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Filed Pursuant to Rule 424(b)(3)
Registration No. 333-115897
PROSPECTUS
DIGITAL RECORDERS, INC.
812,500 Shares of Common Stock
This prospectus relates to the offer and sale of up to 812,500 shares of common stock of Digital Recorders, Inc., a North Carolina corporation, that may be offered and sold from time to time by the shareholders described in this prospectus under “Selling Shareholders” or by pledgees, donees, transferees, assignees or other successors-in-interest that receive any of the shares as a gift, distribution or other non-sale related transfer. As used in this prospectus, “we,” “us,” “our” and similar expressions refer to Digital Recorders, Inc. and its subsidiaries.
The Selling Shareholders may offer their shares from time to time through or to one or more underwriters, brokers or dealers, on the Nasdaq SmallCap Market, in the over-the-counter market at market prices prevailing at the time of sale, in one or more negotiated transactions at prices acceptable to the Selling Shareholders or otherwise. We will not receive any proceeds from the sale of shares by the Selling Shareholders. In connection with any sales, the Selling Shareholders and any underwriters, agents, brokers or dealers participating in such sales may be deemed to be “underwriters” within the meaning of the Securities Act.
We will pay the expenses related to the registration of the shares covered by this prospectus. The Selling Shareholders will pay commissions and selling expenses, if any, incurred by them.
Our common stock is traded on the Nasdaq SmallCap Market under the symbol “TBUS.” The closing sale price on Nasdaq on July 7, 2004 was $6.05 per share. Our common stock is also traded on the Boston Stock Exchange under the symbol “TBU.”
Investing in the common stock offered by this prospectus is speculative and involves a high degree of risk. See “Risk Factors” beginning on page 5.
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.
The date of this prospectus is July 8, 2004.
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ABOUT THIS PROSPECTUS
This prospectus is part of a registration statement that we filed with the Securities and Exchange Commission using the SEC’s shelf registration rules. Under the shelf registration rules, using this prospectus and, if required, one or more prospectus supplements, the Selling Shareholders may sell from time to time, in one or more offerings, the shares of common stock covered by this prospectus. The shares covered by this prospectus include 625,000 outstanding shares of common stock and 187,500 shares of common stock issuable upon the exercise of warrants that we previously issued to the Selling Shareholders. This prospectus also covers certain rights that we have granted to holders of our common stock, including shares issued in the future, to purchase fractions of a share of our Series D Junior Participating Preferred Stock in the event of an acquisition of, or an announced tender offer for, 15% or more of our outstanding common stock. Until such a triggering event occurs, these preferred stock purchase rights are attached to shares of our common stock, and are neither evidenced by separate certificates nor transferable separately from our common stock. If the rights become exercisable, we will take further action, if required, to register with the SEC the issuance of shares of our Series D Junior Participating Preferred Stock. Our board of directors has voted to terminate our shareholders’ rights plan effective on July 15, 2004. The rights will expire on that date unless sooner redeemed or exchanged. This prospectus also covers any shares of common stock, and related preferred stock purchase rights, that may become issuable pursuant to anti-dilution adjustment provisions that would increase the number of shares issuable upon exercise of the warrants as a result of stock splits, stock dividends or similar transactions.
A prospectus supplement may add, update or change information contained in this prospectus. We recommend that you read carefully this entire prospectus, especially the section entitled “Risk Factors” beginning on page 5, and any supplements before making a decision to invest in our common stock.
You should rely only on the information contained in this prospectus and any supplements. We have not authorized anyone to provide you with different information. Neither we nor any Selling Shareholder is making an offer to sell, or soliciting an offer to buy, these securities in any state where the offer or solicitation is not permitted. The information contained in this prospectus is provided as of the date on the front of this prospectus, and the delivery of this prospectus does not imply that there has been no change in our affairs or any other information since that date.
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PROSPECTUS SUMMARY
This summary highlights important information about this offering and our business. It does not include all information you should consider before investing in our common stock. Please review this prospectus in its entirety, including the risk factors and our financial statements and the related notes, before you decide to invest. Unless otherwise noted, the terms the “company,” “Digital Recorders,” “we,” “us” and “our” refer to Digital Recorders, Inc. and its consolidated subsidiaries.
Our Company
We were incorporated in 1983 and became a public company through an initial public offering in November 1994. We are a market leader in transit, transportation and law enforcement digital communications and audio enhancement systems using proprietary software applications. Our products improve the flow and mobility of people through transportation infrastructure, as well as enhance law enforcement agencies’ surveillance capabilities. Our transit communications products — TwinVision® and Mobitec route destination signage systems, Talking Bus® voice announcement systems, and Internet-based, automatic vehicle monitoring systems — enhance public transportation in a number of countries around the globe. Our electronic surveillance tools, including microphone amplifiers and processors, countermeasures devices, speech activity detectors, and radio/television noise cancellers, help law-enforcement agencies capture, arrest and prosecute criminals. We currently operate through the following two major business segments: (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 market. We conduct these operations through our Digital Recorders business unit in the United States and through our TwinVision® and DRI Europa AB subsidiaries, and the subsidiaries of DRI Europa AB, Transit Media-Mobitec GmbH and Mobitec AB, outside the United States. This segment accounted for approximately 97 percent of our net sales in 2003 and 96 percent in 2002 and 2001. We sell to transportation vehicle equipment customers generally in two broad categories, including end-user customers and original equipment manufacturers. Our end-user customers include:
• | municipalities; | |||
• | regional transportation districts; | |||
• | federal, state, and local departments of transportation; | |||
• | transit agencies; | |||
• | public, private, or commercial operators of vehicles; and | |||
• | rental car agencies. |
Our original equipment manufacturer customers are the manufacturers of transportation vehicles. The relative percentage of sales to end customers compared to original equipment manufacturer customers varies widely and frequently from quarter-to-quarter and year-to-year and within products and product lines comprising our mix of total revenue in any given period.
Law Enforcement and Surveillance Segment.Our law enforcement and surveillance segment consists of our wholly owned subsidiary, Digital Audio Corporation, in Durham, North Carolina, which we acquired in 1995. Digital Audio serves customers in the federal, state and local law enforcement agencies or organizations in the United States, as well as similar agencies in foreign countries such as the Royal Canadian Mounted Police, Australian Federal Police and London Metropolitan Police. It produces a line of digital
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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:
• | U.S. federal, state, and local law enforcement agencies or organizations; | |||
• | U.S. military and intelligence organizations; | |||
• | comparable national and regional agencies of foreign governments; and | |||
• | private and industrial security and investigation firms. |
An Overview of Our Industry, Markets and Products
Our electronic signage and automatic voice announcement and vehicle locating systems provide customers of our transportation communications segment with next stop, transfer point, route and destination information, vehicle location and operational condition information, and public service announcements. On the public side of this market, mass transit operating authorities can normally obtain funding for equipment purchases from the U.S. Federal Transit Administration. While as much as 80 percent of major capital acquisitions can be federally funded in most instances, overall federal funding in the U.S. transportation communications segment market accounts for roughly 20 percent of all funding of all activities in the U.S. market. The balance comes from a combination of state and local sources and passenger fare revenues. Typical privately funded users of our transit communications sector products include rental car shuttle vehicles and tour vehicle operators. Funding for markets outside of the U.S. comes from a variety of sources. These sources vary widely region-to-region and may include combinations of local, regional, municipal, federal and private entities or funding mechanisms.
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, and was acknowledged to be ADA-compliant.
The automatic vehicle location capability of the Digital Recorders Talking Bus® system has enabled us to expand our served market to include fleet management services for operators of transit vehicle systems.
The electronic destination sign market, which is served by Transit Media-Mobitec GmbH, TwinVision® and Mobitec AB, is highly competitive and mature, with business growth closely tied to overall market size, increased market share, or technological advances. Virtually all new transit buses manufactured worldwide have some form of destination sign system, and approximately 95 percent of those systems in the U.S. and 70 percent in major international markets are electronic. We believe that TwinVision® holds approximately the same level of market share in the U.S. as its only significant competitor, while Mobitec AB and Transit Media-Mobitec GmbH hold significant market shares internationally. Those market shares vary widely from region to region. For example, we believe Mobitec AB has a majority of the market share in Nordic markets and we believe that Transit Media-Mobitec GmbH has less than 10 percent of the market share in Central Europe.
Our Digital Audio subsidiary’s market within our law enforcement and surveillance segment consists of government organizations at the local, state and federal level. Digital Audio also markets its products, which include audio collection, filtering, forensic examination and countermeasures devices, in North America and approximately 15 foreign countries directly and through a network of dealers. Typically, about 30 percent of Digital Audio’s sales are to international customers, although that percentage varies widely from quarter-to-quarter and year-to-year.
Competition
Most of the markets in which we participate are highly competitive and are subject to rapid 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.
Customers
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 to which we made sales greater than 10 percent of our total sales) in 2003, 2002 and 2001 were transit bus original equipment manufacturers. In 2003, one major customer accounted for 16.2 percent of our net sales, compared to two major customers accounting for 21.9 percent in 2002, and three major customers accounting for 36.4 percent in 2001. We sell our products to a limited, fixed set of customers. Concentration
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and credit risk is therefore a function of orders we receive in any given period of time. Loss of one or more of these larger key customers could have an adverse impact, possibly material, on our company.
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. Research and development expenses (excluding certain capitalized software development costs) were $2,057,312, or 4.7 percent of net sales in 2003, compared to $2,492,428, or 5.5 percent of net sales, in 2002, and $2,648,510, or 7.1 percent of net sales, in 2001. Because we believe that technological advances are necessary to maintain and improve our product lines and, thus, our market position in a highly competitive market environment, we expect to continue to invest a significant amount of capital relative to our revenues on research and development in the foreseeable future. As a result of our 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.
Our Manufacturing Operations
Our Digital Audio Corporation and Mobitec AB subsidiaries primarily manufacture and assemble their products internally, using raw materials and components purchased from well-established vendors and smaller local suppliers. Our Digital Recorders division and TwinVision® and Transit Media-Mobitec GmbH subsidiaries outsource most of their manufacturing and assembly operations, although TwinVision® moved parts of its assembly process in-house in 2002. Our Digital Recorders business unit was solely dependent on a single contract-manufacturing firm, CEA of North Carolina, for most of fiscal year 2003. We do not intend to be solely dependent on that firm or other suppliers for major components in the longer term. In keeping with this policy, we have executed contracts with other suppliers to perform some of the services CEA currently provides to our Digital Recorders business unit. We believe alternative suppliers would be readily available for all raw materials and components for all of our business units.
Our website address is www.digitalrecorders.com. Information on our website is not part of this prospectus. More detailed information about our business is contained under the heading “Business” below.
Risk Factors
See “Risk Factors” beginning on page 5 for a discussion of factors you should carefully consider before deciding to invest in our common stock.
The Offering
Common stock offered by the selling shareholders | 812,500 shares | |
Offering prices | The shares may be offered and sold at prevailing market prices or such other prices as the selling shareholders may determine. | |
Common stock outstanding | 7,943,874 shares as of June 8, 2004 | |
Dividend policy | Holders of Series AAA Redeemable Nonvoting Preferred Stock and Series E Redeemable Nonvoting Convertible Preferred Stock are entitled to receive cumulative quarterly dividends when and if declared by our board of directors, at the rate of 10% per annum and 7% per annum, respectively, in cash, on the liquidation value of those shares. Subject to the rights of our outstanding preferred stock and subject to restrictions imposed by an outstanding convertible subordinated debenture and related purchase agreement and our domestic senior credit facility, dividends on our common stock may be declared and paid when and as determined by our board of directors. We do not presently intend to begin paying dividends on our common stock in the foreseeable future. | |
Nasdaq SmallCap Market symbol | TBUS | |
Boston Stock Exchange symbol | TBU | |
Use of proceeds | We are not selling any of the shares of common stock being offered by this prospectus and will receive no proceeds from the sale of the shares by the selling shareholders. All of the proceeds from the sale of common stock offered by this prospectus will go to the selling shareholders who offer and sell their shares. | |
Voting rights | The holders of our common stock are entitled to one vote per share on all matters to be voted on by shareholders. Under North Carolina law, the approval of the holders of shares of each series of our outstanding preferred stock, voting as a separate class, may be required for certain matters, such as mergers and amendments to our articles of incorporation. |
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Our Address
Our principal executive offices are located at 5949 Sherry Lane, Suite 1050, Dallas, Texas 75225, and our telephone number is (214) 378-8992.
Summary Consolidated Financial Information
The following table presents summary consolidated financial information. The statement of operations data for the years ended December 31, 2001, 2002 and 2003 and the balance sheet data as of December 31, 2002 and 2003 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The statement of operations data for the years ended December 31, 1999 and 2000 and the balance sheet data as of December 31, 1999, 2000 and 2001 have been derived from our audited consolidated financial statements that are not included herein. The statement of operations data for the three months ended March 31, 2003 and 2004, and the balance sheet data as of March 31, 2003 and 2004 have been derived from unaudited consolidated financial statements that, in the opinion of management, include all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the data for such periods. The results of operations for the interim periods are not necessarily indicative of the operating results for the entire year or any future period.
The information included in this table should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited and unaudited consolidated financial statements and accompanying notes thereto included elsewhere in this prospectus.
Statements of Operations Data:
THREE MONTHS | ||||||||||||||||||||||||||||
ENDED MARCH 31, | YEARS ENDED DECEMBER 31, | |||||||||||||||||||||||||||
2004 | 2003 | 2003 | 2002 | 2001 | 2000 | 1999 | ||||||||||||||||||||||
(Unaudited) | ||||||||||||||||||||||||||||
Net sales | $ | 12,135,706 | $ | 10,917,194 | $ | 44,026,242 | $ | 45,137,986 | $ | 37,215,352 | $ | 29,886,168 | $ | 22,441,234 | ||||||||||||||
Gross profit | 5,083,592 | 4,343,991 | 17,250,212 | 16,274,994 | 13,825,786 | 10,905,599 | 7,886,100 | |||||||||||||||||||||
Operating income (loss) | 594,906 | 131,298 | (420,275 | ) | 724,218 | 418,843 | 232,754 | (283,029 | ) | |||||||||||||||||||
Net income (loss) applicable to common shareholders | 85,597 | (211,466 | ) | (2,232,508 | ) | (366,503 | ) | (61,735 | ) | (456,463 | ) | (776,572 | ) | |||||||||||||||
Net income (loss) applicable to common shareholders per common share | ||||||||||||||||||||||||||||
Basic | $ | 0.02 | $ | (0.06 | ) | $ | (0.58 | ) | $ | (0.10 | ) | $ | (0.02 | ) | $ | (0.14 | ) | $ | (0.24 | ) | ||||||||
Diluted | $ | 0.02 | $ | (0.06 | ) | $ | (0.58 | ) | $ | (0.10 | ) | $ | (0.02 | ) | $ | (0.14 | ) | $ | (0.24 | ) | ||||||||
Weighted average number of common shares and common equivalent shares outstanding: | ||||||||||||||||||||||||||||
Basic | 3,944,475 | 3,804,475 | 3,873,133 | 3,746,119 | 3,495,954 | 3,274,108 | 3,274,075 | |||||||||||||||||||||
Diluted | 4,110,127 | 3,804,475 | 3,873,133 | 3,746,119 | 3,495,954 | 3,274,108 | 3,274,075 | |||||||||||||||||||||
Balance Sheet Data:
MARCH 31, | DECEMBER 31, | |||||||||||||||||||||||||||
| 2004 | 2003 | 2003 | 2002 | 2001 | 2000 | 1999 | |||||||||||||||||||||
(Unaudited) | ||||||||||||||||||||||||||||
Current assets | $ | 20,884,253 | $ | 19,223,466 | $ | 18,677,183 | $ | 20,177,571 | $ | 18,000,755 | $ | 15,515,456 | $ | 10,971,984 | ||||||||||||||
Total assets | 36,209,063 | 32,856,512 | 34,551,896 | 33,383,186 | 28,810,149 | 17,820,225 | 13,184,573 | |||||||||||||||||||||
Current liabilities | 18,513,137 | 17,420,329 | 16,334,982 | 17,855,617 | 10,248,857 | 12,217,721 | 7,034,938 | |||||||||||||||||||||
Long term debt | 6,284,783 | 7,584,741 | 6,647,052 | 7,737,940 | 11,601,020 | — | — | |||||||||||||||||||||
Redeemable Preferred Stock | — | — | — | 1,770,000 | 1,770,000 | 1,770,000 | 1,770,000 | |||||||||||||||||||||
Minority interest | 374,411 | 305,000 | 338,199 | 267,566 | 208,659 | — | — | |||||||||||||||||||||
Stockholders’ equity | 11,036,732 | 7,546,442 | 11,231,663 | 5,752,063 | 4,981,613 | 3,832,504 | 4,379,635 |
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RISK FACTORS
An investment in our common stock involves significant risks. You should consider carefully the following information about these risks, together with the other information contained in this prospectus, before buying shares of our common stock. Many of the risks discussed below have affected our business in the past, and many are likely to continue to do so. These risks may materially adversely affect our business, financial condition, operating results or cash flows, or the market price of our common stock. Each of these risk factors could adversely affect the value of an investment in our common stock.
Risks Related to Our Indebtedness, Financial Condition and Results of Operations
Our substantial debt could adversely affect our financial position, operations and ability to grow.
We have a substantial amount of debt. As of May 31, 2004, our total debt of approximately $8.4 million consisted of long-term debt in the amount of $3.5 million, including current maturities of approximately $1.3 million, and short-term debt of $4.9 million. Included in the long-term debt is $2.0 million of unsecured indebtedness to one of our shareholders, $1.5 million outstanding under a term loan to a Swedish bank and $250,000 under our outstanding 8.0% convertible debenture held by a shareholder and director. The short-term debt consisted of the outstanding balances under our domestic and European revolving credit facilities. Our substantial indebtedness could have adverse consequences in the future. For example, it could:
• | Require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, which would reduce amounts available for working capital, capital expenditures, research and development and other general corporate purposes; |
• | Limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; |
• | Increase our vulnerability to general adverse economic and industry conditions; |
• | Place us at a competitive disadvantage compared to our competitors that may have less debt than we do; |
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• | Make it more difficult for us to obtain additional financing that may be necessary in connection with our business; |
• | Make it more difficult for us to implement our business and growth strategies; and |
• | Cause us to have to pay higher interest rates on future borrowings. |
Some of our debt bears interest at variable rates. If interest rates increase, or if we incur additional debt, the potential adverse consequences, including those described above, may be intensified. If our cash flow and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay planned expansion and capital expenditures, sell assets, obtain additional equity financing or restructure our debt. Our existing credit facilities contain covenants that, among other things, limit our ability to incur additional debt.
Future cash requirements or restrictions on cash could adversely impact our financial position, and an event of default under our outstanding debt instruments could impair our ability to conduct business operations.
Our overall cash balance has significantly fluctuated in fiscal 2002, 2003 and 2004, and we could incur negative overall cash flow in future quarters. If cash flow significantly deteriorates in the future, our liquidity and ability to operate our business could be adversely impacted. Additionally, our ability to raise financial capital may be hindered due to our net losses and the possibility of future negative cash flow, thus reducing our operating flexibility.
The following items, among others, could require unexpected future cash payments, limit our ability to generate cash or restrict our use of cash:
• | triggering of certain payment obligations, or acceleration of payment obligations, under our revolving credit facilities or our outstanding convertible debenture; |
• | triggering of redemption obligations under our outstanding convertible debenture; |
• | costs associated with unanticipated litigation relating to our intellectual property or other matters; |
• | taxes due upon the transfer of cash held in foreign locations; and |
• | taxes assessed by local authorities where we conduct business. |
During the third quarter of 2003, we entered into a $10.0 million revolving credit facility with LaSalle Business Credit, LLC. This facility permits us to borrow an amount determined on the basis of a formula that applies specified percentages to our domestic inventory and accounts receivable balances and then deducts a reserve amount established by the lender (currently $600,000). After we used borrowings under this facility to repay debt that was outstanding under a facility that we had with another lender, and applying that borrowing base formula, the new facility provided us with additional borrowing capacity of approximately $1.5 million as of the date of execution. Our maximum borrowing availability under this facility at May 31, 2004 was approximately $2.0 million, following the transfer of funds borrowed under that facility in the amount of $1.5 million to our European subsidiaries to reduce the outstanding balances under our Swedish credit facilities described below. The credit facility with LaSalle has an initial term of three years and is secured by substantially all of our domestic assets. The credit agreement also has affirmative, negative and financial covenants with which we must comply. We also have revolving credit facilities with a Swedish bank that we use in connection with our European operations and which are secured by substantially all the assets of our Mobitec AB subsidiary. Our maximum borrowing availability under the various European credit facilities at May 31, 2004 was equivalent to approximately $0.1 million in U.S. dollars. After we applied the $1.5 million referred to above to reduce the outstanding balances under these facilities on June 2, 2004, our maximum borrowing availability under these facilities increased to approximately $1.6 million, and our combined borrowing availability under our U.S. domestic and European credit facilities increased to approximately $3.6 million. Our European facilities also contain affirmative, negative and financial covenants. As of May 31, 2004, our outstanding balances were $2.8 million under the domestic facility and $1.9 million under the European facilities.
At September 30, 2003, we were not in compliance with a capital expenditures limitation under our prior domestic credit facility, but we replaced that facility during the third quarter as described above. We were in default of one negative covenant under our new domestic credit facility at December 31, 2003. The tangible net worth covenant was not achieved due to our below-plan operating performance and consolidated operating losses for the three months ended December 31, 2003. Our lender, LaSalle Business Credit, LLC, has re-set the financial covenants for 2004 to reflect the changes in tangible net worth caused by the fourth quarter of 2003 and to start the fixed charge coverage ratio measurement with the three months ended March 31, 2004. As a result, at March 31, 2004, we were in compliance with the financial covenants under the new credit facility, as amended.
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A convertible subordinated debenture in the amount of $250,000 dated August 26, 2002, is payable to a shareholder and member of our 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. At March 31, 2004, we were not in compliance with the current ratio financial covenant within the agreement, but received a waiver for violation of this covenant from the holder.
While we plan to adhere to the covenants in our credit facilities to the best of our ability, in the event that it appears we are unable to avoid an event of default, it may be necessary or advisable to retire and terminate one or more of the facilities and pay all remaining balances borrowed. Any such payment would further limit our available cash and cash equivalents. Furthermore, we may not be able to retire the credit facilities if we do not have adequate resources available when necessary to avoid an event of default or if we do not have adequate time to retire the credit facilities. The consequences of an event of default under one or more of our credit facilities or other debt instruments may prevent us from conducting normal business operations.
The above cash requirements or restrictions could lead to an inadequate level of cash for operations or for capital requirements, which could have a material negative impact on our financial position and significantly harm our ability to operate the business.
We have a history of net losses and cannot assure you that we will achieve or maintain profitability.
We have incurred losses in almost every fiscal year since we have been a public company. Our net loss applicable to common shareholders was $2,232,508 in 2003, $366,503 in 2002 and $61,735 in 2001. We cannot assure you that we will become profitable in fiscal year 2004 or any future period or, if we do, that we will be able to sustain or increase profitability in the future. We had an accumulated deficit of $7.4 million as of December 31, 2002, $9.4 million as of December 31, 2003 and $9.2 million as of March 31, 2004. If we cannot achieve or sustain profitability, our financial condition will be materially adversely affected and it will be much more difficult, if possible at all, to obtain additional financing and to continue to grow our business.
Our efforts to reduce costs may not be effective. If we fail to reduce costs effectively, we may not achieve profitability or positive cash flow.
We believe cost containment and expense reductions are essential to achieving profitability and positive cash flow from operations in future quarters. Our efforts to reduce expenses have positively impacted our results in recent periods, and we recorded net income applicable to common shareholders of $85,597 for the quarter ended March 31, 2004. However, we must continue to contain costs and further reduce expenses in order to achieve and sustain profitability in future periods. We cannot assure you that we will be able to do so. If we are not able to grow our revenues while reducing our costs, as a percentage of revenue, we will not be able to achieve profitability and our business and financial condition could be materially and adversely affected.
Our operating results will continue to fluctuate.
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 two years 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. Moreover, we derive revenue primarily from significant orders from a limited number of customers. For that reason, a delay in delivery of our products in connection with a single order may significantly impact the timing of our recognition of revenue between periods. Moreover, revenue lost due to the cancellation of, or our inability to fill, an order in one period may not necessarily be made up by revenue in any future period.
Our ability to benefit from our tax loss carryforwards may be limited.
Because of our history of losses, we have significant net operating loss carryforwards that may be used to offset taxable income in future periods. However, our ability to use those carryforwards may be limited by certain factors, including, for example, our failure to generate sufficient income before the expiration of the net operating loss carryforwards.
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Changes in our equity ownership may also limit our ability to benefit from the carryforwards. As a result of our consummation of certain equity transactions during the second quarter of 2004, we have determined that our net operating loss carryforwards and related tax benefits will be limited under the Internal Revenue Code to some extent.
Risks Related to Our Operations and Product Development
A significant portion of our revenues is derived from sales to a small number of customers. If we are not able to obtain new customers or repeat business from existing customers, our business could be seriously harmed.
We sell our products to a limited and largely fixed set of customers and potential customers. In our transportation communications segment, we sell primarily to original equipment manufacturers and to end users such as municipalities, regional transportation districts, transit agencies, federal, state and local departments of transportation and rental car agencies. The identity of the customers who generate the most significant portions of our sales may vary from year to year. In 2003, one major customer accounted for 16.2 percent of our net sales, compared to two major customers accounting for 21.9 percent in 2002 and three major customers accounting for 36.4 percent in 2001. If any of our major customers stopped purchasing products from us, and we were not able to obtain new customers to replace the lost business, our business and financial condition would be materially adversely affected. Many factors affect whether customers reduce or delay their investments in products such as those we offer, including decisions regarding technology spending levels and general economic conditions in the countries and specific markets where the customers are located.
We depend on third parties to supply components we need to produce our products.
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 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 some single-sourced supplier relationships, either because alternative sources are not readily or economically 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.
Many of our customers rely on government funding, and that subjects us to risks associated with governmental budgeting and authorization processes.
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 on us. For example, the Transportation Equity Act for the 21st Century (TEA-21), the legislation under which many of the domestic customers of our transportation products business segment derive funding, was subject to reauthorization in 2003; however, the current TEA-21 program has been extended through a series of Continuing Resolutions pending enactment of new legislation. Although the Environmental and Public Works Committee of the U.S. Senate has approved legislation reauthorizing TEA-21, and the House of Representatives “T&I” Committee has acted similarly with its proposal, this legislation is still subject to further review and negotiation and could even fail to be enacted. These continuing resolutions, and delay in enactment of reauthorization legislation, tend to create uncertainty in the market. That uncertainty in turn can tend to delay, or depress, order opportunities. We are involved through the industry trade association, the America Public Transportation Association, the web site of which (www.APTA.com) regularly posts status information on legislative matters. We do not participate in compiling or presenting information on that website, and that information is not part of this prospectus. While we believe the reauthorization will occur, and that resulting federal funding will be at or above the present approximately $8 billion annually, we cannot assure you that the legislation will be reauthorized as we expect. In addition to federal funding to the public transit side of our domestic market, some of our customers rely on state and local funding. These tend to be affected by general economic conditions. For example, some transit operating authorities reduced service in 2002 and 2003, extending into 2004, in response to the slow economy; this can have a depressing effect on sales of our products. It is not possible to precisely quantify this impact. Any unfavorable change in any of these factors and considerations could have a material adverse effect upon us.
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We must continually improve our technology to remain competitive.
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. We cannot assure you that we will be able to continue to achieve or sustain the technological leadership that is necessary for success in our industry. In addition, our competitors may develop new technologies that give them a competitive advantage, and we may not be able to obtain the right to use those technologies at a reasonable cost, if at all, or to develop alternative solutions that enable us to compete effectively. A failure on our part to manage effectively the 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 anticipate or address these technological changes, our business may be adversely impacted.
We cannot assure you that any new products we develop will be accepted by customers.
Even if we are able to continue to enhance our technology and offer improved products and solutions, we cannot assure you we will be able to deliver commercial quantities of new products in a timely manner or that our 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.
If we lose the services of our key personnel, we may be unable to replace them, and our business could be negatively affected.
Our success depends in large part on the continued service of our management and other key personnel who have significant knowledge, experience and contacts in the industries that comprise our primary markets. Our ability to continue to attract, motivate and retain employees having these qualifications is essential to our future success. The loss of the services of key personnel could cause us to lose market share to a competitor or otherwise materially adversely affect our business or financial condition.
Risks Related to Our International Operations
There are numerous risks associated with international operations, which represent a significant part of our business.
Our international operations generated about one-third of our sales in 2003 and in the first quarter of 2004. Our sales outside the United States were primarily in Europe (particularly the Nordic countries), South America, the Middle East and Australia. 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.
We maintain cash deposits in foreign locations, portions of which may be subject to significant tax or tax withholding upon transfer or withdrawal.
Many countries impose taxes or fees upon removal from the country of cash earned in that country. Moreover, complying with foreign tax laws can be complicated and we may incur unexpected tax obligations in some jurisdictions. While we believe our tax positions in the foreign jurisdictions in which we operate are proper and fully defensible, tax authorities in those jurisdictions may nevertheless assess taxes and render judgments against us if we are unable to convince them of our position. In such an event, we could be required to make unexpected cash payments in satisfaction of such assessments or judgments or incur additional expenses to defend our position. This risk is mitigated, but not completely eliminated, by the existence of our net operating losses and tax credit carryforwards.
Risks Related to Our Intellectual Property
We may not be able to defend ourselves successfully against claims that we are infringing on the intellectual property rights of others, and defending ourselves could be costly.
Third parties, including our competitors, individual inventors or others, may have patents or other proprietary rights that may cover technologies that are relevant to our business. Several claims of infringement have been asserted against us in the past, and we have recently settled one lawsuit in which a third party claimed that we infringed its intellectual property.
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Even if we believe a claim asserted against us is not valid, defending against the claim may be costly. Intellectual property litigation can be complex, protracted and highly disruptive to business operations by diverting the attention and energies of management and key technical personnel. Further, plaintiffs in intellectual property cases often seek injunctive relief and the measures of damages in intellectual property litigation are complex and often subjective or uncertain. In some cases, we may decide that it is not economically feasible to pursue a vigorous and protracted defense and decide, instead, to negotiate licenses or cross-licenses authorizing us to use a third party’s technology in our products. If we are unable to successfully defend against litigation of this type, or to obtain and maintain licenses on favorable terms, we could be prevented from manufacturing or selling our products, which would cause severe disruptions to our operations. For these reasons, intellectual property litigation could have a material adverse effect on our business or financial condition.
Misappropriation of our intellectual property and proprietary rights could impair our competitive position, and enforcing our rights could be costly.
We rely upon a combination of patents, copyrights, alliances, trade secrets, nondisclosure agreements and licensing agreements to establish and protect our ownership of, and rights to use, proprietary and intellectual property rights. Although we consider the results of our research and development efforts to be proprietary to us, and we attempt to maintain the confidentiality of those results, we may not be able to prevent others from using the information or technology that we develop. 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. Policing unauthorized use of our proprietary rights is difficult. We cannot assure that the steps we take will prevent misappropriation of our technology or that the agreements we enter into for that purpose will be enforceable. In addition, laws governing intellectual property rights are less protective in some countries in which we operate, or may operate in the future, than in the United States. Litigation may be necessary in the future to enforce or protect our intellectual property rights, and we cannot be certain that we will be successful in any such litigation. Moreover, even if we are successful, litigation to enforce our rights can be complex, costly, protracted and highly disruptive to business operations. Misappropriation of our intellectual property or potential litigation could have a material adverse effect on our business or financial condition.
Risks Related to Our Equity Securities and Convertible Debenture
The public market for our common stock may be volatile, especially since market prices for technology stocks often have been unrelated to operating performance.
We cannot assure you that an active trading market will be sustained or that the market price of our common stock will not decline. From time to time, the stock market in general, and the shares of technology companies in particular (including our own stock), have experienced significant price fluctuations. The market price of our common stock is likely to continue to be highly volatile and could be subject to wide fluctuations in response to factors such as:
• | Actual or anticipated variations in our quarterly operating results; |
• | Historical and anticipated operating results; |
• | Announcements of new product or service offerings; |
• | Technological innovations; |
• | Competitive developments in the public transit industry; |
• | Changes in financial estimates by securities analysts; |
• | Conditions and trends in the public transit industry; |
• | Funding initiatives and other legislative developments affecting the transit industry; |
• | Adoption of new accounting standards affecting the technology industry or the public transit industry; and |
• | General market and economic conditions and other factors. |
Further, the stock markets, and particularly the Nasdaq Small Cap Market, have experienced extreme price and volume fluctuations that have particularly affected the market prices of equity securities of many technology companies (including our company) and have often been unrelated or disproportionate to the operating performance of such companies. These broad market factors have materially affected, and may continue to materially affect the market price of our common stock. In addition, general economic, political and market conditions, such as recessions, interest rate variations, international currency fluctuations, terrorist acts, military actions or war, may adversely affect the market price of our common stock.
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Our preferred stock and convertible debenture have preferential rights over our common stock.
As of May 31, 2004, we currently have outstanding shares of Series AAA Redeemable Nonvoting Preferred Stock and Series E Redeemable Nonvoting Convertible Preferred Stock, as well as an 8.0% convertible subordinated debenture, all of which have rights in preference to holders of our common stock in connection with any liquidation of our company. As of May 31, 2004, the aggregate liquidation preference is approximately $1.2 million for the Series AAA stock and approximately $2.2 million for the Series E stock, in each case plus accrued but unpaid dividends, and the aggregate principal amount of the outstanding 8.0% convertible subordinated debenture is $250,000. Holders of the Series AAA and Series E stock are entitled to receive cumulative quarterly dividends at the rate of 10% per annum and 7% per annum, respectively, in cash, on the liquidation value of those shares. The purchase agreement pursuant to which we issued our outstanding 8.0% convertible subordinated debenture, as well as our domestic senior credit facility, prohibits the payment of dividends to holders of our common stock. The holder of the debenture has the right to require us to redeem the debenture upon the occurrence of certain events, including certain changes in control of the company or our failure to continue to have our stock listed on The Nasdaq Stock Market or another stock exchange. In such an event, the holder would have the right to require us to redeem the debenture for an amount equal to the principal amount plus an 18% annual yield on the principal amount through the date of redemption. The preferential rights of the holders of our convertible subordinated debenture and preferred stock could substantially limit the amount, if any, that the holders of our common stock would receive upon any liquidation of the company.
Future sales of our stock, or the possibility of future sales, could adversely affect the market price of our stock.
Sales of substantial numbers of shares of our common stock in the public market, or the perception that significant sales are likely, could adversely affect the market price of our common stock. The number of shares of common stock covered by this prospectus, 77% of which are currently outstanding, is equal to approximately 10% of the currently outstanding shares of our common stock. In addition to the shares covered by this prospectus, up to 633,333 shares of common stock are currently issuable upon conversion of our outstanding shares of Series E stock. We issued those shares of Series E stock on various dates between July 1, 2003 and March 23, 2004. Those shares of common stock generally will become tradable pursuant to Rule 144 under the Securities Act of 1933 one year after the date of issuance of the shares of Series E stock being converted, or earlier if we file another registration statement covering the resale of those shares in the market. In addition, 156,250 shares of our common stock are currently issuable upon conversion of outstanding shares of our Series AAA stock. Upon conversion, those shares of common stock would be freely tradable in the market pursuant to Rule 144(k) under the Securities Act of 1933. If all the shares of common stock described in this paragraph are issued and sold in the market, the number of shares of our common stock outstanding, and potentially tradable in the public market, would increase from approximately 7.9 million shares to approximately 8.9 million shares. We cannot predict the effect that market sales of such a large number of shares would have on the market price of our common stock. Sales of substantial amounts of such shares in the public market could adversely affect the market price of our common stock.
Risks Related to Anti-Takeover Provisions and Our Shareholder Rights Plan
Our articles of incorporation, bylaws and North Carolina law contain provisions that may make takeovers more difficult or limit the price third parties are willing to pay for our stock.
Our articles of incorporation authorize the issuance of shares of “blank check” preferred stock, which would have the designations, rights and preferences as may be determined from time to time by the board of directors. Accordingly, the board of directors is empowered, without shareholder approval (but subject to applicable regulatory restrictions), to issue additional preferred stock with dividend, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of the common stock. Our board of directors could also use the issuance of preferred stock, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of the company. Our articles of incorporation also provide that our board of directors is divided into three classes, which may have the effect of delaying or preventing changes in control or changes in our management because less than a majority of the existing directors are up for election at each annual meeting. In addition, our bylaws require that certain shareholder proposals, including proposals for the nomination of directors, be submitted specified periods of time in advance of our annual shareholders’ meetings. These provisions could make it more difficult for shareholders to effect corporate actions such as a merger, asset sale or other change of control of the company. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock, and they may have the effect of delaying or preventing a change in control.
We are also subject to two North Carolina statutes that may have anti-takeover effects. The North Carolina Shareholder Protection Act generally requires, unless certain “fair price” and procedural requirements are satisfied, the affirmative vote of 95% of our voting shares to approve certain business combination transactions with an entity that is the beneficial owner, directly or indirectly, of more than 20% of our voting shares, or with one of our affiliates if that affiliate has
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previously been a beneficial owner of more than 20% of our voting shares. The North Carolina Control Share Acquisition Act, which applies to public companies that have substantial operations and significant shareholders in the state of North Carolina, eliminates the voting rights of shares acquired in transactions (referred to as “control share acquisitions”) that cause the acquiring person to own a number of our voting securities that exceeds certain threshold amounts, specifically, one-fifth, one-third and one-half of our total outstanding voting securities. There are certain exceptions. For example, this statute does not apply to shares that an acquiring person acquires directly from us. The holders of a majority of our outstanding voting stock (other than such acquiring person, our officers and our employee directors) may elect to restore voting rights that would be eliminated by this statute. If voting rights are restored to a shareholder that has made a control share acquisition and holds a majority of all voting power in the election of our directors, then our other shareholders may require us to redeem their shares at fair value. These statutes could discourage a third party from making a partial tender offer or otherwise attempting to obtain a substantial position in our equity securities or seeking to obtain control of us. They also might limit the price that certain investors might be willing to pay in the future for our shares of common stock, and they may have the effect of delaying or preventing a change of control.
Our board of directors has adopted a shareholder rights plan that could discourage or prevent takeover attempts.
On December 14, 1999, our board of directors approved a Rights Agreement that establishes a shareholder rights plan designed to prevent any potential acquirer from obtaining control of the company without negotiating the terms of the transaction with our board of directors. Under our rights plan, as amended, among other things, in the event of an acquisition of, or an announced tender offer for, 15% or more of our outstanding common stock, holders of our common stock have been granted the right to purchase a fraction of a share of our Series D Junior Participating Preferred Stock or shares of our common stock having a market value of twice the exercise price of the rights. See “Description of Securities—Preferred Stock Purchase Rights” for more information about our rights plan. The existence of our rights plan may have anti-takeover effects. The rights will cause substantial dilution to a person or group that attempts to acquire us on terms not approved by a majority of our board of directors. Although the rights plan is not intended to prevent acquisitions through negotiations with our board of directors, the existence of the rights plan may nevertheless discourage a third party from making a partial tender offer or otherwise attempting to obtain a substantial position in our equity securities or seeking to obtain control of us. To the extent any potential acquirers are deterred by our rights plan, the rights plan may have the effect of preserving incumbent directors and management in office or preventing acquisitions of the company, even if you might consider such an acquisition to be in your best interest as a holder of our common stock.
Our board of directors has voted to terminate the rights plan effective on July 15, 2004. The rights will expire on that date unless sooner redeemed or exchanged.
Risks Associated with Potential Growth
We may not be able to obtain the financing we will need to continue to grow.
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 on finding and securing financing sources of various types in both equity and debt categories. Success in these financing requirements can be adversely impacted by economic conditions and other factors beyond our control. Although we believe that our revolving credit facilities and cash flow from operations will be adequate to fund our current business operations through the end of 2004, we cannot assure you that we will not require additional sources of financing to fund our operations. Any significant acquisition or other growth initiative would also require additional financing. Additional financing may not be available to us on terms we consider acceptable, if it is available at all. If we cannot raise funds on acceptable terms, we may not be able to develop next-generation products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, any of which could have a material adverse effect on our ability to grow our business. Further, if we issue equity securities, you will experience dilution of your ownership percentage, and the new equity securities may have rights, preferences or privileges senior to those of our common stock.
There are many risks associated with potential acquisitions.
We intend to continue to evaluate potential acquisitions that we believe will enhance our existing business or enable us to grow. If we acquire other companies or product lines in the future, it may dilute the value of existing shareholders’ ownership. The impact of dilution may restrict our ability to consummate further acquisitions. Issuance of equity securities in connection with an acquisition may further restrict utilization of net operating loss carryforwards because of an annual limitation due to ownership change limitations under the Internal Revenue Code. We may also incur debt and losses related to the impairment of goodwill and other intangible assets if we acquire another company, and this could negatively impact our results of operations. We currently do not have any definitive agreements to acquire any company or business, and we may not be able to identify or complete any acquisition in the future. Additional risks associated with acquisitions include the following:
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• | It may be difficult to assimilate the operations and personnel of an acquired business into our own business; |
• | Management information and accounting systems of an acquired business must be integrated into our current systems; |
• | Our management must devote its attention to assimilating the acquired business, which diverts attention from other business concerns; |
• | We may enter markets in which we have limited prior experience; and |
• | We may lose key employees of an acquired business. |
FORWARD-LOOKING STATEMENTS
Some of the statements in this prospectus constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. In particular, any statement, express or implied, concerning future events or expectations is a forward-looking statement. Use of words such as “expect,” “fully expect,” “expected,” “appears,” “believe,” “plan,” “anticipate,” “would,” “goal,” “potential,” “potentially,” “range,” “pursuit,” “run rate,” “stronger,” “preliminarily,” etc., is intended to identify forward-looking statements that are subject to risks and uncertainties. There can be no assurance that any expectation, express or implied, in a forward-looking statement will prove correct or that the contemplated event or result will occur as anticipated. The risks associated with forward-looking statements include, but are not limited to, the ones described under the heading “Risk Factors” above.
USE OF PROCEEDS
We are not selling any of the shares of common stock being offered by this prospectus and will receive no proceeds from the sale of the shares by the Selling Shareholders. All of the proceeds from the sale of common stock offered by this prospectus will go to the Selling Shareholders who offer and sell their shares.
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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 SET FORTH UNDER THE HEADING “FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” ELSEWHERE IN THIS PROSPECTUS.
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 percent to 2 percent of net sales for the years ended December 31, 2003, 2002, and 2001.
Our transportation communications segment produces products sold in a number of countries 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:
• | municipalities; | |||
• | regional transportation districts; | |||
• | federal, state, and local departments of transportation; | |||
• | transit agencies; | |||
• | public, private, or commercial operators of vehicles; and | |||
• | rental car agencies; |
and secondly, OEMs (original equipment manufacturers) of transportation vehicles. The relative percentage of sales to end customers as compared to OEM customers varies widely and frequently from quarter to quarter and year to year 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 supporting 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 “Business.”
Critical Accounting Policies
Our significant accounting policies and methods used in the preparation of the Consolidated Financial Statements are discussed in Note 1 of the Notes to Consolidated Financial Statements included elsewhere in this prospectus. The following is a listing of our critical accounting policies and a brief description of each:
• | Allowance for doubtful accounts; |
• | Inventory valuation; |
• | Intangible assets and goodwill; |
• | Income taxes, including deferred tax assets; and |
• | 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
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another. Most of our company’s 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 is 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 collections 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. At December 31, 2003 and March 31, 2004, our allowance for doubtful accounts decreased to $115,142 from $146,066 at December 31, 2002. This decrease of 21.2 percent was greater than the 2.5 percent decrease in net sales from December 31, 2002 to December 31, 2003 and does not relate to any general trend. We make our 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. Our company, as a part of the sale, typically extends a warranty term generally ranging from one to three years. We account for this liability through a warranty reserve on the balance sheet. Additionally, in special situations, we may, solely at our discretion, use extended or 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 $162,202 and $126,342 of intangible amortization during 2003 and 2002, respectively. We recorded approximately $430,393 of goodwill and intangible amortization during 2001. Net intangible assets and goodwill amounted to approximately $12,193,405 as of December 31, 2003. We do 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 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 was no impairment of goodwill as of the date of adoption. Management is not aware of any events, through the date of this prospectus, which indicate that an impairment has been experienced. Management is also unaware of any circumstance or trend that is reasonably likely to give rise to impairment in our company’s goodwill valuations.
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 U.S., several states, and in 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
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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.
Our company and its subsidiaries are subject to income tax laws in each of the countries in which they do business. We make a comprehensive review of the income tax requirements of each of our operations, file appropriate returns and make appropriate income tax provisions. These are determined at an individual subsidiary level and at the corporate level on both an interim and annual basis. 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. We provide valuation allowances on deferred tax assets for our subsidiaries that have a history of losses. Because of our history of losses, we have significant net operating loss carryforwards that may be used to offset taxable income in future periods. However, our ability to use those carryforwards may be limited by certain factors, including, for example, our failure to generate sufficient income before the expiration of the net operating loss carryforwards. Management cannot assert that there will likely be sufficient profits generated by certain of these subsidiaries in the near future to allow us to fully utilize these carryforwards. Changes in our equity ownership may also limit our ability to benefit from the carryforwards. As a result of our consummation of certain equity transactions during the second quarter of 2004, we have determined that our net operating loss carryforwards and related tax benefits will be limited under the Internal Revenue Code to some extent.
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. We intend to reinvest such undistributed earnings indefinitely; accordingly, no provision has been made for U.S. taxes on those earnings. We regularly review the status of the accumulated earnings of each of our U.S. and foreign subsidiaries as part of our overall financing plans.
Revenue Recognition.Revenue from product sales is recognized upon shipment to customers based upon the defined shipping terms. Even though we receive 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 2003, 2002, and 2001, but may increase in 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. This should be read in conjunction with our consolidated financial statements and related notes thereto. The operating results of the periods 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:
Three Months Ended | ||||||||||||||||||||
March 31, | Years Ended December 31, | |||||||||||||||||||
2004 | 2003 | 2003 | 2002 | 2001 | ||||||||||||||||
Net Sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | |||||||||||
Cost of Sales | 58.1 | 60.2 | 60.8 | 63.9 | 62.9 | |||||||||||||||
Gross profit | 41.9 | 39.8 | 39.2 | 36.1 | 37.1 | |||||||||||||||
Operating Expenses: | ||||||||||||||||||||
Selling, general and administrative | 31.0 | 32.6 | 35.5 | 28.9 | 28.9 |
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Three Months Ended | ||||||||||||||||||||
March 31, | Years Ended December 31, | |||||||||||||||||||
2004 | 2003 | 2003 | 2002 | 2001 | ||||||||||||||||
Research and development | 6.0 | 6.0 | 4.7 | 5.5 | 7.1 | |||||||||||||||
Total operating expenses | 37.0 | 38.6 | 40.2 | 34.4 | 36.0 | |||||||||||||||
Operating income (loss) | (1.0 | ) | 1.7 | 1.1 | ||||||||||||||||
Other Expense, foreign currency translation and interest | (2.6 | ) | (2.4 | ) | (1.5 | ) | (1.8 | ) | (2.2 | ) | ||||||||||
Income (loss) before income tax benefit (expense) | 2.3 | (1.2 | ) | (2.5 | ) | (0.1 | ) | (1.1 | ) | |||||||||||
Income tax benefit (expense) | (0.6 | ) | — | (0.2 | ) | (0.1 | ) | 1.4 | ||||||||||||
Income (loss) before minority interest in income of consolidated subsidiary | 1.7 | (1.2 | ) | (2.7 | ) | (0.2 | ) | 0.3 | ||||||||||||
Minority interest in consolidated subsidiary | (0.3 | ) | (0.3 | ) | (0.2 | ) | (0.1 | ) | — | |||||||||||
Net income (loss) | 1.4 | % | (1.5 | )% | (2.9 | )% | (0.3 | )% | 0.3 | % | ||||||||||
Comparison of Our Results for the Three Months Ended March 31, 2004 and March 31, 2003
Net Sales and Gross Profit
Our net sales for the three months ended March 31, 2004 increased $1,218,512 or 11.2 percent, from $10,917,194 for the three months ended March 31, 2003 to $12,135,706 for the three months ended March 31, 2004. Our gross profit for the three months ended March 31, 2004 increased $739,601, or 17.0 percent, from $4,343,991 for the three months ended March 31, 2003 to $5,083,592 for the three months ended March 31, 2004. Following is a discussion of these changes in net sales and gross profit by segment.
Transportation Communications Segment.For the three months ended March 31, 2004, sales of our transportation communications segment increased $1,582,318, or 15.4 percent, from $10,251,383 for the three months ended March 31, 2003 to $11,833,701 for the three months ended March 31, 2004. The increase resulted from an increase in U.S. domestic sales revenues of $494,760 and an increase in international sales of $1,087,558. The increase in U.S. domestic sales is attributed to the increase in the Digital Recorders division sales revenues for automatic voice announcement systems. The increase in international sales was primarily attributed to the higher sales volume in our German subsidiary for All-LED electronic destination sign systems and more favorable average foreign currency exchange rates in 2004 as compared to 2003. The increase in net sales due to foreign currency fluctuations in 2004 was approximately $950,000 and is not expected, by management, to be that significant in 2004 as compared to the prior year where foreign currency fluctuations were more volatile when the U.S. dollar continued to weaken. We have no control over the foreign currency fluctuations and do not require the use of currency hedging tools as the respective foreign companies primarily transact business in its functional currency thereby reducing the impact of foreign currency translation differences. If the U.S. dollar strengthens compared to the foreign currencies converted, it is likely the total foreign sales reported in U.S. dollars could decline. Product prices on sales of products which comprise a majority of our revenue have remained relatively stable in the three months ended March 31, 2004. Our expected sales growth in the transportation communications segment will be dependent upon the expansion of new product offerings and technology, as well as our expansion into new geographic areas. We believe our relatively high market share positions in our current markets preclude significant sales growth from increased market share.
Our transportation communications segment gross profit for the three months ended March 31, 2004 increased $966,231, or 25.1 percent, from $3,855,020 for the three months ended March 31, 2003 to $4,821,251 for the three months ended March 31, 2004. As a percentage of segment sales, our gross profit was 40.7 percent of our net segment sales for the three months ended March 31, 2004 as compared to 37.6 percent for the three months ended March 31, 2003. The net increase of $966,231 was attributed to the international operations which realized a net margin increase of $418,636 and an increase in U.S. domestic gross profit of $547,595. The U.S. gross profit percentage of sales for the three months ended March 31, 2004 was 39.5% as compared to 33.8% for the prior year. The 5.7% increase in average U.S. gross margins is primarily the result of ongoing cost reduction and profit improvement programs initiated in the last half of 2003. The consolidated international operations realized average gross margins in the three months ended March 31, 2004 of 43.4% and 32.4% in 2003. The decrease in gross margins is attributed to product mix and lower costs of materials and services to manufacture and assemble our products in the European markets. The gross margins are affected by selling prices which are expected to be relatively stable in the near term and direct cost of materials and services to manufacture and assemble our products. We expect to realize gross margin improvements in 2004 reflecting the full
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effect of 2004 initiatives and through negotiating with suppliers lowered unit component costs, introduced technology improvements decreasing the overall system cost and in-house production of sub-assemblies such as cabling and wire harness assemblies that are less expensive than third party manufactured harness assemblies. We believe improvement in our gross profit percentage is dependent primarily upon overall economic and competitive conditions in the transportation sector, introduction of new technology products, and the continued success of our ongoing profit improvement initiatives.
Law Enforcement and Surveillance Segment.For the three months ended March 31, 2004, sales for our law enforcement and surveillance segment decreased $363,806 or 54.6 percent, from $665,811 for the three months ended March 31, 2003 to $302,005 for the three months ended March 31, 2004. Sales for the three months ended March 31, 2003 were unusually high relative to historical levels, largely due to a single order for approximately $270,000 to the federal government and a $50,000 milestone on a foreign-customer-funded research project, both of which shipped in that quarter. The sales of $302,005 for the three months ended March 31, 2004 reflects more traditional business activity levels during this period of the fiscal year.
During the three months ended March 31, 2004, the quoting activity to government agencies has been very strong relative to prior years, with dollar volume of projects on which we submitted bids substantially higher than that which occurred during the same periods in both 2002 and 2003. Management believes this increase in quoting will generate new orders in 2004.
The segment gross profit for the three months ended March 31, 2004 decreased $226,630, or 46.3 percent, from $488,971 for the three months ended March 31, 2003 to $262,341 for the three months ended March 31, 2004. As a percentage of segment sales, our gross profit was 86.9 percent of our net segment sales for the three months ended March 31, 2004 as compared to 73.4 percent during the three months ended March 31, 2003. The increase in the average gross margin percentage was primarily attributed to sales of products having a lower content of material costs including lower costs incurred for third party components. The lower sales to the U.S. federal government primarily contributed to the decline in gross margin amounts. 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 three months ended March 31, 2004 increased $192,491, or 5.4 percent, from $3,562,696 for the three months ended March 31, 2003 to $3,755,187 for the three months ended March 31, 2004. The majority of this increase was attributed to foreign currency fluctuations of approximately $254,000 which were offset by net favorable decreases in other expenses. As a percentage of our sales, these expenses were 31.0 percent for the three months ended March 31, 2004 and 32.6 percent for the three months ended March 31, 2003. Management believes these expenses will decrease as a percentage of our sales in future periods if our revenue increases substantially and we continue to focus on expense and cost reduction and controls.
Our research and development expenses for the three months ended March 31, 2004 increased $83,502, or 12.8 percent, from $649,997 for the three months ended March 31, 2003 to $733,499 for the three months ended March 31, 2004. 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 remained at 6.0 percent for both three month periods ending March 31, 2004 and 2003. Certain engineering personnel were used in the development of software and other expense incurred that met the capitalization criteria of SFAS No. 86, “Capitalization of Software Development Costs” during the three months ended March 31, 2004. The total amount of personnel and other expense capitalized in the three months ended March 31, 2004 was $175,283 as compared to $74,480 for the three months ended March 31, 2003. In the longer term, we expect these expenses to remain in the same general range (approximately 5 to 8 percent) as a percentage of sales.
Operating Income
The net change in our operating income for the three months ended March 31, 2004 was an increase of $463,608 from net operating income of $131,298 for the three months ended March 31, 2003 to net operating income of $594,906 for the three months ended March 31, 2004. This increase is primarily due to higher sales and lower cost of sales in the transportation communications segment partially offset by lower sales in the law enforcement and surveillance segment and higher operating expenses and personnel costs as described above.
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Other Expense and Income Tax Expense
Our total other expense for the three months ended March 31, 2004 was $315,393, a net increase in expense of $53,712 as compared to $261,681 for the three months ended March 31, 2003. This increase was primarily due to net foreign currency translation losses that totaled $114,646 for the three months ended March 31, 2004 as compared to net translation gains of $28,659 for the three months ended March 31, 2003. The net increase in other income totaled $12,802. We do not expect to realize any significant foreign currency translation gains or losses in 2004 as management believes the functional currencies will remain similar to the foreign currency exchange rates at March 31, 2004. However, the economic uncertainty in the global markets in which we operate may result in volatility of the U.S. dollar thereby generating the possibility of foreign currency exchange gains and losses on that debt denominated in U.S. dollars in Sweden. The net interest expense decreased $76,791 from $309,823 for the three months ended March 31, 2003 to $233,032 for the three months ended March 31, 2004. The decrease in interest expense was due to a decrease in the weighted average outstanding balance of long-term debt and to lower interest rates.
Our net income tax expense was $76,923 for the three months ended March 31, 2004, as compared with an income tax benefit of $601 for the three months ended March 31, 2003. In the three months ended March 31, 2004, the current tax expense of $76,923 was from foreign jurisdictions.
Net Income Applicable to Common Shareholders
The net change in our net income applicable to common shareholders for the three months ended March 31, 2004 was an increase of $297,063 from a net loss of $211,466 for the three months ended March 31, 2003 to net income of $85,597 for the three months ended March 31, 2004. This change primarily results from an increase of net income before minority interest in income of consolidated subsidiary of $332,372 from a loss of $129,782 for the three months ended March 31, 2003 to income of $202,590 for the three months ended March 31, 2004. This amount was partially offset by preferred stock dividends in the amount of $80,781. The preferred stock dividends increased $36,531 from $44,250 for the three months ended March 31, 2003 to $80,781 for the three months ended March 31, 2004 due to the additional dividend requirements for the Series E Redeemable Nonvoting Convertible Preferred stock issued during 2003 and 2004.
Comparison of Our Results for the Years Ended December 31, 2003 and 2002
Net Sales and Gross Profit
Our net sales for the year ended December 31, 2003 decreased $1,111,744 or 2.5 percent, from $45,137,986 for the year ended December 31, 2002 to $44,026,242 for the year ended December 31, 2003. Our gross profit for the year ended December 31, 2003 increased $975,218, or 6.0 percent, from $16,274,994 for the year ended December 31, 2002 to $17,250,212 for the year ended December 31, 2003. Following is a discussion of these changes in net sales and gross profit by segment.
Transportation Communications Segment.For the year ended December 31, 2003, sales of our transportation communications segment decreased $981,185, or 2.3 percent, from $43,550,637 for the year ended December 31, 2002 to $42,569,452 for the year ended December 31, 2003. The decrease resulted from a decrease in U.S. domestic sales revenues of $3,978,851 partially offset by an increase in international sales of $2,997,666. The decrease in U.S. domestic sales in 2003 was attributed to late year contract shifts to 2004 and lost business due to order timing difficulties as more fully described in Note 2 — Management Plans — of the Notes to Consolidated Financial Statements included elsewhere in this prospectus. The net sales for the three months ended December 31, 2003 was $9,975,728 as compared to $13,035,873 for the three months ended December 31, 2002. The decrease of $3,060,145 or 23.5% was primarily the result of the order shifts and ultimate cancellation of certain transit authority orders due to contract differences. See Note 20 — Quarterly Financial Data — of the Notes to Consolidated Financial Statements included elsewhere in this prospectus. The canceled orders are extraordinary and the underlying issues leading to such cancellation are not likely to materialize in 2004. All of these orders may or may not be realized in 2004 and, to the extent realized, may not be incremental to the year 2004 as planned. The increase in international sales is attributed to higher sales in the Nordic and Brazilian markets and also more favorable average foreign currency exchange rates in 2003 compared to 2002. The increase in net sales due to foreign currency fluctuations in 2003 was approximately $2.6 million and is not expected to be that significant in 2004 as compared to prior years where foreign currency fluctuations were more radical when the U.S. dollar continued to weaken. We have no control over the foreign currency fluctuations and do not require the use of currency hedging tools as the respective foreign companies primarily transact business in its functional currency thereby reducing the impact of foreign currency translation differences. If the U.S. dollar strengthens compared to the foreign currencies converted, it is possible the total sales reported in U.S. dollars could decline. Product prices on sales of products which comprise a majority of our revenue have declined in the year ended December 31, 2003 as compared to the prior year due to competition. Our expected sales growth in the transportation communications segment will be dependent upon the expansion
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of new product offerings and technology, as well as our expansion into new geographic areas. We believe our relatively high market share positions in most markets preclude significant sales growth from increased market share.
Our transportation communications segment gross profit for the year ended December 31, 2003 increased $1,021,970, or 6.8 percent, from $15,072,753 for the year ended December 31, 2002 to $16,094,723 for the year ended December 31, 2003. As a percentage of segment sales, our gross profit was 37.8 percent of our net segment sales in 2003 as compared to 34.6 percent during 2002. The net increase of $1,021,970 was attributed to the international operations which realized a net margin increase of $1,078,179 offset by a small margin decrease of $56,209 in the U.S. domestic gross margins. Substantially due to a lower revenue volume resulting from the above-noted order shifts and delays, our U.S. domestic gross margins remained relatively flat for 2003. As a percent of sales, our U.S. operations increased average gross margins from 31.7% in 2002 to 36.4% in 2003, which was primarily attributed to decreases in key components in the electronic destination sign systems. The consolidated international operations realized average gross margins in 2003 of 39.9% and 40.6% in 2002. The slight decrease in gross margins is attributed to product mix and introduction in 2003 of the lower priced ALL LED sign systems in the European markets. The gross margins are affected by selling prices which are expected to be relatively stable in the near term and direct cost of materials and services to manufacture and assemble our products. We expect to realize gross margin improvements in 2004 reflecting the full effect of 2003 initiatives and through negotiating with suppliers lowered unit component costs, introduced technology improvements decreasing the overall system cost and began in-house production of sub-assemblies such as cabling and wire hardness assemblies that are less expensive than third party manufactured harness assemblies. We believe improvement in our gross profit percentage is dependent primarily 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, 2003, sales for our law enforcement and surveillance segment decreased $130,559 or 8.2 percent, from $1,587,349 for the year ended December 31, 2002 to $1,456,790 for the year ended December 31, 2003. 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, 2003 decreased $46,752, or 3.9 percent, from $1,202,241 for the year ended December 31, 2002 to $1,155,489 for the year ended December 31, 2003. As a percentage of segment sales, our gross profit was 79.3 percent of our net segment sales in 2003 as compared to 75.7 percent during 2002. The increase in gross margin percentage was primarily attributed to higher sales revenue from a special research project for a foreign government having lower material costs than traditional products. The lower sales to the U.S. federal government primarily contributed to the decline in gross margins. 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.
We expect to increase operating income in 2004 due to the cost and overhead reduction programs and increasing sales in selected product lines through more aggressive pricing and increase in both U.S. domestic and foreign distribution channels.
Selling, General and Administrative, Research and Development Expenses
Our selling, general and administrative expenses for the year ended December 31, 2003 increased $2,554,827, or 19.6 percent, from $13,058,348 for the year ended December 31, 2002 to $15,613,715 for the year ended December 31, 2003. The majority of this increase was attributed to a net increase in compensation and benefits of $784,185; an increase in depreciation of $355,851; an increase in legal expense of $284,760; an increase in audit and tax services of $135,485; an increase in travel related expense of $82,096 along with a $815,051 increase in all other general operating and administrative expenses. The increase also includes foreign currency fluctuations, but the overall increase is attributed to additional personnel added during the year to support the additional requirements of reporting and management; an increase in average health care benefits and taxes; higher legal expenses in patent litigation, higher audit and tax services due to changes in regulations such as the Sarbanes-Oxley Act; higher depreciation from increases in capital asset purchase and capitalization of internal developed systems and software and general economic increases in goods and services. As a percentage of our sales, these expenses were 35.5 percent for the year ended December 31, 2003 and 28.9 percent for the year ended December 31, 2002. Management believes these expenses will decrease as a percentage of our sales in future periods if our revenue increases substantially and we continue to focus on expense and cost reduction and controls. However, our selling, general and administrative expenses are planned to 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, 2003 decreased $435,116, or 17.5 percent, from $2,492,428 for the year ended December 31, 2002 to $2,057,312 for the year ended December 31, 2003. This category
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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 5.5 percent in 2002 to 4.7 percent in 2003. During 2003, 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 of $1,059,844 of 2003 costs as an asset that will be amortized as the sales of the software are realized over a period no longer than three years. Had this amount not been capitalized, research and development expenses for the year ended December 31, 2003 would have been $3,117,156 as compared to $2,985,721 for the year ended December 31, 2002. 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 percent to 8 percent).
Operating Income
The net change in our operating income for the year ended December 31, 2003 was a decrease of $1,444,493 from operating income of $724,218 for the year ended December 31, 2002 to a net operating loss of $420,275 for the year ended December 31, 2003. This decrease is primarily due to decreased sales in both operating segments and higher operating expenses and personnel costs as described above. The more significant increases in selling, general and administrative expenses were in the U.S. parent entities expense categories of legal, audit, tax, accounting and bank fees.
Other Expense and Income Tax Expense
Our total other expense for the year ended December 31, 2003 was $680,096, a net decrease in expense of $132,750 as compared to $812,666 for 2002. This decrease was primarily due to higher net foreign translation gains that totaled $332,493 for 2003 as compared to $309,456 for 2002 and an increase in net other income and expense totaling $61,864. We do not expect to realize any significant foreign currency translation gains in 2004 as the functional currencies are expected to stabilize and remain similar to the rates at December 31, 2003. The net interest expense decreased $57,669 from $1,150,962 for 2002 to $1,093,293 for 2003. The decrease in interest expense was due to a decrease in the weighted average outstanding balance of long-term debt partially offset by lower interest rates.
Our net income tax expense consisting primarily of net deferred tax expense was $109,610 for the year ended December 31, 2003, as compared with an income tax expense of $42,148 for the year ended December 31, 2002. In 2003 our current tax expense of $1,229, arising from foreign jurisdictions, was partially offset by deferred tax benefits of $110,839 arising primarily from United States federal and state jurisdictions.
Net Loss Applicable to Common Shareholders
The net change in our net loss applicable to common shareholders for the year ended December 31, 2003 was an increase of $1,866,005 from a net loss of $366,503 for the year ended December 31, 2002 to a net loss of $2,232,008 for the year ended December 31, 2003. This decrease is primarily the result of the net operating loss before minority interest in income of consolidated subsidiary of $1,100,371 for the year ended December 31, 2003 and recording a non-cash beneficial conversion charge of $702,626 on issuance of Series F convertible preferred stock. See Note 8 — Preferred Stock — of the Notes to Consolidated Financial Statements included elsewhere in this prospectus.
Profit Improvement in 2003
In 2003, we estimate that approximately $400,000 of profit improvement was realized from various profit improvement initiatives. This is partially evidenced by the gross margin improvement during 2003. See Note 2 — Management’s Plans — of the Notes to Consolidated Financial Statements included elsewhere in this prospectus, under the heading “Reduce the costs of Company products and operating costs.”
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 percent, 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 percent, 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 percent, from $35,546,489 for the year ended December 31, 2001 to $43,550,637 for the year ended December 31, 2002. This resulted from an increase in international sales of $5,893,473 and
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increase in domestic sales of $2,110,675. The increase in international sales was 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 was 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.
Our transportation communications segment gross profit for the year ended December 31, 2002 increased $2,552,888, or 20.4 percent, 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.
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 percent, 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 percent, 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. Government contributed to these results.
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 percent, 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 on June 27, 2001, which had a full twelve months of activity in 2002 as compared to the prior year period. 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 percent, 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 costs 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 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 percent 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 percent, 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 operating Mobitec. In addition, we increased our head count in field technicians and support personnel, hourly assembly labor and two employees in U.S. corporate administration. The more significant increases in other expenses were in: (1) the U.S. parent of the parent entities segment of the administrative expense categories of audit, tax, and accounting fees (increase of $237,936); (2) American Public Transportation Association trade show expense ($184,884), which is incurred every three years when the public transportation industry trade show convenes; (3) insurance-other (increase of $67,745 for Directors’ and Officers’ insurance premiums); (4) rent for building and office space (increase of $91,992); and (5) travel and lodging (increase of $38,950).
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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 currency 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 U.S. 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.
Our Liquidity and Capital Resources
Our net working capital as of March 31, 2004 was $2,371,116 compared to $2,342,201 as of December 31, 2003. Our principal sources of liquidity from current assets included cash and cash equivalents of $191,727, trade and other receivables of $9,986,505, inventories of $10,239,477 and prepaid and other current assets of $466,544. The U.S. asset-based lending agreement provides for borrowings up to 85% of eligible trade accounts receivable and up to 35% of eligible inventory. The lending relationship with our foreign bank allows 75% advance rates on trade accounts receivable and 50% on inventory. The present asset-based lending agreements are sufficient for day-to-day cash requirements although we would prefer to level the sometimes erratic monthly sales volume thereby permitting liquidity projections to be more easily maintained and controlled. We continue to decrease the average sales outstanding on accounts receivable and expect to decrease inventory through better materials requirement planning, reworking what otherwise might be considered slow moving inventory and negotiating lower component prices through volume purchase programs. The most significant current liabilities at March 31, 2004 included short-term bank and asset-based borrowings of $7,206,563, accounts payable of $7,291,380, accrued expenses of $2,177,664, and current maturities of long-term debt, deferred tax liabilities and dividends payable of $1,541,348, $184,651 and $111,531, respectively. Relationships with our suppliers enable us to utilize trade accounts payable as short-term financing during periods of erratic sales, which historically have been experienced with large end-of-quarter shipments. The short-term bank borrowings are primarily asset-based lending agreements and directly related to the sales and customer account collections. The senior asset-based revolving debt with LaSalle Business Credit, LLC is classified as a current liability rather than a long-term liability. The loan agreement with LaSalle was negotiated with the intent that the revolving debt would be classified and managed as long-term debt; however, Emerging Issues Task Force (EITF) Issue No. 95-22 “Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements That Include both a Subjective Acceleration Clause and a Lock-Box Arrangement”, requires us to classify all of our outstanding debt under this loan agreement as a current liability. The loan agreement has a subjective acceleration clause which could enable LaSalle to call the loan, but such language is customary in asset-based lending agreements and management does not expect LaSalle to use this particular clause to inhibit us from making borrowings as provided under the agreement. It is our intention to manage the loan agreement as long-term debt with a final maturity date in 2006, as provided for in the loan agreement. Our maximum borrowing availability under the various U.S. domestic and European credit facilities at May 31, 2004 was equivalent to approximately $2.1 million in U.S. dollars. Our combined borrowing availability under those facilities increased to approximately $3.6 million on June 2, 2004, when we reduced the outstanding balances under our European credit facilities by applying approximately $1.5 million of cash that we had previously borrowed under our senior U.S. domestic facility and transferred to our European subsidiaries for that purpose.
Our operating activities used cash of $1,857,229 during the quarter ended March 31, 2004 and provided cash of $709,186 during the quarter ended March 31, 2003. Primary uses of cash for the quarter ended March 31, 2004 included increases in trade and other receivables and inventories in the amounts of $2,741,903 and $557,304, respectively; and a decrease in accrued expenses of $105,225. The increase in trade accounts receivable is a direct result of a significant portion of sales occurring late during the first quarter. Primary sources of cash included a decrease in prepaids and other current assets of $83,356 and an increase in accounts payable of $913,096. The balance of net cash provided by operating activities of $550,751 resulted from net income of $166,378 and from non-cash expenses for deferred taxes, depreciation, intangible amortization, foreign currency gains and minority interest in the amount of $384,373. Our 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 $352,770 for the quarter ended March 31, 2004 and $261,818 for the quarter ended March 31, 2003. For the quarters ended March 31, 2004 and 2003, the primary uses of cash were for expenditures relating to: (1) internally developed software; and (2) purchases of computer, test, and office equipment.
Our net working capital as of December 31, 2003 was $2,342,201 compared to $2,321,954 as of December 31, 2002. Our principal sources of liquidity from current assets included cash and cash equivalents of $970,222, trade and other
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receivables of $7,354,283 and inventories of $9,797,610. Our U.S. asset-based loan agreement with LaSalle provides for borrowings up to 85% of eligible trade accounts receivable and up to 35% of eligible inventory. The lending relationship with our foreign bank allows 75% advance rates on trade accounts receivable and 50% on inventory. The most significant current liabilities at December 31, 2003 included short-term bank and asset-based borrowings of $5,893,051, accounts payable of $6,456,870, accrued expenses of $2,334,050, and current maturities of long-term debt, deferred tax liabilities and dividends payable of $1,249,110, $193,918 and $117,983, respectively. Trade accounts payable and relationships with our suppliers and vendors enable us to utilize trade accounts payable as short-term cash flow sources during periods of erratic sales, which have historically been experienced with large end-of-quarter shipments. The short-term bank borrowings are primarily asset-based lending agreements and directly related to sales and customer account collections. The senior asset-based revolving debt under our loan agreement with LaSalle is classified as a current liability rather than a long-term liability, as described above.
Our operating activities provided cash of $1,498,507 for the year ended December 31, 2003. Primary sources of cash included decreases in trade and other receivables of $3,739,507. The increased collections decreased the short-term bank loans thereby increasing liquidity by 15% to 25% as the advance rates on eligible trade accounts receivable are 85% in the U.S. and 45% in the foreign countries. Primary uses of cash included an increase in inventories of $362,183, decreases in accounts payable and accrued expenses of $1,013,783 and $115,919, respectively. The decrease in trade accounts receivable is a direct result of the lower fourth quarter sales and aggressive collections efforts to manage accounts receivable. The balance of net cash used by operating activities of $701,319 resulted from the net loss of $1,302,533 partially offset by non-cash expenses for deferred taxes, depreciation, intangible amortization, bad debt, foreign currency losses and minority interest in the amount of $1,335,901. Our 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 $1,576,837 for the year ended December 31, 2003. The primary use of cash was for expenditures relating to: (1) internally developed software; and (2) purchases of computer, test, and office equipment. 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 2004.
Our Financing Activities
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Our financing activities provided net cash of $1,563,200 for the quarter ended March 31, 2004 and used cash of $809,292 for the quarter ended March 31, 2003. For the quarter ended March 31, 2004, our primary sources of cash were borrowings under our Loan and Security Agreement with LaSalle and our foreign credit facilities and the issuance of convertible preferred stock, net of costs, of $12,776,045 and $290,079, respectively. Our primary uses of cash for financing activities were payment of dividends and repayment of borrowings under our domestic and foreign asset-based lending agreements of $44,250 and $11,458,674, respectively. Future dividend requirements are expected to decrease in 2004 due to the expected conversion of most of the Series AAA and Series E preferred stock. Cash provided by financing activities for the quarters ended March 31, 2004 and 2003 was primarily used to fund working capital requirements and for the purchase of fixed assets.
At March 31, 2004, our Loan and Security Agreement with LaSalle, which is a senior asset-based lending agreement, provided up to $10.0 million in borrowing to be used for acquisitions, working capital and general corporate purposes is connection with our domestic operations. The borrowing is inclusive of $2.0 million for letters of credit and $0.5 million for term loans. The interest rate on loans under this agreement is LaSalle’s published prime lending rate (4.00 percent at March 31, 2004) plus 1 percent. There is a fee equal to 2.5 percent on the aggregate undrawn face amount of all letters of credit outstanding.
The LaSalle loan agreement includes customary covenants and conditions relating to the conduct and operation of our business. Specifically, the agreement subjects us to an escalating fixed charge coverage ratio from 1.0 to 1.5 and an escalating tangible net worth value (as defined) from $2.5 million to $3.9 million over the term of the agreement calculated on a quarterly and rolling 12-month basis; limits annual capital expenditures to $1.5 million; and limits credit by providing for a reserve of $500,000 until certain financial covenants have been met. At March 31, 2004, available collateral based on the value of eligible trade accounts receivable and inventories was $6,630,927 which, given the outstanding debt balance under this agreement of $5,465,428, would have resulted in additional borrowing availability of $1,165,499. However, the required reserve reduced additional borrowing availability by $500,000 to $665,499. The outstanding debt under the loan agreement is secured by substantially all of our U.S.-based assets.
On April 14, 2004, we and LaSalle agreed to further amendments to the escalating tangible net worth and escalating fixed charge coverage ratio loan covenants. The amendments take into account our results of operations for the three months ended December 31, 2003 that affected the initial covenant computations. These covenants were revised after considering the results of operations for the three months ended December 31, 2003 and the Company’s projected operating plan for the year ending December 31, 2004.
The escalating tangible net worth covenant’s “Minimum Tangible Net Worth” requirement has been reduced by $1.0 million and reset to $1.5 million from $2.5 million for the period of December 31, 2003 through December 30, 2004 and increases $600,000 per year thereafter for the remaining life of the loan. The time periods required to maintain the escalating fixed charged coverage ratio have also been reduced to exclude the three months ended December 31, 2003; and are now 1.00:1.00 for the three and six months ended March 31, 2004 and June 30, 2004; and 1.15:1.00 for the nine and twelve
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months ended September 30, 2004 and December 31, 2004. Additionally, the interest rate on borrowings increased from prime plus 1.00 to prime plus 1.75 effective April 14, 2004 and forward. The reserve on borrowings was increased to $600,000 from $500,000 until receipt of the certified 2004 financial statements reflecting an EBITDA to fixed charge coverage ratio of at least 1.15:1.00, resulting in an as amended borrowering availability of $565,499 as of March 31, 2004. At March 31, 2004, we were in compliance with its financial covenants within the loan agreement, as amended.
Mobitec AB, our 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 $1,315,000 (based on the March 31, 2004 conversion rate). At March 31, 2004, 9,398,996 krona (SEK), or $1,235,968 was outstanding, resulting in additional borrowing availability of 601,004 krona (SEK), or $79,032. 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 $289,300. The terms of this agreement require payment of an unused credit line fee equal to 0.5 percent of the unused portion and average interest of 4.1 percent of the outstanding balance. This agreement is secured by substantially all assets of Mobitec AB. The agreement has an expiration date of December 31, 2004. On or before expiration, we expect to renew this agreement with an agreement substantially similar in terms and conditions.
Mobitec AB also has an agreement with the same bank from which it may borrow up to 6,000,000 krona (SEK), or $789,000 (based on the March 31, 2004 conversion rate). Based upon the availability formula under this agreement, 3,841,574 krona (SEK), or $505,167 was outstanding at March 31, 2004, resulting in additional borrowing availability of 2,158,426 krona (SEK), or $283,833. The line of credit bears average interest of 5.29 percent and is collateralized by accounts receivable of Mobitec AB. The agreement has an expiration date of December 31, 2004. On or before expiration, we expect to renew this agreement with an agreement substantially similar in terms and conditions.
An unsecured note in the amount of $1,765,235 and obligation in the amount of $225,000 are due a shareholder. The note, as amended, requires three incrementally increasing quarterly payments beginning July 1, 2004 in the amounts of $50,000, $75,000, and $100,000 with the remaining balance in the amount of $1,540,235 due June 30, 2005. The unsecured note has an annual interest rate of 9 percent paid annually increasing to 10 percent beginning July 1, 2004. The obligation balance of $225,000 at March 31, 2004 and December 31, 2003 is non-interest bearing and is due in full June 30, 2004.
A term loan from a Swedish bank dated June 28, 2001 having a balance of 12,100,000 krona (SEK), or $1,591,150 (based on the March 31, 2004 conversion rate), is payable in 10 remaining quarterly payments of 1,100,000 krona (SEK), or $144,650 (based on the March 31, 2004 conversion rate), at an annual interest rate of 5.35 percent and is secured by stock of our Swedish holding company subsidiary, DRI-Europa AB, and its consolidated subsidiary, Mobitec AB.
Four convertible subordinated debentures in the amount of $3,000,000 dated June 22, 2001 and $1,150,000 dated July 31, 2002, collectively the “Renaissance Notes,” were payable to two investment funds managed by Renaissance Capital Group, Inc. The president of Renaissance Capital Group, Inc. is a member of our board of directors. Two Renaissance Notes having an aggregate principal amount of $3,000,000 were payable in full on June 22, 2008, if not sooner redeemed or converted, with annual interest at 8 percent paid monthly. They also provided 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 two Renaissance Notes having an aggregate principal amount of $1,150,000 were payable in full on July 31, 2009, if not sooner redeemed or converted, with annual interest at 8 percent paid monthly. They also provided 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 under which the convertible debentures were issued subjected us 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. At March 31, 2004, we were not in compliance with the financial covenants within the agreement; however, a waiver for violation of these covenants was not required from the holder as all four Renaissance Notes were converted into shares of common stock on April 22, 2004. See Note 3 — Pro Forma Balance Sheet and Supplemental Data — and Note 12 — Subsequent Events — of the Notes to the March 31, 2004 Consolidated Financial Statements (Unaudited) included elsewhere in this prospectus.
A convertible subordinated debenture in the amount of $250,000 dated August 26, 2002, is payable to 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 percent 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 under which the convertible debenture was issued subjects us 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. At March 31, 2004, we were not in compliance with the financial covenants within the agreement but received a waiver for violation of these covenants from the
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holder.
Our financing activities provided net cash of $805,804 for the year ended December 31, 2003. Our primary sources of cash were the issuance of convertible preferred stock in the gross amount of $3,140,000. Expenses related to the issuance of the preferred stock were $286,661. Our primary uses of cash for financing activities were payment of dividends and repayment of borrowings under the asset-based lending agreement and credit lines. The future dividend requirements will increase in 2004 due to the additional Series E convertible preferred stock holders receiving quarterly payments for a full year. In November 2003, we paid off the loan with the previous asset-based lender, Guaranty Business Credit, in the amount of $3,584,070 and secured new funding from LaSalle under the Loan and Security Agreement described above, in the amount of $3,684,070, inclusive of the closing fee of $100,000. We terminated the credit facility with Guaranty. Net cash from financing activities was used to fund working capital requirements and for the purchase of fixed assets.
Commencing in the second quarter of 2003, we issued, pursuant to private placements, shares of Series E Redeemable Nonvoting Convertible Preferred Stock. As of December 31, 2003, we had sold 363 shares to 24 private investors for an aggregate purchase price of $1.8 million. See “Description of Securities,” for a description of the terms of the Series E Stock. We used the proceeds of our sale of Series E stock, after payment of offering expenses, to service debt and for other general purposes.
On March 6, 2003, we announced that at a special meeting of the Series AAA Preferred Stock shareholders, the holders of the Series AAA Preferred Stock approved an amendment to the Articles of Incorporation to remove the mandatory redemption date, which would have occurred in December 2003. We may now redeem the Series AAA Preferred Stock at our sole discretion upon providing preferred shareholders with appropriate written notice. Had the holders of the Series AAA Preferred Stock not approved the amendment, we would have had 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, 2003 was $1,858,500.
On June 26, 2003, we and one of our shareholders, who held an unsecured promissory note of our company, agreed to: (1) convert $350,000 of the note, which was issued June 28, 2001, was payable in full June 28, 2004 and had a balance of $2,111,235, to common stock and (2) extend the due date on the remaining note balance of $1,761,235 to June 28, 2005. The note requires three incrementally increasing quarterly payments beginning July 1, 2004 in the amounts of $50,000, $75,000 and $100,000 with the remaining balance in the amount of $1,536,235 due June 28, 2005. The unsecured note has an annual interest rate of 9 percent paid annually increasing to 10 percent beginning July 1, 2004.
On November 6, 2003, we entered into the Loan and Security Agreement with LaSalle described above, pursuant to which we received a three-year senior secured $10 million revolving credit facility.
On November 10, 2003, we closed the sale of 300 shares of Series F Convertible Preferred Stock, par value $.10, to Dolphin Offshore Partners, L.P. for a purchase price of $1.5 million. We used the proceeds of our sale of Series F stock, after payment of offering expenses, to service debt and for other general purposes.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that would be material to investors. 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.
Contractual Obligations
We lease facilities under various operating and capital lease agreements with various terms and conditions, expiring at various dates through 2009. Our material contractual obligations at December 31, 2003 are as follows:
Payments Due by Period | ||||||||||||||||||||
After | ||||||||||||||||||||
Contractual Obligations | Total amounts committed | Less than 1 year | 1-3 years | 4-5 years | 5 years | |||||||||||||||
Long-Term Debt Obligations | $ | 7,896,162 | $ | 1,249,110 | $ | 3,652,034 | $ | 2,295,018 | $ | — | ||||||||||
Capital Lease Obligations | 69,000 | 69,000 | — | — | — | |||||||||||||||
Operating Lease Obligations | 2,420,246 | 746,230 | 1,434,328 | 239,688 | — | |||||||||||||||
Purchase Obligations | — | — | — | — | — | |||||||||||||||
Other Long-Term Liabilities | — | — | — | — | — | |||||||||||||||
Total | $ | 10,385,408 | $ | 2,064,340 | $ | 5,086,362 | $ | 3,234,706 | $ | — | ||||||||||
At May 31, 2004, our material contractual obligations consisted primarily of long-term debt obligations in the amount of $3,762,582 and operating lease obligations in the amount of $2,109,317. The significant change in our long-term debt obligations between December 31, 2003 and that date resulted primarily from the conversion on April 23, 2004 of outstanding convertible debentures with a carrying value of $3,997,000 into 2,075,000 shares of common stock. See “Our Financing Activities and Management’s Plans for 2004” below.
Restructuring Costs
We acquired Mobitec AB in June 2001. As part of our plan relative to the acquisition, we accrued for certain business activities duplicated within the existing and newly acquired international operations. We believed that it was reasonably likely that beginning in 2003 we would save approximately $200,000 per year in reduced employee expense, and beginning in 2004 we would 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, we 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.
No amounts were credited against the reserve during 2001. 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. During 2003, lease payments in the amount of $13,639 were charged against the reserve. 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 $9,361, we can reasonably expect $4,278 to be charged to the reserve during 2004.
Impact of Inflation
We believe that inflation has not had a material impact upon our results of operations for any of our fiscal years in the three-year period ended December 31, 2003 or for the three months ended March 31, 2004 or 2003. However, there can be no assurance that future inflation will not have an adverse impact upon our operating results and financial condition.
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Our Financing Activities and Management’s Plans for 2004
We initiated financing plans and strategies in 2003 to reduce the pressure on liquidity in 2004. The primary elements of our strategies, objective, plans and actions are:
1. | Restructure Debt. We have raised significant amounts of cash through secured and subordinated debt financing and have good relationships with debt holders, quasi-debt holders and vendors to mitigate liquidity pressures. On November 6, 2003, we replaced our asset-based lending agreement formerly with Guaranty Business Credit Corporation with a three-year agreement with LaSalle Business Credit, LLC. The agreement with LaSalle provides up to $10.0 million in borrowing to be used for acquisitions, working capital and general corporate purposes, as described above. We presently do not anticipate the need to secure additional debt financing, negotiate debt restructurings or negotiate conversion of trade payables to equity to mitigate liquidity pressures in 2004. This belief is based on the first quarter results for 2004, forecasts for the remainder of the year, and other management plans that were implemented in 2003 or which are being implemented in 2004. However, we will pursue all appropriate measures to address liquidity should cash flow prove unsatisfactory in 2004. On April 23, 2004, the holders of convertible debentures with a carrying value of $3,997,000 converted those debentures into 2,075,000 shares of common stock. As a result of this conversion, we will record a charge of $153,000 to write off the unamortized debt discount and $4,150,000 will be recorded as equity on the balance sheet. This will result in a reduction of the annual cash interest expense by approximately $332,000. See Note 3 — Pro Forma Balance Sheet and Supplemental Data— of the Notes to the March 31, 2004 Consolidated Financial Statements (Unaudited) indicated elsewhere in this prospectus. We believe we have relationships with both debt holders and suppliers to enable us to manage the timing of planned cash disbursements to the positive generation of cash during 2004. | |||
2. | Reduce Operating Costs and Improve Efficiency. In the normal course of business, we have aggressively sought opportunities to reduce the cost structure and increase overall efficiency and responsiveness to our customers. In 2003, we initiated “tracked and monitored” profit improvement initiatives designed to further leverage the economy of scale that was developing in our operations. We intend to continue developing our manufacturing and assembly infrastructure and organization to meet expected production requirements. We will continue manufacturing in-house certain key components of our products such as cable harnesses and assemblies, electronic destination sign systems, digital audio filter equipment and sub-system electronics. We believe this will enable us to: (1) produce highly reliable, quality products; (2) protect the proprietary nature of our technology and processes; (3) properly control our manufacturing and assembly processes and operations; and (4) achieve significant cost reductions. The cost reductions encompass all major elements of cost and operating expenses. We believe that in 2004 the strategies above will generate year-over-year improvement | |||
3. | Increase Ownership Equity. On April 24, 2004, we sold 625,000 shares of common stock to investors for $8.00 per share. The proceeds to us, net of issuance expenses, were $4,575,000. We also granted the investors warrants to acquire 125,000 shares of common stock at an exercise price of $8.80 per share, exercisable for a period of five years. Additionally, we granted a placement agent warrants to acquire 62,500 shares of common stock at an exercise price of $10.25, exercisable for a period of five years. These placement agent warrants are restricted from conversion to common stock for a period of six months from the date of placement above. In connection with the above transaction, we granted registration rights for both the common stock and the shares of common stock issuable upon exercise of the warrants. Between April 22, 2004 and April 30, 2004, certain other warrant holders exercised their rights to acquire common stock. The warrants were issued in conjunction with investment banking activities in prior years. We received total cash in the amount of $605,500 for issuing 170,000 shares under the warrant agreements. Between April 22, 2004 and April 30, 2004, the holders of Series AAA preferred stock converted 104 shares with a carrying value of $520,000 to 65,000 common shares. As a result of this conversion, we will reclassify $520,000 from Series AAA preferred stock to common stock as of the dates of the conversion, the result of which is a reduction of annual dividends expense by $52,000. On April 23, 2004, the holders of convertible debentures with a carrying value of $3,997,000 converted those debentures into 2,075,000 shares of common stock, as described above. On April 27, 2004, the holder of the Series F convertible preferred stock with a carrying value of $1,500,000 converted 304 preferred shares to 760,232 shares of common stock. This conversion represents 100% of the total conversion number of shares available. As a result of this conversion, $1.5 million of Series F convertible preferred stock will be reclassified as common stock as of the date of conversion. During the three months ended March 31, 2004, we issued in private placements an additional 67 shares of Series E Convertible Preferred stock. The net proceeds to us of such transactions were approximately $290,079. Our board of directors has authorized us to raise the limit on Series E issuance from 500 to 600 |
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shares. As of March 31, 2004, the present placements total 430 shares leaving available up to 170 shares for future placement. The Series E placements to date in 2004 are evidence that we are capable of securing additional equity when necessary. Notwithstanding this plan, we believe the balance sheet equity raised through Series E, Series F and common stock placements to date is sufficient for the balance of 2004 when considered in combination with our other plans and strategies to alleviate liquidity pressures. We anticipate that additional equity financing may be sought in the latter part of 2004 in conjunction with potential acquisitions or launch of new business initiatives. In this regard, we are presently evaluating alternative measures and action plans, and soliciting proposals to secure additional equity from investment banks. | ||||
4. | Maintain Our Focus on Technical Excellence and Innovation.We are continuing to maintain our leadership in the transportation and law enforcement and surveillance markets served. In order to expand and protect our technology, we will continue to seek patent protection for our products and/or licenses of key technology owned by others. We have introduced improved and new technologies in 2003 including the DR600 vehicle logic unit (“VLU”) that is the integration communication platform for transit vehicle systems including fare collection, automatic passenger counting, automatic vehicle announcement systems, engine monitoring, vehicle location and monitoring (for fleet management and security purposes) and other applications. We have introduced full color electronic destination sign systems and with our global presence are leveraging our purchasing power to realize decreased cost of materials. Our subsidiary, Digital Audio, continues to develop new products for the law enforcement and surveillance markets taking advantage of the initiatives in U.S Homeland Security. We consider any increase in government funding related to national security, intelligence, and law enforcement initiatives as having the potential to influence positively the opportunity to sell our audio processing solutions. Additionally, as a result of increased attention to the potential for terrorist’s threats to transit vehicles and infrastructure, we are well suited to leverage on the vehicle locating and monitoring aspect of our Transportation Segment; an essential element of security is knowing, on a real time basis, the precise location of critical assets. | |||
5. | Pursue Strategic Partnerships, Alliances and Acquisitions.In September 2003, we and GE Transportation Systems Global Signaling, LLC (GETSGS) through General Electric’s (“GE”) Advanced Communications division based in Hingham, Massachusetts signed a three-year Teaming Agreement. Through this agreement, we and GETSGS will work together to deliver advanced technology systems integration projects. Our Digital Recorders division will focus on vehicle location and passenger information processing and delivery systems while GETSGS will focus on communications technology, project management, and system integration. Through this agreement with GE, an organization that is uniquely capable of integrating our products with much larger systems in ways that exceed our independent technological and financial capabilities, we believe we will significantly extend our transit market reach. We further believe the GPS-based vehicle location products, including the security aspect of such as noted above, may represent one of our more significant internal growth opportunities in fiscal year 2004. | |||
6. | Increase working capital through better asset management. We recognize that the working capital assets of trade accounts receivable and inventories represent significant opportunities if properly and aggressively managed. Customer account balances are continually monitored and evaluated by reviewing payment history and patterns of heavy shipments that could limit credit line borrowings with our asset-based lender. We believe the decrease in the average days sales outstanding will help mitigate period to period liquidity tightness. As our inventories increased in recent years due to the requirements of the markets served and improvements in technology, we have developed initiatives to promote retro-fit sales programs and incentives to use existing versions of technology in inventory. |
We have historically met cash needs from the proceeds of debt and sale of preferred equity in private placements. Management continues to assess our product lines in light of technology trends and economic conditions, to identify how to enhance existing product lines or create new distribution channels.
Management’s Conclusions. We believe the cash and cash equivalents at March 31, 2004, together with available borrowing under our asset-based loan agreements, are sufficient to fund operations through the end of fiscal 2004, assuming continued improvement in our overall cost structure resulting from continued cost reduction activities, ongoing efforts aimed at controlling costs and improvements in asset management of trade accounts receivable and inventories.
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CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
In the past, we purchased electronic components supporting the transportation communications segment from a major shareholder, Lite Vision Corporation, a Taiwan-based company. Lite Vision held 12.7 percent (500,000) of the outstanding shares of our common stock at December 31, 2003. Subsequently, that stock was acquired by an individual investor on January 16, 2004. The components purchased from Lite Vision consisted primarily of LED printed circuit display boards and LED/Flip-Dot printed circuit boards. We purchased from Lite Vision approximately $3.5 million and $4.4 million in components and assemblies during 2002 and 2001, respectively, but did not make any purchases from Lite Vision during 2003. There were not any amounts due to Lite Vision as of December 31, 2003. The accounts payable balance due to Lite Vision was $859,425 as of December 31, 2002. Mr. Joseph Tang, previously President of Lite Vision and affiliated with Lite Vision in early 2003, while also pursuing other private business interests, served on our board of directors through October 4, 2003. During 2002 we issued 100,000 shares of restricted, unregistered common stock to Lite Vision at $3.00 per share in exchange for a $300,000 reduction in accounts payable.
John D. Higgins, one of our directors, 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 AB acquisition. Investec Ernst & Co. received a fee of $120,000, plus reasonable actual expenses, for furnishing the fairness opinion in 2001. In addition, also as part of the Mobitec AB acquisition, Mr. Higgins received a fee of $17,500 for the successful completion of certain convertible debenture financing in 2001. On August 26, 2002, we completed a privately negotiated sale of a $250,000 convertible subordinated debenture to Mr. Higgins. Mr. Higgins received a closing fee of $5,850 related to the placement of the debenture.
On August 2, 2002, we completed a privately negotiated sale of $1.15 million of convertible subordinated debentures to two funds managed by Dallas-based Renaissance Capital Group. Russell C. Cleveland, Renaissance Capital Group’s President, Chief Executive Officer and majority shareholder, serves on our board of directors. In June 2001, prior to Mr. Cleveland’s involvement as one of our directors, we issued $3.0 million of convertible subordinated debentures to those two funds containing substantially the same terms as the convertible debentures issued in 2002. Renaissance Capital Group received a closing fee of $17,250 related to the placement of the debentures in 2002. As a result of their ownership of those debentures, those two funds, BFSUS Special Opportunities Trust PLC and Renaissance U.S. Growth Investment Trust PLC, each beneficially owned 23 percent of our common stock. The funds converted all such debentures and sold the stock in April 2004. Mr. Cleveland is also a director of Renaissance U.S. Growth Investment Trust PLC.
On April 20, 2004, we engaged Roth Capital Partners, LLC, which is one of the Selling Shareholders listed in the Selling Shareholders table elsewhere in this prospectus, to serve as our exclusive placement agent in connection with a private placement of our common stock. We issued the warrant described in footnote 12 to the Selling Shareholders table to Roth Capital Partners, LLC and also paid that firm a cash fee in the amount of $425,000 as compensation for its services as placement agent in connection with a private placement completed pursuant to that agreement. That private placement related to the additional 750,000 shares of common stock covered by this prospectus.
BUSINESS
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.
In 1995, we acquired our law enforcement and surveillance subsidiary, Digital Audio Corporation. In 1996, we formed TwinVision® of North America, Inc. (“TwinVision®”). For reasons of market position and technology transfer, we acquired another start-up company (Transit-Media GmbH) in 1996, which, together with TwinVision®, focused on electronic destination sign systems.
In 1998, a change in our senior management led to significant growth as we:
• | sought to lead product development and technology development in the market and brought development 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 intensified attention to customers’ needs and requirements; and |
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• | emphasized the new electronic destination sign system that TwinVision® and Transit-Media GmbH pioneered. |
TwinVision® and Transit-Media GmbH grew rapidly and, with the June 2001 acquisition of Mobitec AB, these units now represent approximately 80 percent of our net sales. With this growth, we have added personnel at all levels and categories including sales personnel, software and hardware engineers, operations management and personnel, field service technicians, hourly assembly and administrative personnel.
We currently operate through the following two major business segments: (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 market. We sell to transportation vehicle equipment customers generally in two broad categories, including end-user customers and OEMs (original equipment manufacturers).
Our end-user customers include:
• | municipalities; | |||
• | regional transportation districts; | |||
• | federal, state, and local departments of transportation; | |||
• | transit agencies; | |||
• | public, private, or commercial operators of vehicles; and | |||
• | rental car agencies. |
Our OEM customers are the manufacturers of transportation vehicles. The relative percentage of sales to end customers compared to OEM customers varies widely and frequently from quarter-to-quarter and year-to-year and within products and product lines comprising our mix of total revenue in any given period. Our transportation communications segment consists of the following units and wholly owned subsidiaries:
• | Digital Recorders (Durham, N.C.), our business unit established in September 1983; | |||
• | RTI, Inc. (Dallas, Texas), acquired in July 1998; | |||
• | Transit Media-Mobitec GmbH (Ettlingen, Germany). This business unit consists of our former wholly owned subsidiaries Transit-Media GmbH and Mobitec GmbH that were merged effective January 1, 2002. Transit-Media GmbH was acquired in May 1996 and Mobitec GmbH was acquired in June 2001; | |||
• | TwinVision® (Durham, N.C.), established in May 1996; | |||
• | Mobitec AB (Herrljunga, Sweden), originally founded in 1987 and acquired by us in June 2001; | |||
• | DRI-Europa AB (Herrljunga, Sweden), established in February 2001 in connection with our acquisition of Mobitec AB. |
Through the Digital Recorders business unit, we supply the transportation vehicle equipment market with information technology products, including 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, vehicle location, vehicle operational conditions, 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 (“ADA”) 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 TwinVision® business development and market capability, as well as an exclusive license to Lite Vision Corporation’s display technology. RTI, presently generating minimal business activity, is a marketing consulting firm 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 in a number of countries around the world on transit and transportation vehicles. These products are sold under the TwinVision® and Mobitec brand names. Mobitec serves the Nordic, South American and selected European markets as well as selected Asian and Mid-Eastern markets. Transit-Media, and its successor company, Transit Media-Mobitec GmbH, serve selected European and Far- and Mid-Eastern markets. 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.
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Originally founded in 1987 and based in Herrljunga, Sweden, we believe our Mobitec AB subsidiary is, according to internal company market calculations, the largest market share supplier of electronic destination sign systems in the Nordic markets. The Nordic market 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 in 2001 to serve as the umbrella organizational structure for our operations in Europe. As a result, Mobitec AB and Transit Media-Mobitec GmbH are subsidiaries of DRI-Europa AB. The Mobitec AB 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, in Durham, 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 similar agencies in foreign countries such as the Royal Canadian Mounted Police, Australian Federal Police and London Metropolitan Police. 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:
• | U.S. federal, state, and local law enforcement agencies or organizations; | |||
• | U.S. military and intelligence organizations; | |||
• | comparable national and regional agencies of foreign governments; and | |||
• | 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 factors. In the past, that market was influenced by the Americans with Disabilities Act, the Clean Air Act, the Intermodal Surface Transportation Efficiency Act and successor legislation, and intelligent transportation systems initiatives. However, a more fundamental and longer-term impetus for development of this market is the need to provide improved passenger information and customer services to operators and riders of transit and transportation vehicles. Our electronic signage and automatic voice announcement and vehicle locating systems provide customers of transit systems with next stop, transfer point, route and destination information, vehicle location and operational condition 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, mass transit operating authorities can normally draw up to approximately 80 percent of funding for equipment purchases from the U.S. Federal Transit Administration with the remainder of product acquisition funding being provided by state and local sources. Typical privately funded users of our transit communications sector products include rental car shuttle vehicles and tour vehicle operators.
In the U.S., the Transportation Equity Act of the 21st Century (“TEA-21”), a $41 billion, six-year federal funding initiative, was the follow-up legislation to the Intermodal Surface Transportation Efficiency Act of 1991. That legislation expired in third quarter 2003 and has been continued under a series of Continuing Resolutions pending enactment of new long-term legislation. This is the primary program funding the U.S. public surface transit market at the federal level. TEA-21 and its Continuing Resolutions, as well as replacement legislation under consideration by Congress at this time, promote the development of modern, expanded, intermodal public transit systems nationwide and designate a wide range of tools, services and programs intended to increase the capacity of the nation’s mobility systems. While as much as 80 percent of major capital acquisitions can be federally funded in most instances, overall federal funding in the U.S. transportation communications segment market accounts for roughly 20 percent of all funding of all activities in the U.S. market. The balance comes from a combination of state and local sources and passenger fare revenues. We expect TEA-21 to be reauthorized during the coming twelve-month period but we cannot assure you that it will be. Funding for markets outside of the U.S. comes from a variety of sources. These sources vary widely region-to-region and may include combinations of local, regional, municipal, federal and private entities or funding mechanisms. The relative percentage of the various sources of funding varies widely country-to-country and period-to-period making analysis and presentation in any meaningful form problematic at best. However, the U.S. market typically has the largest percentage of funding from governmental sources.
The automatic voice announcement systems market, which we serve through 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, and was acknowledged to be ADA compliant. That regulatory-driven acceptance has now grown into a basic customer service issue as the automatic voice systems market matures. We believe that about 40 percent of all new bus vehicles in North America contained automatic voice systems in 2002 and 2003. We expect this percentage to slightly 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 GmbH and Mobitec AB, as well as pilot projects and alliances established since 1999, may enable
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Digital Recorders to develop growth in the international market in the future. We believe Digital Recorders holds a significant 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 automatic vehicle location capability of the Digital Recorders Talking Bus® system has enabled us to expand our served market to include fleet management services for operators of transit vehicle systems. A side outcome of this is the ability to provide more and better information to the users of transit systems by placing vehicle information at passenger boarding locations and other strategic locations. In this new business area we have entered into a Teaming Agreement with the GE Transportation Systems Global Signaling — Advanced Communications Systems business unit of General Electric Corporation to deliver advanced technology systems integration projects. Pursuant to the agreement, our Digital Recorders division will focus on vehicle location and passenger information processing and delivery systems while General Electric Corporation will focus on communications technology, project management, and system integration.
The electronic destination sign market, which we serve through Transit Media-Mobitec GmbH, TwinVision® and Mobitec AB, is highly competitive and mature, with business growth closely tied to overall market size, increased market share, or technological advances. Virtually all new transit buses manufactured worldwide have some form of destination sign system, and we believe that approximately 95 percent of those systems in the U.S. and 70 percent in major international markets are electronic. We believe that TwinVision® holds approximately the same level of market share in the U.S. as its only significant competitor, while Mobitec AB and Transit Media-Mobitec GmbH hold significant market shares internationally. Those market shares vary widely from region to region. For example, we believe Mobitec AB has a majority of the market share in Nordic markets and we believe that Transit Media-Mobitec GmbH has less than 10 percent of the 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’s sales are to international customers, although that percentage varies widely from quarter-to-quarter and year-to-year.
Our Key Competitors
Most of the markets in which we participate are highly competitive and are subject to rapid 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’s electronic destination sign market, 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 announcement systems market. In the integrated systems market we consider INIT GmbH, Siemens Corp, and Orbital Sciences Corporation to be our most significant competitors. 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: Meister, Apricot, LLE, Hanover Displays, Gorba, INIT, Siemens, and Orbital. All of these, with the exception of Orbital and Hanover Displays, are based in Central Europe. Hanover Displays is based in the United Kingdom with the majority market share there, as well as sales in selected regions of the continental European market. LLE, Hanover Displays, Brose Infosystems, Meister, Siemens and INIT all have sales in the international markets outside of Europe. Orbital is based in the U.S.
Within the law enforcement and surveillance segment, we believe Digital Audio is a leading market force among the small number of participants in this 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:
• | DR500C+ Talking Bus® and a replacement technologically advanced product, the DR600, which we recently introduced; |
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• | A Software Suite that provides modules for customized transit applications including Computer Aided Dispatch/Automatic Vehicle Location, Wireless Data Exchange and Central Recording Station; | |||
• | TwinVision® light-emitting diode (LED) illuminated flip-dot electronic destination sign systems; | |||
• | TwinVision® all-LED electronic destination sign systems; | |||
• | TwinVision® Chromatic Series family of color electronic destination sign systems; | |||
• | ELYSE® and Central Recording Station software; and | |||
• | Mobitec electronic destination sign systems. |
This segment accounted for approximately 97 percent of our net sales in 2003 and 96 percent in 2002 and 2001.
The Digital Recorders Talking Bus® system enables voice-announced transit vehicle stops, vehicle location and conditions, 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 and 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 (“PCMCIA”) format. Wireless downloading also is available. This system is designed to meet the severe operating demands of temperature, humidity, shock, vibration, and other environmental conditions found in typical applications. It is manufactured in an ISO 9002-compliant facility. Programming is accomplished with our proprietary Central Recording Station hardware and software.
Digital Audio’s 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.
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 original electronic destination sign products, which are generally known by the TwinVision® and Mobitec brand names, represent state-of-the-art technology licensed to or pioneered by Transit-Media, TwinVision® and Mobitec. The product line includes various models covering essentially all popular applications. Where applicable, these products adhere to ADA requirements and function under industry-recognized standards. They possess an open architecture, microprocessor-based design. 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 by our European subsidiaries including Mobitec. As the name implies, the “all-LED” 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 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.
Message programming for all of these products is accomplished via proprietary ELYSE® software developed by Transit-Media and refined by TwinVision® or a similar companion software developed by Mobitec. Programming is accomplished through PCMCIA memory card download, and wireless capabilities also are available. In 2002, TwinVision® finalized the second generation of the ELYSE® software to accommodate the advancement to color.
In January 2001, we entered into a 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®
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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 our product offerings 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. Humming sounds, room noises, acoustic resonance, muffling, background music, street traffic, and other noises often obscure such recordings. 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 of four new products for law enforcement, intelligence, military and security markets. These products, now well into market launch, are designed to expand our offerings in the areas of audio collection, forensic examination and technical countermeasures applications. The products include:
• | SSABR™, a state-of-the-art, covert, solid-state digital audio recorder; | |||
• | QuickEnhance QE-10, a new, simplified, digital tape enhancement system for real-time and laboratory use; | |||
• | UltraScope, an ultrasonic spectrum analyzer for audio countermeasures applications; and | |||
• | ProbeAmp, a multi-meter/high-gain amplifier for audio countermeasures applications. |
This segment accounted for approximately three percent of our net sales in 2003 and four percent in both 2002 and 2001.
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 to change its core digital signal processing development efforts from the Motorola DSP56200 processor to the Texas Instruments C6000 series processor technology. Digital signal processing is the technology that we generally utilize in the majority of our filtering products. This processor change allowed an increase in computational speed and resources, increased flexibility in application programming, and longer product life cycles due to improved upgrade paths.
Department of Homeland Security
The U.S. Government has established the Department of Homeland Security as the nation focuses on improving its capacity to deal with terrorist and other security threats. We believe this centralized federal focus will increase funding for security-related products and services such as those produced by Digital Audio. 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 we will have to sell our audio processing solutions in the core traditional security markets, as well as in the transportation communications segment.
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, subsidiary and market segment. Marketing and sales activities employ a wide range of 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 systems 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 the 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. Web site and Internet-based marketing techniques currently serve to assist marketing and sales efforts although the custom-specification,
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request-for-quote nature of our served markets does not yet lend itself to full-scale, Internet-driven marketing and sales efforts.
Customers
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 to which we made sales greater than 10 percent of our total sales) in 2003, 2002 and 2001 were transit bus original equipment manufacturers. In 2003, one major customer accounted for 16.2 percent of our net sales, compared to two major customers accounting for 21.9 percent in 2002, and three major customers accounting for 36.4 percent in 2001. We sell our 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. Loss of one or more of these larger key customers could have an adverse impact, possibly material, on our company.
Seasonality, Fluctuation in Results
Our sales are not generally 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. 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 and local governments operate on an October to September fiscal year. Many of our key international government customers operate on an April to March fiscal year. Also, government agencies occasionally have a tendency to purchase infrequently in large quantities, creating uneven demand cycles throughout the year. This results in periods with little order activity punctuated by periods of intense order activity. This fluctuation in government-related ordering also tends to make our sales patterns uneven and difficult to forecast quarter-to-quarter and year-to-year results.
Sales to our customers in both product segments are characterized by lengthy sales cycles that generally extend for a period of two months to 24 months. However, our sales revenues are recognized upon physical shipment of product, and our service revenues upon completion of the service. 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, for both law enforcement activities and public transportation. Law enforcement agencies are the principal customers for our audio products, while manufacturers 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, governmental purchases generally involve a longer lead time than might be the case in the private sector. Further, government agencies generally are required to make acquisitions through a public bidding process. 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 quarter to quarter and year to year.
Our Backlog
Our firm backlog as of March 31, 2004 was $5.6 million compared to $6.5 million and $8.5 million as of December 31, 2003 and December 31, 2002, respectively. The 14.5 percent decrease from December 31, 2003 to March 31, 2004 and 23.5 percent decrease from December 31, 2002 to December 31, 2003 were due to 1) timing of the receipt of orders, 2) order cycle fluctuations arising from the factors described under the heading “Seasonality, Fluctuations in Results” above, 3) relatively fewer long-term orders in the marketplace, and 4) a degree of market uncertainty arising, in our opinion, out of the transition from the expired “TEA-21” authorizing legislation through a series of continuing resolutions to the pending new authorizing legislation. We currently anticipate that we will ship all, or substantially all, of the backlog as of March 31, 2004 during the fiscal year 2004.
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 company from our competition.
We anticipate that technological enhancements to our Talking Bus® system and the TwinVision® and Mobitec electronic destination sign products will continue in the future. This should enhance our ability to integrate these products
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with other technologies, reduce unit cost of production, advance state-of-the-art technologies 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, licensed portions of the technology developed by the University of Washington into the Talking Bus® system also will allow customers to provide Internet access to passengers. 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 subsequently been replaced with other technological advances as noted below.
In 2000, Transit-Media and TwinVision® again led an industry technology change with the wide-spread 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 2003. Research and development expenses were $2,057,312 or 4.7 percent of net sales in 2003, compared to $2,492,428, or 5.5 percent of net sales, in 2002, and compared to $2,648,510, or 7.1 percent of net sales, in 2001. During 2003, 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 $1,059,844 of 2003 costs as an asset to be amortized as the sales of the software are realized over a period not to exceed three years. This compares to $493,293 and $223,046 for such costs for the years ended December 31, 2002 and 2001, respectively. Had these amounts not been capitalized, research and development expenses for the years ended December 31, 2003, 2002 and 2001 would have been $3,117,156, $2,985,721 and $2,871,556, respectively. Our main research and development projects include Digital Recorder’s new “DR600” 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 system for digital signal processing products.
Because we believe that technological advances are necessary to maintain and improve our product lines and, thus, our market position in a highly competitive market environment, we expect to continue to invest a significant amount of capital relative to our revenues on research and development in the foreseeable future. As a result of our 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.
Our Acquisition History
We acquired Digital Audio Corporation in 1995. We acquired Transit-Media and established TwinVision® in 1996, and we acquired RTI in 1998. Our acquisition of Digital Audio increased our revenue and profit, and provided us with a leading product line and technology development platform in the law enforcement and surveillance market. Our acquisition of Transit-Media provided us with 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 AB in June 2001 as part of our strategy to grow our company at an accelerated pace through both internal and external means. Mobitec AB is a subsidiary of DRI-Europa AB, our corporate framework for international operations that also includes Transit Media-Mobitec GmbH. Together, these subsidiaries primarily serve the European, Nordic, 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.
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Our Manufacturing Operations
Our principal supplier for the Digital Recorders business unit for most of fiscal year ended 2003, 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. Although we were solely dependent on CEA for most of fiscal year ended 2003 to manufacture products for our Digital Recorders business unit, we do not intend to be solely dependent on them or other suppliers for major components in the longer term. In keeping with this policy, we executed contracts with other suppliers to perform some of the services CEA currently provides.
TwinVision® and Transit Media-Mobitec GmbH purchase display components and assemblies for electronic destination sign systems from Lite Vision Corporation in Taiwan, the Republic of China, Meccanica UGO Amelie in Impruneta, Italy, Superior Manufacturing Services in West Virginia and UTM in Dallas, Texas. Until January 2004, Lite Vision was one of our major shareholders, holding approximately 12.7 percent of our outstanding common stock, $.10 par value per share. We purchased from Lite Vision Corporation approximately $3.5 million and $4.4 million in components and assemblies during 2002 and 2001, respectively, but did not make any purchases from that company in 2003. 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.
The Digital Audio subsidiary primarily 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 AB 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 suppliers located in Sweden, The Czech Republic, and Germany. Mobitec AB has two principal suppliers, BUSE s.r.o. in the Czech Republic and Elecktronikpartner AB, in Sweden providing display components and assemblies for electronic designation sign systems.
We believe alternative suppliers would be readily available for all raw materials and components for all of our business units.
Our Customer Service
We believe our commitment to customer service has enhanced the customer’s view of our company compared to our competition. Our plan has been to continue to define and 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 attempts to keep the results of our research and development efforts proprietary may not be sufficient 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 some of 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 use our best efforts 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 31, 2004, we employed 152 people, of which 82 were employed domestically and 70 were employed internationally. Our employees were deployed as follows: 53 were in operations; 28 were in engineering; 36 were in sales and marketing; and 35 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. We believe that our future success will depend in part on our continued ability to attract, hire and retain qualified personnel.
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PROPERTIES
We do not own any real estate. We have five real property lease agreements within the United States and six real property lease agreements elsewhere. Following are our locations, leased areas (square feet = sf, square meters = sm), use, monthly rents and lease expirations. All monthly rental amounts are stated in United States dollars, converting monthly payments in foreign currencies, where applicable, to United States dollars based on the December 31, 2003 exchange rate.
City and | ||||||||||||||||||
State | Country | Area | Use | Monthly Rent | Expiration | |||||||||||||
Durham, NC | USA | 18,484 | sf | Office, Service and Repair, warehouse and assembly | (a),(c) | $ | 13,486-17,083 | March 2008 | ||||||||||
Durham, NC | USA | 4,416 | sf | Warehouse | (a) | $ | 2,190-2,539 | April 2009 | ||||||||||
Durham, NC | USA | 4,000 | sf | Warehouse | (a) | $ | 1,983-2,299 | April 2009 | ||||||||||
Durham, NC | USA | 4,688 | sf | Office and assembly | (b) | $ | 2,715-3,145 | April 2009 | ||||||||||
Dallas, TX | USA | 3,000 | sf | Office | (c) | $ | 4,044 | April 2008 | ||||||||||
Peakhurst | Australia | 271 | sm | Office | (a) | $ | 2,813 | November 2006 | ||||||||||
Caxias do Sul | Brazil | 88 | sm | Office and assembly | (a) | $ | 1,131 | Open ended | ||||||||||
Paris | France | 23 | sm | Office | (d) | $ | 1,123 | November 2004 | ||||||||||
Herrljunga | Sweden | 2,000 | sm | Office, warehouse and assembly | (a),(d) | $ | 8,479 | March 2006 | ||||||||||
Ettlingen | Germany | 242 | sm | Office | (a) | $ | 2,173 | March 2007 |
(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, rates currently paid, if needed, to accommodate further internal growth.
LEGAL PROCEEDINGS
Our company, in the normal course of our operations, is involved in 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 our company or future results of operations.
On April 3, 2003, we filed a declaratory judgment action in the United States District Court for the Northern District of Texas, Dallas Division, seeking a finding by the court to the effect that we were not infringing on U.S. Patent No. 6,522,754, entitled “Digital Vehicle Microphone System and Method,” held by Clever Devices, Ltd. That company had previously asserted in letters to us that our StealthMic product infringed that patent. Clever Devices filed a counterclaim on May 23, 2003, seeking injunctive relief and unspecified damages. We entered into a settlement agreement with Clever Devices, and all claims and causes of action were dismissed with prejudice on June 3, 2004. The terms of the settlement are not material to us.
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Our company, to the best of its ability at all times seeks to avoid infringing, and will not knowingly violate the intellectual property rights of others. We believe the allegations of Clever are totally without merit and will proceed to defend our rights to conduct business freely while not infringing upon the legitimate intellectual property rights of Clever.
MARKET FOR OUR COMMON EQUITY AND RELATED SHAREHOLDER 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 sale prices, as reported by the Nasdaq Small Cap Market®, from January 1, 2002 through June 30, 2004.
High | Low | |||||||
Year Ended December 31, 2002 | ||||||||
First Quarter | $ | 3.55 | $ | 2.35 | ||||
Second Quarter | 3.70 | 2.30 | ||||||
Third Quarter | 3.05 | 1.98 | ||||||
Fourth Quarter | 2.69 | 1.72 | ||||||
Year Ended December 31, 2003 | ||||||||
First Quarter | $ | 2.89 | $ | 2.00 | ||||
Second Quarter | 3.00 | 2.15 | ||||||
Third Quarter | 2.85 | 2.20 | ||||||
Fourth Quarter | 3.00 | 2.30 | ||||||
Year Ended December 31, 2004 | ||||||||
First Quarter | $ | 4.00 | $ | 2.30 | ||||
Second Quarter | 16.87 | 2.42 |
The closing sale price of our common stock, as reported by the Nasdaq Small Cap Market®, on July 7, 2004 was $6.05. We estimate that, as of June 22, 2004, there were approximately 5,150 holders of our common stock.
We have not paid cash dividends on our common stock nor do we anticipate doing so in the foreseeable future. In addition, an outstanding convertible debenture and related purchase agreement and our current senior domestic credit facility restrict the payment of dividends upon any class of stock except on our preferred stock. We also have outstanding two series of preferred stock having dividend rights that have priority over any dividends payable to holders of common stock.
MANAGEMENT
Director Biographies
The following are biographical summaries for our directors.
Russell C. Cleveland,age 64, was appointed as one of our directors by our board of directors in August 2001 pursuant to a position established by the board under the Convertible Subordinated Debentures issued to entities with which
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Mr. Cleveland is affiliated in connection with our Mobitec AB acquisition. He was the principal founder of Renaissance Capital Group, Inc. in 1973 and is its majority shareholder. Renaissance Capital provides capital to emerging publicly owned companies. Mr. Cleveland is a Chartered Financial Analyst and has specialized in investing in emerging growth companies for more than 40 years. Mr. Cleveland is a graduate of the University of Pennsylvania, Wharton School of Finance and Commerce. He has served as President of the Dallas Association of Investment Analysts and has held executive positions with major southwest regional brokerage firms. For more than 10 years, he was a contributing editor ofTexas Business Magazine,for which he analyzed investment trends. Mr. Cleveland currently serves as President and Director of Renaissance Capital Growth & Income Fund III, Inc. (Nasdaq: RENN). He also is Director and Manager of Renaissance U.S. Growth Investment Trust PLC, which is traded on the London Exchange, and U.S. Portfolio manager of BFSUS Special Opportunities Trust PLC, based in London. Mr. Cleveland currently serves on the following public company boards of directors: Tutogen Medical, Inc., Integrated Securities Systems, Inc., and Cover-All Technologies, Inc. Over the years, Mr. Cleveland has served on the boards of many publicly traded emerging growth companies.
Nuria I. Fernandez,age 44, has served as a director since May 2004. She also serves as Senior Vice President of Business Development at Earth Tech, an engineering consulting firm headquartered in Long Beach, Calif., and owned by Tyco International Ltd. (NYSE: TYC). Working from Earth Tech’s Alexandria, Va., office since 2001, Ms. Fernandez is responsible for expanding Earth Tech’s transportation business opportunities in the U.S. and abroad. From 1997 to 2001, Ms. Fernandez was Deputy Administrator and Acting Administrator at the Federal Transit Administration, U.S. Department of Transportation, in Washington, D.C., where she managed and directed operations for the 500-employee agency responsible for securing funding for planning, design, construction, and technology for bus and rail systems in the U.S. and its territories. She also established policies and developed guidelines on the implementation of rules and regulations that governed federally funded mass transit programs. From 1994 to 1997, she led the design and construction division of the Washington Metropolitan Area Transit Authority in Washington, D.C. From 1989 to 1993, she served as Senior Vice President of the Chicago Transit Authority. From 1982 to 1989, she served as Coordinating Engineer of the City of Chicago’s Department of Public Works, where she was involved with the $1.2 billion expansion of O’Hare International Airport. Ms. Fernandez has received numerous transit industry awards, including: the Minority Business and Professionals’ Outstanding Leadership Award; the Woman’s Transportation Seminar Woman of the Year and National Member of the Year awards; the Conference of Minority Transportation Officials’ Women in Transportation Award; and the White House Elizabeth Cady Stanton Achievement Award. Ms. Fernandez received a Bachelor of Science degree in Civil Engineering from Bradley University and a Master of Science degree in Business Administration from Roosevelt University.
John D. Higgins,age 71, has served as a director since February 1998. He also serves as a director of Sparrow Systems, Inc., a privately held developer and marketer of specialized software for use in managing physician practices. From 1990 through November 1999, Mr. Higgins was Senior Vice President of Corporate Finance for Royce Investment Group, Inc., certain assets of which were subsequently acquired by Investec Ernst & Company, an international investment and merchant banking firm. Mr. Higgins is currently retired from Investec Ernst and pursuing personal business interests. He holds B.B.A. and M.B.A. degrees from Hofstra University.
J. Phillips L. Johnston, J.D., age 64, has served as a director since April 1990. He currently is Vice Chairman and Chief Legal Counsel for Remote Light, Inc., a privately held technology company located in Research Triangle Park, N.C. From September 1999 to June 2002, he was a director, Chief Executive Officer and President of ID Technologies, a publicly held company. He served as Chief Executive Officer of Pilot Therapeutic Holdings, Inc., a publicly held company, from September 1998 to September 1999. From April 1998 to May 1998, Mr. Johnston was President and Special Programs Administrator of Digital Recorders. He served as Digital Recorders’ Special Programs Administrator from May 1998 to December 1998. Mr. Johnston served as our Chairman of the Board, President and Chief Executive Officer from April 1990 to May 1998 and served as Administrator of the North Carolina Credit Unions from September 1987 to April 1990. From October 1979 to September 1987, Mr. Johnston served as President and Chief Executive Officer of Data Pix, Inc., Norman Perry, Chantry, Ltd., and Erwin-Lambeth, Inc., all of which were privately held companies, and was President and Chief Executive Officer of Currier Piano Company from 1971 through 1979. He was founding Chairman of the North Carolina Information and Electronics Trade Association, now the largest trade association in that state, and was named the Council for Entrepreneurial DevelopmentEntrepreneur of the Yearin 1997. Mr. Johnston is a director of several privately held companies, the author of two books, and a Babcock Entrepreneurial Fellow at Wake Forest University. Mr. Johnston received his A.B. degree in economics from Duke University, attended the Stern Graduate Business School at New York University and received his law degree from the University of North Carolina.
C. James Meese Jr., age 62, has been a director since 1991. He also was an independent sales representative for the Digital Recorders business unit from February 1993 through May 1995. Since 1989, Mr. Meese has provided advice and assistance to high growth companies on issues of company valuations, acquisitions and divestitures, market development, capitalization, corporate governance and organizational structuring through Business Development Associates, Inc., where he
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serves as the President. Prior to 1989, he spent approximately 20 years in various senior corporate marketing, business development and finance positions. Mr. Meese also is a director of New Wave Powerboats, Inc. and The Railroaders Memorial Museum. Mr. Meese received a B.A. degree in Economics from the University of Pennsylvania and an M.B.A. from Temple University.
Stephanie L. Pinson, age 66, has been a director since 2001. She has served as president of Gilbert Tweed Associates, Inc. (“Gilbert Tweed”), a well established retained executive search firm based in New York City. She joined Gilbert Tweed in 1981, and has been an owner since 1987 and served as principal prior to 1996. She is a member of the Gilbert Tweed Board of Directors and has responsibility for the operations of the firm. Ms. Pinson is the practice leader for Gilbert Tweed’s widely recognized Transportation Search Practice, specializing in searches for Public Transit Authorities and their suppliers and supporting aviation and port clients. With her partner, Janet Tweed Gusman, Ms. Pinson also is engaged in the Information Technology, Insurance and Industrial Practices. Her work with high technology and manufacturing companies is global in nature, and she directs Gilbert Tweed’s offices in Bombay and New Delhi, India. Prior to joining Gilbert Tweed Associates, Ms. Pinson served as Director of Relocation Services for Real Estate World in Boulder, Colo., from 1978 to 1980. From 1972 to 1980, she studied and taught Medieval English Literature at Rutgers University. Ms. Pinson serves in a variety of association and not-for-profit board positions. She is a past member of the APTA Executive Committee, having served as Vice Chair-Business Members and Vice Chair-Business Members at Large. She also serves on the APTA Chairman’s Diversity Council and is a member of the WTS Advisory Board. Ms. Pinson received her bachelors and masters degrees in English Literature from Rutgers University where she also qualified for the Ph.D.
John K. Pirotte, age 53, has been a director since 1996. He is President of Axxiom Manufacturing, Inc., a privately held manufacturer of air blast equipment. He has been Chairman and Chief Executive Officer of CORPEX Technologies Inc., a privately held company that develops and markets surface active chemical technology, since 1990. From March 1997 to December 2003, he served as President of Matrix Surface Technologies Inc., a privately held company that develops and markets mechanical surface treatment technologies. Mr. Pirotte also served as President and Chief Operating Officer of Teleion Wireless, Inc., a privately held company that develops and markets wireless data communication modules, from August 2000 to March 2002. In addition, Mr. Pirotte was Chairman and Chief Executive Officer from 1981 until 1988 and Chief Financial Officer from 1979 to 1981 of The Aviation Group, Inc., a former Nasdaq-listed company that was acquired in 1985. He is a member of the Board of Directors of Pharmanetics, Inc., a Nasdaq-listed biotech company specializing in theranostic management of various therapeutics affecting coagulation. He is a founding director of North Carolina Enterprise Corp., a venture capital fund. Mr. Pirotte holds a B.A. degree from Princeton University and an M.S. from New York University Graduate School of Business Administration.
Lawrence A. Taylor,age 57, has been our Secretary, Chief Financial Officer and Vice President since May 1998, and one of our directors since 2001. He has more than 13 years’ experience in the transit industry, as well as extensive knowledge and experience in auditing, merger and acquisition reporting, analysis and financial information technology systems. From March 1997 to June 1999, Mr. Taylor was a partner in the Dallas office of Tatum CFO, LLP, a professional partnership of career chief financial officers. From March 1995 to August 1996, he was Senior Vice President and Chief Financial Officer of Precept Business Products, Inc., a privately held holding company that distributed business forms, construction and on-demand courier services. From May 1991 to December 1994, he was Vice President and Group Controller of Mark IV’s Transportation Products Group, which included nine companies, subsidiaries and operating units serving transit and transportation markets worldwide. Prior to 1991, he served in various financial managerial capacities in the food processing, commercial construction and oil field supply industries, as well as other manufacturing environments. Mr. Taylor earned a B.S. degree in Accounting from Wayne State University. He is a Certified Public Accountant and a member of the Texas Society of CPAs and its Dallas Chapter, the American Institute of CPAs, and Financial Executive International.
Juliann Tenney, J.D., age 51, has been a director since April 1991. Employed by Duke University since September 1998, she presently serves as Associate Dean, Compliance, for the Duke University School of Medicine. She has been a lecturer in Duke University’s Nonprofit Management program since 1989. From August 1990 through July 1993, she served as Executive Director of the Southern Growth Policies Board, an interstate alliance charged with designing economic development and growth strategies for southern governors and legislators. From August 1988 to August 1990, Ms. Tenney served as Director for the Economic and Corporate Development Division of the North Carolina Biotechnology Center and also as their House Legal Counsel. From November 1987 to August 1988, Ms. Tenney was Assistant Secretary at the North Carolina Department of Commerce. From August 1985 to November 1987, she was Executive Director of the North Carolina Technological Development Authority. Prior to that time, she was a practicing attorney. Ms. Tenney received a B.A. degree from the University of North Carolina and a law degree from Duke University.
David L. Turney, age 60, has been our Chairman of the Board and Chief Executive Officer since May 1998 and a director since May 1996. Mr. Turney was co-founder, Chairman and CEO of Robinson Turney International, Inc. (subsequently known as
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RTI, Inc.), which was acquired by Digital Recorders, Inc. in April 1998. A consulting firm, RTI engaged in business development, marketing services, advisory services, and merger, acquisition and financing assignments for selected clients. Until the merger, our company was an RTI client and all RTI clients were in the transit and transportation equipment industries. From March 1994 to December 1995, Mr. Turney was also engaged in strategic planning and development consulting services for his former employer, Mark IV Industries, Inc., a New York Stock Exchange listed company prior to its acquisition by a private investor. Mr. Turney founded the Mark IV Transportation Products Group, a group of nine companies, subsidiaries and operating units serving transit and transportation markets worldwide and served as its Group Executive from February 1991 to February 1994. From 1984 to 1991, Mr. Turney was President of the Luminator division of Gulton Industries, Inc., which became a wholly owned subsidiary of Mark IV in 1987. Prior to 1984, he served in various managerial and engineering capacities in four corporations spanning the telecommunications, industrial hard goods, consumer electronics and electromagnetic components industries. Mr. Turney is active in the American Public Transportation Association (“APTA”), the trade association of the industry and market that our company serves. A former chair of APTA’s business member group, he presently serves on the APTA Business Member Board of Governors, as well as other industry elected and appointed positions. He also is a corporate member of the National Association of Corporate Directors. Mr. Turney received his B.S. in industrial management from the University of Arkansas in Fayetteville, and he has participated in numerous postgraduate study courses in finance, mergers and acquisitions, public company administration and operations.
Executive Officer and Key Management Biographies
The following are biographical summaries for our executive officers and key management who are not directors.
Floyd J. Diaz,age 44, has 11 years’ transit industry experience. He has been the Vice President and General Manager of our Digital Records business unit since May 2002. He was promoted to President and General Manager of the Digital Recorders business unit in September 2003. He joined our company as that unit’s Vice President and Sales and Marketing Manager in 1999. From 1993 to 1999, Mr. Diaz was Vice President of Sales & Marketing at ERG Transit Systems in Toronto, Ontario. From 1986 to 1992, Mr. Diaz held various positions with the Houston-based Schlumberger Oil and Gas Exploration Division. A 1984 graduate of Queen’s University in Kingston, Ontario, Mr. Diaz has a B.Sc. in Geological Engineering. In 1992, he received an M.B.A. from Houston Baptist University.
Lawrence A. Hagemann,age 60, has 12 years’ transit industry experience, including extensive experience in advanced software and micro-processor systems. In 2000, he was appointed chief operating officer of our North Carolina Operations. Since February 1998, he has served as our Executive Vice President and TwinVision na, Inc.’s president and general manager. From July 1996 to February 1998, he was TwinVision’s vice president and general manager. In addition, Mr. Hagemann currently serves as a director of Transtel Communications Ltd., a developer of news media software based in London, England. He has held this position since October 1993. From July 1995 to July 1996, Mr. Hagemann was Vice President of ADDAX Sound Company, a privately held company in Illinois. From April 1991 to December 1993, he served as Assistant to the President of Vapor-Mark IV in Illinois. From 1973 to 1990, he was Vice President of Sales and Marketing for Extel Corporation in Illinois, as well as a director of Excom Communications Limited in Slough, England, and Extel Overseas Limited in Hong Kong. Mr. Hagemann earned a bachelor’s degree in Electrical Engineering from the University of Detroit in 1967. In 1972, he earned an M.B.A. from Loyola University in Chicago.
Robert W. Huber,age 65, has more than 20 years’ transit industry experience. Mr. Huber serves as DRI-Europa AB’s Executive Vice President and Director of Business and Market Development. Mr. Huber founded our German destination-sign subsidiary, Transit-Media GmbH, in August 1995. Prior to joining our company, Mr. Huber was the Managing Director of a Mark IV Industries company. Mr. Huber received a Management degree from the Université de Genève. A member of the International Union of Public Transport, Mr. Huber serves as the Industry Committee’s honorary chairman and as the Industry Assembly’s executive vice president. In addition, he is a Commercial Attaché and active in the IHK Industrie und Handelskammer Karlsruhe.
Björn Rönnhede,age 42, has 15 years’ transit industry experience and extensive bus market knowledge. He has been the Managing Director of our Swedish destination-sign subsidiary, Mobitec AB, since 1998. From 1989 to 1998, Mr. Rönnhede was Mobitec AB’s Sales and Marketing Manager. Mr. Rönnhede graduated from IHM Business School in 1989 with a Sales and Marketing degree. In 2000, Mr. Rönnhede completed a six-week Management course at the Institutet for Foretagsledning.
Gerald Sheehan,age 47, has more than 16 years’ transit industry experience. He was appointed Vice President and General Manager of TwinVision na, Inc. in August 2002 and promoted to President and General Manager of TwinVision na, Inc. in September 2003. He joined our company in 1998 as TwinVision’s Vice President of Sales and Marketing, working directly with our sales representatives and OEM accounts. Mr. Sheehan has been instrumental in shaping marketing and sales programs for
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the TwinVision® Electronic Destination Sign System, which has enabled TwinVision to become the technology leader in the transit market. Previously, Mr. Sheehan held key marketing and sales management positions with Voith Transmissions in York, Pennsylvania, and Prima Facie in Conshohocken, Pennsylvania.
Donald Tunstall,age 39, has 22 years’ technology industry experience, including 18 years’ experience specific to the government/law-enforcement sector. Mr. Tunstall replaced Craig Scates, who is serving our company in other capacities, as Vice President and General Manager of the Digital Audio Corporation business unit in January 2004. Initially joining Digital Audio Corporation as a part-time Assembler/ Technician in 1986, he became a full-time Staff Engineer in 1989. He was promoted to Chief Engineer in 1997, holding that position until he was appointed to his current position. Mr. Tunstall received his B.S. degree in Electrical Engineering from North Carolina State University in 1988. He is a member of both the Audio Engineering Society and the Armed Forces Communications and Electronics Association.
Nepotism
There is no relationship by blood, marriage or adoption between any of our directors or executive officers.
Audit Committee
The Audit Committee is appointed by our board of directors upon the recommendation of the Corporate Governance and Nominating Committee to assist our board of directors in monitoring: (1) the integrity of our financial statements; (2) our compliance with legal, regulatory, and stock exchange or Nasdaq listing requirements and (3) the independence and performance of our independent auditors. We select our independent auditors subject to ratification by our board of directors. We further directly manage the relationship with the audit firm, including setting of all related fees.
The Audit Committee has three members, all of whom are “independent” directors as defined in the listing standards of Nasdaq and in Item 7(d)(3)(iv) of Schedule 14A of the Securities Exchange Act. At least two Audit Committee members, C. James Meese Jr. and John K. Pirotte, meet the requirements of “audit committee financial expert,” as defined by Item 401(h)(2) of Regulation S-K. Each Audit Committee member is financially literate as required by the pronouncements of the Securities and Exchange Commission and Nasdaq, possesses appropriate accounting or equivalent financial expertise, and maintains up-to-date knowledge related to the duties appropriate for the Audit Committee. Each Audit Committee member is a current shareholder of our company.
The following members of our board of directors comprise the Audit Committee:
C. James Meese Jr. (Chairman)
John D. Higgins
John K. Pirotte
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Human Resource and Compensation Committee Interlocks and Insider Participation in Compensation Decisions
None.
The following members of our board of directors comprise the Human Resource and Compensation Committee:
Juliann Tenney, J.D. (Chairman)
J. Phillips L. Johnston, J.D.
Stephanie L. Pinson
Board of Directors’
Total Compensation Package
Monetary Compensation
Effective in August 2003, we instituted the following compensation program for non-employee directors.
Digital Recorders, Inc.
Board Compensation
Cash Retainer | ||
Payable at the End of Each Month | $2,000 | |
Cash Meeting Fees | ||
Base (Board and Committee) | $1,000 | |
Premium (Chair, Audit Committee, Lead Director and Oversight) | $ 500 | |
Equity | ||
Option Grant | At 100% of market value on date of grant with awards vesting annually in equal amounts over a three-year period in amounts to bring: (1) each of John D. Higgins, J. Phillips L. Johnston, J.D., C. James Meese Jr., and John K. Pirotte to a total of 35,000 shares underlying their respective awards; (2) Juliann Tenney, J.D. to a total of 33,000 shares underlying the award; and (3) Russell C. Cleveland and Stephanie L. Pinson to a total of 20,000 shares each underlying their respective awards. |
This policy is restricted to non-employee directors who attended at least 75 percent of all meetings, including meetings of all committees of which they were members, from January 1, 2003 through December 31, 2003.
Employee directors receive no salary or fringe benefits for their services as directors, although travel or other out-of-pocket expenses incurred by all directors, including employee directors, in attending meetings of our board of directors and committee meetings are reimbursed on an actual but reasonable basis.
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Stock Options
During fiscal year 2003, our board of directors granted options to purchase 76,000 shares of our common stock to seven board members under our 2003 Stock Option Plan (see table below). No stock options were exercised by any non-employee director during the fiscal year that ended December 31, 2003. Each of the awards listed in the table was granted on May 1, 2003 and vests annually in three approximately equal increments over a three-year period ending May 1, 2006.
Digital Recorders, Inc.
Stock Options Awarded to Non-Employee Directors
During Fiscal Year 2003
Individual Grants | ||||||||||||||
% of Total | ||||||||||||||
Number of | Options/SARs | |||||||||||||
Securities | Granted to Non- | |||||||||||||
Underlying | Employee | |||||||||||||
Options/SARs | Directors in | Exercise/Base | Expiration | |||||||||||
Name and Position | Granted (#) | Fiscal Year 2003 | Price ($/Share) | Date | ||||||||||
Russell C Cleveland, Director | 13,000 | 17.1 | % | $ | 2.35 | May 1, 2013 | ||||||||
John D. Higgins, Director | 10,000 | 13.2 | % | $ | 2.35 | May 1, 2013 | ||||||||
J. Phillips L Johnston, J.D., Director | 10,000 | 13.2 | % | $ | 2.35 | May 1, 2013 | ||||||||
C. James Meese Jr., Director | 10,000 | 13.2 | % | $ | 2.35 | May 1, 2013 | ||||||||
Stephanie L Pinson, Director | 13,000 | 17.1 | % | $ | 2.35 | May 1, 2013 | ||||||||
John K. Pirotte, Director | 10,000 | 13.2 | % | $ | 2.35 | May 1, 2013 | ||||||||
Juliann Tenney, J.D., Director | 10,000 | 13.2 | % | $ | 2.35 | May 1, 2013 |
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Executive Compensation
The following Summary Compensation Table sets forth the compensation during the last three fiscal years of our chief executive officer and the four other most highly compensated executive officers (collectively, the “Named Executive Officers”) based on compensation for services rendered in all capacities to our company during the year ended December 31, 2003.
Long-Term | ||||||||||||||||
Compensation | ||||||||||||||||
Awards (1) | ||||||||||||||||
Annual Compensation | Securities Underlying | |||||||||||||||
Name and Position | Year | Salary | Bonus | Options/SARs | ||||||||||||
David L. Turney | 2003 | $ | 258,500 | — | — | |||||||||||
Chairman, Chief Executive Officer and | 2002 | $ | 219,375 | $ | 32,500 | — | ||||||||||
President, DRI, and Chairman and Managing | 2001 | $ | 215,000 | $ | 37,500 | — | ||||||||||
Director, DRI-Europa AB | ||||||||||||||||
Lawrence A. Taylor | 2003 | $ | 184,000 | — | 10,000 | |||||||||||
Secretary, Chief Financial Officer and Vice | 2002 | $ | 163,000 | $ | 20,000 | 10,000 | ||||||||||
President, DRI, and Board of Directors, | 2001 | $ | 151,667 | $ | 25,000 | 25,000 | ||||||||||
DRI-Europa AB | ||||||||||||||||
Lawrence A Hagemann | 2003 | $ | 178,750 | — | 10,000 | |||||||||||
Executive Vice President, DRI, and Chief | 2002 | $ | 157,083 | — | 10,000 | |||||||||||
Operating Officer, North Carolina Operations | 2001 | $ | 151,667 | — | 25,000 | |||||||||||
Gerald Sheehan | 2003 | $ | 152,500 | — | 10,000 | |||||||||||
President and General Manager of the | 2002 | $ | 135,000 | — | 10,000 | |||||||||||
TwinVision na, Inc. Business Unit | 2001 | $ | 119,840 | — | 10,000 | |||||||||||
Floyd J. Diaz | 2003 | $ | 137,500 | — | 27,000 | |||||||||||
President and General Manager of the | 2002 | $ | 123,850 | $ | 45,650 | 10,000 | ||||||||||
Digital Recorders Business Unit | 2001 | $ | 110,000 | $ | 32,640 | 3,000 |
Notes:
1. | All options awarded in fiscal year 2003 were granted under our 2003 Stock Option Plan. |
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Option Grants in Fiscal Year 2003
The following table provides information about stock options awarded to the Named Executive Officers under our 2003 Stock Option Plan in fiscal year 2003. The table shows the potential value of each grant assuming that the market value of our common stock appreciates in the ten years from the date of grant to the date of expiration at annual rates of five percent and 10 percent, compounded annually. These assumed rates of appreciation have been specified by the Securities and Exchange Commission for illustrative purposes only and are not intended to predict future prices of our common stock, which will depend upon various factors, including market conditions and our future performance and prospects.
Option Grants in Fiscal Year 2003(1)
Individual Grants | Potential Realizable Value | |||||||||||||||||||||
Number of | at Assumed | |||||||||||||||||||||
Securities | % of Total | Annual Rates of Stock | ||||||||||||||||||||
Underlying | Options | Price Appreciation for | ||||||||||||||||||||
Options | Granted to | Exercise or | Option Term(2) | |||||||||||||||||||
Granted in | Employees | Base Price | Expiration | |||||||||||||||||||
Name and Position | 2003 | in 2003(3) | ($/Share) | Date | 5% | 10% | ||||||||||||||||
David L. Turney | — | — | — | — | — | — | ||||||||||||||||
Chairman, Chief Executive Officer and President, DRI, and Chairman and Managing Director, DRI-Europa AB | ||||||||||||||||||||||
Lawrence A. Taylor | 10,000 | 11.8 | % | 2.55 | May 13, 2013 | $ | 16,037 | $ | 40,640 | |||||||||||||
Secretary, Chief Financial Officer and Vice President, DRI, and Board of Directors, DRI-Europa AB | ||||||||||||||||||||||
Lawrence A. Hagemann | 10,000 | 11.8 | % | 2.55 | May 13, 2013 | $ | 16,037 | $ | 40,640 | |||||||||||||
Executive Vice President, DRI, and Chief Operating Officer, North Carolina Operations | ||||||||||||||||||||||
Gerald Sheehan | 10,000 | 11.8 | % | 2.55 | May 13, 2013 | $ | 16,037 | $ | 40,640 | |||||||||||||
President and General Manager of the TwinVision na, Inc. Business Unit | ||||||||||||||||||||||
Floyd J. Diaz | 27,000 | 31.8 | % | 2.55 | May 13, 2013 | $ | 43,299 | $ | 109,729 | |||||||||||||
President and General Manager of the Digital Recorders Business Unit |
Notes:
1. | No stock options granted during fiscal year 2003 were exercisable by employees at December 31, 2003. | |||
2. | No stock options granted during fiscal year 2003 were in the money on the grant date. | |||
3. | Based on 85,000 total options granted to employees in fiscal year 2003. |
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Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values
The following table provides summary information regarding the stock options exercised during fiscal year 2003 and the stock options held as of December 31, 2003 by the Named Executive Officers.
Digital Recorders, Inc.
Aggregated Option/ SAR Exercises in Fiscal Year 2003 and
Fiscal Year-End Option/ SAR Values for the Named Executive Officers
Number of Securities | Value of Unexercised, | |||||||||||||||||||||||
Underlying Unexercised | In-the-Money | |||||||||||||||||||||||
Options/SARs at | Options/SARs(1) | |||||||||||||||||||||||
Shares Acquired | Value | Fiscal Year-End (#) | Fiscal Year-End (#) | |||||||||||||||||||||
Name and Position | on Exercise | Realized | Exercisable | Unexercisable | Exercisable | Unexercisable | ||||||||||||||||||
David L. Turney | — | — | 100,000 | 150,000 | $ | 63,640 | (2) | |||||||||||||||||
Chairman, Chief Executive Officer and President, DRI, and Chairman and Managing Director, DRI-Europa AB | ||||||||||||||||||||||||
Lawrence A. Taylor | — | — | 83,333 | 6,667 | $ | 33,633 | $ | 1,267 | ||||||||||||||||
Secretary, Chief Financial Officer and Vice President, DRI, and Board of Directors, DRI-Europa AB | ||||||||||||||||||||||||
Lawrence A. Hagemann | — | — | 93,333 | 6,667 | $ | 37,621 | $ | 1,267 | ||||||||||||||||
Executive Vice President, DRI, and Chief Operating Officer, North Carolina Operations | ||||||||||||||||||||||||
Gerald Sheehan | — | — | 37,333 | 6,667 | $ | 17,333 | $ | 1,267 | ||||||||||||||||
President and General Manager of the TwinVision na, Inc. Business Unit | ||||||||||||||||||||||||
Floyd J. Diaz | — | — | 26,000 | 18,000 | $ | 12,760 | $ | 3,240 | ||||||||||||||||
President and General Manager of the Digital Recorders Business Unit |
Notes:
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1. | Options or free-standing SARs are in-the-money if the fair market value of the underlying securities exceeds the exercise or base price of the option or SAR. The closing market price of our common stock on December 31, 2003 was $2.74. | |
2. | The unexercisable options held by Mr. Turney as of December 31, 2003 were not in-the-money. |
401(k) Plan
In January 1996, we implemented a defined contribution savings plan for all eligible employees (as defined). The savings plan is intended to qualify under Section 401(k) of the Internal Revenue Code. Under the savings plan, a participant may contribute from one percent to 15 percent of his or her compensation, not to exceed an amount which would cause the plan to violate Section 401(k) and other applicable sections of the Internal Revenue Code. We have not made any matching contributions to the savings plan. All participants’ contributions are invested, in accordance with the participant’s election, in various investment funds managed by the plan trustee. The savings plan permits withdrawals in the event of disability, death, attainment of age 59 1/2, termination of employment or proven financial hardship. We pay all the costs of administering the savings plan.
Employment Contracts and Termination of Employment and
Chief Executive Officer
David L. Turney serves as our Chief Executive Officer and President. His employment agreement, which was extended as of December 17, 2001, is for a period of four years ending December 17, 2005 and provides for a minimum annual base salary of $235,000 effective as of January 1, 2002. The agreement provides for discretionary bonus and incentive stock option compensation. In the event of a “Triggering Event,” which includes a change in ownership of our company of at least 50 percent, or a merger, consolidation, reorganization or liquidation of our company, Mr. Turney would be entitled to receive 2.9 times his annual salary, incentive and bonus payments during the most recent 12 month period, if Mr. Turney’s employment was terminated or he was unable to reach a satisfactory new agreement. The agreement can be terminated by our company or Mr. Turney with or without cause, requires Mr. Turney to keep confidential certain of our technology and trade secrets, and prohibits Mr. Turney from engaging in business competing with us during his employment and for one year after termination, if initiated by him, or six months, if initiated by us.
Other Named Executives
Effective January 1, 1999, we entered into employment agreements with each of Lawrence A. Hagemann and Lawrence A. Taylor to serve as our Executive Vice President and Chief Financial Officer, respectively, for a period of one year, subject to periodic extensions for like periods, and have been so extended each year. The agreements provide for an annual salary of $122,727 for Mr. Hagemann and $127,000 for Mr. Taylor, initially, and bonuses or stock options, at the discretion of the Human Resource and Compensation Committee. In the event of a “Triggering Event,” which includes a change in ownership of our company of at least 50 percent, or a merger, consolidation, reorganization or liquidation of our company, Mr. Hagemann and Mr. Taylor would be entitled to receive two times their annual salary, incentive and bonus payments during the most recent 12 month period, if their employment is terminated or they are unable to reach a satisfactory new agreement. The agreements may be terminated by us or Mr. Hagemann and Mr. Taylor, as applicable, with or without cause. The agreements require Mr. Hagemann and Mr. Taylor to keep confidential certain of our technology and trade secrets, and prohibit Mr. Hagemann and Mr. Taylor from engaging in business competing with us during their employment and for two years after termination.
Floyd Diaz, President and General Manager of the Digital Recorders business unit, and Gerald Sheehan, President and General Manager of the TwinVision na, Inc. business unit are each party to an employment agreement with our company, dated August 1, 2003, and amended September 1, 2003, for a period of one year, subject to periodic extensions for like periods. The agreements provide for an annual salary of $137,500 for Mr. Diaz and $152,500 for Mr. Sheehan, initially, and bonuses or stock options, at the discretion of the Human Resource and Compensation Committee. In the event of a “Triggering Event,” which includes a change in ownership of our company of at least 50 percent, or a merger, consolidation, reorganization or liquidation of our company, Mr. Diaz and Mr. Sheehan, as applicable, would be entitled to receive two times their annual salary, incentive and bonus payments during the most recent 12 month period, if their employment is terminated or they are unable to reach a satisfactory new agreement. The agreements may be terminated by us or Mr. Diaz and Mr. Sheehan, as applicable, with or without cause. The agreements require Mr. Diaz and Mr. Sheehan to keep confidential certain of our technology and trade secrets, and prohibit Mr. Diaz and Mr. Sheehan from engaging in business competing with us during their employment and for two years after termination.
Our 2003 Stock Option Plan provides that, in the event we enter into an agreement providing for the merger of our company into another corporation or the sale of substantially all of our assets, any outstanding unexercised option shall become exercisable at any time prior to the effective date of such agreement. Upon the consummation of the merger or sale of assets, such options shall terminate unless they are assumed or other options are substituted by the successor corporation.
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Security Ownership of Certain Beneficial Owners
As of June 8, 2004, there are no beneficial owners of our voting securities known by us to own beneficially more than five percent of our voting securities.
Security Ownership of Named Executive Officers and Directors
The following table sets forth certain information regarding beneficial ownership of our common stock as of June 8, 2004 by: (1) each director; (2) each named executive officer; and (3) all executive officers and directors as a group. Unless otherwise noted, each person has sole voting and sole investment or dispositive power with respect to the shares shown. None of the individuals listed in the following table owns any shares of any series of our preferred stock.
Security Ownership of Named Executive Officers and Directors(1)
As of June 8, 2004
Common Stock | ||||||||
Beneficially | % of | |||||||
Owned(1) | Class(2) | |||||||
Named Executive Officers | ||||||||
David L. Turney(3) | 315,950 | 3.9 | % | |||||
Lawrence A. Taylor(4) | 127,633 | 1.6 | % | |||||
Lawrence A. Hagemann(5) | 110,333 | 1.4 | % | |||||
Gerald Sheehan(6) | 37,833 | * | ||||||
Floyd J. Diaz(7) | 26,000 | * | ||||||
Non-Executive Directors | ||||||||
Russell C. Cleveland(8) | 11,333 | * | ||||||
Nuria I. Fernandez | — | — | ||||||
John D. Higgins(9) | 153,333 | 1.9 | % | |||||
J. Phillips L. Johnston(10) | 95,615 | 1.2 | % | |||||
C. James Meese Jr.(11) | 29,333 | * | ||||||
Stephanie L. Pinson(12) | 13,333 | * | ||||||
John K. Pirotte(13) | 34,028 | * | ||||||
Juliann Tenney(14) | 42,315 | * | ||||||
Executive Officers and Non-Executive Directors as a Group (16 persons)(15) | 1,065,706 | 12.1 | % |
* | Less than one percent |
Notes:
1. | Beneficial ownership includes both outstanding common stock and shares issuable upon the conversion of convertible securities or the exercise of options or warrants that are currently convertible or exercisable or will become convertible or exercisable within 60 days after the date hereof. Unless otherwise noted, sole voting and dispositive power is possessed with respect to all common stock shown. All percentages are calculated based on the number of outstanding shares at June 8, 2004 plus shares which a person or group has the right to acquire within 60 days thereafter. | |||
2. | Based on 7,943,874 shares of common stock outstanding as of June 8, 2004. | |||
3. | Consists of 65,950 shares of common stock owned outright as joint tenant with right of survivorship with Mr. Turney’s wife and 250,000 shares of common stock issuable upon the exercise of options presently exercisable or exercisable |
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within 60 days after the date hereof. The address for Mr. Turney is: 5949 Sherry Lane, Suite 1050; Dallas, TX 75225. | ||||
4. | Consists of 44,300 shares of common stock owned outright as joint tenant with right of survivorship with Mr. Taylor’s wife, and 83,333 shares of common stock issuable upon the exercise of options presently exercisable or exercisable within 60 days after the date hereof. | |||
5. | Consists of 17,000 shares of common stock owned outright and 93,333 shares of common stock issuable upon the exercise of options presently exercisable or exercisable within 60 days after the date hereof. | |||
6. | Consists of 500 shares of common stock owned outright and 37,333 shares of common stock issuable upon the exercise of options presently exercisable or exercisable within 60 days after the date hereof. | |||
7. | Consists of 26,000 shares of common stock issuable upon the exercise of options presently exercisable or exercisable within 60 days after the date hereof. | |||
8. | Consists of 11,333 shares of common stock issuable upon the exercise of options presently exercisable or exercisable within 60 days after the date hereof. | |||
9. | Consists of 28,333 shares of common stock issuable upon the exercise of options presently exercisable or exercisable within 60 days after the date hereof and 125,000 shares of common stock issuable upon conversion of debentures. | |||
10. | Consists of 17,282 shares of common stock owned outright, 28,333 shares of common stock issuable upon the exercise of options presently exercisable or exercisable within 60 days after the date hereof and 50,000 shares of common stock issuable upon the exercise of presently exercisable warrants. | |||
11. | Consists of 1,000 shares of common stock owned outright and 28,333 shares of common stock issuable upon the exercise of options presently exercisable or exercisable within 60 days after the date hereof. | |||
12. | Consists of 2,000 shares of common stock owned by Ms. Pinson’s spouse and 11,333 shares of common stock issuable upon the exercise of options presently exercisable or exercisable within 60 days after the date hereof. | |||
13. | Consists of 9,695 shares of common stock owned outright and 24,333 shares of common stock issuable upon the exercise of options presently exercisable or exercisable within 60 days after the date hereof. | |||
14. | Consists of 17,982 shares of common stock owned outright and 24,333 shares of common stock issuable upon the exercise of options presently exercisable or exercisable within 60 days after the date hereof. | |||
15. | Of the 1,065,706 shares of our common stock beneficially owned by our executive officers and non-executive directors as a group, 889,997 shares are issuable upon the conversion of convertible securities or the exercise of options or warrants that are currently convertible or exercisable or will become convertible or exercisable within 60 days after the date hereof. |
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CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
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 currency 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 1.0 percent. If the bank’s prime rate on December 31, 2003 increased by 100 basis points on that date and then remained constant at the higher rate throughout 2004, our interest costs on our outstanding variable rate borrowings at December 31, 2003 of $4,222,336 would increase by approximately $42,223 for the year ending December 31, 2004. Similarly, if the bank’s prime rate on December 31, 2003 decreased by 100 basis points on that date and then remained constant at the lower rate throughout 2004, our interest costs on our outstanding variable rate borrowings at December 31, 2003 of $4,222,336 would decrease by approximately $42,223 for the year ending December 31, 2004. We currently do not use derivative instruments to manage our interest rate risk.
At December 31, 2003, we had outstanding long-term fixed rate borrowings (including current portions) of $7,896,162. We believe the carrying amount of our fixed rate borrowings approximates the estimated fair value for debt with similar terms, interest rates and remaining maturities currently available to companies with similar credit ratings at December 31, 2003. We do not expect changes in the fair value of our long-term fixed rate borrowings to have a significant effect upon our operations, cash flow or financial position.
The table below provides information about our financial instruments that are sensitive to changes in interest rates, consisting solely of debt obligations. The table presents principal cash flows and related weighted average interest rates by expected maturity dates. The information is presented in U.S. dollar equivalents, which is our reporting currency. The instruments’ actual cash flows are denominated in either U.S. dollars ($US) or Swedish Krona (SEK), as indicated in parentheses.
Expected Maturity Date | ||||||||||||||||||||||||||||
Liabilities | 2004 | 2005 | 2006 | 2007 | 2008 | Thereafter | Total | |||||||||||||||||||||
Long-term debt: | ||||||||||||||||||||||||||||
Fixed rate ($US) | $ | 489,560 | * | $ | 1,993,748 | * | $ | 399,706 | * | $ | 350,203 | * | $ | 2,067,824 | * | $ | 927,194 | $ | 6,228,235 | |||||||||
Average interest rate | 5.05 | % | 9.62 | % | 8.00 | % | 8.00 | % | 8.00 | % | 8.00 | % | ||||||||||||||||
Fixed rate (SEK) | 759,550 | 607,640 | 300,737 | — | — | — | 1,667,927 | |||||||||||||||||||||
Average interest rate | 5.35 | % | 5.35 | % | 5.35 | % | — | % | — | % | — | % | ||||||||||||||||
* Amounts are net of the value of warrants issued totaling $162,000. | $ | 7,896,162 | ||||||||||||||||||||||||||
Foreign Currency Exchange Rate Risk
Our international subsidiaries operate in Europe (particularly the Nordic countries), South America, the Middle East and Australia and use local currencies as the functional currency and the U.S. dollar as the reporting currency. Transactions between our 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 Middle East and South America is mitigated due to those revenues representing only approximately five percent (5%) of our consolidated revenues.
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Our international operations represent a substantial portion of our overall operating results and asset base. Our identifiable foreign currency 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. We primarily manage our foreign currency risk by making use of naturally offsetting positions. These natural hedges are accomplished, for example, by include 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 $336,224 and $309,456 in 2003 and 2002, respectively. The gain primarily was due to the increase in value in the Swedish krona (SEK) from a December 31, 2002 rate of 8.746 (SEK per U.S. dollar) to a December 31, 2003 rate of 7.2449 (SEK per U.S. dollar); and 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, our foreign currency exposure was minimal due to a lower foreign asset base, fewer transactions and little change in foreign exchange rates between period end balance sheet dates. We currently do not use derivative instruments to manage our 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.
On-Balance Sheet | Expected Maturity Date | |||||||||||||||||||||||
Financial Instruments | 2004 | 2005 | 2006 | 2007 | 2008 | Thereafter | ||||||||||||||||||
Long-term debt: | ||||||||||||||||||||||||
Fixed rate (SEK) | $ | 759,550 | 607,640 | 300,737 | $ | — | $ | — | $ | — | ||||||||||||||
Average interest rate | 5.35 | % | 5.35 | % | 5.35 | % | — | % | — | % | — | % |
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SELLING SHAREHOLDERS
The following table sets forth, as of June 8, 2004, information as to the shares of common stock that may be sold in this offering by the Selling Shareholders. Because the Selling Shareholders may offer all or a portion of the shares of common stock offered by this prospectus at any time and from time to time after the date hereof, we cannot predict the number of shares that each Selling Shareholder may retain upon completion of this offering. In the table below, the percentage ownership after the offering is based upon the assumed sale by the Selling Shareholders of all shares they may offer for sale pursuant to this prospectus. Beneficial ownership includes both outstanding common stock and shares issuable upon the exercise of warrants. Except as indicated in the footnotes to the table, all such warrants are exercisable presently or within 60 days after the date of this prospectus. The percentages for each shareholder are calculated based on the number of outstanding shares at June 8, 2004 (7,943,874) plus the additional shares that the shareholder is deemed to beneficially own as set forth in the table, which includes some of the shares offered by this prospectus. The exercise prices of the warrants pursuant to which those additional securities are issuable are subject to adjustment in certain circumstances. The shares offered by this prospectus shall be deemed to include shares offered by any pledgee, donee, transferee or other successor in interest of any of the Selling Shareholders listed below, provided that this prospectus is amended or supplemented if required by applicable law.
Beneficial Ownership | Beneficial Ownership | |||||||||||||||||||
Before this Offering | After this Offering | |||||||||||||||||||
Number of | Shares Being | Number of | ||||||||||||||||||
Name | Shares | Percentage | Offered | Shares | Percentage | |||||||||||||||
Bonanza Master Fund Ltd.(1) | 120,000 | 1.5 | 120,000 | 0 | — | |||||||||||||||
Cohanzick Absolute Return Master Fund, Ltd.(2) | 18,000 | * | 18,000 | 0 | — | |||||||||||||||
Cranshire Capital, LP(3) | 60,000 | * | 60,000 | 0 | — | |||||||||||||||
Elliott Associates, L.P.(4) | 48,000 | * | 48,000 | 0 | — | |||||||||||||||
Elliott International, L.P.(5) | 72,000 | * | 72,000 | 0 | — | |||||||||||||||
Gabriel Capital, L.P.(6) | 42,000 | * | 42,000 | 0 | — | |||||||||||||||
Heimdall Investments Ltd.(7) | 120,000 | 1.5 | 120,000 | 0 | — | |||||||||||||||
Langley Partners, L.P.(8) | 60,000 | * | 60,000 | 0 | — | |||||||||||||||
Omicron Master Trust(9) | 108,000 | 1.4 | 108,000 | 0 | — | |||||||||||||||
Portside Growth and Opportunity Fund(10) | 24,000 | * | 24,000 | 0 | — | |||||||||||||||
Smithfield Fiduciary LLC(11) | 78,000 | * | 78,000 | 0 | — | |||||||||||||||
Roth Capital Partners, LLC(12) | 62,500 | * | 62,500 | 0 | — |
* | Less than one percent |
(1) | The shares beneficially owned and being offered by Bonanza Master Fund Ltd. consist of 20,000 shares issuable upon the exercise of presently exercisable warrants with an exercise price of $8.80 per share, and 100,000 shares of our common stock held outright. |
(2) | The shares beneficially owned and being offered by Cohanzick Absolute Return Master Fund, Ltd. consist of 3,000 shares issuable upon the exercise of presently exercisable warrants with an exercise price of $8.80 per share, and 15,000 shares of our common stock held outright. |
(3) | The shares beneficially owned and being offered by Cranshire Capital, LP consist of 10,000 shares issuable upon the exercise of presently exercisable warrants with an exercise price of $8.80 per share, and 50,000 shares of our common stock held outright. |
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(4) | The shares beneficially owned and being offered by Elliott Associates, L.P. consist of 8,000 shares issuable upon the exercise of presently exercisable warrants with an exercise price of $8.80 per share, and 40,000 shares of our common stock held outright. |
(5) | The shares beneficially owned and being offered by Elliott International, L.P. consist of 12,000 shares issuable upon the exercise of presently exercisable warrants with an exercise price of $8.80 per share, and 60,000 shares of our common stock held outright. |
(6) | The shares beneficially owned and being offered by Gabriel Capital, L.P. consist of 7,000 shares issuable upon the exercise of presently exercisable warrants with an exercise price of $8.80 per share, and 35,000 shares of our common stock held outright. |
(7) | The shares beneficially owned and being offered by Heimdall Investments Ltd. consist of 20,000 shares issuable upon the exercise of presently exercisable warrants with an exercise price of $8.80 per share, and 100,000 shares of our common stock held outright. HBK Investments L.P. may be deemed to have sole voting and dispositive power over the shares held by Heimdall Investments Ltd., pursuant to an investment management agreement between HBK Investments L.P. and Heimdall Investments Ltd. |
(8) | The shares beneficially owned and being offered by Langley Partners, L.P. consist of 10,000 shares issuable upon the exercise of presently exercisable warrants with an exercise price of $8.80 per share, and 50,000 shares of our common stock held outright. |
(9) | The shares beneficially owned and being offered by Omicron Master Trust consist of 18,000 shares issuable upon the exercise of presently exercisable warrants with an exercise price of $8.80 per share, and 90,000 shares of our common stock held outright. Omicron Capital, L.P., a Delaware limited partnership (“Omicron Capital”), serves as investment manager to Omicron Master Trust, a trust formed under the laws of Bermuda (“Omicron”), Omicron Capital, Inc., a Delaware corporation (“OCI”), serves as general partner of Omicron Capital, and Winchester Global Trust Company Limited (“Winchester”) serves as the trustee of Omicron. By reason of such relationships, Omicron Capital and OCI may be deemed to share dispositive power over the shares of our common stock owned by Omicron, and Winchester may be deemed to share voting and dispositive power over the shares of our common stock owned by Omicron. Omicron Capital, OCI and Winchester disclaim beneficial ownership of such shares of our common stock. Omicron Capital has delegated authority from the board of directors of Winchester regarding the portfolio management decisions with respect to the shares of common stock owned by Omicron and, as of April 21, 2003, Mr. Oliver H. Morali and Mr. Bruce T. Bernstein, officers of OCI, have delegated authority from the board of directors of OCI regarding the portfolio management decisions of Omicron Capital with respect to the shares of common stock owned by Omicron. By reason of such delegated authority, Messrs. Morali and Bernstein may be deemed to share dispositive power over the shares of our common stock owned by Omicron. Messrs. Morali and Bernstein disclaim beneficial ownership of such shares of our common stock and neither of such persons has any legal right to maintain such delegated authority. No other person has sole or shared voting or dispositive power with respect to the shares of our common stock being offered by Omicron, as those terms are used for purposes of Regulation 13D-G of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Omicron and Winchester are not “affiliates” of one another, as that term is defined by the Exchange Act, or of any other person named in this prospectus as a Selling Shareholder. No person or “group” (as that term is used in Section 13(d) or Regulation 13D-G of the Exchange Act) controls Omicron and Winchester. |
(10) | The shares beneficially owned and being offered by Portside Growth and Opportunity Fund consist of 4,000 shares issuable upon the exercise of presently exercisable warrants with an exercise price of $8.80 per share, and 20,000 shares of our common stock held outright. Ramius Capital Group, LLC is the investment advisor of Portside Growth and Opportunity Fund and consequently has voting control and investment discretion over securities held by Portside Growth and Opportunity Fund. Ramius Capital Group, LLC disclaims beneficial ownership of the shares held by Portside Growth and Opportunity Fund. Peter A. Cohen, Morgan B. Stark, Thomas W. Strauss and Jeffrey M. Solomon are the sole managing members of C4S & Co., LLC, the sole managing member of Ramius Capital Group, LLC. As a result, Messrs. Cohen, Stark, Strauss and Solomon may be considered beneficial owners of any shares deemed to be beneficially owned by Ramius Capital Group, LLC. Messrs. Cohen, Stark, Strauss and Solomon disclaim beneficial ownership of these shares. |
(11) | The shares beneficially owned and being offered by Smithfield Fiduciary LLC consist of 13,000 shares issuable upon the exercise of presently exercisable warrants with an exercise price of $8.80 per share, and 65,000 shares of our common stock held outright. |
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(12) | The shares beneficially owned and being offered by Roth Capital Partners, LLC consist of 62,500 shares issuable upon the exercise of warrants with an exercise price of $10.25 per share, which are exercisable during a period beginning October 26, 2004. |
On April 20, 2004, we engaged Roth Capital Partners, LLC, which is one of the Selling Shareholders listed above, to serve as our exclusive placement agent in connection with a private placement of our common stock. We issued the warrant described in footnote 12 to the table above to Roth Capital Partners, LLC and also paid that firm a cash fee in the amount of $425,000 as compensation for its services as placement agent in connection with a private placement completed pursuant to that agreement. That private placement related to 750,000 of the shares of common stock covered by this prospectus, including the 625,000 shares that are presently outstanding and the 125,000 shares issuable upon the exercise of the warrants described in footnotes 1 through 11 to the table above.
We have agreed with the Selling Shareholders to file with the Commission, under the Securities Act of 1933, a registration statement of which this prospectus forms a part, with respect to the resale of the shares beneficially owned by them, and have agreed to prepare and file such amendments, including post-effective amendments, to the registration statement as may be necessary to keep the registration statement continuously effective until the earlier of (i) two years after its effective date, (ii) such time as all of the shares beneficially owned by such Selling Shareholders and covered by this registration statement have been sold pursuant to this registration statement or otherwise publicly sold by the Selling Shareholders, or (iii) such time as all of the shares covered by this registration statement and beneficially owned by the Selling Shareholders may be sold by them pursuant to Rule 144(k) as determined by the counsel to our company pursuant to a written opinion letter to such effect, addressed and acceptable to our transfer agent and the Selling Shareholders.
Except as set forth in the preceding paragraphs, the Selling Shareholders and the officers and directors of the Selling Shareholders have not held any positions or offices or had any other material relationship with us or any of our affiliates within the past three years.
All of the securities being offered by this prospectus were or will be issued and sold to the Selling Shareholders pursuant to exemptions from the registration requirements of the Securities Act of 1933 as provided by Rule 506 of Regulation D or Section 4(2) of the Securities Act, or otherwise.
PLAN OF DISTRIBUTION
The Selling Shareholders and any of their pledgees, donees, transferees, assignees and successors-in-interest may, from time to time, sell any or all of their shares of Common Stock on any stock exchange, market or trading facility on which the shares are traded or in private transactions. These sales may be at fixed or negotiated prices. The Selling Shareholders may use any one or more of the following methods when selling shares:
• | ordinary brokerage transactions and transactions in which the broker-dealer solicits investors; |
• | block trades in which the broker-dealer will attempt to sell the shares as agent but may position and resell a portion of the block as principal to facilitate the transaction; |
• | purchases by a broker-dealer as principal and resale by the broker-dealer for its account; |
• | an exchange distribution in accordance with the rules of the applicable exchange; |
• | privately negotiated transactions; |
• | to cover short sales made after the date that the registration statement is declared effective by the Securities and Exchange Commission; |
• | broker-dealers may agree with the Selling Shareholders to sell a specified number of such shares at a stipulated price per share; |
• | a combination of any such methods of sale; and |
• | any other method permitted pursuant to applicable law. |
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The Selling Shareholders may also sell shares under Rule 144 under the Securities Act, if available, rather than under this prospectus.
Broker-dealers engaged by the Selling Shareholders may arrange for other brokers-dealers to participate in sales. Broker-dealers may receive commissions or discounts from the Selling Shareholders (or, if any broker-dealer acts as agent for the purchaser of shares, from the purchaser) in amounts to be negotiated. The Selling Shareholders do not expect these commissions and discounts to exceed what is customary in the types of transactions involved.
The Selling Shareholders may from time to time pledge or grant a security interest in some or all of the shares owned by them and, if they default in the performance of their secured obligations, the pledgees or secured parties may offer and sell shares of our common stock from time to time under this prospectus, or under an amendment to this prospectus under Rule 424(b)(3) or other applicable provision of the Securities Act amending the list of Selling Shareholders to include the pledgee, transferee or other successors in interest as Selling Shareholders under this prospectus.
Upon our company being notified in writing by a Selling Shareholder that any material arrangement has been entered into with a broker-dealer for the sale of our common stock through a block trade, special offering, exchange distribution or secondary distribution or a purchase by a broker or dealer, a supplement to this prospectus will be filed, if required, pursuant to Rule 424(b) under the Securities Act, disclosing (i) the name of each such Selling Shareholder and of the participating broker-dealer(s), (ii) the number of shares involved, (iii) the price at which such the shares of our common stock were sold, (iv) the commissions paid or discounts or concessions allowed to such broker-dealer(s), where applicable, (v) that such broker-dealer(s) did not conduct any investigation to verify the information set forth in this prospectus, and (vi) other facts material to the transaction. In addition, upon our company being notified in writing by a Selling Shareholder that a donee or pledgee intends to sell more than 500 shares of our common stock, a supplement to this prospectus will be filed if then required in accordance with applicable securities law.
The Selling Shareholders also may transfer the shares of our common stock in other circumstances, in which case the transferees, pledgees or other successors-in-interest will be the selling beneficial owners for purposes of this prospectus.
The Selling Shareholders and any broker-dealers or agents that are involved in selling the shares may be deemed to be “underwriters” within the meaning of the Securities Act in connection with such sales. In such event, any commissions received by such broker-dealers or agents and any profit on the resale of the shares purchased by them may be deemed to be underwriting commissions or discounts under the Securities Act. Discounts, concessions, commissions and similar selling expenses, if any, that can be attributed to the sale of shares will be paid by the Selling Shareholder and/or the purchasers. Each Selling Shareholder has represented and warranted to us that it acquired the securities subject to this registration statement in the ordinary course of such Selling Shareholder’s business and, at the time of its purchase of such securities such Selling Shareholder had no agreements or understandings, directly or indirectly, with any person to distribute any such securities.
We have advised each Selling Shareholder that it may not use shares registered on this registration statement to cover short sales of our common stock made prior to the date on which this registration statement shall have been declared effective by the Securities and Exchange Commission. If a Selling Shareholder uses this prospectus for any sale of our common stock, it will be subject to the prospectus delivery requirements of the Securities Act. The Selling Shareholders will be responsible to comply with the applicable provisions of the Securities Act and Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder promulgated, including, without limitation, Regulation M, as applicable to such Selling Shareholders in connection with resales of their respective shares under this registration statement.
We are required to pay all fees and expenses incident to the registration of the shares, but we will not receive any proceeds from the sale of our common stock. We have agreed to indemnify the Selling Shareholders against certain losses, claims, damages and liabilities, including liabilities under the Securities Act.
One of the Selling Shareholders, Roth Capital Partners, LLC, is a broker-dealer registered with the National Association of Securities Dealers, Inc. (the “NASD”). The shares being offered by it pursuant to this prospectus are being offered for sale for its own account, and such firm is not serving as an underwriter, broker or dealer, and is not receiving any compensation, in connection with the offer or sale of any of the securities being offered pursuant to this prospectus. We issued the warrant described in footnote 12 to the Selling Shareholders table to Roth Capital Partners, LLC and also paid that firm a cash fee in the amount of $425,000 as compensation for its services as placement agent in connection with a private placement of our common stock.
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The investment advisor to one of the Selling Shareholders, Portside Growth and Opportunity Fund, is Ramius Capital Group, LLC. Ramius Securities, LLC, a broker-dealer registered with the NASD, is an affiliate of Ramius Capital Group, LLC. The shares being offered by Portside Growth and Opportunity Fund pursuant to this prospectus are being offered for sale for its own account, and Ramius Securities, LLC is not serving as an underwriter, broker or dealer, and is not receiving any compensation, in connection with the offer or sale of any of the securities being offered pursuant to this prospectus.
DESCRIPTION OF SECURITIES
The following discussion is not meant to be complete and is qualified in its entirety by reference to our Amended and Restated Articles of Incorporation, as amended, and our bylaws, which are exhibits to the registration statement of which this prospectus is a part,and to the description of our preferred stock purchase rights and Rights Agreement. You should read this summary together with our Amended and Restated Articles of Incorporation, as amended, our bylaws,and the description of our Rights Agreement, and the applicable provisions of North Carolina statutory law.
Our authorized capital stock currently consists of 30,000,000 shares of capital stock. The authorized capital stock is divided into common stock and preferred stock. The common stock consists of 25,000,000 shares, par value $.10 per share. The preferred stock consists of 5,000,000 shares, par value $.10 per share, 20,000 shares of which are designated as Series AAA Redeemable Nonvoting Preferred Stock, 10,000 shares of which are designated as Series D Junior Participating Preferred Stock, 500 shares of which are designated as Series E Redeemable Nonvoting Preferred Stock, 400 shares of which are designated as Series F Convertible Preferred Stock, and 4,969,000 shares of which remain undesignated. As of June 8, 2004, we had outstanding 7,943,874 shares of common stock, 250 shares of Series AAA stock and 430 shares of Series E stock. There are no shares of Series D stock or Series F stock outstanding. Our Series D stock will be issuable upon exercise of purchase rights under our Rights Agreement, if those rights ever become exercisable. See “Preferred Stock Purchase Rights” below.
Description of Common Stock
Voting. The holders of our common stock are entitled to one vote per share on all matters to be voted on by shareholders. No Cumulative Voting Rights. The holders of our common stock are not entitled to cumulative voting in the election of directors.
Dividends. Subject to the rights of our outstanding preferred stock and subject to restrictions imposed by certain other agreements, dividends on our common stock may be declared and paid when and as determined by our board of directors.
Liquidation, Dissolution or Winding Up. If we liquidate, dissolve or wind up operations, the holders of our common stock are entitled to share equally on a per share basis in any assets remaining after all prior claims are satisfied, all our outstanding debt is repaid and the liquidation preferences on our outstanding preferred stock are paid in full.
Other Rights. Holders of our common stock do not have any preemptive or similar rights to subscribe for shares of our capital stock, or for any rights, warrants, options, bonds, notes, debenture or other securities convertible into or carrying options or warrants to subscribe, purchase or otherwise acquire shares of our capital stock. Our Amended and Restated Articles of Incorporation, as amended, do not contain any provisions providing for the redemption of our common stock or the conversion of our common stock into other securities.
Effect of Preferred Stock, Debenture, and Credit Facilities on our Common Stock. The rights, preferences and privileges of holders of our common stock are subject to, and may be adversely affected by, the rights of holders of our outstanding preferred stock or any series of preferred stock that we may issue in the future, the debenture that we have issued or that we may issue in the future, and our credit facilities. Certain provisions of the instruments that may adversely affect the rights of holders of our common stock are described in the following paragraphs.
Preferred Stock
Our board of directors has the authority, without further shareholder approval, to issue up to 5,000,000 shares of preferred stock in one or more series, to establish the number of shares to be included in each such series, and to fix the designation, powers, preferences and rights, and the qualifications, limitations or restrictions, of the shares of each series. The issuance of preferred stock could decrease the amount of earnings and assets available for distribution to the holders of our common stock. In certain circumstances, such issuances could have the effect of decreasing the market price of the common stock.
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Our outstanding shares of Series AAA stock and Series E stock all have rights in preference to holders of our common stock in connection with any liquidation of the company. The aggregate liquidation preference is $1,250,000 for the Series AAA stock and $2,150,000 for the Series E stock, in each case plus accrued but unpaid dividends. Holders of the Series AAA stock and Series E stock are entitled to receive cumulative quarterly dividends at the rate of 10% per annum and 7% per annum, respectively, in cash, on the liquidation value of those shares in preference to the holders of our common stock. The preferential rights of the holders of our preferred stock could substantially limit the amount, if any, that the holders of our common stock would receive upon any liquidation of the company.
All previously outstanding shares of Series F stock were converted into shares of our common stock on April 30, 2004. We do not contemplate issuing any additional shares of Series F stock.
Under North Carolina law, the approval of the holders of shares of each series of our outstanding preferred stock, voting as a separate class, may be required for certain matters, such as mergers and amendments to the articles of incorporation. These voting rights of our preferred shareholders dilute the voting power of holders of our common stock and could prevent the approval of certain matters that holders of our common stock might approve.
Debenture
We currently have outstanding an 8.0% convertible subordinated debenture with an aggregate principal amount of $250,000. We would have to repay the entire principal amount, plus accrued interest, before holders of our common stock would be entitled to receive any amounts in connection with any liquidation of the company. The agreement with a director and shareholder pursuant to which we issued our outstanding 8.0% convertible subordinated debenture prohibits the payment of dividends to holders of our common stock. The holder of the debenture has the right to require us to redeem the debenture upon the occurrence of certain events, including certain changes in control of the company or our failure to continue to have our stock listed on The Nasdaq Stock Market or another stock exchange. The preferential rights of the holder of the debenture could limit the amount, if any, that the holders of our common stock would receive upon any liquidation of the company.
Credit Facilities
During the third quarter of 2003, we entered into a $10.0 million revolving credit facility with LaSalle Business Credit, LLC. The credit facility has an initial term of three years and is secured by substantially all of our domestic assets. The credit agreement also has affirmative, negative and financial covenants with which we must comply. The credit facility prohibits the payment of dividends on our common stock. We would have to repay all our outstanding debt, including principal and interest outstanding under our revolving credit facilities, before holders of our common stock would be entitled to receive any amounts in connection with any liquidation of the company.
Preferred Stock Purchase Rights
Under our shareholders’ rights plan, as amended, holders of our common stock have been granted the right to purchase, at a specified price, a fraction of a share of our Series D Junior Participating Preferred Stock in the event of an acquisition of, or an announced tender offer for, 15% or more of our outstanding common stock (with certain exceptions, including acquisitions of our stock directly from us). After the occurrence of such an event, each right will also entitle the holder (other than the person making the acquisition or tender offer) to purchase, at the exercise price, shares of our common stock having a market value of twice the exercise price. If, after any person acquires the specified percentage of our common stock, we are involved in a merger, consolidation, sale of assets or similar acquisition transaction, and we are not the acquiring or surviving corporation, then each right will entitle its holder to purchase, at the exercise price, shares of the acquiring or surviving company having a market value of twice the exercise price, and the acquiring or surviving company will be obligated to assume our obligations under the rights plan.
The terms of the rights are set forth in a Rights Agreement dated as of December 14, 1999 between us and Continental Stock Transfer & Trust Company, as rights agent, as amended. The rights are redeemable by us at any time before any person acquires the specified percentage of our outstanding common stock at a redemption price of $0.001 per right, subject to certain adjustments for stock splits or similar events. After any person has acquired the specified percentage of our outstanding common stock and the rights have become exercisable, and before a majority of our common stock has been acquired, we may exchange all or part of the outstanding rights for shares of our common stock at an exchange ratio of one share of common stock per right, subject to certain adjustments for stock splits or similar events.
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The existence of our rights plan may have anti-takeover effects. The rights will cause substantial dilution to a person or group that attempts to acquire us on terms not approved by a majority of our board of directors. Although the rights plan is not intended to prevent acquisitions through negotiations with our board of directors, the existence of the rights plan may nevertheless discourage a third party from making a partial tender offer or otherwise attempting to obtain a substantial position in our equity securities or seeking to obtain control of us. To the extent any potential acquirers are deterred by our rights plan, the rights plan may have the effect of preserving incumbent directors and management in office or preventing acquisitions of the company, even if you might consider such an acquisition to be in your best interest as a holder of our common stock.
Our board of directors has voted to terminate our shareholders’ rights plan effective on July 15, 2004. The rights will expire on that date unless sooner redeemed or exchanged.
Anti-Takeover Provisions
Our board of directors could use the issuance of preferred stock, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of the company. Our articles of incorporation also provide that our board of directors is divided into three classes, which may have the effect of delaying or preventing changes in control or changes in our management because less than a majority of the existing directors are up for election at each annual meeting. In addition, our bylaws require that certain shareholder proposals, including proposals for the nomination of directors, be submitted specified periods of time in advance of our annual shareholders’ meetings. These provisions could make it more difficult for shareholders to effect corporation actions such as a merger, asset sale or other change of control of the company.
We are also subject to two North Carolina statutes that may have anti-takeover effects. The North Carolina Shareholder Protection Act generally requires, unless certain “fair price” and procedural requirements are satisfied, the affirmative vote of 95% of our voting shares to approve certain business combination transactions with an entity that is the beneficial owner, directly or indirectly, of more than 20% of our voting shares, or with one of our affiliates if that affiliate has previously been a beneficial owner of more than 20% of our voting shares. The North Carolina Control Share Acquisition Act, which applies to public companies that have substantial operations and significant shareholders in the state of North Carolina, eliminates the voting rights of shares acquired in transactions (referred to as “control share acquisitions”) that cause the acquiring person to own a number of our voting securities that exceeds certain threshold amounts, specifically, one-fifth, one-third and one-half of our total outstanding voting securities. There are certain exceptions. For example, this statute does not apply to shares that an acquiring person acquires directly from us. The holders of a majority of our outstanding voting stock (other than those shares held by such acquiring person, our officers, and our directors who are also employed by us) may elect to restore voting rights that would be eliminated by this statute. If voting rights are restored to a shareholder that has made a control share acquisition and holds a majority of all voting power in the election of our directors, then our other shareholders may require us to redeem their shares at fair value. These statutes could discourage a third party from making a partial tender offer or otherwise attempting to obtain a substantial position in our equity securities or seeking to obtain control of us. They also might limit the price that certain investors might be willing to pay in the future for our shares of common stock, and they may have the effect of delaying or preventing a change of control.
LEGAL MATTERS
The legality of the shares of common stock offered by this prospectus has been passed upon for us by Gray, Layton, Kersh, Solomon, Sigmon, Furr & Smith, P.A. of Gastonia, North Carolina.
David M. Furr is a partner in the law firm Gray, Layton, Kersh, Solomon, Sigmon, Furr & Smith, P.A. Mr. Furr beneficially owns 101,463 shares of our common stock, including shares held of record, shares issuable upon conversion or exercise of preferred stock and warrants and shares beneficially owned by family members. Mr. Furr disclaims ownership of 48,130 of such shares, which are beneficially owned by his wife.
EXPERTS
The financial statements set forth in this registration statement and prospectus as of December 31, 2002 and 2003 and for each of the three years in the period ended December 31, 2003, have been audited by McGladrey & Pullen, LLP, an independent registered public accounting firm, as indicated in their report with respect thereto, which is set forth herein, and have been included herein in reliance upon the authority of said firm as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form S-1 with the Securities and Exchange Commission with respect to this offering. This prospectus, which is part of the registration statement, does not include all of the information contained in the registration statement. You should refer to the registration statement and its exhibits and schedules for additional
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information. Whenever we make reference in this prospectus to any of our contracts, agreements or other documents, the references are not necessarily complete and you should refer to the exhibits and schedules attached to the registration statement for copies of the actual contract, agreement or other document.
You may read and copy the registration statement, the related exhibits and schedules without charge at the Security and Exchange Commission’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the operation of the Public Reference Room. You may obtain copies of the documents at prescribed rates by writing to the Public Reference Section of the Securities and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. The Securities and Exchange Commission also maintains an Internet site, http://www.sec.gov, which contains reports, proxy and information statements and other information regarding issuers that file electronically with the Securities and Exchange Commission. The other information we file with the Securities and Exchange Commission is not part of the registration statement of which this prospectus forms a part.
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FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
DIGITAL RECORDERS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
PAGE | ||||
Report of Independent Registered Public Accounting Firm | F-2 | |||
Consolidated Balance Sheets — December 31, 2003 and 2002 | F-3 | |||
Consolidated Statements of Operations — Years Ended December 31, 2003, 2002 and 2001 | F-5 | |||
Consolidated Statements of Stockholders’ Equity — Years Ended December 31, 2003, 2002 and 2001 | F-7 | |||
Consolidated Statements of Cash Flows — Years Ended December 31, 2003, 2002 and 2001 | F-8 | |||
Notes to Consolidated Financial Statements | F-11 | |||
Financial Statement Schedule: | ||||
Schedule II — Valuation and Qualifying Accounts | F-37 | |||
Consolidated Balance Sheets — March 31, 2004 (Unaudited) and December 31, 2003 | F-38 | |||
Consolidated Statements of Operations — Three Months Ended March 31, 2004 and 2003 (Unaudited) | F-40 | |||
Consolidated Statements of Cash Flows — Three Months Ended March 31, 2004 and 2003 (Unaudited) | F-41 | |||
Notes to Consolidated Financial Statements (Unaudited) | F-42 |
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Report of Independent Registered
Public Accounting Firm
To the Board of Directors
Digital Recorders, Inc.
Durham, North Carolina
We have audited the consolidated balance sheets of Digital Recorders, Inc. and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003. 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 the standards of the Public Company Accounting Oversight Board (United States). 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, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with U.S. generally accepted accounting principles.
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 31, 2004, except for Note 7, as to
Note 21, as to which the date is
April 1, 2004
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DIGITAL RECORDERS, INC. AND SUBSIDIARIES
2003 | 2002 | |||||||
ASSETS | ||||||||
Current Assets | ||||||||
Cash and cash equivalents (Note 7) | $ | 970,222 | $ | 504,758 | ||||
Trade accounts receivable, less allowance for doubtful accounts of $115,142 and $146,066 at December 31, 2003 and 2002, respectively (Notes 7 and 13) | 6,974,914 | 10,137,955 | ||||||
Other receivables | 379,369 | 251,454 | ||||||
Inventories (Notes 5 and 7) | 9,797,610 | 8,830,522 | ||||||
Prepaids and other current assets | 555,068 | 452,882 | ||||||
Total current assets | 18,677,183 | 20,177,571 | ||||||
Property and equipment, less accumulated depreciation of $2,351,651 and $1,459,953 at December 31, 2003 and 2002, respectively (Notes 4, 6 and 7) | 2,434,589 | 1,572,259 | ||||||
Goodwill, less accumulated amortization of $1,144,248 and $1,066,643 at December 31, 2003 and 2002, respectively (Note 3) | 10,666,113 | 8,960,396 | ||||||
Intangible assets, less accumulated amortization of $598,484 and $362,922 at December 31, 2003 and 2002, respectively (Note 3) | 1,527,292 | 1,392,533 | ||||||
Deferred tax assets (Note 11) | 840,585 | 865,663 | ||||||
Other assets | 406,134 | 414,764 | ||||||
TOTAL ASSETS | $ | 34,551,896 | $ | 33,383,186 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current Liabilities | ||||||||
Lines of credit (Note 7) | $ | 5,983,051 | $ | 7,503,791 | ||||
Current maturities of long-term debt (Note 7) | 1,249,110 | 763,360 | ||||||
Accounts payable | 6,456,870 | 6,339,537 | ||||||
Accounts payable, related party (Note 14) | — | 859,425 | ||||||
Accrued expenses (Note 18) | 2,334,050 | 2,162,309 | ||||||
Deferred tax liabilities (Note 11) | 193,918 | 138,695 | ||||||
Preferred stock dividends payable | 117,983 | 88,500 | ||||||
Total current liabilities | 16,334,982 | 17,855,617 | ||||||
Long-term debt and other obligations, less current maturities (Note 7) | 6,647,052 | 7,737,940 | ||||||
Series AAA Redeemable, Convertible, Nonvoting Preferred Stock, $.10 par value, Liquidation Preference of $5,000 per share; 20,000 shares authorized; 354 shares issued and outstanding at December 31, 2002 (Note 8) | — | 1,770,000 | ||||||
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2003 | 2002 | |||||||
Minority interest in consolidated subsidiary | 338,199 | 267,566 | ||||||
Commitments and contingencies (Notes 6, 7 and 17) | ||||||||
Stockholders’ Equity | ||||||||
Series E Redeemable, Nonvoting, Convertible Preferred Stock, $.10 par value, Liquidation Preference of $5,000 per share; 500 shares authorized; 363 and zero shares issued and outstanding at December 31, 2003 and December 31, 2002, respectively (Note 8) | 1,440,295 | — | ||||||
Series F Convertible Preferred Stock, $.10 par value, Liquidation Preference of $5,000 per share; 300 shares authorized; 300 and zero shares issued and outstanding at December 31, 2003 and December 31, 2002, respectively (Note 8) | 1,500,000 | — | ||||||
Series AAA Redeemable, Nonvoting Preferred Stock, $.10 par value, Liquidation Preference of $5,000 per share; 20,000 shares authorized; 354 shares issued and outstanding at December 31, 2003; redeemable at the discretion of the Company (Note 8) | 1,770,000 | — | ||||||
Common stock, $.10 par value, 25,000,000 and 10,000,000 shares authorized; 3,944,475 and 3,804,475 shares issued and outstanding at December 31, 2003 and December 31, 2002, respectively | 394,447 | 380,447 | ||||||
Additional paid-in capital | 13,259,542 | 12,349,726 | ||||||
Accumulated other comprehensive income — foreign currency translation | 2,271,823 | 421,175 | ||||||
Accumulated deficit | (9,404,444 | ) | (7,399,285 | ) | ||||
Total stockholders’ equity | 11,231,663 | 5,752,063 | ||||||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 34,551,896 | $ | 33,383,186 | ||||
Note: See accompanying notes to consolidated financial statements.
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DIGITAL RECORDERS, INC. AND SUBSIDIARIES
2003 | 2002 | 2001 | ||||||||||
Net sales (Note 13) | $ | 44,026,242 | $ | 45,137,986 | $ | 37,215,352 | ||||||
Cost of sales (Note 14) | 26,776,030 | 28,862,992 | 23,389,566 | |||||||||
Gross profit | 17,250,212 | 16,274,994 | 13,825,786 | |||||||||
Operating expenses: | ||||||||||||
Selling, general and administrative | 15,613,175 | 13,058,348 | 10,758,433 | |||||||||
Research and development | 2,057,312 | 2,492,428 | 2,648,510 | |||||||||
Total operating expenses | 17,670,487 | 15,550,776 | 13,406,943 | |||||||||
Operating income (loss) | (420,275 | ) | 724,218 | 418,843 | ||||||||
Other income (expense) | 90,704 | 28,840 | 3,546 | |||||||||
Foreign currency translation gain | 322,493 | 309,456 | — | |||||||||
Interest expense, net (Note 7) | (1,093,293 | ) | (1,150,962 | ) | (814,207 | ) | ||||||
Total other income and interest expense | (680,096 | ) | (812,666 | ) | (810,661 | ) | ||||||
Loss before income tax benefit (expense) | (1,100,371 | ) | (88,448 | ) | (391,818 | ) | ||||||
Income tax benefit (expense) (Note 11) | (109,610 | ) | (42,148 | ) | 533,135 | |||||||
Income (loss) before minority interest in income of consolidated subsidiary | (1,209,981 | ) | (130,596 | ) | 141,317 | |||||||
Minority interest in income of consolidated subsidiary | (92,552 | ) | (58,907 | ) | (26,052 | ) | ||||||
Net income (loss) | (1,302,533 | ) | (189,503 | ) | 115,265 | |||||||
Returns to preferred shareholders: | ||||||||||||
Beneficial conversion charge (Note 8) | (702,626 | ) | — | — | ||||||||
Stock dividend requirements (Note 8) | (227,349 | ) | (177,000 | ) | (177,000 | ) | ||||||
Net loss applicable to common shareholders | $ | (2,232,508 | ) | $ | (366,503 | ) | $ | (61,735 | ) | |||
Earnings per share: | ||||||||||||
Net loss per share: | ||||||||||||
Basic | $ | (0.58 | ) | $ | (0.10 | ) | $ | (0.02 | ) | |||
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2003 | 2002 | 2001 | ||||||||||
Diluted | $ | (0.58 | ) | $ | (0.10 | ) | $ | (0.02 | ) | |||
Weighted average number of common shares and common equivalent shares outstanding: | ||||||||||||
Basic | 3,873,133 | 3,746,119 | 3,495,954 | |||||||||
Diluted | 3,873,133 | 3,746,119 | 3,495,954 | |||||||||
See accompanying notes to consolidated financial statements.
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DIGITAL RECORDERS, INC. AND SUBSIDIARIES
Common Stock | Preferred Stock | Accumulated | ||||||||||||||||||||||||||||||||||
Number | Number | Additional | Other | Total | ||||||||||||||||||||||||||||||||
of shares | Par | of shares | Carrying | Paid-in | Accumulated | Comprehensive | Comprehensive | Stockholders’ | ||||||||||||||||||||||||||||
issued | Value | issued | Value | Capital | Deficit | Income (loss) | Income (loss) | Equity | ||||||||||||||||||||||||||||
Balance as of January 1, 2001 | 3,274,475 | $ | 327,447 | $ | 11,158,826 | $ | (7,325,047 | ) | $ | (328,722 | ) | $ | 3,832,504 | |||||||||||||||||||||||
Comprehensive income (loss): | ||||||||||||||||||||||||||||||||||||
Net income | 115,265 | $ | 115,265 | 115,265 | ||||||||||||||||||||||||||||||||
Translation adjustment | (87,056 | ) | (87,056 | ) | (87,056 | ) | ||||||||||||||||||||||||||||||
Total comprehensive income | $ | 28,209 | ||||||||||||||||||||||||||||||||||
Issuance of common stock | 430,000 | 43,000 | 872,900 | 915,900 | ||||||||||||||||||||||||||||||||
Issuance of warrants | 382,000 | 382,000 | ||||||||||||||||||||||||||||||||||
Preferred stock dividends | (177,000 | ) | (177,000 | ) | ||||||||||||||||||||||||||||||||
Balance as of December 31, 2001 | 3,704,475 | 370,447 | 12,236,726 | (7,209,782 | ) | (415,778 | ) | 4,981,613 | ||||||||||||||||||||||||||||
Comprehensive income (loss): | ||||||||||||||||||||||||||||||||||||
Net income (loss) | (189,503 | ) | $ | (189,503 | ) | (189,503 | ) | |||||||||||||||||||||||||||||
Translation adjustment | 836,953 | 836,953 | 836,953 | |||||||||||||||||||||||||||||||||
Total comprehensive income | $ | 647,450 | ||||||||||||||||||||||||||||||||||
Issuance of common stock | 100,000 | 10,000 | 290,000 | 300,000 | ||||||||||||||||||||||||||||||||
Preferred stock dividends | (177,000 | ) | (177,000 | ) | ||||||||||||||||||||||||||||||||
Balance as of December 31, 2002 | 3,804,475 | 380,447 | — | 12,349,726 | (7,399,285 | ) | 421,175 | 5,752,063 | ||||||||||||||||||||||||||||
Comprehensive income (loss): | ||||||||||||||||||||||||||||||||||||
Net income (loss) | (1,302,533 | ) | $ | (1,302,533 | ) | (1,302,533 | ) | |||||||||||||||||||||||||||||
Translation adjustment | 1,850,648 | 1,850,648 | 1,850,648 | |||||||||||||||||||||||||||||||||
Total comprehensive income | $ | 548,115 | ||||||||||||||||||||||||||||||||||
Issuance of common stock | 140,000 | 14,000 | 336,000 | 350,000 | ||||||||||||||||||||||||||||||||
Reclassification of Series AAA to Equity | 354 | 1,770,000 | 1,770,000 | |||||||||||||||||||||||||||||||||
Issuance of Series E Preferred | 363 | 1,440,295 | 1,440,295 | |||||||||||||||||||||||||||||||||
Issuance of Series F Preferred (Note 8): | ||||||||||||||||||||||||||||||||||||
Cash proceeds | 300 | 1,500,000 | 1,500,000 | |||||||||||||||||||||||||||||||||
Effect of beneficial conversion charge | 702,626 | (702,626 | ) | — | ||||||||||||||||||||||||||||||||
Issuance of warrants | 98,539 | 98,539 | ||||||||||||||||||||||||||||||||||
Preferred stock dividends | (227,349 | ) | (227,349 | ) | ||||||||||||||||||||||||||||||||
Balance as of December 31, 2003 | 3,944,475 | $ | 394,447 | 1,017 | $ | 4,710,295 | $ | 13,259,542 | $ | (9,404,444 | ) | $ | 2,271,823 | $ | 11,231,663 | |||||||||||||||||||||
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DIGITAL RECORDERS, INC. AND SUBSIDIARIES
2003 | 2002 | 2001 | ||||||||||
Cash flows from operating activities: | ||||||||||||
Net income (loss) | $ | (1,302,533 | ) | $ | (189,503 | ) | $ | 115,265 | ||||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | ||||||||||||
Deferred income taxes | 55,556 | (141,061 | ) | (622,276 | ) | |||||||
Depreciation of property and equipment | 713,361 | 359,795 | 269,921 | |||||||||
Amortization of intangible assets | 162,202 | 126,342 | 95,679 | |||||||||
Amortization of goodwill | — | — | 334,714 | |||||||||
Bad debt expense | (30,924 | ) | 30,924 | 54,736 | ||||||||
Other, primarily affect of foreign currency gain | (366,564 | ) | (309,456 | ) | 53,000 | |||||||
Minority interest | 92,552 | 58,907 | 26,052 | |||||||||
Changes in operating assets and liabilities: | ||||||||||||
(Increase) decrease in trade accounts receivable | 3,672,023 | (2,027,646 | ) | 3,192,746 | ||||||||
(Increase) decrease in other receivables | 67,485 | (4,954 | ) | 396,450 | ||||||||
(Increase) decrease in inventories | (362,183 | ) | 551,255 | (1,591,369 | ) | |||||||
(Increase) decrease in prepaids and other current assets | (72,766 | ) | (123,358 | ) | 57,519 | |||||||
Increase (decrease) in accounts payable | (1,013,783 | ) | 771,489 | 594,247 | ||||||||
Decrease in accounts payable, related party | — | (369,361 | ) | (695,769 | ) | |||||||
Increase (decrease) in accrued expenses | (115,919 | ) | 53,527 | (373,240 | ) | |||||||
Net cash provided by (used in) operating activities | 1,498,507 | (1,213,100 | ) | 1,907,675 | ||||||||
Cash flows from investing activities: | ||||||||||||
Purchases of property and equipment | (1,384,261 | ) | (723,472 | ) | (432,704 | ) | ||||||
Proceeds from sale of assets | 4,000 | 38,618 | — | |||||||||
Purchase of intangibles | (1,173 | ) | (19,790 | ) | (45,071 | ) | ||||||
Purchase of other assets | (195,403 | ) | (268,964 | ) | 258,972 | |||||||
Purchase of Mobitec, net of cash and cash equivalents acquired | — | (15,030 | ) | (5,104,788 | ) | |||||||
Net cash used in investing activities | (1,576,837 | ) | (988,638 | ) | (5,323,591 | ) | ||||||
Cash flows from financing activities: | ||||||||||||
Proceeds from bank borrowings and lines of credit | 44,583,728 | 38,704,333 | 35,964,873 | |||||||||
Principal payments on bank borrowings and lines of credit | (46,520,356 | ) | (36,811,272 | ) | (31,900,033 | ) | ||||||
Proceeds for issuance of preferred stock | 3,226,957 | — | — | |||||||||
Payments related to issuance of preferred stock | (286,661 | ) | — | — | ||||||||
Payment of dividends on preferred stock | (197,864 | ) | (132,750 | ) | (177,000 | ) | ||||||
Net cash provided by financing activities | 805,804 | 1,760,311 | 3,887,840 | |||||||||
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2003 | 2002 | 2001 | ||||||||||
Effect of exchange rate changes on cash and cash equivalents | (262,010 | ) | 435,466 | (85,067 | ) | |||||||
Net increase (decrease) in cash and cash equivalents | 465,464 | (5,961 | ) | 386,857 | ||||||||
Cash and cash equivalents at beginning of year | 504,758 | 510,719 | 123,862 | |||||||||
Cash and cash equivalents at end of year | $ | 970,222 | $ | 504,758 | $ | 510,719 | ||||||
Supplemental Disclosure of Cash Flow Information: | ||||||||||||
Cash paid during the year for interest | $ | 1,111,202 | $ | 1,079,776 | $ | 776,510 | ||||||
Cash paid during the year for income taxes | $ | 118,080 | $ | 115,306 | $ | 31,690 | ||||||
See accompanying notes to consolidated financial statements.
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DIGITAL RECORDERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 | 2002 | 2001 | ||||||||||
Supplemental disclosures of non-cash investing and financing activities: | ||||||||||||
Equipment acquired through issuance of capital lease | $ | — | $ | 125,578 | $ | — | ||||||
Exchange of common and preferred stock for reduction in debt and accounts payable-related party | $ | 525,000 | $ | 300,000 | $ | — | ||||||
Reduction of goodwill from adjustment of restructuring reserve | $ | — | $ | 76,201 | $ | — | ||||||
Acquisition of Mobitec (Note 3): | ||||||||||||
Cash purchase price | $ | — | $ | 15,030 | $ | 5,104,788 | ||||||
Working capital acquired, net of cash and cash equivalents acquired of $347,477 | $ | — | $ | — | $ | 1,065,485 | ||||||
Fair value of other tangible assets acquired, principally property and equipment | — | — | 263,556 | |||||||||
Cost in excess of net assets acquired | — | 15,030 | 6,836,055 | |||||||||
Customer lists acquired | — | — | 1,165,917 | |||||||||
Minority interest assumed | — | — | (113,627 | ) | ||||||||
Promissory note and obligation issued to seller | — | — | (2,591,235 | ) | ||||||||
Fair value of warrants issued to seller | — | — | (95,000 | ) | ||||||||
Fair value of stock issued to seller | — | — | (915,900 | ) | ||||||||
Acquisition costs included in liabilities | — | — | (510,463 | ) | ||||||||
$ | — | $ | 15,030 | $ | 5,104,788 | |||||||
Fair value of warrants issued as part of financing | $ | 88,043 | $ | — | $ | 252,000 | ||||||
Reclassification of Series AAA Preferred Stock to equity | $ | 1,770,000 | $ | — | $ | — | ||||||
See accompanying notes to consolidated financial statements.
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DIGITAL RECORDERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) | ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
(a) | Organization | |||
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. | ||||
(c) | Use of Estimates | |||
The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. 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 but not limited to 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 fair value of equity instruments and warrants, the allowance for warranty claim reserves and the purchase price allocations used in the Company’s acquisitions. | ||||
(d) | Cash Equivalents | |||
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 services and funded research and development projects. Service revenues were not a significant source of revenue for 2003, 2002, and 2001. Product sales and service revenues for 2003, 2002, and 2001 are detailed below: |
Years Ended December 31, | ||||||||||||||||||||||||
2003 | 2002 | 2001 | ||||||||||||||||||||||
Amount | % | Amount | % | Amount | % | |||||||||||||||||||
Product sales, net | $ | 42,775,395 | 97.2 | % | $ | 44,602,462 | 98.8 | % | $ | 36,663,102 | 98.5 | % | ||||||||||||
Service revenues | 1,250,847 | 2.8 | 535,524 | 1.2 | 552,250 | 1.5 | ||||||||||||||||||
Total | $ | 44,026,242 | 100.0 | % | $ | 45,137,986 | 100.0 | % | $ | 37,215,352 | 100.0 | % | ||||||||||||
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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. | ||||
(g) | Inventories | |||
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 primarily 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. Critical assumptions to the evaluation of goodwill impairment for the DAC and Mobitec goodwill include continued increases in sales levels and profitability resulting from execution of cost saving plans implemented in 2003. | ||||
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. |
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(j) | Intangible Assets | |||
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 a listing of customer relationships recorded as part of the acquisition of Mobitec. Intangible assets are amortized using a straight-line method over three to 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 | |||
Research and development costs are charged to operations as incurred. Research and development expenses were $2,057,312, $2,492,428 and $2,648,510 in 2003, 2002 and 2001, respectively. | ||||
(l) | Advertising Costs | |||
Advertising costs are charged to operations as incurred. Advertising expenses were $104,826, $72,728, and $128,843 in 2003, 2002, and 2001, respectively. | ||||
(m) | Shipping and Handling Fees and Costs | |||
The Company includes in net sales shipping and handling fees billed to customers. Shipping and handling costs associated with inbound and outbound freight are included in cost of sales and totaled $902,890, $1,041,658, and $1,023,862 in 2003, 2002, and 2001, respectively. | ||||
(n) | Per Share Amounts | |||
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 amount of income (loss) used in the calculations of diluted and basic income (loss) per common share was the same for each respective year 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, 2003, 2002, and 2001 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. As of December 31, 2003, there were approximately 5,374,525 of dilutive securities from convertible debt and equity securities, vested options and warrants, and warrants related to Series F Stock. | ||||
(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 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. |
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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: |
2003 | 2002 | 2001 | ||||||||||
Net loss applicable to common shareholders | $ | (2,232,508 | ) | $ | (366,503 | ) | $ | (61,735 | ) | |||
Deduct: Stock based employee compensation expense determined under fair value method | (331,782 | ) | (43,413 | ) | (227,390 | ) | ||||||
Pro forma net loss applicable to common shareholders | $ | (2,564,290 | ) | $ | (409,916 | ) | $ | (289,125 | ) | |||
Basic and diluted net loss: | ||||||||||||
As reported | $ | (0.58 | ) | $ | (0.10 | ) | $ | (0.02 | ) | |||
Pro forma | $ | (0.66 | ) | $ | (0.11 | ) | $ | (0.08 | ) |
(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. | ||||
(q) | Income Taxes | |||
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 generally for a period of one to three years 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 |
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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 following table provides a reconciliation of the Company’s warranty reserve account for the years ended December 31, 2003, 2002 and 2001. |
Balance at | Additions | |||||||||||||||
beginning of | charged to costs | Balance at | ||||||||||||||
year | and expenses | Deductions | end of year | |||||||||||||
Year ended December 31, 2003 | $ | 140,655 | $ | 111,305 | $ | (81,666 | ) | $ | 170,294 | |||||||
Year ended December 31, 2002 | 143,189 | — | (2,534 | )(a) | 140,655 | |||||||||||
Year ended December 31, 2001 | 89,958 | 53,231 | — | 143,189 |
(a) Write-off of warranty claims
(t) | Reclassifications | |||
Certain reclassifications have been made to the 2002 financial statements to conform to the presentation used in the 2003 financial statements. These reclassifications have no effect on net loss or stockholders’ equity as previously presented. |
(2) | MANAGEMENT’S PLANS | |||
The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. For the years ended December 31, 2003, 2002 and 2001, the Company incurred net pre-tax losses of $1,100,371, $88,448 and $391,818 and net cash provided (used) in operating activities of $1,498,507, ($1,213,100) and $1,907,675, respectively. Revenues for the fourth quarter of 2003 were down by approximately 23% compared to the 2002 fourth quarter, which contributed to a substantial 2003 fourth quarter loss. The financial covenants requirements under the Company’s working capital line of credit and two other subordinated debts were not met at the end of 2003. If the decline in revenue continues or the Company is not able to make satisfactory arrangements with its lenders for continuing financing, the Company may not be able to sustain operations as a going concern. | ||||
Management believes the operating results for the year ended December 31, 2003 were not representative of a normal year. Because of the nature of the Company’s customers, the fourth quarter is usually the highest revenue quarter. This was expected by management to hold true in 2003. Management believes the quarter ended December 31, 2003 was particularly abnormal due to the fact that several unusual events occurred. Approximately $3.5 million of orders scheduled to ship in the final weeks of the quarter were delayed or canceled. Management attributes this to the Company’s difficulty in obtaining bonding required by certain contracts and transit authority customers deferring orders to 2004. The calculation of the loss attributed to common shareholders in the fourth quarter of 2003 was also significantly affected by the accounting required by issuance of a series of preferred stock and a related warrant in November. Since the operating results for the fourth quarter fell short of management’s expectations, the covenants on the new working capital line of credit were not met. | ||||
The Company’s Board of Directors and management initiated plans and strategies in 2002 to improve the operating results and to reduce the pressure on liquidity. The primary elements of the Company’s strategies, objectives, plans and actions were to restructure the working capital line of credit, secure more subordinated financing and permanent capital, reduce the costs of Company products and operating costs, increase revenues through new product introductions and strategic alliances and better manage working capital and assets. A discussion of the progress through December 31, 2003 on these plans, the expected impact for 2004 and other management plans follows. | ||||
Working Capital Loan.On November 6, 2003, the Company replaced its asset-based lender and agreement with a new three-year agreement (the “Credit Agreement”) with LaSalle Business Credit LLC. The Credit Agreement provides up to $10.0 million in borrowing to be used for acquisitions, working capital and general corporate purposes. The $10 million limit includes $2.0 million for Letters of Credit and $0.5 million for term loans. See Note 7 for further discussion of the terms. The availability of borrowings under this line of credit depends on a daily calculation of a borrowing base, which is a function of eligible accounts receivable and inventory. The allowable amounts under the |
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new agreement exceed the amounts under the prior agreement. The new agreement contains financial covenants as well as a clause which would allow the lender to deem the agreement in default if it felt there was a material adverse change. The Company did not comply with the financial covenants as of December 31, 2003 and believed it was necessary to reset the financial covenants required in 2004. In April 2004 the lender agreed to waive the objective financial covenants as of December 31, 2003, and set covenants for 2004 that management believes will be attained. Management believes these arrangements for 2004 will provide the Company adequate working capital financing. Management presently does not anticipate the need to secure additional debt financing, negotiate debt restructurings or negotiate conversion of trade payables to equity to mitigate liquidity pressures in 2004. However, the Company will pursue all appropriate measures to address liquidity pressures should cash flow prove unsatisfactory in 2004. | ||||
Secure Subordinated Debt and Permanent Capital. In 2003, the Board of Directors approved plans that included raising up to $4 million of new equity. That plan was substantially realized in 2003 through elimination of the existing mandatory redemption clause in the Series AAA Preferred stock and the issuance of new shares of Series E and F Preferred Stock. The events resulted in an increase to equity of approximately $4.7 million through December 31, 2003, including new funds of approximately $2.9 million in 2003. In 2004, more shares of Series E shares were issued; resulting in additional proceeds of approximately $308,000. The limits authorized by the Board of Directors would allow additional proceeds of $600,000 from the issuance of Series E stock. Management has discussed placing more Series E and Series F shares with existing shareholders and other potential investors and believes additional shares could be sold to those investors. | ||||
In August 2002, the Company completed two privately negotiated sales of convertible subordinated debentures with proceeds totaling $1.4 million. It is not expected that more debt of this nature will be sought. | ||||
The Company anticipates that additional equity financing may be sought in 2004 in conjunction with potential acquisitions or launch of new business initiatives. In this regard, the Company is presently evaluating alternative measures and action plans, and soliciting proposals to secure additional equity from investment banks. These alternatives and plans are generally as follows: | ||||
Reduce the costs of Company products and operating costs. In the normal course of business, management has aggressively sought opportunities to reduce the cost structure and increase overall efficiency and responsiveness to its customers. In 2003, management initiated “tracked and monitored” profit improvement initiatives designed to further leverage the economy of scale that was developing in its operations. Management intends to continue developing its manufacturing and assembly infrastructure and organization to meet expected production requirements. The Company will continue manufacturing in-house certain key components of its products such as cable harnesses and assemblies, electronic destination sign systems, digital audio filter equipment and sub-system electronics. The Company believes this will enable it to: (1) produce highly reliable, quality products; (2) protect the proprietary nature of its technology and processes; (3) properly control its manufacturing and assembly processes and operations; and (4) achieve significant cost reductions. The cost reductions encompass all major elements of cost and operating expenses. | ||||
In 2003 management estimates that approximately $400,000 of improvement toward reduced costs was realized from these profit improvement initiatives. This is partially evidenced by gross margin improvement during the year. Management believes that in 2004 a full year’s effect of these initiatives could result in improvement of approximately $1.4 million. | ||||
Increase revenues through new product introductions. The Company strives to be a leader in the transportation and law enforcement and surveillance markets served. In order to expand and protect its technology, the Company will continue to seek patent protection for its products and or licenses of key technology owned by others. The Company has introduced improved and new technologies in 2003 including the DR600 vehicle logic unit (“VLU”) that is the integration communication platform for transit vehicle systems including fare collection, automatic passenger counting, automatic vehicle announcement systems, engine monitoring and other applications. The Company has introduced full color electronic destination sign systems and with its global presence is leveraging on purchasing power to realize decreased cost of materials. The Digital Audio Corporation continues to develop new products for the law enforcement and surveillance markets, and the Company believes that it is in a position to take advantage of the initiatives in the U.S. Homeland Security Department. The Company considers any increase in government funding related to national security, intelligence, and law enforcement initiatives as having the potential to influence positively the opportunity to sell our audio processing solutions. Additionally, as a result of increased attention to the potential for terrorist’s threats to transit vehicles and infrastructure, the Company is ideally suited to leverage on the vehicle locating and monitoring |
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aspect of its Transportation Communications Segment as an essential element of security is knowing, on a real time basis, the precise location of critical assets. | ||||
Increase revenues through strategic alliances.In September 2003, the Company and GE Transportation Systems Global Signaling, LLC (GETSGS) through General Electric’s (GE) Advanced Communications division based in Hingham, Mass signed a three-year Teaming Agreement. Through this agreement, the Company and GETSGS will work together to deliver advanced technology systems integration projects. The DR division will focus on vehicle location and passenger information processing and delivery systems while GETSGS will focus on communications technology, project management, and system integration. Through this agreement with GE, an organization that is uniquely capable of integrating our products with much larger systems in ways that exceed our independent technological and financial abilities, the Company believes it will significantly extend our transit market reach. The Company further believes the GPS-based vehicle location products, including the security aspect of such as noted above, may represent one of the Company’s more significant internal growth opportunities in fiscal year 2004. | ||||
Better working capital and asset management. Management has recognized that the working capital assets of trade accounts receivable and inventories represent significant opportunities if properly and aggressively managed. Customer account balances are continually monitored and evaluated by reviewing payment history and patterns of heavy shipments that could limit credit line borrowings with the asset based lender. The Company believes the decrease in the average days sales outstanding will help mitigate period to period liquidity tightness. As the inventories increased in recent years due to requirement of the markets served and improvements in technology, the Company has developed initiatives to promote retro-fit sales programs and incentives to use good, but other versions of technology. Management continues to assess its product lines in light of technology trends and economic conditions, to identify how to enhance existing product lines or create new distribution channels. | ||||
Management’s Conclusions. Management believes the cash and cash equivalents at December 31, 2003, together with the line of credit availability and additional capital raised in 2004, should be sufficient to fund operations through the end of fiscal 2004, assuming continued improvement in the Company’s overall cost structure resulting from ongoing cost reduction activities, ongoing efforts aimed at controlling costs, increasing revenues and improvements in asset management of trade accounts receivable and inventories. However, if these plans do not achieve the improvements management believes they will, other courses of action would be pursued, which may include sales of divisions of the Company or other actions to curtail operations. If divisions were sold in a liquidation mode, the recorded values may not be realized. | ||||
(3) | GOODWILL AND OTHER INTANGIBLE ASSETS-ADOPTION OF STATEMENTS 141 AND 142 | |||
The Company has recorded goodwill in connection with its acquisition of DAC and Mobitec. The carrying values of these 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. | ||||
The Company completed its annual goodwill and indefinite life intangible asset impairment evaluations as of December 31, 2003 and 2002, and has concluded that no impairment exists. Therefore, as a result of these impairment evaluations, no impairment charges were recorded during the years ended December 31, 2003 and 2002. | ||||
The following table reflects the impact of the new standards and reconciles the reported net loss applicable to common stock to net loss applicable to common stock adjusted for amortization of goodwill and other indefinite life intangible assets, net of the associated tax effects, and the related per share amounts: |
Years Ended December 31, | ||||||||||||
2003 | 2002 | 2001 | ||||||||||
Net loss applicable to common shareholders | $ | (2,232,508 | ) | $ | (366,503 | ) | $ | (61,735 | ) | |||
Add back amortization, net of taxes*: | ||||||||||||
Goodwill | — | — | 334,714 | |||||||||
Adjusted net income (loss) applicable to common shareholders | $ | (2,232,508 | ) | $ | (366,503 | ) | $ | 272,979 | ||||
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Years Ended December 31, | ||||||||||||
2003 | 2002 | 2001 | ||||||||||
Reported net loss per share, basic and diluted | $ | (0.58 | ) | $ | (0.10 | ) | $ | (0.02 | ) | |||
Add back amortization, net of taxes: | ||||||||||||
Goodwill | — | — | 0.10 | |||||||||
Adjusted net income (loss) per share: | ||||||||||||
Basic | $ | (0.58 | ) | $ | (0.10 | ) | $ | 0.08 | ||||
Diluted | $ | (0.58 | ) | $ | (0.10 | ) | $ | 0.07 | ||||
* | The Company’s goodwill amortization expense has not been deductible for tax purposes. |
The change in the carrying amount of goodwill for each of the Company’s operating segments for the years ended December 31, 2003 and 2002 is as follows:
Transportation | Law enforcement | |||||||||||
communications | and surveillance | Total | ||||||||||
Balance as of January 1, 2002 | $ | 6,595,711 | $ | 960,944 | $ | 7,556,655 | ||||||
Acquisitions | 15,030 | — | 15,030 | |||||||||
Adjustment of restructuring reserve | (76,201 | ) | — | (76,201 | ) | |||||||
Effect of exchange rates | 1,464,912 | — | 1,464,912 | |||||||||
Balance as of December 31, 2002 | $ | 7,999,452 | $ | 960,944 | $ | 8,960,396 | ||||||
Effect of exchange rates | 1,705,717 | — | 1,705,717 | |||||||||
Balance as of December 31, 2003 | $ | 9,705,169 | $ | 960,944 | $ | 10,666,113 | ||||||
The composition of the Company’s acquired intangible assets and the associated accumulated amortization as of December 31, 2003 and 2002 is as of follows:
December 31, 2003 | December 31, 2002 | |||||||||||||||||||||||||||
Weighted | ||||||||||||||||||||||||||||
Average | Gross | Net | Gross | Net | ||||||||||||||||||||||||
Remaining Life | Carrying | Accumulated | Carrying | Carrying | Accumulated | Carrying | ||||||||||||||||||||||
(Years) | Amount | Amortization | Amount | Amount | Amortization | Amount | ||||||||||||||||||||||
Intangible assets subject to amortization: | ||||||||||||||||||||||||||||
Patents and development costs | 2.5 | $ | 473,057 | $ | 328,818 | $ | 144,239 | $ | 367,959 | $ | 229,224 | $ | 138,735 | |||||||||||||||
Customer lists | 12.5 | 1,652,719 | 269,666 | 1,383,053 | 1,387,496 | 133,698 | 1,253,798 | |||||||||||||||||||||
9.5 | $ | 2,125,776 | $ | 598,484 | $ | 1,527,292 | $ | 1,755,455 | $ | 362,922 | $ | 1,392,533 | ||||||||||||||||
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The aggregate amount of amortization expense for the years ended December 31, 2003 and 2002 was approximately $162,202 and $126,342, respectively. Amortization expense for each of the years ending December 31, 2004 through 2009 is estimated to range from $110,180 to $166,395. | ||||
(4) | PROPERTY AND EQUIPMENT | |||
Property and equipment consists of the following: |
December 31, | ||||||||
2003 | 2002 | |||||||
Leasehold improvements | $ | 87,561 | $ | 58,461 | ||||
Computer and telecommunications equipment | 2,847,287 | 1,601,624 | ||||||
Test equipment | 224,022 | 197,665 | ||||||
Furniture and fixtures | 1,627,370 | 1,174,462 | ||||||
4,786,240 | 3,032,212 | |||||||
Less accumulated depreciation and amortization | 2,351,651 | 1,459,953 | ||||||
$ | 2,434,589 | $ | 1,572,259 | |||||
(5) | INVENTORIES | |||
Inventories consist of the following: |
December 31, | ||||||||
2003 | 2002 | |||||||
Raw materials | $ | 7,477,081 | $ | 7,237,385 | ||||
Work in process | 233,436 | 148,105 | ||||||
Finished goods | 2,087,093 | 1,445,032 | ||||||
$ | 9,797,610 | $ | 8,830,522 | |||||
(6) | LEASES | |||
The Company leases its premises and certain office equipment under various operating leases that expire at various times through 2009. Rent and lease expense under these operating leases was $741,547, $741,220, and $629,229 for the years ended December 31, 2003, 2002, and 2001, respectively. The Company records rent on a straight-line basis. |
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The Company also has a lease commitment under a capital lease obligation for a tradeshow booth that expires in 2004. | ||||
At December 31, 2003, 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: |
Capital | Operating | |||||||
Year Ending December 31, | Leases | Leases | ||||||
2004 | $ | 69,000 | $ | 746,230 | ||||
2005 | — | 592,166 | ||||||
2006 | — | 464,405 | ||||||
2007 | — | 377,757 | ||||||
2008 | — | 185,025 | ||||||
Thereafter | — | 54,663 | ||||||
Total future minimum lease payments | 69,000 | $ | 2,420,246 | |||||
Less amount representing interest (8.6% interest) | 3,110 | |||||||
Present value of future minimum capital lease payments | 65,890 | |||||||
Less current portion | 65,890 | |||||||
Long-term portion | $ | — | ||||||
(7) | LINES OF CREDIT AND LONG-TERM DEBT |
a) Lines of Credit
On November 6, 2003, the Company replaced its asset-based lending agreement formerly with Guaranty Business Credit Corporation (“GBCC”) with a three year agreement (the “Credit Agreement”) with LaSalle Business Credit LLC (“LBC”). Borrowings under the Credit Agreement are classified as current liabilities in accordance with EITF 95-22Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements That Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement.However, it is management’s intention to manage the Credit Agreement as long-term debt with a final maturity date in 2006, as provided for in the Credit Agreement. | ||||
At December 31, 2003, the Credit Agreement provided up to $10.0 million in borrowing to be used for acquisitions, working capital and general corporate purposes. The borrowing is inclusive of $2.0 million for Letters of Credit and $0.5 million for term loans. The interest rate on loans under this agreement is the published prime lending rate (4.00 percent at December 31, 2003) plus 1 percent. There is a fee equal to 2.5 percent on the aggregate undrawn face amount of all Letters of Credit outstanding. | ||||
The Credit Agreement includes customary covenants and conditions relating to the conduct and operation of the Company’s business. Specifically, the Credit Agreement subjects the Company to an escalating fixed charge coverage ratio from 1.0 to 1.5 and an escalating tangible net worth value (as defined) from $2.5 million to $3.9 million over the term of the Credit Agreement calculated on a quarterly and rolling 12 month basis; limits annual capital expenditures to $1.5 million and limits borrowing by providing for a reserve of $500,000 until the fixed charge coverage ratio of 1.15 to 1.00 has been met. At December 31, 2003, available collateral based on the value of eligible trade accounts receivable and inventories was $5,333,273 which, given the outstanding debt balance under this agreement of |
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$4,222,336, would have resulted in additional borrowing availability of $1,110,937. However, the required reserve reduced additional borrowing availability by $500,000 to $610,937. The outstanding debt under this agreement is secured by substantially all U.S.-based assets of the Company. | ||||
At December 31, 2003, the Company was not in compliance with its financial covenants within the bank agreement except for the capital expenditure covenant, but has received waivers for violation of the covenants. On April 14, 2004, the Company has further received from the lender revisions to the escalating tangible net worth and escalating fixed charge coverage ratio loan covenant parameters taking into effect the results of the three months ended December 31, 2003 that affected the initial covenant computations to which the Credit Agreement was based and negotiated. These covenants were revised after considering the results of the three months ended December 31, 2003 and the Company’s projected operating plan for the year ending December 31, 2004. | ||||
The escalating tangible net worth covenant’s “Minimum Tangible net Worth” has been revised downward by $1,000,000 and reset to $1,500,000 from $2,500,000 for the period of December 31, 2003 to December 30, 2004 and increases $600,000 per year thereafter for the remaining life of the loan. The time periods required to maintain the escalating fixed charged coverage ratio have also been revised downward to exclude the three months ended December 31, 2003; and are now 1.00:1.00 for the three and six months ended March 31, 2004 and June 30, 2004, respectively; and 1.15:1.00 for the nine and twelve months ended September 30, 2004 and December 31, 2004, respectively. Additionally, the interest rate on borrowings increased from prime plus 1.00 to prime plus 1.75. The impact on our 2004 financial statements based on the outstanding balance of this loan as of December 31, 2003 would be approximately $32,000. Also, the reserve on borrowings was increased to $600,000 from $500,000 until receipt of the certified 2004 financial statements reflecting an EBITDA to fixed charge coverage ratio of at least 1.15:1.00. | ||||
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), which is equivalent to $1,381,000. At December 31, 2003,9,822,122 krona (SEK), or $1,356,435 was outstanding, resulting in additional borrowing availability of 177,878 krona (SEK), or $24,565. 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 $303,820. The terms of this agreement require payment of an unused credit line fee equal to 0.5 percent of the unused portion and average interest of 4.1 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, 2004. On or before expiration, the Company expects to renew this credit agreement with an agreement substantially similar in terms and conditions. Mobitec AB also has an agreement with the same bank from which it may borrow up to 6,000,000 krona (SEK), or $828,600. Based upon the availability formula under this agreement, 2,927,443 krona (SEK), or $404,280 was outstanding at December 31, 2003, resulting in additional borrowing availability of 3,072,557 krona (SEK), or $424,320. The line of credit bears average interest of 5.29 percent and is collateralized by accounts receivable. The agreement has an expiration date of December 31, 2004. On or before expiration, the Company expects to renew this credit agreement with an agreement substantially similar in terms and conditions. |
Lines of credit at December 31, 2003 and 2002 consists of the following:
December 31, | ||||||||
2003 | 2002 | |||||||
Credit line with LaSalle Business Credit, dated November 6, 2003, payable in full November 15, 2006, secured by accounts receivable, inventory and all assets of the U.S. based domestic entities of the Company. | $ | 4,222,336 | * | $ | — | |||
Credit line with Guaranty Business Credit Corporation, dated August 23, 1999, payable in full August 23, 2003, extended through November 21, 2003, secured by accounts receivable, inventory and all assets of the U.S. based domestic entities of the Company. | — | 6,489,729 | ||||||
Line of credit with Swedish bank dated December 31, 2003, secured by assets of the Swedish subsidiary, Mobitec AB, and a cash deposit, with average interest of 4.1%. | 1,356,435 | 862,110 | ||||||
Line of credit with Swedish bank dated December 31, 2003 secured by accounts receivable of the Swedish subsidiary, Mobitec AB, with average interest at 5.29%. | 404,280 | 151,952 | ||||||
Total lines of credit | $ | 5,983,051 | $ | 7,503,791 | ||||
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* | Classified as a current liability in conformity with EITF 95-22 |
b) Long-Term Debt
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. | ||||
An unsecured note in the amount of $1,765,235 and obligation in the amount of $225,000 are due a shareholder. On June 26, 2003, the Company and the shareholder agreed to: (1) convert $350,000 of the original note, which was issued June 28, 2001, was payable in full June 28, 2004 and had a balance of $2,111,235, to common stock; and (2) extend the due date on the remaining note balance of $1,761,235 to June 30, 2005. The note, as amended, requires three incrementally increasing quarterly payments beginning July 1, 2004 in the amounts of $50,000, $75,000, and $100,000 with the remaining balance in the amount of $1,536,235 due June 30, 2005. The unsecured note has an annual interest rate of 9 percent paid annually increasing to 10 percent beginning July 1, 2004. The obligation balance of $225,000 at December 31, 2003 is non interest bearing and is due in full June 30, 2004. | ||||
A term loan from a Swedish bank dated June 28, 2001 having a balance of 12,100,000 krona (SEK), or $1,677,927, at December 31, 2003 is payable in 10 remaining quarterly payments of 1,100,000 krona (SEK), or $151,910 at an annual interest rate of 5.35 percent and is secured by stock of the Company’s Swedish holding company, DRI-Europa AB, and its consolidated subsidiary, Mobitec AB. | ||||
Four convertible subordinated debentures in the aggregate amount of $3,000,000 dated June 22, 2001 and $1,150,000 dated July 31, 2002, collectively the “Renaissance Notes,” are payable to two investment funds managed by Renaissance Capital Group, Inc. The president of Renaissance Capital Group, Inc. is a member of the Company’s Board of Directors. The two debentures having an aggregate principal amount of $3,000,000 are payable in full on June 22, 2008, if not sooner redeemed or converted, with annual interest at 8 percent paid monthly. They also provide 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 are payable in full on July 31, 2009, if not sooner redeemed or converted, with annual interest at 8 percent paid monthly. They also provide 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 under which the convertible debentures were issued 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. At December 31, 2003, the Company was not in compliance with its financial covenants under the agreement, but received waivers on April 14, 2004 for violation of the interest coverage and current ratio noted above. | ||||
A convertible subordinated debenture in the amount of $250,000 dated August 26, 2002, is payable to 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 percent 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 under which the convertible debenture was issued 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. At December 31, 2003, the Company was not in compliance with its financial covenants under the agreement, but received waivers on April 14, 2004 for violation of the interest coverage and current ratio noted above. | ||||
Long-term debt at December 31, 2003 and 2002 consists of the following: |
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December 31, | ||||||||
2003 | 2002 | |||||||
Unsecured note to a stockholder, dated June 28, 2001, payable in full June 30, 2005, with interest at 9%, increasing to 10% in July 2004. | $ | 1,765,235 | $ | 2,111,235 | ||||
Unsecured obligation to a stockholder dated June 28, 2001, payable in 12 quarterly installments, with zero interest. | 225,000 | 360,000 | ||||||
Note payable to a Swedish bank, dated June 28, 2001, payable in 20 quarterly installments of $151,910 including interest at 5.35%. Note collateralized by stock of Swedish holding company and consolidated subsidiary. | 1,667,927 | 1,763,050 | ||||||
Convertible debentures dated June 22, 2001, payable in full June 22, 2008, with interest at 8%, net of unamortized discount arising from warrants. | 2,838,000 | 2,802,000 | ||||||
Convertible debentures dated July 31, 2002, payable in full July 31, 2009, with interest at 8%. | 1,150,000 | 1,150,000 | ||||||
Convertible debenture dated August 26, 2002, payable in full August 26, 2009, with interest at 8%. | 250,000 | 250,000 | ||||||
Total long-term debt | 7,896,162 | 8,436,285 | ||||||
Less current maturities | 1,249,110 | 763,360 | ||||||
6,647,052 | 7,672,925 | |||||||
Long-term portion of capital lease | — | 65,015 | ||||||
$ | 6,647,052 | $ | 7,737,940 | |||||
Net interest expense was $1,093,293, $1,150,962 and $814,207 for the years ended December 31, 2003, 2002 and 2001, respectively. |
The repayment amounts of long-term debt are due as follows: |
Year ending December 31, | Amount | |||
2004 | $ | 1,249,110 | ||
2005 | 2,601,388 | |||
2006 | 700,443 | |||
2007 | 350,203 | |||
2008 | 2,067,824 | |||
Thereafter | 927,194 | |||
Total | $ | 7,896,162 | ||
(8) | PREFERRED STOCK | |||
The Company has the authority to issue 5.0 million shares of Preferred Stock, of which 20,000 shares have been designated Series AAA Redeemable Nonvoting Preferred Stock (“Series AAA Preferred Stock”). On December 13, |
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1999, the Board of Directors authorized the creation of 10,000 shares of a Preferred Stock class designated as “Series D Junior Participating Preferred Stock,” which has a par value of $0.10. On June 2, 2003, the Board of Directors authorized the creation of 500 shares of a Preferred Stock class designated as “ Series E Redeemable Nonvoting Convertible Preferred Stock,” which has a par value of $0.10; and on October 13, 2003, the Board of Directors authorized the creation of 300 shares of a Preferred Stock class designated as “Series F Convertible Preferred Stock,” which has a par value of $0.10. Therefore, 4,969,200 shares of undesignated preferred stock are authorized. | ||||
As of December 31, 2003, the Company had sold 363 shares of the Series E Stock for an aggregate purchase price of $1,815,000 to 24 private investors. Series E Stock is convertible at any time into shares of the Common Stock at a conversion price of $3.00 per share of Common Stock, subject to certain adjustments, and, prior to conversion, does not entitle the holders to any voting rights, except as may be required by law. The Company does not have the right to require conversion. Holders of Series E Stock are entitled to receive cumulative quarterly dividends when, and if declared by the Board of Directors, at the rate of 7 percent per annum on the liquidation value of $5,000 per share. Series E Stock is redeemable at the option of the Company at any time, in whole or in part, at a redemption price equal to the liquidation value plus accrued and unpaid dividends. Holders of Series E Stock do not have the right to require redemption. | ||||
On November 10, 2003, the Company closed the sale of 300 shares of Series F Convertible Preferred Stock (“Series F Stock”), par value $.10 to Dolphin Offshore Partners, L.P. (“Dolphin”) for a purchase price of $1.5 million. The terms of the Series F stock were subsequently amended, as described in Note 21. The Series F Stock, as originally issued, was convertible at any time into shares of the Company’s Common Stock at a conversion price of $2.35 per share of Common Stock, subject to certain adjustments, which was the market price of the Company’s Common Stock at the time the parties reached agreement on terms. Prior to conversion, the Series F Stock votes as a single class with holders of Common Stock on an as-if-converted basis. The shares are mandatorily convertible into Common Stock if the Company’s Common Stock hits certain targeted trading prices or upon the conversion of certain subordinated debentures previously issued by the Company (two investment funds managed by Renaissance Capital Group, Inc. — See Note 7(b) “Long-Term Debt”). Dividends were not payable on the Series F Stock, as originally issued, for the first five years after issuance. If certain trading price targets were not met by the Company’s Common Stock within five years after issuance, the conversion price would have been reduced and dividends would thereafter have begun to accrue and be payable quarterly on the Series F Stock at the rate of 10% per annum on the liquidation value (initially, $1.5 million, or $5,000 per share). The Series F Stock is not redeemable at the option of holder, and was to have been redeemable by the Company only if and when dividends began to accrue. In connection with the sale of the Series F Stock to Dolphin, the Company issued warrants (the “Dolphin warrants”) to Dolphin to purchase 319,149 shares of the Company’s Common Stock at an exercise price of $3.00 per share, subject to certain adjustments. The Dolphin warrants were exercisable at any time, for a period of seven years after issuance. The Company also granted to Dolphin a right of first refusal to purchase, in connection with future equity offerings by the Company, for a period of five years after the Series F Stock issuance date, a sufficient number of the securities issued in such equity offering to maintain its proportionate ownership interest in the Company, on a diluted basis. The Company also granted to Dolphin certain rights to have the shares of Common Stock underlying the Series F Stock and issuable upon the exercise of the Dolphin warrants registered with the Securities and Exchange Commission. Pursuant to the registration rights agreement, the conversion price of the Series F Stock and the exercise price of the Dolphin warrants were subject to being decreased if the Company did not file appropriate registration statements or cause such registration statements to be declared effective by certain dates. In connection with the issuance of the Series F Stock, the Company recorded during the fourth quarter a charge against income available for common shareholders of $702,626 based upon the relative fair value of the stock and warrants. | ||||
The Series E Stock and the Series F Stock have equal priority with respect to liquidation, and shares of both series have liquidation preferences prior to the Company’s outstanding shares of Series AAA Preferred Stock and Common Stock. | ||||
On March 6, 2003, the Company announced that at a special meeting of the Series AAA Preferred Stock shareholders, the holders of the Series AAA Preferred Stock approved an amendment to the Articles of Incorporation to remove the mandatory redemption date, which would have occurred in December 2003. The Company may now redeem the Series AAA Preferred 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 had to pay the redemption price, which is equal to the liquidation preference, in December 2003. The liquidation preference is $5,000 per share, plus all accrued and unpaid dividends, which at December 31, 2003 was $1,858,500. |
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(9) | COMMON STOCK WARRANTS | |||
During 2003, the Company granted warrants to one individual and one registered broker dealer that allow the holders to purchase 68,000 shares of Common Stock. The value of those warrants was approximately $98,536. Of this amount, $10,492 was charged to selling, general and administrative expenses, while the balance of $88,044 was charged to issuance costs in connection with the sale of Series E Preferred Stock. The warrants have an exercise price of $2.50 and expire in 2008. | ||||
Also, during 2003, the Company granted warrants to Dolphin Offshore Partners, L.P. (“Dolphin”) that allowed the holder to purchase 319,149 shares of the Company’s common stock at an exercise price of $3.00 per share, subject to certain adjustments. The Dolphin warrants were exercisable at any time, for a period of seven years after issuance. The Dolphin warrants were subsequently terminated as described in Note 21. | ||||
In 2001, the Company granted warrants that allow the holder to purchase 350,000 shares of Common Stock. Of those warrants, 300,000 were granted as part of the Mobitec acquisition and financing. Of that amount, 100,000 warrants are exercisable at $4 per share, valued at approximately $95,000 on the date of acquisition, and 200,000 are exercisable at $2.05 per share, valued at approximately $252,000 on the date of acquisition. Those amounts were capitalized as part of the acquisition financing. The remaining 50,000 warrants were issued to an individual and are exercisable at $2.15 per share. The value of those warrants was approximately $35,000 and was charged to selling, general, and administrative expenses. These warrants are fully vested and expire in 2006. | ||||
During 2000, the Company issued warrants that allow the holder to purchase 121,000 shares of Common Stock. Of that amount, 111,000 are exercisable at $3.75 per share, and 10,000 are exercisable at $3 per share. These warrants have five-year terms and expire in 2005. | ||||
(10) | COMMON STOCK OPTIONS |
(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. |
2003 | 2002 | 2001 | ||||||||||||||||||||||
Weighted- | Weighted- | Weighted- | ||||||||||||||||||||||
Average | Average | Average | ||||||||||||||||||||||
Exercise | Exercise | Exercise | ||||||||||||||||||||||
Shares | Price | Shares | Price | Shares | Price | |||||||||||||||||||
Outstanding at beginning of year | 714,800 | $ | 2.44 | 674,300 | $ | 2.42 | 587,800 | $ | 2.42 | |||||||||||||||
Granted | 85,000 | 2.54 | 50,000 | 2.55 | 88,000 | 2.48 | ||||||||||||||||||
Exercised | — | — | — | — | — | — | ||||||||||||||||||
Expired | (33,300 | ) | 2.56 | (9,500 | ) | 1.97 | (1,500 | ) | 2.15 | |||||||||||||||
Outstanding at end of year | 766,500 | $ | 2.44 | 714,800 | $ | 2.44 | 674,300 | $ | 2.42 | |||||||||||||||
Weighted-average fair value of options granted during the year | $ | 2.05 | $ | 0.72 | $ | 1.72 |
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Options Outstanding | Options Exercisable | |||||||||||||||||||
Number | Weighted-Average | Number | ||||||||||||||||||
Range of | Outstanding | Remaining | Weighted- Average | Exercisable | Weighted- Average | |||||||||||||||
Exercise Price | at 12/31/03 | Contractual Life | Exercise Price | at 12/31/03 | Exercise Price | |||||||||||||||
$1.65 - 2.08 | 308,288 | 5.53 years | $ | 1.96 | 308,288 | $ | 1.96 | |||||||||||||
2.15 - 3.00 | 458,212 | 5.85 years | $ | 2.77 | 192,212 | $ | 2.73 | |||||||||||||
766,500 | 500,500 | |||||||||||||||||||
(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. |
2003 | 2002 | 2001 | ||||||||||||||||||||||
Weighted- | Weighted- | Weighted- | ||||||||||||||||||||||
Average | Average | Average | ||||||||||||||||||||||
Exercise | Exercise | Exercise | ||||||||||||||||||||||
Shares | Price | Shares | Price | Shares | Price | |||||||||||||||||||
Outstanding at beginning of year | 259,987 | $ | 2.25 | 259,987 | $ | 2.25 | 215,987 | $ | 2.20 | |||||||||||||||
Granted | 76,000 | 2.35 | 6,000 | 2.50 | 44,000 | 2.50 | ||||||||||||||||||
Exercised | — | — | — | — | — | — | ||||||||||||||||||
Expired | (91,987 | ) | 2.56 | (6,000 | ) | 2.38 | — | — | ||||||||||||||||
Outstanding at end of year | 244,000 | $ | 2.16 | 259,987 | $ | 2.25 | 259,987 | $ | 2.25 | |||||||||||||||
Weighted-average fair value of options granted during the year | $ | 2.08 | $ | 1.19 | $ | 1.72 |
Options Outstanding | Options Exercisable | |||||||||||||||||||
Number | Weighted-Average | Number | ||||||||||||||||||
Range of | Outstanding | Remaining | Weighted- Average | Exercisable | Weighted- Average | |||||||||||||||
Exercise Prices | at 12/31/03 | Contractual Life | Exercise Price | at 12/31/03 | Exercise Price | |||||||||||||||
$1.63 - 2.00 | 124,000 | 5.87 years | $ | 1.93 | 124,000 | $ | 1.93 | |||||||||||||
2.35 - 3.00 | 120,000 | 8.67 years | $ | 2.41 | 44,000 | $ | 2.50 | |||||||||||||
244,000 | 168,000 | |||||||||||||||||||
(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 |
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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: |
2003 | 2002 | 2001 | ||||||||||
Risk-free interest rate | 4.27 | % | 3.83 | % | 5.00 | % | ||||||
Expected life | 10 years | 1 to 10 years | 10 years | |||||||||
Expected volatility | 64.05 | % | 54.37 | % | 57.50 | % | ||||||
Expected dividends | None | None | None |
(11) | INCOME TAXES | |||
The pretax loss for the years ended December 31, 2003, 2002, and 2001 was taxed by the following jurisdictions: |
2003 | 2002 | 2001 | ||||||||||
Domestic | $ | (786,746 | ) | $ | (303,517 | ) | $ | 733,338 | ||||
Foreign | (313,625 | ) | 215,069 | (1,125,156 | ) | |||||||
$ | (1,100,371 | ) | $ | (88,448 | ) | $ | (391,818 | ) | ||||
The income tax provision charged (benefit credited) for the years ended December 31, 2003, 2002 and 2001 were as follows: |
2003 | 2002 | 2001 | ||||||||||
Current: | ||||||||||||
U.S. federal | $ | — | $ | — | $ | — | ||||||
State | — | (32,405 | ) | 18,353 | ||||||||
Foreign | (1,229 | ) | 215,614 | 70,788 | ||||||||
(1,229 | ) | 183,209 | 89,141 | |||||||||
Deferred: | ||||||||||||
U.S. federal | 80,053 | (86,714 | ) | (605,119 | ) | |||||||
State | 4,730 | (116,589 | ) | (39,642 | ) | |||||||
Foreign | 26,056 | 62,242 | 22,485 | |||||||||
110,839 | (141,061 | ) | (622,276 | ) | ||||||||
$ | 109,610 | $ | 42,148 | $ | (533,135 | ) | ||||||
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The income tax expense (benefit) differs from the expected amount of income tax expense (benefit) determined by applying the U.S. federal income tax rates to the pretax income (loss) for the years ended December 31, 2003, 2002 and 2001 due to the following: |
2003 | 2002 | 2001 | ||||||||||||||||||||||||
Percentage | Percentage | Percentage | ||||||||||||||||||||||||
of pretax | of pretax | of pretax | ||||||||||||||||||||||||
Amount | earnings (loss) | Amount | earnings (loss) | Amount | earnings (loss) | |||||||||||||||||||||
Computed “expected” tax benefit | $ | (385,130 | ) | (35.0 | )% | $ | (30,957 | ) | (35.0 | )% | $ | (137,137 | ) | (35.0 | )% | |||||||||||
Increase (decrease) in income taxes resulting from: | ||||||||||||||||||||||||||
Nondeductible expenses | 136,465 | 12.4 | 309,062 | 349.4 | 318,066 | 81.2 | ||||||||||||||||||||
Nontaxable income | (95,349 | ) | (8.7 | ) | (122,724 | ) | (138.8 | ) | (64,345 | ) | (16.4 | ) | ||||||||||||||
Foreign subsidiary losses | 172,786 | 15.7 | 244,232 | 276.1 | 193,992 | 49.5 | ||||||||||||||||||||
Lower rates on earnings of foreign operations | (9,017 | ) | (0.8 | ) | (154,588 | ) | (174.8 | ) | (10,350 | ) | (2.6 | ) | ||||||||||||||
State taxes, net of federal benefit | (54,285 | ) | (4.9 | ) | (57,818 | ) | (65.4 | ) | 8,740 | 2.2 | ||||||||||||||||
Other changes in valuation allowance | 344,140 | 31.3 | (92,000 | ) | (104.0 | ) | (842,101 | ) | (214.9 | ) | ||||||||||||||||
Refunds of prior years taxes | — | — | (53,059 | ) | (58.3 | ) | — | — | ||||||||||||||||||
$ | 109,610 | 10.0 | % | $ | 42,148 | 49.2 | % | $ | (533,135 | ) | (136.0 | )% | ||||||||||||||
Net deferred tax assets consist of the following components as of December 31, 2003 and 2002:
2003 | 2002 | |||||||
Deferred tax assets: | ||||||||
Federal and state loss carryforwards | $ | 1,022,106 | $ | 427,285 | ||||
Federal tax credits | 87,908 | 87,908 | ||||||
Foreign loss carryforwards | 1,057,574 | 905,000 | ||||||
Foreign currency translation benefits | — | 17,599 | ||||||
Inventory reserve and capitalization | 192,942 | 135,761 | ||||||
Other accruals and reserves | 9,055 | 205,110 | ||||||
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2003 | 2002 | |||||||
Total gross deferred tax assets | 2,369,585 | 1,778,663 | ||||||
Less valuation allowance | (1,529,000 | ) | (913,000 | ) | ||||
840,585 | 865,663 | |||||||
Deferred tax liabilities: | ||||||||
Untaxed foreign reserves | (193,918 | ) | (138,695 | ) | ||||
Net deferred tax assets | $ | 646,667 | $ | 726,968 | ||||
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, 2003, the Company’s deferred tax valuation allowance was attributable to operating loss carryforwards from its various domestic jurisdictions and one of its foreign subsidiaries. The net deferred tax assets at December 31, 2003 would be realized from projected taxable income through 2006. As of December 31, 2002, substantially all of the Company’s deferred tax valuation allowance was attributable to operating loss carryforwards at one of its foreign subsidiaries. The components giving rise to the net deferred tax assets described above have been included in the accompanying consolidated balance sheets as of December 31, 2003 and 2002 as follows: |
2003 | 2002 | |||||||
Noncurrent assets | $ | 840,585 | $ | 865,663 | ||||
Current liabilities | (193,918 | ) | (138,695 | ) | ||||
$ | 646,667 | $ | 726,968 | |||||
At December 31, 2003, the Company has net operating loss carryforwards for federal income tax purposes of $2,550,017 which are available to offset future federal taxable income, if any, which expire beginning in 2009 through 2023. In addition, two of the Company’s domestic subsidiaries have net economic loss carryforwards for state income tax purposes of $1,836,600, which are available to offset future state taxable income, if any, through 2012 and 2013. Further, one of the Company’s foreign subsidiaries also has loss carryforwards for German tax purposes of $3,529,168 which are available to offset future foreign taxable income. | ||||
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. | ||||
The Company also has research and development tax credits for federal income tax purposes of $87,908 at December 31, 2003 that expire in various years from 2007 through 2011. | ||||
(12) | OTHER COMPREHENSIVE INCOME (LOSS) | |||
The following is a summary of the tax effects of the components of other comprehensive income (loss), consisting solely of foreign currency translation adjustments, reported in the statements of shareholders’ equity for the years ended December 31, 2003, 2002 and 2001: |
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Pre-tax Amount | Tax (Expense) Benefit | Net of tax Amount | ||||||||||
Year ended December 31, 2003: | ||||||||||||
Foreign currency translation adjustment | $ | 1,850,648 | — | $ | 1,850,648 | |||||||
Year ended December 31, 2002: | ||||||||||||
Foreign currency translation adjustment | $ | 1,052,546 | (215,593 | ) | $ | 836,953 | ||||||
Year ended December 31, 2001: | ||||||||||||
Foreign currency translation adjustment | $ | (133,307 | ) | 46,251 | $ | (87,056 | ) | |||||
(13) | MAJOR CUSTOMERS | |||
Because of the nature of the Company’s business, the major customers may vary between years. Net sales for the years ended December 31, 2003, 2002 and 2001 include sales in the transportation communications segment to the following major customers: |
Years Ended December 31, | ||||||||||||
Customer | 2003 | 2002 | 2001 | |||||||||
Customer A | $ | 7,118,126 | $ | 4,670,503 | $ | 4,611,774 | ||||||
Customer B | ** | 5,208,182 | 4,797,440 | |||||||||
Customer C | ** | ** | 4,125,710 | |||||||||
$ | 7,118,126 | $ | 9,878,685 | $ | 13,534,924 | |||||||
** The net sales to these customers were less than 10 percent of net sales for the years indicated. Accounts receivable balances for the customers listed above were as follows at December 31, 2003 and 2002: |
December 31, | ||||||||
2003 | 2002 | |||||||
Customer A | $ | 1,448,293 | $ | 929,508 | ||||
Customer B | ** | 2,253,332 | ||||||
Customer C | ** | ** | ||||||
$ | 1,448,293 | $ | 3,182,840 | |||||
** Balances for these customers were not presented for years in which their net sales were not significant. | ||||
(14) | RELATED PARTY TRANSACTIONS | |||
In the past, the Company purchased electronic components supporting the transportation communications segment |
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from a major shareholder, Lite Vision Corporation (“Lite Vision”), a Taiwan-based company. Lite Vision held 12.7 percent (500,000) of the outstanding shares of Common Stock of the Company at December 31, 2003. Subsequently, that stock was acquired by an individual investor on January 16, 2004. The components purchased from Lite Vision consisted primarily of LED printed circuit display boards and LED/Flip-Dot printed circuit boards. The Company purchased from Lite Vision approximately $3.5 million, and $4.4 million in components and assemblies during 2002 and 2001, respectively, but did not make any purchases from Lite Vision during 2003. There were not any amounts due to Lite Vision as of December 31, 2003. The accounts payable balance due to Lite Vision was $859,425 as of December 31, 2002. Mr. Joseph Tang, previously President of Lite Vision and affiliated with Lite Vision in early 2003, while also pursuing other private business interests, served on the Company’s Board of Directors through October 4, 2003. During 2002 the Company issued 100,000 shares of restricted, unregistered Common Stock to Lite Vision at $3.00 per share in exchange for a $300,000 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 Mr. Higgins, who received a closing fee of $5,850 related to the placement of the debenture. | ||||
On August 2, 2002, the Company completed a privately negotiated sale of $1.15 million of convertible subordinated debentures to 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. Renaissance Capital Group received a closing fee of $17,250 related to the placement of the debenture. | ||||
(15) | SEGMENT INFORMATION | |||
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: |
2003 | 2002 | 2001 | ||||||||||
Net sales | ||||||||||||
Transportation communications | $ | 42,569,452 | $ | 43,550,637 | $ | 35,546,489 | ||||||
Law enforcement and surveillance | 1,456,790 | 1,587,349 | 1,668,863 | |||||||||
$ | 44,026,242 | $ | 45,137,986 | $ | 37,215,352 | |||||||
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2003 | 2002 | 2001 | ||||||||||
Income (loss) from operations | ||||||||||||
Transportation communications | $ | 4,316,462 | $ | 4,641,059 | $ | 3,681,976 | ||||||
Law enforcement and surveillance | 88,296 | 151,596 | 17,412 | |||||||||
Parent entities | (4,825,034 | ) | (4,068,437 | ) | (3,280,545 | ) | ||||||
$ | (420,275 | ) | $ | 724,218 | $ | 418,843 | ||||||
Depreciation and amortization | ||||||||||||
Transportation communications | $ | 415,614 | $ | 361,019 | $ | 460,469 | ||||||
Law enforcement and surveillance | 209,135 | 37,867 | 140,822 | |||||||||
Parent entities | 88,612 | 87,251 | 99,023 | |||||||||
$ | 713,361 | $ | 486,137 | $ | 700,314 | |||||||
Capital expenditures | ||||||||||||
Transportation communications | $ | 1,055,094 | $ | 356,257 | $ | 379,916 | ||||||
Law enforcement and surveillance | 270,031 | 205,742 | 16,649 | |||||||||
Parent entities | 59,136 | 161,473 | 36,139 | |||||||||
$ | 1,384,261 | $ | 723,472 | $ | 432,704 | |||||||
Identifiable assets | ||||||||||||
Transportation communications | $ | 29,699,102 | $ | 29,440,853 | $ | 25,528,403 | ||||||
Law enforcement and surveillance | 2,033,961 | 2,144,347 | 1,763,182 | |||||||||
Parent entities | 2,818,833 | 1,797,986 | 1,518,564 | |||||||||
$ | 34,551,896 | $ | 33,383,186 | $ | 28,810,149 | |||||||
Long-lived assets | ||||||||||||
Transportation communications | $ | 13,309,034 | $ | 10,748,888 | $ | 8,698,249 | ||||||
Law enforcement and surveillance | 1,231,936 | 1,224,509 | 1,003,167 | |||||||||
Parent entities | 493,158 | 366,555 | 260,829 | |||||||||
$ | 15,034,128 | $ | 12,339,952 | $ | 9,962,245 | |||||||
Geographic information — net sales | ||||||||||||
NAFTA | $ | 25,909,172 | $ | 30,260,834 | $ | 28,974,134 | ||||||
Europe | 14,819,410 | 11,615,851 | 6,152,232 | |||||||||
Pacific and other | 3,297,660 | 3,261,301 | 2,088,986 | |||||||||
$ | 44,026,242 | $ | 45,137,986 | $ | 37,215,352 | |||||||
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(16) | SHAREHOLDERS’ RIGHTS | |||
On December 13, 1999, the Board of Directors approved a rights areement that establishes a shareholder rights plan designed to prevent any potential acquirer from obtaining control of the Company without negotiating the terms of the transaction with the Board of Directors. Under the rights plan, among other things, in the event of an acquisition of, or an announced tender offer for, 15 percent or more of the Company’s outstanding Common Stock, holders of the Common Stock (other than the person or group who acquired 15 percent or more of the Company’s stock) have been granted the right to purchase a fraction of a share of the Company’s Series D Junior Participating Preferred Stock or shares of the Common Stock having a market value of twice the exercise price of the rights. If, after any person acquires the specified percentage of the Common Stock, the Company is involved in a merger, consolidation, sale of assets or similar acquisition transaction, and it is not the acquiring or surviving corporation, then each right will entitle its holder to purchase, at the exercise price, shares of the acquiring or surviving company having a market value of twice the exercise price, and the acquiring or surviving company will be obligated to assume the Company’s obligations under the rights plan. | ||||
The rights will expire on October 7, 2009, if not previously redeemed or exchanged. The rights are redeemable by the Company at any time before any person acquires the specified percentage of the Company’s outstanding Common Stock at a redemption price of $0.001 per right, subject to certain adjustments for stock splits or similar events. After any person has acquired the specified percentage of the Company’s outstanding Common Stock and the rights have become exercisable, and before a majority of the Common Stock has been acquired, the Company may exchange all or part of the outstanding rights for shares of the Common Stock at an exchange ratio of one share of Common Stock per right, subject to certain adjustments for stock splits or similar events. | ||||
(17) | LEGAL PROCEEDINGS | |||
The Company, in the normal course of its operations, is involved in 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. | ||||
On or about September 17, 2002 the Company received a letter from Clever Devices, Ltd. (“Clever”), a New York corporation with its principal place of business located in Syosset, New York. That letter alleged that the StealthMic product of the Company, as introduced to the market in 1999, would infringe U.S. patent number 6,522,754 (“‘754 Patent”) entitled “Digital Vehicle Microphone System and Method,” which subsequently was issued to Clever by the U.S. Patent Office on February 18, 2003. Upon investigation, and further review by intellectual property counsel of the Company, the Company and its intellectual property counsel were unable to find any basis whatsoever for this allegation of infringement and so informed Clever on several occasions. Nevertheless, Clever proceeded to assert its position without being willing to engage in constructive dialogue to identify the basis for its allegations or to advance understanding of the issues. Therefore, being uncertain as to the intent of Clever, on April 3, 2003 the Company filed an action in the United States District Court for the Northern District of Texas, Dallas Division (“Court”), under the Federal Declaratory Judgment Act, 28 USC 2210 and 2201, and under the Patent Laws of the United States, 35 USC 271. This “declaratory judgment action” sought a finding by the Court to the effect that the Company was not infringing the ‘754 Patent. On May 23, 2003, Clever counter-claimed, seeking injunctive relief and unspecified damages. Subsequently, the Company filed further actions with the Court asking that a hearing on claims construction, referred to as a “Markman” hearing, be held prior to any other actions or discovery in this matter. On August 19, 2003, the Court issued an order so requiring a Markman hearing; which was held on February 3, 2004. On March 16, 2004 the Court handed-down its findings on the Markman hearing. While this recent development is still being evaluated by legal counsel, management believes the ruling virtually supports its contention that there is no valid claims basis for the allegation that the Company infringed the ‘754 Patent. The Company is now awaiting completion of review by |
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legal counsel and discussions are underway between the parties as to any mutually acceptable avenues for settlement. While the Company believes that its position on this matter is correct, there can be no assurance that the case will not proceed to trial in late 2004 and there can be no assurance that the Company would prevail at trial or on subsequent appeal. | ||||
The Company, to the best of its ability at all times seeks to avoid infringing, and will not knowingly violate the intellectual property rights of others. The Company believes the allegations of Clever are totally without merit and will proceed to defend its rights to conduct business freely while not infringing upon the legitimate intellectual property rights of Clever. | ||||
(18) | 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. The Company believed that it was reasonably likely that beginning in 2003 it would save approximately $200,000 per year in reduced employee expense, and beginning in 2004 it would 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. | ||||
No amounts were credited against the reserve during 2001. 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. During 2003, lease payments in the amount of $13,639 were charged against the reserve. 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 $9,361, the Company can reasonably expect $4,278 to be charged to the reserve during 2004. | ||||
(19) | RECENT PRONOUNCEMENTS | |||
In 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46) and its amendment 46R. This interpretation as amended 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. FIN 46R requires a company to evaluate all existing arrangements to identify situations where a company has a “variable interest” in a “variable interest entity” and further determine when such variable interests require a company to consolidate the variable interest entities’ financial statement with its own. The Company must adopt this interpretation by March 31, 2004 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 performed this assessment as of December 31, 2003; however, it is not aware of any variable interest entity which will require consolidation or disclosure. | ||||
In May 2003, the FASB issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 addresses financial accounting and reporting for how an issuer classifies and measures financial instruments with characteristics of both liabilities and equity. The provisions of SFAS 150 are effective for financial instruments entered into or modified after May 15, 2003. Adoption of SFAS No. 150 is not expected to have a material effect upon the Company’s financial position or operating results. |
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(20) | QUARTERLY FINANCIAL DATA (UNAUDITED) | |||
The following is a summary of unaudited quarterly results of operation for the years ended December 31, 2003 and 2002, respectively. |
YEAR ENDED DECEMBER 31, 2003 | ||||||||||||||||||||
First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Total | ||||||||||||||||
Net sales | $ | 10,917,194 | $ | 12,520,913 | $ | 10,612,407 | $ | 9,975,728 | $ | 44,026,242 | ||||||||||
Gross profit | 4,343,991 | 5,006,905 | 4,350,195 | 3,549,121 | 17,250,212 | |||||||||||||||
Operating income (loss) | 131,298 | 637,908 | 517,781 | (1,707,262 | ) | (420,275 | ) | |||||||||||||
Net income (loss) applicable to common shareholders | (211,466 | ) | 215,827 | 104,360 | (2,341,229 | ) | (2,232,508 | ) | ||||||||||||
Net income (loss) applicable to common shareholders per common share: | ||||||||||||||||||||
Basic | $ | (0.06 | ) | $ | 0.06 | $ | 0.03 | $ | (0.60 | ) | $ | (0.58 | ) | |||||||
Diluted | $ | (0.06 | ) | $ | 0.04 | $ | 0.02 | $ | (0.60 | ) | $ | (0.58 | ) | |||||||
Weighted average number of common shares and common equivalent shares outstanding: | ||||||||||||||||||||
Basic | 3,804,475 | 3,812,167 | 3,944,475 | 3,944,475 | 3,873,133 | |||||||||||||||
Diluted | 3,804,475 | 6,198,130 | 6,320,130 | 3,944,475 | 3,873,133 |
YEAR ENDED DECEMBER 31, 2002 | ||||||||||||||||||||
First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Total | ||||||||||||||||
Net sales | $ | 8,623,648 | $ | 12,434,455 | $ | 11,044,010 | $ | 13,035,873 | $ | 45,137,986 | ||||||||||
Gross profit | 3,089,231 | 4,661,101 | 3,748,898 | 4,775,764 | 16,274,994 | |||||||||||||||
Operating income (loss) | (363,112 | ) | 769,982 | 82,341 | 235,007 | 724,218 | ||||||||||||||
Net income (loss) applicable to common shareholders | (703,808 | ) | 618,580 | (319,053 | ) | 37,778 | (366,503 | ) | ||||||||||||
Net income (loss) applicable to common shareholders per common share: | ||||||||||||||||||||
Basic | $ | (0.19 | ) | $ | 0.17 | $ | (0.08 | ) | $ | 0.01 | $ | (0.10 | ) | |||||||
Diluted | $ | (0.19 | ) | $ | 0.11 | $ | (0.08 | ) | $ | 0.01 | $ | (0.10 | ) | |||||||
Weighted average number of common shares and common equivalent shares outstanding: | ||||||||||||||||||||
Basic | 3,704,475 | 3,704,475 | 3,769,692 | 3,804,475 | 3,746,119 | |||||||||||||||
Diluted | 3,704,475 | 5,473,740 | 3,769,692 | 3,804,475 | 3,746,119 |
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(21) | SUBSEQUENT EVENTS |
On March 29, 2004, the Board of Directors adopted Articles of Amendment authorizing an increase in the number of authorized shares of Series E Redeemable Nonvoting Convertible Preferred Stock from 500 to 600 shares
Subsequent to December 31, 2003 and up to the report date, the Company issued in private placements an additional 67 shares of Series E Stock. The proceeds to the Company of such transactions, net of redemption costs and offering expenses in the amount of approximately $26,800, was approximately $308,200. The Company has used these additional Series E proceeds to service and pay down debt and for other general corporate purposes.
On April 1, 2004, the Company and Dolphin Offshore Partners, L.P. (“Dolphin”) agreed to revise and reform the terms of the Series F Stock. The principal terms of the revisions are as follows:
On November 10, 2003, the Company closed the sale of 300 shares of Series F Stock to Dolphin for a purchase price of $1.5 million. Subsequently, the Company and Dolphin agreed to revise and reform the terms of the Series F Stock and related agreements in certain respects, and to terminate a related warrant, in order to comply with certain requirements of Nasdaq listing standards. The Series F Stock, as amended and reformed, is convertible at any time into shares of Common Stock at a conversion price of $2.00 per share of Common Stock, subject to certain adjustments for stock splits or similar events (the “Conversion Price”). Prior to conversion, the Series F Stock votes as a single class with holders of Common Stock, with each share of Series F Stock entitled to a number of votes equal to the liquidation value, which is $5,000 per share, divided by $2.35. The shares are mandatorily convertible into shares of Common Stock if the Common Stock hits certain targeted trading prices or upon the conversion of certain subordinated debentures beneficially owned by Renaissance U.S. Growth Investment Trust PLC and BFSUS Special Opportunities Trust PLC. See Note 7(b) “Long-Term Debt” of the Notes to Consolidated Financial Statements. The holder of the Series F Stock is entitled to receive cumulative quarterly dividends, in preference to the holders of Common Stock, at the rate of 3.0 percent per annum on the liquidation value of those shares, which dividends are currently payable in additional shares of Series F Stock having a liquidation value equal to the dividend amount. The Series F Stock dividend rate will increase to 10 percent per annum beginning in November 2008 if the Common Stock does not meet certain market price objectives before then. The Company also granted to Dolphin a right of first refusal to purchase, in connection with future equity offerings by the Company, for a period of five years after the Series F issuance date, a sufficient number of the securities issued in such equity offering to maintain its proportionate ownership interest in the Company, on a diluted basis, and this right has not been modified. The Company also granted to Dolphin certain rights to have the shares of Common Stock underlying the Series F Stock registered with the SEC.
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FINANCIAL STATEMENT SCHEDULE:
SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 2003, 2002 and 2001
Balance at | Additions | |||||||||||||||
beginning of | charged to costs | Deductions | Balance at | |||||||||||||
year | and expenses | (a) (b) (c) | end of year | |||||||||||||
Allowance for Doubtful Accounts | ||||||||||||||||
Year ended December 31, 2003 | 146,066 | 32,000 | (62,924 | )(a) | 115,142 | |||||||||||
Year ended December 31, 2002 | 115,158 | 87,746 | (56,838 | )(a) | 146,066 | |||||||||||
Year ended December 31, 2001 | 55,000 | 60,158 | — | 115,158 | ||||||||||||
Inventory Reserve | ||||||||||||||||
Year ended December 31, 2003 | 736,795 | 219,890 | (103,641 | )(c) | 853,044 | |||||||||||
Year ended December 31, 2002 | 631,299 | 161,478 | (55,982 | )(c) | 736,795 | |||||||||||
Year ended December 31, 2001 | 349,995 | 302,488 | (21,184 | )(c) | 631,299 |
(a) | Write-off of uncollectible accounts. | |||
(b) | Write-off of warranty claims | |||
(c) | Write-off of obsolete inventory |
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DIGITAL RECORDERS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, 2004 | December 31, 2003 | |||||||
(Unaudited) | (Note) | |||||||
ASSETS | ||||||||
Current Assets | ||||||||
Cash and cash equivalents | $ | 191,727 | $ | 970,222 | ||||
Trade accounts receivable, less allowance for doubtful accounts of $115,317 at March 31, 2004 and $115,042 at December 31, 2003 | 9,579,344 | 6,974,914 | ||||||
Other receivables | 407,161 | 379,369 | ||||||
Inventories (Note 5) | 10,239,477 | 9,797,610 | ||||||
Prepaids and other current assets | 466,544 | 555,068 | ||||||
Total current assets | 20,884,253 | 18,677,183 | ||||||
Property and equipment, less accumulated depreciation of $2,454,742 at March 31, 2004 and $2,351,651 at December 31, 2003 (Note 6) | 2,490,417 | 2,434,589 | ||||||
Goodwill, less accumulated amortization of $1,129,098 at March 31, 2004 and $1,144,248 at December 31, 2003 (Note 4) | 10,184,672 | 10,666,113 | ||||||
Intangible assets, less accumulated amortization of $616,718 at March 31, 2004 and $598,484 at December 31, 2003 (Note 4) | 1,424,832 | 1,527,292 | ||||||
Deferred tax assets | 765,184 | 840,585 | ||||||
Other assets | 459,705 | 406,134 | ||||||
TOTAL ASSETS | $ | 36,209,063 | $ | 34,551,896 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Current Liabilities | ||||||||
Lines of credit (Notes 3 and 7) | $ | 7,206,563 | $ | 5,983,051 | ||||
Current maturities of long-term debt (Notes 3 and 7) | 1,541,348 | 1,249,110 | ||||||
Accounts payable | 7,291,380 | 6,456,870 | ||||||
Accrued expenses | 2,177,664 | 2,334,050 | ||||||
Deferred tax liabilities | 184,651 | 193,918 | ||||||
Preferred stock dividends payable | 111,531 | 117,983 | ||||||
Total current liabilities | 18,513,137 | 16,334,982 | ||||||
Long-term debt and other obligations, less current maturities (Notes 2, 3 and 7) | 6,284,783 | 6,647,052 | ||||||
Minority interest in consolidated subsidiary | 374,411 | 338,199 | ||||||
Commitments and contingencies (Notes 7 and 13) | ||||||||
Shareholders’ Equity | ||||||||
Series E Redeemable, Nonvoting, Convertible Preferred Stock, $.10 par value, Liquidation Preference of $5,000 per share; 500 shares authorized; 430 and 363 shares issued and outstanding at March 31, 2004 and December 31, 2003, respectively. (Note 3) | 1,730,374 | 1,440,295 |
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March 31, 2004 | December 31, 2003 | |||||||
(Unaudited) | (Note) | |||||||
Series F Convertible Preferred Stock, $.10 par value, Liquidation Preference of $5,000 per share; 400 shares authorized; 300 shares issued and outstanding at March 31, 2004 and December 31, 2003, respectively. (Note 3) | 1,500,000 | 1,500,000 | ||||||
Series AAA Redeemable, Nonvoting Preferred Stock, $.10 par value, Liquidation Preference of $5,000 per share; 20,000 shares authorized; 354 shares issued and outstanding at March 31, 2004 and December 31, 2003; redeemable at the discretion of the Company. (Note 3) | 1,770,000 | 1,770,000 | ||||||
Common stock, $.10 par value, 25,000,000 shares authorized; 3,944,475 issued and outstanding at March 31, 2004 and December 31, 2003. (Note 3) | 394,447 | 394,447 | ||||||
Additional paid-in capital | 13,097,151 | 13,259,542 | ||||||
Accumulated other comprehensive income — foreign currency translation | 1,782,836 | 2,271,823 | ||||||
Accumulated deficit | (9,238,076 | ) | (9,404,444 | ) | ||||
Total shareholders’ equity | 11,036,732 | 11,231,663 | ||||||
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 36,209,063 | $ | 34,551,896 | ||||
See accompanying notes to unaudited consolidated financial statements.
Note: The consolidated balance sheet at December 31, 2003 has been derived from the audited financial statements at that date.
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DIGITAL RECORDERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003
Three Months Ended March 31, | ||||||||
2004 | 2003 | |||||||
Net sales | $ | 12,135,706 | $ | 10,917,194 | ||||
Cost of sales | 7,052,114 | 6,573,203 | ||||||
Gross profit | 5,083,592 | 4,343,991 | ||||||
Operating expenses: | ||||||||
Selling, general and administrative | 3,755,187 | 3,562,696 | ||||||
Research and development | 733,499 | 649,997 | ||||||
Total operating expenses | 4,488,686 | 4,212,693 | ||||||
Operating income | 594,906 | 131,298 | ||||||
Other income | 32,285 | 19,483 | ||||||
Foreign currency translation gain (loss) | (114,646 | ) | 28,659 | |||||
Interest expense, net | (233,032 | ) | (309,823 | ) | ||||
Total other expense and interest expense | (315,393 | ) | (261,681 | ) | ||||
Income (loss) before income taxes | 279,513 | (130,383 | ) | |||||
Income tax benefit (expense) | (76,923 | ) | 601 | |||||
Income (loss) before minority interest in income of consolidated subsidiary | 202,590 | (129,782 | ) | |||||
Minority interest in income of consolidated subsidiary | (36,212 | ) | (37,434 | ) | ||||
Net income (loss) | 166,378 | (167,216 | ) | |||||
Preferred stock dividends | (80,781 | ) | (44,250 | ) | ||||
Net income (loss) applicable to common shareholders | $ | 85,597 | $ | (211,466 | ) | |||
Earnings per share: | ||||||||
Net income (loss) per share applicable to common shareholders: | ||||||||
Basic | $ | 0.02 | $ | (0.06 | ) | |||
Diluted | $ | 0.02 | $ | (0.06 | ) | |||
Weighted average number of common shares and common equivalent shares outstanding: | ||||||||
Basic | 3,944,475 | 3,804,475 | ||||||
Diluted | 4,110,127 | 3,804,475 | ||||||
See accompanying notes to unaudited consolidated financial statements.
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DIGITAL RECORDERS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003
Three Months Ended March 31, | ||||||||
2004 | 2003 | |||||||
Cash flows from operating activities: | ||||||||
Net income (loss) | $ | 166,378 | $ | (167,216 | ) | |||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | ||||||||
Deferred income taxes, net | 73,229 | — | ||||||
Depreciation of property and equipment | 157,299 | 134,335 | ||||||
Amortization of intangible assets | 40,633 | 34,792 | ||||||
Other, primarily effect of foreign currency (gain) loss | 77,000 | (52,574 | ) | |||||
Minority interest | 36,212 | 37,434 | ||||||
Changes in operating assets and liabilities: | ||||||||
(Increase) decrease in trade accounts receivable | (2,699,617 | ) | 916,867 | |||||
Increase in other receivables | (42,286 | ) | (275,563 | ) | ||||
(Increase) decrease in inventories | (557,304 | ) | 130,188 | |||||
(Increase) decrease in prepaids and other current assets | 83,356 | (77,494 | ) | |||||
Increase (decrease) in accounts payable | 913,096 | (179,074 | ) | |||||
Decrease in accounts payable, related party | — | 356,628 | ||||||
Decrease in accrued expenses | (105,225 | ) | (149,137 | ) | ||||
Net cash provided by (used in) operating activities | (1,857,229 | ) | 709,186 | |||||
Cash flows from investing activities: | ||||||||
Purchases of property and equipment | (285,537 | ) | (176,317 | ) | ||||
Purchases of other assets | (67,233 | ) | (85,501 | ) | ||||
Net cash used in investing activities | (352,770 | ) | (261,818 | ) | ||||
Cash flows from financing activities: | ||||||||
Proceeds from bank borrowings and lines of credit | 12,776,045 | 12,101,686 | ||||||
Principal payments on bank borrowings and lines of credit | (11,458,674 | ) | (12,866,728 | ) | ||||
Proceeds from issuance of Series E preferred stock, net of issuance cost | 290,079 | — | ||||||
Payment of dividends on preferred stock | (44,250 | ) | (44,250 | ) | ||||
Net cash provided by (used in) financing activities | 1,563,200 | (809,292 | ) | |||||
Effect of exchange rate changes on cash and cash equivalents | (131,694 | ) | (5,934 | ) | ||||
Net decrease in cash and cash equivalents | (778,493 | ) | (367,858 | ) | ||||
Cash and cash equivalents at beginning of Period | 970,222 | 504,758 | ||||||
Cash and cash equivalents at end of period | $ | 191,729 | $ | 136,900 | ||||
Supplemental Disclosure of Cash Flow Information: | ||||||||
Cash paid during the period for interest | $ | 223,448 | $ | 262,774 | ||||
Cash paid during the period for income Taxes | $ | — | $ | 41,681 | ||||
See accompanying notes to unaudited consolidated financial statements.
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DIGITAL RECORDERS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(1) | BASIS OF PRESENTATION AND DISCLOSURE | |||
The unaudited interim consolidated financial statements and related notes of Digital Recorders, Inc. and Subsidiaries (the “Company” or “DRI”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to such rules and regulations. However, in the opinion of management, the accompanying unaudited financial statements contain all adjustments and information (consisting only of normal recurring accruals) considered necessary to present fairly the results for the interim periods presented. | ||||
The accompanying consolidated financial statements and related notes should be read in conjunction with the Company’s audited financial statements included in its Annual Report on Form 10-K/A (Amendment No. 2) for the year ended December 31, 2003. The results of operations for the three months ended March 31, 2004 are not necessarily indicative of the results to be expected for the full calendar year. | ||||
(2) | MANAGEMENT’S PLANS | |||
The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. | ||||
The Company initiated plans and strategies in 2002 and 2003 to improve the operating results and to reduce the pressure on liquidity. The primary elements of the Company’s strategies, objectives, plans and actions are, including updates for the results for the three months ended March 31, 2004 and subsequent events through the date of this prospectus: | ||||
1. | Restructure Debt. The Company has raised significant amounts of cash through secured and subordinated debt financing and has good relationships with debt holders, quasi-debt holders and vendors to mitigate liquidity pressures. | |||
On November 6, 2003, the Company replaced its asset-based lending agreement formerly with Guaranty Business Credit Corporation with a three year agreement (the “Credit Agreement”) with LaSalle Business Credit LLC. The Credit Agreement provides up to $10.0 million in borrowing to be used for acquisitions, working capital and general corporate purposes. The borrowing is inclusive of $2.0 million for Letters of Credit and $0.5 million for term loans. The interest rate on loans under this agreement is the published prime lending rate (4.00 percent at December 31, 2003) plus 1.75 percent. There is a fee equal to 2.5 percent on the aggregate undrawn face amount of all Letters of Credit outstanding. | ||||
The Company presently does not anticipate the need to secure additional debt financing, negotiate debt restructurings or negotiate conversion of trade payables to equity to mitigate liquidity pressures in 2004. This belief of the Company is based on the first quarter results for 2004, forecasts for the remainder of the year, and other management plans that were implemented in 2003 or which are being implemented in 2004. However, the Company will pursue all appropriate measures to address liquidity should cash flow prove unsatisfactory in 2004. | ||||
On April 23, 2004, the holders of convertible debentures with a carrying value of $3,997,000 were converted into common stock shares of 2,075,000. As a result of this conversion, the Company will record a charge of $153,000 to write-off the unamortized debt discount and $4,150,000 will be recorded as equity on the balance sheet. This will result in a reduction of the annual cash interest expense by approximately $332,000. See Note 3. | ||||
The Company believes it has relationships with both debt holders and suppliers to enable the Company to manage the timing of planned cash disbursements to the positive generation of cash during 2004. | ||||
2. | Reduce Operating Costs and Improve Efficiency. In the normal course of business, the Company has aggressively sought opportunities to reduce the cost structure and increase overall efficiency and responsiveness to its customers. In 2003, the Company initiated “tracked and monitored” profit improvement initiatives designed to further leverage the economy of scale that was developing in its operations. The Company intends to continue developing its manufacturing and assembly infrastructure and organization to meet expected production requirements. The Company will continue manufacturing in-house certain key components of its products such as cable harnesses and assemblies, electronic destination sign systems, digital audio filter equipment and sub-system electronics. The Company believes this will enable it to: (1) produce highly reliable, quality products; (2) protect the proprietary nature of our technology and processes; (3) properly control our |
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manufacturing and assembly processes and operations; and (4) achieve significant cost reductions. The cost reductions encompass all major elements of cost and operating expenses. | ||||
The Company believes that in 2004 the strategies above will generate year-over-year improvement. | ||||
3. | Increase Ownership Equity. On April 24, 2004, the Company sold 625,000 shares of common stock to investors for $8.00 per share. The proceeds to the Company, net of issuance expenses, were $4,575,000. The Company has also granted the investors warrants to acquire 125,000 shares of common stock at an exercise price of $8.80 per share, exercisable for a period of five years. Additionally, the Company granted the investors’ placement agent warrants to acquire 65,000 shares of common stock at an exercise price of $10.25, exercisable for a period of five years. These warrants are restricted from conversion to common stock for a period of six months from the date of placement above. In connection with the above transaction, the Company executed Registration Rights agreements for both the common shares and warrants. | |||
Between April 22, 2004 and April 30, 2004, warrant holders exercised their rights to acquire common stock. The warrants were issued in conjunction with investment banking activities in prior years. The Company received total cash in the amount of $605,500 for issuing 170,000 shares under the warrant agreements. | ||||
Between April 22, 2004 and April 30, 2004, the holders of Series AAA preferred stock converted 104 shares with a carrying value of $520,000 to 65,000 common shares. As result of this conversion, the Company will reclassify $520,000 from Series AAA preferred stock to common stock as of the dates of the conversion, the result of which is a reduction of the annual dividends expense by $52,000. | ||||
On April 23, 2004, the holders of convertible debentures with a carrying value of $3,997,000 were converted into common stock shares of 2,075,000. As a result of this conversion, the Company will record a charge of $153,000 to write-off the unamortized debt discount and $4,150,000 will be recorded as equity on the balance sheet. This will result in a reduction of the annual cash interest expense by approximately $332,000. | ||||
On April 27, 2004, the holder of the Series F convertible preferred stock with a carrying value of $1,500,000 converted 304 preferred shares to 760,232 shares of common stock. This conversion represents 100% of the total conversion number of shares available. As a result of this conversion, $1.5 million of Series F convertible preferred stock will be reclassified as common stock as of the date of conversion. | ||||
During the three months ended March 31, 2004, the Company issued in private placements an additional 67 shares of Series E Convertible Preferred stock. The net proceeds to the Company of such transactions were approximately $290,079. | ||||
The Board of Directors has authorized the Company to raise the limit on Series E issuance from 500 to 600 shares. As of March 31, 2004, the present placements total 430 shares leaving available up to 170 shares for future placement. The Series E placements to date in 2004 are evidence that the Company is capable of securing additional equity financing when necessary. Company management considers the Series E and Series F placements to be closed subject to ratification by the Company’s Board of Directors. Notwithstanding this plan, the Company believes the balance sheet equity raised through Series E, Series F and common stock placements to date is sufficient for the balance of 2004 when aggregated with other Company plans and strategies to alleviate liquidity pressures. | ||||
The Company anticipates that additional equity financing may be sought in the latter part of 2004 in conjunction with potential acquisitions or launch of new business initiatives. In this regard, the Company is presently evaluating alternative measures and action plans, and soliciting proposals to secure additional equity from investment banks. | ||||
4. | Maintain Our Focus on Technical Excellence and Innovation.The Company is continuing to maintain its leadership in the transportation and law enforcement and surveillance markets served. In order to expand and protect its technology, the Company will continue to seek patent protection for its products and or licenses of key technology owned by others. The Company has introduced improved and new technologies in 2003 including the DR600 vehicle logic unit (“VLU”) that is the integration communication platform for transit vehicle systems including fare collection, automatic passenger counting, automatic vehicle announcement systems, engine monitoring, vehicle location and monitoring (for fleet management and security purposes) and other applications. The Company has introduced full color electronic destination sign systems and with its global presence is leveraging on purchasing power to realize decreased cost of materials. Our subsidiary, Digital Audio, continues to develop new products for the law enforcement and surveillance markets taking advantage of the initiatives in U.S Homeland Security. The Company considers any increase in government funding related to national security, intelligence, and law enforcement initiatives as having the potential to influence positively the opportunity to sell our audio processing solutions. Additionally, as a result of increased attention to the potential for |
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terrorist’s threats to transit vehicles and infrastructure, the Company has the potential to leverage on the vehicle locating and monitoring aspect of its Transportation Segment; an essential element of security is knowing, on a real time basis, the precise location of critical assets. | ||||
5. | Pursue Strategic Partnerships, Alliances and Acquisitions.In September 2003, the Company and GE Transportation Systems Global Signaling, LLC (“GETSGS”) through General Electric’s (“GE”) Advanced Communications division based in Hingham, Mass signed a three-year Teaming Agreement. Through this agreement, the Company and GETSGS will work together to deliver advanced technology systems integration projects. The Digital Recorders division will focus on vehicle location and passenger information processing and delivery systems while GETSGS will focus on communications technology, project management, and system integration. Through this agreement with GE, an organization that is uniquely capable of integrating our products with much larger systems in ways that exceed our independent technological and financial capabilities, the Company believes it will significantly extend our transit market reach. The Company further believes the GPS-based vehicle location products, including the security aspect of such as noted above, may represent one of the Company’s more significant internal growth opportunities in fiscal year 2004. | |||
6. | Increase working capital through better asset management. The Company has recognized that the working capital assets of trade accounts receivable and inventories represent significant opportunities if properly and aggressively managed. Customer account balances are continually monitored and evaluated by reviewing payment history and patterns of heavy shipments that could limit credit line borrowings with the asset-based lender. The Company believes the decrease in the average days sales outstanding will help mitigate period to period liquidity tightness. As the inventories increased in recent years due to requirement of the markets served and improvements in technology, the Company has developed initiatives to promote retro-fit sales programs and incentives to use existing versions of technology in inventory. |
The Company has historically met cash needs from the proceeds of debt and sale of preferred equity in private placements. Management continues to assess its product lines in light of technology trends and economic conditions, to enhance existing product lines or create new distribution channels.
The Company believes the cash and cash equivalents at March 31, 2004, together with the operating loan and equity proceeds, will be sufficient to fund operations for the remainder of 2004, assuming continued improvement in the Company’s overall cost structure resulting from continued cost reduction activities, ongoing efforts aimed at controlling costs and improvements in asset management of trade accounts receivable and inventories.
(3) | PRO FORMA BALANCE SHEET AND SUPPLEMENTAL DATA |
The following pro forma balance sheet as of March 31, 2004 and supplemental data consider certain transactions occurring after the balance sheet date and on or prior to April 30, 2004, that will have a significant effect on the information included in the Company’s balance sheets for future periods. These transactions involved the issuance by the Company of shares of its common stock, par value $.10 per share (“Common Stock”), and included a private placement of Common Stock to institutional investors and the conversion and exercise of previously issued debt securities, preferred stock and warrants. The pro forma balance sheet and supplemental data give effect to these transactions as if they had occurred on March 31, 2004. Supplemental information is also provided showing the effect of these transactions, on the same pro forma basis, on the Company’s outstanding balances under its lines of credit and the components of the Company’s long-term debt and the shares of Common Stock outstanding assuming all cash proceeds were used to pay down line of credit borrowings.
Proforma Adjustments The following adjustments present the description and related amounts associated with the transactions completed between April 1, 2004 and April 30, 2004:
a. | On April 24, 2004, the Company sold 625,000 shares of common stock to investors for $8.00 per share. The proceeds to the Company, net of issuance expenses, were $4,575,000. The Company has also granted the investors warrants to acquire an aggregate of 125,000 shares of common stock at an exercise price of $8.80 per share, exercisable for a period of five years. Additionally, the Company granted a placement agent a warrant to acquire 62,500 shares of common stock at an exercise price of $10.25, exercisable for a period of five years. The placement agent warrant is restricted from conversion to common stock for a period of six months from the date of placement above. In connection with the above transaction, the Company executed Registration Rights agreements for both the common shares and warrants. | |||
b. | Between April 22, 2004 and April 30, 2004, warrant holders exercised their rights to acquire common stock. The warrants were issued in conjunction with investment banking activities in prior years. The Company received total cash in the amount of $605,500 for issuing 170,000 shares under the warrant agreements. |
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c. | Between April 22, 2004 and April 30, 2004, holders of Series AAA preferred stock converted 104 shares with a carrying value of $520,000 to 65,000 common shares. As a result of this conversion, the Company will reclassify $520,000 from Series AAA preferred stock to common stock as of the dates of the conversion, the result of which is a reduction of the annual dividends expense by $52,000. | |||
d. | On April 23, 2004, convertible debentures with a carrying value of $3,997,000 were converted into 2,075,000 shares of common stock. As a result of this conversion, the Company will record a charge of $153,000 to write-off the unamortized debt discount and $4,150,000 will be recorded as equity on the balance sheet. This will result in a reduction of the annual cash interest expense by approximately $332,000. | |||
e. | On April 27, 2004, the holder of the Series F convertible preferred stock with a carrying value of $1,500,000 and a paid-in-kind dividend of $20,414 converted 304 preferred shares to 760,232 shares of common stock. This conversion represents 100% of the total conversion number of shares available. As a result of this conversion, $1,520,414 of Series F convertible preferred stock will be reclassified as common stock and additional paid-in-capital as of the date of conversion. |
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DIGITAL RECORDERS, INC. AND SUBSIDIARIES
PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
March 31, | ||||||||||||
March 31, 2004 | Pro forma | 2004 (Pro | ||||||||||
(Historical) | Adjustments | forma) | ||||||||||
ASSETS | ||||||||||||
Current Assets | ||||||||||||
Cash and cash equivalents | $ | 191,727 | $ | — | $ | 191,727 | ||||||
Trade accounts receivable | 9,579,344 | — | 9,579,344 | |||||||||
Other receivables | 407,161 | — | 407,161 | |||||||||
Inventories | 10,239,477 | — | 10,239,477 | |||||||||
Prepaids and other current assets | 466,544 | — | 466,544 | |||||||||
Total current assets | 20,884,253 | — | 20,884,253 | |||||||||
Property and equipment | 2,490,417 | — | 2,490,417 | |||||||||
Goodwill | 10,184,672 | — | 10,184,672 | |||||||||
Intangible assets | 1,424,832 | — | 1,424,832 | |||||||||
Deferred tax assets | 765,184 | — | 765,184 | |||||||||
Other assets | 459,705 | — | 459,705 | |||||||||
TOTAL ASSETS | $ | 36,209,063 | $ | — | $ | 36,209,063 | ||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||||||
Current Liabilities | ||||||||||||
Lines of credit (see Lines of Credit and notes a. and b. above) | $ | 7,206,563 | $ | (5,180,500 | ) | $ | 2,026,063 | |||||
Current maturities of long-term debt (see Long-term Debt below) | 1,541,348 | (259,448 | ) | 1,281,900 | ||||||||
Accounts payable | 7,291,380 | — | 7,291,380 | |||||||||
Accrued expenses | 2,177,664 | — | 2,177,664 | |||||||||
Deferred tax liabilities | 184,651 | — | 184,651 | |||||||||
Preferred stock dividends payable | 111,531 | — | 111,531 | |||||||||
Total current liabilities | 18,513,137 | (5,439,948 | ) | 13,073,189 | ||||||||
Long-term debt and other obligations, less current maturities (see Long-term debt below and notes a. and b. above) | 6,284,783 | (3,737,552 | ) | 2,547,231 | ||||||||
Minority interest in consolidated subsidiary | 374,411 | — | 374,411 | |||||||||
Commitments and contingencies | — | — | — | |||||||||
Shareholders’ Equity | ||||||||||||
Series E Redeemable, Nonvoting, Convertible Preferred Stock, $.10 par value, Liquidation Preference of $5,000 per share | 1,730,374 | — | 1,730,374 | |||||||||
Series F Convertible Preferred Stock, $.10 par value, Liquidation Preference of $5,000 per share (see note e. above) | 1,500,000 | (1,500,000 | ) | — |
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March 31, | ||||||||||||
March 31, 2004 | Pro forma | 2004 (Pro | ||||||||||
(Historical) | Adjustments | forma) | ||||||||||
Series AAA Redeemable, Nonvoting Preferred Stock, $.10 par value, Liquidation Preference of $5,000 per share (see note c. above) | 1,770,000 | (520,000 | ) | 1,250,000 | ||||||||
Common stock, $.10 par value | 394,447 | 369,523 | 763,970 | |||||||||
Additional paid-in capital | 13,097,151 | 10,827,977 | 23,925,128 | |||||||||
Accumulated other comprehensive income- foreign currency translation | 1,782,836 | — | 1,782,836 | |||||||||
Accumulated deficit | (9,238,076 | ) | (9,238,076 | ) | ||||||||
Total shareholders’ equity | 11,036,732 | 9,177,500 | 20,214,232 | |||||||||
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 36,209,063 | $ | — | $ | 36,209,063 | ||||||
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Pro Forma Common Stock
The shares of Commons Stock outstanding at March 31, 2004 would consist of the following:
March 31, | March 31, | |||||||||||
2004 | Pro forma | 2004 | ||||||||||
(Historical) | adjustments | (Pro forma) | ||||||||||
Common stock, $.10 par value | 3,944,475 | 3,944,475 | ||||||||||
Common stock sold on April 26, 2004 (see note a. above) | 625,000 | 625,000 | ||||||||||
Common stock issued upon exercise of warrants (see note b. above) | 170,000 | 170,000 | ||||||||||
Common stock issued upon conversion of Series AAA preferred stock (see note c. above) | 65,000 | 65,000 | ||||||||||
Common stock issued upon conversion of sub-debt (see note d. above) | 2,075,000 | 2,075,000 | ||||||||||
Common stock issued upon conversion of Series F convertible preferred stock (see note e. above) | 760,232 | 760,232 | ||||||||||
Total Shares of Common Stock | 3,944,475 | 3,695,232 | 7,639,707 | |||||||||
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Pro Forma Lines of Credit
Lines of credit at March 31, 2004 would consist of the following:
March 31, | March 31, | |||||||||||
2004 | Pro forma | 2004 | ||||||||||
(Historical) | adjustments | (Pro forma) | ||||||||||
Credit line with LaSalle Business Credit LLC, dated November 6, 2003, payable in full November 15, 2006, secured by accounts receivable, inventory and all assets of the U.S. based domestic entities of the Company | $ | 5,465,428 | $ | (5,180,500) | * | $ | 284,928 | |||||
Line of credit with Swedish bank dated December 31, 2003, secured by assets of the Swedish subsidiary, Mobitec AB, and a cash deposit, with average interest of 4.1% | 1,235,968 | — | 1,235,968 | |||||||||
Line of credit with Swedish bank dated December 31, 2003 secured by accounts receivable of the Swedish subsidiary, Mobitec AB, with average interest at 5.29% | 505,167 | — | 505,167 | |||||||||
Total lines of credit | $ | 7,206,563 | $ | (5,180,500 | ) | $ | 2,026,063 | |||||
* | All cash proceeds from equity transactions applied to outstanding credit line debt (see items a., b., and c. above) |
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Pro Forma Long-term Debt
Long-term debt at March 31, 2004 would consist of the following:
March 31, | March 31, | |||||||||||
2004 | Proforma | 2004 | ||||||||||
(Historical) | Adjustments | (Proforma) | ||||||||||
Unsecured note to a stockholder, dated June 28, 2001, payable in full June 30, 2005, with interest at 9%, increasing to 10% in July 2004 | $ | 1,765,235 | $ | — | $ | 1,765,235 | ||||||
Unsecured obligation to a stockholder dated June 28, 2001, payable in 12 quarterly installments, with zero interest | 225,000 | — | 225,000 | |||||||||
Note payable to a Swedish bank, dated June 28, 2001, payable in 20 quarterly installments of $144,650 including interest at 5.35%. Note collateralized by stock of Swedish holding company and consolidated subsidiary. | 1,588,896 | — | 1,588,896 | |||||||||
Convertible debentures dated June 22, 2001, payable in full June 22, 2008, with interest at 8%, net of unamortized discount arising from warrants (see note d. above) | 2,847,000 | (2,847,000 | ) | — | ||||||||
Convertible debentures dated July 31, 2002, payable in full June 27, 2009, with interest at 8% (see note d. above) | 1,150,000 | (1,150,000 | ) | — | ||||||||
Convertible debenture dated August 26, 2002, payable in full August 26, 2009, with interest at 8% | 250,000 | — | 250,000 | |||||||||
Total long-term debt | 7,826,131 | (3,997,000 | ) | 3,829,131 | ||||||||
Less current maturities | 1,541,348 | (259,448 | ) | 1,281,900 | ||||||||
$ | 6,284,783 | $ | (3,737,552 | ) | $ | 2,547,231 | ||||||
(4) | GOODWILL AND OTHER INTANGIBLE ASSETS |
The Company has recorded goodwill in connection with its acquisition of Digital Audio Corporation and Mobitec. The carrying values of these 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. The Company completed its annual goodwill and indefinite life intangible asset impairment evaluations as of December 31, 2003 and 2002, and has concluded that no impairment exists. Therefore, as a result of these impairment evaluations, no impairment charges were recorded during the years ended December 31, 2003 and 2002. No significant changes in the carrying amount of goodwill for each of the Company’s operating segments or in the composition of the Company’s acquired intangible assets and the associated accumulated amortization have occurred since December 31, 2003.
(5) | INVENTORIES |
Inventories consist of the following:
March 31, | December 31, | |||||||
2004 | 2003 | |||||||
Raw materials and system components | $ | 7,363,120 | $ | 7,477,081 | ||||
Work in process | 211,560 | 233,436 | ||||||
Finished goods | 2,664,797 | 2,087,093 | ||||||
$ | 10,239,477 | $ | 9,797,610 | |||||
(6) | PROPERTY AND EQUIPMENT |
Property and equipment consists of the following:
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March 31, | December 31, | |||||||
2004 | 2003 | |||||||
Leashold improvements | $ | 96,785 | $ | 87,561 | ||||
Computer and telecommunications equipment | 3,014,495 | 2,847,287 | ||||||
Test equipment | 223,142 | 224,022 | ||||||
Furniture and fixtures | 1,610,737 | 1,627,370 | ||||||
4,945,159 | 4,786,240 | |||||||
Less accumulated depreciation and amortization | 2,454,742 | 2,351,651 | ||||||
$ | 2,490,417 | $ | 2,434,589 | |||||
(7) | LINES OF CREDIT AND LONG-TERM DEBT |
a) Lines of Credit
On November 6, 2003, the Company replaced its asset-based lending agreement formerly with Guaranty Business Credit Corporation (“GBCC”) with a three-year agreement (the “Credit Agreement”) with LaSalle Business Credit LLC (“LBC”). Borrowings under the Credit Agreement are classified as current liabilities in accordance with EITF 95-22 Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements That Include Both a Subjective Acceleration Clause and a Lock-Box Arrangement. However, it is management’s intention to manage the bank credit facility as long-term debt with a final maturity date in 2006, as provided for in the Credit Agreement.
At March 31, 2004, the Credit Agreement provided up to $10.0 million in borrowing to be used for acquisitions, working capital and general corporate purposes. The borrowing is inclusive of $2.0 million for Letters of Credit and $0.5 million for term loans. The original interest rate on loans under the Credit Agreement is the published prime lending rate (4.00 percent at March 31, 2004) plus 1 percent. There is a fee equal to 2.5 percent on the aggregate undrawn face amount of all Letters of Credit outstanding.
The Credit Agreement, which has been amended on April 14, 2004 as discussed below, includes customary covenants and conditions relating to the conduct and operation of the Company’s business. Specifically, the Credit Agreement subjects the Company to an escalating fixed charge coverage ratio from 1.0 to 1.5 and an escalating tangible net worth value (as defined) from $2.5 million to $3.9 million over the term of the agreement calculated on a quarterly and rolling 12-month basis; limits annual capital expenditures to $1.5 million and limits credit by providing for a reserve of $500,000 until certain financial covenants have been met. At March 31, 2004, available collateral based on the value of eligible trade accounts receivable and inventories was $6,630,927, which, given the outstanding debt balance under the Credit Agreement of $5,465,428, would have resulted in additional borrowing availability of $1,165,499. However, the required reserve reduced additional borrowing availability by $500,000 to $665,499. The outstanding debt under the Credit Agreement is secured by substantially all U.S.-based assets of the Company.
On April 14, 2004, the Company and LBC agreed amendments to the escalating tangible net worth, escalating fixed charge coverage ratio loan covenants and other terms. The amendments to take into account the Company’s results of operations for the three months ended December 31, 2003 that affected the initial covenant computations. These covenants were revised after considering the results of operations for the three months ended December 31, 2003 and the Company’s projected operating plan for the year ending December 31, 2004.
The escalating tangible net worth covenant’s “Minimum Tangible Net Worth” has been reduced by $1.0 million and reset to $1.5 million from $2.5 million for the period of December 31, 2003 through December 30, 2004 and increases $600,000 per year thereafter for the remaining life of the loan. The time periods required to maintain the escalating fixed charged coverage ratio have also been reduced to exclude the three months ended December 31, 2003; and are now 1.00:1.00 for the three and six months ended March 31, 2004 and June 30, 2004; and 1.15:1.00 for the nine and twelve months ended September 30, 2004 and December 31, 2004. Additionally, the interest rate on borrowings increased from prime plus 1.00 to prime plus 1.75 effective April 14, 2004 and forward. Also, the reserve on borrowings was increased to $600,000 from $500,000 until receipt of the certified 2004 financial statements reflecting an EBITDA to fixed charge coverage ratio of at least 1.15:1.00, resulting in an as amended borrowing availability of $565,499 as of March 31, 2004. At March 31, 2004, the Company was in compliance with its financial covenants within the Credit Agreement, as amended.
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 $1,315,000 (based on the March 31, 2004 conversion rate). At March 31, 2004, 9,398,996 krona (SEK), or $1,235,968 was outstanding, resulting in additional borrowing availability of 601,004 krona (SEK), or $79,032. 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 $289,300. The terms of this agreement require payment of an unused credit line fee equal to 0.5 percent of the unused portion and average interest of 4.1 percent of the outstanding balance. This agreement is secured by
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substantially all assets of Mobitec AB. The agreement has an expiration date of December 31, 2004. On or before expiration, the Company expects to renew this agreement with an agreement substantially similar in terms and conditions.
Mobitec AB also has an agreement with the same bank from which it may borrow up to 6,000,000 krona (SEK), or $789,000 (based on the March 31, 2004 conversion rate). Based upon the availability formula under this agreement, 3,841,574 krona (SEK), or $505,167 was available at March 31, 2003, resulting in additional borrowing availability of 2,158,426 krona (SEK), or $283,833. The line of credit bears average interest of 5.29 percent and is collateralized by accounts receivable of Mobitec AB. The agreement has an expiration date of December 31, 2004. On or before expiration, the Company expects to renew this agreement with an agreement substantially similar in terms and conditions.
Lines of credit at March 31, 2004 and December 31, 2003 consist of the following:
March 31, | December 31, | |||||||
2004 | 2003 | |||||||
Credit line with LaSalle Business Credit, dated November 6, 2003, payable in full November 15, 2006, secured by accounts receivable, inventory and all assets of the U.S. based domestic entities of the Company. | $ | 5,465,428 | $ | 4,222,336 | ||||
Line of credit with Swedish bank dated December 31, 2003, secured by assets of the Swedish subsidiary, Mobitec AB, and a cash deposit, with average interest of 4.1%. | 1,235,968 | 1,356,435 | ||||||
Line of credit with Swedish bank dated December 31, 2003 secured by accounts receivable of the Swedish subsidiary, Mobitec AB, with average interest at 5.29%. | 505,167 | 404,280 | ||||||
Total lines of credit | $ | 7,206,563 | $ | 5,983,051 | ||||
b) Long-Term Debt
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.
An unsecured note in the amount of $1,765,235 and obligation in the amount of $225,000 are due a shareholder. The note, as amended, requires three incrementally increasing quarterly payments beginning July 1, 2004 in the amounts of $50,000, $75,000, and $100,000 with the remaining balance in the amount of $1,540,235 due June 30, 2005. The unsecured note has an annual interest rate of 9 percent paid annually, increasing to 10 percent beginning July 1, 2004. The obligation balance of $225,000 at March 31, 2004 and December 31, 2003 is non-interest bearing and is due in full June 30, 2004.
A term loan from a Swedish bank dated June 28, 2001 having a balance of 12,100,000 krona (SEK), or $1,591,150 (based on the March 31, 2004 conversion rate), is payable in 10 remaining quarterly payments of 1,100,000 krona (SEK), or $144,650 (based on the March 31, 2004 conversion rate), at an annual interest rate of 5.35 percent and is secured by stock of the Company’s Swedish holding subsidiary, DRI-Europa AB, and its consolidated subsidiary, Mobitec AB.
See Notes 3 and 12, “Pro Forma Balance Sheet and Supplemental Data” and “Subsequent Events”. Four convertible subordinated debentures in the aggregate amounts of $3,000,000 dated June 22, 2001 and $1,150,000 dated July 31, 2002, collectively the “Renaissance Notes,” are payable to two investment funds managed by Renaissance Capital Group, Inc. The president of Renaissance Capital Group, Inc. is a member of the Company’s Board of Directors. Two Renaissance Notes having an aggregate principal amount of $3,000,000 are payable in full on June 22, 2008, if not sooner redeemed or converted, with annual interest at 8 percent paid monthly. They also provide 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. Two Renaissance Notes having an aggregate principal amount of $1,150,000 are payable in full on July 31, 2009, if not sooner redeemed or converted, with annual interest at 8 percent paid monthly. They also provide 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 under which the Renaissance Notes were issued 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. At March 31, 2004, the Company was not in compliance with the financial covenants within the agreement; however, a waiver for violation of these covenants was not sought from the holder as all four Renaissance Notes were converted into shares of common stock on April 23, 2004.
A convertible subordinated debenture in the amount of $250,000 dated August 26, 2002, is payable to a shareholder and member of the Board of
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Directors, and is due in full August 26, 2009, if not sooner redeemed or converted, with annual interest at 8 percent 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 under which the convertible debenture was issued 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. At March 31, 2004, the Company was not in compliance with the financial covenants within the agreement, but received a waiver for violation of these covenants from the holder.
Long-term debt at March 31, 2004 and December 31, 2003 consists of the following:
March 31, | December 31, | |||||||
2004 | 2003 | |||||||
Unsecured note to a stockholder, dated June 28, 2001, payable in full June 30, 2005, with interest at 9%, increasing to 10% in July 2004. | $ | 1,765,235 | $ | 1,765,235 | ||||
Unsecured obligation to a shareholder dated June 28, 2001, payable in 12 quarterly installments, with zero interest. | 225,000 | 225,000 | ||||||
Note payable to a Swedish bank, dated June 28, 2001, payable in 20 quarterly installments of $144,650 including interest at 5.35%. Note collateralized by stock of Swedish holding company and consolidated subsidiary. | 1,588,896 | 1,667,927 | ||||||
Convertible debentures dated June 22, 2001, payable in full June 22, 2008, with interest at 8%, net of unamortized discount arising from warrants. | 2,847,000 | * | 2,838,000 | * | ||||
Convertible debentures dated July 31, 2002, payable in full June 27, 2009, with interest at 8%. | 1,150,000 | 1,150,000 | ||||||
Convertible debenture dated August 26, 2002, payable in full August 26, 2009, with interest at 8%. | 250,000 | 250,000 | ||||||
Total long-term debt | 7,826,131 | 7,896,162 | ||||||
Less current maturities | 1,541,348 | 1,249,110 | ||||||
$ | 6,284,783 | $ | 6,647,052 | |||||
* Net of unamortized debt discount of $153,000 at March 31, 2004 and $162,000 at December 31, 2003.
See Note 3, “Pro Forma Balance Sheet and Supplemental Data” which reflects, on a pro forma basis, the impact of the conversion on the Company’s debt.
Net interest expense was $233,032 and $309,823 for the three months ended March 31, 2004 and 2003, respectively.
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(8) | PER SHARE AMOUNTS | |||
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 amount of income (loss) used in the calculation of basic and diluted earnings per share was the same for the period ending March 31, 2004. Diluted net income (loss) per common share is fractionally less than basic net income (loss) per common share for the three months ended March 31, 2004 as common equivalent shares from stock options, stock warrants and convertible debentures had a dilutive effect. The amount of income (loss) used in the calculation of basic and diluted earnings per share was the same for the period ending March 31, 2003. Diluted net income (loss) per common share was equal to the basic net income (loss) per common share for the three months ended March 31, 2003 as common equivalent shares from stock options, stock warrants and convertible debentures would not have a dilutive effect. As of March 31, 2004, there were approximately 165,652 dilutive securities consisting of vested, in-the-money options and warrants outstanding as compared to none for March 31. 2003. |
Three Months Ended March 31, | ||||||||
2004 | 2003 | |||||||
Weighted average shares outstanding | 3,944,475 | 3,804,475 | ||||||
Dilutive shares | ||||||||
Options | 115,347 | — | ||||||
Warrants | 50,305 | — | ||||||
Basic and dilutive shares | 4,110,127 | 3,804,475 | ||||||
(9) | 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 period. |
(10) COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) for the three months ended March 31, 2004 and 2003 consists of the following:
Three Months Ended March 31, | ||||||||
2004 | 2003 | |||||||
Net income (loss) | $ | 166,378 | $ | (167,216 | ) | |||
Foreign currency translation adjustment | (488,987 | ) | 235,845 | |||||
Total comprehensive income (loss) | $ | (322,609 | ) | $ | 68,629 | |||
(11) SEGMENT INFORMATION
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
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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:
Three Months Ended March 31, | ||||||||
2004 | 2003 | |||||||
Net sales | ||||||||
Transportation communications | $ | 11,833,701 | $ | 10,251,383 | ||||
Law enforcement and surveillance | 302,005 | 665,811 | ||||||
$ | 12,135,706 | $ | 10,917,194 | |||||
Operating income (loss) | ||||||||
Transportation communications | $ | 1,726,832 | $ | 950,655 | ||||
Law enforcement and surveillance | 1,418 | 241,621 | ||||||
Parent entities | (1,133,344 | ) | (1,060,978 | ) | ||||
$ | 594,906 | $ | 131,298 | |||||
Depreciation and amortization | ||||||||
Transportation communications | $ | 139,442 | $ | 96,019 | ||||
Law enforcement and surveillance | 9,216 | 27,624 | ||||||
Parent entities | 49,274 | 45,484 | ||||||
$ | 197,932 | $ | 169,127 | |||||
Capital expenditures | ||||||||
Transportation communications | $ | 237,147 | $ | 84,836 | ||||
Law enforcement and surveillance | 7,260 | 75,184 | ||||||
Parent entities | 41,130 | 16,297 | ||||||
$ | 285,537 | $ | 176,317 | |||||
Geographic information — net sales | ||||||||
NAFTA | $ | 6,985,843 | $ | 6,869,466 | ||||
Europe | 4,355,556 | 3,514,733 | ||||||
Pacific and other | 794,307 | 532,995 | ||||||
$ | 12,135,706 | $ | 10,917,194 | |||||
March 31, 2004 | December 31, 2003 | |||||||
Identifiable assets | ||||||||
Transportation communications | $ | 31,854,430 | $ | 29,699,102 | ||||
Law enforcement and surveillance | 2,043,396 | 2,033,961 | ||||||
Parent entities | 2,311,327 | 2,818,833 | ||||||
$ | 36,209,063 | $ | 34,551,896 | |||||
Long-lived assets | ||||||||
Transportation communications | $ | 12,700,755 | $ | 13,309,034 | ||||
Law enforcement and surveillance | 1,229,982 | 1,231,936 | ||||||
Parent entities | 628,889 | 493,158 | ||||||
$ | 14,559,626 | $ | 15,034,128 | |||||
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(12) SUBSEQUENT EVENTS
On April 1, 2004, the Company and Dolphin Offshore Partners, L.P. (“Dolphin”) agreed to revise and reform the terms of the Series F Convertible Preferred Stock and a related warrant. The principal terms of the revisions are as follows: (1) the warrant, pursuant to which Dolphin had the right to purchase 319,149 shares of common stock for an exercise price of $3.00 per share, was terminated, in order to comply with certain requirements of Nasdaq listing standards, (2) the price at which the Series F Stock is convertible at any time into shares of common stock was decreased from $2.35 per share to $2.00 per share of common stock, subject to certain adjustments for stock splits or similar events (the “Conversion Price”), (3) prior to conversion, the Series F Stock votes as a single class with holders of common stock, with each share of Series F Stock entitled to a number of votes equal to the liquidation value, which is $5,000 per share, divided by $2.35, (4) the shares of Series F Stock continued to be mandatorily convertible into shares of common stock if the common stock hits certain targeted trading prices or upon the conversion of the Renaissance Notes (Note 7), (5) the holder of the Series F Stock is entitled to receive cumulative quarterly dividends, in preference to the holders of common stock, at the rate of 3.0% per annum on the liquidation value of the Series F shares, which dividends are payable in additional shares of Series F Stock having a liquidation value equal to the dividend amount, and (6) the Series F Stock dividend rate will increase to 10% per annum beginning in November 2008 if the common stock does not meet certain market price objectives before then. The Company also granted to Dolphin a right of first refusal to purchase, in connection with future equity offerings by the Company, for a period of five years after the Series F issuance date, a sufficient number of the securities issued in such equity offering to maintain its proportionate ownership interest in the Company, on a diluted basis, and this right has not been modified. The Company also granted to Dolphin certain rights to have the shares of common stock underlying the Series F Stock registered with the SEC.
On April 26, 2004, the Company sold 625,000 shares of Common Stock for total proceeds, net of issuance expenses, of $4,575,000, and granted to the investors warrants to acquire an additional 125,000 shares of Common Stock at an exercise price of $8.80 per share, exercisable for a period of five (5) years. Between April 22, 2004 and April 30, 2004, certain warrant holders exercised their rights to acquire an aggregate of 170,000 shares of Common Stock, resulting in cash to the Company in the amount of $605,500. In addition, between April 22, 2004 and April 30, 2004, holders of certain previously issued subordinated debt and preferred stock of the Company converted those common-equivalent securities into an aggregate of 2,900,232 shares of Common Stock. Such conversions did not result in any cash proceeds to the Company. See Note 3, “Pro Forma Balance Sheet and Supplemental Data”.
(13) LEGAL PROCEEDINGS
The Company, in the normal course of operations, is involved in 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 financial position of the Company or future results of operations.
On or about September 17, 2002 the Company received a letter from Clever Devices, Ltd. (“Clever”), a New York corporation with its principal place of business located in Syosset, New York. That letter alleged that the StealthMic product of the Company, as introduced to the market in 1999, would infringe U.S. patent number 6,522,754 (“‘754 Patent”) entitled “Digital Vehicle Microphone System and Method,” which subsequently was issued to Clever by the U.S. Patent Office on February 18, 2003. Upon investigation, and further review by intellectual property counsel of the Company, the Company and its intellectual property counsel were unable to find any basis whatsoever for this allegation of infringement and so informed Clever on several occasions. Nevertheless, Clever proceeded to assert its position without being willing to engage in constructive dialogue to identify the basis for its allegations or to advance understanding of the issues. Therefore, being uncertain as to the intent of Clever, on April 3, 2003 the Company filed an action in the United States District Court for the Northern District of Texas, Dallas Division (“Court”), under the Federal Declaratory Judgment Act, 28 USC 2210 and 2201, and under the Patent Laws of the United States, 35 USC 271. This “declaratory judgment action” sought a finding by the Court to the effect that the Company was not infringing the ‘754 Patent. On May 23, 2003, Clever counter-claimed, seeking injunctive relief and unspecified damages. Subsequently, the Company filed further actions with the Court asking that a hearing on claims construction, referred to as a “Markman” hearing, be held prior to any other actions or discovery in this matter. On August 19, 2003, the Court issued an order so requiring a Markman hearing which was held on February 3, 2004. On March 16, 2004 the Court issued its findings on the Markman hearing. While this recent development is still being evaluated by legal counsel, management believes the ruling virtually supports its contention that there is no valid claims basis for the allegation that the Company infringed the ‘754 Patent. A settlement agreement has been executed between the parties; the terms of which are immaterial to the Company and are, by agreement between the parties to remain confidential. While the Company believes that its position on this matter is correct, there can be no assurance that the case will not proceed to trial in late 2004 and there can be no assurance that the Company would prevail at trial or on subsequent appeal.
The Company, to the best of its ability at all times seeks to avoid infringing, and will not knowingly violate the intellectual property rights of others, The Company believes the allegations of Clever are totally without merit and will proceed to defend its rights to conduct business freely while not infringing upon the legitimate intellectual property rights of Clever.
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