UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2009

 

Commission file number 000-28539

 

DRI CORPORATION

(Exact name of Registrant as specified in its Charter)

 

 

13760 Noel Road, Suite 830
Dallas, Texas 75240
(Address of principal executive offices, Zip Code)

 

Registrant’s telephone number, including area code:

(214) 378-8992

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Exchange Act of 1934: Yes o     No þ

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act: Yes o     No þ

 

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 þ     No o

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or such shorter period that the Registrant was required to submit and post such files.) Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) 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. Yes o     No þ

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act):

 

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes o     No þ

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant as of June 30, 2009 was approximately $17,224,139.

 

Indicate the number of shares outstanding of the Registrant’s Common Stock as of April 15, 2010:

 

 

DOCUMENTS INCORPORATED BY REFERENCE:

 

Part III incorporates certain information by reference from the Registrant’s definitive proxy statement, which will be filed on or before April 30, 2010, for the Annual Meeting of Shareholders to be held on or before May 27, 2010.

 

 

FORWARD-LOOKING STATEMENTS

 

“Forward-looking” statements appear throughout this Annual Report. We have based these forward-looking statements upon our current expectations and projections about future events. It is important to note our actual results could differ materially from those contemplated in our forward-looking statements as a result of various factors, including those described in Item 1A “Risk Factors” as well as all other cautionary language in this Annual Report. Readers should be aware that the occurrence of the events described in these considerations and elsewhere in this Annual Report could have an adverse effect on the business, results of operations or financial condition of the entity affected.

 

Forward-looking statements in this Annual Report may include, without limitation, the following:

 

 

 

Readers should be aware that all of our forward-looking statements are subject to a number of risks, assumptions and uncertainties, such as but not limited to, (and in no particular order):

 

 

 

This list is only an example of the risks that may affect the forward-looking statements. If any of these risks or uncertainties materialize (or if they fail to materialize), or if the underlying assumptions are incorrect, then actual results may differ materially from those projected in the forward-looking statements.

 

Additional factors that could cause actual results to differ materially from those reflected in the forward-looking statements include, without limitation, those discussed elsewhere in this Annual Report. Readers are cautioned not to place undue reliance upon these forward-looking statements, which reflect our analysis, judgment, belief or expectation only as of the date of this Annual Report. We undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date of this Annual Report.

 

WHERE YOU MAY FIND ADDITIONAL INFORMATION

 

Our internet address is www.digrec.com. We make publicly available free of charge on our internet website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (the “SEC”). Information contained on our website is not a part of this Annual Report.

 

You may read and copy any materials we file with the SEC at the SEC’s Public Reference Room, 100 F Street, NE, Washington, D.C. 20549-0102. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a website (http://www.sec.gov) that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Securities and Exchange Commission.

INDEX

 

 

 

General

 

In this Annual Report on Form 10-K, we refer to DRI Corporation as “DRI”, “the Company”, “us”, “we” and “our.” DRI was incorporated in March 1983 as Digital Recorders, Inc. and became a public company through an initial public offering in November 1994. In June 2007, our shareholders approved changing the Company’s name to DRI Corporation. DRI’s common stock, $.10 par value per share (“Common Stock”), trades on the NASDAQ Capital Market^® under the symbol “TBUS.”

 

Prior to 2007, DRI had historically operated within two major business segments: (1) the transportation communications segment and (2) the law enforcement and surveillance segment. In April 2007, the Company’s Digital Audio Corporation subsidiary, which comprised all of the operations of the law enforcement and surveillance segment, was divested. Accordingly, the Company currently operates within one major business segment.

 

Through its business units and wholly owned subsidiaries, DRI designs, manufactures, sells, and services information technology products either directly or through manufacturers’ representatives or distributors. DRI produces passenger information communication products under the Talking Bus^®, TwinVision^®, VacTell^tm and Mobitec^® brand names, which are sold to transportation vehicle equipment customers worldwide. The Talking Bus^®, VacTell^tm and TwinVision^® brands are sold by our business units in the United States (“U.S.”) primarily to the U.S. and Canadian markets. Net sales by our U.S. business units represent 40% of total net sales split 70% in the U.S. market, 24% in the Canadian market, and the remaining 6% in the European market. Long-lived assets within the U.S. include 59% of all long-lived assets and are all owned by our U.S. businesses. The Mobitec^® brand, which represents 60% of total net sales, is sold in the Nordic market in Sweden, Norway, Denmark, and Finland, in several countries in the European market including Germany, France, Poland, United Kingdom, Spain, and Hungary, in the South American market, primarily in Brazil, and in the Asia-Pacific and Middle-East markets. Long-lived assets within the Nordic market include 32% of all long-lived assets and are all owned by our subsidiaries in Europe. All other long-lived assets within the remaining markets account for approximately 9% of the total long-lived assets. See the accompanying consolidated financial statements and notes to consolidated financial statements for geographical information regarding the Company’s sales and long-lived assets.

 

DRI’s customers generally fall into one of two broad categories: end-user customers or original equipment manufacturers (“OEM”). DRI’s end-user customers include municipalities; regional transportation districts; state, and local departments of transportation; transit agencies; public, private, or commercial operators of bus and van vehicles; and rental car agencies. DRI’s OEM customers are the manufacturers of transportation rail, bus and van vehicles. The relative percentage of sales to end-user customers compared to OEM customers varies widely and frequently from quarter-to-quarter and year-to-year, and within products and product lines comprising DRI’s mix of total sales in any given period.

 

U.S. Operations

 

Our current U.S.-based operations serve markets primarily in the U.S. and Canada and consist of the following subsidiaries:

 

 

 

International Operations

 

Our current international operations serve markets in Europe, the Far East, the Middle East, South America, Australia, Asia-Pacific and generally all markets throughout the world outside the U.S. and Canada. Our current international operations consist of the following subsidiaries:

 

 

 

Divestiture of Digital Audio Corporation

 

On April 30, 2007 (the “Closing Date”), the Company and its wholly-owned subsidiary Digital Audio Corporation (“DAC”) entered into a Share Purchase Agreement with Dolphin Direct Equity Partners, LP (“Dolphin”), a Delaware limited partnership, pursuant to which Dolphin acquired all of DAC’s issued and outstanding shares of common stock. DAC comprised all of the operations of the law enforcement and surveillance segment reported by the Company prior to divestiture. Accordingly, the Company’s continuing operations consist of only one operating segment, the transportation communications segment.

 

Mobitec Brazil Acquisition

 

Pursuant to terms of a Quota Purchase Agreement entered into on July 22, 2009 and amended September 17, 2009, Mobitec EP acquired the remaining fifty percent (50%) of the issued and outstanding interests of Mobitec Brazil for an aggregate consideration of US$2.95 million. Per terms of the Quota Purchase Agreement, the acquisition by Mobitec EP of the remaining fifty percent (50%) of the interests of Mobitec Brazil is effective July 1, 2009, the date upon which the Company assumed full control of the business. This acquisition is more fully described in Note 2 to the accompanying consolidated financial statements.

 

Industry and Market Overview

 

The digital communications technology market in transit and transportation applications as served by DRI developed because of several factors. In the earliest stages, the digital destination signs market developed due to the quest for lower operating expenses and greater fleet flexibility. Later the market was influenced by the Americans With Disabilities Act (“ADA”), the Clean Air Act, the Intermodal Surface Transportation Efficiency Act (“ISTEA”) and related or follow-on legislation, intelligent transportation systems initiatives, and the need to further enhance fleet flexibility. The ADA initially accelerated the trend toward systems for automatic next-stop announcements by requiring that fixed-route transit systems announce major stops and transfer points to assist visually challenged passengers. However, a more fundamental and longer-term impetus for the development of this market is the need to provide improved passenger information and customer services to operators and riders of public and private transit and transportation vehicles as well as to provide fleet efficiency, management and security services. DRI’s electronic information display systems, automatic voice announcement and vehicle locating systems provide transit systems’ customers with next stop, transfer point, route and destination information, vehicle location and operational condition information, and public service announcements, as well as security-related functionality in certain instances. On the U.S. public side of this

market, in addition to state, local, and regional grants and “fare-box” income, transit operating authorities can normally apply to the U.S. Federal Transit Administration (“FTA”) for grants covering up to approximately 80% of funding for certain equipment purchases with the remainder of product acquisition funding being provided by state and local sources. Additionally, more recently, funds have been allocated in the American Recovery and Reinvestment Act of 2009 to assist transit system operators in securing additional equipment such as that which we supply. This funding is available at 100% of the procured item contracted value. In the international markets, funding comes from a variety of sources including federal, local, and regional grants as well as local operating “fare-box” income. Privately funded users of DRI’s transit communications sector products include rental car shuttle vehicles and tourist vehicle operators.

 

The Safe, Accountable, Flexible, Efficient, Transportation Equity Act — A Legacy for Users (“SAFETEA-LU”) was the primary program funding the U.S. public surface transit market at the federal level through federal fiscal year 2009. SAFETEA-LU promoted the development of modern, expanded, intermodal public transit systems nationwide and also designated a wide range of tools, services, and programs intended to increase the capacity of the nation’s mobility systems. SAFETEA-LU guaranteed a record level $52.6 billion in funding for public transportation through federal fiscal year 2009, including approximately $10.3 billion to fund federal transit programs in federal fiscal year 2009. Economic stimulus legislation under the American Recovery and Reinvestment Act of 2009 (the “ARRA”) included $8.4 billion reserved for U.S. public transportation infrastructure projects, of which approximately $6.9 billion was authorized for use in our core served U.S. market. The Company’s domestic subsidiaries initially saw an increase in customer requests for estimates, quotes and proposals as a direct result of the ARRA funding. However, the actual rate of conversion of those quotes and proposals into firm orders has been slower than expected. Additionally, we cannot determine with any certainty that certain projects would or would not have materialized in absence of the ARRA funding. However, we estimate that, ARRA projects have led to new orders, deliverable to a small extent in 2009, and mostly in 2010, totaling between $2.8 million and $5.5 million. Further, we expect additional order activity under the ARRA to materialize in 2010, which could bring the ultimate total business funded under that program to approximately $8 million. We believe the funding under SAFETEA-LU and the ARRA have led to a favorable and increasing market for most of our products in the U.S. segment of our served market.

 

Authorized federal funding under SAFETEA-LU expired at September 30, 2009. Continuation of the expiring legislation has been implemented under specific legislated extensions. According to reports from the American Public Transportation Association (“APTA”), the U.S. House Appropriations Subcommittee on Transportation, Housing and Urban Development and Related Agencies Appropriations marked-up its annual appropriations bill on July 13, 2009. For fiscal year 2010, the bill would provide $10.5 billion for federal transit programs, roughly a 1 percent increase over the fiscal year 2009 level, as well as $4 billion for high speed rail. Likewise, the Senate subsequently passed its measure. Final passage and reconciliation was expected to occur when Congress reconvened after its August 2009 recess. However, instead of final passage and reconciliation, extensions were utilized to continue funding on a short-term basis leading up to a recent mid-range extension to December 31, 2010.

 

One significant component of U.S. market federal finding is a trust fund that receives income from taxes on motor fuels (note that federal funds provide approximately 20% of all funds in the transit industry). Receipts to the trust fund have been inadequate to provide and sustain the needed federal funding of U.S. transit systems. Recently, additional funds were deposited in the trust fund from general revenue sources and it is believed that such funds are sufficient to extend the life of that program through federal fiscal year 2011.

 

Another significant source of U.S. transit funding is state and local taxes or other forms of state and local resources. As a result of the slow-down in the U.S. economy in recent periods, many transit operating authorities in the U.S. are having trouble maintaining levels of service they have historically provided and some have commenced service cutbacks and reductions. This issue is being addressed through additional operating funding possibly being made available at the federal level.

New authorizing legislation has been prepared by the U.S. House Committee on Transportation & Infrastructure, which has released its proposal for the next surface transportation authorization bill to replace SAFETEA-LU. The proposal, “A Blueprint for Investment and Reform,” recommends a $450 billion investment in surface transportation programs over a six-year period, including $99.8 billion for public transportation programs that, if enacted, would approximate a 90 percent increase over SAFETEA-LU funding levels. The bill recommends an additional $50 billion to create a national high speed rail network. Funding ways and means for the proposed legislation must still be addressed. There can be no assurance that new legislation will materialize and final passage of any form of new legislation is not expected to occur until late in 2010 at the earliest and may not occur until sometime in 2011 or later. Extensions of the expired legislation will be necessary until ways and means to finance a new longer-term legislation can be determined. The Company’s senior management is involved in development of the new legislation and extensions of the expired legislation through active participation in APTA and continues to monitor the development of the new legislation and its potential impact on the Company’s future operating results. Currently, management believes that such legislative issues will have minimal impact on the U.S. market at least into late 2010, at which time there could be a depressing impact on the U.S. market that we serve.

 

Federal funding issues described herein do not impact the larger, international market we serve. Sales by our international subsidiaries increased by approximately 31% in 2009 compared to 2008 (after giving effect to changes in currency exchange rates) as we continued to seek opportunities to expand our presence internationally, both in current served markets and in new markets around the globe. Our international operations have seen some customer procurement plan revisions, including rescheduling of delivery dates and some scale-back. Some of this was due, in the opinion of management, at least partially, to the global economic slowdown in certain specific international market sectors. However, certain other international and domestic customer rescheduling of orders has recently been experienced primarily for reasons other than economic circumstances. While such issues as these can and do occasionally impact the Company, we believe long-term market drivers for the global transit industry, which include traffic grid-lock, high fuel prices, environmental issues, economic issues and the need to provide safe and secure transportation systems, continue to suggest a favorable overall long term trend and environment for DRI, and we remain optimistic about the Company’s prospects in the global transit and transportation markets.

 

While as much as 80% of certain major capital expenditures in the U.S. can be funded federally in most instances, federal funding accounts for less than 20% of all funding in the U.S. market. The remainder comes from a combination of state and local public funds and passenger “fare-box” revenue. However, even though federal funding is a relatively low share of the total, its presence, absence or uncertainty, in our opinion, has a larger impact on the market than the 20% might imply. Funding for markets outside of the U.S. comes from a variety of sources. These sources vary widely from region-to-region and from period-to-period but include combinations of local, regional, municipal, federal, and private entities or funding mechanisms as well as funds generated by collection of fares.

 

The automatic voice announcement systems market served by DRI’s DR subsidiary emerged primarily because of ADA legislation. DR was among the pioneers to develop automatic voice announcement technology including GPS tracking and triggering. DR’s Talking Bus^® system met favorable acceptance in terms of concept, design, and technology, and was acknowledged to be ADA compliant. That regulatory-driven acceptance has evolved and grown into a basic customer service consideration. We believe that over 60% of all new bus vehicles in North America contained automatic voice announcement systems in recent years. We expect this percentage to moderately increase over the next several years as automatic voice announcement systems reduce cost, decrease in maintenance cost and complexity, integrate to deliver other features and services, and become more distinctly perceived as a form of customer service. To date, our DR subsidiary has had minimal international sales. Management believes DR holds a significant U.S. market share in stand-alone (as opposed to similar functionality included in larger integrated information system installations) automatic voice announcement systems.

 

Enhancement and expansion of the AVL and AVM capabilities of DR’s DR-600 Talking Bus^® system has enabled DRI to expand the market it serves to include fleet management (“Engineered Systems”) services for operators and users of transit vehicle systems. An outcome of this is the ability to provide more and better

information to the users of transit systems by placing real-time current vehicle location information at passenger boarding locations and vehicle operating efficiency and vehicle health information at operational headquarters and other strategic locations. Additionally, this capability is emerging as a form of security risk mitigation for our customers. It is in this area of our business that we form alliances with others in order to enhance our market capability and access. Furthering security features and security related transit products, DR produces and sells VacTell^tm video actionable intelligence solutions, which combines well-established Digital Recorders^® on- and off-vehicle location and monitoring products with advanced digital video recording and wireless communications technologies to deliver the ability to enhance management of security events.

 

The electronic destination sign system market served by our U.S. and international operations is highly competitive. Aside from the benefit of opening new geographic market segments, growth of this business is closely tied to overall market growth, increased market share, or technological advances. A significant portion of transit buses in operation worldwide have some form of electronic destination sign system. We estimate approximately 98% of those systems in the U.S. are electronic. The percentage of buses with electronic destination sign systems varies greatly among international markets, with some markets as high as 98% and some markets as low as 5%. We estimate approximately 50% of destination sign systems in our overall international markets are electronic and believe this percentage is trending upward. We believe that TVna holds a significant market share in the U.S., while Mobitec AB holds a majority market share in the Nordic market and Mobitec AB, through subsidiaries, holds significant, and in some cases, majority market share in most of its primary geographic served markets world-wide.

 

Key Competitors

 

Most of the markets in which we participate are highly competitive and are subject to technological advances, as well as evolving industry and regulatory standards. We believe the principal competitive factors in all markets we serve include ease of use, after-sales service and support, local presence and support on a multi-national basis, price, the ability to integrate products with other technologies, maintaining leading edge technology, and responding to governmental regulation.

 

In DRI’s electronic destination sign systems market, management views Luminator Holding L.P. (“Luminator”), an operating unit of Mark IV Industries, Inc., as its principal competitor. Clever Devices Ltd. is the most significant competitor in the domestic automatic voice announcement systems market. In the engineered systems market, management considers INIT GmbH, Continental AG, and the former TMS subsidiary of Orbital Sciences, now owned by ACS, to be DRI’s most significant competitors. Numerous other competitors exist, particularly in the international markets, and most tend to serve discrete regions or territories rather than the global market served by DRI. Of the international competitors, those comprising the majority of competitive market shareholdings are LLE, Luminator, Hanover Displays, Gorba, INIT, Continental, and ACS. All of these except ACS, Luminator, and Hanover Displays are based in Central Europe. Hanover Displays is based in the United Kingdom with significant market share there, as well as sales in selected regions of the continental European market. ACS and Luminator are based in the U.S.

 

Products and Product Design

 

DRI’s current products include:

 

 

 

The Digital Recorders systems enable voice-announced transit vehicle stops, GPS-based automatic vehicle location, automatic vehicle monitoring, and other passenger information, such as next stop, transfer point, route and destination information, and public service announcements. The vehicle locating and monitoring aspect of this product further provides security-related capabilities. These systems can be used in transit buses and vans, light rail vehicles, trains, subway cars, people movers, monorails, airport vehicles and tour buses, as well as other private and commercial vehicles. Compliant with industry-recognized standards, the system uses an open architecture, computer-based microprocessor electronics system design including interoperability with third-party equipment. The open architecture design permits expansion to customer size requirements and integration with other electronic systems. Wireless 802.11x data exchange is available. This system, as well as all of DRI’s products, is designed to meet the severe operating demands of temperature, humidity, shock, vibration, and other environmental conditions found in typical transit applications.

 

DRI’s electronic destination sign system products, which are generally known by the TwinVision^® and Mobitec^® brand names, represent technologically advanced products pioneered by our Mobitec GmbH, TVna, and Mobitec AB subsidiaries. The product line includes various models covering essentially all popular applications. Where applicable, these products adhere to ADA requirements and function under industry-recognized standards. They each possess an open architecture, microprocessor-based design. In 2000, TVna and Mobitec GmbH introduced an all-LED, solid-state product. The all-LED product dominates sales of destination sign systems in North America and in the international markets, while prior generation, mechanical “flip-dot” or “flip-dot/LED” products, accounts for a declining percentage of sales by DRI’s international subsidiaries. As the name implies, the “all-LED” product provides improved illumination and eliminates moving parts, thereby delivering better readability and lowered maintenance expenses.

 

In 2001, TVna and Mobitec GmbH introduced the TwinVision^® Chromatic Series, including TwinVision^® Chroma I and TwinVision^® Chroma IV, which offered DRI’s customers greater color “route identification” flexibility and message display options for electronic destination signage. These products incorporate colorized route capabilities while retaining electronic destination sign system message display advantages for the color-vision impaired. In 2008, TVna introduced the TwinVision^® All-LED Smart Series and TwinVision^® Chromatic Smart Series. The Smart Series products feature a more advanced processing system that has been integrated with the Company’s all-LED and Chromatic Series electronic destination sign systems. In 2009, TVna introduced the new Silver Series destination sign system having significantly better and brighter image features. Utilizing state-of-the-art processors to monitor system health and solid-state LED devices to provide extremely bright messages with wide-angle visibility both day and night, these products help reduce fleet maintenance costs and system diagnostic times, as well as deliver improved message displays.

 

Message programming for all electronic destination sign system products is accomplished via proprietary ELYSÉ^® software developed by Mobitec GmbH and refined by TVna, or similar companion software developed by Mobitec AB. Programming is accomplished through such means as PCMCIA memory card download, USB devices and certain wireless capabilities.

Under terms of a license agreement with the University of Washington, DR uses certain technology developed by the Intelligent Transportation Systems Research program at the University under the names “BusView” and “MyBus.” The technology, some of which we have integrated with the Talking Bus^® system, enables transit system users to access information about the vehicle they wish to board, such as schedule data, via the internet. This technology, combined with DRI’s internal developments, is helping extend DR’s product offerings into automatic vehicle location, fleet management, automatic vehicle monitoring, and off-vehicle passenger information markets and security. Under the license agreement with the University of Washington, the Company pays royalties for use of the technology. The royalties paid are not significant to the Company’s results of operations.

 

Marketing and Sales Organization

 

DRI’s products are marketed by in-house sales and marketing personnel, commissioned independent sales representatives, and by distributors or dealers in selected limited circumstances as appropriate for each business unit and market segment. Marketing and sales activities include database marketing; selective advertising; direct contact selling; publication of customer newsletters; participation in trade shows and industry conventions; and cooperative activities with systems integrators and alliance partners on a selective basis.

 

Management regularly evaluates alternative methods of promoting and marketing DRI’s products and services. Web site and internet-based marketing techniques currently serve to assist marketing and sales efforts, but the custom-specification, request-for-quote nature of DRI’s markets does not lend itself to full-scale, internet-driven marketing and sales efforts.

 

Customers

 

Though we had no major customer (defined as those customers to which we made sales greater than 10% of DRI’s total sales) in 2009, we continue to generate a significant portion of our sales from a relatively small number of key customers. In 2009, 2008 and 2007, our top five customers accounted for 36.0%, 33.4%, and 21.3%, respectively, of total annual sales. These key customers, the composition of which may vary from year to year, are primarily transit bus original equipment manufacturers. We sell our products to a limited set of customers and can experience concentration of revenue with related credit risk. Loss of one or more of these key customers could have an adverse material impact on the Company.

 

Seasonality and Fluctuation in Results

 

DRI’s sales are not generally “seasonal” in nature. However, a significant portion of sales for each product line is made, either directly or indirectly, to government or publicly funded entities. In addition, many sales to transit original equipment manufacturers are themselves related to sales by those manufacturers to government or publicly funded entities. In general, due to project funding availability considerations being somewhat tied to governmental agencies in some instances, we may occasionally experience the appearance of seasonality-like movement in revenue. In the U.S., the federal government and many state and local governments operate on an October to September fiscal year. Several key international government customers operate on an April to March fiscal year. In addition, government agencies occasionally have a tendency to purchase infrequently and in large quantities, creating uneven demand cycles throughout the year. These cycles generate periods of relatively low order activity as well as periods of intense order activity. This fluctuation in ordering tends to make sales patterns uneven and make it difficult to forecast quarter-to-quarter and year-to-year results.

 

Sales to DRI customers are characterized by relatively larger contracts and lengthy sales cycles that generally extend for a period of two months to 24 months. The majority of sales of the Company’s products and services are recognized upon physical shipment of products and completion of the service, provided all accounting criteria for recognition have been met. Sales and revenues for projects involving multiple elements (i.e., products, services, installation and other services) are recognized under specific accounting criteria based on the products and services delivered to the customer and the customer’s acceptance of such products and

services. Sales and revenues from more complex or time-spanning projects within which there are multiple deliverables including products, services, and software are recognized based upon the facts and circumstances unique to each project. This generally involves recognizing sales and revenue over the life of the project based upon (1) meeting specific delivery or performance criteria. See discussion of DRI’s revenue recognition policies in Item 7 below.

 

DRI’s sales tend to be made pursuant to larger contracts, requiring deliveries over several months. Purchases by a majority of DRI’s customers are frequently somewhat dependent, directly or indirectly, on federal, state, regional and local funding. Manufacturers of transportation equipment, who, in turn, sell to agencies or entities dependent on government funding, are the principal customers for DRI’s products. Further, governmental type purchasers generally are required to make acquisitions through a public bidding process. The fact that much of DRI’s sales are derived from relatively large contracts with a small number of customers can result in fluctuations in DRI’s sales and, thus, operating results, from quarter-to-quarter, period-over-period and year-to-year.

 

Due to DRI’s business dealings in foreign countries, the Company may experience foreign currency transaction gains and losses in relation to the changes in foreign currency rates, which can result in variances from quarter-to-quarter and year-to-year. The Company does not engage in currency hedging at this time.

 

Backlog

 

DRI’s backlog as of December 31, 2009, was $26.3 million compared to $9.9 million as of December 31, 2008, and $12.0 million as of December 31, 2007. Fluctuations in backlog can occur and generally are due to: (1) timing of the receipt of orders; (2) order cycle fluctuations arising from the factors described under the heading “Seasonality and Fluctuation in Results”; and (3) the extent of long-term orders in the marketplace. We believe backlog is becoming less of a trend indicator for the Company due to the fact that some of our larger customers depend on the Company to monitor their production and anticipate when Company products will be needed. As a result, customer purchase orders classified as “backlog” may not materialize until relatively close to the necessary delivery date. DRI currently anticipates that it will deliver all, or substantially all, of the backlog as of December 31, 2009 during fiscal year 2010.

 

Research and Development

 

DRI is committed to the continued technological enhancement of all its products and to the development or acquisition of products having advanced technological features. However, continued development of any individual product is dependent upon product acceptance in the marketplace. DRI’s objective is to develop products that are considered high quality, technologically advanced, cost competitive, and capable of capturing a significant share of the addressable market. Product development based upon advanced technologies is one of the primary means by which management differentiates DRI from its competitors.

 

Management anticipates that technological enhancements to the Talking Bus^® automatic voice announcement system, VacTell^tm video surveillance security products, and TwinVision^® and Mobitec^® electronic destination sign system products will continue in the future. Such technological enhancements are designed to enhance DRI’s ability to integrate these products with other technologies, reduce unit cost of production, capture market share and advance the state-of-the-art technologies in DRI’s ongoing efforts to improve profit margins. The enhancements should increase available marketable product features as well as aid in increasing market share, product profit margins and market penetration. In addition to enhancing existing products, DRI generally has new generations of products under various stages of development or under development refinement of U.S. products to make ready for the international market.

 

Research and development activities continued in all product areas during 2009. Research and development expenses were $552,000 in 2009, $974,000 in 2008, and $1.1 million in 2007. During 2009, as in prior years, salaries of certain engineering personnel who were used in the development of software and other related costs met the capitalization criteria of Accounting Standards Codification (“ASC”) Topic 985-20, “Costs of Computer Software to be Sold, Leased or Marketed.” The total amount of personnel and other expense capitalized in 2009 was $2.1 million as compared to capitalization of $1.5 million and $669,000 for

such costs for the years ended December 31, 2008 and 2007, respectively. In 2009, the Company stepped-up its efforts to develop more technologically advanced products that would meet our customers’ needs and which we believe would provide an advantage over our competitors’ products. We increased our engineering resources in 2009, which allowed us to execute our plan to increase these development efforts. We believe the technological advances to our products resulting from these increased capitalized development projects will generate increased revenues for us in future periods. In aggregate, research and development expenditures in 2009 were $2.6 million as compared to aggregate expenditures of $2.5 million and $1.8 million in 2008 and 2007, respectively. This increase in aggregate research and development expenditures is attributable to the Company’s continued efforts to pursue technological enhancements to existing products and to develop new, technologically advanced products that will meet our customers’ needs.

 

Because we believe technological advances are necessary to maintain and improve product lines and, thus, market position, we expect to continue to invest in research and development activities in future periods. Due to our research and development spending, we may experience fluctuations in operating results since costs may be incurred in periods prior to the related or resulting sales. Additionally, technological advances increase the potential for existing products to become obsolete. The Company takes technological advances into consideration when evaluating the carrying amount of its inventory on a period-to-period basis.

 

Manufacturing Operations

 

Our principal suppliers generally are ISO (or substantial equivalent) certified contract-manufacturing firms that produce DRI-designed equipment. DR also performs part of its assembly work in-house purchasing major components and services from several suppliers in the U.S.

 

TVna purchases display components and assemblies for electronic destination sign systems from multiple companies in the U.S., Europe, and Asia. We generally assemble these products, and some related subassemblies, in-house. Domestic production is compliant with “Buy-America” regulations.

 

Mobitec AB produces the majority of the products it sells, as well as products for sales of Mobitec GmbH, Mobitec Pty, and Castmaster Mobitec in Herrljunga, Sweden. It purchases raw materials, components, and assemblies primarily from suppliers located in the Nordic, Asian and European markets. In late 2009, Castmaster Mobitec started local production work in India.

 

Mobitec Brazil Ltda produces its products in Caxias do Sul, Brazil. It purchases raw materials, components and assemblies from companies in Europe, LEDs from DRI’s other subsidiaries and suppliers in Asia, and the remainder primarily from various local suppliers in Brazil.

 

Customer Service

 

We believe our commitment to customer service has enhanced the customer’s opinion of DRI compared to our competitors. Our plan is to continue defining and refining our service-oriented organization as a sustainable competitive advantage.

 

Proprietary Rights

 

We currently own four design patents and have a combination of trademarks, copyrights, alliances, trade secrets, nondisclosure agreements, and licensing agreements to establish and protect our ownership of, and access to, proprietary and intellectual property rights as well as patent applications. Our attempts to keep the results of our research and development efforts proprietary may not be sufficient to prevent others from using some or all of such information or technology. By “designing around” our intellectual property rights, our competitors may be able to offer similar functionality provided by our products without violating our intellectual property rights. We have registered our Digital Recorders^®, Talking Bus^®, TwinVision^®, Mobitec^®, ELYSÉ^®, DR500C+^®, DR600^®, and VacTell^tm trademarks, as well as other trademarks, logos, slogans, taglines, and trade names with the U.S. Patent and Trademark Office and, where appropriate, with similar governmental agencies abroad.

We intend to pursue new patents and other intellectual property rights protection methods covering technology and developments on an on-going basis. We also intend to use our best efforts to maintain the integrity of our trademarks, logos, slogans, taglines, trade names, and other proprietary names, as well as to protect them from unauthorized use, infringement, and unfair competition.

 

Employees

 

As of December 31, 2009, DRI employed 244 people, of which 89 were employed domestically and 155 were employed internationally. Of the 89 domestic employees, 5 were employed in our Dallas corporate administrative office. Although European subsidiaries include some limited work-place agreements, DRI employees are not covered by any collective bargaining agreements and management believes its employee relations are good. We believe future success will depend, in part, on our continued ability to attract, hire, and retain qualified personnel.

 

 

Many of the risks discussed below have affected our business in the past, and many are likely to continue to do so. These risks may materially adversely affect our business, financial condition, operating results or cash flows, or the market price of our Common Stock.

 

Risks Related to Indebtedness, Financial Condition and Results of Operations

 

Our substantial debt could adversely affect our financial position, operations and ability to grow.  As of December 31, 2009, we had total debt of approximately $15 million. Included in this debt is $7.2 million under our domestic and European revolving credit facilities, a $4.8 million term loan due June 30, 2011, a $209,000 loan due on September 30, 2010, a $470,000 loan due on June 30, 2011, a $1.95 million loan due on October 30, 2012, a $132,000 loan due on October 7, 2014, a $22,000 loan due on September 7, 2012, a $93,000 loan due on April 30, 2010, loans of $135,000 with 180-day terms, a $1,900 loan due on January 17, 2010, and three loans of $24,000 due on November 16, 2010. Our domestic revolving credit facility had an outstanding balance of $3.8 million as of December 31, 2009 and matures on June 30, 2011. Our European revolving credit facilities have outstanding balances of $2.0 million as of December 31, 2009 under agreements with a Swedish bank with an expiration date of December 31, 2010 and an outstanding balance of $1.4 million as of December 31, 2009 under an agreement with a German bank with an open-ended term. Our substantial indebtedness could have adverse consequences in the future, including without limitation:

 

 

Some of our debt bears interest at variable rates.  If interest rates increase, or if we incur additional debt, the potential adverse consequences, including those described above, may be intensified. If our cash flow

and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay planned expansion and capital expenditures, sell assets, obtain additional equity financing or restructure our debt. Some of our existing credit facilities contain covenants that, among other things, limit our ability to incur additional debt.

 

Future cash requirements or restrictions on cash could adversely affect our financial position, and an event of default under our outstanding debt instruments could impair our ability to conduct business operations.  The following items, among others, could require unexpected future cash payments, limit our ability to generate cash or restrict our use of cash:

 

 

In the event we are unable to avoid an event of default under one or more of our existing credit facilities, it may be necessary or advisable to retire and terminate one or more of the facilities and pay all remaining balances borrowed. Any such payment would further limit our available cash and cash equivalents. Furthermore, it is unlikely we would have adequate resources available when necessary to avoid an event of default or if we do not have adequate time to retire the credit facilities. The consequences of an event of default under one or more of our credit facilities or other debt instruments may prevent us from continuing normal business operations.

 

The above cash requirements or restrictions could lead to an inadequate level of cash for operations or for capital requirements, which could have a material negative impact on our financial position and significantly harm our ability to operate the business.

 

Our operating results may continue to fluctuate.  Our operating results may fluctuate from period to period and period over period depending upon numerous factors, including: (1) customer demand and market acceptance of our products and solutions; (2) new product introductions; (3) variations in product mix; (4) delivery due-date changes; and (5) other factors. We operate in a market characterized by long and occasionally erratic sales cycles. The time from first contact to order delivery may be a period of two years or longer in certain instances. Delivery schedules, as first established with the customer in this long cycle may change with little or no advance notice as the original delivery schedule draws near. Our business is sensitive to the spending patterns and funding of our customers, which, in turn, are subject to prevailing economic and governmental funding conditions and other factors beyond our control. Moreover, we derive sales primarily from significant orders from a limited number of customers. For that reason, a delay in delivery of our products in connection with a single order may significantly affect the timing of our recognition of sales between periods. Moreover, sales lost due to the cancellation of, or our inability to fill, an order in one period may not be necessarily made up by sales in any future period.

 

Risks Related to Our Operations and Product Development

 

A significant portion of our sales is derived from sales to a small number of customers. If we are not able to obtain new customers or repeat business from existing customers, our business could be seriously harmed.  We sell our products to a limited and largely fixed set of customers and potential customers. We sell primarily to original equipment manufacturers and to end users such as municipalities, regional transportation districts, transit agencies, federal, state and local departments of transportation, and rental car agencies. In 2009, 2008 and 2007, our top five customers accounted for 36.0%, 33.4%, and 21.3%, respectively, of total annual sales. The identity of the customers who generate the most significant portions of our sales may vary from year to year. If any of our major customers stopped purchasing products from us, and we were not able to obtain new customers to replace the lost business, our business and financial condition would be materially adversely affected. Many factors affect whether customers reduce or delay their investments in products such as those

we offer, including decisions regarding spending levels and general economic conditions in the countries and specific markets where the customers are located.

 

We depend on third parties to supply components we need to produce our products.  Our products and solutions are dependent upon the availability of quality components that are procured from third-party suppliers. Reliance upon suppliers, as well as industry supply conditions, generally involves several risks, including the possibility of defective parts (which can adversely affect the reliability and reputation of our products), a shortage of components and reduced control over delivery schedules (which can adversely affect our manufacturing efficiencies and timing of deliveries to customers) and increases in component costs (which can adversely affect our profitability).

 

We have some single-sourced supplier relationships, because either alternative sources are not readily or economically available or the relationship is advantageous due to performance, quality, support, delivery, and capacity or price considerations. If these sources are unable to provide timely and reliable supply, we could experience manufacturing interruptions, delays, or inefficiencies, adversely affecting our results of operations. Even where alternative sources of supply are available, qualification of the alternative suppliers and establishment of reliable supplies could result in delays and a possible loss of sales, which could adversely affect operating results.

 

Many of our customers rely, to some extent, on government funding, which subjects us to risks associated with governmental budgeting and authorization processes.  A majority of our domestic U.S. sales, either directly or indirectly through OEM’s, are to end customers having some degree of national, federal, regional, state, or local governmental-entity funding. These governmental-entity funding mechanisms are beyond our control and often are difficult to predict. Further, general budgetary authorizations and allocations for state, local and federal agencies can change for a variety of reasons, including general economic conditions, and have a material adverse effect on us. SAFETEA-LU, which was the primary program funding the U.S. public surface transit market at the federal level expired in September 2009. Extension of the expired legislation has been implemented under continuing resolutions while new legislation to replace SAFETEA-LU is being developed. It is uncertain when new legislation will be developed and enacted, if at all, and at what levels federal funding for public transportation programs will be available if new legislation is enacted. Such funding uncertainties could lead to disruption in our domestic market, which, in turn, could result in a downturn in demand for our products and have a material adverse effect on our financial position and results of operations.

 

In addition to federal funding to the public transit side of our domestic market, a majority of our customers rely on state and local funding, which tends to be affected by general economic conditions. A decrease in state and local funding in our domestic markets can have a depressing effect on sales of our products. It is not possible to precisely quantify or forecast this type of impact. Any unfavorable change in any of these factors and considerations could have a material adverse effect upon us.

 

We must continually improve our technology to remain competitive.  Our industry is characterized by, and our business strategy is substantially based upon, continuing improvement in technology. This results in frequent introduction of new products, short product life cycles and continual change in product price/performance characteristics. We must develop new technologies in our products and solutions in order to remain competitive. We cannot assure you that we will be able to continue to achieve or sustain the technological leadership that is necessary for success in our industry. In addition, our competitors may develop new technologies that give them a competitive advantage, and we may not be able to develop or obtain a right to use those or equal technologies at a reasonable cost, if at all, or to develop alternative solutions that enable us to compete effectively. A failure on our part to manage effectively the transitions of our product lines to new technologies on a timely basis could have a material adverse effect upon us. In addition, our business depends upon technology trends in our customers’ businesses. To the extent that we do not anticipate or address these technological changes, our business may be adversely impacted.

 

We operate in several international locations and, in India, with less than full ownership control.  Not all countries embrace the full scope of the regulatory requirements placed on U.S. public companies. Operating under those inhibiting circumstances can make it difficult to assure that all of our internal controls are being followed as we would expect and detection of non-compliance may not be as timely as desired.

We cannot assure you that any new products we develop will be accepted by customers.  Even if we are able to continue to enhance our technology and offer improved products and solutions, we cannot assure you we will be able to deliver commercial quantities of new products in a timely manner or that our products will achieve market acceptance. Further, it is necessary for our products to adhere to generally accepted and frequently changing industry standards, which are subject to change in ways that are beyond our control.

 

Risks Related to Our International Operations

 

There are numerous risks associated with international operations, which represent a significant part of our business.  Our international operations generated approximately 59% of our sales in 2009. Our sales outside the U.S. were primarily in Europe (particularly the Nordic countries), South America, the Middle East, India, and Australia. The success and profitability of international operations are subject to numerous risks and uncertainties, such as economic and labor conditions, political instability, tax laws (including U.S. taxes upon foreign subsidiaries), and changes in the value of the U.S. dollar versus the local currency in which products are bought and sold. Any unfavorable change in one or more of these factors could have a material adverse effect on us.

 

Complying with foreign tax laws can be complicated, and we may incur unexpected tax obligations in some jurisdictions.  We maintain cash deposits in foreign locations and many countries impose taxes or fees upon removal from the country of cash earned in that country. While we believe our tax positions in the foreign jurisdictions in which we operate are proper and defensible, tax authorities in those jurisdictions may nevertheless assess taxes and render judgments against us. In such an event, we could be required to make unexpected cash payments in satisfaction of such assessments or judgments or incur additional expenses to defend our position. As an example, Mobitec Brazil was assessed $1.5 million in Industrialized Products Taxes, a form of federal value-added tax in Brazil, and related penalties and fines in 2006. The assessment was the result of an audit performed by Brazil’s Federal Revenue Service in 2006 and varying interpretations of Brazil’s complex tax law by Brazil’s Federal Revenue Service and the Company.

 

Risks Related to Internal Controls

 

Required reporting on internal control over financial reporting.  In accordance with Section 404 of the Sarbanes-Oxley Act, we report on the effectiveness of our internal controls over financial reporting in each Annual Report. In Item 9A(T) of this Annual Report, we report material weaknesses in our internal controls over financial reporting at December 31, 2009. We can give no assurances our efforts to remediate our reported material weaknesses will be successful or that our efforts to maintain effective internal controls over financial reporting will be successful in future reporting periods. This could cause investors to lose confidence in our internal control environment.

 

Risks Related to Intellectual Property

 

We may not be able to defend successfully against claims of infringement against the intellectual property rights of others, and such defense could be costly.  Third parties, including our competitors, individual inventors or others, may have patents or other proprietary rights that may cover technologies that are relevant to our business. Claims of infringement have been asserted against us in the past. Even if we believe a claim asserted against us is not valid, defending against the claim may be costly. Intellectual property litigation can be complex, protracted, and highly disruptive to business operations by diverting the attention and energies of management and key technical personnel. Further, plaintiffs in intellectual property cases often seek injunctive relief and the measures of damages in intellectual property litigation are complex and often subjective or uncertain. In some cases, we may decide that it is not economically feasible to pursue a vigorous and protracted defense and decide instead to negotiate licenses or cross-licenses authorizing us to use a third party’s technology in our products or to abandon a product. If we are unable to defend successfully against litigation of this type, or to obtain and maintain licenses on favorable terms, we could be prevented from manufacturing or selling our products, which would cause severe disruptions to our operations. For these reasons, intellectual property litigation could have a material adverse effect on our business or financial condition.

Risks Related to Our Equity Securities

 

The public market for our Common Stock may be volatile, especially since market prices for technology stocks often have been unrelated to operating performance.  We cannot assure you that an active trading market will be sustained or that the market price of our Common Stock will not decline. The market price of our Common Stock is likely to continue to be highly volatile and could be subject to wide fluctuations in response to factors such as:

 

 

Further, the stock markets, and particularly the NASDAQ Capital Market, have experienced extreme price and volume fluctuations that have particularly affected the market prices of equity securities of many technology companies and have often been unrelated or disproportionate to the operating performance of such companies. These broad market factors have had and may continue to have an adverse affect on the market price of our Common Stock. In addition, general economic, political and market conditions, such as recessions, interest rate variations, international currency fluctuations, terrorist acts, military actions or war, may adversely affect the market price of our Common Stock.

 

Our preferred stock has preferential rights over our Common Stock.  At December 31, 2009 we had outstanding shares of Series AAA Redeemable, Nonvoting, Convertible Preferred Stock, Series E Redeemable, Nonvoting, Convertible Preferred Stock, Series G Redeemable, Convertible Preferred Stock, Series H Redeemable, Convertible Preferred Stock, and Series K Redeemable, Convertible Preferred Stock, all of which have rights in preference to holders of our Common Stock in connection with any liquidation of the Company. The aggregate liquidation preference is $830,000 for the Series AAA Preferred, $400,000 for the Series E Preferred, $2.4 million for the Series G Preferred, $345,000 for the Series H Preferred, $1.5 million for the Series K Preferred, and in each case plus accrued but unpaid dividends. Holders of the Series AAA Preferred, Series E Preferred, Series G Preferred, Series H Preferred, and Series K Preferred are entitled to receive cumulative quarterly dividends at the rate of five percent (5.0%) per annum, seven percent (7.0%) per annum, eight percent (8.0%) per annum, eight percent (8.0%) per annum, and nine and one-half percent (9.5%) per annum, respectively, on the liquidation value of those shares. Dividends on the Series G Preferred are payable in kind in additional shares of Series G Preferred and dividends on the Series H Preferred are payable in kind in additional shares of Series H Preferred. Dividends on the Series K Preferred are payable in kind in additional shares of Series K Preferred or in cash, at the option of the holder. The agreement under which we secured our domestic senior credit facility prohibits the payment of dividends to holders of our Common Stock. The preferential rights of the holders of our preferred stock could substantially limit the amount, if any, that the holders of our Common Stock would receive upon any liquidation of the Company.

 

Risks Related to Anti-Takeover Provisions

 

Our articles of incorporation, bylaws and North Carolina law contain provisions that may make takeovers more difficult or limit the price third parties are willing to pay for our stock.  Our articles of incorporation

authorize the issuance of shares of “blank check” preferred stock, which would have the designations, rights and preferences as may be determined from time to time by the board of directors. Accordingly, the board of directors is empowered, without shareholder approval (but subject to applicable regulatory restrictions), to issue additional preferred stock with dividend, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of the Common Stock. Our board of directors could also use the issuance of preferred stock, under certain circumstances, as a method of discouraging, delaying or preventing a change in control of our company. In addition, our bylaws require that certain shareholder proposals, including proposals for the nomination of directors, be submitted within specified periods of time in advance of our annual shareholders’ meetings. These provisions could make it more difficult for shareholders to effect corporate actions such as a merger, asset sale or other change of control of the Company. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our Common Stock, and they may have the effect of delaying or preventing a change in control.

 

We are also subject to two North Carolina statutes that may have anti-takeover effects. The North Carolina Shareholder Protection Act generally requires, unless certain “fair price” and procedural requirements are satisfied, the affirmative vote of 95% of our voting shares to approve certain business combination transactions with an entity that is the beneficial owner, directly or indirectly, of more than 20% of our voting shares, or with one of our affiliates if that affiliate has previously been a beneficial owner of more than 20% of our voting shares. The North Carolina Control Share Acquisition Act, which applies to public companies that have substantial operations and significant shareholders in the state of North Carolina, eliminates the voting rights of shares acquired in transactions (referred to as “control share acquisitions”) that cause the acquiring person to own a number of our voting securities that exceeds certain threshold amounts, specifically, one-fifth, one-third and one-half of our total outstanding voting securities. There are certain exceptions. For example, this statute does not apply to shares that an acquiring person acquires directly from us. The holders of a majority of our outstanding voting stock (other than such acquiring person, our officers and our employee directors) may elect to restore voting rights that would be eliminated by this statute. If voting rights are restored to a shareholder that has made a control share acquisition and holds a majority of all voting power in the election of our directors, then our other shareholders may require us to redeem their shares at fair value. These statutes could discourage a third party from making a partial tender offer or otherwise attempting to obtain a substantial position in our equity securities or seeking to obtain control of us. They also might limit the price that certain investors might be willing to pay in the future for shares of our Common Stock, and they may have the effect of delaying or preventing a change of control.

 

Provisions of our bylaws limit the ability of shareholders to call special meetings of shareholders and therefore could discourage, delay or prevent a merger, acquisition or other change in control of our company.  Under the Company’s Amended and Restated Bylaws, special meetings of the shareholders may be called by the Chairman of the Board, the President, the Board of Directors or any shareholder or shareholders holding in the aggregate 51% of the voting power of all the shareholders. The effect of this provision of our Amended and Restated Bylaws could delay or prevent a third party from acquiring the Company or replacing members of the Board of Directors, even if the acquisition or the replacements would be beneficial to our shareholders. These factors could also reduce the price that certain investors might be willing to pay for shares of the Common Stock and result in the market price being lower than it might be without these provisions.

 

Risks Associated with Potential Growth

 

We may not be able to obtain the financing we will need to implement our operating strategy.  We cannot assure you that our revolving credit facilities and cash flow from operations will be sufficient to fund our current business operations nor can we assure you that we will not require additional sources of financing to fund our operations. Additional financing may not be available to us on terms we consider acceptable, if available at all. If we cannot raise funds on acceptable terms, we may not be able to develop next-generation products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, any of which could have a material adverse effect on our ability to grow our business. Further, if we issue equity securities, holders of our Common Stock may experience dilution of their ownership

percentage, and the new equity securities could have rights, preferences or privileges senior to those of our Common Stock.

 

There are many risks associated with potential acquisitions.  We intend to continue to evaluate potential acquisitions that we believe will enhance our existing business or enable us to grow. If we acquire other companies or product lines in the future, it may dilute the value of our existing shareholders’ ownership. The impact of dilution may restrict our ability to consummate further acquisitions. Issuance of equity securities in connection with an acquisition may further restrict utilization of net operating loss carryforwards because of an annual limitation due to ownership changes under the Internal Revenue Code. We may also incur debt and losses related to the impairment of goodwill and other intangible assets if we acquire another company, and this could negatively impact our results of operations. We currently do not have any definitive agreements to acquire any company or business, and we may not be able to identify or complete any acquisition in the future. Additional risks associated with acquisitions include the following:

 

 

 

None.

 

 

We do not own any real estate. Instead, we lease properties both in the U.S. and abroad. Following are our locations:

 

 

 

 

The Company is currently in the process of expanding the production, warehouse and office space it currently leases in Sweden. The cost of this expansion is being borne by the landlord and will result in increased rent expense in Sweden when such expansion is completed. Upon completion of the expansion in Sweden, we believe our facilities will be adequate and suitable for current and foreseeable needs, absent future possible acquisitions. We further believe additional office and manufacturing space will be available in, or near, existing facilities at a cost approximately equivalent to, or slightly higher than, rates currently paid, to accommodate further internal growth as necessary.

 

The Company, in the normal course of its operations, is involved in legal actions incidental to the business. In management’s opinion, the ultimate resolution of these matters will not have a material adverse effect upon the current financial position of the Company or future results of operations.

 

 

 

 

The following table sets forth the range of high and low sales prices for our Common Stock, as reported by the NASDAQ Capital Market^®, from January 1, 2008 through December 31, 2009. The prices set forth reflect inter-dealer quotations, without retail markups, markdowns, or commissions, and do not necessarily represent actual transactions.

 

 

As of December 31, 2009, there were approximately 2,541 holders of our Common Stock (including 124 shareholders of record.)

 

We have not paid dividends on our Common Stock nor do we anticipate doing so in the near future. Our prior and current credit facilities restrict the payment of dividends upon any class of stock except on our Preferred Stock. We also have five classes of outstanding Preferred Stock with dividend rights that have priority over any dividends payable to holders of Common Stock.

 

Equity Compensation Plan Information

 

The following table provides information, as of the end of fiscal year 2009, with respect to all compensation plans and individual compensation arrangements of DRI under which equity securities are authorized for issuance to employees or non-employees:

 

 

 

 

The Company has in place a shareholder-approved, equity-based stock compensation plan for members of the Board of Directors and certain key executive managers of the Company (the “Stock Compensation Plan”). The Stock Compensation Plan partially compensates members of the Board of Directors and certain key executive management of the Company in the form of stock of the Company in lieu of cash compensation. The Stock Compensation Plan is made available on a fully voluntary basis. The number of shares payable under the Stock Compensation Plan is determined by dividing the cash value of stock compensation by the higher of (1) the actual closing price on the last trading day of each month or (2) the book value of the Company on the last day of each month. Fractional shares are rounded up to the next full share amount.

 

Issuance of Unregistered Securities

 

The issuances set forth below were made in reliance upon the available exemptions from registration requirements of the Securities Act, contained in Section 4(2), on the basis that such transactions did not involve a public offering. DRI determined that the purchasers of securities described below were sophisticated investors who had the financial ability to assume the risk of their investment in DRI’s securities and acquired such securities for their own account and not with a view to any distribution thereof to the public. The certificates evidencing the securities bear legends stating that the securities are not to be offered, sold or transferred other than pursuant to an effective registration statement under the Securities Act or an exemption from such registration requirements.

 

During the year ended December 31, 2009, the Company issued 80,641 shares of Common Stock to fourteen individuals under the Stock Compensation Plan at an average price of $1.25 per share in lieu of $100,750 in cash compensation. Section 16 reports filed with the SEC include the actual prices at which shares were issued to each individual.

 

 

THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES THAT ARE IN ITEM 8 OF THIS DOCUMENT.

 

Business — General

 

We, directly or through contractors, design, manufacture, sell and service information technology products. Prior to 2007, DRI had historically operated within two major business segments: (1) the transportation communications segment and (2) the law enforcement and surveillance segment. In April 2007, the Company’s DAC subsidiary, which comprised all of the operations of the law enforcement and surveillance segment, was divested. Accordingly, the Company currently operates within one major business segment. While service is a significant aspect of DRI’s marketing strategy, it is not yet a significant generator of revenue for the Company.

 

DRI’s products are sold worldwide within the passenger information communication industry and market. We sell to transportation vehicle equipment customers generally in two broad categories: end customers and original equipment manufacturers of transportation vehicles. End customers include municipalities, regional transportation districts, federal, state and local departments of transportation, transit agencies, public, private, or commercial operators of vehicles, and rental car agencies. The relative percentage of sales to end customers as compared to OEM customers varies widely and frequently from quarter-to-quarter and year-to-year and within products and product lines comprising DRI’s mix of total sales in any given period.

 

Sales to DRI’s customers are characterized by a lengthy sales cycle that generally extends for a period of two to 24 months. In addition, purchases by a majority of DRI’s customers are dependent upon federal, state and local funding that may vary from year to year and quarter to quarter.

 

The majority of sales of the Company’s products and services are recognized upon physical shipment of products and completion of the service, provided all accounting criteria for recognition have been met. Sales and revenues for projects involving multiple elements (i.e., products, services, installation and other services)

are recognized under specific accounting criteria based on the products and services delivered to the customer and the customer’s acceptance of such products and services. Because DRI’s operations are characterized by significant research and development expenses preceding product introduction, net sales and certain related expenses may not be recorded in the same period, thereby producing fluctuations in operating results. DRI’s dependence upon large contracts and orders, as well as upon a small number of relatively large customers or projects, increases the magnitude of fluctuations in operating results particularly on a period-to-period, or period-over-period, comparison basis. For a more complete description of DRI’s business, including a description of DRI’s products, sales cycle and research and development, see “Item 1. Business” in this Annual Report.

 

Results of Operations

 

The following discussion provides an analysis of DRI’s results of operations and liquidity and capital resources. This should be read in conjunction with DRI’s consolidated financial statements and related notes thereto. The operating results of the years presented were not significantly affected by inflation.

 

The following table sets forth the percentage of DRI’s sales represented by certain items included in DRI’s Statements of Operations:

 

 

Comparison of Results for the Years Ended December 31, 2009 and 2008

 

Net Sales and Gross Profit

 

Due to commonality of customers, products, technology, and management, we manage and report our U.S. and foreign operations as a single reporting segment. For discussion purposes, we differentiate between sales and gross profit for the U.S. market and the foreign markets to better provide our investors with useful information.

 

For 2009, sales increased $11.7 million, or 16.6%, from $70.6 million for 2008 to $82.3 million for 2009. The increase resulted from higher sales of $4.1 million by our U.S. subsidiaries and higher sales of $7.6 million from our foreign subsidiaries.

The increase in U.S. sales for the year ended December 31, 2009 as compared to the year ended December 31, 2008 continues a trend we have seen in recent periods which we believe is due to the favorable impact of increased transit funding under SAFETEA-LU and, to some extent, funding under the American Recovery and Reinvestment Act of 2009, as well as the favorable influence of high fuel prices on transit ridership. We believe the enactment of SAFETEA-LU and the record-high funding increases for transit, in addition to higher fuel prices, have had a favorable impact on our business and have contributed to increased sales opportunities in the U.S. market for many of our products.

 

The increase in international sales is inclusive of a decrease due to foreign currency fluctuations for the year ended December 31, 2009 of approximately $5.3 million. Exclusive of this decrease resulting from foreign currency fluctuations, sales by our foreign subsidiaries increased approximately $12.9 million in 2009 compared to 2008. The most significant increase in international sales occurred in India where, in the third and fourth quarter of 2009, Castmaster Mobitec began fulfillment of large orders received earlier in fiscal year 2009 from OEM’s and large transit system operators in that market. Increased sales also occurred in the European market, primarily resulting from our European subsidiaries fulfilling orders from OEM’s for delivery to end-users in Dubai and in the Asia-Pacific market, primarily in Australia. Increased sales in these markets were partially offset by decreased sales in the South America market, primarily in Brazil, where some order scale-back was experienced in the first half of 2009 due to economic issues in that market. DRI does not use currency hedging tools. Each of our foreign subsidiaries primarily conducts business in their respective functional currencies thereby reducing the impact of foreign currency transaction differences. If the U.S. dollar strengthens compared to the foreign currencies converted, it is possible the total sales reported in U.S. dollars could decline.

 

Expected sales growth will be dependent upon the expansion of new product offerings and technology, as well as expansion into new geographic areas. We believe our relatively high market share positions in some markets preclude significant sales growth from increased market share.

 

Our gross profit increased $908,000 or 3.8%, from $23.9 million in 2008 to $24.8 million in 2009. As a percentage of sales, gross profit was 33.9% of net sales in 2008 as compared to 30.1% in 2009. Of the $908,000 net increase in gross profit, an ($86,000) decrease was attributable to U.S. operations and a $994,000 increase was attributable to international operations.

 

The U.S. gross profit as a percentage of sales for 2009 was 29.8% as compared to 34.3% for 2008. Substantially all of the increase in sales in the U.S. in 2009 when compared to 2008 resulted from increased sales of electronic destination sign systems and related products, which yield lower margins than other products sold by the Company. Additionally, the following factors were primary contributors to the decrease in U.S. gross profit percentage in 2009 as compared to 2008: (1) a variation in sales mix on multiple deliverable engineered systems projects resulted in lower gross margins in 2009. As certain elements of these projects are delivered, gross margins on these projects can vary depending on the product or service delivered. In 2009, more deliveries of lower-margin elements were completed, resulting in lower than usual margins for these engineered systems projects; and (2) higher labor absorption costs in 2009 resulting from increased sustained engineering work performed on engineered system products recently introduced into the market. All of these factors contributed to a decreased U.S. gross profit percentage in 2009 when compared to 2008.

 

The international gross profit as a percentage of sales for 2009 was 30.3% as compared to 33.5% for 2008. The decrease in international margins is reflective of a variation in product and customer mix and a variation in geographical dispersion of product sales that resulted in lower margins in 2009 compared to 2008. Decreases in international gross margins in 2009 compared to 2008 resulted primarily from (1) margins on fulfillment of previously-mentioned orders from OEM’s for delivery to end-users in Dubai being lower than margins typically realized on sales of similar products, (2) margins on fulfillment of the large orders in India previously mentioned being lower than margins typically realized as a result of strong competition in that market, and (3) higher labor absorption costs due to an increase in temporary production employees to meet increased production demands of the increased sales previously mentioned.

 

Though we may experience continued pricing pressure, we expect improvements in gross margins through more frequent sales of a combination of products and services offering a broader “project” solution, and

through the introduction of technology improvements. However, period-to-period, overall gross margins will still reflect the variations in sales mix and geographical dispersion of product sales.

 

Selling, General and Administrative

 

Selling, general, and administrative (“SG&A”) expenses for 2009 increased $1.4 million, or 7.4%, from $19.0 million for 2008 to $20.4 million for 2009. Excluding a decrease of $1.5 million due to the change in foreign currency exchange rates from 2008 to 2009, SG&A expenses increased approximately $2.9 million from 2008 to 2009. Exclusive of the decrease due to foreign currency exchange fluctuations, SG&A expenses have increased primarily due to (1) increased personnel-related expenses of approximately $1.6 million resulting from an increase in personnel as well as salary and wage increases for current employees throughout 2009, (2) increased travel expenses of approximately $223,000 and increased promotion, advertising, and business development costs of approximately $294,000, as the Company continues its efforts to market the Company on a global basis, (3) increased bank-related fees of approximately $300,000 due to (a) increased amortization of deferred finance costs resulting from the domestic debt agreements entered into in June 2008 and from additional deferred finance costs incurred in connection with amendments to those domestic debt agreements in 2009 and (b) having a full year of loan-related fees in 2009 on our domestic debt agreements entered into in June 2008 compared to having only 6 months of such fees in 2008, (4) increased compensation expense of approximately $160,000 recorded under ASC Topic 718-20 as a result of stock options issued in the third quarter of 2008 and the second quarter of 2009, (5) increased audit, accounting and tax fees of approximately $162,000 resulting primarily from the engagement of outside firms to provide due diligence and audit services in connection with the acquisition of the remaining 50% interest of Mobitec Brazil and the engagement of an outside firm to provide global tax planning consulting services, (6) an increase of approximately $370,000 in outside consulting fees resulting primarily from (a) consultants engaged in 2009 to assist the Company with product customization and (b) increased fees to consultants engaged to assist the Company in generating and maintaining sales in select North American markets, (7) increased operating taxes of approximately $304,000 resulting from estimated tax liabilities accrued in 2009, and (8) increased income tax penalties of $125,000 recorded in 2009 related to uncertain tax positions. These increases were partially offset by (1) a reduction in expenses in connection with a legal settlement in Australia of $184,000 recorded to SG&A expenses in 2008, (2) a reduction of expenses in connection with a reduction of Mobitec Brazil’s foreign tax settlement of $266,000 recorded to SG&A expenses in 2009, and (3) a reduction of $364,000 in expenses incurred in 2008 related to the Company’s participation in the tri-annual APTA Expo in 2008.

 

Research and Development

 

Research and development expenses for 2009 decreased $422,000, or 43.3%, from $974,000 for 2008 to $552,000 for 2009. This category of expense includes internal engineering personnel and outside engineering expense for software and hardware development, sustaining product engineering, and new product development. During 2009, salaries and related costs of certain engineering personnel who were used in the development of software met the capitalization criteria of ASC Topic 985-20, “Costs of Computer Software to be Sold, Leased or Marketed.” The total amount of personnel and other expense capitalized in 2009 was $2.1 million as compared to $1.5 million for 2008. In aggregate, research and development expenditures in 2009 were $2.6 million as compared to aggregate expenditures of $2.5 million in 2008. This increase in research and development expenditures is attributable to the Company’s continued efforts to pursue technological enhancements to existing products and to develop new, technologically advanced products that will meet our customers’ needs. Product development based upon advanced technologies is one of the primary means by which management believes DRI differentiates itself from its competitors.

 

Operating Income (Loss)

 

The net change in our operating income was a decrease of $72,000 from net operating income of $3.9 million in 2008 to net operating income of $3.8 million in 2009. The decrease in operating income is due to higher sales and gross profit and lower research and development costs offset by higher selling, general and administrative expenses as previously described.

Other Income, Foreign Currency Gain (Loss) and Interest Expense

 

Other income, foreign currency gain (loss), and interest expense decreased $343,000 from ($687,000) in 2008 to ($1.0 million) in 2009 due to an increase in interest expense of $27,000, a decrease in other income (loss) of $289,000, and a decrease in foreign currency gain of $27,000. In 2008, interest expense of $54,000 was recorded to amortize the fair value of a beneficial conversion feature of a debenture that was converted to Common Stock; this resulted in a decrease in interest expense in 2009 as compared to 2008. Interest expense was also lower in 2009 due to lower borrowings on international lines of credit and loans throughout most of 2009 as compared to 2008. These decreases were partially offset by increased interest expense resulting from increased borrowings on our domestic lines of credit and loans.

 

Income Tax Expense

 

Income tax expense was $836,000 in 2009 as compared with an income tax expense of $1.1 million in 2008. The Company’s effective tax rate was 29.7% and 36.3% in 2009 and 2008, respectively. The Company’s 29.7% effective tax rate in 2009 differs from the expected U.S. statutory rate of 34% due primarily to a correcting increase to the prior year net operating loss carryforward, lower rates on income reported in foreign tax jurisdictions, a reduction of tax liabilities for uncertain tax positions, and a decrease in the valuation allowance recorded against deferred tax assets. The Company’s 36.3% effective tax rate in 2008 differed from the expected U.S. statutory rate of 34% due primarily to higher rates on income reported in foreign tax jurisdictions and an increase in the valuation allowance recorded against deferred tax assets, partially offset by a correcting increase to the prior year net operating loss carryforward. A reconciliation of the effective tax rates for 2009 and 2008 to the expected U.S. statutory rate of 34% is provided in Note 16 to the accompanying consolidated financial statements.

 

Net Income (Loss) Applicable to Common Shareholders

 

Net income applicable to common shareholders increased $318,000 from net income of $1.2 million in 2008 to net income of $1.5 million in 2009. This increase is due to the factors previously addressed, as well as a $16,000 increase in preferred stock dividends.

 

Comparison of Results for the Years Ended December 31, 2008 and 2007

 

Net Sales and Gross Profit

 

For 2008, sales increased $12.6 million, or 21.8%, from $57.9 million for 2007 to $70.6 million for 2008. The increase resulted from higher sales of $2.2 million by our U.S. subsidiaries and higher sales of $10.4 million from our foreign subsidiaries.

 

The increase in U.S. sales for 2008 as compared to 2007 was a result of higher OEM sales, with substantially all of the sales increase coming from increased sales of engineered systems and related products. Engineered systems include our computer aided dispatch GPS tracking systems, AVL systems, VacTell^tm video surveillance security systems, AVM systems, and Talking Bus^® automatic voice announcement systems. The increase in sales in 2008 is due in substantial part to the favorable impact of transit funding under the Safe, Accountable, Flexible, Efficient, Transportation Equity Act — A Legacy for Users (“SAFETEA-LU”) and the favorable influence of higher fuel prices during much of 2008 on transit ridership. In 2007, federal funding for public transportation under SAFETEA-LU was $8.975 billion and in 2008, federal public transportation funding increased to $9.492 billion. In 2008, we saw new engineered systems products and new features with advanced technology added to existing engineered systems products being embraced more and more by customers. We believe the increased funding under SAFETEA-LU in combination with customer acceptance of new and enhanced engineered systems products, in addition to the impact of higher fuel prices, resulted in increased sales in the U.S. in 2008.

 

The increase in international sales resulted from higher sales in several established markets in Europe, South America and Asia Pacific, which includes sales generated by our joint venture in India, which began operations in the fourth quarter of 2007. In Europe, increased revenues were most notably generated in

Sweden and the United Kingdom. In South America, the most significant increase was generated in Brazil where an increase in public transit funding by the Brazilian government contributed to increased sales in that market. The increases in these markets were partially offset by lower sales in the Middle East market. The increase in international sales is inclusive of an increase due to foreign currency fluctuations for the period ended December 31, 2008 of approximately $1.7 million.

 

Our gross profit increased $5.3 million or 28.3%, from $18.6 million in 2007 to $23.9 million in 2008. As a percentage of sales, gross profit was 32.1% of net sales in 2007 as compared to 33.9% in 2008. Of the $5.3 million net increase in gross profit, a $1.2 million increase was attributable to U.S. operations and a $4.1 million increase was attributable to international operations.

 

The U.S. gross profit as a percentage of sales for 2008 was 34.3% as compared to 32.7% for 2007. The increase in gross profit margin resulted primarily from the increased sales of engineered systems and related products, which yield higher margins than other products sold by the Company. Additionally contributing to the increase in the U.S. gross profit margin in 2008, though to a lesser extent, was a reduction of direct production labor absorption costs in 2008 resulting from a workforce reduction implemented by the Company in the U.S. in the second quarter of 2007 and a reduction of warranty expense included in cost of sales in 2008. The decrease in warranty expense resulted primarily from warranty part returns, a decrease in the number of specific warranty projects in 2009, as there were two larger warranty projects in 2007 for which the warranty reserve was adjusted and no such projects in 2008, and from the Company reversing warranty reserves previously recorded when a customer determined warranty work previously anticipated was no longer required.

 

The international gross profit as a percentage of sales for 2008 was 33.5% as compared to 31.7% for 2007. Since the third quarter of 2007, the Company entered into new purchasing agreements with several major suppliers to our international subsidiaries, which resulted in more favorable pricing of component parts purchased by the Company. The lower pricing of component parts resulted in lower cost of sales in 2008. Additionally, reduced amortization of capitalized software development costs resulting from certain of those assets becoming fully amortized in 2008 contributed to the increase in gross profit in 2008. These reductions in cost of sales were partially offset by increased shipping costs, primarily due to shipments for sales in India, and higher production costs in Brazil, as some production was outsourced to third-parties to help meet the increased sales demand in that market.

 

Selling, General and Administrative

 

Selling, general, and administrative expenses for 2008 increased $3.8 million, or 24.9%, from $15.2 million for 2007 to $19.0 million for 2008. Excluding an increase of $454,000 due to the change in foreign currency exchange rates from 2007 to 2008, selling, general, and administrative expense increased approximately $3.3 million from 2007 to 2008. Overall, SG&A expenses increased to support the needs of our domestic and international operations in achieving sales growth from 2007 to 2008. The most significant increase in SG&A expenses was due to increased personnel expenses resulting from an increase in personnel as well as salary and wage increases for current employees. In addition, SG&A expenses increased due to (1) increased marketing and business development costs, including increased trade show participation and specifically, participation in the tri-annual APTA Expo in the fourth quarter of 2008, as we strive to market the Company on a global basis, (2) increased travel costs resulting from our increased marketing and business development efforts as well as overall cost increases for travel activity, (3) increased public company costs, including board of director costs, public company reporting costs, investor relations, and audit fees, (4) increased consulting fees resulting primarily from the engagement of an investment banking firm to assist the Company with its strategic financial planning and the engagement of consultants to assist the Company in increasing sales in certain North American markets, (5) increased legal fees, inclusive of a settlement expense, attributable to the Company’s efforts to settle a legal matter in Australia, (6) increased amortization of deferred finance costs in connection with new loan agreements entered into in the third quarter of 2008, (7) increased compensation expense recorded under ASC Topic 718-20 as a result of stock options issued in 2008, and (8) increased bad debt expense recorded to state certain accounts receivable at net realizable value. Additionally, our joint venture in India began operations in the fourth quarter of 2007 and additional SG&A

expenses are now being incurred in support of that operation. Partially offsetting these increases was a reduction of consulting fees resulting from reduced costs in the Company’s efforts to comply with the Sarbanes-Oxley Act of 2002.

 

Research and Development

 

Research and development expenses for 2008 decreased $175,000, or 15.2%, from $1.1 million for 2007 to $974,000 for 2008. This category of expense includes internal engineering personnel and outside engineering expense for software and hardware development, sustaining product engineering, and new product development. During 2008, salaries and related costs of certain engineering personnel who were used in the development of software met the capitalization criteria of ASC Topic 985-20, “Costs of Computer Software to be Sold, Leased or Marketed.” The total amount of personnel and other expense capitalized in 2008 was $1.5 million as compared to $669,000 for 2007. In aggregate, research and development expenditures in 2008 were $2.5 million as compared to aggregate expenditures of $1.8 million in 2007. This increase in research and development expenditures is attributable to the Company’s continued efforts to pursue technological enhancements to existing products and to develop new, technologically advanced products that will meet our customers’ needs. Product development based upon advanced technologies is one of the primary means by which management believes DRI differentiates itself from its competitors.

 

Operating Income (Loss)

 

The net change in our operating income was an increase of $1.6 million from net operating income of $2.3 million in 2007 to net operating income of $3.9 million in 2008. The increase in operating income is due to higher sales and gross profit and lower research and development costs offset by higher selling, general and administrative expenses as previously described.

 

Other Income, Foreign Currency Gain (Loss) and Interest Expense

 

Other income, foreign currency gain (loss), and interest expense decreased $197,000 from $884,000 in 2007 to $687,000 in 2008 due to an increase in interest expense of $236,000, an increase in other income of $85,000, and an increase in foreign currency gain of $348,000. The increase in interest expense is primarily attributable to the increase in debt, which occurred in the last six months of 2008. During the first six months of 2008, interest expense increased $13,000 compared to the first six months of 2007. During the first six months of 2008, interest expense of $54,000 was recorded to amortize the fair value of a beneficial conversion feature of a debenture that was converted to Common Stock. Additionally, in the first six months of 2008, interest expense increased due to increased borrowings and higher interest rates on debt of our international subsidiaries. These increases in interest expense were partially offset by decreased borrowings and lower interest rates on our domestic debt during the first six months of 2008. The Company entered into new debt agreements in the third quarter of 2008, which increased its total outstanding debt. The increase in interest expense of $223,000 in the last six months of 2008 is primarily due to the increase in outstanding debt under these new agreements and increased expense resulting from accruing termination fees on the domestic term loan agreement entered into in the third quarter of 2008 ratably over the three-year term of the agreement. The increase in foreign currency gain is primarily a result of foreign currency gains from sales transactions billed in Euros, which weakened significantly against other currencies in 2008.

 

Income Tax Expense

 

Income tax expense was $1.1 million in 2008 as compared with an income tax expense of $291,000 in 2007. The Company’s effective tax rate was 36.3% and 25.2% in 2008 and 2007, respectively. A reconciliation of the effective tax rates for 2008 and 2007 to the expected U.S. statutory rate of 34% is provided in Note 16 to the accompanying consolidated financial statements.

Discontinued Operations

 

On April 30, 2007, we divested DAC, an operating segment which is reflected as discontinued operations in the accompanying consolidated financial statements. Income and losses from discontinued operations have been reported separately from continuing operations. Since the divestiture of DAC occurred on April 30, 2007, there is no income (loss) from discontinued operations reported in 2008, whereas four months’ results of operations are reported in 2007.

 

Net Income (Loss) Applicable to Common Shareholders

 

Net income applicable to common shareholders increased $813,000 from net income of $380,000 in 2007 to net income of $1.2 million in 2008. This increase is due to the factors previously addressed, as well as a $9,000 increase in preferred stock dividends.

 

Liquidity and Capital Resources

 

Cash Flows

 

The Company’s net working capital as of December 31, 2009, was $11.8 million compared to $9.8 million as of December 31, 2008. Our principal sources of liquidity from current assets included cash and cash equivalents of $1.8 million, trade and other receivables of $19.8 million, inventories of $13.0 million, and prepaids and other current assets of $1.8 million. The most significant current liabilities at December 31, 2009, included asset-based borrowings of $7.2 million, accounts payable of $10.1 million, accrued expenses and other current liabilities of $6.4 million, and the current portion of long-term debt and capital leases of $960,000. The asset-based lending agreements, both foreign and domestic, are directly related to sales and customer account collections and inventory. Our domestic asset-based lending agreement was negotiated with the intent that borrowings on the revolving credit facility would be long-term debt. However, ASC Topic 470-10-45-5, “Classification of Revolving Credit Agreements Subject to Lock-Box Arrangement and Subjective Acceleration Clauses,” requires the Company to classify all of our outstanding debt under this agreement as a current liability. The agreement has a subjective acceleration clause, which could enable the lender to call the loan, but such language is customary in asset-based lending agreements and management does not expect the lender to use this particular clause to inhibit the Company from making borrowings as provided under the loan agreement.

 

Our operating activities provided net cash of $1.6 million for the year ended December 31, 2009. Sources of cash from operations primarily resulted from an increase in accounts payable of $4.1 million, and an increase in accrued expenses of $1.2 million. Cash used in operating activities primarily resulted from an increase in trade accounts receivable of $4.6 million, an increase in inventories of $1.7 million, an increase in prepaids and other current assets of $1.3 million, an increase in other receivables of $394,000, an increase in other assets of $6,000, and a decrease in the foreign tax settlement of $334,000. Non-cash expense items totaling $2.7 million were primarily related to depreciation and amortization, bad debt expense, Common Stock issued in lieu of cash compensation, stock based compensation expense, loan termination fees, inventory obsolescence charges, and a change in the fair value of the warrant liability, offset by a gain on foreign currency translation and an increase in bank fees. The increase in trade accounts receivable primarily results from an overall increase of sales in 2009 compared to 2008 and in particular, a 109.8% increase in sales by our foreign subsidiaries during the fourth quarter of 2009 compared to the fourth quarter in 2008. The increase in inventories resulted from a build-up of inventory to meet higher overall product sales in 2009 compared to 2008. The increase in accounts payable is due to higher inventory purchases to support a significant increase in sales by our foreign subsidiaries in 2009, particularly during the fourth quarter of 2009. The increase in prepaids and other current assets is primarily due to an increase in prepayments to suppliers. The increase in accrued expenses is primarily due to an increase in income taxes payable due to higher income in 2009 compared to 2008, an increase in accrued payroll costs due to an increase in employees, an increase in accrued commissions and warranty reserve due to higher sales in 2009 compared to 2008, offset by lower deferred revenue due to substantial delivery of orders in 2009 for which revenue had been previously deferred in 2008. We consider the changes incurred in our operating assets and liabilities routine, given the number and size of

orders relative to our industry and our size. We expect working capital requirements to continue to increase with growth in sales, primarily due to the timing between when we must pay suppliers and the time we receive payment from our customers.

 

Our investing activities used cash of $3.3 million for the year ended December 31, 2009. The primary uses of cash were for expenditures relating to internally developed software and purchases of computer, test, and office equipment, as well as for the acquisition of the noncontrolling interest in Mobitec Brazil. We do not anticipate any significant expenditures for, or sales of, capital equipment in the near future.

 

Our financing activities provided net cash of $2.8 million for the year ended December 31, 2009. Sources of cash primarily resulted from net borrowings under asset-based lending agreements for both our U.S. and our foreign subsidiaries as well as proceeds from the issuance of Series K Preferred stock. Our primary uses of cash for financing activities were payment of financing costs related to amendments of the BHC agreement and payment of dividends.

 

Significant Financing Arrangements

 

The Company’s primary source of liquidity and capital resources has been from financing activities. The Company has agreements with lenders under which revolving lines of credit have been established to support the working capital needs of our current operations. These lines of credit are as follows:

 

 

In addition to the revolving lines of credit described herein, the Company has agreements under which additional loans and credit facilities have been established to provide working capital to our domestic and foreign operations as follows:

 

 

The Company’s outstanding lines of credit and loans, and the agreements under which these credit facilities were established, are more fully described in Note 9 and Note 10 to the accompanying consolidated financial statements.

 

The PNC Agreement and the BHC Agreement contain certain covenants with which we and our subsidiaries must comply. Among the covenants contained in the PNC Agreement and BHC Agreement are requirements that we and our domestic subsidiaries maintain certain leverage ratios as of the end of each fiscal quarter for the twelve-month period then ending. On March 26, 2009, the PNC Agreement and BHC Agreement were each amended to revise the minimum EBITDA and leverage ratios required to be maintained as of the end of each of the fiscal quarters ending March 31, 2009, June 30, 2009 and September 30, 2009 as set forth below.

 

 

On October 1, 2009, the BHC Agreement was amended (the “BHC Amendment”) to, among other things, effect the following:

 

 

 

On October 5, 2009 (the “PNC Effective Date”), the PNC Agreement was amended (the “PNC Amendment”) to, among other things, effect the following:

 

 

The Prepayment Amount shall be an amount that is dependent upon the gross proceeds that DRI receives from the issuance of the Series K Preferred Stock, as follows: if DRI receives gross proceeds from the issuance of the Series K Preferred Stock of (i) no more than $3.5 million, $250,000, (ii) $5 million, $1 million, and (iii) in excess of $3.5 million, but less than $5 million, $250,000 plus the lesser of (a) $750,000 and (b) an amount determined by multiplying (x) the quotient (expressed as a percentage) of (1) the amount by which gross proceeds from the issuance of the Series K Preferred Stock exceed $3.5 million, divided by (2) $1.5 million, by (y) $750,000 (the foregoing clauses (i) through (iii) are collectively referred to as the “Prepayment Amount”);

 

In addition to the above consents, the PNC Amendment also:

 

• Allows the Borrowers to make dividends or distributions to DRI to enable DRI to pay up to the sum of (a) $150,000 plus (b) the result of 9.5% of the amount of the Series K Preferred Stock issued by DRI on or prior to October 31, 2009;

 

 

For the quarter ended September 30, 2009, we and the Borrowers were not in compliance with the leverage ratio required to be maintained under terms of the PNC Agreement and the BHC Agreement as

amended on March 26, 2009. PNC agreed to amend the PNC Agreement to revise the leverage ratio required to be maintained for the quarter ended September 30, 2009 to 5.25 to 1.00. BHC agreed to waive the violation of the leverage ratio covenant for the quarter ended September 30, 2009. On December 29, 2009, the PNC Agreement and BHC Agreement were each amended to revise the minimum leverage ratios required to be maintained as of the end of each fiscal quarter as set forth below.

 

 

With the exception of the leverage ratio for the quarter ended September 30, 2009, as described herein, we were in compliance with all financial loan covenants in 2009. Additionally, PNC and BHC agreed to extend the date for the Company to provide audited 2009 financial statements to April 30, 2010.

 

Series K Preferred Stock

 

Between October 26, 2009 and January 5, 2010, the Company sold an aggregate of 310 shares of the Company’s Series K Preferred Stock, par value $0.10 per share, to multiple outside investors. Gross proceeds from the sale of the Series K Preferred Stock of $1.6 million were used for general corporate working capital purposes and applied toward a $270,000 payment to BHC. Of the $270,000 payment to BHC, which occurred on November 2, 2009, $250,000 was a payment of principal on the Term Loan and $20,000 was payment of a termination fee pursuant to terms of the BHC Agreement. On January 5, 2010, the Company agreed to issue an aggregate of 24 shares of the Series K Preferred Stock to a placement agent as consideration for such agent’s services to the Company in connection with the placement of the 310 shares of Series K Preferred Stock described herein. Upon the issuance of shares to the placement agent, the Company has 334 shares of Series K Preferred Stock issued and outstanding. The terms and conditions of the Series K Preferred Stock are more fully described in Note 12 to the accompanying consolidated financial statements.

 

Management Conclusion

 

Our liquidity is primarily measured by the borrowing availability on our domestic and international revolving lines of credit and is determined, at any point in time, by comparing our borrowing base (generally, eligible accounts receivable and inventory) to the balances of our outstanding lines of credit. Borrowing availability on our domestic and international lines of credit is driven by several factors, including the timing and amount of orders received from customers, the timing and amount of customer billings, the timing of collections on such billings, lead times and amounts of inventory purchases, and the timing of payments to vendors, primarily on payments to vendors from whom we purchase inventory. In addition to these factors, in fiscal year 2010, we expect revenue growth in our domestic and international markets and increased production efforts to meet such growth to impact the borrowing availability on our domestic and international lines of credit and may require us to seek additional financing to support the working capital and capital expenditure needs of our operations during fiscal year 2010. Historically, the Company has secured financing through lending agreements with banks and other lenders, including amending or extending existing lending agreements, and through offerings of its equity securities. If additional financing is required in fiscal year 2010, we believe we will be able to secure financing through one of these sources on commercially reasonable terms, though we can give no assurances of such.

 

As described herein, certain of our loan agreements contain covenants with which we and our subsidiaries must comply on a quarterly basis. We believe we will be able to comply with such loan covenants in each quarter of fiscal year 2010, though we can give no assurance of such compliance.

Critical Accounting Policies and Estimates

 

DRI’s significant accounting policies and estimates used in the preparation of the Consolidated Financial Statements are discussed in Note 1 of the Notes to Consolidated Financial Statements. The following is a listing of DRI’s critical accounting policies and estimates and a brief description of each:

 

 

Allowance for Doubtful Accounts

 

Our allowance for doubtful accounts relates to trade accounts receivable. It reflects our estimate of the amount of our outstanding accounts receivable that are not likely to be collected. Most of the Company’s sales are to large OEM equipment manufacturers or to state or local governmental units or authorities, so management expects low losses resulting from insolvency or actual inability to pay. The allowance for doubtful accounts is a periodic estimate prepared by management based upon identification of the collections of specific accounts and the overall condition of the receivable portfolios. When evaluating the adequacy of the allowance for doubtful accounts, we analyze our trade receivables, the customer relationships underlying the receivables, historical bad debts, customer concentrations, customer creditworthiness, current economic trends, and changes in customer payment terms.

 

Inventory Valuation and Warranty Reserve

 

We periodically evaluate the carrying amount of inventory based upon current shipping forecasts and warranty and post-warranty component requirements. As a part of the sale, the Company typically extends a warranty term generally ranging from one to five years. We account for this liability through a warranty reserve on the balance sheet. Additionally, in special situations, we may, solely at our discretion, use extended or post-warranty services as a marketing tool. In these instances, such future warranty costs have previously been included in the established warranty reserves. Many of our customers have contractual or legal requirements, which dictate an extended period of time for us to maintain replacement parts. Our evaluation of inventory reserves involves an approach that incorporates both recent historical information and management estimates of trends. Our approach is intended to take into consideration potential excess and obsolescence in relation to our installed base, engineering changes, uses for components in other products, return rights with vendors and end-of-life manufacture. Estimating sales prices, establishing markdown percentages and evaluating the condition of the inventories require judgments and estimates, which may impact the inventory valuation and gross profits. We believe, based on our prior experience of managing and evaluating the recoverability of our slow moving or obsolete inventory, that such established reserves are materially adequate. If actual market conditions and product sales were less favorable than we have projected, additional inventory write-downs may be necessary. The inventory write-down calculations are reviewed periodically and additional write-downs are recorded as deemed necessary.

 

Intangible Assets and Goodwill

 

Goodwill is assigned to our reporting units, which are defined as the domestic and international operating segments. We test goodwill for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test compares the fair value of the reporting unit with its carrying amount. If the carrying amount exceeds its fair value, impairment is indicated. If an impairment is indicated, the impairment is measured as the excess of the recorded goodwill over its fair value, which could materially adversely impact our consolidated financial position and results of operations.

We performed a goodwill impairment test as of December 31, 2009. We estimated fair value for each reporting unit utilizing two valuation approaches: (1) the income approach and (2) the market approach. The income approach measures the present worth of anticipated future net cash flows generated by the reporting unit. Net cash flows are forecast for an appropriate period and then discounted to present value using an appropriate discount rate. Net cash flow forecasts require analysis of the significant variables influencing revenues, expenses, working capital and capital investment and involves a number of significant assumptions and estimates. The market approach is performed by observing the price at which companies comparable to the reporting unit, or shares of those guideline companies, are bought and sold. Adjustments are made to the data to account for operational and other relevant differences between the reporting unit and the guideline companies. To arrive at estimated fair value of each reporting unit, we assigned an appropriate weighting to the value of the reporting unit calculated under of each of the two valuation approaches. The aggregate weighted fair value under the two valuation approaches is the estimated fair value of the reporting unit. Additional judgments and assumptions are made in allocating assets and liabilities to determine the carrying values for each of our reporting units. We believe the assumptions we use in estimating fair value and in determining the carrying value of our reporting units are reasonable, but are also unpredictable and inherently uncertain. At December 31, 2009, our estimated fair value of the reporting units exceeded carrying value of our reporting units thereby indicating no impairment existed. If our estimated fair value of the reporting units declines at some point in the future, the Company may be required to record an impairment charge. Actual future results may differ from those estimates.

 

Income Taxes

 

We are required to pay income taxes in each of the jurisdictions in which we operate. These jurisdictions include the U.S. Government and several states, and a number of foreign countries. Each of these jurisdictions has its own laws and regulations, some of which are quite complex and some of which are the subject of disagreement among experts and authorities as to interpretation and application. The estimation process for preparation of our financial statements involves estimating our actual current tax expense together with assessing temporary differences resulting from differing treatment of items for income tax and accounting purposes. We review our operations and the application of applicable laws and rules to our circumstances. To the extent we believe necessary, we also seek the advice of professional advisers in various jurisdictions.

 

We record an income tax valuation allowance when, based on the weight of the evidence, it is more likely than not that some portion, or all, of the deferred tax asset will not be realized. The ultimate realization of the deferred tax asset depends on our ability to generate sufficient taxable income of the appropriate character in the future and in the appropriate taxing jurisdictions. In assessing the realization of the deferred tax assets, consideration is given to, among other factors, the trend of historical and projected future taxable income, the scheduled reversal of deferred tax liabilities, the carryforward period for net operating losses and tax credits, as well as tax planning strategies available to us. Certain judgments, assumptions and estimates are required in assessing such factors and significant changes in such judgments and estimates may materially affect the carrying value of the valuation allowance and deferred income tax expense or benefit recognized in our consolidated financial statements.

 

We account for uncertain tax positions in accordance with ASC Topic 740-10-25. The application of income tax law is inherently complex. As such, we are required to make certain assumptions and judgments regarding our income tax positions and the likelihood whether such tax positions would be sustained if challenged. Penalties related to uncertain tax positions are recorded as a component of operations. There is no interest charged for underpayment of taxes in the jurisdiction to which our uncertain tax positions relate. Interpretations and guidance surrounding income tax laws and regulations change over time. As such, changes in our assumptions and judgments can materially affect amounts recognized in our consolidated balance sheets and statement of operations.

 

Revenue Recognition

 

The Company recognizes revenue in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements” (“SAB 104”). SAB 104 sets forth guidelines on the timing of revenue

recognition based upon factors such as passage of title, purchase agreements, established pricing and defined shipping and delivery terms. We recognize revenue when all of the following criteria are met: persuasive evidence that an arrangement exists; delivery of the products or services has occurred; the selling price is fixed or determinable and collectibility is reasonably assured. Even though the Company receives customer sales orders that may require scheduled product deliveries over several months, sales are only recognized upon physical shipment of the product to the customer, provided that all other criteria of revenue recognition are met.

 

Multiple element arrangements in 2007 and 2008 — The Company’s transactions sometimes involve multiple element arrangements in which significant deliverables typically include hardware, installation services, and other services. Under a typical multiple element arrangement, the Company delivers the hardware to the customer first, then provides services for the installation of the hardware, followed by system set-up and/or data services. Revenue under multiple element arrangements is recognized in accordance with Accounting Standards Codification (“ASC”) Topic 605-25, “Multiple-Element Arrangements”. ASC Topic 605-25 provides that revenue arrangements with multiple elements should be divided into separate units of accounting if certain criteria are met and provides that fair value of each element is established first by determining if vendor-specific objective evidence exists for that element. Vendor-specific objective evidence includes the price charged when the same element is sold separately or, for an element not yet sold separately, the price established by management with the relevant authority. If vendor-specific objective evidence does not exist, then fair value can be established by third party evidence of the selling price such as competitors’ sales prices for the same or largely interchangeable products or services to similar customers in stand-alone sales. If there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration is allocated to the separate elements based on their relative fair values (the relative fair value method). In cases in which there is objective and reliable evidence of the fair value of undelivered items in an arrangement but no such evidence for the delivered items, the amount of consideration allocated to the delivered items equals the total arrangement consideration less the aggregate fair value of the undelivered items (the residual method). In substantially all of our multiple element arrangements, we establish fair value of the hardware elements using vendor-specific objective evidence of sales of such hardware elements when sold separately by the Company. We establish fair value for the installation services element through third party evidence of the sales price charged by competitors and others in our industry for similar services. Certain multiple element arrangements include the delivery of software. For these arrangements, we establish fair value for the software deliverables through third party evidence of the sales price charged by competitors and others in our industry for similar software. We have not been able to establish fair value for system set-up and data services we deliver because we do not have vendor specific objective evidence of such services being sold separately or third party evidence for such services, since we are the only entity that can provide these specific services to our customers. Under the provisions of ASC Topic 605-25, we cannot separate the hardware elements and installation services into separate units of accounting because we are unable to establish fair value for the system set-up and/or data services. Therefore on multiple element arrangements involving system set-up/data services, we defer revenue on delivery of the hardware and installation services until the system set-up/data services are delivered to the customer.

 

Revenue from more complex or time-spanning projects within which there are multiple deliverables including products, services, and software are accounted for in accordance with ASC Topic 985-605, “Software Revenue Recognition. Under this standard, revenue is recognized over the life of the project based upon meeting specific delivery or performance criteria.

 

Multiple element arrangements in 2009 — In October 2009, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2009-13, which amends ASC Topic 605-25 to require companies to allocate the overall consideration in multiple-element arrangements to each deliverable by using a best estimate of the selling price of individual deliverables in the arrangement in the absence of vendor-specific objective evidence or other third-party evidence of the selling price. Additionally, ASU 2009-13 prohibits use of the residual method to allocate arrangement consideration among units of accounting. ASU 2009-13 will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. However early adoption of ASU 2009-13 is permitted and the Company has elected

to adopt the provisions of ASU 2009-13 as of January 1, 2009 on a prospective basis. Under the provisions of ASU 2009-13, we are able to use best estimate of selling price for the system set-up/data services to be delivered to our customers in a multiple element arrangement, for which vendor-specific objective evidence or other third party evidence is not available. As a result, we are able to separate the hardware and installation services elements into separate units of accounting and recognize revenue on these elements when they are delivered to the customer. In determining the best estimate of selling price for the system set-up/data services, we primarily consider the costs incurred by the Company in providing these services and our profit objective in providing these services. We assume that if we were to sell these services separately, we would price these services to achieve a profit similar to the profit we generally realize on the overall multiple element arrangements we enter into on a regular basis.

 

In October 2009, the FASB also issued ASU 2009-14, which amends ASC Topic 985-605 to exclude from its requirements (a) non-software components of tangible products and (b) software components of tangible products that are sold, licensed, or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s essential functionality. Under ASU 2009-14, if a multiple element arrangement includes a tangible product with both essential and nonessential software components, the arrangement consideration should first be allocated to the software and nonsoftware components based on the relative selling price method under ASC 605-25 as amended by ASU 2009-13. An entity then must apply the amended separation, measurement and allocation guidance in ASC Topic 605-25 to determine whether the nonsoftware items can be further separated and if so, how to allocate the nonsoftware consideration to those units of accounting. An entity must apply the guidance in ASC Topic 985-605 to determine whether the software components can be further separated and if so, how to allocate and recognize revenue for the units of accounting. ASU 2009-14 will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. However, early adoption of ASU 2009-14 is permitted and the Company has elected to adopt the provisions of ASU 2009-14 as of January 1, 2009 on a prospective basis.

 

During the year ended December 31, 2009, the Company’s only multiple element projects for which revenue recognition is impacted by the provisions of ASU 2009-14 include sales of postcontract customer support. On these projects, the arrangement consideration is first allocated to the software and nonsoftware components based on the relative selling price method under ASC 605-25, as amended by ASU 2009-13. The hardware and installation services are considered nonsoftware components and are separated, measured and allocated under the provisions of ASC Topic 605-25, as amended by ASU 2009-13, as described above, while the software components are separated, measured and allocated under the provision of ASC 985-605, which provides that vendor-specific objective evidence must exist to establish fair value of all undelivered elements, including the postcontract customer support. We have not been able to establish fair value of postcontract customer support through the existence of vendor-specific objective evidence. Under the provisions of ASC 985-605, for contracts where postcontract customer support is sold, we are required to defer revenue on the software components delivered and recognize such revenue and the postcontract customer support revenue over the postcontract customer support period. The Company generally does not sell postcontract customer support in multiple element arrangements and only one such arrangement in 2009 included the sale of postcontract customer support.

 

The impact of the adoption of ASU 2009-13 and ASU 2009-14 as of January 1, 2009 on our consolidated financial statements is more fully described in Note 1 to the accompanying consolidated financial statements.

 

Service revenues are recognized upon completion of the services and include product repair not under warranty, city route mapping, product installation, training, consulting to transit authorities and funded research and development projects. Service revenues were less than 3% of total revenue for 2009, 2008, and 2007.

 

Stock-based Compensation

 

The Company accounts for stock-based compensation in accordance with ASC Topic 718-20, “Stock Compensation Awards Classified as Equity”. Under ASC Topic 718-20, the Company estimates the fair value of stock options granted using the Black-Scholes option pricing model. The fair value is then amortized on a

straight-line basis over the requisite service period of the award, which is generally the option vesting term. This option pricing model requires the input of highly subjective assumptions, including an option’s expected life and the expected volatility of the Company’s Common Stock.

 

Off-Balance Sheet Arrangements

 

DRI does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on its financial condition, changes in financial condition, sales or expenses, results of operations, liquidity, capital expenditures or capital resources that would be material to investors. We do, however, have warrants to acquire shares of our Common Stock outstanding at varied exercise prices. Other than lease commitments, legal contingencies incurred in the normal course of business and employment contracts of key employees, we do not have any off-balance sheet financing arrangements or liabilities. We do not have any majority-owned subsidiaries or any interests in or relationships with any special-purpose entities that are not included in the consolidated financial statements.

 

Recent Accounting Pronouncements

 

In June 2009, the Financial Accounting Standards Board (“FASB”) issued ASC Topic 105, “Generally Accepted Accounting Principles”, (formerly referred to as SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles”). ASC Topic 105 establishes the ASC as the source of authoritative principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”). Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. ASC Topic 105 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption of ASC Topic 105 did not have a material impact on our consolidated financial statements for the year ended December 31, 2009.

 

On February 12, 2008, the FASB issued ASC Topic 820-10-15, “Fair Value Measurements and Disclosures”, (formerly referred to as FASB Staff Position (“FSP”) No. FAS 157-2, “Effective date of FASB Statement No. 157”), which delayed the effective date of ASC Topic 820-10, (formerly referred to as SFAS No. 157), for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on at least an annual basis, until 2009. The Company adopted the provisions of ASC Topic 820-10 for nonfinancial assets and nonfinancial liabilities effective January 1, 2009. The adoption of ASC Topic 820-10 with respect to nonfinancial assets and nonfinancial liabilities did not have a significant impact on our results of operations or financial condition.

 

In December 2007, the FASB issued ASC Topic 805-10, “Business Combinations”, (formerly referred to as SFAS No. 141(R)). ASC Topic 805-10 retains the underlying concepts of prior guidance in that all business combinations are still required to be accounted for at fair value under the acquisition method of accounting; but ASC Topic 805-10 changed the method of applying the acquisition method in a number of significant aspects. ASC Topic 805-10 requires companies to recognize, with certain exception, 100% of the fair value of the assets acquired, liabilities assumed and non-controlling interest in acquisitions of less than 100% controlling interest when the acquisition constitutes a change in control; measure acquirer shares issued as consideration for a business combination at fair value on the date of the acquisition; recognize contingent consideration arrangements at their acquisition date fair value, with subsequent change in fair value generally reflected in earnings; recognition of reacquisition loss and gain contingencies at their acquisition date fair value; and expense, as incurred, acquisition related transaction costs. We adopted the provisions of ASC Topic 805-10 effective January 1, 2009 and accounted for the acquisition of the remaining 50% interest in Mobitec Brazil Ltda under the provisions of ASC Topic 805-10 (see Note 2 to the accompanying consolidated financial statements for further discussion of this acquisition).

 

In December 2007, the FASB issued ASC Topic 810-10-65, “Consolidation”, (formerly referred to as SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB 51”). ASC Topic 810-10-65 establishes new standards that govern the accounting for and reporting of (1) noncontrolling interest in partially-owned consolidated subsidiaries and (2) loss of control of subsidiaries. ASC

Topic 810-10-65 requires that entities provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interest of the noncontrolling owners separately within the consolidated statement of position within equity, but separate from the parent’s equity and separately on the face of the consolidated income statement. Further, changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary should be accounted for consistently and when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary should be initially measured at fair value. We adopted the provisions of ASC Topic 810-10-65 effective January 1, 2009 and accounted for the acquisition of the remaining 50% interest in Mobitec Brazil Ltda under the provisions of ASC Topic 810-10-65 (see Note 2 to the accompanying consolidated financial statements for further discussion of this acquisition). The adoption of ASC Topic 810-10-65 impacted the accompanying consolidated financial statements for all periods presented as follows:

 

 

In March 2008, the FASB issued ASC Topic 815-10, “Derivatives and Hedging”, (formerly referred to as SFAS No. 161 “Disclosures about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133”), which is effective on a prospective basis for fiscal years and interim periods beginning after November 15, 2008. ASC Topic 815-10 is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand such effects on financial position, financial performance and cash flow. We adopted the provisions of ASC Topic 815-10 effective January 1, 2009. The adoption of ASC Topic 815-10 did not have a material impact on our results of operations or financial condition.

 

In April 2008, the FASB issued ASC Topic 350-30-65, “Intangibles-Goodwill and Other”, (formerly referred to as FSP FAS 142-3,“Determination of the Useful Life of Intangible Assets”) ASC Topic 350-30-65 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. ASC Topic 350-30-65 is effective for fiscal years beginning after December 15, 2008. We adopted the provisions of ASC Topic 350-30-65 effective January 1, 2009. The adoption of ASC Topic 350-30-65 did not have a material impact on our results of operations or financial condition.

 

In June 2008, the FASB issued ASC Topic 815-40, “Derivatives and Hedging: Contracts in Entity’s Own Equity”, (formerly referred to as Emerging Issues Task Force (“EITF”) Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock”). ASC Topic 815-40 clarifies the determination of whether an instrument (or an embedded feature) is indexed to an entity’s own stock, which would qualify as a scope exception under ASC Topic 815-10-15 (formerly referred to as SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”). ASC Topic 815-40 is effective for financial statements issued for fiscal years beginning after December 15, 2008. In conjunction with a loan agreement pursuant to which a $5.0 million term loan was obtained in June 2008, the Company issued the lender warrants to purchase up to 350,000 shares of our Common Stock. These warrants were determined to be a derivative instrument based on the clarification within ASC Topic 815-40. As of January 1, 2009, the fair value of these warrants was reclassified from equity to a current liability and a cumulative effect adjustment to

retained earnings was recorded for the change in the fair value of the warrants. During the period in which the warrants are classified as a liability, the fair value of the warrants will be periodically remeasured with any changes in value recognized in other income (loss) in the consolidated financial statements. See the “Fair Value of Assets and Liabilities” section of Note 1 to the accompanying consolidated financial statements for further discussion of accounting treatment of these warrants.

 

In May 2009, the FASB issued ASC Topic 855-10, “Subsequent Events”, (formerly referred to as SFAS No. 165, “Subsequent Events”) which was amended in February 2010. ASC Topic 855-10 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. ASC Topic 855-10 is effective for interim or annual financial periods ending after June 15, 2009. The adoption of ASC Topic 855-10, as amended, did not have an impact on our consolidated financial statements for the year ended December 31, 2009, as it is our continuing policy to evaluate subsequent events through the date our financial statements are issued. For the year ended December 31, 2009, we have evaluated subsequent events through April 15, 2010, which is the date our financial statements were issued and filed with the SEC.

 

Impact of Inflation

 

We believe that inflation has not had a material impact upon our results of operations for each of our fiscal years in the three-year period ended December 31, 2009. However, there can be no assurance that future inflation will not have an adverse impact upon our operating results and financial condition.

 

DRI CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

Board of Directors and Stockholders

DRI Corporation and Subsidiaries

 

We have audited the accompanying consolidated balance sheets of DRI Corporation (a North Carolina Corporation) and Subsidiaries as of December 31, 2009 and 2008 and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of DRI Corporation and Subsidiaries as of December 31, 2009 and 2008 and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

As disclosed in Note 1 to the consolidated financial statements, effective January 1, 2009, the Company adopted new accounting guidance related to the accounting for and financial statement presentation of multiple element revenue arrangements, noncontrolling equity interests in consolidated subsidiaries and financial instruments indexed to the Company’s own stock.

 

/s/ GRANT THORNTON LLP

Raleigh, North Carolina

April 15, 2010

 

To the Board of Directors and Shareholders

of DRI Corporation:

 

In our opinion, the consolidated statement of operations, shareholders’ equity and comprehensive income (loss) and cash flows for the year ended December 31, 2007 present fairly, in all material respects, the results of their operations and their cash flows for the year ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

As discussed in Note 16 to the consolidated financial statements, the Company changed the manner in which it accounts for uncertain tax positions in 2007.

 

The consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has insufficient cash resources to satisfy its debt obligations, which raises substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

/s/ PricewaterhouseCoopers LLP

March 31, 2008

Raleigh, North Carolina

 

 

See accompanying notes to consolidated financial statements.

 

 

See accompanying notes to consolidated financial statements.