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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 29, 1998.
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM
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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 [ ] No [X]
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 Nasdaq Stock Market halted trading in the Company's Common Stock
effective April 27, 1998, and delisted the Common Stock on May 11, 1998. 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 July 23, 1998, as reported in the non-Nasdaq over the counter market
was approximately $56,710,285. Number of shares outstanding of the Registrant's
Common Stock, as of June 30, 1998: 12,946,624.
DOCUMENTS INCORPORATED BY REFERENCE:
DOCUMENT INCORPORATED BY REFERENCE: PART OF FORM 10-K INTO WHICH INCORPORATED:
None N/A
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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 and other recent events
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 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 information security products and wireless
communications products and systems. The Company designs and manufactures
information security products which prevent unauthorized access to sensitive
voice and data communications. These products are based on a wide range of
analog scrambling and digital encryption technologies and are sold mainly to the
land mobile radio ("LMR") and telephony security markets. The Company also
manufactures wireless communications products and systems mainly for the LMR
market. Typical end-users of the Company's products include state, local and
foreign governmental agencies, including police and other public safety
departments, and industrial and commercial organizations such as taxi fleets and
railroads, and construction, oil and gas companies.
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. Through the E.F. Johnson subsidiary, the Company designs, develops,
manufactures and markets (i) stationary LMR transmitters/receivers (base
stations or repeaters) and (ii) mobile and portable radios. The Company sells
its LMR products and systems mainly to two broad markets: (i) business and
industrial ("B&I") users and (ii) public safety and other governmental users.
E.F. Johnson provides the Company with a broad line of LMR products and systems
and a platform of products to leverage its information security and digital
technologies.
In December 1991, the Company acquired the business of its predecessor,
which was founded in 1978. Prior to June 30, 1996, the Company operated as a
partnership. The Company's principal business offices are located at 4800 NW 1st
Street, Lincoln, Nebraska 68521, and its phone number is (402) 474-4800.
RECENT DEVELOPMENTS
On March 27, 1998, the Company announced that it would not file its 1997
Annual Report on Form 10-K with the SEC on March 31, 1998 because the audit of
its 1997 financial statements was not yet completed. The Company also announced
that (i) certain accounting principles relating primarily to revenue recognition
were not yet resolved by the Company's independent accountants, (ii) the
accountants and Company
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management were undertaking a review of the Company's accounting policies and
(iii) adjustments would be made to the Company's previously announced financial
results.
On April 13, 1998, the Company announced that it would not file its 1997
Form 10-K on or before the extension date of April 15, 1998 due to ongoing work
being performed by the Company and its independent accountants. The Company also
announced that the Audit Committee of the Board of Directors had retained
independent counsel to conduct an investigation.
In April 1998, the 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.
On April 24, 1998, Coopers & Lybrand, L.L.P. resigned as the Company's
independent accountants. In conjunction with its resignation, Coopers & Lybrand
advised the Company that their reports with respect to the consolidated
financial statements of the Company and its subsidiaries as of and for the years
ended December 31, 1995 and 1996 were withdrawn as of the date of their
resignation.
On April 27, 1998, the Nasdaq National Market ("Nasdaq") effected a
temporary qualification trading halt in the Company's Common Stock. On May 11,
1998, the Common Stock was delisted from the Nasdaq National Market. The Company
has appealed the Nasdaq delisting.
On May 6, 1998, the Company announced that it had engaged KPMG Peat Marwick
LLP as its independent auditors for the fiscal years ended December 31, 1997,
1996 and 1995.
On May 18, 1998, the Company disclosed in a filing with the SEC that its
Quarterly Report on Form 10-Q for the Quarter Ended March 31, 1998 will not be
filed within the period prescribed for such report.
Effective May 31, 1998, Jeffery L. Fuller resigned as President, Chief
Executive Officer ("CEO") and Director of the Company. On June 8, 1998, the
Company announced that the Board of Directors had appointed a committee to
identify a CEO of the Company and that John T. Connor, who serves as Chairman of
the Board, had been appointed as interim CEO. Edgar L. Osborn was appointed
President and Chief Operating Officer of the Company. Mr. Connor accepted
appointment as interim CEO until the earlier of September 8, 1998 or the hiring
of a permanent CEO. Mr. Connor has indicated that if a permanent CEO is not
hired by such date, he will discuss with the Board of Directors the possibility
of staying on for a longer time.
On July 8, 1998, the Company's primary bank lender, U.S. Bank National
Association ("U.S. Bank"), agreed to waive the Company's violations of its bank
credit facility arising out of the Company's failure to timely provide financial
statements, meet certain financial covenants and provide monthly borrowing base
certificates to U.S. Bank. U.S. Bank also agreed to amend the credit facility by
reducing the Company's required tangible net worth amount to $55 million from
$70 million.
The Company has been named as a defendant in several 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 also name one or more officers of the Company 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 complaints generally allege claims under Sections 10 and 20(a) of the
Exchange Act 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 complaints seek unspecified compensatory damages,
punitive damages, attorneys' fees and costs. The federal actions have recently
been consolidated.
See "ITEM 3. LEGAL PROCEEDINGS" for additional information regarding legal
proceedings relating to certain of the matters discussed above.
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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
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 (i) "scrambling" or manipulating the original signal at the point
of transmission and (ii) 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 (i) the use of a mathematical
algorithm to rearrange the bit-stream prior to transmission and (ii) 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 B&I 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 (i)
hand-held or (ii) 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 the substantial majority of LMRs currently in use operate in
analog format only.
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.
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In recent years, the cellular industry has migrated, 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 (i) increased
spectrum efficiency, (ii) perception of greater voice security and (iii)
additional capabilities for advanced features and data communications. PCS
technology typically uses variable rate voice coding (referred to as TDMA or
CDMA 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 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 INDUSTRY
Overview
The mobile wireless communications industry began in the mid-1930s when
police departments began using LMR systems to enable immediate communication
between headquarters and officers patrolling the community. As (i) other public
safety agencies and commercial enterprises recognized the benefit of immediate
communications with their field personnel, (ii) technological advances made LMR
systems more affordable and (iii) 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, including paging, cellular telephone
and personal communication services.
Business and Industrial Systems Market
B&I users include large commercial, industrial and other private
enterprises, such as utility, construction and oil companies, railroads and
universities which require rapid communications among personnel spread out over
relatively large geographic areas. While many B&I LMR users purchase and operate
entire systems for their own use, a large segment of the B&I 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 and 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 Federal
Communications Commission ("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 B&I users, (i)
conventional and (ii) trunked. Both operate on the specific frequency bands
which 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(R)") products) combine
multiple channels so that when a user begins transmitting, an unoccupied 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 B&I
applications. In recent years, technological developments by E.F. Johnson
(included in its LTR(R) products) 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
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interconnections to the public switched telephone network. The Company has
responded to changes in the standard LTR(R) protocol with the creation of
LTR-Net(TM) in 1997, which allows systems operators to link sites together and
provide telephone interconnection, electronic serial numbers and total system
security in an advanced analog 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 system.
In 1995, the APCO Advisory Board promulgated a new standard known as APCO
25. Although public safety agencies are not currently required by the FCC or
APCO to purchase APCO 25 compliant LMR systems or otherwise adopt the APCO 25
standard, the Company believes that APCO 25 compatibility will be one of the key
purchasing factors for the public safety and other government LMR users.
Furthermore, as LMR issuers upgrade their existing APCO 16 systems to comply
with FCC-imposed bandwidth limitations, the Company expects that demand for APCO
25 compliant LMR systems will increase, due in part to the fact that APCO 25
systems are backwardly compatible with much of the older APCO 16 equipment,
allowing early adopters of the APCO 25 standard to purchase new equipment
without replacing entire older systems.
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, (i) LMR Security and (ii) 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: (i) frequency inversion
(inverting or otherwise adjusting the phase of a signal based on a consistent
method), (ii) rolling code transmission (incrementally stepping codes), (iii)
frequency hopping transmission (changing broadcast frequencies multiple times
per second based upon an algorithm) and (iv) 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 (i) another of the Company's secure
cellular telephones, (ii) a PBX interchange or cellular service provider that
has installed one of the Company's Voice Privacy Exchange Units or (iii) 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.
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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, (i) a modular package consisting of a circuit board
that is designed to be permanently soldered into existing circuitry and (ii) a
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. and Motorola. 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 digital encryption standard called "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 telephones, which features 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 complete, Transcrypt-branded, Motorola MicroTAC(TM),
Elite and StarTAC(TM) 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 (i) presenting
the customer with a single vendor, (ii) overcoming customer resistance to
surrendering their telephones during installations and (iii) 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.
In September 1997, the Company introduced its "Secure Office" network
server and DES encryption scrambling modules, which allow for a company-wide
telephony and data security solution based upon products using real-time,
high-speed encryption techniques. The Secure Office product line includes a
network server capable of encryption/decryption for up to 24 simultaneous voice
or data users, a scrambling module for cellular telephone users, and five new
landline security products. Secure Office provides real-time, high-speed
encryption and voice and data security over shared facilities. The Secure Office
products consist of a switch solution for local area networks ("LAN") and
private branch exchange ("PBX") which communicates with computer modems, fax
machines, cellular telephones, digitally encrypted landline telephones and other
LANs and PBXs at different locations. Communications are secured with
proprietary encryption and scrambling algorithms. Since its introduction, the
Company has developed a PCMCIA encryption card for laptop computers. To date,
sales of the Company's Secure Office products have not been material. The
Company is evaluating its marketing strategy for its Secure Office product line.
WIRELESS COMMUNICATIONS PRODUCTS
The Company sells its wireless communications products primarily to LMR
dealers, SMR operators, governmental entities and the utility industry.
End-users include B&I concerns and public safety and other government users
desiring point to multi-point communications. Most of these types of products
are sold
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under the "E.F. Johnson" brand name. The following discussion summarizes the
types of products typically sold to both of these types of users.
Business and Industrial Users
The Company serves the B&I market primarily with its LTR(R) and analog
conventional LMR product lines. The Company's analog conventional LMR product
line is sold into all of the LMR markets which the Company serves. Management
believes that significant niche markets continue to exist for analog
conventional LMR products with value added technology, such as signaling
protocols, security features and scrambling technology.
The LTR(R) product line incorporates the E.F. Johnson LTR(R) trunking
protocols and includes (i) sub-audible signaling, which automatically selects a
clear or unoccupied channel, (ii) open architecture which is compatible with
other analog products and (iii) transmission trunking which holds a channel for
up to 20 seconds of "hang time" after a transmission is terminated to allow for
a reply. In December 1997, the Company completed the design of a trunked LMR
system known as "LTR-Net(TM)," which uses its LTR(R) trunking system in a
wide-area configuration, allowing linked communications over a much larger
geographic area than a single trunked system while also providing a much needed
array of user security functions
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 (i) the low cost of point to
multi-point communications, (ii) flexibility of networking and (iii) support and
responsiveness of the Company and its dealers.
Public Safety and Other Government Users
The Company serves public safety and other government users primarily with
its APCO 16 Multi-Net(TM) analog and APCO 25 digital product lines. The APCO 16
Multi-Net(TM) was built upon the success of the E.F. Johnson LTR(R) trunking
protocol. 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 users, such as (i) emergency queuing,
(ii) over 8,000 unique identification codes, (iii) automatic subscriber
identification (iv) five levels of priority access and (v) simulcast. The
Company provides a broad line of Multi-Net(TM)products, including repeaters,
radio network terminals, system management modules, duplex subscriber units,
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 APCO 25 compliant "dual-mode" digital radios are compatible and fully
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 LMR complying with the APCO 25 "common air
interface" standard and also featuring advanced core scrambling and digital
encryption technologies. All of the Company's APCO 25 radios contain as standard
features voice scrambling and/or digital encryption technology. The Company
believes that such backward compatibility with Motorola's APCO 16 trunking
technology will provide early adopters of the APCO 25 standard, such as the
federal government and many public safety agencies, with the ability to purchase
new equipment without replacing entire older systems.
PRODUCTS UNDER DEVELOPMENT
Consistent with the Company's development efforts for its existing
products, the Company designs new products around common core scrambling and
encryption technologies using common signal processing platforms and circuitry.
Using this approach, the Company has generally been able to incorporate improve-
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ments 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 its 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.
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 for sockets in certain Motorola radios. From time to time, the Company
also has under development a number of custom security modules, including those
incorporating custom encryption and scrambling algorithms.
Wireless Communications
The Company plans to introduce in 1998 additional models of its hand-held
digital LMRs containing different features, as well as a line of mobile digital
LMRs, all of which are intended to comply with the APCO 25 standard. The Company
also plans to introduce additional mobile radio models that transmit in analog
format (e.g., APCO 16 and conventional LMRs) for the existing analog market,
which can be upgraded to complete APCO 25 functionality. All of these radios
will contain as standard features voice scrambling and/or digital encryption
technology. These radios will be compatible and fully interoperable with older
analog LMRs, and some of the radios will offer compatibility with Motorola's
proprietary analog APCO 16 trunking technology (SmartNet(TM)/SmartZone(TM)) and
Motorola's digital encryption algorithms.
CUSTOMERS
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. Purchasers of the Company's
information security and wireless communications 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. No customer accounted for more then 10% of the Company's revenues
during 1997, except Modern Scientific and Electric Corporation ("Moseco") of the
Kingdom of Saudi Arabia. Moseco purchased approximately $4.4 million of wireless
system products as the prime contractor for Aramco Inc. of Suadi Arabia.
SALES AND MARKETING
The following discussion summarizes the Company's current sales and
marketing approaches for its different products:
Information Security
The Company sells its add-on products domestically primarily to
distributors, 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. International sales
accounted for approximately 38.1% and 53.9% of the Company's revenues in 1997
and 1996, respectively. See "-- Summary of Business Considerations and Certain
Factors That May Affect Future Results of Operations and/or Stock Price -- Risks
Associated with International Sales."
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The Company distributes its add-on information security products to both
(i) end-users in the LMR and telephony markets and (ii) distributors, such as
LMR dealers, that resell these products to end-users. Currently, the Company
sells self-branded, complete, analog secure cellular telephone 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, technical articles, white paper
publication, periodic newsletters, training and presentation material, and
distribution of demonstration and loaner equipment, which are sometimes
coordinated with product launches and trade shows.
Wireless Communications
The Company's sales and marketing functions for LMR systems focus on (i)
the North American market and (ii) the international market. For North American
sales, the Company uses a direct sales force of account executives and sales
managers, who sell Company products primarily (i) in the APCO market and (ii) to
larger dealers, 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.
LTR(R) and conventional LMR products are sold in North America primarily to
an extensive network of approximately 600 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 a network of approximately 100 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.
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. The issuer of the Company's
bonds has recently indicated that it may, following its review of the restated
financial statements, reduce the maximum amount of bonding coverage available to
the Company. Further, the Company is experiencing problems with the completion
of systems contracts for certain E.F. Johnson projects begun prior to the
Company's acquisition of E.F. Johnson. Although the Company is working to
correct these system problems, no assurance can be given that it will be
successful. Even if the Company is successful in correcting these problems, the
Company will incur costs associated with correcting the systems for which there
may be no corresponding revenues. Further, if the customer for the 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.
Further, such an event or the need for the Company to incur substantial costs to
correct the system contract problems being experienced could materially
adversely affect the Company's business, financial condition, results of
operations, liquidity and cash flows. See "-- Summary of Business
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Considerations and Certain Factors That May Affect Future Results of Operations
And/or Stock Price -- Systems Contract Problems."
CUSTOMER SERVICE
For the Transcrypt product line, the Company provides toll-free telephone
access for customers with technical or other problems. Product training includes
classes, seminars and video programs offered at 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 2,000 OEM products, including
almost all commercially available two-way radio models sold worldwide. For the
E.F. Johnson product line, the Company's customer service group provides
worldwide 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, seminars and video programs
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
The Company depends to a large extent on a number of significant
relationships with Motorola. Motorola has been a large customer of the Company
since 1994. The sales to Motorola during 1997 consisted primarily of
Motorola-labeled LMR socket scrambling modules available for resale by Motorola
as an accessory to certain of Motorola's portable LMRs sold worldwide.
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. Furthermore, pursuant to a product sales agreement
executed in June 1996, Motorola has agreed to sell to the Company, upon the
Company's request, original equipment cellular telephones and related
accessories from Motorola's MicroTAC(TM) line, including StarTAC(TM) telephones,
which the Company resells equipped with its DSP-based encryption devices and
labeled with the Transcrypt logo. This agreement with Motorola specifies fixed
prices for purchases of such equipment, and its original term expired on
December 31, 1997, after which either party may terminate the agreement upon 30
days' prior notice. The Company may also purchase from Motorola base stations,
repeaters and other LMR infrastructure components in order to fulfill systems
contracts requiring compatibility with these devices.
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 APCO 25 compliant LMR products. The IPR License
includes rights to use Motorola's proprietary analog APCO 16 trunking technology
(SmartNet(TM)), APCO 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 APCO 25 compliant digital LMRs. This license covered
infrastructure and other APCO 25
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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.
In addition to the direct benefits of the IPR License to the Company's APCO
25 development efforts, the Company believes that sales of its APCO 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 APCO 25 marketplace. Motorola is the largest manufacturer of APCO
25 compliant LMR products and has been the principal public supporter of the
APCO 25 digital transmission standard for the LMR market. Any reduction in such
support could lead to reduced demand for APCO 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 which cover software
containing algorithms for frequency hopping, scrambling and signaling
technologies for LMR and cellular telephony, and one domestic patent, which
covers continuous synchronization methods used in analog scrambling products.
Transcrypt has been granted five 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 18 additional
domestic patents in this area. These patents and patent applications were the
result of Transcrypt's expanded intellectual property program, which is intended
to enhance the patent protection afforded the Company's new and advanced
intellectual property rights. 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
21 U.S. patents, 10 pending applications for U.S. patents, 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. Furthermore,
the Company designs its information security devices to make the underlying
software and processes difficult to reverse engineer, providing an additional
level of protection.
RESEARCH AND DEVELOPMENT
As of June 30, 1998, the Company had a research and development staff of
109 individuals, including 87 engineers. The Company organizes research and
development efforts along its two main product lines, (i) information security
and (ii) wireless communications products. As part of the integration of E.F.
Johnson's research and development team with Transcrypt's research and
development efforts, the Company has focused significantly on integrating
technologies in order to offer new advanced products by taking advantage of the
competencies of each of the engineering staffs of Transcrypt and E.F. Johnson.
For example, the combined staffs are working on projects to integrate digital
signal processing technology into the E.F. Johnson radios to make them
interoperable with Multi-Net(TM), SmartNet(TM) and APCO 25. Other integration
work underway relates to the incorporation of Transcrypt's encryption technology
into E.F. Johnson radio products.
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. Since 1995, the Company's research and development efforts have
increased significantly, and it has expanded development of secure telephony and
data products. In order to facilitate the Company's new product line development
plans, research and development staffing has been
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increased during 1997 with additional expertise in the areas of data networking,
cryptography and digital signal processing.
Wireless Communications
The Company's wireless communications research and development organization
have expertise in RF technology, computer architecture, switch architecture,
networking, software and hardware designs. Ongoing engineering efforts are
focused on adding advanced 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
and mobile radios for the Company's principal product lines. The Company also
has a staff of systems applications design, manufacturing and customer service
engineers that focuses on design and implementation of custom radio systems.
MANUFACTURING
The Company's manufacturing operation generally consists of the procurement
of commercially available (i) subassemblies, (ii) parts and (iii) 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 all 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 APCO 25 compliant products, at its Waseca, Minnesota facility. The
Company manufactures all of its information security products and many of its
wireless communications circuit boards at its facility in Lincoln, Nebraska. The
Company is currently evaluating alternative manufacturing strategies to reduce
costs and improve efficiencies.
MATERIALS AND 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 signalling 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 RF 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."
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 all components and subassemblies in a timely manner from
existing sources. Currently, Motorola is the sole supplier of a majority 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 B&I market have been
manufactured by Icom Japan ("ICOM") under contract by the Company. Products
produced by Icom have included hand-held portable
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radios that operate in both conventional and trunked mode and more recently,
mobile units as well. In general, new products produced by Icom for the Company
have been jointly developed by the Company and Icom. 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 B&I customers. Icom has recently
requested that the Company supply a letter of credit before products are shipped
to the Company. See "-- Summary of Business Considerations and Certain Factors
That May Affect Future Results of Operations and/or Stock Price -- Effects of
Recent Developments on the Company's Business."
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."
GOVERNMENT REGULATION AND EXPORT CONTROLS
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. Although to date the
Company has been able to secure most required U.S. export licenses, including
for export to approximately 113 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.
In November 1996, President Clinton issued an Executive Order (the
"Executive Order") altering the federal government's policies governing the
export of encryption products, such as those currently offered and proposed to
be offered by the Company. The Executive Order shifts jurisdiction for export
controls and licensing relating to encryption technology from the Department of
State to the Department of Commerce and removes from the "munitions" list most
encryption products. In addition, the Executive Order establishes a key
management control program, under which a third-party would hold "keys" to
unlock encrypted information for legitimate law enforcement and national
security needs. As a result of the Executive Order, certain products featuring
digital encryption technology that had not previously been exportable can now be
exported. This development may increase competition for international sales of
the Company's analog scrambling products. Under interim regulations adopted in
December 1996 by the Department of Commerce, during a two-year transition
period, non-key recoverable 56-bit digital encryption products may be approved
for export if the manufacturer (i) commits to build and market key recovery
products and support key management infrastructure in the future and (ii)
provides to the government interim reports detailing internal development
efforts.
Since December 1996, the Department of Commerce has been preparing draft
proposed final regulations similar to the interim regulations. Industry
opposition to the approach taken by the interim regulations has substantially
delayed the issuance of a proposed draft, which has not been issued to date.
Recently, Secretary of Commerce William Daley expressed serious concerns about
U.S. encryption policy and urged the various concerning parties to find a
compromise. Since making these comments, Secretary Daley has engaged an
interagency group in an effort to resolve the issue. But substantial industry
opposition to the "key recovery" approach and Clinton Administration concerns
about national security continue to delay the regulations. While pending
lawsuits have questioned the constitutionality of the Commerce Department
regulation, it is unclear what impact, if any, these suits will have on
commercial encryption exports when the cases are resolved. The United States
Court of Appeals for the Ninth Circuit is currently considering an appeal from
an
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April 1996 decision in which U.S. District Court Judge Marilyn Patel found that
the Commerce Department's export controls on encryption source code and software
were an unconstitutional prior restraint on free speech. The effect of a Ninth
Circuit ruling is likely to be limited, however, as the case involved export of
software that constituted academic speech, which generally receives more
protection than commercial speech. The commercial speech standard would likely
be applied to the export of commercial encryption software. It is uncertain when
this case will be resolved. If the Ninth Circuit upholds Judge Patel's opinion,
the U.S. Government is expected to appeal to the Supreme Court.
In response to industry opposition to the President's Executive Order and
the interim regulations, Members of Congress have taken aggressive steps to
further expand exports of encryption products. In the 105th Congress, Members of
the House of Representatives and Senate introduced legislation to eliminate
"key" controls the Administration imposes on encryption exports. In the House,
legislation eliminating the "key" recovery system and other controls may be
considered, but opposition form key Members has to date, prevented the bill from
coming to the House Floor. The House bill would lift many remaining controls on
encryption exports, including the Administration's "key" management requirement.
President Clinton opposes the House legislation and similar measures introduced
in the Senate, on the grounds that the bill's provisions eliminating the key
recovery system would seriously compromise national security, among other
things, and may veto the measure if enacted.
In the Senate, Sen. John Ashcroft recently introduced a bill to the
Judiciary Committee designed to revise the Administration's encryption
technology export policy, but less drastically than the House bill. Under the
terms of the Ashcroft bill, entitled the "Encryption Protects the Rights of
Individuals from Violations and Abuse in Cyberspace (E-PROVACY) Act" exporters
would be able to sell more powerful encryption products than those allowed under
the interim regulations. The bill would establish an Encryption Export Advisory
Board comprised of industry and governmental representatives that would consider
applications for license exceptions for encryption products based on the
availability of comparable encryption products outside the United States. After
making a determination, the Board is required to notify the Secretary of
Commerce, who shall specifically approve or disapprove each determination of the
Board within 30 days of submittal. A decision of disapproval by the Secretary of
the Board's determination shall be subject to judicial review pursuant to the
provisions of the Administrative Procedures Act. Management cannot predict
whether any legislation easing 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.
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 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.
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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.
E.F. Johnson also offers products in bands below 800 MHz where channels are
shared by multiple users in the same geographic area. 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.
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. As part of this process, the FCC is
reviewing the current use of the public safety wireless spectrum, reallocation
of additional spectrum for public safety use, and use of commercial service
providers for additional public safety capacity. This FCC process could affect
products manufactured by the Company. Management cannot predict the outcome of
the FCC review or any specific changes in the spectrum or FCC policies, or any
potential effect on the Company's sales.
COMPETITION
Information Security
The markets for information security products are highly competitive.
Significant competitive factors in these markets include product quality and
performance, including (i) the effectiveness of security features, (ii) the
quality of the resulting voice or data signal, (iii) the development of new
products and features, (iv) price, (v) name recognition and (vi) 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 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).
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As of June 30, 1998, the Company and Motorola are believed to be the only
current suppliers of APCO 25 LMR products. However, a number of companies are
actively developing APCO 25 compliant products and have displayed working
prototypes. Companies which have announced or are anticipated to announce the
availability of APCO 25 compliant products or digital LMRs include Kenwood,
Racal Communications, Relm Communications, ADI, AMP, Ericsson, Garmin Industries
and Midland Systems.
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.
Wireless Communications
In North America, Motorola, Kenwood and 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 specialized radio systems in North
America. However, the Company's share of this market is relatively small in
comparison to sales by Motorola and 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. 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, the Company's
competitors include Motorola, Ericsson, Uniden America Corporation ("Uniden"),
Kenwood U.S.A. Corp., ICOM America, Inc. 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.
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. The Company does not believe that its backlog figures are indicative
of actual sales of products in future periods.
EMPLOYEES
At December 31, 1997, the Company had 464 full-time equivalent employees,
including 114 at its Lincoln, Nebraska facility, 313 at its Waseca, Minnesota
facility, 11 at its Burnsville, Minnesota sales office and approximately 26
field sales people, sales managers or staff located in the sales territories in
which they serve. As of June 30, 1998, the Company had 494 full-time equivalent
employees. The Company also uses temporary employees when necessary to manage
fluctuations in demand. None of the Company's employees are covered by a
collective bargaining agreement.
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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 recent restatement of its financial statements and other recent events
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 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 thirteen 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. Certain of the complaints also name one or more
officers of the Company as additional defendants. See "ITEM 3. LEGAL
PROCEEDINGS." The Company may also in the future be the subject of additional
lawsuits or claims in connection with the events or facts surrounding the
restatement of its financial statements. In addition, the Company may be
required to indemnify its directors and officers for judgments rendered against
them in connection therewith. 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.
Although these complaints do not allege the amount of damages and other
relief that the plaintiffs are seeking, the Company believes the amount of
damages ultimately sought by the plaintiffs will be significant. In light of the
Company's restatement of financial information contained in its various
registration statements and prospectuses, the Company believes that there may be
an unfavorable outcome for at least some of the claims asserted in the lawsuits
or which may be asserted in the future against the Company. The Company believes
that the stockholder class actions are more likely to settle than proceed to
trial, judgment and appeal. Given the circumstances of these cases, the terms of
a settlement would be structured in a manner to avoid causing the Company to
seek protection under the federal bankruptcy reorganization laws. In any
circumstances where the Company could not structure a settlement of all claims
within its financial resources, it would vigorously defend any attempt to
establish the amount of liability or to require payment beyond its resources.
The Company has directors' and officers' liability insurance that may cover a
portion of the legal fees incurred and certain of the damages sought in
connection with the class action lawsuits. Many factors will ultimately affect
and determine the results of the litigation however, and the Company can provide
no assurances that the outcome will not have a significant adverse effect on the
Company's business, financial condition, liquidity, results of operations and
cash flows.
The pending litigation, SEC investigation and any future litigation against
the Company and its officers or directors, regardless of outcome, has resulted,
and will continue to result, in substantial costs and expenses to the Company
for legal and related assistance. Accordingly, any such pending or future
litigation could have a material adverse effect on the Company, regardless of
the outcome of the litigation.
SEC Investigation
In April 1998, the 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. While it is not possible at this time
to determine whether the SEC is likely to initiate proceedings against the
Company or the outcome of the SEC's investigation, the SEC has the authority to
impose a variety of sanctions against the Company
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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 Recent Developments on the Company's Business
The restatement of the Company's financial statements, class action
lawsuits, SEC investigation and other recent events have had an adverse impact
on the Company's financial condition, results of operations, liquidity and cash
flows. During the quarter ended June 30, 1998, the Company experienced declining
revenues which it is anticipated will be between $13 and $14 million and
incurred substantial costs primarily in connection with the audit of the
Company's financial statements and legal fees relating to the restatements, the
class action lawsuits, the SEC investigation and the previously announced Audit
Committee investigation. As a result primarily of the foregoing, the Company
expects to report a loss of between $3.0 million and $5.0 million in the second
quarter of 1998.
These events have had, to varying degrees, an adverse impact on the
Company's relationships with its vendors and customers. A company that
manufactures radios under contract for the Company has required the Company to
supply a letter of credit before radios are shipped to the Company. The Company
did not enter into any new domestic systems contracts during the second quarter
of 1998. In addition, in connection with the bidding requirements on systems
contracts with governmental agencies, the bidding procedures often include the
posting of bonds. The issuer of the Company's bonds has indicated that it may,
following its review of the Company's restated financial statements, reduce the
maximum amount of bonding coverage available to the Company. On May 21, 1998,
the Company's line of credit with U.S. Bank was amended to include additional
collateral of $10.0 million of time certificates of deposit. On July 8, 1998,
U.S. Bank agreed to waive the Company's violations of the credit facility
arising out of the Company's failure to timely provide financial statements,
meet certain financial covenants and provide monthly borrowing base
certificates. U.S. Bank also agreed to amend the Company's credit line by
reducing the Company's required tangible net worth amount to $55 million from
$70 million.
Because of the uncertainties resulting from the restatement and other
recent events, the Company is also evaluating all of its product lines, and
looking at various initiatives to reduce operating expenses in order to keep
them in line with revenues. Implementation of any plan resulting from these
initiatives may result at some future date in substantial up front cost.
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 financial condition, results of operations, liquidity
and cash flows.
Systems Contract Problems
The Company is experiencing problems with the completion of systems
contracts for certain E.F. Johnson projects begun prior to the Company's
acquisition of E.F. Johnson. Although the Company is working to correct these
system problems, no assurance can be given that it will be successful. Even if
the Company is successful in correcting these problems, the Company will incur
costs associated with correcting the systems for which there may be no
corresponding revenues. Further, if the customer for the 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. Further, such an event or
the need for the Company to incur substantial costs to correct the system
contract problems being experienced could materially adversely affect the
Company's business, financial condition, results of operations, liquidity and
cash flows.
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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 25 compliant products or digital LMRs. See
"-- Competition." Many 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 (i) it
will be able to continue to compete effectively in its markets, (ii) competition
will not intensify or (iii) future competition will not have a material adverse
effect on the Company. In addition, 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 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 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 Ericsson. In addition to providing equipment to the industry,
Motorola is one of the largest SMR operators in the United States. Motorola,
Kenwood, and 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. Certain of the Company's competitors, including
Motorola and 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 (i) may involve the acquisition or
merger of some of the significant manufacturers of these types of products and
(ii) 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, particularly in light of its acquisition of E.F. Johnson. This
perception could impact Motorola's willingness to do business with the Company.
Although the Company has certain contractual relationships with Motorola, both
as a customer and a supplier, 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 Company believes that the LMR and cellular telephone markets are
migrating from analog to digital equipment. This migration is primarily due to
bandwidth capacity constraints 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 25. However, the Company cannot assure
that it will be able to effect this transition on a
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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
some delay in the marketplace acceptance of digital LMR communications
standards, and this delay may result in decreased sales of the Company's APCO 25
products. A significant delay in the marketplace acceptance of digital LMR
communications standards could result in a significant decrease in sales of the
Company's APCO 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.
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. As
a result of recent developments affecting the Company, the Company may not have,
either currently or in the future, adequate capital resources to respond to
these changes. See "-- Recent Developments."
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 products that comply with the APCO 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."
A recent technological development in the digital LMR industry has been 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 would be required to make a
substantial investment of capital and human resources, which resources may not
be available to the Company. 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 1997 and 1996, international sales constituted approximately 38.1% and
53.9% of revenues, respectively. International sales are subject to a number of
risks not found in domestic sales. These risks include (i) unexpected changes in
regulatory requirements, (ii) tariffs and other trade barriers, (iii) political
and economic instability in foreign markets, (iv) difficulties in establishing
foreign distribution channels, (v) longer payment cycles, (vi) uncertainty in
the collection of accounts receivable, (vii) increased costs associated with
maintaining international marketing efforts and (viii) 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 being currently experienced in Asia, could result in lower revenues for
the Company.
Some of the Company's products, particularly in the information security
area, are subject to export controls under U.S. law, which in most cases
requires the approval of the Department of Commerce in order
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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. President Clinton issued an Executive Order removing most
encryption products from the "munitions" list and transferring jurisdiction over
the export of such products from the Department of State to the Department of
Commerce. The Executive Order allows the export of products featuring digital
encryption technology that previously could not be exported, which may increase
competition for international sales of the Company's restricted analog
scrambling products. In addition, recent legislative actions in the U.S.
Congress may further ease export controls over digital encryption devices. See
"-- Government Regulation and Export Controls." The Company cannot predict the
impact of these factors on the international market for its products.
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 purchase through
dealers, 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 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.
These bidding procedures often include the posting of bonds. The issuer of the
Company's bonds has recently indicated that it may, following its review of the
restated financial statements, reduce the maximum amount of bonding coverage
available to the Company. Further, the Company is experiencing problems with the
completion of systems contracts for certain E.F. Johnson projects begun prior to
the Company's acquisition of E.F. Johnson. Any inability by the Company to
obtain requisite bonds would prevent it from bidding on LMR systems contracts,
which could have a material adverse effect on the Company. See "-- Systems
Contract Problems."
Dependence on Key Personnel
The Company's success depends to a significant extent upon a number of key
employees. The loss of the services of one or more of these key employees or the
Company's inability to attract and retain other qualified employees could have a
material adverse effect on the Company. 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 cannot assure that it will be successful in attracting,
motivating or retaining such personnel.
Effective May 31, 1998, Jeffery L. Fuller resigned as President, CEO and
Director of the Company. On June 8, 1998, the Company announced that the Board
of Directors had appointed a committee to identify a CEO of the Company and that
John T. Connor, who serves as Chairman of the Board, had been appointed as
interim CEO. Mr. Connor accepted appointment as interim CEO until the earlier of
September 8, 1998 or the hiring of a permanent CEO. Mr. Connor has indicated
that if a permanent CEO is not hired by such date, he will discuss with the
Board of Directors the possibility of staying on for a longer time.
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. The
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Company's inability to obtain key components could result in lost sales, the
need to maintain excessive inventory levels and higher component costs, 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 revenues and net income 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 data encryption products are subject to
regulation by United States and foreign laws and international treaties. The
regulatory environment is inherently 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 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.
Although the Company has not to date suffered any material adverse effects
in complying with applicable environmental laws, 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
(i) copyright
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and trade secret law and (ii) 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."
ITEM 2. PROPERTIES
The Company occupies a 43,500 square foot two-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 owns
this facility and approximately 10 acres of surrounding land. The Company has
begun Phase 3 construction of additional administrative facilities at its
Lincoln, Nebraska campus totaling approximately 33,000 square feet. On January
28, 1998, the Company purchased the 250,000 square-foot manufacturing facility
located on a 20-acre site in Waseca, Minnesota. The Company also leases
additional sales and service facilities in Burnsville, Minnesota, Miami,
Florida, and Hong Kong.
ITEM 3. LEGAL PROCEEDINGS
The Company has been named as a defendant in thirteen 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 also name one or more officers of the Company 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 complaints generally allege claims under 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 complaints seek unspecified
compensatory damages, punitive damages, attorneys' fees and costs. The federal
actions have recently been consolidated. The Company is not required to answer
or otherwise respond to the federal complaints until a consolidated complaint is
filed.
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.
Although the complaints described above do not allege the amount of damages
and other relief that the plaintiffs are seeking, the Company believes the
amount of damages ultimately sought by the plaintiffs will be significant. In
light of the Company's restatement of financial information contained in its
various registration statements and prospectuses, the Company believes that
there may be an unfavorable outcome for at least some of the claims asserted in
the lawsuits or which may be asserted in the future against the Company. The
Company believes that the stockholder class actions are more likely to settle
than proceed to trial, judgment and appeal. Given the circumstances of these
cases, the terms of a settlement would be structured in a manner to avoid
causing the Company to seek protection under the federal bankruptcy
reorganization laws. In any circumstances where the Company could not structure
a settlement of all claims within its financial resources, it would vigorously
defend any attempt to establish the amount of liability or to require payment
beyond its resources. The Company has directors' and officers' liability
insurance that may cover a portion of the legal fees incurred and certain of the
damages sought in connection with the class action lawsuits. Many factors will
ultimately affect and determine the results of the litigation however, and the
Company can provide no
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assurances that the outcome will not have a significant adverse effect on the
Company's business, financial condition, results of operations and cash flows.
In April 1998, the 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. At the present time, the Company is
unable to predict whether the SEC is likely to initiate proceedings against the
Company or its affiliated parties relating to these events.
During 1997, on the basis of product orders placed with the Company by
federal personnel within the Maryland Procurement Office ("MPO"), which acts as
the purchasing arm for various federal agencies in the Washington DC area, the
Company shipped approximately $2.2 million of encrypted radio equipment and
related items to MPO. MPO has taken the position that the person placing the
orders on behalf of MPO was not authorized to do so, and therefore, has refused
payment. In March 1998, the Company filed a certified contract claim for
payment. Alternatively, the Company has requested ratification, by which MPO
would treat the procurement as an authorized commitment. To date, MPO has
rejected ratification. The contract claim is pending, and the Company is unable
to predict whether the likelihood of a favorable final outcome is probable or
remote.
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 a vote of the Company's stockholders during
the fourth quarter of 1997.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
From the completion of the Company's initial public offering on January 22,
1997 through May 11, 1998, the Company's Common Stock was quoted on The Nasdaq
Stock Market as a National Market issue 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 Nasdaq for the periods presented. As
of July 22, 1998, the Company had 155 stockholders of record.
1997 HIGH LOW
---- ------- -------
Fourth Quarter........................... $26.00 $ 20.125
Third Quarter............................ $21.75 $ 10.00
Second Quarter........................... $14.75 $ 6.75
First Quarter............................ $10.063 $ 7.00
Based on its review of recent events regarding the Company and the
Company's failure to timely file its periodic reports and audited financial
statements for the 1997 fiscal year, 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. The Company has appealed the delisting. The Company
intends that, if it is unsuccessful in its appeal, it will reapply to have its
Common Stock listed on The Nasdaq Stock Market. However, no assurance can be
given as to the Company's ability to obtain a listing for the Common Stock.
The last sale price of the Common Stock on July 23, 1998, as reported in
the non-Nasdaq over the counter market, was $5.25.
If the Common Stock were neither relisted on the Nasdaq National Market
System nor listed for trading on the Nasdaq Small-Cap Market, trading, if any,
in the Common Stock might be conducted on the OTC Bulletin Board or may continue
to be conducted in the non-Nasdaq over the counter market. However, if the
Company is not able to list the Common Stock on any Nasdaq market, it may
materially adversely affect the trading market and prices for the Common Stock
and the Company's ability to issue additional securities or to secure additional
financing.
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.
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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, 1997, 1996 and 1995 and the Consolidated Balance
Sheet data as of December 31, 1997 and 1996 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
December 31, 1994 and 1993 and the Consolidated Balance Sheet data as of
December 31, 1995, 1994, and 1993 are derived from financial statements not
included herein.
The Company restated its previously released results for the three months
and year ended December 31, 1997, the Company's financial statements as of and
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. See Notes 2 and 21 of Notes to Consolidated
Financial Statements. The restatements relate primarily to: (i) revenue
recognition for certain sales for which collection was determined to not be
reasonably assured or was contingent on a future event, (ii) revenue recognition
for certain sales where a formal written agreement was not received, (iii)
revenue recognized on sales of certain products which were subsequently returned
to the Company, (iv) application of the percentage of completion method on
system contract sales at E.F. Johnson and (v) the allocation of the purchase
price of the acquisition of E.F. Johnson.
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1993 1994 1995 1996 1997(6)
------ ------ ---------- ---------- -----------
(RESTATED) (RESTATED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues................................... $6,900 $9,155 $ 8,128 $ 10,619 $ 40,423
Cost of sales.............................. 1,616 2,901 2,983 4,274 26,106
------ ------ ---------- ---------- -----------
Gross profit............................... 5,284 6,254 5,145 6,345 14,317
------ ------ ---------- ---------- -----------
Operating costs and expenses:
Research and development................. 1,138 1,180 1,953 2,234 4,469
Sales and marketing...................... 982 1,590 2,109 2,187 7,031
General and administrative(1)............ 2,243 2,166 2,284 2,529 4,711
Special compensation expense(2).......... -- -- -- 5,568 --
In-process research and development
costs(3).............................. -- -- -- -- 9,828
------ ------ ---------- ---------- -----------
Total operating costs and
expenses....................... 4,363 4,936 6,346 12,518 26,039
------ ------ ---------- ---------- -----------
Income (loss) from operations.............. 921 1,318 (1,201) (6,173) (11,722)
Interest income (expense), net............. (133) (111) (137) (131) 231
Other income............................... -- -- -- -- 18
Benefit for income taxes................... -- -- -- (2,186) (524)
------ ------ ---------- ---------- -----------
Net income (loss).......................... $ 788 $1,207 $ (1,338) $ (4,118) $ (10,949)
====== ====== ========== ========== ===========
Loss before pro forma taxes................ $ (1,338) $ (6,304) $ (11,473)
Pro forma and provision (benefit) for
taxes(4)................................. (496) (2,190) (524)
---------- ---------- -----------
Pro forma net loss......................... $ (842) $ (4,114) $ (10,949)
========== ========== ===========
Pro forma net loss per share(5) -- Basic
and Diluted.............................. $ (0.12) $ (0.61) $ (1.09)
========== ========== ===========
Weighted average common shares -- Basic and
Diluted(5)............................... 6,783,078 6,783,078 10,056,690
========== ========== ===========
27
28
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1993 1994 1995 1996 1997(6)
------ ------ ---------- ---------- -----------
(RESTATED) (RESTATED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
CONSOLIDATED BALANCE SHEET DATA:
Working capital............................ $1,726 $3,353 $ 1,684 $ 1,844 $ 44,836
Total assets............................... $7,908 $9,627 $ 7,523 $ 11,938 $ 106,694
Long-term debt and capitalized lease
obligations, net of current portion...... $2,035 $2,164 $ 1,847 $ 2,632 $ 2,758
Stockholders' equity....................... $4,599 $5,945 $ 3,907 $ 4,966 $ 75,390
- ---------------
(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 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) 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.
(5) 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 income (loss) per share.
(6) Statement of Operations Data reflect the operations of E.F. Johnson since
the date of its acquisition on July 31, 1997.
28
29
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 began operations in 1978 to manufacture and distribute embedded
voice privacy and specialized signaling add-on devices for LMR users. In
December 1991, an investor group led by John T. Connor, the Company's current
Chairman and interim CEO, acquired substantially all of the assets of the
Company and certain intellectual property rights held by the Company's founders,
creating intangible assets of approximately $5.5 million, which the Company
amortized on a straight-line basis over a 60-month period ending November 30,
1996. Following the acquisition, management took steps to diversify the
Company's product lines and further exploit its core competencies in information
security technologies.
In order to take advantage of the growing demand for digital
communications, in 1993 the Company began investing in digital product and
technology research and development. In September 1994, the Company began
developing an APCO 25 compliant hand-held digital LMR. In connection with the
development of this new product, the Company hired additional technical
personnel and, in September 1994, the Company raised $1.0 million through the
sale of equity to its existing equityholders. As a result of these efforts, the
Company introduced many voice and data security products, including a digital
landline telephone encryptor in October 1995 and an APCO 25 compliant digital
hand-held radio in August 1996.
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 connection with the Company's acquisition of E.F. Johnson, the Company
recorded intangible assets totaling $18.0 million at closing, which are being
amortized on a straight-line basis over periods of 5 to 15 years beginning in
August 1997. Also, as a result of the acquisition, the Company's interest
expense in 1997 increased because of E.F. Johnson's debt of approximately $15.7
million which the Company retired with the proceeds from its secondary stock
offering in October 1997. The Company also incurred a write-off in the third
quarter of 1997 of in-process research and development costs acquired in
connection with the acquisition of E.F. Johnson totaling approximately $9.8
million.
RESTATEMENT AND RECENT EVENTS
On February 6, 1998, the Company issued a press release announcing its
consolidated financial results for 1997. Subsequently, it was determined to be
necessary to restate the Company's previously released results for the three
months and year ended December 31, 1997, the Company's financial statements as
of and 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 restatements relate primarily to: (i) revenue recognition for certain
sales for which collection was determined to not be reasonably assured or was
contingent on a future event, (ii) revenue recognition for certain sales where a
formal written agreement was not received, (iii) revenue recognized on sales of
certain products which were subsequently returned to the Company, (iv)
application of the percentage of completion method on system contract sales at
E.F. Johnson and (v) the allocation of the purchase price of the
29
30
acquisition of E.F. Johnson. As a result, the financial statements of the
Company have been restated from amounts previously reported.
A summary of the significant changes as of December 31, 1997 and 1996 and
for the years then ended is set forth in Note 2 of Notes to Consolidated
Financial Statements. A summary of the significant quarterly changes during the
years ended December 31, 1997 and 1996 is set forth in Note 21 of Notes to
Consolidated Financial Statements.
The restatement of the Company's financial statements, class action
lawsuits, SEC investigation and other recent events, have had an adverse impact
on the Company's financial condition, results of operations, liquidity and cash
flows. During the quarter ended June 30, 1998, the Company experienced declining
revenues which it is anticipated will be between $13 and $14 million and
incurred substantial costs primarily in connection with the audit of the
financial statements and legal fees relating to the restatements, the class
action lawsuits, the SEC investigation and the previously announced Audit
Committee investigation. As a result primarily of the foregoing, the Company
expects to report a loss of between $3.0 million and $5.0 million in the second
quarter of 1998.
These events have had, to varying degrees, an adverse impact on the
Company's relationships with its vendors and customers. A company that
manufactures radios under contract for the Company has required the Company to
supply a letter of credit before radios are shipped to the Company. The Company
did not enter into any new domestic systems contracts during the second quarter
of 1998. In addition, in connection with the bidding requirements on systems
contracts with governmental agencies, the bidding procedures often include the
posting of bonds. The issuer of the Company's bonds has indicated that it may,
following its review of the Company's restated financial statements, reduce the
maximum amount of bonding coverage available to the Company. On May 21, 1998,
the line of credit with U.S. Bank was amended to include additional collateral
of $10.0 million of time certificates of deposit. On July 8, 1998, U.S. Bank
agreed to waive the Company's violations of the credit facility arising out of
the Company's failure to timely provide financial statements, meet certain
financial covenants and provide monthly borrowing base certificates. U.S. Bank
also agreed to amend the credit line by reducing the Company's required tangible
net worth amount to $55 million from $70 million.
Because of the uncertainties resulting from the restatement and other
recent events, the Company is also evaluating all of its product lines, and
looking at various initiatives to reduce operating expenses in order to keep
them in line with revenues. Implementation of any plan resulting from these
initiatives may result at some future date in substantial up front cost.
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 financial condition, results of operations, liquidity
and cash flows.
30
31
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,
---------------------------------
1995 1996 1997
----- ---------- ----------
(RESTATED) (RESTATED)
Revenues.............................................. 100.0% 100.0% 100.0%
Cost of sales......................................... 36.7% 40.2% 64.6%
----- ----- -----
Gross profit.......................................... 63.3% 59.8% 35.4%
----- ----- -----
Operating costs and expenses:
Research and development............................ 24.0% 21.0% 11.1%
Sales and marketing................................. 26.0% 20.6% 17.4%
General and administrative.......................... 28.1% 23.8% 11.7%
Special compensation expense........................ -- 52.4% --
In-process research and development costs........... -- -- 24.3%
----- ----- -----
Total operating costs and expenses.......... 78.1% 117.9% 64.4%
----- ----- -----
Loss from operations.................................. (14.8)% (58.1)% (29.0)%
Interest income (expense), net........................ (1.7)% (1.2)% 0.6%
Other income.......................................... -- -- --
Benefit for income taxes.............................. (20.6)% (1.3)%
----- ----- -----
Net loss.............................................. (16.5)% (38.8)% (27.1)%
===== ===== =====
Loss before pro forma income taxes.................... (16.5)% (59.4)% (28.4)%
Pro forma benefit for income taxes.................... (6.1)% (20.6)% (1.3)%
----- ----- -----
Pro forma net loss.................................... (10.4)% (38.8)% (27.1)%
===== ===== =====
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 advanced payment received for products to be
sold to a former division of EFJ. The advance payment was negotiated as part of
the sale agreement of the division by EFJ. The advanced payment is recognized as
revenue is earned.
Revenues increased 280.7% to $40.4 million in 1997 from $10.6 million in
1996. This increase 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 and recent events, sales of products,
including LMR systems to governmental agencies, are expected to be adversely
impacted during 1998. Although the Company
31
32
had revenues of $22.0 million in the first quarter of 1998, it expects revenues
to decline to between $12 and $13.5 million in the second quarter of 1998.
The Company is experiencing problems with the completion of systems
contracts for certain E.F. Johnson projects begun prior to the Company's
acquisition of E.F. Johnson. Although the Company is working to correct these
system problems, no assurance can be given that it will be successful. Even if
the Company is successful in correcting these problems, the Company will incur
costs associated with correcting the systems for which there may be no
corresponding revenues. Further, if the customer for the 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 materially adversely affect the
Company's ability to bid on new system contracts in the future. Further, such an
event or the need for the Company to incur substantial costs to correct the
system contract problems being experienced could materially adversely affect the
Company's business, financial condition, results of operations, liquidity and
cash flows.
Revenues increased to $10.6 million in 1996 from $8.1 million in 1995. This
increase was attributable primarily to revenues in 1996 associated with several
large new sales contracts, including the commencement of shipments of socket
scramblers to Motorola. The Company also began shipment of its first stand-alone
radio and cellular products in September 1996, which contributed to the increase
in 1996 revenues. In addition, revenues for 1995 were negatively impacted due to
management conflicts over the future direction and control of the Company, which
led to a management restructuring commencing in the second quarter of 1995 and
resulted in the departure of five senior executive officers.
International sales as a percentage of revenues in 1997 were 38.1%,
compared to 53.9% in 1996. The decline in 1997 is primarily due to the inclusion
of E.F. Johnson, which has a larger percentage of its sales to domestic markets.
International sales as a percentage of revenues were 71.4% in 1995. The
proportion of international sales in 1995 reflects large sales to Egypt and
Turkey and lower domestic sales. As a result of the troubled Asian economies,
the Company expects a decline in revenues from the region during 1998 as
compared to 1997.
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 increased to $14.3 million
(35.4% gross margin) in 1997, compared to $6.3 million (59.8% gross margin) in
1996. The decrease in gross margin percentage from 1996 to 1997 was
predominantly due to the addition of E.F. Johnson's revenues beginning in August
1997, which generally carry a lower gross margin compared to Transcrypt's
historical margins and inventory obsolescence which was charged to cost of goods
sold for products returned by a customer which was not sellable to other
customers. Future gross margins are likely to vary in the future based
predominantly upon the mix of product sales comprising revenues for that period.
Gross profit increased to $6.3 million in 1996 from $5.1 million in 1995.
Gross margin decreased to 59.8% in 1996 from 63.3% in 1995. The Company began
shipment of its first stand-alone products in September 1996, which generally
have lower gross margins than add-on products.
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 increased 100.0% to $4.5 million in 1997 from $2.2 million in 1996 due
to the addition of E.F. Johnson and an increase in the members of the
engineering staff. However, research and development expenses as a percentage of
sales decreased to 11.1% in 1997, compared to 21.0% in 1996, due to increased
revenues in 1997. The information security and wireless communications product
markets in which the
32
33
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. As a result
of the restatement of its financial statements and recent events, the Company
may not have, either currently or in the future, adequate capital resources to
respond to these changes.
Research and development expenses increased to $2.2 million in 1996 from
$2.0 million in 1995. This increase was due primarily to expenses related to the
continued development of the Company's APCO 25 digital LMRs and the related
development of internal manufacturing capabilities for certain radio components.
Research and development expenses as a percentage of revenues decreased to 21.0%
in 1996 from 24.0% in 1995, due to greater revenues in 1996.
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, bad debt provisions and trade show
participation. Sales and marketing expenses increased 221.5% to $7.0 million, or
17.4% of sales, in 1997, compared to $2.2 million, or 20.6% of sales, in 1996.
The increase in 1997 was due primarily to the acquisition of E.F. Johnson and an
increase in the number of direct sales personnel and associated expenses and
increased participation in advertising and trade shows.
Sales and marketing expenses increased slightly to $2.2 million in 1996
from $2.1 million in 1995, although the expense figure for 1995 includes
severance payments and recruiting and relocation costs for new sales executives
related to the Company's management restructuring. Sales and marketing expenses
decreased as a percentage of revenues to 20.6% in 1996 from 26.0% in 1995, due
primarily to the increase in revenues in 1996.
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 increased
86.3% to $4.7 million in 1997, compared to $2.5 million in 1996. The increase
was attributable primarily to the addition of E.F. Johnson and several
administrative employees and costs associated with becoming, and maintaining its
status as, a publicly held company in 1997. General and administrative expenses
as a percentage of revenues declined to 11.7% in 1997, compared to 23.8% in
1996, primarily as a result of the increased revenues during 1997.
General and administrative expenses increased to $2.5 million in 1996 from
$2.3 million in 1995. This increase was attributable primarily to salaries,
recruiting and relocation expenses associated with hiring several key management
employees.
The Company expects that general and administrative expenses will increase
substantially in 1998, in part, as a result of the first full year of
amortization of the intangibles resulting from the acquisition of E.F. Johnson.
In addition, general and administrative expenses will increase in the second
quarter of 1998 primarily due to legal and other professional fees relating to
the restatement, class action lawsuits, SEC investigation and the previously
announced Audit Committee investigation.
33
34
Special Compensation Expense
In September 1996, the Company incurred 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
Company at a weighted average exercise price of $1.81 per share, and a special
compensation expense of $210,000 payable to the Company's Chief Executive
Officer for services rendered related to the original purchase in 1991.
In-process Research and Development Costs
The Company incurred a write-off in the third quarter of 1997 totaling
approximately $9.8 million of in-process research and development costs acquired
in the acquisition of E.F. Johnson. This write-off was recognized as the
technological feasibility of such in-process technology had not yet been
established and the technology had no alternative future use.
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 $231,000 in
1997, compared to a $131,000 net interest expense in 1996. The increase in net
interest income in 1997 is attributable to the repayment of certain debt during
1997 and an increase in interest income due to investment of a portion of the
net proceeds from the Company's initial and secondary public offerings in
interest-bearing instruments. Net interest expense in 1995 was $137,000. With
the increase of bank debt in 1998 and the declining balance of cash and cash
equivalents, interest income will decline while interest expense will increase
on a quarterly basis over amounts experienced by the Company in the fourth
quarter ended December 31, 1997.
Provision for Income Taxes
Prior to June 1996, Transcrypt was organized as a partnership, and
therefore was not subject to income taxation except to the extent that its
earnings were attributed to its partners. Transcrypt converted from a
partnership to a "C" corporation effective June 30, 1996. Pro forma net loss and
pro forma net loss per share calculations reflect a pro forma benefit for income
taxes as if the Company had been taxed as a "C" corporation in the first six
months of 1996. The Company's benefit for income taxes for 1997 was $524,000
compared to a pro forma benefit for income taxes of $2.2 million for the year
ended 1996. The Company's benefit for income taxes for the year ended December
31, 1996 primarily resulted from a deferred tax benefit of $1.8 million in
connection with the stock option related special compensation expense of $5.4
million. The Company's effective tax rate was 33.7% in 1997, excluding the $9.8
million write-off of in-process research and development costs, which was not a
tax deductible item. The acquisition of E.F. Johnson resulted in an addition of
$5.1 million in deferred tax assets.
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
(i) ten percent of the purchase price of new equipment, (ii) a refund of sales
taxes (currently at a rate of 6.0%) paid on purchases of new equipment during
each year, and (iii) 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 expected 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.
34
35
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, 1997. 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.
QUARTER ENDED
--------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1996 1996 1996 1996 1997 1997
--------- -------- ------------- ------------ --------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(AS RESTATED, SEE NOTE 21 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS)
Revenues.................... $2,442 $2,577 $ 2,617 $2,983 $3,512 $ 2,915
Cost of sales............... 880 903 998 1,493 1,272 2,289
------ ------ ------- ------ ------ -------
Gross profit................ 1,562 1,674 1,619 1,490 2,240 626
------ ------ ------- ------ ------ -------
Operating costs and
expenses:
Research and development.... 436 649 602 547 633 683
Sales and marketing......... 469 404 681 633 942 731
General and
administrative(1)......... 626 615 695 593 572 651
Special compensation
expense(2)................ -- -- 5,568 -- -- --
In-process research and
development costs(3)...... -- -- -- -- -- --
------ ------ ------- ------ ------ -------
Total operating costs and
expenses................ 1,531 1,668 7,546 1,773 2,147 2,065
------ ------ ------- ------ ------ -------
Income (loss) from
operations................ 31 6 (5,927) (283) 93 (1,439)
Interest (expense) income
and other income, net..... (19) (31) (29) (52) 76 159
Provision (benefit) for
income taxes (4).......... -- -- (2,051) (135) 27 (490)
------ ------ ------- ------ ------ -------
Net income (loss)........... $ 12 $ (25) $(3,905) $ (200) $ 142 $ (790)
====== ====== ======= ====== ====== =======
Income (loss) before income
taxes..................... $ 12 $ (25) $(5,956) $ (335) $ 169 $(1,280)
Pro forma provision(benefit)
for income taxes.......... 5 (9) (2,051) (135) 27 (490)
------ ------ ------- ------ ------ -------
Pro forma net income
(loss)(4)................. $ 7 $ (16) $(3,905) $ (200) $ 142 $ (790)
====== ====== ======= ====== ====== =======
Pro forma net income (loss)
per share(5)
Basic..................... -- -- $ (0.58) $(0.03) $ 0.02 $ (0.09)
====== ====== ======= ====== ====== =======
Diluted................... -- -- $ (0.58) $(0.03) $ 0.02 $ (0.09)
====== ====== ======= ====== ====== =======
Weighted average common
shares(5)
Basic..................... 6,783 6,783 6,783 6,783 8,700 9,283
====== ====== ======= ====== ====== =======
Diluted................... 7,325 6,783 6,783 6,783 9,282 9,283
====== ====== ======= ====== ====== =======
As a Percentage of Revenues
Revenues.................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales............... 36.0 35.0 38.1 50.1 36.2 78.5
------ ------ ------- ------ ------ -------
Gross margin................ 64.0 65.0 61.9 49.9 63.8 21.5
Operating costs and
expenses:
Research and
development............. 17.9 25.1 23.0 18.3 18.0 23.4
Sales and marketing....... 19.2 15.7 26.0 21.2 26.8 25.1
General and
administrative(1)....... 25.6 23.9 26.5 19.8 16.3 22.3
Special compensation
expense(2).............. -- -- 212.8 -- -- --
In-process research and
development costs(3).... -- -- -- -- -- --
------ ------ ------- ------ ------ -------
Total operating costs and
expenses................ 62.7 64.7 288.3 59.4 61.1 70.8
------ ------ ------- ------ ------ -------
Income (loss) from
operations................ 1.3 .2 (226.5) (9.5) 2.6 (49.4)
Interest income (expense)
and other income, net..... (.8) (1.2) (1.1) (1.7) 2.2 5.5
Provision for income
taxes(4).................. -- -- (78.4) (4.5) .8 (16.8)
------ ------ ------- ------ ------ -------
Net income (loss)........... .5% (1.0)% (149.2)% (6.7)% 4.0% (27.1)%
====== ====== ======= ====== ====== =======
QUARTER ENDED
----------------------------
SEPTEMBER 30, DECEMBER 31,
1997 (6) 1997 (6)
------------- ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(AS RESTATED, SEE NOTE 21 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS)
Revenues.................... $ 13,428 $20,568
Cost of sales............... 9,561 12,984
-------- -------
Gross profit................ 3,867 7,584
-------- -------
Operating costs and
expenses:
Research and development.... 1,298 1,855
Sales and marketing......... 2,361 2,997
General and
administrative(1)......... 1,647 1,841
Special compensation
expense(2)................ -- --
In-process research and
development costs(3)...... 9,828 --
-------- -------
Total operating costs and
expenses................ 15,134 6,693
-------- -------
Income (loss) from
operations................ (11,267) 891
Interest (expense) income
and other income, net..... (227) 241
Provision (benefit) for
income taxes (4).......... (468) 407
-------- -------
Net income (loss)........... $(11,026) $ 725
======== =======
Income (loss) before income
taxes..................... $(11,494) $ 1,132
Pro forma provision(benefit)
for income taxes.......... (468) 407
-------- -------
Pro forma net income
(loss)(4)................. $(11,026) $ 725
======== =======
Pro forma net income (loss)
per share(5)
Basic..................... $ (1.12) $ 0.06
======== =======
Diluted................... $ (1.12) $ 0.06
======== =======
Weighted average common
shares(5)
Basic..................... 9,844 12,362
======== =======
Diluted................... 9,844 13,103
======== =======
As a Percentage of Revenues
Revenues.................... 100.0% 100.0%
Cost of sales............... 71.2 63.1
-------- -------
Gross margin................ 28.8 36.9
Operating costs and
expenses:
Research and
development............. 9.7 9.0
Sales and marketing....... 17.6 14.6
General and
administrative(1)....... 12.3 8.9
Special compensation
expense(2).............. -- --
In-process research and
development costs(3).... 73.2 --
-------- -------
Total operating costs and
expenses................ 112.7 32.5
-------- -------
Income (loss) from
operations................ (83.9) 4.3
Interest income (expense)
and other income, net..... (1.7) 1.2
Provision for income
taxes(4).................. (3.5) 2.0
-------- -------
Net income (loss)........... (82.1)% 3.5%
======== =======
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- ---------------
(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 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 Company at a weighted average
exercise price of $1.81 per shares, 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 resulting from
the write-off of in-process research and development costs obtained in the
acquisition of E.F. Johnson.
(4) 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.
(5) 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 net income (loss) per share.
(6) The results of E.F. Johnson are included in the results of operations
beginning July 31, 1997.
- ---------------
The Company historically has experienced, and expects to continue
experiencing, substantial variability in its revenues and profitability from
quarter to quarter. The level of revenues in a particular quarter varies
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 level of revenues in a particular quarter include
acquisitions, such as the acquisition of E.F. Johnson, 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
During 1997, the Company has financed its operations and met its capital
requirements primarily through a combination of short-term borrowings, long-term
debt, an initial public offering completed on January 22, 1997 and a secondary
public offering completed on October 15, 1997. The Company's operating
activities used cash of $18.1 million in 1997 and generated cash of $921,000 in
1996. Cash used in operating activities in 1997 consisted primarily of increases
in accounts receivable and inventory and the reduction of accounts payable.
Approximately $7.2 million of the cash used in the Company's operations was
attributable to the reduction of liabilities incurred due to the E.F. Johnson
acquisition and the buildup of E.F. Johnson's inventory, which E.F. Johnson's
prior management had not maintained at adequate levels due to their cash
position, to meet sales demands. Accounts payable to vendors of E.F. Johnson
amounted to $13.0 million upon the Company's acquisition of E.F. Johnson on July
31, 1997. The Company believes that this level of trade payables was
significantly higher than that historically associated with E.F. Johnson's
business as a result of decisions by E.F. Johnson's prior management to defer
payments to certain vendors. The Company has scheduled out payment terms with
certain of these vendors. Therefore, the Company's net cash flow was negative
for 1997 and may continue to be so in the near future as payables are worked out
and brought to normal levels. Additionally, the Company will incur legal and
professional fees during 1998 related to the restatement, class action lawsuits
and SEC investigation that will adversely impact cash flows. Cash flow may also
be adversely impacted by the uncertainty of sales volumes resulting from the
restatement of the Company's financial statements and recent events.
Cash used for investing activities, attributable primarily to capital
expenditures and purchase of investments in 1997 and capital expenditures and
payments for non-compete agreements in 1996, totaled $20.9 million and $3.0
million, respectively. Capital expenditures consisted primarily of computer and
networking equipment, office furniture and manufacturing equipment for both
years and expenses related to
36
37
the expansion of the Company's Lincoln facility during the second quarter of
1997. In May 1997, the Company completed construction, begun in August 1996, of
the 21,000-square-foot expansion of its existing Lincoln facility, primarily to
accommodate additional manufacturing capacity. The Company began construction
related to a further expansion of its facilities in the fourth quarter of 1997,
and is expecting to complete the expansion in late 1998 at an estimated cost of
approximately $2.6 million of which $177,000 had been paid at December 31, 1997.
The deferred tax assets totaling $8.0 million (which 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) were 7.5% and 10.6% of total assets and stockholders' equity,
respectively, at December 31, 1997. A minimum of approximately $17.7 million of
future taxable income will need to be generated to fully realize the deferred
tax assets and 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, 1997. 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 the valuation allowance as of December 31, 1997 will be allocated to
goodwill. These net operations loss carryforwards expire in 2012. Tax
regulations limit the amount that may be utilized on an annual basis to
approximately $588,000.
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 generated $54.3 million, net and
$1.8 million, net in 1997 and 1996, respectively. 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. As of December 31, 1997,
the Company had approximately $31 million in cash, cash equivalents and
investments remaining from its stock offerings.
The Company had outstanding on its IDR at December 31, 1996 a principal
amount of $850,000, which bore a fixed interest rate of 6.25%, non-amortizing
and was scheduled to mature in January 2004. On March 25, 1997, the $850,000 IDR
and the construction note payable of $870,000 were repaid through the issuance
of a new IDR totaling $2,850,000. The new IDR is due in annual principal
payments of $140,000, plus interest at a variable rate (3.65% at December 31,
1997), from March 1, 1998 through March 1, 2007, increasing to annual principal
payments of $145,000, plus interest at a variable rate, from March 1, 2008
through March 1, 2016, with the remaining principal and accrued interest due on
March 1, 2017. At December 31, 1997, the remaining net proceeds of $496,000 were
held in escrow for the Company pending the completion of the Company's
construction project and related purchases of certain fixed assets.
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. See "-- Revenues." The letters of credit, which expire on various
dates in 1998, have a total undrawn balance of $2.1 million, and bonds which
expire on various dates through 1999, totaling $22.4 million at December 31,
1997.
As a result of the acquisition of E.F. Johnson, E.F. Johnson's revolving
credit line of $10.1 million and term loan of $5.6 million as of July 31, 1997
were reflected as liabilities on the Company's balance sheet. The balances
outstanding on the revolving credit line and term loan were paid off in October
1997 with a portion of the net proceeds of the secondary offering. At December
31, 1997, E.F. Johnson also had a capital lease for land and buildings with a
principal balance of $2.4 million outstanding. Subsequent to December 31, 1997,
the Company liquidated the lease by purchasing the land and buildings for $2.4
million.
As of December 31, 1997, the Company obtained a $10 million line of credit
with U.S. Bank National Association ("U.S. Bank"), collateralized by
substantially all of the assets of the Company. Interest is at a variable rate
and the due date of the credit line is December 31, 1998. The credit line
carries standard restrictive covenants such as limitations on additional
borrowings, capital expenditures, acquisitions, and maintenance of specified
financial ratios. On May 21, 1998, the line of credit with U.S. Bank was amended
to
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38
include additional collateral of $10.0 million in time certificates of deposit.
As of June 30, 1998, the Company had $9.1 million in outstanding indebtedness
under the this line of credit with U.S. Bank. On July 8, 1998, U.S. Bank agreed
to waive the Company's violations of its bank credit facility arising out of the
Company's failure to timely provide financial statements, meet certain financial
covenants and provide monthly borrowing base certificates to U.S. Bank. U.S.
Bank also agreed to amend the credit facility by reducing the Company's required
tangible net worth amount to $55 million from $70 million.
The Company currently intends to retain earnings, if any, and does not
anticipate paying cash dividends in the foreseeable future.
As of June 30, 1998, the Company had approximately $14 million in
unrestricted cash, cash equivalents, and investments, not including the
certificates of deposit securing the U.S. Bank line of credit. The Company
believes that its cash, cash equivalents and lines of credit will probably be
sufficient to meet anticipated cash needs for working capital and capital
expenditures through 1998. However, if sales continue to decline, vendors impose
stricter payment requirements on the Company, bond coverage is reduced, or the
Company incurs substantial cost to correct problems experienced in connection
with completion of systems contracts for a number of E.F. Johnson projects begun
prior to the Company's acquisition of E.F. Johnson, the Company may be required
to seek additional financing or funding sources. No assurance can be given that
the Company will be able to obtain such additional funding or financing or be
able to obtain it 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 several 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 also name one or more officers of the Company 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 complaints generally allege claims under 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 complaints seek unspecified
compensatory damages, punitive damages, attorneys' fees and costs. The federal
actions have recently been consolidated.
Although the complaints described above do not allege the amount of damages
and other relief that the plaintiffs are seeking, the Company believes the
amount of damages ultimately sought by the plaintiffs will be significant. In
light of the Company's restatement of financial information contained in its
various registration statements and prospectuses, the Company believes that
there may be an unfavorable outcome for at least some of the claims asserted in
the lawsuits or which may be asserted in the future against the Company. The
Company believes that the stockholder class actions are more likely to settle
than proceed to trial, judgment and appeal. Given the circumstances of these
cases, the terms of a settlement would be structured in a manner to avoid
causing the Company to seek protection under the federal bankruptcy
reorganization laws. In any circumstances where the Company could not structure
a settlement of all claims within its financial resources, it would vigorously
defend any attempt to establish the amount of liability or to require payment
beyond its resources. The Company has directors' and officers' liability
insurance that may cover a portion of the legal fees incurred and certain of the
damages sought in connection with the class action lawsuits. Many factors will
ultimately affect and determine the results of the litigation however, and the
Company can provide no
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39
assurances that the outcome will not have a significant adverse effect on the
Company's business, financial condition, results of operations and cash flows.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130, Reporting Comprehensive
Income ("SFAS 130"). SFAS 130 establishes standards for reporting and displaying
comprehensive income and its components. Comprehensive income includes net
income and several other items that current accounting standards require to be
recognized outside of net income. SFAS 130 is effective for years beginning
after December 15, 1997. The Company currently has no items that would cause a
differentiation between net income and comprehensive income.
In June 1997, FASB issued Statement of Financial Accounting Standards No.
131, Disclosures about Segments of an Enterprise and Related Information ("SFAS
131"). SFAS 131 requires publicly-held enterprises to report certain information
about their operating segments, to report certain enterprise-wide information
about their products and services, their activities in different geographic
areas, and their reliance on major customers, and to also disclose certain
segment information in their interim financial statements. The basis for
determining an enterprise's operating segments is the manner in which management
operates the business. SFAS 131 is effective for financial statements for
periods beginning after December 31, 1997, however implementation is not
required for interim periods in the first year. The Company is continuing to
assess its reporting requirements under SFAS 131 as to whether or not the
Company has more than one operating segment.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have date-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions or engage in similar
normal business activities.
In order to correct any problems expected to arise as a result of the Year
2000 issue, the Company has supplied software updates for all of its products.
All products currently being shipped by the Company are Year 2000 compliant.
Should a customer use the Company's software with a personal computer that is
not compliant with the year 2000, at that time, the customer may experience
erroneous dates on reports, but should not experience any operational issues.
The Company is in the process of converting its manufacturing and financial
information system to that currently being utilized by its acquired subsidiary,
E.F. Johnson. Once converted, the Company will then upgrade to a newer version
of the same information system or will purchase a separate information system
that will be Year 2000 compliant. The conversion to a Year 2000 compliant system
is anticipated to be completed by mid-year 1999 with the cost estimated to be
between $750,000 and $1.5 million. These expenditures were planned for in an
effort to upgrade the quality of the Company's manufacturing and financial
information system and not as a direct remediation of any Year 2000 issues,
although that will be a valuable by-product of the upgrade. There are other
computerized systems involved in manufacturing and engineering systems. A
preliminary assessment has been made as to what effect, if any, the Year 2000
issue will have on these systems and whether or not there will be a material
effect on future financial results. As of June 30, 1998, no conclusions have
been drawn. Furthermore, the Company has not yet initiated formal communications
with all of its significant suppliers to determine the extent to which the
Company is vulnerable to those third parties' failure to remediate their own
Year 2000 issue.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
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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 (i) Current Report on Form 8-K filed with the SEC on May 4,
1998, (ii) Current Report on Form 8-K filed with the SEC on May 12, 1998 and
(iii) Amendment No. 1 to Current Report on Form 8-K filed with the SEC on May
20, 1998.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
DIRECTORS
The following are the biographies of the Company's current directors.
Effective May 31, 1998, Jeffery L. Fuller, a Class II director, resigned his
positions with the Company.
Class I Directors. The following are the Company's current Class I
directors. Each Class I director was elected at the Company's 1997 annual
meeting of stockholders for terms expiring in 2000:
NAME AND AGE PRINCIPAL OCCUPATION AND BUSINESS EXPERIENCE
------------ --------------------------------------------
Thomas R. Larsen (54).................. Mr. Larsen has served as a director of the Company since
October 1995 and was originally appointed director as a
representative of John Kuijvenhoven and affiliates, which
was formerly a principal stockholder of the Company. Mr.
Larsen has been a certified public accountant since 1975
and is currently President and Chief Executive Officer of
Larsen, Bryant & Porter, CPAs, P.C., a public accounting,
tax and consulting firm. Mr. Larsen is also a director of
Smith Hayes Trust, Inc., a mutual fund management company.
Winston J. Wade (59)................... Mr. Wade has served as a director of the Company since
July 1996. Since December 1996, he has served as Chief
Executive Officer and Chief Operating Officer of
Binariang-Malaysia, a joint venture of U.S. West
International. From February to December 1996, he served
as managing director of BPL U.S. West Cellular in India.
From 1963 to 1996, he held various positions with
Northwestern Bell, AT&T and U.S. West Communications. Mr.
Wade also serves as a director of the University of
Nebraska Foundation, Ameritas Variable Life Insurance
Company and Binariang-Malaysia.
Class II Directors. The following are the Company's current Class II
directors. Each Class II director's term expires in 1998.
NAME AND AGE PRINCIPAL OCCUPATION AND BUSINESS EXPERIENCE
------------ --------------------------------------------
Thomas R. Thomsen (63)................. Mr. Thomsen has served as a director of the Company since
July 1995. Since August 1995, he has served as Chairman of
the Board of Directors and Chief Executive Officer of
Lithium Technology Corporation ("LTC"), a public company
that manufactures rechargeable batteries. Mr. Thomsen has
served as a director of LTC since February 1995. In
January 1990, Mr. Thomsen retired as President of AT&T
Technologies, after holding numerous senior management
positions including director of Sandia Labs, Lucent
Technologies, AT&T Credit Corp. and Oliveti Inc. Mr.
Thomsen also serves as a director of the University of
Nebraska Technology Park.
Thomas C. Smith (53)................... Mr. Smith has served as a director of the Company since
October 1995 and was originally appointed director as a
representative of the Farm Bureau Insurance Company, which
was formerly a principal stockholder of the Company. Since
December 1985, he has been Chairman of the Board of
Directors and President of Consolidated Investment
Corporation, the parent company of Smith Hayes Financial
Services Corporation, a financial services firm, and
Conley Smith Inc., a registered investment advisor. Mr.
Smith is also the President of Smith Hayes Financial
Services Corporation. He is a director of the Nebraska
Research and Development Authority and First Mid-America
Finance Corporation. Mr. Smith is also a director of Smith
Hayes Trust, Inc., a mutual fund management company.
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Class III Directors. The following are the Company's current Class III
directors. Each Class III director was elected at the Company's 1996 annual
meeting of stockholders for terms expiring in 1999:
NAME AND AGE PRINCIPAL OCCUPATION AND BUSINESS EXPERIENCE
------------ --------------------------------------------
John T. Connor (54).................... Mr. Connor led the investor group which purchased the
Company from its founder in 1991. Mr. Connor has served as
the Company's Chairman of the Board of Directors since its
inception in December 1991 through the present. He served
as the Chief Executive Officer from December 1991 through
July 1997 and was reappointed interim CEO in June 1998.
From 1969 to June 1991, he held numerous senior management
positions with Deloitte & Touche LLP, an international
accounting, tax and consulting firm, and its predecessor
firm, Touche Ross & Co., including National Director of
Tax, Associate Managing Partner, Mid-Atlantic Regional
Managing Partner and a member of the management committee
and Board of Directors.
Terry L. Fairfield (49)................ Mr. Fairfield has served as a director of the Company
since December 1991. Since 1987, he has served as
President and Chief Executive Officer of the University of
Nebraska Foundation, a nonprofit corporation. Mr.
Fairfield also serves as a director of Aliant
Communications Inc., a Nasdaq listed, telecommunications
company.
Thomas E. Henning (45)................. Mr. Henning was appointed to serve the remaining term as
director for Harold S. Myers, a former director of the
Company who passed away in December 1996. Mr. Henning
previously served as director of the Company from February
1993 through July 1996. Mr. Henning has, since February
1995, served as President, Chief Executive Officer and
director of The Security Mutual Life Insurance Company, a
life insurance, annuity and pension products company, and
also serves as a director of National Bank of Commerce, a
subsidiary of First Commerce Bancshares, Inc., a
publicly-held, exchange-listed bank holding company. From
March 1990 to February 1995, Mr. Henning served as
President and Chief Operating Officer of The Security
Mutual Life Insurance Company.
DIRECTOR COMPENSATION
Meeting Fees In 1997, the Company paid its non-employee directors a fee of:
- $1,000 for attendance at each Board meeting; and
- $400 for attendance at each committee meeting.
The annual maximum fee per director was $5,000 plus expenses per year.
In January 1998, the Compensation Committee set the fees for directors of
the Board at $1,000 for each Board meeting attended; $500 for each telephonic
Board meeting; and $500 for each committee meeting. In addition, the annual
maximum cap on fees paid to directors was eliminated. In addition, the Company's
directors are eligible to participate in the Company's 1996 Stock Incentive Plan
(the "1996 Stock Incentive Plan").
Expenses and Benefits The Company reimburses all directors for
out-of-pocket and travel expenses incurred in attending Board meetings.
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EXECUTIVE OFFICERS
The following are the biographies of the Company's current executive
officers, except for Mr. Connor, the interim Chief Executive Officer of the
Company, whose biography is included above under "Directors."
NAME AND AGE PRINCIPAL OCCUPATION AND BUSINESS EXPERIENCE
------------ --------------------------------------------
Frederick G. Hamer (55)................ Mr. Hamer joined the Company from E.F. Johnson as Vice
President of International Sales in July 1997. From
October 1992 through June 1995, he served as Vice
President, International for E.F. Johnson. Mr. Hamer
served as Vice President, Sales and Distribution for E.F.
Johnson from March 1983 through October 1992 and June 1995
to January 1996. From January 1997 to July 1997, Mr. Hamer
served as Vice President, Sales and Marketing for E.F.
Johnson. In addition, Mr. Hamer was Vice President of
Sales and Marketing for Dispatch Industries, Inc. from
January 1996 through December 1997.
Craig J. Huffaker (52)................. Mr. Huffaker, a certified public accountant, joined the
Company as Senior Vice President and Chief Financial
Officer in January 1998. From July 1996 to January 1998,
he served as Vice President and Chief Financial Officer of
Tie Communications, Inc., and from August 1994 to April
1996, served as Senior Vice President and Chief Financial
Officer of TSW International, Inc. Mr. Huffaker served as
Senior Vice President and Chief Financial Officer of
Applied Immune Sciences, Inc. from November 1991 to August
1994.
Christopher S. Litras (45)............. Mr. Litras joined the Company as Vice President of Human
Resources in June of 1998. From 1993 to 1998, he served as
Vice President of Human Resources at the Manfield/Dover
Operations and Director of Human Resources and Information
Systems at Eastern Stainless Corporation for ARMCO, Inc.
Prior to joining ARMCO, Inc., he worked for USX
Corporation where he held multiple positions in Human
Resources and Operations from 1975 to 1988.
R. Andrew Massey (29).................. Mr. Massey, an attorney, serves as Corporate Secretary for
the Company. From November 1995 to July 1997, he served as
a legal assistant to the Nebraska Public Service
Commission.
Edgar L. Osborn (45)................... Mr. Osborn joined the Company as Vice President of
Marketing in March of 1998, and in June 1998 he was
appointed interim President of the Company. Mr. Osborn
served as Director of Marketing and Sales and later as
Vice President of Westinghouse Industry Products
International Company, Inc. for Westinghouse Electric
Corporation from 1995 to March 1998. From 1992 to 1995, he
held numerous positions with Harris Corporation, a
manufacturer and developer of wireless communications.
From 1990 to 1992, he served as Market Manager for
Ericsson General Electric.
Michael P. Wallace (37)................ Mr. Wallace joined the Company as Vice President of
Operations in February 1994. From December 1989 to
February 1994, he served as the Electric Card Assembly and
Test Engineering Manager of Scientific Atlanta Inc., a
manufacturer and distributor of broadband communications
products.
Joel K. Young (33)..................... Mr. Young joined the Company as Vice President of
Engineering in February 1996 and was appointed Vice
President of Marketing and Engineering in June 1997. From
1986 to January 1996, he held numerous positions with
AT&T, the former AT&T Bell Laboratories and
telecommunications research companies, and specialized in
signaling, network implementation and voice processing. He
served most recently as District Manager, AT&T Business
Communication Services. Mr. Young has been awarded five
patents on various telecommunications systems and
techniques.
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COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES AND EXCHANGE ACT OF 1934
Section 16(a) of the Exchange Act requires the Company's directors,
executive officers, and greater-than-10% stockholders to file reports with the
SEC and The Nasdaq Stock Market reflecting changes in their beneficial ownership
of Company Common Stock and to provide the Company with copies of the reports.
Based on the Company's review of these reports and of certifications furnished
to the Company, except for Frederick G. Hamer and Glenn P. Oorlog, each of whom
filed one late report involving their initial statement of beneficial ownership
of Common Stock on Form 3, and Thomas E. Henning and Thomas C. Smith, each of
whom filed one late report involving the purchase of Common Stock on Form 4, the
Company believes that all of these reporting persons complied with their filing
requirements for 1997.
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ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table shows the compensation paid during the last three
fiscal years to the two individuals who served as the Chief Executive Officer
("CEO") of the Company during 1997 and the other individuals who were serving as
executive officers of the Company at the end of 1997 and who received salary and
bonus at a rate in excess of $100,000 during 1997 (collectively, the "Named
Executive Officers"). No other executive officer received salary and bonus in
excess of $100,000 during 1997.
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
-------------------------------------- ------------
OTHER ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS ANNUAL OPTIONS # COMPENSATION(1)
- --------------------------- ---- -------- -------- -------- ------------ ---------------
John T. Connor(2).......... 1997 $196,539 $ 40,000 $ -- -- $ 6,864
Chairman of the Board 1996 172,885 50,000 210,000(3) -- 8,716
and interim CEO 1995 169,808 86,830 -- -- 4,760
Jeffery L. Fuller(2)....... 1997 $182,308 $ 53,000 $ -- 125,000 $ 9,006
Former President, CEO, 1996 156,923 35,000 -- -- 1,440
Chief Operating Officer 1995 66,346(4) 14,840 -- 163,829 25,066
and Director
C. Eric Baumann(5)......... 1997 $109,438 $ 2,000 $ 75,813(7) 20,000 $ 3,000
Former Vice President of 1996 103,000 2,000 58,254(7) 32,766 14,705
Sales and Distribution 1995 15,054(6) 3,168 154(7) -- --
Joel K. Young.............. 1997 $107,885 $ 14,573 -- 20,000 $ 3,000
Vice President 1996 88,461(8) 2,000 -- 32,766 36,852
of Engineering 1995 N/A
Michael P. Wallace......... 1997 $107,403 $ 23,375 -- 20,000 $13,623
Vice President of 1996 N/A
Operations 1995 N/A
Frederick G. Hamer......... 1997 $ 62,000(9) $113,742 -- 20,000 $ 6,793
Vice President of 1996 N/A
International Sales 1995 N/A
- ---------------
(1) Represents contributions to the Company's 401(k) Profit Sharing & Savings
Plan, moving allowances and personal use of Company-owned automobiles.
(2) Mr. Connor served as CEO through July 1997 and Mr. Fuller served as
President and Chief Operating Officer through July 1997. In July 1997, Mr.
Fuller became CEO of the Company and served as President and CEO through May
31, 1998. Effective May 31, 1998, Mr. Fuller resigned from all positions
with the Company. In June 1998, Mr. Connor was appointed interim CEO of the
Company.
(3) Represents remaining amount due to Mr. Connor for deferred fees payable
under his employment contract.
(4) Represents salary at the rate of $150,000 per year beginning in July 1995.
(5) Mr. Baumann resigned from all positions with the Company effective May 31,
1998.
(6) Represents salary at the rate of $103,000 per year beginning in November
1995.
(7) Represents sales commissions Mr. Baumann earned.
(8) Represents salary at the rate of $100,000 per year beginning in February
1996.
(9) Represents salary at the rate of $150,000 per year beginning in August 1997.
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The following table sets forth information concerning stock options granted
to the Named Executive Officers during 1997.
OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS POTENTIAL REALIZABLE VALUE
----------------------------------------------------------- AT ASSUMED ANNUAL RATES
NUMBER OF PERCENT OF OF STOCK PRICE
SECURITIES TOTAL OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO OPTION TERM(2)
OPTIONS EMPLOYEES EXPIRATION --------------------------
NAME GRANTED(1) IN 1997 EXERCISE PRICE DATE 5% 10%
---- ---------- ------------- -------------- ---------- ----------- -----------
John T. Connor....... N/A N/A N/A N/A N/A N/A
Jeffery L. Fuller.... 125,000(3) 27.2%(3) $ 8.00 9/30/99(3) $ 20,500(3) $ 42,000(3)
C. Eric Baumann...... 20,000(3) 4.4%(3) $ 8.00 3/31/99(3) $ 3,280(3) $ 6,720(3)
Frederick G. Hamer... 25,000 5.4% $11.375 7/31/07 $ 78,842 $453,221
Michael P. Wallace... 20,000 4.4% $ 8.00 1/22/07 $100,623 $254,999
Joel K. Young........ 20,000 4.4% $ 8.00 1/22/07 $100,623 $254,999
- ---------------
(1) Options vest 20% per year, at the end of each year, for five years
commencing on the date of grant. Options were granted pursuant to the terms
of the 1996 Stock Incentive Plan.
(2) The amounts shown are hypothetical gains based on the indicated assumed
rates of appreciation of the Common Stock, compounded annually from the date
of grant to the expiration date and assuming that the closing price was the
market value of the Common Stock on the date of grant. The actual value (if
any) that an executive officer receives from a stock option will depend upon
the amount by which the market price of the Company's Common Stock exceeds
the exercise price of the option on the date of exercise. The Company cannot
assure that the Common Stock will appreciate at any particular rate or at
all in future years.
(3) In connection with a Severance Agreement and Mutual Release entered into
between the Company and each of Messrs. Fuller and Baumann, only that
portion of the options vested as of May 31, 1998 (which was 25,000 shares
for Mr. Fuller and 4,000 shares for Mr. Baumann) remain outstanding. Such
options expire on September 30, 1999 for Mr. Fuller and March 31, 1999 for
Mr. Baumann. The potential realizable value at assumed annual rates of stock
appreciation for option terms for Messrs. Fuller and Baumann is based upon
25,000 and 4,000 shares, respectively. See "-- Employment Agreements."
The following table sets forth the number and value of stock options held
by the Named Executive Officers at December 31, 1997.
FISCAL YEAR-END OPTION VALUE TABLE
VALUE OF UNEXERCISED
NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS
SHARES OPTIONS AT YEAR-END AT YEAR-END(1)
ACQUIRED VALUE --------------------------- ---------------------------
NAME ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ---------- ----------- ------------- ----------- -------------
John T. Connor............ 95,000 $1,747,050 294,257 -- $7,096,008 $ --
Jeffery L. Fuller(2)...... 30,000 $ 538,500 133,829 125,000 $2,917,788 $2,109,375
C. Eric Baumann(2)........ 5,000 $ 89,750 27,766 20,000 $ 600,929 $ 337,500
Frederick G. Hamer........ -- -- -- 25,000 -- $ 337,500
Michael P. Wallace........ 5,000 $ 89,750 27,766 20,000 $ 605,993 $ 337,500
Joel K. Young............. 5,000 $ 89,750 27,766 20,000 $ 605,993 $ 337,500
- ---------------
(1) Solely for purposes of this table, the fair market value per share of Common
Stock is assumed to be $24.875, the closing price of the Common Stock on the
Nasdaq National Market on December 31, 1997. The Common Stock currently
trades in the non-Nasdaq over the counter market. The last sale price of the
Common Stock on July 23, 1998, as reported in the non-Nasdaq over the
counter market was $5.25.
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(2) The number of options held by Messrs. Fuller and Baumann were adjusted
subsequent to year-end pursuant to a Severance Agreement and Mutual Release
entered into between the Company and each of Messrs. Fuller and Baumann. See
"-- Employment Agreements."
EMPLOYMENT AGREEMENTS
The Company entered into an employment agreement with John T. Connor, its
Chairman and interim CEO, for a term beginning on July 23, 1997 and ending
December 31, 1999. The agreement sets forth a base salary of $200,000 per year
and provides for a quarterly bonus of (i) 20% of his salary if the Company meets
or exceeds quarterly sales goals and (ii) 20% of his salary if the Company meets
or exceeds quarterly profit goals, which goals are based upon Board-approved
plans. The agreement provides for certain benefits to Mr. Connor, including paid
vacations, pension benefits, qualified profit-sharing plans, employee group
insurance and disability insurance. The agreement includes a Noncompete
Agreement, which is effective during the term of the agreement. On January 29,
1997, the Board of Directors and Mr. Connor eliminated Mr. Connor's quarterly
bonus provisions based on the Company sales and profitability goals effective
August 1, 1997.
The Company entered into an employment agreement with Jeffery L. Fuller,
the Company's former President and CEO, for a term beginning July 31, 1997 and
ending on December 31, 1999. Mr. Fuller's employment was terminated effective
May 31, 1998, pursuant to a Severance Agreement and Mutual Release dated June 2,
1998, described further below. The employment agreement set forth a base salary
of $200,000 per year and provided for an annual bonus in an amount to be
determined by the Board of Directors, provided the Company met or exceeded
certain performance objectives provided to the Board of Directors. Mr. Fuller
was entitled, at a minimum, to receive a bonus of 20% of his quarterly salary if
the Company met or exceeded its quarterly sales goals and 20% of his quarterly
salary if the Company met or exceeded its quarterly profit goals. The agreement
also provided for certain benefits to Mr. Fuller, including paid vacations,
pension benefits, qualified profit-sharing plans, employee group insurance and
disability insurance. The agreement includes a Noncompete Agreement, effective
during the term of the agreement. On January 29, 1998, the Board of Directors
increased Mr. Fuller's base annual salary to $235,000 effective January 1, 1998.
On July 29, 1997, the Company entered into an employment agreement with
Frederick G. Hamer, Vice President of International Sales. Mr. Hamer's
employment agreement sets forth a base salary of $150,000 and provides for
commission payments based on sales if the Company achieves its quarterly plans.
Under the agreement, Mr. Hamer will receive a one-time payment of $100,000 if
(i) Transcrypt terminates his employment before July 31, 1998 for any reason
other than cause or (ii) he continues to be employed with Transcrypt on July 31,
1998. The agreement also provides for certain benefits, including paid
vacations, pension benefits, qualified profit-sharing plans, employee group
insurance and disability insurance. This agreement expires on July 31, 1998. Mr.
Hamer has entered into a Noncompete Agreement effective during the term of the
employment agreement.
On September 30, 1996, the Company entered into employment agreements with
Michael P. Wallace and Joel K. Young, each of whom is a Company Vice President,
and C. Eric Baumann, who was a Company Vice President until his resignation
effective May 31, 1998. The agreements set forth base salaries and provide for
annual bonuses to be determined by the Board of Directors, and provide for
certain benefits, including paid vacations, pension benefits, qualified
profit-sharing plans, employee group insurance and disability insurance. The
term of each such agreement continues for two years, unless otherwise terminated
according to the terms of the agreements. Each of these individuals has entered
into a Noncompete Agreement effective during the term of each individual's
employment agreement.
In connection with their resignation from the Company, Messrs. Baumann and
Fuller each entered into a Severance Agreement and Mutual Release with the
Company effective May 31, 1998. The agreements provide compensation to Mr.
Fuller of approximately $333,785 and to Mr. Baumann of $158,756, less applicable
payroll taxes, for all unpaid monetary compensation for the period of June 1,
1998 through September 30, 1999 and June 1, 1998 through March 31, 1999,
respectively. Messrs. Fuller and Baumann will
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also receive the same medical, dental, disability and life insurance benefits
which each has received from the Company in the past until the earlier to occur
of September 30, 1999 for Mr. Fuller and March 31, 1999 for Mr. Baumann or each
individual's procurement of employment elsewhere. The severance agreements set
forth that no additional shares of Common Stock held by Messrs. Fuller and
Baumann pursuant to stock options shall vest or become vested after May 31,
1998. Any vested stock options held by Messrs. Fuller and Baumann which are not
exercised on or before September 30, 1999 or March 31, 1999, respectively, shall
expire. The agreements also provide that the Indemnification Agreements
previously entered into between each of Messrs. Fuller and Baumann and the
Company shall remain in full force and effect, subject to certain modifications.
The agreements also include provisions concerning (i) non-competition and
non-solicitation for the period ending September 30, 1999 for Mr. Fuller and
March 31, 1999 for Mr. Baumann, (ii) unauthorized disclosure of certain trade
secrets or confidential information, and (iii) mutual releases of certain
claims.
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table shows, as of July 23, 1998, all persons the Company
knows to be "beneficial owners" of more than five percent of the Company's
Common Stock. With the exception of information about John and Janice Connor,
this information is based on Schedules 13D and 13G reports filed with the SEC by
each of the individuals and firms listed in the table below.
NUMBER OF SHARES PERCENT OF
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED CLASS(1)
------------------------------------ ------------------ ----------
John T. Connor(2)................................. 1,501,528 11.6%
4800 NW 1st Street
Lincoln, Nebraska 68521
Franklin Advisers, Inc.(3)........................ 1,327,900 10.3
777 Mariners Island Boulevard
San Mateo, California 94404
Janice K. Connor(4)............................... 1,207,271 9.3
4800 NW 1st Street
Lincoln, Nebraska 68512
University of Nebraska Foundation................. 661,622 5.1
1111 Lincoln Mall, Suite 200
Lincoln, Nebraska 68508
- ---------------
(1) Shares of Common Stock issuable upon exercise of stock options currently
exercisable, or exercisable within 60 days after July 23, 1998, are
considered outstanding for purposes of computing the percentage of the
person or entity holding those options but are not considered outstanding
for computing the percentage of any other person or entity. The Company
considers the 217,542 shares of its non-voting common stock held by First
Commerce Bancshares, Inc. outstanding for computing the percentage each
person or entity owns.
(2) Includes 294,257 shares which are issuable upon the exercise of stock
options that are exercisable within 60 days of July 23, 1998. Of the
1,501,528 shares, Mr. Connor shares voting and investment power of 1,207,271
shares with his wife, Janice K. Connor. Mr. Connor disclaims beneficial
ownership of 490,258 shares held by Mrs. Connor and 97,980 shares held by or
in trust for other members of the Connor family.
(3) Franklin Advisers, Inc. beneficially owns these shares through one or more
open or closed-end investment companies or other managed accounts. Franklin
Advisers advises these accounts under advisory contracts that grant it
investment and/or voting power over the Transcrypt shares that the accounts
hold. Franklin Advisers is a wholly-owned subsidiary of Franklin Resources,
Inc. Charles B. Johnson and Rupert H. Johnson, Jr. each own in excess of 10%
of the outstanding common stock of Franklin Resources and are the principal
shareholders of Franklin Resources. The shares which Franklin Advisers
beneficially owns do not include 7,310 shares beneficially owned by Franklin
Management, Inc., a subsidiary of Franklin Resources. Franklin Advisers,
Franklin Resources, Charles B. Johnson and Rupert H. Johnson, Jr. disclaim
beneficial ownership of the Transcrypt shares attributed to Franklin
Advisers in this Annual Report on Form 10-K.
(4) Mrs. Connor shares voting and investment power of these shares with her
husband, John T. Connor. Mrs. Connor disclaims beneficial ownership of
619,033 shares held by Mr. Connor and 97,980 shares held by or in trust for
other members of the Connor family.
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The following table shows, as of June 30, 1998, the Common Stock that the
Company's directors and Named Executive Officers beneficially own, and those
shares of Common Stock owned by all executive officers and directors as a group.
NUMBER OF SHARES PERCENT OF
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED CLASS(1)
------------------------ ------------------ ----------
John T. Connor(2)................................. 1,501,528 11.3%
Jeffery L. Fuller(3).............................. 158,829 *
C. Eric Baumann(3)................................ 31,766 *
Michael P. Wallace(3)............................. 31,766 *
Joel K. Young(3).................................. 31,766 *
Thomas R. Thomsen(4).............................. 7,553 *
Winston J. Wade(3)(5)............................. 6,553 *
Thomas E. Henning(6).............................. 8,000 *
Thomas C. Smith(7)................................ 2,800 *
Terry L. Fairfield(3)(8).......................... 1,000 *
Thomas R. Larsen(3)............................... 1,000 *
Frederick G. Hamer................................ 0 *
All executive officers and directors as a group
(16 persons).................................... 1,782,561 13.5%
- ---------------
* Less than 1%
(1) Shares of Common Stock issuable upon exercise of stock options currently
exercisable, or exercisable within 60 days of June 30, 1998, are considered
outstanding for computing the percentage of the person or entity holding
those options but are not considered outstanding for computing the
percentage of any other person or entity. The Company considers the 217,542
shares of its non-voting common stock held by First Commerce Bancshares,
Inc. outstanding for computing the percentage each person or entity owns.
Except as indicated by footnote, and subject to community property laws
where applicable, the persons named in the table above have sole voting and
investment power, if any, with respect to all shares of Common Stock each
beneficially owns.
(2) Includes 294,257 shares which are issuable upon the exercise of stock
options that are exercisable within 60 days of June 30, 1998. Of the
1,501,528 shares, Mr. Connor shares voting and investment power of 1,207,271
shares with his wife, Janice K. Connor. Mr. Connor disclaims beneficial
ownership of 490,258 shares held by Mrs. Connor and 97,980 shares held by or
in trust for other members of the Connor family.
(3) Consists solely of shares issuable upon the exercise of stock options that
are exercisable within 60 days of June 30, 1998.
(4) Includes 6,553 shares issuable upon the exercise of stock options that are
exercisable within 60 days of June 30, 1998.
(5) Does not include shares held by the University of Nebraska Foundation, of
which Mr. Wade serves as director.
(6) Includes 1,000 shares issuable upon the exercise of stock options that are
exercisable within 60 days of June 30, 1998. Does not include shares held by
The Security Mutual Life Insurance Company, of which Mr. Henning serves as
President, CEO and director.
(7) Includes 1,000 shares issuable upon the exercise of stock options that are
exercisable within 60 days of June 30, 1998.
(8) Does not include shares held by the University of Nebraska Foundation, of
which Mr. Fairfield serves as President and CEO.
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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None of the members of the Company's Compensation Committee is or has been
an officer or employee of Transcrypt. In 1991 the Company entered into an
agreement with Connor Enterprises for investment banking services. During fiscal
1997, the Company paid Connor Enterprises $210,000 earned in 1996 for the
services performed in 1991. Mr. Connor is the President of Connor Enterprises.
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.
1. FINANCIAL STATEMENTS AND SCHEDULES
PAGE NO.
--------
Independent Auditors' Report................................ F-1
Consolidated Balance Sheets as of December 31, 1997 and
1996........................................................ F-2
Consolidated Statements of Operation for the Years ended
December 31, 1997, 1996 and 1995............................ F-3
Consolidated Statements of Changes in Stockholders' Equity
for the Years ended December 31, 1997, 1996 and 1995........ F-4
Consolidated Statements of Cash Flows for the Years ended
December 31, 1997, 1996 and 1995............................ F-5
Notes to Consolidated Financial Statements.................. F-6 to F-28
2. FINANCIAL STATEMENT SCHEDULES
Independent Auditors' Report................................ S-1
Schedule III -- Valuation and Qualifying Accounts and
Reserves.................................................... S-2
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
(i) 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. Employment Agreement between the Company and John T. Connor dated as of
July 31, 1997 (incorporated herein by reference to Exhibit 10.1.1 to the
Company's Registrant Statement on Form S-1, No. 333-35469, declared
effective on October 15, 1997).
2. Employment Agreement between the Company and Jeffery L. Fuller dated as
of July 31, 1997 (incorporated herein by reference to Exhibit 10.2.1 to
the Company's Registration Statement on Form S-1, No. 333-35469,
declared effective on October 15, 1997).
3. Form of Employment Agreement between the Company and C. Eric Baumann,
Michael P. Wallace and Joel K. Young (incorporated herein by reference
to Exhibit 10.3 to the Company's Registration Statement on Form S-1, No.
333-14351, declared effective on January 22, 1997).
4. Employment Agreement between the Company and Frederick G. Hamer dated as
of July 29, 1997 (Exhibit 10.3.1 below).
5. Transcrypt International, Inc. 1996 Stock Incentive Plan, as amended
(Exhibit 10.4 below).
6. 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).
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7. Severance Agreement and Mutual Release between the Company and Jeffery
L. Fuller dated June 2, 1998 (Exhibit 10.39 below).
8. Severance Agreement and Mutual Release between the Company and Charles
E. Baumann dated June 2, 1998 (Exhibit 10.40 below).
(ii) 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 Registration
Statement on Form S-1, No. 333-14351, declared effective on
January 22, 1997 (hereinafter the "January 1997 Registration
Statement")).
3.2 Amended and Restated Bylaws of the Company (incorporated
herein by reference to Exhibit 3.2 to 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 RESERVED
10.1.1 Employment Agreement between the Company and John T. Connor
dated as of July 31, 1997 (incorporated herein by reference
to Exhibit 10.1.1 to the Company's Registration Statement on
Form S-1, No. 333-35469, declared effective October 15, 1997
(hereinafter the "October 1997 Registration Statement")).
10.2 RESERVED
10.2.1 Employment Agreement between the Company and Jeffery L.
Fuller dated as of July 31, 1997 (incorporated herein by
reference to Exhibit 10.2.1 to the October 1997 Registration
Statement).
10.3 Form of Employment Agreement between the Company and C. Eric
Baumann, Michael P. Wallace and Joel K. Young (incorporated
herein by reference to Exhibit 10.3 to the January 1997
Registration Statement).
10.3.1 Employment Agreement between the Company and Frederick G.
Hamer dated as of July 29, 1997.
10.4 Transcrypt International, Inc. 1996 Stock Incentive Plan, as
amended.
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).
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EXHIBIT
NUMBER DESCRIPTION
-------- -----------
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).
10.10* Private Label/Supplier Agreement for Analog Scrambling
Modules between Motorola, Inc. and the Company dated as of
August 8, 1995 (incorporated herein by reference to Exhibit
10.10 to the January 1997 Registration Statement).
10.10.1* Second Amendment, dated March 31, 1997, to Private
Label/Supplier Agreement for Analog Scrambling Modules
between Motorola, Inc. and the Company dated as of August 8,
1995 (incorporated herein by reference to Exhibit 10.10.1 to
the Company's Quarterly Report on Form 10-Q for the Quarter
Ended March 31, 1997, File No. 0-21681 (hereinafter "1Q 1997
Form 10-Q")).
10.11* Motorola Cellular Subscriber Products Sales Agreement, dated
as of June 13, 1996, by and between Motorola, Inc. and the
Company (incorporated herein by reference to Exhibit 10.11
to the January 1997 Registration Statement).
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
10.16
10.17 Amended and Restated Loan Agreement, dated as of May 18,
1994, by and between Norwest Bank Nebraska, N.A., and the
Company (incorporated herein by reference to Exhibit 10.17
to the January 1997 Registration Statement).
10.18 First Amendment, dated as of June 1, 1995, to Amended and
Restated Loan Agreement, dated as of May 18, 1994, by and
between Norwest Bank Nebraska, N.A., and the Company
(incorporated herein by reference to Exhibit 10.18 to the
January 1997 Registration Statement).
10.19 Second Amendment, dated as of April 10, 1996, to Amended and
Restated Loan Agreement, dated as of May 18, 1994, by and
between Norwest Bank Nebraska, N.A., and the Company
(incorporated herein by reference to Exhibit 10.19 to the
January 1997 Registration Statement).
10.20- 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 Third Amendment, dated as of October 22, 1996, to Amended
and Restated Loan Agreement, dated as of May 18, 1994, by
and between Norwest Bank Nebraska, N.A., and the Company,
together with Modification of Note (incorporated herein by
reference to Exhibit 10.26 to the January 1997 Registration
Statement).
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EXHIBIT
NUMBER DESCRIPTION
-------- -----------
10.27 Fourth Amendment, dated as of November 19, 1996, to Amended
and Restated Loan Agreement, dated as of May 18, 1994, by
and between Norwest Bank Nebraska, N.A., and the Company,
together with Commercial Installment Note, dated November
19, 1996 (incorporated herein by reference to Exhibit 10.27
to the January 1997 Registration Statement).
10.27.1 Fifth Amendment, dated as of March 1, 1997, to Amended and
Restated Loan Agreement, dated as of May 18, 1994, by and
between Norwest Bank Nebraska, N.A., and the Company
(incorporated herein by reference to Exhibit 10.27.1 to the
1Q 1997 Form 10-Q).
10.28 Construction Loan, dated November 15, 1996, by and between
Norwest Bank Nebraska, N.A., and the Company, together with
related documents (incorporated herein by reference to
Exhibit 10.28 to the Company's Annual Report on Form 10-K
for the Year Ended December 31, 1996, File No. 0-21681
(hereinafter "1996 Form 10-K")).
10.29 Commercial Installment Note, dated January 9, 1997, related
to Amended and Restated Loan Agreement, dated as of May 18,
1994, by and between Norwest Bank Nebraska, N.A., and the
Company (incorporated herein by reference to Exhibit 10.29
to the 1996 Form 10-K).
10.30 Commercial Installment Note secured by equipment, dated
December 23, 1996, by and between Norwest Bank Nebraska,
N.A., and the Company, together with Security Agreement
(incorporated herein by reference to Exhibit 10.30 to the
1996 Form 10-K).
10.31 Nebraska Investment Finance Authority $2,850,000 Variable
Rate Demand Industrial Development Revenue Bond (Transcrypt
International, Inc. Project), Series 1997, dated as of March
25, 1997 (incorporated herein by reference to Exhibit 10.31
to the 1Q 1997 Form 10-Q).
10.32 Trust Indenture, dated as of March 1, 1997, for $2,850,000
Variable Rate Demand Industrial Development Revenue Bond
(Transcrypt International, Inc. Project), Series 1997,
between Nebraska Investment Finance Authority as Issuer and
Norwest Bank Nebraska, N.A. as Trustee (incorporated herein
by reference to Exhibit 10.32 to the 1Q 1997 Form 10-Q).
10.33 Loan Agreement, dated as of March 1, 1997, for $2,850,000
Variable Rate Demand Industrial Development Revenue Bond
(Transcrypt International, Inc. Project), Series 1997,
between Nebraska Investment Finance Authority as Issuer and
the Company (incorporated herein by reference to Exhibit
10.33 to the 1Q 1997 Form 10-Q).
10.34- 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.
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.
10.39 Severance Agreement and Mutual Release between the Company
and Jeffery L. Fuller dated June 2, 1998.
10.40 Severance Agreement and Mutual Release between the Company
and Charles E. Baumann dated June 2, 1998.
11.1 Statement re: Computation of Per Share Earnings.
54
55
EXHIBIT
NUMBER DESCRIPTION
-------- -----------
21 Subsidiaries of the Registrant.
23.1 Consent of KPMG Peat Marwick 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 1997.
(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
III -- Valuation and Qualifying Accounts and Reserves.
55
56
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/ JOHN T. CONNOR
------------------------------------
John T. Connor
Chairman of the Board of Directors
and interim Chief Executive Officer
(Principal Executive Officer)
Dated: July 28, 1998
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
--------- ----- -------------
/s/ JOHN T. CONNOR Chairman of the Board of July 28, 1998
- ----------------------------------------------------- Directors
John T. Connor and interim Chief Executive
Officer
(Principal Executive Officer)
/s/ CRAIG J. HUFFAKER Senior Vice President of Finance July 28, 1998
- ----------------------------------------------------- and
Craig J. Huffaker Chief Financial Officer
(Principal
Financial and Accounting Officer)
/s/ TERRY L. FAIRFIELD Director July 27, 1998
- -----------------------------------------------------
Terry L. Fairfield
/s/ THOMAS E. HENNING Director July 27, 1998
- -----------------------------------------------------
Thomas E. Henning
/s/ THOMAS R. LARSEN Director July 27, 1998
- -----------------------------------------------------
Thomas R. Larsen
Director July , 1998
- -----------------------------------------------------
Thomas C. Smith
/s/ THOMAS R. THOMSEN Director July 27, 1998
- -----------------------------------------------------
Thomas R. Thomsen
Director July , 1998
- -----------------------------------------------------
Winston J. Wade
56
57
INDEPENDENT AUDITORS' 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, 1997 and 1996, 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,
1997. 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, 1997 and
1996, and the consolidated results of their operations and their cash flows for
each of the years in the three-year period ended December 31, 1997, in
conformity with generally accepted accounting principles.
As discussed in Note 2, the accompanying consolidated financial statements
as of December 31, 1996 and for the year then ended have been restated.
/s/ KPMG Peat Marwick LLP
Omaha, Nebraska
June 26, 1998
F-1
58
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
ASSETS
1997 1996
-------- -------
Current assets:
Cash and cash equivalents................................. $ 15,384 $ --
Investments............................................... 15,900 --
Accounts receivable, net of allowance for returns and
doubtful accounts of $2,417 and $430 in 1997 and 1996,
respectively........................................... 16,008 1,256
Receivables -- other...................................... 785 29
Cost in excess of billings on uncompleted contracts....... 942 --
Inventory................................................. 18,363 2,853
Income taxes recoverable.................................. 1,065 213
Prepaid expenses.......................................... 478 60
Deferred tax assets....................................... 3,523 1,773
-------- -------
Total current assets.............................. 72,448 6,184
Property, plant and equipment, net.......................... 11,261 4,325
Deferred tax assets......................................... 4,504 439
Intangible assets, net of accumulated amortization.......... 18,029 422
Other assets................................................ 452 --
Deferred initial public offering costs...................... -- 568
-------- -------
$106,694 $11,938
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank overdraft............................................ $ -- $ 386
Revolving line of credit.................................. -- 1,022
Current portion of long-term debt......................... 2,545 596
Accounts payable.......................................... 9,305 1,174
Billings in excess of cost on uncompleted contracts....... 6,696 --
Deferred revenue.......................................... 1,743 216
Accrued expenses.......................................... 7,323 946
-------- -------
Total current liabilities......................... 27,612 4,340
Long-term debt, net of current portion...................... 2,758 1,840
Revolving line of credit.................................... -- 792
Deferred revenue............................................ 934 --
-------- -------
31,304 6,972
-------- -------
Commitments and contingencies Stockholders' equity:
Preferred stock ($.01 par value; 3,000,000 shares
authorized; none issued)............................... -- --
Common stock ($.01 par value; 19,400,000 voting shares
authorized, 12,729,082 issued and outstanding in 1997
and 6,565,536 issued and outstanding in 1996; 600,000
non-voting shares authorized, 217,542 issued and
outstanding)........................................... 129 68
Additional paid-in capital................................ 90,315 9,003
Accumulated deficit....................................... (15,054) (4,105)
-------- -------
75,390 4,966
-------- -------
$106,694 $11,938
======== =======
See accompanying notes to the consolidated financial statements
F-2
59
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1997 1996 1995
----------- ---------- ----------
Revenues.................................................. $ 40,423 $ 10,619 $ 8,128
Cost of sales............................................. 26,106 4,274 2,983
----------- ---------- ----------
Gross profit.................................... 14,317 6,345 5,145
----------- ---------- ----------
Operating costs and expenses:
Research and development................................ 4,469 2,234 1,953
Sales and marketing..................................... 7,031 2,187 2,109
General and administrative.............................. 4,711 2,529 2,284
Special compensation expense............................ -- 5,568 --
In-process research and development costs............... 9,828 -- --
----------- ---------- ----------
Total operating costs and expenses.............. 26,039 12,518 6,346
----------- ---------- ----------
Loss from operations............................ (11,722) (6,173) (1,201)
Other income.............................................. 18 -- --
Interest income........................................... 874 31 53
Interest expense.......................................... (643) (162) (190)
----------- ---------- ----------
Loss before income taxes........................ (11,473) (6,304) (1,338)
Benefit for income taxes.................................. (524) (2,186) --
----------- ---------- ----------
Net loss........................................ $ (10,949) $ (4,118) $ (1,338)
=========== ========== ==========
Pro forma information:
Loss before income taxes................................ $ (11,473) $ (6,304) $ (1,338)
Pro forma benefit for income taxes...................... (524) (2,190) (496)
----------- ---------- ----------
Pro forma net loss...................................... $ (10,949) $ (4,114) $ (842)
=========== ========== ==========
Pro forma net loss per share -- Basic and Diluted....... $ (1.09) $ (0.61) $ (0.12)
=========== ========== ==========
Weighted average common shares -- Basic and Diluted..... 10,056,690 6,783,078 6,783,078
=========== ========== ==========
See accompanying notes to the consolidated financial statements
F-3
60
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT UNITS AND SHARE DATA)
COMMON STOCK
------------------ ADDITIONAL
PAR PAID-IN ACCUMULATED PARTNERS'
UNITS SHARES VALUE CAPITAL DEFICIT CAPITAL TOTAL
---------- ---------- ----- ---------- ----------- --------- --------
Balance, December 31, 1994.......... 5,175,434 -- $ -- $ -- $ -- $5,945 $ 5,945
Distributions....................... -- -- -- -- -- (700) (700)
Net loss............................ -- -- -- -- -- (1,338) (1,338)
---------- ---------- ---- ------- -------- ------ --------
Balance, December 31, 1995.......... 5,175,434 -- -- -- -- 3,907 3,907
Distributions....................... -- -- -- -- -- (181) (181)
Net loss............................ -- -- -- -- (4,105) (13) (4,118)
Issuance of stock in exchange for
units of the Predecessor.......... (5,175,434) 5,175,434 52 3,661 -- (3,713) --
Additional shares issued in
1.3106311-for-1 stock split
effected in the form of a stock
dividend.......................... -- 1,607,644 16 (16) -- -- --
Special compensation -- options
issued............................ -- -- -- 5,358 -- -- 5,358
---------- ---------- ---- ------- -------- ------ --------
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
========== ========== ==== ======= ======== ====== ========
See accompanying notes to the consolidated financial statements
F-4
61
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
(IN THOUSANDS)
1997 1996 1995
-------- ------- -------
Cash flows from operating activities:
Net loss.................................................. $(10,949) $(4,118) $(1,338)
-------- ------- -------
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Special compensation expense......................... -- 5,358 --
In-process research and development costs............ 9,828 -- --
Depreciation and amortization........................ 2,206 1,580 1,625
Loss (gain) on sale of fixed assets.................. (15) 6 (2)
Provisions for warranty and inventory reserves....... 1,100 114 102
Provisions for bad debts............................. 162 289 94
Deferred taxes....................................... (706) (2,207) --
Changes in assets and liabilities, net of effects of
acquisitions:
Accounts receivable............................... (8,844) 489 (673)
Cost in excess of billings on uncompleted
contracts....................................... 201 -- --
Inventory......................................... (6,179) (1,733) 83
Income taxes recoverable.......................... (357) (213) --
Prepaid expenses and other assets................. (144) -- 113
Accounts payable.................................. (4,855) 997 (117)
Billings in excess of cost on uncompleted
contracts....................................... (823) -- --
Accrued expenses.................................. 325 359 264
Deferred revenue.................................. 933 -- (96)
-------- ------- -------
Total adjustments............................ (7,168) 5,039 1,393
-------- ------- -------
Net cash provided by (used in) operating
activities................................. (18,117) 921 55
-------- ------- -------
Cash flows from investing activities:
Purchases of investments.................................. (15,900) -- --
Issue notes receivable.................................... -- -- (12)
Payments received on note receivable...................... -- -- 10
Proceeds from sale of fixed assets........................ 15 31 37
Purchase of fixed assets.................................. (2,422) (2,119) (1,029)
Increase in intangible assets............................. -- (581) (1)
Decrease in other assets.................................. 118 -- --
Payments on restructuring reserve......................... (2,380) -- --
Acquisition of E.F. Johnson Company, net of cash
acquired............................................... (292) -- --
Payments under noncompete agreements...................... -- (340) (340)
-------- ------- -------
Net cash used in investing activities........ (20,861) (3,009) (1,335)
-------- ------- -------
Cash flows from financing activities:
Payments on revolving lines of credit, net................ (11,914) 1,022 --
Borrowings on term loans.................................. 2,850 1,377 1,016
Payments on term loans.................................... (7,634) (408) (867)
Principal payments on capitalized leases.................. -- (16) (13)
Partnership distributions paid............................ -- (181) (700)
Bank overdraft............................................ (386) 386 --
Issuance of common stock, net of issuance costs........... 71,217 -- --
Proceeds from the exercise of employee stock options...... 229 -- --
Initial public offering costs............................. -- (384) --
-------- ------- -------
Net cash provided by (used in) financing
activities................................. 54,362 1,796 (564)
-------- ------- -------
Net increase (decrease) in cash and cash equivalents........ 15,384 (292) (1,844)
Cash and cash equivalents, beginning of period.............. -- 292 2,136
-------- ------- -------
Cash and cash equivalents, end of period.................... $ 15,384 $ -- $ 292
======== ======= =======
See accompanying notes to the consolidated financial statements
F-5
62
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, Ltd. (the "Predecessor") was a limited
partnership formed in 1991 composed of the general partner, Transcrypt
International, Inc. (a Nebraska corporation) and various limited partners. One
percent of the profits or losses was allocated to the general partner and the
remaining 99% was allocated to the limited partners based on their respective
units of partnership interest.
Effective June 30, 1996, the assets and liabilities of the partnership were
merged tax-free into a Delaware corporation, Transcrypt International, Inc. (the
"Company"). Each respective partnership unit was converted pro rata into common
shares of the Company.
The Company is engaged in the design, manufacture and marketing of
information security products for the land mobile radio, telephony and data
security markets. Through its E.F. Johnson subsidiary, 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 one industry segment.
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 E.F. Johnson Company (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.
INVESTMENTS
Investments include Dutch auction securities, which are bought and held
primarily for the purpose of selling them in the near term and, accordingly,
these investments are classified as trading securities. Trading securities are
recorded at fair value and unrealized holding gains and losses are included in
earnings.
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
F-6
63
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
1. SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
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, 15 years. The Company assesses the recoverability of this
intangible asset by determining whether the amortization of the goodwill balance
over its remaining life can be recovered through undiscounted future operating
cash flows of the acquired operation. The amount of goodwill 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 of goodwill will be impacted if estimated future operating
cash flows are not achieved.
Other intangibles are also carried at cost less applicable amortization.
Provision for amortization of other intangible assets is 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. Management reviews intangible assets whenever events or changes in
circumstances indicate that the carrying amount of the assets may not be fully
recoverable.
INCOME TAXES
The Predecessor as a partnership was not subject to Federal or state income
taxes. Any tax liabilities arising from the Predecessor's operations were the
direct responsibility of the individual partners.
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.
The pro forma provision for income taxes reflects the provision for income
taxes as if the Company had been taxed as a C Corporation under the Internal
Revenue Code for all years presented. The actual provision for income taxes for
1996 included in the consolidated statements of operations is reflective only of
the results of operations for the period that the Company was a C Corporation,
July 1, 1996 through December 31, 1996.
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
F-7
64
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
1. SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
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 advanced payment received for products to be
sold to a former division of EFJ. The advance payment was negotiated as part of
the sale agreement of the division by EFJ. The advanced payment is recognized as
revenue is earned.
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:
1997 1996 1995
------- ------ ------
Europe.......................................... $ 804 $1,960 $2,464
Middle East and Asia............................ 7,657 1,525 2,276
Central and Latin America....................... 6,933 2,235 1,060
------- ------ ------
$15,394 $5,720 $5,800
======= ====== ======
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.
LOSS PER SHARE
The Company has adopted Statement of Financial Accounting Standards No.
128, "Earnings Per Share" (FAS 128), effective as of December 31, 1997. FAS 128
requires a basic calculation of earnings per share (EPS), based upon the
weighted average number of common shares outstanding during the period. FAS 128
also requires a diluted EPS calculation that reflects the potential dilution
from common stock equivalents such as stock options. All current and prior
years' EPS calculations included herein have been restated under the provisions
of FAS 128. As the years ended December 31, 1997, 1996 and 1995 have net losses,
the impact of outstanding stock options on weighted average common shares is
anti-dilutive.
Pro forma net loss per share for 1996 and 1995 is computed on the basis of
the weighted average number of partnership interest units outstanding during the
year converted into common shares on a one-to-one ratio, and adjusted for the
stock split discussed below.
STOCK SPLIT
On September 30, 1996, the Board of Directors and the shareholders approved
an increase in the Company's authorized common shares from 10 million to 20
million shares. On November 18, 1996, the Company declared a 1.3106311-for-1
stock split in the form of a stock dividend. All shares and per share
information have been restated to reflect the split.
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
F-8
65
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
1. SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
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.
2. RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS:
On February 6, 1998, the Company issued a press release announcing its
consolidated financial results for 1997. Subsequently, it was determined to be
necessary to restate its previously released results for the three-months and
year ended December 31, 1997, the Company's financial statements as of and 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 restatements relate primarily to: (i) revenue recognition for certain
sales for which collection was determined to not be reasonably assured or was
contingent on a future event; (ii) revenue recognition for certain sales where a
formal written agreement was not received; (iii) revenue recognized on sales of
certain products which were subsequently returned to the Company; (iv)
application of the percentage of completion method on system contract sales at
EFJ, and (v) the allocation of the purchase price of the EFJ acquisition. As a
result, the financial statements of the Company have been restated from amounts
previously reported.
F-9
66
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
2. RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED)
The summary of the significant changes as of December 31, 1997 and 1996 and
for the years then ended is as follows:
AS OF DECEMBER 31, 1997 AS OF DECEMBER 31, 1996
---------------------------- ----------------------------
AS PREVIOUSLY AS PREVIOUSLY
RELEASED AS RESTATED REPORTED AS RESTATED
------------- ----------- ------------- -----------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents................ $ 15,384 $ 15,384 $ -- $ --
Investments.............................. 15,900 15,900 -- --
Accounts receivable, net................. 24,182 16,008 4,216 1,256
Receivables -- other..................... 1,803 785 11 29
Cost in excess of billings on uncompleted
contracts............................. 3,804 942 -- --
Inventory................................ 17,855 18,363 2,261 2,853
Income taxes recoverable................. -- 1,065 -- 213
Prepaid expenses and other current
assets................................ 478 478 60 60
Deferred tax assets...................... 3,345 3,523 196 1,773
-------- -------- ------- -------
Total current assets.................. 82,751 72,448 6,744 6,184
Property, plant and equipment, net....... 11,343 11,261 4,908 4,325
Deferred tax assets...................... 6,340 4,504 1,723 439
Intangible assets, net................... 7,655 18,029 38 422
Other assets............................. 1,193 452 -- --
Deferred public offering costs........... -- -- 568 568
-------- -------- ------- -------
$109,282 $106,694 $13,981 $11,938
======== ======== ======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Bank overdraft........................... $ -- $ -- $ 386 $ 386
Revolving line of credit and bank notes
payable............................... -- -- 1,022 1,022
Current portion of long-term debt........ 416 2,545 596 596
Accounts payable......................... 10,526 9,305 1,174 1,174
Billings in excess of cost on uncompleted
contracts............................. 1,370 6,696 -- --
Income taxes payable..................... -- -- 152 --
Deferred revenue......................... 1,208 1,743 -- 216
Accrued expenses......................... 5,547 7,323 946 946
-------- -------- ------- -------
Total current liabilities............. 19,067 27,612 4,276 4,340
Long-term debt, net of current portion... 4,279 2,758 1,840 1,840
Deferred revenue......................... 1,417 934 -- --
Revolving line of credit................. -- -- 792 792
-------- -------- ------- -------
24,763 31,304 6,908 6,972
-------- -------- ------- -------
Stockholders' equity:
Common stock............................. 129 129 68 68
Additional paid-in capital............... 90,995 90,315 9,683 9,003
Accumulated deficit...................... (6,605) (15,054) (2,678) (4,105)
-------- -------- ------- -------
84,519 75,390 7,073 4,966
-------- -------- ------- -------
$109,282 $106,694 $13,981 $11,938
======== ======== ======= =======
F-10
67
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
2. RESTATEMENT OF CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED)
FOR THE YEAR ENDED
---------------------------------------------------------
DECEMBER 31, 1997 DECEMBER 31, 1996
--------------------------- ---------------------------
AS PREVIOUSLY AS PREVIOUSLY
RELEASED AS RESTATED REPORTED AS RESTATED
------------- ----------- ------------- -----------
(UNAUDITED)
Revenues.................................. $ 51,762 $ 40,423 $ 13,775 $ 10,619
Cost of sales............................. 27,218 26,106 4,864 4,274
----------- ----------- ---------- ----------
Gross profit......................... 24,544 14,317 8,911 6,345
----------- ----------- ---------- ----------
Operating costs and expenses:
Research and development................ 4,469 4,469 2,234 2,234
Sales and marketing..................... 8,133 7,031 2,103 2,187
General and administrative.............. 3,382 4,711 2,414 2,529
Special compensation expense............ -- -- 5,568 5,568
In-process research and development
costs................................ 9,828 9,828 -- --
----------- ----------- ---------- ----------
Total operating costs and expenses... 25,812 26,039 12,319 12,518
----------- ----------- ---------- ----------
Loss from operations................. (1,268) (11,722) (3,408) (6,173)
Other income.............................. 35 18 -- --
Interest income........................... 841 841 30 31
Interest expense.......................... (610) (610) (162) (162)
----------- ----------- ---------- ----------
Loss before income taxes............. (1,002) (11,473) (3,540) (6,304)
Provision (benefit) for income taxes...... 2,925 (524) (1,529) (2,186)
----------- ----------- ---------- ----------
Net loss............................. $ (3,927) $ (10,949) $ (2,011) $ (4,118)
=========== =========== ========== ==========
Pro forma information:
Loss before pro forma income taxes...... $ (1,002) $ (11,473) $ (3,540) $ (6,304)
Pro forma provision (benefit) for income
taxes................................ 2,925 (524) (1,393) (2,190)
----------- ----------- ---------- ----------
Pro forma net loss...................... $ (3,927) $ (10,949) $ (2,147) $ (4,114)
=========== =========== ========== ==========
Pro forma net loss per share -- Basic
and Diluted.......................... $ (0.39) $ (1.09) $ (0.31) $ (0.61)
=========== =========== ========== ==========
Weighted average common shares -- Basic
and Diluted............................. 10,056,690 10,056,690 6,968,712 6,783,078
=========== =========== ========== ==========
3. 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 Note 12 for
discussion of restructuring reserve recorded in conjunction with the acquisition
and see Note 2 for discussion of proper allocation of opening balance sheet for
EFJ).
F-11
68
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
3. ACQUISITION: (CONTINUED)
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
1996. 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 1996
----------- -----------
(UNAUDITED) (UNAUDITED)
Total revenues.............................................. $70,959 $ 89,585
Net loss.................................................... $(9,949) $(32,077)
Loss per share -- Basic and Diluted......................... $ (0.94) $ (4.21)
4. 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,
1997 were as follows:
Costs on uncompleted contracts.............................. $31,814
Profits in uncompleted contracts............................ 13,547
-------
45,361
Less billings............................................... 51,115
-------
$(5,754)
=======
Included in the consolidated balance sheet:
Cost in excess of billings on uncompleted contracts....... $ 942
Billings in excess of cost on uncompleted contracts....... (6,696)
-------
$(5,754)
=======
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 on open contracts in excess of costs and accrued
profits.
5. INVENTORY:
The following is a summary of inventory at December 31, 1997 and 1996, net
of reserves for obsolescence of $4,114 and $41, respectively
1997 1996
------- ------
Raw materials and supplies................................ $ 7,523 $1,373
Work in process........................................... 1,977 715
Finished goods............................................ 8,863 765
------- ------
$18,363 $2,853
======= ======
F-12
69
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
6. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment consists of the following at December 31,
1997 and 1996:
1997 1996
------- ------
Land and land improvements.............................. $ 262 $ 150
Buildings and improvements.............................. 4,860 1,302
Equipment............................................... 8,152 3,380
Leased equipment........................................ 136 74
Furniture and fixtures.................................. 1,255 397
Construction in progress................................ 178 797
------- ------
14,843 6,100
Less accumulated depreciation and amortization........ 3,582 1,775
------- ------
$11,261 $4,325
======= ======
7. INTANGIBLE ASSETS:
Intangible assets consist of the following at December 31, 1997 and 1996:
1997 1996
------- ------
Goodwill.................................................. $10,880 $ 290
Proprietary technology and licensing agreements........... 3,763 3,756
Acquired work force, customer base, trade name............ 6,234 117
Non-compete agreements.................................... -- 1,700
Other..................................................... 1,038 43
------- ------
21,915 5,906
Less accumulated amortization........................... 3,886 5,484
------- ------
$18,029 $ 422
======= ======
8. REVOLVING LINES OF CREDIT:
The Company has several lines of credit with regional banks. One is a
working capital revolving line of credit not to exceed $3,000 calculated using a
specified borrowing base of eligible inventories and accounts receivable. This
line of credit was due as of June 30, 1998 and was not renewed. Interest for the
line of credit is payable monthly at a regional bank's national money market
rate. At December 31, 1997, the Company opened up a secured line of credit not
to exceed $10,000 with another regional bank. Interest is at a variable rate,
1.00% under the highest prime rate published in the Wall Street Journal. This
line of credit is due on December 30, 1998. The working capital lines are
collateralized by substantially all the Company's assets and the capital line is
collateralized by certain fixed assets. EFJ had a working capital and term loan
of approximately $13,200 when it was acquired on July 31, 1997. This loan was
paid off in October 1997 with a portion of the proceeds from the Company's
secondary stock offering.
At December 31, 1997, the Company had no amounts outstanding on these lines
of credit. The weighted average interest rate was 8.5% during 1997 and 8.3%
during 1996. Average borrowings under the Company's lines of credit and the
weighted average interest rate during 1997 were $761 and 8.5% and during 1996
were $256 and 8.3%. The total available credit as of December 31, 1997 was
$13,000 under the above lines.
F-13
70
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
9. LONG-TERM DEBT:
Long-term debt at December 31, 1997 and 1996 consists of the following
1997 1996
------ ------
Term note payable to bank due in monthly installments of $18
including interest at 7.75% based on a specified rate of a
regional bank. The note was collateralized by
substantially all the assets of the Company in addition to
the personal guarantees of certain stockholders........... $ -- $ 251
Term note payable to bank due in monthly installments of $14
including interest at 8% based on a specified rate of a
regional bank. The note was collateralized by essentially
all the assets of the Company in addition to personal
guarantees of certain stockholders........................ -- 376
Installment note for equipment purchase payable to bank due
in monthly installments of $10 including daily adjusted
interest at a specified rate above the prime rate. The
note was collateralized by specific equipment and
inventory. The note was guaranteed by a stockholder....... -- 359
Industrial development revenue bonds (IDR) payable to bank
with interest payments due March 1 and September 1 and
annual principal payments of $140 beginning March 1, 1998
at variable interest rates with principal due on March 1,
2017. This note is collateralized by a deed of trust...... 2,850 850
Construction note payable to bank, due in August 1997,
including interest at 8.75%............................... -- 585
Capital lease obligation, due in monthly principal and
interest installments of $32 through July 31, 2002,
effective interest rate of 9.1% per annum, secured by land
and building.............................................. 2,400 --
Other capital lease obligations............................. 53 15
------ ------
5,303 2,436
Less current portion........................................ 2,545 596
------ ------
$2,758 $1,840
====== ======
The agreements of the term notes payable and the revolving lines of credit
discussed in Note 8 require, among other things, that the Company maintain
certain levels of working capital, net worth and debt-to-equity ratios and limit
capital expenditures, investments, other indebtedness, distributions, mergers
and acquisitions. At December 31, 1997, the Company was in compliance with these
debt covenants or had obtained the appropriate waivers. The IDR bonds require
the Company to maintain at all times a letter of credit in an amount at least
equal to 103% of the aggregate principal amount of bonds then outstanding plus a
specified portion of interest payable.
Future minimum long-term debt payments for the next five years are $140 per
annum on the IDR bonds.
The term and installment notes payable were retired using a portion of the
net proceeds from the initial public offering.
10. LEASE OBLIGATIONS:
The Company leases certain buildings and improvements under an arrangement
which is accounted for as a capital lease. The lease requires monthly
installments of $52, including an effective average annual interest rate of 7.8%
through July 31, 2002. In January 1998, the Company exercised an option to buy
the building and
F-14
71
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
10. LEASE OBLIGATIONS: (CONTINUED)
improvements under this capital lease. Accordingly, the balance of $2,400 under
this capital lease has been classified as current.
The Company also leases various equipment, automobiles and buildings under
operating leases. Rent expense for the year ended December 31, 1997 was $520 and
was immaterial in 1996 and 1995. Future minimum rental payments under
noncancelable operating lease agreements are as follows:
YEAR ENDING DECEMBER 31
-----------------------
1998........................................................ $ 610
1999........................................................ 432
2000........................................................ 310
2001........................................................ 274
2002........................................................ 4
Thereafter.................................................. 8
------
Total minimum lease payments...................... $1,638
======
11. INCOME TAXES:
The components of the benefit for income taxes for the period ending
December 31, 1997 and 1996 are as follows:
1997 1996
----- -------
Current:
Federal................................................. $ 163 $ 21
State................................................... 19 --
----- -------
182 21
----- -------
Deferred:
Federal................................................. (637) (2,207)
State................................................... (69) --
----- -------
(706) (2,207)
----- -------
$(524) $(2,186)
===== =======
The Company's effective tax rate on pretax loss differs from U.S. federal
statutory tax rate as follows:
1997 1996
--------------- ---------------
U.S. federal tax at statutory tax rate........... $(3,901) (34.0)% $(2,143) (34.0)%
Income taxable directly to partners of the
Predecessor.................................... -- -- 4 --
In-process research and development costs........ 3,341 29.1 -- --
Benefit of foreign sales corporation............. (61) (0.5) (53) (0.7)
State taxes, net of federal benefit.............. (33) (0.3) -- --
Non deductible amortization...................... 49 0.4 -- --
Other............................................ 81 0.7 6 --
------- ----- ------- -----
$ (524) (4.6)% $(2,186) (34.7)%
======= ===== ======= =====
F-15
72
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
11. INCOME TAXES: (CONTINUED)
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, 1997 and 1996 relate to the following. The 1997 amounts include
deferred tax assets resulting from the EFJ acquisition on July 31, 1997:
1997 1996
------ ------
Deferred tax assets:
Special compensation expense............................. $1,403 $1,822
Allowance for bad debts.................................. 993 58
Net operating loss carryforwards......................... 5,549 376
Difference between tax and book amortization............. 1,547 --
Difference between tax and book liability accruals....... 1,939 55
------ ------
Gross deferred tax assets................................ 11,431 2,311
Less valuation allowance................................. 3,000 --
------ ------
8,431 2,311
------ ------
Deferred tax liabilities:
Difference between tax and book depreciation............. 404 99
------ ------
Net deferred asset......................................... $8,027 $2,212
====== ======
There was no valuation allowance for deferred tax assets as of January 1,
1997, 1996 and 1995. A valuation allowance of $3,000 was established at the time
of the purchase of EFJ. Any subsequently recognized tax benefits relating to the
valuation allowance as of December 31, 1997 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 year ended December 31, 1997 and the six months ended December 31, 1996 were
approximately ($7,800) and ($1,300), 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, 1997. 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 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 annual basis to
approximately $588.
F-16
73
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
12. ACCRUED EXPENSES:
Accrued expenses consist of the following:
1997 1996
------ ----
Payroll, bonuses and employee benefits...................... $1,534 $329
Warranty reserve............................................ 806 73
Commissions................................................. 789 101
Special compensation expense................................ -- 210
Restructuring reserve....................................... 2,581 --
Other expenses.............................................. 1,613 233
------ ----
$7,323 $946
====== ====
In connection with the acquisition of EFJ, a portion of the purchase price
was allocated to a restructuring reserve to cover costs associated with the
purchase such as severance and relocation costs. A reserve of $4,961 was
recorded, and as of December 31, 1997, $2,380 has been expended. The EFJ
workforce was reduced by 105 employees across all lines of the organization.
13. COMMITMENTS AND CONTINGENCIES:
The Company has been named as a defendant in several 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 also name one or more officers of the Company 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 complaints generally allege claims under 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 complaints seek unspecified
compensatory damages, punitive damages, attorneys' fees and costs. The
plaintiffs in the Federal actions have stipulated to the consolidation of the
Federal actions and the appointment of a lead plaintiff(s). The Company is not
required to answer or otherwise respond to the federal complaints until after
the lead plaintiff(s) files a consolidated complaint.
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.
Although the complaints described above do not allege the amount of damages
and other relief that the plaintiffs are seeking, the Company believes the
amount of damages ultimately sought by the plaintiffs will be significant. In
light of the Company's restatement of financial information contained in its
various registration statements and prospectuses, the Company believes that
there may be an unfavorable outcome for at least some of the claims asserted in
the lawsuits or which may be asserted in the future against the Company. The
Company believes that the stockholder class actions are more likely to settle
than proceed to trial, judgment and appeal. Given the circumstances of these
cases, the terms of a settlement would be structured in a manner to avoid
causing the Company to seek protection under the federal bankruptcy
reorganization laws. In any circumstances where the Company could not structure
a settlement of all claims within its financial resources,
F-17
74
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
13. COMMITMENTS AND CONTINGENCIES: (CONTINUED)
it would vigorously defend any attempt to establish the amount of liability or
to require payment beyond its resources. Many factors will ultimately affect and
determine the results of the litigation however, and the Company can provide no
assurances that the outcome will not have a significant adverse effect on the
Company's business, financial condition, results of operations and cash flows.
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. At
the present time, the Company is unable to predict whether the SEC is likely to
initiate proceedings against the Company or its affiliated parties relating to
these events.
During 1997, on the basis of product orders placed with the Company by
federal personnel within the Maryland Procurement Office ("MPO"), which acts as
the purchasing arm for various federal agencies in the Washington D.C. area, the
Company shipped approximately $2.2 million worth of encrypted radio equipment
and related items to MPO. MPO has taken the position that the person placing the
orders on behalf of MPO was not authorized to do so, and therefore, has refused
payment. In March 1998, the Company filed a certified contract claim for
payment. Alternatively, the Company has requested ratification, by which MPO
would treat the procurement as an authorized commitment. To date, MPO has
rejected ratification. The contract claim is pending, and the Company is unable
to predict whether the likelihood of a favorable final outcome is probable or
remote.
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 agreed to pay fees totaling $350 to its chairman and chief
executive officer for initiating the purchase of the net assets of Transcrypt
International, Incorporated in 1991. Payment was contingent upon the original
limited partners receiving capital distributions equal to their original capital
contributions or upon the approval of the Board of Directors of the Company for
the sale of equity interests in the Company to the public. Payments of $70 were
made as of December 31, 1995 and an additional payment of $70 was approved and
paid during February 1996. These payments were accounted for as a bonus and the
officer waived his rights to receive fees to the extent of such payments. The
Board of Directors approved the payment of the remaining $210 fees on September
30, 1996. These remaining fees are included in special compensation expense in
the consolidated statements of operations. The $210 was paid in February 1997.
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 1998,
have a total undrawn balance of $2.1 million, and bonds which expire on various
dates through 1999, totaling $22.4 million at December 31, 1997.
As a result of the EFJ acquisition, the Company has an agreement with a
vendor to purchase 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. In 1997, the Company paid $396 as a result of this take or pay
contract. Future minimum purchase quantities are as follows: 1998 -- $2,500;
1999 -- $2,500; 2000 -- $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.
The Company is in the process of converting its manufacturing and financial
information system to that currently being utilized by its acquired subsidiary,
EFJ. Once converted, the Company will then upgrade to a
F-18
75
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
13. COMMITMENTS AND CONTINGENCIES: (CONTINUED)
newer version of the same information system or will purchase a separate
information system that will be Year 2000 compliant. The conversion to a Year
2000 compliant system is anticipated to be completed by mid-year 1999 with the
cost estimated to be from $750 to $1,500. These expenditures were planned and
budgeted for in an effort to upgrade the quality of the Company's manufacturing
and financial information system and not as a direct remediation of any Year
2000 issue, although that will be a valuable by-product of the upgrade. There
are other computerized systems involved in manufacturing and engineering
systems. A preliminary assessment has been made as to what effect, if any, the
Year 2000 issue will have on these systems and whether or not there will be a
material effect on future financial results. As of December 31, 1997, no
conclusions have been drawn. Furthermore, the Company has not yet initiated
formal communications with all of its significant suppliers to determine the
extent to which the Company is vulnerable to those third parties' failure to
remediate their own Year 2000 issue.
The Company has entered into contracts for the completion of a new addition
to its Lincoln, Nebraska headquarters facility. Total dollar amount of the
contracts is approximately $2,250 with the total project cost estimated at
approximately $3,000.
14. OPTION PLANS:
In January 1992, the Board of Directors approved a 1992 Partnership
Interest Option Plan which provided for the granting of up to 1,297,525 units of
non-qualified interest options to certain officers and key employees. Under the
Plan, the exercise price for the options was the fair market value at the date
of grant as determined by the Board of Directors. The term of each option
granted will in no event exceed 10 years from the date of grant. Effective June
30, 1996, the unit options were converted to stock options on a one to one
ratio. No options were exercisable under the Plan provisions until the Board of
Directors approved granting of all reserved options and full vesting of the
716,916 stock options then outstanding on September 30, 1996. The vesting
resulted in a special compensation charge of $5,358 in the quarter ended
September 30, 1996.
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. The aggregate number of
shares issued under the Plan shall not exceed 1,200,000. The aforementioned
716,916 options have been issued under the Plan, all of which are vested and
compensation recognized. 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. In January 1997,
the Company granted stock options for an additional 325,000 shares, with an
exercise price equal to the price per share in the initial public offering.
F-19
76
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
14. OPTION PLANS: (CONTINUED)
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards 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 1997 and 1996
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:
1997 1996
-------- -------
Pro forma net loss -- as reported........................... $(10,949) $(4,114)
Pro forma net loss -- as adjusted under SFAS No. 123........ (11,149) (4,114)
Pro forma net loss per share -- as reported:
Basic and Diluted......................................... (1.09) (.61)
Pro forma net loss per share -- as adjusted under SFAS No.
123:
Basic and Diluted......................................... (1.11) (.61)
Fair value of the options was not determinable prior to September 30, 1996
when the Board of Directors approved full vesting of the outstanding options. No
options were granted subsequent to September 30, 1996, during the year ended
December 31, 1996. The weighted average fair value at date of grant for options
granted during 1997 was $7.92.
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:
1997 1996
-------- --------
Expected option life........................................ 10 years 10 years
Expected annual volatility.................................. 68% N/A
Risk-free interest rate..................................... 6.62% 6.50%
Dividend yield.............................................. 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, 1994........................... 1,140,905 $ .96 --
Granted.............................................. 137,617 3.05
Exercised............................................ -- --
Forfeited............................................ (813,903) 1.22
--------- ------
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
========= ======
F-20
77
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
14. OPTION PLANS: (CONTINUED)
WEIGHTED
NUMBER AVERAGE WEIGHTED NUMBER EXERCISABLE
OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT WEIGHTED
DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, AVERAGE
EXERCISE PRICE 1997 LIFE PRICE 1997 EXERCISE PRICE
- -------------- -------------- ----------- --------- -------------- ---------------
$ 0.760 294,257 7.67 $ 0.7600 294,257 $ 0.760
3.050 259,676 8.15 3.0500 259,676 3.050
8.000 259,000 9.06 8.0000 -- --
311.375 30,000 9.58 11.3750 -- --
21.688 30,000 9.79 21.6880 -- --
23.500 10,000 9.88 23.5000 -- --
24.875 600 10.00 24.8750 -- --
- --------------- ------- ----- --------- ------- -------
$0.76 -- $24.875 883,533 8.14 $ 4.9002 553,933 $1.8335
=============== ======= ===== ========= ======= =======
15. BENEFIT PLANS:
The Company has a profit sharing plan which covers substantially all
employees. Contribution levels are determined by the Board of Directors
annually. Profit sharing expense approximated $100, $60 and $27 for the years
ended December 31, 1997, 1996 and 1995, respectively.
The Company also has a 401(k) plan which covers substantially all
employees. Participants may contribute up to 10% of their annual compensation
and the Company makes matching contributions of 25% of the amount contributed by
participants. Contributions may not exceed the maximum allowable by law. Company
contributions approximated $111, $16 and $13 for the years ended December 31,
1997, 1996 and 1995, respectively.
The Company does not currently provide post-retirement healthcare benefits.
16. CONCENTRATIONS:
Sales to major customers were as follows:
1997 1996 1995
------ ------ ----
Individual customers representing 10% or more of
consolidated sales in each year:
Ministry of Interior -- Egypt............................ $ -- $ -- $849
Motorola, Inc............................................ $ -- $2,180 $ --
Modern Scientific and Electronic Corporation............. $4,374 $ -- $ --
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.
In addition to being a major customer, Motorola is also a key manufacturer
of electronic components used by the Company. Purchases by the Company from
Motorola totaled approximately $3,862, $1,878, and $726 in 1997, 1996, and 1995,
respectively.
17. FAIR VALUE OF FINANCIAL INSTRUMENTS:
The carrying amount of cash and cash equivalents, accounts receivable,
receivable-other, cost in excess of billings on uncompleted contracts, prepaid
expenses, bank overdraft, accounts payable, billings in excess of
F-21
78
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
17. FAIR VALUE OF FINANCIAL INSTRUMENTS: (CONTINUED)
cost on uncompleted contracts, income taxes payable, 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.
18. 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 the 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.
19. SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid by the Company during the years ended December 31, 1997, 1996
and 1995 amounted to $618, $163 and $190, respectively. Income taxes paid, net
of refunds, during the years ended December 31, 1997 and 1996 were $642 and
$294, respectively.
During 1996, the Company made non-cash additions to property, plant and
equipment and deferred initial public offering costs of $174 and $184,
respectively.
In conjunction with the acquisition during the year ended December 31, 1997
(see Note 3) 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
========
20. SUBSEQUENT EVENTS:
On March 27, 1998, the Company issued a press release announcing that it
would not file its 1997 Annual Report on Form 10-K with the SEC on March 31,
1998 because the audit of its 1997 financial statements was not yet completed.
The Company also announced that (i) certain accounting principles relating
primarily to revenue recognition were not yet resolved by the Company's
independent accountants, (ii) the accountants
F-22
79
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
20. SUBSEQUENT EVENTS: (CONTINUED)
and Company management were undertaking a review of the Company's accounting
policies and (iii) adjustments would be made to the Company's previously
announced financial results.
On April 13, 1998, the Company announced that it would not file its 1997
Form 10-K on or before the extension date of April 15, 1998 due to ongoing work
being performed by the Company and its independent accountants. The Company also
announced that the Audit Committee of the Board of Directors had retained
independent counsel to conduct an investigation.
In April 1998, the 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.
On April 24, 1998, Coopers & Lybrand, L.L.P. resigned as the Company's
independent accountants. In conjunction with its resignation, Coopers & Lybrand
advised the Company that their reports with respect to the consolidated
financial statements of the Company and its subsidiaries as of and for the years
ended December 31, 1995 and 1996 were withdrawn as of the date of their
resignation.
On April 27, 1998, the Nasdaq National Market ("Nasdaq") effected a
temporary qualification trading halt in the Company's common stock. On May 11,
1998, the common stock was delisted from the Nasdaq National Market. The Company
has appealed the Nasdaq delisting.
On May 6, 1998, the Company announced that it had engaged KPMG Peat Marwick
LLP as its independent auditors for the fiscal years ended December 31, 1997,
1996 and 1995.
On May 18, 1998, the Company disclosed in a filing with the SEC that its
Quarterly Report on Form 10-Q for the Quarter Ended March 31, 1998 will not be
filed within the period prescribed for such report.
Effective May 31, 1998, Jeffery L. Fuller resigned as President, Chief
Executive Officer ("CEO") and Director of the Company. On June 8, 1998, the
Company announced that the Board of Directors had appointed a committee to
identify a CEO of the Company and that John T. Connor, who serves as Chairman of
the Board, had been appointed as interim CEO. Mr. Connor accepted such
appointment until the earlier of September 8, 1998 or the hiring of a permanent
CEO. Mr. Connor has indicated that if a permanent CEO is not hired by such date,
he will discuss with the Board of Directors the possibility of staying on for a
longer time.
On July 8, 1998, the Company's primary bank lender, US Bank National
Association, agreed to waive the Company's violations of its bank credit
facility arising out of the Company's failure to timely provide financial
statements, meet certain financial covenants and provide monthly borrowing base
certificates to U.S. Bank. U.S. Bank also agreed to amend the credit facility by
reducing the Company's required tangible net worth amount to $55 million from
$70 million.
The Company has been named as a defendant in several 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 also name one or more officers of the Company 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.
F-23
80
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
20. SUBSEQUENT EVENTS: (CONTINUED)
The complaints generally allege claims under 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 complaints seek unspecified
compensatory damages, punitive damages, attorneys' fees and costs. The
plaintiffs in the Federal actions have stipulated to the consolidation of the
Federal actions and the appointment of a lead plaintiff(s).
21. RESTATEMENT OF CONSOLIDATED UNAUDITED QUARTERLY FINANCIAL DATA:
On February 6, 1998, the Company issued a press release announcing its
consolidated financial results for 1997. Subsequently, it was determined to be
necessary to restate its previously released results for the three-months and
year ended December 31, 1997, the Company's financial statements as of and 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 restatements relate primarily to: (i) revenue recognition for certain
sales for which collection was determined to not be reasonably assured or was
contingent on a future event; (ii) revenue recognition for certain sales where a
formal written agreement was not received; (iii) revenue recognized on sales of
certain products which were subsequently returned to the Company; (iv)
application of the percentage of completion method on system contract sales at
EFJ in the third and fourth quarters of 1997, and (v) the allocation of the
purchase price of the EFJ acquisition at July 31, 1997. As a result, the
financial statements of the Company have been restated from amounts previously
reported.
F-24
81
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
21. RESTATEMENT OF CONSOLIDATED UNAUDITED QUARTERLY FINANCIAL DATA: (CONTINUED)
The summary of the significant quarterly changes for the years ended
December 31, 1997 and 1996 is as follows:
MARCH 31, 1997 JUNE 30, 1997
--------------------------- ---------------------------
AS PREVIOUSLY AS PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
------------- ----------- ------------- -----------
Revenues....................................... $ 4,728 $ 3,512 $ 5,550 $ 2,915
Cost of sales.................................. 1,632 1,272 2,233 2,289
---------- ---------- ---------- ----------
Gross profit......................... 3,096 2,240 3,317 626
---------- ---------- ---------- ----------
Operating expenses:
Research and development..................... 633 633 683 683
Sales and marketing.......................... 1,086 942 879 731
General and administrative................... 478 572 559 651
---------- ---------- ---------- ----------
Total operating expenses............. 2,197 2,147 2,121 2,065
---------- ---------- ---------- ----------
Income (loss) from operations........ 899 93 1,196 (1,439)
Interest income................................ 125 125 192 192
Interest expense............................... (49) (49) (33) (33)
---------- ---------- ---------- ----------
Income (loss) before income taxes.... 975 169 1,355 (1,280)
Provision (benefit) for income taxes........... 292 27 380 (490)
---------- ---------- ---------- ----------
Net income (loss).................... $ 683 $ 142 $ 975 $ (790)
========== ========== ========== ==========
Pro forma information:
Income (loss) before pro forma income taxes.... $ 975 $ 169 $ 1,355 $ (1,280)
Pro forma provision (benefit) for income
taxes........................................ 292 27 380 (490)
---------- ---------- ---------- ----------
Pro forma net income (loss).................... $ 683 $ 142 $ 975 $ (790)
========== ========== ========== ==========
Pro forma net income (loss) per share
-- Basic..................................... $ 0.08 $ 0.02 $ 0.10 $ (0.09)
========== ========== ========== ==========
-- Diluted................................... $ 0.07 $ 0.02 $ 0.10 $ (0.09)
========== ========== ========== ==========
Weighted average common shares
-- Basic..................................... 8,699,744 8,699,745 9,876,806 9,283,078
========== ========== ========== ==========
-- Diluted................................... 9,177,989 9,281,849 9,876,806 9,283,078
========== ========== ========== ==========
F-25
82
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
21. RESTATEMENT OF CONSOLIDATED UNAUDITED QUARTERLY FINANCIAL DATA: (CONTINUED)
SEPTEMBER 30, 1997 DECEMBER 31, 1997
--------------------------- ---------------------------
AS PREVIOUSLY AS PREVIOUSLY
REPORTED AS RESTATED RELEASED AS RESTATED
------------- ----------- ------------- -----------
Revenues..................................... $ 17,555 $ 13,428 $ 23,929 $ 20,568
Cost of sales................................ 9,623 9,561 13,731 12,984
---------- ---------- ----------- -----------
Gross profit....................... 7,932 3,867 10,198 7,584
---------- ---------- ----------- -----------
Operating expenses:
Research and development................... 1,298 1,298 1,855 1,855
In-process research and development........ 9,828 9,828 -- --
Sales and marketing........................ 2,721 2,361 3,447 2,997
General and administrative................. 1,229 1,647 1,115 1,841
---------- ---------- ----------- -----------
Total operating expenses........... 15,076 15,134 6,417 6,693
---------- ---------- ----------- -----------
Income (loss) from operations...... (7,144) (11,267) 3,781 891
Other income................................. -- -- 35 18
Interest income.............................. 119 119 405 438
Interest expense............................. (346) (346) (182) (215)
---------- ---------- ----------- -----------
Income (loss) before income
taxes............................ (7,371) (11,494) 4,039 1,132
Provision (benefit) for income taxes......... 893 (468) 1,360 407
---------- ---------- ----------- -----------
Net income (loss).................. $ (8,264) $ (11,026) $ 2,679 $ 725
========== ========== =========== ===========
Pro forma information:
Income (loss) before pro forma income
taxes...................................... $ (7,371) $ (11,494) $ 4,039 $ 1,132
Pro forma provision (benefit) for income
taxes...................................... 893 (468) 1,360 407
---------- ---------- ----------- -----------
Pro forma net income (loss).................. $ (8,264) $ (11,026) $ 2,679 $ 725
========== ========== =========== ===========
Pro forma net income (loss) per share
-- Basic................................... $ (0.84) $ (1.12) $ 0.21 $ 0.06
========== ========== =========== ===========
-- Diluted................................. $ (0.84) $ (1.12) $ 0.21 $ 0.06
========== ========== =========== ===========
Weighted average common shares
-- Basic................................... 9,844,087 9,844,087 12,849,322 12,361,944
========== ========== =========== ===========
-- Diluted................................. 9,844,087 9,844,087 12,849,322 13,103,404
========== ========== =========== ===========
F-26
83
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
21. RESTATEMENT OF CONSOLIDATED UNAUDITED QUARTERLY FINANCIAL DATA: (CONTINUED)
MARCH 31, 1996 JUNE 30, 1996
--------------------------- ---------------------------
AS PREVIOUSLY AS PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
------------- ----------- ------------- -----------
Revenues....................................... $ 2,580 $ 2,442 $ 3,148 $ 2,577
Cost of sales.................................. 911 880 939 903
---------- ---------- ---------- ----------
Gross profit......................... 1,669 1,562 2,209 1,674
---------- ---------- ---------- ----------
Operating expenses:
Research and development..................... 436 436 649 649
Sales and marketing.......................... 431 469 404 404
General and administrative................... 626 626 615 615
---------- ---------- ---------- ----------
Total operating expenses............. 1,493 1,531 1,668 1,668
---------- ---------- ---------- ----------
Income (loss) from operations........ 176 31 541 6
Interest income................................ -- -- -- --
Interest expense............................... (18) (19) (32) (31)
---------- ---------- ---------- ----------
Income (loss) before income taxes.... 158 12 509 (25)
Provision (benefit) for income taxes........... -- -- -- --
---------- ---------- ---------- ----------
Net income (loss).................... $ 158 $ 12 $ 509 $ (25)
========== ========== ========== ==========
Pro forma information:
Income (loss) before pro forma income taxes.... $ 158 $ 12 $ 509 $ (25)
Pro forma provision (benefit) for income
taxes........................................ 38 5 97 (9)
---------- ---------- ---------- ----------
Pro forma net income (loss).................... $ 120 $ 7 $ 412 $ (16)
========== ========== ========== ==========
Pro forma net income per share
-- Basic..................................... $ 0.02 $ 0.00 $ 0.06 $ (0.00)
========== ========== ========== ==========
-- Diluted................................... $ 0.02 $ 0.00 $ 0.06 $ (0.00)
========== ========== ========== ==========
Weighted average common shares
-- Basic..................................... 6,783,078 6,783,078 6,968,712 6,783,078
========== ========== ========== ==========
-- Diluted................................... 6,968,712 7,325,492 6,968,712 6,783,078
========== ========== ========== ==========
F-27
84
TRANSCRYPT INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
21. RESTATEMENT OF CONSOLIDATED UNAUDITED QUARTERLY FINANCIAL DATA: (CONTINUED)
SEPTEMBER 30, 1996 DECEMBER 31, 1996
--------------------------- ---------------------------
AS PREVIOUSLY AS PREVIOUSLY
REPORTED AS RESTATED RELEASED AS RESTATED
------------- ----------- ------------- -----------
Revenues....................................... $ 3,547 $ 2,617 $ 4,500 $ 2,983
Cost of sales.................................. 1,036 998 1,979 1,493
---------- ---------- ---------- ----------
Gross profit......................... 2,511 1,619 2,521 1,490
---------- ---------- ---------- ----------
Operating expenses:
Research and development..................... 602 602 547 547
Sales and marketing.......................... 671 681 597 633
General and administrative................... 630 695 543 593
Special compensation expense................. 5,568 5,568 -- --
---------- ---------- ---------- ----------
Total operating expenses............. 7,471 7,546 1,687 1,773
---------- ---------- ---------- ----------
Income (loss) from operations........ (4,960) (5,927) 834 (283)
Interest income................................ 6 6 25 25
Interest expense............................... (35) (35) (77) (77)
---------- ---------- ---------- ----------
Income (loss) before income taxes.... (4,989) (5,956) 782 (335)
Provision (benefit) for income taxes........... (1,759) (2,051) 230 (135)
---------- ---------- ---------- ----------
Net income (loss).................... $ (3,230) $ (3,905) $ 552 $ (200)
========== ========== ========== ==========
Pro forma information:
Income (loss) before pro forma income taxes.... $ (4,989) $ (5,956) $ 782 $ (335)
Pro forma provision (benefit) for income
taxes........................................ (1,759) (2,051) 230 (135)
---------- ---------- ---------- ----------
Pro forma net income (loss).................... $ (3,230) $ (3,905) $ 552 $ (200)
========== ========== ========== ==========
Pro forma net income (loss) per share -- Basic
and Diluted.................................. $ (0.46) $ (0.58) $ 0.08 $ (0.03)
========== ========== ========== ==========
Weighted average common shares -- Basic and
Diluted...................................... 6,968,712 6,783,078 6,968,712 6,783,078
========== ========== ========== ==========
In third quarter of 1997, the Company recorded a charge to "In-process
research and development costs" of $9,828 in connection with the acquisition of
E.F. Johnson, Inc.
In the third quarter of 1996, the Company recorded a charge to "Special
compensation expense" of $5,568 in connection with the vesting of stock options
and accrual of a special compensation expense.
F-28
85
21. RESTATEMENT OF CONSOLIDATED UNAUDITED QUARTERLY FINANCIAL DATA: (CONTINUED)
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Transcrypt International, Inc.:
The audits referred to in our report dated June 26, 1998, included the
related financial statement schedule as of December 31, 1997, and for each of
the years in the three-year period ended December 31, 1997, 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 PEAT MARWICK LLP
Omaha, Nebraska
June 26, 1998
S-1
86
21. RESTATEMENT OF CONSOLIDATED UNAUDITED QUARTERLY FINANCIAL DATA: (CONTINUED)
SCHEDULE III -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
BALANCE AT CHARGED TO CHARGED BALANCE AT
BEGINNING EXPENSES TO OTHER DEDUCTIONS END
OF PERIOD (PROVISIONS) ACCOUNTS (WRITEOFFS) OF PERIOD
---------- ------------ ---------- ----------- ----------
Allowance for Bad Debts for the:
Year Ended December 31, 1995........ $188,014 $ 94,285 $ -- $ 100,640 $ 181,659
Year Ended December 31, 1996........ $181,659 $ 288,596 $ -- $ 40,004 $ 430,251
Year Ended December 31, 1997........ $430,251 $ 109,321 $1,996,972 $ 513,099 $2,023,445
Inventory Obsolescence Reserve for
the:
Year Ended December 31, 1995........ $ 33,562 $ 61,495 $ -- $ 13,016 $ 82,041
Year Ended December 31, 1996........ $ 82,041 $ 127,650 $ -- $ 170,842 $ 38,849
Year Ended December 31, 1997........ $ 38,849 $2,636,107 $5,187,000 $3,747,526 $4,114,430
S-2
87
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 Registration
Statement on Form S-1, No. 333-14351, declared effective on
January 22, 1997 (hereinafter the "January 1997 Registration
Statement")).
3.2 Amended and Restated Bylaws of the Company (incorporated
herein by reference to Exhibit 3.2 to 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 RESERVED
10.1.1 Employment Agreement between the Company and John T. Connor
dated as of July 31, 1997 (incorporated herein by reference
to Exhibit 10.1.1 to the Company's Registration Statement on
Form S-1, No. 333-35469, declared effective October 15, 1997
(hereinafter the "October 1997 Registration Statement")).
10.2 RESERVED
10.2.1 Employment Agreement between the Company and Jeffery L.
Fuller dated as of July 31, 1997 (incorporated herein by
reference to Exhibit 10.2.1 to the October 1997 Registration
Statement).
10.3 Form of Employment Agreement between the Company and C. Eric
Baumann, Michael P. Wallace and Joel K. Young (incorporated
herein by reference to Exhibit 10.3 to the January 1997
Registration Statement).
10.3.1 Employment Agreement between the Company and Frederick G.
Hamer dated as of July 29, 1997.
10.4 Transcrypt International, Inc. 1996 Stock Incentive Plan, as
amended.
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).
10.10* Private Label/Supplier Agreement for Analog Scrambling
Modules between Motorola, Inc. and the Company dated as of
August 8, 1995 (incorporated herein by reference to Exhibit
10.10 to the January 1997 Registration Statement).
88
EXHIBIT
NUMBER DESCRIPTION
- -------- -----------
10.10.1* Second Amendment, dated March 31, 1997, to Private
Label/Supplier Agreement for Analog Scrambling Modules
between Motorola, Inc. and the Company dated as of August 8,
1995 (incorporated herein by reference to Exhibit 10.10.1 to
the Company's Quarterly Report on Form 10-Q for the Quarter
Ended March 31, 1997, File No. 0-21681 (hereinafter "1Q 1997
Form 10-Q")).
10.11* Motorola Cellular Subscriber Products Sales Agreement, dated
as of June 13, 1996, by and between Motorola, Inc. and the
Company (incorporated herein by reference to Exhibit 10.11
to the January 1997 Registration Statement).
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
10.16
10.17 Amended and Restated Loan Agreement, dated as of May 18,
1994, by and between Norwest Bank Nebraska, N.A., and the
Company (incorporated herein by reference to Exhibit 10.17
to the January 1997 Registration Statement).
10.18 First Amendment, dated as of June 1, 1995, to Amended and
Restated Loan Agreement, dated as of May 18, 1994, by and
between Norwest Bank Nebraska, N.A., and the Company
(incorporated herein by reference to Exhibit 10.18 to the
January 1997 Registration Statement).
10.19 Second Amendment, dated as of April 10, 1996, to Amended and
Restated Loan Agreement, dated as of May 18, 1994, by and
between Norwest Bank Nebraska, N.A., and the Company
(incorporated herein by reference to Exhibit 10.19 to the
January 1997 Registration Statement).
10.20- 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 Third Amendment, dated as of October 22, 1996, to Amended
and Restated Loan Agreement, dated as of May 18, 1994, by
and between Norwest Bank Nebraska, N.A., and the Company,
together with Modification of Note (incorporated herein by
reference to Exhibit 10.26 to the January 1997 Registration
Statement).
10.27 Fourth Amendment, dated as of November 19, 1996, to Amended
and Restated Loan Agreement, dated as of May 18, 1994, by
and between Norwest Bank Nebraska, N.A., and the Company,
together with Commercial Installment Note, dated November
19, 1996 (incorporated herein by reference to Exhibit 10.27
to the January 1997 Registration Statement).
10.27.1 Fifth Amendment, dated as of March 1, 1997, to Amended and
Restated Loan Agreement, dated as of May 18, 1994, by and
between Norwest Bank Nebraska, N.A., and the Company
(incorporated herein by reference to Exhibit 10.27.1 to the
1Q 1997 Form 10-Q).
10.28 Construction Loan, dated November 15, 1996, by and between
Norwest Bank Nebraska, N.A., and the Company, together with
related documents (incorporated herein by reference to
Exhibit 10.28 to the Company's Annual Report on Form 10-K
for the Year Ended December 31, 1996, File No. 0-21681
(hereinafter "1996 Form 10-K")).
89
EXHIBIT
NUMBER DESCRIPTION
- -------- -----------
10.29 Commercial Installment Note, dated January 9, 1997, related
to Amended and Restated Loan Agreement, dated as of May 18,
1994, by and between Norwest Bank Nebraska, N.A., and the
Company (incorporated herein by reference to Exhibit 10.29
to the 1996 Form 10-K).
10.30 Commercial Installment Note secured by equipment, dated
December 23, 1996, by and between Norwest Bank Nebraska,
N.A., and the Company, together with Security Agreement
(incorporated herein by reference to Exhibit 10.30 to the
1996 Form 10-K).
10.31 Nebraska Investment Finance Authority $2,850,000 Variable
Rate Demand Industrial Development Revenue Bond (Transcrypt
International, Inc. Project), Series 1997, dated as of March
25, 1997 (incorporated herein by reference to Exhibit 10.31
to the 1Q 1997 Form 10-Q).
10.32 Trust Indenture, dated as of March 1, 1997, for $2,850,000
Variable Rate Demand Industrial Development Revenue Bond
(Transcrypt International, Inc. Project), Series 1997,
between Nebraska Investment Finance Authority as Issuer and
Norwest Bank Nebraska, N.A. as Trustee (incorporated herein
by reference to Exhibit 10.32 to the 1Q 1997 Form 10-Q).
10.33 Loan Agreement, dated as of March 1, 1997, for $2,850,000
Variable Rate Demand Industrial Development Revenue Bond
(Transcrypt International, Inc. Project), Series 1997,
between Nebraska Investment Finance Authority as Issuer and
the Company (incorporated herein by reference to Exhibit
10.33 to the 1Q 1997 Form 10-Q).
10.34- 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.
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.
10.39 Severance Agreement and Mutual Release between the Company
and Jeffery L. Fuller dated June 2, 1998.
10.40 Severance Agreement and Mutual Release between the Company
and Charles E. Baumann dated June 2, 1998.
11.1 Statement re: Computation of Per Share Earnings.
21 Subsidiaries of the Registrant.
23.1 Consent of KPMG Peat Marwick LLP.
27.1 Financial Data Schedule.
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* Confidential treatment has previously been granted by the SEC as to a portion
of this exhibit.