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-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UTafpQDAnbveN8a4uC8fZ2D2AHVSdD0NZHA+VSi4iA0nxFmofN+npO+Q6bdB5ZUZ PmNvaTUMUYJGhgNnzjgpcg== 0000950134-07-011641.txt : 20070515 0000950134-07-011641.hdr.sgml : 20070515 20070515161810 ACCESSION NUMBER: 0000950134-07-011641 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20070331 FILED AS OF DATE: 20070515 DATE AS OF CHANGE: 20070515 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DIGITAL RECORDERS INC CENTRAL INDEX KEY: 0000853695 STANDARD INDUSTRIAL CLASSIFICATION: COMMUNICATIONS EQUIPMENT, NEC [3669] IRS NUMBER: 561362926 STATE OF INCORPORATION: NC FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-28539 FILM NUMBER: 07853520 BUSINESS ADDRESS: STREET 1: 5949 SHERRY LANE STREET 2: SUITE 1050 CITY: DALLAS STATE: TX ZIP: 75225 BUSINESS PHONE: (214) 378-8992 MAIL ADDRESS: STREET 1: 5949 SHERRY LANE STREET 2: SUITE 1050 CITY: DALLAS STATE: TX ZIP: 75225 10-Q 1 d46691e10vq.htm FORM 10-Q e10vq

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarterly Period Ended March 31, 2007

Commission File Number 1-13408

DIGITAL RECORDERS, INC.

(Exact name of Registrant as specified in its Charter)


North Carolina		56-1362926
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification Number)

5949 Sherry Lane, Suite 1050
Dallas, Texas 75225
(Address of principal executive offices, Zip Code)

Registrant’s telephone number, including area code: (214) 378-8992

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer o Non-accelerated filer þ

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

Indicate the number of shares outstanding of the Registrant’s Common Stock as of April 30, 2007:


Common Stock, par value $.10 per share		10,387,055
(Class of Common Stock)		Number of Shares

DIGITAL RECORDERS, INC. AND SUBSIDIARIES

INDEX


		Page No.
	PART I - FINANCIAL INFORMATION

Item 1.	Financial Statements
	Consolidated Balance Sheets – March 31, 2007 (Unaudited) and December 31, 2006		3
	Consolidated Statements of Operations – Three Months Ended March 31, 2007 and 2006 (Unaudited)		4
	Consolidated Statements of Cash Flows – Three Months Ended March 31, 2007 and 2006 (Unaudited)		5
	Notes to Unaudited Consolidated Financial Statements		7
Item 2.	Management's Discussion and Analysis of Financial Conditions and Results of Operations		17
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		24
Item 4T.	Controls and Procedures		24

	PART II - OTHER INFORMATION

Item 1.	Legal Proceedings		26
Item 1A.	Risk Factors		26
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		33
Item 3.	Defaults Upon Senior Securities		33
Item 4.	Submission of Matters to a Vote of Securityholders		33
Item 5.	Other Information		33
Item 6.	Exhibits		34

	SIGNATURES		37
Share Purchase Agreement
Promissory Note
Waiver and Consent
Section 302 Certification of David L. Turney
Section 302 Certification of Stephen P. Slay
Section 906 Certification of David L. Turney
Section 906 Certification of Stephen P. Slay

PART I — FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

DIGITAL RECORDERS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except shares and per share amounts)


	March 31, 2007			December 31, 2006
	(Unaudited)			(Note 1)
ASSETS
Current Assets
Cash and cash equivalents	$	604		$	611
Trade accounts receivable, net		9,228			10,368
Other receivables		376			147
Inventories		9,525			9,324
Prepaids and other current assets		357			429

Total current assets		20,090			20,879


Property and equipment, net		2,924			3,131
Goodwill		11,016			11,250
Intangible assets, net		1,058			1,110
Deferred tax assets, net		186			191
Other assets		657			797

Total assets	$	35,931		$	37,358

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Lines of credit	$	7,235		$	7,608
Notes payable, net		1,596			1,584
Current portion of long-term debt		254			254
Current portion of foreign tax settlement		420			393
Accounts payable		5,278			5,620
Accrued expenses		3,178			2,935
Preferred stock dividends payable		22			23

Total current liabilities		17,983			18,417


Long-term debt and capital leases, long-term		35			42


Foreign tax settlement, long-term		1,122			1,087


Deferred tax liabilities		366			383


Minority interest in consolidated subsidiary		209			234


Commitments and contingencies (Notes 6 and 7)

Shareholders’ Equity
Series E Redeemable, Nonvoting, Convertible Preferred Stock, $.10 par value, liquidation preference of $5,000 per share; 500 shares authorized; 183 shares issued and outstanding at March 31, 2007, and December 31, 2006; redeemable at the discretion of the Company at any time.		495			495
Series G Redeemable, Convertible Preferred Stock, $.10 par value, liquidation preference of $5,000 per share; 600 shares authorized; 386 and 379 shares issued and outstanding at March 31, 2007 and December 31, 2006, respectively; redeemable at the discretion of the Company after five years from date of issuance.		1,648			1,613
Series H Redeemable, Convertible Preferred Stock, $.10 par value, liquidation preference of $5,000 per share; 600 shares authorized; 55 and 54 shares issued and outstanding at March 31, 2007, and December 31, 2006, respectively; redeemable at the discretion of the Company after five years from date of issuance.		227			222
Series I Redeemable, Convertible Preferred Stock, $.10 par value, liquidation preference of $5,000 per share; 200 shares authorized; 0 and 104 shares issued and outstanding at March 31, 2007, and December 31, 2006, respectively; redeemable at the discretion of the Company after five years from date of issuance.		—			471
Series AAA Redeemable, Nonvoting, Convertible Preferred Stock, $.10 par value, liquidation preference of $5,000 per share; 20,000 shares authorized; 178 shares issued and outstanding at March 31, 2007 and December 31, 2006; redeemable at the discretion of the Company at any time.		890			890
Common stock, $.10 par value, 25,000,000 shares authorized; 10,387,055 and 10,045,675 shares issued and outstanding at March 31, 2007 and December 31, 2006, respectively.		1,039			1,004
Additional paid-in capital		31,907			31,517
Accumulated other comprehensive income — foreign currency translation		3,194			3,397
Accumulated deficit		(23,184	)		(22,414	)

Total shareholders’ equity		16,216			17,195

Total liabilities and shareholders’ equity	$	35,931		$	37,358

See accompanying notes to unaudited consolidated financial statements.

DIGITAL RECORDERS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006

(In thousands, except shares and per share amounts)

(Unaudited)


	Three Months Ended March 31,
	2007			2006
Net sales	$	12,168		$	11,112
Cost of sales		8,521			7,669

Gross profit		3,647			3,443


Operating expenses
Selling, general and administrative		3,747			3,673
Research and development		332			258

Total operating expenses		4,079			3,931


Operating loss		(432	)		(488	)


Other income (loss)		11			(76	)
Foreign currency gain (loss )		(25	)		26
Interest expense		(315	)		(213	)

Total other income and expense		(329	)		(263	)


Loss before income tax expense		(761	)		(751	)

Income tax expense		(34	)		(46	)


Loss before minority interest in loss of consolidated subsidiary		(795	)		(797	)

Minority interest in loss of consolidated subsidiary		25			48


Net loss		(770	)		(749	)

Provision for preferred stock dividends		(76	)		(68	)
Amortization for discount on preferred stock		—			(49	)


Net loss applicable to common shareholders	$	(846	)	$	(866	)


Net loss per share applicable to common shareholders
Basic and diluted	$	(0.08	)	$	(0.09	)


Weighted average number of common shares and common share equivalent outstanding
Basic and diluted		10,173,578			9,751,290

See accompanying notes to unaudited consolidated financial statements.

DIGITAL RECORDERS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

FOR THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006

(In thousands)


	Three Months Ended March 31,
	2007			2006
Cash flows from operating activities
Net loss	$	(770	)	$	(749	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities
Deferred income taxes		(15	)		2
Depreciation and amortization of property and equipment		317			337
Amortization of intangible assets		30			27
Amortization of deferred financing costs		83			94
Amortization of the fair value of warrants		69			25
Stock issued in lieu of cash compensation		21			—
Stock-based compensation expense		9			—
Loss on sale of fixed assets		1			5
Other, primarily effect of foreign currency gain/loss		(8	)		57
Minority interest in loss of consolidated subsidiary		(25	)		(48	)
Changes in operating assets and liabilities
(Increase ) decrease in trade accounts receivable		1,151			(1,080	)
(Increase ) decrease in other receivables		(225	)		12
(Increase ) decrease in inventories		(181	)		488
(Increase ) decrease in prepaids and other current assets		71			(63	)
Increase in other assets		—			(7	)
Increase (decrease) in accounts payable		(306	)		66
Increase (decrease) in accrued expenses		235			(231	)
Increase in foreign tax settlement		39			—

Net cash provided by (used in) operating activities		496			(1,065	)


Cash flows from investing activities
Proceeds from sale of fixed assets		39			2
Purchases of property and equipment		(80	)		(63	)
Investments in software development		(98	)		(48	)

Net cash used in investing activities		(139	)		(109	)


Cash flows from financing activities
Proceeds from bank borrowings and lines of credit		16,633			15,885
Principal payments on bank borrowings and lines of credit		(16,975	)		(14,910	)
Proceeds from issuance of Preferred stock, net of costs		—			485
Payments related to financing of new line of credit		—			(329	)
Payment of dividends on Preferred stock		(36	)		(29	)

Net cash provided by (used in) financing activities		(378	)		1,102


Effect of exchange rate changes on cash and cash equivalents		14			32


Net decrease in cash and cash equivalents		(7	)		(40	)

Cash and cash equivalents at beginning of period		611			807


Cash and cash equivalents at end of period	$	604		$	767


	Three Months Ended March 31,
	2007		2006
Supplemental disclosures of non-cash investing and financing activities:

Conversion of preferred stock to common stock	$	520	$	120

Relative fair value allocated to warrants issued in connection with sale of preferred stock	$	—	$	49

Amortization of preferred stock beneficial conversion feature	$	—	$	49

Amortization of convertible subordinated debenture beneficial conversion feature	$	—	$	81

Fair value of warrants issued in connection with financing of new line of credit	$	—	$	590

See accompanying notes to unaudited consolidated financial statements.

DIGITAL RECORDERS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

In this Quarterly Report on Form 10-Q, we will refer to Digital Recorders, Inc. as “DRI,” “Company,” “we,” “us” and “our.” DRI was incorporated in 1983. DRI’s Common Stock, $.10 par value per share, trades on the NASDAQ Capital Market(TM) under the symbol “TBUS” and on the Boston Stock Exchange under the symbol “TBUS.”

Through its business units and wholly owned subsidiaries, DRI manufactures, sells, and services information technology, security, and audio surveillance technology products either directly or through manufacturers’ representatives. DRI currently operates within two business segments: (1) the Transportation Communications segment, and (2) the Law Enforcement and Surveillance segment. Customers include municipalities, regional transportation districts, federal, state and local departments of transportation, bus manufacturers, and law enforcement agencies and organizations. The Company markets to customers located in North and South America, the Far East, the Middle East, Asia, Australia, and Europe.

(1) BASIS OF PRESENTATION AND DISCLOSURE

The unaudited interim consolidated financial statements and related notes have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and footnote disclosures normally included in the financial statements prepared in accordance with generally accepted accounting principles in the United States of America have been omitted pursuant to such rules and regulations. In the opinion of management, the accompanying unaudited interim consolidated financial statements contain all adjustments and information (consisting only of normal recurring accruals) considered necessary for a fair statement of the results for the interim periods presented.

The year end balance sheet data was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America. The accompanying unaudited interim consolidated financial statements and related notes should be read in conjunction with the Company’s audited financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2006. The results of operations for the three months ended March 31, 2007, are not necessarily indicative of the results to be expected for the full fiscal year.

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. As a result of the Company’s short-term liquidity needs, recurring losses, and significant accumulated deficit, the Report of Independent Registered Public Accounting Firm on the financial statements of the Company as of and for the year ended December 31, 2006 included in the Company’s 2006 Annual Report on Form 10-K (“2006 Annual Report”) contained an explanatory paragraph expressing substantial doubt about the Company’s ability to continue as a going concern. Management’s plans to address the liquidity needs of the Company were included in Note 1 of the Notes to Consolidated Financial Statements presented in the 2006 Annual Report. The accompanying consolidated financial statements do not reflect any adjustments that might be necessary if the Company is unable to continue as a going concern.

We have incurred substantial losses to date, including a net loss applicable to common shareholders of $846,000 in the first quarter of 2007, and, as of March 31, 2007, have an accumulated deficit of $23.2 million. Operating losses in recent periods have narrowed as a result of increased sales and lower operating expenses and those improvements may continue in future periods. However, those results could vary and such variance could have a significant adverse effect on the Company’s liquidity. We believe that cost containment and expense reductions are essential if we are to achieve profitability and continue our current operations. During late 2006 and the first quarter of 2007, the Company implemented limited workforce reduction by attrition and, as a result, payroll expense was reduced by approximately $264,000 annually. Management has additionally implemented, effective in the second quarter of 2007, adjustments to the work force to reduce expenses by an estimated $1.2 million annually, bringing the total reduction of expenses of such actions to an estimated $1.4 million annually. We cannot assure you these expense reductions or expense reductions that may occur in the future will be sufficient to allow us to achieve profitability or continue our operations.

Our primary source of liquidity and capital resources has been from financing activities. The payment of $1.1 million on the outstanding note payable with Laurus Master Fund, Ltd. in April 2007 (Note 13) addressed a significant short-term liquidity need. However, we expect to require additional financing to continue to support operations. Historically, we have supplementally financed operations through private placements of our securities. However, there can be no assurances that such placements will occur or be possible in the future.

Currently, we are managing our cash accounts on a day-to-day basis and have deferred payments on trade payables which are otherwise due to vendors that supply component parts critical to producing the products we sell to our customers. Further deferrals of payments to these critical vendors could result in one or more of these vendors placing us on credit hold and not making further shipments to us until we have paid past due amounts. If this occurs and we are unable to cause such vendors to resume shipments before our on-hand inventory of those components is exhausted, we may be unable to fulfill customer orders for our products. The failure to meet customer orders in a timely fashion could cause us to lose customers or cause our customers to reduce their orders for our products. In either event, this could substantially reduce our revenues and have a material adverse effect on the Company’s financial position.

Any or all of the circumstances described herein could cause us to be unable to continue our operations. These circumstances raise substantial doubt about our ability to continue as a going concern.

Product Warranties

The Company provides a limited warranty for its products, generally for a period of one to three years. The Company’s standard warranties require the Company to repair or replace defective products during such warranty period at no cost to the customer. The Company estimates the costs that may be incurred under its basic limited warranty and records a liability in the amount of such costs at the time product sales are recognized. Factors that affect the Company’s warranty liability include such things as the number of units sold, historical and anticipated rates of warranty claims, and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. The following table summarizes product warranty activity during the three months ended March 31, 2007 and 2006.


	Three Months ended March 31,
	2007			2006
Balance at beginning of period	$	384		$	214
Additions charged to costs and expenses		—			—
Deductions		(20	)		—
Foreign exchange translation (gain) loss		(2	)		4

Balance at end of period	$	362		$	218

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements.” The Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company believes the adoption of SFAS 157 will not have a material impact on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115.” SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS No. 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We do not expect our adoption of this new standard to have a material impact on our financial position, results of operations or cash flows.

(2) GOODWILL AND OTHER INTANGIBLE ASSETS

The change in goodwill from December 31, 2006 to March 31, 2007 of $233,000 is due to foreign exchange rate fluctuation.

(3) INVENTORIES


	March 31,		December 31,
	2007		2006
	(In thousands)
Raw materials and system components	$	6,478	$	6,162
Work in process		134		144
Finished goods		2,913		3,018

Total inventories	$	9,525	$	9,324

(4) PROPERTY AND EQUIPMENT


	Estimated
	Depreciable	March 31,		December 31,
	Lives (years)	2007		2006
		(In thousands)
Leasehold improvements	5 - 9	$	276	$	276
Automobiles	5		16		16
Computer and telecommunications equipment	3		1,300		1,296
Software	3 - 5		4,858		4,912
Test equipment	3 - 5		275		273
Furniture and fixtures	3 - 7		2,531		2,526
Software projects in progress			152		54

			9,408		9,353
Less accumulated depreciation and amortization			6,484		6,222

Total property and equipment, net		$	2,924	$	3,131

(5) ACCRUED EXPENSES


	March 31,		December 31,
	2007		2006
	(In thousands)
Salaries, commissions, and benefits	$	1,408	$	1,187
Taxes — payroll, sales, income, and other		588		623
Warranties		362		384
Current portion of capital leases		22		22
Interest payable		68		51
Deferred revenue		484		196
Other		246		472

Total accrued expenses	$	3,178	$	2,935

(6) LINES OF CREDIT AND NOTES PAYABLE

(a) Domestic lines of credit and notes payable

U.S. Working Capital Line of Credit. In March 2006, the Company entered into a two-year, asset-based lending agreement with Laurus Master Fund, Ltd. (“Laurus Credit Agreement”) to replace an existing lending agreement with LaSalle Business Credit (“LaSalle Credit Agreement”). The Laurus Credit Agreement provides up to $6.0 million in borrowings under a revolving credit facility and is secured by all tangible and intangible assets of the Company in the U.S. Borrowing availability under the Laurus Credit Agreement is based upon an advance rate equal to 90% of eligible accounts receivable and up to $2.0 million based upon 40% of eligible inventory. The interest rate on borrowings under the Laurus Credit Agreement is the Wall Street Journal prime rate (8.25% at March 31, 2007) plus 1.75%, subject to a floor of 8%. The Laurus Credit Agreement contains no financial covenants. Borrowings

under the revolving credit facility were used to retire all outstanding debt under the LaSalle Credit Agreement and have been and will be used for general corporate purposes. At March 31, 2007, remaining borrowing availability under the revolving credit facility was approximately $1.0 million. The Company incurred expenses of $329,000 directly attributable to executing the Laurus Credit Agreement which have been recorded as deferred financing costs to be amortized over the term of the agreement. These deferred financing costs are included in other assets in the accompanying consolidated balance sheet.

In conjunction with the closing of the Laurus Credit Agreement, the Company issued Laurus Master Fund Ltd. (“Laurus”) detachable warrants to purchase, at any time, 550,000 shares of Common Stock at $0.10 per share. The fair value allocated to the warrants of $590,000, calculated using the Black-Scholes model, has been recorded as an asset to be amortized over the term of the Laurus Credit Agreement and was recorded as an increase in additional paid in capital. The unamortized balance of the fair value of the warrants was $287,000 at March 31, 2007, all of which was included in other assets in the accompanying consolidated balance sheet. Laurus agreed to not hold greater than 4.99% of the Company’s outstanding Common Stock at any time under terms of the Laurus Credit Agreement.

On April 28, 2006, the Company, along with certain of its subsidiaries, entered into a Securities Purchase Agreement with Laurus whereby the Company issued a one-year, secured term promissory note in the original principal amount of $1.6 million (the “Note”). Under its original terms, the Note bears interest at an annual rate of 10%, with interest payable monthly in arrears, and matures April 28, 2007. The Note is secured by all U.S. assets of the Company pursuant to the Security Agreement executed as part of the Laurus Credit Agreement entered into in March 2006, which was extended to cover the Note. In addition, the Note carried a $160,000 fee upon payment of the Note, whether the Note is paid on or prior to the maturity date, which was being recognized ratably over the term of the Note. As of March 31, 2007, the entire original principal amount of $1.6 million was outstanding on the Note. See amended terms of the Note in this footnote below and disclosure of payment of a portion of the outstanding principal of the Note in Note 13.

As part of the financing, the Company granted Laurus warrants to purchase, at any time during a seven-year period, 80,000 shares of Common Stock at an exercise price of $2.00 per share (the “Warrants”). The fair value allocated to the warrants of $49,000, calculated using the Black-Scholes model, has been recorded as a contra-liability to be amortized over the term of the Note agreement and was recorded as an increase in additional paid in capital. The unamortized balance of the fair value of the warrants was $4,000 at March 31, 2007. Laurus agreed to a 12-month lock-up on trading of the Common Stock underlying the Warrants as well as on the warrants to purchase 550,000 shares of Common Stock previously issued to Laurus in connection with the Laurus Credit Agreement entered into in March 2006. Pursuant to an Amended and Restated Registration Rights Agreement, the Company filed a registration statement with respect to the shares of Common Stock issuable upon exercise of the 630,000 warrants issued to Laurus with the Securities and Exchange Commission on May 15, 2006, and the registration was declared effective on May 23, 2006.

Fees and expenses related to the Note and issuance of the Warrants totaled approximately $81,000, netting proceeds to the Company of approximately $1.5 million, which was used for general corporate purposes. The related fees and expenses have been recorded as deferred financing costs and are being amortized over the term of the Note. These deferred financing costs are included in other assets in the accompanying consolidated balance sheet as of March 31, 2007.

Pursuant to an Omnibus Amendment (the “Amendment”) effective December 31, 2006, and in exchange for the issuance by the Company to Laurus of 225,000 shares of our Common Stock and the payment of a servicing fee by the Company to Laurus in the amount of $18,000, the Company and Laurus (1) increased the limitation on the amount of our Common Stock that Laurus is permitted to hold from 4.99% to 9.99%; (2) agreed that (a) Laurus shall not sell any shares of our Common Stock before the first anniversary of the date of execution of the Amendment and (b) at any time after the first anniversary of the date of execution of the Amendment, Laurus shall not sell any shares of our Common Stock in a number that, together with any sales by any affiliate of Laurus, would exceed 25% of the aggregate dollar trading volume of the Common Stock of the Company for the 22-day period immediately preceding such proposed sale; (3) extended the maturity date of the revolving credit facility under the Laurus Credit Agreement until June 30, 2008; (4) amended and restated the Note to (a) eliminate the $160,000 fee that was due and payable on the maturity date of the Note and (b) allow the Company the option to extend up to $500,000 of the principal amount due under the Note until April 30, 2008; and (5) amended and restated the Amended and Restated Registration Rights Agreement dated as of April 28, 2006 to require the Company to register the 225,000 shares of Common Stock issued to Laurus with the Securities and Exchange Commission within 365 days after issuance of such shares.

b) International lines of credit

Mobitec AB, the Company’s wholly owned Swedish subsidiary, has agreements with banks in Sweden from which it may currently borrow up to a maximum of 19 million krona, or $2.7 million U.S., based on the March 31, 2007, exchange rate of 0.1429. Additional borrowing availability at March 31, 2007, amounted to approximately $420,000 U.S. Of the $2.7 million borrowing capacity under these agreements, $2.3 million renews annually on a calendar-year basis and $429,000 renews at various periods agreed-upon by both parties, with current expiration of June 30, 2007.

Mobitec GmbH (formerly known as Transit Media-Mobitec GmbH), the Company’s wholly owned subsidiary in Germany, has an agreement with a German bank from which it may currently borrow up to a maximum of 512,000 Euros, or $683,000 U.S., based on the March 31, 2007, exchange rate of 1.3335. Additional borrowing availability at March 31, 2007, amounted to approximately $27,000 U.S. The agreement under which this line of credit is extended has an open-ended term.

Lines of credit consist of the following:


	March 31,		December 31,
	2007		2006
	(In thousands)
Line of credit with Laurus Master Fund dated March 16, 2006; payable in full June 30, 2008; secured by a ll tangible and intangible U.S. assets of the Company; bears average interest rate of 9.17% and 9.69% in 2007 and 2006, respectively.	$	4,284	$	4,406

Line of credit with Swedish bank, certain borrowings dated December 31, 2006 which renew annually and certain borrowings dated March 31, 2007 which renew at various periods agreed-to by the bank and the Company; expiration dates of December 31, 2007 for borrowings under annual renewal and June 30, 2007 for borrowings renewing at various periods; secured by certain assets of the Swedish subsidiary, Mobitec AB; bears average interest rate of 4.04% and 3.23% in 2007 and 2006, respectively.		1,180		1,450

Line of credit with Swedish bank dated December 31, 2006; expires on December 31, 2007; secured by accounts receivable of the Swedish subsidiary, Mobitec AB; bears average interest rate of 4.85% and 4.23% in 2007 and 2006, respectively.		1,115		1,116

Line of credit with German bank dated June 23, 2004; open-ended term; secured by accounts receivable and inventory of the German subsidiary, Mobitec GmbH (formerly known as Transit Media-Mobitec GmbH); bears average interest rate of 4.85% and 4.12% in 2007 and 2006, respectively.		656		636


Total lines of credit	$	7,235	$	7,608

(7) LONG-TERM DEBT

Long-term debt consists of the following:


	March 31,		December 31,
	2007		2006
	(In thousands)
Convertible debenture to a director dated August 26, 2002, payable in full August 26, 2009, with an interest rate of 8%.	$	250	$	250

Other long-term debt		7		8


Total long-term debt		257		258
Less current portion		254		254

		3		4

Long-term portion of capital leases		32		38

Total long-term debt and capital leases, less current portion	$	35	$	42

The issuance of Series I Redeemable, Convertible Preferred Stock in March 2006 caused the conversion rate on the $250,000 convertible debenture in the table above to change in accordance with the original terms of the debenture, which include anti-dilution provisions, from $2.00 per share to $1.60 per share. The decrease in conversion price resulted in a beneficial conversion feature of the debenture valued at $81,000 which was treated as a discount to the debenture and was recorded as an increase in additional paid in capital. As the debenture is immediately convertible, the full amount of the discount was amortized and recorded as interest expense for the three months ended March 31, 2006. The issuance of 225,000 shares of our Common Stock to Laurus in December 2006 caused the conversion rate on the $250,000 convertible debenture in the table above to change from $1.60 per share to $1.21 per share. The decrease in conversion price resulted in a beneficial conversion feature of the debenture valued at $131,000 which was treated as a discount to the debenture and was recorded as an increase in additional paid in capital. As the debenture is immediately convertible, the full amount of the discount was amortized and recorded as interest expense in December, 2006. These changes in conversion rates resulted in a potential increase of 81,611 additional shares of Common Stock.

(8) PREFERRED STOCK

The Company’s preferred stock consists of 5,000,000 authorized shares, par value $.10 per share, 20,000 shares of which are designated as Series AAA Redeemable, Nonvoting, Convertible Preferred Stock (“Series AAA Preferred”), 30,000 shares of which are designated as Series D Junior Participating Preferred Stock (“Series D Preferred”), 500 shares of which are designated as Series E Redeemable, Nonvoting, Convertible Preferred Stock (“Series E Preferred”), 400 shares of which are designated as Series F Convertible Preferred Stock (“Series F Preferred”), 600 shares of which are designated as Series G Redeemable, Convertible Preferred Stock (“Series G Preferred”), 600 shares of which are designated as Series H Redeemable, Convertible Preferred Stock (“Series H Preferred”), 200 shares of which are designated as Series I Redeemable, Convertible Preferred Stock (“Series I Preferred”), and 4,947,700 shares of which remain undesignated. As of March 31, 2007, we had outstanding 178 shares of Series AAA Preferred, 183 shares of Series E Preferred, 386 shares of Series G Preferred, and 55 shares of Series H Preferred.

On February 27, 2007, 104 shares of Series I Preferred with a liquidation value of $520,000 were converted into 325,000 shares of the Company’s Common Stock. As a result of this conversion, there are no shares of Series I Preferred outstanding.

There are no shares of Series D and Series F Preferred outstanding.

(9) PER SHARE AMOUNTS

The basic net income (loss) per common share has been computed based upon the weighted average shares of Common Stock outstanding. Diluted net income (loss) per common share has been computed based upon the weighted average shares of Common Stock outstanding and shares that would have been outstanding assuming the issuance of Common Stock for all potentially dilutive equities outstanding. The Company’s convertible preferred stock, convertible debt, options and warrants represent the only potentially dilutive equities outstanding.

No recognition was given to potentially dilutive securities aggregating 4,387,513 and 4,662,484 shares as of March 31, 2007 and 2006, respectively. Due to the net loss applicable to common shareholders in those periods, such securities would have been anti-dilutive.

(10) COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) for the three months ended March 31, 2007 and 2006 consists of the following:


	Three Months Ended March 31,
	2007			2006
Net loss	$	(770	)	$	(749	)
Foreign currency translation adjustment		(203	)		284

Total comprehensive loss	$	(973	)	$	(465	)

(11) SEGMENT INFORMATION

The Company has two business segments, which are based upon differences in products, technology, and markets: (1) Transportation Communications segment; and (2) Law Enforcement and Surveillance segment. The Transportation Communications segment produces automated voice announcement systems, automated vehicle location systems, automated vehicle monitoring systems, passenger information systems, security products, and electronic destination sign products for municipalities, regional transportation districts, departments of transportation, and bus vehicle manufacturers. The Law Enforcement and Surveillance segment produces digital signal processing products for law enforcement agencies and intelligence gathering organizations.

Operating income (loss) for each segment is total sales less operating expenses applicable to the segment. Certain corporate overhead expenses, including executive salaries and benefits, public company administrative expenses, legal and audit fees, and interest expense, are not included in segment operating income (loss), but rather are reported under “Parent entities.” Segment long-lived assets include net property and equipment, net intangible assets, goodwill, and other assets. Sales, operating income (loss), long-lived assets, and geographic information for the operating segments are as follows:


	Three Months Ended March 31,
	2007			2006
	(In thousands)
Net sales
Transportation communications	$	12,000		$	10,755
Law enforcement and surveillance		168			357

	$	12,168		$	11,112


Operating income (loss)
Transportation communications	$	1,037		$	835
Law enforcement and surveillance		(176	)		(39	)
Parent entities (Corporate overhead)		(1,293	)		(1,284	)

	$	(432	)	$	(488	)


Geographic information — net sales
North America	$	6,116		$	6,261
Europe		3,626			2,517
Asia-Pacific		1,088			1,031
Middle East		299			417
South America		1,039			886

	$	12,168		$	11,112


	March 31,		December 31,
	2007		2006
Long -lived assets
North America	$	4,021	$	4,203
Europe		11,404		11,870
Asia-Pacific		31		31
South America		199		184

	$	15,655	$	16,288

(12) INCOME TAXES

On January 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on de-recognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. At the adoption date of January 1, 2007, the Company had no unrecognized income tax benefits.

We have evaluated the impact of adopting FIN 48 on our consolidated financial statements, and the adoption of FIN 48 did not have a material effect on our consolidated financial position, cash flows and results of operations. The Company files its tax returns as prescribed by the tax laws of the U.S. federal jurisdiction and various state and foreign jurisdictions in which it operates. The Company’s 2003 to 2006 tax years remain open to examination. Potential accrued interest on uncertain tax positions is recorded as a component of interest expense and potential accrued penalties are recorded as selling, general and administrative expenses, neither of which was significant upon adoption or at March 31, 2007.

As a result of its net operating loss carryforwards, the Company has significant deferred tax assets. SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”), requires a valuation allowance be established when it is more likely than not that all or a portion of deferred tax assets will not be realized. Accordingly, the Company recorded a benefit of $266,000 resulting from its taxable loss during the three months ended March 31, 2007, and simultaneously recorded a valuation allowance equal to the benefit. The Company’s total deferred tax assets as of March 31, 2007, are $8.0 million and its deferred tax valuation allowance is $7.8 million. In addition, as a result of its equity transactions during 2004, the Company has determined its ability to use its net operating loss carryforwards and related tax benefits in any single year is limited under the Internal Revenue Code.

The Company’s income tax expense of $34,000 for the three months ended March 31, 2007, is comprised of deferred tax benefits of $15,000 arising from domestic tax jurisdictions, deferred tax expense of $62,000 arising from foreign tax jurisdictions and current tax benefits of $13,000 arising from foreign tax jurisdictions. The Company’s effective tax expense (benefit) rate of 4.5% for the three months ended March 31, 2007, differs from the expected statutory tax expense (benefit) rate of (35)% primarily due to recording additional valuation allowance on deferred tax assets and higher rates on earnings of foreign operations.

(13) SUBSEQUENT EVENTS

On April 30, 2007 (the “Closing Date”), the Company and its wholly owned subsidiary Digital Audio Corporation (“DAC”) entered into a Share Purchase Agreement (the “Purchase Agreement”) with Dolphin Direct Equity Partners, LP (“Dolphin”), a Delaware limited partnership, pursuant to which Dolphin acquired all of DAC’s issued and outstanding shares of common stock for an aggregate purchase price equal to DAC’s balance sheet net book value as of April 30, 2007, as preliminarily agreed-to by the Company and Dolphin, of approximately $1.4 million (the “Purchase Price”). The Purchase Price is subject to adjustment upon the Company providing Dolphin with DAC’s final balance sheet net book value as of April 30, 2007 within 30 days of the Closing Date. Dolphin paid $1.1 million of the Purchase Price on the Closing Date and issued the Company a promissory note for the remainder of the Purchase Price, which is payable in four equal annual installments and on which interest is payable semi-annually at the prime rate as published by the Wall Street Journal. Any adjustment to the Purchase Price resulting from adjustments to DAC’s preliminary balance sheet net book value as of April 30, 2007 will be added to or subtracted from the promissory note. The Purchase Agreement also provides for a closing payment adjustment based on a comparison of the first employee payroll payment to be made by DAC following the Closing Date with a previously agreed upon estimate. No adjustment to the Purchase Price resulted from this provision of the Purchase Agreement.

Dolphin is an affiliate of Dolphin Offshore Partners, L.P., which is the beneficial owner of 9.9% of our issued and outstanding Common Stock.

The carrying amounts of assets and liabilities of DAC as of April 30, 2007 (unaudited) upon which the preliminary Purchase Price was established are as follows, in thousands:


Current Assets
Trade accounts receivable, net	$	55
Inventories		318
Prepaids and other current assets		3

Total current assets		376


Property and equipment, net		176
Goodwill		961

Total assets	$	1,513


Current Liabilities
Accounts payable	$	75
Accrued expenses		53

Total current liabilities		128

Total liabilities	$	128

The amount of net sales and loss before income tax expense of DAC for the three months ended March 31, 2007 and 2006 are as follows, in thousands:


	Three Months Ended March 31,
	2007			2006
	(Unaudited)			(Unaudited)
Net sales	$	168		$	357
Loss before income tax expense		(176	)		(39	)

DAC comprises all of the operations of the Law Enforcement and Surveillance Segment of the Company. As a result of the divestiture of DAC, the Company will have only one business segment, the Transportation Communications Segment.

Using proceeds received from Dolphin, on the Closing Date, the Company exercised its option to extend $500,000 of the $1.6 million principal amount due under the Laurus secured term promissory note until April 30, 2008 by making a payment of $1.1 million to Laurus to reduce the outstanding amounts due under the secured term promissory note. All other material terms of the Laurus secured term promissory note remain unchanged and in effect.

On May 2, 2007, 50 shares of Series E Preferred with a liquidation value of $250,000 were converted into 83,332 shares of the Company’s Common Stock. As a result of these conversions, 133 shares of Series E Preferred remain outstanding.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES THAT ARE IN ITEM 1 OF THIS DOCUMENT AND THE 2006 ANNUAL REPORT ON FORM 10-K.

Business — General

DRI directly or through contractors, designs, manufactures, sells, and services information technology and surveillance technology products through two major business segments. These two business segments are the Transportation Communications Segment and the Law Enforcement and Surveillance Segment.

DRI’s Transportation Communications segment produces passenger information communication and security-related products under the Talking Bus^®, TwinVision^®, VacTell^TM, and Mobitec^® brand names, which are sold to transportation vehicle equipment customers worldwide. Some of these products have security-related functionality.

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

DRI’s Law Enforcement and Surveillance segment, which was responsible for approximately 4% of DRI’s 2006 sales, consists of Digital Audio Corporation (“DAC”), a wholly owned subsidiary of DRI based in the Research Triangle Park area of North Carolina. Acquired in 1995, DAC’s products include a line of digital audio filter systems, digital audio recorders, and audio forensic equipment and technology. These products are used to improve the quality and intelligibility of both live and recorded voices. DAC serves U.S. federal, state, and local law enforcement agencies and organizations, as well as some of their qualified and eligible counterparts abroad. DAC’s customers include: U.S. federal, state, and local law enforcement agencies or organizations; U.S. military and intelligence organizations; comparable national and regional agencies of foreign governments; and private and industrial security and investigation firms. This segment was divested by DRI in April 2007.

Critical Accounting Policies and Estimates

Our critical accounting policies and estimates used in the preparation of the Consolidated Financial Statements presented in our 2006 Annual Report on Form 10-K (“2006 Annual Report”) are listed and described in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the 2006 Annual Report and include the following:

	•		Allowance for doubtful accounts

	•		Inventory valuation

	•		Warranty reserve

	•		Intangible assets and goodwill

	•		Income taxes, including deferred tax assets

	•		Revenue recognition

	•		Stock-based compensation

The financial statements include amounts that are based on management’s best estimates and judgments. The most significant estimates relate to allowance for uncollectible accounts receivable, inventory obsolescence, depreciation, intangible asset valuations and useful lives, goodwill impairment, warranty costs, taxes, stock-based compensation, and costs to complete long-term projects.

These estimates may be adjusted as more current information becomes available, and any adjustment could be significant.

The Company believes there were no significant changes during the three-month period ended March 31, 2007 to the items disclosed as critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s 2006 Annual Report. The Company adopted the provisions of FIN 48 on January 1, 2007. FIN 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on de-recognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition

Results of Operations

Management reviews a number of key indicators to evaluate the Company’s financial performance, including net sales, gross profit and selling, general and administrative expenses. The following table sets forth the percentage of our revenues represented by certain items included in our Consolidated Statements of Operations:


	Three Months Ended March 31,
	2007			2006
Net sales		100.0	%		100.0	%
Cost of sales		70.0			69.0

Gross profit		30.0			31.0

Operating expenses:
Selling, general and administrative		30.8			33.1
Research and development		2.7			2.3

Total operating expenses		33.5			35.4

Operating loss		(3.5	)		(4.4	)
Other income and expense		(2.7	)		(2.4	)

Loss before income tax expense		(6.2	)		(6.8	)
Income tax expense		(0.3	)		(0.4	)

Loss before minority interest in loss of consolidated subsidiary		(6.5	)		(7.2	)
Minority interest in loss of consolidated subsidiary		0.2			0.4

Net loss		(6.3	)%		(6.8	)%

COMPARISON OF OUR RESULTS FOR THE THREE MONTHS ENDED MARCH 31, 2007 AND 2006

Net Sales and Gross Profit. Our net sales for the three months ended March 31, 2007, increased $1.1 million or 9.5%, from $11.1 million for the three months ended March 31, 2006, to $12.2 million for the three months ended March 31, 2007. Our gross profit for the three months ended March 31, 2007, increased $204,000, or 5.9%, from $3.4 million for the three months ended March 31, 2006, to $3.6 million for the three months ended March 31, 2007. Following is a discussion of these changes in net sales and gross profit by segment.

Transportation Communications Segment. For the three months ended March 31, 2007, sales of our Transportation Communications Segment increased $1.2 million, or 11.6%, from $10.8 million for the three months ended March 31, 2006, to $12.0 million for the three months ended March 31, 2007. The increase resulted from an increase in sales by our foreign subsidiaries of $1.3 million offset by lower U.S. domestic sales of $30,000.

The increase in international sales of the Transportation Communications Segment resulted from higher sales in the European, Asian-Pacific, and South American markets that were partially offset by lower sales in the Middle East market and is inclusive of an increase due to foreign currency fluctuations for the period ended March 31, 2007 of approximately $489,000. The largest international sales increases occurred in the European market and resulted primarily from increased sales in the United Kingdom, Poland, Belgium, and the Nordic countries as the Company continued to obtain better market penetration in those countries in the first quarter of 2007.

DRI does not use currency hedging tools. Each of our foreign subsidiaries primarily conducts business in their respective functional currencies thereby reducing the impact of foreign currency transaction differences. If the U.S. dollar strengthens compared to the foreign currencies converted, it is possible the total sales reported in U.S. dollars could decline.

Our Transportation Communications Segment gross profit for the three months ended March 31, 2007 was $3.6 million, which increased $343,000, or 10.3%, from $3.3 million for the three months ended March 31, 2006. As a percentage of segment sales, our gross profit was 30.6% of our net segment sales for the three months ended March 31, 2007, as compared to 31.0% for the three months ended March 31, 2006. The net increase in gross profit was attributed to an increase in U.S. domestic gross profits of $412,000 offset by a decrease in foreign gross profits of $69,000.

The U.S. gross profit of the Transportation Communications Segment, as a percentage of sales for the three months ended March 31, 2007, was 31.7% as compared to 24.3% for the three months ended March 31, 2006. The Company realized increased margins on sales of LED destination signs resulting from the Company’s ability to negotiate lower costs for component parts in the later part of 2006 and continuing into 2007. Changes in product mix which yielded higher margins, a reduction in capitalized software amortization and a reduction of warranty expenses included in cost of sales also contributed to higher margins in the first quarter of 2007 as compared to the first quarter of 2006.

The international gross profit of the Transportation Communications Segment, as a percentage of sales for the three months ended March 31, 2007, was 29.7% as compared to 38.5% for the three months ended March 31, 2006. Competitive pricing offered to maintain business with one of the Company’s largest customers resulted in lower margins as did sales to new customers where lower prices were given to gain business with those customers. Our foreign subsidiaries also had higher sales of LED destination signs, which yielded lower margins than the overall product mix, in the first quarter of 2007. Additionally, sales increases occurred in geographic markets where margins are historically lower than in other markets.

We anticipate that improvements in gross margins could occur through more frequent sales of a combination of products and services offering a broader “project” solution, and through the introduction of technology improvements. However, period-to-period, overall gross margins will still reflect the variations in sales mix and geographical dispersion of product sales.

Law Enforcement and Surveillance Segment. Sales for our Law Enforcement and Surveillance segment decreased $189,000 or 53.1%, from $357,000 for the three months ended March 31, 2006, to $168,000 for the three months ended March 31, 2007. Sales in this segment tend to be cyclical in nature and the timing of orders received from customers, especially large orders, can produce significant variations in sales results. In the first quarter of 2006, orders from three customers comprised approximately 58% of the sales for that period, whereas no such large sales were delivered in the first quarter of 2007.

Gross profit of the Law Enforcement and Surveillance segment decreased $139,000 or 128%, to $(31,000) for the three months ended March 31, 2007, from $109,000 for the three months ended March 31, 2006. As a percentage of segment sales, our gross profit was (18.3)% of our net segment sales for the three months ended March 31, 2007, as compared to 30.4% during the three months ended March 31, 2006. The significant decrease in sales in the first quarter of 2007 contributed to the decrease in gross profit.

Selling, General and Administrative. Our selling, general and administrative expenses for the three months ended March 31, 2007, of $3.747 million, increased $74,000, or 0.2%, from $3.673 million for the three months ended March 31, 2006. As a percentage of our net sales, these expenses were 30.8% for the three months ended March 31, 2007, and 33.1% for the three months ended March 31, 2006. Management believes, as sales increase, these expenses will decrease as a percentage of sales. However, in terms of absolute dollars, selling, general and administrative expenses may increase in future periods due to expansion into other geographic areas, introduction of new products and services, and compliance costs related to the Sarbanes-Oxley Act of 2002.

Research and Development Expenses. Our research and development expenses of $332,000 for the three months ended March 31, 2007, represented an increase of $74,000, or 28.7%, from $258,000 for the three months ended March 31, 2006. This category of expense includes internal engineering personnel and outside engineering expense for software and hardware development, sustaining product engineering, and new product development. This expense, as a percentage of net sales, increased from 2.3% for the three months ended March 31, 2006, to 2.7% for the three months ended March 31, 2007.

During the three months ended March 31, 2007, salaries and related costs of certain engineering personnel who were used in the development of software met the capitalization criteria of SFAS No. 86, “Accounting for the Costs of Computer Software to be Sold,

Leased or Otherwise Marketed.” The total amount of personnel and other expense capitalized in the three months ended March 31, 2007, was $98,000 as compared to $48,000 for the three months ended March 31, 2006.

Operating Income (Loss). The net change in our operating loss for the three months ended March 31, 2007, was a decrease of $56,000 from a net operating loss of $488,000 for the three months ended March 31, 2006, to a net operating loss of $432,000 for the three months ended March 31, 2007. The reduction in operating loss is due to higher sales offset by higher cost of sales, higher selling, general and administrative expenses, and higher research and development costs as previously described.

Other Income, Foreign Currency Gain (Loss), and Interest Expense. Other income and interest expense increased $66,000 from $263,000 for the three months ended March 31, 2006 to $329,000 for the three months ended March 31, 2007, due to an increase of $87,000 in other income (loss), a decrease of $51,000 in foreign currency gain (loss), and an increase of $102,000 in interest expense. The increase in interest expense resulted from increased borrowings on our credit facilities and note payable, with additional increases resulting from increased amortization of the fair value of warrants issued in connection with the Laurus line of credit and Laurus note payable of $45,000, amortization of the fair value of Common Stock issued to Laurus in exchange for amending terms of the Company’s line of credit and note payable of $27,000, and increased interest on a foreign tax settlement of $41,000, offset by a decrease of $81,000 due to reduced amortization of a beneficial conversion feature on a convertible debenture.

Income Tax Expense. Net income tax expense was $34,000 for the three months ended March 31, 2007, as compared with net income tax expense of $46,000 for the three months ended March 31, 2006. The tax expense for the three months ended March 31, 2007, consisted of $49,000 arising from foreign jurisdictions offset by tax benefits of $15,000 arising from U.S. federal and state jurisdictions.

Net Loss Applicable to Common Shareholders. The net change in our net loss applicable to common shareholders for the three months ended March 31, 2007, was a decrease of $20,000 from a net loss of $866,000 for the three months ended March 31, 2006, to a net loss of $846,000 for the three months ended March 31, 2007.

Future Outlook

The Safe, Accountable, Flexible, Efficient, Transportation Equity Act – A Legacy for Users (“SAFETEA-LU”) is the primary program funding the U.S. public surface transit market at the federal level. SAFETEA-LU promotes the development of modern, expanded, intermodal public transit systems nationwide and also designates a wide range of tools, services, and programs intended to increase the capacity of the nation’s mobility systems. Enacted in August 2005, SAFETEA-LU guarantees a record level $52.6 billion in funding for public transportation through fiscal year 2009, including $8.975 billion appropriated to fund federal transit programs in 2007, a 5.5% increase over the amount appropriated for 2006. We believe the enactment of SAFETEA-LU and the record-high funding increases for transit have led to an upturn in the market for most of our products. We saw evidence of this in increased sales in 2006 of new bus vehicle manufacturer products, particularly those sold by our wholly-owned subsidiary, TwinVision of North America, Inc. (“TVna”) and of some products of our Digital Recorders (“DR”) business unit, where procurements were being derived primarily from those same manufacturers. Though sales of these products in the first quarter of 2007 were relatively flat as compared to the first quarter of 2006, we believe this is primarily the result of timing of orders received from customers. Market conditions for engineered systems sold by DR, such as Automatic Vehicle Locating, Automatic Vehicle Monitoring, Security and Automatic Passenger Counting Systems are less improved than markets for vehicle-mounted products. We believe this is attributable to the unique nature of the various mechanisms related to federal funding in the market and, if so, we believe the engineered systems related part of our business should improve, although at a rate slower than that of new bus vehicle manufacturer related products. Recently announced order activity, in our opinion, tends to validate that belief.

We also note that legislation being offered in both the U.S. House of Representatives and the U.S. Senate could possibly significantly increase funding for security related investments by customers in our market in the longer term. The engineered systems related part of our business includes security related products, technology and capabilities.

OUR LIQUIDITY AND CAPITAL RESOURCES

Cash Flows For the Three months Ended March 31, 2007 and 2006

Our operating activities provided (used) net cash of $496,000 and $(1.0) million for the three months ended March 31, 2007 and 2006, respectively. For the three months ended March 31, 2007, sources of cash primarily resulted from a decrease in accounts receivable of $1.1 million, a decrease in prepaids and other current assets of $71,000, and an increase in accrued expenses of $235,000. Primary uses of cash resulted from a net loss of $770,000, an increase in other receivables of $225,000, an increase in inventories of $181,000, and a decrease in accounts payable of $306,000. Non-cash expense items totaling $482,000 were for

deferred income taxes, depreciation and amortization, loss on sale of fixed assets, common stock issued in lieu of cash compensation, stock based compensation expense, minority interest, and a gain on foreign currency transactions.

Our investing activities used cash of $139,000 and $109,000 for the three months ended March 31, 2007 and 2006, respectively. For the three months ended March 31, 2007 and 2006, the primary uses of cash were for expenditures relating to internally developed software and purchases of computer, test, and office equipment. We do not anticipate any significant change in expenditures for or sales of capital equipment in the near future.

Our financing activities provided (used) net cash of $(378,000) and $1.1 million for the three months ended March 31, 2007 and 2006, respectively. For the three months ended March 31, 2007, our primary sources of cash were from borrowings under asset-based lending agreements for both our U.S and our foreign subsidiaries. Our primary uses of cash for financing activities were payment of dividends and repayment of borrowings under the asset-based lending agreements of $36,000 and $17.0 million, respectively.

Credit Agreements

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

The Company has an asset-based lending agreement with Laurus Master Fund, Ltd. (“Laurus Credit Agreement”) which provides up to $6.0 million in borrowings under a revolving credit facility. This credit facility is secured by all tangible and intangible assets of the Company in the U.S. and Canada. Borrowing availability under the Laurus Credit Agreement is based upon an advance rate equal to 90% of eligible accounts receivable and up to $2.0 million based upon 40% of eligible inventory. The interest rate on borrowings under the Laurus Credit Agreement is the Wall Street Journal prime rate plus 1.75%, subject to a floor of 8%. The Laurus Credit Agreement contains no financial covenants. At March 31, 2007, remaining borrowing availability under the revolving credit facility was approximately $1.0 million. Effective December 31, 2006, the Laurus Credit Agreement was amended to extend the maturity date from March 16, 2008 to June 30, 2008.

Mobitec AB, the Company’s wholly owned Swedish subsidiary, has an agreement with a bank in Sweden from which it may currently borrow up to a maximum of 10 million Krona, or $1.4 million U.S. based upon the March 31, 2007, exchange rate of 0.1429. At March 31, 2007, $1.2 million U.S. was outstanding, resulting in additional borrowing availability of $249,000 U.S. The terms of this agreement require payment of an unused credit line fee equal to 0.50% of the unused portion and an average interest rate of 4.04% of the outstanding balance in the first quarter of 2007. This agreement is secured by certain assets of Mobitec AB. Of the $1.4 million borrowing capacity under this agreement, $1.0 million renews annually on a calendar-year basis and $429,000 renews at various periods agreed-upon by both parties, with current expiration of June 30, 2007. On or before expiration, the Company expects to renew this credit agreement with an agreement substantially similar in terms and conditions.

Mobitec AB also has an agreement with the bank in Sweden from which it may borrow up to 9.0 million Krona, or $1.3 million U.S. At March 31, 2007, $1.1 million U.S. was outstanding, resulting in additional borrowing availability of $171,000 U.S. The line of credit bore an average interest rate in the first quarter of 2007 of 4.85% and was collateralized by accounts receivable of Mobitec AB. The agreement has an expiration date of December 31, 2007. On or before expiration, the Company expects to renew this credit agreement with an agreement substantially similar in terms and conditions.

Mobitec GmbH, the Company’s wholly owned subsidiary in Germany, has an agreement with a German bank from which it may currently borrow up to a maximum of 512,000 Euros or $683,000 U.S. based upon the March 31, 2007, exchange rate of 1.3335. At March 31, 2007, $656,000 U.S. was outstanding, resulting in additional borrowing availability of $27,000 U.S. The line of credit bore an average interest rate in the first quarter of 2007 of 4.85% and was collateralized by accounts receivable and inventories of Mobitec GmbH. This agreement has an open-ended term.

Additionally, as of March 31, 2007, the Company has outstanding the following note payable and long-term debt:

Note Payable. On April 28, 2006, the Company, along with certain of its subsidiaries, entered into a Securities Purchase Agreement with Laurus whereby the Company issued a one-year, secured term promissory note in the original principal amount of $1.6 million (the “Laurus Note”). Under its original terms, the Laurus Note bears interest at an annual rate of 10%, with interest payable monthly in arrears, is secured by all U.S. assets of the Company, carries a $160,000 fee upon payment and matures April 28, 2007. As of March 31, 2007, the entire original principal amount of $1.6 million was outstanding on the Laurus Note. Pursuant to an amendment effective December 31, 2006, the $160,000 fee due at maturity was eliminated and the Company is allowed the option to

extend up to $500,000 of the principal amount due under the Laurus Note until April 30, 2008. See “Divestiture of Digital Audio Corporation and Use of Proceeds” section below for disclosure of payment of a portion of the outstanding balance of the Laurus Note.

Long-term Debt. A convertible subordinated debenture payable to a shareholder and Director of the Company, dated August 26, 2002, in the amount of $250,000, with an annual interest rate of 8.0%, is due in full on August 26, 2009, if not sooner redeemed or converted.

Divestiture of Digital Audio Corporation and Use of Proceeds

On April 30, 2007, the Company and DAC entered into the Purchase Agreement with Dolphin, pursuant to which Dolphin acquired all of DAC’s issued and outstanding shares of common stock for the Purchase Price. The Purchase Price is subject to adjustment upon the Company providing Dolphin with DAC’s final balance sheet net book value as of April 30, 2007 within 30 days of the Closing Date. Dolphin paid $1.1 million of the Purchase Price on the Closing Date and issued the Company a promissory note for the remainder of the Purchase Price, which is payable in four equal annual installments and on which interest is payable semi-annually at the prime rate as published by the Wall Street Journal. Any adjustment to the Purchase Price resulting from adjustments to DAC’s preliminary balance sheet net book value as of April 30, 2007 will be added to or subtracted from the promissory note. The Purchase Agreement also provides for a closing payment adjustment based on a comparison of the first employee payroll payment to be made by DAC following the Closing Date with a previously agreed upon estimate. No adjustment to the Purchase Price resulted from this provision of the Purchase Agreement.

Using proceeds received from Dolphin, on April 30, 2007, the Company exercised its option to extend $500,000 of the principal amount due under the Laurus Note until April 30, 2008 by making a payment of $1.1 million to Laurus to reduce the outstanding amounts due under the Laurus Note.

Management Conclusion

Our primary source of liquidity and capital resources has been from financing activities. The payment of $1.1 million on the Laurus Note in April, 2007 addressed a significant short-term liquidity need. However, we expect to require additional financing to continue to support operations. Historically, we have supplementally financed operations through private placements of our securities. However, there can be no assurances that such placements will occur or be possible in the future.

Any or all of the circumstances described herein could cause us to be unable to continue our operations. These circumstances raise substantial doubt about our ability to continue as a going concern.

Impact of Inflation

We believe that inflation has not had a material impact on our results of operations for the three months ended March 31, 2007 and 2006. However, there can be no assurance that future inflation would not have an adverse impact upon our future operating results and financial condition.

FORWARD-LOOKING STATEMENTS

“Forward-looking” statements appear throughout this Quarterly Report. We have based these forward-looking statements on our current expectations and projections about future events. It is important to note our actual results could differ materially from those contemplated in our forward-looking statements as a result of various factors, including those described in Part II, Item 1A “Risk Factors” and in our 2006 Annual Report on Form 10-K in Item 7A, “Quantitative and Qualitative Disclosure About Market Risk,” as well as all other cautionary language in this Quarterly Report. In some cases, readers can identify forward-looking statements by the use of words such as “believe”, “anticipate”, “expect”, and similar expressions. Readers should be aware that the occurrence of the events described in these considerations and elsewhere in this Quarterly Report could have an adverse effect on the business, results of operations or financial condition of the entity affected.

Forward-looking statements in this Quarterly Report include, without limitation, the following statements regarding:

•

our ability to meet our capital requirements;

•

our ability to meet and maintain our existing debt obligations, including obligations to make payments under such debt instruments;

•

our future cash flow position;

•

our ability to obtain lender financing sufficient to meet our working capital requirements;

•

our efforts to manage and effect certain necessary fixed cost reductions;

•

our ability to achieve other expense reductions;

•

the timing or amount of future revenues;

•

product sales in future periods;

•

the effectiveness of any of management’s strategic objectives or initiatives or the implications thereof on our shareholders, creditors, or other constituencies;

•

expected results;

•

current trends and indicators;

•

our ability to implement plans for complying with Section 404 of the Sarbanes-Oxley Act of 2002;

•

recent legislative action affecting the transportation and/or security industry, including, without limitation, the Safe, Accountable, Flexible, Efficient, Transportation Equity Act – A Legacy for Users, and any successor legislation;

•

the impact of the recent passage of the Safe, Accountable, Flexible, Efficient, Transportation Equity Act – A Legacy for Users;

•

changes in federal or state funding for transportation and or security-related funding;

•

possible growth through acquisitions;

•

future sources of capital to fund such growth, including sources of additional equity financing;

•

anticipated advancements in technology related to our products and services;

•

future product and service offerings;

•

the success of product and service introductions;

•

the ability to include additional security features to existing products and services;

•

the potential positive effect such additional security features may have on revenues;

•

the expected contribution of sales of new and modified security related products to our profitability;

•

future events or expectations including the expected timing of order deliveries;

•

the expected customer acceptance of products;

•

potential benefits our security features may have for our customers;

•

the success of special alliances with various product partners;

•

the availability of alternate suppliers of the component parts required to manufacture our products; and

•

our intellectual property rights and our efforts to protect and defend such rights.

Readers should be aware that all of our forward-looking statements are subject to a number of risks, assumptions and uncertainties, such as risks regarding:

•

our ability to continue as a going concern;

•

our ability to meet our capital requirements;

•

our ability to meet and maintain our debt obligations, including obligations to make payments under such debt instruments;

•

our future cash flow position;

•

our ability to obtain lender financing sufficient to meet our working capital requirements;

•

our ability to effect desired and planned reductions in certain fixed costs;

•

our ability to achieve other expense reductions;

•

management’s strategic objectives or initiatives that may not be effective;

•

assumptions behind future revenue timing or amounts that may not prove accurate over time;

•

current trends and indicators that may not be indicative of future results;

•

loss of customers or decline in customer demand for our products and services;

•

reductions in federal and/or state funding for the transportation and/or security industry;

•

our ability to grow through acquisitions;

•

our ability to secure additional sources of capital to fund growth, including our ability to secure additional equity financing;

•

future technological advances that may not occur when anticipated or future technological advances that will make our current product and service offerings obsolete;

•

potential benefits our security products may have for our customers that do not materialize;

•

our ability to meet expected timing of order deliveries;

•

product and service offerings that may not be accepted by our customers;

•

product and service introductions that may not produce desired revenue results;

•

our ability to create meaningful security product features in either new or existing products;

•

the uncertainties surrounding our anticipated success of special alliances with various product partners;

•

our ability to address and remediate any deficiencies in our internal controls over financial reporting and/or our disclosure controls;

•

insufficient internal controls over financial reporting that may cause us to fail to meet our reporting obligations, result in material misstatements in our financial statements, and negatively affect investor confidence;

•

our efforts to implement plans to comply with Section 404 of the Sarbanes-Oxley Act of 2002;

•

our ability to obtain alternate suppliers of our component parts if our current suppliers are no longer available or cannot meet our future needs for such parts; and

•

our efforts to protect and defend our intellectual property rights.

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

Additional factors that could cause actual results to differ materially from those reflected in the forward-looking statements include, without limitation, those discussed elsewhere in this Quarterly Report, and in our 2006 Annual Report on Form 10-K. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our analysis, judgment, belief or expectation only as of the date of this Quarterly Report. We undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date of this Quarterly Report.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no significant changes in the Company’s exposure to market risk since December 31, 2006. See Item 7A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

ITEM 4T. CONTROLS AND PROCEDURES

Introduction

“Disclosure Controls and Procedures” are defined in Exchange Act Rules 13a-15(e) and 15d-15(e) as the controls and procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported, within the time period specified by the SEC’s rules and forms. Disclosure Controls and Procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive officer and principal financial officer, to allow timely decisions regarding disclosure.

Evaluation of Disclosure Controls and Procedures

As of March 31, 2007, management, including our principal executive officer and principal financial officer, performed an in-depth review of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15 and concluded that our disclosure controls and procedures are effective in ensuring that information required to be disclosed in the reports filed under the Exchange Act is recorded, processed, summarized and reported within the time period specified by the SEC’s rules and forms and in timely alerting them to material information relating to us (including our consolidated subsidiaries) that is required to be included in our periodic SEC reports.

There were no changes in the Company’s internal control over financial reporting during the quarter ended March 31, 2007, that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Required Reporting on Internal Control Over Financial Reporting

Section 404 of the Sarbanes-Oxley Act of 2002 (the “Act”) requires management to assess internal controls over financial reporting and requires auditors to attest to that assessment. The Securities and Exchange Commission, on December 15, 2006, adopted new measures to grant relief to smaller public companies by extending the date of compliance with Section 404 of the Sarbanes-Oxley Act of 2002. Under these new measures, the Company will be required to comply with the Act in two phases. The first phase will be effective for the Company’s fiscal year ending December 31, 2007 and will require the Company to issue a management report on internal control over financial reporting. The second phase will require the Company to provide an auditor’s attestation report on internal control over financial reporting beginning with the Company’s fiscal year ending December 31, 2008.

We will incur significant increased costs in implementing and responding to these requirements. In particular, the rules governing the standards that must be met for management to assess its internal controls over financial reporting under Section 404 are complex, and require significant documentation, testing and possible remediation. Nothing discussed herein should be interpreted by the reader so as to conclude the Company is currently compliant with the Act.

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

Mr. Lawrence A. Taylor was a director of the Company and, until October 2004, was the Company’s Chief Financial Officer, and until August 2005, the Company’s Executive Vice President of Corporation Development. As such, it was Mr. Taylor’s primary responsibility to identify and pursue mergers and acquisitions. In August 2005, when it became apparent the Company’s finances would not support merger and acquisition activities, Mr. Taylor’s position was eliminated. Mr. Taylor seeks to refute certain provisions of his employment agreement and has stated his intention to arbitrate a claim for, among other things, wrongful termination and age discrimination under the Age Discrimination in Employment Act of 1967 (ADEA). Over a year after his position was eliminated, Mr. Taylor filed a charge of age discrimination with the Equal Employment Opportunity Commission (“EEOC”) alleging discrimination. A mediation conference was held on January 15, 2007 without resolution of any matters. Mr. Taylor’s claim with the EEOC was dismissed without investigation on February 7, 2007. The EEOC’s termination of its investigation does not certify that we are in compliance with ADEA, nor does it affect the rights of Mr. Taylor to file suit under the statutes. Mr. Taylor has not pursued any remedy for his claims, including mandatory arbitration. The Company believes his claims are without merit and does not believe the matter will have a material impact on the Company.

Mr. David N. Pilotte, who served as the Company’s Chief Financial Officer until June 9, 2006, stated an intention to arbitrate a claim for severance compensation. On September 21, 2006, Mr. Pilotte filed an action in Dallas County (Texas) Court alleging that Digital Recorders, Inc., and others affiliated with the Company, have wrongfully withheld such payments in a lump sum form and further that the Company and certain of its officers have provided misleading or false information and representations to him and others. Mr. Pilotte seeks a lump sum payment of all remaining severance obligations, statutory and liquidated damages provided under the North Carolina Wage and Hour Act, as well as reasonable attorney’s fees. The Company paid severance compensation to him in the form of standard payroll installments, and such payments were completed in full, as of March 2007. The parties to this action are contemplating an agreement whereby certain parties and claims will be dismissed, and the remaining dispute shall be resolved through arbitration. The Company believes Mr. Pilotte’s claims are without merit and does not believe the matter will have a material impact on the Company.

ITEM 1A. RISK FACTORS

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

Risks Related to Indebtedness, Financial Condition and Results of Operations

There is substantial doubt concerning our ability to continue as a going concern. The financial statements contained in this Quarterly Report on Form 10-Q have been prepared assuming we will continue as a going concern. However, substantial doubt exists concerning our ability to do so. We have incurred substantial losses to date, including a net loss applicable to common shareholders of $846,000 in the first quarter of 2007, and, as of March 31, 2007, have an accumulated deficit of $23.2 million. We believe that cost containment and expense reductions are essential if we are to continue our current operations, but we cannot assure you that we will be able to achieve sufficient cost reductions to allow us to do so.

Our primary source of liquidity and capital resources has been from financing activities. The payment of $1.1 million on the outstanding note payable with Laurus Master Fund, Ltd. in April, 2007 addressed a significant short-term liquidity need. However, we expect to require additional financing to continue to support operations. Historically, we have supplementally financed operations through private placements of our securities. However, there can be no assurances that such placements will occur or be possible in the future.

shipments to us until we have paid past due amounts. If this occurs and we are unable to cause such vendors to resume shipments before our on-hand inventory of those components is exhausted, we may be unable to fulfill customer orders for our products. The failure to meet customer orders in a timely fashion could cause us to lose customers or cause our customers to reduce their orders for our products. In either event, this could substantially reduce our revenues and have a material adverse effect on the Company’s financial position.

Any or all of the circumstances described herein could cause us to be unable to continue our operations. These circumstances raise substantial doubt about our ability to continue as a going concern.

Our substantial debt could adversely affect our financial position, operations and ability to grow. As of March 31, 2007, our total debt of approximately $9.1 million consisted of long-term debt in the amount of $254,000, most of which is classified as current, and short-term debt of $8.8 million. Included in the long-term debt is $250,000 outstanding under an 8.0% convertible debenture held by a shareholder and director payable in full August 26, 2009. Included in the short-term debt is $7.2 million under our domestic and European revolving credit facilities and $1.1 million and $500,000 under a promissory note due on April 28, 2007 and April 30, 2008, respectively. Our domestic revolving credit facility, with an outstanding balance of $4.3 million as of March 31, 2007, is payable in full on June 30, 2008. Our European revolving credit facilities have outstanding balances of $2.3 million as of March 31, 2007 under agreements with a Swedish bank with expiration dates of June 30, 2007 and December 31, 2007 and an outstanding balance of $656,000 as of March 31, 2007 under an agreement with a German bank with an open-ended term. On or before the expiration dates, the Company expects to renew the credit agreements with the Swedish bank with agreements substantially similar in terms and conditions. Our substantial indebtedness could have adverse consequences in the future, including without limitation:

	•		we could be required to dedicate a substantial portion of our cash flow from operations to payments on our debt, which would reduce amounts available for working capital, capital expenditures, research and development and other general corporate purposes;

	•		our flexibility in planning for, or reacting to, changes in our business and the industries in which we operate could be limited;

	•		we may be more vulnerable to general adverse economic and industry conditions;

	•		we may be at a disadvantage compared to our competitors that may have less debt than we do;

	•		it may be more difficult for us to obtain additional financing that may be necessary in connection with our business;

	•		it may be more difficult for us to implement our business and growth strategies; and

	•		we may have to pay higher interest rates on future borrowings.

Some of our debt bears interest at variable rates, which may have material adverse effects on our business if they increase. If interest rates increase, or if we incur additional debt, the potential adverse consequences to our business and operations, including those described above, may be intensified. If our cash flow and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay planned expansion and capital expenditures, sell assets, obtain additional equity financing or restructure our debt. Some of our existing credit facilities contain covenants that, among other things, limit our ability to incur additional debt.

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

	•		triggering of certain payment obligations, or acceleration of payment obligations, under our revolving credit facilities or our outstanding convertible debentures;

	•		triggering of redemption obligations under our outstanding convertible debentures;

	•		costs associated with unanticipated litigation relating to our intellectual property or other matters;

	•		taxes due upon the transfer of cash held in foreign locations; and

	•		taxes assessed by local authorities where we conduct business.

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

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

Our operating results may continue to fluctuate. Our operating results may fluctuate from period to period and period over period depending upon numerous factors, including:

	•		customer demand and market acceptance of our products and solutions;

	•		new product introductions;

	•		variations in product mix;

	•		delivery due-date changes; and

	•		other factors.

We operate in a market characterized by long and occasionally erratic sales cycles. The time from first contact to order delivery may be a period of two years or longer in certain instances. Delivery schedules, as first established with the customer in this long cycle may change with little or no advance notice as the original delivery schedule draws near. Our business is sensitive to the spending patterns and funding of our customers, which, in turn, are subject to prevailing economic and governmental funding conditions and other factors beyond our control. Moreover, we derive sales primarily from significant orders from a limited number of customers. For that reason, a delay in delivery of our products in connection with a single order may significantly affect the timing of our recognition of sales between periods. Moreover, sales lost due to the cancellation of, or our inability to fill, an order in one period may not be necessarily made up by sales in any future period.

Risks Related to Our Operations and Product Development

A significant portion of our sales is derived from sales to a small number of customers. If we are not able to obtain new customers or repeat business from existing customers, our business could be seriously harmed. We sell our products to a limited and largely fixed set of customers and potential customers. In our Transportation Communications Segment, we sell primarily to original equipment manufacturers and to end users such as municipalities, regional transportation districts, transit agencies, federal, state and local departments of transportation, and rental car agencies. The identity of the customers who generate the most significant portions of our sales may vary from year to year. In 2006, three customers accounted for 19.2% of our net sales, compared to three customers accounting for 22.8% of our net sales in 2005 and two major customers accounting for 22.9% in 2004. If any of our major customers stopped purchasing products from us, and we were not able to obtain new customers to replace the lost business, our business and financial condition would be materially adversely affected. Many factors affect whether customers reduce or delay their investments in products such as those we offer, including decisions regarding spending levels and general economic conditions in the countries and specific markets where the customers are located.

We depend on third parties to supply components we need to produce our products. Our products and solutions are dependent upon the availability of quality components that are procured from third-party suppliers. Reliance upon suppliers, as well as industry supply conditions, generally involves several risks, including the possibility of defective parts (which can adversely affect the reliability and reputation of our products), a shortage of components and reduced control over delivery schedules (which can adversely affect our manufacturing efficiencies) and increases in component costs (which can adversely affect our profitability). As an example, in 2006, our European subsidiaries experienced shortages in the supply of aluminum extrusion materials, which are key components in our destination sign manufacturing process. This shortage, combined with other delivery planning difficulties, caused fulfillment and delivery of certain customer orders in our European market to be delayed. We have resolved this issue, but cannot be certain it will

not occur in the future, and to the extent it does occur, may result in lost sales opportunities in Europe, which may in turn have a material adverse effect on our results of operations.

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

Many of our customers rely, to some extent, on government funding, and that subjects us to risks associated with governmental budgeting and authorization processes. A majority of our sales address end customers having some degree of national, federal, regional, state, or local governmental-entity funding. These governmental-entity funding mechanisms are beyond our control and often are difficult to predict. Further, general budgetary authorizations and allocations for state, local, and federal agencies can change for a variety of reasons, including general economic conditions, and have a material adverse effect on us. For example, the TEA-21 legislation under which the funding for our transportation products business segment domestic sales are derived was subject to reauthorization in 2003, but was not replaced with new legislation, SAFETEA-LU, until August, 2005. In the interim period, federal funding was only available through short-term extensions of TEA-21. Underlying longer term funding uncertainties contribute to significant market disruption.

In addition to federal funding to the public transit side of our domestic market, a majority of our customers rely on state and local funding. These tend to be affected by general economic conditions. For example, some transit operating authorities reduced service in 2004, 2005 and 2006 in response to the slow economy and uncertainties on the reauthorization of SAFETEA-LU. This can have a depressing effect on sales of our products. It is not possible to precisely quantify or forecast this type of impact. Any unfavorable change in any of these factors and considerations could have a material adverse effect upon us.

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

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

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

We may not be able to recruit or retain a qualified workforce. Our success depends in large part upon our ability to attract, motivate and retain an effective management team, qualified engineering staff and a reliable workforce. Qualified personnel to fill these positions are in short supply from time to time. An inability to recruit and retain qualified individuals could have a material adverse effect on our financial condition.

Certain of our products contain technologies that must be developed and enhanced to meet the needs of our customers in securing, completing and fulfilling orders. This requires us to recruit and retain an engineering staff with the skills and experience necessary to develop and enhance the technologies specific to our products. Because of this technology-specific requirement, we may occasionally experience difficulties in recruiting qualified engineers. Our inability to recruit or retain qualified engineering resources may limit the number of revenue-generating projects we have in process at any one time and in turn may limit or prevent the expansion of our present operations.

Competition for qualified employees requires us to continually assess our compensation structure. Competition for qualified employees could require higher wages, resulting in higher labor cost.

Risks Related to Our International Operations

There are numerous risks associated with international operations, which represent a significant part of our business. Our international operations generated approximately 50% of our sales in fiscal year 2006 and approximately 52% of our sales in the first quarter of 2007. Our sales outside the United States were primarily in Europe (particularly the Nordic countries), South America, the Middle East, and Australia. The success and profitability of international operations are subject to numerous risks and uncertainties, such as economic and labor conditions, political instability, tax laws (including U.S. taxes upon foreign subsidiaries), and changes in the value of the U.S. dollar versus the local currency in which products are sold. Any unfavorable change in one or more of these factors could have a material adverse effect upon us.

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

Risks Related to Internal Controls

Required reporting on internal control over financial reporting. In accordance with Section 404 of the Sarbanes-Oxley Act, we will be required to deliver our initial report on the effectiveness of our internal controls over financial reporting in connection with our annual report for the fiscal year ending December 31, 2007. We are in the process of implementing our plan for complying with Section 404 of the Sarbanes-Oxley Act of 2002. These efforts could fail to be successful, which, in turn could cause investors to lose confidence in our internal control environment.

Risks Related to Intellectual Property

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

Risks Related to Our Equity Securities and Convertible Debentures

The public market for our Common Stock may be volatile. We cannot assure you that an active trading market will be sustained or that the market price of our Common Stock will not decline. The market price of our Common Stock is likely to continue to be highly volatile and could be subject to wide fluctuations in response to factors such as:

•

Actual or anticipated variations in our quarterly operating results;

	•		Historical and anticipated operating results;

	•		Announcements of new product or service offerings;

	•		Technological innovations;

	•		Competitive developments in the public transit industry;

	•		Changes in financial estimates by securities analysts;

	•		Conditions and trends in the public transit industry;

	•		Funding initiatives and other legislative developments affecting the transit industry;

	•		Adoption of new accounting standards affecting the technology industry or the public transit industry; and

	•		General market and economic conditions and other factors.

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

Our preferred stock and convertible debentures have preferential rights over our Common Stock. We currently have outstanding shares of Series AAA Redeemable, Nonvoting, Convertible Preferred Stock, Series E Redeemable, Nonvoting, Convertible Preferred Stock, Series G Redeemable, Convertible Preferred Stock, and Series H Redeemable, Convertible Preferred Stock as well as an eight percent (8.0%) convertible debenture, all of which have rights in preference to holders of our Common Stock in connection with any liquidation of the Company. The aggregate liquidation preference is $890,000 for the Series AAA Preferred, $915,000 for the Series E Preferred, $1.9 million for the Series G Preferred, and $275,000 for the Series H Preferred, in each case plus accrued but unpaid dividends, and the aggregate principal amount of the outstanding eight percent (8.0%) convertible debenture is $250,000. Holders of the Series AAA Preferred, Series E Preferred, Series G Preferred, and Series H Preferred are entitled to receive cumulative quarterly dividends at the rate of five percent (5.0%) per annum, seven percent (7.0%) per annum, eight percent (8.0%) per annum, and eight percent (8.0%) per annum, respectively, on the liquidation value of those shares. Dividends on the Series G Preferred are payable in kind in additional shares of Series G Preferred and dividends on the Series H Preferred are payable in kind in additional shares of Series H Preferred. The purchase agreements, pursuant to which we issued our outstanding eight percent (8.0%) convertible debenture, as well as our domestic senior credit facility, prohibit the payment of dividends to holders of our Common Stock. The holder of the debenture has the right to require us to redeem the debenture upon the occurrence of certain events, including certain changes in control of the Company or our failure to continue to have our stock listed on the NASDAQ Stock Market or another stock exchange. In such an event, the holder would have the right to require us to redeem the debenture for an amount equal to the principal amount plus an 18% annual yield on the principal amount through the date of redemption, and we might not have the ability to make the required redemption payments. The preferential rights of the holders of our convertible debenture and preferred stock could substantially limit the amount, if any, that the holders of our Common Stock would receive upon any liquidation of the Company.

Risks Related to Anti-Takeover Provisions

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

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

The adoption of our shareholder rights agreement may discourage third parties from making takeover offers, including takeover offers that might result in a premium being paid for shares of our common stock. Effective September 22, 2006, the Company entered into a shareholder rights agreement designed to prevent any potential acquirer from gaining control of the Company without fairly compensating the stockholders and to protect the Company from unfair or coercive takeover attempts. In furtherance of the shareholder rights agreement, the Board of Directors approved the declaration of a dividend of one right for each outstanding share of the Company’s common stock on the record date of October 9, 2006. Each of the rights, which are not currently exercisable, entitles the holder to purchase 1/1000th of a share of the Company’s Series D Junior Participating Preferred Stock at an exercise price of $5.00. In general, the rights will become exercisable only if any person or group of affiliated persons makes a public announcement that it has acquired 15% or more of the Company’s stock or that it intends to make or makes a tender offer or exchange offer for 15% or more of the Company’s stock. Following the announcement of any such acquisition or offer, the rights are redeemable by us at a price of $0.01 per right.

The effect of this rights plan could prevent or deter a potential unsolicited takeover of us by causing substantial dilution of an acquirer of 15% or more of our outstanding common stock. This could delay or prevent a third party from acquiring us even if the acquisition would be beneficial to our stockholders. These factors could also reduce the price that certain investors might be willing to pay for shares of the common stock and result in the market price being lower than it might be without these provisions. Therefore, mergers and acquisitions of us that our stockholders may consider in their best interests may not occur.

Provisions of our bylaws limit the ability of shareholders to call special meetings of shareholders and therefore could discourage, delay or prevent a merger, acquisition or other change in control of our company. On September 11, 2006, the Board of the Company voted to amend and restate the bylaws of the Company in their entirety. The Amended and Restated Bylaws of the Company became effective on September 12, 2006. Under the amended and restated bylaws, special meetings of the shareholders may be called by the Chairman of the Board, the President, the Board or any shareholder or shareholders holding in the aggregate thirty-five percent (35%) of the voting power of all the shareholders. Prior to the amendment and restatement of the bylaws, special meetings of the shareholders could be called by the Chairman of the Board, the President, the Board or any shareholder or shareholders holding in the aggregate ten percent (10%) of the voting power of all the shareholders.

The effect of this provision of our Amended and Restated Bylaws could delay or prevent a third party from acquiring the Company or replacing members of the Board, even if the acquisition or the replacements would be beneficial to our shareholders. These factors could also reduce the price that certain investors might be willing to pay for shares of the common stock and result in the market price being lower than it might be without these provisions.

Risks Associated with Potential Growth

We may not be able to obtain the financing we will need to implement our operating strategy. We cannot assure you that our

revolving credit facilities and cash flow from operations will be sufficient to fund our current business operations for the next 12 months, nor can we assure you that we will not require additional sources of financing to fund our operations. Additional financing may not be available to us on terms we consider acceptable, if available at all. If we cannot raise funds on acceptable terms, we may not be able to develop next-generation products, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, any of which could have a material adverse effect on our ability to grow our business. Further, if we issue equity securities, holders of our Common Stock may experience dilution of their ownership percentage, and the new equity securities could have rights, preferences or privileges senior to those of our Common Stock.

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

	•		It may be difficult to assimilate the operations and personnel of an acquired business into our own business;

	•		Management information and accounting systems of an acquired business must be integrated into our current systems;

	•		Our management must devote its attention to assimilating the acquired business, which diverts attention from other business concerns;

	•		We may enter markets in which we have limited prior experience; and

	•		We may lose key employees of an acquired business.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

At the annual meeting of shareholders in May 2006, shareholders approved an equity-based stock compensation plan for members of the Board of Directors and certain key executive managers of the Company. The compensation plan partially compensates members of the Board of Directors and certain key executive management of the Company in the form of stock of the Company in lieu of cash compensation. The plan became effective on January 1, 2006, and was made available on a fully voluntary basis. The number of shares payable under this plan is determined by dividing the cash value of stock compensation by the higher of (1) the actual closing price on the last trading day of each month, or (2) the book value of the Company on the last day of each month. Fractional shares are rounded up to the next full share amount.

During the three months ended March 31, 2007, the Company issued 16,380 shares to seven individuals under this plan at an average price of $1.28 per share in lieu of $21,000 in cash compensation. Section 16 reports filed with the Securities and Exchange Commission include the actual prices at which shares were issued to each individual.

The issuances set forth above were made pursuant to the private placement exemption available under Section 4(2) of the Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS

None.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

The following documents are filed herewith or have been included as exhibits to previous filings with the SEC and are incorporated herein by this reference:


Exhibit No.		Document
3.1		Amended and Restated Articles of Incorporation of the Company (incorporated herein by reference from the Company’s Registration Statement on Form S-3, filed with the SEC on December 23, 2003)

3.2		Articles of Amendment to Articles of Incorporation of the Company containing Certificate of Designation of Series E Redeemable Nonvoting Convertible Stock (incorporated herein by reference from the Company’s Report on Form 8-K, filed with the SEC on November 12, 2003)

3.3		Articles of Amendment to Articles of Incorporation of the Company containing Amended and Restated Certificate of Designation of Series F Convertible Preferred Stock (incorporated herein by reference from the Company’s Report on Form 8-K, filed with the SEC on April 14, 2004)

3.4		Articles of Amendment to the Articles of Incorporation of the Company containing Series AAA Preferred Stock Change in Quarterly Dividend Accrual and Conversion Price (incorporated herein by reference to the Company’s Report on Form 10-K for the year ended December 31, 2004)

3.5		Articles of Amendment to Articles of Incorporation of the Company containing Amended and Restated Certificate of Designation of Series G Redeemable Convertible Preferred Stock (incorporated herein by reference to the Company’s Report on Form 8-K filed on June 28, 2005)

3.6		Articles of Correction of Articles of Amendment to the Articles of Incorporation of the Company containing a correction to an error in the Amended Certificate of Designation of Series G Redeemable Convertible Preferred Stock (incorporated herein by reference to the Company’s Report on Form 10-Q for the quarter ended June 30, 2005)

3.7		Articles of Amendment to the Articles of Incorporation of the Company containing an amendment to eliminate a staggered election of Board members (incorporated herein by reference to the Company’s Report on Form 10-Q for the quarter ended June 30, 2005)

3.8		Articles of Amendment to Articles of Incorporation of the Company containing Amended and Restated Certificate of Designation of Series H Convertible Preferred Stock (incorporated herein by reference to the Company’s Report on Form 8-K filed on November 4, 2005)

3.9		Articles of Amendment to Articles of Incorporation of the Company containing Certificate of Designation of Series I Convertible Preferred Stock (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 23, 2006)

3.10		Amended and Restated Bylaws of the Company (incorporated herein by reference from the Company’s Registration Statement on Form SB-2)

3.11		Amendment to Amended and Restated Bylaws of the Company (incorporated herein by reference from the Company’s Proxy Statement for the Annual Meeting of Shareholders for fiscal year 2000, filed with the SEC on June 6, 2001)

3.12		Amended and Restated Bylaws of the Company (incorporated herein by reference to the Company’s Report on Form 8-K filed on September 18, 2006)

3.13		Amendment No. 1 to the Company’s Certificate of Designation with respect to its Series D Junior Participating Preferred Stock (incorporated herein by reference to the Company’s Report on Form 8-K filed with the SEC on September 28, 2006)


Exhibit No.		Document
4.5		Rights Agreement, dated as of September 22, 2006, between the Company and American Stock Transfer & Trust Company, as Rights Agent, together with the following exhibits thereto: Exhibit A – Certificate of Designation of Series D Junior Participating Preferred Stock of Digital Recorders, Inc. and the Amendment to Certificate of Designation of Series D Junior Participating Preferred Stock of Digital Recorders, Inc.; Exhibit B – Form of Right Certificate; and Exhibit C – Summary of Rights to Purchase Shares (incorporated herein by reference to the Company’s Registration Statement on Form 8-A filed with the Securities and Exchange Commission on October 2, 2006)

4.6		Omnibus Amendment dated as of January 10, 2007, effective December 31, 2006, by and among the Company, TwinVision of North America, Inc., Digital Audio Corporation, Robinson-Turney International, Inc., and Laurus Master Fund, Ltd. (incorporated herein by reference to the Company’s report on Form 8-K filed with the SEC on January 16, 2007)

4.7		Amended and Restated Secured Term Note dated as of January 10, 2007, effective December 31, 2006, by and between the Company, TwinVision of North America, Inc., Digital Audio Corporation, Robinson-Turney International, Inc., and Laurus Master Fund, Ltd. (incorporated herein by reference to the Company’s Report on Form 8-K filed with the SEC on January 16, 2007)

4.8		Second Amended and Restated Registration Rights Agreement dated as of January 10, 2007, effective December 31, 2006, by and between the Company and Laurus Master Fund, Ltd. (incorporated herein by reference to the Company’s Report on Form 8-K filed with the SEC on January 16, 2007)

10.1		Secured Non-Convertible Revolving Note between the Company and Laurus Master Fund, Ltd., dated March 16, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 21, 2006)

10.2		Security Agreement (with Schedules) between the Company and Laurus Master Fund, Ltd. dated March 16, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 21, 2006)

10.3		Grant of Security Interest in Patents and Trademarks (with Schedules) between the Company and Laurus Master Fund, Ltd., dated March 16, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 21, 2006)

10.4		Stock Pledge Agreement (with Schedules) between the Company and Laurus Master Fund, Ltd., dated March 16, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 21, 2006)

10.5		Registration Rights Agreement between the Company and Laurus Master Fund, Ltd., dated March 16, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 21, 2006)

10.6		Common Stock Purchase Warrant between the Company and Laurus Master Fund, Ltd., dated March 16, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 21, 2006)

10.7		Share Purchase Agreement between the Company and Transit Vehicle Technology Investments, Inc., dated March 21, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 23, 2006)

10.8		Stock Purchase Warrant between the Company and Transit Vehicle Technology Investments, Inc., dated March 21, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 23, 2006)

10.9		Registration Rights Agreement between the Company and Transit Vehicle Technology Investments, Inc., dated March 21, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 23, 2006)


Exhibit No.		Document
10.10		Securities Purchase Agreement dated as of April 28, 2006, by and between Digital Recorders, Inc., TwinVision of North America, Inc., Digital Audio Corporation, and Robinson-Turney International, Inc., and Laurus Master Fund, Ltd. (incorporated herein by reference to the Company’s Report on Form 8-K filed on May 4, 2006)

10.11		Secured Term Note by Digital Recorders, Inc., TwinVision of North America, Inc., Digital Audio Corporation, and Robinson-Turney International, Inc., issued to Laurus Master Fund, Ltd., in the original principal amount of $1,600,000 (incorporated herein by reference to the Company’s Report on Form 8-K filed on May 4, 2006)

10.12		Common Stock Purchase Warrant dated as of April 28, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on May 4, 2006)

10.13		Amended and Restated Registration Rights Agreement dated as of April 28, 2006, by and between Digital Recorders, Inc. and Laurus Master Fund, Ltd. (incorporated herein by reference to the Company’s Report on Form 8-K filed on May 4, 2006)

10.14		Share Purchase Agreement, dated as of April 30, 2007, entered into by and among Dolphin Direct Equity Partners, LP, Digital Audio Corporation and Digital Recorders, Inc. (filed herewith)

10.15		Promissory Note, dated April 30, 2007, by Dolphin Direct Equity Partners, LP issued to Digital Recorders, Inc. in the original principal sum of $285,000 (filed herewith)

10.16		Waiver and Consent, dated as of April 30, 2007, entered into by and between Digital Recorders, Inc., TwinVision of North America, Inc., Digital Audio Corporation, Robinson-Turney International, Inc. and Laurus Master Fund, Ltd. (filed herewith)

31.1		Section 302 Certification of David L. Turney (filed herewith)

31.2		Section 302 Certification of Stephen P. Slay (filed herewith)

32.1		Section 906 Certification of David L. Turney (filed herewith)

32.2		Section 906 Certification of Stephen P. Slay (filed herewith)

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

DIGITAL RECORDERS, INC.

Exhibit Index


Exhibit No.		Document
3.1		Amended and Restated Articles of Incorporation of the Company (incorporated herein by reference from the Company’s Registration Statement on Form S-3, filed with the SEC on December 23, 2003)

3.2		Articles of Amendment to Articles of Incorporation of the Company containing Certificate of Designation of Series E Redeemable Nonvoting Convertible Stock (incorporated herein by reference from the Company’s Report on Form 8-K, filed with the SEC on November 12, 2003)

3.3		Articles of Amendment to Articles of Incorporation of the Company containing Amended and Restated Certificate of Designation of Series F Convertible Preferred Stock (incorporated herein by reference from the Company’s Report on Form 8-K, filed with the SEC on April 14, 2004)

3.4		Articles of Amendment to the Articles of Incorporation of the Company containing Series AAA Preferred Stock Change in Quarterly Dividend Accrual and Conversion Price (incorporated herein by reference to the Company’s Report on Form 10-K for the year ended December 31, 2004)

3.5		Articles of Amendment to Articles of Incorporation of the Company containing Amended and Restated Certificate of Designation of Series G Redeemable Convertible Preferred Stock (incorporated herein by reference to the Company’s Report on Form 8-K filed on June 28, 2005)

3.6		Articles of Correction of Articles of Amendment to the Articles of Incorporation of the Company containing a correction to an error in the Amended Certificate of Designation of Series G Redeemable Convertible Preferred Stock (incorporated herein by reference to the Company’s Report on Form 10-Q for the quarter ended June 30, 2005)

3.7		Articles of Amendment to the Articles of Incorporation of the Company containing an amendment to eliminate a staggered election of Board members (incorporated herein by reference to the Company’s Report on Form 10-Q for the quarter ended June 30, 2005)

3.8		Articles of Amendment to Articles of Incorporation of the Company containing Amended and Restated Certificate of Designation of Series H Convertible Preferred Stock (incorporated herein by reference to the Company’s Report on Form 8-K filed on November 4, 2005)

3.9		Articles of Amendment to Articles of Incorporation of the Company containing Certificate of Designation of Series I Convertible Preferred Stock (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 23, 2006)

3.10		Amended and Restated Bylaws of the Company (incorporated herein by reference from the Company’s Registration Statement on Form SB-2)

3.11		Amendment to Amended and Restated Bylaws of the Company (incorporated herein by reference from the Company’s Proxy Statement for the Annual Meeting of Shareholders for fiscal year 2000, filed with the SEC on June 6, 2001)

3.12		Amended and Restated Bylaws of the Company (incorporated herein by reference to the Company’s Report on Form 8-K filed on September 18, 2006)

3.13		Amendment No. 1 to the Company’s Certificate of Designation with respect to its Series D Junior Participating Preferred Stock (incorporated herein by reference to the Company’s Report on Form 8-K filed with the SEC on September 28, 2006)

4.5		Rights Agreement, dated as of September 22, 2006, between the Company and American Stock Transfer & Trust Company, as Rights Agent, together with the following exhibits thereto: Exhibit A – Certificate of Designation of Series D Junior Participating Preferred Stock of Digital Recorders,


Exhibit No.		Document
		Inc. and the Amendment to Certificate of Designation of Series D Junior Participating Preferred Stock of Digital Recorders, Inc.; Exhibit B – Form of Right Certificate; and Exhibit C – Summary of Rights to Purchase Shares (incorporated herein by reference to the Company’s Registration Statement on Form 8-A filed with the Securities and Exchange Commission on October 2, 2006)

4.6		Omnibus Amendment dated as of January 10, 2007, effective December 31, 2006, by and among the Company, TwinVision of North America, Inc., Digital Audio Corporation, Robinson-Turney International, Inc., and Laurus Master Fund, Ltd. (incorporated herein by reference to the Company’s report on Form 8-K filed with the SEC on January 16, 2007)

4.7		Amended and Restated Secured Term Note dated as of January 10, 2007, effective December 31, 2006, by and between the Company, TwinVision of North America, Inc., Digital Audio Corporation, Robinson-Turney International, Inc., and Laurus Master Fund, Ltd. (incorporated herein by reference to the Company’s Report on Form 8-K filed with the SEC on January 16, 2007)

4.8		Second Amended and Restated Registration Rights Agreement dated as of January 10, 2007, effective December 31, 2006, by and between the Company and Laurus Master Fund, Ltd. (incorporated herein by reference to the Company’s Report on Form 8-K filed with the SEC on January 16, 2007)

10.1		Secured Non-Convertible Revolving Note between the Company and Laurus Master Fund, Ltd., dated March 16, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 21, 2006)

10.2		Security Agreement (with Schedules) between the Company and Laurus Master Fund, Ltd. dated March 16, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 21, 2006)

10.3		Grant of Security Interest in Patents and Trademarks (with Schedules) between the Company and Laurus Master Fund, Ltd., dated March 16, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 21, 2006)

10.4		Stock Pledge Agreement (with Schedules) between the Company and Laurus Master Fund, Ltd., dated March 16, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 21, 2006)

10.5		Registration Rights Agreement between the Company and Laurus Master Fund, Ltd., dated March 16, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 21, 2006)

10.6		Common Stock Purchase Warrant between the Company and Laurus Master Fund, Ltd., dated March 16, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 21, 2006)

10.7		Share Purchase Agreement between the Company and Transit Vehicle Technology Investments, Inc., dated March 21, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 23, 2006)

10.8		Stock Purchase Warrant between the Company and Transit Vehicle Technology Investments, Inc., dated March 21, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 23, 2006)

10.9		Registration Rights Agreement between the Company and Transit Vehicle Technology Investments, Inc., dated March 21, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on March 23, 2006)

10.10		Securities Purchase Agreement dated as of April 28, 2006, by and between Digital Recorders, Inc., TwinVision of North America, Inc., Digital Audio Corporation, and Robinson-Turney International, Inc., and Laurus Master Fund, Ltd. (incorporated herein by reference to the Company’s Report on Form 8-K filed on May 4, 2006)


Exhibit No.		Document
10.11		Secured Term Note by Digital Recorders, Inc., TwinVision of North America, Inc., Digital Audio Corporation, and Robinson-Turney International, Inc., issued to Laurus Master Fund, Ltd., in the original principal amount of $1,600,000 (incorporated herein by reference to the Company’s Report on Form 8-K filed on May 4, 2006)

10.12		Common Stock Purchase Warrant dated as of April 28, 2006 (incorporated herein by reference to the Company’s Report on Form 8-K filed on May 4, 2006)

10.13		Amended and Restated Registration Rights Agreement dated as of April 28, 2006, by and between Digital Recorders, Inc. and Laurus Master Fund, Ltd. (incorporated herein by reference to the Company’s Report on Form 8-K filed on May 4, 2006)

10.14		Share Purchase Agreement, dated as of April 30, 2007, entered into by and among Dolphin Direct Equity Partners, LP, Digital Audio Corporation and Digital Recorders, Inc. (filed herewith)

10.15		Promissory Note, dated April 30, 2007, by Dolphin Direct Equity Partners, LP issued to Digital Recorders, Inc. in the original principal sum of $285,000 (filed herewith)

10.16		Waiver and Consent, dated as of April 30, 2007, entered into by and between Digital Recorders, Inc., TwinVision of North America, Inc., Digital Audio Corporation, Robinson-Turney International, Inc. and Laurus Master Fund, Ltd. (filed herewith)

31.1		Section 302 Certification of David L. Turney (filed herewith)

31.2		Section 302 Certification of Stephen P. Slay (filed herewith)

32.1		Section 906 Certification of David L. Turney (filed herewith)

32.2		Section 906 Certification of Stephen P. Slay (filed herewith)

EX-10.14 2 d46691exv10w14.htm SHARE PURCHASE AGREEMENT exv10w14

Exhibit 10.14

SHARE PURCHASE AGREEMENT

THIS SHARE PURCHASE AGREEMENT, dated as of April 30, 2007 (this “Agreement”), is entered into by and among DOLPHIN DIRECT EQUITY PARTNERS, LP, a Delaware limited partnership (“Buyer”); DIGITAL AUDIO CORPORATION, a North Carolina corporation (“Company”), and DIGITAL RECORDERS, INC., a North Carolina corporation (“Seller”).

RECITALS

A. Seller owns and shall own as of the Closing Date (as defined below) the number of shares of common stock of the Company (the “Company Shares”) set forth on Exhibit A.

B. The Company Shares collectively owned by Seller will constitute, immediately prior to the Closing (as defined below), one hundred percent (100%) of the issued and outstanding Equity Securities of the Company.

C. Subject to the terms and conditions of this Agreement, Seller will sell to Buyer all of the Company Shares owned by Seller.

D. Buyer desires to acquire all of the issued and outstanding Company Shares owned by Seller, on the terms and conditions set forth herein, in exchange for cash and a Promissory Note (subject to adjustment as set forth herein).

AGREEMENT

Now therefore, in consideration of the foregoing and the mutual agreements and covenants set forth below, the parties hereto agree as follows:

ARTICLE I.
DEFINITIONS.

For purposes of this Agreement:

Section 1.1 Certain Matters of Construction. In addition to the definitions referred to or set forth below in this ARTICLE I:

(a) The words “hereof,” “hereby,” “herein,” “hereunder” and words of similar import shall refer to this Agreement as a whole and not to any particular Section or provision of this Agreement, and reference to a particular Section of this Agreement shall include all subsections thereof.

(b) The words “party” and “parties” shall refer to the Company, the Seller and Buyer.

(c) Definitions shall be equally applicable to both the singular and plural forms of the terms defined, and references to the masculine, feminine or neuter gender shall include each other gender.

(d) Accounting terms used herein and not otherwise defined herein are used herein as defined by GAAP (as defined below) in effect as of the date hereof, consistently applied.

(e) All references in this Agreement to any Exhibit or Schedule shall, unless the context otherwise requires, be deemed to be a reference to an Exhibit or Schedule, as the case may be, to this Agreement, all of which are made a part of this Agreement.

(f) The word “including” shall mean including without limitation.

Section 1.2 Certain Definitions. The following terms shall have the following meanings:

“2007 and 2008 Financial Statements” are defined in Section 4.2(a).

“Action” shall mean any claim, action, cause of action, litigation or suit (in contract, tort or otherwise), inquiry, proceeding, notice of noncompliance, demand letter, audit or investigation by or before any Governmental Authority or arbitrator.

“Affiliate” shall mean, as to any Person, each Person directly or indirectly controlling, controlled by or under common control with such Person. For purposes of this definition, the term “control” (including the terms “controlling,” “controlled by” and “under common control with”) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a Person, whether through ownership of voting securities, by contract or otherwise.

“Agreement” is defined in the Preamble.

“Alternative Transaction” is defined in Section 6.5.

“Audited Financials” is defined in Section 4.2(a)(i).

“Balance Sheet Date” shall mean December 31, 2006.

“Balance Sheet Net Book Value” shall be the book value of the Company as of April 30, 2007, as calculated in accordance with GAAP and consistent in all respects with the methodologies employed in preparation of the Company’s audited financial statements for the year ended December 31, 2006.

“Base Consideration Amount” shall mean an aggregate amount consisting of One Million One Hundred Thousand Dollars ($1,100,000) in cash.

“Business” shall mean the businesses of the Company as such business is currently conducted and as proposed to be conducted.

“Business Day” shall mean any day on which banking institutions in New York, New York are customarily open for the purpose of transacting business.

“Business Intellectual Property” is defined in Section 4.6(a).

“Buyer” is defined in the Preamble.

“Buyer Indemnified Parties” is defined in Section 9.2(a).

“By-laws” shall mean the corporate by-laws of a corporation, as from time to time in effect.

“Cash” shall mean the amount of cash and cash equivalents of the Company, as determined in accordance with GAAP, as of the close of business on the Closing Date.

“Cash Consideration” is defined as the Base Consideration Amount, plus any amounts paid under the Promissory Note.

“Charter” shall mean the certificate or articles of incorporation or organization or other charter or organizational documents of any Person (other than an individual), each as from time to time in effect.

“Closing” is defined in Section 3.1.

“Closing Cash Consideration” shall mean the Cash Consideration.

“Closing Date” is defined in Section 3.1.

“Code” shall mean the United States Internal Revenue Code of 1986, as amended.

“Company” is defined in the Preamble.

“Company Plans” is defined in Section 4.13(a)(i).

“Company Shares” is defined in the Recitals.

“Consolidated Net Income” means, with respect to any specified Person for any period, the aggregate of the Net Income of such Person and its Subsidiaries for such period, on a consolidated basis, determined in accordance with GAAP; provided that: (i) the Net Income (but not loss) of any Person that is not a Subsidiary or that is accounted for by the equity method of accounting will be included only to the extent of the amount of dividends or similar distributions paid in cash to the specified Person or a Subsidiary of the Person and (ii) the cumulative effect of a change in accounting principles will be excluded.

“Contracts” is defined in Section 4.7.

“Contractual Obligation” shall mean, with respect to any Person, any oral or written contract, agreement, deed, mortgage, lease, license, indenture, note, bond, or other document or instrument (including any document or instrument evidencing or otherwise relating

to any indebtedness but excluding the Charter and By-laws of such Person) to which or by which such Person is legally bound.

“Damages” is defined in Section 9.2(a).

“Debt” shall mean all obligations of a Person (i) for borrowed money, (ii) evidenced by notes, bonds, debentures, letters of credit or similar instruments, (iii) under conditional sale, title retention or similar agreements or arrangements with respect to the deferred purchase price of property, and (iv) in the nature of guarantees of obligations of the type described in clauses (i), (ii) and (iii) above of any other Person.

“Employee” shall mean any current or former employee of Company, including any such Person who is on an approved leave of absence.

“Enforceable” shall mean, with respect to any Contractual Obligation, that such Contractual Obligation is the legal, valid and binding obligation of the Person in question, enforceable against such Person in accordance with its terms, except as such enforceability may be limited by bankruptcy, insolvency, reorganization or other laws affecting creditors’ rights generally and general principles of equity (whether considered in a proceeding at law or in equity).

“Environmental Conditions” shall mean the state of the environment, including natural resources (e.g., flora and fauna), soil, surface water, ground water, any drinking water supply, subsurface strata or ambient air.

“Environmental Laws” shall mean any Legal Requirement relating to (i) emissions, discharges, Releases or threatened Releases of Hazardous Substances, (ii) the manufacture, handling, transport, use, treatment, storage, identification, generation, processing, distribution, removal or disposal of Hazardous Substances, and (iii) occupational health and safety.

“Environmental Permits” is defined in Section 4.4(a).

“Equity Securities” of any Person shall mean (i) shares of capital stock, partnership or limited liability company interests or other equity securities of or interests in such Person, (ii) subscriptions, calls, warrants, options or commitments of any kind or character relating to, or entitling any Person to purchase or otherwise acquire, any such shares of capital stock, partnership or limited liability company interests or other equity securities of or interests in such Person, (iii) securities convertible into or exercisable or exchangeable for shares of capital stock, partnership or limited liability company interests or other equity securities of or interests in such Person, and (iv) stock options, equity equivalents, interests in the ownership or earnings of, or stock appreciation, phantom stock or other similar rights of, or with respect to, such Person.

“ERISA” shall mean the federal Employee Retirement Income Security Act of 1974 or any successor statute, as amended and as in effect as of the date hereof.

“ERISA Affiliate” is defined in Section 4.13(a)(i).

“Facilities” means each and every building, office, or physical improvement owned, operated or leased by any Seller.

“Financial Statements” is defined in Section 4.2(a)(i).

“GAAP” shall mean generally accepted accounting principles in the United States.

“Governmental Authority” shall mean any federal, state, foreign or local government, regulatory or administrative agency (or any department, bureau or division thereof).

“Governmental Order” shall mean any decree, stipulation, determination or award entered by any Governmental Authority.

“Hazardous Substances” shall mean (i) substances defined as toxic or hazardous or regulated under the following federal statutes and their state counterparts, as well as these statutes’ implementing regulations, in each case, as amended and as in effect as of the date hereof: the Hazardous Materials Transportation Act, the Resource Conservation and Recovery Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Clean Water Act, the Safe Drinking Water Act, the Asbestos Hazard Emergency Response Act, the Atomic Energy Act, the Toxic Substances Control Act, the Federal Insecticide, Fungicide, and Rodenticide Act and the Clean Air Act, (ii) petroleum and petroleum products, including crude oil and any fractions thereof, (iii) natural gas, synthetic gas and any mixtures thereof, (iv) polychlorinated biphenyls (“PCBs”), (v) urea formaldehyde, and (vi) asbestos-containing materials.

“Indemnification Basket” is defined in Section 9.2(b).

“Indemnified Party” is defined in Section 9.4(a).

“Intellectual Property” is defined in Section 4.6(b).

“Interest Charges” means, with respect to any specified Person for any period, the sum, without duplication, of: (i) the consolidated interest expense of such Person and its Subsidiaries for such period, whether paid or accrued, plus (ii) the consolidated interest expense of such Person and its Subsidiaries that was capitalized during such period.

“Interim Financials” is defined in Section 4.2(a)(ii).

“IRS” shall mean the Internal Revenue Service.

“Knowledge” shall mean (i) in the case of the Seller, the actual knowledge of the CEO, David L. Turney, and the CFO, Stephen P. Slay, after reasonable inquiry of the key management employees of the Company, or what should have been known if due care were used, by the executive officers, managers, general partner or other natural person fulfilling similar duties on behalf of or with respect to these persons, and (ii) in the case of the Company, the actual knowledge of its general manager, Donald Tunstall after reasonable inquiry of the employees of the Company with relevant knowledge of the applicable subject matter, or what

should have been known if due care were used, by the executive officers, managers, general partner or other natural person fulfilling similar duties on behalf of or with respect to these persons.

“Laurus Master Fund, Ltd.” is the primary lender to Seller and Company and shall be referred to throughout as “Laurus”.

“Legal Requirement” shall mean any federal, state, foreign or local law (including common law) statute, ordinance, code, rule or regulation, interpretation, guidance, or any Governmental Order, or any license, franchise, consent, approval, permit or similar right granted under any of the foregoing.

“Licensed Intellectual Property” is defined in Section 4.6(b).

“Licenses” is defined in Section 4.6(c).

“Lien” shall mean any mortgage, pledge, lien, security interest, attachment or encumbrance, provided, however, that the term “Lien” shall not include (i) statutory liens for Taxes not yet due and payable, (ii) encumbrances in the nature of zoning restrictions, easements, rights or restrictions of record on the use of real property if the same do not materially detract from the value of the property encumbered thereby or materially impair the use of such property, (iii) liens to secure landlords, lessors or renters under leases or rental agreements confined to the premises rented, (iv) deposits or pledges made in connection with, or to secure payment of, worker’s compensation, unemployment insurance, old age pension programs mandated under applicable Legal Requirements or other social security, (v) liens in favor of carriers, warehousemen, mechanics and materialmen, to secure amounts not yet due and payable for labor, materials or supplies and other like liens securing amounts not yet due and payable, and (vi) restrictions on transfer of securities imposed by applicable state and federal securities laws.

“Material Adverse Effect” shall mean any event or circumstance that has or could reasonably be expected to have a material adverse effect on the business, results of operations, assets, liabilities or condition (financial or otherwise) of the Company, taken as a whole.

“Most Recent Balance Sheet” is defined in Section 4.2(a)(ii).

“Net Income” means, with respect to any specified Person, the net income (loss) of such Person, determined in accordance with GAAP, excluding, however: (a) any gain (or loss), together with any related provision for Taxes on such gain (or loss), realized in connection with: (i) any sale of any or all of such Person’s assets, or (ii) the disposition of any Equity Securities by such Person or any of its Subsidiaries or the extinguishment of any Debt of such Person or any of its Subsidiaries; and (b) any extraordinary gain (or loss), together with any related provision for Taxes on such extraordinary gain (or loss).

“Notified Party” is defined in Section 9.4(a).

“Operating Agreement” shall mean any operating agreement, partnership agreement, limited liability company agreement or the equivalent document thereof of any Person.

“Ordinary Course of Business” shall mean the ordinary course of the business, consistent with past practices, of the Company.

“Payroll Proration” which may be positive or negative, shall mean, as of the Closing Date, (i) the amount of the Post-Closing Payroll, multiplied by (ii) a fraction the numerator of which is the number of days between Company’s last Employee payroll payment immediately prior to the Closing Date and the Closing Date and the denominator of which is the number of days between the Company’s last Employee payroll payment immediately prior to the Closing Date and the date of the Post-Closing Payroll.

“Permits” is defined in Section 4.10(a).

“Person” shall mean any individual, partnership, corporation, limited liability company, association, trust, joint venture, unincorporated organization or other entity.

“Personalty Leases” is defined in Section 4.5(a).

“Post-Closing Payroll Amount” is defined in Section 2.3(a).

“Pre-Closing Partial Period” is defined in Section 6.9(a).

“Pre-Closing Tax Period” is defined in Section 6.9(a).

“Prime Rate” shall be the prime rate of interest as published on a semi-annual basis by the Wall Street Journal.

“Promissory Note” shall be the secured promise to pay the balance of the Cash Consideration over a four (4) year period and bearing interest at the Prime Rate.

“Property Taxes” means any and all real property taxes, personal property taxes and similar ad valorem obligations.

“Public Statement” is defined in Section 11.6.

“Purchase Price” is defined in Section 2.2(b).

“Real Property” is defined in Section 4.5(b).

“Real Property Leases” is defined in Section 4.5(c).

“Release” means any release, spill, emission, leaking, pumping, pouring, dumping, emptying, injection, deposit, disposal, discharge, dispersal, leaching or migration of Hazardous Substances into air, soil, water, groundwater or other media.

“Seller” as defined in the Preamble.

“Seller Indemnified Parties” is defined in Section 9.3.

“Seller’s Tax Contest” is defined in Section 6.9(d).

“Subsidiary” of any Person shall mean any other Person (i) of which such first Person (either alone or through or together with any other Subsidiary) owns, directly or indirectly Equity Securities of such other Person, or (ii) the operations of which are consolidated with such first Person, pursuant to GAAP, for financial reporting purposes.

“Tax” or “Taxes” means any federal, state, local or foreign net or gross income, gross receipts, sales, use, ad valorem, transfer, franchise, license, withholding, payroll, employment, excise, severance, stamp, occupation, premium, personal property, real property, capital stock, profits, social security (or similar), unemployment, disability, registration, value added, estimated, alternative or add-on minimum taxes, customs duties or other taxes, fees, assessments or charges of any kind whatsoever, together with any interest and any penalties, additions to tax or additional amounts imposed by any Governmental Authority, whether as a primary obligor or as a result of being a “transferee” (within the meaning of Section 6901 of the Code, Treasury Regulation Section 301.6901-1(b) or any other applicable law) of another person or a member of an affiliated, consolidated, unitary or combined group.

“Tax Proceedings” is defined in Section 6.9(e).

“Tax Return” shall mean all federal, state, local, and foreign Tax returns, Tax reports, claims for refund of Tax, and declarations of estimated Tax, or other statement relating to Taxes and any schedule or attachments to any of the foregoing or amendments thereto.

“Third Party Claim” is defined in Section 9.4(a).

ARTICLE II.
PURCHASE AND SALE OF COMPANY SHARES.

Section 2.1 Purchase and Sale of Company Shares. Subject to the terms and conditions of this Agreement, at the Closing, Seller will sell, convey, transfer, assign and deliver to Buyer, and Buyer will purchase from Seller, all of the right, title and interest of Seller in and to the number of Company Shares set forth on Exhibit A.

Section 2.2 Calculation and Payment of Purchase Price.

(a) The Balance Sheet Net Book Value of the Company shall be used in the calculation of the purchase price payable by Buyer for the Company Shares and shall be an amount (the “Purchase Price”) equal to the Cash Consideration, subject to adjustment as provided in Section 2.3. The Balance Sheet Net Book Value shall be provided by the Seller to the Buyer on April 30, 2007 and preliminarily agreed to by the parties on that date. Thirty (30) days after Closing, Seller shall provide Buyer with a final Balance Sheet Net Book Value with any adjustments to the preliminary Balance Sheet Net Book Value being either added to or subtracted from the Promissory Note.

(b) Subject to the terms and conditions of this Agreement (including Section 2.3), at the Closing, Buyer will pay or deliver to Seller One Million One Hundred Thousand Dollars ($1,100,000) at Closing (the “Base Consideration Amount”).

(c) The balance of the Cash Consideration shall consist of a Promissory Note with interest at the Prime Rate. Interest shall be payable in semi-annual payments and principal shall be paid in four (4) equal annual installments.

Section 2.3 Working Capital Adjustment.

(a) Not later than five (5) Business Days prior to the Closing Date, the Company shall deliver to Buyer its good faith estimate of the amount and date of the first Employee payroll payment to be made by the Company following the Closing Date (the “Post-Closing Payroll”), in each case, together with a reasonably detailed explanation thereof.

(b) On the Closing Date, the Company shall deliver to Buyer its calculation of the Payroll Proration, in each case, together with a reasonably detailed explanation thereof.

(c) If the Payroll Proration is less than the Payroll Target, the Purchase Price shall be increased at Closing by the amount of such difference. If the Payroll Proration is greater than the Payroll Target, the Purchase Price shall be decreased at Closing by the amount of such difference.

ARTICLE III.
THE CLOSING.

Section 3.1 Time and Place of Closing. The closing of the transactions contemplated hereby (the “Closing”) shall take place at the offices of Gray, Layton, Kersh, Solomon, Sigmon, Furr & Smith, P.A., 516 S. New Hope Road, Gastonia, North Carolina, at 10:00 a.m. (local time) on the date that is one (1) Business Day after all conditions precedent set forth in ARTICLE VII and ARTICLE VIII have been satisfied or waived (but no later than April 30, 2007), or at such other time or place upon which the parties may agree (the day on which the Closing takes place being referred to herein as the “Closing Date”); provided that all conditions to Closing set forth in ARTICLE VII and ARTICLE VIII have been satisfied or waived.

Section 3.2 Deliveries. At the Closing, subject to the satisfaction or waiver of each of the conditions specified in ARTICLE VII and ARTICLE VIII below, (i) the parties shall execute and deliver to each other the documents referred to in ARTICLE VII and ARTICLE VIII hereof; and (ii) Buyer shall deliver to Seller the Closing Cash Consideration.

ARTICLE IV.
REPRESENTATIONS AND WARRANTIES OF THE SELLER AND THE COMPANY.

Seller and the Company jointly and severally represent and warrant as follows: Section 4.1 Organizational Matters.

(a) Organization, Power and Good Standing. The Company is a corporation or limited liability company, as applicable, duly organized, validly existing and in good standing under the laws of the State of its incorporation as set forth on Schedule 4.1(a) and has the corporate or limited liability power and authority, as applicable, to own, operate or lease its properties and to carry on its business as currently conducted. The Company has made available

true and correct copies of its Charter, By-laws and Operating Agreement, as applicable, each as amended to date and currently in effect. The Company is duly qualified to do business as a foreign corporation or foreign limited liability company, as applicable, in each jurisdiction in which such qualification is necessary under applicable law.

(b) Authorization and Enforceability. Seller and the Company have all necessary power and authority to execute and deliver this Agreement and to perform its obligations hereunder or thereunder. The execution and delivery of this Agreement and the consummation of the transactions contemplated hereby or thereby have been duly authorized, executed and delivered by, and constitute a legal, valid, and binding obligation of Seller and the Company, Enforceable against it in accordance with its terms.

(c) Non-Contravention, etc. Except for items listed on Schedule 4.1(c), neither the execution, delivery or performance of this Agreement nor the consummation of the Closing and the performance by the Seller or the Company of its other obligations hereunder or thereunder in accordance with the terms and conditions hereby or thereby does not or will not constitute, result in or give rise to (i) a breach, violation or default under any Legal Requirement applicable to Seller or Company, (ii) a breach of or default under any Charter, By-law or Operating Agreement provision of Seller or Company, (iii) the imposition of any Lien upon any asset of Company, or (iv) a breach of, default under, contravention of or a right or increased likelihood of termination of (or the acceleration of the time for performance of any obligation under) any Contractual Obligation of Company. Except as set forth in Schedule 4.1(c), no approval, consent, waiver, authorization or other order of, and no declaration, filing, registration, qualification or recording with, any Governmental Authority is required to be obtained from or made by or on behalf of Company in connection with the execution, delivery or performance of this Agreement and the consummation of the Closing and the performance by the Seller and the Company of their other obligations hereunder in accordance with the terms and conditions of this Agreement.

(d) Capitalization. The entire authorized, issued and outstanding Equity Securities of the Company are set forth on Schedule 4.1(d). The Equity Securities set forth on Schedule 4.1(d) constitute all of the issued and outstanding Equity Securities of the Company, and except for the Company set forth on Schedule 4.1(d), the Company owns no Equity Securities, directly or indirectly, of any other Person. All such Equity Securities of the Company are duly authorized, validly issued and are fully paid and nonassessable and are free of any preemptive or other similar rights and were issued in compliance with applicable state and federal securities laws. The Company has any outstanding bonds, debentures, notes or other securities the holders of which have the right to vote (or which are convertible into or exercisable for securities having the right to vote) with the holders of Equity Securities of the Company on any matter. The record holders of each of the Company are set forth on Schedule 4.1(d). There are no (i) outstanding Equity Securities of the Company, or (ii) commitments or obligations of any kind or character (other than this Agreement) for (A) the issuance of Equity Securities of the Company or (B) the repurchase, redemption or other acquisition of any Equity Securities of the Company.

Section 4.2 Financial Statements, etc.

(a) Financial Information. Buyer has been furnished with each of the following:

(i) The audited consolidated balance sheet of the Seller as of December 31, 2006 and the related audited statements of operations and cash flows for the year ended December 31, 2006 (the “Audited Financials” and, together with the Interim Financials, the “Financial Statements”); and

(ii) The unaudited consolidated balance sheet of the Seller as of April 30, 2007 (the “Most Recent Balance Sheet”) and the related unaudited statements of operations and cash flows for the four (4) months then ended (collectively, the “Interim Financials”).

(iii) The unaudited consolidated balance sheets of the Company as of December 31, 2006 and April 30, 2007 and the related unaudited statements of operations and cash flows for the year-ending December 31, 2006 and the four (4) months ending April 30, 2007.

(b) Character of Financial Information. The Financial Statements were prepared in accordance with GAAP consistently applied throughout the periods specified therein and present fairly the consolidated financial position and results of operations of the Company as of the dates and for the periods specified therein in accordance with GAAP, subject in the case of the Interim Financials to the absence of notes thereto.

(c) No Undisclosed Liabilities. There are no liabilities of any nature (whether absolute, accrued, contingent or otherwise and whether matured or unmatured) of Company, other than (i) liabilities reflected or reserved against on the Interim Financials, (ii) liabilities incurred since the date of the Interim Financials in the Ordinary Course of Business, and (iii) liabilities set forth in Schedule 4.2(c) hereto.

Section 4.3 Change in Condition Since Balance Sheet Date. Except for matters set forth in Schedule 4.3, since the Balance Sheet Date the Business of the Company has been conducted only in the Ordinary Course of Business and:

(a) The Company has not:

(i) Entered into any Contractual Obligation other than this Agreement relating to (A) the sale of any Equity Securities of Company, (B) the purchase of assets constituting a business, or (C) any merger, consolidation, reorganization or other business combination;

(ii) Settled or agreed to settle any Action;

(iii) Mortgaged, pledged or subjected to any Lien any of its assets other than (A) conditional sales or similar security interests granted in connection with the lease or purchase of equipment or supplies in the Ordinary Course of Business and (B) Liens disclosed on Schedule 4.3;

(iv) Sold, leased, transferred or exchanged any property for less than the fair value thereof;

(v) Declared or paid any dividends or made distributions with respect to its Equity Securities;

(vi) (A) Increased (or committed to increase) the compensation payable or to become payable to or the benefits afforded any Employee, or (B) increased (or committed to increase) the rate of benefits payable under, amended the terms of, or entered into any new, bonus, incentive, pension, insurance, severance, deferred compensation, retirement profit sharing or other employee benefit plan or compensation or commission arrangement (contingent or otherwise) covering any current of former director, independent contractor, or Employee, other than as required by any applicable Legal Requirement;

(vii) Entered into any new or amended any (or committed to entering into or amending any) employment, severance, retention, compensation or change in control agreement for any current or former director, independent contractor or Employee (other than customary offer letters for employment at will in the Ordinary Course of Business that do not provide severance or change of control benefits);

(viii) Experienced any change in relations between the Company and any unions or the Employees that adversely affects Company;

(ix) Made any loan to (other than the advancement of expenses to directors and Employees in the Ordinary Course of Business), or entered into any other transaction with any of its current or former directors, officers and Employees or entered into any collective bargaining agreement;

(x) Added to or modified in any material respect any of the Company Plans other than (i) contributions made in accordance with the normal practices of Company, or (ii) the extension of coverage to other personnel who became eligible after the Balance Sheet Date;

(xi) Sold, assigned or transferred any assets having a value in excess of Ten Thousand Thousand Dollars ($10,000) other than in the Ordinary Course of Business;

(xii) Cancelled, terminated or materially amended any Contract, Permit or Contractual Obligation with respect to Intellectual Property or other instrument to which Company is a party outside the Ordinary Course of Business;

(xiii) Made any capital expenditure or incurred a liability therefor, in each case involving payments in excess of Ten Thousand Dollars ($10,000);

(xiv) Failed to operate the Business in the Ordinary Course so as to use reasonable efforts to preserve the Business intact, to keep available the services of personnel or Company and to preserve the goodwill of customers and others having business relations with Company;

(xv) Changed accounting methods or practices, other than such changes required by law or GAAP;

(xvi) Revalued the respective assets or properties of Company, including writing off notes or accounts receivable having a value in excess of Ten Thousand Dollars ($10,000);

(xvii) Experienced damage, destruction or loss with respect to any property or assets of Company having a value in excess of Ten Thousand Dollars ($10,000) (whether or not covered by insurance);

(xviii) Incurred indebtedness for borrowed money or any commitment to incur indebtedness, or any loans made or agreed to be made by Company, in each case in excess of Ten Thousand Dollars ($10,000);

(xix) Executed, terminated or materially amended any lease for real or personal property involving annual payments in excess of Ten Thousand Dollars ($10,000);

(xx) Made any material change in collection practices, policies or terms or payment practices, policies or terms applicable to any of the suppliers or customers of Company; or

(xxi) Entered into any agreement, whether or not in writing, to do any of the foregoing.

(b) There has not been any Material Adverse Effect.

Section 4.4 Environmental Matters, etc.

(a) Except as set forth on Schedule 4.4(a), the Company is and at all times have been, in compliance in all material respects with all Environmental Laws and have obtained and are in compliance in all material respects with all Permits from all Governmental Authorities issued pursuant thereto (collectively, “Environmental Permits”) for the operation of the Business of the Company as now conducted and as now contemplated to be conducted, and no material modification or change to the operations of the Business will be required upon the renewal of any such Environmental Permits other than modifications or changes required due to changes in law occurring after the date hereof.

(b) Except as set forth on Schedule 4.4(b), there is no Action pending or, to the Knowledge of the Seller or the Company, threatened against Company in respect of (i) noncompliance by Company with any Environmental Laws, (ii) the Release or threatened Release into the environment of any Hazardous Substance by Company, or (iii) the handling, storage, use, transportation or disposal of any Hazardous Substance by Company.

Section 4.5 Personal and Real Property

(a) Company has valid title to all of its personal property (other than leased or licensed personal property), and such personal property is not subject to any Lien except as set forth on Schedule 4.5(a). All leases and licensing agreements for personal property (“Personalty Leases”) leased or licensed by Company are valid and in full force and effect and are listed on Schedule 4.5(a). Company has performed all obligations required to be performed by them under such Personalty Leases and no event or condition exists which constitutes or, with the giving of notice or the passage of time or both, would constitute a default by Company as lessee or licensee under such leases.

(b) Schedule 4.5(b) sets forth a list of all real property leased by the Company (the “Real Property”). Company has valid title to all of its owned Real Property. The present use of the Real Property is permitted and constitutes a conforming structure under applicable zoning and building laws and ordinances. There are no pending or, to the Knowledge of the Seller or the Company, threatened requests, applications or proceedings to alter or restrict the zoning or other use restrictions applicable to the Real Property. No variance, special permit, special exception or other approval is required under local zoning and planning laws from any Governmental Authority to operate the business of the Company as it is currently being conducted at the Real Property. The buildings, structures, fixtures and equipment in or on the Real Property have been reasonably maintained consistent with standards generally followed in the industry.

(c) Each of the leases of Real Property (the “Real Property Leases”) leased to the Company is valid and in full force and effect. Company has performed all obligations required to be performed by it under such Real Property Leases, and no event or condition exists which constitutes or, with the giving of notice or passage of time or both, would constitute a default by Company as lessee under such Real Property Leases.

(d) The Company has made available to Buyer true and correct copies of the Personalty Leases and Real Property Leases and any amendments thereto. Buyer and Seller will enter a sublease of the Real Property Lease that creates a pass-through of all required performances under said Real Property Lease.

Section 4.6 Intellectual Property.

(a) Schedule 4.6(a) lists all patents, registered copyrights, registered trademarks and service marks, internet domain names and all applications for any of the foregoing, as well as any material unregistered trademarks and service marks that are owned by Company (together with the Company’s various unregistered copyrights and trade secrets and other intellectual property rights, the “Business Intellectual Property”). Except as set forth on Schedule 4.6(a), Company has good and marketable title to each item of Business Intellectual Property owned by it free and clear of any Lien and no other Person has the right to use such Business Intellectual Property other than pursuant to the Contractual Obligations listed on Schedule 4.6(c).

(b) Schedule 4.6(b) lists all license agreements or other Contractual Obligations pursuant to which any patents, copyrights, trademarks and service marks, Internet domain names and trade secrets are licensed to the Company that are either (i) material to the Company, or (ii) incorporated into or included as part of the Business Intellectual Property (the “Licensed Intellectual Property” and together with the Business Intellectual Property, the “Intellectual Property”).

(c) Schedule 4.6(c) lists each license, sublicense or other Contractual Obligation under which Intellectual Property is licensed by the Company to third parties (the “Licenses”). The use by Company of the Intellectual Property does not infringe any registered United States patent, trademark, service mark or copyright or, to the Knowledge of the Seller or the Company, any other enforceable intellectual property right of a third party. To the Knowledge of the Seller or the Company, no activity of any third party infringes upon the rights of the Company with respect to any of the Intellectual Property. No written notice of claims, or, to the Knowledge of the Seller or the Company, unwritten notices of claims have been asserted by any Person against Company with respect to the use of any Intellectual Property used by Company or licensed pursuant to the Licenses challenging or questioning the validity or effectiveness of such use or any license or sublicense agreements to which Company is a party and other than any royalties or payments due to any of the licensors of the Licensed Intellectual Property pursuant to the license agreements listed on Schedule 4.6(b), no Person has a right to a royalty or similar payment in respect of the Company’s use of any Intellectual Property.

(d) Except as set forth on Schedule 4.6(d), to the Knowledge of the Seller and the Company, the conduct of the Business does not infringe any registered United States patent, trademark, service mark or copyright, or any other enforceable intellectual property right of a third party.

Section 4.7 Certain Contractual Obligations

Set forth on Schedule 4.7 is a true and complete list of all of the following Contractual Obligations of the Company:

(a) All collective bargaining agreements and all written employment, severance, independent contractor, and consulting agreements, other than customary offer letters for employment at will that do not provide severance benefits beyond customary policies in the Ordinary Course of Business of Company;

(b) All Contractual Obligations under which Company is or will after the Closing be restricted in any respect from carrying on any business or other activities anywhere in the world;

(c) All Contractual Obligations of Company to sell or otherwise dispose of any assets having a fair market value in excess of Ten Thousand Dollars ($10,000) except in the Ordinary Course of Business;

(d) All Contractual Obligations between Company, on the one hand, and an Affiliate of Company, as the case may be, on the other hand;

(e) All Contractual Obligations (including partnership and joint venture agreements) under which (i) Company has any liability or obligation for Debt or constituting or giving rise to a guarantee of any liability or obligation of any Person (other than Company), or (ii) any Person has any liability or obligation constituting or giving rise to a guarantee of any liability or obligation of Company;

(f) All Contractual Obligations entered into since January 1, 2007 pursuant to which Company has incurred an obligation to pay any amounts in excess of Ten Thousand Dollars ($10,000) in respect of indemnification obligations, purchase price adjustment or otherwise in connection with any (i) acquisition or disposition of assets constituting a business or securities representing a controlling interest in any Person, (ii) merger, consolidation or other business combination, or (iii) series or group of related transactions or events of a type specified in subclauses (i) or (ii);

(g) All Contractual Obligations pursuant to which Company may be obligated to pay for goods and services to be delivered or performed in excess of Ten Thousand Dollars ($10,000) per year, except for purchase orders issued in the Ordinary Course of Business and except for Contractual Obligations with customers;

(h) All joint ventures, limited liability company or partnership agreements, or other agreements (however named) involving a sharing of profits, losses, costs or liabilities by Company with any other Person;

(i) Any agreement relating to the sale or disposition of material assets (other than in the Ordinary Course of Business) by Company; and

(j) Any Contractual Obligation entered into by Company since the Balance Sheet Date other than in the Ordinary Course of Business and involving payments in excess of Ten Thousand Dollars ($10,000); and

(k) Any Contractual Obligation requiring the Company to pay, at any time (i) any fees or expenses to the Seller or their respective Affiliates in connection with the transactions contemplated by this Agreement or (ii) any bonus or other compensation to be paid to any officer or other employee of Company as a result of the transactions contemplated by this Agreement.

Each of the Contractual Obligations described in the foregoing clauses and all other customer contracts shall be referred to herein collectively as the “Contracts.” The Company has made available to Buyer true and correct copies of the Contracts. No breach or default in performance by Company under any of the Contracts required to be listed on Schedule 4.7 has occurred, and no event has occurred which with notice or lapse of time or both would constitute such a breach or default. No breach or default in performance by Company under any of the Contracts not required to be listed on Schedule 4.7 has occurred, and no event has occurred which with notice or lapse of time or both would constitute such a breach or default. To the Knowledge of the Seller or the Company, (i) no breach or default by any other Person under any of the Contracts required to be listed on Schedule 4.7 has occurred and is continuing, and no event has occurred which with notice or lapse of time or both would constitute such a breach or default, (ii) no

breach or default by any other Person under any of the Contracts not required to be listed on Schedule 4.7 has occurred and is continuing, and no event has occurred which with notice or lapse of time on both would constitute such a breach or default. To the Knowledge of the Seller or the Company, no third party intends to terminate or fail to renew any of the Contracts required to be listed on Schedule 4.7.

Section 4.8 Insurance, etc. Set forth on Schedule 4.8 is a true and accurate list as of the date hereof of all insurance arrangements (including self insurance and trust accounts) and current primary, excess and umbrella policies or binders of insurance owned or held by or on behalf of or covering the operations, assets, business, equipment, properties, operations, employees, officers and directors of the Company, and all such policies and arrangements are in full force and effect. With respect to all arrangements, policies or binders providing coverage to the Company, no premiums are in arrears, no notice of cancellation or termination has been received with respect to any such arrangement, policy or binder, other than notices of cancellation routinely sent at the end of a policy term, and all such insurance arrangements, policies or binders are valid, outstanding, and Enforceable policies. The Company has delivered or made available to Buyer true and accurate copies of all such policies, arrangements or binders as in effect on the date hereof. The Company is not in default with respect to its obligations under any of such policies, arrangements or binders. Neither the Seller nor the Company has Knowledge of any threatened termination of, or premium increase with respect to, and the consummation of the transactions contemplated by this Agreement will not affect the validity of, any such policy, arrangement or binder.

Section 4.9 Litigation, etc. Except as set forth on Schedule 4.9, there is no Action against Company pending or, to the Knowledge of the Seller or the Company, threatened, nor, to the Knowledge of the Seller or the Company, have any events occurred that could give rise to an Action. There is no Action pending or, to the Knowledge of the Seller or the Company, threatened which seeks rescission of or seeks to enjoin the consummation of this Agreement or any of the transactions contemplated hereby. Except as set forth on Schedule 4.9, there is no unsatisfied judgment, order, injunction or decree binding upon Company or the Business. Except as set forth in Schedule 4.9, there have been no Actions by any Governmental Authority against or involving Company during the most recent five (5) years.

Section 4.10 Compliance with Laws.

(a) Company holds all permits, licenses, accreditations, authorizations, certificates, exemptions, variances, filings, franchises, notices, rights, grants, authorizations, consents and approvals of Governmental Authorities (the “Permits”) necessary for it to lawfully operate its Business. The Permits are in full force and effect and Company is in compliance with the Permits. The Company has not received any notification or communication from any Governmental Authority threatening to terminate, revoke, cancel, or reform, or asserting that Company is not in compliance with, any Permit. Each employee or contractor of the Company who is required to hold a Permit in connection with his employment by, or contractual or other arrangement with, Company holds such required Permits and, to the Knowledge of the Seller and the Company, such Permits are in good standing and not subject to any restrictions, suspensions, or other adverse limitations.

(b) The Company is not or has not been in conflict with, in default under, or in violation of, in any material respect, any Legal Requirement applicable to it, the services it provides, or any of its employees, or by which its assets or properties are bound or affected during the past three (3) years.

(c) The Company has not conducted any internal investigation for which it engaged outside counsel concerning any actual or alleged violation of any Legal Requirement or Permit on the part of Company or any of their respective officers, directors, Affiliates or agents.

Section 4.11 Labor Matters

(a) The Company is not a party to any labor agreement with respect to its employees with any labor organization, group or association. To the Knowledge of the Seller or the Company, there has been no attempt by organized labor or its representatives to make Company conform to the demands of organized labor that would cover the Employees. Company is and has complied, in all material respects with, all applicable Legal Requirements respecting employment practices, terms and conditions of employment and wages and hours and is not, and has not been, engaged in any unfair labor practice. Company has made all deductions required by law to be made for Employees’ wages and salaries and either remitted the same to appropriate Governmental Authorities or provided the same in their accounts and are not liable for any arrears of wages or any Taxes or penalties for failure to comply with the payment or repayment of any of the foregoing. There is no unfair labor practice charge or complaint against Company pending before the National Labor Relations Board or any comparable state agency. There are, and during the past five (5) years there have been, no labor strikes, labor disturbances or work stoppages or other material labor disputes pending against Company. Company, each ERISA Affiliate and each Company Plan has properly classified individuals providing services to Company and any ERISA Affiliate as independent contractors or employees, as the case may be.

Section 4.12 Tax Matters.

(a) Except as set forth on Schedule 4.12(a), all Tax Returns required to have been filed by or with respect to the Company and the income, operations, business and assets of the Company has been timely and properly filed (taking into account any extension of time to file granted or obtained) and such Tax Returns are true, correct and complete in all material respects.

(b) All Taxes of the Company that have become due or payable have been timely paid. The unpaid Taxes of the Company (i) did not, as of December 31, 2006, exceed the reserve for Taxes (excluding any reserve for deferred Taxes established to reflect timing differences between book and Tax income) set forth on the face of the Most Recent Balance Sheet (rather than in any notes thereto) and (ii) do not exceed that reserve as adjusted for the passage of time through the Closing Date in accordance with the past custom and practice of the Company in filing their Tax Returns.

(c) No deficiency for any amount of Tax has been asserted or assessed by a Governmental Authority against the Company. There are no Liens for Taxes on the assets of the Company other than liens for Taxes that are not yet due and payable.

(d) The Company (i) has withheld from any employee, customer, independent contractor, creditor, shareholder and any other applicable payee proper and accurate amounts for all taxable periods in compliance with all Tax withholding provisions of applicable Legal Requirement, (ii) has remitted on a timely basis, such amounts to the appropriate Governmental Authority, and (iii) has received properly completed exemption certificates for all exempt transactions.

(e) No Tax audits or other administrative or judicial Tax proceedings with respect to Taxes of the Company is pending or are being conducted. There is no claim or assessment pending, or, to the Knowledge of the Company or the Seller, threatened against Company for any alleged deficiency in Taxes. The Company has waived any statute of limitations in respect of Taxes or agreed to any extension thereof that is currently in effect. No claim has been made by a Governmental Authority in a jurisdiction where the Company does not file a Tax Return that the Company is or may be subject to taxation by that jurisdiction.

Section 4.13 Employee Benefit Plans.

(a) Disclosure.

(i) Schedule 4.13(a) lists all benefit and compensation plans, programs, policies, agreements, understanding, commitments arrangements and contracts (whether oral or written) including “employee benefit plans” within the meaning of Section 3(3) of ERISA, and any deferred compensation, stock option, stock purchase, restricted stock, stock appreciation rights, phantom stock or cash based incentive and bonus plans and pension, profit sharing, savings and thrift or other retirement, fringe benefits, vacation, cafeteria, medical, accidental death and dismemberment, disability, workers compensation, unemployment compensation, post-retirement insurance, post-employment, termination, retention, employment, consulting, change in control and severance plans, programs, arrangements or contracts sponsored, adopted, administered, maintained, contributed to or required to be contributed to, by Company or any Person who is, or at the relevant time was, a member of a “controlled group of corporations” with or under “common control” or a member of an “affiliated service group” with Company, as defined in Sections 414(b) or (c), (m) or (o) of the Code, or Sections 4001(a)(16) or 4001(b)(1) of ERISA (any such Person, an “ERISA Affiliate”) for the benefit of any current, former or retired employee, director, officer, independent contractor, or consultant of Company or any ERISA Affiliate or with respect to which Company may have any liability or Obligation (the “Company Plans”). No Person has any express or implied commitment, whether legally enforceable or not, to modify, change or terminate any Company Plan, other than with respect to a modification, change or termination required by ERISA or the Code.

(ii) The Seller has made available to Buyer current, true, correct and complete copies of the following documents (including any amendments): (i) all Company Plans (or if not written, a summary of material terms thereof), including any plan documents, trust agreements, written descriptions forming a part of a Company Plan, annuity contracts, insurance

contracts, or other funding instruments relating to any Company Plan; (ii) summary plan descriptions and summary of material modifications for each Company Plan required to be prepared and distributed; (iii) the IRS Form 5500 (including all schedules thereto) for the last three (3) completed plan years for each Company Plan required to file an IRS Form 5500; (iv) the most recent determination letter or opinion letter, if any received from the IRS with respect to each Company Plan that is intended to be qualified under Section 401 of the Code and any pending request for such determination; (v) the discrimination testing, if any, for the past three (3) years, with respect to each Company Plan; (vi) copies of all documents and correspondence received by or provided to the Department of Labor, the IRS or the Pension Benefit Guaranty Corporation in connection with or relating to any Company Plan; (vii) actuarial reports and other financial statements relating to each Company Plan required to file an IRS Form 5500, as applicable; (viii) a description setting forth the amount of any liability of Company or any ERISA Affiliate as of the Closing Date for payments more than thirty (30) days past due with respect to each Company Plan which is a pension benefit plan; (ix) all summaries furnished to employees, officers, independent contractors, or directors of the Company, and any ERISA Affiliate, of any Company Plan that is not required to prepare and distribute summary plan descriptions; and (x) copies of any investment management agreements, administrative services or recordkeeping agreements relating to any Company Plan.

(b) Compliance.

(i) Each Company Plan which is intended to be “qualified” within the meaning of Section 401(a) of the Code has received a favorable determination letter from the IRS as to qualification under Section 401(a) of the Code and neither the Company nor any ERISA Affiliate knows of any fact or set of circumstances that has adversely affected, or is reasonably likely to adversely affect, such qualification of any Company Plan, result in the revocation of such favorable determination letter, or cause such trust to be deemed not tax-exempt.

(ii) Each Company Plan, related trust agreement, annuity contract or other funding instrument is legally valid and binding, is in full force and effect and is and has been administered in accordance with its terms and is and at all times has been in compliance, both as to form and operation as of the date hereof, in all material respects with the applicable Legal Requirements (including where applicable, ERISA and the Code). The Company knows of no factor or set of circumstances that have adversely affected, or could reasonably be expected to adversely affect, the tax qualification of a Company Plan.

(iii) Each group health plan of the Company, or any ERISA Affiliate has been operated in material compliance with the provisions of the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended, and the regulations (including proposed regulations) thereunder any similar state law, and the Health Insurance Portability and Accountability Act of 1996, as amended, and the regulations (including proposed regulations) thereunder.

(c) Fiduciary Duties and Prohibited Transactions. The Company, and no ERISA Affiliate or any plan fiduciary of any Company Plan has not engaged in any transaction in violation of Sections 404 or 406 of ERISA or has any liability with respect to any “prohibited

transactions,” as defined in Section 4975(c)(1) of the Code, for which no exemption exists under Section 408 of ERISA or Sections 4975(c)(2) or (d) of the Code, or has otherwise violated the provisions of Title I, Subtitle B of ERISA. The Company nor any ERISA Affiliate has not knowingly participated in a violation of Part 4 of Title I, Subtitle B of ERISA by any plan fiduciary of any Company Plan or has incurred any civil penalty under Section 502(1) of ERISA.

(d) Retirement Plans. The Company nor any ERISA Affiliate has not at any time sponsored, contributed to, been required to contribute to, maintained or established (i) a plan covered by Title IV of ERISA, (ii) any “multiemployer plan” as defined in Section 4001(a)(3) of ERISA, or (iii) any plan subject to Section 412 of the Code.

(e) Unpaid Contributions. All amounts, premiums or contributions required to be made under the terms of any Company Plans have been timely made or, if not yet due, have been properly reflected on the most recent financial statements of the Company.

(f) Claims.

(i) There are no existing, pending, or, to the Knowledge of the Seller or the Company, threatened or anticipated Actions relating to any Company Plan, other than routine claims for information or benefits in the normal course. No Company Plan is or, within the last six (6) calendar years, has been, the subject of examination or audit by a Governmental Authority or a participant in a government sponsored amnesty, voluntary compliance or similar program.

(ii) No event has occurred and, to the Knowledge of the Seller or the Company, there exists no condition or set of circumstances, in connection with which Company, any ERISA Affiliate or any Company Plan, directly or indirectly, could be subject to any material liability (A) under the terms of the Company Plan, (B) under any statute, regulation or governmental order relating to any Company Plan, or (C) pursuant to any obligation of Company, or any ERISA Affiliate to indemnify any Person against liability incurred under any such statute, regulation, or order as it relates to the Company Plans.

(g) Retiree Benefits. Other than as required under Section 601, et seq. of ERISA, no Company Plan that is a welfare plan provides benefits or coverage for employees or former employees of the Company following retirement or other termination of employment.

(h) Castleton Group. Company is part of a Professional Employment Organization with Seller under the Castleton Group. At or after the Closing, Buyer may cancel the Company’s arrangements with the Castleton Group at any time with no further obligation or penalty.

Section 4.14 Brokers, etc. No broker, finder, investment bank or similar agent is entitled to any brokerage or finder’s fee in connection with the transactions contemplated by this Agreement based upon agreements or arrangements made by or on behalf of Company.

Section 4.15 Assets. Except as set forth on Schedule 4.15, the Company has good and marketable title to, or in the case of property held under lease or other contract or agreement, a valid and enforceable right to use, the present assets of the Company. The Seller owns no other

assets related to the Business other than Equity Securities of the Company. The assets of the Company as of the date hereof include all of the assets used or held for use in the Business.

Section 4.16 Continuation of Business. The Seller is not aware of any circumstances that could result in a material adverse change in the sources of business to the Company, including, without limitation, acceptance of the Company’s products and services.

Section 4.17 Accounts Receivable. All accounts receivable of the Company, whether reflected on the Financial Statements or subsequently created, have arisen from bona fide transactions in the Ordinary Course of Business. All such accounts receivable are good and collectible at the aggregate recorded amounts thereof, net of any applicable reserves for doubtful accounts reflected on the Financial Statements. The Company has good and marketable title to their respective accounts receivable, free and clear of all encumbrances. Since the date of the Financial Statements, there have not been any write-offs as uncollectible of any notes or accounts receivable of Company, except for write-offs in the Ordinary Course of Business.

ARTICLE V.
REPRESENTATIONS AND WARRANTIES OF BUYER.

Buyer represents and warrants as follows:

Section 5.1 Corporate Matters, etc.

(a) Organization, Power and Standing. Buyer is a corporation duly organized, validly existing and in good standing under the laws of Delaware and has full power and authority to enter into this Agreement, to carry out and perform its obligations hereunder and to consummate the transactions contemplated hereby.

(b) Authorization and Enforceability. This Agreement has been duly authorized, executed and delivered by, and is Enforceable against, Buyer.

(c) Non-Contravention, etc. The execution, delivery and performance of this Agreement by Buyer and the consummation by Buyer of the Closing hereunder in accordance with the terms and conditions of this Agreement does not and will not conflict with or result in the breach of any terms or provisions of, or constitute a default, under any Contractual Obligation of or the Charter or By-laws of Buyer or a breach of any Legal Requirement applicable to Buyer. No consent or filing is required to be obtained or made by or on behalf of Buyer in connection with the execution, delivery or performance of this Agreement and the consummation of the transactions contemplated hereby, except (i) for items which shall have been obtained or made on or prior to, and shall be in full force and effect at, the Closing Date, and (ii) where failure to obtain the consent would not materially and adversely affect Buyer’s ability to consummate the Closing hereunder in accordance with the terms and conditions of this Agreement and would not prevent Buyer from performing in all material respects any of its obligations under this Agreement.

Section 5.2 Financial Condition, etc. Buyer will have on the Closing Date sufficient funds available to it to pay the Cash Consideration pursuant to this Agreement and otherwise

satisfy all of its obligations in connection with this Agreement and the transactions contemplated hereby, subject to the consummation of necessary financing arrangements.

Section 5.3 Brokers, etc. No broker, finder, investment bank or similar agent is entitled to any brokerage or finder’s fee in connection with the transactions contemplated by this Agreement based upon agreements or arrangements made by or on behalf of Buyer or any of its Affiliates.

ARTICLE VI.

CERTAIN AGREEMENTS OF THE PARTIES.

Section 6.1 Payment of Transfer Taxes and Other Charges. The Seller shall be responsible for and shall pay all stock transfer Taxes, real property transfer Taxes, sales Taxes, documentary stamp Taxes, recording charges and other similar Taxes arising in connection with the transactions contemplated by this Agreement. Each of the parties hereto shall prepare and file, and shall fully cooperate with each other party with respect to the preparation and filing of, any Tax Returns and other filings relating to any such Taxes or charges as may be required.

Section 6.2 Confidentiality. The Seller and its Affiliates will treat and hold as confidential, all confidential information relating to the operations or affairs of the Business and this Agreement and the transactions contemplated hereby. In the event the Seller or its Affiliates are requested or required (by oral or written request for information or documents in any legal proceeding, interrogatory, subpoena, civil investigative demand or similar process or by Legal Requirement) to disclose any such confidential information, then Seller, shall notify Buyer promptly of the request or requirement so that Buyer, at its expense, may seek an appropriate protective order or waive compliance with this Section 6.2. If, in the absence of a protective order or receipt of a waiver hereunder, the Seller or its Affiliates are, on the advice of counsel, compelled to disclose such confidential information, the Seller or its Affiliates, as applicable, may so disclose the confidential information; provided that Seller shall use reasonable efforts to obtain reliable assurance that confidential treatment will be accorded to such confidential information. The provisions of this Section 6.2 shall not be deemed to prohibit the disclosure of confidential information (i) relating to the operations or affairs of the Business by the Seller or its Affiliates to the extent reasonably required to prepare or complete any required Tax Returns or financial statements or (ii) to the Seller’s legal, accounting and financial advisors; provided that such Persons are bound by an obligation of confidentiality to the Seller to keep such information confidential. Notwithstanding the foregoing, the provisions of this Section 6.2 shall not apply to information that (i) is or becomes publicly available other than as a result of a disclosure by the Seller or its Affiliates, (ii) is or becomes available to the Seller or its Affiliates on a non-confidential basis from a source that, to the Seller’s Knowledge, is not prohibited from disclosing such information by a legal, contractual or fiduciary duty or (iii) is or has been independently developed by the Seller or its Affiliates.

Section 6.3 Operation of Business; Related Matters. From the date hereof until the Closing Date, except as otherwise permitted or required by this Agreement, the Company shall, and shall cause each of its Subsidiaries to, (i) conduct the Business in the Ordinary Course of Business and substantially as presently operated, (ii) use reasonable efforts to maintain the value of the Business as a going concern, and (iii) use reasonable efforts to preserve intact the present

business organization and assets of the Business and preserve the present relationships of the Company with the payors, vendors and the Employees of the Business. Without limiting the foregoing, except as set forth in Schedule 6.3 or as contemplated by this Agreement, from the date hereof until the Closing Date, the Company shall not, without the prior written consent of Buyer:

(a) Enter into any transactions with any Affiliate of the Seller or the Company (other than transactions in the Ordinary Course of Business among the Company);

(b) Except as required by applicable Legal Requirements or the terms of existing Company Plans (i) pay any compensation or provide any benefits to any current or former Employee, officer, director, or independent contractor, other than in the Ordinary Course of Business, (ii) increase any compensation payable to or the benefits afforded any current of former director, independent contractor, officer or Employee, other than such increases in compensation or benefits as may be made in the Ordinary Course of Business, (iii) or commit to do any of the foregoing;

(d) Amend the Charter, By-laws or Operating Agreement of Company or sell, lease or otherwise dispose of any assets (except (i) for sales or other dispositions of inventory or excess equipment in the Ordinary Course of Business, and (ii) as may otherwise be permitted by the terms of this Agreement);

(e) (i) Make any material change in the Business or operations of Company, or (ii) hire or promote any employee, independent contractor, or consultant;

(f) Make any capital expenditure individually in excess of Ten Thousand Dollars ($10,000) with respect to the Business or enter into any Contractual Obligation therefor;

(g) Authorize, declare or set aside any dividend payment or other distribution, payable in Cash, Equity Securities, property or otherwise, with respect to any of its Equity Securities;

(h) Make any change in collection policies or payment terms applicable to any of the suppliers or customers of Company;

(i) Create any Lien on any of the assets of the Business;

(j) Except in the Ordinary Course of Business, (i) sell, assign, transfer, lease or otherwise dispose of or agree to sell, assign, transfer, lease or otherwise dispose of any of the assets of the Business or (ii) cancel any indebtedness owed to Company, in the case of both (i) and (ii) above, having, individually or in the aggregate, a value exceeding Ten Thousand Dollars ($10,000);

(k) Enter into any agreements or contracts which would require payments of more than Ten Thousand Dollars ($10,000) over any period of twelve (12) months or enter into

any agreement or contract of the type which, if in effect on the date hereof, would be required to be listed as a Contract on Schedule 4.7, or amend, terminate or extend any such Contract, except Contracts entered into in the Ordinary Course of Business;

(l) Change the accounting methods, principles or practices used by Company, except where required by law or GAAP;

(m) Revalue any of the assets of the Business, including writing off receivables or reserves, other than in the Ordinary Course of Business;

(n) Cause Company to acquire by merger or consolidation with, or merge or consolidate with, or purchase substantially all of the assets of, or otherwise acquire any material assets or business of, any corporation, partnership, association or other business organization or division thereof;

(o) Make or change any Tax election, settle or compromise any claim, notice, audit report or assessment in respect of its Taxes, change any annual Tax accounting period, adopt or change any method of Tax accounting, take any action not in accordance with past practice that would have the effect of deferring any Tax liability of Company from a taxable period ending on or before the Closing Date to any subsequent taxable period, enter into any tax allocation agreement, tax sharing agreement, tax indemnity agreement or Closing agreement relating to any Tax of Company, surrender any right to claim a Tax refund of Company, or consent to any extension or waiver of the statute of limitations period applicable to any Tax claim or assessment of Company;

(p) Issue, sell, pledge, encumber, authorize the issuance of, enter into any Contract to issue, sell, pledge, encumber, or authorize the issuance of, or otherwise permit to become outstanding any Equity Securities of Company, or permit the exercise of any option, warrant, or other right requiring the issuance of any Equity Securities by Company or any phantom rights thereon;

(q) Repurchase, redeem, or otherwise acquire or exchange, directly or indirectly, any securities convertible into any Equity Securities or any other interests of Company;

(r) Adjust, split, subdivide, combine, or reclassify any capital stock or other interests of Company, or authorize the issuance of any other securities in respect of or in substitution for the Equity Securities or other interests of Company;

(s) Enter into or amend any employment, severance, change in control, retention, or other similar Contract or other instrument between Company, and any employee, independent contractor, officer or director of Company that Buyer does not have the unconditional right to terminate without liability (other than ordinary salary or wage compensation for services already provided), at any time on or after the Closing;

(t) (i) Adopt any new employee benefit plan, program, policy, or arrangement, (ii) make any change in or to any existing employee benefit plans that would

increase the annual cost of the plan to Company, other than any such change required by a Legal Requirement, or (iii) commit to do any of the foregoing;

(u) Settle any Action involving any liability or asset of the Business for money damages exceeding Ten Thousand Dollars ($10,000) an individual basis or imposing material restrictions upon the operations of the Business;

(v) Other than renewals, modifications or amendments without adverse change of terms, modify, amend, or terminate any Contract affecting Company or waive, release, compromise, or assign any rights or claims; or

(w) Enter into any Contractual Obligation to do any of the actions referred to in this Section 6.3.

Section 6.4 Preparation for Closing. Buyer on the one hand and the Seller and the Company on the other hand will each use all reasonable best efforts to bring about the fulfillment of each of the conditions precedent to the obligations of the others set forth in this Agreement. In furtherance thereof:

(a) Consents, etc. Prior to the Closing Date, the Seller and the Company shall use best efforts to secure required written consents or waivers under or with respect to the Contracts and Permits indicated on Schedule 7.3.

(b) Disclosure Obligation. From time to time, on and prior to the Closing Date, the Seller shall promptly notify Buyer upon becoming aware of any fact, occurrence or event that could cause any of the representations and warranties contained in ARTICLE IV to be inaccurate or incomplete in any respect.

Section 6.5 No Solicitation. Prior to the Closing, or such earlier date on which this Agreement is terminated in accordance with its terms, none of the Seller, the Company and their shareholders, Affiliates, officers, employees, agents and representatives will, directly or indirectly, solicit from any Person, initiate with any Person, continue discussions with any Person regarding or otherwise encourage any Person to make any inquiries or proposals, or furnish information relating to the acquisition, in whole or in part, of the Business or any merger, consolidation, business combination, sale of a substantial portion of the assets, other similar transactions involving the Business or any other transaction that would impair the ability of the Seller to consummate the transactions contemplated hereby (any such transaction, an “Alternative Transaction”) or engage in any negotiations or enter into any agreement or understanding with any Person (other than Buyer) regarding an Alternative Transaction. The Seller and their shareholders, Affiliates, officers, employees, agents and representatives will not furnish any information concerning the Business to any Person other than Buyer for the purpose of, or with the intent of, permitting such Person to evaluate an Alternative Transaction and the Seller will notify Buyer in writing of any proposals or inquiries received by the Seller or their agents, as applicable, concerning any Alternative Transaction.

Section 6.6 Access to Properties and Records Pre-Closing and Post-Closing. (a) From the date of this Agreement through and including the Closing Date, upon reasonable notice, the Seller will (i) give Buyer and its counsel, accountants and other representatives reasonable access to all books, records, offices and other Facilities and properties of the Company, as applicable, (ii) permit Buyer to make such inspections of the foregoing as Buyer may reasonably request and (iii) cause its officers to furnish Buyer with such financial and operating data and other information with regard to the Business and properties of the Company, as applicable, as Buyer may from time to time reasonably request. Any such access will be provided, and all such inspections will be conducted, at reasonable times and in such a manner as not to interfere unreasonably with the operation of the Business.

(b) After Closing and through September 30, 2007, Seller shall provide Company with accounting and administrative services at no cost to Company. Such accounting services shall include monthly income, balance sheet and cash flow statements as well as supporting schedules as would normally be utilized by management in the operations of the Company. Such administrative services shall include check generation for accounts payable activities; however, Seller shall have no responsibility or authority with regards to banking activities.

(c) At or prior to the Closing, Seller and Company shall deliver to its customers instructions that all future payments to the Company must be made to the Company at its physical address, attention: Don Tunstall, and shall have taken reasonable measures to ensure that no such payments are unduly delayed or otherwise diverted. Any payments subsequently received by Seller in respect of Company business shall be immediately paid to the Company.

Section 6.7 Product and Technology License. For two (2) years following the Closing, Seller shall retain the exclusive right to purchase Company products for resale in the United States surface mass transit market at prices equal to a 20% reseller discount from the Company’s list prices as published from time to time, and otherwise on the terms and conditions offered to other like customers. At the end of the second year, the aforementioned arrangement shall renew for an additional year if sales to the Seller thereunder have generated a minimum of $250,000 of revenues to the Company in the period beginning at the Closing.

Section 6.8 Further Assurances. Each party, upon the request from time to time of any other party hereto after the Closing, and at the expense of the requesting party but without further consideration, will do each and every act and thing as may be necessary or reasonably requested to consummate the transactions contemplated hereby in an orderly fashion.

Section 6.9 Tax Matters.

(a) Tax Returns. Buyer shall prepare or cause to be prepared and shall file or cause to be filed all Tax Returns of the Company for (i) any period ending on or before the Closing Date (a “Pre-Closing Tax Period”) and (ii) the portion of any period beginning before and ending after the Closing Date to the extent any Taxes are attributable to the portion of such period ending on the Closing Date (a “Pre-Closing Partial Periods”). Buyer shall permit the Seller to review and comment on each such income Tax Return.

(b) Payment of Taxes. Buyer shall notify the Seller of any Taxes of the Company that are to be paid after Closing with respect to a Pre-Closing Tax Period or a Pre-Closing Partial Period and the Seller shall pay to the Buyer, on behalf of the Seller, the amount of such Taxes three (3) days after receiving such notification, provided, the Seller shall not be obligated to make any payment earlier than three (3) days prior to the date such Taxes are payable.

(c) Prorations. For purposes of this Agreement, in the case of any Taxes that are payable for a period that begins before and ends after the Closing Date, the portion of such Taxes that are allocable to the Pre-Closing Partial Period shall be (i) in the case of any property or ad valorem Taxes, the amount of such Tax for the entire Tax period multiplied by a fraction the numerator of which is the number of days in the Tax period ending on the Closing Date and the denominator of which is the number of days in the entire Tax period, and (ii) in the case of all other Taxes, equal to the amount which would be payable as computed on a “closing-of-the-books” basis if the relevant Tax period ended on the Closing Date.

(d) Tax Contests. Buyer, the Company and Seller agree to give prompt written notice to each other of any proposed adjustment to Taxes of the Company for which an indemnity claim may be made under Section 9.2 or Section 9.3 of this Agreement, provided, however, that no delay on the part of a party to this Agreement to provide such notice shall relieve any party from any obligation hereunder unless (and then solely to the extent) such party thereby is prejudiced. The Seller shall have the right to control the conduct of any Tax audit or proceeding of the Company for a Pre-Closing Tax Period (a “Seller’s Tax Contest”) so long as (i) the Seller notifies the Buyer, on behalf of the Seller, that the indemnification provisions of this Agreement will apply to any Damages the Buyer Indemnified Party may suffer resulting from, arising out of or relating to such Seller’s Tax Contest, (ii) the Seller conducts the defense of the Seller’s Tax Contest actively and diligently at its own cost, (iii) the Seller keeps Buyer informed regarding the progress and substantive aspects of any Seller’s Tax Contest upon written request for information relating to the Seller’s Tax Contest, and (iv) the Seller shall not compromise or settle any Seller’s Tax Contest without Buyer’s consent, which consent shall not be unreasonably withheld.

(e) Tax Matters Cooperation. Each of the parties to this Agreement shall cooperate in both (i) the preparation of all Tax Returns for any Tax periods for which one party could reasonably require the assistance of the other party in obtaining any necessary information, including without limitation any information that is required under Treasury Regulation Section 1.351-3, and (ii) any subsequent audits, claims, contests, litigation or other proceedings with respect to Taxes of any of the Company (collectively, “Tax Proceedings”). Such cooperation shall include, but not be limited to, furnishing prior years’ Tax Returns or return preparation packages to the extent related to the Company, and furnishing such other information within such party’s possession (or the possession of its accountant) requested by the party filing such Tax Returns or participating in Tax Proceedings, as is relevant to the preparation of such Tax Returns or the conduct of such Tax Proceedings, respectively. Such cooperation and information also shall include without limitation provision of powers of attorney for the purpose of signing Tax Returns and defending audits and promptly forwarding copies of appropriate notices and forms or other communications received from or sent to any applicable governmental authority which relate to the Company, and providing copies of all relevant Tax Returns to the extent

related to the Company, together with accompanying schedules and related work papers, documents relating to rulings or other determinations by any governmental authority and records concerning the ownership and tax basis of property, which the requested party may possess. The parties and their respective affiliates shall make their respective employees and facilities available on a mutually convenient basis to explain any documents or information provided hereunder.

(f) For purposes of this Section 6.9, references to the Company, Buyer and the Seller shall include successors and assigns.

(g) The covenants and agreements of the parties contained in this Section 6.9 shall survive the Closing and shall remain in full force and effect until such covenant or agreement is fully performed.

ARTICLE VII.

CONDITIONS TO THE OBLIGATION TO CLOSE OF BUYER.

The obligation of Buyer to consummate the Closing under this Agreement is subject to the satisfaction, on the Closing Date, of all of the following conditions, compliance with which, or the occurrence of which, may be waived prior to the Closing in writing by Buyer in its sole discretion:

Section 7.1 Representations, Warranties and Covenants.

(a) Continued Accuracy of Representations and Warranties. The representations and warranties of the Seller and the Company contained in this Agreement shall be true and correct at, and as of, the Closing Date with the same force and effect as if made on the Closing Date.

(b) Performance of Agreements. The Seller and the Company shall have performed and satisfied all covenants and agreements required by this Agreement to be performed or satisfied by it at or prior to the Closing.

(c) Closing Certificates of the Company. At the Closing, Company shall furnish a certificate, signed by an officer of the Company, as applicable, dated the Closing Date, to the effect that the conditions specified in Section 7.1(a) and Section 7.1(b) have been satisfied.

(d) Laurus Payoff. Seller shall have obtained a payoff letter from Laurus effective as of April 30, 2007 and shall have arranged by appropriate wire instruction for the Base Consideration Amount to be used to payoff the payment due Laurus as of April 30, 2007.

(e) Laurus Waiver. Laurus shall have agreed, effective upon receipt of an amount equal to the Base Consideration Amount from Buyer or Seller, to release all claims against the Company and all security interests, liens, mortgages and/or other charges or encumbrances created on or with respect to the capital stock of the Company and with respect to the underlying assets of the Company, including patents and trademarks owned by the Company.

Section 7.2 Legality; Governmental Authorization; Litigation. The consummation of the transactions contemplated hereby shall not be prohibited by any Legal Requirement, and all necessary filings, if any, pursuant to any material Legal Requirement shall have been made and all applicable waiting periods thereunder shall have expired or been terminated. No Action shall have been instituted at or prior to the Closing by any Person other than a party hereto or any Affiliate thereof, or instituted by any Governmental Authority, relating to this Agreement or any of the transactions contemplated hereby, the result of which would prevent or make illegal the consummation of any such transaction or would reasonably be expected to have a material adverse effect on the ability of Buyer to consummate the transactions contemplated hereby.

Section 7.3 Third Party Consents. There shall have been obtained by the Seller and the Company the consents, including the consents of Governmental Authorities, listed on Schedule 7.3.

Section 7.4 General. All corporate proceedings required to be taken on the part of the Company in connection with the transactions contemplated by this Agreement shall have been taken. Buyer shall have received copies of such officers’ certificates, good standing certificates, incumbency certificates and other customary closing documents as Buyer may reasonably request in connection with the transactions contemplated hereby.

ARTICLE VIII.

CONDITIONS TO THE OBLIGATION TO CLOSE OF THE SELLER AND THE COMPANY.

The obligations of the Seller and the Company to consummate the Closing under this Agreement are subject to the satisfaction, on the Closing Date, of all of the following conditions, compliance with which, or the occurrence of which, may be waived prior to the Closing in writing by the Seller and the Company in their sole discretion:

Section 8.1 Representations, Warranties and Covenants.

(a) Continued Accuracy of Representations and Warranties. The representations and warranties of Buyer contained in this Agreement shall be true and correct at, and as of, the Closing Date with the same force and effect as if made on the Closing Date.

(b) Performance of Agreements. Buyer shall have performed and satisfied all covenants and agreements required by this Agreement to be performed or satisfied by Buyer at or prior to the Closing.

(c) Closing Certificate of Buyer. At the Closing, Buyer shall furnish to the Company a certificate signed by a officer of Buyer, dated as of the Closing Date, to the effect that the conditions specified in Section 8.1(a) and Section 8.1(b) have been satisfied by Buyer.

Section 8.2 Legality; Government Authorization; Litigation. The consummation of the transactions contemplated hereby shall not be prohibited by any Legal Requirement, and all necessary filings, if any, pursuant to any material Legal Requirement shall have been made and all applicable waiting periods thereunder shall have expired or been terminated. No Action shall have been instituted at or prior to the Closing by any Person other than a party hereto or any

Affiliate thereof, or instituted by any Governmental Authority, relating to this Agreement or any of the transactions contemplated hereby, which has a reasonable probability of success and the result of which would prevent or make illegal the consummation of any such transaction or would reasonably be expected to have a material adverse effect on the ability of the Seller and Company to consummate the transactions contemplated hereby.

Section 8.3 General. All corporate proceedings required to be taken by Buyer in connection with the transactions contemplated by this Agreement shall have been taken. The Company shall have received copies of such officers’ certificates, good standing certificates, incumbency certificates and other customary closing documents as the Seller may reasonably request in connection with the transactions contemplated hereby.

ARTICLE IX.

INDEMNIFICATION.

Section 9.1 Survival of Representations and Warranties. The representations and warranties contained in this Agreement shall survive the Closing and will expire on the second (2^nd) anniversary following Closing; provided, however, that the representations and warranties contained in Section 4.1, shall survive indefinitely.

Section 9.2 Indemnification of Buyer.

(a) Indemnification of Buyer by the Seller. Subject to the other provisions of this Section 9.2, from and after the Closing, the Seller shall indemnify and hold harmless Buyer, and its officers, directors, employees, Affiliates, shareholders and agents, including the Company (collectively, the “Buyer Indemnified Parties”) from and against any and all losses, liabilities, damages, costs or expenses (including reasonable attorneys’ fees, losses, claims, judgments, liabilities, fines, amounts paid in settlement and damages) (collectively, “Damages”), arising out of, relating to or incurred as a result of (A) the breach of any representation or warranty of the Seller or the Company contained in this Agreement or in any certificate delivered at the Closing, (B) the breach or nonperformance of any covenant or agreement of the Seller or the Company contained in this Agreement, (C) any Taxes of the Company with respect to a Pre-Closing Tax Period or a Pre-Closing Partial Period, (D) any Taxes imposed on the Company by reason of any of them being a member of any affiliated, consolidated, unitary or combined group for a Pre-Closing Tax Period or a Pre-Closing Partial Period, as a transferee or successor with respect to such periods, under any Tax allocation, sharing or assumption agreement with respect to such periods or by contract or otherwise with respect to such periods, (E) any Action threatened, asserted, filed or otherwise commenced by any current or former holder of Equity Securities of Company, and (F) the ownership or claim of ownership by any Person other than the Company of any Equity Securities of Company.

(b) Deductible. No Buyer Indemnified Party shall be entitled to indemnification for any Damages pursuant to Section 9.2(a) unless the aggregate amount of all Damages for which all Buyer Indemnified Parties are entitled to indemnification pursuant to Section 9.2(a) exceeds Ten Thousand Dollars ($10,000) (the “Indemnification Basket”), in which case such Buyer Indemnified Party shall be entitled to the indemnification for all such Damages in excess of the Indemnification Basket, up to a maximum amount equal to the Purchase Price.

(c) Offset Against Seller Promissory Note. Notwithstanding anything in this Agreement to the contrary, if a Buyer Indemnified Party shall suffer or incur any Damages for which such Buyer Indemnified Party shall be entitled to indemnification under this ARTICLE IX, then Buyer shall first (to the extent of such Damages) reduce the amounts owing to the Seller under Section 2.2(c) by the amount of such Damages.

Section 9.3 Seller’s Indemnification. Subject to the other provisions of this ARTICLE IX, from and after the Closing, Buyer shall indemnify and hold harmless the Seller (the “Seller Indemnified Parties”) from and against any and all Damages arising out of, relating to or incurred as a result of (a) the breach of any representation or warranty of Buyer contained in this Agreement or in any certificate delivered at the Closing, or (b) the breach or nonperformance of any covenant or agreement of Buyer contained in this Agreement. No Seller Indemnified Party shall be entitled to indemnification for any Damages pursuant to this Section 9.3 unless the aggregate amount of all Damages for which all Seller Indemnified Parties are entitled to indemnification pursuant to this Section 9.3 exceeds the Indemnification Basket set forth in Section 9.2 (b) (and then only to the extent of such excess), up to a maximum amount equal to the Purchase Price.

Section 9.4 Matters Involving Third Parties.

(a) If any third party shall notify either a Buyer Indemnified Party or a Seller Indemnified Party (either, an “Indemnified Party”) with respect to any claim or Action (including notification of a Tax audit, proceeding or other Action) (a “Third Party Claim”) which may give rise to a claim for indemnification under this ARTICLE IX, then the Indemnified Party shall promptly notify the Seller, in the case of a Third Party Claim against a Buyer Indemnified Party, or Buyer, in the case of a Third Party Claim against a Seller Indemnified Party (in each case a “Notified Party”) thereof in writing; provided, however, that no delay on the part of the Indemnified Party to provide such notice shall relieve any Party from any obligation hereunder unless (and then solely to the extent) such Party thereby is prejudiced.

(b) The Notified Party will have the right to defend the Indemnified Party against the Third Party Claim with counsel of its choice reasonably satisfactory to the Indemnified Party so long as (i) the Notified Party notifies the Indemnified Party that has given notice of the Third Party Claim that the indemnification provisions of this Agreement will apply to any Damages the Indemnified Party may suffer resulting from, arising out of, relating to, in the nature of, or caused by the Third Party Claim, (ii) the Notified Party conducts the defense of the Third Party Claim actively and diligently at its own cost and expense, and (iii) in the reasonable opinion of the Indemnified Party, the Notified Party has the demonstrated financial resources to pay the full amount of any Third Party Claim at all times that it is defending the Indemnified Party.

(c) So long as the Notified Party is conducting the defense of the Third Party Claim in accordance with Section 9.4(b) above, (i) the Indemnified Party may retain separate co-counsel at its sole cost and expense and participate in the defense of the Third Party Claim, and (ii) the Indemnified Party will not consent to the entry of any judgment or enter into any settlement with respect to the Third Party Claim without the prior written consent of the Notified Party (which consent shall not unreasonably be withheld). The Notified Party will not consent to

the entry of any judgment or enter into any settlement with respect to the Third Party Claim unless written agreement is obtained releasing the Indemnified Party from all liability thereunder and the settlement does not call for any monetary payment by the Indemnified Party or any other liability on the part of the Indemnified Party.

Section 9.5 Tax Treatment of Indemnity Payments and Adjustments to Purchase Price. All amounts paid, offset or received with respect to indemnity claims under this Agreement or pursuant to Section 6.9 hereof shall be treated by the parties hereto for all Tax purposes as adjustments to the Purchase Price, unless otherwise required by law in which case such payments shall be made in an amount sufficient to indemnify the relevant party on a net after-Tax basis.

Section 9.6 Exclusive Remedy. If the Closing occurs, the Parties hereto acknowledge and agree that the exclusive remedy with respect to any Action arising out of or based upon this agreement or the subject matter hereof shall be pursuant to the provisions of this ARTICLE IX.

ARTICLE X.

TERMINATION.

Section 10.1 Termination of Agreement. This Agreement may be terminated by the parties only as provided below:

(a) The parties may terminate this Agreement by mutual written consent at any time prior to the Closing.

(b) Buyer may terminate this Agreement by giving written notice to the Seller at any time prior to the Closing in the event that the Seller or the Company is in material breach of any representation, warranty, covenant or agreement contained in this Agreement, Buyer has notified the Seller of the breach and such breach has continued without cure for a period of fifteen (15) days after the notice of breach.

(c) The Company may terminate this Agreement by giving written notice to Buyer at any time prior to the Closing in the event Buyer is in material breach of any representation, warranty, covenant or agreement contained in this Agreement, the Company has notified Buyer of the breach and such breach has continued without cure for a period of fifteen (15) days after the notice of breach.

(d) The Company on or after April 30, 2007 if the Closing of the transactions contemplated by this Agreement shall not have occurred by such date, and by Buyer on or after April 30, 2007, if the Closing of the transactions contemplated by this Agreement shall not have occurred by such date; provided, however, that the right to terminate this Agreement under this Section 10.1(b) shall not be available to any party whose improper action or failure to act has caused the failure of the transactions contemplated hereby to occur on or before such date.

Section 10.2 Effect of Termination. In the event of the termination of this Agreement pursuant to Section 10.1, all obligations of the parties hereunder (other than obligations under Section 6.2, ARTICLE X and ARTICLE XI, which shall survive termination) shall terminate without any liability of any party to any other party; provided, however, that (i) no termination

by a party pursuant to clause (b), (c) or (d) of Section 10 shall relieve such party from any liability arising from or relating to any breach by such party prior to termination.

Section 10.3 Time of Essence. Time is and shall be of the essence in this Agreement.

ARTICLE XI.

MISCELLANEOUS.

Section 11.1 Entire Agreement; Waivers. This Agreement constitutes the entire agreement among the parties hereto pertaining to the subject matter hereof and supersedes all prior and contemporaneous agreements, understandings, negotiations and discussions, whether oral or written, of the parties with respect to such subject matter. No waiver of any provision of this Agreement shall be deemed or shall constitute a waiver of any other provision hereof (whether or not similar), shall constitute a continuing waiver unless otherwise expressly provided nor shall be effective unless in writing and executed (i) in the case of a waiver by Buyer, by Buyer, (ii) in the case of a waiver by the Seller, by Seller.

Section 11.2 Amendment or Modification. The parties hereto may not amend or modify this Agreement except in such manner as may be agreed upon by a written instrument executed by each of the parties.

Section 11.3 Severability. In the event that any provision hereof would, under applicable law, be invalid or unenforceable in any respect, such provision shall (to the extent permitted under applicable law) be construed by modifying or limiting it so as to be valid and Enforceable to the maximum extent compatible with, and possible under, applicable law. The provisions hereof are severable, and in the event any provision hereof should be held invalid or unenforceable in any respect, it shall not invalidate, render unenforceable or otherwise affect any other provision hereof.

Section 11.4 Successors and Assigns. All of the terms and provisions of this Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective permitted transferees and assigns (each of which transferees and assigns, other than any lender or other Person described in clause (b) below, shall be deemed to be a party hereto for all purposes hereof). Notwithstanding the foregoing, (a) no transfer or assignment by any party hereto shall be permitted without the prior written consent of the other parties hereto and any such attempted transfer or assignment without consent shall be null and void, and (b) no transfer or assignment by any party shall relieve such party of any of its obligations hereunder, except that (i) Buyer, without the consent of the Seller, may assign its rights, but not its obligations, under this Agreement to an Affiliate, at any time, (ii) Buyer, without the consent of the Seller, may collaterally assign its rights under this Agreement to one or more lenders or other Persons providing financing to Buyer in connection with the transactions contemplated hereby and (iii) Buyer, without the consent of the Seller, may assign its rights and obligations under this Agreement to any Person or Persons in connection with the sale of all or substantially all of the assets of Buyer.

Section 11.5 Notices. Any notices or other communications required or permitted hereunder shall be sufficiently given if in writing and delivered personally or sent by telecopier, Federal Express, or registered or certified mail, postage prepaid, addressed as follows:

If to the Seller to:

David L. Turney
Digital Recorders, Inc.
5949 Sherry Lane, Suite 1050
Dallas, TX 75225
Tel No.: 214-378-9429
Facsimile: 214-378-8437

with a copy to:

David M. Furr
Gray, Layton, Kersh, Solomon,
Sigmon, Furr & Smith, P.A.
516 S. New Hope Road
Post Office Box 2636
Gastonia, NC 28053-2636
Tel No.: (704) 865-4400
Facsimile: (704) 866-8010

If to Buyer, to:

Peter E. Salas
Dolphin Asset Management Corp.
129 East 17^th Street
New York, NY 10003
Tel. No.: (212) 982-5071
Facsimile:(212) 202-3817

with a copy to:

Gary J. Simon
Hughes, Hubbard & Reed LLP
One Battery Park Plaza
New York, NY 10004
Tel. No.: (212) 837-6770
Facsimile: (212) 299-6770

Unless otherwise specified herein, such notices or other communications shall be deemed received (a) on the date delivered, if delivered personally, (b) two (2) Business Days after being sent by Federal Express, if sent by Federal Express, (c) one (1) Business Day after being delivered, if delivered by telecopier, and (d) three (3) Business Days after being sent, if sent by

registered or certified mail. Each of the parties hereto shall be entitled to specify a different address by giving notice as aforesaid to each of the other parties hereto.

Section 11.6 Public Announcements. At all times no party hereto will issue or make any reports, statements or releases to the public with respect to this Agreement or the transactions contemplated hereby (a “Public Statement”) without the consent of the Seller (in the case of a Public Statement by Buyer) or the consent of Buyer (in the case of a Public Statement by the Seller), which consent shall not be unreasonably withheld, delayed or conditioned. If any party hereto is unable to obtain, after reasonable effort, the approval of its public report, statement or release from the other parties hereto and such report, statement or release is, in the written opinion of legal counsel to such party, required by law in order to discharge such party’s disclosure obligations, then such party may make or issue the legally required report, statement or release and promptly furnish the other parties with a copy thereof. Notwithstanding the foregoing, Buyer and/or Seller may issue a customary press release announcing the execution of this Agreement and/or the Closing.

Section 11.7 Headings, etc. Section and subsection headings are not to be considered part of this Agreement, are included solely for convenience, are not intended to be full or accurate descriptions of the content thereof and shall not affect the construction hereof.

Section 11.8 Disclosure. Any item listed or referred to in any Schedule pursuant to any Section of this Agreement shall be deemed to have been listed in or incorporated by reference into each other Schedule to the extent such listing or description would be reasonably understood to apply to the information called for by such other Schedule.

Section 11.9 Third Party Beneficiaries. Nothing in this Agreement is intended or shall be construed to entitle any Person, other than the parties or their respective transferees and assigns permitted hereby to any Action, remedy or right of any kind.

Section 11.10 Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed an original, but all of which together shall constitute but one and the same instrument.

Section 11.11 Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New York, without giving effect to any choice or conflict of law provision or rule that would cause the application of the laws of any other jurisdiction.

Section 11.12 Consent to Jurisdiction. Each party to this Agreement, by its execution hereof, (i) hereby irrevocably submits, and agrees to cause each of its Subsidiaries to submit, to the exclusive jurisdiction of the state courts of the State of New York or the United States District Court located in the State of New York for the purpose of any Action, arising out of or based upon this Agreement or relating to the subject matter hereof, (ii) hereby waives, and agrees to cause each of its Subsidiaries to waive, to the extent not prohibited by applicable law, and agrees not to assert, and agrees not to allow any of its Subsidiaries to assert, by way of motion, as a defense or otherwise, in any such Action, any claim that it is not subject personally to the jurisdiction of the above-named courts, that its property is exempt or immune from attachment or

execution, that any such proceeding brought in one of the above-named courts is improper, or that this Agreement or the subject matter hereof may not be enforced in or by such court, and (iii) hereby agrees not to commence or to permit any of its Subsidiaries to commence any Action arising out of or based upon this Agreement or relating to the subject matter hereof other than before one of the above-named courts nor to make any motion or take any other action seeking or intending to cause the transfer or removal of any such Action to any court other than one of the above-named courts whether on the grounds of inconvenient forum or otherwise. Each party hereby consents to service of process in any such proceeding in any manner permitted by New York law, and agrees that service of process by registered or certified mail, return receipt requested, at its address specified pursuant to Section 11.5 is reasonably calculated to give actual notice.

Section 11.13 WAIVER OF JURY TRIAL. TO THE EXTENT NOT PROHIBITED BY APPLICABLE LAW WHICH CANNOT BE WAIVED, EACH OF THE PARTIES HERETO HEREBY WAIVES, AND AGREES TO CAUSE EACH OF ITS SUBSIDIARIES TO WAIVE, AND COVENANTS THAT NEITHER IT NOR ANY OF ITS SUBSIDIARIES WILL ASSERT (WHETHER AS PLAINTIFF, DEFENDANT OR OTHERWISE) ANY RIGHT TO TRIAL BY JURY IN ANY FORUM IN RESPECT OF ANY ISSUE OR ACTION, CLAIM, CAUSE OF ACTION OR SUIT (IN CONTRACT, TORT OR OTHERWISE), INQUIRY, PROCEEDING OR INVESTIGATION ARISING OUT OF OR BASED UPON THIS AGREEMENT OR THE SUBJECT MATTER HEREOF OR IN ANY WAY CONNECTED WITH OR RELATED OR INCIDENTAL TO THE TRANSACTIONS CONTEMPLATED HEREBY, IN EACH CASE WHETHER NOW EXISTING OR HEREAFTER ARISING. ANY PARTY HERETO MAY FILE AN ORIGINAL COUNTERPART OR A COPY OF THIS SECTION 11.13 WITH ANY COURT AS WRITTEN EVIDENCE OF THE CONSENT OF EACH SUCH PARTY TO THE WAIVER OF ITS RIGHT TO TRIAL BY JURY.

Section 11.14 Strict Construction. No rule of strict construction shall apply to or be used against any party hereto.

Section 11.15 No Personal Liability. No officer, director, employee, shareholder, partner or member of any party shall have any obligation or liability under this Agreement, and no party shall assert or attempt to assert any claim against any Person in connection with this Agreement or the transactions contemplated hereby unless such Person is also a party to this Agreement, and then only to the extent of any liabilities created pursuant to this Agreement.

Section 11.16 Expenses. Seller and Buyer shall be responsible for its own costs and expenses incurred in connection with this Agreement and the transactions contemplated hereby.

Section 11.17 Time of the Essence. Time is of the essence relating to Closing in order to payoff the Laurus obligation. The parties agree that the Base Consideration Amount may be paid in advance of a formal Closing if all paperwork is being completed on April 30, 2007.

IN WITNESS WHEREOF, the parties hereto, intending to be legally bound hereby, have caused this Agreement to be executed, as of the date first above written by their respective officers thereunto duly authorized.


		DOLPHIN DIRECT EQUITY PARTNERS, LP

		By:		Dolphin Advisors, LLC
				Its managing general partner
		By:		Dolphin Management Inc.
				Its managing member

		By:		/s/ Peter E. Salas
		Name: Peter E. Salas
		Title: President

		DIGITAL AUDIO CORPORATION

		By:		/s/ David L. Turney
		Name: David L. Turney
		Title: Chairman, President and CEO

		DIGITAL RECORDERS, INC.

		By:		/s/ David L. Turney
		Name: David L. Turney
		Title: Chairman, President and CEO

EXHIBIT A

100 shares of common stock of Digital Audio Corporation issued to Digital Recorders, Inc.

EX-10.15 3 d46691exv10w15.htm PROMISSORY NOTE exv10w15

Exhibit 10.15

THIS PROMISSORY NOTE HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933. NO SALE OR DISPOSITION MAY BE AFFECTED EXCEPT IN COMPLIANCE WITH RULE 144 UNDER SAID ACT OR AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO OR AN OPINION OF COUNSEL FOR THE HOLDER, SATISFACTORY TO THE COMPANY, THAT SUCH REGISTRATION IS NOT REQUIRED UNDER THE ACT OR RECEIPT OF A NO-ACTION LETTER FROM THE SECURITIES AND EXCHANGE COMMISSION.

PROMISSORY NOTE


$285,000.00		April 30, 2007
		Durham, North Carolina

FOR VALUE RECEIVED, the undersigned (“Maker”), promises to pay to DIGITAL RECORDERS, INC. (“Payee”) at P. O. Box 14068, Research Triangle Park, NC 27709-4068, the principal sum of Two Hundred Eighty-Five Thousand Dollars and no/100 ($285,000.00), payable as follows:

Principal shall be payable in four (4) equal annual installments of $71,250.00 each, with the first payment due April 30, 2008 and subsequent payments due April 30, 2009, April 30, 2010 and April 30, 2011. In addition, interest on the unpaid balance shall be paid in semi-annual installments at the prime rate of interest as published by the Wall Street Journal on the date of its issuance, such rate to be adjusted on the anniversary date of this Promissory Note.

1. Subject to Offset. The obligation of Maker under this Note is subject to modification, offset or reduction as set forth in Sections 2.2(a) and 9.2(c) of the Share Purchase Agreement of even date herewith between Maker, Payee and Digital Audio Corporation.

2. Default. This note and all other obligations and liabilities of the Maker to the Payee shall become immediately due and payable without notice or demand upon the occurrence of any of the following events with respect to Maker: filing of a voluntary or involuntary petition under any provision of the state or federal insolvency law (whether for bankruptcy, reorganization, arrangement, composition, extension, wage

earner’s plan, or otherwise); application for or the appointment of a receiver; assignment for the benefit of creditors; entry of judgment or issuance of a warrant of attachment; appointment of a committee of creditors or a liquidating agent, or calling of a meeting of creditors; or an offer of composition or extension to creditors, or a breach in the terms of the security agreement, or a default in payment of any installment due hereunder if such default is not cured within fifteen (15) days of written notice thereof.

3. Release and Modification. The Payee may renew or extend this note, release any party hereto, or waive or modify any provision hereof, without affecting the obligation of the Maker.

4. Right of Prepayment. Maker shall have the right to prepay this note at any time without penalty.

5. Captions. The use of captions in this note is for convenience only. Captions are not intended to be used for, nor shall any caption be used in, the interpretation or construction of this note.

6. Collection. In the event this note is not paid when due at any stated or accelerated maturity, the Maker agrees to pay, in addition to the principal and interest, all costs of collection, including reasonable attorneys’ fees.


		DOLPHIN DIRECT EQUITY PARTNERS, LP

		By:		Dolphin Advisors, LLC
				Its managing general partner
		By:		Dolphin Management Inc.
				Its managing member

		By:		/s/ Peter E. Salas
		Name: Peter E. Salas
		Title: President

EX-10.16 4 d46691exv10w16.htm WAIVER AND CONSENT exv10w16

Exhibit 10.16

WAIVER AND CONSENT

This WAIVER (this “Waiver”), dated as of April 30, 2007, is entered into by and between by and between Digital Recorders, Inc., a North Carolina corporation (the “Company”), Twinvision of North America, Inc., a North Carolina corporation (“Twinvision”), Digital Audio Corporation, a North Carolina corporation (“DAC”), and Robinson-Turney International, Inc., a Texas corporation (“RTI” and together with the Company, Twinvision and DAC, the “Credit Parties” and each a “Credit Party”) and Laurus Master Fund, Ltd., a Cayman Islands company (the “Purchaser”), for the purpose of amending and amending and restating and waiving certain terms of that certain Security Agreement, dated as of March 15, 2006 (the “Initial Closing Date”), by and between the Credit Parties and Purchaser (as amended, modified or supplemented from time to time, the “Security Agreement”); that certain Secured Non-Convertible Revolving Note, dated March 15, 2006 made by the Company in favor of Purchaser for the total principal amount of $6,000,000 (as amended and restated, amended, modified or supplemented from time to time, the “Revolving Note”); that certain Warrant issued by the Company to Purchaser to purchase up to 550,000 shares of Common Stock of the Purchaser dated March 15, 2006 (as amended, modified or supplemented from time to time, “Warrant 1”); that certain Securities Purchase Agreement dated April 28, 2006 by and between the Credit Parties and the Purchaser (as amended, modified or supplemented from time to time, the “SPA”); that certain Secured Term Note dated April 28, 2006, made by the Credit Parties in favor of Purchaser for the total principal amount of $1,600,000 (as amended, modified or supplemented from time to time, the “Term Note”); that certain Warrant issued by the Company to Purchaser to purchase up to 80,000 shares of Common Stock of the Company dated April 28, 2006 (as amended, modified or supplemented from time to time, “Warrant 2”), and that certain Amended and Restated Registration Rights Agreement, dated April 28, 2006, by and between the Company and the Purchaser (as amended, modified or supplemented, the “Registration Rights Agreement” and, together with the Security Agreement, the Revolving Note, Warrant 1, the SPA, the Term Note, Warrant 2 and the other Ancillary Agreements (as defined in the Securities Agreement), and Restated Agreements (as defined in the SPA) the “Funding Documents”). Capitalized terms used but not defined herein shall have the meanings given them in the Security Agreement.

WHEREAS, The Company intends to sell all of the capital stock of its wholly-owned subsidiary, Digital Audio Corporation, (“DAC”), to Dolphin Direct Equity Partners, LP (“Purchaser”) pursuant to that certain Share Purchase Agreement by and between the Company and Purchaser (the “Purchase Agreement”) and the documents ancillary thereto (the “Share Purchase Agreements”).

WHEREAS, the Company and Laurus have agreed to make certain changes to the Funding Documents as set forth herein, and that Laurus will waive certain provisions of the Funding Documents.

NOW, THEREFORE, in consideration of the above, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows:

WAIVERS

1. Laurus hereby consents to consummation of the transactions contemplated by the Share Purchase Agreements (the “Stock Transaction”); provided that, upon consummation of the Share Transaction, $1,100,000 of the net proceeds otherwise payable to DAC by Purchaser as a result of the Share Purchase Transaction shall instead be applied (the “Repayment”) via direct wire transfer from Purchaser to Laurus (pursuant to wire instructions set forth by Laurus in writing) to repay indebtedness owing to Laurus by the Company and its subsidiaries (receipt of such Repayment, the “Repayment Funding”)

2. On and after the Repayment Funding, (i) all of Laurus’s security interests, liens, mortgages and/or other charges or encumbrances created on or with respect solely to the capital stock of DAC, with respect to the underlying assets solely of DAC, and with respect to patents and trademarks solely owned by DAC under the Funding Documents are, without further action, forever released and discharged; and (ii) Laurus shall return any stock certificates of DAC in its possession and amend any UCC filings in need of amendment to reflect that it no longer has a security interest in the underlying assets of DAC or in the patents and trademarks owned by DAC. In addition to the requirements set forth above, the Company agrees to deliver to Laurus, and Laurus’ obligations hereunder are conditioned upon its receipt, prior to consummation of the Share Transaction, of a true and complete copy of the Purchase Agreement and all related documents, schedules and exhibits, relating to the assignment and sale, which documents shall each be in form and substance reasonably satisfactory to Laurus.

3. Effective on the Repayment Funding, Laurus on behalf of itself and any affiliates hereby releases and forever discharges DAC and its successors and assigns of and from any and all manner of action or actions, cause or causes of action, in law or in equity, suits, debts, liens, agreements, promises, liabilities, claims, demands, damages, loss, cost, or expense of any nature whatsoever, whether known or unknown by Laurus.

3. Nothing in this letter shall be deemed to release or discharge Laurus’s security interests, liens, pledges, mortgages and/or other charges or encumbrances created on or with respect to any assets of the Company or the Company’s Subsidiaries other than the capital stock of DAC and the underlying assets of DAC, including patents and trademarks owned by DAC.

MISCELLANEOUS

1. The Company understands that the Company has an affirmative obligation to make prompt public disclosure of material agreements and material amendments to such agreements. It is our determination that neither this letter nor the terms and provisions of this letter, (collectively, the “Information”) are material. Company has had an opportunity to consult with counsel concerning this determination. Company hereby agrees that Laurus shall not be in violation of any duty to Company or its shareholders, nor shall Laurus be deemed to be misappropriating any information of Company, if Laurus sells shares of common stock of Company, or otherwise engages in transactions with respect to securities of Company, while in possession of the Information.

2. Except as specifically set forth in this Waiver, there are no other amendments, modifications or waivers to the Funding Documents, and all of the other forms, terms and provisions of the Funding Documents remain in full force and effect.

3. This Waiver shall be binding upon the parties hereto and their respective successors and permitted assigns and shall inure to the benefit of and be enforceable by each of the parties hereto and their respective successors and permitted assigns. THIS WAIVER SHALL BE CONSTRUED AND ENFORCED IN ACCORDANCE WITH AND GOVERNED BY THE LAW OF THE STATE OF NEW YORK. This Waiver may be executed in any number of counterparts, each of which shall be an original, but all of which shall constitute one instrument.

[THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK]

IN WITNESS WHEREOF, each of the Company and Laurus has caused this Amendment to be signed in its name effective as of this 30th day of April, 2007.


		DIGITAL RECORDERS, INC.

		By:		/s/ David L. Turney
		Name: David L. Turney
		Title: Chairman, President and CEO
		DIGITAL AUDIO CORPORATION

		By:		/s/ David L. Turney
		Name: David L. Turney
		Title: Chairman, President and CEO

		TWIN VISION OF NORTH AMERICA INC.

		By:		/s/ David L. Turney
		Name: David L. Turney
		Title: Chairman, President and CEO

		ROBINSON TURNEY INTERNATIONAL INC.

		By:		/s/ David L. Turney
		Name: David L. Turney
		Title: Chairman, President and CEO

		LAURUS MASTER FUND, LTD.

		By:		/s/ David Grin
		Name: David Grin
		Title: Fund Manager

EX-31.1 5 d46691exv31w1.htm SECTION 302 CERTIFICATION OF DAVID L. TURNEY exv31w1

Exhibit 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, David L. Turney, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Digital Recorders, Inc.;

Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

	A)		designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	B)		evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation;

	C)		disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

	A)		all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	B)		any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


/s/ David L. Turney David L. Turney
Chief Executive Officer
May 15, 2007

A signed copy of this written statement required by Section 302 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

EX-31.2 6 d46691exv31w2.htm SECTION 302 CERTIFICATION OF STEPHEN P. SLAY exv31w2

Exhibit 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Stephen P. Slay, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Digital Recorders, Inc.;

	A)		designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	B)		evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation;

	C)		disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

	A)		all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	B)		any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


/s/ STEPHEN P. SLAY
Stephen P. Slay
Chief Financial Officer
May 15, 2007

EX-32.1 7 d46691exv32w1.htm SECTION 906 CERTIFICATION OF DAVID L. TURNEY exv32w1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Digital Recorders, Inc. (the “Company”) on Form 10-Q for the quarter ended March 31, 2007, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, David L. Turney, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

	1)		The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

	2)		The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.


/s/ David L. Turney
David L. Turney
Chief Executive Officer
May 15, 2007

A signed copy of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

EX-32.2 8 d46691exv32w2.htm SECTION 906 CERTIFICATION OF STEPHEN P. SLAY exv32w2

Exhibit 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Digital Recorders, Inc. (the “Company”) on Form 10-Q for the period ended March 31, 2007, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Stephen P. Slay, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

	1)		The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

	2)		The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.


/s/ STEPHEN P. SLAY
Stephen P. Slay
Chief Financial Officer
May 15, 2007

-----END PRIVACY-ENHANCED MESSAGE-----

Signature:

/s/ STEPHEN P. SLAY

Stephen P. Slay

Title:

Chief Financial Officer (Principal Financial and Accounting Officer)

May 15, 2007