<PAGE>
FORM 10-QSB
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934. FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from ___________ to ______________
Commission file number 1-13408
DIGITAL RECORDERS, INC.
(Name of small business issuer as specified in its charter)
NORTH CAROLINA 56-1362926
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
4018 PATRIOT DRIVE, SUITE 100
DURHAM, NORTH CAROLINA 27703
(Address of principal executive offices)
(919) 361-2155
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 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
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the
issuer's classes of common equity
Common stock: 3,274,075 shares outstanding
as of November 3, 1999
Transitional Small Business Disclosure Format (check one); Yes No X
<PAGE>
PART 1 FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
ITEM PAGE
<S> <C>
Financial Statements:
Consolidated Balance Sheets............................................. 3
Consolidated Statements of Operations................................... 4
Consolidated Statements of Cash Flows .................................. 5-6
Notes to Consolidated Financial Statements.............................. 7-10
</TABLE>
2
<PAGE>
DIGITAL RECORDERS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, 1999 December 31, 1998
ASSETS (Unaudited) Audited
-------------------- ----------------
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 411,351 $ 703,639
Trade accounts receivable, less allowance for doubtful accounts of $50,000
at September 30, 1999 and December 31, 1998, respectively 4,549,449 3,371,365
Other receivables 113,145 38,799
Inventories 4,881,159 4,047,830
Prepaids and other current assets 492,769 148,911
-------------------- ----------------
Total current assets 10,447,873 8,310,544
-------------------- ----------------
Property and equipment, less accumulated deprecication of
$424,132 and $354,179 at September 30, 1999 and December 31, 1998, respectively 497,549 315,550
Goodwill, less accumulated amortization of $623,422 and $546,679
at September 30, 1999 and December 31, 1998, respectively 1,246,612 1,361,756
Intangible assets, less accumulated amortization of $276,092 and $409,251
at September 30, 1999 and December 31, 1998, respectively 101,866 298,149
Other assets 352,333 5,451
-------------------- ----------------
TOTAL ASSETS $ 12,646,233 $ 10,291,450
==================== ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Short-term bank borrowings $ 1,921,383 $ 925,000
Accounts payable 3,457,161 1,479,740
Accrued expenses 714,001 546,178
Income taxes payable - 49,977
Dividends payable 44,250 39,825
Other current liabilities 1,064 136,084
-------------------- ----------------
Total current liabilities 6,137,859 3,176,804
-------------------- ----------------
TOTAL LIABILITIES 6,137,859 3,176,804
-------------------- ----------------
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 September 30, 1999 and December 31, 1998,
respectively 1,770,000 1,770,000
-------------------- ----------------
Stockholders' Equity:
Common stock, $.10 par value, 10,000,000 shares authorized; 3,274,075
shares issued and outstanding at September 30, 1999
and at December 31, 1998 327,407 327,407
Additional paid-in capital 11,379,340 11,507,190
Accumulated other comprehensive income - foreign currency translation (187,877) (48,839)
Accumulated deficit (6,780,496) (6,441,112)
-------------------- ----------------
Total stockholders' equity 4,738,374 5,344,646
-------------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 12,646,233 $ 10,291,450
==================== ================
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
DIGITAL RECORDERS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTH AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 1999 AND 1998
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
<S> <C> <C> <C> <C>
Net sales $ 6,559,334 $ 3,297,574 $ 15,554,977 $ 8,469,983
Cost of sales 4,156,221 1,815,521 9,857,189 4,742,949
-------------- ------------- ------------- --------------
Gross profit 2,403,113 1,482,053 5,697,788 3,727,033
-------------- ------------- ------------- --------------
Operating expenses:
Selling, general and administrative 1,621,132 1,323,356 4,580,638 4,135,972
Engineering, research and development 475,022 263,948 1,206,704 726,475
-------------- ------------- ------------- --------------
Total operating expenses 2,096,154 1,587,304 5,787,342 4,862,447
-------------- ------------- ------------- --------------
Operating income (loss) 306,959 (105,251) (89,554) (1,135,414)
Other income (expense), net (58,098) (13,493) (118,142) (72,487)
-------------- ------------- ------------- --------------
Income (loss) before income taxes 248,860 (118,744) (207,696) (1,207,901)
Income tax expense (benefit) - Note 6 - - - (478,955)
-------------- ------------- ------------- --------------
Income (loss) from continuing operations 248,860 (118,744) (207,696) (728,946)
-------------- ------------- ------------- --------------
Discontinued operations:
Income from operations of HIS division, net
of tax - Note 6 - - - 84,123
Gain on sale of HIS division, net of tax - Note 6 - - - 671,356
-------------- ------------- ------------- --------------
Income (loss) from discontinued operations - - - 755,479
-------------- ------------- ------------- --------------
Net income (loss) 248,860 (118,744) (207,696) 26,533
Preferred dividend requirements (44,250) (39,825) (127,850) (119,475)
-------------- ------------- ------------- --------------
Net income (loss) before change in accounting principle 204,610 (158,569) (335,546) (92,942)
Less: Cumulative effect of change in accounting
principle - Note 10 - - 131,687 -
-------------- ------------- ------------- --------------
Net income (loss) applicable to common shareholders $ 204,610 $ (158,569) $ (467,233) $ (92,942)
============== ============= ============= ==============
Earnings per share:
Net Income (loss) from continuing operations before
income taxes $ 0.07 $ (0.04) $ (0.06) $ (0.42)
Income tax benefit - - - 0.17
Net income from discontinued operations,
net of tax - - - 0.26
Preferred dividend requirements (0.01) (0.01) (0.04) (0.04)
Cumulative effect of change in accounting principle - - (0.04) -
-------------- ------------- ------------- --------------
Total basic and diluted net income (loss) per share $ 0.06 $ (0.05) $ (0.14) $ (0.03)
============== ============= ============= ==============
Weighted average number of common shares and common
equivalent shares outstanding 3,274,075 3,252,900 3,274,075 2,867,700
============== ============= ============= ==============
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
DIGITAL RECORDERS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTH AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 1999 AND 1998
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net Income (Loss) $ 248,860 $ (118,744) $ (339,383) $ 26,534
Adjustments to reconcile net income (loss) to net cash
used by operating activities:
Depreciation and amortization of property and equipment 45,329 48,551 115,282 180,517
Amortization of goodwill and intangible assets 59,540 66,268 180,371 196,525
Net book value of intangible assets written off - - 131,687 -
Changes in operating assets and liabilities:
Decrease (increase) in trade accounts receivable (803,978) (421,674) (1,178,083) 214,668
Decrease (increase) in other receivables (57,838) 529 (74,347) 27,475
(Increase) in inventories (352,030) (12,405) (833,329) (129,211)
Decrease (Increase) in prepaids and other current assets 95,573 (64,499) (343,858) (81,358)
(Increase) in intangible assets (11,716) (29,439) (630) (34,004)
(Increase) in other assets (346,883) (1,279) (346,883) (842)
Increase (decrease) in accounts payable 1,160,716 (473,283) 1,977,423 (424,577)
Increase (decrease) in accrued expenses 36,523 22,155 167,823 (70,458)
(Decrease) in deferred revenue - - - (80,585)
(Decrease) in income taxes payble - - (49,977) -
Increase (decrease) in other current liabilities 3,672 125,322 (135,020) 192,843
------------ ------------ ------------ ------------
Net cash provided (used) by operating activities 77,767 (858,498) (728,924) 17,527
------------ ------------ ------------ ------------
Cash flows from investing activities:
Purchases of property and equipment (127,609) (30,516) (297,282) (136,770)
Sales of property and equipment - - - 193,206
Sales of intangible assets - - - 10,538
------------ ------------ ------------ ------------
Net cash provided (used) by investing activities (127,609) (30,516) (297,282) 66,974
------------ ------------ ------------ ------------
Cash flows from financing activities:
Issuance of common stock - Note 7 - 1,064,656 - 1,064,656
Proceeds from short-term bank borrowings - Note 4 3,642,089 1,150,000 5,422,089 4,779,461
Principal payments on short-term bank borrowings - Note 4 (3,425,708) (1,170,000) (4,425,708) (6,073,000)
Payment of dividends on preferred stock (41,800) (39,825) (123,425) (159,300)
------------ ------------ ------------ ------------
Net cash provided (used) by financing activities 174,581 1,004,831 872,956 (388,183)
------------ ------------ ------------ ------------
Effect of exchange rate changes 69,774 138,455 (139,038) 185,729
------------ ------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 194,513 254,272 (292,288) (117,953)
Cash and cash equivalents at beginning of period 216,838 100,060 703,639 472,285
============ ============ ============ ============
Cash and cash equivalents at end of period $ 411,351 $ 354,332 $ 411,351 $ 354,332
============ ============ ============ ============
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for interest $ 54,260 $ 13,372 $ 117,278 $ 99,147
============ ============ ============ ============
Cash paid during the period for income taxes $ - $ - $ 118,915 $ -
============ ============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
DIGITAL RECORDERS, INC.
Consolidated Statements of Cash Flows, Continued (Unaudited)
For the three month periods ended September 30, 1999 and 1998
Supplemental disclosures of non cash financing activities:
The Company declared $44,250 and $39,825 in dividends on Series AAA
Preferred Stock in the three month periods ended September 30, 1999 and
1998, respectively. The Company paid $41,800 and $39,825 in cash dividends
in the three month periods ended September 30, 1999 and 1998, respectively.
6
<PAGE>
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements (Unaudited)
September 30, 1999 and 1998
(1) BASIS OF PRESENTATION AND DISCLOSURE
The unaudited interim condensed financial statements and related notes
have been prepared pursuant to the rules and regulations of the Securities
and Exchange Commission. Accordingly, certain information and footnote
disclosures normally included in the financial statements prepared in
accordance with generally accepted accounting principles have been omitted
pursuant to such rules and regulations. However, in the opinion of
management, the accompanying unaudited financial statements contain all
adjustments (consisting of only normal recurring accruals) considered
necessary to present fairly the results for the interim periods presented.
The accompanying condensed financial statements and related notes
should be read in conjunction with the Company's audited financial
statements included in its Annual Report on Form 10-KSB for the year ended
December 31, 1998. The results of operations for the three months ended
September 30, 1999 are not necessarily indicative of the results to be
expected for the full calendar year.
(2) 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 assuming dilution has been computed
based upon the weighted average 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 loss used in the
calculations of diluted and basic income loss per common share were the
same for all the periods presented. Diluted net loss per common share is
equal to the basic net loss per common share for the nine month periods
ended September 30, 1999 and 1998, respectively, as all common equivalent
shares from stock options and stock warrants would have an antidilutive
effect. Cash dividends declared on the preferred stock during the period
were added to the net loss to determine the net loss per share. Cash
dividends declared were $44,250 and $39,825 for each of the three month
periods ended September 30, 1999 and 1998, respectively.
(3) 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
period. 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 period.
(4) DEBT
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. August 1, 1998 the amount of funds available under the
secured line of credit facility increased to $3,000,000 and secured letter
of credit decreased to $500,000. Both facilities are with the same
financial institution. These facilities provided for short-term borrowings
and import letters of credit, were subject to certain loan covenants, were
secured by substantially all of the Company's accounts receivable,
inventory and equipment, and bear interest, payable monthly, at the 90 day
London Inter Bank Offer Rate base rate plus 4.0%. The borrowing base and
credit line availability were computed at eighty percent (80%) of all U.S.
trade accounts receivable less those accounts exceeding ninety days (90)
outstanding.
7
<PAGE>
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements - Continued (Unaudited)
September 30, 1999 and 1998
(4) DEBT - CONTINUED
On March 25, 1999, the Company extended its $3,000,000 secured line of
credit facility and $500,000 secured letter of credit facility through July
31, 1999 which was subsequently extended to August 31, 1999 while the
Company concluded negotiations with a new lender. The outstanding
indebtedness was retired on August 23, 1999 as the Company entered into a
new credit agreement with Fremont Financial Corporation as of that date.
On August 23, 1999, Digital Recorders, Inc. ("DRI") and related
subsidiaries signed a four (4) year Revolving and Term Lines of Credit
Agreement ("Credit Agreement") with Fremont Financial Corporation, a
subsidiary of Fremont General Corporation (NYSE: FMT). The Credit Agreement
provides up to $10 million for borrowing by DRI to be used for
acquisitions, working capital and general corporate purposes. The amount
available to borrow under the revolving portion of the Credit Agreement is
determined based on a formula of eligible trade accounts receivable and
inventory. The trade accounts receivable basis will be eighty-five percent
(85%) of eligible domestic U.S. trade accounts plus fifty percent (50%) or
$750,000 of eligible trade accounts of the German subsidiary. The inventory
basis will be a weighted average formula on the ratio of domestic U.S.
inventory to the total confirmed sales orders with advances of thirty-five
percent (35%) of primary components and eight percent (8%) of general
inventory with a combined phase in limit of $750,000. The term portion of
the Credit Agreement will be primarily used to fund the machinery and
equipment and real estate assets of acquisitions. The interest rate on the
revolving credit portion of the agreement is the "prime" lending rate plus
one and three-quarters percent. Credit extended for acquisitions will bear
an interest rate of prime plus two percent. The outstanding debt under this
agreement at September 30, 1999 was $1,921,831 with additional borrowing
availability of $2,045,499.
The Credit Agreement includes other customary covenants and conditions
relating to the conduct and operation of DRI's businesses. Specifically,
DRI will be subject to a 1:1 Earnings Before Interest Taxes Depreciation
and Amortization to interest coverage ratio to be calculated on a
cumulative basis for the initial four (4) fiscal quarters after the signing
date and hereafter calculated for the four (4) fiscal quarters immediately
preceding the date of determination. In addition, the acquisition of any
companies will require approval from Fremont
(5) "AAA" PREFERRED STOCK
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. The amendment was presented to
a vote of the holders of Common Stock at the Shareholders Annual Meeting
held June 30, 1998 and was approved by a majority of the holders of Common
Stock.
(6) SALE OF HIGHWAY INFORMATION SYSTEMS ("HIS") GROUP
On April 14, 1998, the Company sold its Highway Information Systems
("HIS") business group to Quixote Corporation for $2.8 million in cash plus
other consideration of approximately $200,000. The Company realized a gain
on disposal, before applicable income taxes, of $1,097,012. The income tax
expense on this transaction, which the Company will offset with the tax
loss carryforwards existing as of December 31, 1998, totaled approximately
$425,656. Net proceeds to the Company were used primarily to reduce bank
borrowings under the Company's secured line of credit facility. Operating
revenues for the nine months ended September 30, 1998 totaled $685,930 and
have been excluded from the net sales amount for the nine month period
ended September 30, 1998. The net operating income, net of tax for the nine
month period ended September 30, 1998 was $84,123.
8
<PAGE>
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements - Continued (Unaudited)
September 30, 1999 and 1998
(7) LITE VISION CORPORATION SHARE PURCHASE AGREEMENT
On June 30, 1998, the Company and Lite Vision Corporation, a Taiwan
corporation ("Lite Vision"), entered into a share purchase agreement
whereby Lite Vision agreed to purchase 400,000 shares of the Registrant's
restricted Common Stock for a purchase price of $1,050,000. Lite Vision
also acquired an option to purchase an additional 100,000 shares at $2.4375
per share exercisable for a three year period from the closing date. Lite
Vision was granted "piggyback" registration rights on the shares purchased
and the option shares which can be purchased. The closing occurred on July
24, 1998.
Lite Vision is the developer and owner of certain technology used by
the Company in its transit display systems. Mr. Joseph Tang, President of
Lite Vision, was appointed to the Company's Board of Directors at the
closing.
(8) RTI\DRI REORGANIZATION
On July 1, 1998, the Company, Robinson Turney International, Inc.
("RTI"), Digital Recorders Acquisition, Inc., a wholly owned subsidiary of
the Company (the "Subsidiary") and David L. Turney and Claude G. Robinson,
the two shareholders of RTI (the "Shareholders") consummated an Agreement
and Plan of Reorganization (the "Agreement") pursuant to which the
Subsidiary merged into RTI (the "Merger"). A disinterested majority of the
directors voting with respect to the transaction approved the Merger on
behalf of the Company.
Pursuant to the Merger, 200,000 restricted shares of the Company's
Common Stock were issued to the RTI Shareholders. For two years commencing
July 1, 1998, the RTI Shareholders have "piggyback" registration rights and
until January 1, 1999, the Shareholders also have demand registration
rights covering the 200,000 shares of Common Stock issued to them in the
Merger.
RTI is engaged in business development, marketing services, advisory
services, and merger, acquisition and financing assignments for selected
clients, including the Company, who are primarily in the transit and
transportation equipment industries. RTI assigned a sublicense agreement
and marketing agreement between RTI and TwinVision, Inc. to the Company and
also assigned a management services agreement between RTI and Transit Media
GmbH to the Company. Mr. Turney served as the Chairman of the Board and the
Chief Executive Officer of RTI since he and Mr. Robinson co-founded RTI in
August 1994. Their respective employment agreements with RTI were cancelled
on effectiveness of the Merger. Mr. Turney has served as the Company's
Chairman of the Board and Chief Executive Officer since April 1998 and as a
director since May 1996. The Company entered into a consulting agreement
with Mr. Robinson, that commenced July 1, 1998 and terminated June 30,
1999.
(9) SEGMENT INFORMATION
The Company has two principal business segments which are based upon
differences in products and technology: (1) transportation products and (2)
law enforcement and surveillance. The transportation products segment
produces automated announcement and passenger information systems and
electronic destination sign products for municipalities, transportation
districts, departments of transportation and bus manufacturers. The law
enforcement and surveillance segment produces digital signal processing
products for law enforcement agencies and organizations.
Operating income (loss) for each segment is total sales less operating
expenses applicable to the segment. Certain corporate overhead expenses
including executive salaries and benefits, public company administrative
expenses, legal and audit fees, and interest expense are not included in
segment operating income (loss). Segment identifiable assets include
accounts receivable, inventories, net property and equipment, net
intangible assets and net goodwill.
9
<PAGE>
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements - Continued (Unaudited)
September 30, 1999 and 1998
Sales, operating income (loss), identifiable assets and depreciation and
amortization information for the Company's two operating segments are as
follows:
<TABLE>
<CAPTION>
Three Months Ended September 30,
1999 1998
--------------- --------------
<S> <C> <C>
Net sales
Transportation products $ 6,259,678 $ 2,587,571
Law enforcement and surveillance 299,656 710,003
--------------- --------------
$ 6,559,334 $ 3,297,574
=============== ==============
Income (loss) from operations
Transportation products $ 881,951 $ (7,138)
Law enforcement and surveillance (866) 436,556
Corporate office and administration (574,125) (479,354)
--------------- --------------
$ 306,959 $ (49,935)
=============== ==============
Depreciation and amortization
Transportation products $ 36,397 $ 26,470
Law enforcement and surveillance 45,830 40,373
Corporate office and administration 22,642 47,975
--------------- --------------
$ 104,869 $ 114,819
=============== ==============
September 30, 1999 Dcember 31, 1998
Identifiable assets
Transportation products $ 10,110,525 $ 7,584,136
Law enforcement and surveillance 1,947,536 2,457,252
Corporate office and administration 588,172 250,062
--------------- --------------
$ 12,646,233 $ 10,291,450
=============== ==============
</TABLE>
(10) PRONOUNCEMENT ISSUED
In April, 1998, the Accounting Standards Executive Committee issued
Statement of Position 98-5, REPORTING ON THE COSTS OF START-UP ACTIVITIES,
which requires start-up activities, including organization costs to be
expensed as incurred. The impact of this pronouncement required the Company
to charge against operations, as a cumulative effect of a change in
accounting principle in the three month period ended March 31, 1999,
$131,687 of organization costs to conform with this statement.
(11) SUBSEQUENT EVENTS
On October 22, 1999, the Company's Board of Directors declared a
dividend on Series AAA Preferred Stock for stockholders of record as of
September 30, 1999. The dividends totaled $44,250.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
Digital Recorders, Inc. (the "Company") incorporated in 1983 designs,
manufactures or contracts for the manufacturing of, and sells information
technology products primarily through two major business segments. These
segments are 1) the transportation products segment ("TPS"); and, 2) the law
enforcement and surveillance segment. TPS consists of Digital Recorders ("DR"),
which was previously recognized asTransit Communication Systems ("TCS") and two
wholly-owned subsidiaries, Transit-Media GmbH ("Transit-Media") and TwinVision
Corp. of North America, Inc. ("TwinVision"). The Company's TPS products are
marketed to the mass transit market. TPS customers include municipalities,
regional transportation districts, federal, state, and local departments of
transportation, transit agencies, turnpikes, and bus manufacturers. The law
enforcement and surveillance segment of the Company is known as Digital Audio
Corporation ("DAC") and serves the law enforcement market consisting of foreign
and U.S. federal, state, and local law enforcement agencies or organizations.
Digital Recorders 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. Customers include transit operating agencies which use mass
transit vehicles, commercial bus transportation vehicle operators, and
manufacturers of those vehicles.
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 used on transit bus vehicles worldwide. Transit-Media serves the
European and Far Eastern markets while TwinVision serves the NAFTA market.
Customers include transit operating agencies which use mass transit vehicles as
well as the manufacturers of those vehicles.
The DAC group was established in 1995 upon the Company's acquisition of
Digital Audio Corporation. The DAC group produces a line of digital signal
processing 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.
The following discussion provides an analysis of the Company's results of
operations and liquidity and capital resources. This 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.
11
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth the percentage of revenues represented by
certain items included in the Company's Statements of Operations:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
-------------------------- ------------------------
1999 1998 1999 1998
------------ ---------- ---------- -----------
<S> <C> <C> <C> <C>
Net sales 100.0 % 100.0 % 100.0 % 100.0 %
Cost of sales 63.4 55.1 63.4 56.0
------------ ---------- ---------- -----------
Gross profit 36.6 44.9 36.6 44.0
------------ ---------- ---------- -----------
Operating expenses:
Selling, general and administrative 24.7 40.1 29.4 48.8
Engineering, research and development 7.2 8.0 7.8 8.6
------------ ---------- ---------- -----------
Total operating expenses 31.9 48.1 37.2 57.4
------------ ---------- ---------- -----------
Operating income (loss) 4.7 (3.3) (0.6) (13.4)
Other income (expense), net (0.9) (0.3) (0.8) (0.8)
------------ ---------- ---------- -----------
Income (loss) before income taxes from continuing operations 3.8 (3.6) (1.4) (14.2)
Income tax expense (benefit) -- -- -- (5.7)
------------ ---------- ---------- -----------
Income (loss) from continuing operations before accounting change 3.8 (3.6) (1.4) (8.5)
Change in accounting -- -- (0.8) --
Discontinued operations:
Income (loss) from operations of HIS division, net of tax -- -- -- 8.8
============ ========== ========== ===========
Net income (loss) 3.8 % (3.6)% (2.2)% 0.3 %
============ ========== ========== ===========
</TABLE>
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Net sales for the three months ended September 30, 1999 were $6,559,334, an
increase of $3,261,760 or 98.9%, as compared to $3,297,574 for the comparable
three months in 1998. Increased sales resulting from an increase in market share
and overall increase in served market volume in the TPS were the most
significant factors contributing to the increase.
During the three months ended September 30, 1999, TPS sales increased
$3,672,107 or 141.9% from the corresponding three months in the prior year. TPS
sales increased from $2,587,571 in 1998 to $6,259,678 in 1999. This significant
increase is primarily the result of additional market share capture and market
acceptance of the TwinVision LeDot-C- Destination Sign System and DR AVAS
products.
During the three months ended September 30, 1999, DAC sales decreased
$410,347, or 57.8%, from the corresponding three months in the prior year. DAC
sales decreased from $710,003 in 1998 to $299,656 in 1999. Such quarter over
quarter differences are normal for this type of business as DAC does not
specifically work from any significant backlog. During the quarter ended
September 30, 1998, DAC recorded sales revenues of $245,748 to one specific
customer which is extraordinary when compared to average order revenues.
Gross profit for the three months ended September 30, 1999 was $2,403,113,
an increase of $921,060 or 62.1%, over gross profit of $1,482,053 for the three
months ended September 30, 1998. As a percentage of sales, gross profit during
the three months ended September 30, 1999 was 36.6 % net sales, as compared to
44.9% during the corresponding three months in 1998 The decrease in gross profit
percentage was caused primarily by a lower percentage of overall DRI sales out
of DAC which historically has higher gross margins than the TPS business units.
Selling, general and administrative expenses ("SG&A") during the three
months ended September 30, 1999 were $1,621,132, an increase of $297,776 or
22.5% as compared to expenses of $1,323,356 during the three months ended
September 30, 1998. This increase was attributed primarily to personnel actions,
increased travel related expense, increased public company and legal expense.
The percent to sales for SG&A for the quarter ended September 30, 1999 decreased
by 15.4% of sales when compared to the same time period of a year ago.
12
<PAGE>
Engineering, research and development expenses for the three months ended
September 30, 1999 were $475,022, an increase of $211,074, or 80%, as compared
to expenses of $263,948 during the three months ended September 30, 1998. This
increase related primarily to additional hardware and software engineering
personnel plus an increase in outside software consulting expense for sustaining
product engineering and new product development . ALL operating units of DRI are
introducing new products in year 2000.
Operating Income increased by $412,210 from the operating loss of $105,251
for the three months ended September 30, 1998 to operating income of $306,959
for the three months ended September 30, 1999 primarily due to the factors set
forth above.
Total other income (expense) for the three months ended September 30, 1999
was a net expense of $58,098, an increase of $44,606 as compared to a net
expense for the three months ended September 30, 1998 of $13,493. This increase
is primarily the result of higher interest expense in the three months ended
September 30, 1999.
The Company's financial statements contain, when necessary, a provision for
income tax expense due to alternative minimum tax. For the three month periods
ended September 30, 1999 and 1998, the Company did not record any U.S. income
tax expense. As a result of the accumulated losses incurred in past years, the
Company had a net operating loss carry forward for federal income tax purposes
of $2,342,020 as of December 31, 1998. This carry forward will be available to
offset federal taxable income, if any, through 2006 to 2012. Also, as of
December 31, 1998, one of the Company's subsidiaries had a net economic loss
carry forward for state income tax purposes of $1,524,112, which will be
available to offset future state taxable income, if any, through 2002 and 2003.
Following utilization of the existing federal and state loss carry forwards, the
Company's future operations, if profitable, will be subject to income tax
expense.
LIQUIDITY AND CAPITAL RESOURCES
On August 23, 1999, Digital Recorders, Inc. ("DRI") and related
subsidiaries signed a four (4) year Revolving and Term Lines of Credit Agreement
("Credit Agreement") with Fremont Financial Corporation, a subsidiary of Fremont
General Corporation (NYSE: FMT). The Credit Agreement provides up to $10 million
for borrowing by DRI to be used for acquisitions, working capital and general
corporate purposes. The amount available to borrow under the revolving portion
of the Credit Agreement is determined based on a formula of eligible trade
accounts receivable and inventory. The trade accounts receivable basis will be
eighty-five percent (85%) of eligible domestic U.S. trade accounts plus fifty
percent (50%) or $750,000 of eligible trade accounts of the German subsidiary.
The inventory basis will be a weighted average formula on the ratio of domestic
U.S. inventory to the total confirmed sales orders, with advances of thirty-five
percent (35%) of primary components and eight percent (8%) of general inventory,
with a combined phase in limit of $750,000. The term portion of the Credit
Agreement will be primarily used to fund the machinery and equipment and real
estate assets of acquisitions. The interest rate on the revolving credit portion
of the agreement is the "prime" lending rate plus one and three-quarters
percent. Credit extended for acquisitions will bear an interest rate of prime
plus two percent.
The Credit Agreement includes other customary covenants and conditions
relating to the conduct and operation of DRI's businesses. Specifically, DRI
will be subject to a 1:1 Earnings Before Income Tax, Dividends and Amortization
to interest coverage ratio to be calculated on a cumulative basis for the
initial four (4) fiscal quarters after the signing date. After that it will be
calculated for the four (4) fiscal quarters immediately proceeding the date of
determination. In addition, the acquisition of any companies will require
approval from Fremont. DRI was compliant with this covenant for the quarter
ended September 30, 1999.
At September 30, 1999, there was $1,921,381 of borrowing outstanding under
the line of credit agreement.
As of September 30, 1999, the Company's principal sources of liquidity
included cash and cash equivalents of $411,351, trade accounts receivable of
$4,549,449, inventory of $4,881,159, short-term bank borrowing of $1,921,383 and
trade accounts payable of $3,457,161 providing the Company with net working
capital of $4,463,415.
The Company's operating activities provided cash of $77,767 for the
three-month period ended September 30, 1999 and used cash of $858,498 for the
three-month period ended September 30, 1998. For the three-month period ended
September 30, 1999, the net operating income, increases in accounts payable and
decreases in other assets were offset by increases in trade receivables,
inventories and prepaid expenses. For the three-month period ended September 30,
1998 the net operating loss, increases in trade receivables and inventory due to
increases in sales volume accounted for the majority of the use of cash.
13
<PAGE>
The other assets increase includes deposits on the new building lease,
financing costs for new revolving and term credit agreement being amortized
over the life of the new loan and legal and professional retainers for patent
defense litigation. Working capital requirements will increase as sales grow
resulting in significant spans of time being experienced between the payments
to suppliers in their terms and the payments being received from the
Company's customers.
The Company's investing activities used cash of $127,609 during the
three-month period ended September 30, 1999 and $30,516 during the three-month
period ended September 30, 1998. During both periods, the use of cash was
primarily used for computer system and telecommunication related expenditures.
The Company's financing activities provided cash of $174,581 during the
three-month period ended September 30, 1999 and $1,004,831 during the
three-month period ended September 30, 1998. Financing activities during the
three-month period ended September 30, 1999 related to the net increase in short
term borrowing of $216,381 and the payment of dividends on preferred stock of
$41,800. Financing activities during the three-month period ended September 30,
1998 related to the net proceeds from the sale of common stock providing
$1,064,656 (Note 7), the net reduction of short-term bank borrowings totaling
$20,000 and the payment of dividends on preferred stock of $39,825.
The Company's cash requirements, other than for normal operating expenses,
will relate 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 existing credit facilities, and the modification of the terms of the
Series AAA Preferred Stock will provide the liquidity and capital resources
necessary to satisfy the Company's currently anticipated cash requirements for
the balance of 1999.
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; timely collection of accounts receivable; inadequacy of the
Company's working capital and existing credit arrangement 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.
YEAR 2000 ISSUE
The Company has conducted a review of its computer systems to identify the
systems that could be affected by the Year 2000 issue, and as of this date has
updated approximately ninety-eight percent (98%) of the internal systems
including hardware and software to Year 2000 compliance. The issue is whether
the computer systems will properly recognize date-sensitive information when the
year changes to 2000. Systems that do not properly recognize such information
could generate erroneous data or cause a system to fail.
The Company has inquiries to suppliers of components and its processing
vendors that, in instances where the Company utilizes software or hardware that
is not Year 2000 compliant, such vendors are implementing plans to address Year
2000 issues.
14
<PAGE>
Year 2000 issues may also affect the computer systems of the Company's
financing source. The Company has made inquiry of its financing source and has
been advised that its financing source is or will be Year 2000 compliant in
sufficient time to allow for testing and system implementation before December
31, 1999.
Based on the review of the computer systems and progress to date,
management does not anticipate any additional material expenditures to achieve
complete Year 2000 compliance.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On February 24, 1999, Mark IV Industries, Ltd. ("Mark IV") filed a lawsuit,
Mark IV Industries, Ltd. v. Digital Recorders, Inc., in the United States
District Court for the Northern District of Texas, alleging the Company is
infringing two U.S. patents held by Mark IV and seeking unspecified monetary
damages, treble damages, and injunctive relief. The allegations relate to the
display elements used in the destination sign systems manufactured and marketed
by a subsidiary of the Company under an exclusive license for the technology
from Lite Vision Corporation ("Lite Vision") of Taiwan. Lite Vision also
supplies certain display components and assemblies used in the systems. On April
7, 1999, the Company filed an answer to the complaint, in which it denied all
the plaintiff's allegations and asserted counterclaims against Mark IV,
including alleged violations of the antitrust laws. The Company has subsequently
filed amended answers and counterclaims, and has moved for summary judgment of
noninfringement.
In a separate action filed July 26, 1999, also in the United States
District Court for the Northern District of Texas, Mark IV further alleged the
Company is infringing a continuation patent related to one of the two patents
that is the subject of the lawsuit filed in February described above. In this
second action, Mark IV asserts similar claims and seeks similar relief. On April
27, 1999, a U.S. patent on the technology used in the sign systems product
issued to Lite Vision, and a continuation of that patent presently is pending
with claims allowed in the United States Patent and Trademark Office. The
Company believes that Lite Vision's U.S. and foreign patents, and patents
pending, will support the Company's position in both matters described above.
The Company believes Mark IV's claims and allegations, in both actions, are
without merit. The Company intends to defend itself vigorously by all available
legal means. However, there can be no assurance that the Company will be
successful in its defense of this matter or that any liabilities or costs
incurred in connection therewith will not have a material impact on the
Company's financial condition. The Company has entered into a joint defense
agreement pursuant to which a third party will bear a portion of the defense
costs. The Company also has certain contractual rights to indemnification
relating to the technology that is the subject of this dispute.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None.
15
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
27 Financial Data Schedule
(b) REPORTS on FORM 8-K
(1) The Company filed a report on Form 8-K, dated August 5, 1998
regarding the Lite Vision Corporation Common Stock Share
Agreement.
(2) The Company filed a report on Form 8-K, dated August 5, 1998
regarding the Robinson-Turney International Agreement and Plan of
Reorganization.
(3) The Company filed a report on Form 8-K, dated April 26, 1999
regarding the Board of Director's approval of extending the term
of Redeemable Warrants to April 30, 2000.
(4) The Company filed a report on Form 8-K, dated August 23, 1999
regarding the $10,000,000 four year Revolving and Term Lines of
Credit Agreement with Fremont Financial Corporation, a subsidiary
of Fremont General Corporation (NYSE: FMT).
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934,
the Registrant has caused this Form 10-QSB to be signed on its behalf by the
undersigned, thereunto duly authorized.
DIGITAL RECORDERS, INC.
Dated: November 3, 1999 By: /s/ David L. Turney
-------------------------------------------
David L. Turney, Chairman of the Board and
Chief Executive Officer
Dated: November 3, 1999 By: /s/ Lawrence A. Taylor
-------------------------------------------
Lawrence A. Taylor, Chief Financial Officer
16
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<CASH> 411,351
<SECURITIES> 0
<RECEIVABLES> 4,712,594
<ALLOWANCES> (50,000)
<INVENTORY> 4,881,159
<CURRENT-ASSETS> 10,447,873
<PP&E> 921,681
<DEPRECIATION> 424,132
<TOTAL-ASSETS> 12,646,233
<CURRENT-LIABILITIES> 6,137,859
<BONDS> 0
1,770,000
0
<COMMON> 327,407
<OTHER-SE> 4,410,967
<TOTAL-LIABILITY-AND-EQUITY> 12,646,233
<SALES> 6,559,334
<TOTAL-REVENUES> 6,559,334
<CGS> 4,156,221
<TOTAL-COSTS> 4,156,221
<OTHER-EXPENSES> 2,096,154
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (58,098)
<INCOME-PRETAX> 248,860
<INCOME-TAX> 0
<INCOME-CONTINUING> 248,860
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 204,610
<EPS-BASIC> 0.07
<EPS-DILUTED> 0.07
</TABLE>
