ITEM 1. DESCRIPTION OF BUSINESS
Our Business in General
Digital Recorders, Inc. was incorporated in 1983 and we became a public company through an initial public offering in November 1994. We directly, or through our contractors, design, manufacture, sell, and service information technology and audio surveillance technology products.
We acquired our law enforcement and surveillance subsidiary, Digital Audio Corporation, in 1995. In 1997 we formed TwinVision of North America, Inc. ("TwinVision") and acquired another startup, Transit-Media GmbH, both of which were focused on electronic destination sign systems. A change in our senior management in 1998 led to significant growth as we: sought to control product development, bringing it in-house rather than depending on outside consultants and service companies; focused on changes and improvements in our products and services through technology leadership, including more attention to customers' needs and requirements; and emphasized the electronic destination sign system that TwinVision and Transit-Media GmbH provided. TwinVision and Transit-Media GmbH grew rapidly and, with the June 2001 acquisition of Mobitec AB, these units now represents approximately 70% of our net sales. With this growth, we have added personnel to all levels and categories including sales personnel, software and hardware engineers, operations managers and personnel, field technicians, hourly assembly and administrative personnel. See Item 6, Selected Financial Data.
We currently operate through two major business segments. These two business segments are: (1) the transportation communications segment; and (2) the law enforcement and surveillance segment.
Transportation Communications Segment. Our transportation communications segment produces products sold worldwide within the passenger information communication industry and market. We transact our sales with transportation vehicle equipment customers generally in two broad categories. Those categories are end-user customers and Original Equipment Manufacturers ("OEM"). Our end-user customers include: (1) municipalities; (2) regional transportation districts; (3) federal, state, and local departments of transportation; (4) transit agencies; (5) public, private, or commercial operators of such vehicles; and (6) rental car agencies. Our OEM customers are the manufacturers of those vehicles. The relative percentage of sales to end customers as compared to OEM customers varies widely and frequently from period to period and within products and product lines comprising our mix of total revenue in any given period. Our transportation communication segment consists of the following units and wholly owned subsidiaries:
We supply the transportation vehicle equipment market with automatic voice announcement systems and related services. Our 500C+ Talking Bus® automatic voice systems product includes four core components: (1) a vehicle logic unit (the DR500C+), (2) an Operator Control Unit, (3) an internal light-emitting diode or LED sign, and (4) a global positioning satellite or GPS navigation system. Our Talking Bus® system automatically provides voice announcements about passenger information including next stop, transfer points, route and destination identification, and public service messages. The system enhances service and improves mobility for all passengers, assists compliance with the U.S. Americans with Disabilities Act, and also assists the vehicle operator and fleet management personnel with vehicle management and monitoring. The Talking Bus system integrates with other "intelligent transportation systems" technologies on board the vehicles, such as radios and fare collection equipment. Our customers for the Talking Bus system include transit operating agencies, commercial transportation vehicle operators and manufacturers of those vehicles.
RTI Inc., formerly known as Robinson Turney International, was established in August 1994. We acquired RTI in 1998 and with it acquired the essence of TwinVision® business development and market capability, as well as an exclusive
license to Lite Vision Corporation display technology. RTI is a marketing consultancy devoted to the public transit industry's needs, primarily those of European-based businesses.
We also, either through internal capability or through contractors design, manufacture, sell and service new generations of electronic destination sign systems used worldwide on transit and transportation vehicles. These products are sold under the TwinVision® brand name. Transit-Media, and its successor company, Transit Media - Mobitec GmbH serve the European and Far and Mid-Eastern markets while TwinVision® serves the North American Free Trade Agreement markets, which consist of the United States, Canada, Mexico and other Latin American countries. Customers include transit operating agencies, commercial transportation vehicle operators, and manufacturers of those vehicles.
Originally founded in 1987 and based in Göteborg, Sweden, our Mobitec subsidiary is the largest supplier of electronic destination sign systems in the Nordic markets, which consists of Iceland, Greenland, Sweden, Norway, Denmark and Finland. Mobitec also has business units in Australia, as well as a joint venture in Brazil. We acquired Mobitec in June 2001. DRI-Europa AB was established at the time of the Mobitec acquisition to serve as the umbrella organizational structure for our operations in Europe. As a result, Mobitec and Transit Media -Mobitec are part of DRI Europa AB. Together, these subsidiaries serve the European, Middle East, South American, Australian and Asian markets. The Mobitec acquisition significantly expanded our geographical reach and cross-selling opportunities.
Law Enforcement and Surveillance Segment. Our law enforcement and surveillance segment consists of our wholly owned subsidiary, Digital Audio Corporation ("Digital Audio" or "DAC"), in Raleigh, North Carolina. We acquired Digital Audio in 1995. Digital Audio serves customers in the federal, state, and local law enforcement agencies or organizations in the United States, as well as some of their qualified and eligible counterparts abroad. It produces a line of digital audio filter systems and tape transcribers used to improve the quality and intelligibility of both live and recorded voices. We market Digital Audio products to various customers, including: (1) U.S. federal, state, and local law enforcement agencies or organizations; (2) U.S. military and intelligence organizations; (3) Comparable national and regional agencies of foreign governments; and (4) Private and industrial security and investigation firms.
An Overview of Our Industry and Markets
The passenger information communications market, served by our transportation communications segment, developed as a result of several forces. More recently, that involved the Americans with Disabilities Act ("ADA"), the Clean Air Act, the Intermodal Surface Transportation Efficiency Act, and Intelligent Transportation Systems initiatives. However, a more fundamental and longer-term impetus for development of this market was the need to provide improved passenger information and customer services to operators and riders of transit and transportation vehicles. The Company's electronic signage and automatic voice announcement systems will provide customers of transit systems with next stop, transfer point, route and destination information and public service announcements. The ADA initially served to accelerate the trend toward such systems by requiring that fixed route transit systems announce major stops and transfer points to assist visually challenged passengers. On the public side of this market, transit operating authorities can normally draw up to approximately 80 percent of funding for equipment purchases from the U.S. Federal Transit Administration ("FTA") with the remainder of product acquisition funding being provided by state and local sources. Typical private operator and privately funded users of our transit communications sector products include rental car shuttle vehicles and tour vehicle operators.
TEA-21, the follow-up legislation to the Intermodal Surface Transportation Efficiency Act, is currently the primary program funding the U.S. public surface transit market at the federal level. TEA-21 is a $41 billion, six-year federal funding initiative. It promotes the development of modern, expanded, intermodal public transit systems nationwide and designates a wide range of tools, services and programs intended to increase the capacity of the nation's mobility systems. While major capital acquisitions can be federally funded as high as the 80 percent range in most instances, overall federal funding in the transportation communications segment market accounts for roughly 20 percent of all funding; the balance comes from a combination of state, local, and fare-box sources. The TEA-21 federal legislation is now in its final year as enacted. The Company expects TEA-21 to be reauthorized during the coming two-year period.
The automatic voice announcement systems market, served by our Digital Recorders business unit, emerged primarily because of ADA legislation. Our Digital Recorders business unit pioneered development of automatic voice announcement technology. Our Digital Recorders Talking Bus® system met favorable acceptance in terms of concept, design, and technology, as well as in an ADA compliance context. That regulatory-driven acceptance has now grown into a basic customer service issue as the automatic voice systems market matures. We believe that at least 25 percent of all new bus vehicles in North America contained automatic voice systems in 2001 and 2002. We expect this percentage to increase over the next several years as automatic voice systems reduce cost, decrease maintenance expense and complexity, integrate to deliver other features and services and become perceived as a form of customer service.
Our Digital Recorders business unit to date has had minimal international sales, but we believe future acquisitions, cultivating new relationships through Transit Media-Mobitec and Mobitec, as well as pilot projects and alliances established since 1999, may enable Digital Recorders to develop growth in the international market in the future. We believe Digital Recorders has a majority market share in the stand-alone (as opposed to such systems included in larger integrated information system installations) automatic voice announcement systems market in the U.S.
The electronic destination sign market, which is served by Transit Media-Mobitec, TwinVision and Mobitec, is highly competitive and mature with business growth closely tied to overall market size, increased market share, or technological advances. Virtually all transit buses manufactured worldwide have some form of destination sign system, and the percentage of those systems that are electronic is approximately 95 percent in the United States and 70 percent in major international markets. We believe that TwinVision holds approximately the same level of market share in the United States as its only significant competitor, while Mobitec and Transit Media-Mobitec hold significant market shares internationally. Those market shares vary widely from region to region. For example, we believe Mobitec has majority market share in Nordic markets and we believe that Transit Media-Mobitec has less than 15% market share in central Europe.
Our Digital Audio subsidiary's market within the law enforcement and surveillance segment consists of government organizations at the local, state, and federal level. Digital Audio also markets its products in North America and approximately 15 foreign countries directly and through a network of dealers. Typically, about 30 percent of Digital Audio sales are to international customers, although that percentage varies widely from period-to-period. Digital Audio digital filter and tape transcriber technology reduces background noises that might otherwise make recorded voice signals unintelligible. Additionally, customers use Digital Audio's products in vibration, acoustic, and communications disciplines in commercial markets.
Our Key Competitors
Most of the markets in which we participate are highly competitive and are subject to technological advances, as well as evolving industry and regulatory standards. We believe the principal competitive factors in all markets we serve include ease of use, after sales service and support, price, the ability to integrate products with other technologies, maintaining leading edge technology and responding to governmental regulation.
In the transportation communications segment, we view Luminator Holding L. P., an operating unit of Mark IV Industries, Inc., as our principal competitor. Clever Devices Ltd. and Meister Electronics, LC, are two of our significant competitors in the domestic automatic voice announce systems market. Numerous other competitors exist in the international market, most tending to primarily serve discrete territories. Of those international competitors, the more noteworthy, comprising the majority of competitive market share holders, are: Brose Infosystems, Apricot, LLE, Hanover Displays, and Gorba. All except Hanover Displays are based in Germany with sales primarily to the European Union market. Hanover is based in the UK with majority market share there as well as sales into selected regions of the continental European market. LLE, Hanover, and Brose all have sales into the international markets outside of Europe although we do not believe they are selling into the USA.
Within the law enforcement and surveillance segment, we believe Digital Audio is the dominant market force among the small number of participants in the industry. Filtering products produced for the commercial sound industry by companies such as AKG Acoustics GmbH are not specifically designed for voice filtering. As a result we do not believe companies manufacturing those products pose significant competition. We recognize Adaptive Digital Systems, Inc., REI®, and Intelligent Devices as key competitors in a small industry group that compete with similar technologies.
Our Products and Our Product Design
Transportation Communications Segment. Our current transportation communications products include:
2.
TransitWorks Software Suite that provides modules for customized transit applications including: Computer Aided Dispatch/Automatic Vehicle Location, Central Recording Station, Wireless Data Exchange, Central Recording Station.
3.
TwinVision® light-emitting diode illuminated flip-dot route destination sign systems,
4.
TwinVision® all-LED route destination sign systems,
5.
TwinVision® Chromatic Series family of color electronic route destination sign systems, and
6.
ELYSE® and Central Recording Station software.
This segment accounted for approximately 96 percent of our net sales in 2002 and 2001 and 97 percent in 2000.
The Digital Recorders Talking Bus® system enables customers to voice-announce transit vehicle stops and other passenger information, such as next stop, transfer point, route and destination information and public service announcements. The system can be used in transit buses, light rail vehicles, trains, subway cars, people movers, monorails, airport vehicles, tour buses, as well as other private and commercial vehicles. Compliant with ADA and industry-recognized standards, the system uses an open architecture, computer-based microprocessor electronics system design that accommodates additional new features and capabilities including interoperability with third-party equipment. The open architecture design permits expansion to customer size requirements and integration with other electronic systems. It offers software downloading or transfer using an industry standard personal computer memory card international association format. Wireless download also is available. This system is designed to meet the severe operating demands of temperature, humidity, shock, vibration and other environmental conditions found in its typical applications, and it is manufactured in an ISO 9002-compliant facility. Programming is accomplished with our proprietary Central Recording Station hardware and software.
When activated by a vehicle operator or by an automatic trigger such as a Global Positioning Satellite signal, the Talking Bus® system provides a digital audio "next stop" announcement properly timed to the route location. Messages can be in any language. Audio messages are stored in flash memory not requiring battery backup.
Our electronic route destination sign products, which are generally known by the TwinVision® brand name, represent state-of-the-art technology licensed to or pioneered by Transit-Media and TwinVision. The product line includes various models covering essentially all popular applications. These products adhere to ADA requirements and function under industry-recognized standards. They possess an open architecture, microprocessor-based system. The LED-flip-dot product, which we license through our RTI subsidiary, improves distance readability while reducing end-user maintenance expenses. In 2000, TwinVision and Transit-Media introduced an all-LED, solid-state product. The all-LED product dominates sales of these systems in North America while the prior generation "flip-dot" type product accounts for the majority of sales in our European subsidiaries. As the name implies, this product eliminates mechanical, moving flip-dots, delivering a further enhancement to distance readability and lowered maintenance expenses.
In 2001, TwinVision and Transit-Media introduced the TwinVision® Chromatic Series, TwinVision® Chroma I and TwinVision® Chroma IV, which offer our customers greater color flexibility and message display options for route and destination signage. These products incorporate colorized route capabilities while retaining electronic sign system message display advantages for the color vision impaired. Initial orders for these products were received and delivered in 2002. In 2002, TwinVision introduced additional variations of the Chromatic product line allowing for color capable signs.
Message programming for all these products is accomplished via proprietary ELYSE® software developed by Transit-Media and refined by TwinVision. Programming is accomplished through personal computer memory card international association ("PCMCIA") memory card download and wireless capabilities are available. In 2002, TwinVision finalized the next generation of the ELYSE software to accommodate the advancement to color.
In January 2001, Digital Recorders entered into an exclusive license agreement with the University of Washington to use certain technology developed by the Intelligent Transportation Systems Research program at the University under the names, "BusView" and "MyBus." The technology, some of which we have integrated with the Digital Recorders Talking Bus® system, enables transit system users to access information via the Internet, such as schedule data about the vehicle they wish to board. This technology, combined with our internal developments, is extending the product offerings of the company into Automatic Vehicle Location, fleet management, Automatic Vehicle Monitoring and off-vehicle passenger information markets.
Law Enforcement and Surveillance Segment. Our Digital Audio subsidiary designs, manufactures, markets and sells a line of digital signal processing instruments and digital-tape transcription machines to law enforcement agencies and organizations worldwide. Such recordings often are obscured by humming sounds, room noises, acoustic resonance, muffling, background music, street traffic, and other noises. Digital Audio products make the recordings understandable through a sequence of highly specialized adaptive audio filters. Additionally, in a similar process, Digital Audio products can be used in live real-time applications. Digital Audio products have major computational power with the typical digital filter employing multiple microprocessor devices.
In 2001, Digital Audio began development on four new products to law enforcement, intelligence, military and security markets. Designed to expand our offerings in the areas of audio collection, forensic examination and technical countermeasures applications, the new products included:
1.
SSABR™, a state-of-the-art, covert solid state digital audio recorder;
2.
QuickEnhance QE-10, a new, simplified, digital tape enhancement system for real-time and laboratory use;
3.
UltraScope, an ultrasonic spectrum analyzer for audio countermeasures applications; and
4.
ProbeAmp, a multi-meter/high-gain amplifier for audio countermeasures applications.
This segment accounted for approximately 4 percent of our net sales in 2002 and 2001 and 3 percent in 2000.
In 2002, Digital Audio launched a joint marketing initiative with Avid Technology, Inc. and Ocean Systems to introduce the Digital Audio QuickEnhance™/AS forensic audio suite plug-in, designed to integrate with the Avid Xpress ® video editing system. The QuickEnhance/AS software is being distributed by Ocean Systems in the U.S. markets and by Matek, Ltd. in the international markets.
In 2002, Digital Audio began the process to change its core Digital Signal Processing ("DSP") development efforts from the Motorola DSP56200 processor to the Texas Instruments C6000 series processor technology. DSP is the technology which we generally utilize in the majority of our filtering products. This processor change will allow for an increase in computational speed and resources, increased flexibility in application programming, and longer product life cycles due to improved upgrade paths.
Homeland Security
We view any increase in government funding related to national security, intelligence, and law enforcement initiatives as having the potential to positively influence the opportunity to sell our audio processing solutions.
Our Marketing and Sales Organization
All of our products are marketed on a direct basis by our sales and marketing personnel or through commissioned independent sales agents and dealers, as appropriate for each business unit and subsidiary. Marketing and sales activities employ virtually all commonly used techniques, as well as highly refined relationship and contact selling. Techniques include database marketing, highly selective advertising, direct contact selling, publication of customer newsletters, participation in trade shows and industry conventions and cooperative activities with system integrators. Additionally, Digital Audio utilizes specialized continuing education programs to ensure end-users have multiple opportunities to learn about digital signal processing technology and fully comprehend Digital Audio product operation through hands-on instruction. This continuing education offering is a minor generator of revenue and is primarily used as a marketing tool.
We regularly evaluate alternative modes of promoting and marketing our products and services. Website and Internet-based marketing techniques currently serve to assist marketing and sales efforts although the custom-specification, request-for-quote nature of our served markets does not yet lend itself to full-scale, Internet-driven marketing and sales efforts.
We generate a significant portion of our sales from a relatively small number of key customers, the identity of which may vary from year to year. Our major customers (defined as those customers with sales greater than 10% of total sales) in 2002, 2001 and 2000 were transit bus original equipment manufacturers. In 2002, two major customers accounted for 21.9 percent of our net sales, compared to three major customers accounting for 36.4 percent in 2001 and four major customers accounting for 53.6 percent in 2000. The Company sells its products to a limited, fixed set of customers. Concentration and credit risk is therefore a function of orders we receive in any given period of time.
Seasonality, Fluctuation in Results
Our sales are not seasonal in nature. However, a significant portion of our sales in each of our product lines are to governments or publicly funded entities. In addition, many of our sales to transit equipment manufacturers are themselves related to sales by those manufacturers to governments or publicly funded entities. However, in general, due to budgetary and funding availability considerations, government purchasing sometimes increases during the last quarter of our fiscal year period. In the U.S., the federal government and many state/local governments operate on an October - September fiscal year. Many of our key international government customers operate on an April - March fiscal year. Also, government agencies have a tendency to purchase infrequently in large quantities, creating uneven demand
cycles throughout the year. This results in sustained periods with little order activity punctuated by brief periods of intense order activity. These factors may combine to give the appearance of "seasonality" when in fact they are an anomaly. This fluctuation in government related ordering also tends to make our sales patterns uneven period-to-period and period-over-period.
Sales to our customers in both product segments are characterized by lengthy sales cycles that generally extend for a period of two to 24 months. In addition, our sales tend to be made pursuant to larger contracts, contemplating deliveries over months or years. Purchases by a majority of our customers are dependent, directly or indirectly, on federal, state and local funding, either of law enforcement activities or public transportation. Law enforcement agencies are the principal customers for our audio products, while manufactures of transportation equipment, who in turn sell to government agencies or entities dependent on government funding, are the principal customers for our transportation products. Government funding tends to vary significantly from year to year and quarter to quarter. In addition, government purchases generally involve a longer lead time that might be the case is the public sector, because governments generally are required to make acquisitions through a public bidding process. Finally, when they do make purchases, governments tend to make multi-year commitments particularly where they are acquiring capital equipment. The fact that much of our revenues are derived from relatively large contracts with a small number of customers can result in fluctuations in our revenue, and thus operating results, from period-to-period.
We spend a large amount of money relative to our revenues on research and development, and we believe our continued success depends upon continuing to do so. For example, our research and development activities for all segments amounted to 5.5% of net sales in 2002, 7.1% of net sales in 2001 and 7.7% in 2000. This means we spend significant amounts on product development preceding the period in which sales are recorded for that product. As a result of this high level of research and development spending, we may experience fluctuations in our operating results because costs may be incurred in periods prior to the related or resulting revenues, and because research and development costs fluctuate in accordance with projects undertaken as opposed to being a percentage of revenue or otherwise related to sales. See "Item 1 - Business - Our Research and Development."
Our Research and Development
We are committed to the continued technological enhancement of all of our products and to the development or acquisition of products having related applications, although continued development of any product is dependent upon product acceptance in the market place. Our objective is to develop products that are considered to be high quality, technologically advanced, cost competitive, and capable of capturing a significant share of the applicable market. Product development to an advanced technology product offering stage is one of the primary means by which we differentiate our self from our competition.
We anticipate that technological enhancements to our Talking Bus® system and the TwinVision® electronic route destination sign products will continue in the future. This should enhance our ability to integrate these products with other technologies, reduce unit cost of production, and advance the state-of-the-art in our ongoing program to improve profit margins, and increase available marketable product features as well as increase market share and market penetration. Our plan to integrate, and expand upon, certain of the technology developed by the University of Washington into the Talking Bus® system will also allow customers to provide Internet access to passenger information. In addition to enhancement of existing products, we currently have totally new generations of products under various stages of development.
In 1996 and 1997, Transit-Media and TwinVision respectively introduced a new generation display element through the TwinVision® LeDot® electronic route destination signs. The new products combined known and proven benefits of LED with improved electromagnetic flip-dot elements to enhance product performance. These enhancements improved distance readability and reduced maintenance expense. This development, under a product display technology licensed to TwinVision and Transit-Media through RTI from Lite Vision Corporation at the time, virtually changed the entire electronic route destination sign industry and quickly became the industry standard. This generation of product has been substantially replaced with other technological advances as noted in the following.
In 2000, Transit-Media and TwinVision again led an industry technology change with the introduction of a low-energy, high-brightness, all-LED display element that eliminated the mechanical, moving flip-dot typically used in prior generations of electronic route destination signs.
TwinVision and Transit-Media introduced the TwinVision® Chromatic Series, TwinVision® Chroma I and TwinVision® Chroma IV, in 2001. These products offer customers greater color flexibility in message display options
for destination signage. They incorporate colorized message display capabilities while retaining electronic sign system message display advantages for the color vision impaired.
Our research and development activities continued in all business segments during 2002. Research and development expenses were $2,492,428, or 5.5 percent of net sales, in 2002, compared to $2,648,510, or 7.1 percent of net sales, in 2001 and $2,294,620, or 7.7 percent of net sales, in 2000. During 2002, certain engineering personnel were used in the development of software that met the capitalization criteria of SFAS No. 86, "Capitalization of Software Development Costs", which resulted in recording $185,938 of 2002 costs as an asset that will be amortized as the sales of the software are realized and over a period no longer than three years. Had this amount not been capitalized, research and development expenses for the year ended December 31, 2002 would have been $2,678,366 as compared to $2,648,510 for the year ended December 31, 2001. Our main research and development projects include Digital Recorder's new on-board platform (vehicle logic unit) for bus automatic vehicle monitoring, automatic vehicle location and automatic vehicle schedule adherence communication systems and programs and Digital Audio Corporation's next generation laboratory system for digital signal processing. Because we believe that technological advances are necessary to maintain and improve our product lines and thus our market position in a highly competitive, we expect to continue to incur similar levels of research and development in the foreseeable future.
Our Acquisition History
We acquired Digital Audio in 1995. We also acquired Transit-Media and established TwinVision in 1996 and we acquired RTI in 1998. Our acquisition of Digital Audio increased our revenue and profit, as well as provided us with a leading product line and technology development platform. Our acquisition of Transit-Media provided us an important European market foothold, as well as the origins of the TwinVision® electronic route destination sign technology. Our acquisition of RTI brought us business development and market capability, as well as direct access to and control of a technology license held by RTI and sub-licensed at the time to TwinVision.
We completed our acquisition of Mobitec in June 2001 to grow the Company at an accelerated pace through both internal and external means. Mobitec is part of DRI Europa AB, our corporate framework for international operations that also includes Transit-Media Mobitec GmbH. Together, these subsidiaries serve the European, Far and Middle Eastern, South American, Australian and Asian markets. The acquisition, which significantly expanded our geographical reach and cross-selling opportunities, had a purchase price of approximately $8.0 million paid in a combination of cash, common stock, warrants, and seller financing. See Note 2 to our Consolidated Financial Statements set forth elsewhere in this Form 10-K.
Our Manufacturing Operations
Our principal supplier for the Digital Recorders business unit, CEA of North Carolina, is a contract-manufacturing firm that produces Digital Recorders-designed equipment. Digital Recorders also performs part of its assembly work in-house. We believe our relationship with CEA is good. Although we are dependent upon CEA to manufacture products for us, there are a number of contract manufacturers domestically and internationally who could perform the service CEA currently provides if CEA were unable or unwilling to continue to do so.
TwinVision and Transit-Media Mobitec purchases display components and assemblies for electronic route destination sign systems from Lite Vision Corporation in Taiwan, the Republic of China, Meccanica UGO Amelie in Impruneta, Italy and Superior Manufacturing Services in West Virginia. Lite Vision is one of our major stockholders, holding approximately 13.1 percent of our outstanding common stock. We purchased from Lite Vision approximately $3.5 million, $4.4 million and $6.7 million during 2002, 2001 and 2000, respectively. We have contracts with domestic and foreign electronic manufacturing and/or contract assembly firms to assemble these components and assemblies. Domestic production is compliant with "Buy-America" regulations. In 2002, TwinVision moved part of its assembly process in-house.
Digital Audio subsidiary manufactures or assembles its products internally. Printed circuit board components and enclosures are purchased from well-established vendors and small local suppliers. Digital Audio typically works with ISO-certified suppliers.
Mobitec purchases raw materials and components and assembles the majority of its products in Herrljunga, Sweden. These materials are purchased from suppliers not situated in high-risk areas and include Sweden, Czech Republic, and Germany.
Our Customer Service
We believe our commitment to customer service has enhanced the customer's view of our company as compared to our competition. Our plan has been to continue to define/refine the sustainable competitive advantage through a service-oriented organization.
Our Proprietary Rights
We currently rely upon a combination of patents, copyrights, alliances, trade secrets, nondisclosure agreements, and licensing agreements to establish and protect our ownership of, and access to, proprietary and intellectual property rights. Our attempt to keep the results of our research and development efforts proprietary may not be able to prevent others from using some or all of such information or technology. In addition, by "designing around" our intellectual property rights, our competitors may be able to offer the same functionality provided by our products without violating our intellectual property rights. We have licenses to certain intellectual property rights under which the TwinVision® products are produced. We have registered our Digital Recorders®, Talking Bus® and TwinVision® trademarks, logos, slogans, by-lines, and trade names with the U.S. Patent and Trademark Office.
We intend to pursue new patents and other intellectual property rights protection covering new technologies and developments on an on-going basis. We also intend to maintain the integrity of our service marks, trade names and trademarks and other proprietary names and protect them from unauthorized use, infringement and unfair competition.
Our Employees
As of March 1, 2003, we employed 149 people, of which 80 were employed domestically and 69 were employed internationally. Our employees were deployed as follows; 53 were in operations, 28 were in engineering, 35 were in sales and marketing and 33 were in administration. Although European subsidiaries include some limited work-place agreements, our employees are not covered by any collective bargaining agreements and we believe that our employee relations are good.
ITEM 2.
ITEM 2. DESCRIPTION OF PROPERTY
We have three real property lease agreements within the United States and five real property lease agreements elsewhere. The location, leased area (in square feet or square meters), use, monthly rent and lease expiration, are as follows:
(a) Used by transportation communications segment
(b) Used by law enforcement and surveillance segment
(c) Used by administration - U.S. corporate
(d) Used by administration - international
We believe that our current facilities are adequate and suitable for our current and foreseeable use, absent acquisition. We believe additional office and manufacturing space will be available in, or near, our existing facilities at a cost approximately equivalent to, or slightly higher than, rentals currently paid, if needed, for our existing facilities.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of operations, we are involved from time to time in legal actions incidental to our business. In our opinion, the ultimate resolution of these matters will not have a material adverse effect upon our financial position.
On February 7, 2001, NextBus Information Systems, Inc, ("NextBus") a California corporation, filed suit in the United States District Court for the Northern District of California accusing us of infringing U.S. Patent 6,006,159 ("the 159 patent") and sought injunctive relief as well as damages. NextBus had based their case on a news release of ours and not on an allegedly infringing act. In response we filed a complaint for declaratory relief on June 25, 2001, in the United States District Court, Northern District of Texas, Dallas Division, asking the court to interpret the scope of the 159 patent. The NextBus action in the United States District Court for the Northern District of California proceeded to hearing on July 3, 2002. On January 21, 2003 we settled the matter and, as a result, we will market our own predictive product. Under the settlement agreement both parties agreed to bear their own expenses in the litigation, and no settlement consideration was paid.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the shareholders during the fourth quarter of 2002.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is quoted on the NASDAQ Small Cap Market under the symbol "TBUS" and on the Boston Stock Exchange under the symbol "TBU." The following table sets forth the range of high and low closing bid prices, as reported by the Nasdaq SmallCap Market, from January 1, 2001 through December 31, 2002. The prices set forth reflect inter-dealer quotations, without retail markups, markdowns or commissions, and do not necessarily represent actual transactions.
We estimate that, as of March 1, 2003 there are approximately 900 record holders of common stock of the Company.
We have not paid cash dividends on our common stock nor do we anticipate doing so in the foreseeable future. In addition, our current credit facilities restrict the payment of dividends upon any class of stock to $177,000 annually which is the dividend paid on our series AAA Preferred stock.
Equity Compensation Plan Information
The following table provides information as of the end of 2002, with respect to all compensation plans and individual compensation arrangements of the Company under which equity securities of the Company are authorized for issuance to employees or non-employees:
Plan Category
Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights (a)
Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights (b)
Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column (a))
(c)
Incentive Stock Option Plan (an equity compensation plan approved by the Shareholders)
980,000
$2.70
$ -
Issuance of Unregistered Securities
Each issuance set forth below was made in reliance upon the exemptions from registration requirements of the Securities Act of 1933, as amended, contained in Section 4(2) on the basis that such transactions did not involve a public offering. We determined that the purchasers of securities described below were sophisticated investors who had the financial ability to assume the risk of their investment in our securities and acquired such securities for their own account and not with a view to any distribution thereof to the public. The certificates evidencing the securities bear legends stating that the securities are not to be offered, sold or transferred other than pursuant to an effective registration statement under the Securities Exchange Act of 1933 or an exemption from such registration requirements.
In July 2002 the Company issued $300,000 of restricted, unregistered common stock to Lite Vision Corporation ("Lite Vision"), a Taiwan-based company, in exchange for a reduction of the same amount in their accounts payable balance. Lite Vision holds 13.1 percent of the outstanding shares of common stock. We purchase electronic components supporting our transportation communications segment from Lite Vision.
On August 2, 2002, we completed a privately negotiated sale of $1.15 million of convertible subordinated debentures through funds managed by Dallas-based Renaissance Capital Group. Russell C. Cleveland, Renaissance Capital Group's President and Chief Executive Officer, serves on our Board of Directors. In June 2001, prior to Mr. Cleveland's involvement as one of our directors, we issued convertible debentures in the amount of $3 million (the "2001 Debentures") to Renaissance Capital Group containing substantially the same terms as the convertible debentures issued in 2002.
On August 26, 2002, we completed a privately negotiated sale of a $250,000 convertible subordinated debenture to John D. Higgins, a private investor and one of our directors. Mr. Higgins received a closing fee of $5,850 related to the $250,000 convertible subordinated debenture and Renaissance Capital Group received a closing fee of $17,250 related to the $1.15 million convertible subordinated debentures.
Each of the convertible debentures has a seven-year term, 8 percent interest rate, and, subject to Shareholder ratification at the 2003 Annual Meeting of Shareholders (see Proposal Four in our 2003 proxy statement for the Annual Meeting), is initially convertible into the Company's Common Stock at $2 per share (the "Conversion Price"). The Conversion Price is subject to adjustment in the event the Company issues shares at less than the Conversion Price and in the event of stock splits and subdivisions, and stock dividends. At the current Conversion Price, the Renaissance Capital Group funds' subordinated debentures would convert into 575,000 shares or 13 percent of the Company's outstanding Common Stock after the conversion and Mr. Higgins' subordinated convertible debentures would convert into 125,000 shares or 3 percent of the Company's outstanding Common Stock after the conversion. In the event the conversion price adjusted downward more shares would be issued. In the event that the Shareholders do not ratify the issuance of the convertible debentures, the holders of the convertible subordinated debentures shall have the right to cause us to redeem the debentures for an amount of the principal amount of the debentures plus accrued and unpaid interest.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below as of and for the years ended December 31, 2002, 2001, 2000, 1999 and 1998 has been derived from our audited consolidated financial statements. This information should be read in conjunction with "Item 1. Description of Business" and "Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES THAT ARE IN ITEM 8 OF THIS DOCUMENT.
Business - General
We directly or through contractors, design, manufacture, sell, and service information technology and audio surveillance technology products through two major business segments. These two business segments are: (1) the transportation communications segment; and (2) the law enforcement and surveillance segment. While service is a significant aspect of our marketing strategy, it is not yet a material generator of revenue and was approximately 1% to 2% of net sales for the years ended December 31, 2002, 2001 and 2000.
Our transportation communications segment produces products sold worldwide within the passenger information communication industry and market. We transact our sales with transportation vehicle equipment customers generally in two broad categories. Those categories are firstly end customers including (1) municipalities; (2) regional transportation districts; (3) federal, state, and local departments of transportation; (4) transit agencies; (5) public, private, or commercial operators of such vehicles; and (6) rental car agencies; and secondly, Original Equipment Manufacturers ("OEM") of those vehicles. The relative percentage of sales to end customers as compared to OEM customers varies widely and frequently from period to period and within products and product lines comprising our mix of total revenue in any given period.
Our law enforcement and surveillance segment serves customers in the U.S. federal, state, and local law enforcement agencies or organizations, as well as their counterparts abroad. We produce a line of digital audio filter systems and tape transcribers used to improve the quality and intelligibility of both live and recorded voices. We market our law enforcement and surveillance products domestically and internationally to law enforcement entities and other customers in or support of government organizations.
Sales to our customers are characterized by a lengthy sales cycle that generally extends for a period of two to 24 months. In addition, purchases by a majority of our customers are dependent upon federal, state and local funding that may vary from year to year and quarter to quarter.
We recognize product revenue upon shipment of products to customers and service revenue upon completion of the service. Because our operations are characterized by significant research and development expenses preceding product introduction, net sales and certain related expenses may not be recorded in the same period, thereby producing fluctuations in operating results. Our dependence upon large contracts and orders, as well as upon a small number of relatively large customers or projects, increases the magnitude of fluctuations in operating results particularly on a period to period, or period over period, comparison basis. For a more complete description of our business, including a description of our products, sales cycle and research and development, see "Item 1 - Business."
Critical Accounting Policies
Our significant accounting policies and methods used in the preparation of the Consolidated Financial Statements are discussed in Note 1and 3 of the Notes to Consolidated Financial Statements. The following is a listing of the Company's critical accounting policies and a brief discussion of each:
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Allowance for doubtful accounts
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Inventory valuation
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Intangible assets and goodwill
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Income taxes, including deferred tax assets
•
Revenue recognition
Allowance for Doubtful Accounts. Our allowance for doubtful accounts relate to trade accounts receivable. It reflects our estimate of the amount of our outstanding accounts receivable that are not likely to be collected for one reason or another. Most of the Company sales are to large OEM equipment manufacturers or to state or local governmental units or authorities, so management's expectation of losses from true collectibility problems resulting from insolvency or actual inability to pay are very low. However, we also include amounts in the allowance for doubtful accounts when the credit of the customer may not be at issue, but a dispute exists over precise purchase order or invoice terms or quality of
the product or service. The allowance for doubtful accounts is an estimate prepared by management based upon identification of the collectibility of specific accounts and the overall condition of the receivable portfolios. We analyze our trade receivables, the customer relationships underlying the receivables, historical bad debts, customer credits, customer concentrations, customer credit-worthiness, current economic trends and changes in customer payment terms, when evaluating the adequacy of the allowance for doubtful accounts. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Also, if we conclude that a disagreement or dispute has arisen with a customer over products or services provided on account, we may add to our allowance for doubtful accounts. Likewise, should we determine that we would be able to collect more of our receivables than previously estimated, an adjustment to the allowance would increase income in the period such determination was made. The allowance for doubtful accounts is reviewed periodically and adjustments are recorded as deemed necessary. Our allowance for doubtful accounts will generally increase or decrease in the future as our sales increase or decrease. We do not expect our allowance for doubtful accounts to increase or decrease, materially, as a percentage of sales, in coming years as a result of any trends in the credit worthiness of our customers or as a result of an increase or decrease in disputes with customers regarding the terms of purchase orders or invoices or acceptability of the products or services. However, to the extent that our sales in parts of the world, such as the Middle East, South America or Africa, increase as a percentage of all sales, our allowance for doubtful accounts may also increase relative to sales to reflect the lower credit quality of governmental or publicly funded entities in those areas and the general instability of certain parts of those regions. In 2002, our allowance for doubtful accounts increased to $146,066 from $115,158 for 2001. This increase of 26.8% was greater than the 21.3% increase in net sales over the same period and does not relate to any general trend. The Company makes its evaluation on facts and circumstances related to specific customers.
Inventory Valuation. We periodically evaluate the carrying amount of inventory based upon the identification of inventory to achieve current shipping forecasts and provide sufficient inventory to meet both warranty and post-warranty component requirements. The Company, as a part of the sale, typically extends a warranty term generally ranging from 1-3 years. The Company accounts for this liability through a warranty reserve on the balance sheet. Additionally, in special situations, the Company may, solely at its discretion, use post warranty services as a marketing tool. In these instances, the expense is treated as a period cost and is in all respects discretionary. Many of our customers have contractual or legal requirements which dictate an extended period of time for us to maintain replacement parts. Our evaluation involves a multi-element approach incorporating inventory turnover and the stratification of inventory by risk category, among other elements. The approach incorporates both recent historical information and management estimates of trends. Our approach is intended to take into consideration potential excess and obsolescence in relation to our installed base, engineering changes, uses for components in other products, return rights with vendors and end of manufacture. If any of the elements of our estimate were to deteriorate, additional write-downs may be required. The inventory write-down calculations are reviewed periodically and additional write-downs are recorded as deemed necessary.
Intangible Assets and Goodwill. In 2002, Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" became effective, and as a result, we ceased to amortize goodwill at January 1, 2002. We recorded approximately $126,342 of intangible amortization during 2002. We recorded approximately $430,393 and $178,925 of goodwill and intangible amortization during 2001 and 2000. Net intangible assets and goodwill amounted to approximately $10,352,929 as of December 31, 2002. The Company does not have any indefinite life intangible assets. In lieu of amortization, SFAS No. 142 requires that we perform an impairment review of goodwill at least annually. SFAS No. 142 requires us to test goodwill for impairment at a level referred to as a reporting unit. Goodwill is considered impaired and a loss is recognized when the carrying value of a reporting unit exceeds its fair value. We may use a number of valuation methods including quoted market prices, discounted cash flows and revenue multiples to determine fair value. We have completed our goodwill impairment evaluation in connection with the adoption of the new standard and determined that there is no impairment of goodwill as of the date of adoption. Management is not aware of any events, through the date of the Company's Annual Report on Form 10-K, which indicates that an impairment has been experienced. Management is also unaware of any circumstance or trend that is reasonably likely to give rise to an impairment in the Company's goodwill.
Income Taxes. We are required to pay income taxes in each of the jurisdictions in which we operate. Thus, we pay income taxes in the United States, several U.S. states and a number of foreign countries. Each of these jurisdictions has its own laws and regulations, some of which are quite complex and some of which are the subject of disagreement among experts and authorities as to interpretation and application. The estimation process for preparation of our financial statements involves estimating our actual current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that the deferred tax assets will be recovered from future taxable income, reversal of deferred tax liabilities and other sources. To the extent that we believe recovery is not likely, we must establish a valuation allowance. When a valuation allowance is
recorded or adjusted in a period, we must include an entry within the tax provision in the statement of operations. We have established a valuation allowance to reduce the carrying amount of recorded deferred tax assets to an amount management believes is more likely than not to be realized. In the event we were to determine that we would be able to realize additional (or less) deferred tax assets in the future, an adjustment to the net deferred tax asset would increase or decrease income in the period such determination was made. If the valuation allowance needs to be increased, income tax expense for that period would increase.
In estimating our tax expense we review internally our operations and the application of applicable laws and rules to our circumstances. To the extent we believe necessary, we also seek the advice of professional advisers in various jurisdictions. Because the application of tax laws and rules is not always certain, our estimates of tax liability may be more or less than our actual tax liability as ultimately determined by us and reported or as ultimately determined by a tax authority or court reviewing the matter in the future. As a difference between our estimates and actually reported tax becomes likely, we try to adjust our estimation process appropriately. We do not do so however, unless it appears likely that such a change is necessary to be consistent with applicable law.
Revenue Recognition. Revenue from product sales is recognized upon shipment to customers based upon the defined shipping terms. Even though the Company receives customer sales orders that may require scheduled product deliveries over several months, sales revenues are only recognized upon physical shipment of the product to the customer. Service revenues are recognized upon completing the service. Service revenues include product repair not under a warranty agreement, city route mapping, product installation, training, consulting to transit authorities and funded research and development projects. Service revenues were not a significant source of revenue for 2002, 2001 and 2000, but may increase in 2003 and future periods due to higher post warranty repairs, retrofit installation and other service related revenues not offered in previous years.
Results of Operations
The following discussion provides an analysis of our results of operations and liquidity and capital resources. This should be read in conjunction with our consolidated financial statements and related notes thereto. The operating results of the years presented were not significantly affected by inflation.
The following table sets forth the percentage of our revenues represented by certain items included in our Statements of Operations:
COMPARISON OF OUR RESULTS FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001
Net Sales and Gross Profit
Our net sales for the year ended December 31, 2002 increased $7,922,634, or 21.3%, from $37,215,352 for the year ended December 31, 2001 to $45,137,986 for the year ended December 31, 2002. Our gross profit for the year ended December 31, 2002 increased $2,449,208, or 17.7%, from $13,825,786 for the year ended December 31, 2001 to $16,274,994 for the year ended December 31, 2002. Following is a discussion of these changes in net sales and gross profit by segment.
Transportation Communications Segment
For the year ended December 31, 2002, sales for our transportation communications segment increased $8,004,148, or 22.5%, from $35,546,489 for the year ended December 31, 2001 to $43,550,637 for the year ended December 31, 2002. This results from an increase in international sales of $5,893,473 and increase in domestic sales of $2,110,675. The increase in international sales is primarily attributed to the inclusion of Mobitec sales for a full twelve months in 2002 as compared to sales in 2001 when Mobitec sales were only included from June 27, 2001 through December 31, 2001. The total sales of only the Mobitec companies in 2002 were $12,169,284 as compared to $5,865,936 for the post acquisition period in 2001. The increase in domestic sales is attributed to higher volumes to existing customers as well as sales to new customers of both existing and new products. Product prices on sales of products which comprise a majority of our revenue have declined in the year ended December 31, 2002 as compared to the prior year due to competition. Sales growth in the transportation communications segment will continue to be dependent upon the expansion of new products and technology, as well as our expansion into new geographic areas. We believe our relatively high market share positions in most markets precludes significant sales growth from increased market share.
Our transportation communications segment gross profit for the year ended December 31, 2002 increased $2,552,888, or 20.4%, from $12,519,865 for the year ended December 31, 2001 to $15,072,753 for the year ended December 31, 2002. As a percentage of segment sales, our gross profit was 34.6 percent of our net segment sales in 2002 as compared to 35.2 percent during 2001. International operations contributed $3,057,763 of the increase in gross profit for 2002. This was offset by a decrease of $608,555 due to lower margins and lower revenues from certain higher margin products in the domestic transportation communications segment. We believe improvement in our gross profit percentage is dependent upon overall economic and competitive conditions in the transportation sector, introduction of new technology products, and the continued success of our on-going cost reduction programs.
Law Enforcement and Surveillance Segment
For the year ended December 31, 2002, sales for our law enforcement and surveillance segment decreased $81,514, or 4.9%, from $1,668,863 for the year ended December 31, 2001 to $1,587,349 for the year ended December 31, 2002. The decrease is attributed to the reallocation of federal and state funds to support post 911 security issues as well as a delay in approval of the 2003 U.S. federal budget.
Our segment gross profit for the year ended December 31, 2002 decreased $103,680, or 7.9%, from $1,305,921 for the year ended December 31, 2001 to $1,202,241 for the year ended December 31, 2002. As a percentage of segment sales, our gross profit was 75.7 percent of our net segment sales in 2002 as compared to 78.3 percent during 2001. Lower sales to the U.S. Federal Government contributed to these results. We believe improvement in our gross profit percentage is dependent upon overall economic and competitive conditions in the law enforcement and surveillance sector, introduction of new technology products, and the continued success of our on-going cost reduction programs.
Selling, General and Administrative, Research and Development Expenses
Our selling, general and administrative expenses for the year ended December 31, 2002 increased $2,299,915, or 21.4%, from $10,758,433 for the year ended December 31, 2001 to $13,058,348 for the year ended December 31, 2002. The majority of this increase was attributed to the acquisition of Mobitec, which had a full twelve months of activity in 2002 as compared to the prior year period; Mobitec was acquired June 27, 2001. As a percentage of our sales, these expenses remained level at 28.9 percent in 2001 and in 2002. Management believes these expenses will decrease as a percentage of our sales in future periods. However, our selling, general and administrative expenses may increase in future periods due to: (1) expansion into other geographic areas; (2) expansion through acquisition; and (3) introduction of new products and services.
Our research and development expenses for the year ended December 31, 2002 decreased $156,082, or 5.9%, from
$2,648,510 for the year ended December 31, 2001 to $2,492,428 for the year ended December 31, 2002. This category of expenses includes internal engineering personnel and outside engineering expense for software and hardware development, sustaining product engineering and new product development. As a percentage of net sales, these expenses decreased from 7.1 percent in 2001 to 5.5 percent in 2002. During 2002, certain engineering personnel were used in the development of software that met the capitalization criteria of SFAS No. 86, "Capitalization of Software Development Costs", which resulted in recording $185,938 of 2002 costs as an asset that will be amortized as the sales of the software are realized and over a period no longer than three years. Had this amount not been capitalized, research and development expenses for the year ended December 31, 2002 would have been $2,678,366 as compared to $2,648,510 for the year ended December 31, 2001. In the longer term, we expect these expenses to remain in the same general range as a percentage of sales, as in the past three years (approximately 5 to 8 percent).
Operating Income
The net change in our operating income for the year ended December 31, 2002 was an increase of $305,375 or 72.9%, from operating income of $418,843 for the year ended December 31, 2001 to net operating income of $724,218 for the year ended December 31, 2002. This increase is primarily due to increased sales from a full year of operating the Mobitec companies in the transportation communications segment partially offset by increased personnel and operating expenses for a full year of Mobitec. In addition, we increased our head count in field technicians and support personnel, hourly assembly labor and two people in U.S. corporate administration. The more significant increases in other expenses were in the U.S. parent of the parent entities segment of the administrative expense categories of audit, tax and accounting fees (increase of $237,936), American Public Transportation Association trade show expense ($184,884) as this expense is incurred every three years when the public transportation industry trade show convenes, insurance-other (increase of $67,745 for Directors & Officers insurance premiums), rent-building & office (increase of $91,992) and travel and lodging (increase of $38,950).
Other Expense and Income Tax Expense
Our total other expense for the year ended December 31, 2002 was $812,666, a net increase in expense of $2,005 as compared to $810,661 for 2001. This increase was primarily due to higher interest expense ($1,183,328 for 2002 as compared to $814,207 in 2001) partially offset by a foreign translation exchange gain of $309,456 for 2002. The increase in interest expense was due to an increase in the weighted average outstanding balance of long-term debt which was partially offset by lower interest rates.
Our net income tax expense was $42,148 for the year ended December 31, 2002, as compared with an income tax benefit of $533,135 for the year ended December 31, 2001. In 2002 our current tax expense of $183,209, arising primarily from foreign jurisdictions, was partially offset by deferred tax benefits of $141,061 arising primarily from United States federal and state jurisdictions. In 2001 our income tax benefit was primarily attributed to a reduction in the valuation allowance for deferred tax assets which were more likely than not to be realized based upon projected taxable income in the appropriate jurisdictions.
COMPARISON OF OUR RESULTS FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000
Net Sales and Gross Profit
Our net sales for the year ended December 31, 2001 increased $7,329,184, or 24.5%, from $29,886,168 for the year ended December 31, 2000 to $37,215,352 for the year ended December 31, 2001. Our gross profit for the year ended December 31, 2002 increased $2,920,187, or 26.8 %, from $10,905,599 for the year ended December 31, 2000 to $13,825,786 for the year ended December 31, 2001. Following is a discussion of these changes in net sales and gross profit by segment.
Transportation Communications Segment
For the year ended December 31, 2001, sales for our transportation communications segment increased $6,560,036, or 22.6%, from $28,986,453 for the year ended December 31, 2000 to $35,546,489 for the year ended December 31, 2001. Of this increase, $5,865,936 reflects sales from Mobitec and the remaining increase of $694,100 represents higher sales levels to existing customers and orders from new customers. Overall, our product prices declined in 2001 as a result of competition. We believe better product technology and competitive pricing, and an underlying growth in the transportation sector; have contributed to improved transportation communications segment sales results. Sales growth in the transportation communications segment will continue to be dependent upon the expansion of new products and technology, as well as our expansion into new geographic areas. We believe our relatively high market share positions in most markets precludes significant sales growth from increased market share.
Our transportation communications segment gross profit for the year ended December 31, 2001 increased $2,318,799, or 22.7%, from $10,201,066 for the year ended December 31, 2000 to $12,519,865 for the year ended December 31, 2001.
This increase was directly related to the increase in net sales. As a percentage of segment sales, our gross profit was 35.2 percent of our net segment sales in both 2001 and 2000. Of the dollar increase in our gross profit during 2001, $2,258,465 was attributed to the acquisition of Mobitec. We believe improvement in our gross profit percentage is dependent upon overall economic and competitive conditions in the transportation sector, introduction of new technology products, and the continued success of our on-going cost reduction programs.
Law Enforcement and Surveillance Segment
For the year ended December 31, 2001, sales for our law enforcement and surveillance segment increased $769,148, or 85.5%, from $899,715 for the year ended December 31, 2000 to $1,668,863 for the year ended December 31, 2001. The increase is primarily the result of an increase in sales to both local and federal government agencies. The law enforcement and surveillance sales declined in 2000 following a change in general management at the end of 1999. A new general manager and sales manager were hired in June and September 2000, respectively, to assume the leadership roles, the efforts of which materialized in 2001.
Our segment gross profit for the year ended December 31, 2001 increased $601,389, or 85.4%, from $704,533 for the year ended December 31, 2000 to $1,305,921 for the year ended December 31, 2001. As a percentage of segment sales, our gross profit was 78.3 percent of our net segment sales for both 2001 and 2000. This increase was directly related to the increase in net sales to both local and federal government agencies. We believe improvement in our gross profit percentage is dependent upon overall economic and competitive conditions in the law enforcement and surveillance sector, introduction of new technology products, and the continued success of our on-going cost reduction programs.
Selling, General and Administrative, Research and Development Expenses
Our selling, general and administrative expenses during 2001 were $10,758,433, an increase of $2,380,208 or 28.4 percent as compared to $8,378,225 for such expenses during 2000. We attribute this increase to our acquisition of Mobitec and higher payroll and related fringe benefits necessary to support our continued growth. As a percentage of our sales, these expenses increased from 28.0 percent in 2000 to 28.9 percent in 2001.
Our research and development expenses for 2001 were $2,648,510, an increase of $353,890, or 15.4 percent, as compared to such expenses of $2,294,620 in 2000. As a percentage of net sales, these expenses decreased to 7.1 percent in 2001 from 7.7 percent in 2000. The increase in total dollars was primarily related to our acquisition of Mobitec. This category of expenses includes internal engineering personnel and outside engineering expense for software and hardware development, sustaining product engineering and new product development.
Operating Income
The net change in our operating income was an increase of $186,089 from income of $232,754 in 2000 to income of $418,843 in 2001. This increase was due primarily to the factors set forth above.
Other Expense and Income Tax Expense
Our total other expense for 2001 was $810,661, a net increase in expense of $298,444 as compared to $512,217 for 2000. This increase was primarily the result of higher interest expense due to an increase in long-term debt resulting from our acquisition of Mobitec and increased short-term borrowings.
Our income tax benefit for 2001 of $533,135 was primarily attributed to a reduction in the valuation allowance for deferred tax assets which are more likely than not to be realized based upon future projected taxable income in the appropriate jurisdictions. In 2000 we had no current or deferred income tax expense or benefit.
Our Liquidity and Capital Resources
The Company's net working capital as of December 31, 2002 was $2,321,954 compared to $7,751,898 as of December 31, 2001. Our principal sources of liquidity from current assets included cash and cash equivalents of $504,758, trade and other receivables of $10,389,409, inventories of $8,830,522 and prepaids and other current assets of $452,882. Liquidity derived from current liabilities included short-term bank and asset based borrowings of $7,503,791, accounts payable of $7,198,962, accrued expenses of $2,162,309, and current maturities of long-term debt, deferred tax liabilities and dividends payable of $763,360, $138,695 and $88,500 respectively. The decline in net working capital is substantially attributed to the credit line being reclassified as a current liability due to the expiration date of the agreement being less than one year from the balance sheet date. The Company anticipates either renewing the existing line which expires in
August 2003 or securing a new facility by the expiration date however, there can be no assurance that this will occur (See "Our Financing Activities in 2003" below). Substantially all of our assets are pledged as security for various elements of long- and short-term debt described below.
Our operating activities used cash of $903,660 for the year ended December 31, 2002. Primary uses of cash included a net loss of $189,503 combined with increases in trade and other receivables, prepaids and a decrease in our related party accounts payable of $2,032,600, $123,358 and $369,361, respectively. Primary sources of cash included a decrease in inventories of $551,225 and increases in accounts payable and accrued expenses of $402,128 and $53,527, respectively. The increase in trade accounts receivable and payables is a direct result of record sales in the fourth quarter with a significant portion of both sales and purchases occurring late in the quarter. The balance of cash provided by operating activities of $434,891 resulted from non-cash expenses for deferred taxes, depreciation, intangible amortization, bad debt and minority interest. The Company's working capital requirements will continue to increase with growth in our sales, primarily due to the timing between when we must pay our suppliers and the time we receive payment from our customers.
Our investing activities used cash of $988,638 for the year ended December 31, 2002. The primary use of cash was for expenditures relating to internally developed software; purchases of computer, test and office equipment and the reclassification of a trade account receivable to a note receivable. Cash flows from investing activities were a result of equipment asset sales. We do not anticipate any significant expenditures for or sales of capital equipment in the near future.
Our financing activities generated net cash of $1,760,311 for the year ended December 31, 2002. Our primary sources of cash were from net short- and long-term bank borrowings of $493,061 and from the issuance of long-term debt in the amount of $1,400,000. Our primary uses of cash for financing activities were payment of dividends. Net cash from financing activities were used to fund working capital requirements and for the purchase of fixed assets.
On August 23, 1999, we and our subsidiaries signed a four year Revolving and Term Lines of Credit Agreement with Fremont Financial Corporation, a subsidiary of Finova Group, Inc. On January 31, 2001, Finova Group, Inc. sold certain loan portfolio assets to Guaranty Business Credit Corporation, the asset-based financial services subsidiary of Guaranty Bank, a wholly owned subsidiary of Temple-Inland, Inc., which included our loan and Credit Agreement. Our Credit Agreement provides up to $11.75 million in borrowing to be used for acquisitions, working capital and general corporate purposes. The working capital (accounts receivable and inventory) borrowing portion of the agreement was limited at December 31, 2002 to a combined maximum limit of $6.75 million. The interest rate on the revolving credit portion of the agreement is the published prime lending rate (4.25% at December 31, 2002) plus 1.75 percent. Credit extended for acquisitions bears an interest rate of prime (4.25% at December 31, 2002) plus 2 percent. At December 31, 2002, available collateral based on the value of eligible trade accounts receivable and inventories was $7,504,062, which, given the outstanding debt balance under this agreement of $6,489,729, resulted in a potential additional borrowing availability of $1,014,333. However, due to the working capital limit of $6,750,000 imposed by Guaranty Business Credit Corporation, the additional borrowing availability was limited to $260,271. The outstanding debt under this agreement is secured by substantially all U.S.-based assets including the assets of the Company's subsidiaries. The Company expects to renew or replace this credit agreement with a long-term agreement substantially similar in terms and conditions.
As amended, the Credit Agreement includes customary covenants and conditions relating to the conduct and operation of the Company's business. Specifically, as amended, the Credit Agreement limits the payment of dividends on any class of stock to $177,000 annually, subjects the Company to a 1:1 Earnings Before Interest, Taxes, Depreciation and Amortization to interest coverage ratio to be calculated upon a quarterly and year to date basis and limits capital expenditures to $25,000 for individual transactions and $250,000 in aggregate. In addition, overadvances are permitted under the agreement up to $400,000 and acquisitions require approval from the lender. The Company was in compliance with all agreement covenants except the capital expenditure covenant for the year ended December 31, 2002, but received a waiver from Guarantee Business Credit Corporation on March 28, 2003. The Company was in compliance with all covenants at December 31, 2001 and December 31, 2000.
Mobitec AB, the Company's wholly owned Swedish subsidiary, has an agreement with its bank in Sweden from which it may currently borrow up to a maximum of 10,000,000 krona (SEK) or $1,144,000. At December 31, 2002, 7,535,924 krona (SEK), or $862,110, was outstanding, resulting in additional borrowing availability of 2,464,076 krona (SEK), or $281,890. The maximum borrowing in the amount of 10,000,000 krona (SEK) is secured by cash on deposit with the bank in the amount of 2,200,000 krona (SEK), or $251,680. The terms of this agreement require payment of an unused credit line fee equal to 0.5 percent of the unused portion and interest at 5 percent of the outstanding balance. This agreement is secured by substantially all assets of Mobitec AB. The line of credit agreement has an expiration date of December 31, 2003.
Mobitec AB also has an agreement with the same bank from which it may borrow up to 6,000,000 krona (SEK), or $686,400. Based upon the availability formula under this agreement, 1,328,251 krona (SEK), or $151,952, was
outstanding at December 31, 2002, resulting in additional borrowing availability of 4,671,749 krona (SEK), or $534,448. The line of credit bears interest at 5.1 percent and is collateralized by accounts receivable. The agreement has an expiration date of December 31, 2003.
An unsecured note and obligation in the amount of $2,471,235 are due a shareholder. The unsecured note in the amount of $2,111,235 is payable in full June 28, 2004 with an annual interest of 9% paid quarterly. The obligation balance of $360,000 at December 31, 2002 is due in six remaining non-interest bearing quarterly payments.
A term loan from the Company's Swedish bank dated June 28, 2001 having a balance of 15,400,000 krona (SEK), or $1,763,050, at December 31, 2002 is payable in 14 remaining quarterly payments of 1,100,000 krona (SEK), or $125,840, at an annual interest rate of 5.35% and is secured by stock of the Swedish holding company and the consolidated subsidiary.
Two convertible subordinated debentures in the amount of $3,000,000 dated June 22, 2001 and $1,150,000 dated July 31, 2002 are payable to Renaissance Capital Group. The president of Renaissance Capital Group, Russell C. Cleveland, is a member of the Company's Board of Directors. The $3,000,000 debenture is payable in full on June 28, 2008, if not sooner redeemed or converted, with annual interest at 8% paid monthly. It also provides for monthly principal redemption installments commencing June 27, 2004, each of such installments to be in the dollar amount of ten dollars ($10) per thousand dollars ($1,000) of the then remaining principal amount. The $1,150,000 debenture is payable in full on June 27, 2009, if not sooner redeemed or converted, with annual interest at 8% paid monthly. It also provides for monthly principal redemption installments commencing July 31, 2005, each of such installments to be in the dollar amount of ten dollars ($10) per thousand dollars ($1,000) of the then remaining principal amount. The loan agreement subjects the Company to a 1:1 Earnings Before Interest, Depreciation and Amortization to interest coverage ratio to be calculated quarterly on a rolling four quarter basis and a 1.3:1 current ratio to be calculated at each quarter end. The Company was not in compliance with the current ratio covenant as of December 31, 2002, but received an appropriate waiver from Renaissance Capital Group on March 21, 2003.
A convertible subordinated debenture in the amount of $250,000 dated August 26, 2002, is payable to John D. Higgins, a stockholder and member of the Board of Directors, and is due in full August 26, 2009, if not sooner redeemed or converted, with annual interest at 8% paid monthly. It also provides for monthly principal redemption installments commencing August 26, 2005, each of such installments to be in the dollar amount of ten dollars ($10) per thousand dollars ($1,000) of the then remaining principal amount. The loan agreement subjects the Company to a 1:1 Earnings Before Interest, Depreciation and Amortization to interest coverage ratio to be calculated quarterly on a rolling four quarter basis and a 1.3:1 current ratio to be calculated at each quarter end. The Company was not in compliance with the current ratio covenant as of December 31, 2002, but received an appropriate waiver from Mr. Higgins on March 21, 2003.
Our net interest expense for all our debt and obligations was $1,150,962, $814,207 and $510,598 for the years ended December 31, 2002, 2001 and 2000, respectively. The increase was due to an increase in the weighted average outstanding balance of long-term debt which was partially offset by lower interest rates.
The senior lender line of credit expires in August 2003. We have been pursuing new lines of credit, and/or extensions of the present line, for several months. Based upon term sheets received to date and our experience on these matters, we believe new and/or extended lines of credit will be secured on a timely basis and on terms no less favorable than at present.
Our Financing Activities in 2003
(a)
The Board of Directors of the Company has approved, subject to shareholder approval at its 2003 Annual Meeting, a proposal authorizing the Company to issue an undetermined number of shares of convertible Preferred Stock and warrants that would convert into an aggregate of up to 2,000,000 shares of Common Stock in connection with a potential private equity financing.
If the shareholders approve the Board's recommendation to approve the issuance of preferred shares, the Company is also contemplating entering into a transaction to raise up to $5,000,000 in new capital through the issuance of shares of a new series of preferred stock convertible into Common Stock ("New Convertible Preferred Stock") and warrants to purchase Common Stock. The Company will issue New Convertible Preferred Stock, warrants, or some combination of the two to the purchasers in the potential financing. The issuance would be made in a private placement to one or more accredited investors, as defined in Rule 501 of
Regulation D pursuant to the Securities Act of 1933, as amended. The terms of the financing have not been determined.
The Company anticipates that the aggregate number of shares of Common Stock into which any New Convertible Preferred Stock and warrants will be convertible may be in excess of 20 percent of the Company's Common Stock and 20 percent of the voting power of the Company outstanding before the issuance for. In addition, the conversion rate of any New Convertible Preferred Stock and the applicable exercise price of any warrants may be set beneath the market price of the Company's Common Stock at the closing of the sale which is less than the greater of book or market value of the stock as of the date of the transaction. The Company, therefore has submitted this Proposal for Shareholder approval in accordance with NASDAQ Marketplace Rule 4350(i)(1)(D)(ii). Please consult the Company's proxy filing on Form DEF 14A for further information. While we anticipate that this matter will be favorably received by our stockholders, there can be no assurance that the proposal relating to the Common Stock issuable upon the conversion of the New Convertible Preferred Stock will receive the required approval of our stockholders or that the investment banking firm will be successful in its efforts to identify purchasers for the anticipated amount, or any amount, of capital.
On February 20, 2003, the Company entered into a Placement Agency Agreement with a Dallas-based investment banking firm, under which the investment banking firm will identify purchasers to participate in the potential equity financing. Because the potential equity financing is in the early stages it is not possible to describe the transaction. As part of the agreement, the investment banking firm will act on a best efforts basis to identify prospective purchasers of equity securities of the Company. Such equity securities are intended to be sold under an exemption from the registration requirements of the Securities Act of 1933. The agreement with the investment banking firm is non-exclusive and is terminable upon 30 days notice. The investment banking firm is entitled to compensation based upon the gross proceeds from the sale of equity securities of the Company sold. The investment banking firm is entitled to 8 percent of the first $5 million in such gross proceeds, 7 percent of the next $5 million, and 6 percent of the gross proceeds over $10 million. The Company will pay the investment banking firm the relevant compensation upon closing of the sale generating the compensation. The Company will also issue to the investment banking firm a warrant to purchase 10 percent of the total number of equity securities sold, exercisable for a period of five years at the price at which the equity securities were sold. The Company also paid the investment banking firm a $25,000 nonrefundable expense allowance and will reimburse the investment banking firm for all reasonable out-of-pocket expenses in providing services to the Company.
The Company's management believes it to be in the Company's best interest to reduce the level of the Company's indebtedness, and expects to use substantially all of the net proceeds of the proposed financing to repay outstanding debt. Reducing the Company's indebtedness should improve the Company's balance sheet and permit the Company additional financial flexibility.
(b)
On March 6, 2003, the Company announced that at a special meeting of the AAA Preferred Stock shareholders, the holders of the Series AAA Preferred Stock approved an amendment to the preferred shareholders' Articles of Incorporation to remove the mandatory redemption date, which would have been in December 2003. The Company may now redeem the Series AAA Preferred Stock at its Stock at its sole discretion upon providing preferred shareholders with appropriate written notice. Had the holders of the Series AAA Preferred Stock not approved the amendment, the Company would have to pay the redemption price, which is equal to the liquidation preference, in December 2003. The liquidation preference equals $5,000 per share, plus all accrued and unpaid dividends, which at December 31, 2002 was $1,858,500.
(c)
Our senior lender line of credit expires in August 2003. We have been pursuing new lines of credit, and/or extensions of the present line, for several months. Based upon term sheets received to date and our experience on these matters, we believe new and/or extended lines of credit will be secured on a timely basis and on terms no less favorable than at present..
RELATED PARTY TRANSACTIONS
The Company purchases electronic components supporting the transportation communications segment from a major stockholder, Lite Vision Corporation ("Lite Vision"), a Taiwan-based company. Lite Vision holds 13.1 percent (500,000) of the outstanding shares of common stock of the Company. The components consist primarily of Light Emitting Diodes (LED) printed circuit boards. The Company purchased from Lite Vision approximately $3.5 million, $4.4 million and $6.7 million during 2002, 2001 and 2000, respectively. The accounts payable balance due to Lite Vision was $859,425, $1,528,786 and $2,224,555 at December 31, 2002, 2001 and 2000, respectively. Mr. Joseph Tang, previously President of Lite Vision and currently affiliated with Lite Vision while also pursuing other private business interests, serves on the Company's Board of Directors. During 2002 the Company issued 100,000 shares of restricted, unregistered common stock to Lite Vision at $3.00 per share in exchange for an equivalent reduction in accounts payable.
John D. Higgins, a director of the Company, was an employee of Investec Ernst & Co., a securities and investment banking firm that was engaged in December 2000 to provide a fairness opinion from a financial point of view with respect to the Mobitec acquisition. Investec Ernst & Co. received a fee of $120,000, plus reasonable actual expenses, for furnishing the fairness opinion. In addition, also as part of the Mobitec acquisition, Mr. Higgins received a fee of $17,500 for the successful completion of certain convertible debenture financing. On August 26, 2002, the Company completed a privately negotiated sale of a $250,000 convertible subordinated debenture to John D. Higgins, a private investor and a director of the Company. Mr. Higgins received a closing fee of $5,850 related to the $250,000 convertible subordinated debenture and Renaissance Capital Group received a closing fee of $17,250 related to the $1.15 million convertible subordinated debentures.
On August 2, 2002, the Company completed a privately negotiated sale of $1.15 million of convertible subordinated debentures through funds managed by Dallas-based Renaissance Capital Group. Russell C. Cleveland, Renaissance Capital Group's President and Chief Executive Officer, serves on the Company's Board of Directors. In June 2001, prior to Mr. Cleveland's involvement as a director of the Company, the Company issued convertible debentures in the amount of $3 million (the "2001 Debentures") to Renaissance Capital Group containing substantially the same terms as the convertible debentures issued in 2002.
Contractual Obligations
We lease facilities under various operating and capital lease agreements with various terms and conditions, expiring at various dates through 2008. Our material contractual obligations at December 31, 2002 are as follows:
(1)
Please see "Series AAA Preferred Stock" above.
(2)
Please see "Our Liquidity and Capital Resources" above.
Other than lease commitments, legal contingencies incurred in the normal course of business and employment contracts of key employees, we do not have any off-balance sheet financing arrangements or liabilities. We do not have any majority-owned subsidiaries or any interests in or relationships with any special-purpose entities that are not included in the consolidated financial statements.
Restructuring Costs
The Company acquired Mobitec in June 2001. As part of its plan relative to the acquisition, the Company accrued for certain business activities duplicated within the existing and newly acquired international operations. We believe that it is reasonably likely that beginning in 2003 we will save approximately $200,000 per year in reduced employee expense, and that beginning in 2004 we will save approximately $12,000 per year in reduced lease expense.
The accrued restructuring costs totaled $190,000 at December 31, 2001 and were comprised of staff reduction costs, lease payments and other selling, general and administrative expenses in the amount of $151,925, $3,075 and $35,000, respectively. Upon finalization of the restructuring plan in 2002, the Company reduced the accrual by $76,201 which was credited to the acquisition cost; and adjusted reserve components to $36,066, $33,927 and $43,806 for staff reduction costs, lease payments and other selling, general and administrative expenses, respectively.
During 2002, $90,799 was credited to the reserve for staff reduction costs, lease payments and other selling, general and administrative expenses in the amount of $36,066, $10,927 and $43,806, respectively. No amounts were credited against the reserve during 2001. All costs to be charged against the accrual, consisting solely of lease payments, are expected to conclude during the first quarter of 2004. Of the remaining reserve amount of $23,000, we can reasonably expect $18,400 to be charged to the reserve during 2003 and $4,600 during 2004.
New Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46). This interpretation clarifies existing accounting principles related to the preparation of consolidated financial statements when the equity investors in an entity do not have the characteristics of a controlling financial interest or when the equity at risk is not sufficient for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 requires a company to evaluate all existing arrangements to identify situations where a company has a "variable interest" (commonly evidenced by a guarantee arrangement or other commitment to provide financial support) in a "variable interest entity" (commonly a thinly capitalized entity) and further determine when such variable interests require a company to consolidate the variable interest entities' financial statement with its own. The Company is required to perform this assessment by September 30, 2003 and consolidate any variable interest entities for which it will absorb a majority of the entities' expected losses or receive a majority of the expected residual gains. Management has not yet performed this assessment, however it is not aware of any material variable interest entity that it may be required to consolidate.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal of Activities." SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities. The provisions of SFAS No. 146 are effective for exit or disposal activities initiated after December 31, 2002. Adoption of SFAS No. 146 is not expected to have a material effect upon the Company's financial position or operating results.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement is effective for the Company beginning January 1, 2003. Management does not expect that adoption of this standard will have a material impact upon the Company's financial statements.
Impact of Inflation
We believe that inflation has not had a material impact upon our results of operations for each of our fiscal years in the three-year period ended December 31, 2002. However, there can be no assurance that future inflation would not have an adverse impact upon our operating results and financial condition.
FACTORS AFFECTING OUR BUSINESS AND PROSPECTS
General Economic Conditions
Our business partly depends upon general economic and business conditions both domestic and abroad. In this context, about one-third of our sales are outside the USA, primarily in Europe (particularly the Nordic countries), South America, the mid-East and Australia. Our sales are to businesses involved in transportation communications and law enforcement and surveillance. We transact our sales with transportation vehicle equipment customers generally in two broad categories. Those categories are end user customers and Original Equipment Manufacturers ("OEM"). General economic conditions that cause customers in such industries, countries and markets to reduce or delay their investments in products and solutions such as those offered by us could have a material adverse effect upon us. Delays or reductions in technology spending could have a material adverse effect upon demand for our products and services, and consequently upon our business, operating results, financial condition, and prospects.
Dependence on Suppliers
Our products and solutions are dependent upon the availability of quality components that are procured from third-party suppliers. Reliance upon suppliers, as well as industry supply conditions, generally involves several risks, including the possibility of defective parts (which can adversely affect the reliability and reputation of the our products), a shortage of components and reduced control over delivery schedules (which can adversely affect our manufacturing efficiencies) and increases in component costs (which can adversely affect our profitability).
We have several single-sourced supplier relationships, either because alternative sources are not available or the relationship is advantageous due to performance, quality, support, delivery, capacity or price considerations. If these sources are unable to provide timely and reliable supply, we could experience manufacturing interruptions, delays or inefficiencies, adversely affecting our results of operations. Even where alternative sources of supply are available, qualification of the alternative suppliers and establishment of reliable supplies could result in delays and a possible loss of sales, which could affect operating results adversely. We do not believe any material aspect of our supply base involves operating locations in geographic high-risk areas.
International Activities
Our international operations are a significant part of our business comprising about one-third of our sales. The success and profitability of international operations are subject to numerous risks and uncertainties, such as economic and labor conditions, political instability, tax laws (including U.S. taxes upon foreign subsidiaries) and changes in the value of the U.S. dollar versus the local currency in which products are sold. Any unfavorable change in one or more of these factors could have a material adverse effect upon us.
Fluctuations in Operating Results
Our operating results may fluctuate from period to period and period over period depending upon numerous factors, including: customer demand and market acceptance of our products and solutions, new product introductions, varying product mix, delivery due date changes and other factors. We operate in a market characterized by a relatively long sales cycle. From first contact to order delivery may be a time period of one year or longer in certain instances. Delivery schedules, as first established with the customer in this long cycle, may change with little or no advance notice as the original delivery schedule draws near. Our business is sensitive to the spending patterns and funding of our customers, which in turn are subject to prevailing economic conditions and other factors beyond our control.
Governmental Legislation
A majority of our sales address end customers having some degree of national, federal, regional, state or local governmental-entity funding. These governmental-entity funding mechanisms are beyond our control and often are difficult to predict. Further, general budgetary authorizations and allocations for state, local, and federal agencies can change for a variety of reasons, including general economic conditions, and have a material adverse effect upon us. For example, the legislation (TEA-21) under which our transportation products business segment domestic sales are derived is subject to reauthorization in 2003. While we believe such reauthorization will occur, and that resulting federal funding will be between the present approximately $8 billion annually and $14 Billion annually, there can be no advance assurance of such. This matter is in early stages of legislative action and top management of the company is involved through the industry trade association the America Public Transportation Association the web site of which (www.APTA.com) regularly posts status information on such legislative matters. Further, in addition to Federal funding to the public transit side of our USA served Market there is state and local funding to be considered. These tend to be affected by general economic conditions. For example, some transit operating authorities are reducing service in 2003 in response to the slow economy; this can have a depressing effect upon sales of our products. It is not possible to precisely quantify this impact. However, it is the opinion of management that new product introductions, new served markets entered, and emphasis upon market sectors not so adversely impacted by economic conditions such as exist in 2003, will allow the company to continue growth in 2003 and beyond. However, any unfavorable change in any of these factors and considerations could have a material adverse effect upon us.
Technological Changes and Product Transitions
Our industry is characterized by, and our business strategy is substantially based upon, continuing improvement in technology. This results in frequent introduction of new products, short product life cycles and continual change in product price/performance characteristics. We must develop new technologies in our products and solutions in order to remain competitive. There can be no assurance that we will be able to continue to manage and drive technological transitions. A failure upon our part to effectively manage these transitions of our product lines to new technologies on a timely basis could have a material adverse effect upon us. In addition, our business depends upon technology trends in our customers' businesses. To the extent that we do not address these technological changes, our business may be adversely impacted.
Product Development Activities
The strength of our overall business is partially dependent upon our ability to develop products and solutions based upon new or evolving technology and the market's acceptance of those products. There can be no assurance that our product development activities will be successful, that new technologies will be available to us, that we will be able to deliver commercial quantities of new products in a timely manner, that those products will adhere to generally accepted industry standards or that products will achieve market acceptance. Further, it is necessary for our products to adhere to generally accepted and frequently changing industry standards, which are subject to change in ways that are beyond our control.
Financing
Our business and operating strategy embraces growth. That includes internal organic as well as external acquisition oriented growth scenarios. This requires that we maintain a high degree of emphasis upon finding and securing financing sources of various types both in equity and debt categories. Success in these financing requirements can be adversely impacted by economic conditions and other factors beyond our control. Recently, we have removed the mandatory redemption date, which would have been in December 2003, from the Series AAA Preferred Stock, which the Company may now redeem at its sole discretion. Additionally, our Board of Directors has approved, subject to shareholder approval, a proposal authorizing the Company to issue an undetermined number of shares of convertible Preferred Stock and warrants that would convert into an aggregate of 2,000,000 shares of Common Stock in connection with a potential private equity financing. Also, our senior lender line of credit expires in August 2003. We have been pursuing new lines of credit, and/or extensions of the present line, for several months. Based upon term sheets received to date and our experience on these matters, we believe new and/or extended lines of credit will be secured on a timely basis and on terms no less favorable than at present.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are subject to certain risks arising from transactions in the normal course of our business, and from debt instruments. Such risk is principally associated with interest rate and foreign exchange fluctuations, as explained below.
Interest Rate Risk
We utilize both long-term fixed rate and short-term variable rate borrowings to finance the working capital and capital requirements of our business.
We utilize variable rate debt through a revolving credit facility to support working capital needs. Borrowings bear interest at the bank's prime rate plus 1.75%. If the bank's prime rate on December 31, 2002 increased by 100 basis points on that date and then remained constant at the higher rate throughout 2003, our interest costs on our outstanding variable rate borrowings at December 31, 2002 of $6,489,729 would increase by approximately $64,897 for the year ending December 31, 2003. Similarly, if the bank's prime rate on December 31, 2002 decreased by 100 basis points on that date and then remained constant at the lower rate throughout 2003, our interest costs on our outstanding variable rate borrowings at December 31, 2002 of $6,489,729 would decrease by approximately $64,897 for the year ending December 31, 2003. The Company currently does not use derivative instruments to manage its interest rate risk.
At December 31, 2002, we had outstanding long-term fixed rate borrowings (including current portions) of $8,436,285. We believe the carrying amount of our fixed rate borrowings approximates the estimated fair value for debt with similar terms, interest rates and remaining maturities currently available to companies with similar credit ratings at December 31, 2002. We do not expect changes in the fair value of our long-term fixed rate borrowings to have a significant effect upon our operations, cash flow or financial position.
The table below provides information about the Company's financial instruments that are sensitive to changes in interest rates, consisting solely of debt obligations. The table presents principal cash flows and related weighted average interest rates by expected maturity dates. The information is presented in U.S. dollar equivalents, which is the Company's reporting currency. The instrument's actual cash flows are denominated in both U.S. dollars ($US) and Swedish Krona (SEK), as indicated in parentheses.
Foreign Currency Risk
Our international subsidiaries operate in Europe (particularly the Nordic countries), South America, the mid-East and Australia and use local currencies as the functional currency and the U.S. dollar as the reporting currency. Transactions between the Company and the international subsidiaries are generally denominated in U.S. dollars. Approximately one-third of our revenues are denominated in international currencies. As a result, we have certain exposures to foreign currency risk. However, management believes that such exposure does not present a significant risk due to the relative stability of the European and Nordic countries and Australia. Risk in the mid-East and South America is mitigated due to those revenues representing only approximately (4%) of our consolidated revenues.
Our international operations represent a substantial portion of our overall operating results and asset base. Our identifiable foreign exchange rate exposures result primarily from accounts receivable from customer sales, anticipated purchases of product from third-party suppliers and the repayment of intercompany loans with foreign subsidiaries denominated in foreign currencies. The company primarily manages its foreign currency risk by making use of naturally offsetting positions. These natural hedges include the using local manufacturing facilities that conduct business in local currency and the use of borrowings denominated in local currencies.
Transaction gains and losses on U.S. dollar denominated transactions are recorded within other income and expense in the consolidated statements of operations and the net gain totaled $ 379,984 in 2002 primarily due to the decrease in the Swedish krona (SEK) from a December 31, 2001 rate of 10.571 (SEK per U.S. dollar to a December 31, 2002 rate of 8.746 (SEK per U.S. dollar). In 2001 and 2000, the foreign currency exposure was minimal due to lower foreign asset base, fewer transactions and little change in foreign exchange rates between period end balance sheet dates. The Company currently does not use derivative instruments to manage its foreign currency risk.
The table below provides information about our financial instruments and firmly committed sales transactions by functional currency and presents such information in U.S. dollar equivalents. The table summarizes information on instruments and transactions that are sensitive to foreign currency exchange rates, consisting solely of (SEK) denominated debt obligations. The table presents principal cash flows and related weighted average interest rates by expected maturity dates.
ITEM 7B. TAX AND REPATRIATION MATTERS
The Company and its subsidiaries are subject to income tax laws in each of the countries in which they do business. The Company makes a comprehensive review of the income tax requirements of each of its operations, files appropriate returns and makes appropriate income tax provisions. These are determined upon an individual subsidiary level and at the corporate level on both an interim and annual basis. The Company provides valuation allowances on deferred tax assets for its subsidiaries that have a history of losses.
Management cannot assert that there will likely be sufficient profits generated by certain of these subsidiaries in the near future to offset these losses. We follow these processes using an appropriate combination of internal staff at both the subsidiary and corporate levels as well as independent outside advisors in review of the various tax laws and in compliance reporting for the various operations.
The undistributed earnings of certain foreign subsidiaries are not subject to additional foreign income taxes nor considered to be subject to U.S. income taxes unless remitted as dividends. The Company intends to reinvest such undistributed earnings indefinitely; accordingly, no provision has been made for U.S. taxes on those earnings. The Company regularly reviews the status of the accumulated earnings of each of its U.S. and foreign subsidiaries as part of its overall financing plans.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Consolidated Financial Statements follow this page.
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Independent Auditor's Report
To the Board of Directors
Digital Recorders, Inc.
Durham, North Carolina
We have audited the accompanying consolidated balance sheets of Digital Recorders, Inc. and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2002. These 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 audit to obtain reasonable assurance about whether the 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 Digital Recorders, Inc. and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America.
As described in Note 3 to the financial statements, effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets."
Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The consolidated supplemental schedule II is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in our audits of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole.
/s/ MCGLADREY & PULLEN, LLP
Raleigh, North Carolina
March 6, 2003, except for certain portions
of Notes 7 and 21, as to which the dates are
March 21, 2003 and March 28, 2003.
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
See accompanying notes to consolidated financial statements.
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
See accompanying notes to consolidated financial statements.
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1)
ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Digital Recorders, Inc. (the "Company") was incorporated in 1983 and became a public company through an initial public offering in November 1994. The Company itself, or through contractors, designs, manufactures, sells, and services information technology and audio surveillance technology products through the transportation communications segment and the law enforcement and surveillance segment. Customers include municipalities, regional transportation districts, federal, state and local departments of transportation, bus manufacturers, and law enforcement agencies and organizations. The Company markets primarily to customers located in North and South America, Far and Middle East, Asia, Australia and Europe.
(b)
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
The Company's operations are affected by numerous factors, including changes in laws and governmental regulations and technological advances. The Company cannot predict if any of these factors might have a significant impact upon the transportation communications and the law enforcement and surveillance industries in the future, nor can it predict what impact, if any, the occurrence of these or other events might have upon the Company's operations and cash flows. Significant estimates and assumptions made by management are used for, but not limited to, the allowance for doubtful accounts, the allowance for slow moving inventory, the estimated useful lives of long-lived and intangible assets, the recoverability of such assets by their estimated future undiscounted cash flows, the fair value of reporting units and indefinite life intangible assets, the allowance for warranty claim reserves and the purchase price allocations used in the Company's acquisitions.
The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. At times, the Company places temporary cash investments with high credit quality financial institutions in amounts that may be in excess of FDIC insurance limits.
(e)
Revenue Recognition
Revenue from product sales is recognized upon shipment to customers based upon the defined shipping terms. Even though the Company receives customer sales orders that may require scheduled product deliveries over several months, sales revenues are only recognized upon physical shipment of the product to the customer. Service revenues are recognized upon completing the service. Service revenues include product repair not under a warranty agreement, city route mapping, product installation, training, consulting to transit authorities and funded research and development projects. Service revenues were not a significant source of revenue for 2002, 2001 and 2000. Product sales and service revenues for 2002, 2001 and 2000 are detailed below:
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
The Company's customer sales agreements do not provide any post-sales service, support, subsequent upgrade rights or right of return.
(f)
Trade Accounts Receivable
The Company routinely assesses the financial strength of its customers and, as a consequence, believes that its trade receivable credit risk exposure is limited. Trade receivables are carried at original invoice amount less an estimate provided for doubtful receivables, based upon a review of all outstanding amounts on a monthly basis. A valuation allowance is provided for known and anticipated credit losses, as determined by management in the course of regularly evaluating individual customer receivables. This evaluation takes into consideration a customer's financial condition and credit history, as well as current economic conditions. Trade receivables are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received. No interest is charged on customer accounts.
Inventories are valued at the lower of cost or market, with cost determined by the first-in, first-out method.
(h)
Property and Equipment
Property and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful lives of the assets ranging from three to ten years. The Company periodically evaluates the recoverability of its property and equipment. If facts and circumstances suggest that the property and equipment will not be recoverable, as determined based upon the undiscounted cash flows over the remaining depreciable period, the carrying value of property and equipment will be reduced to its fair value using prices for similar assets. To date, management has determined that no impairment of property and equipment exists.
(i)
Goodwill and Indefinite Life Intangible Assets
Beginning January 1, 2002, goodwill and indefinite life intangible assets are not amortized but are tested annually for impairment, or more frequently if events or changes in circumstances indicate that the assets might be impaired. Management has determined the Company does not have indefinite life intangible assets. In assessing the recoverability of goodwill, the Company must make assumptions about the estimated future cash flows and other factors to determine the fair value of these assets.
Assumptions about future revenue and cash flows require significant judgment because of the current state of the economy, the fluctuation of actual revenue and the timing of expenses. The Company's management develops future revenue estimates based upon customer commitments and other available data. Estimates of future cash flows assume that expenses will grow at rates consistent with historical rates. If the expected cash flows are not realized or if market conditions result in lower valuation multiples, impairment losses may be recorded in the future.
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
For goodwill, the impairment evaluation includes a comparison of the carrying value of the reporting unit (including goodwill) to that reporting unit's fair value. If the reporting unit's estimated fair value exceeds the reporting unit's carrying value, no impairment of goodwill exists. If the fair value of the reporting unit does not exceed the unit's carrying value, then an additional analysis is performed to allocate the fair value of the reporting unit to all of the assets and liabilities of that unit as if that unit had been acquired in a business combination and the fair value of the unit was the purchase price. If the excess of the fair value of the reporting unit over the fair value of the identifiable assets and liabilities is less than the carrying value of the unit's goodwill, an impairment charge is recorded for the difference. To date, management has determined that no impairment of goodwill exists.
Intangible assets recorded as part of the acquisitions of Transit-Media and Digital Audio consist of certain deferred costs, tooling and related costs, and costs incurred to apply for and obtain patents on internally developed technology. Intangible assets also consist of customer list relationships recorded as part of the acquisition of Mobitec. Intangible assets are amortized using a straight-line method over 3-15 years. The Company periodically evaluates the recoverability of its intangible assets. If facts and circumstances suggest that the intangible assets will not be recoverable, as determined based upon the undiscounted cash flows of the entity acquired and the patented products over the remaining amortization period, the carrying value of the intangible assets will be reduced to its fair value (estimated discounted future cash flows). To date, management has determined that no impairment of intangible assets exists.
(k)
Research and Development Costs
(m)
Shipping and Handling Fees and Costs
The basic net income (loss) per common share has been computed based upon the weighted average of shares of common stock outstanding. Diluted net income (loss) per common share has been computed based upon the weighted average of shares of common stock outstanding and shares that would have been outstanding assuming the issuance of common stock for all dilutive potential common stock outstanding. The Company's convertible preferred stock and debt and outstanding stock options and warrants represent the only dilutive potential common stock outstanding. The amounts of income (loss) used in the calculations of diluted and basic income (loss) per common share were the same for all the years presented. Diluted net income (loss) per common share is equal to the basic net income (loss) per common share for the years ended December 31, 2002, 2001 and 2000 as common equivalent shares from stock options, stock warrants and convertible debentures would not have a dilutive effect because of the loss from continuing operations.
(o)
Stock-Based Compensation
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," prescribes accounting and reporting standards for all stock-based compensation plans, including employee stock option plans. As allowed by SFAS No. 123, the Company has chosen to continue to account for stock-based
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
compensation using the intrinsic value method prescribed in Accounting Principles Board No. 25, "Accounting for Stock Issued To Employees," and related interpretations, which does not require compensation to be recorded if the consideration to be received is at least equal to the fair value of the common stock to be received at the measurement date. Under the requirements of SFAS No. 123, non-employee stock-based transactions require compensation to be recorded based on the fair value of the securities issued or the services received, whichever is more reliably measurable.
Had compensation cost for the stock option plans been determined consistent with Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," the pro forma basic and diluted net loss per common share would have been as follows:
(p)
Translation of Foreign Currency
The local currency of each of the countries of the operating foreign subsidiaries is considered to be the functional currency. Assets and liabilities of these foreign subsidiaries are translated into U.S. dollars using the exchange rates in effect at the balance sheet date. Results of operations are translated using the average exchange rate prevailing throughout the year. The effects of unrealized exchange rate fluctuations on translating foreign currency assets and liabilities into U.S. dollars are accumulated as the cumulative translation adjustment included in accumulated comprehensive income (loss) in stockholders' equity. Realized gains and losses on foreign currency transactions, if any, are included in operations for the year.
Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
(r)
Fair Value of Financial Instruments
The following summarizes the major methods and assumptions used in estimating the fair values of financial instruments:
-
Cash and Cash Equivalents - The carrying amount approximates fair value due to the relatively short- term period to maturity of these instruments.
-
Short- and Long-Term Borrowings - The carrying amount approximates the estimated fair value for debt with similar terms, interest rates and remaining maturities currently available to companies with similar credit ratings.
(s)
Product Warranties
The Company provides a limited warranty for its products. The Company’s standard warranties require the Company to repair or replace defective products during such warranty period at no cost to the customer. The Company estimates the costs that may be incurred under its basic limited warranty and records a liability in the amount of such costs at the time product revenue is recognized. Factors that affect the Company’s warranty liability include the number of units sold, historical and anticipated rates of warranty claims, and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. The Company utilizes historical trends and actuarial analysis tools to assist in determining the appropriate loss reserve levels.
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
(2)
BUSINESS COMBINATION
On June 28, 2001, the Company and its wholly owned subsidiary, DRI Europa AB, acquired all of the outstanding stock of Mobitec, a Swedish manufacturer. The acquisition of the Mobitec shares was made pursuant to an Amended Option Agreement, dated March 13, 2001, and a Stock Purchase Agreement, dated June 27, 2001. Both agreements were between the Company and DRI Europa AB as the purchasers and the individual Mobitec shareholders as the sellers.
The acquisition has been accounted for as a purchase and the results of the Mobitec operations since the date of acquisition are included in the consolidated financial statements.
The above amounts reflect adjustments for amortization of goodwill and intangible assets, as well as imputed interest on borrowed funds. The proforma results are not necessarily indicative of what actually would have occurred if the acquisition had been completed as of the beginning of each fiscal year presented, nor are they necessarily indicative of future consolidated results.
In June 2001, the Financial Accounting Standards Board issued SFAS Nos. 141 and 142, "Business Combinations" and "Goodwill and Other Intangible Assets." Under the new rules, goodwill and other intangible assets deemed to have indefinite useful lives are no longer amortized but are subject to impairment tests at least annually, or more frequently if circumstances occur that indicate impairment may have occurred. Management has determined that the Company does not currently have any indefinite life intangible assets. Other intangible assets continue to be amortized over their useful lives. Amortization of certain of these intangible assets continues to be deductible for income tax purposes.
For acquisitions completed prior to June 30, 2001, the Company has applied the new rules on accounting for business combinations and goodwill and other intangible assets beginning on January 1, 2002. Effective upon the adoption of SFAS No. 142 on January 1, 2002, the Company identified its two operating segments each to be separate reporting units. The carrying values of the reporting units are determined by allocating all applicable assets (including goodwill) and liabilities based upon the unit in which the assets are employed and to which the liabilities relate, considering the methodologies utilized to determine the fair value of the reporting units.
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
In connection with the adoption of SFAS No. 142, the Company was required to carry out a transitional goodwill impairment evaluation, which required an assessment of whether there was an indication that goodwill was impaired at the date of adoption. The Company identified its reporting units and determined the carrying value of each reporting unit by assigning the assets and liabilities (including goodwill) to those reporting units as of the date of adoption. All existing goodwill at the date of adoption was assigned to one or more reporting units in a reasonable and supportable manner as prescribed in the standard. The Company assessed the fair value of each reporting unit and compared it to the unit's carrying value.
The Company has completed its goodwill impairment evaluation in connection with the adoption of the new standard and determined that there is no impairment of goodwill as of the date of adoption. As a result of these impairment evaluations, no impairment charges were recorded during the year ended December 31, 2002. Management is not aware of any events, through the date of the Company's Annual Report on Form 10-K, which indicates that an impairment has been experienced. Under the new standard, goodwill will be required, at a minimum, to be evaluated annually for impairment.
The following table reflects the impact of the new standards and reconciles the reported net loss applicable to common shareholders to net loss applicable to common shareholders adjusted for amortization of goodwill, net of the associated tax effects, and the related per share amounts:
* The Company's goodwill amortization expense has not been deductible for tax purposes.
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
(4)
PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
Inventories consist of the following:
The Company also has a lease commitment under a capital lease obligation for a tradeshow booth that expires in 2004.
At December 31, 2002, future minimum lease payments under the non-cancelable operating leases and the future minimum lease payments and the present value of the capital lease are as follows:
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
(7)
LINES OF CREDIT AND LONG-TERM DEBT
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
* Reclassified during 2002 as a current liability due to the expiration date of the agreement being less than one year from the balance sheet date.
Long-term debt consists of the following notes and obligations, the proceeds of which were used to finance the Mobitec acquisition and for working capital requirements.
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
*
Reclassified during 2002 as a current liability due to the expiration date of the agreement being less than one year from the balance sheet date.
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
The repayment amounts of long-term debt are due as follows:
Series AAA Preferred shares are cumulative, nonvoting, fully participating, convertible and redeemable at our discretion with the redemption price equal to the liquidation preference. The liquidation preference equals $5,000 per share, plus all accrued and unpaid dividends.
(9)
COMMON STOCK WARRANTS
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
(a)
Incentive Stock Option Plan
The Company has an incentive stock option plan for employees whereby options to purchase Common Stock are granted at no less than the stock's estimated fair market value at the date of the grant and may be exercised during specified future periods.
(b)
Non-Qualified Stock Options
The Company has issued options to purchase Common Stock primarily to non-employee members of the Board of Directors or committees of the Board of Directors which are exercisable at times and in increments as specified by the individual agreements.
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
(c)
Stock-Based Compensation
The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations and, accordingly, no compensation cost has been recognized for stock options issued under the stock option plans. As disclosed in Note 1, SFAS No. 123 requires the disclosure of pro forma net income and earnings per share had the Company adopted the fair value method. Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option-pricing models. These models require subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated value. Significant assumptions used by the Company for the pro forma calculations disclosed in Note 1 are as follows:
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
The Company reduces its deferred tax assets by a valuation allowance when, based upon the available evidence, it is more likely than not that a significant portion of the deferred tax assets will not be realized. At December 31, 2002 and 2001, substantially all of the Company's deferred tax valuation allowance is attributable to operating loss carryforwards at one of its foreign subsidiaries.
The Tax Reform Act of 1986 contains provisions that limit the ability to utilize net operating loss carryforwards in the case of certain events including significant changes in ownership interests. If the net operating loss carryforwards are limited, and the Company has taxable income which exceeds the permissible yearly net operating loss, the Company would incur a federal income tax liability even though net operating losses would be available in future years.
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
**
The net sales to these customers were not significant for the years indicated.
**
Balances for these customers are not presented for years in which their net sales were not significant.
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
On August 2, 2002, the Company completed a privately negotiated sale of $1.15 million of convertible subordinated debentures through funds managed by Dallas-based Renaissance Capital Group. Russell C. Cleveland, Renaissance Capital Group's President and Chief Executive Officer, serves on the Company's Board of Directors. In June 2001, prior to Mr. Cleveland's involvement as a director of the Company, the Company issued convertible debentures in the amount of $3 million (the "2001 Debentures") to Renaissance Capital Group containing substantially the same terms as the convertible debentures issued in 2002.
The Company has two principal business segments, which are based upon differences in products and technology: (1) transportation communications segment and (2) law enforcement and surveillance segment. The transportation communications segment produces automated announcement and passenger information systems and electronic destination sign products for municipalities, regional transportation districts, and departments of transportation and bus vehicle manufacturers. The law enforcement and surveillance segment produces digital signal processing products for law enforcement agencies and organizations.
Operating income (loss) for each segment is total sales less operating expenses applicable to the segment. Certain corporate overhead expenses including executive salaries and benefits, public company administrative expenses, legal and audit fees, and interest expense are not included in segment operating income (loss). Segment identifiable assets include accounts receivable, inventories, net property and equipment, net intangible assets and net goodwill. Sales, operating income (loss), identifiable assets, capital expenditures, long-lived assets, depreciation and amortization, and geographic information for the operating segments are as follows:
Effective December 13, 1999, the Board of Directors adopted a stockholder rights agreement designed to prevent any potential acquirer from gaining control of the Company without fairly compensating the stockholders and to protect the Company from any unfair or coercive takeover attempts. The plan was not adopted in response to any specific effort to acquire the Company.
The Board of Directors approved the declaration of a dividend of one right for each outstanding share of our common stock on the record date of December 27, 1999. Each of the rights, which are not currently exercisable, entitles the holder to purchase 1/1000th of a share of our newly designated Series D Junior Participating Preferred Stock at an exercise price of $20.00. Until exercisable, the rights are represented by and traded with our common stock and no separate certificates for the rights will be issued.
In general, the rights will become exercisable only if any person or group of affiliated persons makes a public announcement that it has acquired 15 percent or more of our stock or that it intends to make or makes a tender offer or exchange offer for 15 percent or more of our stock. Under certain circumstances, each holder of a right (other than the person or group who acquired 15 percent or more of our stock) is entitled to purchase shares of our common stock having a market value equal to two times the exercise price. If, after a person has acquired 15 percent or more of our common stock, the Company is acquired in a merger or other business combination transaction or there is a sales or transfer of a majority of our assets or earning power, each holder of a right is entitled to purchase shares of the acquiring company's common stock having a fair market value equal to two times the exercise price.
The Company may redeem the rights for $.001 per right prior to the acquisition or ownership of 15 percent or more of our common stock and the rights will expire in ten years. The rights distribution is not taxable to the shareholders.
The Company, in the normal course of its operations, is involved in several legal actions incidental to the business. In management's opinion, the ultimate resolution of these matters will not have a material adverse effect upon the current financial position of the Company or future results of operations.
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
On February 7, 2001, NextBus Information Systems, Inc, ("NextBus") a California Corporation, filed suit in the United States District Court for the Northern District of California accusing the Company of infringing U.S. Patent 6,006,159 ("the 159 patent"). NextBus based the case on a Company news release and not on an allegedly infringing act. In response, a complaint for declaratory relief was filed on June 25, 2001, in the United States District Court, Northern District of Texas, Dallas Division, asking the court to interpret the scope of the 159 patent. The NextBus action in the United States District Court for the Northern District of California proceeded to hearing on July 3, 2002. The findings of the Court were substantially consistent with the arguments of the Company's Intellectual Property Counsel. In response to the findings of the courts, the Company and NextBus settled the action subsequent to year end. See Subsequent Events - Note 21.
The Company acquired Mobitec in June 2001. As part of its plan relative to the acquisition, the Company accrued for certain business activities duplicated within the existing and newly acquired international operations.
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46). This interpretation clarifies existing accounting principles related to the preparation of consolidated financial statements when the equity investors in an entity do not have the characteristics of a controlling financial interest or when the equity at risk is not sufficient for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 requires a company to evaluate all existing arrangements to identify situations where a company has a "variable interest" (commonly evidenced by a guarantee arrangement or other commitment to provide financial support) in a "variable interest entity" (commonly a thinly capitalized entity) and further determine when such variable interests require a company to consolidate the variable interest entities' financial statement with its own. The Company is required to perform this assessment by September 30, 2003 and consolidate any variable interest entities for which it will absorb a majority of the entities' expected losses or receive a majority of the expected residual gains. Management has not yet performed this assessment, however it is not aware of any material variable interest entity that it may be required to consolidate.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations," which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement is effective for the Company beginning January 1, 2003. Management does not expect that adoption of this standard will have a material impact upon the Company's financial statements.
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
Subsequent to the issuance of the Company's September 30, 2002 consolidated unaudited financial statements filed on Form 10-Q, management recorded certain adjustments to capitalized software costs and foreign currency translation gains. As a result of the adjustments, the Company's unaudited interim financial information for each of the first three 2002 calendar quarters and the associated year-to-date amounts in those periods have been retroactively restated (1) to record certain project development costs to a capitalized software asset in the pre-tax amount of $166,551 and (2) to adjust pre-tax foreign currency translation gains of $267,344. The change had no impact upon cash flows provided by operations.
The effect of the restatements from the adjustments of the capitalized software asset and foreign currency translation gains on the Company's unaudited interim consolidated quarterly financial statements and a summary of the quarterly results of operations for the year ended December 31, 2002 is as follows:
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
During the fourth quarter of 2001, the Company completed its final allocation of the Mobitec purchase price to the specific assets acquired. As a result of the final allocation and other adjustments, an additional amount of $75,751 was charged to selling, general and administrative expenses.
On January 21, 2003, the Company settled its pending legal action with NextBus. Under the terms of the settlement, no consideration was paid and each organization paid their own litigation expenses.
On February 20, 2003, the Company entered into a Placement Agency Agreement with a Dallas-based investment banking firm, under which the investment banking firm will identify purchasers to participate in the potential equity financing. As part of the agreement, the investment banking firm will act on a best efforts basis to identify prospective purchasers of equity securities of the Company. Such equity securities are intended to be sold under an exemption from the registration requirements of the Securities Act of 1933. The agreement with the investment banking firm is non-exclusive and is terminable upon 30 days notice. The investment banking firm is entitled to compensation based upon the gross proceeds from the sale of equity securities of the Company sold. The investment banking firm is entitled to 8 percent of the first $5 million in such gross proceeds, 7 percent of the next $5 million, and 6 percent of the gross proceeds over $10 million. The Company will pay the investment banking firm the relevant compensation upon closing of the sale generating the compensation. The Company will also issue to the investment banking firm a warrant to purchase 10 percent of the total number of equity securities sold, exercisable for a period of five years at the price at which the equity securities were sold. The Company also paid the investment banking firm a $25,000 nonrefundable expense allowance and will reimburse the investment banking firm for all reasonable out-of-pocket expenses in providing services to the Company.
On March 6, 2003, the Company announced that at a special meeting of the AAA Preferred Stock shareholders, the holders of the Series AAA Preferred Stock approved an amendment to the preferred shareholders' Articles of Incorporation to remove the mandatory redemption date, which would have been December 31, 2003. The Company may now redeem the Series AAA Preferred Stock at its sole discretion upon providing preferred shareholders with 30 days' written notice. All other terms of the AAA Preferred Stock remained the same.
On March 21, 2003, the Board of Directors of the Company approved, subject to shareholder approval, a proposal authorizing the Company to issue an undetermined number of shares of convertible Preferred Stock and warrants that would convert into an aggregate of 2,000,000 shares of Common Stock in connection with a potential private equity financing. The sale of the convertible Preferred Stock and warrants contemplated by this proposal shall only be consummated if an additional proposal is approved by the Shareholders. The
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements-Continued
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
Certain information required by Part III is omitted from this Report in that the Registrant will file a definitive proxy statement pursuant to Regulation 14A (the "Proxy Statement) not later than 120 days after the end of the fiscal year covered by this report and certain information included therein is incorporated herein by reference. Only those sections of the Proxy Statement that specifically addresses the items set forth herein are incorporated by reference.
ITEM 10.
ITEM 10. EXECUTIVE OFFICERS, DIRECTORS AND AND KEY EMPLOYEES
The response to this Item regarding our directors and executive officers and compliance with Section 16(a) of the Exchange Act by our officers and directors will be contained in the Proxy Statement for the 2003 Annual Meeting of Shareholders under the captions "Proposal One", "Other Pertinent Information" and "Section 16(A) Beneficial Ownership Reporting Compliance" and is incorporated by reference herein.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The response to this Item will be contained in the Proxy Statement for the 2003 Annual Meeting of Shareholders under the caption "Other Pertinent Information -- Executive Compensation" and is incorporated by reference herein.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The response to this Item will be contained in the Proxy Statement for the 2003 Annual Meeting of Shareholders under the caption "Other Pertinent Information - Security Ownership of Certain Beneficial Owners and Key Management" and is incorporated by reference herein.
ITEM 13.
ITEM 13. CERTAIN TRANSACTIONS
The response to this Item will be contained in the Proxy Statement for the 2003 Annual Meeting of Shareholders under the caption "Other Pertinent Information -- Certain Relationships and Related Transactions" and is incorporated by reference herein.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us (including our consolidated subsidiaries) that is required to be included in our periodic SEC reports. There have been no significant changes in our internal controls or in other factors that could significantly affect those controls subsequent to the date we carried out this evaluation.
ITEM 15.
ITEM 15. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees
The aggregate fees billed by McGladrey for professional fees rendered for the audit of the Company's fiscal year 2002 financial statements and the reviews of the financial statements included in the Company's Forms 10-Q for that fiscal year was $302,073. This compares to the $242,992 in aggregate fees billed for audit of the Company's annual financial statements for fiscal year 2001 and the reviews of the financial statements included in the Company's Forms 10-QSB for that fiscal year.
Audit Related Fees
The Company did not engage McGladrey for any assurance and related services that are reasonably related to the audit that are not disclosed under the caption "Audit Fees" above.
Tax Fees
The aggregate fees billed by McGladrey for professional fees rendered for tax compliance, tax advice or tax planning services for the fiscal year 2002 was $80,161. This compares to the $36,871 for professional fees rendered for tax compliance, tax advice or tax planning services for the fiscal year fiscal year 2001.
All Other Fees
There were no other fees billed by McGladrey during fiscal year 2002. This compares to an aggregate of $165,829 for all other fees billed by McGladrey in fiscal year 2001, the majority of which was for due diligence in connection with our acquisition of Mobitec and Proxy Statement procedures, as well as assistance in preparing tax returns. The Audit Committee considers the nature of this work to be compatible with maintaining McGladrey's independence.
PART IV
ITEM 16.
EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
See the Index to Consolidated Financial Statements and Financial Statements Schedules in Part II, Item 8.
The following documents are filed herewith or have been included as exhibits to previous filings with the Securities and Exchange Commission and are incorporated herein by this reference:
(1)
Incorporated by reference from Exhibit to our Registration on Form SB-2 (SEC File No. 33-82870-A)
(2)
Incorporated by reference from our Form 10-KSB dated March 31, 1997.
(3)
Incorporated by reference from our Proxy Statement for its annual meeting for fiscal 2000, filed on June 6, 2001.
(4)
Incorporated by reference from the Company's Form 10-KSB/A filed on June 6, 2001.
(5)
Incorporated by reference to the Company's Form 8-K, filed on September 8, 1999
(6)
Incorporated by reference from the Company's Form 10-KSB filed on March 27, 2002.
(7)
Incorporated by reference to the Company's Form 8-K filed on August 8, 2002
(8)
Incorporated by reference to the Company's Form 8-K filed on August 30, 2002
(b) Reports on Form 8-K
No current reports on Form 8-K were filed during the fourth quarter of 2002.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DIGITAL RECORDERS, INC.
Signature:
/S/ DAVID L. TURNEY
By:
David L. Turney
Title:
Chairman of the Board, Chief Executive Officer and President (Principal Executive Officer)
Date:
March 31, 2003
SIGNATURES - CONTINUED
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.
I, David L. Turney, certify that:
1. I have reviewed this annual report on Form 10-K of Digital Recorders, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a)
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
(b)
evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
(c)
presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
(a)
all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
(b)
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
March 31, 2003
/s/ David L. Turney
David L. Turney
Chief Executive Officer
I, Lawrence A. Taylor, certify that:
1. I have reviewed this annual report on Form 10-K of Digital Recorders, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(d)
designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
(e)
evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
(f)
presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
(c)
all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
(d)
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
March 31, 2003
/s/ Lawrence A. Taylor
Lawrence A. Taylor
Chief Financial Officer
SCHEDULE II
DIGITAL RECORDERS, INC.
VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 2002, 2001 and 2000
(a) Write-off of uncollectible accounts.
(b) Write-off of warranty claims
(c) Write-off of obsolete inventory
Exhibit 21.1
Digital Recorders, Inc.
Wholly-Owned Subsidiaries
Unless Otherwise Noted
Exhibit 99.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Digital Recorders, Inc. (the Company) on Form 10-K for the year ending December 31, 2002 as filed with the Securities and Exchange Commission on March 31, 2003 (the Report), I, David L. Turney, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
(2)
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
/s/ David L. Turney
__________________________________
David L. Turney
Chief Executive Officer
March 31, 2003
Exhibit 99.2
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Digital Recorders, Inc. (the Company) on Form 10-K for the year ending December 31, 2002 as filed with the Securities and Exchange Commission on March 31, 2003 (the Report), I, Lawrence A. Taylor, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:
(2)
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
/s/ Lawrence A. Taylor
__________________________________
Lawrence A. Taylor
Chief Financial Officer
March 31, 2003