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FORM 10-KSB
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the fiscal year ended
December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
for the transition period from ____________ to ____________
Commission file number: 1-13408
DIGITAL RECORDERS, INC.
(Name of small business issuer in its charter)
North Carolina 56-1362926
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2300 Englert Drive, Suite B
Durham, North Carolina 27713
(Address of principal executive offices)
Issuer's telephone number: (919) 361-2155
Securities registered under Section 12(b) of the Exchange Act:
Name of each exchange
Title of each class on which registered
- ------------------- -------------------
Common Stock, $.10 par value Boston Stock Exchange, Inc.
Warrants to Purchase Common Stock Boston Stock Exchange, Inc.
Securities registered pursuant to section 12(g) of the Exchange Act:
None
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B
is not contained in this form, and no disclosure will be contained, to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB [ ]
State issuer's revenues for its most recent fiscal year: $11,672,773
As of February 28, 1998, 2,674,075 shares of the registrant's Common Stock were
outstanding. The aggregate market value of the 2,309,145 shares of Common Stock
held by non-affiliates was $3,463,718 as of February 28, 1998. The market value
of the shares was calculated based on the closing bid price of such shares on
The NASDAQ SmallCap Market(SM) on such date.
DOCUMENTS INCORPORATED BY REFERENCE:
The information required by Part III of this annual report is incorporated by
reference to the Registrant's definitive proxy statement if filed with the
Commission on or before April 30, 1998 or if such proxy statement is not filed,
will be filed with the Commission as an amendment to this Form 10-KSB under
cover of Form 10-KSB/A not later than April 30, 1998.
Transitional Small Business Disclosure Format: Yes [ ] No [X]
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
Digital Recorders, Inc. (the "Company") designs, manufactures or
contracts for the manufacture of, and sells information technology products
through its three business groups, consisting of Transit Communication Systems
("TCS"), Highway Information Systems ("HIS") and Digital Audio Company ("DAC"),
and its two wholly-owned subsidiaries, Transit-Media GmbH ("Transit-Media") and
TwinVision Corp. of North America, Inc. ("TwinVision"). The Company's products
are currently marketed to the mass transit market, the travelers information
station/highway advisory radio ("TIS/HAR") market and the law enforcement
market. Customers include municipalities, regional transportation districts,
federal, state, and local departments of transportation, turnpikes, bus
manufacturers, and law enforcement agencies or organizations.
The TCS group focuses on supplying the public transit market with
Automatic Voice Announcement Systems ("AVAS") and services. The DR500C Talking
Bus(R) system marketed by the Company includes four core components: a vehicle
logic unit (the DR500C), an Operator Control Unit ("OCU"), an internal
light-emitting diode ("LED") sign and a Global Positioning Satellite ("GPS")
navigation system. The Talking Bus(R) system automatically provides voice
announcements including next stop, transfer points, route and destination
identification and public service messages. This system enhances public transit
service for all passengers and complies with Americans with Disabilities Act
("ADA") legislation. The demonstrated and ongoing integration of the DR500C
product with other "smart bus" technologies is a key element for potential
market growth.
The HIS group develops radio broadcast systems, authorized by the
Federal Communications Commission ("FCC"), which permit broadcast of voice audio
over low-power AM radio stations. The Company's digital messaging systems for
the TIS/HAR market serve the communication needs of motorists for a variety of
purposes, such as advising of traffic and weather conditions, construction
delays and availability of alternate routes to a particular destination.
The DAC group was established in 1995 upon the Company's acquisition
of Digital Audio Corporation. (see "Acquisitions"). The DAC group produces a
line of digital filter systems and tape transcribers used to improve the quality
and intelligibility of live and recorded voices. Products are marketed, both
domestically and internationally, to law enforcement entities and other
customers in government organizations.
Transit-Media became a wholly-owned subsidiary of Digital Recorders
after being acquired by the Company in May 1996 (see "Acquisitions"). Shortly
thereafter, the Company formed TwinVision as another wholly-owned subsidiary of
the Company. Both of these subsidiaries design, manufacture or contract for
manufacture of, sell and service a new generation of electronic destination sign
systems primarily used on transit bus vehicles worldwide. Transit-Media serves
the European and Far Eastern markets while TwinVision serves the North American
market. Customers include transit operating agencies which use mass transit
vehicles as well as the manufacturers of those vehicles.
Industry Overviews
The transit communication industry is a market which has developed
principally as a result of the enactment of the Americans with Disabilities Act,
the Clean Air Act ("CAA"), the Intermodal Surface Transportation Efficiency Act
("ISTEA") and Smart Highway initiatives. ADA requires that fixed route transit
systems announce major stops and transfer points to assist visually-impaired
passengers. Public transit authorities typically draw between 80% and 90% of
funding for purchases of ADA compliant products from the Federal Transit
Administration, with the remainder of product acquisition funding being provided
by state and local sources. The CAA, which requires large employers to gather
data concerning the routes their employees travel to and from work and their
methods of transportation, is designed to develop more effective transportation
routing information for public transit agencies. The
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ISTEA, a $40 billion federal funding initiative, promotes the development of a
"smart highway" system in the United States and designates a wide range of
devices, services and programs intended to increase the capacity of the nation's
highway system without adding additional physical lanes of highway. The "smart
highway" system is expected to utilize sophisticated computer aided
dispatch/automatic vehicle location ("CAD/AVL") software and hardware for
"intelligent" transit vehicles.
The AVAS market has emerged as a result of ADA legislation and has
been sustained by overall favorable acceptance of concept, design and technology
by transit management, operators and passengers. Less than 20% of new bus
vehicles contained voice announcement systems in 1997. This percentage, however,
is expected to increase over the next few years as industry participants present
AVAS solutions that address cost, maintenance expense and complexity issues.
While the TCS group has had nominal international sales, the Company believes
that the ownership of Transit-Media may enable the Company to cross-sell TCS
products overseas.
The TIS/HAR market consists of mobile and stationary broadcasting
systems which operate on the AM radio band. Although the FCC has considered
proposals to open TIS/HAR communications to the FM radio band, no such action
has been taken to date by the FCC. HAR products typically operate on battery or
electrical power, provide limited coverage of three to six miles and compete
with other methods of motorist communications such as variable message signs.
Technological advances in the TIS/HAR industry have expanded potential
applications as users can change messages or check the broadcasting unit by
remote control from any touch-tone telephone. Although the TIS/HAR market is
more mature than the transit communication market, management believes the
potential market for HAR systems will expand as computer-controlled systems such
as the Company's DR2000 achieve market acceptance. The Company believes that
solar-powered mobile HAR systems are better suited than traditional variable
message signs to provide information to motorists especially where power is
unavailable.
The DAC market consists of government organizations at the local,
state, and federal level. DAC also markets its products in twelve foreign
countries through a network of dealers. Approximately 39% of DAC sales are
international sales. DAC's digital filter and tape transcriber technology
reduces background noises that might otherwise make recorded voice signals
unintelligible. Additionally, DAC's products are applicable to the vibration,
acoustic, and communications disciplines in the commercial sector.
The electronic destination sign industry, which is the primary
market for Transit-Media and TwinVision, is a highly competitive, mature market
with growth limited to overall industry growth or that which is precipitated by
technological advances. Virtually all transit buses manufactured worldwide have
some form of destination signs and the percentage of those signs that are
electronic signs is approximately 70% and 95% in Europe and the United States,
respectively. A single competitor in the domestic electronic destination sign
market holds dominant market share; no one supplier dominates the worldwide
market.
Products and Product Design
The Company's current products include the DR500C Talking Bus(R), a
broad line of HAR broadcasting systems which operate on the AM radio band, DAC's
product line, which includes ten digital filter instruments and two digital tape
transcription machines, and light-emitting diode flip-dot electronic destination
signs being marketed by Transit-Media and TwinVision. During 1997, 1996 and
1995, TCS accounted for 29%, 57% and 36% of the Company's net sales,
respectively. During the same periods, HIS accounted for 19%, 13% and 40% of the
Company's net sales, respectively. DAC accounted for 19%, 26% and 24% of net
sales in 1997, 1996 and 1995, respectively. In addition, Transit-Media accounted
for 16% and 4% of net sales in 1997 and 1996, respectively, and TwinVision
accounted for 17% of sales in 1997.
TCS Product Line. The Talking Bus(R) is an automated next stop
announcement and passenger information system which is designed for
use in transit buses, light rail vehicles, trains or subway cars,
people movers, monorails, airport vehicles and tour buses. The
Talking Bus(R) complies with ADA legislation and industry recognized
protocol standards. It uses an open architecture computer-based
electronics system design which accommodates the addition of new
features and capabilities, including interoperability with
third-party
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equipment. In the case of the Talking Bus(R), the open architecture
permits the expansion of memory capacity to the size required by the
transit customer and the integration of the Talking Bus(R) with
CAD/AVL, GPS receivers, internal and external signs, and possibly
other future electronic systems. The Talking Bus(R) offers easy
downloading or transfer of software using an industry standard
personal computer memory card international association ("PCMCIA").
Also, by installing a modem, software can be downloaded by radio
frequency. The Talking Bus(R) is designed to meet the operating
standards for temperature, humidity, shock, vibration and other
environmental conditions found in transit applications, and to
satisfy all ADA requirements for internal and external stop
announcements. The Talking Bus(R) is manufactured in an ISO 9002
compliant facility.
When activated by a transit operator or by an automatic trigger such
as GPS or signpost radio, the Talking Bus(R) provides a high quality
digital audio announcement which can be recorded in any language.
The Talking Bus(R) uses the vehicle's power supply and can be wired
for a 12-volt or 24-volt source. The Talking Bus(R)' memory is
provided by expandable memory cards with up to 40 megabyte capacity.
The audio messages are stored in flash memory, which does not
require battery backup.
HIS Product Line. The Company markets a line of stationary and
mobile HAR products. Each HAR product is manufactured in compliance
with FCC rules and regulations and provides the maximum transmission
power permitted by the FCC. The various models of the HAR products
offered by the Company can be generally divided into two classes of
products, the Solar Max and stationary highway advisory radio
systems. The Solar Max operates from a solar power system including
battery backup which is mounted on a trailer for easy transportation
and setup. With the exception of this trailer, the Solar Max
includes no moving parts, which limits the amount of maintenance
which may be required. The Solar Max can be programmed and on the
air within ten minutes and can be controlled remotely using the
built-in cellular telephone. Stationary highway advisory radio
products offered by the Company can be directly linked to nearby
utilities or can be installed using solar power and battery options.
In addition, the Company has introduced a new computer-controlled
HAR digital messaging system called the DR2000. This product will
permit multiple HAR systems to be networked together for operation
from a central traffic operation center.
DAC Product Line. The Company markets an extensive line of digital
signal processing ("DSP") instruments that are used by law
enforcement agencies and organizations to enhance forensic tape
recordings collected from a variety of sources. Voices on such
recordings are often obscured by hum, room noises, acoustic
resonances, muffling, background music, and street noises. To
enhance such recordings and make them understandable, the tape's
audio is played through a sequence of audio filters. These real-time
devices have substantial computational power with the typical
digital filter employing 20 microprocessors.
DAC's most popular product is the Personal Computer Audio Processor
("PCAP"). The PCAP is a mouse driven, Windows(TM)-based processor
used to reduce non-voice sounds on an audio source. This
PC-controlled digital processor implements up to five different
digital filters simultaneously and has built-in dual channel
spectral analysis. An expanded version, the Multi-Channel Audio
Processor ("MCAP") was introduced in 1996 and is a complement to the
PCAP for more sophisticated users.
Transit-Media and TwinVision Product Line. The Company's electronic
destination sign products include various models. These products
adhere to ADA requirements and function under most industry
recognized protocol standards. They possess an open architecture,
microprocessor-based system incorporating a new generation display
device which utilizes hybrid light-emitting diode/flip-dot
technology. This new generation display device improves distance of
readability while reducing end user maintenance expense. Destination
message programming is accomplished via proprietary software
developed by the Company through PCMCIA memory card download. The
product is manufactured under various contracts in ISO certified
facilities.
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Marketing and Sales
All of the Company's products are marketed on a direct basis by the
Company's sales and marketing personnel. The Company's marketing activities
combine data base marketing, selective media advertising, publication of
newsletters directed to customers, participation in trade shows and industry
conventions, cooperative activities with system integrators, and, in the case of
DAC, a one-week DAC School. This school offers end users opportunities to
understand DSP technology and to learn about DAC product operation via hands-on
instruction. In addition, the Company's TCS products are marketed by five
outside sales representatives. These sales representatives are compensated
through commissions and reimbursement of certain business expenses. HIS products
are also marketed in California and Nevada by a manufacturer's sales
representative company. DAC products are sold directly by the Company in the
United States and through a network of dealers internationally. The Company's
electronic destination sign products are marketed both direct by the Company and
through independent sales representatives to vehicle manufacturers and the end
user transit operating agencies. Several of HIS's and DAC's products have been
approved for purchase by the General Services Administration of the U.S.
Government, which the Company believes enhances its sales opportunities to
federal agencies because the agency can, if they so choose, purchase scheduled
products from the Company at a specified negotiated price.
The Company generates a significant portion of its revenues from a
relatively few key customers, the identity of which may vary from year to year.
In 1997, no particular customer accounted for more than 10% of total Company
revenues. Combined revenues from three major customers accounted for
approximately 34% and 35% of net sales during 1996 and 1995, respectively.
The Company's customer base includes a significant number of
governmental and quasi-governmental entities. The Company derived approximately
33%, 48% and 65% of its net sales from purchases by governmental and
quasi-governmental entities in 1997, 1996 and 1995, respectively. Sales to these
customers are characterized by a lengthy sales cycle which generally extends for
a period of two to twenty-four months. The Company's sales cycle at DAC is also
characterized by higher sales during the third quarter as the governmental
budgetary cycle ends on September 30 of each year. In addition, purchases by
these customers are dependent on federal, state and local funding, which may
vary from year to year. The Company's sales and marketing staff will generally
attempt to assist customers in the preparation of transportation improvement
plans which are used to prepare budgets for submission to governmental and
legislative bodies.
Research and Development
The Company is committed to the continued enhancement of all of its
products and to the development or acquisition of products having related
applications. The Company's objective is to develop products that are considered
to be high quality, technically advanced and capable of capturing a significant
share of the applicable market.
In the transit market, enhancement of the Talking Bus(R) and
TwinVision LeDot(TM) destination sign system products will continue over the
next year to increase the Company's ability to integrate these products with
other technologies such as CAD/AVL, GPS, dead reckoning, and other on-vehicle
electronic systems. The Company believes that the convergence of core
technologies, combined with the need for capital improvements in the transit
industry, will justify continuing high levels of research and development. This
research and development will focus primarily on the ability to integrate
technologies with the Company's stop announcement system and cost reduction.
The Company's research and development in the TIS/HAR area will be
more limited, and will focus primarily on the continued development of the
DR2000 series of computer-controlled HAR products and the TR 10 class `E'
transmitter as well as ways to reduce product costs and improve product
reliability.
DAC currently has development contracts with several government
agencies to design products for specific DSP applications. In addition, DAC is
continuing to upgrade and enhance designs of existing products to incorporate
new technology and to meet customer requirements.
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In October 1996, the Company introduced a new generation display
element in its TwinVision LeDot(TM) destination sign system. This new generation
display combines known and proven benefits of light-emitting diodes with proven
electromagnetic flip-dot elements to enhance product performance. These
enhancements improve distance of readability and reduce maintenance expense.
The Company's research and development costs increased in 1997 as
development activities continued in all business groups and in the Transit-Media
and TwinVision subsidiaries. The Company attempts to maximize its use of the
funds available for research and development by following strategies to
accelerate the development and introduction of new products, reduce product
costs and focus on systems integration. Research and development expenses were
$1,157,997, $643,223 and $379,870 in 1997, 1996 and 1995, respectively.
Acquisitions
On April 30, 1996, the Company acquired all of the outstanding stock
of Transit-Media, a company which assembles and markets proprietary on-board,
electronic destination signs for mass transit systems in Europe and the Far
East. The Company paid $35,000 for all of Transit-Media's stock at closing. The
Company recorded cash ($440), other receivables (valued at $1,736), fixed assets
(valued at $10,523), accounts payable (valued at $3,957), short-term bank
borrowings (valued at $117,177), and certain intangible assets (valued at
$143,435). Upon completing the acquisition, the Company invested $350,000 in
Transit-Media to pay off an existing bank credit line and provide working
capital.
On February 28, 1995, the Company entered into and closed an Asset
Purchase and Sale Agreement (the "Agreement") with Digital Audio Corporation
("Digital Audio"). Pursuant to this Agreement, the Company obtained
substantially all of the assets of Digital Audio for a purchase price in the
aggregate amount of approximately $2,100,000 which consisted of cash in the
amount of $1,171,000, a promissory note in the amount of $709,000 and 33,846
shares of the Company's Common Stock valued at $220,000 ("Acquisition Shares").
As additional consideration, the Agreement provided for an earn-out payment to
be made over two years if certain performance criteria were met. The Company did
not make any earn-out payments pursuant to this agreement. The unsecured
promissory note payable to Digital Audio, which accrued interest at the rate of
6% per annum, was paid in January 1996.
Competition
The markets in which the Company participates are highly
competitive. The transit market in particular is characterized by rapid
technological advances, evolving industry standards and technological
obsolescence. The Company believes that the principal competitive factors in the
markets for the TCS, Transit-Media and TwinVision products include ease of use,
service and support, price and the ability to integrate these products with
other technologies. The Company currently views Luminator, an operating unit of
Mark IV Industries, Inc., as its principal competitor in the transit market.
Luminator is a significant competitor in signage and announcements. The Company
believes that Luminator now purchases some of its stop announcement technology
from an outside party. The Company also recognizes Clever Devices Ltd. and
Meister Electronics, LC., a German company, as competitors in the transit
market, although neither of these competitors have the capital and other
resources of Luminator. In the TIS/HAR market, the Company's principal
competitor is Information Station Specialists ("ISS"). The Company also
considers LPB, Inc. a competitor in the TIS/HAR market, although with a
significantly smaller market share than ISS.
Competition in the voice noise filtering business is limited, and
the Company believes that its DAC group is a leader among the small number of
participants in the industry. The Company will attempt to maintain that position
through frequent product improvements and new product introduction. Analog
filtering products produced for the commercial sound industry by companies such
as AKG are not specifically designed for voice filtering and are not considered
significant competition. The Company recognizes Adaptive Digital System, Inc. as
a competitor producing similar technology products.
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Manufacturing
The Company's principal supplier for TCS products, Quality
Manufacturing and Design of Raleigh, North Carolina ("QMD"), is a contract
electronics manufacturing firm. QMD has achieved ISO 9002 certification for
manufacturing. The Company believes that QMD has sufficient manufacturing
capacity to address the Company's short-term requirements for the Talking Bus(R)
and could significantly increase production if requested to do so by the
Company. Some TCS components, such as memory cards, may be subject to
considerable variations in price and availability from time to time. Although
the Company has not experienced production delays due to a lack of available
parts, a significant increase in the Company's sales could result in the Company
having to increase its inventory of certain key components in order to ensure
their availability.
Although the Company is currently dependent on QMD as its sole
supplier for major electronic components included in the Talking Bus(R),
management believes that alternate suppliers are available. Nonetheless, the
loss of this supplier could have a short-term adverse effect on the Company's
ability to timely deliver products to its customers.
Beginning in late 1996, the Company started to perform most of the
engineering and manufacturing work for its HIS products through its DAC business
group.
The Company's DAC group manufactures its own products as well as,
starting in late 1996, some of those used by HIS. Printed circuit board and
enclosure fabrication is purchased from specialized vendors including Texas
Instruments, Motorola, and Crystal Semiconductor. Because of the rapid advances
in technology, the Company believes that this practice is necessary to maintain
its competitive position and does not place the Company at excessive supply
risk.
The Company purchases major components for its electronic
destination signs from Lite Vision Corporation, an entity based in Taiwan. The
Company has contracts with electronic manufacturing firms to manufacture these
products both domestically and overseas. The display element is essentially a
sole-source device, and the Company is managing its inventory levels to minimize
the risk of delays in parts availability. The domestic production is compliant
with all "Buy America" regulations.
Proprietary Rights
The Company currently relies on a combination of patent, copyright
and trade secret protection, nondisclosure agreements and licensing agreements
to establish and protect its ownership of proprietary rights. The Company will
attempt to keep the results of its research and development efforts proprietary,
but may not be able to prevent others from using some or all of such information
or technology. The Company has been issued two patents relating to the memory
efficiency and the power efficiency of its technology and a design patent on the
Solar Max HAR system. The Company has registered its Talking Bus(R) trademark
logo with the United States Patent and Trademark Office and has registered
various trademarks and logos for its new generation technology display element.
In addition, Digital Recorders and Solar Max are trademarks of the Company. The
Company intends to pursue patents covering new technologies and registration of
its other trademarks and service marks as advised by counsel. The Company
intends to maintain the integrity of its service marks, trade names and
trademarks and other proprietary names and marks against unauthorized use and to
protect against infringement and unfair competition where circumstances warrant.
Employees
As of February 28, 1998 the Company employed sixty people. The
Company's employees are not covered by any collective bargaining agreements and
the Company believes that its employee relations are good.
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ITEM 2. DESCRIPTION OF PROPERTY
The Company leases approximately 6,700, 5,400 and 4,600 square feet
of office space in three different locations in an office complex in Durham,
North Carolina. This space is leased under three separate lease agreements. One
lease agreement provides for monthly rental payments of $5,641 and expired in
January 1998. The Company is continuing to lease this space on a month to month
basis. The second agreement provides for monthly rental payments ranging from
$2,800 to $2,920 and expires in April 2000. The third agreement provides for
monthly rental payments of $4,943 and expires in October 2002. The Company also
leases approximately 4,700 square feet of office and manufacturing space in
Raleigh, North Carolina. This lease agreement contains rental rates ranging from
$4,241 to $5,013 per month and runs through December 2002.
Management believes that, if necessary, additional office and
manufacturing space will be available in or adjacent to its existing facilities
at a cost approximately equivalent to or slightly higher than that now paid by
the Company for its existing facilities.
On July 1, 1994, the Company entered into an agreement pursuant to
which William H. Wilson and Linda E. Wilson (the "Sellers") agreed to transfer
ownership to the Company of a condominium located in the Wailea resort
development known as the Polo Beach Club at 20 Makena Road, in Wailea, Maui,
Hawaii (the "Property"). In exchange for the Property, the Sellers received a
total of 120 shares of Series AAA Preferred Stock and warrants to acquire 54,284
shares of Common Stock at a price of $2.95 per share. The Company had the
Property listed for sale from 1994 until December 20, 1996 when the Company sold
this property for net proceeds of $467,625. (See Note 4 of the Notes to the
Consolidated Financial Statements.) The Company rented the property prior to
this sale.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any litigation and is not aware of any
threatened or pending legal action which would have a material adverse effect on
the Company's business, operations or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR THE COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is quoted on The NASDAQ SmallCap MarketSM
under the symbol "TBUS" and on the Boston Stock Exchange under the symbol "TBU".
The following table sets forth the range of high and low closing bid prices, as
reported by The NASDAQ SmallCap Market(SM), from January 1, 1996 through
December 31, 1997. The prices set forth reflect interdealer quotations, without
retail markups, markdowns or commissions, and do not necessarily represent
actual transactions.
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High Low
---- ---
1996
First Quarter............................ $6.75 6.00
Second Quarter........................... 6.75 5.38
Third Quarter............................ 6.75 4.69
Fourth Quarter........................... 5.13 3.25
1997
First Quarter............................ $4.00 3.00
Second Quarter........................... 3.50 2.25
Third Quarter............................ 4.25 2.25
Fourth Quarter........................... 3.13 1.69
On February 28, 1998, the closing bid price of the Common Stock was
$1.50. As of February 28, 1998, the number of beneficial holders of the
Company's Common Stock was in excess of 1,000.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
General
Digital Recorders, Inc. designs, manufactures or contracts for the
manufacture of, and sells information technology products to the mass transit,
highway advisory radio and law enforcement markets. Since 1987, when the Company
generated net sales of $348,000, net sales have increased each year, reaching
$11,672,773 in 1997. The Company attributes its sales growth primarily to the
introduction of new products, increased market penetration, growing markets for
its products and strategic acquisitions of companies with complementary
technologies.
The Company typically recognizes revenue either upon shipment of
products to customers or on a percentage of completion basis for certain
longer-term contracts. Because the Company's operations are characterized by
significant research and development expenses preceding a product introduction,
net sales and their related expenses may not be recorded in the same period,
thereby producing fluctuations in operating results. The Company's dependence on
a small number of relatively large customers or projects may increase the
magnitude of fluctuations in operating results.
The Company's financial statements contain a provision for income tax
expense of zero and $20,000 for the years ended December 31, 1997 and 1996,
respectively due to the alternative minimum tax in 1996. As a result of the
accumulated losses incurred in past years, the Company had a net operating loss
carryforward as of December 31, 1997 of $2,845,535. Management expects this
carryforward will be available to offset federal taxable income, if any, through
2012. Also, as of December 31, 1997, one of the Company's subsidiaries had a net
economic loss carryforward for state income tax purposes of $758,446, which is
expected to be available to offset future state taxable income, if any, through
2002. Following utilization of the existing federal and state loss
carryforwards, the Company's future operations, if profitable, will be subject
to income tax expense.
The following discussion provides an analysis of the Company's results
of operations and liquidity and capital resources and should be read in
conjunction with the consolidated financial statements of the Company and notes
thereto. The operating results of the periods presented were not significantly
affected by inflation.
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Results of Operations
The following table sets forth, for the periods indicated, the
percentage of revenues represented by certain items included in the Company's
Consolidated Statements of Operations:
Year Ended December 31,
------------------------
1997 1996 1995
---- ---- ----
Net sales..................................... 100% 100% 100%
Cost of sales................................. 59 44 50
-- -- --
Gross profit.................................. 41 56 50
-- -- --
Operating expenses:
Selling, general and administrative........ 46 43 45
Research and development................... 10 7 6
-- - -
Total operating expenses...................... 56 50 51
-- -- --
Operating income (loss) ...................... (15) 6 (1)
Other income (expense), net................... * 1 3
- - -
Income (loss) before income taxes............. (15) 7 2
Income tax expense............................ * * *
- - -
Net income (loss)............................. (15)% 7% 2%
===== == ==
* - represents less than 1%.
Comparison of Years Ended December 31, 1997 and 1996.
Net sales for 1997 were $11,672,773, an increase of $2,472,504, or 27%,
as compared to $9,200,269 for 1996. This sales increase was primarily due to
higher sales at HIS, Transit-Media and TwinVision which were partially offset by
lower sales at TCS. The sales increase at HIS of $1,108,873, or 96%, related to
one large contract and the introduction of new products, such as the DR1500, a
new digital recording device, and the DR2000. Combined sales for Transit-Media
and TwinVision increased $3,462,795, or 913%, primarily because these business
groups were in the start-up phase during 1996. The decline in revenues at TCS of
$1,945,562, or 37%, was primarily related to increased competition in this
maturing market.
Gross profit for 1997 was $4,794,401, a decline of $389,206, or 8%, as
compared to gross profit of $5,183,607 in 1996. As a percentage of sales, gross
profit was 41% of net sales in 1997 as compared to 56% during 1996. The decrease
in gross profit percentage reflected a change in the composition of the
Company's sales during 1997, as there were increased sales of the lower margin
electronic destination sign products at Transit-Media and TwinVision and fewer
sales of the higher margin TCS product line. The Company anticipates that the
gross profit margins will improve for the Transit-Media and TwinVision business
groups during 1998 as various cost reduction initiatives, in conjunction with
economies of scale coinciding with the growth of these businesses, take effect.
Selling, general and administrative expenses during 1997 were
$5,388,923, an increase of $1,374,457, or 34%, as compared to selling, general
and administrative expenses of $4,014,466 during 1996. This increase is
attributable in general to the overall growth of the Company and, specifically,
to the expenses incurred at Transit-Media and TwinVision as these business
groups moved from their start-up phase during 1997.
Research and development expenses for 1997 were $1,157,997, an increase
of $514,774, or 80%, as compared to research and development expenses of
$643,223 during 1996. This increase related primarily to additional product
development in every business group but DAC. The Company does not anticipate
that these expenses will increase at this same rate during 1998 as many of the
Company's research and development activities resulted in new product
introductions during 1997.
10
<PAGE> 11
Operating loss increased by $2,278,437 to $1,752,519 in 1997 as
compared to operating income of $525,918 during 1996 primarily due to the
factors set forth above.
Total other income (expense) for 1997 resulted in expense of $13,120, a
decrease of $146,587, as compared to total other income (expense) for 1996 which
resulted in income of $133,467. This decrease was due primarily to changes in
interest income and interest expense. Interest income for 1997 was $58,485, a
decrease of $71,598, or 55%, as compared to interest income for 1996 of
$130,083. This decrease was due to the Company having lower cash balances to
invest during 1997, as cash was used to fund growing working capital needs and
operating losses. Interest expense for 1997 was $62,405, an increase of $51,517,
or 473%, as compared to interest expense for 1996 of $10,888. This increase was
primarily due to the Company being in a net borrowing position during the latter
part of 1997 for the reasons noted above.
Comparison of Years Ended December 31, 1996 and 1995.
Net sales for 1996 were $9,200,269, an increase of $2,837,840, or 45%,
as compared to $6,362,429 for 1995. This increase was attributable primarily to
increases in sales in the TCS and DAC business groups being offset by a decline
in sales in the HIS business group. TCS revenues increased by $2,984,691 or
131%, primarily because of increased sales of the DR500C. DAC's revenues
increased by $850,696, or 55%, primarily because of increased sales of the PCAP
and MCAP products as well as the inclusion of twelve months of DAC's operations
in the Company's Statement of Operations in 1996 versus only ten months in 1995.
HIS sales decreased by $1,376,619, or 54%, due to lower sales to the National
Weather Service and of DR1000 products.
Gross profit for 1996 was $5,183,607, an increase of $1,991,349, or
62%, over gross profit of $3,192,258 in 1995. As a percentage of sales, gross
profit during 1996 was 56% of net sales, as compared to 50% during 1995. The
increase in gross profit percentage was caused mainly by the change in sales mix
towards higher margin products in the Company's TCS and DAC business groups.
Selling, general and administrative expenses during 1996 were
$4,014,466, an increase of $1,148,840, or 40%, as compared to selling, general
and administrative expenses of $2,865,626 during 1995. This increase is
attributable to expansion of the Company's sales and marketing activities as
well as the expenses incurred in the Company's two new wholly-owned subsidiaries
during 1996. These expenses as a percentage of net sales were 43% in 1996 as
compared to 45% during 1995.
Research and development expenses for 1996 were $643,223, an increase
of $263,353, or 69%, as compared to research and development expenses of
$379,870 during 1995. This increase reflects the continuing development costs
incurred by the Company across all of its business groups.
Operating income increased by $579,516 to $525,918 in 1996 from an
operating loss of $53,238 in 1995 primarily due to the factors set forth above.
Total other income (expense) for 1996 was $133,467, a decrease of
$74,674, or 36%, as compared to total other income (expense) for 1995 of
$208,141. This decrease was due primarily to changes in interest income and
interest expense. Interest income for 1996 was $130,083, a decrease of $176,588,
or 58%, as compared to interest income for 1995 of $306,671. This decrease was
primarily attributable to the Company having lower cash balances to invest
during 1996. Interest expense for 1996 was $10,888, a decrease of $102,186, or
90%, as compared to interest expense for 1995 of $113,074. This decrease was
primarily due to acquisition-related interest expense not being incurred in
1996.
11
<PAGE> 12
Liquidity and Capital Resources
In December of 1994, the Company completed its initial public offering
of 1,265,000 units (the "Units"), each Unit consisting of one share of Common
Stock and one warrant to purchase one share of Common Stock, which included an
over-allotment of 165,000 units. The Company realized gross proceeds of
$7,273,750 and net proceeds of $5,562,225 after deducting offering costs of
$1,711,525.
The funds from this offering satisfied the Company's working capital
requirements until 1997. During 1997, the Company started to borrow money under
a $2,000,000 unsecured credit facility from a financial institution. On July 24,
1997, the Company's $2,000,000 unsecured credit facility from this financial
institution expired and was replaced by a $2,500,000 secured line of credit
facility and a $1,000,000 secured letter of credit facility from the same
financial institution. The new credit facility provides for short-term
borrowings and import letters of credit, is subject to certain loan covenants,
is secured by substantially all of the Company's accounts receivable, inventory
and equipment, and bears interest, payable quarterly, at the 90 day LIBOR base
rate plus 2.3% to 3.3% dependent upon the Company's rolling four quarter
earnings before interest, taxes, depreciation and amortization. At December 31,
1997, the borrowings under this agreement totaled $1,893,540. In addition, at
December 31, 1997, the Company had $127,427 committed under two import letters
of credit for inventory purchases from an overseas supplier.
As of December 31, 1997, the Company's principal sources of liquidity
included cash and cash equivalents of $472,285 and accounts receivable of
$3,173,959, providing the Company with net working capital of $3,727,124. The
Company had outstanding short-term borrowings at December 31, 1997, of
$1,893,540.
The Company's operating activities used cash of $3,782,213 during 1997
and provided cash of $456,911 during 1996. For 1997, increases in inventories of
$1,833,540, increases in accounts payable of $281,402 and increases in accounts
receivable of $1,083,078 were the primary components of changes in working
capital. For 1996, increases in inventories of $802,403, increases in accounts
payable of $486,148 and increases in accounts receivable of $262,155 were the
primary components of changes in working capital. The Company anticipates that
its working capital needs will continue to increase as the Company implements
its expansion plans. Working capital requirements will increase with growth in
the Company's sales, primarily due to the time gap between the time the Company
must pay its suppliers and the time the Company receives payment from its
customers, particularly its governmental customers.
The Company's investing activities provided cash of $1,327,779 and
$194,901 during 1997 and 1996, respectively. Investing activities during 1997
related primarily to the net sales of short-term investments totaling $1,606,422
and purchases of property and equipment of $278,643. Investing activities during
1996 included capital expenditures of $277,147 being offset by net sales of
short-term investments totaling $506,608.
The Company's financing activities provided cash of $1,774,065 during
1997 and used cash of $488,852 during 1996. In 1997, cash of $8,004,540 was
provided from short-term bank borrowings. These proceeds were offset by cash
payments on those borrowings of $6,111,000 and cash dividend payments on
preferred stock of $119,475. In 1996, principal payments on long-term debt of
$709,000, net payments on short-term borrowings of $117,177 and dividend
payments on preferred stock of $105,300 all used cash while $442,625 of proceeds
were received from the sale of resort property.
On April 6, 1998 the holders of the Series AAA Preferred Stock approved
an amendment to the Company's Articles of Incorporation to (i) extend the
mandatory redemption date of the Series AAA Preferred stock (the "Preferred
Shares") to December 31, 2003, (ii) permit the earlier redemption of the
Preferred Shares at the Company's option at any time upon 30 days' written
notice, (iii) increase the amount of the quarterly dividend payable with respect
to each Preferred Share from $112.50 to $125.00, and (iv) increase the number of
shares of Common Stock of the Company issuable upon conversion of each Preferred
Share from 500 shares of Common Stock to 625 shares of Common Stock. Such
amendment will be presented to a vote of the holders of Common Stock in the
Company's fiscal 1997 Proxy Statement and, if approved by a majority of the
holders of Common Stock, will be adopted by the Company.
On April 14, 1998 the Company sold its Highway Information Systems
business group for $2,800,000 in cash plus other consideration of approximately
$200,000. The Company realized a gain on disposal, before applicable income
taxes, of approximately
12
<PAGE> 13
$1,500,000. The income tax expense on this transaction, which the Company will
offset with the tax loss carryforwards which existed as of December 31, 1997,
totaled approximately $600,000.
The Company's cash requirements, other than for normal operating
expenses, will relate primarily to the development of new products and
enhancement of existing products, financing anticipated growth, and the possible
acquisition of products or technologies complementary to the Company's business.
The Company believes that a combination of its net working capital, the
borrowing capacity available under its credit facility, the cash proceeds
received from the sale in April 1998 of the Highway Information Systems business
group and the modification of the terms of the Series AAA Preferred Stock
provides the liquidity and capital resources available to satisfy its currently
anticipated cash requirements for 1998. In addition, the Company is reviewing
various proposals which would provide additional capital resources to the
Company.
Year 2000 Compliance
The Company is reviewing its current computer applications with respect
to the year 2000 issue. The Company believes that the costs associated with year
2000 compliance will not be material. The Company intends to implement a new
accounting system which would be year 2000 compliant. In addition, the Company
is currently unable to determine the effect of year 2000 compliance by its
customers or suppliers.
Forward-Looking Statements
The statements contained herein that are not purely historical are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including
statements regarding the Company's expectations, hopes, intentions or strategies
regarding the future. Forward-looking statements include expectations of trends
to continue through the remainder of the current and the forthcoming fiscal
year, including the development and introduction of new products.
Forward-looking statements involve a number of risks and uncertainties. Among
other factors that could cause actual results to differ materially are the
following: business conditions and growth in the markets in which the Company
participates and the general economy; competitive factors, such as the entry of
new competitors into any of the markets in which the Company participates; price
pressures and increased competition in those markets; inventory risks due to
shifts in market demand and/or price erosion of purchased components; changes in
product mix; that the Company's working capital and existing credit arrangement
will be adequate to fund its operations; and the risk factors listed from time
to time in the Company's SEC reports, including but not limited to the Company's
reports on Form 10-QSB, 8-K, 10-KSB, Annual Reports to Shareholders, and reports
or other documents filed pursuant to the Securities Act of 1933 or the
Securities Exchange Act of 1934. All forward-looking statements included herein
are based on information available to the Company on the date hereof, and the
Company assumes no obligation to update any such forward-looking statements. It
is important to note that the Company's actual results could differ materially
from those in such forward-looking statements due to the factors cited above. As
a result of these factors, there can be no assurance the Company will not
experience material fluctuations in future operating results on a quarterly or
annual basis, which would materially and adversely affect the Company's
business, financial condition and results of operations.
ITEM 7. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Financial Statements follow this page.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
13
<PAGE> 14
DIGITAL RECORDERS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Independent Auditors' Report ................................................................. 15
Consolidated Balance Sheets - December 31, 1997 and 1996 ..................................... 16
Consolidated Statements of Operations - Years ended December 31, 1997, 1996 and 1995 ......... 17
Consolidated Statements of Stockholders' Equity - Years ended December 31, 1997, 1996 and 1995 18
Consolidated Statements of Cash Flows - Years ended December 31, 1997, 1996 and 1995 ......... 19-20
Notes to Consolidated Financial Statements ................................................... 21-32
</TABLE>
14
<PAGE> 15
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Digital Recorders, Inc.:
We have audited the accompanying consolidated balance sheets of Digital
Recorders, Inc. and subsidiaries as of December 31, 1997 and 1996 and the
related consolidated statements of operations, stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 1997.
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 generally accepted auditing
standards. 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 financial statements referred to above present fairly, in
all material respects, the financial position of Digital Recorders, Inc. and
subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
KPMG Peat Marwick LLP
Raleigh, North Carolina
March 20, 1998
15
<PAGE> 16
DIGITAL RECORDERS, INC.
Consolidated Balance Sheets
December 31, 1997 and 1996
<TABLE>
<CAPTION>
Assets 1997 1996
------------ -----------
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 472,285 1,328,944
Investments -- 1,606,422
Trade accounts receivable, less allowance for doubtful accounts of $50,000 and zero 3,173,959 2,090,881
at December 31, 1997 and 1996, respectively
Other receivables 54,288 120,014
Inventories 3,723,446 1,889,906
Prepaids and other current assets 74,486 51,329
------------ -----------
Total current assets 7,498,464 7,087,496
Property and equipment, less accumulated depreciation and amortization
of $405,642 and $252,628 at December 31, 1997 and 1996, respectively 528,033 458,011
Goodwill, less accumulated amortization of $393,154 and $239,628
at December 31, 1997 and 1996, respectively 1,515,281 1,668,807
Intangible assets, less accumulated amortization of $273,988 and $145,428
at December 31, 1997 and 1996, respectively 403,263 403,900
Other assets 6,152 7,099
------------ -----------
$ 9,951,193 9,625,313
============ ===========
Liabilities and Stockholders' Equity
Current Liabilities:
Short-term bank borrowings 1,893,540 --
Accounts payable 1,112,285 830,883
Accrued expenses 237,048 172,892
Accrued commissions 261,165 199,485
Accrued warranty reserve 146,892 161,971
Deferred revenue 80,585 --
Dividends payable 39,825 --
------------ -----------
Total current liabilities 3,771,340 1,365,231
------------ -----------
Total liabilities 3,771,340 1,365,231
------------ -----------
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, 1997 and 1996, respectively 1,770,000 1,770,000
Stockholders' Equity:
Common stock, $.10 par value, 10,000,000 shares authorized;
2,674,075 shares issued and outstanding at December 31,
1997 and 1996, respectively 267,407 267,407
Additional paid-in capital 10,694,443 10,832,743
Translation adjustment (186,081) (9,791)
Accumulated deficit (6,365,916) (4,600,277)
------------ -----------
Total stockholders' equity 4,409,853 6,490,082
------------ -----------
$ 9,951,193 9,625,313
============ ===========
</TABLE>
See accompanying notes to consolidated financial statements.
16
<PAGE> 17
DIGITAL RECORDERS, INC.
Consolidated Statements of Operations
Years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
------------ ---------- ----------
<S> <C> <C> <C>
Net sales $ 11,672,773 9,200,269 6,362,429
Cost of sales 6,878,372 4,016,662 3,170,171
------------ ---------- ----------
Gross profit 4,794,401 5,183,607 3,192,258
Selling, general and administrative expenses 5,388,923 4,014,466 2,865,626
Research and development expenses 1,157,997 643,223 379,870
------------ ---------- ----------
Operating income (loss) (1,752,519) 525,918 (53,238)
Other income (expense):
Interest income 58,485 130,083 306,671
Interest expense (62,405) (10,888) (113,074)
Other income, net (9,200) 14,272 14,544
------------ ---------- ----------
Total other income (expense) (13,120) 133,467 208,141
Income (loss) before income taxes (1,765,639) 659,385 154,903
Income tax expense -- 20,000 10,000
------------ ---------- ----------
Net income (loss) (1,765,639) 639,385 144,903
Preferred dividend requirements (159,300) (159,300) (154,800)
------------ ---------- ----------
Net income (loss) applicable to common stockholders $ (1,924,939) 480,085 (9,897)
============ ========== ==========
Basic net income (loss) per common share $ (0.72) 0.18 0.00
============ ========== ==========
Diluted net income (loss) per common share $ (0.72) 0.18 0.00
============ ========== ==========
Weighted average number of common shares outstanding
for basic and diluted calculations 2,674,075 2,674,075 2,652,892
============ ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
17
<PAGE> 18
DIGITAL RECORDERS, INC.
Consolidated Statements of Stockholders' Equity
Years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
Number Additional Total
of shares paid-in Translation Accumulated stockholders'
issued Par value capital adjustment deficit equity
------ --------- ------- ---------- ------- ------
<S> <C> <C> <C> <C> <C> <C>
Balance as of December 31, 1994 2,561,043 $256,104 10,407,741 -- (5,070,465) 5,593,380
Issuance of common stock 33,846 3,385 216,615 -- -- 220,000
Additional public offering expenses -- -- (30,283) -- -- (30,283)
Cash dividends declared and paid -- -- -- -- (105,300) (105,300)
Dividends payable -- -- -- -- (49,500) (49,500)
Exercise of warrants 79,186 7,918 238,670 -- -- 246,588
Net income -- -- -- -- 144,903 144,903
--------- -------- ----------- -------- ---------- ----------
Balance as of December 31, 1995 2,674,075 267,407 10,832,743 -- (5,080,362) 6,019,788
Cash dividends declared and paid -- -- -- -- (105,300) (105,300)
Dividends payable -- -- -- -- (54,000) (54,000)
Net income -- -- -- -- 639,385 639,385
Translation adjustment -- -- -- (9,791) -- (9,791)
--------- -------- ----------- -------- ---------- ----------
Balance as of December 31, 1996 2,674,075 267,407 10,832,743 (9,791) (4,600,277) 6,490,082
Cash dividends declared and paid -- -- (119,475) -- -- (119,475)
Dividends payable -- -- (39,825) -- -- (39,825)
Issuance of stock warrants for services rendered -- -- 21,000 -- -- 21,000
Net loss -- -- -- -- (1,765,639) (1,765,639)
Translation adjustment -- -- -- (176,290) -- (176,290)
--------- -------- ----------- -------- ---------- ----------
Balance as of December 31, 1997 2,674,075 $267,407 10,694,443 (186,081) (6,365,916) 4,409,853
========= ======== =========== ======== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
18
<PAGE> 19
DIGITAL RECORDERS, INC.
Consolidated Statements of Cash Flows
Years ended December 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
----------- ---------- ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $(1,765,639) 639,385 144,903
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Depreciation and amortization of
property and equipment 208,621 140,779 78,085
Amortization of goodwill and intangible assets 282,085 224,090 142,748
Other non-cash expense related to issuance of
stock warrants for services rendered 21,000 -- --
Loss on sale of property and equipment -- -- 1,272
Changes in operating assets and liabilities:
Increase in trade accounts receivable (1,083,078) (262,155) (476,644)
Decrease in other receivables 65,726 48,370 33,482
Increase in inventories (1,833,540) (802,403) (172,008)
Decrease (increase) in prepaids and other current assets (23,157) 26,822 (65,015)
Increase in intangible assets (127,922) (234,191) (57,400)
Decrease (increase) in other assets 947 (198) (800)
Increase (decrease) in accounts payable 281,402 486,148 (68,732)
Increase in accrued expenses 110,757 190,264 35,953
Increase (decrease) in other liabilities 80,585 -- (17,406)
----------- ---------- ----------
Net cash provided (used) by operating activities (3,782,213) 456,911 (421,562)
----------- ---------- ----------
Cash flows from investing activities:
Purchases of property and equipment (278,643) (277,147) (236,975)
Proceeds from sale of property and equipment -- -- 1,200
Purchases of short-term investments (161,102) (121,725) (905,322)
Sales and maturities of short-term investments 1,767,524 628,333 2,275,000
Payments for businesses acquired, net of cash received -- (34,560) (1,171,000)
----------- ---------- ----------
Net cash provided (used) by investing activities 1,327,779 194,901 (37,097)
----------- ---------- ----------
Cash flows from financing activities:
Principal payments on long-term debt -- (709,000) (58,658)
Principal payments on capital lease obligations -- -- (7,910)
Proceeds from short-term bank borrowings 8,004,540 520,000 --
Principal payments on short-term bank borrowings (6,111,000) (637,177) --
Proceeds from sale of property held for resale -- 442,625 --
Payment of additional public offering expenses -- -- (30,283)
Payment of dividends on preferred stock (119,475) (105,300) (105,300)
Proceeds from exercise of warrants - Series AAA -- -- 179,116
Proceeds from exercise of warrants - Series AA -- -- 67,472
----------- ---------- ----------
Net cash provided (used) by financing activities 1,774,065 (488,852) 44,437
----------- ---------- ----------
Effect of exchange rate changes (176,290) (9,791) --
----------- ---------- ----------
Net increase (decrease) in cash and cash equivalents (856,659) 153,169 (414,222)
Cash and cash equivalents at beginning of year 1,328,944 1,175,775 1,589,997
----------- ---------- ----------
Cash and cash equivalents at end of year $ 472,285 1,328,944 1,175,775
=========== ========== ==========
Supplemental Disclosure of Cash Flow Information:
Cash paid during the year for interest $ 41,772 10,888 113,074
=========== ========== ==========
Cash paid during the year for income taxes $ 65,800 15,000 --
=========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
19
<PAGE> 20
DIGITAL RECORDERS, INC.
Consolidated Statements of Cash Flows, Continued
Years ended December 31, 1997, 1996 and 1995
Supplemental disclosures of noncash investing and financing activities:
During 1997, 1996 and 1995, the Company declared dividends on Series AAA
Preferred Stock in the amount of $159,300, $159,300, and $154,800 respectively.
During 1997, the Company paid $119,475 in cash dividends relating to dividends
declared. As of December 31, 1997, $39,825 of the remaining dividends declared
were unpaid. During 1996 and 1995, the Company paid $105,300 in cash dividends
relating to the 1996 and 1995 dividends declared.
During 1996, the Company acquired Transit-Media GmbH. The Company paid $35,000
for all of Transit-Media's stock at closing. The Company recorded cash ($440),
other receivables (valued at $1,736), fixed assets (valued at $10,523), accounts
payable (valued at $3,957), short-term bank borrowings (valued at $117,177), and
certain intangible assets (valued at $143,435).
During 1995, the Company acquired certain assets of Digital Audio Corporation.
The Company acquired inventory (valued at $100,000), fixed assets (valued at
$10,000) and goodwill and intangible assets (valued at $1,990,000) in exchange
for cash of $1,171,000, a note payable for $709,000 and common stock valued at
$220,000.
During 1994, the Company issued 80 shares of Series AAA Preferred Stock and an
unissued subscription of 40 shares of Series AAA Preferred Stock in exchange for
resort property with an estimated fair market value of $550,000. During 1995,
the 40 shares of subscribed Series AAA Preferred Stock were issued. On December
20, 1996, the Company closed on the sale of the resort property. The Company
received net proceeds of $467,625 of which $25,000 was outstanding at December
31, 1996. Because the property was sold for less than $600,000, all dividends
declared and payable to this shareholder who received Series AAA Preferred Stock
in exchange for the resort property were forfeited back to the Company until the
difference between the net sales price and $600,000 was reduced to zero. At
December 31, 1996, $108,900 in Series AAA Preferred Stock dividends were
forfeited back to the Company, and a receivable was established for $23,475 for
the remaining difference between the net sales price, the forfeited dividends,
and $600,000. Additional declared dividends totaling $23,475 were forfeited back
to the Company in 1997 as payment for this receivable.
20
<PAGE> 21
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements
December 31, 1997, 1996 and 1995
(1) Organization and Summary of Significant Accounting Policies
(a) Organization
Digital Recorders, Inc. (the "Company") designs, manufactures or contracts
for the manufacture of, and sells products to the mass transit market, the
travelers information station/highway advisory radio market and the law
enforcement market. Customers include municipalities, regional transportation
districts, federal, state and local departments of transportation, turnpikes,
bus manufacturers, and law enforcement agencies or organizations.
(b) Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
(c) Cash Equivalents
The Company considers all highly liquid investments with an original maturity
of three months or less to be cash equivalents.
(d) Investments
The Company's investments consist primarily of U.S. Treasury obligations
which the Company has classified as available-for-sale securities in
accordance with Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities". These
securities are carried at fair value based on quoted market prices at
December 31, with the unrealized gains and losses, net of tax, reported as a
separate component of stockholders' equity. At December 31, 1996, there were
immaterial unrealized gains and losses on the Company's investments.
(e) Trade Accounts Receivable
The Company establishes an allowance for doubtful accounts equal to the
estimated collection losses to be incurred. The estimated losses are based on
actual collection experience and management's opinion of the current status
of existing receivables.
(f) Inventories
Inventories, consisting principally of component parts and finished goods,
are stated at the lower of cost or market, with cost determined by the
first-in, first-out method.
(g) Property and Equipment
Property and equipment are stated at cost and are depreciated using the
straight-line method over the estimated useful lives of the assets (which
range from three to ten years).
21
<PAGE> 22
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
1) Organization and Summary of Significant Accounting Policies, Continued
(h) Goodwill
Goodwill was recorded as part of the acquisitions of Transit-Media GmbH
("Transit-Media") and Digital Audio Corporation ("Digital Audio"). Goodwill
is amortized using a straight-line method over 4 to 15 years. The Company
periodically evaluates the recoverability of its goodwill. If facts and
circumstances suggest that the excess of cost over net assets acquired will
not be recoverable, as determined , based on the undiscounted cash flows of
the entity acquired over the remaining amortization period, the Company's
carrying value of the excess cost over net assets acquired will be reduced by
the estimated shortfalls of cash flows.
(i) Intangible Assets
Intangible assets consist of certain deferred costs recorded as part of the
acquisitions of Transit-Media and Digital Audio, tooling and related costs,
and costs incurred to apply for and obtain patents on internally developed
technology. Intangible assets are amortized using a straight-line method over
3-17 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 on the undiscounted cash
flows of the entity acquired and the patented products over the remaining
amortization period, the Company's carrying value of the intangible assets
will be reduced by the estimated shortfalls of cash flows.
(j) Revenue Recognition
The Company typically recognizes revenue upon shipment of products to
customers. On certain longer-term contracts, the Company recognizes revenue
on a percentage of completion basis.
(k) Research and Development Costs
Research and development costs are charged to operations as incurred.
(l) Per Share Amounts
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No.
128"), which establishes new standards for computing and presenting basic and
diluted earnings per share. As required by SFAS No. 128, the Company adopted
the provisions of the new standard with retroactive effect beginning in 1997.
Accordingly, all net income (loss) per common share amounts for all prior
periods have been restated to comply with SFAS No. 128.
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 outstanding stock options and
warrants represent the only dilutive potential common stock outstanding. The
amounts of income (loss) used in the calculations of diluted and basic income
(loss) per common share were the same for all the years presented. Diluted
net income (loss) per common share is equal to the basic net income (loss)
per common share for the years ended December 31, 1997, 1996, and 1995, as
common equivalent shares from stock options and stock warrants would have an
antidilutive effect.
22
<PAGE> 23
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
1) Organization and Summary of Significant Accounting Policies, Continued
(m) Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reported period.
Actual results could differ from those estimates.
(n) Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation", encourages but does not require companies to
record compensation cost for stock-based employee compensation plans at fair
value. 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. Accordingly, compensation cost for stock options is
measured as the excess, if any, of the estimated fair value of the Company's
stock at the date of grant over the amount an employee must pay to acquire
the stock.
(o) Translation of Foreign Currency
Foreign currency assets and liabilities are translated 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 in stockholders' equity. Realized gains and
losses on foreign currency transactions, if any, are included in operations
for the year.
(p) Certain Reclassifications
Certain reclassifications have been made to the 1995 and 1996 financial
statement balances to conform to the 1997 financial statement
classifications.
(2) Acquisitions
(a) Acquisition of Transit-Media GmbH
On April 30, 1996, the Company acquired Transit-Media in a transaction
accounted for using the purchase method of accounting and, accordingly, the
assets and liabilities of the acquired entity were recorded at their fair
market value at the date of acquisition. Transit-Media assembles and markets
proprietary on-board, electronic destination signs for mass-transit systems
in Europe and the Far East. The Company paid $35,000 for all of
Transit-Media's stock at closing. The Company recorded cash ($440), other
receivables (valued at $1,736), fixed assets (valued at $10,523), accounts
payable (valued at $3,957), short-term bank borrowings (valued at $117,177),
and certain intangible assets (valued at $143,435). Upon completing the
acquisition, the Company invested $350,000 in Transit-Media to pay off an
existing bank credit line and provide working capital. The Company's results
of operations for the twelve months ended December 31, 1996 include the
operations of Transit-Media from May 1, 1996 to December 31, 1996.
23
<PAGE> 24
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(2) Acquisitions, Continued
The following unaudited pro forma results of operations assume the
transaction described above occurred as of January 1, 1995 after giving
effect to certain adjustments, including the amortization of the excess cost
over the fair value of the net assets acquired.
<TABLE>
<CAPTION>
Twelve Months Ended
December 31, 1996 December 31, 1995
----------------- -----------------
<S> <C> <C>
Net sales $9,200,269 6,362,429
Net income $ 566,575 2,976
Basic and diluted net income (loss) per common share $ 0.15 (0.06)
</TABLE>
The pro forma information given above does not purport to be indicative of
the results that actually would have been obtained if the operations were
combined during the years presented and is not intended to be a projection of
future results or trends.
(b) Acquisition of Digital Audio Corporation
On February 28, 1995, the Company purchased certain assets of Digital Audio
in a transaction accounted for using the purchase method of accounting and,
accordingly, the assets of the acquired entity were recorded at their
estimated fair market value at the date of acquisition. Digital Audio
designs, manufactures and markets digital signal processing equipment to
commercial and governmental organizations. The purchase price was $2,100,000
with an earnout payment to be made over two years if certain performance
criteria were met. The Company did not make any earn-out payments pursuant to
this agreement. The Company paid $1,171,000 at closing, recorded an unsecured
note payable to the seller of $709,000 and issued 33,846 shares of the
Company's Common Stock (valued at $220,000) to the seller in exchange for
inventory (valued at $100,000), fixed assets (valued at $10,000) and goodwill
and intangible assets (valued at $1,990,000). The Company's 1995 results of
operations include the operations of Digital Audio from March 1, 1995 through
December 31, 1995.
The following unaudited pro forma results of operations assume the
transaction described above occurred as of January 1, 1995 after giving
effect to certain adjustments, including the amortization of the excess cost
over the fair value of the net assets acquired.
<TABLE>
<CAPTION>
Twelve months ended
December 31, 1995
-----------------
<S> <C>
Net sales $6,636,749
Net income $ 228,662
Basic and diluted net income per common share $ 0.09
</TABLE>
The pro forma information given above does not purport to be indicative of
the results that actually would have been obtained if the operations were
combined during the year presented and is not intended to be a projection of
future results or trends.
24
<PAGE> 25
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(3) Property and Equipment
Property and equipment consists of the following:
<TABLE>
<CAPTION>
December 31,
------------------------
1997 1996
-------- -------
<S> <C> <C>
Leasehold improvements $131,966 131,966
Automobiles 24,304 24,304
Computer equipment 389,704 318,525
Test equipment 122,456 109,913
Furniture and fixtures 265,245 125,931
-------- -------
932,675 710,639
Less accumulated depreciation and amortization 405,642 252,628
-------- -------
$528,033 458,011
======== =======
</TABLE>
(4) Property Held for Resale
During 1994, the Company issued 80 shares of Series AAA Preferred Stock and a
subscription for 40 shares of Series AAA Preferred Stock in exchange for
resort property, which the Company listed for sale. During 1995, the 40
shares of subscribed Series AAA Preferred Stock were issued. The fair market
value of the property was estimated at $550,000 and, therefore, both the
property and equity exchanged were recorded at $550,000. On December 20,
1996, the Company closed on the sale of the resort property. The Company
received net proceeds of $467,625 of which $25,000 was outstanding at
December 31, 1996. Based on the original agreement, since the property sold
for less than the initial $600,000 stock valuation, all dividends declared
and payable to this shareholder were forfeited back to the Company until
the difference between the net sales price and $600,000 was reduced to zero.
At December 31, 1996, $108,900 in Series AAA Preferred Stock dividends were
forfeited back to the Company, and a receivable was established for $23,475
for the remaining difference between the net sales price, the forfeited
dividends, and $600,000. Additional declared dividends totaling $23,475 were
forfeited back to the Company in 1997 as payment for this receivable.
(5) Leases
The Company leases its premises under various operating leases which expire
at various times through 2002. Rent expense under these operating leases was
$195,272, $162,736 and $84,869 for the years ended December 31, 1997, 1996
and 1995, respectively.
At December 31, 1997, future minimum lease payments under the noncancellable
operating leases are as follows:
<TABLE>
<S> <C>
Year ending December 31,
1998 $ 176,988
1999 175,820
2000 154,426
2001 132,447
2002 108,794
-----------
Total minimum lease payments $ 747,475
===========
</TABLE>
25
<PAGE> 26
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(6) Debt
On May 24, 1996, the Company obtained a $2,000,000 unsecured credit facility
from a financial institution. The agreement provided for short-term
borrowings and import letters of credit, was subject to certain loan
covenants, and bore interest at a rate of LIBOR plus 2.3%, payable quarterly.
At December 31, 1996, there were no outstanding borrowings under the credit
agreement, but there was $460,425 committed under an import letter of credit
for inventory purchases from an overseas supplier.
On July 24, 1997, the Company's $2,000,000 unsecured credit facility from a
financial institution expired and was replaced by a $2,500,000 secured line
of credit facility and a $1,000,000 secured letter of credit facility from
the same financial institution. The new credit facility provides for
short-term borrowings and import letters of credit, is subject to certain
loan covenants, is secured by substantially all of the Company's accounts
receivable, inventory and equipment, and bears interest, payable quarterly,
at the 90 day LIBOR base rate plus 2.3% to 3.3% dependent upon the Company's
rolling four quarter earnings before interest, taxes, depreciation and
amortization. At December 31, 1997, the borrowings under this agreement
totaled $1,893,540. In addition, at December 31, 1997, the Company had
$127,427 committed under two import letters of credit for inventory purchases
from an overseas supplier. This secured facility requires the Company to meet
certain financial and other covenants. At December 31, 1997, the Company was
in compliance with all of the covenants not expressly waived by this lender.
At December 31, 1995, the Company had $709,000 outstanding under an unsecured
6% note incurred in the Digital Audio acquisition. The note was paid in
January 1996.
(7) Preferred Stock
The Company has the authority to issue 1,000,000 shares of preferred stock of
which 700,000 shares have been designated Series A Convertible Preferred
Stock and 10,000, 7,500, 10,020 and 20,000 shares have been designated Series
B, Series C, Series AA and Series AAA Redeemable Nonvoting Preferred Stock,
respectively. In addition, 252,480 shares of undesignated preferred stock are
authorized and unissued.
Series AAA Preferred shares are cumulative, nonvoting, fully participating,
convertible and redeemable at the Company's discretion with the redemption
price equal to the liquidation preference. The liquidation preference equals
$5,000 per share, plus all accrued and unpaid dividends. Dividends accrue at
a quarterly rate of $112.50 per share. Each Preferred share may be converted
into 500 shares of Common Stock. The Company, at its option, may redeem these
shares at any time but no later than the fifth anniversary of the date of
issuance of these shares. These fifth anniversary dates range from December
1998 through June 1999.
(8) Common Stock Warrants
Each warrant granted in connection with the public offering allows the holder
to purchase one share of Common Stock at a price of $7.50 per share. These
warrants were to initially expire in November 1997 but were extended until
August 1998. No other terms of these warrants were changed. At December 31,
1997 and 1996, 1,265,000 warrants were outstanding, and no warrants had been
exercised.
During 1997, 75,000 warrants were granted which allow the holder to purchase
one share of Common Stock for each warrant granted. 37,500 of these warrants
are to purchase Common Stock at a price of $3.00 per share, 18,750 are to
purchase Common Stock at a price of $5.00 per share and the remaining 18,750
are to purchase Common Stock at a price of $7.50 per share. At December 31,
1997, 50% of each group of these warrants had vested and all 75,000 of these
warrants were outstanding. These warrants expire in June 2002.
26
<PAGE> 27
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(8) Common Stock Warrants, Continued
During 1996, 30,000 warrants were granted which allow the holder to purchase
one share of Common Stock for each warrant granted. Exercise of these
warrants into common shares is contingent upon the market price of the
Company's common shares exceeding prices ranging from $6.50 to $14.00 per
share for ninety consecutive calendar days prior to the exercise date. At
December 31, 1997, all 30,000 of these warrants were outstanding. These
warrants expire in April 2006.
Each warrant granted in connection with the Series AAA Preferred Stock allows
the holder to buy, based on the number of Series AAA Preferred Stock shares
purchased, up to 23,160 shares of Common Stock at a price of $2.95 per share
which price increases annually to a maximum of $11.79 per share. These
warrants expire in December 1998. At December 31, 1997 and 1996, there were
warrants outstanding to purchase 408 shares of Common Stock. During 1995,
warrants were exercised to purchase 60,851 shares of Common Stock at $2.95
per share.
(9) 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.
The following is a summary of incentive stock option transactions:
<TABLE>
<CAPTION>
Exercise Price
Shares per share
------ ---------
<S> <C> <C>
Balance at December 31, 1995 196,507 $3.20 - 7.00
Granted 69,800 3.75 - 7.25
Canceled (47,750) 3.20 - 7.00
-------
Balance at December 31, 1996 218,557 3.20 - 7.25
Granted 84,300 2.19 - 4.08
Canceled (6,600) 4.50 - 6.75
-------
Balance at December 31, 1997 296,257 $2.19 - 7.25
=======
</TABLE>
(b) Non-Qualified Stock Options
---------------------------
The Company has issued options to purchase Common Stock to certain key
executives and 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.
The following is a summary of nonqualified stock options:
<TABLE>
<CAPTION>
Exercise Price
Shares per share
------ ---------
<S> <C> <C>
Balance at December 31, 1995 30,041 $3.20 - 5.16
Canceled (2,339) 4.50 - 5.00
-------
Balance at December 31, 1996 27,702 3.20 - 5.16
Granted 13,000 2.38
Canceled --- ---
-------
Balance at December 31, 1997 40,702 $2.38 - 5.16
=======
</TABLE>
27
<PAGE> 28
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(9) Common Stock Options, Continued
(c) Stock-Based Compensation
------------------------
As described in Note 1, the Company has chosen to continue to account for
stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" and related interpretations and, accordingly, no compensation cost
has been recognized for stock options issued under the Company's stock option
plans or stock warrant grants other than $21,000 of expense recorded in 1997
pursuant to the stock warrant grant to a non-employee as more fully described
in Footnote (8). Had compensation cost for the Company's stock option plans
and stock warrant grants been determined consistent with Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation", the Company's pro forma net income (loss) applicable to common
stockholders and net income (loss) per common and common equivalent share
would have been as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Net income (loss) applicable to
common stockholders $ (1,924,939) 480,085
Pro forma net income (loss) applicable
to common stockholders $ (2,067,984) 319,870
Basic and diluted net income (loss)
per common share $ (0.72) 0.18
Pro forma basic and diluted net income (loss)
per common share $ (0.77) 0.12
</TABLE>
In the pro forma calculations shown above, the Company used the Black-Scholes
option pricing model to calculate the fair value of the stock options and
stock warrants granted during 1997 and 1996. Significant assumptions used by
the Company for these pro forma calculations are as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Risk-free interest rate 6.50% 6.75%
Expected life 7 years 7 years
Expected volatility 50.52% 21.82%
Expected dividends None None
</TABLE>
(10) Income Taxes
(a) The components of income tax expense for the years ended December 31,
1997, 1996 and 1995 consisted of the following:
<TABLE>
<CAPTION>
1997 1996 1995
-------- ------ ------
<S> <C> <C> <C>
Current expense:
Federal $ -- 20,000 10,000
State -- -- --
-------- ------ ------
-- 20,000 10,000
Deferred expense:
Federal -- -- --
State -- -- --
-------- ------ ------
Income tax expense $ -- 20,000 10,000
======== ====== ======
</TABLE>
28
<PAGE> 29
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(10) Income Taxes, Continued
(b) The components of the net deferred tax assets as of December 31, 1997
and 1996 are as follows:
<TABLE>
<CAPTION>
1997 1996
---- ----
Deferred tax assets:
<S> <C> <C>
Net operating loss carryforwards $ 1,006,276 978,104
Tax credits 120,185 109,898
Warranty reserve 57,456 63,355
Inventory reserve 88,009 82,142
Inventory capitalization 30,544 28,241
Accrued bonuses 23,712 24,922
Depreciation and amortization 53,759 29,248
Organization and start-up costs 171,774 72,563
Other accruals and reserves 50,087 18,207
----------- ----------
Total gross deferred tax assets 1,601,802 1,406,680
Less valuation allowance (1,601,802) (1,406,680)
----------- ----------
Net deferred tax assets $ - -
=========== ==========
</TABLE>
The Company has determined that the need for a valuation allowance
arises due to the Company's history of operating losses.
(c) The reasons for the difference between actual income tax expense for
the years ended December 31, 1997, 1996 and 1995 and the amount
computed by applying the statutory federal income tax rate to earnings
before income taxes are as follows:
<TABLE>
<CAPTION>
1997
---------------------------
% of
Pretax
Amount Earnings
------ --------
<S> <C> <C>
Income tax benefit at statutory rate $(600,317) (34.0%)
Foreign subsidiary losses 387,408 21.9%
Change in the beginning-of-year balance of the 195,122 11.1%
valuation allowance for deferred tax assets
allocated to the provision for income taxes
Other 17,787 1.0%
--------- ----
Income tax expense $ -- --
========= ====
</TABLE>
29
<PAGE> 30
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(10) Income Taxes, Continued
<TABLE>
<CAPTION>
1996
----------------------------
% of
Pretax
Amount Earnings
------ --------
<S> <C> <C>
Income tax expense at statutory rate $ 224,191 34.0%
Foreign subsidiary losses 132,227 20.1%
Change in the beginning-of-year balance of the
valuation allowance for deferred tax assets
allocated to the provision for income taxes (337,221) (51.1%)
Other 803 0.0%
--------- ----
Income tax expense $ 20,000 3.0%
========= ====
</TABLE>
<TABLE>
<CAPTION>
1995
----------------------------
% of
Pretax
Amount Earnings
------ --------
<S> <C> <C>
Income tax expense at statutory rate $ 52,667 34.0%
State income taxes, net of federal income tax
benefit 9,350 6.0%
Research and experimentation tax credits (62,228) (40.2%)
Change in the beginning-of-year balance of the
valuation allowance for deferred tax assets
allocated to the provision for income taxes (2,472) (1.5%)
Other 12,683 8.2%
--------- ----
Income tax expense $ 10,000 6.5%
========= ====
</TABLE>
(d) At December 31, 1997, the Company has net operating loss carryforwards
for federal income tax purposes of $2,845,535 which are available to
offset future federal taxable income, if any, through 2012. In
addition, one of the Company's subsidiaries has net economic loss
carryforwards for state income tax purposes of $758,446 which are
available to offset future state taxable income, if any, through 2002.
The Tax Reform Act of 1986 contains provisions which limit the ability
to utilize net operating loss carryforwards in the case of certain
events including significant changes in ownership interests. If the
Company's 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 has research and development tax credits for federal income
tax purposes of $120,815 at December 31, 1997 which expire in various
years through 2012.
(11) Foreign Operations
Transit-Media, headquartered in Germany, assembles and markets propriety
on-board, electronic destination signs for mass-transit systems in Europe and
the Far East. Summarized financial information for the Company's domestic and
foreign operations for the year ended December 31, 1997 is as follows:
Domestic Foreign Consolidated
-------- ------- ------------
Net sales $ 9,848,164 1,824,609 11,672,773
Operating losses (934,014) (818,505) (1,752,519)
Identifiable assets 7,150,669 2,800,524 9,951,193
The operating losses shown above do not reflect the allocation of any
domestic corporate overhead costs to the foreign subsidiary. In addition,
foreign sales did not represent 10% of consolidated sales in 1996.
(12) Major Customers
The Company typically generates a significant portion of its revenues from a
relatively few key customers, the identity of which may vary from year to
year. During 1997, no particular customer accounted for more than 10% of
total Company revenues. Combined revenues from three major customers
accounted for approximately 34% and 35% of net sales during 1996 and 1995,
respectively.
30
<PAGE> 31
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(13) Related Party Transactions
Effective March 1996, the Company entered into various marketing,
distribution, licensing and management agreements with an affiliate of a
director of the Company. The Company paid fees and commissions earned under
these various agreements totaling $233,660 and $173,880 during 1997 and 1996,
respectively.
The Company has retained a director of the Company to perform certain
business consulting services for the Company. The Company paid fees under
this agreement totaling $83,860, $67,000 and $55,000 during 1997, 1996 and
1995, respectively.
Effective March 1995, the Company entered into a lease agreement for an
office building with a stockholder. The Company paid $43,369, $20,800 and
$17,333 in rental fees during 1997, 1996 and 1995 to this stockholder.
Effective July 1995, the Company modified an existing agreement with an
affiliate of a director and shareholder to provider acquisition consulting
services. The Company paid fees under this agreement totaling $36,000,
$33,250, and $23,750 during 1997, 1996, and 1995, respectively.
Effective February 1993, the Company engaged an affiliate of a director of
the Company as an independent sales representative in marketing the Company's
products. Pursuant to such agreement, as amended effective May 15, 1994, the
sales representative received a monthly draw of $3,000 against commissions
and reimbursement of certain business expenses. No commissions were paid
under this agreement in 1997. The Company paid fees under this agreement
totaling $26,179 and $17,521 during 1996 and 1995, respectively.
(14) Subsequent Events (Unaudited)
In January 1998, the Company's Board of Directors declared a dividend on
Series AAA Preferred Stock for shareholders of record as of December 31,
1997. The dividends totaled $39,825.
On February 26, 1998 the Company renewed its $2,500,000 secured line of
credit facility and $1,000,000 secured letter of credit facility through
February of 1999 with the same financial institution. This revised facility
provides for short-term borrowings and import letters of credit, is subject
to certain loan covenants, is secured by substantially all of the Company's
accounts receivable, inventory and equipment, and bears interest, payable
monthly, at the 90 day LIBOR base rate plus 4.0%.
On April 6, 1998 the holders of the Series AAA Preferred Stock approved an
amendment to the Company's Articles of Incorporation to (i) extend the
mandatory redemption date of the Series AAA Preferred stock (the "Preferred
Shares") to December 31, 2003, (ii) permit the earlier redemption of the
Preferred Shares at the Company's option at any time upon 30 days' written
notice, (iii) increase the amount of the quarterly dividend payable with
respect to each Preferred Share from $112.50 to $125.00, and (iv) increase
the number of shares of Common Stock of the Company issuable upon conversion
of each Preferred Share from 500 shares of Common Stock to 625 shares of
Common Stock. Such amendment will be presented to a vote of the holders of
Common Stock in the Company's fiscal 1997 Proxy Statement and, if approved by
a majority of the holders of Common Stock, will be adopted by the Company.
On April 14, 1998 the Company sold its Highway Information Systems business
group for $2,800,000 in cash plus other consideration of approximately
$200,000. The Company realized a gain on disposal, before applicable income
taxes, of approximately $1,500,000. The income tax expense on this
transaction, which the Company will offset with the tax loss carryforwards
which existed as of December 31, 1997, totaled approximately $600,000.
31
<PAGE> 32
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(15) Quarterly Information (Unaudited)
<TABLE>
<CAPTION>
1997
-----------------------------------------------------------------------
Three months ended 3/31/97 6/30/97 9/30/97 12/31/97
----------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net sales $ 2,398,210 2,905,773 3,942,788 2,426,002
Gross profit 1,222,389 1,377,547 1,642,897 551,568
Net loss (147,509) (188,731) (137,462) (1,291,937)
Net loss applicable to
common stockholders (187,334) (228,556) (177,287) (1,331,762)
Basic and diluted net loss per
common share $ (0.07) (0.09) (0.07) (0.50)
</TABLE>
<TABLE>
<CAPTION>
1996
------------------------------------------------------------------
Three months ended 3/31/96 6/30/96 9/30/96 12/31/96
----------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net sales $1,750,568 2,173,448 3,062,101 2,214,152
Gross profit 986,781 1,140,763 1,631,075 1,424,988
Net income 187,862 97,846 306,221 47,456
Net income applicable to
common stockholders 148,037 58,021 266,396 7,631
Basic and diluted net income per
common share $ 0.06 0.02 0.10 0.00
</TABLE>
32
<PAGE> 33
PART III
Certain information required by Part III is omitted from this Report in
that the Registrant will file a definitive proxy statement pursuant to
Regulation 14A (the "Proxy Statement") not later than 120 days after the end of
the fiscal year covered by this report and certain information included therein
is incorporated herein by reference. Only those sections of the Proxy Statement
that specifically address the items set forth herein are incorporated by
reference.
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The information required by this Item is incorporated by reference to
the Company's Proxy Statement.
ITEM 10. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to
the Company's Proxy Statement.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to
the Company's Proxy Statement
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to
the Company's Proxy Statement
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following documents are filed herewith or have been included as
exhibits to previous filings with the Securities and Exchange Commission and are
incorporated herein by this reference:
Exhibit No. Document
- ----------- --------
+++ 2.1 Stock Acquisition Agreement, dated March 20, 1996, between
the Company and Transit-Media GmbH.
+++ 2.2 Notary Public Closing Document, dated April 30, 1996,
between the Company and Transit-Media GmbH.
* 3.1.1 Articles of Incorporation of the Company as filed on
March 2, 1983 with the Secretary of State of the State of
North Carolina.
* 3.1.2 Articles of Amendment to Articles of Incorporation of
the Company as filed on September 13, 1983 with the Secretary
of State of the State of North Carolina.
* 3.1.3 Articles of Amendment to Articles of Incorporation of
the Company as filed on June 26, 1986 with the Secretary of
State of the State of North Carolina.
* 3.1.4 Articles of Amendment to Articles of Incorporation of
the Company as filed on November 19, 1986 with the Secretary
of State of the State of North Carolina.
33
<PAGE> 34
Exhibit No. Document
- ----------- --------
* 3.1.5 Articles of Amendment to Articles of Incorporation of
the Company as filed on March 3, 1988 with the Secretary of
State of the State of North Carolina.
* 3.1.6 Amended and Restated Articles of Incorporation of the
Company as filed on December 28, 1990 with the Secretary of
State of the State of North Carolina.
* 3.1.7 Articles of Amendment to Articles of Incorporation of
the Company as filed on January 14, 1993, with the Secretary
of State of the State of North Carolina.
* 3.1.8 Articles of Amendment to Articles of Incorporation of
the Company as filed on February 4, 1993 with the Secretary of
State of the State of North Carolina.
* 3.1.9 Articles of Amendment to Articles of Incorporation of
the Company as filed on October 20, 1993 with the Secretary of
State of the State of North Carolina.
* 3.1.10 Form of Amended and Restated Articles of Incorporation
to be filed with the Secretary of State of the State of North
Carolina.
* 3.1.11 Form of Amendment to Articles of Incorporation to be
filed with the Secretary of State of the State of North
Carolina.
* 3.2.1 Form of Amended and Restated By-Laws of the Company.
* 4.1 Form of specimen certificate for Common Stock of the
Company.
* 4.2 Form of specimen certificate for Warrants of the Company.
* 4.3 Form of Underwriter's Warrants to be issued by the Company
to the Underwriter.
* 4.4 Warrant Agreement between the Company and Continental
Stock Transfer & Trust Company.
* 10.1.1 Form of Employment Agreement, by and between J.
Phillips L. Johnston and the Company.
* 10.1.3 Employment Agreement, dated June 26, 1986, by and
between Virgil D. Duncan and the Company.
* 10.2 Incentive Stock Option Plan, adopted April 27, 1993,
authorizing 200,000 shares of Common Stock for issuance
pursuant to the Plan.
* 10.4 Form of 12.5% Subordinated Debentures, issued in the
aggregate principal amount of $250,050.
* 10.5 Promissory Note, dated January 1, 1993, payable to John
M. Reeves in the principal amount of $85,843.
* 10.6 Exclusive Marketing and Sales Agreement, dated February
1, 1992, by and between the Company and Federal Signal
Corporation.
* 10.7 International Master Distributor Agreement, dated June
22, 1994, by and between First Exim Financial Limited and the
Company.
* 10.8 Form of domestic Sales Representative Agreement.
* 10.9 Office Lease Agreement, dated September 20, 1989, by and
between Research Triangle Industrial Park West Associates
Joint Venture and the Company.
** 10.9.1 Commercial Lease Agreement, dated February 28, 1995, by
and between James E. Paul, Jr. and the Company.
34
<PAGE> 35
Exhibit No. Document
- ----------- --------
++ 10.9.2 Sublease, dated April 24, 1996, by and between Family
Health International and the Company.
++++ 10.9.3 Commercial Lease Agreement, dated April 24, 1997, by
and between Realmark Property Investors Ltd. Partnership V and
the Company.
* 10.10 Technology Purchase and Consulting Agreement, dated July
17, 1987, as amended on July 10, 1990, by and between the
Company and Intermark Corp.
* 10.11 Representation Agreement, dated February 8, 1993 as
amended May 12, 1994, by and between Business Development
Associates, Inc. and the Company.
* 10.12 Highway Advisory Radio System Agreement, dated February
25, 1994, by and between the Company and the New Jersey
Turnpike Authority.
* 10.13 Memorandum concerning consulting services, dated as of
January 10, 1992, as amended on April 28, 1993, by and between
the Company and Curtis L. Kring.
* 10.14 Purchase Order, dated September 9, 1993, by and between
the Company and Harris Corporation.
* 10.15 Purchase Order, dated September 9, 1994, by and between
New Flyer Industries, Ltd. and the Company.
* 10.16 Purchase Order, dated September 15, 1994, by and between
Gillig Corporation and the Company.
* 10.17 Agreement for Transfer of Hawaii condominium, dated July
1, 1994, by and between William H. Wilson and Linda E. Wilson,
on the one hand, and the Company, on the other.
* 10.18 Apartment Deed, filed August 2, 1994, from William H.
Wilson and Linda E. Wilson to the Company.
* 10.19 Appraisal Report, dated as of May 10, 1994, from Island
Appraisals to the Company.
+ 10.20 Asset Purchase and Sale Agreement, dated February 28,
1995, by and between Digital Audio Corporation and the
Company.
++ 10.21 Note, Commitment Letter, and Continuing Letter of Credit
Agreement, dated May 24, 1996, by and between Wachovia Bank of
North Carolina, N.A. and the Company.
++++ 10.21.1 Note, Commitment Letter and General Security
Agreement, dated July 24, 1997, by and between Wachovia Bank
of North Carolina N.A. and the Company.
*** 10.22 Services Agreement, dated April 19, 1996, by and between
the Company and Robinson Turney International, Inc.
*** 10.22.1 Amendment to April 19, 1996 Services Agreement, dated
July 29, 1996, by and between the Company and Robinson Turney
International, Inc.
*** 10.23 Exclusive Distribution and Sublicense Agreement, dated
June 1, 1996, by and between Robinson Turney International,
Inc. and TwinVision Corp. of North America, Inc.
*** 10.23.1 Amendment and Supplement to June 1, 1996 Exclusive
Distribution and Sublicense Agreement, also dated June 1,
1996, by and between Robinson Turney International, Inc. and
TwinVision Corp. of North America, Inc.
*** 10.23.2 Amendment to June 1, 1996 Exclusive Distribution and
Sublicense Agreement, dated July 29, 1996, by and between
TwinVision Corp. of North America, Inc. and Robinson Turney
International, Inc.
35
<PAGE> 36
Exhibit No. Document
- ----------- --------
*** 10.24 Management Services Agreement, dated as of April 19,
1996, by and between the Company, Transit-Media GmbH and
Robinson Turney International, Inc.
*** 10.24.1 Amendment to April 19, 1996 Management Services
Agreement, also dated April 19, 1996, by and between the
Company, Transit-Media GmbH and Robinson Turney International,
Inc.
++++ 10.24.2 Amendment to April 19, 1996 Management Services
Agreement dated May 15, 1997 by and between the Company and
Robinson Turney International, Inc.
++++ 10.24.3 Amendment to April 19, 1996 Management Services
Agreement and to April 19, 1996 Services Agreement dated June
30, 1997 by and between the Company, Transit-Media GmbH,
TwinVision Corp. of North America, Inc. and Robinson Turney
International, Inc.
*** 10.25 Exclusive International Marketing Agreement, dated as of
April 19, 1996, by and between the Company, TwinVision Corp.
of North America, Inc. and Robinson Turney International, Inc.
*** 10.26 Common Stock Warrant Agreement by and between Robinson
Turney International, Inc. and the Company.
11 Not Applicable.
13 Not applicable.
16 Not applicable.
18 Not applicable.
*** 21 Listing of Subsidiaries of the Company.
22 Not applicable.
* 23.4 Consent of Island Appraisals.
27 Financial Data Schedule.
28 Not applicable.
99 Not applicable.
- -----------------------
* Incorporated by reference from the Company's Registration Statement on
Form SB-2 (S.E.C. File No. 33-82870-A).
** Incorporated by reference from the Company's Form 10-KSB dated March
28, 1996.
*** Incorporated by reference from the Company's Form 10-KSB dated March
31, 1997.
+ Incorporated by reference from the Company's current Report on Form 8-K
dated on or about March 15, 1995.
++ Incorporated by reference from the Company's third quarter Form 10-QSB
dated August 14, 1996.
+++ Incorporated by reference from the Company's Form 8-K dated May 15,
1996.
++++ Incorporated by reference from the Company's second quarter Form 10-QSB
dated August 14, 1997.
- ------------------
(b) Reports on Form 8-K
None
36
<PAGE> 37
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
DIGITAL RECORDERS, INC.
Date: April 20, 1998 By: /s/ J. PHILLIPS L. JOHNSTON
-------------------------------
J. Phillips L. Johnston,
Chairman of the Board
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
Signature Title Date
--------- ----- ----
/s/ J. PHILLIPS L. JOHNSTON Chairman of the Board and April 20, 1998
- ------------------------------ Chief Executive Officer
J. Phillips L. Johnston (Principal Executive Officer)
/s/ JONATHAN E. KENNEDY Chief Financial Officer and April 20, 1998
- ------------------------------ Secretary (Principal Financial
Jonathan E. Kennedy and Accounting Officer)
/s/ JOHN H HIGGINS, SR. Director April 20, 1998
- ------------------------------
John H. Higgins, Sr
/s/ C. JAMES MEESE, JR. Director April 20, 1998
- ------------------------------
C. James Meese, Jr.
/s/ JOHN K. PIROTTE Director April 20, 1998
- ------------------------------
John K. Pirotte
/s/ JOHN M. REEVES, II Director April 20, 1998
- ------------------------------
John M. Reeves, II
/s/ JULIANN TENNEY Director April 20, 1998
- ------------------------------
Juliann Tenney
/s/ JOHN W. THOMAS, JR. Director April 20, 1998
- ------------------------------
John W. Thomas, Jr.
/s/ DAVID L. TURNEY Director April 20, 1998
- ------------------------------
David L. Turney
37
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 472,285
<SECURITIES> 0
<RECEIVABLES> 3,223,959
<ALLOWANCES> (50,000)
<INVENTORY> 3,723,446
<CURRENT-ASSETS> 7,498,464
<PP&E> 933,675
<DEPRECIATION> (405,642)
<TOTAL-ASSETS> 9,951,193
<CURRENT-LIABILITIES> 0
<BONDS> 0
1,770,000
0
<COMMON> 267,407
<OTHER-SE> 4,142,446
<TOTAL-LIABILITY-AND-EQUITY> 9,951,193
<SALES> 11,672,773
<TOTAL-REVENUES> 11,672,773
<CGS> 6,878,372
<TOTAL-COSTS> 6,878,372
<OTHER-EXPENSES> 6,546,920
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 62,405
<INCOME-PRETAX> (1,765,639)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,765,639)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,765,639)
<EPS-PRIMARY> (0.72)
<EPS-DILUTED> (0.72)
</TABLE>
