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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 23, 2000.
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
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
FOR THE TRANSITION PERIOD FROM ______________ TO ______________.
COMMISSION FILE NUMBER: 0-21681
TRANSCRYPT INTERNATIONAL, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 47-0801192
(State or other jurisdiction (I.R.S. Employee
of incorporation or organization) Identification No.)
4800 NW 1ST STREET
LINCOLN, NEBRASKA 68521
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (402) 474-4800
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $0.01 PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not 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-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting and non-voting Common Stock held by
non-affiliates of the Registrant, based upon the last sale price of the Common
Stock on March 9, 2000, as reported in the Over the Counter Bulletin Board
market was approximately $65,649,782. Shares of Common Stock held by each
executive officer and director and each person owning more than 5% of the
outstanding Common Stock of the Registrant have been excluded in that such
persons may be deemed to be affiliates of the Registrant. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes. Number of shares outstanding of the Registrant's Common Stock, as of
March 9, 2000: 12,954,124.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the Registrant's 2000 Annual
Meeting of Stockholders to be filed within 120 days of the fiscal year ended
December 31, 1999 are incorporated by reference in Items 10, 11, 12 and 13 of
Part III of this Annual Report on Form 10-K.
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PART I
ITEM 1. BUSINESS
Unless the context otherwise provides, all references in this Annual Report
on Form 10-K to the "Company" includes Transcrypt International, Inc.
("Transcrypt"), its predecessor entities, and its subsidiaries, including E.F.
Johnson Company, on a combined basis, and all references to "E.F. Johnson" refer
to E.F. Johnson Company.
In addition to the historical information contained herein, certain matters
discussed in this Annual Report may constitute forward-looking statements under
Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). These statements may involve risks and uncertainties. These
forward-looking statements relate to, among other things, the outcome of pending
class action litigation involving the Company, the outcome of the pending
investigation by the Securities and Exchange Commission (the "SEC"), the effects
of the Company's restatement of its financial statements on the Company's
product development efforts, future sales levels and customer confidence, the
Company's future financial condition, liquidity and business prospects
generally, perceived opportunities in the marketplace for the Company's products
and its products under development, expectations regarding the Company's efforts
to resolve Year 2000 issues and the effects of a failure to resolve such issues
and the Company's other business plans for the future. The actual outcomes of
these matters may differ significantly from the outcomes expressed or implied in
these forward-looking statements. For a discussion of some of the factors that
might cause such a difference, see "--Summary of Business Considerations and
Certain Factors That May Affect Future Results of Operations and/or Stock Price"
below.
GENERAL
The Company is a manufacturer of wireless communications products and
systems and information security products. Through its E.F. Johnson subsidiary,
the Company designs, develops, manufactures and markets (1) stationary land
mobile radio ("LMR") transmitters/receivers (base stations or repeaters) and
(2) mobile and portable radios. The Company sells its LMR products and systems
mainly to two broad markets: (1) commercial users and (2) public safety and
other governmental users. Through its Secure Technologies division, the Company
designs and manufactures information security products which prevent
unauthorized access to sensitive voice communications. These products are based
on a wide range of analog scrambling and digital encryption technologies and are
sold mainly to the LMR and telephony security markets.
In July 1997, the Company expanded its presence in the wireless
communications market by acquiring E.F. Johnson, an established provider of
products and systems for the LMR market. This acquisition was made through the
issuance of shares of Transcrypt common stock ("Common Stock"), the payment of
cash and the assumption of certain indebtedness of E.F. Johnson. The total value
of the cash and shares paid at the time of acquisition was approximately
$10.4 million.
Prior to June 30, 1996, the Company operated as a partnership. In
December 1991, the Company acquired the business of its predecessor, which was
founded in 1978. The Company's principal business offices are located at 4800 NW
1st Street, Lincoln, Nebraska 68521, and its phone number is (402) 474-4800.
RESTATEMENT OF FINANCIAL STATEMENTS AND RELATED EVENTS
In 1998, the Company restated its previously released results for the year
ended December 31, 1997, the Company's financial statements for the year ended
December 31, 1996 and the financial statements as of and for each of the
quarterly periods ended March 31, June 30, September 30 and December 31 during
1997 and 1996. The restatement of the Company's financial statements and other
events relating to the
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restatement, including the filing of class action lawsuits against the Company
and the initiation of an SEC investigation (See "Item 3. Legal Proceedings.")
which occurred subsequent to March 31, 1998, have had and continue to have an
adverse impact on the Company's business, financial condition, results of
operations, liquidity and cash flows.
RECENT DEVELOPMENTS
On February 14, 2000, the Company announced the formation of three new
business units at its E.F. Johnson subsidiary to further strengthen its position
in the wireless systems and digital radio products market. The new State, Local,
and Commercial business unit will be focused on marketing, sales, and turnkey
delivery of high level public safety and commercial private wireless
communications networks. The new Federal business unit will be focused on the
sales of E.F. Johnson's digital APCO Project 25 products to Federal government
agencies. The new Value Added Services and Original Equipment Manufacturer
("OEM") business unit was formed to consolidate E.F. Johnson's OEM production
services and engineering design and support services. The Company also announced
that it would also open offices in the Washington, D.C. area to exploit
opportunities in the Federal and commercial markets.
WIRELESS COMMUNICATIONS INDUSTRY
OVERVIEW
The mobile wireless communications industry began in the mid-1930s when
police departments began using land mobile radio systems to enable immediate
communication between headquarters and officers patrolling the community. As
(1) other public safety agencies and commercial enterprises recognized the
benefit of immediate communications with their field personnel,
(2) technological advances made LMR systems more affordable, and (3) increasing
amounts of spectrum were allocated for LMR use, LMR dispatch service expanded
beyond its traditional police and fire applications to become an integral
communications service for a variety of government and commercial enterprises.
Today, in addition to dispatch-oriented LMR service, many other forms of mobile
wireless communication technologies have emerged and are continuing to be
developed to meet the varied communication needs of an increasingly mobile
society. These include paging, wireless data, cellular telephone and personal
communication services.
COMMERCIAL SYSTEMS MARKET
Commercial users include large industrial and other private enterprises,
such as utility, construction and oil companies, railroads and universities that
require rapid communications among personnel spread out over relatively large
geographic areas. While many commercial LMR users purchase and operate entire
systems for their own use, a large segment of the commercial market consists of
specialized mobile radio ("SMR") operators such as Nextel Corp. and Centennial
Communications, and their customers. SMR operators build and lease private LMR
systems on a for-profit basis. They sell airtime to end-users whose mobile
communication needs can be served by renting or purchasing subscriber units as
opposed to purchasing an entire system, or who are unable to obtain a FCC
license to operate their own system. Traditionally, end-users of SMR services
have included taxi fleets and smaller construction and delivery service
companies. Currently, many SMR operators in the larger metropolitan markets,
such as Nextel Corp., are also offering more consumer-oriented, cellular-like
SMR services.
There are two general types of LMR systems serving commercial users,
(1) conventional and (2) trunked. Both operate on the specific frequency bands
that the FCC has allocated for such types of systems. Conventional LMR systems
use a single channel to transmit and receive information. All users have
unrestricted access, similar to a "party" telephone line, and the user must
monitor the system and wait until the channel is unoccupied. Trunked systems,
including the Company's logic trunked radio ("LTR-Registered Trademark-")
product, combine multiple channels so that when a user begins transmitting, an
unoccupied
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channel is automatically selected. Conventional LMR systems are relatively
inefficient compared to trunked systems.
The development of trunked LMR systems and the allocation of additional
frequency spectrum in the 1970s triggered significant growth in LMR use for
commercial applications. In recent years, technological developments by E.F.
Johnson and others have enabled LMR systems to be "networked," involving
multiple "sites" linked together through a switch to provide extended
geographical coverage. In addition, many trunked subscriber units are capable of
functioning as mobile telephones through interconnections to the public switched
telephone network. With the creation of LTR-Net-TM- in 1997, the Company has
developed a networking system that is backward compatible to the standard
LTR-Registered Trademark- protocol. LTR-Net-TM- allows systems operators to link
sites together and provide telephone interconnection, individual and group
calling, electronic serial numbers and improved system security in an advanced
commercially focused trunking system.
PUBLIC SAFETY AND OTHER GOVERNMENT USERS MARKET
Public safety and other government users include state and local agencies,
such as law enforcement, fire and emergency medical personnel, and military and
non-military federal governmental agencies. Many of these users operate LMR
equipment which complies with specifications established by the Association of
Public Safety Communications Officials International Inc. ("APCO"), while the
remainder operate mostly conventional and non-APCO trunked LMRs. The most widely
used APCO standard is the "APCO 16" standard established in 1979, which includes
specifications for 800 MHz transmission, analog voice modulation, and trunking
functions for using the frequency spectrum. In 1988, E.F. Johnson entered the
market for APCO 16 products with its Multi-Net-Registered Trademark- system.
In 1995, the APCO Advisory Board promulgated a new standard known as Project
25. Project 25 specifies features and signaling for narrow band digital voice
and data, and conventional and trunking modes of operation. The standard has
been adopted by the U.S. Federal government, which specified a conversion to
Project 25 by the year 2005. Although public safety agencies are not currently
required by the FCC or APCO to purchase Project 25 compliant LMR systems or
otherwise adopt the Project 25 standard, the Company believes that Project 25
compatibility will be one of the key purchasing factors for public safety and
other government LMR users. Furthermore, as LMR users upgrade their existing
APCO 16 systems to comply with FCC-imposed bandwidth limitations, the Company
expects that demand for Project 25 compliant LMR systems will increase, due in
part to the fact that Project 25 systems can potentially be configured for
compatibility with older APCO 16 mobile and portable radios, allowing early
adopters of the Project 25 standard to purchase new equipment without replacing
all of their subscriber radios. Additionally, the Company's Project 25 radios
can be used on most Motorola APCO 16 systems using the Smartnet-TM-protocol,
which E.F. Johnson licensed from Motorola. However, to date the Project 25
market is developing slowly which the Company believes is primarily due to the
higher cost of Project 25 compliant system infrastructure and radios.
INFORMATION SECURITY INDUSTRY
OVERVIEW
The electronic information security industry is generally comprised of
products designed to protect the transmission of sensitive voice and data
communications through both wireless and wireline mediums. Without such
protection, many forms of electronic communications, such as LMR and telephone
conversations and remote data communications, are vulnerable to interception and
theft.
The information security industry originated from the need to secure
sensitive wireless military communications. By the late 1970s, the availability,
quality and cost of information security devices had improved so that the use of
these devices became economically and functionally feasible for non-military
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governmental users (such as law enforcement, fire, emergency medical and other
public safety personnel) and large commercial users (such as railroads,
construction and oil companies).
Initially, all electronic communications were transmitted in analog format.
Analog transmissions typically consist of a voice or other signal modulated
directly onto a continuous radio "carrier" wave. An analog transmission can be
made secure by (1) "scrambling" or manipulating the original signal at the point
of transmission and (2) reconstituting the original signal at the receiving end.
By the late 1980s, accelerating use of wireless communications devices, such as
LMRs and cellular telephones, resulted in increased demand for limited radio
spectrum. In response to this demand, and enabled by the low-cost availability
of digital signal processors ("DSPs"), electronics manufacturers developed
spectrally efficient (I.E., low-bandwidth) digital communications devices. In
digital communications, an analog signal is "digitized," or converted into a
series of discrete information "bits" in the form of ones and zeroes prior to
transmission. Digital transmissions can be made secure by a process known as
"encryption," which involves (1) the use of a mathematical algorithm to
rearrange the bit-stream prior to transmission and (2) a decoding algorithm to
reconstitute the transmitted information back into its original form at the
receiving end.
Manufacturers of information security products such as the Company typically
charge higher prices for devices featuring more advanced levels of security.
Therefore, the types of end-users at each level of security tend to vary based
upon the importance of the information that the end-user wants to secure.
Typical users of the most basic form of scrambler, the frequency inversion
scrambler, include taxi dispatchers, other types of consumer businesses and
transportation companies. Typical users for medium-level security devices
include commercial users and international customers who do not need an export
license. High-level scrambling and encryption devices are used primarily by
public safety agencies, federal government personnel and international customers
who have obtained the required export license.
LAND MOBILE RADIO SECURITY MARKET
One of the earliest applications of information security technology outside
of the military was in protecting LMR voice communications. LMRs consist of
(1) hand-held or (2) mobile (vehicle mounted) two-way radios. A typical LMR
system consists of one or more base control stations networked with each other
and with hand-held and/or mobile LMRs. As with all other major forms of wireless
communications devices, LMRs transmit information in either analog or digital
format, although there is an increasing migration to the digital format.
TELEPHONY SECURITY MARKET
Since its inception in 1983, cellular telephone service has grown rapidly
and become available to most of the United States population. Cellular telephone
subscribers and revenues have grown rapidly in recent years and are expected to
grow in the future. This increased volume has raised significant new security
and privacy issues and an increased sensitivity to the potential risks involved
in intercepted signals. Unprotected wireless transmissions generally provide
minimal or no security and allow eavesdropping by even casual listeners with
compatible scanners.
In recent years, the cellular industry has been migrating, on an accelerated
basis, away from analog devices towards digital forms of communications, which
are commonly referred to as Personal Communication Services ("PCS"). Similar to
the LMR industry, this migration has occurred principally due to (1) increased
spectrum efficiency, (2) perception of greater voice security and
(3) additional capabilities for advanced features and data communications. PCS
technology typically uses variable rate voice coding, which maximizes the
efficiency of transmissions by only transmitting critical pieces of information
and omitting other information, such as pauses in a conversation. In the area of
voice security, digital telephony is functionally more secure than analog
telephony. While there are some characteristics that make digital transmissions
more difficult to intercept, most digital services do not use any type of active
encryption
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technology. However, unlike analog scanning technology, digital scanners are not
yet widely available. The increased use of digital devices has resulted and will
likely continue to result in reduced demand for add-on voice security devices,
such as those produced by the Company.
WIRELESS COMMUNICATIONS PRODUCTS
The Company sells its wireless communications products primarily to LMR
dealers, SMR operators, governmental entities, and commercial industry.
End-users include commercial concerns and public safety and other government
users desiring point to multi-point communications. Most of these types of
products are sold under the "E.F. Johnson" brand name. To increase its product
offering to its wireless customers, the Company has incorporated its encryption
technology into some of its wireless communications radio products. The
following discussion summarizes the types of products typically sold to both of
these types of users.
COMMERCIAL USERS
The Company serves the commercial market primarily with its
LTR-Registered Trademark- and analog conventional LMR product lines. Management
believes that significant niche markets continue to exist for analog
conventional LMR products with value added technology, such as signaling
protocols and scrambling technology.
The LTR-Registered Trademark- product line incorporates the E.F. Johnson
LTR-Registered Trademark- trunking protocols and includes (1) sub-audible
signaling, which automatically selects a clear or unoccupied channel, (2) open
architecture that is compatible with other analog products and (3) transmission
trunking which provides efficient use of the channels. In December 1997, the
Company completed the design of a trunked LMR system known as "LTR-Net-TM-,"
which uses its LTR-Registered Trademark- trunking system in a wide-area
networked configuration, allowing linked communications over a much larger
geographic area than a single trunked system while also providing a much needed
array of user features and security functions. During 1999, the company
delivered a number of LTR-Net-TM- systems, including one that provides statewide
coverage.
The Company's products for the SMR market include mobile radios, portable
radios and repeaters, along with other infrastructure to provide a complete SMR
system. The Company targets smaller regional SMR operators which offer a
combination of dispatch and interconnect services and the traditional local SMR
operators and dealers who serve local businesses primarily with dispatch
service. In serving this market, the Company relies heavily on its network of
dealers, many of whom are authorized by the Company as service centers and
provide installation, maintenance, repair and warranty service. The Company
believes that the end-users of these products value (1) the low cost of point to
multi-point communications, (2) flexibility of networking, and (3) support and
responsiveness of the Company and its dealers.
Competition in the domestic commercial market has been increasing. New 800
MHz SMR frequencies are not available and existing channels are filling up. SMR
operator's with licenses for 900 MHz channels have been slow to develop their
build outs. There has been consolidation in both of these SMR marketplaces. A
large number of SMR systems have been converting from analog to digital, which
has resulted in the increasing availability of used analog radios and repeaters
in the marketplace. These factors have contributed to reduced market demand for
new and existing products. Competitors have been reducing their prices and
therefore putting pressure on the Company's prices and margins in this market.
PUBLIC SAFETY AND OTHER GOVERNMENT USERS
The Company serves public safety and other government users primarily with
its APCO 16 Multi-Net-TM- analog trunking system and Project 25 digital product
lines. The Company believes that its Multi-Net-TM- system, which links together
multiple sites for wide-area coverage using a proprietary architecture, is a
high-quality, cost-effective alternative to comparable APCO 16 systems produced
by other manufacturers. The Company's system offers many features specifically
designed for public safety
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users, such as (1) emergency queuing, (2) over 8,000 unique identification
codes, (3) automatic subscriber identification, (4) five levels of priority
access, (5) simulcast, and (6) a wide area system configuration. The Company
provides a broad line of Multi-Net-TM- products, including repeaters, radio
network terminals, system management modules, dispatcher consoles, audio and
data link and related accessories. E.F. Johnson Multi-Net-TM- systems are sold
both domestically and internationally. The Company's Project 25 compliant
analog/digital radios are compatible and interoperable with older analog radio
systems, as well as with Motorola's proprietary analog APCO 16 trunking
technology (SmartNet-TM- and Smartzone-TM-) and proprietary digital encryption
algorithms. In August 1996, the Company introduced a hand held digital radio
complying with the Project 25 "common air interface" standard and also featuring
advanced core scrambling and digital encryption technologies. The Company's
Project 25 radios contain, as standard features, voice scrambling and/or digital
encryption technology. The Company believes that such backward compatibility
with most of Motorola's APCO 16 trunking technology will provide early adopters
of the Project 25 standard, such as the federal government and many public
safety agencies, with the ability to purchase new equipment without replacing
entire older systems. During 1999, the Company also introduced new products that
operate in the analog mode on existing Motorola Smartnet-TM- and Smartzone-TM-
trunking systems. The Company believes these products, being lower cost than
digital Project 25 radios, will provide a competitive alternative for existing
Smartnet-TM- and Smartzone-TM- customers.
INFORMATION SECURITY PRODUCTS
OVERVIEW
Transcrypt first entered the information security market in 1978 with
simple, transistor-based add-on scrambling modules for use in analog LMRs using
basic single-inversion scrambling techniques. Transcrypt marketed these products
primarily to public safety agencies and international governments. Since that
time, the Company has further developed and improved upon its core information
security technologies, which have at various times been implemented into the
Company's scrambler modules and other products within its major information
security product families, (1) LMR Security and (2) Telephony Security.
The core technologies currently available to the Company for incorporation
in its products include the following methods, which are listed in increasing
order of sophistication of security technique: (1) frequency inversion
(inverting or otherwise adjusting the phase of a signal based on a consistent
method), (2) rolling code transmission (incrementally stepping codes),
(3) hopping code transmission (changing broadcast frequencies multiple times per
second based upon an algorithm) and (4) digital encryption (encoding a digital
bit-stream based upon a mathematical encryption algorithm).
As with all of the Company's information security products, the use of
scrambling and encryption equipment is required on both the transmitting and
receiving sides of communications in order to operate in secure mode. For
example, in order to achieve secure LMR communications, it would be necessary
for both the transmitting and receiving equipment, including hand-held, mobile
devices and base stations, to be equipped with one of the Company's modules,
whether as an add-on installation or in the form of one of the Company's
complete LMRs. In the Company's telephony family, a scrambled cellular telephone
may communicate in secure mode only with (1) another of the Company's secure
cellular telephones, (2) a PBX interchange or cellular service provider that has
installed one of the Company's Voice Privacy Exchange Units or (3) a landline
telephone equipped with one of the Company's external desktop units. However,
all of the Company's products can be used in the clear, non-scrambled mode with
equipment that does not contain a security device.
LAND MOBILE RADIO SECURITY
The Company offers a variety of add-on LMR scrambling products featuring its
core technologies at varying levels of security. Add-on scramblers are available
in two packages, (1) a modular package consisting of a circuit board that is
designed to be permanently soldered into existing circuitry and (2) a
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socket package designed for installation in sockets with standard pin
configurations which original equipment manufacturers ("OEM") may install.
Products sold by the Company are compatible with sockets of OEM
manufacturers, including ICOM America, Inc., Motorola, Kenwood, and Midland. The
Company also produces modules that add signaling features to radios, including
"man-down" (emergency signal broadcast if radio position becomes horizontal),
"stun-kill" (disables lost or stolen radios remotely) and "over-the-air
reprogramming" (changes encryption and scrambling codes remotely). In
December 1997, the Company introduced an LMR encryption module for use as an
add-on or in OEM equipment that uses the U.S. digital encryption standard known
as "DES." This module uses the widely recognized DES algorithm for encoding
transmissions.
TELEPHONY SECURITY
The Company's add-on scramblers for cellular telephones typically consist of
a modular circuit board designed to be permanently soldered into existing
telephone circuitry. The add-on scrambler product line includes a model designed
specifically for Motorola, Nokia, and Qualcomm telephones, which feature
advanced digital signal processing technology. With the increased deployment of
digital or PCS systems by cellular service providers, the demand for add-on
voice security products for analog equipment has resulted and will likely
continue to result in reduced demand for add-on voice security devices for
analog telephones, such as those produced by the Company.
The Company offers cellular telephones upgraded to include the Company's
advanced add-on scrambling modules. The Company believes that offering cellular
telephone security through a complete telephone product offers certain
advantages over add-on scrambler sales. These advantages include (1) presenting
the customer with a single vendor, (2) overcoming customer resistance to
surrendering their telephones during installations and (3) allowing the Company
to market cellular security directly to cellular service providers. In the area
of landline telephone voice security, the Company has, since 1995, produced
landline scrambling and encryption devices for installation between the handset
and telephone base, which have been purchased primarily by overseas government
and corporate users. In 1997, the Company introduced a line of complete landline
telephones with built-in voice security capability.
PRODUCTS UNDER DEVELOPMENT
Consistent with the Company's development efforts for its existing products,
the Company designs new products around common wireless technologies using
common signal processing platforms and circuitry. Using this approach, the
Company has generally been able to incorporate improvements in core technologies
into its new products more quickly and with relatively lower development costs
compared to developing entire products separately. The following discussion
contains a summary of the Company's principal products under development. The
Company cannot assure that it will be able to successfully develop any of these
products or, if developed, that any such products will be commercially viable or
result in material sales.
WIRELESS COMMUNICATIONS
The Company plans to develop in 2000, for expected shipment during 2001,
additional models of its hand-held digital radios containing different features,
as well as a line of mobile digital radios, which are intended to comply with
the Project 25 standard. The Company has undertaken the development of Project
25 infrastructure equipment, including Project 25 trunking infrastructure. The
Company believes Project 25 trunking will be more widely implemented as costs
come down and additional competitively priced equipment becomes available. In
addition, the Company is analyzing the potential of applying standard Internet
Protocol switching techniques for voice and data interconnectivity between
wireless sites.
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LAND MOBILE RADIO SECURITY
The LMR security products under development are new versions of the
Company's SC20-DES module for deployment in different models of radios,
including sockets in certain new model Motorola radios introduced in late 1998.
From time to time, the Company also has under development a number of custom
security modules, including those incorporating custom encryption and scrambling
algorithms.
TELEPHONY SECURITY
No new telephony security products are under development at this time.
CUSTOMERS
Purchasers of the Company's wireless communications and information security
products include public safety agencies and police forces, federal government
agencies, foreign governments, the military, cellular service providers, LMR
manufacturers and business and corporate users in finance, manufacturing and
media/entertainment, among other industries. The Company's customers use
information security products in a variety of situations involving differing
security needs. For example, domestic and international police forces typically
have a medium to high need for security, while military users which are often
faced with hostile and determined threats typically have a very high need for
security. No customer accounted for more than 10% of the Company's revenues
during 1999.
SALES AND MARKETING
The following discussion summarizes the Company's current sales and
marketing approaches for its different products:
WIRELESS COMMUNICATIONS
The Company's sales and marketing functions for LMR systems focus on the
Americas, including the North American and Latin American markets. Other
international markets are covered by distributors, agents, and manufacturer's
representatives. For North American sales, the Company uses a direct sales force
of account executives and sales managers, who sell Company products primarily in
(1) the state and local government markets, (2) the Federal markets, and (3) to
larger dealers and SMR operators, and telemarketing personnel who sell primarily
to smaller dealers and SMR operators. The Company's international sales are made
through a specialized international direct sales force and by Company authorized
dealer/distributors. In 1999, the Company decided to close its Hong Kong office
due to cost and market considerations, and to focus on its markets in the
Americas.
LTR-Registered Trademark- and conventional LMR products are sold in North
America primarily to independently owned and operated dealers, some of which are
also SMR operators. The dealers typically carry other competitive product lines
as well. These products are distributed internationally primarily through
dealers and distributors located in more than 45 countries. Many of the dealers
also are authorized as service centers and provide installation, maintenance,
repair and warranty service. The Company provides comprehensive dealer support,
including cooperative advertising programs, advertising materials, sales and
service training, and technical support.
The majority of system sales of LMR products to both commercial and
governmental purchasers involves soliciting and responding to "requests for
proposals," commonly referred to as "RFPs." The RFP process for system sales has
a relatively long cycle time. The period from proposal requirements to contract
award typically takes at least one year, and depending on the size of the
system, it can take multiple years for complete installation and acceptance of
the project. Public sector end-users issuing RFPs often require suppliers of LMR
systems to supply a bond from an approved surety company at the time that the
bid is submitted and at the time that the contract is awarded.
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A number of factors can limit the availability of such bonds, including the
applicant's financial condition and operating results, the applicant's record
for completing similar systems contracts in the past and the extent to which the
applicant has bonds in place for other projects. During 1999, the Company
focused on the completion of systems contracts for certain E.F. Johnson projects
begun prior to the Company's acquisition of E.F. Johnson. The Company believes
that it has substantially corrected these systems problems. However, if a
customer for a systems contract declares an event of default under the
outstanding bond related to the system contract, the issuer of the Company's
bonds could reduce the maximum amount of bond coverage available to the Company,
or impose additional restrictions with respect to the issuance of bonds on
behalf of the Company. A reduction in the amount of bond coverage available to
the Company or any restrictions imposed in connection with the issuance of bonds
would adversely affect the Company's ability to bid on new system contracts in
the future. In early 2000, the Company negotiated an agreement with a bonding
insurer that provides for up to $20 million in new bonding capability at
competitive terms.
INFORMATION SECURITY
The Company sells its add-on products domestically primarily to distributors
and dealers, OEMs and self-servicing end-users, through sales managers while
complete radio products are sold domestically primarily to end-users.
Furthermore, the Company is continuing to market radio and other complete
products to its existing add-on customer base.
The Company conducts international sales through its sales managers, who
focus on specific regions of the world outside of the United States. The
majority of international sales are made by the sales managers in conjunction
with a Company-authorized distributor, which typically provides a local contact
and arranges for technical training in foreign countries. See "--Summary of
Business Considerations and Certain Factors That May Affect Future Results of
Operations and/or Stock Price--Risks Associated with International Sales."
The Company distributes its add-on information security products to both
(1) end-users in the LMR and telephony markets and (2) distributors, such as LMR
dealers, that resell these products to end-users. Currently, the Company sells
self-branded, complete, analog secure cellular telephones primarily through
distributors and cellular service resellers.
The Company's basic marketing strategy has been to increase market awareness
of the need for information security products and to convey the technical
capabilities of its products. The telephony security products marketing staff
conducts promotions through a mix of print advertising, trade shows, direct mail
campaigns, press releases and presentation material, and distribution of
demonstration and loaner equipment, which are sometimes coordinated with product
launches and trade shows.
CUSTOMER SERVICE
For the Secure Technologies division product line, the Company provides
toll-free telephone access for customers with technical or other problems. The
Company will customize product training for its customers using a classroom
approach or seminars at either or both the customer's site and the Company's
Lincoln facility. The Company offers a standard warranty on all products, which
covers parts and labor for a period of one year from purchase, with an extended
warranty service option available at an additional cost.
The Company installs, for a fee, all models of scrambler modules into
customers' LMRs and telephones. Scrambler modules that the Company does not
install are generally installed by local radio and cellular telephone dealers.
The Company documents installation instructions for its products in OEM devices
and has developed these instructions for more than 2,500 OEM products, including
almost all commercially available two-way radio models sold worldwide.
10
For the E.F. Johnson product line, the Company's customer service group
provides after-sales service and support, including technical support through a
toll-free telephone number, on-site technical personnel for repairs and
applications issues, 24-hour turnaround for spare parts and extensive product
training. Product training includes classes and seminars available at both the
customer's site and Waseca manufacturing facility. Such training provides
assistance to the end-user in the use, operation and application of LMR products
and systems, and trains other end-users and dealers to perform network
programming changes and preventive maintenance and repair to products and
systems. LMR products and systems are generally sold with a one year warranty
which covers parts and labor in North America and parts internationally. Broader
warranty and service coverage is provided in certain instances to private
systems customers on a contractual basis, usually for an additional charge.
MOTOROLA RELATIONSHIP
Motorola is a key manufacturer of electronic components used by the Company.
These components include microprocessors and components used in most of the
Company's scramblers and LMRs, which the Company purchases through an
electronics wholesaler.
The Company has obtained from Motorola a royalty-bearing, irrevocable,
non-exclusive, worldwide license (the "IPR License") to manufacture products
containing certain proprietary LMR and digital encryption technology. The
Company believes this technology will be important to the success of certain of
its existing and proposed Project 25 compliant LMR products. The IPR License
includes rights to use Motorola's proprietary analog APCO 16 trunking technology
(SmartNet-TM-), Project 25 required products and certain Motorola digital
encryption algorithms in LMR products. The digital encryption technology may
also be incorporated into certain other information security products. In
addition, E.F. Johnson, prior to its acquisition by the Company, obtained a
license to certain proprietary technology from Motorola relating to the
development of Project 25 compliant digital LMRs. This license covered
infrastructure and other Project 25 technology. Subsequent to the acquisition,
Motorola agreed to expand the coverage of Transcrypt's license to SmartNet-TM-
to cover E.F. Johnson's products.
During 1999, Motorola purchased approximately $4 million worth of E.F.
Johnson Project 25 mobile radio products. At this time, the Company cannot
guarantee that there will be further sales of this product line to Motorola, but
it is conducting active discussions on enhanced offerings related to this
purchase. Also during 1999, the Company signed a Memorandum of Understanding
with Motorola for the exploration of joint development projects and the license
of E.F. Johnson technology.
In addition to the direct benefits of the IPR License to the Company's
Project 25 development efforts, the Company believes that sales of its Project
25 digital LMR products have been, and expect that such sales will in the
foreseeable future be, substantially dependent upon Motorola's dominant position
as a market leader in the Project 25 marketplace. Motorola is the largest
manufacturer of Project 25 compliant LMR products and has been the principal
public supporter of the Project 25 digital transmission standard for the LMR
market. Any reduction in such support could lead to reduced demand for Project
25 compliant LMR systems generally. See "--Summary of Business Considerations
and Certain Factors That May Affect Future Results of Operations and/or Stock
Price--Reliance on Motorola."
INTELLECTUAL PROPERTY
Transcrypt presently holds registered copyrights that cover software
containing algorithms for frequency hopping, scrambling and signaling
technologies for LMR and cellular telephony. Transcrypt has been granted 11
patents relating to high-end scrambling and encryption techniques and methods of
integrating after-market devices, such as the Company's modules, into OEM
products, and has applied for nine additional domestic patents in this area.
Transcrypt also holds three registered trademarks related to the "Transcrypt"
name and product names. In addition to the rights held by Transcrypt, E.F.
Johnson currently holds or has been assigned at least 23 U.S. patents, 10
pending applications for U.S. patents, 11
11
patents in foreign countries and 8 pending applications for patents in foreign
countries. These patents and applications cover a broad range of technologies,
including trunking protocols and a high-speed data interface for LMR
communications. Furthermore, E.F. Johnson holds numerous registered trademarks
related to the "E.F. Johnson" name and product names. In addition to copyright
and patent laws, the Company relies on trade secret law and employee and
third-party non-disclosure agreements to protect its proprietary intellectual
property rights.
RESEARCH AND DEVELOPMENT
As of December 31, 1999, the Company had a research and development staff of
48 individuals, including 39 engineers. The Company organizes research and
development efforts along its two main product lines, (1) information security
and (2) wireless communications products. During 1999, the engineering staffs
were realigned to allow focus on research and development of products for E.F.
Johnson and Secure Technologies separately. While engineering staffs will
combine efforts when appropriate, the Company believes that this more focused
environment will foster a more efficient approach to new product development.
WIRELESS COMMUNICATIONS
The Company's wireless communications research and development organization
have expertise in radio frequency technology, computer architecture, switch
architecture, networking, software, and analog and digital hardware designs.
Ongoing engineering efforts are focused on adding additional features to
existing product lines and developing new and innovative platforms.
Cross-disciplinary planning groups involving marketing, manufacturing and
engineering are used for product planning and definition. Present research and
development efforts are involved in upgrading existing product lines, including
the development of next generation repeaters, network switching equipment, and
mobile and portable radios for the Company's principal product lines. The
Company also has a staff of systems applications design, manufacturing, and
customer service engineers that focus on design and implementation of customized
radio systems.
INFORMATION SECURITY
The Company's research and development personnel in the information security
area have expertise in various fields, including cryptography, analog hardware,
digital hardware, and object-oriented software. The research and development
staff designs and develops products incorporating digital signal processing,
voice coding (including improved multi-band excitation), encryption, spectral
manipulation and rotation, systems simulation and mixed signal scrambling.
MANUFACTURING
The Company's manufacturing operation generally consists of the procurement
of commercially available (1) subassemblies, (2) parts, and (3) components, such
as integrated circuits, printed circuit boards and plastic and metal parts, and
their assembly into finished products. Certain components and subassemblies are
manufactured by vendors to the Company's specific design criteria. The Company
inspects components and subassemblies for mechanical and electrical compliance
to its specifications in order to ensure high yield and quality.
The Company produces many of its wireless communications products, including
its Project 25 compliant products, at its Waseca, Minnesota facility. The
Company assembles its information security products at its facility in Lincoln,
Nebraska. During 1999, the Company consolidated its surface mount printed
circuit board assembly at its Waseca, Minnesota location. The Company is
continuing to evaluate alternative manufacturing strategies to reduce costs and
improve efficiencies.
12
MATERIALS AND SUPPLIERS
WIRELESS COMMUNICATIONS
Certain components and subassemblies used in the Company's wireless
communications products are presently available only from a single supplier or a
limited group of suppliers. To date, the Company has been able to obtain
adequate supplies of key components and subassemblies in a timely manner from
existing sources. Currently, Motorola is the sole supplier of a number of the
semiconductors used in certain of the Company's LMR products. Although
historically the Company has not experienced a disruption of Motorola's supply
of this product, disruption or termination of Motorola's supply of this product
would have a material adverse effect on the Company's operations.
Most of the Company's newer analog LMRs for the commercial market have been
manufactured by Icom Japan ("ICOM") under contract by the Company. Products
produced by ICOM have included hand-held portable radios that operate in both
conventional and trunked mode and more recently, mobile units as well. In
general, the Company and ICOM have jointly developed new products produced by
ICOM for the Company. Although historically the Company has not experienced a
disruption in ICOM's ability to supply these products, disruption or termination
would have a material adverse effect on the Company's ability to supply certain
LMRs to its customers. ICOM requires that the Company supply a letter of credit
before products are shipped to the Company. In addition to the Company's
relationship with ICOM, the Company began development projects with Kukjae of
Korea and Tokyo Wireless of Japan for products expected to be available for
shipment during 2000. Should a long-term relationship develop with either or
both of these firms, the Company can expect that relationship to be similar to
its relationship with ICOM, particularly with respect to its ability to supply
products to its customers.
With respect to other electronic parts, components and subassemblies, the
Company believes that alternative sources could be obtained to supply these
products, if necessary. Nevertheless, a prolonged inability to obtain certain
components and subassemblies could impair customer relationships and could have
an adverse effect on the Company's operating results. See "--Summary of Business
Considerations and Certain Factors That May Affect Future Results of Operations
and/or Stock Price--Dependence on Suppliers."
INFORMATION SECURITY
The Company obtains most of its electronic parts and components for
information security and radio products from one principal distributor,
Arrow/Schwebber Electronics Group. The Company believes that concentrating its
purchases through one principal distributor lowers procurement costs and
enhances the ability to control the quality of these components and
subassemblies. The distributor stores several months' supply of basic
components, such as microprocessors, flash, and digital signaling processors,
on-site at the Company's manufacturing location on a consignment basis, which
reduces inventory maintenance costs. Additionally, the Company acquires from
other manufacturers certain high-end subassemblies, such as radio frequency
boards for use in complete LMR units that the Company manufactures. See
"--Summary of Business Considerations and Certain Factors That May Affect Future
Results of Operations and/or Stock Price--Dependence on Suppliers."
GOVERNMENT REGULATION AND EXPORT CONTROLS
WIRELESS COMMUNICATIONS
The Company's stand alone wireless products are subject to regulation by the
FCC under the Communications Act of 1934, as amended, and the FCC's rules and
policies as well as the regulations of the telecommunications regulatory
authority in each country where the Company sells its products. These
regulations are in the form of general approval to sell products within a given
country for operation in a given frequency band, one-time equipment
certification, and, at times, local approval for installation. In
13
addition, the construction, operation and acquisition of wireless communications
systems, as well as certain aspects of the performance of mobile communications
products, are regulated by the FCC and foreign regulatory authorities. Many of
these governmental regulations are highly technical and subject to change. The
Company believes that it and its products are in material compliance with all
governmental rules and policies in the jurisdictions where the Company sells its
products.
In the United States, all of Transcrypt's wireless products are subject to
FCC Part 15 rules on unlicensed spread spectrum operation. In those countries
that have accepted certain worldwide standards, such as the FCC rulings or those
from the European Telecommunications Standards Institute, Transcrypt has not
experienced significant regulatory issues in bringing its products to market.
Approval in these markets involves retaining local testing agencies to verify
specific product compliance. However, many developing countries, including
certain markets in Asia, have not fully developed or have no frequency
allocation, equipment certification or telecommunications regulatory standards.
The majority of the systems operated by E.F. Johnson's customers must comply
with the rules and regulations governing what has traditionally been
characterized as "private radio" or private carrier communications systems.
Licenses are issued to use frequencies on either a shared or exclusive basis,
depending upon the frequency band in which the system operates. Some of the
channels designated for exclusive use are employed on a for-profit basis; others
are used to satisfy internal communications requirements. Most SMR systems in
operation today use 800 MHz channels. Within the top 50 metropolitan markets,
900 MHz frequencies licensed for exclusive use systems have been made available
to both SMR and non-SMR licensees. Additional channels designated for exclusive
use were made available in the 220 MHz band for both commercial and
non-commercial systems.
Generally, SMR licenses are issued for five-year terms, initially in blocks
of five channels, and may be renewed upon showing compliance with FCC rules and
may be revoked for cause. Such licenses typically are subject to channel
"loading" or usage requirements, such as loading a minimum of 70 subscriber
units for each channel within the initial five-year term. If an SMR licensee
fails to meet its loading requirements in an area where existing applications
are pending on a wait list, the FCC may cancel the license, in whole or in part,
or deny a request to renew or expand the license. Other than loading
requirements, private systems are subject to similar restrictions. For example,
licenses for private systems are also issued for five-year terms, may be renewed
upon showing compliance with FCC rules, and may be revoked for cause. In 1999,
the FCC ruled to relax the build-out requirements, which was a contributing
factor in some frequency holding customers delaying their SMR system purchases.
E.F. Johnson also offers products in bands below 800 MHz where multiple
users in the same geographic area share channels. In this "shared" or
conventional spectrum, there is no requirement for loading the channel to any
particular level in order to retain use of the frequencies. These channels are
generally used by entities satisfying traditional dispatch requirements in,
among others, the transportation and services industries. In addition, some
customers are applying trunking capabilities to their channels in the UHF
(primarily 450-470 MHz) frequency band.
The FCC is considering a number of regulatory changes that could affect the
wireless communications industry and the Company's business. Therefore, the
regulatory environment is inherently uncertain and changes in the regulatory
structure and laws and regulations, both in the United States and
internationally, can adversely affect the Company and its customers. Such
changes could make existing or planned products of the Company obsolete or
unsaleable in one or more markets, which could have a material adverse effect on
the Company.
The FCC, through the Public Safety Wireless Advisory Committee, is
considering regulatory measures to facilitate a transition by public safety
agencies to a more competitive, innovative environment so that the agencies may
gain access to higher-quality transmission, emerging technologies, and broader
services, including interoperability. In August 1998, the FCC adopted rules for
licensing the largest block of spectrum ever allocated at one time for public
safety. The FCC established rules for licensing 24 megahertz
14
in the 700 MHz band and established a band plan for use of this spectrum. In
accordance with this rule, in January 1999 the FCC established a Public Safety
National Coordination Committee (NCC) to advise it on issues relating to the use
of the 700 MHz public safety spectrum. The Committee would be responsible for
formulating a national interoperability plan, recommending technical standards
to achieve interoperability spectrum, and providing policy recommendations on an
advisory basis to the regional planning committees in order to facilitate the
development of coordinated plans. The NCC has recommended that Project 25 be
established as the interim interoperability mode for digital voice
communications in this new band. The Committee's recommendations could affect
products manufactured by the Company. Management cannot predict the outcome of
the FCC review or any specific changes in the spectrum of FCC policies, or any
potential effect on the Company's sales.
INFORMATION SECURITY
The Company's information security products have been subject to export
restrictions administered by the Department of State and the Department of
Commerce, which permit the export of encryption products only with the required
level of export license. U.S. export laws also prohibit the export of encryption
products to a number of specified hostile countries. Recent changes in export
policy will allow export of any encryption products to non-governmental
entities, while foreign government entities will still be subject to license
restrictions. Although to date the Company has been able to secure most required
U.S. export licenses, including for export to approximately 120 countries since
1978, there can be no assurance that the Company will continue to be able to
secure such licenses in a timely manner in the future or at all. Based on prior
experience in securing export approvals, the Company believes that it maintains
good relations with federal government agencies with jurisdiction over its
products. Additionally, in certain foreign countries, the Company's distributors
are required to secure licenses or formal permission before encryption products
can be imported.
Management cannot predict whether any new legislation regarding export
controls will be enacted, what form it will take or how the Executive Order or
any such legislation will impact international sales of the Company's products.
COMPETITION
WIRELESS COMMUNICATIONS
In North America, Motorola, Kenwood and Com-Net Ericsson are the leading
providers of LMR equipment. The remainder of the LMR market is divided among a
large number of suppliers who focus on particular segments of the market. The
Company believes it is the third largest provider of public safety radio systems
in North America. However, the Company's share of this market is relatively
small in comparison to sales by Motorola and Com-Net Ericsson.
The Company competes in the wireless communications market on the basis of
price, technology and the flexibility, support and responsiveness provided by
the Company and its dealers. The Company is also experiencing reduced demand for
and downward pricing pressure on its wireless communication analog products sold
to commercial users. Management believes that this is due to several factors.
These include the fact that (1) no new 800 MHz SMR frequencies are being made
available and existing channels are filling up; (2) SMR operator's with licenses
for 900 MHz channels have been slow to develop their build outs; (3) there has
been consolidation in both of these SMR marketplaces; and (4) a large number of
SMR systems have been converting from analog to digital which has resulted in
the increasing availability of used analog radios and repeaters in the
marketplace. Most of the Company's competitors in wireless communications have
financial, technical, marketing, sales, manufacturing, distribution and other
resources substantially greater than those of the Company.
In addition, many of the Company's competitors also possess entrenched
market positions, other intellectual property rights and substantial
technological capabilities. In the North American SMR market,
15
the Company's competitors include Motorola, Com-Net Ericsson, Uniden America
Corporation ("Uniden"), Kenwood U.S.A. Corp., ICOM America, Inc., Relm
Corporation and Midland International Corp. The Company believes that cellular
telephones and personal communication services devices provide, to some extent,
the same functionality as SMRs and other LMRs and, as such, may compete with its
products. The Company believes that the international wireless communications
market is fragmented, with Motorola, Kenwood, Nokia, and Ericsson the dominant
suppliers. The Company also competes with Uniden, Hitachi Denshi, Ltd. and Tait
in Asia.
As of March 12, 2000, the Company, Motorola, Relm Communications, King
Radio, and Racal Communications are believed to be the current suppliers of
Project 25 LMR products. Companies which have announced or are anticipated to
announce the availability of Project 25 compliant products or digital LMRs
include ADI and Daniels Communications.
Many of the Company's competitors have substantially greater financial,
technical, marketing, distribution and other resources, greater name recognition
and longer-standing relationships with customers than the Company. Competitors
with greater financial resources are better able to engage in sustained price
reductions in order to gain market share. Any period of sustained price
reductions would have a material adverse effect on the Company's financial
condition and results of operations. The Company cannot assure that it will be
able to compete successfully in the future or that competitive pressures will
not materially and adversely affect its financial condition and results of
operations.
INFORMATION SECURITY
The markets for information security products are highly competitive.
Significant competitive factors in these markets include product quality and
performance, including (1) the effectiveness of security features, (2) the
quality of the resulting voice or data signal, (3) the development of new
products and features, (4) price, (5) name recognition and (6) the quality and
experience of sales, marketing and service personnel. A number of companies
currently offer add-on scramblers for LMRs that compete with the Company's
add-on information security products, including Selectone Corp., Midian
Electronics Inc., and MX-COM Inc. Also, Motorola and Com-net Ericsson offer
high-end, proprietary digital encryption for their LMR products. Cycomm
International Inc./Privaphone and Motorola offer add-on security products for
cellular telephones. Competitors to the Company's secure landline telephone
products include AT&T Corporation/Datatek, Motorola, Cycomm International Inc.,
Cylink Corporation and TCC (Technical Communications Corporation).
BACKLOG
The Company presently ships a small amount of information security products
against backlog, due to the typically short manufacturing cycle of these
products. Because of generally longer manufacturing cycle times required for the
production of complete wireless communication products, the Company's backlog
for wireless communication products has been larger than for its security
products. At December 31, 1999, E.F. Johnson had a total backlog of
approximately $13.0 million. However, the Company does not believe that its
backlog figures are indicative of actual sales of products in future periods.
EMPLOYEES
At December 31, 1999, the Company had 330 full-time equivalent employees,
including 65 at its Lincoln, Nebraska facility, 241 at its Waseca, Minnesota
facility, and 24 field sales people, sales managers or staff located in the
sales territories in which they serve. The Company also uses temporary
employees, independent contractors and consultants when necessary to manage
fluctuations in demand. None of the Company's employees are covered by a
collective bargaining agreement.
16
SUMMARY OF BUSINESS CONSIDERATIONS AND CERTAIN FACTORS THAT MAY AFFECT FUTURE
RESULTS OF
OPERATIONS AND/OR STOCK PRICE
Certain matters discussed in this Annual Report may constitute
forward-looking statements under Section 27A of the Securities Act and 21E of
the Exchange Act. These forward-looking statements relate to, among other
things, the outcome of pending class action litigation involving the Company,
the outcome of the pending investigation by the SEC, the effects of the
Company's restatement of its financial statements on the Company's product
development efforts, future sales levels and customer confidence, the Company's
future financial condition, liquidity and business prospects generally,
perceived opportunities in the marketplace for the Company's products and its
products under development, and the effects of a failure to resolve such issues
and the Company's other business plans for the future. The actual outcomes of
these matters may differ significantly from the outcomes expressed or implied in
these forward-looking statements. The following is a summary of some of the
important factors that could affect the Company's future results of operations
and its stock price, and should be considered carefully.
SECURITIES CLASS ACTION CLAIMS
The Company has been named as a defendant in class action lawsuits that were
filed subsequent to the Company's announcement on March 27, 1998 that the filing
of its Annual Report on Form 10-K for year ended December 31, 1997 would be
delayed and that adjustments would be made to the Company's previously announced
financial results. Between March 31, 1998 and May 27, 1998, twelve purported
class action lawsuits were filed against the Company in the United States
District Court for the District of Nebraska, and one complaint was filed in the
District Court of Scotts Bluff County, Nebraska. Certain of the complaints, as
amended, also name one or more current employees and former officers of the
Company and PriceWaterhouseCoopers, LLP as additional defendants. The longest
class period alleged in any of the class complaints is the period from
January 22, 1997 through April 24, 1998.
The federal class actions generally allege claims under Sections 11 and 15
of the Securities Act of 1933 and Sections 10 and 20(a) of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and relate primarily
to allegations of false and misleading financial statements and representations
and material omissions by the Company. The Nebraska action alleges violations of
Nebraska securities laws. The class action complaints seek unspecified
compensatory damages, attorneys' fees and costs. The federal class actions have
been consolidated and lead plaintiff appointed.
In July 1999, the Company announced that a memorandum of understanding had
been signed with plaintiff's counsel to settle the pending federal consolidated
class action lawsuits and its state class action lawsuit. The parties
subsequently memorialized the terms of the memorandum of understanding in a
stipulation of settlement. The stipulation of settlement creates a settlement
fund for distribution to class members and class counsel consisting of
(a) 4,460,000 shares of Transcrypt common stock and (b) at least $3,850,000 and
up to $8,850,000 to be paid by Transcrypt's insurance carriers (depending on the
outcome of an arbitration between plaintiffs and one of the insurance carriers).
Transcrypt would also pay $2,000,000 to the class if there is a purchase of a
majority of Transcrypt by acquisition or merger that occurs before January 1,
2001.
In January 2000, Honorable Warren K. Urbom of the United States District
Court for the District of Nebraska preliminarily approved a settlement of the
pending stockholder class action suits. The settlement, if finally approved,
will also result in the dismissal of the stockholder class action suit pending
in the District Court for Scotts Bluff County, Nebraska. The court has scheduled
a hearing for final approval of the settlement for March 27, 2000.
The Company has reserved for the issuance of the number of shares of Common
Stock to be distributed if the Court finally approves the settlement. However,
no assurance can be given that the Court will finally approve the settlement,
and if the settlement is not finally approved, that the outcome of the
litigation will not have a material adverse effect on the Company's business,
financial condition, results of
17
operations, and cash flows. For further information regarding legal proceedings,
see "ITEM 3. LEGAL PROCEEDINGS."
SEC INVESTIGATION
In April 1998, the Securities and Exchange Commission ("SEC") issued a
formal order of investigation to determine whether violations of certain aspects
of the federal securities laws had occurred in connection with the Company. As
part of this investigation, the SEC is also examining the conduct of certain
former officers of the Company. The Company has an obligation to defend and/or
indemnify certain former employees. The Company has discussed possible
settlement of the investigation or any pending enforcement action against the
Company or its affiliated parties relating to these events. At this time, it is
unknown whether the Company will settle the SEC formal order of investigation.
In addition, it is unknown what actions will be taken against former officers
and, therefore, the Company cannot determine the exposure of any future
obligations to defend and/or indemnify these former officers. The SEC has the
authority to impose a variety of sanctions against the Company and
Company-affiliated parties. Such sanctions could include monetary penalties,
imposition of a cease and desist order and issuance of removal and prohibition
orders against Company-affiliated persons, among other things.
EFFECTS OF RESTATEMENT, CLASS ACTION LAWSUITS AND SEC INVESTIGATION ON THE
COMPANY'S BUSINESS
The restatement of the Company's financial statements, class action lawsuits
and the SEC investigation have had an adverse impact on the Company's business,
financial condition, results of operations, liquidity and cash flows. Subsequent
to March 31, 1998, the Company experienced declining revenues, substantial
operating losses, and substantially reduced liquidity. However, the Company
experienced an increase in revenues on a quarter to quarter basis after the
first quarter of 1999. Despite this improvement, there can be no assurance that
this trend will continue in the future.
The Company can provide no assurance that the restatement of its financial
statements and the ongoing class action lawsuits and SEC investigation,
regardless of their outcomes, will not continue to have a material adverse
effect on the Company's business, financial condition, results of operations,
liquidity and cash flows. See "ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
COMPETITION
The information security and wireless communications equipment industries,
and the LMR market segment in particular, are highly competitive. Competition in
the sale of stand-alone and digital products is more intense than for add-on and
analog products. In addition, other wireless communication technologies,
including cellular telephone, paging, SMR, satellite communications and PCS
(personal communication services) currently compete and are expected to compete
in the future with certain of the Company's stand-alone products. Furthermore,
other manufacturers have announced or are anticipated to announce the
availability of APCO Project 25 compliant products or digital land mobile
radios.
In addition, the competition in the domestic commercial market has been
increasing because of reduced demand for radios due to the absence of new 800
MHz SMR frequencies being made available, the slow build out of 900 MHz channels
and the consolidation in both 800 MHz and 900 MHz SMR marketplaces reducing the
number of potential buyers. There are also a large number of SMR systems
converting from analog to digital, which has resulted in the increasing
availability of used analog radios and repeaters in the marketplace.
Some of the Company's competitors or potential competitors have
significantly greater financial, managerial, technical and marketing resources
than the Company. Accordingly, the Company cannot assure that (1) it will be
able to continue to compete effectively in its markets, (2) competition will not
intensify, or (3) future competition will not have a material adverse effect on
the Company. In addition,
18
the Company cannot assure that new competitors will not arise and begin to
compete in the markets for the Company's products.
Motorola, Nokia, Kenwood, and Com-Net Ericsson hold a dominant position in
the market for wireless communication products, especially in the LMR and
cellular telephone market segments. In North America, Motorola, Kenwood and
Com-Net Ericsson are the leading providers of LMR equipment. While the Company
believes that it is the third-largest supplier in the North American specialized
LMR equipment market, the Company's share of this market is relatively small in
comparison to Motorola and Com-Net Ericsson. In addition, Motorola, Kenwood, and
Com-Net Ericsson have financial, technical, marketing, sales, manufacturing,
distribution and other resources substantially greater than those of the
Company, and have entrenched market positions in certain segments of the North
American LMR market. Finally, certain of the Company's competitors, including
Motorola and Com-Net Ericsson, have established trade names, trademarks, patents
and other intellectual property rights and substantial technological
capabilities.
The Company believes that the wireless communications equipment industry is
undergoing a period of consolidation which (1) may involve the acquisition or
merger of some of the significant manufacturers of these types of products and
(2) a concentration of market share in a relatively few companies. The Company
cannot assure that consolidations in the industry would not result in the
strengthening of its existing competitors or the creation of new competitors,
some of which may have significantly greater financial, managerial, technical
and marketing resources than the Company. See "--Competition."
RELIANCE ON MOTOROLA
The Company is dependent on continuing access to certain Motorola products,
electrical components and proprietary intellectual property. Although the
Company believes that its relationship with Motorola is good, the Company cannot
assure that Motorola will continue to supply products, electrical components and
proprietary intellectual property to the Company on the scale or at the price
that it now does. In addition, Motorola may increasingly perceive the Company as
a competitor. This perception could impact Motorola's willingness to do business
with the Company. Although the Company has certain contractual relationships
with Motorola as a customer, most of these agreements are subject to termination
in certain circumstances and expire by their terms within one to ten years. Any
reduction of the Company's contractual relations with Motorola or a decision by
Motorola to reduce or eliminate the provision of products, components and
technology to the Company could have a material adverse effect on the Company.
See "--Motorola Relationship."
TRANSITION FROM ANALOG TO DIGITAL PRODUCTS
The LMR and cellular telephone markets are migrating from analog to digital
equipment. This migration is primarily due to bandwidth capacity constraints,
availability of additional features, and the perception that digital
transmissions are more secure than analog transmissions. As a result, the
Company is seeking to upgrade many of E.F. Johnson's LMR products to be
compatible with digital LMR communications standards, including APCO Project 25.
However, the Company cannot assure that it will be able to effect this
transition on a timely basis or that digital products will compete successfully
in the LMR marketplace. The failure of products to compete successfully in the
marketplace would have a material adverse effect on the Company. In addition,
there has been delay in the LMR marketplace acceptance of digital communications
standards. This delay may continue to adversely affect sales of the Company's
APCO Project 25 products. Furthermore, the transition from analog to digital
communications is resulting in, and in the future is likely to continue to
result in, a decrease in demand for the Company's add-on security modules, as
customers may perceive digital communications to be more secure than
communications using analog devices.
19
RAPIDLY EVOLVING MARKETS
The information security and wireless communications products markets in
which the Company competes are rapidly evolving and can be expected to further
evolve in the future as a result of changing technology, industry standards and
customer requirements. The Company's ability to compete effectively will depend
upon its ability to anticipate and react to these changes in a timely manner.
The Company may not have, either currently or in the future, adequate capital or
human resources to respond to these changes.
The development of new technologies by existing or future competitors may
place the Company at a competitive disadvantage by rendering some or all of its
existing or new products obsolete. The Company has invested heavily in the
introduction of LMR radios that comply with the APCO Project 25 standard. Some
manufacturers have adopted and actively support other digital LMR transmission
standards for the public safety marketplace. The widespread acceptance of one or
more other standards in the public safety market would have a material adverse
effect on the Company. See "--Competition."
Technological developments in the digital LMR industry include the use of
digital trunking, digital simulcast and digital voting technologies. These
technologies have led a number of manufacturers to change the architectures and
methodologies used in designing, developing, and implementing large LMR systems.
In order for the Company to develop and integrate these new technologies into
its products, the Company has made a substantial investment in capital and human
resources. However, there can be no assurance that such resources will be
readily available to the Company in the future.
The failure of the Company to incorporate these technologies into its LMR
products could in the future place the Company's LMR products at a competitive
disadvantage to those offered by other manufacturers and possibly make the
Company's hand-held and mobile LMRs incompatible with systems developed by other
manufacturers, which would have a material adverse effect on the Company.
RISKS ASSOCIATED WITH INTERNATIONAL SALES
In 1999 and 1998, international sales constituted approximately 22.6% and
36.6% of revenues, respectively. International sales are subject to a number of
risks not found in domestic sales. These risks include (1) unexpected changes in
regulatory requirements, (2) tariffs and other trade barriers, (3) political and
economic instability in foreign markets, (4) difficulties in establishing
foreign distribution channels, (5) longer payment cycles, (6) uncertainty in the
collection of accounts receivable, (7) increased costs associated with
maintaining international marketing efforts and (8) difficulties in protecting
intellectual property. In particular, the purchase of Company products by
international customers presents increased risks of, among other things, delayed
or reduced collection of revenues. Because most of the Company's sales are
denominated in U.S. dollars, fluctuations in the value of international
currencies relative to the U.S. dollar may also affect the price,
competitiveness and profitability of the Company's products sold in
international markets. Furthermore, the uncertainty of monetary exchange values
has caused, and may in the future cause, some foreign customers to delay new
orders or delay payment for existing orders. Troubled economic conditions, such
as that recently experienced in Asia and in Latin America, could result in lower
revenues for the Company.
Some of the Company's information security products are subject to export
controls under U.S. law, which in most cases requires the approval of the
Department of Commerce in order to ship internationally. The Company cannot
assure that such approvals will be available to it or its products in the future
in a timely manner or at all or that the federal government will not revise its
export policies or the list of products and countries for which export approval
is required. The Company's inability to obtain required export approvals would
adversely affect the Company's international sales, which would have a material
adverse effect on the Company. In addition, foreign companies not subject to
United States export restrictions may have a competitive advantage in the
international information security market. The Company cannot predict the impact
of these factors on the international market for its products. See "--Government
Regulation and Export Controls."
20
RELIANCE ON PUBLIC SECTOR MARKETS
Public safety agencies and other governmental entities comprise a
significant portion of the Company's current and anticipated customer base.
Because there is an unknown amount of governmental customers that purchase
through dealers for the Company's Information Security segment, the Company
cannot determine the percentage of its products that are ultimately sold to
governmental agencies. However, the Company believes that domestic and
international governments are the end-users of most of its products. As the
transition in the Company's Information Security product line from add-on to
stand-alone products progresses and as competition for such sales intensifies,
the Company expects that it will increasingly be subject to competitive bidding
requirements for sales to governmental customers, which can be expected to
result in lower prices and longer sales cycles with resulting lower margins.
The Company's wireless communication segment public safety sales accounted
for approximately 44% of total sales for the Company in 1999. The Company
entered into three major new domestic systems contracts during 1999, and sold a
number of Y2K related system upgrades. The RFP bidding cycle and contract award
stage can take six months to two years before a contract is awarded and the
governmental customers funding process for these systems can delay the bidding
cycle as well.
DEPENDENCE ON KEY PERSONNEL
The Company believes that its future success will depend in part on its
ability to attract, motivate and retain highly skilled engineering, technical,
managerial and marketing personnel. Competition for such personnel is intense
and the Company competes in the market for such personnel against numerous
companies, including larger, more established companies with significantly
greater financial resources than the Company. The Company currently has openings
for engineers and other personnel, and it cannot assure that it will be
successful in attracting, motivating or retaining such personnel.
DEPENDENCE ON SUPPLIERS
Most of the Company's current and proposed products require essential
electronic components supplied by outside vendors. Certain components may be
available from only one supplier and may occasionally be in short supply. For
example, in late 1993 and early 1994, there was a shortage of certain Motorola
surface-mount microprocessors, which resulted in a substantial increase in the
cost of these components. In 1998 and 1999, certain RF semiconductors and RF
power modules were discontinued by Motorola and other manufacturers. The
Company's inability to obtain these and other key components could result in
lost sales, the need to maintain excessive inventory levels, higher component
costs, or the need to redesign certain affected electronic sub-assemblies, which
could increase the cost of producing the Company's products and have a material
adverse effect on the Company.
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company has experienced, and expects to continue to experience,
quarterly variations in its results of operations as a result of many factors.
These factors include the timing of customer orders, the timing of the receipt
of cash payment on sales which are recorded on a cash basis, the timing of the
introduction of new products, the timing and mix of product sales, general
economic conditions and specific economic conditions in the information security
and wireless communications industry. See "ITEM 7. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--Quarterly Results of
Operations."
REGULATORY ENVIRONMENT
Wireless communications and encryption products are subject to regulation by
United States and foreign laws and international treaties. The regulatory
environment is uncertain and changes in the regulatory structure and laws and
regulations can adversely affect the Company and its customers. Such changes
could make the Company's existing or planned products obsolete or unsaleable in
one or more
21
markets, which could have a material adverse effect on the Company. See "--Risks
Associated with International Sales" and "--Government Regulation and Export
Controls."
ENVIRONMENTAL REGULATION
The Company is subject to various federal, state and local environmental
statutes, ordinances and regulations relating to the use, storage, handling and
disposal of certain toxic, volatile or otherwise hazardous substances and wastes
used or generated in the manufacturing and assembly of the Company's products.
Under these laws, the Company may become liable for the costs of removal or
remediation of certain hazardous substances or wastes that have been or are
being released on or in the Company's facilities, or have been or are being
disposed of offsite as wastes. Such laws may impose liability without regard to
whether the Company knew of, or caused, the release of such hazardous substances
or wastes.
During 1999, the Company completed the sale of its facility in Waseca,
Minnesota (see Item 2. Properties). As a part of that sale, the Company agreed
to pay for the cost of the initial testing for potential contaminants, as well
as for subsequent monitoring of the site, if warranted. The Company has set up a
reserve of $80,000 to cover the cost of the testing and monitoring. While the
Company feels that this amount is adequate to cover any potential liability
associated with this issue, there is no guarantee that it will fully cover all
costs and liabilities that may arise in the future.
The Company cannot assure that any environmental assessments the Company has
undertaken with respect to its facilities have revealed all potential
environmental liabilities, that any prior owner or operator of the Company's
properties did not create any material environmental condition not known to the
Company, or that an environmental condition that could result in penalties,
expenses, or liability to the Company does not otherwise exist in any one or
more of the Company's facilities. In addition, the amount of hazardous
substances or wastes produced or generated by the Company may increase in the
future depending on changes in the Company's operations. Any failure by the
Company to comply with present or future environmental laws could subject it to
the imposition of substantial fines, suspension of production, alteration of
manufacturing processes or cessation of operations, any of which could have a
material adverse effect on the Company. Compliance with such environmental laws
could require the Company to acquire expensive remediation equipment or to incur
substantial expenses. Furthermore, the presence of hazardous substances on a
property or at certain offsite locations could result in the Company incurring
substantial liabilities as a result of a claim by a private third-party for
personal injury or a claim by an adjacent property owner for property damage.
The imposition of any of the foregoing liabilities could materially adversely
affect the Company.
LIMITED PROTECTION OF INTELLECTUAL PROPERTY RIGHTS; RISK OF THIRD-PARTY CLAIMS
OF INFRINGEMENT
The Company currently holds a number of domestic and international patents
and has on file applications for additional patents. Although the Company
assesses the advisability of patenting any technological development, the
Company has historically relied, in the information security area, primarily on
(1) copyright and trade secret law and (2) employee and third-party
non-disclosure agreements to protect its proprietary intellectual property and
rights. The protection afforded by such means may not be as complete as patent
protection. In addition, the laws of some countries do not protect trade
secrets. There are limitations on the availability of patent protection as a
means to protect the Company's products. Even when patent protection can be
obtained, there are often limitations on the enforceability of such patent
rights. The Company's inability to preserve all of its proprietary intellectual
property and rights could have a material adverse effect on the Company. See
"--Intellectual Property."
RISKS PRESENTED BY THE YEAR 2000 ISSUE
The Company was able to assess its systems and products, and took the
necessary steps to ensure that no significant impact would result from the year
2000 date change. As a result, the Company has not, to date, experienced any
material impact due to the Y2K date change. While it does not expect to
experience
22
any latent effects, it cannot ensure that its systems or those of third parties
with which it interacts will be entirely free of any such occurrences.
The Company did not experience any material Year 2000 system failure or
miscalculations causing disruptions of operations. In addition, we have not
received a significant amount of customer notification regarding experiencing
erroneous dates on usage reports or Year 2000 operational issues. It is still
possible for customers to have issues with previously shipped products. See
"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS--Results of the Year 2000 Issue."
ITEM 2. PROPERTIES
The Company occupies a portion of a 76,500 square foot multi-story
administrative and manufacturing facility located at 4800 NW 1st Street,
Lincoln, Nebraska, 68521, which is located in the University of Nebraska
Technology Park. The Company sold this facility and approximately 10 acres of
surrounding land during August 1999 for approximately $5.2 million. In
conjunction with the sale, the Company leased approximately 23,000 square feet
of the facility for five years, and for which the company will pay approximately
$231,000 during 2000. On January 28, 1998, the Company purchased the 250,000
square-foot manufacturing facility located on a 20-acre site in Waseca,
Minnesota. During December 1999, the Company sold the Waseca facility for
approximately $2.7 million. In conjunction with the sale, the Company leased
136,000 square feet of the facility for five years, and for which the company
will pay approximately $962,000 during 2000. In addition, the Company owns a
facility in Garner, Iowa, which it leases to a third party. The Company also
leases additional sales and service facilities in Burnsville, Minnesota, and
Miami, Florida. During 2000, the Company plans to lease office space for
executive, administrative, and sales personnel in Washington, D.C.
ITEM 3. LEGAL PROCEEDINGS
The Company has been named as a defendant in class action lawsuits that were
filed subsequent to the Company's announcement on March 27, 1998 that the filing
of its Annual Report on Form 10-K for year ended December 31, 1997 would be
delayed and that adjustments would be made to the Company's previously announced
financial results. Between March 31, 1998 and May 27, 1998, twelve purported
class action lawsuits were filed against the Company in the United States
District Court for the District of Nebraska, and one complaint was filed in the
District Court of Scotts Bluff County, Nebraska. Certain of the complaints, as
amended, also name one or more current employees and former officers of the
Company and PriceWaterhouseCoopers, LLP as additional defendants. The longest
class period alleged in any of the class complaints is the period from
January 22, 1997 through April 24, 1998.
The federal class actions generally allege claims under Sections 11 and 15
of the Securities Act of 1933 and Sections 10 and 20(a) of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and relate primarily
to allegations of false and misleading financial statements and representations
and material omissions by the Company. The Nebraska action alleges violations of
Nebraska securities laws. The class action complaints seek unspecified
compensatory damages, attorneys' fees and costs. The federal class actions have
been consolidated.
In July 1999, the Company announced that a memorandum of understanding had
been signed with plaintiff's counsel to settle the pending federal consolidated
class action lawsuits and its state class action lawsuit. The parties
subsequently memorialized the terms of the memorandum of understanding in a
stipulation of settlement. The stipulation of settlement agreement creates a
settlement fund for distribution to class members and class counsel consisting
of (a) 4,460,000 shares of Transcrypt common stock and (b) at least $3,850,000
and up to $8,850,000 to be paid by Transcrypt's insurance carriers (depending on
the outcome of an arbitration between plaintiffs and one of the insurance
carriers). Transcrypt would also pay $2,000,000 to the class if there is a
purchase of a majority of Transcrypt by acquisition or merger that occurs before
January 1, 2001.
23
In January 2000, Honorable Warren K. Urbom of the United States District
Court for the District of Nebraska preliminarily approved a settlement of the
pending stockholder class action suits. The settlement class period is defined
as persons that purchased stock during the period from January 22, 1997 through
April 24, 1998. The settlement, if finally approved, will also result in the
dismissal of the stockholder class action suit pending in the District Court for
Scotts Bluff County, Nebraska. The preliminary approval precludes any persons
from asserting any claims of indemnity or contribution against Transcrypt or any
of its current or former officers, directors, or employees. The Court has
scheduled a hearing for final approval of the settlement for March 27, 2000. In
addition, the Honorable Randall L Lippstreau of the District Court for Scotts
Bluff County, Nebraska, has entered an order that is effective on the final
approval of the settlement by Judge Urbom, which dismisses the action against
the Company and certain former employees is the class action pending in District
Court for Scotts Bluff County, Nebraska.
The Company has reserved for the issuance of the number of shares of Common
Stock to be distributed if the court finally approves the settlement. However,
no assurance can be given that the Court will finally approve the settlement,
and that if the settlement is not finally approved, that the outcome of the
litigation will not have a material adverse effect on the Company's business,
financial condition, results of operations, and cash flows.
On November 4, 1998, Physician's Mutual Insurance Company filed an action in
the District Court of Douglas County, Nebraska against the Company,
PriceWaterhouseCoopers, LLP and two former officers of the Company. The
complaint contains common law causes of action for fraudulent misrepresentation,
fraudulent concealment and negligent misrepresentation against the defendants
arising from the same facts and circumstances underlying the class actions. The
complaint seeks damages in an amount to be proved at trial, but which is
currently alleged to be approximately $850,000. The Company is unable to predict
the likelihood of the outcome or range or amount of potential liability that may
arise therefrom.
The Company may in the future be the subject of additional lawsuits or
claims in connection with the events or facts surrounding its restatement of
previously announced financial results. The Company is unable to predict when or
whether such additional lawsuits or claims may be initiated or the likelihood of
the outcome or range or amount of potential liability that may arise therefrom.
In April 1998, the Securities and Exchange Commission ("SEC") issued a
formal order of investigation to determine whether violations of certain aspects
of the federal securities laws had occurred in connection with the Company. As
part of this investigation, the SEC is also examining the conduct of certain
former officers of the Company. The Company has an obligation to defend and/or
indemnify certain former employees. The Company has discussed possible
settlement of the investigation or any pending enforcement action against the
Company or its affiliated parties relating to these events. At this time, it is
unknown whether the Company will settle the SEC formal order of investigation.
In addition, it is unknown what actions will be taken against former officers
and, therefore, the Company cannot determine the exposure of any future
obligations to defend and/or indemnify these former officers. The SEC has the
authority to impose a variety of sanctions against the Company and
Company-affiliated parties. Such sanctions could include monetary penalties,
imposition of a cease and desist order and issuance of removal and prohibition
orders against Company-affiliated persons, among other things.
The Company is involved in certain other legal proceedings incidental to the
normal conduct of its business. The Company does not believe that any
liabilities relating to such other legal proceedings are likely to be,
individually or in the aggregate, material to the Company's business, financial
condition, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to the stockholders during the fourth quarter of
1999.
24
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock was quoted on The Nasdaq Stock Market as a
National Market issue under the symbol "TRII" from the completion of the
Company's initial public offering on January 22, 1997 through May 11, 1998. The
Nasdaq Stock Market halted trading in the Company's Common Stock effective
April 27, 1998 and delisted the Common Stock on May 11, 1998 based on its review
of events regarding the Company and as a result of the Company's failure to
timely file its periodic reports and audited financial statements for the 1997
fiscal year. The Common Stock on August 28, 1998 began trading on the Over the
Counter ("OTC") Bulletin Board under the symbol "TRII".
The following table sets forth, in the periods indicated, the high and low
sales prices per share of the Common Stock, as reported by all markets for the
periods presented. As of December 31, 1999, the Company had 213 stockholders of
record.
HIGH LOW
-------- --------
1998
First Quarter............................................. $27.25 $8.87
Second Quarter............................................ $11.06 $3.00
Third Quarter............................................. $ 7.00 $1.50
Fourth Quarter............................................ $ 3.69 $1.88
1999
First Quarter............................................. $ 5.00 $2.50
Second Quarter............................................ $ 3.25 $1.38
Third Quarter............................................. $ 3.31 $1.34
Fourth Quarter............................................ $ 3.75 $2.00
The last sale price of the Common Stock on December 31, 1999, as reported in
the OTC Bulletin Board, was $3.00.
DIVIDENDS
The Company has never paid and has no present intention of paying cash
dividends on its Common Stock. Any determination in the future to pay dividends
will depend on the Company's financial condition, capital requirements, results
of operations, contractual limitations and any other factors deemed relevant by
the Company's Board of Directors.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data of the Company is
qualified by reference to, and should be read together with, the Consolidated
Financial Statements and Notes thereto and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included elsewhere in this
Annual Report on Form 10-K. The Consolidated Statement of Operations data for
the years ended December 31, 1999, 1998 and 1997 and the Consolidated Balance
Sheet data as of December 31, 1999 and 1998 are derived from the Consolidated
Financial Statements of the Company included elsewhere in this Annual Report on
Form 10-K. The Consolidated Statement of Operations data for the years ended
25
December 31, 1996 and 1995 and the Consolidated Balance Sheet data as of
December 31, 1997, 1996, and 1995 are derived from financial statements not
included herein.
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1995 1996 1997(8) 1998 1999
--------- --------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Consolidated Statement of Operations
Data:
Revenues............................. $ 8,128 $ 10,619 $ 40,423 $ 62,041 $ 53,520
Cost of sales........................ 2,983 4,274 26,106 44,905 36,059
--------- --------- ---------- ---------- ----------
Gross profit......................... 5,145 6,345 14,317 17,136 17,461
--------- --------- ---------- ---------- ----------
Operating costs and expenses:
Research and development........... 1,953 2,234 4,469 8,812 5,724
Sales and marketing................ 2,109 2,187 7,031 11,476 8,282
General and administrative(1)...... 2,284 2,529 4,711 12,529 9,601
Special compensation expense(2).... -- 5,568 -- -- --
In-process research and development
costs(3)......................... -- -- 9,828 -- --
Restructuring charge (4)........... -- -- -- 1,230 523
Provision for litigation settlement
(5).............................. -- -- -- 10,000 (2,221)
--------- --------- ---------- ---------- ----------
Total operating costs and
expenses..................... 6,346 12,518 26,039 44,047 21,909
--------- --------- ---------- ---------- ----------
Loss from operations................. (1,201) (6,173) (11,722) (26,911) (4,448)
Interest income (expense), net....... (137) (131) 231 655 386
Other income......................... -- -- 18 46 235
Benefit for income taxes............. -- (2,186) (524) (3,916) --
--------- --------- ---------- ---------- ----------
Net Loss............................. $ (1,338) $ (4,118) $ (10,949) $ (22,294) $ (3,827)
========= ========= ========== ========== ==========
Loss before pro forma taxes.......... $ (1,338) $ (6,304) $ (11,473) $ (26,210) $ (3,827)
Pro forma benefit from taxes (6)..... (496) (2,190) (524) (3,916) --
--------- --------- ---------- ---------- ----------
Pro forma net loss................... $ (842) $ (4,114) $ (10,949) $ (22,294) $ (3,827)
========= ========= ========== ========== ==========
Pro forma net loss per share
(7)--Basic and Diluted............. $ (0.12) $ (0.61) $ (1.09) $ (1.72) $ (0.30)
========= ========= ========== ========== ==========
Weighted average common shares--Basic
and Diluted (7).................... 6,783,078 6,783,078 10,056,690 12,946,624 12,947,795
========= ========= ========== ========== ==========
Consolidated Balance Sheet Data:
Working capital...................... $ 1,684 $ 1,844 $ 44,836 $ 17,426 $ 26,793
Total assets......................... $ 7,523 $ 11,938 $ 106,694 $ 87,212 $ 85,521
Long-term debt and capitalized lease
obligations, net of current
portion............................ $ 1,847 $ 2,632 $ 2,758 $ 6 $ 197
Stockholders' equity................. $ 3,907 $ 4,966 $ 75,390 $ 53,096 $ 49,286
- ------------------------
(1) Includes amortization of intangible assets. For years prior to 1997,
includes the amortization of intangible assets related to the acquisition of
the Company's business in December 1991. Commencing in August 1997,
amortization of intangible assets related to the acquisition of E.F. Johnson
began. See "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--Results of Operations--General and
Administrative."
(2) Represents a non-recurring, non-cash compensation expense of $5.4 million
resulting from the vesting in September 1996 of 716,916 stock options for 10
executive officers and key employees of the
26
Company at a weighted average exercise price of $1.81 per share, and the
accrual of a special compensation expense of $210,000 in September 1996.
(3) Represents a non-recurring, non-cash expense of $9.8 million due to the
write-off of purchased in-process research and development costs associated
with the acquisition of E.F. Johnson.
(4) Represents a charge for a 25% reduction in workforce taken in the third
quarter of 1998, and a charge for the closing of E.F. Johnson's Hong Kong
office taken in the second quarter of 1999.
(5) Represents a special provision taken in the fourth quarter of 1998 for
potential class action litigation settlement, and the reversal of a portion
of that reserve in the second quarter of 1999.
(6) Prior to June 30, 1996, the Company operated as a partnership. The Pro Forma
provision for income taxes reflects the provision for income taxes as if the
Company had been taxed as a Subchapter "C" corporation under the Internal
Revenue Code.
(7) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the method used to determine the number of shares used to compute pro
forma and net loss per share.
(8) Statement of Operations Data reflects the operations of E.F. Johnson since
the date of its acquisition on July 31, 1997.
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Annual Report on Form 10-K, including the following Management's
Discussion and Analysis of Financial Condition and Results of Operations,
contains forward-looking statements that may involve risks and uncertainties.
The Company's actual results may differ significantly from those discussed
herein. Factors that might cause such a difference include, but are not limited
to, those discussed under "ITEM 1. BUSINESS--Summary of Business Considerations
and Certain Factors That May Affect Future Results of Operations and/or Stock
Price." The following discussion should be read together with the Company's
Consolidated Financial Statements and Notes thereto appearing elsewhere in this
Annual Report on Form 10-K.
OVERVIEW
The Company is a manufacturer of wireless communications products and
systems and information security products. Through the E.F. Johnson subsidiary,
the Company designs, develops, manufactures and markets (1) stationary LMR
transmitters/receivers (base stations or repeaters), (2) mobile and portable
radios, and (3) communications systems comprising products from (1) and
(2) along with other system elements to provide turnkey communication system
solutions. The Company sells its LMR products and systems mainly to two broad
markets: (1) commercial users and (2) public safety and other governmental
users. Through it's Secure Technologies division, the Company designs and
manufactures information security products that prevent unauthorized access to
sensitive voice communications. These products are based on a wide range of
analog scrambling and digital encryption technologies and are sold mainly to the
LMR and telephony security markets.
On July 31, 1997, the Company acquired the outstanding shares of capital
stock and assumed certain indebtedness of E.F. Johnson. In exchange, the Company
paid cash consideration of $436,000 and issued 832,465 shares of Common Stock.
The acquisition was accounted for under the purchase method of accounting.
In 1998, the Company restated its previously released results for the year
ended December 31, 1997, the Company's financial statements for the year ended
December 31, 1996 and the financial statements as of and for each of the
quarterly periods ended March 31, June 30, September 30 and December 31 during
1997 and 1996. The restatement of the Company's financial statements and other
events relating to the restatement, including the class action lawsuits and the
SEC investigation which occurred subsequent to March 31, 1998, have had an
adverse impact on the Company's business, financial condition, results of
operations, liquidity and cash flows. These events have had, to varying degrees,
an adverse impact on the Company's relationships with its customers and vendors.
The Company continues to evaluate its product lines, and has implemented and is
continuing to look at various initiatives to reduce operating expenses in order
to keep them in line with revenues. During the third quarter of 1998, the
Company implemented a reduction in workforce. In addition, during the second
quarter of 1999, the Company closed its Hong Kong office. Implementation of any
other plan resulting from these initiatives in the future may result in
substantial up front costs and cash expenditures. The Company can provide no
assurance that the ongoing class action and securities lawsuits and SEC
investigation, regardless of their outcomes, will not continue to have a
material adverse effect on the Company's business, financial condition, results
of operations, liquidity and cash flows.
During 1999, the Company replaced a significant portion of its senior
management, including its Chairman and Chief Executive Officer, the Chief
Financial Officer, and several positions at the Vice President level. The new
management has continued the process begun in 1998 of evaluating product lines
and implementing initiatives to reduce operating expenses, reemphasize processes
and procedures, and refocus the organization on its core competencies. While the
Company has shown considerable improvement in areas such as cost control (as
evidenced by improved gross margin and lower indirect expenses)
28
and customer relationships (as evidenced by the three new major systems
contracts awarded during 1999), there can be no assurances that these efforts
will result in a significant improvement in the Company's business, financial
condition, results of operations, liquidity and cash flows.
RESULTS OF OPERATIONS
The following table sets forth certain Consolidated Statement of Operations
information as a percentage of revenues during the periods indicated. These
results include the results of E.F. Johnson only since July 31, 1997, the date
it was acquired.
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1998 1999
-------- -------- --------
Revenues.................................................... 100.0% 100.0% 100.0%
Cost of sales............................................... 64.6% 72.4% 67.4%
----- ----- -----
Gross profit................................................ 35.4% 27.6% 32.6%
----- ----- -----
Operating costs and expenses:
Research and development.................................... 11.1% 14.2% 10.7%
Sales and marketing......................................... 17.4% 18.5% 15.5%
General and administrative.................................. 11.7% 20.2% 17.9%
In-process research and development costs................... 24.3% -- --
Restructuring charge........................................ -- 2.0% 1.0%
Provision for litigation settlement......................... -- 16.1% (4.2%)
----- ----- -----
Total operating costs and expenses.......................... 64.4% 71.0% 40.9%
----- ----- -----
Loss from operations........................................ (29.0)% (43.4)% (8.3)%
Interest income (expense), net.............................. 0.6% 1.1% 0.7%
Other income................................................ -- .1% 0.4%
Benefit for income taxes.................................... (1.3)% (6.3)% 0.0%
----- ----- -----
Net loss.................................................... (27.1)% (35.9)% (7.2)%
===== ===== =====
Pro forma net loss.......................................... (27.1)% (35.9)% (7.2)%
===== ===== =====
REVENUES
Revenues are recognized when product is shipped, less an estimate for an
allowance for returns, if applicable, if collection is reasonably assured. For
shipments where collection is not reasonably assured, the Company recognizes
revenue as cash is received. If collection is contingent on a future event, such
as a reseller of product selling the product to the end user, the Company
recognizes revenue when the contingency lapses, generally upon cash collection.
System sales under long-term contracts are accounted for under the
percentage of completion method. Under this method, revenues are recognized as
work on a contract progresses. The recognized revenue is that percentage of
estimated total revenue that incurred costs to date bear to estimated total
costs to complete the contract. Revisions in cost and profit estimates are made
when conditions requiring such revisions become known. Anticipated losses on
contracts are recognized in operations as soon as such losses are determined to
be probable and reasonably estimable.
Deferred revenue includes unearned warranty fees on extended product
warranty contracts sold to customers. The Company recognizes the fees based on
the expected warranty repairs to be incurred over the life of the contract.
Deferred revenue also includes an advance payment received for products to be
sold to Motorola. The advance payment was negotiated as part of an agreement to
produce certain products during 2000, and is recognized as revenue is earned.
29
Revenues declined by 14% to $53.5 million in 1999 from $62.0 million in
1998. Of total revenues for 1999, the wireless communication segment comprised
85.8%, and the information security segment comprised 14.2%. This decline in
revenues is primarily the result of factors associated with the restatement in
1998 of the Company's financial statements for 1997 and 1996. The general
disruption of the Company's business caused by the restatements resulted in a
decline in revenues on a quarter to quarter basis throughout 1998 and into the
first quarter of 1999. Revenues declined from $22.0 million in the first quarter
of 1998, which was prior to the restatement, to $9.7 million in the first
quarter of 1999. However, the Company experienced an increase in revenues on a
quarter to quarter basis after the first quarter of 1999, ending with
$15.8 million in revenues during the fourth quarter of 1999.
Approximately $1.8 million of 1999 revenues were derived from systems
contracts and other sales that were primarily related to repairs, replacements,
and solutions for potential Y2K related issues. Revenues from this source cannot
be expected to continue in the future. In addition, the Company has made a
decision to eliminate its physical presence in the Asian market, and focus its
marketing and sales efforts primarily on the North, Central, and South American
markets (the "Americas"). This decision could result in lower revenues in both
the near term and long term. The Company generated $2.7 million in revenues from
the Asian and Middle East market during 1999.
Revenues increased 53.5% to $62.0 million in 1998 from $40.4 million in
1997. Of total revenues for 1998, the information security segment comprised
17.6% and the wireless communication segment comprised 82.4%. The increase in
revenue was attributable primarily to revenues derived from the sale of E.F.
Johnson products subsequent to July 31, 1997. As a result of the uncertainty
raised by the restatement which was completed in the third quarter of 1998 and
other related events, sales of products, including LMR systems to governmental
agencies, were adversely impacted during 1998. Revenues declined from
$22.0 million in the first quarter of 1998 to $13.9 million in the second
quarter, $14.3 million in the third quarter and $11.9 million in the fourth
quarter of 1998. Further, the Company did not enter into any major new domestic
systems contracts during 1998. However, during the first quarter of 1999, the
Company was awarded two contracts in the domestic public safety market.
The Company is also experiencing reduced demand for and downward pricing
pressure on its wireless communication analog products sold to commercial users.
Management believes that this is due to several factors. These include the fact
that (1) no new 800 MHz SMR frequencies are being made available and existing
channels are filling up; (2) SMR operator's with licenses for 900 MHz channels
have been slow to develop their build outs; (3) there has been consolidation in
both of these SMR marketplaces; and (4) a large number of SMR systems have been
converting from analog to digital which has resulted in the increasing
availability of used analog radios and repeaters in the marketplace. As a result
of these issues, domestic commercial sales declined by approximately 40% between
1998 and 1999. The Company anticipates that revenues will stabilize at 1999
levels in the near term, and return to a growth trend in the future.
International sales as a percentage of revenues in 1999 were 22.6%, compared
to 36.6% in 1998 and 38.1% in 1997. The Company experienced a 32.1% decline in
revenues from the Middle East and Asian regions during 1999 as compared to 1998
primarily from its wireless communications segment and as a result of the effect
of the decision to exit the Asian market. The Company expects this trend to
continue as it refocuses its efforts on the Americas. The Company also
experienced a 55% decline in revenues from the Central and Latin American region
during 1999 as compared to 1998. This decline was primarily due to the
termination of a relationship with a distributor focused on the region that
exited the LMR market, as well as the completion of a significant system
implementation contract in Brazil. The Company anticipates that revenues derived
from the Latin American region will increase as it focuses its sales and
marketing efforts on the Americas.
30
GROSS PROFIT
Cost of sales includes materials, labor, depreciation and overhead costs
associated with the production of the Company's products, as well as shipping,
royalty and warranty product costs. Gross profit was $17.5 million (32.6% gross
margin) in 1999, compared to $17.1 million (27.6% gross margin) in 1998 and
$14.3 million (35.4% gross margin) in 1997. Gross margins for the wireless
communications segment were 27.4% in 1999, 22.1% in 1998 and 32.3% in 1997.
Gross margins for the information security segment were 64.4% in 1999, 53.3% in
1998 and 44.1% in 1997.
The increase in overall gross margins from 1998 to 1999 is primarily the
result of the realignment of the Company's infrastructure and general cost
cutting that occurred as part of the restructuring instituted during 1998. The
Company benefited from revenues associated with systems contracts at its E.F.
Johnson subsidiary, which tend to have higher margins. In addition, there were
several contracts associated with Y2K at E.F. Johnson, which also tend to have
higher margins. Also, the Company incurred approximately $1.0 million in costs
during 1998 that was associated with correcting systems contract problems for
certain E.F. Johnson projects that were begun prior to Transcrypt's acquisition
of E.F. Johnson. While costs associated with this issue were not significant
during 1999, the Company expects cash outlays during 2000 and beyond in order to
finalize solutions to these problems, for which adequate reserves have been
provided. However, the Company set aside approximately $3.7 million in a reserve
to cover those expenses. Finally, the Company benefited from the sale at a
reduced value of surplus inventory at its Secure Technologies division that had
previously been written down. As a result of these surplus inventory sales,
gross margin as a percent of revenue was unusually high, and should not be
expected to continue.
The overall decline in gross margin percentage from 1998 to 1997 was due to
a number of factors. These include (1) the inclusion of E.F. Johnson's revenues,
which has historically had lower gross margins than Transcrypt's business, for a
full year in 1998 compared to five months in 1997; (2) the decline in sales of
domestic system contracts to the public safety market, which provides a higher
margin than the commercial portion of E.F. Johnson's wireless segment;
(3) product mix and the level of sales not being sufficient to fully absorb the
Company's manufacturing overhead; (4) a shift in the Company's information
security product segment from primarily add-on products to more radios and
cellular phones incorporating the Company's encryption products, which tend to
have a lower gross margin; and (5) the approximately $1.0 million in costs to
correct systems contract problems in 1998 for certain E.F. Johnson projects
begun prior to the Company's acquisition of E.F. Johnson.
RESEARCH AND DEVELOPMENT
Research and development expenses consist primarily of costs associated with
research and development personnel, materials and the depreciation of research
and development equipment and facilities. The Company expenses all research and
development costs as they are incurred. Research and development expenses
decreased 35.1% in 1999 to $5.7 million from $8.8 million in 1998, which equates
to 10.7% of sales in 1999 compared to 14.2% in 1998.
During 1999, the Company separated the research and development efforts of
the E.F. Johnson subsidiary and the Secure Technologies division. These efforts
are now in line with the market segments that they serve. Previously, one group
of engineers served the needs of both entities.
Research and development expenses declined during 1999 due to reductions in
the overall number of engineers at both the E.F. Johnson subsidiary and the
Secure Technologies division. The Company also implemented a new product
development process in 1998 that requires a reduced amount of resources and is
intended to speed up the Company's ability to deliver products to market, which
also aided in reducing expenses. That implementation continued into 1999. As of
December 31, 1999, the Company had numerous openings for engineers in its
Research and Development departments. While expenses in this area are expected
to increase as a result of higher staffing levels and increased focus on new
product
31
development, the Company expects these costs to remain at a ratio of expenses to
revenues as was experienced during 1999.
Research and development expenses increased 97.2% in 1998 to $8.8 million
from $4.5 million in 1997. The increase is attributable to the inclusion of E.F.
Johnson for a full year in 1998, as compared to only five months in 1997.
Research and development expenses were 14.2% of sales in 1998 compared to 11.1%
in 1997.
The information security and wireless communications product markets in
which the Company competes are rapidly evolving and can be expected to further
evolve in the future as a result of changing technology, industry standards and
customer requirements. The Company's ability to compete effectively will depend
upon its ability to anticipate and react to these changes in a timely manner.
The Company may not have, either currently or in the future, adequate capital or
human resources to respond to these changes.
SALES AND MARKETING
Sales and marketing expenses consist primarily of salaries and related costs
of sales personnel, including sales commissions and travel expenses, and costs
of advertising, public relations and trade show participation. Sales and
marketing expenses decreased 27.8% to $8.3 million in 1999, compared to
$11.5 million in 1998. These amounts represent 15.5% of sales in 1999, and 18.5%
of sales in 1998. The decrease in 1999 was due primarily to the restructuring
instituted during 1998, which began the process of bringing the Company's sales
and marketing efforts more in line with the needs of the market. The Company
anticipates expenses in the sales and marketing area to continue to decline as a
percentage of revenue going forward as the Company continues to bring its
operating expenses in line with future revenue expectations.
Sales and marketing expenses increased 63.2% to $11.5 million in 1998,
compared to $7.0 million in 1997. These amounts represent 18.5% of sales in 1998
and 17.4% of sales in 1997. The increase in 1998 was due primarily to a full
year of E.F. Johnson sales and marketing expenses compared to only five months
of E.F. Johnson sales and marketing expenses in 1997.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist primarily of salaries and other
expenses associated with the Company's management, accounting, finance and
administrative functions, and amortization of intangible assets. In connection
with Transcrypt's purchase of all of the outstanding shares of capital stock of
E.F. Johnson, the Company recorded $18.0 million of goodwill and other
intangibles at the closing of this acquisition. The Company is amortizing this
amount on a straight-line basis over a period of 5 to 15 years. This
amortization began in August 1997.
General and Administrative expenses declined by 23.4% to $9.6 million in
1999 from $12.5 million in 1998. As a percent of revenues, G&A expenses were
17.9% of revenues in 1999 as compared to 20.2% of revenues in 1998. The lower
expenses are primarily the result of the restructuring begun in 1998, which
brought the administrative organization more in line with the needs of the
Company. This trend should continue, as a percent of revenue, as the Company
furthers the implementation of the plan begun in 1998.
General and administrative expenses increased 165.9% to $12.5 million during
1998, from $4.7 million in 1997. The increase is attributable primarily to the
inclusion of EFJ for a full year in 1998 compared to only five months in 1997,
the addition of several administrative employees, the amortization of goodwill
and other intangibles relating to the E.F. Johnson acquisition for a full year,
severance payments and substantial legal and professional fees incurred in
connection with the restatement of the Company's financial statements and
related class action lawsuits, and SEC and Audit Committee investigations. On a
32
percentage of revenue basis, general and administrative expenses were 20.2% in
1998 compared to 11.7% in 1997.
RESTRUCTURING CHARGES
The Company incurred a restructuring charge in the third quarter of 1998 of
approximately $1.2 million in connection with the 25% reduction in its
workforce. The reduction in force utilized a voluntary severance program which,
among other things, provided outplacement services to the employees who chose to
participate in the program. In addition, during the second quarter of 1999, the
Company established a reserve of approximately $0.5 million primarily to cover
the costs of closing E.F. Johnson's Hong Kong office, which was completed during
1999.
PROVISION FOR LITIGATION SETTLEMENT
In December 1998, the Company took a special provision of $10.0 million
relating to the federal and state class action lawsuits pending in Nebraska
against the Company and certain of its current and former officers. During
June 1999, the Company revised its estimated costs related to the settlement of
actions against it. The result was a $2.2 million reduction of the special
provision to $7.8 million. In addition, the Company incurred expenses of
$0.3 million during 1999 related to this issue, which were applied against the
reserve. As of December 31, 1999, the litigation reserve had a balance of
$6.0 million, and other associated reserves had a total balance of
$1.5 million. The Company is in ongoing settlement discussions regarding these
lawsuits. While no settlement agreement has been finalized, the Honorable Warren
K. Urbom of the United States District Court for the District of Nebraska
preliminarily approved a settlement. The settlement, if finally approved, will
also result in a dismissal of the stockholder class action suit pending in the
District Court for Scotts Bluff County, Nebraska. The preliminary approval
precludes any persons from asserting any claims of indemnity of contribution
against Transcrypt or any of its current or former officers, directors, or
employers. The Court has scheduled a hearing for final approval of the
settlement on March 27, 2000. The settlement is subject to a number of
contingencies, including final court approval of the settlement.
NET INTEREST INCOME OR EXPENSE
Net interest income consists of interest income earned on cash and invested
funds, net of interest expense related to amounts payable on its term and
installment loans and bank lines of credit. Net interest income was $386,000 in
1999 compared to $655,000 in 1998. Net interest expense was $231,000 in 1997.
The decrease in net interest income in 1999 is due primarily to the decrease in
interest income as the Company's cash, cash equivalents and investments declined
throughout 1998. The increase in net interest income in 1998, as compared to
1997, is due primarily to an increase in interest income from the investment of
the net proceeds from the Company's initial and secondary public offerings in
interest-bearing instruments for the full year of 1998, and a repayment of
certain debt during 1997. The Company expects net interest income to continue to
decline in 2000 as the cost of the Company's borrowings continues to increase.
PROVISION FOR INCOME TAXES
The Company's benefit for income taxes was zero in 1999, $3.9 million in
1998, and $524,000 in 1997. The Company did not recognize a tax benefit
associated with its loss during 1999 because the amount of the Deferred Tax
Assets shown on the Consolidated Balance Sheet is management's estimate of the
amount that is more likely than not to be realized. The Company has total
Deferred Tax Assets of $21.4 million, which is partly offset by a $9.0 million
valuation allowance. In the future, management will continue to analyze the
amount of the deferred tax assets expected to be realized.
33
The increase in the benefit for income taxes in 1998 from 1997 is a result
of a larger operating loss in 1998 as compared to 1997 and the write-off of
in-process research and development costs in 1997 of $9.8 million not being tax
deductible.
The Company benefits from state tax credits arising from a 1993 agreement
with the State of Nebraska (the "Nebraska Agreement") to create at least 30 new
jobs and invest at least $3.0 million in new equipment prior to December 31,
1999. This agreement results in annual state income tax credits through 1999 of
(1) ten percent of the purchase price of new equipment, (2) a refund of sales
taxes (currently at a rate of 6.0%) paid on purchases of new equipment during
each year, and (3) beginning on January 1, 1996, a credit of five percent of the
annual compensation paid to the new employees exceeding the base year's
aggregate compensation. The Company believes that sufficient tax credits will be
available through the life of the Nebraska Agreement to offset a substantial
portion of its potential Nebraska state income tax liability during such period.
In addition, the Company utilizes its foreign sales corporation subsidiary
located in Guam to exempt from income taxation a portion of its foreign sales
income.
NET LOSS
The Company had a net loss of $3.8 million during 1999. However, this amount
includes a $0.5 million restructuring expense and $2.2 million of income from a
reduction in a litigation reserve set up during the previous year. Without these
two items, the net loss would have been approximately $5.5 million. During 1998,
the Company had a net loss of $22.2 million, which included $1.2 million of
restructuring charges and a $10.0 million provision for litigation settlement.
Without these two items, the Company would have had a net loss of approximately
$11.4 million (net of tax benefit). During 1997, the Company had a net loss of
$10.9 million. This loss included a $9.8 million charge for in-process research
and development. Without this item, the Company would have had a net loss of
approximately $1.6 million (net of tax benefit).
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth certain unaudited financial information in
dollars and as a percentage of revenues for the Company for the eight quarters
ended December 31, 1999. In the opinion of the Company's management, this
information has been prepared on the same basis as the audited Consolidated
Financial Statements appearing elsewhere in this Annual Report on Form 10-K and
includes all adjustments, consisting only of normal recurring adjustments,
necessary to present fairly the unaudited results set forth herein. The
operating results for any quarter are not necessarily indicative of results for
any subsequent period or for the entire fiscal year.
34
QUARTER ENDED
-----------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1998 1998 1998 1998 1999 1999 1999 1999
- ------------------------------------- --------- -------- --------- -------- --------- -------- --------- --------
Revenues.............................. $21,988 $13,877 $14,325 $ 11,851 $ 9,709 $12,727 $15,323 $15,760
Cost of sales......................... 12,910 10,853 11,220 9,922 7,735 8,646 9,917 9,762
------- ------- ------- -------- ------- ------- ------- -------
Gross profit.......................... 9,078 3,024 3,105 1,929 1,974 4,081 5,406 5,998
------- ------- ------- -------- ------- ------- ------- -------
Operating costs and expenses:
Research and development.............. 2,038 2,703 2,174 1,897 1,714 1,510 1,220 1,279
Sales and marketing................... 3,210 3,355 2,626 2,285 1,726 2,396 1,885 2,275
General and administrative(1)......... 2,113 4,715 3,030 2,671 2,634 2,460 2,287 2,220
Restructuring charge(2)............... -- -- 1,230 -- -- 523 -- --
Provision for litigation
settlement(3)....................... -- -- -- 10,000 -- (2,221) -- --
------- ------- ------- -------- ------- ------- ------- -------
Total operating costs and expenses.... 7,361 10,773 9,060 16,853 6,074 4,668 5,392 5,774
------- ------- ------- -------- ------- ------- ------- -------
Income (loss) from operations......... 1,717 (7,749) (5,955) (14,924) (4,100) (587) 14 224
Interest (expense) income and other
income, net......................... 311 108 29 253 143 251 135 93
Net income (loss) before income
taxes............................... 2,028 (7,641) (5,926) (14,671) (3,957) (336) 149 317
------- ------- ------- -------- ------- ------- ------- -------
Provision (benefit) for income
taxes............................... 712 (2,598) (2,030) -- -- -- -- --
------- ------- ------- -------- ------- ------- ------- -------
Net income (loss)..................... $ 1,316 $(5,043) $(3,896) $(14,671) $(3,957) $ (336) $ 149 $ 317
======= ======= ======= ======== ======= ======= ======= =======
Net income (loss) per share
Basic................................. $ 0.10 $ (0.39) $ (0.30) $ (1.13) $ (0.31) $ (0.03) $ 0.01 $ 0.02
======= ======= ======= ======== ======= ======= ======= =======
Diluted............................... $ 0.10 $ (0.39) $ (0.30) $ (1.13) $ (0.31) $ (0.03) $ 0.01 $ 0.02
======= ======= ======= ======== ======= ======= ======= =======
Weighted average common shares
Basic................................. 12,947 12,947 12,947 12,947 12,947 12,947 12,947 12,951
======= ======= ======= ======== ======= ======= ======= =======
Diluted............................... 13,621 12,947 12,947 12,947 12,947 12,947 13,203 13,250
======= ======= ======= ======== ======= ======= ======= =======
As a Percentage of Revenues
Revenues.............................. 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales......................... 58.7 78.2 78.3 83.7 79.7 67.9 64.7 61.9
------- ------- ------- -------- ------- ------- ------- -------
Gross profit.......................... 41.3 21.8 21.7 16.3 20.3 32.1 35.3 38.1
Operating costs and expenses:
Research and development.............. 9.3 19.5 15.2 16.0 17.7 11.9 8.0 8.1
Sales and marketing................... 14.6 24.2 18.3 19.3 17.8 18.8 12.3 14.5
General and administrative(1)......... 9.6 34.0 21.2 22.5 27.1 19.3 14.9 14.1
Restructuring charge(2)............... 0.0 0.0 8.6 0.0 0.0 4.1 0.0 0.0
Provision for litigation
settlement(3)....................... 0.0 0.0 0.0 84.4 0.0 (17.4) 0.0 0.0
------- ------- ------- -------- ------- ------- ------- -------
Total operating costs and expenses.... 33.5 77.6 63.3 142.2 62.6 36.7 35.2 36.7
------- ------- ------- -------- ------- ------- ------- -------
Income (loss) from operations......... 7.8 (55.8) (41.6) (125.9) (42.3) (4.6) 0.1 1.4
Interest (expense) income and other
income, net......................... 1.4 0.8 0.2 2.1 1.5 2.0 0.9 0.6
Provision (benefit) for income
taxes............................... 3.2 (18.7) (14.2) 0.0 0.0 0.0 0.0 0.0
------- ------- ------- -------- ------- ------- ------- -------
Net income (loss)..................... 6.0% (36.3)% (27.2)% (123.8)% (40.8)% (2.6)% 1.0% 2.1%
======= ======= ======= ======== ======= ======= ======= =======
- ------------------------------
(1) Includes amortization of intangible assets. For years prior to 1997,
reflects the amortization of intangible assets related to the acquisition of
the Company's business in December 1991. Commencing in August 1997,
amortization of intangible assets related to the acquisition of E.F. Johnson
began.
(2) Represents a charge for a 25% reduction in workforce taken in the third
quarter of 1998, and the closing of the E.F. Johnson Hong Kong office during
the second quarter of 1999.
(3) Represents a special provision taken in the fourth quarter of 1998 for
potential class action litigation settlement and subsequent partial reversal
during the second quarter of 1999.
The Company historically has experienced, and expects to continue
experiencing, substantial variability in its results of operations from quarter
to quarter. The level of revenues in a particular quarter varies
35
primarily based upon the timing of customer purchase orders, due principally to
the seasonal nature of governmental budgeting processes and the needs of
competing budgetary concerns of the Company's customers during the year. Other
factors which affect the results of operations in a particular quarter include
the timing of the introduction of new products, general economic conditions, the
timing and mix of product sales and specific economic conditions in the
information security and wireless communications industries. The Company
believes that quarterly results are likely to vary for the foreseeable future.
LIQUIDITY AND CAPITAL RESOURCES
Since January 1, 1997, the Company has financed its operations and met its
capital requirements primarily through short-term borrowings, long-term debt and
stock offerings completed on January 22, 1997 and October 15, 1997.
The Company's operating activities generated cash of $0.7 million in 1999,
used $11.0 million of cash during 1998, and used $18.1 million of cash during
1997. During 1999, cash generated by operations and cash used as a result of
increases in accounts receivable, costs in excess of billings on completed
contracts, and inventory were offset by cash generated from increases in
accounts payable and deferred revenue. Deferred revenue includes $3.6 million in
advance payments from Motorola for products that are to be shipped during 2000.
During 1999, $4.9 million in cash was provided by investing activities.
Specifically, $7.9 million was provided by the sales of the Lincoln and Waseca
facilities. This was offset by $1.6 million in payments on restructuring
activities, $1.0 million in fixed asset purchases, and $0.3 million in other
investing activities. Also during 1999, the Company used $4.3 million in
financing activities, primarily for payments on long-term debt and the Company's
line of credit with US Bank.
Cash used in operating activities in 1998 consisted primarily of a loss from
operations and reductions to accounts payable, accrued expenses and billings in
excess of cost on uncompleted contracts off-set by decreases in accounts
receivable, inventory and an increase in a special provision for litigation
settlement. The Company incurred approximately $3.0 million (net of
reimbursement from the Company's insurance carrier) on legal, audit and
severance payments during 1998 related to the restatement, class action
lawsuits, the audit committee investigation and SEC investigation, which
adversely impacted cash flows. Cash flows may continue to be adversely impacted
by the uncertainty of sales volumes.
Cash provided from investing activities were attributable primarily to the
sale of investments in 1998 offset in part by capital expenditures related to
the completion of the Company's Phase III expansion of its corporate
headquarters in Lincoln, Nebraska. The net amount of cash provided from
investing activities in 1998 was $11.1 million.
The deferred tax assets totaling $12.4 million for each of the years ended
December 31, 1999 and 1998, resulted primarily from the E.F. Johnson acquisition
in 1997, net operating loss carryforwards, and stock option related special
compensation expense of $5.4 million incurred in September 1996. Deferred tax
assets were 14.4% and 25.1% of total assets and stockholders' equity,
respectively, at December 31, 1999. The Company believes that it is more likely
than not that future taxable income will be sufficient to utilize deferred tax
assets recorded, net of existing valuation allowances at December 31, 1999.
Approximately $3.0 million of the deferred tax assets relate to $8.6 million of
federal and state net operating loss carryforwards attributable to its acquired
E.F. Johnson subsidiary. A valuation allowance was established at the time of
the purchase of E.F. Johnson for this amount. Any subsequently recognized tax
benefits relating to this portion of the valuation allowance as of December 31,
1999 will be allocated to goodwill.
Net operating loss carryforwards, which originated in 1999, 1998, 1997, and
1996, will begin to expire in 2011. The Company has approximately $8.6 million
in Federal and state net operating loss carryforwards attributable to EFJ, which
expire in 2012. Tax regulations limit the amount that may be utilized on these
acquired net operating losses on an annual basis to approximately $588,000.
36
The Company's financing activities have consisted primarily of borrowings
under and payments on an industrial development revenue bond issue ("IDR"), term
and installment notes payable, bank lines of credit and proceeds from an initial
public offering and secondary public offering completed in January 1997 and
October 1997, respectively. Such activities used $4.3 million of cash in 1999,
generated $4.9 million in 1998, and generated $54.3 million in 1997. The amount
generated in 1997 was reduced by the liquidation of the revolving credit line
and term loans of $15.7 million assumed in the E.F. Johnson acquisition.
In the normal course of its business activities, the Company is required
under contracts with various governmental authorities to provide letters of
credit or bonds that may be drawn upon if the Company fails to perform under its
contracts. The letters of credit, which expire on various dates in 2000, have a
total undrawn balance of $1,981. Of this total, $1,172 for one specific contract
is collateralized by a cash reserve. Bonds, which expire on various dates
through 2000, totaled $12,680 at December 31, 1999. In early 2000, the Company
obtained a commitment from a major insurance company that provides for up to
$20 million in new bonding arrangements at favorable rates and terms.
The Company has a line of credit with a regional bank. It is a secured line
of credit not to exceed $10.0 million. Interest was 7.62% at December 31, 1999
and is at a variable rate of 1.25% over the interest rate earned on the
$10.0 million on certificates of deposits pledged as security on the bank line
of credit. This line of credit is due on June 1, 2000. The working capital line
is collateralized by substantially all the Company's assets including
$10.0 million in a certificate of deposit with the bank.
At December 31, 1999, the Company had $5.8 million outstanding on the
revolving line of credit. Average borrowings under the Company's line of credit
and the weighted average interest rate during 1999 were $7.0 million and 6.35%.
The total available credit as of December 31, 1999 was $4.2 million under the
above line.
The Company currently intends to retain earnings, if any, and does not
anticipate paying cash dividends in the foreseeable future.
The Company does not anticipate any additional expenditures to ensure that
its systems are ready for processing information during the Year 2000.
As of December 31, 1999, the Company had approximately $21.6 million in cash
and cash equivalents, which includes $10.0 million of certificates of deposit
pledged as security on its line of credit. There was approximately $4.2 million
available under its bank line of credit at December 31, 1999. The Company's bank
line of credit expires on June 1, 2000 and the Company is currently in the
process of either renewing the current line of credit or securing a replacement
facility. The Company believes that its cash, cash equivalents, and lines of
credit will be sufficient to meet anticipated cash needs for working capital and
for capital expenditures through 2000. However, if sales do not increase and
operating losses do not decline, or the Company incurs unanticipated substantial
costs, the Company may be required to seek additional financing or funding
sources, including possible sale of securities. No assurance can be given that
the Company will be able to obtain such additional funding or financing, or a
renewal of its line of credit or be able to obtain financing on satisfactory
terms. Additionally, see "Pending Litigation" below for a discussion regarding
certain pending litigation, the resolution of which could materially adversely
affect the Company's liquidity, operating results and financial condition.
PENDING LITIGATION
The Company has been named as a defendant in class action lawsuits that were
filed subsequent to the Company's announcement on March 27, 1998 that the filing
of its Annual Report on Form 10-K for year ended December 31, 1997 would be
delayed and that adjustments would be made to the Company's previously announced
financial results. Between March 31, 1998 and May 27, 1998, twelve purported
class action lawsuits were filed against the Company in the United States
District Court for the District of
37
Nebraska, and one complaint was filed in the District Court of Scotts Bluff
County, Nebraska. Certain of the complaints, as amended, also name one or more
current employees and former officers of the Company and PriceWaterhouseCoopers,
LLP as additional defendants. The longest class period alleged in any of the
class complaints is the period from January 22, 1997 through April 24, 1998.
The federal class actions generally allege claims under Sections 11 and 15
of the Securities Act of 1933 and Sections 10 and 20(a) of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and relate primarily
to allegations of false and misleading financial statements and representations
and material omissions by the Company. The Nebraska action alleges violations of
Nebraska securities laws. The class action complaints seek unspecified
compensatory damages, attorneys' fees and costs. The federal class actions have
been consolidated.
In July 1999, the Company announced that a memorandum of understanding had
been signed with plaintiff's counsel to settle the pending federal consolidated
class action lawsuits and its state class action lawsuit. The parties
subsequently memorialized the terms of the memorandum of understanding in a
stipulation of settlement. The stipulation of settlement agreement creates a
settlement fund for distribution to class members and class counsel consisting
of (a) 4,460,000 shares of Transcrypt common stock and (b) at least $3,850,000
and up to $8,850,000 to be paid by Transcrypt's insurance carriers (depending on
the outcome of an arbitration between plaintiffs and one of the insurance
carriers). Transcrypt would also pay $2,000,000 to the class if there is a
purchase of a majority of Transcrypt by acquisition or merger that occurs before
January 1, 2001.
In January 2000, Honorable Warren K. Urbom of the United States District
Court for the District of Nebraska preliminarily approved a settlement of the
pending stockholder class action suits. The settlement class period is defined
as persons that purchased stock during the period from January 22, 1997 through
April 24, 1998. The settlement, if finally approved, will also result in the
dismissal of the stockholder class action suit pending in the District Court for
Scotts Bluff County, Nebraska. The preliminary approval precludes any persons
from asserting any claims of indemnity or contribution against Transcrypt or any
of its current or former officers, directors, or employees. The Client has
scheduled a hearing for final approval of the settlement for March 27, 2000. In
addition, the Honorable Randall L Lippstreau of the District Court for Scotts
Bluff County, Nebraska has entered an order that is effective on the final
approval of the settlement by Judge Urbom. This order dismisses the action
against the Company and certain former employees in the class action pending in
District Court for Scotts Bluff County, Nebraska.
The Company has reserved for the issuance of the number of shares of Common
Stock to be distributed if the court finally approves the settlement. However,
no assurance can be given that the Court will finally approve the settlement,
and that if the settlement is not finally approved the outcome of the litigation
will not have a material adverse effect on the Company's business, financial
condition, results of operations, and cash flows.
On November 4, 1998, Physician's Mutual Insurance Company filed an action in
the District Court of Douglas County, Nebraska against the Company,
PriceWaterhouseCoopers, LLP and two former officers of the Company. The
complaint contains common law causes of action for fraudulent misrepresentation,
fraudulent concealment and negligent misrepresentation against the defendants
arising from the same facts and circumstances underlying the class actions. The
complaint seeks damages in an amount to be proved at trial, but which is
currently alleged to be approximately $850,000. The Company is unable to predict
the likelihood of the outcome or range or amount of potential liability that may
arise therefrom.
In April 1998, the Securities and Exchange Commission ("SEC") issued a
formal order of investigation to determine whether violations of certain aspects
of the federal securities laws had occurred in connection with the Company. As
part of this investigation, the SEC is also examining the conduct of certain
former officers of the Company. The Company has an obligation to defend and/or
indemnify certain former employees. The Company has discussed possible
settlement of the investigation or any pending enforcement action against the
Company or its affiliated parties relating to these events. At this
38
time, it is unknown whether the Company will settle the SEC formal order of
investigation. In addition, it is unknown what actions will be taken against
former officers and, therefore, the Company cannot determine the exposure of any
future obligations to defend and/or indemnify these former officers. The SEC has
the authority to impose a variety of sanctions against the Company and
Company-affiliated parties. Such sanctions could include monetary penalties,
imposition of a cease and desist order and issuance of removal and prohibition
orders against Company-affiliated persons, among other things.
The Company is involved in certain other legal proceedings incidental to the
normal conduct of its business. The Company does not believe that any
liabilities relating to such other legal proceedings are likely to be,
individually or in the aggregate, material to the Company's business, financial
condition, results of operations or cash flows.
The Company may in the future be the subject of additional lawsuits or
claims in connection with the events or facts surrounding its restatement of
previously announced financial results. The Company is unable to predict when or
whether such additional lawsuits or claims may be initiated or the likelihood of
the outcome or range or amount of potential liability that may arise therefrom.
RECENTLY ISSUED ACCOUNTING STANDARDS
As of the date of this filing, there were no recently issued accounting
standards that impact the Company.
RESULTS OF THE YEAR 2000 ISSUE
The Company did not experience any material Year 2000 system failure or
miscalculations causing disruptions of operations resulting for computer
programs being written using two digits rather than four to define the
applicable year. In addition, we have not received a significant amount of
customer notification regarding experiencing erroneous dates on usage reports or
Year 2000 operational issues. It is still possible for customers to have issues
with previously shipped products. The Year 2000 Compliance Manager will continue
to respond in writing to any possible solutions to any Year 2000 Product issues.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does a significant amount of business in foreign countries. The
Company sales in these foreign countries are denominated in United States
dollars. Certain sales in foreign countries may be secured with irrevocable
letters of credit.
The Company has a line of credit with a regional bank, which carries a
variable interest rate that changes based on changes in certain time
certificates of deposits issued by the lender.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See "Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K" for the Company's Consolidated Financial Statement, and the notes
thereto, and the financial statement schedules filed as part of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The information called for under this item has been previously reported by
the Company in its (1) Current Report on Form 8-K filed with the SEC on May 4,
1998, (2) Current Report on Form 8-K filed with the SEC on May 12, 1998 and
(3) Amendment No. 1 to Current Report on Form 8-K filed with the SEC on May 20,
1998.
39
PART III
Incorporated by reference in Items 10 to 13 below are certain sections of
the Company's definitive proxy statement, to be filed pursuant to
Regulation 14A with the SEC within 120 days after December 31, 1999.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
Incorporated by reference in this Annual Report is the information required
by this Item 10 contained in the sections entitled "Discussion of Proposals
Recommended by the Board--Proposal 1: Elect Two Directors," "Information About
Directors and Executive Officers" and "Information About Transcrypt Common Stock
Ownership--Did Directors, Executive Officers and Greater-Than-10% Stockholders
Comply With Section 16(a) Beneficial Ownership Reporting in 1999?" of the
Company's definitive proxy statement, to be filed pursuant to Regulation 14A
with the SEC within 120 days after December 31, 1999.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated by reference in this Annual Report is the information required
by this Item 11 contained in the sections entitled "Information About Directors
and Executive Officers" and "Information About Transcrypt Common Stock
Ownership--Compensation Committee Interlocks and Insider Participation" of the
Company's definitive proxy statement, to be filed pursuant to Regulation 14A
with the SEC within 120 days after December 31, 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated by reference in this Annual Report is the information required
by this Item 12 contained in the section entitled "Information About Transcrypt
Common Stock Ownership" of the Company's definitive proxy statement, to be filed
pursuant to Regulation 14A with the SEC within 120 days after December 31, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference in this Annual Report is the information required
by this Item 13 contained in the section entitled "Information About Directors
and Executive Officers--Certain Relationships and Related Transactions" of the
Company's definitive proxy statement, to be filed pursuant to Regulation 14A
with the SEC within 120 days after December 31, 1999.
40
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are included in this report at the page numbers
indicated.
PAGE NO.
-------------
1. FINANCIAL STATEMENTS AND SCHEDULES
Independent Auditors' Report................................ F-1
Consolidated Balance Sheets as of December 31, 1999 and F-2
1998........................................................
Consolidated Statements of Operation for the Years ended F-3
December 31, 1999, 1998 and 1997............................
Consolidated Statements of Changes in Stockholders' Equity F-4
for the Years ended December 31, 1999, 1998 and 1997........
Consolidated Statements of Cash Flows for the Years ended F-5
December 31, 1999, 1998 and 1997............................
Notes to Consolidated Financial Statements.................. F-6 to F-20
2. SUPPLEMENTAL FINANCIAL STATEMENT SCHEDULES
Independent Auditor's Report................................ S-1
Schedule II--Valuation and Qualifying Accounts and S-2
Reserves....................................................
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the financial
statements or notes thereto.
3. EXHIBITS
(1) EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS:
The following is a summary of the Company's executive compensation plans and
arrangements, which are required to be filed as exhibits to this Annual Report
on Form 10-K:
1. Transcrypt International, Inc. 1999 Non Employee Director Stock Purchase
Plan (Exhibit 10.1 below).
2. Transcrypt International, Inc. 1999 Executive Officer Stock Purchase Plan
(Exhibit 10.2 below).
3. Transcrypt International, Inc. 1996 Stock Incentive Plan, as amended.
Incorporated by reference to Exhibit 10.4 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1998, File No. O-21681
(hereinafter known as the "1998 Form 10-K").
4. Form of Indemnification Agreement between the Company and each executive
officer and director of the Company. Incorporated herein by reference to
Exhibit 10.5 to the Company's Registration Statement on Form S-1,
No. 333-14351, declared effective January 22, 1997.
5. Consulting Agreement and Termination of Employment Agreement between the
Company and John T. Connor dated February 23, 1999. Incorporated herein by
reference to Exhibit 10.41 to the 1998 Form 10-K
6. Employment Agreement between the Company and Michael E. Jalbert dated
March 1, 1999. Incorporated herein by reference to Exhibit 10.42 to the 1998
Form 10-K.
7. Employment Agreement between the Company and Mike Wallace dated March 1,
1999. Incorporated herein by reference to Exhibit 10.43 to the 1998
Form 10-K.
8. Employment Agreement between the Company and George R. Spiczak dated
April 1, 1999. Incorporated herein by reference to Exhibit 10.44 to the 2Q
1999 Form 10-Q.
41
9. Employment Agreement between the Company and Massoud Safavi dated
October 19, 1999 (Exhibit 10.45 below).
10. Chief Executive Officer Nonqualified Stock Option Agreement dated
October 19, 1999 between Transcrypt International, Inc. and Michael E.
Jalbert (Exhibit 10.46 below).
11. Promissory Note dated January 7, 2000 between Transcrypt
International, Inc. and Michael E. Jalbert (Exhibit 10.47 below).
(2) EXHIBIT INDEX:
EXHIBIT
NUMBER DESCRIPTION
- --------------------- ------------------------------------------------------------
3.1 Second Amended and Restated Certificate of Incorporation of
the Company filed on September 30, 1996 with the Secretary
of State of the State of Delaware (incorporated herein by
reference to Exhibit 3.1 to the Company's Quarterly Report
on Form 10-Q for the Quarter Ended June 30, 2999, File No.
O-21681 (hereinafter the "2Q 1999 Form 10-Q")
3.2 Amended and Restated Bylaws of the Company (incorporated
herein by reference to Exhibit 3.2 to the Registration
Statement on Form S-1, No. 333-14351, declared effective on
January 22, 1997 (hereinafter the "January 1997 Registration
Statement")).
4.1 Form of Common Stock certificate (incorporated herein by
reference to Exhibit 4.1 to the January 1997 Registration
Statement).
4.2 Registration Rights Agreement, dated as of July 31, 1997, by
and among NorAm Energy Corp., Intek Diversified Corporation
and the Company (incorporated herein by reference to Exhibit
4.1 to the Company's Current Report on Form 8-K, File No.
0-21681, filed with the SEC on August 14, 1997).
10.1 Transcrypt International, Inc. 1999 Non Employee Director
Stock Plan.
10.2 Transcrypt International, Inc. 1999 Executive Officer Stock
Purchase Plan.
10.3 RESERVED
10.4 Transcrypt International, Inc. 1996 Stock Incentive Plan, as
amended. Incorporated by reference to Exhibit 10.4 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1998, File No. O-21681 (hereinafter known as
the "1998 Form 10-K")
10.5 Form of Indemnification Agreement between the Company and
each executive officer and director of the Company
(incorporated herein by reference to Exhibit 10.5 to the
January 1997 Registration Statement).
10.6 License Agreement for APCO 25 Compliant Product between
Motorola, Inc. and the Company dated as of August 2, 1994
(incorporated herein by reference to Exhibit 10.6 to the
January 1997 Registration Statement).
10.7* Amendment, dated as of June 28, 1996, to License Agreement
for APCO Project 25 Compliant Product between Motorola, Inc.
and the Company dated as of August 2, 1994 (incorporated
herein by reference to Exhibit 10.7 to the January 1997
Registration Statement).
10.8 OEM Agreement between Motorola, Inc. and the Company dated
as of August 2, 1994 (incorporated herein by reference to
Exhibit 10.8 to the January 1997 Registration Statement).
10.9* Amendment, dated as of July 15, 1996, to OEM Agreement
between Motorola, Inc. and the Company dated as of August 2,
1994 (incorporated herein by reference to Exhibit 10.9 to
the January 1997 Registration Statement).
42
EXHIBIT
NUMBER DESCRIPTION
- --------------------- ------------------------------------------------------------
10.10 RESERVED
10.11 RESERVED
10.12 License Agreement for APCO Fed Project 25 Algorithm between
Digital Voice Systems, Inc. and the Company, dated as of
August 14, 1995 (incorporated herein by reference to
Exhibit 10.12 to the January 1997 Registration Statement).
10.13 Consigned Inventory Agreement between Arrow/Schweber
Electronics Group and the Company, dated as of June 22, 1994
(incorporated herein by reference to Exhibit 10.13 to the
January 1997 Registration Statement).
10.14- RESERVED
10.23
10.24 Form of Adoption Agreement for Nonstandardized 401(k) Profit
Sharing Plan (incorporated herein by reference to Exhibit
10.24 to the January 1997 Registration Statement).
10.25 Defined Contribution Master Plan and Trust Agreement of
Norwest Bank Nebraska, N.A., Master Plan Sponsor
(incorporated herein by reference to Exhibit 10.25 to the
January 1997 Registration Statement).
10.26- RESERVED
10.35
10.36 License Agreement, dated as of January 15, 1997, between
E.F. Johnson Company and Johnson Data Telemetry Corporation
(incorporated herein by reference to Exhibit 10.36 to the
October 1997 Registration Statement).
10.37 Loan Agreement, dated as of December 31, 1997, by and
between U.S. Bank National Association d/b/a First Bank
N.A., and the Company, together with related documents.
(incorporated herein by reference to Exhibit 10.37 to the
1997 Form 10-K).
10.38 First Amendment to Loan Agreement dated May 21, 1998 by and
between U.S. Bank National Association and the Company,
together with related documents (incorporated herein by
reference to Exhibit 10.38 to the 1997 Form 10-K).
10.39- RESERVED
10.40
10.41 Consulting Agreement and Termination of Employment Agreement
between the Company and John T. Connor dated February 23,
1999 (incorporated herein by reference to Exhibit 10.41 to
the 1998 Form 10-K).
10.42 Employment Agreement between the Company and Michael E.
Jalbert dated March 1, 1999 (incorporated herein by
reference to Exhibit 10.42 to the 1998 Form 10-K).
10.43 Employment Agreement between the Company and Mike Wallace
dated March 30, 1999 (incorporated herein by reference to
Exhibit 10.42 to the 1998 Form 10-K).
10.44 Employment Agreement between the Company and George Spiczak
dated April 1, 1999 (incorporated herein by reference to
Exhibit 10.44 to the 2Q 1999 Form 10-Q).
10.45 Employment Agreement between the Company and Massoud Safavi
dated October 19, 1999.
43
EXHIBIT
NUMBER DESCRIPTION
- --------------------- ------------------------------------------------------------
10.46 Chief Executive Officer Nonqualified Stock Option Agreement
dated October 19, 1999 between the Company and Michael E.
Jalbert.
10.47 Promissory Note dated January 7, 2000 between the Company
and Michael E. Jalbert.
10.48 Second Amendment to Loan Agreement by and between U.S. Bank
National Association and the Company dated August 31, 1999.
10.49 Lease Agreement between the Company and Waseca Properties,
LLC dated December 30, 1999.
11.1 Statement re: Computation of Per Share Earnings.
21 Subsidiaries of the Registrant (incorporated herein by
reference to Exhibit 21 to the 1997 Form 10-K).
23.1 Consent of KPMG LLP.
27.1 Financial Data Schedule.
- ------------------------
* Confidential treatment has previously been granted by the SEC as to a portion
of this exhibit.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the fourth quarter of 1999.
(c) EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-K
See Item 14(a)(3) above.
(d) ADDITIONAL FINANCIAL STATEMENTS
See page S-2 to this Annual Report on Form 10-K for Schedule II--Valuation
and Qualifying Accounts and Reserves.
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
TRANSCRYPT INTERNATIONAL, INC.
BY: /S/ MICHAEL E. JALBERT
-----------------------------------------
Michael E. Jalbert
CHAIRMAN OF THE BOARD OF DIRECTORS
AND CHIEF EXECUTIVE OFFICER
(Principal Executive Officer)
Dated: March 22, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
Chairman of the Board of
/s/ MICHAEL E. JALBERT Directors, President and
------------------------------------------- Chief Executive Officer March 22, 2000
Michael E. Jalbert (Principal Executive
Officer)
Senior Vice President of
/s/ MASSOUD SAFAVI Finance and Chief Financial
------------------------------------------- Officer (Principal Financial March 22, 2000
Massoud Safavi and Accounting Officer)
/s/ EDWARD H. BERSOFF Director
------------------------------------------- March 22, 2000
Edward H. Bersoff
/s/ THOMAS R. LARSEN Director
------------------------------------------- March 22, 2000
Thomas R. Larsen
/s/ THOMAS C. SMITH Director
------------------------------------------- March 22, 2000
Thomas C. Smith
/s/ THOMAS R. THOMSEN Director
------------------------------------------- March 22, 2000
Thomas R. Thomsen
/s/ WINSTON J. WADE Director
------------------------------------------- March 22, 2000
Winston J. Wade
45
INDEPENDENT AUDITOR'S REPORT
To the Stockholders and Board of Directors
Transcrypt International, Inc.
We have audited the accompanying consolidated balance sheets of Transcrypt
International, Inc. and Subsidiaries as of December 31, 1999 and 1998 and the
related consolidated statements of operations, changes in stockholders' equity
and cash flows for each of the years in the three-year period ended
December 31, 1999. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Transcrypt International, Inc. and Subsidiaries as of December 31, 1999 and
1998, and the consolidated results of operations and cash flows for each of the
years in the three-year period ended December 31, 1999, in conformity with
generally accepted accounting principles.
/s/ KPMG LLP
Omaha, Nebraska
February 11, 2000
F-1
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1999 1998
-------- --------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 21,571 $ 20,262
Accounts receivable, net of allowance for returns and
doubtful accounts of $1,570 and $1,997 in 1999 and 1998,
respectively............................................ 12,675 9,287
Receivables--other........................................ 316 605
Cost in excess of billings on uncompleted contracts....... 2,298 1,216
Inventory................................................. 16,447 13,907
Prepaid expenses.......................................... 500 552
Deferred tax assets....................................... 2,395 5,157
-------- --------
Total current assets.................................. 56,202 50,986
Property, plant, and equipment, net......................... 3,766 11,885
Deferred tax assets......................................... 9,981 7,219
Intangible assets, net of accumulated amortization.......... 15,011 16,711
Other assets................................................ 561 411
-------- --------
$ 85,521 $ 87,212
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Revolving line of credit.................................. $ 5,809 $ 7,426
Current portion of long-term debt......................... 116 2,732
Accounts payable.......................................... 8,514 2,620
Billings in excess of cost on uncompleted contracts....... 5,116 4,541
Deferred revenue.......................................... 4,090 1,140
Accrued expenses.......................................... 5,764 5,101
Provision for litigation settlement....................... -- 10,000
-------- --------
Total current liabilities............................. 29,409 33,560
Provision for litigation settlement....................... 5,996 --
Long-term debt, net of current portion.................... 197 6
Deferred revenue.......................................... 633 550
-------- --------
36,235 34,116
======== ========
Commitments and contingencies
Stockholders' equity:
Preferred stock ($.01 par value; 3,000,000 shares
authorized; none issued)................................ -- --
Common stock ($.01 par value; 25,000,000 voting shares
authorized, 12,736,582 issued and outstanding; 600,000
non voting shares authorized, 217,542 issued and
outstanding)............................................ 130 129
Additional paid-in capital................................ 90,331 90,315
Accumulated deficit....................................... (41,175) (37,348)
-------- --------
49,286 53,096
-------- --------
$ 85,521 $ 87,212
======== ========
See accompanying notes to the consolidated financial statements.
F-2
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1999 1998 1997
----------- ----------- -----------
Revenues.............................................. $ 53,520 $ 62,041 $ 40,423
Cost of sales......................................... 36,059 44,905 26,106
----------- ----------- -----------
Gross profit...................................... 17,461 17,136 14,317
----------- ----------- -----------
Operating expenses:
Research and development.............................. 5,724 8,812 4,469
Sales and marketing................................... 8,282 11,476 7,031
General and administrative............................ 9,601 12,529 4,711
In-process research and development................... -- -- 9,828
Restructuring charge.................................. 523 1,230 --
Provision for litigation settlement................... (2,221) 10,000 --
----------- ----------- -----------
Total operating expenses.......................... 21,909 44,047 26,039
----------- ----------- -----------
Loss from operations.............................. (4,448) (26,911) (11,722)
Other income.......................................... 235 46 18
Interest income....................................... 920 1,304 874
Interest expense.................................... (534) (649) (643)
----------- ----------- -----------
Loss before income taxes.......................... (3,827) (26,210) (11,473)
Income tax benefit.................................. -- (3,916) (524)
----------- ----------- -----------
Net loss........................................ $ (3,827) $ (22,294) $ (10,949)
=========== =========== ===========
Net loss per share--Basic and Diluted................. $ (0.30) $ (1.72) $ (1.09)
=========== =========== ===========
Weighted average common shares--Basic and Diluted..... 12,947,795 12,946,624 10,056,690
=========== =========== ===========
See accompanying notes to the consolidated financial statements
F-3
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
(IN THOUSANDS, EXCEPT UNITS AND SHARE DATA)
COMMON STOCK
--------------------- ADDITIONAL
PAR PAID-IN ACCUMULATED
SHARES VALUE CAPITAL DEFICIT TOTAL
---------- -------- ---------- ----------- --------
Balance, December 31, 1996................. 6,783,078 $ 68 $ 9,003 $ (4,105) $ 4,966
Net loss................................... -- -- -- (10,949) (10,949)
Initial public offering, net of related
costs.................................... 2,500,000 25 17,685 -- 17,710
Issuance of shares in connection with the
purchase of the E.F. Johnson Company..... 832,465 8 9,992 -- 10,000
Secondary stock offering, net of related
costs.................................... 2,684,481 27 52,912 -- 52,939
Exercise of stock options.................. 146,600 1 228 -- 229
Income tax benefit of exercise of stock
options.................................. -- -- 495 -- 495
---------- ---- ------- -------- --------
Balance, December 31, 1997................. 12,946,624 129 90,315 (15,054) 75,390
Net loss................................... -- -- -- (22,294) (22,294)
---------- ---- ------- -------- --------
Balance, December 31, 1998................. 12,946,624 $129 $90,315 $(37,348) $ 53,096
Exercise of stock options.................. 7,500 1 16 -- 17
Net loss................................... -- -- -- (3,827) (3,827)
---------- ---- ------- -------- --------
Balance, December 31, 1999................. 12,954,124 $130 $90,331 $(41,175) $ 49,286
========== ==== ======= ======== ========
See accompanying notes to the consolidated financial statements
F-4
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997
(IN THOUSANDS)
1999 1998 1997
-------- -------- --------
Cash flows from operating activities:
Net loss.................................................. $ (3,827) $(22,294) $(10,949)
-------- -------- --------
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Special compensation expense............................ -- -- --
In-process research and development costs............... -- -- 9,828
Provision for litigation settlement..................... (2,221) 10,000 --
Depreciation and amortization........................... 4,260 4,596 2,206
Gain on sale of fixed assets............................ (803) (102) (15)
Provisions for inventory reserves....................... 829 978 1,100
Provisions for bad debts................................ 104 922 202
Deferred taxes.......................................... -- (4,349) (706)
Changes in assets and liabilities, net of effects of
acquisitions:
Accounts receivable................................... (3,492) 5,979 (8,884)
Cost in excess of billings on uncompleted contracts... (1,082) (274) 201
Inventory............................................. (3,369) 3,478 (6,179)
Income taxes recoverable.............................. -- 1,065 (357)
Prepaid expenses and other assets..................... 341 (74) (144)
Accounts payable...................................... 5,894 (6,685) (4,855)
Billings in excess of cost on uncompleted contracts... 575 (2,155) (823)
Accrued expenses...................................... 498 (1,138) 325
Deferred revenue...................................... 3,033 (987) 933
-------- -------- --------
Total adjustments................................... 4,567 11,254 (7,168)
-------- -------- --------
Net cash provided by (used in) operating
activities.......................................... 740 (11,040) (18,117)
-------- -------- --------
Cash flows from investing activities:
Purchases of investments.................................. -- -- (15,900)
Sale of investments....................................... -- 15,900 --
Proceeds from sale of fixed assets........................ 7,889 111 15
Purchase of fixed assets.................................. (1,046) (3,504) (2,422)
Increase in intangible assets............................. (141) (407) --
Increase (decrease) in other assets....................... (150) 41 118
Payments on restructuring reserve......................... (1,618) (1,084) (2,380)
Acquisition of E.F. Johnson Company, net of cash
acquired................................................ -- -- (292)
-------- -------- --------
Net cash provided by (used in) investing
activities.......................................... 4,934 11,057 (20,861)
-------- -------- --------
Cash flows from financing activities:
(Payments) proceeds on revolving lines of credit, net..... (1,617) 7,426 (11,914)
Proceeds from long term debt.............................. -- -- 2,850
Payments on long term debt................................ (2,710) (2,540) (7,634)
Principal payments on capitalized leases.................. (55) (25) --
Bank overdraft............................................ -- -- (386)
Issuance of common stock, net of issuance costs........... -- -- 71,217
Proceeds from the exercise of employee stock options...... 17 -- 229
-------- -------- --------
Net cash (used in) provided by financing
activities.......................................... (4,365) 4,861 54,362
-------- -------- --------
Net increase in cash and cash equivalents................... 1,309 4,878 15,384
Cash and cash equivalents, beginning of period.............. 20,262 15,384 --
-------- -------- --------
Cash and cash equivalents, end of period.................... $ 21,571 $ 20,262 $ 15,384
======== ======== ========
See accompanying notes to the consolidated financial statements
F-5
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
1. SIGNIFICANT ACCOUNTING POLICIES:
The following is a summary of significant accounting policies followed in
the preparation of these consolidated financial statements.
ORGANIZATION
Transcrypt International, Inc. (the "Company") is a Delaware corporation
which is engaged in the design, manufacture, and marketing of information
security products for the land mobile radio and telephony markets. Through its
E.F. Johnson subsidiary (EFJ), the Company designs, develops, manufactures, and
markets stationary land mobile radio transmitters/receivers and mobile and
portable radios. The Company markets its products to customers worldwide in two
broad markets: business and industrial users and public safety and other
governmental users. Management considers its operations to comprise two industry
segments. One segment consists of business conducted in the information security
industry (Transcrypt Secure Technologies) and the second business segment
competes in the wireless communication industry (EFJ).
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in the consolidation. The results of
operations of EFJ are included from the date of its acquisition, July 31, 1997.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with original maturities
less than 90 days as cash equivalents. The Company places its temporary cash
investments with high credit qualified financial institutions. Such investments
are carried at cost, which approximates fair value.
INVENTORY
Inventory is recorded at the lower of cost or market. Cost is determined by
the first-in, first-out (FIFO) method.
PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment are recorded at cost. The Company's policy is
to capitalize expenditures for major improvements and to charge to operating
expenses the cost of maintenance and repairs. Depreciation is computed on the
straight-line method over the estimated useful lives of the assets as follows:
land improvements--15 years; buildings and improvements--15 to 30 years;
equipment and furniture and fixtures--3 to 7 years. The cost and related
accumulated depreciation of assets retired or otherwise disposed of are
eliminated from the respective accounts at the time of disposition. Any
resulting gain or loss is included in current operating results.
INTANGIBLE ASSETS
Goodwill, which represents the excess of purchase price over fair value of
assets acquired, is amortized on a straight-line basis over the expected periods
to be benefited, which is 15 years. Other intangibles are also carried at cost
less applicable amortization. Provision for amortization of other intangible
assets is
F-6
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
1. SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
based upon the estimated useful lives of the related assets and is computed
using the straight-line method. Intangible assets are being amortized over
periods from 5 to 15 years. The Company assesses the recoverability of goodwill
and other intangible assets by determining whether the amortization of the
balances over its remaining lives can be recovered through undiscounted future
operating cash flows. The amount of impairment, if any, is measured based on
projected discounted future operating cash flows using a discount rate
reflecting the Company's average cost of funds. The assessment of the
recoverability will be impacted if estimated future operating cash flows are not
achieved.
INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
REVENUE RECOGNITION
Revenues are recognized when product is shipped, less an estimate for an
allowance for returns, if applicable, if collection is reasonably assured. For
shipments where collection is not reasonably assured, the Company recognizes
revenue as cash is received. If collection is contingent on a future event, such
as a reseller of product selling the product to the end user, the Company
recognizes revenue when the contingency lapses, generally upon cash collection.
System sales under long-term contracts are accounted for under the
percentage-of-completion method. Under this method, revenues are recognized as
work on a contract progresses. The recognized revenue is that percentage of
estimated total revenue that incurred costs to date bear to estimated total
costs to complete the contract. Revisions in cost and profit estimates are made
when conditions requiring such revisions become known. Anticipated losses on
contracts are recognized in operations as soon as such losses are determined to
be probable and reasonably estimable.
Deferred revenue includes unearned warranty fees on extended product
warranty contracts sold to customers. The Company recognizes the fees based on
the expected warranty repairs to be incurred over the life of the contract.
Deferred revenue also includes an advance payment received for products to be
sold to Motorola. The advanced payment is recognized as revenue is earned.
Finally, deferred revenue includes the deferred gain discussed in Note 9.
WARRANTY COSTS
The Company provides for warranty costs based on estimated future
expenditures that will be incurred under product guarantees and warranties
presently in force.
F-7
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
1. SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
LOSS PER SHARE
Basic earnings per share (EPS) is calculated based upon the weighted average
number of common shares outstanding during the period. The diluted EPS
calculation reflects the potential dilution from common stock equivalents such
as stock options. As the years ended December 31, 1999, 1998 and 1997 have net
losses, the impact of outstanding stock options on diluted EPS is anti-dilutive.
MANAGEMENT ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain estimates and
assumptions that affect carrying amounts of assets and liabilities and
disclosures of contingent assets and liabilities as of financial statement
dates, as well as the reported revenues and expenses for the years then ended.
Actual results may differ from management's estimates.
STOCK OPTION PLAN
The Company applies the intrinsic value-based method of accounting
prescribed by Accounting Principles Board ("APB") Opinion No. 25, ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES, and related interpretations, in accounting for its
fixed plan stock options.
2. ACQUISITION:
On July 31, 1997, the Company acquired all of the outstanding shares of
capital stock and certain indebtedness of EFJ for $436 in cash and 832,465
shares of common stock, with an approximate market value of $10,000. The
acquisition was accounted for by the purchase method of accounting. Purchased
in-process research and development costs of $9,828 were written off as the
technological feasibility of such in-process technology had not yet been
established and the technology had no alternative future use. Intangibles
recorded as part of the purchase include goodwill of $10,880, core technology of
$891, work force of $1,374, customer base of $1,561, and trade names of $3,299.
The intangible assets are being amortized over 5 to 15 years. See also Note 18.
The operating results of EFJ are included in the Company's consolidated
results of operations from the date of acquisition. The following unaudited pro
forma financial information assumes the acquisition occurred at the beginning of
1997. These results have been prepared for comparative purposes only and do not
purport to be indicative of what would have occurred had the acquisition been
made at the beginning of 1996, or of the results, which may occur in the future.
1997
-----------
(UNAUDITED)
Total revenues.............................................. $70,959
Net loss.................................................... (9,949)
Loss per share--Basic and Diluted........................... $ (0.94)
F-8
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
3. BILLINGS IN EXCESS OF COSTS ON UNCOMPLETED CONTRACTS:
Amounts included in the consolidated financial statements that relate to
billings on uncompleted contracts in excess of incurred costs as of
December 31, 1999 and 1998 were as follows:
1999 1998
-------- --------
Costs on uncompleted contracts............................ $34,497 $30,615
Profits in uncompleted contracts.......................... 13,252 10,501
------- -------
47,749 41,116
Less billings............................................. 50,567 44,441
------- -------
$(2,818) $(3,325)
======= =======
Included in the consolidated balance sheet:
Cost in excess of billings on uncompleted contracts....... $ 2,298 $ 1,216
Billings in excess of cost on uncompleted contracts....... (5,116) (4,541)
------- -------
$(2,818) $(3,325)
======= =======
Cost in excess of billings on uncompleted contracts includes direct costs of
manufacturing, installation, project management, engineering, and allocable
manufacturing overhead costs and accrued profits in excess of amounts billed.
Billings in excess of costs on uncompleted contracts includes amounts billed and
accrued anticipated losses (anticipated losses were $3,442 and $3,644 at
December 31, 1999 and 1998, respectively, of which $3,773 was established in
connection with the E.F. Johnson acquisition described in Note 2) on open
contracts in excess of costs and accrued profits.
4. INVENTORY:
The following is a summary of inventory at December 31, 1999 and 1998, net
of reserves for obsolescence of $3,719 and $3,146, respectively
1999 1998
-------- --------
Raw materials and supplies................................ $ 9,027 $ 6,267
Work in process........................................... 1,816 1,337
Finished goods............................................ 5,604 6,303
------- -------
$16,447 $13,907
======= =======
F-9
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
5. PROPERTY, PLANT, AND EQUIPMENT:
Property, plant, and equipment consists of the following at December 31,
1999 and 1998:
1999 1998
-------- --------
Land and land improvements................................. $ 58 $ 262
Buildings and improvements................................. 262 7,245
Equipment.................................................. 8,870 9,107
Furniture and fixtures..................................... 1,265 1,317
Construction in progress................................... 441 209
------ -------
10,896 18,140
Less accumulated depreciation and amortization............. 7,130 6,255
------ -------
$3,766 $11,885
====== =======
6. INTANGIBLE ASSETS:
Intangible assets consist of the following at December 31, 1999 and 1998:
1999 1998
-------- --------
Goodwill.................................................. $10,880 $10,880
Proprietary technology and licensing agreements........... 400 400
Acquired work force, customer base, trade name............ 6,234 6,234
Other..................................................... 1,587 1,446
------- -------
19,101 18,960
Less accumulated amortization............................. 4,090 2,249
------- -------
$15,011 $16,711
======= =======
7. REVOLVING LINES OF CREDIT:
The Company has a line of credit with a regional bank. It is a secured line
of credit not to exceed $10,000. Interest was 7.62% at December 31, 1999 and is
at a variable rate of 1.25% over the interest rate earned on the $10,000 cash
collateral used as security on the bank line of credit. This line of credit was
due on August 31, 1999 and was renewed until June 1, 2000. The working capital
line is collateralized by substantially all the Company's assets including
$10,000 in certificate of deposits with the bank.
At December 31, 1999 and 1998, the Company had $5,809 and $7,426,
respectively, outstanding on the revolving line of credit. Average borrowings
under the Company's line of credit and the weighted average interest rate during
1999 were $6,995 and 6.35% and during 1998 were $6,564 and 6.94%. The total
available credit as of December 31, 1999 was $4,191 under the above line. The
Company had an additional fixed line of credit with the same regional bank in
the amount of $196, which was paid off in 1999.
The revolving line of credit requires, among other things, that the Company
maintain certain levels of net worth. At December 31, 1999, the Company was in
compliance with these debt covenants or had obtained the appropriate waivers.
F-10
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
8. LONG-TERM DEBT:
Long-term debt at December 31, 1999 and 1998 consists of the following:
1999 1998
-------- --------
Industrial development revenue bonds paid in full during
1999...................................................... $ -- $2,710
Other capital lease obligations............................. 313 28
---- ------
313 2,738
Less current portion........................................ 116 2,732
---- ------
$197 $ 6
==== ======
9. LEASES:
Effective May 19, 1999 and December 30, 1999, the Company entered into
sale-leaseback transactions involving the facilities in Lincoln, Nebraska and
Waseca, Minnesota, respectively. Under the terms of the Lincoln agreement, the
Company leases a minor portion of the facility under a five year operating
lease. Under Statement of Financial Accounting Standard (SFAS) No. 98,
ACCOUNTING FOR LEASES, the gain on the sale of the building of $330 was realized
in current year income and is included in other income in the statements of
operations.
Under the terms of the Waseca agreement, the Company leases less than
substantially all but more than a minor portion of the facilities under a five
year operating lease. Under SFAS No. 98, the gain on the sale of the building
was deferred and will be realized on a straight-line basis over the life of the
lease. The deferred gain of $528 is included in deferred revenue at
December 31, 1999.
The Company is obligated under various capital leases for certain machinery
and equipment that expire at various dates during the next three years. At
December 31, 1999 and 1998, the gross amount of plant and equipment and related
accumulated depreciation recorded under capital leases were as follows:
1999 1998
-------- --------
Machinery and equipment..................................... $543 $203
Accumulated depreciation.................................... (235) (181)
---- ----
$308 $ 22
==== ====
The Company also leases various equipment, automobiles and buildings under
operating leases. Rent expense was $792, $706, and $520 for the years ended
December 31, 1999, 1998, and 1997, respectively.
F-11
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
9. LEASES: (CONTINUED)
Future minimum rental payments under noncancelable operating lease agreements
and future minimum capital lease payments as of December 31, 1999 are as
follows:
OPERATING CAPITAL
YEAR ENDING DECEMBER 31 LEASES LEASES
- ----------------------- --------- --------
2000....................................................... $1,503 $142
2001....................................................... 1,403 121
2002....................................................... 1,302 95
2003....................................................... 1,250 --
2004....................................................... 1,083 --
Thereafter................................................. -- --
------ ----
6,541 358
Less amounts representing interest......................... -- (45)
------ ----
Total...................................................... $6,541 $313
====== ====
10. INCOME TAXES:
The components of the benefit for income taxes for the years ending
December 31, 1999, 1998, and 1997 are as follows:
1999 1998 1997
-------- -------- --------
Current:
Federal............................................. $ -- $ 433 $ 163
State............................................... -- -- 19
------ ------- -----
-- 433 182
------ ------- -----
Deferred:
Federal............................................. -- (4,349) (637)
State............................................... -- -- (69)
------ ------- -----
-- (4,349) (706)
------ ------- -----
$ -- $(3,916) $(524)
====== ======= =====
The Company's effective tax rate on pretax loss differs from U.S. federal
statutory tax rate as follows:
1999 PERCENT 1998 PERCENT 1997 PERCENT
-------- -------- -------- -------- -------- --------
U.S. federal tax at statutory tax
rate............................... $(1,301) (34.0) $(8,911) (34.0) $(3,901) (34.0)
Income taxable directly to partners
of Predecessor..................... -- -- -- -- -- --
Increase in valuation allowance...... 1,021 26.7 5,013 19.1 -- --
In-process research and development
costs.............................. -- -- -- -- 3,341 29.1
Benefit of foreign sales
corporation........................ -- -- -- -- (61) (0.5)
State taxes, net of federal
benefit............................ -- -- -- -- (33) (0.3)
Non deductible amortization.......... 251 6.6 251 0.1 49 0.4
Other................................ 29 0.7 (269) (0.1) 81 0.7
------- ----- ------- ----- ------- -----
$ -- 0% $(3,916) (14.9)% $ (524) (4.6)%
======= ===== ======= ===== ======= =====
F-12
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
10. INCOME TAXES:
Temporary differences between the financial statement carrying amounts and
tax bases of assets and liabilities that give rise to deferred income taxes at
December 31, 1999 and 1998 relate to the following.
1999 1998
-------- --------
Deferred tax assets and liabilities:
Special compensation expense.............................. $ 1,403 $ 1,403
Allowance for bad debts................................... 457 525
Net operating loss carryforwards.......................... 14,343 12,255
Provision for litigation settlement....................... 2,038 3,400
Difference between tax and book amortization.............. 1,500 1,538
Difference between tax and book depreciation.............. 21 (1,184)
Difference between tax and book liability accruals........ 1,648 2,452
------- -------
Gross deferred tax assets................................. 21,410 20,389
Less valuation allowance.................................. 9,034 8,013
------- -------
$12,376 $12,376
======= =======
There was no valuation allowance for deferred tax assets as of January 1,
1997. A valuation allowance of $3,000 was established at the time of the
purchase of EFJ. An additional $1,021 and $5,013 was added to the valuation
allowance during 1999 and 1998, respectively. Any subsequently recognized tax
benefits relating to $3,000 of this valuation allowance as of December 31, 1999
will be allocated to goodwill. In assessing the realizability of deferred tax
assets, management considers whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income, and tax planning strategies in
making this assessment. In order to fully realize the deferred tax asset, the
Company will need to generate future taxable income prior to expiration of the
net operating loss carryforwards. Taxable losses for the years ended
December 31, 1999, 1998 and 1997 were approximately $3,003, $16,950, and $7,800,
respectively. Based upon the level of historical taxable income and projections
for future taxable income over the periods which the deferred tax assets are
deductible, management believes it is more likely than not the Company will
realize the benefits of these deductible differences, net of existing valuation
allowances at December 31, 1999. The amount of the deferred tax asset considered
realizable, however, could be reduced in the near term if estimates of future
taxable income during the carryforward period are reduced.
Net operating loss carryforwards, which originated in 1999, 1998, 1997, and
1996, will begin to expire in 2011. The Company has approximately $8,600 in
Federal and state net operating loss carryforwards attributable to EFJ, which
expire in 2012. Tax regulations limit the amount that may be utilized on these
acquired net operating losses on an annual basis to approximately $588.
F-13
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
11. ACCRUED EXPENSES:
Accrued expenses consist of the following:
1999 1998
-------- --------
Payroll, bonuses and employee benefits...................... $1,463 $1,361
Warranty reserve............................................ 503 530
Commissions................................................. 362 65
Restructuring reserve....................................... 705 1,800
Other expenses.............................................. 2,731 1,345
------ ------
$5,764 $5,101
====== ======
In August 1998, the Company announced a voluntary reduction in force for
which the Company took a restructuring reserve of $1,230 to cover costs
associated with severance and other related costs to reduce the workforce by
approximately 125 employees. In addition, during June 1999 the Company incurred
a restructuring charge of approximately $523 primarily due to the closure of the
EFJ sales office in Hong Kong. As of December 31, 1999, all of these costs have
been expended. In connection with the acquisition of EFJ, a portion of the
purchase price was allocated to a restructuring reserve in 1997 to cover costs
associated with the purchase such as severance, relocation costs and contractual
obligations. A reserve of $4,961 was recorded, and as of December 31, 1999,
$4,256 has been expended.
12. COMMITMENTS AND CONTINGENCIES:
As previously disclosed, the Company has been named as a defendant in class
action lawsuits that were filed subsequent to the Company's announcement on
March 27, 1998 that the filing of its Annual Report on Form 10-K for year ended
December 31, 1997 would be delayed and that adjustments would be made to the
Company's previously announced financial results. Between March 31, 1998 and
May 27, 1998, twelve purported class action lawsuits were filed against the
Company in the United States District Court for the District of Nebraska, and
one complaint was filed in the District Court of Scotts Bluff County, Nebraska.
Certain of the complaints, as amended, also name one or more current and former
officers of the Company and PriceWaterhouseCoopers, LLP as defendants. The
longest class period alleged in any of the class complaints is the period from
January 22, 1997 through April 24, 1998.
The federal class actions generally allege claims under Sections 11 and 15
of the Securities Act of 1933 and Sections 10 and 20(a) of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and relate primarily
to allegations of false and misleading financial statements and representations
and material omissions by the Company. The Nebraska action alleges violations of
Nebraska securities laws.
In July 1999, the Company announced that a memorandum of understanding had
been signed with lead plaintiffs' counsel to settle the pending stockholder
class action suits against the Company and certain of its current or former
officers. The parties subsequently memorialized the terms of the memorandum of
understanding in a stipulation of settlement. The stipulation of settlement will
create a settlement fund for distribution to class members and class counsel
consisting of (a) 4,460,000 shares of Transcrypt common stock and (b) at least
$3,850 and up to $8,850 to be paid by Transcrypt's insurance carriers (depending
on the outcome of an arbitration between plaintiffs and one of the insurance
carriers). Transcrypt would also pay $2,000 to the class if there is a purchase
of Transcrypt by acquisition or merger that occurs before January 1, 2001.
F-14
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
12. COMMITMENTS AND CONTINGENCIES: (CONTINUED)
In January 2000, Honorable Warren K. Urbom of the United States District
Court for the District of Nebraska preliminarily approved the settlement. The
settlement, if finally approved, will also result in a dismissal of the
stockholder class action suit pending in the District Court for Scotts Bluff
County, Nebraska. The preliminary approval precludes any persons from asserting
any claims of indemnity of contribution against Transcrypt or any of its current
or former officers, directors, or employers. The court has scheduled a hearing
for final approval of the settlement on March 27, 2000. The settlement is
subject to a number of contingencies, including final court approval of the
settlement.
On November 4, 1998, Physician's Mutual Insurance Company filed an action in
the District Court of Douglas County, Nebraska against the Company,
PriceWaterhouseCoopers, LLP and two former officers of the Company. The
complaint contains common law causes of action for fraudulent misrepresentation,
fraudulent concealment, and negligent misrepresentation against the defendants
arising from the same facts and circumstances underlying the class actions. The
complaint seeks damages in an amount to be proved at trial, but which is
currently alleged to be approximately $850.
In the quarter ended December 31, 1998, the Company recorded a special
provision of $10 million related to actions pending against the Company. Upon
entering the memorandum of understanding, the Company revised its estimated
costs related to the settlement of actions against the Company. This lowered the
Company's operating expenses by $2.2 million in the second quarter of 1999 as
the settlement was for an amount less than previously provided. The remaining
reserves for litigation settlement and related costs include $1,560 included in
accrued expenses and $5,996 included in the provision for litigation settlement.
The remaining reserves for litigation settlement have been classified as long
term to the extent that they will be extinguished through the issuance of common
stock of the Company.
In April 1998, the Securities and Exchange Commission ("SEC") issued a
formal order of investigation to determine whether violations of certain aspects
of the federal securities laws had occurred in connection with the Company. As
part of this investigation, the SEC is also examining the conduct of certain
former officers of the Company. The Company has an obligation to defend and/or
indemnify certain former employees. The Company has discussed possible
settlement of the investigation or any pending enforcement action against the
Company or its affiliated parties relating to these events. At this time, it is
unknown whether the Company will settle the SEC formal order of investigation.
In addition, it is unknown what actions will be taken against former officers
and, therefore, the Company cannot determine the exposure of any future
obligations to defend and/or indemnify these former officers. The SEC has the
authority to impose a variety of sanctions against the Company and
Company-affiliated parties. Such sanctions could include monetary penalties,
imposition of a cease and desist order and issuance of removal and prohibition
orders against Company-affiliated persons, among other things.
The Company is involved in certain other legal proceedings incidental to the
normal conduct of its business. The Company does not believe that any
liabilities relating to such other legal proceedings are likely to be,
individually or in the aggregate, material to the Company's business, financial
condition, results of operations or cash flows.
In the normal course of its business activities, the Company is required
under a contract with various governmental authorities to provide letters of
credit and bonds that may be drawn upon if the Company fails to perform under
its contracts. The letters of credit, which expire on various dates in 2000,
have a total undrawn balance of $1,981. Of this total, $1,172 for one specific
contract is collateralized by a cash reserve.
F-15
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
12. COMMITMENTS AND CONTINGENCIES: (CONTINUED)
Bonds, which expire on various dates through 2000, totaled $12,680 at
December 31, 1999. As of December 31, 1999 no bonds have been drawn upon.
As a result of the EFJ acquisition, the Company has an agreement with a
vendor to purchase a certain annual dollar volume of products. In the event the
Company fails to purchase the minimum volume, it must pay a penalty equal to 35%
of the shortfall. The agreement expires in 2000 and future minimum purchase
quantities through the end of the agreement equals $391. The Company does not
anticipate meeting its future minimum purchase commitments. This shortfall was
anticipated and accrued as a liability in the allocation of the purchase price
for EFJ. At the end of the year, the Company has accrued restructuring and other
reserves of $705 for the 1999 liability and $133 for the 2000 liability as a
result of this take or pay contract.
The Company did not experience any material Year 2000 system failure or
miscalculations causing disruptions of operations resulting from computer
programs being written using two digits rather than four to define the
applicable year. In addition, we have not received a significant amount of
customer notification regarding experiencing erroneous dates on usage reports or
Year 2000 operational issues. It is still possible for customers to have issues
with previously shipped products. The Year 2000 Compliance Manager will continue
to respond in writing to any possible solutions to any Year 2000 Product issues.
13. OPTION PLANS:
Effective as of September 6, 1996, the Company established the 1996 Stock
Incentive Plan (the "Plan"). Any employee, including any director of the Company
and any non employee director or independent contractor of the Company, is
eligible to be considered for the issuance of shares of common stock, $0.01 par
value per share, of the Company or of any other class of security or right of
the Company which is convertible into common stock. As of December 31, 1999, the
remaining shares available to be issued under this Plan are 243,739. The Plan
provides that, unless otherwise provided by the Plan committee, any stock option
granted shall have an exercise price not less than 100% of the market value of a
share of common stock on the date the option is granted and that the term of
such option shall be ten years from date of grant with vesting of the options at
a rate of 20% per year.
The Company has adopted the disclosure-only provisions of SFAS No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION. Had compensation cost for the Company's
stock option plans been determined based on the fair value at the grant date for
awards in 1999, 1998 and 1997 consistent with the provisions of SFAS No. 123,
the Company's pro forma net loss and pro forma loss per share would have been as
follows:
1999 1998 1997
-------- -------- --------
Pro forma net loss--as reported............................. $(3,827) $(22,294) $(10,949)
Pro forma net loss--as adjusted under SFAS No. 123.......... (5,123) (23,010) (11,149)
Pro forma net loss per share--as reported:
Basic and Diluted....................................... (0.30) (1.72) (1.09)
Pro forma net loss per share--as adjusted under SFAS No.
123:
Basic and Diluted....................................... (0.40) (1.78) (1.11)
The weighted average fair value per option at date of grant during 1999,
1998, and 1997 was $2.23, $11.33, and $7.92, respectively.
F-16
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
13. OPTION PLANS: (CONTINUED)
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions for options granted:
1999 1998 1997
-------- -------- --------
Expected option life........................... 10 years 10 years 10 years
Expected annual volatility..................... 138% 110% 68%
Risk-free interest rate........................ 6.80% 4.65% 6.62%
Dividend yield................................. 0% 0% 0%
The status of stock options under the Plan are summarized as follows:
WEIGHTED AVERAGE
NUMBER OF PRICE PER OPTIONS
SHARES SHARE EXERCISABLE
--------- --------- ----------------
Balance at December 31, 1995.............. 464,619 $1.13
Granted............................... 252,297 3.05
Exercised............................. -- --
Forfeited............................. -- --
---------
Balance at December 31, 1996.............. 716,916 1.81 716,916
Granted............................... 459,600 10.29
Exercised............................. (146,600) 1.57
Forfeited............................. (146,383) 10.01
---------
Balance at December 31, 1997.............. 883,533 4.90 553,933
Granted............................... 215,000 7.72
Exercised............................. -- --
Forfeited............................. (135,600) 5.12
---------
Balance at December 31, 1998.............. 962,933 4.94 627,933
Granted............................... 920,000 2.39
Exercised............................. (7,500) 2.25
Forfeited............................. (273,272) 5.26
---------
Balance at December 31, 1999.............. 1,602,161 3.44 874,927
=========
F-17
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
13. OPTION PLANS: (CONTINUED)
WEIGHTED
NUMBER AVERAGE WEIGHTED NUMBER EXERCISABLE
OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT WEIGHTED
RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, AVERAGE
EXERCISE PRICE 1999 LIFE PRICE 1998 EXERCISE PRICE
- ------------------------ -------------- ----------- -------- -------------- --------------
$ 0.760 -- 0.760 294,257 5.67 $0.760 294,257 $0.760
1.438 -- 2.125 205,000 9.49 1.455 175,000 1.438
2.250 -- 2.250 307,500 9.61 2.250 116,666 2.250
2.688 -- 2.750 70,000 8.78 2.710 14,000 2.710
2.984 -- 2.984 400,000 9.16 2.984 100,000 2.984
3.050 -- 8.000 240,404 6.45 5.508 147,004 4.588
10.500 -- 21.688 50,000 8.06 14.975 14,000 16.893
23.500 -- 23.500 10,000 7.88 23.500 4,000 23.500
23.938 -- 23.938 25,000 8.08 23.938 10,000 23.938
--------- -------
0.760 -- 23.938 1,602,161 8.17 3.435 874,927 2.650
========= =======
14. BENEFIT PLANS:
The Company has a profit sharing plan, which covers substantially all
employees. Contribution levels are determined annually by the Board of
Directors. Profit sharing expense approximated $0, $0 and $100 for the years
ended December 31, 1999, 1998, and 1997, respectively.
The Company also has a 401(k) plan, which covers substantially all
employees. Participants may contribute up to 15% of their annual compensation
and the Company makes matching contributions of 40% for the first 6% of the
amount contributed by participants. Contributions may not exceed the maximum
allowable by law. Company contributions approximated $236, $372, and $111 for
the years ended December 31, 1999, 1998, and 1997, respectively.
15. CONCENTRATIONS:
No customer accounted for sales 10% or greater in 1999 or 1998. Sales to one
customer represented 10.8% of 1997 sales.
In addition, a substantial portion of the Company's revenue is from
customers in the governmental sector, both domestic and foreign. The Company's
policy does not require significant collateral or other security to support such
receivables. However, the Company typically requests collateral on certain
foreign sales that carry higher than normal risk characteristics.
In addition to being a customer, Motorola is also a key manufacturer of
electronic components used by the Company. Purchases by the Company from
Motorola totaled approximately $808, $1,244, and $3,862 in 1999, 1998, and 1997,
respectively.
F-18
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
16. FAIR VALUE OF FINANCIAL INSTRUMENTS:
The carrying amount of cash and cash equivalents, accounts receivable,
receivables-other, cost in excess of billings on uncompleted contracts, prepaid
expenses, accounts payable, billings in excess of cost on uncompleted contracts,
and accrued expenses approximate fair value because of the short maturity of
these instruments. The carrying amount of long-term debt and the revolving line
of credit approximate fair value as calculated by discounting the future cash
flows of each instrument at rates currently offered to the Company for similar
debt instruments of comparable maturities by the Company's bankers.
17. STOCK OFFERINGS:
On January 22, 1997, the Company completed an initial public offering of
2,900,000 shares of common stock at a price of $8.00 per share. Of the 2,900,000
shares offered, 2,500,000 shares were sold by the Company and 400,000 were sold
by certain of the Company's stockholders. The Company's net proceeds from the
offering, after underwriting commissions and expenses, were approximately
$17,710.
A portion of the Company's net proceeds from the offering was used to retire
term and installment notes payable and the revolving lines of credit. The
remaining net proceeds were used for general working capital purposes and to
support the Company's growth and business strategy.
On October 15, 1997, the Company completed a secondary public offering of
3,175,000 shares of common stock at a price of $21.00 per share. Of the
3,175,000 shares offered, 2,684,481 shares were sold by the Company and 490,519
were sold by certain of the Company's stockholders. The Company's net proceeds
from the offering, after underwriting commissions and expenses, were
approximately $52,939.
A portion of the Company's net proceeds from the offering was used to retire
the revolving credit facility and term facility of EFJ. The remaining net
proceeds have been and will be used to finance expansion and modernization of
the Company's manufacturing and administrative facilities, and for working
capital and general corporate purposes.
18. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid by the Company during the years ended December 31, 1999, 1998,
and 1997 amounted to $559, $514, and $618, respectively. Income taxes paid, net
of refunds, during the years ended December 31, 1999, 1998, and 1997 were $0,
$0, and $642 respectively.
During 1999, the Company made non-cash additions to property, plant, and
equipment of $340.
In conjunction with the acquisition during the year ended December 31, 1997
(see Note 2) assets acquired, liabilities assumed and common stock issued were
as follows:
Fair value of assets acquired............................... $30,574
Excess of cost over net tangible assets acquired............ 27,833
Liabilities assumed......................................... (48,115)
Common stock issued......................................... (10,000)
-------
Cash paid, net of cash received............................. $ 292
=======
F-19
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
19. SEGMENT AND RELATED INFORMATION:
The Company's reporting segments are strategic business units that offer
different products and services. Management considers its operations to comprise
two industry segments. One segment consists of business conducted in the
information security industry (Transcrypt Secure Technologies), which comprises
the design, manufacture and sale of devices that prevent the unauthorized
interception on sensitive voice and data communication. The second business
segment competes in the wireless communication industry (EFJ) where the Company
designs, develops, manufactures and markets stationary land mobile radio
transmitters/receivers, mobile and portable radios and complete radio
communication systems.
The following table is a summary of unaudited annual results for the years
ended December 31, 1999, 1998 and 1997. E.F. Johnson was acquired on July 31,
1997. Prior to the acquisition, the Company was comprised solely of the
Information Security business segment.
YEAR ENDED
------------------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31,
IN THOUSANDS 1999 1998 1997
- ------------ ------------ ------------ ------------
SALES
Information Security.................................... $ 7,575 $10,925 $10,586
Wireless Communication.................................. 45,945 51,116 29,837
------- ------- -------
TOTAL SALES............................................. 53,520 62,041 40,423
------- ------- -------
COST OF GOODS SOLD
Information Security.................................... 2,699 5,105 5,919
Wireless Communication.................................. 33,360 39,800 20,187
------- ------- -------
TOTAL COST OF GOODS SOLD................................ 36,059 44,905 26,106
------- ------- -------
GROSS MARGIN
Information Security.................................... 4,876 5,820 4,667
Wireless Communication.................................. 12,585 11,316 9,650
------- ------- -------
TOTAL GROSS MARGIN...................................... $17,461 $17,136 $14,317
======= ======= =======
Gross margin percentage
Information Security.................................... 64.4% 53.3% 44.1%
Wireless Communication.................................. 27.4% 22.1% 32.3%
------- ------- -------
TOTAL GROSS MARGIN PERCENTAGE........................... 32.6% 27.6% 35.4%
======= ======= =======
F-20
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
19. SEGMENT AND RELATED INFORMATION: (CONTINUED)
EXPORT SALES
A significant portion of the Company's sales are made to customers outside
of the United States. Export sales are recorded and settled in U.S. dollars.
Export sales by major geographic area were as follows:
1999 1998 1997
-------- -------- --------
Europe........................................... $ 1,918 $ 1,902 $ 804
Middle East and Asia............................. 2,684 3,953 7,657
Central and Latin America........................ 7,516 16,859 6,933
------- ------- -------
$12,118 $22,714 $15,394
======= ======= =======
20. UNAUDITED QUARTERLY FINANCIAL DATA:
The following table sets forth unaudited condensed operating results for
each of the eight quarters in the two-year period ending December 31, 1999. This
information has been prepared on the same basis as the consolidated financial
statements appearing elsewhere in this report. The Company's operating results
for any one quarter are not indicative of results for any future period.
Earnings per share for each quarter are computed independently of earnings
per share for the year. The sum of the quarterly may not equal the earnings per
share for the year because of (i) transactions
F-21
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
20. UNAUDITED QUARTERLY FINANCIAL DATA: (CONTINUED)
affecting the weighted-average number of common shares outstanding in each
quarter and (ii) the uneven distribution of earnings during the year.
QUARTER ENDED
-------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC.31,
--------- -------- --------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1999
Revenues............................................... $ 9,709 $12,727 $15,323 $ 15,760
Income (loss) from operations.......................... (4,100) (587) 14 224
Interest (expense) income and other income, net........ 143 251 135 93
------- ------- ------- --------
Net income (loss) before income taxes.................. (3,957) (336) 149 317
Provision (benefit) for income taxes................... -- -- -- --
------- ------- ------- --------
Net income (loss)...................................... $(3,957) $ (336) $ 149 $ 317
======= ======= ======= ========
Net income (loss) per share
Basic.................................................. $ (0.31) $ (0.03) $ 0.01 $ 0.02
======= ======= ======= ========
Diluted................................................ $ (0.31) $ (0.03) $ 0.01 $ 0.02
======= ======= ======= ========
1998
Revenues............................................... $21,988 $13,877 $14,325 $ 11,851
Income (loss) from operations.......................... 1,717 (7,749) (5,955) (14,924)
Interest (expense) income and other income, net........ 311 108 29 254
------- ------- ------- --------
Net income (loss) before income taxes.................. 2,028 (7,641) (5,926) (14,670)
Provision (benefit) for income taxes................... 712 (2,598) (2,030) --
------- ------- ------- --------
Net income (loss)...................................... $ 1,316 $(5,043) $(3,896) $(14,670)
======= ======= ======= ========
Net income (loss) per share
Basic.................................................. $ 0.10 $ (0.39) $ (0.30) $ (1.13)
======= ======= ======= ========
Diluted................................................ $ 0.10 $ (0.39) $ (0.30) $ (1.13)
======= ======= ======= ========
The Company incurred a charge of $1.2 million for restructuring the
workforce in the third quarter ended September 30, 1998. In the quarter ended
December 31, 1998, a special provision of $10.0 million was made for the
potential settlement of pending class action litigation. Also during that
quarter, no provision was made for future tax benefits in connection with the
loss. The tax benefit was fully offset by an increase in the valuation allowance
(See Note 10). In the second quarter of 1999, the Company signed a memorandum of
understanding to settle the class action litigation for which the $10.0 million
special provision was made in the second quarter of 1998. The Company reduced
the special provision by $2.2 million to reflect a lower than anticipated
settlement.
F-22
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Transcrypt International, Inc.
The audits referred to in our report dated February 11, 2000 included the
related financial statement schedule as of December 31, 1999, and for each of
the years in the three-year period ended December 31, 1999 included in
Form 10-K. The financial statement schedule is the responsibility of the
Company's management. Our responsibility is to express an opinion on the
financial statement schedule based on our audits. In our opinion, such financial
statement schedule when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
/s/ KMPG LLP
Omaha, Nebraska
February 11, 2000
S-1
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
BALANCE AT CHARGED TO CHARGED BALANCE AT
BEGINNING EXPENSES TO OTHER DEDUCTIONS END
OF PERIOD (PROVISIONS) ACCOUNTS (WRITE-OFFS) OF PERIOD
---------- ------------ ---------- ------------ ----------
Allowance for doubtful accounts
for the:
Year Ended December 31, 1997... $ 430,251 $ 202,321 $2,337,291 $ 553,361 $2,416,502
Year Ended December 31, 1998... 2,416,502 921,684 -- 1,341,395 1,996,791
Year Ended December 31, 1999... 1,996,791 246,698 -- 673,877 1,569,612
Inventory Obsolescence Reserve
for the:
Year Ended December 31, 1997... $ 38,849 $2,636,107 $5,187,000 $3,747,526 $4,114,430
Year Ended December 31, 1998... 4,114,430 977,688 -- 1,946,186 3,145,932
Year Ended December 31, 1999... 3,145,932 957,841 -- 385,059 3,718,714
Allowance for Restructuring Reserve
for the:
Year Ended December 31, 1997... $ -- $ -- $4,960,500 $2,379,424 $2,581,076
Year Ended December 31, 1998... 2,581,076 1,230,000 -- 2,010,412 1,800,664
Year Ended December 31, 1999... 1,800,664 523,485 -- 1,618,952 705,197
Allowance for Warranty Reserve
for the:
Year Ended December 31, 1997... $ 73,315 $ 408,687 $ 706,244 $ 381,757 $ 806,489
Year Ended December 31, 1998... 806,489 264,539 -- 540,881 530,147
Year Ended December 31, 1999... 530,147 450,260 -- 477,601 502,806
S-2
INDEX OF ATTACHED EXHIBITS
The following documents are included in this report.
EXHIBIT
NUMBER DESCRIPTION
- --------------------- -----------
10.1 Transcrypt International, Inc. 1999 Non Employee Director
Stock Plan.
10.2 Transcrypt International, Inc. 1999 Executive Officer Stock
Purchase Plan.
10.45 Employment Agreement between the Company and Massoud Safavi
dated October 19, 1999.
10.46 Chief Executive Officer Nonqualified Stock Option Agreement
dated October 19, 1999 between the Company and Michael E.
Jalbert.
10.47 Promissory Note dated January 7, 2000 between the Company
and Michael E. Jalbert.
10.48 Second Amendment to Loan Agreement by and between U.S. Bank
National Association and the Company dated August 31,
1999.
10.49 Lease Agreement between the Company and Waseca Properties,
LLC dated December 30, 1999.
11.1 Statement re: Computation of Per Share Earnings.
21 Subsidiaries of the Registrant (incorporated herein by
reference to Exhibit 21 to the 1997 Form 10-K).
23.1 Consent of KPMG LLP.
27.1 Financial Data Schedule.