<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark One)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED] For THE FISCAL YEAR ENDED DECEMBER
31, 1999
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 No.)
4018 PATRIOT DRIVE, ONE PARK CENTER SUITE 100
DURHAM, NORTH CAROLINA 27703
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (919) 361-2155
Securities registered pursuant to Section 12(b) of the Exchange Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE 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 /X/
The issuer's revenues for its most recent fiscal year were $22,441,234.
As of March 3, 2000, 3,274,075 shares of the issuer's Common Stock were
outstanding. The aggregate market value of the 2,496,866 shares of Common Stock
held by non-affiliates was $8,739,031 as of March 3, 2000. The market value of
the shares was calculated based on the closing bid price of such shares on The
Nasdaq SmallCap Market 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 March 31, 2000 or if such proxy statement is not filed,
will be filed with the Commission as an amendment to this Form 10-KSB under the
cover of Form 10-KSB/A not later than April 30, 2000.
<PAGE>
Transitional Small Business Disclosure Format: Yes No X
--- ---
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Digital Recorders, Inc. (the "Company") incorporated in 1983 designs,
manufactures or contracts for the manufacturing of, sells, and services
information technology products primarily through two major business segments.
These segments are 1) the transportation products segment; and 2) the law
enforcement and surveillance segment. The transportation products segment
consists of the Digital Recorders business unit and two wholly owned
subsidiaries, Transit-Media GmbH and TwinVision of North America, Inc. The
Company's transportation products segment products are sold in the transit and
transportation vehicle equipment market. These customers include municipalities,
regional transportation districts, federal, state, and local departments of
transportation, transit agencies, vehicle manufacturers, and public, private, or
commercial operators of those vehicles. The law enforcement and surveillance
segment of the Company is known as Digital Audio Corporation and primarily
serves the law enforcement market consisting of foreign and United States
federal, state, and local law enforcement agencies or organizations.
The Digital Recorders business unit focuses on supplying the transit
and transportation vehicle equipment market with Automatic Voice Announcement
Systems and services. The DR500C+ Talking Bus-Registered Trademark- system
marketed by the Company includes four core components: a vehicle logic unit (the
DR500C+), an Operator Control Unit, an internal light-emitting diode sign and a
Global Positioning Satellite navigation system. The Talking Bus system
automatically provides voice announcements including next stop, transfer points,
route and destination identification and public service messages. This system
enhances service for all passengers, complies with Americans with Disabilities
Act legislation, and further assists the vehicle operator with vehicle
management and monitoring capabilities. The demonstrated and ongoing integration
of the DR500C+ product with other "Intelligent Transportation Systems"
technologies is a key element for potential market growth. Customers include
operating agencies which use transit and transportation vehicles, commercial
transportation vehicle operators, and manufacturers of those vehicles.
Transit-Media GmbH became a wholly owned subsidiary of Digital
Recorders, Inc. after being acquired by the Company in May 1996. Shortly
thereafter, the Company formed TwinVision of North America, Inc. as another
wholly owned subsidiary of the Company and transferred the new technology of the
then recently acquired Transit-Media GmbH to TwinVision of North America, Inc.
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. These products are primarily
sold under the name "TwinVision-Registered Trademark-". Transit-Media GmbH
serves the European and Far Eastern markets while TwinVision of North America,
Inc. serves the North American Free Trade Agreement market. Customers include
operating agencies, which use transit and transportation vehicles, commercial
transportation vehicle operators, and manufacturers of those vehicles.
Digital Audio Corporation, a wholly owned subsidiary of Digital
Recorders, Inc., was acquired in 1995. It produces a line of digital audio
filter systems and tape transcribers used to improve the quality and
intelligibility of both live and recorded voices. Products are marketed, both
domestically and internationally, to law enforcement entities and other
customers in government organizations.
INDUSTRY OVERVIEWS
The transit communication industry, as served by the transportation
products segment, developed principally as a result of the enactment of the
Americans with Disabilities Act, the Clean Air Act, the Intermodal Surface
Transportation Efficiency Act, and Intelligent Transportation Systems
initiatives, together with the need to provide improved customer services to
operators and riders of transit and transportation vehicles. The Americans with
Disabilities Act accelerated the trend toward such systems by requiring that
fixed route transit systems
2
<PAGE>
announce major stops and transfer points to assist visually-challenged
passengers. On the Public transit side of this market, operating authorities
typically draw between 80% and 90% of funding for equipment purchases from
the Federal Transit Administration with the remainder of product acquisition
funding being provided by state and local sources.
TEA-21, the follow-on legislation to the Intermodal Surface
Transportation Efficiency Act, is the primary program funding the transit market
from the federal level. TEA-21 is a $41 billion six-year federal funding
initiative. Within the transit market sector, it promotes development of modern
and expanded public transit systems in the United States and designates a wide
range of devices, services and programs intended to increase the capacity of the
nation's mobility systems. TEA-21 authorizes increased funding each of the six
years covered (1998-2003) progressing from $4.8 billion authorization in 1998 to
$8.2 billion in 2003. Federal funding accounts for roughly 20% of all transit
industry funding with the balance being derived from a combination of state,
local, and fare-box sources.
The Automatic Voice Announcement Systems market, as served by the
Digital Recorders business unit of the company, emerged primarily as a result of
the Americans with Disabilities Act legislation and has been sustained by
overall favorable acceptance of concept, design and technology by transit
management operators and passengers including being perceived as a service
enhancement. The Company believes approximately 35% of new bus vehicles
contained such automated voice announcement systems in 1999. This percentage is
expected to increase over the next few years as industry participants present
Automatic Voice Announcement Systems solutions that address cost, maintenance
expense and complexity issues, and as the customer service aspect of the product
becomes more of the purchase decision. While the Digital Recorders business unit
has had nominal international sales, the Company believes that the ownership of
Transit-Media GmbH, as well as pilot projects started in 1999, may enable the
Company to accelerate penetration of this important market segment.
The electronic destination sign market, which is the primary market for
Transit-Media GmbH and TwinVision of North America, Inc., is a highly
competitive, mature market with growth closely tied to overall market size
growth, increased market share capture, or that which is precipitated by
technological advances. Virtually all transit buses manufactured worldwide have
some form of destination sign system and the percentage of those systems that
are electronic is approximately 70% and 95% in Europe and the United States,
respectively. A single competitor in the domestic electronic destination sign
market holds the dominant market share, while no one supplier dominates the
worldwide market.
The Digital Audio Corporation ("DAC") market, as served in the law
enforcement and surveillance segment, consists of government organizations at
the local, state, and federal level. DAC also markets its products in
approximately fifteen foreign countries through a network of dealers.
Approximately 32% of Digital Audio Corporation sales are international
customers. Its' digital filter and tape transcriber technology reduces
background noises that might otherwise make recorded voice signals
unintelligible. Additionally, Digital Audio Corporation's products are
applicable to the vibration, acoustic, and communications disciplines in the
commercial sector.
PRODUCTS AND PRODUCT DESIGN
TRANSPORTATION PRODUCTS SEGMENT
The Company's current products include the DR500C+ Talking
Bus-Registered Trademark- by the Digital Recorders business unit and
TwinVision-Registered Trademark- light-emitting diode illuminated flip-dot
electronic destination signs marketed by Transit-Media GmbH and TwinVision of
North America, Inc. The Digital Recorders business unit accounted for
approximately 35% of the Company's sales in 1999 and 1998. Transit-Media GmbH
accounted for approximately 15% of net sales in 1999 and 22% in 1998. TwinVision
of North America, Inc. accounted for approximately 42% of net sales in 1999 and
29% in 1998.
Digital Recorders's "Talking Bus-Registered Trademark-" PRODUCT LINE.
The Talking Bus-Registered Trademark- product 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, tour buses, as well as other
private and commercial vehicles. Talking Bus complies with the
Americans with Disabilities Act and industry-recognized standards. It
uses an open architecture computer-based electronics system design that
3
<PAGE>
accommodates the addition of new features and capabilities, including
interoperability with third-party equipment. Talking Bus' open
architecture design permits the expansion of memory capacity to the
size required by the customer and integration with other current and
future electronic systems. Talking Bus offers easy downloading or
transfer of software using an industry standard personal computer
memory card international association format; additionally, wireless
download is available. Talking Bus is designed to meet the severe
operating demands of temperature, humidity, shock, vibration and other
environmental conditions found in its typical applications and is
manufactured in an ISO 9002 compliant facility.
When activated by a vehicle operator, or by an automatic trigger such
as the Global Positioning Satellite signal, Talking Bus provides a high
quality digital audio announcement properly timed to the route
location. It can be recorded in any language. Talking Bus uses the
vehicle's power supply and can be operated on most vehicle voltage
sources. Its memory is provided by expandable memory cards with up to a
40-megabyte capacity. Audio messages are stored in flash memory not
requiring battery backup.
Transit-Media GmbH and TwinVision of North America, Inc. PRODUCT LINE.
The Company's electronic destination sign products, generally known as
"TwinVision-Registered Trademark-" Destination Sign Systems include
various models covering essentially all popular applications. These
products adhere to Americans with Disabilities Act requirements and
function under industry recognized standards. They possess an open
architecture, microprocessor-based system incorporating a new
generation display device that utilizes a unique Patented
light-emitting diode configuration to individually illuminate an
improved electro-magnetic flip-dot device. This new generation display
device, under license to the Company, improves the distance of
readability while reducing end user maintenance expense. Destination
message programming is accomplished via proprietary software developed
by the Company. The programming is accomplished through personal
computer memory card international association memory card download;
additionally, wireless download is available. The product is
manufactured under various contracts in ISO certified facilities.
LAW ENFORCEMENT AND SURVEILLANCE SEGMENT
The Company's current products by Digital Audio Corporation include
digital filter instruments and digital tape transcription machines. DAC
accounted for approximately 8% of the Company's sales in 1999 and 14% in 1998.
Digital Audio Corporation PRODUCT LINE. The Company markets an
extensive line of digital signal processing instruments used by law
enforcement agencies and organizations to enhance tape recordings
collected from a variety of sources. Voices on such recordings are
often obscured by hum, room noises, acoustic resonance, muffling,
background music, and street noises. To enhance such recordings and
make them understandable, the tape's audio is processed through a
sequence of highly specialized adaptive audio filters. These real-time
devices have substantial computational power with the typical digital
filter employing multiple microprocessor devices.
MARKETING AND SALES
All of the Company's products are marketed on a direct basis by the
Company's sales and marketing personnel or through commissioned independent
sales agents and dealers. The Company's marketing activities combine database
marketing, selective media advertising, direct contact selling, 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 digital signal processing technology and to learn about Digital Audio
Corporation product operation via hands-on instruction.
The Company typically generates a significant portion of its sales from
a relatively few key customers, the identity of which may vary from year to
year. One major customer accounted for approximately 20% of net sales for 1999
and two major customers accounted for 21% of net sales in 1998. Revenue from
these customers consists primarily of electronic destination sign and automatic
voice announcement systems.
RESEARCH AND DEVELOPMENT
4
<PAGE>
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, cost competitive, and
capable of capturing a significant share of the applicable market.
Enhancement of the Talking Bus-Registered Trademark- Automatic Voice
Announcement Systems and TwinVision LeDot -Registered Trademark- destination
sign system products will continue in the future in order to increase the
Company's ability to integrate these products with other technologies as well
as to reduce unit cost of production. Further, new generations of product are
under various stages of development some having been inserted into the market
in late 1999.
The Company introduced a new generation display element in its
TwinVision LeDot -Registered Trademark- destination sign system in October
1996. This new generation display combines known and proven benefits of
light-emitting diodes with improved electromagnetic flip-dot elements to
enhance product performance. These enhancements improve distance of
readability and reduce maintenance expense. Further development of this
product, and complimentary as well as next generation developments, are
underway by the TwinVision of North America, Inc. and Transit-Media GmbH
subsidiaries.
The Company's engineering, research and development costs increased
in 1999 as development activities continued in all business segments.
Engineering, research and development expenses were $1,865,940 in 1999 and
$1,022,084 in 1998, an increase of 82.6%. The Company believes convergence of
core technologies, combined with the need for capital improvements and
efficiencies and customer service in the transit and transportation market,
will justify continuing high levels of research and development.
ACQUISITIONS AND REORGANIZATION
On February 28, 1995, the Company entered into and closed an Asset
Purchase and Sale Agreement (the "Agreement") with Digital Audio Corporation.
Pursuant to this Agreement, the Company obtained substantially all of the
assets of Digital Audio Corporation 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 Corporation, which accrued interest
at the rate of 6% per annum, was paid in January 1996.
On July 1, 1998, the Company, Robinson Turney International, Inc.,
Digital Recorders Acquisition, Inc., a wholly owned subsidiary of the Company
(the "Subsidiary"), David L. Turney and Claude G. Robinson, the two
shareholders of Robinson Turney International (the "Shareholders")
consummated an Agreement and Plan of Reorganization (the "Agreement")
pursuant to which the RTI merged into the Subsidiary (the "Merger"). A
disinterested majority of the directors voting with respect to the
transaction approved the Merger on behalf of the Company pursuant to a
fairness opinion related to the transaction. Pursuant to the Merger, 200,000
restricted shares of the Company's Common Stock were issued to the Robinson
Turney International, Inc. shareholders. For two years commencing July 1,
1998, the RTI Shareholders have "piggyback" registration rights and until
January 1, 1999, the Shareholders also had demand registration rights
covering the 200,000 shares of Common Stock issued to them in the Merger.
Robinson Turney International, Inc. ("RTI") was 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 license agreement and marketing agreement between RTI and
TwinVision Corp. of North America, Inc. to the Company. RTI 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 at the
effective date 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, which commenced July 1, 1998 and terminated June 30, 1999.
COMPETITION
5
<PAGE>
The markets in which the Company participates are highly competitive
and are subject to technological advances as well as evolving industry
standards. The Company believes the principal competitive factors in the
markets for the Digital Recorders, Transit-Media GmbH and TwinVision of North
America, Inc. products include ease of use, service and support, price and
the ability to integrate these products with other technologies. The Company
currently views Luminator Holding L. P., an operating unit of Mark IV
Industries, Inc., as its principal competitor in the transit market (see Item
3 - Legal Proceedings). Luminator is a significant competitor in destination
signage. The Company also recognizes Clever Devices Ltd. and Meister
Electronics, LC., as competitors in the domestic transit market, although
neither of these competitors have the capital and other resources of
Luminator.
Competition in the digital signal processing filtering business is
limited and the Company believes that Digital Audio Corporation is the
dominant leader among the small number of participants in the industry.
Analog filtering products produced for the commercial sound industry by
companies such as AKG Acoustics GmbH 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 but in a narrower product application range.
MANUFACTURING
The Company's principal supplier for its Digital Recorder business
unit products, Xetel Corporation, is a contract manufacturing firm producing
Digital Recorder designed equipment. Trimble Navigation Ltd. supplies the
Global Positioning Satellite equipment.
The Company purchases major components for its TwinVision electronic
destination signs from Lite Vision Corporation, an entity based in Taiwan.
Lite Vision Corporation is a major stockholder in the company holding
approximately 12.2% of the outstanding common stock. The Company has
contracts with electronic manufacturing or contract assembly 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.
The Company's Digital Audio Corporation subsidiary manufactures or
assembles its own products. Printed circuit board components and enclosures
are purchased from specialized vendors such as Texas Instruments, Motorola,
and Crystal Semiconductor, and small local hardware suppliers.
PROPRIETARY RIGHTS
The Company currently relies on a combination of patents,
copyrights, trade secrets, nondisclosure agreements, and licensing agreements
to establish and protect its ownership of proprietary and intellectual
property rights. The Company attempts 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 or otherwise from
"designing around" the intellectual property rights of the Company. Patents
have been issued related to certain intellectual property rights under which
the TwinVision products are produced. The Company has registered its Talking
Bus -Registered Trademark- and TwinVision -Registered Trademark- trademarks and
logos, as well as certain slogans, by-lines, and trade-names with the United
States Patent and Trademark Office.
The Company intends to pursue new patents and other intellectual
property right protection covering new technologies and developments on an
on-going basis. 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 March 3, 2000, the Company employs sixty-seven people. The
Company's employees are not covered by any collective bargaining agreements
and the Company believes that its employee relations are good.
6
<PAGE>
ITEM 2. DESCRIPTION OF PROPERTY
The Company leases 18,484 square feet of office space in an office
complex in Durham, North Carolina. The lease agreement provides for monthly
rental payments ranging from $13,486 to $17,083 and expires in May 2009. The
Company leases approximately 2,200 square feet in Dallas, Texas and provides
for monthly rental payments of approximately $4,350. 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. The German
subsidiary, Transit-Media GmbH, leases office and engineering space in
Ettlingen, Germany with monthly rental payments of $2,551 and runs through
May 2001.
Management believes, if necessary, additional office and
manufacturing space will be available in or near its existing facilities at a
cost approximately equivalent to or slightly higher than that now paid by the
Company for its existing facilities.
ITEM 3. 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 TwinVision destination
sign systems manufactured and marketed by the TwinVision of North America,
Inc. subsidiary of the Company under an exclusive license for the display
patented 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, moved for
summary judgment of non-infringement, and achieved U. S. Patent Office
agreement to review the validity, or lack thereof, of one of the two Mark IV
patents in question.
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 1999 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
TwinVision sign systems product was issued to Lite Vision. Further, on
February 15, 2000, the U.S. Patent Office issued a second patent to Lite
Vision under a continuation of the first Lite Vision Patent.
On February 15, 2000, the TwinVision of North America, Inc. subsidiary
of the Company filed a legal action, TWINVISION V. LUMINATOR, in the United
States District Court for the Eastern District of Texas, against the Luminator
Holding LP subsidary of Mark IV Industries, Inc., the ultimate parent of Mark IV
Industries, Ltd. This action alleges infringement of the Lite Vision patents
including the recently issued continuation patent, under which TwinVision holds
an exclusive license, seeks damages, and injunctive relief.
The Company believes Mark IV's claims and allegations, in both
actions brought against the Company, are without merit. The Company believes
that Lite Vision's U.S. and foreign patents, and patents pending, will
support the Company's position in all matters described above. The Company
intends to defend itself vigorously, and assert its rights, 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.
7
<PAGE>
The Company is not a party to any other litigation and is not aware
of any other 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 Small Cap Market
under the symbol "TBus" and on the Boston Stock Exchange under the symbol
"TBU". There are approximately 1,200 stockholders. The following table sets
forth the range of high and low closing bid prices, as reported by The NASDAQ
SmallCap Market, from January 1, 1998 through December 31, 1999. The prices
set forth reflect interdealer quotations, without retail markups, markdowns
or commissions, and do not necessarily represent actual transactions.
<TABLE>
<CAPTION>
1998 HIGH LOW
<S> <C> <C>
First Quarter................................................$ 2.50 1.38
Second Quarter............................................... 3.63 1.50
Third Quarter................................................ 3.19 1.81
Fourth Quarter............................................... 1.88 1.41
1999 HIGH LOW
First Quarter................................................$ 2.38 1.38
Second Quarter............................................... 2.19 1.75
Third Quarter................................................ 2.09 1.63
Fourth Quarter............................................... 4.81 1.50
</TABLE>
The Company had not declared any dividends on Common Stock during 1999 and 1998.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company designs, manufactures or contracts for the manufacture
of, and sells information technology products primarily through two major
business segments. These segments are 1) the transportation products segment
and, 2) the law enforcement and surveillance segment. The transportation
products segment consists of the Digital Recorders business unit and two
wholly owned subsidiaries, Transit-Media GmbH and TwinVision of North
America, Inc. The law enforcement and surveillance segment of the Company is
Digital Audio Corporation, a wholly owned subsidiary. On April 14, 1998, the
Company divested the Highway Information Systems business group as more fully
described in Note 2 to the consolidated financial statements. Since 1987,
when the Company generated net sales of $348,000, net sales have increased
each year, reaching $22,441,234 in 1999 for its continuing operations. The
Company attributes its sales growth primarily to introduction of new
products, increased market penetration, competitive prices, strong customer
service, growing markets for its products, and strategic acquisitions.
8
<PAGE>
The Company's products are currently marketed to the transit,
transportation and law enforcement markets. Customers include municipalities,
regional transit districts, federal, state, and local departments of
transportation, bus manufacturers, and law enforcement agencies or
organizations. Sales to these customers are characterized by a lengthy sales
cycle that generally extends for a period of two to twenty-four months. In
addition, purchases by a majority of these customers are dependent on
federal, state and local funding that may vary from year to year.
The Company typically recognizes revenue upon shipment of products
to customers. Because the Company's operations are characterized by
significant research and development expenses preceding product introduction,
net sales and 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 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 years presented were not
significantly affected by inflation.
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>
YEAR ENDED DECEMBER 31,
-----------------------
1999 1998
------ ------
<S> <C> <C>
Net sales.................................................. 100.0% 100.0%
Cost of sales.............................................. 64.9 60.5
----- -----
Gross profit......................................... 35.1 39.5
----- -----
Operating expenses:
Selling, general and administrative.................. 28.1 39.9
Engineering, research and development................ 8.3 7.2
----- -----
Total operating expenses......................... 36.4 47.1
----- -----
Operating loss...................................... (1.3) (7.6)
Other expense and interest................................. (0.8) (0.8
----- -----
Loss before income taxes from continuing operations.. (2.1) (8.4)
Income tax expense (benefit)............................... -- (2.6)
----- -----
Loss from continuing operations..................... (2.1) (5.8)
Discontinued operations:
Income from operations of HIS division, net of tax... -- 0.6
Gain on disposal of HIS division, net of tax......... -- 4.7
Cumulative effect of change in accounting principle........ (0.6) --
----- -----
Net income (loss).......................................... (2.7)% (0.5)%
===== =====
</TABLE>
COMPARISON OF YEARS ENDED DECEMBER 31, 1999 AND 1998.
Net sales from continuing operations for 1999 were $22,441,234, an
increase of $8,201,983 or 57.6%, as compared to $14,239,251 for 1998. The
sales increase was primarily due to higher sales for destination sign systems
in the Company's transportation products segment. Combined sales for
Transit-Media GmbH and TwinVision of North America, Inc. increased $5,616,384
or 78.1% as these two subsidiaries realized increased orders for its
destination sign products. Digital Recorders business unit sales increased
$2,767,662 or 54.9%, an increase primarily attributed to increasing market
share. In the Company's law enforcement and surveillance segment, Digital
Audio Corporation experienced a sales decline of $182,163 or 9.3% as this
limited niche market did not realize any above average government orders as
compared to prior years.
Gross profit from continuing operations for 1999 was $7,886,100, an
increase of $2,264,865, or 40.3% as compared to gross profit of $5,621,235 in
1998. As a percentage of sales, gross profit was 35.1% of net sales in 1999
9
<PAGE>
as compared to 39.5% during 1998. The dollar increase in gross profit
coincided with the growth of the Transportation Products Segment (TPS). The
gross profit percentage decrease was caused primarily by a lower percentage
of overall sales from Digital Audio Corporation which historically has higher
gross margins than the TPS business units.
Selling, general and administrative expenses during 1999 were
$6,303,189, an increase of $624,885 or 11% as compared to selling, general
and administrative expenses of $5,678,304 during 1998. This increase is
attributed to the overall growth of the Company.
Engineering, research and development expenses for 1999 were
$1,865,940, an increase of $843,856, or 82.6%, as compared to engineering,
research and development expenses of $1,022,084 in 1998. This increase
relates to the increase in technical personnel for all three U.S. business
units and development of new products and improvement of existing products.
The operating loss decreased by $796,124 to $283,029 in 1999 as
compared to the operating loss of $1,079,153 for 1998. This decrease during
1999 is due primarily to the factors set forth above.
Total other income (expense) and interest for 1999 resulted in a net
expense of ($185,556), an increase of $75,503 as compared to total net income
(expense) for 1998 of ($110,053.) This increase was primarily due to an
increase in interest expense resulting from an increase in the line of credit
borrowing. Interest expense in 1999 was $186,189 and $101,635 in 1998.
LIQUIDITY AND CAPITAL RESOURCES
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 with
Wachovia Bank, N.A. through February, 1999. At August 1, 1998, the amount of
funds available under the secured line of credit facility increased to
$3,000,000 and the secured letter of credit decreased to $500,000. Both
facilities were 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 had 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 outstanding.
On February 25, 1999, the Company extended its $3,000,000 secured
line of credit facility and $500,000 secured letter of credit facility
through March 25, 1999 which was subsequently extended to August 31, 1999 as
the Company completed a new and expanded financing agreement with Fremont
Financial Corporation. 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. and related subsidiaries
signed a four year Revolving and Term Lines of Credit Agreement ("Credit
Agreement") with Fremont Financial Corporation, now Finova Group, Inc. The
Credit Agreement provides up to $10 million for borrowing by the Company 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 is eighty-five
percent (85%) of eligible domestic U.S. trade accounts plus the lesser of
fifty percent (50%) or $750,000 of eligible accounts of the German subsidiary.
The inventory basis is a weighted average formula on a 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 limit of $750,000. The term portion of the Credit
Agreement will be primarily used to fund purchases of machinery and equipment
and acquisitions. The interest rate on the revolving credit portion of the
agreement is the bank's 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 the Company's business.
Specifically, the Company is 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
10
<PAGE>
fiscal quarters after the signing date. After that it will be calculated for
the four fiscal quarters immediately preceeding the date of determination. In
addition, any acquisition will require prior approval from Finova.
At December 31, 1999, there was $3,292,619 of borrowing outstanding
under the line of credit agreement with additional borrowing availability of
$909,448.
As of December 31, 1999, the Company's principal sources of liquidity
included cash and cash equivalents of $242,820, trade accounts receivable of
$5,571,452, inventory of $4,322,391, amount due under the credit line of
$3,292,619 and trade accounts payable of $3,047,336 providing the Company with
net working capital of $3,937,046.
The Company's operating activities used cash of $2,060,611 during 1999
and $2,611,025 during 1998. For 1999, the increase in accounts receivable of
$2,200,087, increase in inventory of $274,561 and increase in other assets of
$22,922 were offset by increase in accounts payable of $1,567,597. For 1998,
excluding the gain on sale of the HIS division of $1,097,012 and net book value
of HIS assets disposed of $1,702,987, the net cash provided by operating
activities would be $188,973. For 1998, the increases of inventory of $324,384
and accounts receivable of $197,406 were offset by increases in accounts payable
of $367,454. The Company anticipates that its working capital needs will
increase with the growth in the Company's sales and as the Company implements
its expansion plans.
The Company's net investing activities during 1999 used cash of
$411,713 to purchase test equipment, computer and telecommunications equipment
and office furniture and fixtures. In 1998 it provided cash of $2,800,931,
primarily as the result of the HIS division sale recorded in the second quarter.
The Company's net financing activities provided cash of $2,199,944 in
1999 and used cash of $95,793 during 1998. In 1999, net borrowings under the
line of credit amounted to $2,367,619, which was used in operations and to pay
dividends of $167,675 on the AAA preferred Stock. In 1998, $1,071,872 of
proceeds was received from the issuance of common stock. Available cash was used
to decrease the line of credit and pay "AAA" preferred stock dividends of
$199,125.
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 quarterly dividend payable with respect to
each Preferred Share from $112.50 to $125.00 beginning in 1999, 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 was presented to a vote of the holders of Common
Stock in the Company's fiscal 1999 Proxy Statement and was approved. The
conversion rate of the 625 shares of Common Stock for each preferred share is
$8.00 per share.
On April 14, 1998 the Company sold its Highway Information Systems
(HIS) 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 $1,097,012. The federal income tax expense on this
transaction, which the Company offset with operating loss carryforwards, was
approximately $346,000. The state tax expense was approximately $80,000.
The Company's cash requirements, other than for normal operating
expenses, relate primarily to the development of new products and enhancement of
existing products, financing growth, and the possible acquisition of companies,
products, or technologies. The Company believes that a combination of its net
working capital and the borrowing capacity available under its existing credit
facility provides the liquidity and capital resources to satisfy its currently
anticipated cash requirements for 2000.
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
11
<PAGE>
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.
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
DIGITAL RECORDERS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE(S)
-------
<S> <C>
Independent Auditor's Report ............................................................................ 13
Consolidated Balance Sheets - December 31, 1999 and 1998 ................................................ 14
Consolidated Statements of Operations - Years Ended December 31, 1999 and 1998 .......................... 15
Consolidated Statements of Stockholders' Equity -
Years Ended December 31, 1999 and 1998 ............................................................ 16
Consolidated Statements of Cash Flows - Years Ended December 31, 1999 and 1998 ......................... 17 - 18
Notes to Consolidated Financial Statements .............................................................. 19 - 31
</TABLE>
12
<PAGE>
To the Board of Directors
Digital Recorders, Inc.
Durham, North Carolina
We have audited the accompanying consolidated balance sheets of Digital
Recorders, Inc. and subsidiaries as of December 31, 1999 and 1998, and the
related consolidated statements of operations, stockholders' equity, and cash
flows for the years then ended. 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 general 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 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Digital
Recorders, Inc. and subsidiaries as of December 31, 1999 and 1998, and the
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
As described in Note 1 to the consolidated financial statements, on January 1,
1999, the Company changed its method of accounting for the costs of start-up
activities to adopt Statement of Position 98-5, "Reporting on the Cost of
Start-up Activities."
/s/ RSM McGladrey, Inc.
RSM McGladrey, Inc.
Raleigh, North Carolina
February 23, 2000
13
<PAGE>
DIGITAL RECORDERS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
ASSETS 1999 1998
------ ------------ ------------
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 242,820 $ 703,639
Trade accounts receivable, less allowance for doubtful accounts of
$77,250 and $50,000 at December 31, 1999 and 1998, respectively 5,571,452 3,371,365
Other receivables 212,182 38,799
Inventories 4,322,391 4,047,830
Prepaids and other current assets 623,139 148,911
------------ ------------
Total current assets 10,971,984 8,310,544
------------ ------------
Property and equipment, less accumulated depreciation of
$525,875 and $354,179 at December 31, 1999 and 1998, respectively 555,567 315,550
Goodwill, less accumulated amortization of $700,205 and $546,679
at December 31, 1999 and 1998, respectively 1,208,230 1,361,756
Intangible assets, less accumulated amortization of $290,771 and $236,670
at December 31, 1999 and 1998, respectively 86,974 86,939
Deferred taxes 122,235 -
Other assets 239,583 216,661
------------ ------------
TOTAL ASSETS $ 13,184,573 $ 10,291,450
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
--------------------------------------
Current Liabilities:
Line of credit $ 3,292,619 $ 925,000
Accounts payable 3,047,336 1,479,739
Accrued expenses 650,733 682,263
Income tax payable - 49,977
Preferred stock dividends payable 44,250 39,825
------------ ------------
Total current liabilities 7,034,938 3,176,804
------------ ------------
TOTAL LIABILITIES 7,034,938 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 December 31, 1999 and 1998 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 December 31, 1999 and 1998 327,407 327,407
Additional paid-in capital 11,335,090 11,507,190
Accumulated other comprehensive loss (237,278) (48,839)
Accumulated deficit (7,045,584) (6,441,112)
------------ ------------
Total stockholders' equity 4,379,635 5,344,646
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 13,184,573 $ 10,291,450
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
DIGITAL RECORDERS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Net sales $ 22,441,234 $ 14,239,251
Cost of sales 14,555,134 8,618,015
------------ ------------
Gross profit 7,886,100 5,621,236
------------ ------------
Operating expenses:
Selling, general and administrative 6,303,189 5,678,304
Engineering, research and development 1,865,940 1,022,084
------------ ------------
Total operating expenses 8,169,129 6,700,388
------------ ------------
Operating loss (283,029) (1,079,152)
------------ ------------
Other expense (18,390) (20,238)
Interest expense (167,166) (89,815)
------------ ------------
Total other expense and interest (185,556) (110,053)
------------ ------------
Loss before income taxes (468,585) (1,189,205)
Income tax expense (benefit) - (358,530)
------------ ------------
Loss from continuing operations (468,585) (830,675)
------------ ------------
Discontinued operations:
Income from operations of HIS division, net of tax - 84,123
Gain on sale of HIS division, net of tax - 671,356
------------ ------------
Income from discontinued operations - 755,479
------------ ------------
Net loss before change in accounting principle (468,585) (75,196)
Less: Cumulative effect of change in accounting principle 135,887 -
------------ ------------
Net loss (604,472) (75,196)
Preferred stock dividend requirements (172,100) (159,300)
------------ ------------
Net loss applicable to common shareholders $ (776,572) $ (234,496)
============ ============
Earnings per share:
Loss from continuing operations $ (0.20) $ (0.33)
Income from discontinued operations - 0.25
Cumulative effect of change in accounting principle (0.04) -
------------ ------------
Total basic and diluted net loss per share $ (0.24) $ (0.08)
============ ============
Weighted average number of common shares and common
equivalent shares outstanding 3,274,075 2,962,294
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
DIGITAL RECORDERS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
Common Stock
---------------------- Accumulated
Number Additional Other Total
of shares Par Paid-in Accumulated Comprehensive Comprehensive Stockholders'
issued Value Capital Deficit Income (loss) Income (loss) Equity
----------- --------- ------------ ------------- ------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance as of January 1, 1998 2,674,075 $ 267,407 $ 10,694,443 $ (6,365,916) $ (186,081) $ 4,409,853
Comprehensive income (loss):
Net loss (75,196) $ (75,196) (75,196)
Translation adjustment 137,242 137,242 137,242
------------
Total comprehensive income $ 62,046
============
Issuance of common stock 600,000 60,000 1,011,872 1,071,872
Preferrred stock dividends paid (159,300) (159,300)
Preferred stock dividends payable (39,825) (39,825)
----------- --------- ------------ ------------- ------------- -------------
Balance as of December 31, 1998 3,274,075 327,407 11,507,190 (6,441,112) (48,839) 5,344,646
Comprehensive income (loss):
Net loss (604,472) $ (604,472) (604,472)
Translation adjustment (188,439) (188,439) (188,439)
------------
Total comprehensive loss $ (792,911)
============
Preferrred stock dividends paid (127,850) (127,850)
Preferred stock dividends payable (44,250) (44,250)
----------- --------- ------------ ------------- ------------- -------------
Balance as of December 31, 1999 3,274,075 $ 327,407 $ 11,335,090 $ (7,045,584) $ (237,278) $ 4,379,635
=========== ========= ============ ============= ============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
DIGITAL RECORDERS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
--------------------- --------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (604,472) $ (75,196)
Adjustments to reconcile net loss to net cash
used by operating activities:
Depreciation of property and equipment 171,696 222,090
Amortization of goodwill and intangible assets 71,740 262,975
Net book value of intangible assets written off 135,887 -
Gain on sale of HIS division - (1,097,012)
Net book value of HIS assets disposed - (1,702,987)
Changes in operating assets and liabilities:
(Increase) in trade accounts receivable (2,200,087) (197,406)
(Increase) decrease in other receivables (173,383) 15,489
(Increase) in inventories (274,561) (324,384)
(Increase) in prepaids and other current assets (474,228) (74,425)
(Increase) in deferred taxes (122,235) -
(Increase) in intangible assets (54,136) (14,874)
Decrease (increase) in other assets (22,922) 701
Increase in accounts payable 1,567,597 367,454
Increase (decrease) in accrued expenses (31,530) 37,158
Increase (decrease) in deferred revenue - (80,585)
Increase (decrease) in income tax payable (49,977) 49,977
--------------------- --------------------
Net cash used by operating activities (2,060,611) (2,611,025)
--------------------- --------------------
Cash flows from investing activities:
Proceeds from sale of HIS division - 2,800,000
Purchases of property and equipment (411,713) (201,548)
Proceeds from sale of property and equipment - 191,941
Proceeds from sale of intangible assets - 10,538
--------------------- --------------------
Net cash provided (used) by investing activities (411,713) 2,800,931
--------------------- --------------------
Cash flows from financing activities:
Issuance of common stock - 1,071,872
Proceeds from short-term bank borrowings 11,973,171 5,379,460
Principal payments on short-term bank borrowings (9,605,552) (6,348,000)
Payment of dividends on preferred stock (167,675) (199,125)
--------------------- --------------------
Net cash provided (used) by financing activities 2,199,944 (95,793)
--------------------- --------------------
Effect of exchange rate changes (188,439) 137,242
--------------------- --------------------
Net increase (decrease) in cash and cash equivalents (460,819) 231,355
Cash and cash equivalents at beginning of year 703,639 472,284
--------------------- --------------------
Cash and cash equivalents at end of year $ 242,820 $ 703,639
===================== ====================
Supplemental Disclosure of Cash Flow Information:
Cash paid during the year for interest $ 186,189 $ 94,515
===================== ====================
Cash paid during the year for income taxes $ 43,710 $ -
===================== ====================
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
DIGITAL RECORDERS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
YEARS ENDED DECEMBER 31, 1999 AND 1998
Supplemental disclosures of non-cash investing and financing activities
During 1999 and 1998, the Company declared dividends on Series AAA
Preferred Stock in the amount of $172,100 and $159,300 respectively. During
1999, the Company paid $167,675 in cash dividends which included $39,825 of
unpaid prior year dividends which had been accrued at the end of 1998. In
addition, the 1998 cash dividends paid include the fourth quarter 1997 dividends
of $39,825 which were inadvertently not accrued at December 31, 1997. As of
December 31, 1999, $44,250 of remaining dividends, representing one quarter's
declared dividends, were unpaid.
18
<PAGE>
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) ORGANIZATION
Digital Recorders, Inc. (the "Company") designs, manufactures or
contracts for the manufacture of, sells, and services products to the
transit and transportation market and the law enforcement market.
Customers include municipalities, regional transportation districts,
federal, state and local departments of transportation, vehicle
manufacturers, private and commercial vehicle operators, and law
enforcement agencies or organizations. The Company markets primarily to
customers located in North America, Asia, and Europe.
(b) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant
inter-company accounts and transactions have been eliminated in
consolidation.
(c) ADOPTION OF NEW ACCOUNTING PRONOUNCEMENT
Effective January 1, 1999, the Company adopted the provisions of
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 in
1999 resulted in a one time charge to operations, as a cumulative
effect of a change in accounting principle, of $135,887 of organization
costs to conform with this statement.
(d) CASH EQUIVALENTS
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents. At times the
Company places temporary cash investments with high credit quality
financial institutions in amounts that may be in excess of FDIC
insurance limits.
(e) REVENUE RECOGNITION AND TRADE ACCOUNTS RECEIVABLE
The Company recognizes operating revenues upon shipment of goods to
customers. 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, are valued 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).
19
<PAGE>
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 to its fair market value.
(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 to its fair market value.
(j) RESEARCH AND DEVELOPMENT COSTS
Research and development costs are charged to operations as incurred.
(k) PER SHARE AMOUNTS
The basic net income (loss) per common share has been computed based
upon the weighted average of shares of common stock outstanding.
Diluted net income (loss) per common share has been computed based upon
the weighted average of shares of common stock outstanding and shares
that would have been outstanding assuming the issuance of common stock
for all dilutive potential common stock outstanding. The Company's
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, 1999 and 1998 as common
equivalent shares from stock options and stock warrants would not have
a dilutive effect because of the Company's loss from continuing
operations.
(l) 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 reporting period. Actual results could differ
from those estimates.
20
<PAGE>
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(1) ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
(m) 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.
(n) 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 included in accumulated comprehensive income in
stockholders' equity. Realized gains and losses on foreign currency
transactions, if any, are included in operations for the year.
(o) INCOME TAXES
Deferred taxes are provided on a liability method whereby deferred tax
assets are recognized for deductible temporary differences and
operating loss and tax credit carryforwards and deferred tax
liabilities are recognized for taxable temporary differences. Temporary
differences are the differences between the reported amounts of assets
and liabilities and their tax bases. Deferred tax assets are reduced by
a valuation allowance when, in the opinion of management, it is more
likely than not that some portion or all of the deferred tax assets
will not be realized. Deferred tax assets and liabilities are adjusted
for the effects of changes in tax laws and rates on the date of
enactment.
(p) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following summarizes the major methods and assumptions used in
estimating the fair values of financial instruments:
Cash and cash equivalents - The carrying amount approximates fair
value due to the relatively short- term period to maturity of
these instruments.
Short-term borrowings - The carrying amount approximates fair
value due to the variable interest rate adjustments based upon
market conditions.
(q) CERTAIN RECLASSIFICATIONS
Certain reclassifications have been made to the 1998 financial
statement balances to conform to the 1999 financial statement
classifications with no effect on the net loss or stockholders' equity.
21
<PAGE>
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(2) ACQUISITIONS AND DIVESTITURES
(a) RTI MERGER
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 RTI merged into the Subsidiary (the "Merger"). A disinterested
majority of the directors voting with respect to the transaction
approved the Merger on behalf of the Company pursuant to a fairness
opinion related to same. The merger was accounted for as a pooling of
interests; however, the operating results of RTI are not material to
the operating results 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
had demand registration rights covering the 200,000 shares of Common
Stock issued to them in the Merger.
RTI was 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
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 at the effective date 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 one year consulting
agreement with Mr. Robinson, which commenced July 1, 1998 and
terminated June 30, 1999.
(b) SALE OF HIS
On April 14, 1998, the Company sold its Highway Information Systems
("HIS") 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 $1,097,012. The federal income tax
expense on this transaction, which the Company offset with operating
loss carryforwards, was approximately $346,000. The state tax expense
was approximately $80,000.
(3) PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
December 31,
-------------
1999 1998
----- -----
<S> <C> <C>
Leasehold improvements $ 19,726 $ 480
Automobiles 4,000 4,000
Computer equipment 489,563 349,401
Test equipment 152,384 94,531
Furniture and fixtures 415,769 221,317
------- -------
1,081,442 669,729
Less accumulated depreciation and amortization 525,875 354,179
---------- ----------
$ 555,567 $ 315,550
========== ==========
</TABLE>
22
<PAGE>
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
4) LEASES
The Company leases its premises and certain office equipment under
various operating leases which expire at various times through 2008.
Rent and lease expense under these operating leases was $362,028 and
$250,817 for the years ended December 31, 1999 and 1998, respectively.
At December 31, 1999, future minimum lease payments under the
non-cancelable operating leases are as follows:
<TABLE>
<CAPTION>
Year ending December 31,
<S> <C>
2000 $ 424,213
2001 381,815
2002 251,376
2003 184,009
2004 182,138
Thereafter 631,110
--------------
Total minimum lease payments $ 2,054,661
==============
</TABLE>
(5) 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
with Wachovia Bank, N.A. through February 1999. At 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. 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 had 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.
On February 25, 1999, the Company extended its $3,000,000 secured line
of credit facility and $500,000 secured letter of credit facility
through March 25, 1999 which was subsequently extended to August 31,
1999 as the Company completed a new and expanded financing agreement
with Fremont Financial Corporation. 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 year Revolving and Term Lines of Credit
Agreement ("Credit Agreement") with Fremont Financial Corporation, a
subsidiary of Finova Group Inc. 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 is eighty-five percent (85%) of
eligible domestic U.S. trade accounts plus the lesser of fifty percent
(50%) or $750,000 of eligible trade accounts of the German subsidiary.
The inventory basis is 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 at the bank's 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 the
revolving
23
<PAGE>
credit portion of the agreement at December 31, 1999 was
$3,292,619 with additional borrowing availability of $909,448.
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(5) DEBT - CONTINUED
The Credit Agreement includes 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 fiscal quarters
after the signing date and thereafter calculated for the four fiscal
quarters immediately preceding the date of determination. In addition,
the acquisition of any companies will require approval from Fremont.
Interest expense was $186,189 and $101,635 for 1999 and 1998,
respectively.
(6) 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, 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.
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 beginning in 1999, 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 was presented to a vote of the holders of Common
Stock during the Company's annual stockholders meeting and was adopted.
On December 13, 1999, the Board of Directors authorized the creation of
10,000 shares of a class of preferred stock designated as "Series D
Junior Participating Preferred Stock" having a par value of $ .10. See
Stockholders' Rights - note 14.
(7) COMMON STOCK WARRANTS
Each warrant granted in connection with the DRI public offering allows
the holder to purchase one share of Common Stock at a price of $7.50
per share. These warrants were to expire in August 1998 but were
extended until April 2000. No other terms of these warrants were
changed. At December 31, 1999 and 1998, 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, 1999, 100% of each group
24
<PAGE>
of these warrants had vested and all 75,000 of these warrants were
outstanding. These warrants expire in June 2002.
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(8) 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.
<TABLE>
<CAPTION>
1999 1998
---------------------- ---------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Shares Price Shares Price
----------- --------- ----------- --------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 381,412 $ 2.75 296,257 $ 4.12
Granted 104,688 1.94 310,341 2.73
Exercised - - - -
Canceled (7,900) 2.51 (225,186) 4.29
----------- --------- ----------- --------
Outstanding at end of year 478,200 2.54 381,412 2.75
=========== ========= =========== ========
Weighted-average fair value of
options granted during the year $ 3.33 $ 1.09
</TABLE>
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------------------- ----------------------------------
Number Weigted-Average Number
Range of Outstanding Remaing Weighted- Average Exercisable Weighted- Average
Exercise Prices at 12/31/99 Contractual Life Exercise Price at 12/31/99 Exercise Price
<S> <C> <C> <C> <C> <C>
$1.94 - 3.00 478,200 8.1 years $2.54 465,110 $2.54
</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>
1999 1998
---------------------- ---------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Shares Price Shares Price
----------- --------- ----------- --------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 83,988 $ 2.64 40,702 $ 3.61
Granted 68,000 1.87 65,987 2.62
Exercised - - - -
Canceled (14,000) 2.91 (22,701) 3.67
----------- --------- ----------- --------
Outstanding at end of year 137,988 2.28 83,988 2.64
=========== ========= =========== ==========
Weighted-average fair value of
options granted during the year $ 3.35 $ 1.11
</TABLE>
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
-------------------------------------------------- ----------------------------------
Number Weigted-Average Number
Range of Outstanding Remaing Weighted- Average Exercisable Weighted- Average
Exercise Prices at 12/31/99 Contractual Life Exercise Price at 12/31/99 Exercise Price
<S> <C> <C> <C> <C> <C>
$1.63 - 3.00 137,988 8.4 years $2.28 137,988 $2.28
</TABLE>
25
<PAGE>
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, 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. 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 basic and diluted net income (loss) per common
share would have been as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Net income (loss) applicable to
common stockholders $ (776,572) (234,496)
Pro forma net income (loss) applicable
to common stockholders $ (1,302,828) (638,167)
Basic and diluted net income (loss)
per common share $ (0.24) (0.08)
Pro forma basic and diluted net income (loss)
per common share $ (0.41) (0.22)
</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 1999 and 1998.
Significant assumptions used by the Company for these pro forma
calculations are as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Risk-free interest rate 6.80% 4.75%
Expected life 10 years 10 years
Expected volatility 63.93% 73.91%
Expected dividends None None
</TABLE>
(9) INCOME TAXES
(a) The components of income tax expense (benefit) charged to
continuing operations for the years ended December 31, 1999 and
1998, consisted of the following:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Current expense:
Federal $ - $ 9,562
State - 21,367
----------------- ---------
- 30,929
Deferred expense (benefit):
Federal - (389,459)
State - -
----------------- ----------
Income tax expense (benefit) $ - $ (358,530)
================= ==========
</TABLE>
Income tax expense attributable to the discontinued operations
was $ 0 in 1999 and $478,775 in 1998, respectively.
26
<PAGE>
<TABLE>
<CAPTION>
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(9) INCOME TAXES -CONTINUED
(b) The components of the net deferred tax assets as of December 31, 1999 and 1998 are as follows:
1999 1998
---- ----
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 833,954 $ 869,216
Tax credits 87,908 106,156
Foreign translation benefits 122,235 -
Warranty reserve 23,271 23,271
Inventory reserve 17,543 31,028
Inventory capitalization 39,535 43,536
Accrued bonuses - 39,990
Depreciation and amortization - 6,921
Organization and start-up costs 208,570 170,325
Other accruals and reserves 2,912 36,968
------------ ----------
Total gross deferred tax assets 1,335,838 1,327,411
Less valuation allowance (1,213,603) (1,327,411)
------------ -----------
Net deferred tax assets $ 122,235 $ -
============ ===========
</TABLE>
The Company has determined that the need for a valuation allowance
arises due to the Company's history of operating losses.
The components giving rise to the net deferred tax assets
described above have been included in the accompanying balance
sheets as of December 31, 1999 and 1998 as follows:
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Noncurrent assets $ 122,235 $ -
========= =========
</TABLE>
(c) The reasons for the difference between actual income tax expense
(benefit) for the years ended December 31, 1999 and 1998 and the
amount computed by applying the statutory federal income tax rate
to pretax earnings (loss) are as follows:
<TABLE>
<CAPTION>
1999
---------------------------
% of
Pretax
Amount Earnings (Loss)
------ ---------------
<S> <C> <C>
Income tax (benefit) at statutory rate ( $205,520) (34.0%)
State income taxes, net of federal income tax benefit - -
Foreign subsidiary losses 279,401 46.2
Change in the valuation allowance ( 113,808) (18.8)
Other 39,927 6.6
Income tax expense (benefit) $ - - %
============ ===========
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
1998
---------------------------
% of
Pretax
Amount Earnings (Loss)
------ ---------------
<S> <C> <C>
Income tax (benefit) at statutory rate ($404,330) ( 34.0%)
State income taxes, net of federal income tax benefit 21,367 1.8
Foreign subsidiary losses 278,665 23.5
Change in the valuation allowance (274,391) (23.1)
Other 20,159 1.7
---------- --------
Income tax expense (benefit) ($ 358,530) ( 30.1%)
========== ========
</TABLE>
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(9) INCOME TAXES -CONTINUED
(d) At December 31, 1999, the Company has net operating loss
carryforwards for federal income tax purposes of $ 2,280,925 which
are available to offset future federal taxable income, if any,
through 2006 to 2012. In addition, two of the Company's
subsidiaries have net economic loss carryforwards for state income
tax purposes of $ 1,435,193 which are available to offset future
state taxable income, if any, through 2002 and 2003.
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 also has research and development tax credits for
federal income tax purposes of $ 87,908 at December 31, 1999 which
expire in various years through 2013.
(10) OTHER COMPREHENSIVE INCOME
The following is a summary of the tax effects of the components of
other comprehensive income, consisting solely of foreign currency
translation adjustments, reported in the statements of stockholders'
equity for the years ended December 31, 1999 and 1998:
<TABLE>
<CAPTION>
Tax
Pre-tax (Expense) Net-of-tax
Amount Benefit Amount
--------- --------- ----------
<S> <C> <C> <C>
Year end December 31,1999:
Foreign currency translation adjustments $( 310,674) $ 122,235 $( 188,439)
========= ========== ==========
Year end December 31,1998:
Foreign currency translation adjustments $ 137,242 $ - $ 137,242
========= ========== =========
</TABLE>
(11) MAJOR CUSTOMERS
The Company typically generates a significant portion of its sales from
a relatively few key customers, the identity of which may vary from
year to year. One major customer accounted for approximately 20% of net
sales for 1999 and two major customers accounted for approximately 21%
of the net sales in 1998.
There were outstanding receivables from these customers of $ 756,800
and $ 644,400 at December 31, 1999 and 1998, respectively.
28
<PAGE>
(12) 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 $55,013 during 1998. There were
no fees and commissions paid during 1999 under these agreements.
The Company had retained a director of the Company to perform certain
business consulting services for the Company. The Company paid fees
under this agreement totaling $48,023 during 1998. There were no fees
paid during 1999 under this agreement.
Effective April 1997, the Company entered into a lease agreement for an
office building with a stockholder. The Company paid $53,118 and
$50,892 in rental fees during 1999 and 1998 to the stockholder.
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(12) RELATED PARTY TRANSACTIONS - CONTINUED
The Company purchases electronic components supporting the
transportation products segment from a major stockholder, Lite Vision
Corporation ("Lite Vision"), a public Taiwan company. Lite Vision holds
12.2% of the outstanding shares of common stock. The components consist
primarily of light emitting diodes (LED) printed circuit boards and
power supplies. The Company purchased approximately $ 5.3 million and
$4.0 million during 1999 and 1998, respectively.
(13) 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, private and
commercial transportation services operators and related vehicle
manufacturers. The law enforcement and surveillance segment produces
digital signal processing products for law enforcement agencies and
organizations.
Operating income (loss) for each segment is total sales less operating
expenses applicable to the segment. Certain corporate overhead expenses
including executive salaries and benefits, public company
administrative expenses, legal and audit fees, and interest expense are
not included in segment operating income (loss). Segment identifiable
assets include accounts receivable, inventories, net property and
equipment, net intangible assets and net goodwill. Sales, operating
income (loss), identifiable assets, capital expenditures, long-lived
assets, depreciation and amortization, and geographic information for
the Company's two operating segments are as follows:
<PAGE>
BUSINESS SEGMENT TABLE
<TABLE>
<CAPTION>
1999 1998
----------------- ----------------
<S> <C> <C>
Net sales
Transportation products $ 20,665,129 $ 12,280,982
Law enforcement and surveillance 1,776,106 1,958,269
================= ================
$ 22,441,234 $ 14,239,251
================= ================
Income (loss) from operations
Transportation products $ 1,451,198 $ (196,175)
Law enforcement and surveillance 427,287 862,105
Corporate office and administration (2,347,070) (1,855,135)
================= ================
$ (468,585) $ (1,189,205)
================= ================
Identifiable assets
Transportation products $ 10,308,837 $ 7,119,285
Law enforcement and surveillance 1,911,158 2,072,882
Corporate office and administration 964,578 1,099,283
================= ================
$ 13,184,573 $ 10,291,450
================= ================
Long-lived assets
Transportation products $ 425,024 $ 325,801
Law enforcement and surveillance 1,251,013 1,447,174
Corporate office and administration 536,554 207,932
================= ================
$ 2,212,590 $ 1,980,907
================= ================
Capital expenditures
Transportation products $ 127,905 $ 128,757
Law enforcement and surveillance 30,248 11,749
Corporate office and administration 253,560 61,042
$ 411,713 $ 201,548
Depreciation and amortization
Transportation products $ 108,452 $ 161,955
Law enforcement and surveillance 184,315 181,778
Corporate office and administration 86,556 141,332
================= ================
$ 379,323 $ 485,065
================= ================
Geographic information
Domestic $ 16,450,978 $ 9,521,543
Foreign 5,990,256 4,717,708
================= ================
Total $ 22,441,234 $ 14,239,251
================= ================
</TABLE>
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
<PAGE>
(14) STOCKHOLDER RIGHTS
Effective December 14, 1999, the Board of Directors adopted a
stockholder rights agreement designed to prevent any potential acquirer
from gaining control of the Company without fairly compensating the
stockholders and to protect the Company from any unfair or coercive
takeover attempts. The plan was not adopted in response to any specific
effort to acquire the Company.
The Board of Directors approved the declaration of a dividend of one
right for each outstanding share of the Company's common stock on the
record date of December 27, 1999. Each of the rights, which are not
currently exercisable, entitles the holder to purchase 1\1000th of a
share of the Company's newly designated Series D Junior Participating
Preferred Stock at an exercise price of $20.00. Until exercisable, the
rights are represented by and traded with the Company's common stock
and no separate certificates for the rights will be issued.
In general, the rights will become exercisable only if any person or
group of affiliated persons makes a public announcement that it has
acquired 15% or more of the Company's stock or that it intends to make
or makes a tender offer or exchange offer for 15% or more of the
Company's stock. Under certain circumstances, each holder of a right
(other than the person or group who acquired 15% or more of he
30
<PAGE>
Company's stock) is entitled to purchase shares of the Company's common
stock having a market value equal to two times the exercise price. If,
after a person has acquired 15% or more of the Company's common stock,
the Company is acquired in a merger or other business combination
transaction or there is a sales or transfer of a majority of the
Company's assets or earning power, each holder of a right is entitled
to purchase shares of the acquiring company's common stock having a
fair market value equal to two times the exercise price.
The rights may be redeemed by the Company for $.001 per right prior to
the acquisition or ownership of 15% or more of the Company's common
stock and the rights will expire in ten years. The rights distribution
is not taxable to the shareholders.
(15) 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.
DIGITAL RECORDERS, INC.
Notes to Consolidated Financial Statements, Continued
(15) LEGAL PROCEEDINGS - CONTINUED
The allegations relate to the display elements used in the TwinVision
destination sign systems manufactured and marketed by the TwinVision of
North America, Inc. subsidiary of the Company under an exclusive
license for the display patented 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,
moved for summary judgment of non-infringement, and achieved U. S.
Patent Office agreement to review the validity, or lack thereof, of one
of the two Mark IV patents in question.
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
1999 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
TwinVision sign systems product was issued to Lite Vision. Further, on
February 15, 2000, the U.S. Patent Office issued a second patent to
Lite Vision under a continuation of the first Lite Vision Patent.
On February 15, 2000, the TwinVision of North America, Inc. subsidiary
of the Company filed a legal action, TWINVISION V. LUMINATOR, in the
United States District Court for the Eastern District of Texas, against
the Luminator Holding LP subsidary of Mark IV Industries, Inc., the
ultimate parent of Mark IV Industries, Ltd. This action alleges
infringement of the Lite Vision patents including the recently issued
continuation patent, under which TwinVision holds an exclusive license,
seeks damages, and injunctive relief.
The Company believes Mark IV's claims and allegations, in both actions
brought against the Company are without merit. The Company believes
that Lite Vision's U.S. and foreign patents, and patents pending, will
support the Company's position in all matters described above. The
Company intends to defend itself vigorously, and assert its rights, 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
31
<PAGE>
costs. The Company also has certain contractual rights to
indemnification relating to the technology that is the subject of this
dispute.
The Company is not a party to any other litigation and is not aware of
any other threatened or pending legal action, which would have a
material adverse effect on the Company's business, operations or
financial condition.
32
<PAGE>
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 BENEFICAIL 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:
<TABLE>
<CAPTION>
EXHIBIT NO. DOCUMENT
- ---------- --------
<S> <C>
+++ 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.
+++++ 2.3 Agreement and Plan of Reorganization among Robinson Turney International, Inc., the Company, Digital Recorders,
Inc., a wholly owned subsidiary of the Company, and the shareholders of Robinson Turney International, Inc.
+++++ 2.4 Registration Rights Agreement among the Company, David L. Turney and Claude G. Robinson.
* 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.
</TABLE>
33
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. DOCUMENT
- ------------ --------
<S> <C>
* 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.
* 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
xxx 3.1.12 Amendment to Articles of Incorporation together with Exhibit A - Certificate of Designation of Series D Junior
Participating Preferred Stock.
* 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.
xxx 4.5 Rights Agreement, dated as of December 14, 1999, between Digital Recorders, Inc. and Continental Stock
Transfer & Trust Company, as Rights Agent, together with the following exhibits thereto: Exhibit A - Form
of Certificate of Designation of Series D Junior Participating Preferred Stock of Digital Recorders, Inc.;
Form B - Form of Right Certificate; and Exhibit C - Summary of Rights to Purchase Shares.
* 10.2 Incentive Stock Option Plan, adopted April 27, 1993, authorizing 200,000 shares of Common Stock for issuance
pursuant to the Plan.
** 10.9.1 Commercial Lease Agreement, dated February 28, 1995, by and between James E. Paul, Jr. 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.
+ 10.20 Asset Purchase and Sale Agreement, dated February 28, 1995, by and between Digital Audio Corporation and the
Company.
++++++ 10.27 Share Purchase Agreement between Lite Vision Corporation and the Company.
++++++ 10.28 Option Agreement between Lite Vision Corporation and the Company.
xxxx 10.29 Credit Agreement between Digital Recorders, Inc. and Fremont Financial Corporation dated August 23, 1999
11 Not Applicable
13 Not Applicable
16 Not Applicable
18 Not Applicable
*** 21 Listing of Subsidiaries of the Company
34
<PAGE>
22 Not Applicable
</TABLE>
<TABLE>
<CAPTION>
EXHIBIT NO. DOCUMENT
- ----------- --------
<S> <C>
27 Financial Data Schedule
28 Not Applicable
99 Not Applicable
</TABLE>
- ----------------------------------------------------
* Incorporated by reference from the Company's Registration 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.
+++++ Incorporated by reference from the Company's Form 8-K dated August 15,
1998.
+++++ Incorporated by reference from the Company's Form 8-K dated August 15,
1998.
xxx Incorporated by reference from the Company's Form 8-K dated December
14, 1999.
xxxx Incorporated by reference from the Company's Form 8-K dated August 23,
1999.
- ---------------------------------------------------
(b) REPORTS ON FORM 8-K
(1) The Company filed a report on Form 8-K, dated December 14, 1999
regarding the adoption of a shareholders' rights agreement
designed to prevent any potential acquiror from gaining control of
the Company without fairly compensating the stockholders and to
protect the Company from unfair or coercive takeover attempts.
35
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
DIGITAL RECORDERS, INC.
Date: March 17, 2000 By: /s/ DAVID L. TURNEY
----------------------------------
David L. Turney, Chairman of the
Board and Chief Executive Officer
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.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ --------------------------------- -------
<S> <C> <C>
/s/ DAVID L. TURNEY Chairman of the Board, Chief March 17, 2000
- ----------------------- Executive Officer (Principal
David L. Turney Executive Officer)
/s/ LAWRENCE A. TAYLOR Chief Financial Officer and March 17, 2000
- ------------------------- Secretary (Principal Financial
Lawrence A. Taylor and Accounting Officer)
/s/ JOHN D. HIGGINS, SR. Director March 17, 2000
- ----------------------------
John D. Higgins, Sr.
/s/ J. PHILLIPS L. JOHNSTON Director March 17, 2000
- -------------------------------
J. Phillips L. Johnston
/s/ C. JAMES MEESE, JR. Director March 17, 2000
- ---------------------------
C. James Meese, Jr.
/s/ JOHN K. PIROTTE Director March 17, 2000
- -----------------------
John K. Pirotte
/s/ JOHN M. REEVES, II Director March 17, 2000
- ---------------------------
John M. Reeves, II
/s/ JOSEPH TANG Director March 17, 2000
- -------------------
Joseph Tang
/s/ JULIANN TENNEY Director March 17, 2000
- ---------------------
Juliann Tenney
</TABLE>
36
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 242,820
<SECURITIES> 0
<RECEIVABLES> 5,860,884
<ALLOWANCES> (77,250)
<INVENTORY> 4,322,391
<CURRENT-ASSETS> 10,971,984
<PP&E> 3,367,623
<DEPRECIATION> 1,516,851
<TOTAL-ASSETS> 13,184,573
<CURRENT-LIABILITIES> 7,034,938
<BONDS> 0
1,770,000
(172,100)
<COMMON> 327,407
<OTHER-SE> 4,052,228
<TOTAL-LIABILITY-AND-EQUITY> 13,184,573
<SALES> 22,441,234
<TOTAL-REVENUES> 22,441,234
<CGS> 14,555,134
<TOTAL-COSTS> 7,886,100
<OTHER-EXPENSES> 8,169,129
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 185,556
<INCOME-PRETAX> (468,585)
<INCOME-TAX> 0
<INCOME-CONTINUING> (468,585)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (135,887)
<NET-INCOME> (776,572)
<EPS-BASIC> (0.24)
<EPS-DILUTED> (0.24)
</TABLE>
