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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 23, 2000.
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________.
COMMISSION FILE NUMBER: 0-21681
TRANSCRYPT INTERNATIONAL, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 47-0801192
(State or other jurisdiction (I.R.S. Employee
of incorporation or organization) Identification No.)
4800 NW 1ST STREET
LINCOLN, NEBRASKA 68521
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (402) 474-4800
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, PAR VALUE $0.01 PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting and non-voting Common Stock held by
non-affiliates of the Registrant, based upon the last sale price of the Common
Stock on March 9, 2000, as reported in the Over the Counter Bulletin Board
market was approximately $65,649,782. Shares of Common Stock held by each
executive officer and director and each person owning more than 5% of the
outstanding Common Stock of the Registrant have been excluded in that such
persons may be deemed to be affiliates of the Registrant. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes. Number of shares outstanding of the Registrant's Common Stock, as of
March 9, 2000: 12,954,124.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the Registrant's 2000 Annual
Meeting of Stockholders to be filed within 120 days of the fiscal year ended
December 31, 1999 are incorporated by reference in Items 10, 11, 12 and 13 of
Part III of this Annual Report on Form 10-K.
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PART I
ITEM 1. BUSINESS
Unless the context otherwise provides, all references in this Annual Report
on Form 10-K to the "Company" includes Transcrypt International, Inc.
("Transcrypt"), its predecessor entities, and its subsidiaries, including E.F.
Johnson Company, on a combined basis, and all references to "E.F. Johnson" refer
to E.F. Johnson Company.
In addition to the historical information contained herein, certain matters
discussed in this Annual Report may constitute forward-looking statements under
Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). These statements may involve risks and uncertainties. These
forward-looking statements relate to, among other things, the outcome of pending
class action litigation involving the Company, the outcome of the pending
investigation by the Securities and Exchange Commission (the "SEC"), the effects
of the Company's restatement of its financial statements on the Company's
product development efforts, future sales levels and customer confidence, the
Company's future financial condition, liquidity and business prospects
generally, perceived opportunities in the marketplace for the Company's products
and its products under development, expectations regarding the Company's efforts
to resolve Year 2000 issues and the effects of a failure to resolve such issues
and the Company's other business plans for the future. The actual outcomes of
these matters may differ significantly from the outcomes expressed or implied in
these forward-looking statements. For a discussion of some of the factors that
might cause such a difference, see "--Summary of Business Considerations and
Certain Factors That May Affect Future Results of Operations and/or Stock Price"
below.
GENERAL
The Company is a manufacturer of wireless communications products and
systems and information security products. Through its E.F. Johnson subsidiary,
the Company designs, develops, manufactures and markets (1) stationary land
mobile radio ("LMR") transmitters/receivers (base stations or repeaters) and
(2) mobile and portable radios. The Company sells its LMR products and systems
mainly to two broad markets: (1) commercial users and (2) public safety and
other governmental users. Through its Secure Technologies division, the Company
designs and manufactures information security products which prevent
unauthorized access to sensitive voice communications. These products are based
on a wide range of analog scrambling and digital encryption technologies and are
sold mainly to the LMR and telephony security markets.
In July 1997, the Company expanded its presence in the wireless
communications market by acquiring E.F. Johnson, an established provider of
products and systems for the LMR market. This acquisition was made through the
issuance of shares of Transcrypt common stock ("Common Stock"), the payment of
cash and the assumption of certain indebtedness of E.F. Johnson. The total value
of the cash and shares paid at the time of acquisition was approximately
$10.4 million.
Prior to June 30, 1996, the Company operated as a partnership. In
December 1991, the Company acquired the business of its predecessor, which was
founded in 1978. The Company's principal business offices are located at 4800 NW
1st Street, Lincoln, Nebraska 68521, and its phone number is (402) 474-4800.
RESTATEMENT OF FINANCIAL STATEMENTS AND RELATED EVENTS
In 1998, the Company restated its previously released results for the year
ended December 31, 1997, the Company's financial statements for the year ended
December 31, 1996 and the financial statements as of and for each of the
quarterly periods ended March 31, June 30, September 30 and December 31 during
1997 and 1996. The restatement of the Company's financial statements and other
events relating to the
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restatement, including the filing of class action lawsuits against the Company
and the initiation of an SEC investigation (See "Item 3. Legal Proceedings.")
which occurred subsequent to March 31, 1998, have had and continue to have an
adverse impact on the Company's business, financial condition, results of
operations, liquidity and cash flows.
RECENT DEVELOPMENTS
On February 14, 2000, the Company announced the formation of three new
business units at its E.F. Johnson subsidiary to further strengthen its position
in the wireless systems and digital radio products market. The new State, Local,
and Commercial business unit will be focused on marketing, sales, and turnkey
delivery of high level public safety and commercial private wireless
communications networks. The new Federal business unit will be focused on the
sales of E.F. Johnson's digital APCO Project 25 products to Federal government
agencies. The new Value Added Services and Original Equipment Manufacturer
("OEM") business unit was formed to consolidate E.F. Johnson's OEM production
services and engineering design and support services. The Company also announced
that it would also open offices in the Washington, D.C. area to exploit
opportunities in the Federal and commercial markets.
WIRELESS COMMUNICATIONS INDUSTRY
OVERVIEW
The mobile wireless communications industry began in the mid-1930s when
police departments began using land mobile radio systems to enable immediate
communication between headquarters and officers patrolling the community. As
(1) other public safety agencies and commercial enterprises recognized the
benefit of immediate communications with their field personnel,
(2) technological advances made LMR systems more affordable, and (3) increasing
amounts of spectrum were allocated for LMR use, LMR dispatch service expanded
beyond its traditional police and fire applications to become an integral
communications service for a variety of government and commercial enterprises.
Today, in addition to dispatch-oriented LMR service, many other forms of mobile
wireless communication technologies have emerged and are continuing to be
developed to meet the varied communication needs of an increasingly mobile
society. These include paging, wireless data, cellular telephone and personal
communication services.
COMMERCIAL SYSTEMS MARKET
Commercial users include large industrial and other private enterprises,
such as utility, construction and oil companies, railroads and universities that
require rapid communications among personnel spread out over relatively large
geographic areas. While many commercial LMR users purchase and operate entire
systems for their own use, a large segment of the commercial market consists of
specialized mobile radio ("SMR") operators such as Nextel Corp. and Centennial
Communications, and their customers. SMR operators build and lease private LMR
systems on a for-profit basis. They sell airtime to end-users whose mobile
communication needs can be served by renting or purchasing subscriber units as
opposed to purchasing an entire system, or who are unable to obtain a FCC
license to operate their own system. Traditionally, end-users of SMR services
have included taxi fleets and smaller construction and delivery service
companies. Currently, many SMR operators in the larger metropolitan markets,
such as Nextel Corp., are also offering more consumer-oriented, cellular-like
SMR services.
There are two general types of LMR systems serving commercial users,
(1) conventional and (2) trunked. Both operate on the specific frequency bands
that the FCC has allocated for such types of systems. Conventional LMR systems
use a single channel to transmit and receive information. All users have
unrestricted access, similar to a "party" telephone line, and the user must
monitor the system and wait until the channel is unoccupied. Trunked systems,
including the Company's logic trunked radio ("LTR-Registered Trademark-")
product, combine multiple channels so that when a user begins transmitting, an
unoccupied
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channel is automatically selected. Conventional LMR systems are relatively
inefficient compared to trunked systems.
The development of trunked LMR systems and the allocation of additional
frequency spectrum in the 1970s triggered significant growth in LMR use for
commercial applications. In recent years, technological developments by E.F.
Johnson and others have enabled LMR systems to be "networked," involving
multiple "sites" linked together through a switch to provide extended
geographical coverage. In addition, many trunked subscriber units are capable of
functioning as mobile telephones through interconnections to the public switched
telephone network. With the creation of LTR-Net-TM- in 1997, the Company has
developed a networking system that is backward compatible to the standard
LTR-Registered Trademark- protocol. LTR-Net-TM- allows systems operators to link
sites together and provide telephone interconnection, individual and group
calling, electronic serial numbers and improved system security in an advanced
commercially focused trunking system.
PUBLIC SAFETY AND OTHER GOVERNMENT USERS MARKET
Public safety and other government users include state and local agencies,
such as law enforcement, fire and emergency medical personnel, and military and
non-military federal governmental agencies. Many of these users operate LMR
equipment which complies with specifications established by the Association of
Public Safety Communications Officials International Inc. ("APCO"), while the
remainder operate mostly conventional and non-APCO trunked LMRs. The most widely
used APCO standard is the "APCO 16" standard established in 1979, which includes
specifications for 800 MHz transmission, analog voice modulation, and trunking
functions for using the frequency spectrum. In 1988, E.F. Johnson entered the
market for APCO 16 products with its Multi-Net-Registered Trademark- system.
In 1995, the APCO Advisory Board promulgated a new standard known as Project
25. Project 25 specifies features and signaling for narrow band digital voice
and data, and conventional and trunking modes of operation. The standard has
been adopted by the U.S. Federal government, which specified a conversion to
Project 25 by the year 2005. Although public safety agencies are not currently
required by the FCC or APCO to purchase Project 25 compliant LMR systems or
otherwise adopt the Project 25 standard, the Company believes that Project 25
compatibility will be one of the key purchasing factors for public safety and
other government LMR users. Furthermore, as LMR users upgrade their existing
APCO 16 systems to comply with FCC-imposed bandwidth limitations, the Company
expects that demand for Project 25 compliant LMR systems will increase, due in
part to the fact that Project 25 systems can potentially be configured for
compatibility with older APCO 16 mobile and portable radios, allowing early
adopters of the Project 25 standard to purchase new equipment without replacing
all of their subscriber radios. Additionally, the Company's Project 25 radios
can be used on most Motorola APCO 16 systems using the Smartnet-TM-protocol,
which E.F. Johnson licensed from Motorola. However, to date the Project 25
market is developing slowly which the Company believes is primarily due to the
higher cost of Project 25 compliant system infrastructure and radios.
INFORMATION SECURITY INDUSTRY
OVERVIEW
The electronic information security industry is generally comprised of
products designed to protect the transmission of sensitive voice and data
communications through both wireless and wireline mediums. Without such
protection, many forms of electronic communications, such as LMR and telephone
conversations and remote data communications, are vulnerable to interception and
theft.
The information security industry originated from the need to secure
sensitive wireless military communications. By the late 1970s, the availability,
quality and cost of information security devices had improved so that the use of
these devices became economically and functionally feasible for non-military
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governmental users (such as law enforcement, fire, emergency medical and other
public safety personnel) and large commercial users (such as railroads,
construction and oil companies).
Initially, all electronic communications were transmitted in analog format.
Analog transmissions typically consist of a voice or other signal modulated
directly onto a continuous radio "carrier" wave. An analog transmission can be
made secure by (1) "scrambling" or manipulating the original signal at the point
of transmission and (2) reconstituting the original signal at the receiving end.
By the late 1980s, accelerating use of wireless communications devices, such as
LMRs and cellular telephones, resulted in increased demand for limited radio
spectrum. In response to this demand, and enabled by the low-cost availability
of digital signal processors ("DSPs"), electronics manufacturers developed
spectrally efficient (I.E., low-bandwidth) digital communications devices. In
digital communications, an analog signal is "digitized," or converted into a
series of discrete information "bits" in the form of ones and zeroes prior to
transmission. Digital transmissions can be made secure by a process known as
"encryption," which involves (1) the use of a mathematical algorithm to
rearrange the bit-stream prior to transmission and (2) a decoding algorithm to
reconstitute the transmitted information back into its original form at the
receiving end.
Manufacturers of information security products such as the Company typically
charge higher prices for devices featuring more advanced levels of security.
Therefore, the types of end-users at each level of security tend to vary based
upon the importance of the information that the end-user wants to secure.
Typical users of the most basic form of scrambler, the frequency inversion
scrambler, include taxi dispatchers, other types of consumer businesses and
transportation companies. Typical users for medium-level security devices
include commercial users and international customers who do not need an export
license. High-level scrambling and encryption devices are used primarily by
public safety agencies, federal government personnel and international customers
who have obtained the required export license.
LAND MOBILE RADIO SECURITY MARKET
One of the earliest applications of information security technology outside
of the military was in protecting LMR voice communications. LMRs consist of
(1) hand-held or (2) mobile (vehicle mounted) two-way radios. A typical LMR
system consists of one or more base control stations networked with each other
and with hand-held and/or mobile LMRs. As with all other major forms of wireless
communications devices, LMRs transmit information in either analog or digital
format, although there is an increasing migration to the digital format.
TELEPHONY SECURITY MARKET
Since its inception in 1983, cellular telephone service has grown rapidly
and become available to most of the United States population. Cellular telephone
subscribers and revenues have grown rapidly in recent years and are expected to
grow in the future. This increased volume has raised significant new security
and privacy issues and an increased sensitivity to the potential risks involved
in intercepted signals. Unprotected wireless transmissions generally provide
minimal or no security and allow eavesdropping by even casual listeners with
compatible scanners.
In recent years, the cellular industry has been migrating, on an accelerated
basis, away from analog devices towards digital forms of communications, which
are commonly referred to as Personal Communication Services ("PCS"). Similar to
the LMR industry, this migration has occurred principally due to (1) increased
spectrum efficiency, (2) perception of greater voice security and
(3) additional capabilities for advanced features and data communications. PCS
technology typically uses variable rate voice coding, which maximizes the
efficiency of transmissions by only transmitting critical pieces of information
and omitting other information, such as pauses in a conversation. In the area of
voice security, digital telephony is functionally more secure than analog
telephony. While there are some characteristics that make digital transmissions
more difficult to intercept, most digital services do not use any type of active
encryption
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technology. However, unlike analog scanning technology, digital scanners are not
yet widely available. The increased use of digital devices has resulted and will
likely continue to result in reduced demand for add-on voice security devices,
such as those produced by the Company.
WIRELESS COMMUNICATIONS PRODUCTS
The Company sells its wireless communications products primarily to LMR
dealers, SMR operators, governmental entities, and commercial industry.
End-users include commercial concerns and public safety and other government
users desiring point to multi-point communications. Most of these types of
products are sold under the "E.F. Johnson" brand name. To increase its product
offering to its wireless customers, the Company has incorporated its encryption
technology into some of its wireless communications radio products. The
following discussion summarizes the types of products typically sold to both of
these types of users.
COMMERCIAL USERS
The Company serves the commercial market primarily with its
LTR-Registered Trademark- and analog conventional LMR product lines. Management
believes that significant niche markets continue to exist for analog
conventional LMR products with value added technology, such as signaling
protocols and scrambling technology.
The LTR-Registered Trademark- product line incorporates the E.F. Johnson
LTR-Registered Trademark- trunking protocols and includes (1) sub-audible
signaling, which automatically selects a clear or unoccupied channel, (2) open
architecture that is compatible with other analog products and (3) transmission
trunking which provides efficient use of the channels. In December 1997, the
Company completed the design of a trunked LMR system known as "LTR-Net-TM-,"
which uses its LTR-Registered Trademark- trunking system in a wide-area
networked configuration, allowing linked communications over a much larger
geographic area than a single trunked system while also providing a much needed
array of user features and security functions. During 1999, the company
delivered a number of LTR-Net-TM- systems, including one that provides statewide
coverage.
The Company's products for the SMR market include mobile radios, portable
radios and repeaters, along with other infrastructure to provide a complete SMR
system. The Company targets smaller regional SMR operators which offer a
combination of dispatch and interconnect services and the traditional local SMR
operators and dealers who serve local businesses primarily with dispatch
service. In serving this market, the Company relies heavily on its network of
dealers, many of whom are authorized by the Company as service centers and
provide installation, maintenance, repair and warranty service. The Company
believes that the end-users of these products value (1) the low cost of point to
multi-point communications, (2) flexibility of networking, and (3) support and
responsiveness of the Company and its dealers.
Competition in the domestic commercial market has been increasing. New 800
MHz SMR frequencies are not available and existing channels are filling up. SMR
operator's with licenses for 900 MHz channels have been slow to develop their
build outs. There has been consolidation in both of these SMR marketplaces. A
large number of SMR systems have been converting from analog to digital, which
has resulted in the increasing availability of used analog radios and repeaters
in the marketplace. These factors have contributed to reduced market demand for
new and existing products. Competitors have been reducing their prices and
therefore putting pressure on the Company's prices and margins in this market.
PUBLIC SAFETY AND OTHER GOVERNMENT USERS
The Company serves public safety and other government users primarily with
its APCO 16 Multi-Net-TM- analog trunking system and Project 25 digital product
lines. The Company believes that its Multi-Net-TM- system, which links together
multiple sites for wide-area coverage using a proprietary architecture, is a
high-quality, cost-effective alternative to comparable APCO 16 systems produced
by other manufacturers. The Company's system offers many features specifically
designed for public safety
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users, such as (1) emergency queuing, (2) over 8,000 unique identification
codes, (3) automatic subscriber identification, (4) five levels of priority
access, (5) simulcast, and (6) a wide area system configuration. The Company
provides a broad line of Multi-Net-TM- products, including repeaters, radio
network terminals, system management modules, dispatcher consoles, audio and
data link and related accessories. E.F. Johnson Multi-Net-TM- systems are sold
both domestically and internationally. The Company's Project 25 compliant
analog/digital radios are compatible and interoperable with older analog radio
systems, as well as with Motorola's proprietary analog APCO 16 trunking
technology (SmartNet-TM- and Smartzone-TM-) and proprietary digital encryption
algorithms. In August 1996, the Company introduced a hand held digital radio
complying with the Project 25 "common air interface" standard and also featuring
advanced core scrambling and digital encryption technologies. The Company's
Project 25 radios contain, as standard features, voice scrambling and/or digital
encryption technology. The Company believes that such backward compatibility
with most of Motorola's APCO 16 trunking technology will provide early adopters
of the Project 25 standard, such as the federal government and many public
safety agencies, with the ability to purchase new equipment without replacing
entire older systems. During 1999, the Company also introduced new products that
operate in the analog mode on existing Motorola Smartnet-TM- and Smartzone-TM-
trunking systems. The Company believes these products, being lower cost than
digital Project 25 radios, will provide a competitive alternative for existing
Smartnet-TM- and Smartzone-TM- customers.
INFORMATION SECURITY PRODUCTS
OVERVIEW
Transcrypt first entered the information security market in 1978 with
simple, transistor-based add-on scrambling modules for use in analog LMRs using
basic single-inversion scrambling techniques. Transcrypt marketed these products
primarily to public safety agencies and international governments. Since that
time, the Company has further developed and improved upon its core information
security technologies, which have at various times been implemented into the
Company's scrambler modules and other products within its major information
security product families, (1) LMR Security and (2) Telephony Security.
The core technologies currently available to the Company for incorporation
in its products include the following methods, which are listed in increasing
order of sophistication of security technique: (1) frequency inversion
(inverting or otherwise adjusting the phase of a signal based on a consistent
method), (2) rolling code transmission (incrementally stepping codes),
(3) hopping code transmission (changing broadcast frequencies multiple times per
second based upon an algorithm) and (4) digital encryption (encoding a digital
bit-stream based upon a mathematical encryption algorithm).
As with all of the Company's information security products, the use of
scrambling and encryption equipment is required on both the transmitting and
receiving sides of communications in order to operate in secure mode. For
example, in order to achieve secure LMR communications, it would be necessary
for both the transmitting and receiving equipment, including hand-held, mobile
devices and base stations, to be equipped with one of the Company's modules,
whether as an add-on installation or in the form of one of the Company's
complete LMRs. In the Company's telephony family, a scrambled cellular telephone
may communicate in secure mode only with (1) another of the Company's secure
cellular telephones, (2) a PBX interchange or cellular service provider that has
installed one of the Company's Voice Privacy Exchange Units or (3) a landline
telephone equipped with one of the Company's external desktop units. However,
all of the Company's products can be used in the clear, non-scrambled mode with
equipment that does not contain a security device.
LAND MOBILE RADIO SECURITY
The Company offers a variety of add-on LMR scrambling products featuring its
core technologies at varying levels of security. Add-on scramblers are available
in two packages, (1) a modular package consisting of a circuit board that is
designed to be permanently soldered into existing circuitry and (2) a
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socket package designed for installation in sockets with standard pin
configurations which original equipment manufacturers ("OEM") may install.
Products sold by the Company are compatible with sockets of OEM
manufacturers, including ICOM America, Inc., Motorola, Kenwood, and Midland. The
Company also produces modules that add signaling features to radios, including
"man-down" (emergency signal broadcast if radio position becomes horizontal),
"stun-kill" (disables lost or stolen radios remotely) and "over-the-air
reprogramming" (changes encryption and scrambling codes remotely). In
December 1997, the Company introduced an LMR encryption module for use as an
add-on or in OEM equipment that uses the U.S. digital encryption standard known
as "DES." This module uses the widely recognized DES algorithm for encoding
transmissions.
TELEPHONY SECURITY
The Company's add-on scramblers for cellular telephones typically consist of
a modular circuit board designed to be permanently soldered into existing
telephone circuitry. The add-on scrambler product line includes a model designed
specifically for Motorola, Nokia, and Qualcomm telephones, which feature
advanced digital signal processing technology. With the increased deployment of
digital or PCS systems by cellular service providers, the demand for add-on
voice security products for analog equipment has resulted and will likely
continue to result in reduced demand for add-on voice security devices for
analog telephones, such as those produced by the Company.
The Company offers cellular telephones upgraded to include the Company's
advanced add-on scrambling modules. The Company believes that offering cellular
telephone security through a complete telephone product offers certain
advantages over add-on scrambler sales. These advantages include (1) presenting
the customer with a single vendor, (2) overcoming customer resistance to
surrendering their telephones during installations and (3) allowing the Company
to market cellular security directly to cellular service providers. In the area
of landline telephone voice security, the Company has, since 1995, produced
landline scrambling and encryption devices for installation between the handset
and telephone base, which have been purchased primarily by overseas government
and corporate users. In 1997, the Company introduced a line of complete landline
telephones with built-in voice security capability.
PRODUCTS UNDER DEVELOPMENT
Consistent with the Company's development efforts for its existing products,
the Company designs new products around common wireless technologies using
common signal processing platforms and circuitry. Using this approach, the
Company has generally been able to incorporate improvements in core technologies
into its new products more quickly and with relatively lower development costs
compared to developing entire products separately. The following discussion
contains a summary of the Company's principal products under development. The
Company cannot assure that it will be able to successfully develop any of these
products or, if developed, that any such products will be commercially viable or
result in material sales.
WIRELESS COMMUNICATIONS
The Company plans to develop in 2000, for expected shipment during 2001,
additional models of its hand-held digital radios containing different features,
as well as a line of mobile digital radios, which are intended to comply with
the Project 25 standard. The Company has undertaken the development of Project
25 infrastructure equipment, including Project 25 trunking infrastructure. The
Company believes Project 25 trunking will be more widely implemented as costs
come down and additional competitively priced equipment becomes available. In
addition, the Company is analyzing the potential of applying standard Internet
Protocol switching techniques for voice and data interconnectivity between
wireless sites.
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LAND MOBILE RADIO SECURITY
The LMR security products under development are new versions of the
Company's SC20-DES module for deployment in different models of radios,
including sockets in certain new model Motorola radios introduced in late 1998.
From time to time, the Company also has under development a number of custom
security modules, including those incorporating custom encryption and scrambling
algorithms.
TELEPHONY SECURITY
No new telephony security products are under development at this time.
CUSTOMERS
Purchasers of the Company's wireless communications and information security
products include public safety agencies and police forces, federal government
agencies, foreign governments, the military, cellular service providers, LMR
manufacturers and business and corporate users in finance, manufacturing and
media/entertainment, among other industries. The Company's customers use
information security products in a variety of situations involving differing
security needs. For example, domestic and international police forces typically
have a medium to high need for security, while military users which are often
faced with hostile and determined threats typically have a very high need for
security. No customer accounted for more than 10% of the Company's revenues
during 1999.
SALES AND MARKETING
The following discussion summarizes the Company's current sales and
marketing approaches for its different products:
WIRELESS COMMUNICATIONS
The Company's sales and marketing functions for LMR systems focus on the
Americas, including the North American and Latin American markets. Other
international markets are covered by distributors, agents, and manufacturer's
representatives. For North American sales, the Company uses a direct sales force
of account executives and sales managers, who sell Company products primarily in
(1) the state and local government markets, (2) the Federal markets, and (3) to
larger dealers and SMR operators, and telemarketing personnel who sell primarily
to smaller dealers and SMR operators. The Company's international sales are made
through a specialized international direct sales force and by Company authorized
dealer/distributors. In 1999, the Company decided to close its Hong Kong office
due to cost and market considerations, and to focus on its markets in the
Americas.
LTR-Registered Trademark- and conventional LMR products are sold in North
America primarily to independently owned and operated dealers, some of which are
also SMR operators. The dealers typically carry other competitive product lines
as well. These products are distributed internationally primarily through
dealers and distributors located in more than 45 countries. Many of the dealers
also are authorized as service centers and provide installation, maintenance,
repair and warranty service. The Company provides comprehensive dealer support,
including cooperative advertising programs, advertising materials, sales and
service training, and technical support.
The majority of system sales of LMR products to both commercial and
governmental purchasers involves soliciting and responding to "requests for
proposals," commonly referred to as "RFPs." The RFP process for system sales has
a relatively long cycle time. The period from proposal requirements to contract
award typically takes at least one year, and depending on the size of the
system, it can take multiple years for complete installation and acceptance of
the project. Public sector end-users issuing RFPs often require suppliers of LMR
systems to supply a bond from an approved surety company at the time that the
bid is submitted and at the time that the contract is awarded.
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A number of factors can limit the availability of such bonds, including the
applicant's financial condition and operating results, the applicant's record
for completing similar systems contracts in the past and the extent to which the
applicant has bonds in place for other projects. During 1999, the Company
focused on the completion of systems contracts for certain E.F. Johnson projects
begun prior to the Company's acquisition of E.F. Johnson. The Company believes
that it has substantially corrected these systems problems. However, if a
customer for a systems contract declares an event of default under the
outstanding bond related to the system contract, the issuer of the Company's
bonds could reduce the maximum amount of bond coverage available to the Company,
or impose additional restrictions with respect to the issuance of bonds on
behalf of the Company. A reduction in the amount of bond coverage available to
the Company or any restrictions imposed in connection with the issuance of bonds
would adversely affect the Company's ability to bid on new system contracts in
the future. In early 2000, the Company negotiated an agreement with a bonding
insurer that provides for up to $20 million in new bonding capability at
competitive terms.
INFORMATION SECURITY
The Company sells its add-on products domestically primarily to distributors
and dealers, OEMs and self-servicing end-users, through sales managers while
complete radio products are sold domestically primarily to end-users.
Furthermore, the Company is continuing to market radio and other complete
products to its existing add-on customer base.
The Company conducts international sales through its sales managers, who
focus on specific regions of the world outside of the United States. The
majority of international sales are made by the sales managers in conjunction
with a Company-authorized distributor, which typically provides a local contact
and arranges for technical training in foreign countries. See "--Summary of
Business Considerations and Certain Factors That May Affect Future Results of
Operations and/or Stock Price--Risks Associated with International Sales."
The Company distributes its add-on information security products to both
(1) end-users in the LMR and telephony markets and (2) distributors, such as LMR
dealers, that resell these products to end-users. Currently, the Company sells
self-branded, complete, analog secure cellular telephones primarily through
distributors and cellular service resellers.
The Company's basic marketing strategy has been to increase market awareness
of the need for information security products and to convey the technical
capabilities of its products. The telephony security products marketing staff
conducts promotions through a mix of print advertising, trade shows, direct mail
campaigns, press releases and presentation material, and distribution of
demonstration and loaner equipment, which are sometimes coordinated with product
launches and trade shows.
CUSTOMER SERVICE
For the Secure Technologies division product line, the Company provides
toll-free telephone access for customers with technical or other problems. The
Company will customize product training for its customers using a classroom
approach or seminars at either or both the customer's site and the Company's
Lincoln facility. The Company offers a standard warranty on all products, which
covers parts and labor for a period of one year from purchase, with an extended
warranty service option available at an additional cost.
The Company installs, for a fee, all models of scrambler modules into
customers' LMRs and telephones. Scrambler modules that the Company does not
install are generally installed by local radio and cellular telephone dealers.
The Company documents installation instructions for its products in OEM devices
and has developed these instructions for more than 2,500 OEM products, including
almost all commercially available two-way radio models sold worldwide.
10
For the E.F. Johnson product line, the Company's customer service group
provides after-sales service and support, including technical support through a
toll-free telephone number, on-site technical personnel for repairs and
applications issues, 24-hour turnaround for spare parts and extensive product
training. Product training includes classes and seminars available at both the
customer's site and Waseca manufacturing facility. Such training provides
assistance to the end-user in the use, operation and application of LMR products
and systems, and trains other end-users and dealers to perform network
programming changes and preventive maintenance and repair to products and
systems. LMR products and systems are generally sold with a one year warranty
which covers parts and labor in North America and parts internationally. Broader
warranty and service coverage is provided in certain instances to private
systems customers on a contractual basis, usually for an additional charge.
MOTOROLA RELATIONSHIP
Motorola is a key manufacturer of electronic components used by the Company.
These components include microprocessors and components used in most of the
Company's scramblers and LMRs, which the Company purchases through an
electronics wholesaler.
The Company has obtained from Motorola a royalty-bearing, irrevocable,
non-exclusive, worldwide license (the "IPR License") to manufacture products
containing certain proprietary LMR and digital encryption technology. The
Company believes this technology will be important to the success of certain of
its existing and proposed Project 25 compliant LMR products. The IPR License
includes rights to use Motorola's proprietary analog APCO 16 trunking technology
(SmartNet-TM-), Project 25 required products and certain Motorola digital
encryption algorithms in LMR products. The digital encryption technology may
also be incorporated into certain other information security products. In
addition, E.F. Johnson, prior to its acquisition by the Company, obtained a
license to certain proprietary technology from Motorola relating to the
development of Project 25 compliant digital LMRs. This license covered
infrastructure and other Project 25 technology. Subsequent to the acquisition,
Motorola agreed to expand the coverage of Transcrypt's license to SmartNet-TM-
to cover E.F. Johnson's products.
During 1999, Motorola purchased approximately $4 million worth of E.F.
Johnson Project 25 mobile radio products. At this time, the Company cannot
guarantee that there will be further sales of this product line to Motorola, but
it is conducting active discussions on enhanced offerings related to this
purchase. Also during 1999, the Company signed a Memorandum of Understanding
with Motorola for the exploration of joint development projects and the license
of E.F. Johnson technology.
In addition to the direct benefits of the IPR License to the Company's
Project 25 development efforts, the Company believes that sales of its Project
25 digital LMR products have been, and expect that such sales will in the
foreseeable future be, substantially dependent upon Motorola's dominant position
as a market leader in the Project 25 marketplace. Motorola is the largest
manufacturer of Project 25 compliant LMR products and has been the principal
public supporter of the Project 25 digital transmission standard for the LMR
market. Any reduction in such support could lead to reduced demand for Project
25 compliant LMR systems generally. See "--Summary of Business Considerations
and Certain Factors That May Affect Future Results of Operations and/or Stock
Price--Reliance on Motorola."
INTELLECTUAL PROPERTY
Transcrypt presently holds registered copyrights that cover software
containing algorithms for frequency hopping, scrambling and signaling
technologies for LMR and cellular telephony. Transcrypt has been granted 11
patents relating to high-end scrambling and encryption techniques and methods of
integrating after-market devices, such as the Company's modules, into OEM
products, and has applied for nine additional domestic patents in this area.
Transcrypt also holds three registered trademarks related to the "Transcrypt"
name and product names. In addition to the rights held by Transcrypt, E.F.
Johnson currently holds or has been assigned at least 23 U.S. patents, 10
pending applications for U.S. patents, 11
11
patents in foreign countries and 8 pending applications for patents in foreign
countries. These patents and applications cover a broad range of technologies,
including trunking protocols and a high-speed data interface for LMR
communications. Furthermore, E.F. Johnson holds numerous registered trademarks
related to the "E.F. Johnson" name and product names. In addition to copyright
and patent laws, the Company relies on trade secret law and employee and
third-party non-disclosure agreements to protect its proprietary intellectual
property rights.
RESEARCH AND DEVELOPMENT
As of December 31, 1999, the Company had a research and development staff of
48 individuals, including 39 engineers. The Company organizes research and
development efforts along its two main product lines, (1) information security
and (2) wireless communications products. During 1999, the engineering staffs
were realigned to allow focus on research and development of products for E.F.
Johnson and Secure Technologies separately. While engineering staffs will
combine efforts when appropriate, the Company believes that this more focused
environment will foster a more efficient approach to new product development.
WIRELESS COMMUNICATIONS
The Company's wireless communications research and development organization
have expertise in radio frequency technology, computer architecture, switch
architecture, networking, software, and analog and digital hardware designs.
Ongoing engineering efforts are focused on adding additional features to
existing product lines and developing new and innovative platforms.
Cross-disciplinary planning groups involving marketing, manufacturing and
engineering are used for product planning and definition. Present research and
development efforts are involved in upgrading existing product lines, including
the development of next generation repeaters, network switching equipment, and
mobile and portable radios for the Company's principal product lines. The
Company also has a staff of systems applications design, manufacturing, and
customer service engineers that focus on design and implementation of customized
radio systems.
INFORMATION SECURITY
The Company's research and development personnel in the information security
area have expertise in various fields, including cryptography, analog hardware,
digital hardware, and object-oriented software. The research and development
staff designs and develops products incorporating digital signal processing,
voice coding (including improved multi-band excitation), encryption, spectral
manipulation and rotation, systems simulation and mixed signal scrambling.
MANUFACTURING
The Company's manufacturing operation generally consists of the procurement
of commercially available (1) subassemblies, (2) parts, and (3) components, such
as integrated circuits, printed circuit boards and plastic and metal parts, and
their assembly into finished products. Certain components and subassemblies are
manufactured by vendors to the Company's specific design criteria. The Company
inspects components and subassemblies for mechanical and electrical compliance
to its specifications in order to ensure high yield and quality.
The Company produces many of its wireless communications products, including
its Project 25 compliant products, at its Waseca, Minnesota facility. The
Company assembles its information security products at its facility in Lincoln,
Nebraska. During 1999, the Company consolidated its surface mount printed
circuit board assembly at its Waseca, Minnesota location. The Company is
continuing to evaluate alternative manufacturing strategies to reduce costs and
improve efficiencies.
12
MATERIALS AND SUPPLIERS
WIRELESS COMMUNICATIONS
Certain components and subassemblies used in the Company's wireless
communications products are presently available only from a single supplier or a
limited group of suppliers. To date, the Company has been able to obtain
adequate supplies of key components and subassemblies in a timely manner from
existing sources. Currently, Motorola is the sole supplier of a number of the
semiconductors used in certain of the Company's LMR products. Although
historically the Company has not experienced a disruption of Motorola's supply
of this product, disruption or termination of Motorola's supply of this product
would have a material adverse effect on the Company's operations.
Most of the Company's newer analog LMRs for the commercial market have been
manufactured by Icom Japan ("ICOM") under contract by the Company. Products
produced by ICOM have included hand-held portable radios that operate in both
conventional and trunked mode and more recently, mobile units as well. In
general, the Company and ICOM have jointly developed new products produced by
ICOM for the Company. Although historically the Company has not experienced a
disruption in ICOM's ability to supply these products, disruption or termination
would have a material adverse effect on the Company's ability to supply certain
LMRs to its customers. ICOM requires that the Company supply a letter of credit
before products are shipped to the Company. In addition to the Company's
relationship with ICOM, the Company began development projects with Kukjae of
Korea and Tokyo Wireless of Japan for products expected to be available for
shipment during 2000. Should a long-term relationship develop with either or
both of these firms, the Company can expect that relationship to be similar to
its relationship with ICOM, particularly with respect to its ability to supply
products to its customers.
With respect to other electronic parts, components and subassemblies, the
Company believes that alternative sources could be obtained to supply these
products, if necessary. Nevertheless, a prolonged inability to obtain certain
components and subassemblies could impair customer relationships and could have
an adverse effect on the Company's operating results. See "--Summary of Business
Considerations and Certain Factors That May Affect Future Results of Operations
and/or Stock Price--Dependence on Suppliers."
INFORMATION SECURITY
The Company obtains most of its electronic parts and components for
information security and radio products from one principal distributor,
Arrow/Schwebber Electronics Group. The Company believes that concentrating its
purchases through one principal distributor lowers procurement costs and
enhances the ability to control the quality of these components and
subassemblies. The distributor stores several months' supply of basic
components, such as microprocessors, flash, and digital signaling processors,
on-site at the Company's manufacturing location on a consignment basis, which
reduces inventory maintenance costs. Additionally, the Company acquires from
other manufacturers certain high-end subassemblies, such as radio frequency
boards for use in complete LMR units that the Company manufactures. See
"--Summary of Business Considerations and Certain Factors That May Affect Future
Results of Operations and/or Stock Price--Dependence on Suppliers."
GOVERNMENT REGULATION AND EXPORT CONTROLS
WIRELESS COMMUNICATIONS
The Company's stand alone wireless products are subject to regulation by the
FCC under the Communications Act of 1934, as amended, and the FCC's rules and
policies as well as the regulations of the telecommunications regulatory
authority in each country where the Company sells its products. These
regulations are in the form of general approval to sell products within a given
country for operation in a given frequency band, one-time equipment
certification, and, at times, local approval for installation. In
13
addition, the construction, operation and acquisition of wireless communications
systems, as well as certain aspects of the performance of mobile communications
products, are regulated by the FCC and foreign regulatory authorities. Many of
these governmental regulations are highly technical and subject to change. The
Company believes that it and its products are in material compliance with all
governmental rules and policies in the jurisdictions where the Company sells its
products.
In the United States, all of Transcrypt's wireless products are subject to
FCC Part 15 rules on unlicensed spread spectrum operation. In those countries
that have accepted certain worldwide standards, such as the FCC rulings or those
from the European Telecommunications Standards Institute, Transcrypt has not
experienced significant regulatory issues in bringing its products to market.
Approval in these markets involves retaining local testing agencies to verify
specific product compliance. However, many developing countries, including
certain markets in Asia, have not fully developed or have no frequency
allocation, equipment certification or telecommunications regulatory standards.
The majority of the systems operated by E.F. Johnson's customers must comply
with the rules and regulations governing what has traditionally been
characterized as "private radio" or private carrier communications systems.
Licenses are issued to use frequencies on either a shared or exclusive basis,
depending upon the frequency band in which the system operates. Some of the
channels designated for exclusive use are employed on a for-profit basis; others
are used to satisfy internal communications requirements. Most SMR systems in
operation today use 800 MHz channels. Within the top 50 metropolitan markets,
900 MHz frequencies licensed for exclusive use systems have been made available
to both SMR and non-SMR licensees. Additional channels designated for exclusive
use were made available in the 220 MHz band for both commercial and
non-commercial systems.
Generally, SMR licenses are issued for five-year terms, initially in blocks
of five channels, and may be renewed upon showing compliance with FCC rules and
may be revoked for cause. Such licenses typically are subject to channel
"loading" or usage requirements, such as loading a minimum of 70 subscriber
units for each channel within the initial five-year term. If an SMR licensee
fails to meet its loading requirements in an area where existing applications
are pending on a wait list, the FCC may cancel the license, in whole or in part,
or deny a request to renew or expand the license. Other than loading
requirements, private systems are subject to similar restrictions. For example,
licenses for private systems are also issued for five-year terms, may be renewed
upon showing compliance with FCC rules, and may be revoked for cause. In 1999,
the FCC ruled to relax the build-out requirements, which was a contributing
factor in some frequency holding customers delaying their SMR system purchases.
E.F. Johnson also offers products in bands below 800 MHz where multiple
users in the same geographic area share channels. In this "shared" or
conventional spectrum, there is no requirement for loading the channel to any
particular level in order to retain use of the frequencies. These channels are
generally used by entities satisfying traditional dispatch requirements in,
among others, the transportation and services industries. In addition, some
customers are applying trunking capabilities to their channels in the UHF
(primarily 450-470 MHz) frequency band.
The FCC is considering a number of regulatory changes that could affect the
wireless communications industry and the Company's business. Therefore, the
regulatory environment is inherently uncertain and changes in the regulatory
structure and laws and regulations, both in the United States and
internationally, can adversely affect the Company and its customers. Such
changes could make existing or planned products of the Company obsolete or
unsaleable in one or more markets, which could have a material adverse effect on
the Company.
The FCC, through the Public Safety Wireless Advisory Committee, is
considering regulatory measures to facilitate a transition by public safety
agencies to a more competitive, innovative environment so that the agencies may
gain access to higher-quality transmission, emerging technologies, and broader
services, including interoperability. In August 1998, the FCC adopted rules for
licensing the largest block of spectrum ever allocated at one time for public
safety. The FCC established rules for licensing 24 megahertz
14
in the 700 MHz band and established a band plan for use of this spectrum. In
accordance with this rule, in January 1999 the FCC established a Public Safety
National Coordination Committee (NCC) to advise it on issues relating to the use
of the 700 MHz public safety spectrum. The Committee would be responsible for
formulating a national interoperability plan, recommending technical standards
to achieve interoperability spectrum, and providing policy recommendations on an
advisory basis to the regional planning committees in order to facilitate the
development of coordinated plans. The NCC has recommended that Project 25 be
established as the interim interoperability mode for digital voice
communications in this new band. The Committee's recommendations could affect
products manufactured by the Company. Management cannot predict the outcome of
the FCC review or any specific changes in the spectrum of FCC policies, or any
potential effect on the Company's sales.
INFORMATION SECURITY
The Company's information security products have been subject to export
restrictions administered by the Department of State and the Department of
Commerce, which permit the export of encryption products only with the required
level of export license. U.S. export laws also prohibit the export of encryption
products to a number of specified hostile countries. Recent changes in export
policy will allow export of any encryption products to non-governmental
entities, while foreign government entities will still be subject to license
restrictions. Although to date the Company has been able to secure most required
U.S. export licenses, including for export to approximately 120 countries since
1978, there can be no assurance that the Company will continue to be able to
secure such licenses in a timely manner in the future or at all. Based on prior
experience in securing export approvals, the Company believes that it maintains
good relations with federal government agencies with jurisdiction over its
products. Additionally, in certain foreign countries, the Company's distributors
are required to secure licenses or formal permission before encryption products
can be imported.
Management cannot predict whether any new legislation regarding export
controls will be enacted, what form it will take or how the Executive Order or
any such legislation will impact international sales of the Company's products.
COMPETITION
WIRELESS COMMUNICATIONS
In North America, Motorola, Kenwood and Com-Net Ericsson are the leading
providers of LMR equipment. The remainder of the LMR market is divided among a
large number of suppliers who focus on particular segments of the market. The
Company believes it is the third largest provider of public safety radio systems
in North America. However, the Company's share of this market is relatively
small in comparison to sales by Motorola and Com-Net Ericsson.
The Company competes in the wireless communications market on the basis of
price, technology and the flexibility, support and responsiveness provided by
the Company and its dealers. The Company is also experiencing reduced demand for
and downward pricing pressure on its wireless communication analog products sold
to commercial users. Management believes that this is due to several factors.
These include the fact that (1) no new 800 MHz SMR frequencies are being made
available and existing channels are filling up; (2) SMR operator's with licenses
for 900 MHz channels have been slow to develop their build outs; (3) there has
been consolidation in both of these SMR marketplaces; and (4) a large number of
SMR systems have been converting from analog to digital which has resulted in
the increasing availability of used analog radios and repeaters in the
marketplace. Most of the Company's competitors in wireless communications have
financial, technical, marketing, sales, manufacturing, distribution and other
resources substantially greater than those of the Company.
In addition, many of the Company's competitors also possess entrenched
market positions, other intellectual property rights and substantial
technological capabilities. In the North American SMR market,
15
the Company's competitors include Motorola, Com-Net Ericsson, Uniden America
Corporation ("Uniden"), Kenwood U.S.A. Corp., ICOM America, Inc., Relm
Corporation and Midland International Corp. The Company believes that cellular
telephones and personal communication services devices provide, to some extent,
the same functionality as SMRs and other LMRs and, as such, may compete with its
products. The Company believes that the international wireless communications
market is fragmented, with Motorola, Kenwood, Nokia, and Ericsson the dominant
suppliers. The Company also competes with Uniden, Hitachi Denshi, Ltd. and Tait
in Asia.
As of March 12, 2000, the Company, Motorola, Relm Communications, King
Radio, and Racal Communications are believed to be the current suppliers of
Project 25 LMR products. Companies which have announced or are anticipated to
announce the availability of Project 25 compliant products or digital LMRs
include ADI and Daniels Communications.
Many of the Company's competitors have substantially greater financial,
technical, marketing, distribution and other resources, greater name recognition
and longer-standing relationships with customers than the Company. Competitors
with greater financial resources are better able to engage in sustained price
reductions in order to gain market share. Any period of sustained price
reductions would have a material adverse effect on the Company's financial
condition and results of operations. The Company cannot assure that it will be
able to compete successfully in the future or that competitive pressures will
not materially and adversely affect its financial condition and results of
operations.
INFORMATION SECURITY
The markets for information security products are highly competitive.
Significant competitive factors in these markets include product quality and
performance, including (1) the effectiveness of security features, (2) the
quality of the resulting voice or data signal, (3) the development of new
products and features, (4) price, (5) name recognition and (6) the quality and
experience of sales, marketing and service personnel. A number of companies
currently offer add-on scramblers for LMRs that compete with the Company's
add-on information security products, including Selectone Corp., Midian
Electronics Inc., and MX-COM Inc. Also, Motorola and Com-net Ericsson offer
high-end, proprietary digital encryption for their LMR products. Cycomm
International Inc./Privaphone and Motorola offer add-on security products for
cellular telephones. Competitors to the Company's secure landline telephone
products include AT&T Corporation/Datatek, Motorola, Cycomm International Inc.,
Cylink Corporation and TCC (Technical Communications Corporation).
BACKLOG
The Company presently ships a small amount of information security products
against backlog, due to the typically short manufacturing cycle of these
products. Because of generally longer manufacturing cycle times required for the
production of complete wireless communication products, the Company's backlog
for wireless communication products has been larger than for its security
products. At December 31, 1999, E.F. Johnson had a total backlog of
approximately $13.0 million. However, the Company does not believe that its
backlog figures are indicative of actual sales of products in future periods.
EMPLOYEES
At December 31, 1999, the Company had 330 full-time equivalent employees,
including 65 at its Lincoln, Nebraska facility, 241 at its Waseca, Minnesota
facility, and 24 field sales people, sales managers or staff located in the
sales territories in which they serve. The Company also uses temporary
employees, independent contractors and consultants when necessary to manage
fluctuations in demand. None of the Company's employees are covered by a
collective bargaining agreement.
16
SUMMARY OF BUSINESS CONSIDERATIONS AND CERTAIN FACTORS THAT MAY AFFECT FUTURE
RESULTS OF
OPERATIONS AND/OR STOCK PRICE
Certain matters discussed in this Annual Report may constitute
forward-looking statements under Section 27A of the Securities Act and 21E of
the Exchange Act. These forward-looking statements relate to, among other
things, the outcome of pending class action litigation involving the Company,
the outcome of the pending investigation by the SEC, the effects of the
Company's restatement of its financial statements on the Company's product
development efforts, future sales levels and customer confidence, the Company's
future financial condition, liquidity and business prospects generally,
perceived opportunities in the marketplace for the Company's products and its
products under development, and the effects of a failure to resolve such issues
and the Company's other business plans for the future. The actual outcomes of
these matters may differ significantly from the outcomes expressed or implied in
these forward-looking statements. The following is a summary of some of the
important factors that could affect the Company's future results of operations
and its stock price, and should be considered carefully.
SECURITIES CLASS ACTION CLAIMS
The Company has been named as a defendant in class action lawsuits that were
filed subsequent to the Company's announcement on March 27, 1998 that the filing
of its Annual Report on Form 10-K for year ended December 31, 1997 would be
delayed and that adjustments would be made to the Company's previously announced
financial results. Between March 31, 1998 and May 27, 1998, twelve purported
class action lawsuits were filed against the Company in the United States
District Court for the District of Nebraska, and one complaint was filed in the
District Court of Scotts Bluff County, Nebraska. Certain of the complaints, as
amended, also name one or more current employees and former officers of the
Company and PriceWaterhouseCoopers, LLP as additional defendants. The longest
class period alleged in any of the class complaints is the period from
January 22, 1997 through April 24, 1998.
The federal class actions generally allege claims under Sections 11 and 15
of the Securities Act of 1933 and Sections 10 and 20(a) of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and relate primarily
to allegations of false and misleading financial statements and representations
and material omissions by the Company. The Nebraska action alleges violations of
Nebraska securities laws. The class action complaints seek unspecified
compensatory damages, attorneys' fees and costs. The federal class actions have
been consolidated and lead plaintiff appointed.
In July 1999, the Company announced that a memorandum of understanding had
been signed with plaintiff's counsel to settle the pending federal consolidated
class action lawsuits and its state class action lawsuit. The parties
subsequently memorialized the terms of the memorandum of understanding in a
stipulation of settlement. The stipulation of settlement creates a settlement
fund for distribution to class members and class counsel consisting of
(a) 4,460,000 shares of Transcrypt common stock and (b) at least $3,850,000 and
up to $8,850,000 to be paid by Transcrypt's insurance carriers (depending on the
outcome of an arbitration between plaintiffs and one of the insurance carriers).
Transcrypt would also pay $2,000,000 to the class if there is a purchase of a
majority of Transcrypt by acquisition or merger that occurs before January 1,
2001.
In January 2000, Honorable Warren K. Urbom of the United States District
Court for the District of Nebraska preliminarily approved a settlement of the
pending stockholder class action suits. The settlement, if finally approved,
will also result in the dismissal of the stockholder class action suit pending
in the District Court for Scotts Bluff County, Nebraska. The court has scheduled
a hearing for final approval of the settlement for March 27, 2000.
The Company has reserved for the issuance of the number of shares of Common
Stock to be distributed if the Court finally approves the settlement. However,
no assurance can be given that the Court will finally approve the settlement,
and if the settlement is not finally approved, that the outcome of the
litigation will not have a material adverse effect on the Company's business,
financial condition, results of
17
operations, and cash flows. For further information regarding legal proceedings,
see "ITEM 3. LEGAL PROCEEDINGS."
SEC INVESTIGATION
In April 1998, the Securities and Exchange Commission ("SEC") issued a
formal order of investigation to determine whether violations of certain aspects
of the federal securities laws had occurred in connection with the Company. As
part of this investigation, the SEC is also examining the conduct of certain
former officers of the Company. The Company has an obligation to defend and/or
indemnify certain former employees. The Company has discussed possible
settlement of the investigation or any pending enforcement action against the
Company or its affiliated parties relating to these events. At this time, it is
unknown whether the Company will settle the SEC formal order of investigation.
In addition, it is unknown what actions will be taken against former officers
and, therefore, the Company cannot determine the exposure of any future
obligations to defend and/or indemnify these former officers. The SEC has the
authority to impose a variety of sanctions against the Company and
Company-affiliated parties. Such sanctions could include monetary penalties,
imposition of a cease and desist order and issuance of removal and prohibition
orders against Company-affiliated persons, among other things.
EFFECTS OF RESTATEMENT, CLASS ACTION LAWSUITS AND SEC INVESTIGATION ON THE
COMPANY'S BUSINESS
The restatement of the Company's financial statements, class action lawsuits
and the SEC investigation have had an adverse impact on the Company's business,
financial condition, results of operations, liquidity and cash flows. Subsequent
to March 31, 1998, the Company experienced declining revenues, substantial
operating losses, and substantially reduced liquidity. However, the Company
experienced an increase in revenues on a quarter to quarter basis after the
first quarter of 1999. Despite this improvement, there can be no assurance that
this trend will continue in the future.
The Company can provide no assurance that the restatement of its financial
statements and the ongoing class action lawsuits and SEC investigation,
regardless of their outcomes, will not continue to have a material adverse
effect on the Company's business, financial condition, results of operations,
liquidity and cash flows. See "ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
COMPETITION
The information security and wireless communications equipment industries,
and the LMR market segment in particular, are highly competitive. Competition in
the sale of stand-alone and digital products is more intense than for add-on and
analog products. In addition, other wireless communication technologies,
including cellular telephone, paging, SMR, satellite communications and PCS
(personal communication services) currently compete and are expected to compete
in the future with certain of the Company's stand-alone products. Furthermore,
other manufacturers have announced or are anticipated to announce the
availability of APCO Project 25 compliant products or digital land mobile
radios.
In addition, the competition in the domestic commercial market has been
increasing because of reduced demand for radios due to the absence of new 800
MHz SMR frequencies being made available, the slow build out of 900 MHz channels
and the consolidation in both 800 MHz and 900 MHz SMR marketplaces reducing the
number of potential buyers. There are also a large number of SMR systems
converting from analog to digital, which has resulted in the increasing
availability of used analog radios and repeaters in the marketplace.
Some of the Company's competitors or potential competitors have
significantly greater financial, managerial, technical and marketing resources
than the Company. Accordingly, the Company cannot assure that (1) it will be
able to continue to compete effectively in its markets, (2) competition will not
intensify, or (3) future competition will not have a material adverse effect on
the Company. In addition,
18
the Company cannot assure that new competitors will not arise and begin to
compete in the markets for the Company's products.
Motorola, Nokia, Kenwood, and Com-Net Ericsson hold a dominant position in
the market for wireless communication products, especially in the LMR and
cellular telephone market segments. In North America, Motorola, Kenwood and
Com-Net Ericsson are the leading providers of LMR equipment. While the Company
believes that it is the third-largest supplier in the North American specialized
LMR equipment market, the Company's share of this market is relatively small in
comparison to Motorola and Com-Net Ericsson. In addition, Motorola, Kenwood, and
Com-Net Ericsson have financial, technical, marketing, sales, manufacturing,
distribution and other resources substantially greater than those of the
Company, and have entrenched market positions in certain segments of the North
American LMR market. Finally, certain of the Company's competitors, including
Motorola and Com-Net Ericsson, have established trade names, trademarks, patents
and other intellectual property rights and substantial technological
capabilities.
The Company believes that the wireless communications equipment industry is
undergoing a period of consolidation which (1) may involve the acquisition or
merger of some of the significant manufacturers of these types of products and
(2) a concentration of market share in a relatively few companies. The Company
cannot assure that consolidations in the industry would not result in the
strengthening of its existing competitors or the creation of new competitors,
some of which may have significantly greater financial, managerial, technical
and marketing resources than the Company. See "--Competition."
RELIANCE ON MOTOROLA
The Company is dependent on continuing access to certain Motorola products,
electrical components and proprietary intellectual property. Although the
Company believes that its relationship with Motorola is good, the Company cannot
assure that Motorola will continue to supply products, electrical components and
proprietary intellectual property to the Company on the scale or at the price
that it now does. In addition, Motorola may increasingly perceive the Company as
a competitor. This perception could impact Motorola's willingness to do business
with the Company. Although the Company has certain contractual relationships
with Motorola as a customer, most of these agreements are subject to termination
in certain circumstances and expire by their terms within one to ten years. Any
reduction of the Company's contractual relations with Motorola or a decision by
Motorola to reduce or eliminate the provision of products, components and
technology to the Company could have a material adverse effect on the Company.
See "--Motorola Relationship."
TRANSITION FROM ANALOG TO DIGITAL PRODUCTS
The LMR and cellular telephone markets are migrating from analog to digital
equipment. This migration is primarily due to bandwidth capacity constraints,
availability of additional features, and the perception that digital
transmissions are more secure than analog transmissions. As a result, the
Company is seeking to upgrade many of E.F. Johnson's LMR products to be
compatible with digital LMR communications standards, including APCO Project 25.
However, the Company cannot assure that it will be able to effect this
transition on a timely basis or that digital products will compete successfully
in the LMR marketplace. The failure of products to compete successfully in the
marketplace would have a material adverse effect on the Company. In addition,
there has been delay in the LMR marketplace acceptance of digital communications
standards. This delay may continue to adversely affect sales of the Company's
APCO Project 25 products. Furthermore, the transition from analog to digital
communications is resulting in, and in the future is likely to continue to
result in, a decrease in demand for the Company's add-on security modules, as
customers may perceive digital communications to be more secure than
communications using analog devices.
19
RAPIDLY EVOLVING MARKETS
The information security and wireless communications products markets in
which the Company competes are rapidly evolving and can be expected to further
evolve in the future as a result of changing technology, industry standards and
customer requirements. The Company's ability to compete effectively will depend
upon its ability to anticipate and react to these changes in a timely manner.
The Company may not have, either currently or in the future, adequate capital or
human resources to respond to these changes.
The development of new technologies by existing or future competitors may
place the Company at a competitive disadvantage by rendering some or all of its
existing or new products obsolete. The Company has invested heavily in the
introduction of LMR radios that comply with the APCO Project 25 standard. Some
manufacturers have adopted and actively support other digital LMR transmission
standards for the public safety marketplace. The widespread acceptance of one or
more other standards in the public safety market would have a material adverse
effect on the Company. See "--Competition."
Technological developments in the digital LMR industry include the use of
digital trunking, digital simulcast and digital voting technologies. These
technologies have led a number of manufacturers to change the architectures and
methodologies used in designing, developing, and implementing large LMR systems.
In order for the Company to develop and integrate these new technologies into
its products, the Company has made a substantial investment in capital and human
resources. However, there can be no assurance that such resources will be
readily available to the Company in the future.
The failure of the Company to incorporate these technologies into its LMR
products could in the future place the Company's LMR products at a competitive
disadvantage to those offered by other manufacturers and possibly make the
Company's hand-held and mobile LMRs incompatible with systems developed by other
manufacturers, which would have a material adverse effect on the Company.
RISKS ASSOCIATED WITH INTERNATIONAL SALES
In 1999 and 1998, international sales constituted approximately 22.6% and
36.6% of revenues, respectively. International sales are subject to a number of
risks not found in domestic sales. These risks include (1) unexpected changes in
regulatory requirements, (2) tariffs and other trade barriers, (3) political and
economic instability in foreign markets, (4) difficulties in establishing
foreign distribution channels, (5) longer payment cycles, (6) uncertainty in the
collection of accounts receivable, (7) increased costs associated with
maintaining international marketing efforts and (8) difficulties in protecting
intellectual property. In particular, the purchase of Company products by
international customers presents increased risks of, among other things, delayed
or reduced collection of revenues. Because most of the Company's sales are
denominated in U.S. dollars, fluctuations in the value of international
currencies relative to the U.S. dollar may also affect the price,
competitiveness and profitability of the Company's products sold in
international markets. Furthermore, the uncertainty of monetary exchange values
has caused, and may in the future cause, some foreign customers to delay new
orders or delay payment for existing orders. Troubled economic conditions, such
as that recently experienced in Asia and in Latin America, could result in lower
revenues for the Company.
Some of the Company's information security products are subject to export
controls under U.S. law, which in most cases requires the approval of the
Department of Commerce in order to ship internationally. The Company cannot
assure that such approvals will be available to it or its products in the future
in a timely manner or at all or that the federal government will not revise its
export policies or the list of products and countries for which export approval
is required. The Company's inability to obtain required export approvals would
adversely affect the Company's international sales, which would have a material
adverse effect on the Company. In addition, foreign companies not subject to
United States export restrictions may have a competitive advantage in the
international information security market. The Company cannot predict the impact
of these factors on the international market for its products. See "--Government
Regulation and Export Controls."
20
RELIANCE ON PUBLIC SECTOR MARKETS
Public safety agencies and other governmental entities comprise a
significant portion of the Company's current and anticipated customer base.
Because there is an unknown amount of governmental customers that purchase
through dealers for the Company's Information Security segment, the Company
cannot determine the percentage of its products that are ultimately sold to
governmental agencies. However, the Company believes that domestic and
international governments are the end-users of most of its products. As the
transition in the Company's Information Security product line from add-on to
stand-alone products progresses and as competition for such sales intensifies,
the Company expects that it will increasingly be subject to competitive bidding
requirements for sales to governmental customers, which can be expected to
result in lower prices and longer sales cycles with resulting lower margins.
The Company's wireless communication segment public safety sales accounted
for approximately 44% of total sales for the Company in 1999. The Company
entered into three major new domestic systems contracts during 1999, and sold a
number of Y2K related system upgrades. The RFP bidding cycle and contract award
stage can take six months to two years before a contract is awarded and the
governmental customers funding process for these systems can delay the bidding
cycle as well.
DEPENDENCE ON KEY PERSONNEL
The Company believes that its future success will depend in part on its
ability to attract, motivate and retain highly skilled engineering, technical,
managerial and marketing personnel. Competition for such personnel is intense
and the Company competes in the market for such personnel against numerous
companies, including larger, more established companies with significantly
greater financial resources than the Company. The Company currently has openings
for engineers and other personnel, and it cannot assure that it will be
successful in attracting, motivating or retaining such personnel.
DEPENDENCE ON SUPPLIERS
Most of the Company's current and proposed products require essential
electronic components supplied by outside vendors. Certain components may be
available from only one supplier and may occasionally be in short supply. For
example, in late 1993 and early 1994, there was a shortage of certain Motorola
surface-mount microprocessors, which resulted in a substantial increase in the
cost of these components. In 1998 and 1999, certain RF semiconductors and RF
power modules were discontinued by Motorola and other manufacturers. The
Company's inability to obtain these and other key components could result in
lost sales, the need to maintain excessive inventory levels, higher component
costs, or the need to redesign certain affected electronic sub-assemblies, which
could increase the cost of producing the Company's products and have a material
adverse effect on the Company.
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company has experienced, and expects to continue to experience,
quarterly variations in its results of operations as a result of many factors.
These factors include the timing of customer orders, the timing of the receipt
of cash payment on sales which are recorded on a cash basis, the timing of the
introduction of new products, the timing and mix of product sales, general
economic conditions and specific economic conditions in the information security
and wireless communications industry. See "ITEM 7. MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--Quarterly Results of
Operations."
REGULATORY ENVIRONMENT
Wireless communications and encryption products are subject to regulation by
United States and foreign laws and international treaties. The regulatory
environment is uncertain and changes in the regulatory structure and laws and
regulations can adversely affect the Company and its customers. Such changes
could make the Company's existing or planned products obsolete or unsaleable in
one or more
21
markets, which could have a material adverse effect on the Company. See "--Risks
Associated with International Sales" and "--Government Regulation and Export
Controls."
ENVIRONMENTAL REGULATION
The Company is subject to various federal, state and local environmental
statutes, ordinances and regulations relating to the use, storage, handling and
disposal of certain toxic, volatile or otherwise hazardous substances and wastes
used or generated in the manufacturing and assembly of the Company's products.
Under these laws, the Company may become liable for the costs of removal or
remediation of certain hazardous substances or wastes that have been or are
being released on or in the Company's facilities, or have been or are being
disposed of offsite as wastes. Such laws may impose liability without regard to
whether the Company knew of, or caused, the release of such hazardous substances
or wastes.
During 1999, the Company completed the sale of its facility in Waseca,
Minnesota (see Item 2. Properties). As a part of that sale, the Company agreed
to pay for the cost of the initial testing for potential contaminants, as well
as for subsequent monitoring of the site, if warranted. The Company has set up a
reserve of $80,000 to cover the cost of the testing and monitoring. While the
Company feels that this amount is adequate to cover any potential liability
associated with this issue, there is no guarantee that it will fully cover all
costs and liabilities that may arise in the future.
The Company cannot assure that any environmental assessments the Company has
undertaken with respect to its facilities have revealed all potential
environmental liabilities, that any prior owner or operator of the Company's
properties did not create any material environmental condition not known to the
Company, or that an environmental condition that could result in penalties,
expenses, or liability to the Company does not otherwise exist in any one or
more of the Company's facilities. In addition, the amount of hazardous
substances or wastes produced or generated by the Company may increase in the
future depending on changes in the Company's operations. Any failure by the
Company to comply with present or future environmental laws could subject it to
the imposition of substantial fines, suspension of production, alteration of
manufacturing processes or cessation of operations, any of which could have a
material adverse effect on the Company. Compliance with such environmental laws
could require the Company to acquire expensive remediation equipment or to incur
substantial expenses. Furthermore, the presence of hazardous substances on a
property or at certain offsite locations could result in the Company incurring
substantial liabilities as a result of a claim by a private third-party for
personal injury or a claim by an adjacent property owner for property damage.
The imposition of any of the foregoing liabilities could materially adversely
affect the Company.
LIMITED PROTECTION OF INTELLECTUAL PROPERTY RIGHTS; RISK OF THIRD-PARTY CLAIMS
OF INFRINGEMENT
The Company currently holds a number of domestic and international patents
and has on file applications for additional patents. Although the Company
assesses the advisability of patenting any technological development, the
Company has historically relied, in the information security area, primarily on
(1) copyright and trade secret law and (2) employee and third-party
non-disclosure agreements to protect its proprietary intellectual property and
rights. The protection afforded by such means may not be as complete as patent
protection. In addition, the laws of some countries do not protect trade
secrets. There are limitations on the availability of patent protection as a
means to protect the Company's products. Even when patent protection can be
obtained, there are often limitations on the enforceability of such patent
rights. The Company's inability to preserve all of its proprietary intellectual
property and rights could have a material adverse effect on the Company. See
"--Intellectual Property."
RISKS PRESENTED BY THE YEAR 2000 ISSUE
The Company was able to assess its systems and products, and took the
necessary steps to ensure that no significant impact would result from the year
2000 date change. As a result, the Company has not, to date, experienced any
material impact due to the Y2K date change. While it does not expect to
experience
22
any latent effects, it cannot ensure that its systems or those of third parties
with which it interacts will be entirely free of any such occurrences.
The Company did not experience any material Year 2000 system failure or
miscalculations causing disruptions of operations. In addition, we have not
received a significant amount of customer notification regarding experiencing
erroneous dates on usage reports or Year 2000 operational issues. It is still
possible for customers to have issues with previously shipped products. See
"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS--Results of the Year 2000 Issue."
ITEM 2. PROPERTIES
The Company occupies a portion of a 76,500 square foot multi-story
administrative and manufacturing facility located at 4800 NW 1st Street,
Lincoln, Nebraska, 68521, which is located in the University of Nebraska
Technology Park. The Company sold this facility and approximately 10 acres of
surrounding land during August 1999 for approximately $5.2 million. In
conjunction with the sale, the Company leased approximately 23,000 square feet
of the facility for five years, and for which the company will pay approximately
$231,000 during 2000. On January 28, 1998, the Company purchased the 250,000
square-foot manufacturing facility located on a 20-acre site in Waseca,
Minnesota. During December 1999, the Company sold the Waseca facility for
approximately $2.7 million. In conjunction with the sale, the Company leased
136,000 square feet of the facility for five years, and for which the company
will pay approximately $962,000 during 2000. In addition, the Company owns a
facility in Garner, Iowa, which it leases to a third party. The Company also
leases additional sales and service facilities in Burnsville, Minnesota, and
Miami, Florida. During 2000, the Company plans to lease office space for
executive, administrative, and sales personnel in Washington, D.C.
ITEM 3. LEGAL PROCEEDINGS
The Company has been named as a defendant in class action lawsuits that were
filed subsequent to the Company's announcement on March 27, 1998 that the filing
of its Annual Report on Form 10-K for year ended December 31, 1997 would be
delayed and that adjustments would be made to the Company's previously announced
financial results. Between March 31, 1998 and May 27, 1998, twelve purported
class action lawsuits were filed against the Company in the United States
District Court for the District of Nebraska, and one complaint was filed in the
District Court of Scotts Bluff County, Nebraska. Certain of the complaints, as
amended, also name one or more current employees and former officers of the
Company and PriceWaterhouseCoopers, LLP as additional defendants. The longest
class period alleged in any of the class complaints is the period from
January 22, 1997 through April 24, 1998.
The federal class actions generally allege claims under Sections 11 and 15
of the Securities Act of 1933 and Sections 10 and 20(a) of the Securities
Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and relate primarily
to allegations of false and misleading financial statements and representations
and material omissions by the Company. The Nebraska action alleges violations of
Nebraska securities laws. The class action complaints seek unspecified
compensatory damages, attorneys' fees and costs. The federal class actions have
been consolidated.
In July 1999, the Company announced that a memorandum of understanding had
been signed with plaintiff's counsel to settle the pending federal consolidated
class action lawsuits and its state class action lawsuit. The parties
subsequently memorialized the terms of the memorandum of understanding in a
stipulation of settlement. The stipulation of settlement agreement creates a
settlement fund for distribution to class members and class counsel consisting
of (a) 4,460,000 shares of Transcrypt common stock and (b) at least $3,850,000
and up to $8,850,000 to be paid by Transcrypt's insurance carriers (depending on
the outcome of an arbitration between plaintiffs and one of the insurance
carriers). Transcrypt would also pay $2,000,000 to the class if there is a
purchase of a majority of Transcrypt by acquisition or merger that occurs before
January 1, 2001.
23
In January 2000, Honorable Warren K. Urbom of the United States District
Court for the District of Nebraska preliminarily approved a settlement of the
pending stockholder class action suits. The settlement class period is defined
as persons that purchased stock during the period from January 22, 1997 through
April 24, 1998. The settlement, if finally approved, will also result in the
dismissal of the stockholder class action suit pending in the District Court for
Scotts Bluff County, Nebraska. The preliminary approval precludes any persons
from asserting any claims of indemnity or contribution against Transcrypt or any
of its current or former officers, directors, or employees. The Court has
scheduled a hearing for final approval of the settlement for March 27, 2000. In
addition, the Honorable Randall L Lippstreau of the District Court for Scotts
Bluff County, Nebraska, has entered an order that is effective on the final
approval of the settlement by Judge Urbom, which dismisses the action against
the Company and certain former employees is the class action pending in District
Court for Scotts Bluff County, Nebraska.
The Company has reserved for the issuance of the number of shares of Common
Stock to be distributed if the court finally approves the settlement. However,
no assurance can be given that the Court will finally approve the settlement,
and that if the settlement is not finally approved, that the outcome of the
litigation will not have a material adverse effect on the Company's business,
financial condition, results of operations, and cash flows.
On November 4, 1998, Physician's Mutual Insurance Company filed an action in
the District Court of Douglas County, Nebraska against the Company,
PriceWaterhouseCoopers, LLP and two former officers of the Company. The
complaint contains common law causes of action for fraudulent misrepresentation,
fraudulent concealment and negligent misrepresentation against the defendants
arising from the same facts and circumstances underlying the class actions. The
complaint seeks damages in an amount to be proved at trial, but which is
currently alleged to be approximately $850,000. The Company is unable to predict
the likelihood of the outcome or range or amount of potential liability that may
arise therefrom.
The Company may in the future be the subject of additional lawsuits or
claims in connection with the events or facts surrounding its restatement of
previously announced financial results. The Company is unable to predict when or
whether such additional lawsuits or claims may be initiated or the likelihood of
the outcome or range or amount of potential liability that may arise therefrom.
In April 1998, the Securities and Exchange Commission ("SEC") issued a
formal order of investigation to determine whether violations of certain aspects
of the federal securities laws had occurred in connection with the Company. As
part of this investigation, the SEC is also examining the conduct of certain
former officers of the Company. The Company has an obligation to defend and/or
indemnify certain former employees. The Company has discussed possible
settlement of the investigation or any pending enforcement action against the
Company or its affiliated parties relating to these events. At this time, it is
unknown whether the Company will settle the SEC formal order of investigation.
In addition, it is unknown what actions will be taken against former officers
and, therefore, the Company cannot determine the exposure of any future
obligations to defend and/or indemnify these former officers. The SEC has the
authority to impose a variety of sanctions against the Company and
Company-affiliated parties. Such sanctions could include monetary penalties,
imposition of a cease and desist order and issuance of removal and prohibition
orders against Company-affiliated persons, among other things.
The Company is involved in certain other legal proceedings incidental to the
normal conduct of its business. The Company does not believe that any
liabilities relating to such other legal proceedings are likely to be,
individually or in the aggregate, material to the Company's business, financial
condition, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to the stockholders during the fourth quarter of
1999.
24
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock was quoted on The Nasdaq Stock Market as a
National Market issue under the symbol "TRII" from the completion of the
Company's initial public offering on January 22, 1997 through May 11, 1998. The
Nasdaq Stock Market halted trading in the Company's Common Stock effective
April 27, 1998 and delisted the Common Stock on May 11, 1998 based on its review
of events regarding the Company and as a result of the Company's failure to
timely file its periodic reports and audited financial statements for the 1997
fiscal year. The Common Stock on August 28, 1998 began trading on the Over the
Counter ("OTC") Bulletin Board under the symbol "TRII".
The following table sets forth, in the periods indicated, the high and low
sales prices per share of the Common Stock, as reported by all markets for the
periods presented. As of December 31, 1999, the Company had 213 stockholders of
record.
HIGH LOW
-------- --------
1998
First Quarter............................................. $27.25 $8.87
Second Quarter............................................ $11.06 $3.00
Third Quarter............................................. $ 7.00 $1.50
Fourth Quarter............................................ $ 3.69 $1.88
1999
First Quarter............................................. $ 5.00 $2.50
Second Quarter............................................ $ 3.25 $1.38
Third Quarter............................................. $ 3.31 $1.34
Fourth Quarter............................................ $ 3.75 $2.00
The last sale price of the Common Stock on December 31, 1999, as reported in
the OTC Bulletin Board, was $3.00.
DIVIDENDS
The Company has never paid and has no present intention of paying cash
dividends on its Common Stock. Any determination in the future to pay dividends
will depend on the Company's financial condition, capital requirements, results
of operations, contractual limitations and any other factors deemed relevant by
the Company's Board of Directors.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data of the Company is
qualified by reference to, and should be read together with, the Consolidated
Financial Statements and Notes thereto and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included elsewhere in this
Annual Report on Form 10-K. The Consolidated Statement of Operations data for
the years ended December 31, 1999, 1998 and 1997 and the Consolidated Balance
Sheet data as of December 31, 1999 and 1998 are derived from the Consolidated
Financial Statements of the Company included elsewhere in this Annual Report on
Form 10-K. The Consolidated Statement of Operations data for the years ended
25
December 31, 1996 and 1995 and the Consolidated Balance Sheet data as of
December 31, 1997, 1996, and 1995 are derived from financial statements not
included herein.
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
1995 1996 1997(8) 1998 1999
--------- --------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Consolidated Statement of Operations
Data:
Revenues............................. $ 8,128 $ 10,619 $ 40,423 $ 62,041 $ 53,520
Cost of sales........................ 2,983 4,274 26,106 44,905 36,059
--------- --------- ---------- ---------- ----------
Gross profit......................... 5,145 6,345 14,317 17,136 17,461
--------- --------- ---------- ---------- ----------
Operating costs and expenses:
Research and development........... 1,953 2,234 4,469 8,812 5,724
Sales and marketing................ 2,109 2,187 7,031 11,476 8,282
General and administrative(1)...... 2,284 2,529 4,711 12,529 9,601
Special compensation expense(2).... -- 5,568 -- -- --
In-process research and development
costs(3)......................... -- -- 9,828 -- --
Restructuring charge (4)........... -- -- -- 1,230 523
Provision for litigation settlement
(5).............................. -- -- -- 10,000 (2,221)
--------- --------- ---------- ---------- ----------
Total operating costs and
expenses..................... 6,346 12,518 26,039 44,047 21,909
--------- --------- ---------- ---------- ----------
Loss from operations................. (1,201) (6,173) (11,722) (26,911) (4,448)
Interest income (expense), net....... (137) (131) 231 655 386
Other income......................... -- -- 18 46 235
Benefit for income taxes............. -- (2,186) (524) (3,916) --
--------- --------- ---------- ---------- ----------
Net Loss............................. $ (1,338) $ (4,118) $ (10,949) $ (22,294) $ (3,827)
========= ========= ========== ========== ==========
Loss before pro forma taxes.......... $ (1,338) $ (6,304) $ (11,473) $ (26,210) $ (3,827)
Pro forma benefit from taxes (6)..... (496) (2,190) (524) (3,916) --
--------- --------- ---------- ---------- ----------
Pro forma net loss................... $ (842) $ (4,114) $ (10,949) $ (22,294) $ (3,827)
========= ========= ========== ========== ==========
Pro forma net loss per share
(7)--Basic and Diluted............. $ (0.12) $ (0.61) $ (1.09) $ (1.72) $ (0.30)
========= ========= ========== ========== ==========
Weighted average common shares--Basic
and Diluted (7).................... 6,783,078 6,783,078 10,056,690 12,946,624 12,947,795
========= ========= ========== ========== ==========
Consolidated Balance Sheet Data:
Working capital...................... $ 1,684 $ 1,844 $ 44,836 $ 17,426 $ 26,793
Total assets......................... $ 7,523 $ 11,938 $ 106,694 $ 87,212 $ 85,521
Long-term debt and capitalized lease
obligations, net of current
portion............................ $ 1,847 $ 2,632 $ 2,758 $ 6 $ 197
Stockholders' equity................. $ 3,907 $ 4,966 $ 75,390 $ 53,096 $ 49,286
- ------------------------
(1) Includes amortization of intangible assets. For years prior to 1997,
includes the amortization of intangible assets related to the acquisition of
the Company's business in December 1991. Commencing in August 1997,
amortization of intangible assets related to the acquisition of E.F. Johnson
began. See "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS--Results of Operations--General and
Administrative."
(2) Represents a non-recurring, non-cash compensation expense of $5.4 million
resulting from the vesting in September 1996 of 716,916 stock options for 10
executive officers and key employees of the
26
Company at a weighted average exercise price of $1.81 per share, and the
accrual of a special compensation expense of $210,000 in September 1996.
(3) Represents a non-recurring, non-cash expense of $9.8 million due to the
write-off of purchased in-process research and development costs associated
with the acquisition of E.F. Johnson.
(4) Represents a charge for a 25% reduction in workforce taken in the third
quarter of 1998, and a charge for the closing of E.F. Johnson's Hong Kong
office taken in the second quarter of 1999.
(5) Represents a special provision taken in the fourth quarter of 1998 for
potential class action litigation settlement, and the reversal of a portion
of that reserve in the second quarter of 1999.
(6) Prior to June 30, 1996, the Company operated as a partnership. The Pro Forma
provision for income taxes reflects the provision for income taxes as if the
Company had been taxed as a Subchapter "C" corporation under the Internal
Revenue Code.
(7) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the method used to determine the number of shares used to compute pro
forma and net loss per share.
(8) Statement of Operations Data reflects the operations of E.F. Johnson since
the date of its acquisition on July 31, 1997.
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Annual Report on Form 10-K, including the following Management's
Discussion and Analysis of Financial Condition and Results of Operations,
contains forward-looking statements that may involve risks and uncertainties.
The Company's actual results may differ significantly from those discussed
herein. Factors that might cause such a difference include, but are not limited
to, those discussed under "ITEM 1. BUSINESS--Summary of Business Considerations
and Certain Factors That May Affect Future Results of Operations and/or Stock
Price." The following discussion should be read together with the Company's
Consolidated Financial Statements and Notes thereto appearing elsewhere in this
Annual Report on Form 10-K.
OVERVIEW
The Company is a manufacturer of wireless communications products and
systems and information security products. Through the E.F. Johnson subsidiary,
the Company designs, develops, manufactures and markets (1) stationary LMR
transmitters/receivers (base stations or repeaters), (2) mobile and portable
radios, and (3) communications systems comprising products from (1) and
(2) along with other system elements to provide turnkey communication system
solutions. The Company sells its LMR products and systems mainly to two broad
markets: (1) commercial users and (2) public safety and other governmental
users. Through it's Secure Technologies division, the Company designs and
manufactures information security products that prevent unauthorized access to
sensitive voice communications. These products are based on a wide range of
analog scrambling and digital encryption technologies and are sold mainly to the
LMR and telephony security markets.
On July 31, 1997, the Company acquired the outstanding shares of capital
stock and assumed certain indebtedness of E.F. Johnson. In exchange, the Company
paid cash consideration of $436,000 and issued 832,465 shares of Common Stock.
The acquisition was accounted for under the purchase method of accounting.
In 1998, the Company restated its previously released results for the year
ended December 31, 1997, the Company's financial statements for the year ended
December 31, 1996 and the financial statements as of and for each of the
quarterly periods ended March 31, June 30, September 30 and December 31 during
1997 and 1996. The restatement of the Company's financial statements and other
events relating to the restatement, including the class action lawsuits and the
SEC investigation which occurred subsequent to March 31, 1998, have had an
adverse impact on the Company's business, financial condition, results of
operations, liquidity and cash flows. These events have had, to varying degrees,
an adverse impact on the Company's relationships with its customers and vendors.
The Company continues to evaluate its product lines, and has implemented and is
continuing to look at various initiatives to reduce operating expenses in order
to keep them in line with revenues. During the third quarter of 1998, the
Company implemented a reduction in workforce. In addition, during the second
quarter of 1999, the Company closed its Hong Kong office. Implementation of any
other plan resulting from these initiatives in the future may result in
substantial up front costs and cash expenditures. The Company can provide no
assurance that the ongoing class action and securities lawsuits and SEC
investigation, regardless of their outcomes, will not continue to have a
material adverse effect on the Company's business, financial condition, results
of operations, liquidity and cash flows.
During 1999, the Company replaced a significant portion of its senior
management, including its Chairman and Chief Executive Officer, the Chief
Financial Officer, and several positions at the Vice President level. The new
management has continued the process begun in 1998 of evaluating product lines
and implementing initiatives to reduce operating expenses, reemphasize processes
and procedures, and refocus the organization on its core competencies. While the
Company has shown considerable improvement in areas such as cost control (as
evidenced by improved gross margin and lower indirect expenses)
28
and customer relationships (as evidenced by the three new major systems
contracts awarded during 1999), there can be no assurances that these efforts
will result in a significant improvement in the Company's business, financial
condition, results of operations, liquidity and cash flows.
RESULTS OF OPERATIONS
The following table sets forth certain Consolidated Statement of Operations
information as a percentage of revenues during the periods indicated. These
results include the results of E.F. Johnson only since July 31, 1997, the date
it was acquired.
YEAR ENDED DECEMBER 31,
--------------------------------------
1997 1998 1999
-------- -------- --------
Revenues.................................................... 100.0% 100.0% 100.0%
Cost of sales............................................... 64.6% 72.4% 67.4%
----- ----- -----
Gross profit................................................ 35.4% 27.6% 32.6%
----- ----- -----
Operating costs and expenses:
Research and development.................................... 11.1% 14.2% 10.7%
Sales and marketing......................................... 17.4% 18.5% 15.5%
General and administrative.................................. 11.7% 20.2% 17.9%
In-process research and development costs................... 24.3% -- --
Restructuring charge........................................ -- 2.0% 1.0%
Provision for litigation settlement......................... -- 16.1% (4.2%)
----- ----- -----
Total operating costs and expenses.......................... 64.4% 71.0% 40.9%
----- ----- -----
Loss from operations........................................ (29.0)% (43.4)% (8.3)%
Interest income (expense), net.............................. 0.6% 1.1% 0.7%
Other income................................................ -- .1% 0.4%
Benefit for income taxes.................................... (1.3)% (6.3)% 0.0%
----- ----- -----
Net loss.................................................... (27.1)% (35.9)% (7.2)%
===== ===== =====
Pro forma net loss.......................................... (27.1)% (35.9)% (7.2)%
===== ===== =====
REVENUES
Revenues are recognized when product is shipped, less an estimate for an
allowance for returns, if applicable, if collection is reasonably assured. For
shipments where collection is not reasonably assured, the Company recognizes
revenue as cash is received. If collection is contingent on a future event, such
as a reseller of product selling the product to the end user, the Company
recognizes revenue when the contingency lapses, generally upon cash collection.
System sales under long-term contracts are accounted for under the
percentage of completion method. Under this method, revenues are recognized as
work on a contract progresses. The recognized revenue is that percentage of
estimated total revenue that incurred costs to date bear to estimated total
costs to complete the contract. Revisions in cost and profit estimates are made
when conditions requiring such revisions become known. Anticipated losses on
contracts are recognized in operations as soon as such losses are determined to
be probable and reasonably estimable.
Deferred revenue includes unearned warranty fees on extended product
warranty contracts sold to customers. The Company recognizes the fees based on
the expected warranty repairs to be incurred over the life of the