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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 29, 1998.
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM
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COMMISSION FILE NUMBER: 0-21681
TRANSCRYPT INTERNATIONAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 47-0801192
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYEE
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
4800 NW 1ST STREET
LINCOLN, NEBRASKA 68521
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (402) 474-4800
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $0.01 PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ ] No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The Nasdaq Stock Market halted trading in the Company's Common Stock
effective April 27, 1998, and delisted the Common Stock on May 11, 1998. The
aggregate market value of the voting and non-voting Common Stock held by
non-affiliates of the Registrant, based upon the last sale price of the Common
Stock on July 23, 1998, as reported in the non-Nasdaq over the counter market
was approximately $56,710,285. Number of shares outstanding of the Registrant's
Common Stock, as of June 30, 1998: 12,946,624.
DOCUMENTS INCORPORATED BY REFERENCE:
DOCUMENT INCORPORATED BY REFERENCE: PART OF FORM 10-K INTO WHICH INCORPORATED:
None N/A
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PART I
ITEM 1. BUSINESS
Unless the context otherwise provides, all references in this Annual Report
on Form 10-K to the "Company" includes Transcrypt International, Inc.
("Transcrypt"), its predecessor entities, and its subsidiaries, including E.F.
Johnson Company, on a combined basis, and all references to "E.F. Johnson" refer
to E.F. Johnson Company.
In addition to the historical information contained herein, certain matters
discussed in this Annual Report may constitute forward-looking statements under
Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). These statements may involve risks and uncertainties. These
forward-looking statements relate to, among other things, the outcome of pending
class action litigation involving the Company, the outcome of the pending
investigation by the Securities and Exchange Commission (the "SEC"), the effects
of the Company's restatement of its financial statements and other recent events
on the Company's product development efforts, future sales levels and customer
confidence, the Company's future financial condition, liquidity and business
prospects generally, perceived opportunities in the marketplace for the
Company's products and its products under development, and the Company's other
business plans for the future. The actual outcomes of these matters may differ
significantly from the outcomes expressed or implied in these forward-looking
statements. For a discussion of some of the factors that might cause such a
difference, see "-- Summary of Business Considerations and Certain Factors That
May Affect Future Results of Operations and/or Stock Price" below.
GENERAL
The Company is a manufacturer of information security products and wireless
communications products and systems. The Company designs and manufactures
information security products which prevent unauthorized access to sensitive
voice and data communications. These products are based on a wide range of
analog scrambling and digital encryption technologies and are sold mainly to the
land mobile radio ("LMR") and telephony security markets. The Company also
manufactures wireless communications products and systems mainly for the LMR
market. Typical end-users of the Company's products include state, local and
foreign governmental agencies, including police and other public safety
departments, and industrial and commercial organizations such as taxi fleets and
railroads, and construction, oil and gas companies.
In July 1997, the Company expanded its presence in the wireless
communications market by acquiring E.F. Johnson, an established provider of
products and systems for the LMR market. This acquisition was made through the
issuance of shares of Transcrypt common stock ("Common Stock"), the payment of
cash and the assumption of certain indebtedness of E.F. Johnson. The total value
of the cash and shares paid at the time of acquisition was approximately $10.4
million. Through the E.F. Johnson subsidiary, the Company designs, develops,
manufactures and markets (i) stationary LMR transmitters/receivers (base
stations or repeaters) and (ii) mobile and portable radios. The Company sells
its LMR products and systems mainly to two broad markets: (i) business and
industrial ("B&I") users and (ii) public safety and other governmental users.
E.F. Johnson provides the Company with a broad line of LMR products and systems
and a platform of products to leverage its information security and digital
technologies.
In December 1991, the Company acquired the business of its predecessor,
which was founded in 1978. Prior to June 30, 1996, the Company operated as a
partnership. The Company's principal business offices are located at 4800 NW 1st
Street, Lincoln, Nebraska 68521, and its phone number is (402) 474-4800.
RECENT DEVELOPMENTS
On March 27, 1998, the Company announced that it would not file its 1997
Annual Report on Form 10-K with the SEC on March 31, 1998 because the audit of
its 1997 financial statements was not yet completed. The Company also announced
that (i) certain accounting principles relating primarily to revenue recognition
were not yet resolved by the Company's independent accountants, (ii) the
accountants and Company
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management were undertaking a review of the Company's accounting policies and
(iii) adjustments would be made to the Company's previously announced financial
results.
On April 13, 1998, the Company announced that it would not file its 1997
Form 10-K on or before the extension date of April 15, 1998 due to ongoing work
being performed by the Company and its independent accountants. The Company also
announced that the Audit Committee of the Board of Directors had retained
independent counsel to conduct an investigation.
In April 1998, the SEC issued a formal order of investigation to determine
whether violations of certain aspects of the Federal securities laws had
occurred in connection with the Company.
On April 24, 1998, Coopers & Lybrand, L.L.P. resigned as the Company's
independent accountants. In conjunction with its resignation, Coopers & Lybrand
advised the Company that their reports with respect to the consolidated
financial statements of the Company and its subsidiaries as of and for the years
ended December 31, 1995 and 1996 were withdrawn as of the date of their
resignation.
On April 27, 1998, the Nasdaq National Market ("Nasdaq") effected a
temporary qualification trading halt in the Company's Common Stock. On May 11,
1998, the Common Stock was delisted from the Nasdaq National Market. The Company
has appealed the Nasdaq delisting.
On May 6, 1998, the Company announced that it had engaged KPMG Peat Marwick
LLP as its independent auditors for the fiscal years ended December 31, 1997,
1996 and 1995.
On May 18, 1998, the Company disclosed in a filing with the SEC that its
Quarterly Report on Form 10-Q for the Quarter Ended March 31, 1998 will not be
filed within the period prescribed for such report.
Effective May 31, 1998, Jeffery L. Fuller resigned as President, Chief
Executive Officer ("CEO") and Director of the Company. On June 8, 1998, the
Company announced that the Board of Directors had appointed a committee to
identify a CEO of the Company and that John T. Connor, who serves as Chairman of
the Board, had been appointed as interim CEO. Edgar L. Osborn was appointed
President and Chief Operating Officer of the Company. Mr. Connor accepted
appointment as interim CEO until the earlier of September 8, 1998 or the hiring
of a permanent CEO. Mr. Connor has indicated that if a permanent CEO is not
hired by such date, he will discuss with the Board of Directors the possibility
of staying on for a longer time.
On July 8, 1998, the Company's primary bank lender, U.S. Bank National
Association ("U.S. Bank"), agreed to waive the Company's violations of its bank
credit facility arising out of the Company's failure to timely provide financial
statements, meet certain financial covenants and provide monthly borrowing base
certificates to U.S. Bank. U.S. Bank also agreed to amend the credit facility by
reducing the Company's required tangible net worth amount to $55 million from
$70 million.
The Company has been named as a defendant in several class action lawsuits
that were filed subsequent to the Company's announcement on March 27, 1998 that
the filing of its Annual Report on Form 10-K for year ended December 31, 1997
would be delayed and that adjustments would be made to the Company's previously
announced financial results. Between March 31, 1998 and May 27, 1998, twelve
purported class action lawsuits were filed against the Company in the United
States District Court for the District of Nebraska and one complaint was filed
in the District Court of Scotts Bluff County, Nebraska. Certain of the
complaints also name one or more officers of the Company as additional
defendants. The longest class period alleged in any of the class complaints is
the period from January 22, 1997 through April 24, 1998.
The complaints generally allege claims under Sections 10 and 20(a) of the
Exchange Act and Rule 10b-5 promulgated thereunder, and relate primarily to
allegations of false and misleading financial statements and representations and
material omissions by the Company. The Nebraska action alleges violations of
Nebraska securities laws. The complaints seek unspecified compensatory damages,
punitive damages, attorneys' fees and costs. The federal actions have recently
been consolidated.
See "ITEM 3. LEGAL PROCEEDINGS" for additional information regarding legal
proceedings relating to certain of the matters discussed above.
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INFORMATION SECURITY INDUSTRY
Overview
The electronic information security industry is generally comprised of
products designed to protect the transmission of sensitive voice and data
communications through both wireless and wireline mediums. Without such
protection, many forms of electronic communications, such as LMR and telephone
conversations and remote data communications, are vulnerable to interception and
theft.
The information security industry originated from the need to secure
sensitive wireless military communications. By the late 1970s, the availability,
quality and cost of information security devices had improved so that the use of
these devices became economically and functionally feasible for non-military
governmental users (such as law enforcement, fire, emergency medical and other
public safety personnel) and large commercial users (such as railroads,
construction and oil companies).
Initially, all electronic communications were transmitted in analog format.
Analog transmissions typically consist of a voice or other signal modulated
directly onto a continuous radio "carrier" wave. An analog transmission can be
made secure by (i) "scrambling" or manipulating the original signal at the point
of transmission and (ii) reconstituting the original signal at the receiving
end. By the late 1980s, accelerating use of wireless communications devices,
such as LMRs and cellular telephones, resulted in increased demand for limited
radio spectrum. In response to this demand, and enabled by the low-cost
availability of digital signal processors ("DSPs"), electronics manufacturers
developed spectrally efficient (i.e., low-bandwidth) digital communications
devices. In digital communications, an analog signal is "digitized," or
converted into a series of discrete information "bits" in the form of ones and
zeroes prior to transmission. Digital transmissions can be made secure by a
process known as "encryption," which involves (i) the use of a mathematical
algorithm to rearrange the bit-stream prior to transmission and (ii) a decoding
algorithm to reconstitute the transmitted information back into its original
form at the receiving end.
Manufacturers of information security products such as the Company
typically charge higher prices for devices featuring more advanced levels of
security. Therefore, the types of end-users at each level of security tend to
vary based upon the importance of the information that the end-user wants to
secure. Typical users of the most basic form of scrambler, the frequency
inversion scrambler, include taxi dispatchers, other types of consumer
businesses and transportation companies. Typical users for medium-level security
devices include B&I users and international customers who do not need an export
license. High-level scrambling and encryption devices are used primarily by
public safety agencies, federal government personnel and international customers
who have obtained the required export license.
Land Mobile Radio Security Market
One of the earliest applications of information security technology outside
of the military was in protecting LMR voice communications. LMRs consist of (i)
hand-held or (ii) mobile (vehicle mounted) two-way radios. A typical LMR system
consists of one or more base control stations networked with each other and with
hand-held and/or mobile LMRs. As with all other major forms of wireless
communications devices, LMRs transmit information in either analog or digital
format, although the substantial majority of LMRs currently in use operate in
analog format only.
Telephony Security Market
Since its inception in 1983, cellular telephone service has grown rapidly
and become available to most of the United States population. Cellular telephone
subscribers and revenues have grown rapidly in recent years and are expected to
grow in the future. This increased volume has raised significant new security
and privacy issues and an increased sensitivity to the potential risks involved
in intercepted signals. Unprotected wireless transmissions generally provide
minimal or no security and allow eavesdropping by even casual listeners with
compatible scanners.
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In recent years, the cellular industry has migrated, on an accelerated
basis, away from analog devices towards digital forms of communications, which
are commonly referred to as Personal Communication Services ("PCS"). Similar to
the LMR industry, this migration has occurred principally due to (i) increased
spectrum efficiency, (ii) perception of greater voice security and (iii)
additional capabilities for advanced features and data communications. PCS
technology typically uses variable rate voice coding (referred to as TDMA or
CDMA coding), which maximizes the efficiency of transmissions by only
transmitting critical pieces of information and omitting other information, such
as pauses in a conversation. In the area of voice security, digital telephony is
functionally more secure than analog telephony. While there are some
characteristics that make digital transmissions more difficult to intercept,
most digital services do not use any type of active encryption technology.
However, unlike analog scanning technology, digital scanners are not yet widely
available. The increased use of digital devices has resulted and will likely
continue to result in reduced demand for add-on voice security devices, such as
those produced by the Company.
WIRELESS COMMUNICATIONS INDUSTRY
Overview
The mobile wireless communications industry began in the mid-1930s when
police departments began using LMR systems to enable immediate communication
between headquarters and officers patrolling the community. As (i) other public
safety agencies and commercial enterprises recognized the benefit of immediate
communications with their field personnel, (ii) technological advances made LMR
systems more affordable and (iii) increasing amounts of spectrum were allocated
for LMR use, LMR dispatch service expanded beyond its traditional police and
fire applications to become an integral communications service for a variety of
government and commercial enterprises. Today, in addition to dispatch-oriented
LMR service, many other forms of mobile wireless communication technologies have
emerged and are continuing to be developed to meet the varied communication
needs of an increasingly mobile society, including paging, cellular telephone
and personal communication services.
Business and Industrial Systems Market
B&I users include large commercial, industrial and other private
enterprises, such as utility, construction and oil companies, railroads and
universities which require rapid communications among personnel spread out over
relatively large geographic areas. While many B&I LMR users purchase and operate
entire systems for their own use, a large segment of the B&I market consists of
specialized mobile radio ("SMR") operators such as NEXTEL Corp. and Centennial
Communications, and their customers. SMR operators build and lease private LMR
systems on a for-profit basis and sell airtime to end-users whose mobile
communication needs can be served by renting or purchasing subscriber units as
opposed to purchasing an entire system, or who are unable to obtain a Federal
Communications Commission ("FCC") license to operate their own system.
Traditionally, end-users of SMR services have included taxi fleets and smaller
construction and delivery service companies. Currently, many SMR operators in
the larger metropolitan markets, such as NEXTEL Corp., are also offering more
consumer-oriented, cellular-like SMR services.
There are two general types of LMR systems serving B&I users, (i)
conventional and (ii) trunked. Both operate on the specific frequency bands
which the FCC has allocated for such types of systems. Conventional LMR systems
use a single channel to transmit and receive information. All users have
unrestricted access, similar to a "party" telephone line, and the user must
monitor the system and wait until the channel is unoccupied. Trunked systems
(including the Company's logic trunked radio ("LTR(R)") products) combine
multiple channels so that when a user begins transmitting, an unoccupied channel
is automatically selected. Conventional LMR systems are relatively inefficient
compared to trunked systems.
The development of trunked LMR systems and the allocation of additional
frequency spectrum in the 1970s triggered significant growth in LMR use for B&I
applications. In recent years, technological developments by E.F. Johnson
(included in its LTR(R) products) and others have enabled LMR systems to be
"networked," involving multiple "sites" linked together through a switch to
provide extended geographical coverage. In addition, many trunked subscriber
units are capable of functioning as mobile telephones through
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interconnections to the public switched telephone network. The Company has
responded to changes in the standard LTR(R) protocol with the creation of
LTR-Net(TM) in 1997, which allows systems operators to link sites together and
provide telephone interconnection, electronic serial numbers and total system
security in an advanced analog trunking system.
Public Safety and Other Government Users Market
Public safety and other government users include state and local agencies,
such as law enforcement, fire and emergency medical personnel, and military and
non-military federal governmental agencies. Many of these users operate LMR
equipment which complies with specifications established by the Association of
Public Safety Communications Officials International Inc. ("APCO"), while the
remainder operate mostly conventional and non-APCO trunked LMRs. The most widely
used APCO standard is the "APCO 16" standard established in 1979, which includes
specifications for 800 MHz transmission, analog voice modulation and trunking
functions for using the frequency spectrum. In 1988, E.F. Johnson entered the
market for APCO 16 products with its Multi-Net system.
In 1995, the APCO Advisory Board promulgated a new standard known as APCO
25. Although public safety agencies are not currently required by the FCC or
APCO to purchase APCO 25 compliant LMR systems or otherwise adopt the APCO 25
standard, the Company believes that APCO 25 compatibility will be one of the key
purchasing factors for the public safety and other government LMR users.
Furthermore, as LMR issuers upgrade their existing APCO 16 systems to comply
with FCC-imposed bandwidth limitations, the Company expects that demand for APCO
25 compliant LMR systems will increase, due in part to the fact that APCO 25
systems are backwardly compatible with much of the older APCO 16 equipment,
allowing early adopters of the APCO 25 standard to purchase new equipment
without replacing entire older systems.
INFORMATION SECURITY PRODUCTS
Overview
Transcrypt first entered the information security market in 1978 with
simple, transistor-based add-on scrambling modules for use in analog LMRs using
basic single-inversion scrambling techniques. Transcrypt marketed these products
primarily to public safety agencies and international governments. Since that
time, the Company has further developed and improved upon its core information
security technologies, which have at various times been implemented into the
Company's scrambler modules and other products within its major information
security product families, (i) LMR Security and (ii) Telephony Security.
The core technologies currently available to the Company for incorporation
in its products include the following methods, which are listed in increasing
order of sophistication of security technique: (i) frequency inversion
(inverting or otherwise adjusting the phase of a signal based on a consistent
method), (ii) rolling code transmission (incrementally stepping codes), (iii)
frequency hopping transmission (changing broadcast frequencies multiple times
per second based upon an algorithm) and (iv) digital encryption (encoding a
digital bit-stream based upon a mathematical encryption algorithm).
As with all of the Company's information security products, the use of
scrambling and encryption equipment is required on both the transmitting and
receiving sides of communications in order to operate in secure mode. For
example, in order to achieve secure LMR communications, it would be necessary
for both the transmitting and receiving equipment, including hand-held, mobile
devices and base stations, to be equipped with one of the Company's modules,
whether as an add-on installation or in the form of one of the Company's
complete LMRs. In the Company's telephony family, a scrambled cellular telephone
may communicate in secure mode only with (i) another of the Company's secure
cellular telephones, (ii) a PBX interchange or cellular service provider that
has installed one of the Company's Voice Privacy Exchange Units or (iii) a
landline telephone equipped with one of the Company's external desktop units.
However, all of the Company's products can be used in the clear, non-scrambled
mode with equipment that does not contain a security device.
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Land Mobile Radio Security
The Company offers a variety of add-on LMR scrambling products featuring
its core technologies at varying levels of security. Add-on scramblers are
available in two packages, (i) a modular package consisting of a circuit board
that is designed to be permanently soldered into existing circuitry and (ii) a
socket package designed for installation in sockets with standard pin
configurations which original equipment manufacturers ("OEM") may install.
Products sold by the Company are compatible with sockets of OEM
manufacturers, including ICOM America, Inc. and Motorola. The Company also
produces modules that add signaling features to radios, including "man-down"
(emergency signal broadcast if radio position becomes horizontal), "stun-kill"
(disables lost or stolen radios remotely) and "over-the-air reprogramming"
(changes encryption and scrambling codes remotely). In December 1997, the
Company introduced an LMR encryption module for use as an add-on or in OEM
equipment that uses the digital encryption standard called "DES." This module
uses the widely recognized DES algorithm for encoding transmissions.
Telephony Security
The Company's add-on scramblers for cellular telephones typically consist
of a modular circuit board designed to be permanently soldered into existing
telephone circuitry. The add-on scrambler product line includes a model designed
specifically for Motorola telephones, which features advanced digital signal
processing technology. With the increased deployment of digital or PCS systems
by cellular service providers, the demand for add-on voice security products for
analog equipment has resulted and will likely continue to result in reduced
demand for add-on voice security devices for analog telephones, such as those
produced by the Company.
The Company offers complete, Transcrypt-branded, Motorola MicroTAC(TM),
Elite and StarTAC(TM) cellular telephones upgraded to include the Company's
advanced add-on scrambling modules. The Company believes that offering cellular
telephone security through a complete telephone product offers certain
advantages over add-on scrambler sales. These advantages include (i) presenting
the customer with a single vendor, (ii) overcoming customer resistance to
surrendering their telephones during installations and (iii) allowing the
Company to market cellular security directly to cellular service providers. In
the area of landline telephone voice security, the Company has, since 1995,
produced landline scrambling and encryption devices for installation between the
handset and telephone base, which have been purchased primarily by overseas
government and corporate users. In 1997, the Company introduced a line of
complete landline telephones with built-in voice security capability.
In September 1997, the Company introduced its "Secure Office" network
server and DES encryption scrambling modules, which allow for a company-wide
telephony and data security solution based upon products using real-time,
high-speed encryption techniques. The Secure Office product line includes a
network server capable of encryption/decryption for up to 24 simultaneous voice
or data users, a scrambling module for cellular telephone users, and five new
landline security products. Secure Office provides real-time, high-speed
encryption and voice and data security over shared facilities. The Secure Office
products consist of a switch solution for local area networks ("LAN") and
private branch exchange ("PBX") which communicates with computer modems, fax
machines, cellular telephones, digitally encrypted landline telephones and other
LANs and PBXs at different locations. Communications are secured with
proprietary encryption and scrambling algorithms. Since its introduction, the
Company has developed a PCMCIA encryption card for laptop computers. To date,
sales of the Company's Secure Office products have not been material. The
Company is evaluating its marketing strategy for its Secure Office product line.
WIRELESS COMMUNICATIONS PRODUCTS
The Company sells its wireless communications products primarily to LMR
dealers, SMR operators, governmental entities and the utility industry.
End-users include B&I concerns and public safety and other government users
desiring point to multi-point communications. Most of these types of products
are sold
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under the "E.F. Johnson" brand name. The following discussion summarizes the
types of products typically sold to both of these types of users.
Business and Industrial Users
The Company serves the B&I market primarily with its LTR(R) and analog
conventional LMR product lines. The Company's analog conventional LMR product
line is sold into all of the LMR markets which the Company serves. Management
believes that significant niche markets continue to exist for analog
conventional LMR products with value added technology, such as signaling
protocols, security features and scrambling technology.
The LTR(R) product line incorporates the E.F. Johnson LTR(R) trunking
protocols and includes (i) sub-audible signaling, which automatically selects a
clear or unoccupied channel, (ii) open architecture which is compatible with
other analog products and (iii) transmission trunking which holds a channel for
up to 20 seconds of "hang time" after a transmission is terminated to allow for
a reply. In December 1997, the Company completed the design of a trunked LMR
system known as "LTR-Net(TM)," which uses its LTR(R) trunking system in a
wide-area configuration, allowing linked communications over a much larger
geographic area than a single trunked system while also providing a much needed
array of user security functions
The Company's products for the SMR market include mobile radios, portable
radios and repeaters, along with other infrastructure to provide a complete SMR
system. The Company targets smaller regional SMR operators which offer a
combination of dispatch and interconnect services and the traditional local SMR
operators and dealers who serve local businesses primarily with dispatch
service. In serving this market, the Company relies heavily on its network of
dealers, many of whom are authorized by the Company as service centers and
provide installation, maintenance, repair and warranty service. The Company
believes that the end-users of these products value (i) the low cost of point to
multi-point communications, (ii) flexibility of networking and (iii) support and
responsiveness of the Company and its dealers.
Public Safety and Other Government Users
The Company serves public safety and other government users primarily with
its APCO 16 Multi-Net(TM) analog and APCO 25 digital product lines. The APCO 16
Multi-Net(TM) was built upon the success of the E.F. Johnson LTR(R) trunking
protocol. The Company believes that its Multi-Net(TM) system, which links
together multiple sites for wide-area coverage using a proprietary architecture,
is a high-quality, cost-effective alternative to comparable APCO 16 systems
produced by other manufacturers. The Company's system offers many features
specifically designed for public safety users, such as (i) emergency queuing,
(ii) over 8,000 unique identification codes, (iii) automatic subscriber
identification (iv) five levels of priority access and (v) simulcast. The
Company provides a broad line of Multi-Net(TM)products, including repeaters,
radio network terminals, system management modules, duplex subscriber units,
dispatcher consoles, audio and data link and related accessories. E.F. Johnson
Multi-Net(TM) systems are sold both domestically and internationally. The
Company's APCO 25 compliant "dual-mode" digital radios are compatible and fully
interoperable with older analog radio systems, as well as with Motorola's
proprietary analog APCO 16 trunking technology (SmartNet(TM) and Smartzone(TM))
and proprietary digital encryption algorithms. In August 1996, the Company
introduced a hand held digital LMR complying with the APCO 25 "common air
interface" standard and also featuring advanced core scrambling and digital
encryption technologies. All of the Company's APCO 25 radios contain as standard
features voice scrambling and/or digital encryption technology. The Company
believes that such backward compatibility with Motorola's APCO 16 trunking
technology will provide early adopters of the APCO 25 standard, such as the
federal government and many public safety agencies, with the ability to purchase
new equipment without replacing entire older systems.
PRODUCTS UNDER DEVELOPMENT
Consistent with the Company's development efforts for its existing
products, the Company designs new products around common core scrambling and
encryption technologies using common signal processing platforms and circuitry.
Using this approach, the Company has generally been able to incorporate improve-
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ments in core technologies into its new products more quickly and with
relatively lower development costs compared to developing entire products
separately. The following discussion contains a summary of the Company's
principal products under development. The Company cannot assure that its will be
able to successfully develop any of these products or, if developed, that any
such products will be commercially viable or result in material sales.
Land Mobile Radio Security
The LMR security products under development are new versions of the
Company's SC20-DES module for deployment in different models of radios,
including for sockets in certain Motorola radios. From time to time, the Company
also has under development a number of custom security modules, including those
incorporating custom encryption and scrambling algorithms.
Wireless Communications
The Company plans to introduce in 1998 additional models of its hand-held
digital LMRs containing different features, as well as a line of mobile digital
LMRs, all of which are intended to comply with the APCO 25 standard. The Company
also plans to introduce additional mobile radio models that transmit in analog
format (e.g., APCO 16 and conventional LMRs) for the existing analog market,
which can be upgraded to complete APCO 25 functionality. All of these radios
will contain as standard features voice scrambling and/or digital encryption
technology. These radios will be compatible and fully interoperable with older
analog LMRs, and some of the radios will offer compatibility with Motorola's
proprietary analog APCO 16 trunking technology (SmartNet(TM)/SmartZone(TM)) and
Motorola's digital encryption algorithms.
CUSTOMERS
The Company's customers use information security products in a variety of
situations involving differing security needs. For example, domestic and
international police forces typically have a medium to high need for security,
while military users which are often faced with hostile and determined threats
typically have a very high need for security. Purchasers of the Company's
information security and wireless communications products include public safety
agencies and police forces, federal government agencies, foreign governments,
the military, cellular service providers, LMR manufacturers and business and
corporate users in finance, manufacturing and media/entertainment, among other
industries. No customer accounted for more then 10% of the Company's revenues
during 1997, except Modern Scientific and Electric Corporation ("Moseco") of the
Kingdom of Saudi Arabia. Moseco purchased approximately $4.4 million of wireless
system products as the prime contractor for Aramco Inc. of Suadi Arabia.
SALES AND MARKETING
The following discussion summarizes the Company's current sales and
marketing approaches for its different products:
Information Security
The Company sells its add-on products domestically primarily to
distributors, OEMs and self-servicing end-users, through sales managers while
complete radio products are sold domestically primarily to end-users.
Furthermore, the Company is continuing to market radio and other complete
products to its existing add-on customer base.
The Company conducts international sales through its sales managers, who
focus on specific regions of the world outside of the United States. The
majority of international sales are made by the sales managers in conjunction
with a Company-authorized distributor, which typically provides a local contact
and arranges for technical training in foreign countries. International sales
accounted for approximately 38.1% and 53.9% of the Company's revenues in 1997
and 1996, respectively. See "-- Summary of Business Considerations and Certain
Factors That May Affect Future Results of Operations and/or Stock Price -- Risks
Associated with International Sales."
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The Company distributes its add-on information security products to both
(i) end-users in the LMR and telephony markets and (ii) distributors, such as
LMR dealers, that resell these products to end-users. Currently, the Company
sells self-branded, complete, analog secure cellular telephone primarily through
distributors and cellular service resellers.
The Company's basic marketing strategy has been to increase market
awareness of the need for information security products and to convey the
technical capabilities of its products. The telephony security products
marketing staff conducts promotions through a mix of print advertising, trade
shows, direct mail campaigns, press releases, technical articles, white paper
publication, periodic newsletters, training and presentation material, and
distribution of demonstration and loaner equipment, which are sometimes
coordinated with product launches and trade shows.
Wireless Communications
The Company's sales and marketing functions for LMR systems focus on (i)
the North American market and (ii) the international market. For North American
sales, the Company uses a direct sales force of account executives and sales
managers, who sell Company products primarily (i) in the APCO market and (ii) to
larger dealers, SMR operators, and telemarketing personnel who sell primarily to
smaller dealers and SMR operators. The Company's international sales are made
through a specialized international direct sales force and by Company authorized
dealer/distributors.
LTR(R) and conventional LMR products are sold in North America primarily to
an extensive network of approximately 600 independently owned and operated
dealers, some of which are also SMR operators. The dealers typically carry other
competitive product lines as well. These products are distributed
internationally primarily through a network of approximately 100 dealers and
distributors located in more than 45 countries. Many of the dealers also are
authorized as service centers and provide installation, maintenance, repair and
warranty service. The Company provides comprehensive dealer support, including
cooperative advertising programs, advertising materials, sales and service
training, and technical support.
The majority of system sales of LMR products to both commercial and
governmental purchasers involves soliciting and responding to "requests for
proposals," commonly referred to as "RFPs." The RFP process for system sales has
a relatively long cycle time. The period from proposal requirements to contract
award typically takes at least one year, and depending on the size of the
system, it can take multiple years for complete installation and acceptance of
the project. Public sector end-users issuing RFPs often require suppliers of LMR
systems to supply a bond from an approved surety company at the time that the
bid is submitted and at the time that the contract is awarded.
A number of factors can limit the availability of such bonds, including the
applicant's financial condition and operating results, the applicant's record
for completing similar systems contracts in the past and the extent to which the
applicant has bonds in place for other projects. The issuer of the Company's
bonds has recently indicated that it may, following its review of the restated
financial statements, reduce the maximum amount of bonding coverage available to
the Company. Further, the Company is experiencing problems with the completion
of systems contracts for certain E.F. Johnson projects begun prior to the
Company's acquisition of E.F. Johnson. Although the Company is working to
correct these system problems, no assurance can be given that it will be
successful. Even if the Company is successful in correcting these problems, the
Company will incur costs associated with correcting the systems for which there
may be no corresponding revenues. Further, if the customer for the systems
contract declares an event of default under the outstanding bond related to the
system contract, the issuer of the Company's bonds could reduce the maximum
amount of bond coverage available to the Company or impose additional
restrictions with respect to the issuance of bonds on behalf of the Company. A
reduction in the amount of bond coverage available to the Company or any
restrictions imposed in connection with the issuance of bonds would adversely
affect the Company's ability to bid on new system contracts in the future.
Further, such an event or the need for the Company to incur substantial costs to
correct the system contract problems being experienced could materially
adversely affect the Company's business, financial condition, results of
operations, liquidity and cash flows. See "-- Summary of Business
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Considerations and Certain Factors That May Affect Future Results of Operations
And/or Stock Price -- Systems Contract Problems."
CUSTOMER SERVICE
For the Transcrypt product line, the Company provides toll-free telephone
access for customers with technical or other problems. Product training includes
classes, seminars and video programs offered at both the customer's site and the
Company's Lincoln facility. The Company offers a standard warranty on all
products, which covers parts and labor for a period of one year from purchase,
with an extended warranty service option available at an additional cost.
The Company installs, for a fee, all models of scrambler modules into
customers' LMRs and telephones. Scrambler modules that the Company does not
install are generally installed by local radio and cellular telephone dealers.
The Company documents installation instructions for its products in OEM devices
and has developed these instructions for more than 2,000 OEM products, including
almost all commercially available two-way radio models sold worldwide. For the
E.F. Johnson product line, the Company's customer service group provides
worldwide after-sales service and support, including technical support through a
toll-free telephone number, on-site technical personnel for repairs and
applications issues, 24-hour turnaround for spare parts and extensive product
training. Product training includes classes, seminars and video programs
available at both the customer's site and Waseca manufacturing facility. Such
training provides assistance to the end-user in the use, operation and
application of LMR products and systems, and trains other end-users and dealers
to perform network programming changes and preventive maintenance and repair to
products and systems. LMR products and systems are generally sold with a one
year warranty which covers parts and labor in North America and parts
internationally. Broader warranty and service coverage is provided in certain
instances to private systems customers on a contractual basis, usually for an
additional charge.
MOTOROLA RELATIONSHIP
The Company depends to a large extent on a number of significant
relationships with Motorola. Motorola has been a large customer of the Company
since 1994. The sales to Motorola during 1997 consisted primarily of
Motorola-labeled LMR socket scrambling modules available for resale by Motorola
as an accessory to certain of Motorola's portable LMRs sold worldwide.
Motorola is a key manufacturer of electronic components used by the
Company. These components include microprocessors and components used in most of
the Company's scramblers and LMRs, which the Company purchases through an
electronics wholesaler. Furthermore, pursuant to a product sales agreement
executed in June 1996, Motorola has agreed to sell to the Company, upon the
Company's request, original equipment cellular telephones and related
accessories from Motorola's MicroTAC(TM) line, including StarTAC(TM) telephones,
which the Company resells equipped with its DSP-based encryption devices and
labeled with the Transcrypt logo. This agreement with Motorola specifies fixed
prices for purchases of such equipment, and its original term expired on
December 31, 1997, after which either party may terminate the agreement upon 30
days' prior notice. The Company may also purchase from Motorola base stations,
repeaters and other LMR infrastructure components in order to fulfill systems
contracts requiring compatibility with these devices.
The Company has obtained from Motorola a royalty-bearing, irrevocable,
non-exclusive, worldwide license (the "IPR License") to manufacture products
containing certain proprietary LMR and digital encryption technology. The
Company believes this technology will be important to the success of certain of
its existing and proposed APCO 25 compliant LMR products. The IPR License
includes rights to use Motorola's proprietary analog APCO 16 trunking technology
(SmartNet(TM)), APCO 25 required products and certain Motorola digital
encryption algorithms in LMR products. The digital encryption technology may
also be incorporated into certain other information security products. In
addition, E.F. Johnson, prior to its acquisition by the Company, obtained a
license to certain proprietary technology from Motorola relating to the
development of APCO 25 compliant digital LMRs. This license covered
infrastructure and other APCO 25
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technology. Subsequent to the acquisition, Motorola agreed to expand the
coverage of Transcrypt's license to SmartNet(TM) to cover E.F. Johnson's
products.
In addition to the direct benefits of the IPR License to the Company's APCO
25 development efforts, the Company believes that sales of its APCO 25 digital
LMR products have been, and expect that such sales will in the foreseeable
future be, substantially dependent upon Motorola's dominant position as a market
leader in the APCO 25 marketplace. Motorola is the largest manufacturer of APCO
25 compliant LMR products and has been the principal public supporter of the
APCO 25 digital transmission standard for the LMR market. Any reduction in such
support could lead to reduced demand for APCO 25 compliant LMR systems
generally. See "-- Summary of Business Considerations and Certain Factors That
May Affect Future Results of Operations and/or Stock Price -- Reliance on
Motorola."
INTELLECTUAL PROPERTY
Transcrypt presently holds registered copyrights which cover software
containing algorithms for frequency hopping, scrambling and signaling
technologies for LMR and cellular telephony, and one domestic patent, which
covers continuous synchronization methods used in analog scrambling products.
Transcrypt has been granted five patents relating to high-end scrambling and
encryption techniques and methods of integrating after-market devices, such as
the Company's modules, into OEM products, and has applied for 18 additional
domestic patents in this area. These patents and patent applications were the
result of Transcrypt's expanded intellectual property program, which is intended
to enhance the patent protection afforded the Company's new and advanced
intellectual property rights. Transcrypt also holds three registered trademarks
related to the "Transcrypt" name and product names. In addition to the rights
held by Transcrypt, E.F. Johnson currently holds or has been assigned at least
21 U.S. patents, 10 pending applications for U.S. patents, 11 patents in foreign
countries and 8 pending applications for patents in foreign countries. These
patents and applications cover a broad range of technologies, including trunking
protocols and a high-speed data interface for LMR communications. Furthermore,
E.F. Johnson holds numerous registered trademarks related to the "E.F. Johnson"
name and product names. In addition to copyright and patent laws, the Company
relies on trade secret law and employee and third-party non-disclosure
agreements to protect its proprietary intellectual property rights. Furthermore,
the Company designs its information security devices to make the underlying
software and processes difficult to reverse engineer, providing an additional
level of protection.
RESEARCH AND DEVELOPMENT
As of June 30, 1998, the Company had a research and development staff of
109 individuals, including 87 engineers. The Company organizes research and
development efforts along its two main product lines, (i) information security
and (ii) wireless communications products. As part of the integration of E.F.
Johnson's research and development team with Transcrypt's research and
development efforts, the Company has focused significantly on integrating
technologies in order to offer new advanced products by taking advantage of the
competencies of each of the engineering staffs of Transcrypt and E.F. Johnson.
For example, the combined staffs are working on projects to integrate digital
signal processing technology into the E.F. Johnson radios to make them
interoperable with Multi-Net(TM), SmartNet(TM) and APCO 25. Other integration
work underway relates to the incorporation of Transcrypt's encryption technology
into E.F. Johnson radio products.
Information Security
The Company's research and development personnel in the information
security area have expertise in various fields, including cryptography, analog
hardware, digital hardware, and object-oriented software. The research and
development staff designs and develops products incorporating digital signal
processing, voice coding (including improved multi-band excitation), encryption,
spectral manipulation and rotation, systems simulation and mixed signal
scrambling. Since 1995, the Company's research and development efforts have
increased significantly, and it has expanded development of secure telephony and
data products. In order to facilitate the Company's new product line development
plans, research and development staffing has been
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increased during 1997 with additional expertise in the areas of data networking,
cryptography and digital signal processing.
Wireless Communications
The Company's wireless communications research and development organization
have expertise in RF technology, computer architecture, switch architecture,
networking, software and hardware designs. Ongoing engineering efforts are
focused on adding advanced features to existing product lines and developing new
and innovative platforms. Cross-disciplinary planning groups involving
marketing, manufacturing and engineering are used for product planning and
definition. Present research and development efforts are involved in upgrading
existing product lines, including the development of next generation repeaters
and mobile radios for the Company's principal product lines. The Company also
has a staff of systems applications design, manufacturing and customer service
engineers that focuses on design and implementation of custom radio systems.
MANUFACTURING
The Company's manufacturing operation generally consists of the procurement
of commercially available (i) subassemblies, (ii) parts and (iii) components,
such as integrated circuits, printed circuit boards and plastic and metal parts,
and their assembly into finished products. Certain components and subassemblies
are manufactured by vendors to the Company's specific design criteria. The
Company inspects all components and subassemblies for mechanical and electrical
compliance to its specifications in order to ensure high yield and quality.
The Company produces many of its wireless communications products,
including its APCO 25 compliant products, at its Waseca, Minnesota facility. The
Company manufactures all of its information security products and many of its
wireless communications circuit boards at its facility in Lincoln, Nebraska. The
Company is currently evaluating alternative manufacturing strategies to reduce
costs and improve efficiencies.
MATERIALS AND SUPPLIERS
Information Security
The Company obtains most of its electronic parts and components for
information security and radio products from one principal distributor,
Arrow/Schwebber Electronics Group. The Company believes that concentrating its
purchases through one principal distributor lowers procurement costs and
enhances the ability to control the quality of these components and
subassemblies. The distributor stores several months' supply of basic
components, such as microprocessors, flash, and digital signalling processors,
on-site at the Company's manufacturing location on a consignment basis, which
reduces inventory maintenance costs. Additionally, the Company acquires from
other manufacturers certain high-end subassemblies, such as RF boards for use in
complete LMR units that the Company manufactures. See "-- Summary of Business
Considerations and Certain Factors That May Affect Future Results of Operations
and/or Stock Price -- Dependence on Suppliers."
Wireless Communications
Certain components and subassemblies used in the Company's wireless
communications products are presently available only from a single supplier or a
limited group of suppliers. To date, the Company has been able to obtain
adequate supplies of all components and subassemblies in a timely manner from
existing sources. Currently, Motorola is the sole supplier of a majority of the
semiconductors used in certain of the Company's LMR products. Although
historically the Company has not experienced a disruption of Motorola's supply
of this product, disruption or termination of Motorola's supply of this product
would have a material adverse effect on the Company's operations.
Most of the Company's newer analog LMRs for the B&I market have been
manufactured by Icom Japan ("ICOM") under contract by the Company. Products
produced by Icom have included hand-held portable
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radios that operate in both conventional and trunked mode and more recently,
mobile units as well. In general, new products produced by Icom for the Company
have been jointly developed by the Company and Icom. Although historically the
Company has not experienced a disruption in Icom's ability to supply these
products, disruption or termination would have a material adverse effect on the
Company's ability to supply certain LMRs to its B&I customers. Icom has recently
requested that the Company supply a letter of credit before products are shipped
to the Company. See "-- Summary of Business Considerations and Certain Factors
That May Affect Future Results of Operations and/or Stock Price -- Effects of
Recent Developments on the Company's Business."
With respect to other electronic parts, components and subassemblies, the
Company believes that alternative sources could be obtained to supply these
products, if necessary. Nevertheless, a prolonged inability to obtain certain
components and subassemblies could impair customer relationships and could have
an adverse effect on the Company's operating results. See "-- Summary of
Business Considerations and Certain Factors That May Affect Future Results of
Operations and/or Stock Price -- Dependence on Suppliers."
GOVERNMENT REGULATION AND EXPORT CONTROLS
Information Security
The Company's information security products have been subject to export
restrictions administered by the Department of State and the Department of
Commerce, which permit the export of encryption products only with the required
level of export license. U.S. export laws also prohibit the export of encryption
products to a number of specified hostile countries. Although to date the
Company has been able to secure most required U.S. export licenses, including
for export to approximately 113 countries since 1978, there can be no assurance
that the Company will continue to be able to secure such licenses in a timely
manner in the future or at all. Based on prior experience in securing export
approvals, the Company believes that it maintains good relations with federal
government agencies with jurisdiction over its products. Additionally, in
certain foreign countries, the Company's distributors are required to secure
licenses or formal permission before encryption products can be imported.
In November 1996, President Clinton issued an Executive Order (the
"Executive Order") altering the federal government's policies governing the
export of encryption products, such as those currently offered and proposed to
be offered by the Company. The Executive Order shifts jurisdiction for export
controls and licensing relating to encryption technology from the Department of
State to the Department of Commerce and removes from the "munitions" list most
encryption products. In addition, the Executive Order establishes a key
management control program, under which a third-party would hold "keys" to
unlock encrypted information for legitimate law enforcement and national
security needs. As a result of the Executive Order, certain products featuring
digital encryption technology that had not previously been exportable can now be
exported. This development may increase competition for international sales of
the Company's analog scrambling products. Under interim regulations adopted in
December 1996 by the Department of Commerce, during a two-year transition
period, non-key recoverable 56-bit digital encryption products may be approved
for export if the manufacturer (i) commits to build and market key recovery
products and support key management infrastructure in the future and (ii)
provides to the government interim reports detailing internal development
efforts.
Since December 1996, the Department of Commerce has been preparing draft
proposed final regulations similar to the interim regulations. Industry
opposition to the approach taken by the interim regulations has substantially
delayed the issuance of a proposed draft, which has not been issued to date.
Recently, Secretary of Commerce William Daley expressed serious concerns about
U.S. encryption policy and urged the various concerning parties to find a
compromise. Since making these comments, Secretary Daley has engaged an
interagency group in an effort to resolve the issue. But substantial industry
opposition to the "key recovery" approach and Clinton Administration concerns
about national security continue to delay the regulations. While pending
lawsuits have questioned the constitutionality of the Commerce Department
regulation, it is unclear what impact, if any, these suits will have on
commercial encryption exports when the cases are resolved. The United States
Court of Appeals for the Ninth Circuit is currently considering an appeal from
an
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April 1996 decision in which U.S. District Court Judge Marilyn Patel found that
the Commerce Department's export controls on encryption source code and software
were an unconstitutional prior restraint on free speech. The effect of a Ninth
Circuit ruling is likely to be limited, however, as the case involved export of
software that constituted academic speech, which generally receives more
protection than commercial speech. The commercial speech standard would likely
be applied to the export of commercial encryption software. It is uncertain when
this case will be resolved. If the Ninth Circuit upholds Judge Patel's opinion,
the U.S. Government is expected to appeal to the Supreme Court.
In response to industry opposition to the President's Executive Order and
the interim regulations, Members of Congress have taken aggressive steps to
further expand exports of encryption products. In the 105th Congress, Members of
the House of Representatives and Senate introduced legislation to eliminate
"key" controls the Administration imposes on encryption exports. In the House,
legislation eliminating the "key" recovery system and other controls may be
considered, but opposition form key Members has to date, prevented the bill from
coming to the House Floor. The House bill would lift many remaining controls on
encryption exports, including the Administration's "key" management requirement.
President Clinton opposes the House legislation and similar measures introduced
in the Senate, on the grounds that the bill's provisions eliminating the key
recovery system would seriously compromise national security, among other
things, and may veto the measure if enacted.
In the Senate, Sen. John Ashcroft recently introduced a bill to the
Judiciary Committee designed to revise the Administration's encryption
technology export policy, but less drastically than the House bill. Under the
terms of the Ashcroft bill, entitled the "Encryption Protects the Rights of
Individuals from Violations and Abuse in Cyberspace (E-PROVACY) Act" exporters
would be able to sell more powerful encryption products than those allowed under
the interim regulations. The bill would establish an Encryption Export Advisory
Board comprised of industry and governmental representatives that would consider
applications for license exceptions for encryption products based on the
availability of comparable encryption products outside the United States. After
making a determination, the Board is required to notify the Secretary of
Commerce, who shall specifically approve or disapprove each determination of the
Board within 30 days of submittal. A decision of disapproval by the Secretary of
the Board's determination shall be subject to judicial review pursuant to the
provisions of the Administrative Procedures Act. Management cannot predict
whether any legislation easing export controls will be enacted, what form it
will take or how the Executive Order or any such legislation will impact
international sales of the Company's products.
Wireless Communications
The Company's stand alone wireless products are subject to regulation by
the FCC under the Communications Act of 1934, as amended, and the FCC's rules
and policies as well as the regulations of the telecommunications regulatory
authority in each country where the Company sells its products. These
regulations are in the form of general approval to sell products within a given
country for operation in a given frequency band, one-time equipment
certification, and, at times, local approval for installation. In addition, the
construction, operation and acquisition of wireless communications systems, as
well as certain aspects of the performance of mobile communications products,
are regulated by the FCC and foreign regulatory authorities. Many of these
governmental regulations are highly technical and subject to change. The Company
believes that it and its products are in material compliance with all
governmental rules and policies in the jurisdictions where the Company sells its
products.
In the United States, all of Transcrypt's wireless products are subject to
FCC Part 15 rules on unlicensed spread spectrum operation. In those countries
that have accepted certain worldwide standards, such as the FCC rulings or those
from the European Telecommunications Standards Institute, Transcrypt has not
experienced significant regulatory issues in bringing its products to market.
Approval in these markets involves retaining local testing agencies to verify
specific product compliance. However, many developing countries, including
certain markets in Asia, have not fully developed or have no frequency
allocation, equipment certification or telecommunications regulatory standards.
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The majority of the systems operated by E.F. Johnson's customers must
comply with the rules and regulations governing what has traditionally been
characterized as "private radio" or private carrier communications systems.
Licenses are issued to use frequencies on either a shared or exclusive basis,
depending upon the frequency band in which the system operates. Some of the
channels designated for exclusive use are employed on a for-profit basis; others
are used to satisfy internal communications requirements. Most SMR systems in
operation today use 800 MHz channels. Within the top 50 metropolitan markets,
900 MHz frequencies licensed for exclusive use systems have been made available
to both SMR and non-SMR licensees. Additional channels designated for exclusive
use were made available in the 220 MHz band for both commercial and
non-commercial systems.
Generally, SMR licenses are issued for five-year terms, initially in blocks
of five channels, and may be renewed upon showing compliance with FCC rules and
may be revoked for cause. Such licenses typically are subject to channel
"loading" or usage requirements, such as loading a minimum of 70 subscriber
units for each channel within the initial five-year term. If an SMR licensee
fails to meet its loading requirements in an area where existing applications
are pending on a wait list, the FCC may cancel the license, in whole or in part,
or deny a request to renew or expand the license. Other than loading
requirements, private systems are subject to similar restrictions. For example,
licenses for private systems are also issued for five-year terms, may be renewed
upon showing compliance with FCC rules and may be revoked for cause.
E.F. Johnson also offers products in bands below 800 MHz where channels are
shared by multiple users in the same geographic area. In this "shared" or
conventional spectrum, there is no requirement for loading the channel to any
particular level in order to retain use of the frequencies. These channels are
generally used by entities satisfying traditional dispatch requirements in,
among others, the transportation and services industries.
The FCC is considering a number of regulatory changes that could affect the
wireless communications industry and the Company's business. Therefore, the
regulatory environment is inherently uncertain and changes in the regulatory
structure and laws and regulations, both in the United States and
internationally, can adversely affect the Company and its customers. Such
changes could make existing or planned products of the Company obsolete or
unsaleable in one or more markets, which could have a material adverse effect on
the Company.
The FCC, through the Public Safety Wireless Advisory Committee, is
considering regulatory measures to facilitate a transition by public safety
agencies to a more competitive, innovative environment so that the agencies may
gain access to higher-quality transmission, emerging technologies, and broader
services, including interoperability. As part of this process, the FCC is
reviewing the current use of the public safety wireless spectrum, reallocation
of additional spectrum for public safety use, and use of commercial service
providers for additional public safety capacity. This FCC process could affect
products manufactured by the Company. Management cannot predict the outcome of
the FCC review or any specific changes in the spectrum or FCC policies, or any
potential effect on the Company's sales.
COMPETITION
Information Security
The markets for information security products are highly competitive.
Significant competitive factors in these markets include product quality and
performance, including (i) the effectiveness of security features, (ii) the
quality of the resulting voice or data signal, (iii) the development of new
products and features, (iv) price, (v) name recognition and (vi) the quality and
experience of sales, marketing and service personnel. A number of companies
currently offer add-on scramblers for LMRs that compete with the Company's add-
on information security products, including Selectone Corp., Midian Electronics
Inc., and MX-COM Inc. Also, Motorola and Ericsson offer high-end, proprietary
digital encryption for their LMR products. Cycomm International Inc./Privaphone
and Motorola offer add-on security products for cellular telephones. Competitors
to the Company's secure landline telephone products include AT&T
Corporation/Datatek, Motorola, Cycomm International Inc., Cylink Corporation and
TCC (Technical Communications Corporation).
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As of June 30, 1998, the Company and Motorola are believed to be the only
current suppliers of APCO 25 LMR products. However, a number of companies are
actively developing APCO 25 compliant products and have displayed working
prototypes. Companies which have announced or are anticipated to announce the
availability of APCO 25 compliant products or digital LMRs include Kenwood,
Racal Communications, Relm Communications, ADI, AMP, Ericsson, Garmin Industries
and Midland Systems.
Many of the Company's competitors have substantially greater financial,
technical, marketing, distribution and other resources, greater name recognition
and longer-standing relationships with customers than the Company. Competitors
with greater financial resources are better able to engage in sustained price
reductions in order to gain market share. Any period of sustained price
reductions would have a material adverse effect on the Company's financial
condition and results of operations. The Company cannot assure that it will be
able to compete successfully in the future or that competitive pressures will
not materially and adversely affect its financial condition and results of
operations.
Wireless Communications
In North America, Motorola, Kenwood and Ericsson are the leading providers
of LMR equipment. The remainder of the LMR market is divided among a large
number of suppliers who focus on particular segments of the market. The Company
believes it is the third largest provider of specialized radio systems in North
America. However, the Company's share of this market is relatively small in
comparison to sales by Motorola and Ericsson.
The Company competes in the wireless communications market on the basis of
price, technology and the flexibility, support and responsiveness provided by
the Company and its dealers. Most of the Company's competitors in wireless
communications have financial, technical, marketing, sales, manufacturing,
distribution and other resources substantially greater than those of the
Company. In addition, many of the Company's competitors also possess entrenched
market positions, other intellectual property rights and substantial
technological capabilities. In the North American SMR market, the Company's
competitors include Motorola, Ericsson, Uniden America Corporation ("Uniden"),
Kenwood U.S.A. Corp., ICOM America, Inc. and Midland International Corp. The
Company believes that cellular telephones and personal communication services
devices provide, to some extent, the same functionality as SMRs and other LMRs
and, as such, may compete with its products. The Company believes that the
international wireless communications market is fragmented, with Motorola,
Kenwood, Nokia, and Ericsson the dominant suppliers. The Company also competes
with Uniden, Hitachi Denshi, Ltd. and Tait in Asia.
BACKLOG
The Company presently ships a small amount of information security products
against backlog, due to the typically short manufacturing cycle of these
products. Because of generally longer manufacturing cycle times required for the
production of complete wireless communication products, the Company's backlog
for wireless communication products has been larger than for its security
products. The Company does not believe that its backlog figures are indicative
of actual sales of products in future periods.
EMPLOYEES
At December 31, 1997, the Company had 464 full-time equivalent employees,
including 114 at its Lincoln, Nebraska facility, 313 at its Waseca, Minnesota
facility, 11 at its Burnsville, Minnesota sales office and approximately 26
field sales people, sales managers or staff located in the sales territories in
which they serve. As of June 30, 1998, the Company had 494 full-time equivalent
employees. The Company also uses temporary employees when necessary to manage
fluctuations in demand. None of the Company's employees are covered by a
collective bargaining agreement.
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SUMMARY OF BUSINESS CONSIDERATIONS AND CERTAIN FACTORS THAT MAY AFFECT FUTURE
RESULTS OF OPERATIONS AND/OR STOCK PRICE
Certain matters discussed in this Annual Report may constitute
forward-looking statements under Section 27A of the Securities Act and 21E of
the Exchange Act. These forward-looking statements relate to, among other
things, the outcome of pending class action litigation involving the Company,
the outcome of the pending investigation by the SEC, the effects of the
Company's recent restatement of its financial statements and other recent events
on the Company's product development efforts, future sales levels and customer
confidence, the Company's future financial condition, liquidity and business
prospects generally, perceived opportunities in the marketplace for the
Company's products and its products under development, and the Company's other
business plans for the future. The actual outcomes of these matters may differ
significantly from the outcomes expressed or implied in these forward-looking
statements. The following is a summary of some of the important factors that
could affect the Company's future results of operations and its stock price, and
should be considered carefully.
Securities Class Action Claims
The Company has been named as a defendant in thirteen class action lawsuits
that were filed subsequent to the Company's announcement on March 27, 1998 that
the filing of its Annual Report on Form 10-K for year ended December 31, 1997
would be delayed and that adjustments would be made to the Company's previously
announced financial results. Certain of the complaints also name one or more
officers of the Company as additional defendants. See "ITEM 3. LEGAL
PROCEEDINGS." The Company may also in the future be the subject of additional
lawsuits or claims in connection with the events or facts surrounding the
restatement of its financial statements. In addition, the Company may be
required to indemnify its directors and officers for judgments rendered against
them in connection therewith. The Company is unable to predict when or whether
such additional lawsuits or claims may be initiated or the likelihood of the
outcome or range or amount of potential liability that may arise therefrom.
Although these complaints do not allege the amount of damages and other
relief that the plaintiffs are seeking, the Company believes the amount of
damages ultimately sought by the plaintiffs will be significant. In light of the
Company's restatement of financial information contained in its various
registration statements and prospectuses, the Company believes that there may be
an unfavorable outcome for at least some of the claims asserted in the lawsuits
or which may be asserted in the future against the Company. The Company believes
that the stockholder class actions are more likely to settle than proceed to
trial, judgment and appeal. Given the circumstances of these cases, the terms of
a settlement would be structured in a manner to avoid causing the Company to
seek protection under the federal bankruptcy reorganization laws. In any
circumstances where the Company could not structure a settlement of all claims
within its financial resources, it would vigorously defend any attempt to
establish the amount of liability or to require payment beyond its resources.
The Company has directors' and officers' liability insurance that may cover a
portion of the legal fees incurred and certain of the damages sought in
connection with the class action lawsuits. Many factors will ultimately affect
and determine the results of the litigation however, and the Company can provide
no assurances that the outcome will not have a significant adverse effect on the
Company's business, financial condition, liquidity, results of operations and
cash flows.
The pending litigation, SEC investigation and any future litigation against
the Company and its officers or directors, regardless of outcome, has resulted,
and will continue to result, in substantial costs and expenses to the Company
for legal and related assistance. Accordingly, any such pending or future
litigation could have a material adverse effect on the Company, regardless of
the outcome of the litigation.
SEC Investigation
In April 1998, the SEC issued a formal order of investigation to determine
whether violations of certain aspects of the Federal securities laws had
occurred in connection with the Company. While it is not possible at this time
to determine whether the SEC is likely to initiate proceedings against the
Company or the outcome of the SEC's investigation, the SEC has the authority to
impose a variety of sanctions against the Company
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and Company-affiliated parties. Such sanctions could include monetary penalties,
imposition of a cease and desist order and issuance of removal and prohibition
orders against Company-affiliated persons, among other things.
Effects of Recent Developments on the Company's Business
The restatement of the Company's financial statements, class action
lawsuits, SEC investigation and other recent events have had an adverse impact
on the Company's financial condition, results of operations, liquidity and cash
flows. During the quarter ended June 30, 1998, the Company experienced declining
revenues which it is anticipated will be between $13 and $14 million and
incurred substantial costs primarily in connection with the audit of the
Company's financial statements and legal fees relating to the restatements, the
class action lawsuits, the SEC investigation and the previously announced Audit
Committee investigation. As a result primarily of the foregoing, the Company
expects to report a loss of between $3.0 million and $5.0 million in the second
quarter of 1998.
These events have had, to varying degrees, an adverse impact on the
Company's relationships with its vendors and customers. A company that
manufactures radios under contract for the Company has required the Company to
supply a letter of credit before radios are shipped to the Company. The Company
did not enter into any new domestic systems contracts during the second quarter
of 1998. In addition, in connection with the bidding requirements on systems
contracts with governmental agencies, the bidding procedures often include the
posting of bonds. The issuer of the Company's bonds has indicated that it may,
following its review of the Company's restated financial statements, reduce the
maximum amount of bonding coverage available to the Company. On May 21, 1998,
the Company's line of credit with U.S. Bank was amended to include additional
collateral of $10.0 million of time certificates of deposit. On July 8, 1998,
U.S. Bank agreed to waive the Company's violations of the credit facility
arising out of the Company's failure to timely provide financial statements,
meet certain financial covenants and provide monthly borrowing base
certificates. U.S. Bank also agreed to amend the Company's credit line by
reducing the Company's required tangible net worth amount to $55 million from
$70 million.
Because of the uncertainties resulting from the restatement and other
recent events, the Company is also evaluating all of its product lines, and
looking at various initiatives to reduce operating expenses in order to keep
them in line with revenues. Implementation of any plan resulting from these
initiatives may result at some future date in substantial up front cost.
The Company can provide no assurance that the restatement of its financial
statements and the ongoing class action lawsuits and SEC investigation,
regardless of their outcomes, will not continue to have a material adverse
effect on the Company's financial condition, results of operations, liquidity
and cash flows.
Systems Contract Problems
The Company is experiencing problems with the completion of systems
contracts for certain E.F. Johnson projects begun prior to the Company's
acquisition of E.F. Johnson. Although the Company is working to correct these
system problems, no assurance can be given that it will be successful. Even if
the Company is successful in correcting these problems, the Company will incur
costs associated with correcting the systems for which there may be no
corresponding revenues. Further, if the customer for the systems contract
declares an event of default under the outstanding bond related to the system
contract, the issuer of the Company's bonds could reduce the maximum amount of
bond coverage available to the Company or impose additional restrictions with
respect to the issuance of bonds on behalf of the Company. A reduction in the
amount of bond coverage available to the Company or any restrictions imposed in
connection with the issuance of bonds would adversely affect the Company's
ability to bid on new system contracts in the future. Further, such an event or
the need for the Company to incur substantial costs to correct the system
contract problems being experienced could materially adversely affect the
Company's business, financial condition, results of operations, liquidity and
cash flows.
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Competition
The information security and wireless communications equipment industries,
and the LMR market segment in particular, are highly competitive. Competition in
the sale of stand-alone and digital products is more intense than for add-on and
analog products. In addition, other wireless communication technologies,
including cellular telephone, paging, SMR, satellite communications and PCS
(personal communication services) currently compete and are expected to compete
in the future with certain of the Company's stand-alone products. Furthermore,
other manufacturers have announced or are anticipated to announce the
availability of APCO 25 compliant products or digital LMRs. See
"-- Competition." Many of the Company's competitors or potential competitors
have significantly greater financial, managerial, technical and marketing
resources than the Company. Accordingly, the Company cannot assure that (i) it
will be able to continue to compete effectively in its markets, (ii) competition
will not intensify or (iii) future competition will not have a material adverse
effect on the Company. In addition, the Company cannot assure that new
competitors will not arise and begin to compete in the markets for the Company's
products.
Motorola, Nokia, Kenwood, and Ericsson hold a dominant position in the
market for wireless communication products, especially in the LMR and cellular
telephone market segments. In North America, Motorola, Kenwood and Ericsson are
the leading providers of LMR equipment. While the Company believes that it is
the third-largest supplier in the North American specialized LMR equipment
market, the Company's share of this market is relatively small in comparison to
Motorola and Ericsson. In addition to providing equipment to the industry,
Motorola is one of the largest SMR operators in the United States. Motorola,
Kenwood, and Ericsson have financial, technical, marketing, sales,
manufacturing, distribution and other resources substantially greater than those
of the Company, and have entrenched market positions in certain segments of the
North American LMR market. Certain of the Company's competitors, including
Motorola and Ericsson, have established trade names, trademarks, patents and
other intellectual property rights and substantial technological capabilities.
The Company believes that the wireless communications equipment industry is
undergoing a period of consolidation which (i) may involve the acquisition or
merger of some of the significant manufacturers of these types of products and
(ii) a concentration of market share in a relatively few companies. The Company
cannot assure that consolidations in the industry would not result in the
strengthening of its existing competitors or the creation of new competitors,
some of which may have significantly greater financial, managerial, technical
and marketing resources than the Company. See "-- Competition."
Reliance on Motorola
The Company is dependent on continuing access to certain Motorola products,
electrical components and proprietary intellectual property. Although the
Company believes that its relationship with Motorola is good, the Company cannot
assure that Motorola will continue to supply products, electrical components and
proprietary intellectual property to the Company on the scale or at the price
that it now does. In addition, Motorola may increasingly perceive the Company as
a competitor, particularly in light of its acquisition of E.F. Johnson. This
perception could impact Motorola's willingness to do business with the Company.
Although the Company has certain contractual relationships with Motorola, both
as a customer and a supplier, most of these agreements are subject to
termination in certain circumstances and expire by their terms within one to ten
years. Any reduction of the Company's contractual relations with Motorola or a
decision by Motorola to reduce or eliminate the provision of products,
components and technology to the Company could have a material adverse effect on
the Company. See "-- Motorola Relationship."
Transition from Analog to Digital Products
The Company believes that the LMR and cellular telephone markets are
migrating from analog to digital equipment. This migration is primarily due to
bandwidth capacity constraints and the perception that digital transmissions are
more secure than analog transmissions. As a result, the Company is seeking to
upgrade many of E.F. Johnson's LMR products to be compatible with digital LMR
communications standards, including APCO 25. However, the Company cannot assure
that it will be able to effect this transition on a
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timely basis or that digital products will compete successfully in the LMR
marketplace. The failure of products to compete successfully in the marketplace
would have a material adverse effect on the Company. In addition, there has been
some delay in the marketplace acceptance of digital LMR communications
standards, and this delay may result in decreased sales of the Company's APCO 25
products. A significant delay in the marketplace acceptance of digital LMR
communications standards could result in a significant decrease in sales of the
Company's APCO 25 products. Furthermore, the transition from analog to digital
communications is resulting in, and in the future is likely to continue to
result in, a decrease in demand for the Company's add-on security modules, as
customers may perceive digital communications to be more secure than
communications using analog devices.
Rapidly Evolving Markets
The information security and wireless communications products markets in
which the Company competes are rapidly evolving and can be expected to further
evolve in the future as a result of changing technology, industry standards and
customer requirements. The Company's ability to compete effectively will depend
upon its ability to anticipate and react to these changes in a timely manner. As
a result of recent developments affecting the Company, the Company may not have,
either currently or in the future, adequate capital resources to respond to
these changes. See "-- Recent Developments."
The development of new technologies by existing or future competitors may
place the Company at a competitive disadvantage by rendering some or all of its
existing or new products obsolete. The Company has invested heavily in the
introduction of LMR products that comply with the APCO 25 standard. Some
manufacturers have adopted and actively support other digital LMR transmission
standards for the public safety marketplace. The widespread acceptance of one or
more other standards in the public safety market would have a material adverse
effect on the Company. See "-- Competition."
A recent technological development in the digital LMR industry has been the
use of digital trunking, digital simulcast and digital voting technologies.
These technologies have led a number of manufacturers to change the
architectures and methodologies used in designing, developing and implementing
large LMR systems. In order for the Company to develop and integrate these new
technologies into its products, the Company would be required to make a
substantial investment of capital and human resources, which resources may not
be available to the Company. The failure of the Company to incorporate these
technologies into its LMR products could in the future place the Company's LMR
products at a competitive disadvantage to those offered by other manufacturers
and possibly make the Company's hand-held and mobile LMRs incompatible with
systems developed by other manufacturers, which would have a material adverse
effect on the Company.
Risks Associated with International Sales
In 1997 and 1996, international sales constituted approximately 38.1% and
53.9% of revenues, respectively. International sales are subject to a number of
risks not found in domestic sales. These risks include (i) unexpected changes in
regulatory requirements, (ii) tariffs and other trade barriers, (iii) political
and economic instability in foreign markets, (iv) difficulties in establishing
foreign distribution channels, (v) longer payment cycles, (vi) uncertainty in
the collection of accounts receivable, (vii) increased costs associated with
maintaining international marketing efforts and (viii) difficulties in
protecting intellectual property. In particular, the purchase of Company
products by international customers presents increased risks of, among other
things, delayed or reduced collection of revenues. Because most of the Company's
sales are denominated in U.S. dollars, fluctuations in the value of
international currencies relative to the U.S. dollar may also affect the price,
competitiveness and profitability of the Company's products sold in
international markets. Furthermore, the uncertainty of monetary exchange values
has caused, and may in the future cause, some foreign customers to delay new
orders or delay payment for existing orders. Troubled economic conditions, such
as that being currently experienced in Asia, could result in lower revenues for
the Company.
Some of the Company's products, particularly in the information security
area, are subject to export controls under U.S. law, which in most cases
requires the approval of the Department of Commerce in order
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to ship internationally. The Company cannot assure that such approvals will be
available to it or its products in the future in a timely manner or at all or
that the federal government will not revise its export policies or the list of
products and countries for which export approval is required. The Company's
inability to obtain required export approvals would adversely affect the
Company's international sales, which would have a material adverse effect on the
Company. In addition, foreign companies not subject to United States export
restrictions may have a competitive advantage in the international information
security market. President Clinton issued an Executive Order removing most
encryption products from the "munitions" list and transferring jurisdiction over
the export of such products from the Department of State to the Department of
Commerce. The Executive Order allows the export of products featuring digital
encryption technology that previously could not be exported, which may increase
competition for international sales of the Company's restricted analog
scrambling products. In addition, recent legislative actions in the U.S.
Congress may further ease export controls over digital encryption devices. See
"-- Government Regulation and Export Controls." The Company cannot predict the
impact of these factors on the international market for its products.
Reliance on Public Sector Markets
Public safety agencies and other governmental entities comprise a
significant portion of the Company's current and anticipated customer base.
Because there is an unknown amount of governmental customers purchase through
dealers, the Company cannot determine the percentage of its products that are
ultimately sold to governmental agencies. However, the Company believes that
domestic and international governments are the end-users of most of its
products. As the transition in the Company's product line from add-on to
stand-alone products progresses and as competition for such sales intensifies,
the Company expects that it will increasingly be subject to competitive bidding
requirements for sales to governmental customers, which can be expected to
result in lower prices and longer sales cycles with resulting lower margins.
These bidding procedures often include the posting of bonds. The issuer of the
Company's bonds has recently indicated that it may, following its review of the
restated financial statements, reduce the maximum amount of bonding coverage
available to the Company. Further, the Company is experiencing problems with the
completion of systems contracts for certain E.F. Johnson projects begun prior to
the Company's acquisition of E.F. Johnson. Any inability by the Company to
obtain requisite bonds would prevent it from bidding on LMR systems contracts,
which could have a material adverse effect on the Company. See "-- Systems
Contract Problems."
Dependence on Key Personnel
The Company's success depends to a significant extent upon a number of key
employees. The loss of the services of one or more of these key employees or the
Company's inability to attract and retain other qualified employees could have a
material adverse effect on the Company. The Company believes that its future
success will depend in part on its ability to attract, motivate and retain
highly skilled engineering, technical, managerial and marketing personnel.
Competition for such personnel is intense and the Company competes in the market
for such personnel against numerous companies, including larger, more
established companies with significantly greater financial resources than the
Company. The Company cannot assure that it will be successful in attracting,
motivating or retaining such personnel.
Effective May 31, 1998, Jeffery L. Fuller resigned as President, CEO and
Director of the Company. On June 8, 1998, the Company announced that the Board
of Directors had appointed a committee to identify a CEO of the Company and that
John T. Connor, who serves as Chairman of the Board, had been appointed as
interim CEO. Mr. Connor accepted appointment as interim CEO until the earlier of
September 8, 1998 or the hiring of a permanent CEO. Mr. Connor has indicated
that if a permanent CEO is not hired by such date, he will discuss with the
Board of Directors the possibility of staying on for a longer time.
Dependence on Suppliers
Most of the Company's current and proposed products require essential
electronic components supplied by outside vendors. Certain components may be
available from only one supplier and may occasionally be in short supply. For
example, in late 1993 and early 1994, there was a shortage of certain Motorola
surface-mount microprocessors, which resulted in a substantial increase in the
cost of these components. The
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Company's inability to obtain key components could result in lost sales, the
need to maintain excessive inventory levels and higher component costs, which
could increase the cost of producing the Company's products and have a material
adverse effect on the Company.
Fluctuations in Quarterly Operating Results
The Company has experienced and expects to continue to experience quarterly
variations in revenues and net income as a result of many factors. These factors
include the timing of customer orders, the timing of the receipt of cash payment
on sales which are recorded on a cash basis, the timing of the introduction of
new products, the timing and mix of product sales, general economic conditions
and specific economic conditions in the information security and wireless
communications industry. See "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Quarterly Results of
Operations."
Regulatory Environment
Wireless communications and data encryption products are subject to
regulation by United States and foreign laws and international treaties. The
regulatory environment is inherently uncertain and changes in the regulatory
structure and laws and regulations can adversely affect the Company and its
customers. Such changes could make the Company's existing or planned products
obsolete or unsaleable in one or more markets, which could have a material
adverse effect on the Company. See "-- Risks Associated with International
Sales" and "-- Government Regulation and Export Controls."
Environmental Regulation
The Company is subject to various federal, state and local environmental
statutes, ordinances and regulations relating to the use, storage, handling and
disposal of certain toxic, volatile or otherwise hazardous substances and wastes
used or generated in the manufacturing and assembly of the Company's products.
Under these laws, the Company may become liable for the costs of removal or
remediation of certain hazardous substances or wastes that have been or are
being released on or in the Company's facilities, or have been or are being
disposed of offsite as wastes. Such laws may impose liability without regard to
whether the Company knew of, or caused, the release of such hazardous substances
or wastes.
Although the Company has not to date suffered any material adverse effects
in complying with applicable environmental laws, the Company cannot assure that
any environmental assessments the Company has undertaken with respect to its
facilities have revealed all potential environmental liabilities, that any prior
owner or operator of the Company's properties did not create any material
environmental condition not known to the Company, or that an environmental
condition that could result in penalties, expenses, or liability to the Company
does not otherwise exist in any one or more of the Company's facilities. In
addition, the amount of hazardous substances or wastes produced or generated by
the Company may increase in the future depending on changes in the Company's
operations. Any failure by the Company to comply with present or future
environmental laws could subject it to the imposition of substantial fines,
suspension of production, alteration of manufacturing processes or cessation of
operations, any of which could have a material adverse effect on the Company.
Compliance with such environmental laws could require the Company to acquire
expensive remediation equipment or to incur substantial expenses. Furthermore,
the presence of hazardous substances on a property or at certain offsite
locations could result in the Company incurring substantial liabilities as a
result of a claim by a private third-party for personal injury or a claim by an
adjacent property owner for property damage. The imposition of any of the
foregoing liabilities could materially adversely affect the Company.
Limited Protection of Intellectual Property Rights; Risk of Third-Party Claims
of Infringement
The Company currently holds a number of domestic and international patents
and has on file applications for additional patents. Although the Company
assesses the advisability of patenting any technological development, the
Company has historically relied, in the information security area, primarily on
(i) copyright
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and trade secret law and (ii) employee and third-party non-disclosure agreements
to protect its proprietary intellectual property and rights. The protection
afforded by such means may not be as complete as patent protection. In addition,
the laws of some countries do not protect trade secrets. There are limitations
on the availability of patent protection as a means to protect the Company's
products. Even when patent protection can be obtained, there are often
limitations on the enforceability of such patent rights. The Company's inability
to preserve all of its proprietary intellectual property and rights could have a
material adverse effect on the Company. See "-- Intellectual Property."
ITEM 2. PROPERTIES
The Company occupies a 43,500 square foot two-story administrative and
manufacturing facility located at 4800 NW 1st Street, Lincoln, Nebraska, 68521,
which is located in the University of Nebraska Technology Park. The Company owns
this facility and approximately 10 acres of surrounding land. The Company has
begun Phase 3 construction of additional administrative facilities at its
Lincoln, Nebraska campus totaling approximately 33,000 square feet. On January
28, 1998, the Company purchased the 250,000 square-foot manufacturing facility
located on a 20-acre site in Waseca, Minnesota. The Company also leases
additional sales and service facilities in Burnsville, Minnesota, Miami,
Florida, and Hong Kong.
ITEM 3. LEGAL PROCEEDINGS
The Company has been named as a defendant in thirteen class action lawsuits
that were filed subsequent to the Company's announcement on March 27, 1998 that
the filing of its Annual Report on Form 10-K for year ended December 31, 1997
would be delayed and that adjustments would be made to the Company's previously
announced financial results. Between March 31, 1998 and May 27, 1998, twelve
purported class action lawsuits were filed against the Company in the United
States District Court for the District of Nebraska and one complaint was filed
in the District Court of Scotts Bluff County, Nebraska. Certain of the
complaints also name one or more officers of the Company as additional
defendants. The longest class period alleged in any of the class complaints is
the period from January 22, 1997 through April 24, 1998.
The complaints generally allege claims under Sections 10 and 20(a) of the
Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and
relate primarily to allegations of false and misleading financial statements and
representations and material omissions by the Company. The Nebraska action
alleges violations of Nebraska securities laws. The complaints seek unspecified
compensatory damages, punitive damages, attorneys' fees and costs. The federal
actions have recently been consolidated. The Company is not required to answer
or otherwise respond to the federal complaints until a consolidated complaint is
filed.
The Company may in the future be the subject of additional lawsuits or
claims in connection with the events or facts surrounding its restatement of
previously announced financial results. The Company is unable to predict when or
whether such additional lawsuits or claims may be initiated or the likelihood of
the outcome or range or amount of potential liability that may arise therefrom.
Although the complaints described above do not allege the amount of damages
and other relief that the plaintiffs are seeking, the Company believes the
amount of damages ultimately sought by the plaintiffs will be significant. In
light of the Company's restatement of financial information contained in its
various registration statements and prospectuses, the Company believes that
there may be an unfavorable outcome for at least some of the claims asserted in
the lawsuits or which may be asserted in the future against the Company. The
Company believes that the stockholder class actions are more likely to settle
than proceed to trial, judgment and appeal. Given the circumstances of these
cases, the terms of a settlement would be structured in a manner to avoid
causing the Company to seek protection under the federal bankruptcy
reorganization laws. In any circumstances where the Company could not structure
a settlement of all claims within its financial resources, it would vigorously
defend any attempt to establish the amount of liability or to require payment
beyond its resources. The Company has directors' and officers' liability
insurance that may cover a portion of the legal fees incurred and certain of the
damages sought in connection with the class action lawsuits. Many factors will
ultimately affect and determine the results of the litigation however, and the
Company can provide no
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assurances that the outcome will not have a significant adverse effect on the
Company's business, financial condition, results of operations and cash flows.
In April 1998, the SEC issued a formal order of investigation to determine
whether violations of certain aspects of the Federal securities laws had
occurred in connection with the Company. At the present time, the Company is
unable to predict whether the SEC is likely to initiate proceedings against the
Company or its affiliated parties relating to these events.
During 1997, on the basis of product orders placed with the Company by
federal personnel within the Maryland Procurement Office ("MPO"), which acts as
the purchasing arm for various federal agencies in the Washington DC area, the
Company shipped approximately $2.2 million of encrypted radio equipment and
related items to MPO. MPO has taken the position that the person placing the
orders on behalf of MPO was not authorized to do so, and therefore, has refused
payment. In March 1998, the Company filed a certified contract claim for
payment. Alternatively, the Company has requested ratification, by which MPO
would treat the procurement as an authorized commitment. To date, MPO has
rejected ratification. The contract claim is pending, and the Company is unable
to predict whether the likelihood of a favorable final outcome is probable or
remote.
The Company is involved in certain other legal proceedings incidental to
the normal conduct of its business. The Company does not believe that any
liabilities relating to such other legal proceedings are likely to be,
individually or in the aggregate, material to the Company's business, financial
condition, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's stockholders during
the fourth quarter of 1997.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
From the completion of the Company's initial public offering on January 22,
1997 through May 11, 1998, the Company's Common Stock was quoted on The Nasdaq
Stock Market as a National Market issue under the symbol "TRII." The following
table sets forth, in the periods indicated, the high and low sales prices per
share of the Common Stock, as reported by Nasdaq for the periods presented. As
of July 22, 1998, the Company had 155 stockholders of record.
1997 HIGH LOW
---- ------- -------
Fourth Quarter........................... $26.00 $ 20.125
Third Quarter............................ $21.75 $ 10.00
Second Quarter........................... $14.75 $ 6.75
First Quarter............................ $10.063 $ 7.00
Based on its review of recent events regarding the Company and the
Company's failure to timely file its periodic reports and audited financial
statements for the 1997 fiscal year, The Nasdaq Stock Market halted trading in
the Company's Common Stock effective April 27, 1998, and delisted the Common
Stock on May 11, 1998. The Company has appealed the delisting. The Company
intends that, if it is unsuccessful in its appeal, it will reapply to have its
Common Stock listed on The Nasdaq Stock Market. However, no assurance can be
given as to the Company's ability to obtain a listing for the Common Stock.
The last sale price of the Common Stock on July 23, 1998, as reported in
the non-Nasdaq over the counter market, was $5.25.
If the Common Stock were neither relisted on the Nasdaq National Market
System nor listed for trading on the Nasdaq Small-Cap Market, trading, if any,
in the Common Stock might be conducted on the OTC Bulletin Board or may continue
to be conducted in the non-Nasdaq over the counter market. However, if the
Company is not able to list the Common Stock on any Nasdaq market, it may
materially adversely affect the trading market and prices for the Common Stock
and the Company's ability to issue additional securities or to secure additional
financing.
DIVIDENDS
The Company has never paid and has no present intention of paying cash
dividends on its Common Stock. Any determination in the future to pay dividends
will depend on the Company's financial condition, capital requirements, results
of operations, contractual limitations and any other factors deemed relevant by
the Company's Board of Directors.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data of the Company is
qualified by reference to, and should be read together with, the Consolidated
Financial Statements and Notes thereto and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included elsewhere in this
Annual Report on Form 10-K. The Consolidated Statement of Operations data for
the years ended December 31, 1997, 1996 and 1995 and the Consolidated Balance
Sheet data as of December 31, 1997 and 1996 are derived from the Consolidated
Financial Statements of the Company included elsewhere in this Annual Report on
Form 10-K. The Consolidated Statement of Operations data for the years ended
December 31, 1994 and 1993 and the Consolidated Balance Sheet data as of
December 31, 1995, 1994, and 1993 are derived from financial statements not
included herein.
The Company restated its previously released results for the three months
and year ended December 31, 1997, the Company's financial statements as of and
for the year ended December 31, 1996 and the financial statements as of and for
each of the quarterly periods ended March 31, June 30, September 30, and
December 31 during 1997 and 1996. See Notes 2 and 21 of Notes to Consolidated
Financial Statements. The restatements relate primarily to: (i) revenue
recognition for certain sales for which collection was determined to not be
reasonably assured or was contingent on a future event, (ii) revenue recognition
for certain sales where a formal written agreement was not received, (iii)
revenue recognized on sales of certain products which were subsequently returned
to the Company, (iv) application of the percentage of completion method on
system contract sales at E.F. Johnson and (v) the allocation of the purchase
price of the acquisition of E.F. Johnson.
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1993 1994 1995 1996 1997(6)
------ ------ ---------- ---------- -----------
(RESTATED) (RESTATED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues................................... $6,900 $9,155 $ 8,128 $ 10,619 $ 40,423
Cost of sales.............................. 1,616 2,901 2,983 4,274 26,106
------ ------ ---------- ---------- -----------
Gross profit............................... 5,284 6,254 5,145 6,345 14,317
------ ------ ---------- ---------- -----------
Operating costs and expenses:
Research and development................. 1,138 1,180 1,953 2,234 4,469
Sales and marketing...................... 982 1,590 2,109 2,187 7,031
General and administrative(1)............ 2,243 2,166 2,284 2,529 4,711
Special compensation expense(2).......... -- -- -- 5,568 --
In-process research and development
costs(3).............................. -- -- -- -- 9,828
------ ------ ---------- ---------- -----------
Total operating costs and
expenses....................... 4,363 4,936 6,346 12,518 26,039
------ ------ ---------- ---------- -----------
Income (loss) from operations.............. 921 1,318 (1,201) (6,173) (11,722)
Interest income (expense), net............. (133) (111) (137) (131) 231
Other income............................... -- -- -- -- 18
Benefit for income taxes................... -- -- -- (2,186) (524)
------ ------ ---------- ---------- -----------
Net income (loss).......................... $ 788 $1,207 $ (1,338) $ (4,118) $ (10,949)
====== ====== ========== ========== ===========
Loss before pro forma taxes................ $ (1,338) $ (6,304) $ (11,473)
Pro forma and provision (benefit) for
taxes(4)................................. (496) (2,190) (524)
---------- ---------- -----------
Pro forma net loss......................... $ (842) $ (4,114) $ (10,949)
========== ========== ===========
Pro forma net loss per share(5) -- Basic
and Diluted.............................. $ (0.12) $ (0.61) $ (1.09)
========== ========== ===========
Weighted average common shares -- Basic and
Diluted(5)............................... 6,783,078 6,783,078 10,056,690
========== ========== ===========
27
28
YEAR ENDED DECEMBER 31,
-------------------------------------------------------
1993 1994 1995 1996 1997(6)
------ ------ ---------- ---------- -----------
(RESTATED) (RESTATED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
CONSOLIDATED BALANCE SHEET DATA:
Working capital............................ $1,726 $3,353 $ 1,684 $ 1,844 $ 44,836
Total assets............................... $7,908 $9,627 $ 7,523 $ 11,938 $ 106,694
Long-term debt and capitalized lease
obligations, net of current portion...... $2,035 $2,164 $ 1,847 $ 2,632 $ 2,758
Stockholders' equity....................... $4,599 $5,945 $ 3,907 $ 4,966 $ 75,390
- ---------------
(1) Includes amortization of intangible assets. For years prior to 1997,
includes the amortization of intangible assets related to the acquisition of
the Company's business in December 1991. Commencing in August 1997,
amortization of intangible assets related to the acquisition of E.F. Johnson
began. See "ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS -- Results of Operations -- General and
Administrative."