- -- -- (32,999)
Prepaid warrant converted 16,666 50,000 -- -- (50,000) -- -- --
Net income -- -- -- -- -- -- 139,592 139,592
----------- ----------- -------- ------------ -------- ---------- ------------ -----------
BALANCE, DECEMBER 28, 2003 15,241,257 $49,004,021 -- $ -- $ -- $2,000,000 $(14,258,770) $36,745,251
=========== =========== ======== ============ ======== ========== ============ ===========

The accompanying notes are an integral part of these statements.

ESSEX CORPORATION AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001

2003 2002 2001
------------- ------------- --------------

Cash Flows From Operating Activities:

Net Income (Loss) $ 139,592 $ (2,173,617) $ (3,569,199)
Adjustments to reconcile Net Income (Loss) to
Net Cash Used In Operating Activities:
Depreciation and amortization 187,085 147,401 193,117
Amortization of other intangibles 380,608 -- --
Stock compensation expense -- 269,325 49,000
Contract reserve/account allowance 120,000 -- --
Inventory valuation reserve -- 29,983 60,000
Interest waived 51,528 -- --
Other 1,115 (91) (1,047)

Change in Assets and Liabilities:
Accounts receivable (2,256,428) (280,977) (119,035)
Inventory 65,000 -- (40,126)
Prepayments and other assets 25,906 (30,480) (43,536)
Accounts payable (66,615) 346,236 181,807
Accrued wages, vacation and retirement 683,641 (2,536) 116,987
Accrued lease settlement -- -- (107,766)
Billings in excess of costs 327,000 135,000 --
Other assets and liabilities 113,134 (57,861) (41,448)
------------- ------------- --------------

Net Cash Used In Operating Activities (228,434) (1,617,617) (3,321,246)
------------- ------------- --------------

Cash Flows From Investing Activities:
Acquisition of company (309,000) -- --
Purchases of property and equipment (193,956) (29,677) (81,965)
Proceeds from sale of property and equipment 2,118 -- 1,047
------------- ------------- --------------

Net Cash Used In Investing Activities (500,838) (29,677) (80,918)
------------- ------------- --------------

Cash Flows From Financing Activities:
Sales of common stock 31,391,242 1,450,003 2,250,000
Sales of preferred stock -- -- 750,000
Convertible note payable -- 500,000 --
Exercise of stock options 283,370 117,148 74,724
Proceeds from note payable 100,000 -- --
Short-term borrowings/repayments, net (169,432) 169,432 --
Prepaid warrant -- 50,000 --
Payment of capital lease obligations (71,261) (177,220) (120,016)
Other 400 -- --
------------- ------------- --------------

Net Cash Provided By Financing Activities 31,534,319 2,109,363 2,954,708
------------- ------------- --------------

Cash and Cash Equivalents
Net increase (decrease) 30,805,047 462,069 (447,456)
Balance - beginning of period 1,030,247 568,178 1,015,634
------------- ------------- --------------
Balance - end of period $ 31,835,294 $ 1,030,247 $ 568,178
============= ============= ==============

The accompanying notes are an integral part of these statements.

ESSEX CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001

NOTE 1: Summary of Significant Accounting Policies and Other Important Factors

These consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary Sensys Development Laboratories, Inc. ("SDL").
As of December 30, 2003, SDL was merged into Essex. All material intercompany
transactions have been eliminated in consolidation.

REPORTING YEAR

The Company is on a 52/53 week fiscal year ending the last Sunday in
December. Years 2003, 2002 and 2001 were 52-week fiscal years.

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Estimates are used when accounting for
uncollectible accounts receivable, inventory obsolescence and valuation,
depreciation and amortization, intangible assets, employee benefit plans and
contingencies, among others. Actual results could differ from those estimates.

IMPORTANT BUSINESS RISK FACTORS

The Company has historically been principally a supplier of technical
services under contracts or subcontracts with departments or agencies of the
U.S. Government, primarily the military services and other departments and
agencies of the Department of Defense, or DoD. The Company's revenues have been
and continue to come from such programs. The Company is focusing and expanding
in this business area. See Note 11 -- Acquisition.

In recent years, the Company has expended significant funds to transition into
the commercial marketplace, particularly the productization of its proprietary
technologies in telecommunications and optoelectronic processors. In June 2000,
the Company announced that it had filed applications to secure patent protection
for innovative technologies in two communications device families: HYPERFINE WDM
(wavelength division multiplexing) devices and wireless optical processor
enhanced receiver architecture. Since September 2000, the Company has received
over $6 million in financing from its Private Investors or affiliates to advance
its programs to capitalize upon these inventions. The long-term success of the
Company in these areas is dependent on its ability to successfully develop and
market products related to its communications devices and optoelectronic
processors. The success of these efforts is subject to changing technologies,
competition and ultimately, market acceptance.

ESSEX CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001

Primarily due to the expenditures for research and development ("R&D") and
marketing of its optoelectronics products and services, particularly the optical
telecommunications device technologies, the Company incurred significant losses
in 2002 and 2001. The Company reduced R&D expenses to $403,000 in 2003 and had
$140,000 in net income. The Company plans to continue research and development
spending in 2004 in the optoelectronics operations.

The Company is seeking to establish joint ventures or strategic
partnerships including licensing of its technologies with major industrial
concerns to facilitate these goals. Significant delays in the commercialization
of the Company's optoelectronic products or failure to market such products
would have an adverse effect on the Company's future operating results.

CONTRACT ACCOUNTING

Revenues consist of services rendered on cost-plus-fixed-fee, time and
materials and fixed-price contracts. Revenue on time and materials contracts
(approximately 57%, 5% and 16% of total revenues in 2003, 2002 and 2001,
respectively) is recognized to the extent of billable rates multiplied by hours
delivered, plus other direct costs. Revenue on cost-plus-fixed-fee contracts
(approximately 27%, 67% and 39% of total revenues in 2003, 2002 and 2001,
respectively) is recognized to the extent of costs incurred plus a proportionate
amount of fee earned. Revenue on fixed-price contracts (approximately 16%, 28%
and 45% of total revenues in 2003, 2002 and 2001, respectively) is recognized on
the percentage-of-completion method of accounting based on costs incurred in
relation to the total estimated costs. Anticipated losses are recognized as soon
as they become known. A portion of the Company's business is with agencies of
the U.S. Government and such contracts are subject to audit by cognizant
government audit agencies. Furthermore, while such contracts are fully funded by
appropriations, they may be subject to other risks inherent in government
contracts, such as termination for the convenience of the government. Because of
the inherent uncertainties in estimating costs and the potential for audit
adjustments by U.S. Government agencies, it is at least reasonably possible that
the estimates will change in the near term.

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments purchased with expected
original maturities of three months or less to be cash equivalents.

ESSEX CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost. Depreciation is calculated using
straight-line methods based on useful lives as follows:

Leasehold improvements Life of lease
Computers and special equipment 3 to 5 years
Furniture and equipment 3 to 5 years

Repairs and maintenance are charged to expense as incurred. When assets are
retired or otherwise disposed of, the asset and related allowance for
depreciation are eliminated from the accounts and any resulting gain or loss is
reflected in income.

PATENT COSTS

Patent costs include legal and filing fees covering the various patents
which have been issued or are issuable to the Company. Patent costs are
amortized over their respective lives (15-20 years) and amortization was $16,000
in 2003 and $15,000 in 2002 and 2001.

IMPAIRMENT OF LONG-LIVED ASSETS

Long-lived assets and identifiable intangibles to be held and used are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount should be addressed. Impairment is measured by
comparing the carrying value to the estimated undiscounted future cash flows
expected to result from use of the assets and their eventual disposition. No
impairment was recognized in 2001 - 2003.

INCOME TAXES

Deferred income taxes are recorded under the asset and liability method
whereby deferred tax assets and liabilities are recognized for the future tax
consequences, measured by enacted tax rates, attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss carryforwards. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period the rate change becomes effective. Valuation allowances are
recorded for deferred tax assets when it is more likely than not that such
deferred tax assets will not be realized.

BASIC AND DILUTED EARNINGS (LOSS) PER COMMON SHARE

Basic earnings (loss) per common share are computed using the weighted
average number of common shares outstanding during the period reduced by
contingently returnable shares and, in 2001, includes common shares issuable
upon the required conversion of preferred stock. Diluted

ESSEX CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001

earnings per common share incorporates the incremental shares issuable upon the
assumed exercise of stock options, warrants and conversion of convertible debt.
Such incremental shares were anti dilutive for 2002 and 2001.

In October 1995, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation." SFAS No. 123 defines a "fair value based method" of
accounting for an employee stock option or similar equity instrument. Under the
fair value based method, compensation cost is measured at the grant date based
on the value of the award and is recognized over the service period. The Company
has historically accounted for employee stock options or similar equity
instruments under the "intrinsic value method" as defined by APB Opinion No. 25,
"Accounting for Stock Issued to Employees." Under the intrinsic value method,
compensation cost is the excess, if any, of the quoted market price of the stock
at grant date or other measurement date over the amount an employee must pay to
acquire the stock.

SFAS No. 123 allows an entity to continue to use the intrinsic value method
and management has elected to do so. However, entities electing to remain with
the accounting in APB Opinion No. 25 must make pro forma disclosures of net
income and earnings per share, as if the fair value based method of accounting
had been applied. Because the SFAS No. 123 method of accounting has not been
applied to options granted prior to January 1, 1995, the resulting pro forma
compensation costs may not be representative of the cost to be expected in
future years. Accordingly, net loss and loss per share would be as follows:

DECEMBER 28, DECEMBER 29, DECEMBER 30,
2003 2002 2001
---- ---- ----

Net income (loss) attributable to common

shareholders $ 139,592 $ (2,173,617) $ (4,319,199)

Less: Total stock-based employee compensation
expense determined under fair value
based method for all awards (837,553) (897,452) (1,224,974)
------------ ------------ -------------

Pro forma loss attributable to common
shareholders $ (697,961) $ (3,071,069) $ (5,544,173)
============ ============ =============

Loss per share:

Basic-as reported $ 0.02 $ (0.29) $ (0.67)

Basic-pro forma $ (0.08) $ (0.41) $ (0.85)

Diluted-as reported $ 0.01 $ (0.29) $ (0.67)

Diluted-pro forma $ (0.08) $ (0.41) $ (0.85)

ESSEX CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001

The fair value of each option is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions:

2003 2002 2001
---- ---- ----

Dividend yield 0.00% 0.00% 0.00%

Volatility 63.97% 101.50% 84.85%

Weighted average risk free interest rate 3.97% 4.32% 5.18%

Weighted average expected lives of grants 10 years 9.7 years 9.6 years

The weighted average grant date fair value of the options issued in 2003,
2002 and 2001 was approximately $3.23, $2.30 and $3.81, respectively.

RESEARCH AND DEVELOPMENT

Research and development costs are expensed as incurred. Such costs include
direct labor and materials as well as a reasonable allocation of indirect costs.
However, no selling, general and administrative costs are included. Equipment
which has alternative future uses is capitalized and charged to expense over its
estimated useful life.

STATEMENTS OF CASH FLOWS

Supplemental disclosures of cash flow information are as follows:

A. Cash paid during the year for --

2003 2002 2001
---- ---- ----

Interest $ 39,000 $ 27,000 $ 16,600
Income taxes $ -- $ -- $ --

B. There were no new capital leases in 2003. In 2002 and 2001, there were new
capital leases of $62,000 and $288,000, respectively.

C. The Company issued approximately 683,000 shares of common stock related to
the March 1, 2003 acquisition of Sensys Development Laboratories. The
additional 422,000 shares of common stock issued into escrow were returned
in early 2004. See Note 11- Acquisition.

ESSEX CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001

NOTE 2: Accounts Receivable

Accounts receivable consist of the following:

2003 2002
---- ----
U.S. Government

Amounts billed, including retainages $ 4,139,601 $ 611,526

Commercial and other -- 4,100
----------- ---------
4,139,601 615,626

Contract reserves and allowances for
doubtful accounts (170,000) (50,000)
----------- ---------
$ 3,969,601 $ 565,626
=========== =========

U.S. Government receivables arise from U.S. Government prime contracts and
subcontracts. Retainages (which are not material) will be collected upon job
completion or settlement of audits performed by cognizant U.S. Government audit
agencies. The accuracy and appropriateness of the Company's direct and indirect
costs and expenses under its government contracts and, therefore, its
receivables recorded pursuant to such contracts, are subject to extensive
regulation and audit by the Defense Contract Audit Agency or by other
appropriate governmental agencies. These agencies have the right to challenge
the Company's direct and indirect costs charged to any such contract.
Additionally, substantial portions of the payments to the Company under
government contracts are provisional payments that are subject to potential
adjustment upon audit by such agencies. Company cost records have been audited
through 2000. In the year an audit is settled, the difference between audit
adjustments and previously established reserves is reflected in income.

Contract reserves and allowances for doubtful accounts have been provided
where less than full recovery under the contract is expected.

NOTE 3: Accounts Receivable Financing

The Company has a working capital financing agreement with an accounts
receivable factoring organization. Under such an agreement, the factoring
organization may purchase certain of the Company's accounts receivable subject
to full recourse against the Company in the case of nonpayment by the customers.
The Company generally receives 85%-90% of the invoice amount at the time of
purchase and the balance when the invoice is paid. The Company is charged an
interest fee and other processing charges, payable at the time each invoice is
paid. There were no funds advanced as of December 28, 2003 and $169,000 of funds
advanced as of December 29, 2002.

ESSEX CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001

NOTE 4: Major Customer Information

In fiscal 2003, the Company had revenues of $3.5 million (approximately
21.5% of revenues) from its subcontract to provide communications systems
support to the intelligence community. The Company also had $3.3 million in
revenues (approximately 20.6% of 2003 revenues) from the DoD Missile Defense
Agency to design a next generation optoelectronic radar processor. Begun in
2002, such work amounted to $2,052,000 of 2002 revenues (46% of revenues). The
Company had revenues in 2003 of $1.7 million (approximately 10.2%) from a
subcontract to the Boeing Corporation to provide engineering advisory services
to the intelligence community. Another significant customer program in prior
years was for work to an agency of the Department of Defense. The Company is
continuing research work under this subcontract on the use of its
optoelectronics technology and devices in certain customer systems and
applications. Such work amounted to approximately $541,000 (3%) of revenues in
2003, $1,002,000 (22%) of revenues in 2002 and $1,030,000 (39%) of 2001
revenues.

NOTE 5: Commitments and Contingencies

LEASE OBLIGATIONS

The Company leases office space and certain equipment. As of December 28,
2003, the Company is committed to pay aggregate rentals under these leases as
follows:

2004 $ 436,000
2005 $ 397,000
2006 $ 201,000
2007 $ 207,000

Rental expense charged to operations, including payments made under
short-term leases, amounted to $442,000, $275,000 and $261,000 in 2003, 2002 and
2001, respectively.

The Company has one office facility under a long-term lease which expires
October 2005 and another office under a long-term lease which expires December
2007. The leases contain provisions to pay for proportionate increases in
operating costs and property taxes.

NOTE 6: Convertible Note Payable

On December 17, 2002, the Company entered into a Convertible Note Purchase
Agreement with one of its Private Investors. The Company issued a $500,000
unsecured promissory note due December 31, 2004. The note bore interest at 10%;
such interest was deferrable until maturity. The outstanding principal balance
was convertible into common stock at $2.60 per share, the approximate market
price of the Company's stock at the date of issuance of the note. If the note
was converted, then no interest would be paid. The note was converted into
192,307 shares of common stock on December 22, 2003 and $51,528 of interest was
waived.

ESSEX CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001
NOTE 7: Retirement Plan

The Company has a qualified defined contribution retirement plan, the Essex
Corporation Retirement Plan and Trust, which includes a salary reduction 401(k)
feature for its employees. The Plan calls for an employer matching contribution
of up to 3% of eligible employee compensation under the salary reduction feature
and allows for a discretionary contribution. Total authorized contributions
under the matching contribution feature of the Plan were approximately $125,000
in 2003, $78,000 in 2002 and $64,000 in 2001. There were no discretionary
contributions in these years.

In accordance with the retirement plan and trust, as amended, such
authorized contributions and the resulting annual expense can be reduced by
forfeitures by terminated employees of unvested amounts of prior years'
contributions. Forfeitures of $5,000, $13,000 and $2,000 were utilized to reduce
annual expenses in 2003, 2002 and 2001, respectively.

The Company is continuing the qualified defined contribution and profit
sharing retirement plan of the acquired company, SDL, until December 2004. Under
this plan, the Company recognized the required contribution of 8% or $154,000
and an additional contribution of 5% or $96,000, total $250,000, for the period
since acquisition, March 1, 2003 to December 28, 2003.

NOTE 8: Income Taxes

The components of the Company's net deferred tax asset account are as
follows as of the end of each fiscal year:

2003 2002
-------------- --------------

NOL and tax credit carryforward $ 4,043,000 $ 4,075,000

Inventory valuation reserve 104,000 107,000

Accrued employee benefit costs 81,000 40,000

Allowance for doubtful accounts 58,000 17,500

Other, net 6,000 18,000
-------------- --------------
Deferred tax assets 4,292,000 4,257,500
-------------- --------------
Cash basis tax reporting (613,000) --

Billings in excess of costs (146,000) --
-------------- --------------
Deferred tax liabilities (759,000 --
-------------- --------------
Net deferred tax assets 3,533,000 4,257,500

Valuation Reserve (3,533,000) (4,257,500)
-------------- --------------
Net Deferred Tax Asset $ -- $ --
============== ==============

ESSEX CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001

The valuation allowance decreased during 2003 due primarily to cash basis
reporting for the acquired company and increased in 2002 by $712,000, due
primarily to the increase in the net operating loss carryforward.

Income taxes (benefit) are reconciled to the amount computed by applying
the federal corporate tax rate of 34% to income (loss) before taxes as follows:

Fiscal Year
------------------------------------------
2003 2002 2001
----------- ----------- ------------
Income tax expense (benefit) at

federal corporate rate $ 47,000 $ (739,000) $(1,214,000)
Change in valuation allowance (725,000) 712,000 1,115,000
Acquisition adjustments 613,000 -- --
Other 65,000 27,000 99,000
----------- ----------- -----------

Income tax expense $ -- $ -- $ --
=========== =========== ===========

As of December 28, 2003, the Company has a net operating loss ("NOL")
carryforward of $10,919,000 and tax credit carryforwards of $331,000 that are
available, subject to certain limitations, to offset future book income and
taxes payable. The NOL begins to expire in 2008 and the tax credit carryforwards
expire through 2023.

The evaluation of the realizability of such deferred tax assets in future
periods is made based upon a variety of factors for generating future taxable
income, such as intent and ability to sell assets and historical and projected
operating performance. At this time, the Company has established a valuation
reserve for all of its deferred tax assets. Such tax assets are available to be
recognized and benefit future periods.

NOTE 9: Stock Option and Stock Bonus Plans; Other Stock Options

The Company has several stock option plans with similar terms and
conditions. The plans reserve 1,810,100 shares of the Company's unissued shares
for option and stock appreciation rights ("SAR") grants. The plans expire
through 2012. Options, which may be tax qualified ("ISOs") and non-qualified
("NSOs"), are exercisable for a period of up to 10 years at prices at or above
market price as established on the date of grant. Under the plans, the Company
will accept shares of its stock that were previously owned for at least 6 months
by the option holder as payment for options being exercised. In such a
transaction, the Company retires the stock tendered and issues the new shares at
the same overall consideration. There is no change on the capital accounts but
there is a net increase in the shares outstanding. In other transactions, the
option holder may use a broker to sell a portion of the option shares in the
open market to provide the option exercise proceeds. In this case, the option
holder is the owner of the option shares being sold and the broker/option holder
bear the risk of the open market sale. Upon the exercise of a stock appreciation
right, the recipient will receive payment in the form of stock, cash, or both,
as determined by the Company, equal to the appreciation in value of the shares
to
73

ESSEX CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001

which the rights were awarded. A total of 228,500 ISO or NSO options were
granted under the plans in 2003. No SARs were granted under the plans in 2003 or
are outstanding.

STOCK OPTION PLANS

NUMBER OF SHARES RANGE OF PRICE PER SHARE

Outstanding, 12/31/00.......... 956,700 $1.00-$3.00

Granted........................ 441,300 $3.00-$6.07

Exercised ..................... (49,182) $1.00-$3.00
------------

Outstanding, 12/30/01.......... 1,348,818 $1.00-$6.07

Granted........................ 199,250 $2.36-$4.96

Exercised...................... (71,350) $1.00-$3.00

Canceled....................... (14,500) $2.40-$3.96
------------

Outstanding, 12/29/02.......... 1,462,218 $1.00-$6.07

Granted........................ 228,500 $3.14-$9.02

Exercised...................... (50,418) $1.00-$3.96

Canceled....................... (103,100) $1.00-$6.07
------------

Outstanding, 12/28/03.......... 1,537,200 $1.00-$9.02
============

Exercisable, 12/28/03.......... 1,448,650 $1.00-$9.02
============

As of December 28, 2003, the weighted average price for options outstanding
was $3.26 and for options exercisable $3.15. The weighted average life for
options outstanding was 6.4 years and for options exercisable 5.9 years. The
following table summarizes information about all plan stock options outstanding
at December 28, 2003:

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
REMAINING AVERAGE AVERAGE
RANGE OF CONTRACTUAL EXERCISE EXERCISE
EXERCISE PRICES SHARES # LIFE (YEARS) PRICE ($) SHARES # PRICE ($)
--------------- -------- ------------ --------- -------- ---------

$1.00 - $1.69 324,400 5.0 $1.18 324,400 $1.18

$2.04 - $2.70 382,350 7.4 $2.23 381,800 $2.22

$3.00 - $3.96 618,650 6.2 $3.63 555,650 $3.65

$4.65 - $5.71 67,000 7.3 $5.37 52,000 $5.34

$6.07 - $9.02 144,800 7.8 $6.67 134,800 $6.44
---------- ----------
1,537,200 1,448,650
========== ==========

The Company has a Restricted Stock Bonus Plan covering key employees and
directors of the Company. The Plan can reserve up to 50,000 of the Company's
unissued shares for awards.

ESSEX CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001

There were no shares awarded in 2003, 2002 or 2001. As of December 28, 2003,
there were 4,050 shares available for award under the Plan.

The Company has issued, outside of existing plans, non-qualified stock
options and warrants directly to certain parties, including employees. In
connection with a l994 lease settlement, an option for 125,000 shares was issued
with an exercise price (as adjusted) of $1.29 per share. Holders exercised
10,000 and 40,000 of these options in fiscal 2002 and 2003, respectively, and
40,000 in January 2004. In 2003, the Company issued non-qualified options for
30,000 shares to its Chief Scientist and for 10,000 shares to its Chief
Financial Officer/Treasurer ("CFO"). In 2001, the Company issued non-qualified
options for 85,000 shares directly to its President, for 40,000 shares to its
CFO and for 45,000 shares to another employee of the Company. In all cases, the
exercise price to these employees was equal to the market price on the date of
grant.

In connection with the March 2003 acquisition, the Company issued
approximately 195,000 non-qualified fully vested options for its common stock at
below market prices in exchange for the fully vested outstanding options of the
acquired company. As of December 28, 2003, there were 179,173 of these options
outstanding at prices ranging from $0.01 to $1.01.

As of December 28, 2003, a summary of all non plan stock options and
warrants is as follows:

OPTIONS OUTSTANDING AND EXERCISABLE
WEIGHTED-
AVERAGE WEIGHTED-
REMAINING AVERAGE
RANGE OF CONTRACTUAL EXERCISE
EXERCISE PRICES SHARES # LIFE (YEARS) PRICE ($)

$0.01 - $1.01 254,173 4.0 $0.82

$1.29 - $1.69 96,500 2.2 $1.55

$2.04 - $3.69 280,000 7.2 $2.91

$6.07 - $8.50 65,000 4.7 $6.33
---------
695,673

NOTE 10: Common Stock; Warrants; Preferred Stock

The Company's Articles of Incorporation authorize 1 million shares of
preferred stock, par value $0.01 per share, the series and rights of which may
be designated by the Board of Directors in accordance with applicable state and
federal law. In September 2000, the Board designated 500,000 shares of such
preferred stock as Series B. There were 312,500 shares of Series B issued in
2000 for $1,250,000 and the remaining 187,500 issued in 2001 for $750,000 to the
Company's Private Investors. The 500,000 Series B shares were converted as
required into 2 million shares of common stock in September 2002. No Series A or
Series B preferred shares are currently outstanding.

ESSEX CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001

In connection with the issuance of the preferred stock, the Company also
issued common stock warrants to the preferred stock holders. These warrants were
for an additional 2 million shares of common stock. The warrants did not become
exercisable until certain terms and conditions were met. The Company determined
that the warrants had a nominal fair value at issuance due to the restrictive
covenants. The warrants became exercisable upon the completion of the follow-on
public offering on December 9, 2003. The warrants were exercised in December
2003 at a price of $2,000.

In addition to the preferred stock transactions, the Company completed
several private placement transactions of its common stock directly with its
Private Investors or their affiliates. In 2001, the Company received $2,250,000
and issued approximately 539,000 shares of common stock. In 2002, the Company
received $1,450,000 and issued approximately 528,000 shares of common stock. In
January 2003, a prepaid warrant for $50,000 was converted into approximately
16,000 shares of common stock.

In accordance with Emerging Issues Task Force Issue No. 98-5 "Accounting
for Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios," the Company imputed and recorded a deemed
dividend of $2,000,000 on its Series B Preferred Stock, of which $1,250,000 was
recognized in 2000 and $750,000 was recognized in 2001. The deemed dividend was
equal to the difference between the estimated current market price at original
date of issuance and the conversion price (the "beneficial conversion feature").
Such imputed dividends have no impact on net loss from operations or cash flows
but have to be considered when calculating loss per share attributable to common
shareholders.

NOTE 11: Acquisition

As of March 1, 2003, the Company acquired 100% of the common stock of
Sensys Development Laboratories, Inc. ("SDL") in exchange for the issuance of
approximately 1,105,000 shares of Company stock and $309,000 in cash. The
agreement provided that approximately 422,000 of these shares be placed into an
escrow account, to be released based upon certain factors, principally the
future market price of the Company's stock. In accordance with SFAS No. 141,
"Business Combinations", Emerging Issues Task Force 97-15, "Accounting for
Contingency Arrangements Based on Security Prices in a Purchase Business
Combination" and Emerging Issues Task Force 99-12, "Determination of the
Measruement Date for the Market Price of Acquirer Securities Issued in a
Purchase Business Combination", the Company stock portion of the acquisition
price was recorded at the current market price of the common stock multiplied by
the maximum number of shares issuable, or $3.17 times 1,105,000 common shares,
or $3.5 million. Subsequent to year end the 422,000 shares in escrow were
returned to the Company in accordance with the terms of the agreement. The
Company also issued approximately 195,000 non-qualified fully vested options for
its common stock at below market exercise prices in exchange for SDL fully
vested outstanding options.

SDL provides both system and software engineering technical support to U.S.
Government customers and prime contractors supporting government programs. SDL
has an established workforce with specialized experience and credentials.

ESSEX CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001

The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition.

Current assets $ 1,447,000
Equipment and other 33,000
Goodwill 2,998,000
Intangible assets 431,000
--------------
Total assets acquired 4,909,000
Current liabilities (504,000)
--------------
Net assets acquired $ 4,405,000
==============

The intangible assets of $431,000 were primarily assigned to contract
backlog which has an estimated overall amortization life of less than one year.

The following information is presented on a pro forma basis as though the
business combination had been completed as of the beginning of fiscal 2003.

For Fiscal Year Ended December 28, 2003
---------------------------------------

Pro Forma
As Reported (Unaudited)
--------------- ---------------

Revenues $ 16,286,000 $ 17,551,000
=============== ===============
Net Income $ 140,000 $ 402,000
=============== ===============
Earnings Per Share:
Basic $ 0.02 $ 0.04
=============== ===============
Fully diluted $ 0.01 $ 0.04
=============== ===============
WEIGHTED AVERAGE NUMBER OF SHARES
Basic 8,706,498 9,247,587

Effect of Dilution -
Stock Options 1,091,456 1,091,456
--------------- ---------------
Diluted 9,797,954 10,339,043
=============== ===============

Included in the pro forma revenues and net income are $420,000 and
$155,000, respectively, from a product sale by SDL which is not expected to
occur in future periods. Common shares issued in connection with the acquisition
and returned from escrow of approximately 422,000 shares are excluded from the
calculation above of the weighted average number of shares.

ESSEX CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001

NOTE 12: Other Accrued Expenses

Other accrued expenses consists of the following:

2003 2002
----------- ------------

Legal and printing registration statement expenses $ 230,439 $ --
Patent legal expenses 89,262 24,000
Other 202,837 122,041
----------- ------------
Total accrued expenses $ 522,538 $ 146,041

=========== ============

NOTE 13: Quarterly Financial Data (Unaudited)

(In thousands, except per share data)

2003 QUARTER ENDED DEC. 28 SEPT. 28 JUNE 29 MARCH 30
------------------- ------- -------- ------- --------

Revenue $ 5,066 $ 4,071 $ 4,148 $ 3,001

Gross margin 1,719 1,690 1,529 959

Net income (loss) 74 11 75 (20)

Income (loss) per share (1):

Basic $ 0.01 $ 0.00 $ 0.01 $ (0.00)

Diluted $ 0.01 $ 0.00 $ 0.01 $ (0.00)

2002 QUARTER ENDED DEC. 29 SEPT. 29 JUNE 30 MARCH 31
------------------- ------- -------- ------- --------

Revenue $ 1,413 $ 1,601 $ 729 $ 763

Gross margin 533 636 370 374

Net loss (327) (182) (835) (830)

Loss per share (1):

Basic $ (0.04) $ (0.02) $ (0.12) $ (0.11)

Diluted $ (0.04) $ (0.02) $ (0.12) $ (0.11)

2001 QUARTER ENDED DEC. 30 SEPT. 30 JULY 1 APRIL 1
------------------ ------- -------- ------ -------

Revenue $ 761 $ 745 $ 723 $ 413

Gross margin 367 363 355 214

Net loss (819) (1,234) (1,068) (1,198)

Loss per share (1):

Basic $ (0.11) $ (0.19) $ (0.17) $ (0.20)

Diluted $ (0.11) $ (0.19) $ (0.17) $ (0.20)

(1) Quarterly per share amounts may not total to full-year amounts due to
rounding.

ESSEX CORPORATION AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

FOR THE FISCAL YEARS ENDED DECEMBER 28, 2003, DECEMBER 29, 2002
AND DECEMBER 30, 2001

NOTE 14: Recent Accounting Pronouncements

In December 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - an Amendment of FASB
Statement No. 123", which is effective for financial statements for fiscal years
ending after December 15, 2002, with early adoption permitted. SFAS No. 148
enables companies that choose to adopt the fair value based method to report the
full effect of employee stock options in their financial statements immediately
upon adoption, and to make available to investors better and more frequent
disclosure about the cost of employee stock options. As further discussed within
Note 1, the Company will continue to apply the disclosure-only provisions of
both SFAS No. 123 and SFAS No. 148.

In January 2003, the FASB issued Financial Interpretation No. 46 (FIN 46),
"Consolidation Of Variable Interest Entities". FIN 46 requires that if an entity
has a controlling financial interest in a variable interest entity, the assets,
liabilities and results of activities of the variable interest entity should be
included in the consolidated financial statements of the entity. FIN 46 is
effective immediately for all new variable interest entities created or acquired
after January 31, 2003. For variable interest entities created or acquired prior
to February 1, 2003, the provisions of FIN 46 must be applied for the first
interim or annual period beginning after June 15, 2003. Since the Company is not
involved with any variable interest entities, the adoption of FIN 46 did not
have a material impact on the Company's results of operations or financial
position.

In May 2003, the FASB issued SFAS No. 150, "Accounting For Certain
Financial Instruments With Characteristics Of Both Liabilities And Equity". SFAS
No. 150 establishes standards on the classification and measurement of certain
financial instruments with characteristics of both liabilities and equity. The
provisions of SFAS No. 150 are effective for financial instruments entered into
or modified after May 31, 2003 and to all other instruments that exist as of the
beginning of the first interim financial reporting period beginning after June
15, 2003. The adoption of SFAS No. 150 did not have a material impact on the
Company's results of operations or financial position.

CONSENT OF INDEPENDENT AUDITORS

We hereby consent to the incorporation of our report dated February 23,
2004, included in this Form 10-K, into Essex Corporation's previously filed
Registration Statements on Form S-8, File No. 33-47900, File No. 33-336770, File
No. 333-57122, File No. 333-65466 and File No. 333-108709; and on Form S-3, File
No. 333-61200 and File No. 333-104819 and on Form S-1, File No. 333-110287.

/s/ Stegman & Company

Stegman & Company

Baltimore, Maryland
March 15, 2004

ESSEX CORPORATION

FINANCIAL STATEMENT SCHEDULES

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

A. Inventory Valuation Allowance

Charged/ Inventory
Balance at (Credited) to Disposed of Balance at
Beginning of Costs and or Written End of
Fiscal Year Ended Period Expenses Off Period
--------------------- ------------ ------------- ----------- ----------
(In Thousands)

December 28, 2003 $ 305 $ -- $ 148 $ 157
December 29, 2002 $ 275 $ 30 $ -- $ 305
December 30, 2001 $ 435 $ 60 $ (220) $ 275

B. Contract Reserves and Allowance for Doubtful Accounts

Charged/
Balance at (Credited) to Balance at
Beginning of Costs and Amounts End of
Fiscal Year Ended Period Expenses Written Off Period
------------------- ------------- ------------- ----------- ----------
(In Thousands)

December 28, 2003 $ 50 $ 120 $ -- $ 170
December 29, 2002 $ 50 $ -- $ -- $ 50
December 30, 2001 $ 50 $ -- $ -- $ 50