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Network-1 Technologies -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934(Mark One)[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended March 31, 2000 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to ________________ Commission file number 000-10605 ODETICS, INC. (Exact Name of Registrant as Specified in Its Charter) ---------------- Delaware 95-2588496 (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification No.) 1515 South Manchester Avenue, Anaheim, California 92802 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code: (714) 774-5000 ---------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Class A common stock, $.10 par value Class B common stock, $.10 par value (Title of Class) Indicate by check mark whether the registrant: (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. Yes [x] No [_] Indicate by a check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of registrant's knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K [_] Based on the closing sale price on Nasdaq National Market on June 26, 2000,the aggregate market value of the voting stock held by nonaffiliates of theregistrant was $91,597,073. For the purposes of this calculation, shares ownedby officers, directors and 10% stockholders known to the registrant have beendeemed to be owned by affiliates. This determination of affiliate status is notnecessarily a conclusive determination for other purposes. Odetics has two classes of common stock outstanding, the Class A commonstock and the Class B common stock. The rights, preferences and privileges ofeach class of common stock are identical in all respects, except for votingrights. Each share of Class A common stock entitles its holder to one-tenth ofone vote per share and each share of Class B common stock entitles its holder toone vote per share. As of June 26, 2000, there were 8,204,351 shares of Class Acommon stock and 1,051,541 shares of Class B common stock outstanding. Unlessotherwise indicated, all references to common stock shall collectively refer tothe Class A common stock and the Class B common stock DOCUMENTS INCORPORATED BY REFERENCE Part III incorporates certain information by reference from theregistrant's definitive proxy statement for the annual meeting of thestockholders scheduled to be held on September 8, 2000.-------------------------------------------------------------------------------- ODETICS, INC. FORM 10-K ANNUAL REPORT TABLE OF CONTENTS Page ---- PART IITEM 1. BUSINESS........................................................ 1ITEM 2. PROPERTIES...................................................... 20ITEM 3. LEGAL PROCEEDINGS............................................... 20ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............. 20 PART IIITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS......................................................... 21ITEM 6. SELECTED FINANCIAL DATA......................................... 23ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS....................................... 25ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK....... 31ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..................... 32ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE........................................ 32 PART IIIITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.............. 32ITEM 11. EXECUTIVE COMPENSATION.......................................... 32ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.. 32ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................. 32 PART IVITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K........................................................ 33 i Note: When used in this Annual Report on Form 10-K and the informationincorporated herein by reference, the words "expect(s)," "feel(s),""believe(s)," "will," "may," "anticipate(s)," and similar expressions areintended to identify forward-looking statement. Such statements are subject tocertain risks and uncertainties which could cause actual results to differmaterially from those projected. You should not place undue reliance on theseforward-looking statements that speak only as of the date hereof. We undertakeno obligation to republish revised forward-looking statements to reflect eventsor circumstances after the date hereof or to reflect the occurrence ofunanticipated events. We encourage you to carefully review and consider thevarious disclosures made by us which describe certain factors which affect ourbusiness, including the risk factors set forth at the end of Part I, Item 1 ofthis report and in Part II, Item 7. "Management's Discussion and Analysis ofFinancial Condition and Results of Operations." PART IITEM 1. BUSINESSGeneral Odetics, Inc. was founded in 1969 to supply digital recorders for use inthe United States space program. We pioneered new designs and standards fordigital magnetic tape recorders offering high reliability and enhanced performance in the adverse environment attendant to space flight. In the 1970s,we broadened our information automation product line to include time-lapsevideocassette recorders for commercial and industrial security and surveillanceapplications, and entered the business of manufacturing telecom networksynchronization products. Through our Gyyr division, we became a leadingsupplier of time-lapse videotape cassette recorders, digital image processingmodules and related products used in security and surveillance systems. Weincorporated our Gyyr division in 1997, forming a wholly-owned subsidiary, Gyyr,Inc. In October 1997, we expanded Gyyr by acquiring Intelligent Controls Inc.,a manufacturer of access control products specializing in PC based, remote siteand fiber optic communications. In December 1999, we acquired the SecurityProducts Division of Digital Systems Processing, Inc., which expanded ourproduct line to include digital time-lapse recording based on hard disk drivetechnology. We manufactured telecom synchronization products in our Communicationsdivision beginning in the late 1970s. We incorporated our Communicationsdivision in fiscal 1999 as our wholly-owned subsidiary, Zyfer, Inc., as part ofour business expansion to develop products for secured communications over theInternet. Leveraging our expertise in video image processing, we entered into theintelligent transportation system ("ITS") business with the introduction of avideo-based vehicle detection system in 1993. In June 1997, we acquired certainassets comprising the Transportation Systems business from RockwellInternational, creating our ITS division, which expanded our offerings toinclude advanced traffic management systems and advanced traveler informationsystems. We incorporated our ITS division in 1998 as Odetics ITS, Inc. InOctober 1998, we broadened our systems offerings by acquiring Meyer, MohaddesAssociates, Inc., which currently operates as a subsidiary of Odetics ITS. InJanuary 2000, we reincorporated Odetics ITS in Delaware and changed its name toIteris, Inc. 1 In the early 1980s, we set out to develop the technical expertise to applyautomation to new commercial applications and established our Odetics Broadcastdivision. We incorporated our Odetics Broadcast division in 1999 as Broadcast,Inc. Broadcast develops and manufactures broadcast automation control systemsand pioneered the use of video tape libraries in broadcast television stationsand satellite uplink operations. The success of our video tape libraries led usto pursue new applications for information automation technologies. In 1991, weintroduced an automated tape handling subsystem for integration into tapelibraries designed for midrange computers and client/server networks. InJanuary 1993, we formed a separate subsidiary, ATL Products, Inc., to pursue themarket for automated tape libraries. In March 1997, ATL completed an initialpublic offering of 1,650,000 shares of its Class A common stock. We distributedour remaining 82.9% interest in ATL to our stockholders in a tax-freedistribution in October 1997. Today, Odetics serves as an incubator of high technology companies, eachwith its own marketplace, customers and products. These operations share acommon corporate overhead for support for facilities, human resources, benefitsand certain accounting, finance and executive management services. We arepursuing our incubator business strategy to nurture and develop each of theseoperations with the ultimate goal of achieving a tax-free spin-off of eachentity to our stockholders. In October 1999, we received a determination letterfrom the Internal Revenue Service to confirm the tax-free status of our proposedspin-off of Gyyr, Broadcast and Iteris. To date, we have not spun-off any ofthe entities for which we have received determination letters. Subject tofavorable market conditions, it is still our intention to move forward with theproposed spin-offs. We currently define our business segments as video products, telecomproducts and ITS. Our video products segment includes our Broadcast subsidiaryand our Gyyr subsidiary. Our telecom products segment includes our Zyfersubsidiary and our Mariner Networks subsidiary. Our ITS segment consists of ourIteris subsidiary. For more information concerning our business segments,please see Note 13 of Notes to Consolidated Financial Statements.Video Products Broadcast, Inc. Broadcast develops systems to automate the storage and scheduling ofcommercials, news stories and other television programming recorded on videotapeand video server storage systems. We believe that enhanced operationalefficiencies are a principal factor underlying the automation of broadcasttelevision stations and satellite uplink operations as the industry transitionsto digital television. Broadcast is developing proprietary software solutionsfor broadband video content management and delivery to serve broadcast and cableoperations as well as broadband Internet. The earliest commercial success for Broadcast came from the manufacture ofvideo tape libraries. The video tape library market has experienced a trendtoward smaller libraries, coupled with digital hard disk recording devices. Toaddress this market, we introduced the TCS45 tape library, which incorporateshighly integrated caching systems. The TCS45 can be coupled with hard driverecorders available from several recognized suppliers to the broadcastcommunity. As 2 a result of the industry's transition to digital television and high definitioncontent origination, we continue to see strong demand for tape libraries. Weoffer software to form powerful integrated systems, including our AIRO(TM) andMicrostation(TM) automation products. Our Roswell(TM) facility management systemis designed for enterprise automation of operations at television broadcastfacilities. Multi-channel presentation systems, which integrate the completeline of our hardware with commonly available broadcast quality video diskrecorders, are quickly becoming the core business of Broadcast. Broadcast isfocused on video asset management including desktop video browsing using anetwork PC architecture, which can be extended to wide area network applicationsand Internet applications. Sales, Marketing and Principal Customers. Broadcast sells directly tobroadcast television stations, satellite uplink operations, and other broadcasttelevision and cable television system operators. The sales and marketingmanagement for Broadcast is located at our principal facilities in Anaheim,California. Broadcast maintains a dedicated field sales force of five personsoperating in five U.S. sales regions and Canada, and a sales manager for LatinAmerica. The European sales and marketing activities for Broadcast areconducted and managed by Odetics Europe Limited, a wholly-owned United Kingdomsubsidiary of Odetics. Odetics Asia Pacific Pte. Ltd., Odetics' wholly-ownedsubsidiary located in Singapore, conducts Asian sales and marketing activitiesfor Broadcast. Broadcast also utilizes additional independent representativeorganizations to promote its products in various other foreign markets. The customers of Broadcast include major television networks such as Fox,the Canadian Broadcasting Corporation, CNBC, Euronews, Televisa, MeasatBroadcast Network Systems, NBC, the PBS Network, Group W SatelliteCommunications (for the Arts & Entertainment Network and the Discovery Channel),Asia Broadcast Centre, Univision and over 100 independent and network-affiliatedtelevision stations. Broadcast currently has systems installed in over 40countries. Manufacturing and Materials. Broadcast maintains a dedicated manufacturingoperation located within our Anaheim, California facilities. Our AIRO productsare serviced primarily in a facility located in Austin, Texas. At our Anaheimfacility, Broadcast maintains infrastructure to support production and inventorycontrol, purchasing, quality assurance, manufacturing and engineering. Broadcast purchases video servers from Grass Valley Group, Leitch andPinnacle Systems and video switching, conversion and monitoring equipment fromGrass Valley Group and Leitch for installation in our automated video managementsystems. Broadcast also purchases cabinets and other fabricated parts andcomponents from other third party suppliers. Gyyr, Inc. Gyyr produces analog and digital video products and access control systemsthat meet the security and surveillance needs for a variety of markets includingbanking, commercial/industrial and retail. Gyyr's time-lapse VCRs are installedin automated teller machines and retail point of sale systems to recordtransaction information in an effort to deter and address incidents of theft andother crimes. Gyyr's access control systems offer managed access and monitoringof public, private and high security facilities. Customer demand for moresophisticated capabilities and 3 integration due to digital technology has also contributed to the recent growthin the market for Gyyr's products. Gyyr's strategy is to provide completesoftware-based system integration of digital security devices over the Internet.Recent additions to Gyyr's product offerings include network and Internet-basedvideo and device control, intelligent dome cameras, video multiplexing anddigital recording. In December 1999, we expanded our product line to include theDVMS family of digital time-lapse recorders based on hard disk drivearchitecture. This product line expansion was the result of our acquisition ofthe Security Products Division of Digital Systems Processing, Inc. We sell ourproducts as individual devices as well as components of fully-integrated networksecurity control systems. Sales, Marketing and Principal Customers. Gyyr markets and sells itsproducts through three established channels: OEMs, independent distributors andsystem integrators. Gyyr personnel located at our principal facilities andsales offices throughout the world oversee approximately 1,000 of these channelpartners. Gyyr has a business development and service organization located atour Odetics Europe Limited subsidiary. Through January 2000, Odetics EuropeLimited assisted Gyyr with management in the development of European, MiddleEast and African markets. Commencing in January 2000, Gyyr formed Gyyr EuropeLimited to succeed Odetics Europe Limited in its support services. ThroughSeptember 1999, Gyyr utilized Odetics Asia Pacific Pte. Ltd. to assist insales to the Asian markets. Commencing in October 1999, Gyyr consolidated itsAsian sales and marketing activities into its Anaheim, California facilities.Gyyr's principal customers include major security equipment companies such asDiebold, Inc., ADT Security Systems, Inc., Honeywell, Inc., Mosler, Inc.,Hamilton Safe and ADI. Manufacturing and Materials. Gyyr maintains a dedicated manufacturing arealocated within our principal facilities in Anaheim, California. Gyyr primarilyuses continuous demand flow techniques in its assembly lines. Gyyr maintainsinfrastructure to support production and inventory control, purchasing, qualityassurance and manufacturing engineering. Gyyr purchases VCRs modified to our specifications exclusively throughNissei Sangyo America, the United States distribution affiliate of Hitachi,Ltd., into which we incorporate certain value-added features. As a result ofits reliance on Hitachi, Ltd, Gyyr is vulnerable to Hitachi's actions, whichmight necessitate changes in the design or manufacturing of Gyyr's products.While other suppliers are available who can manufacture VCRs suitable for use inGyyr's products, we would be required to make changes in our product design ormanufacturing methods to accommodate other VCRs, and Gyyr could experiencedelays or interruptions in supply while these changes are incorporated or a newsupplier is procured.Telecom Products Zyfer, Inc. We incorporated our Communications division in 1999 as Zyfer, Inc. Zyferdevelops and manufactures telecom network synchronization products and providesservice support for space borne digital data recorders. Our telecom networksynchronization products synchronize communications for data security, timingnetworks and wireless communications systems. These products are based on GPSand oscillator technologies and are sold for new applications in 4 wireless networks and satellite communications for both commercial andgovernment customers. Significant customers of Zyfer include LGIC of Korea, andthe U.S. government. See "Risk Factors--Our Operating Results Have BeenAdversely Affected by the Asian Economic Crisis." Zyfer has developed a new class of encryption products for securingenterprise wide communications. These products provide transparent security tousers and system administrators. Transparency results from the elimination oftraditional key exchange and key management requirements and from our ability toencrypt and decrypt at high data rates. Zyfer also provides service support for space borne digital data recorders that are used in manned and unmanned space vehicles to store data gathered byonboard sensors prior to transmission of the data to ground receiving stations.These recorders are employed in satellite programs for space research, earthresource and environmental observation and weather monitoring, as well as globalsurveillance and classified government programs. Sales, Marketing and Principal Customers. Zyfer conducts its selling andmarketing activities worldwide directly from our principal facilities inAnaheim, California. Zyfer sells its telecom synchronization products primarilythrough manufacturers' representatives. Manufacturing and Materials. Zyfer manufactures its telecomsynchronization products to best commercial practices and is ISO certified.Most of the manufacturing processes consist of final assembly and test. Weoutsource board assembly and some preliminary fabrication processes. Mariner Networks, Inc. Mariner Networks, Inc. has developed and will manufacture a family ofbroadband integrated access devices that enable branch offices to costeffectively combine their separate voice, video and data networks onto a singlewide area transport network. The Dexter(R) product family provides wire speedtransport of most data traffic types. Mariner Networks' products include ATMsubsystems, Frame Relay-to-ATM networking components and systems, and ATM widearea network access concentrators for handling intranet, data, voice and videotraffic. Sales, Marketing and Principal Customers. Mariner Networks sells itsproducts through OEMs and resellers in North America and in Europe. MarinerNetworks maintains sales offices at our facilities in the United States inAnaheim, California and at Odetics Europe Limited in the United Kingdom. Manufacturing and Materials. Mariner Networks' manufacturing processes areISO 9000 certified and consist primarily of final assembly and test. MarinerNetworks currently outsources circuit board assembly and some fabricationprocesses.ITS Products Iteris, Inc. Iteris, Inc. designs, develops, markets and implements software basedsolutions that improve the safety and efficiency of vehicle transportation.Using its proprietary software and 5 ITS industry expertise, Iteris provides video sensor systems and transportationmanagement and traveler information systems for the ITS industry. The ITSindustry is comprised of companies applying a variety of technologies to enablethe safe and efficient movement of people and goods. Iteris uses its outdoorimage recognition software expertise to develop proprietary algorithms for videosensor systems that improve vehicle safety and the flow of traffic. Ourknowledge of the ITS industry enables Iteris to design and implementtransportation solutions that help public agencies reduce traffic congestion andprovide greater access to traveler information. Iteris' proprietary image recognition systems include AutoVue and Vantage.AutoVue is a small windshield mounted sensor that utilizes proprietary softwareto detect and warn drivers of unintended lane departures. Through new softwaredevelopment, Iteris is expanding the AutoVue platform to incorporate additionalsafety and convenience features. Vantage is a video vehicle sensing system thatdetects the presence of vehicles at signalized intersections enabling a moreefficient allocation of green signal time. Iteris, Inc. designs, develops and implements software based systems thatintegrate sensors, video surveillance, computers and advanced communicationsequipment enabling public agencies to monitor, control and direct traffic flow,assist in the quick dispatch of emergency crews and distribute real-timeinformation about traffic conditions and alternative routes. Sales, Marketing and Principal Customers. Iteris markets and sells itstransportation management systems and services directly to government agenciespursuant to negotiated contracts which involve competitive bidding and specific qualification requirements. Sales of Iteris' systems generally involve longlead times and require extensive specification development, evaluation and pricenegotiations. Iteris sells its Vantage vehicle detection systems primarily throughindirect sales channels comprised of independent dealers in the United Statesand Canada who sell integrated solutions and related products to the trafficintersection market. The independent dealers for Iteris are primarilyresponsible for sales, installation and support of Vantage systems. Thesedealers maintain an inventory of demonstration traffic products including theVantage vehicle detection systems and sell directly to government agencies andinstallation contractors. These dealers often have long-term arrangements withthe government agencies in their territory for the supply of various productsfor the construction and renovation of traffic intersections. Iteris holdstechnical training classes for our dealers and maintains a full-time staff ofcustomer support technicians to provide technical assistance when needed. The marketing strategy for AutoVue is to establish it as the leadingplatform for in vehicle video sensing for trucks and passenger cars. AutoVue issold directly by Iteris to vehicle manufacturers. Iteris currently has a directsales force of three product managers, and intends to expand its sales force inthe future to include engineers and product managers who will be responsible forsales and customer service to specific vehicle manufacturers. Since its targetcustomer base is well known, Iteris currently does not plan to engage in largescale marketing campaigns. 6 Manufacturing and Materials. Iteris designs, assembles and tests thecomponents of its Vantage systems in approximately 5,000 square feet of space atour Anaheim facility. Production equipment consists of assembly lines and testapparatus for final assembly and testing of the manufactured product.Production volume is based upon quarterly forecasts that Iteris readjusts on amonthly basis to control inventory. Iteris subcontracts the manufacture of itsAutoVue systems to two manufacturers. We anticipate these manufacturers will beable to produce unit volume sufficient to support sales to heavy truckmanufacturers. Iteris intends to engage additional manufacturers with expertisein high volume production to produce higher volumes for light and medium trucksand passenger cars. Iteris does not manufacture any of the hardware used in thetransportation management and traveler information systems that it designs andimplements. The production facility for Iteris is ISO 9001 certified.Customer Support and Services Each of our business units is responsible for its own customer support andservice organizations. We provide warranty service for each of our productlines, as well as follow-up service and support, for which we typically chargeseparately. We also offer separate software maintenance agreements to ourcustomers. We view customer support services as a critical competitive factoras well as a revenue source.Backlog Our backlog of unfulfilled firm orders was approximately $27.3 million asof March 31, 2000 and approximately $22.0 million as of March 31, 1999.Approximately 82% of our backlog at March 31, 1999 was recognized as revenues infiscal 2000, and approximately 68% of our backlog at March 31, 2000 is expectedto be recognized as revenues in fiscal 2001. Pursuant to the customary terms ofour agreements with government contractors and other customers, customers cangenerally cancel or reschedule orders with little or no penalties. Lead timesfor the release of purchase orders depend upon the scheduling and forecastingpractices of our individual customers, which also can affect the timing of theconversion of our backlog into revenues. For these reasons, among others, ourbacklog at a particular date may not be indicative of our future revenues.Product Development Each of our business units directs and staffs its own product developmentactivities. Our businesses require substantial ongoing research and developmentexpenditures and other product development activities. Our company-sponsoredresearch and development costs and expenses were approximately $9.3 million infiscal 1998, $11.2 million in fiscal 1999 and $16.9 in fiscal 2000. We expectto continue to pursue significant product development programs and incursignificant research and development expenditures in each of our business units. Competition Our business units generally face significant competition in each of theirrespective markets. Increased competition may result in price reductions,reduced gross margins and loss of market share, any of which could have amaterial adverse effect on our business, financial condition and results ofoperations. 7 Broadcast's primary competitors include Sony, Panasonic, Louth and Pro-bel.Sony and Panasonic are large, international suppliers of extensive professionalquality products, including video tape libraries, for the broadcast televisionmarket. Louth and Probel principally provide automation control for videolibraries and disk recorders. Broadcast's systems compete primarily in thearena of facility management and enterprise wide automation. We believe thatthe capability of our systems to integrate the broadcast station businesssystems acquisition processes, storage devices and presentation devices under arelational data base management system represents a unique and differentiablecapability. As Gyyr expands its product base from time-lapse VCRs to providingintegrated security systems in CCTV and electronic access control, it willcompete with a broader set of companies. Major Japanese competitors in Gyyr'slegacy tape-based time-lapse VCR business include Panasonic, Toshiba, Sony,Sanyo, Mitsubishi and JVC. Gyyr also competes with large systems suppliersincluding Sensormatic, Honeywell, Pelco, Ultrak, Ademco and Vicon. In the saleof access control systems, Gyyr principally competes with Casi-Rusco,Checkpoint, Cardkey and Lenel. Gyyr generally competes based upon its strengthin the integration of its various component products into systems that providecomplete solutions through the use of advanced software and networkingtechnologies. Zyfer's primary competition for network synchronization products is Datum,Inc. and TrueTime Inc. Zyfer anticipates that its competition for encryptionproducts for secured communications will include Zyling Corporation, RainbowTechnologies, Inc. and Redcreek Communications Inc. For its integrated access devices, Mariner Networks' principal competitionincludes networking vendors Vina Technologies, Sonoma Systems and AcceleratedNetworks. While we believe that AutoVue is the only commercially-available lanedeparture warning system, potential competitors including Delphi AutomotiveSystems Corporation domestically and NEC Corporation and Hitachi Ltd. in Japanand Robert Bosch Gmbh in Europe are currently developing video sensor technologyfor the vehicle industry that could be used for lane departure warning systems.In the market for our Vantage vehicle detection systems, we compete with bothmanufacturers of "above ground" video camera detection systems, such asEconolite Control Products, Inc. and the Peek Traffic Systems division of ThermoElectron Corporation, and other non-intrusive detection devices includingmicrowave, infrared, ultrasonic and magnetic detectors, as well as manufacturersand installers of in-pavement inductive loop products. The transportation management and traveler information systems market ishighly fragmented and is subject to evolving national and regional quality andsafety standards. Iteris' competitors vary in number, scope and breadth of theproducts and services they offer. Iteris' competitors in advancedtransportation management and traveler information systems include corporationssuch as TRW, Inc., Transcore, Lockheed Martin Corporation, PB Farradyne Inc.,Kimley-Horn and Associates, Inc. and National Engineering Technology, Inc.Iteris' competitors in transportation engineering, planning and design includemajor firms such as Parsons Brinkerhoff, Inc. and Parsons Transportation GroupInc., as well as many regional engineering firms. 8 In general, the markets for the products and services offered by ourbusinesses are highly competitive and are characterized by rapidly changingtechnology and evolving standards. We believe that our ability to competeeffectively in our target markets depends on a number of factors, including thesuccess and timing of our new product development, the compatibility of our products with a broad range of computing systems, product quality andperformance, reliability, functionality, price, and service and technicalsupport. Many of our current and prospective competitors have longer operatinghistories, greater name recognition, access to larger customer bases andsignificantly greater financial, technical, manufacturing, distribution andmarketing resources than us. As a result, they may be able to adapt morequickly to new or emerging standards or technologies or to devote greaterresources to the promotion and sale of their products. It is also possible thatnew competitors or alliances among competitors could emerge and rapidly acquiresignificant market share. Our failure to provide services and develop andmarket products that compete successfully with those of other suppliers andconsultants in our target markets would have a material adverse effect on ourbusiness, financial condition and results of operations.Intellectual Property and Proprietary Rights Our ability to compete effectively depends in part on our ability todevelop and maintain the proprietary aspects of our technology. Our policy isto obtain appropriate proprietary rights protection for any potentiallysignificant new technology acquired or developed each of our business units. Wecurrently hold a number of United States and foreign patents and trademarks,which will expire at various dates commencing in 2004. We also have pending anumber of United States and foreign patent applications relating to certain ofour products; however, we cannot be certain that any patents will be grantedpursuant to these applications. In addition to patent laws, we rely on copyright and trade secret laws toprotect our proprietary rights. We attempt to protect our trade secrets andother proprietary information through agreements with customers and suppliers,proprietary information agreements with our employees and consultants, and othersimilar measures. We cannot be certain that we will be successful in protectingour proprietary rights. While we believe our patents, patent applications,software and other proprietary know-how have value, changing technology makesour future success dependent principally upon our employees' technicalcompetence and creative skills for continuing innovation. Litigation has been necessary in the past and may be necessary in thefuture to enforce our proprietary rights, to determine the validity and scope ofthe proprietary rights of others, or to defend us against claims of infringementor invalidity by others. An adverse outcome in such litigation or similarproceedings could subject us to significant liabilities to third parties,require disputed rights to be licensed from others or require us to ceasemarketing or using certain products, any of which could have a material adverseeffect on our business, financial condition and results of operations. Inaddition, the cost of addressing any intellectual property litigation claim,both in legal fees and expenses, as well as from the diversion of management'sresources, regardless of whether the claim is valid, could be significant andcould have a material adverse effect on our business, financial condition andresults of operations. 9 Employees We refer to our employees as associates. As of June 23, 2000, we employed569 associates, including 113 associates in general management, administrationand finance; 82 associates in sales and marketing; 196 associates in productdevelopment; 124 associates in operations, manufacturing and quality; and 54associates in customer service. None of our associates are represented by alabor union and we have not experienced a work stoppage. We provide centralized support for human resources management for each ofour business units and subsidiaries. These services include recruiting,administration and outplacement.Government Regulation Our manufacturing operations are subject to various federal, state andlocal laws, including those restricting the discharge of materials into theenvironment. We are not involved in any pending or threatened proceedings whichwould require curtailment of our operations because of such regulations. Wecontinue to expend funds in connection with our compliance with applicableenvironmental regulations. These expenditures have not, however, beensignificant in the past, and we do not expect any significant expenditures in the near future. From time to time, a portion of our work relating to digital data recordersmay constitute classified United States government information or may be used inclassified programs of the United States Government. For this purpose, wepossess certain relevant security clearances. Our affected facilities andoperations are also subject to security regulations of the United StatesGovernment. We believe we are currently in full compliance with theseregulations. RISK FACTORS Our business is subject to a number of risks, some of which are discussedbelow. Other risks are presented elsewhere in this report. You should considerthe following risks carefully in addition to the other information contained inthis report before purchasing the shares of our common stock. If any of thefollowing risks actually occur, they could seriously harm our business,financial condition or results of operations. In such case, the trading priceof our common stock could decline, and you may lose all or part of yourinvestment. Our Quarterly Operating Results Fluctuate as a Result of Many Factors. Ourquarterly operating results have fluctuated and are likely to continue tofluctuate due to a number of factors, many of which are not within our control.Factors that could affect our revenues include the following: . our significant investment in research and development for our subsidiaries and divisions; . our ability to develop, introduce, market and gain market acceptance of new products applications and product enhancements in a timely manner; 10 . the size and timing of significant customer orders; . the introduction of new products by competitors; . the availability of components used in the manufacture of our products; . our ability to control costs; . changes in our pricing policies and the pricing policies by our suppliers and competitors, as well as increased price competition in general; . the long lead times associated with government contracts or required by vehicle manufacturers; . our success in expanding and implementing our sales and marketing programs; . technological changes in our target markets; . our relatively small level of backlog at any given time; . the mix of sales among our divisions; . deferrals of customer orders in anticipation of new products, applications or product enhancements; . the Asian economic crisis and instability; . currency fluctuations and our ability to get currency out of certain foreign countries; and . general economic and market conditions. In addition, our sales in any quarter may consist of a relatively smallnumber of large customer orders. As a result, the timing of a small number oforders may impact our quarter to quarter results. The loss of or a substantialreduction in orders from any significant customer could seriously harm ourbusiness, financial condition and results of operations. Because of the factors listed above and other risks discussed in thisreport, our future operating results could be below the expectations ofsecurities analysts and/or investors. If that happens, the trading price of ourcommon stock could be adversely affected. We Have Experienced Substantial Losses and Expect Future Losses. We haveexperienced substantial operating losses of $38.7 million for the year endedMarch 31, 2000 and $18.3 million for the year ended March 31, 1999. We may notbe able to achieve profitability on a quarterly or annual basis in the future.Most of our expenses are fixed in advance, and we generally are unable to reduceour expenses significantly in the short-term to compensate for any unexpecteddelay or decrease in anticipated revenues. In addition, in order to implementour incubator strategy successfully, we expect to continue to make significantinvestments in each of 11 our business units. As a result, we may continue to experience losses whichcould cause the market price of our common stock to decline. Our Incubator Strategy is Expensive and May Not Be Successful. We haveinitiated a business strategy called our incubator strategy which is expensiveand highly risky. The goal of this strategy is to nurture and develop companiesthat can be spun-off to our stockholders. This strategy has in the pastrequired us to make significant investments in our business units, both forresearch and development, and also to develop a separate infrastructure for eachof our divisions, sufficient to allow the division to function as an independentpublic company. We expect to continue to invest heavily in the development ofour divisions with the goal of conducting additional public offerings. We maynot recognize the benefits of this investment for a significant period of time,if at all. Our ability to complete an initial public offering of any of ourdivisions and/or spin-off our interest to our stockholders will depend upon manyfactors, including: . the overall performance and results of operations of the particular businesa unit; . the potential market for our business unit; . our ability to assemble and retain a broad, qualified management team for the business unit; . our financial position and cash requirements; . the business unit's customer base and product line; . the current tax treatment of spin-off transactions and our ability to obtain favorable determination letters from the Internal Revenue Service; and . general economic and market conditions, including the receptivity of the stock markets to initial public offerings. We may not be able to complete a successful initial public offering orspin-off of any of our divisions in the near future, or at all. During fiscal2000, we attempted to complete the initial public offering of Iteris. Weaborted the offering due to adverse market conditions. Even if we do completeadditional public offerings, we may decide not to spin-off a particular businessunit, or to delay the spin-off until a later date. We Must Keep Pace with Rapid Technological Change to Remain Competitive.Our target markets are in general characterized by the following factors: . rapid technological advances; . downward price pressure in the marketplace as technologies mature; . changes in customer requirements; . frequent new product introductions and enhancements; and 12 . evolving industry standards and changes in the regulatory environment. We believe that we must continue to make substantial investments to supportongoing research and development in order to remain competitive. In particular,we will need to modify certain of our products to accommodate the anticipateddeployment of digital television and the corresponding phase-out of analogtransmissions. We will also have to continue to develop and introduce newproducts that incorporate the latest technological advancements in hardware,storage media, operating system software and applications software in responseto evolving customer requirements. Our recent shift towards providing moresoftware solutions may create additional challenges for us, particularly inBroadcast. Our business and results of operations could be adversely affectedif we do not anticipate or respond adequately to technological developments orchanging customer requirements. Our Future Success Depends on the Successful Development and MarketAcceptance of New Products. We believe our revenue growth and future operatingresults will depend on our ability to complete development of new products andenhancements, achieve broad market acceptance of these products andenhancements, and reduce our product costs. We may not be able to introduce anynew products or any enhancements to our existing products on a timely basis, orat all. In addition, the introduction of any new products could adverselyaffect the sales of our certain of our existing products. Our future success will also depend in part on the success of severalrecently introduced products including: . Roswell, our automated facility management system for broadcast television stations; . Bowser, our visual asset manager; . MicroStation, our integrated disk recorder and automation system; . Vortex, our high performance dome product; . Digi Scan Pro, our advanced digital multiplexer; . DVMS, our family of digital time-lapse recorders; . Vantage One and Vantage Edge, our single camera traffic detection systems; . AutoVue, our lane departure warning system; and . Dexter, our networking access device. Market acceptance of our new products depends upon many factors, includingour ability to resolve technical challenges in a timely and cost-effectivemanner, the perceived advantages of our new products over traditional productsand the marketing capabilities of our independent distributors and strategicpartners. Our business and results of operations could be seriously harmed byany significant delays in our new product development. We have experienceddelays in the past in the introduction of new products, particularly with ourRoswell system. Certain of 13 our new products could contain undetected design faults and software errors or"bugs" when first released by us, despite our testing. We may not discover thesefaults or errors until after a product has been installed and used by ourcustomers. Any faults or errors in our existing products or in our new productsmay cause delays in product introduction and shipments, require designmodifications or harm customer relationships, any of which could adverselyaffect our business and competitive position. We currently anticipate that we will outsource the manufacture of ourAutoVue product line to a single manufacturer. This manufacturer may not beable to produce sufficient quantities of this product in a timely manner or at areasonable cost, which could materially and adversely affect our ability tolaunch or gain market acceptance of AutoVue. We May Need Additional Capital in the Future and May Not Be Able to Secure Adequate Funds on Terms Acceptable to Us. We raised approximately $7.3 millionin a private placement of Odetics Class A common stock in December 1998 andapproximately $2.0 million in March 1999. We raised $5.0 million through thesale of an option on our principal Anaheim facility in July 1999. In addition,we raised $3.75 million through the issuance of debt to Daimler ChryslerVentures, which is convertible into 2.5% of the equity securities of Iteris. Wemay need to raise additional capital in the near future, either throughadditional bank borrowings or other debt or equity financings. Our capitalrequirements will depend on many factors, including: . market acceptance of our products; . increased research and development funding, and required investments in our divisions; . increased sales and marketing expenses; . potential acquisitions of businesses and product lines; and additional working capital needs. If our capital requirements are materially different from those currentlyplanned, we may need additional capital sooner than anticipated. If additionalfunds are raised through the issuance of equity securities, the percentageownership of our stockholders will be reduced and such securities may haverights, preferences and privileges senior to our common stock. Additionalfinancing may not be available on favorable terms or at all. If adequate fundsare not available or are not available on acceptable terms, we may be unable todevelop or enhance our products, expand our sales and marketing programs, takeadvantage of future opportunities or respond to competitive pressures. We Have Significant International Sales and Are Subject to Risks Associatedwith Operating in International Markets. International product salesrepresented approximately 19% of our total net sales and contract revenues forthe fiscal year ended March 31, 2000, approximately 27% for the fiscal yearended March 31, 1999 and approximately 34% for the fiscal year ended March 31,1998. International business operations are subject to inherent risks,including, among others: 14 . unexpected changes in regulatory requirements, tariffs and other trade barriers; . longer accounts receivable payment cycles; . difficulties in managing and staffing international operations; . potentially adverse tax consequences; . the burdens of compliance with a wide variety of foreign laws; . reduced protection for intellectual property rights in some countries; . currency fluctuations and restrictions; and . political and economic instability. We believe that international sales will continue to represent asignificant portion of our revenues, and that continued growth and profitabilitymay require further expansion of our international operations. Ourinternational sales are currently denominated primarily in U.S. dollars. As aresult, an increase in the relative value of the dollar could make our productsmore expensive and potentially less price competitive in international markets.We do not engage in any transactions as a hedge against risks of loss due toforeign currency fluctuations. Any of these factors may adversely effect our future international salesand, consequently, on our business and operating results. Furthermore, as weincrease our international sales, our total revenues may also be affected to agreater extent by seasonal fluctuations resulting from lower sales thattypically occur during the summer months in Europe and other parts of the world. Our Operating Results Have Been Adversely Affected by the Asian EconomicCrisis. Our telecommunications products are sold principally to LGIC of Korea. As a result of economic instability in Asia, particularly in Korea, our sales inthis region declined over 60% in fiscal year 1999 as compared to fiscal 1998.While sales to LGIC in fiscal 2000 increased, the aggregate sales to LGIC infiscal 2000 were still significantly below fiscal 1998 sales. It is possiblethat these sales could be further impacted by the currency devaluations andrelated economic problems in this region, and sales in this region couldcontinue to decline. We Need to Manage Growth and the Integration of Our Acquisitions. Over thepast three years, we have significantly expanded our operations and made severalsubstantial acquisitions of diverse businesses, including Intelligent Controls,Inc., International Media Integration Services, Ltd., Meyer Mohaddes Associates,Inc., Viggen Corporation, certain assets of the Transportation Systems businessof Rockwell International, and the Security Products Division of Digital SystemsProcessing, Inc. A key element of our business strategy involves expansionthrough the acquisition of complementary businesses, products and technologies.Acquisitions may require significant capital infusions and, in general,acquisitions also involve a number of special risks, including: 15 . potential disruption of our ongoing business and the diversion of our resources and management's attention; . the failure to retain or integrate key acquired personnel; . the challenge of assimilating diverse business cultures; . increased costs to improve managerial, operational, financial and administrative systems and to eliminate duplicative services; . the incurrence of unforeseen obligations or liabilities; . potential impairment of relationships with employees or customers as a result of changes in management; and . increased interest expense and amortization of acquired intangible assets. Our competitors are also soliciting potential acquisition candidates, whichcould both increase the price of any acquisition targets and decrease the numberof attractive companies available for acquisition. Acquisitions, combined with the expansion of our business divisions andrecent growth has placed and is expected to continue to place a significantstrain on our resources. To accommodate this growth, we anticipate that we willbe required to implement a variety of new and upgraded operational and financialsystems, procedures and controls, including the improvement of our accountingand other internal management systems. All of these updates will requiresubstantial management effort. Our failure to manage growth and integrate ouracquisitions successfully could adversely affect our business, financialcondition and results of operations. We Depend on Government Contracts and Subcontracts and Face AdditionalRisks Related to Fixed Price Contracts. A significant portion of the sales byIteris, a portion of our sales by Zyfer were derived from contracts withgovernmental agencies, either as a general contractor, subcontractor orsupplier. Government contracts represented approximately 23% of our total netsales and contract revenues for the year ended March 31, 2000. We expectrevenue from government contracts will continue to increase in the near future.Government business is, in general, subject to special risks and challenges,including: . long purchase cycles; . competitive bidding and qualification requirements; . performance bond requirements; . delays in funding, budgetary constraints and cut-backs; . milestone requirements, and liquidated damage provisions for failure to meet contract milestones. 16 In addition, a large number of our government contracts are fixed pricecontracts. As a result, we may not be able to recover for any cost overruns.These fixed price contracts require us to estimate the total project cost basedon preliminary projections of the project's requirements. The financialviability of any given project depends in large part on our ability to estimatethese costs accurately and complete the project on a timely basis. In the eventour costs on these projects exceed the fixed contractual amount, we will berequired to bear the excess costs. These additional costs adversely affect ourfinancial condition and results of operations. Moreover, certain of ourgovernment contracts are subject to termination or renegotiation at theconvenience of the government, which could result in a large decline in our netsales in any given quarter. Our inability to address any of the foregoingconcerns or the loss or renegotiation of any material government contract couldseriously harm our business, financial condition and results of operations. The Markets in Which We Operate Are Highly Competitive and Have Many MoreEstablished Competitors. We compete with numerous other companies in our targetmarkets and we expect such competition to increase due to technologicaladvancements, industry consolidations and reduced barriers to entry. Increasedcompetition is likely to result in price reductions, reduced gross margins andloss of market share, any of which could seriously harm our business, financialcondition and results of operations. Many of our competitors have far greatername recognition and greater financial, technological, marketing and customerservice resources than we do. This may allow them to respond more quickly tonew or emerging technologies and changes in customer requirements. It may alsoallow them to devote greater resources to the development, promotion, sale andsupport of their products than we can. Recent consolidations of end users,distributors and manufacturers in our target markets have exacerbated thisproblem. As a result of the foregoing factors, we may not be able to competeeffectively in our target markets and competitive pressures could adverselyaffect our business, financial condition and results of operations. We Cannot Be Certain of Our Ability to Attract and Retain Key Personnel andWe Do Not Have Employment Agreements with Any Key Personnel. Due to thespecialized nature of our business, we are highly dependent on the continuedservice of our executive officers and other key management, engineering andtechnical personnel, particularly Joel Slutzky, our Chief Executive Officer andChairman of the Board, and Gregory A. Miner, our Chief Operating Officer andChief Financial Officer. We do not have any employment contracts with any ofour officers or key employees. The loss of any of these persons would seriouslyharm our development and marketing efforts, and would adversely affect ourbusiness. Our success will also depend in large part upon our ability tocontinue to attract, retain and motivate qualified engineering and other highlyskilled technical personnel. Competition for employees, particularlydevelopment engineers, is intense. We may not be able to continue to attractand retain sufficient numbers of such highly skilled employees. Our inabilityto attract and retain additional key employees or the loss of one or more of ourcurrent key employees could adversely affect upon our business, financialcondition and results of operations. We May Not be Able to Adequately Protect or Enforce Our IntellectualProperty Rights. If we are not able to adequately protect or enforce theproprietary aspects of our technology, competitors could be able to access ourproprietary technology and our business, financial condition and results ofoperations will likely be seriously harmed. We currently 17 attempt to protect our technology through a combination of patent, copyright,trademark and trade secret laws, employee and third party nondisclosureagreements and similar means. Despite our efforts, other parties may attempt todisclose, obtain or use our technologies or solutions. Our competitors may alsobe able to independently develop products that are substantially equivalent orsuperior to our products or design around our patents. In addition, the laws ofsome foreign countries do not protect our proprietary rights as fully as do thelaws of the United States. As a result, we may not be able to protect ourproprietary rights adequately in the United States or abroad. We have engaged in litigation in the past and litigation may be necessaryin the future to enforce our intellectual property rights or to determine thevalidity and scope of the proprietary rights of others. Litigation may also be necessary to defend against claims of infringement or invalidity by others. Anadverse outcome in litigation or any similar proceedings could subject us tosignificant liabilities to third parties, require us to license disputed rightsfrom others or require us to cease marketing or using certain products ortechnologies. We may not be able to obtain any licenses on terms acceptable tous, or at all. Any of these results could adversely affect on our business,financial condition and results of operations. In addition, the cost ofaddressing any intellectual property litigation claim, both in legal fees andexpenses, and the diversion of management resources, regardless of whether theclaim is valid, could be significant and could seriously harm our business,financial condition and results of operations. The Trading Price of Our Common Stock Is Volatile. The trading price ofour common stock has been subject to wide fluctuations in the past. We may notbe able to increase or sustain the current market price of our common stock inthe future. The market price of our common stock could continue to fluctuate inthe future in response to various factors, including, but not limited to: . quarterly variations in operating results; . shortages announced by suppliers; . announcements of technological innovations or new products; . acquisitions or businesses, products or technologies; . changes in pending litigation; . our ability to spin-off any division; . applications or product enhancements by us or by our competitors; and . changes in financial estimates by securities analysts. The stock market in general has recently experienced volatility which hasparticularly affected the market prices of equity securities of many hightechnology companies. This volatility has often been unrelated to the operatingperformance of these companies. These broad market fluctuations may adverselyaffect the market price of our common stock. 18 We Are Controlled by Certain of Our Officers and Directors. As of March31, 2000, our officers and directors beneficially owned approximately 29% of thetotal combined voting power of the outstanding shares of our Class A commonstock and Class B common stock. As a result of their stock ownership, ourmanagement will be able to significantly influence the election of our directorsand the outcome of corporate actions requiring stockholder approval, such asmergers and acquisitions, regardless of how our other stockholders may vote.This concentration of voting control may have a significant effect in delaying,deferring or preventing a change in our management or change in control and mayadversely affect the voting or other rights of other holders of common stock. Our Stock Structure and Certain Anti-Takeover Provisions May Effect thePrice of Our Common Stock. Certain provisions of our certificate ofincorporation and our stockholder rights plan could make it difficult for athird party to acquire us, even though an acquisition might be beneficial to ourstockholders. These provisions could limit the price that investors might bewilling to pay in the future for shares of our common stock. Our Class A commonstock entitles the holder to one-tenth of one vote per share and our Class Bcommon stock entitles the holder to one vote per share. In addition, holders ofthe Class B common stock are presently entitled to elect six of our ninedirectors. The disparity in the voting rights between our common stock, as wellas our insiders' significant ownership of the Class B common stock, coulddiscourage a proxy contest or make it more difficult for a third party to effecta change in our management and control. In addition, our Board of Directors isauthorized to issue, without stockholder approval, up to 2,000,000 shares ofpreferred stock with voting, conversion and other rights and preferencessuperior to those of our common stock, as well as additional shares of Class Bcommon stock. Our future issuance of preferred stock or Class B common stockcould be used to discourage an unsolicited acquisition proposal. In March 1998, we adopted a stockholder rights plan and declared a dividendof preferred stock purchase rights to our stockholders. In the event a third party acquires more than 15% of the outstanding voting control of our company or15% of our outstanding common stock, the holders of these rights will be able topurchase the junior participating preferred stock at a substantial discount offof the then current market price. The exercise of these rights and purchase ofa significant amount of stock at below market prices could cause substantialdilution to a particular acquiror and discourage the acquiror from pursuing ourcompany. The mere existence of the stockholder rights plan often delays ormakes a merger, tender offer or proxy contest more difficult. We Do Not Pay Cash Dividends. We have never paid cash dividends on ourcommon stock and do not anticipate paying any cash dividends on either class ofour common stock in the foreseeable future. We May Be Subject to Additional Risks. The risks and uncertaintiesdescribed above are not the only ones facing our company. Additional risks anduncertainties not presently known to us or that we currently deem immaterial mayalso adversely affect our business operations. 19 ITEM 2. PROPERTIES. Our headquarters and principal operations are located in Anaheim,California. In 1984, we purchased and renovated a three building complexcontaining approximately 257,900 square feet situated on approximately 14 acresadjacent to the Interstate 5 freeway, one block from Disneyland. Our facilitieshouse our corporate and administrative offices (approximately 43,600 dedicatedsquare feet), as well as the operations of Gyyr and Broadcast, (approximately113,400 dedicated square feet), Zyfer (approximately 56,300 dedicated squarefeet), Mariner Networks (approximately 20,600 dedicated square feet) and Iteris(approximately 24,000 dedicated square feet). Zyfer leases approximately 4,500 square feet of space in a manufacturingfacility located in El Paso, Texas. Broadcast leases approximately 5,000 squarefeet in Austin, Texas primarily for service and sales support. Odetics EuropeLimited's offices are located in leased space near London, England. OdeticsAsia Pacific Pte. Ltd. offices are located in leased space in Singapore. Iterisleases seven office suites representing an aggregate of approximately 25,000square feet within the United States for its support staff and developmentteams. We currently operate a single shift in each of our manufacturing andassembly facilities, and we believe that our facilities are adequate for ourcurrent needs and for possible future growth. We may, however, elect to expandor relocate its offices and facilities in the future.ITEM 3. LEGAL PROCEEDINGS. We brought an action against Storage Technology Corporation, commonly knownas StorageTek, in the Eastern District Court of Virginia alleging thatStorageTek had infringed our patent covering robotics tape cassette handlingsystems (United States Patent No. 4,779,151). StorageTek counterclaimedalleging that we infringed several of StorageTek's patents. Prior to trial, thecourt dismissed two of the infringement claims against us and the third claimwas dismissed upon resolution between the parties. In October 1999, we enteredinto a settlement agreement with StorageTek pursuant to which we granted them anon-exclusive license of this patent and released StorageTek from pastinfringement and all claims to civil actions. In exchange for settlement, wereceived total consideration of $100 million, of which $80 million was paidduring the fiscal year ended March 31, 2000, and $10 million was to be paid ineach of fiscal years ending March 31, 2001 and 2002. The initial cash paymentof $80 million resulted in cash proceeds to us, net of expenses and fees, ofapproximately $38.4 million. In June 2000, we amended the settlement agreementwith StorageTek to provide for the acceleration of the $10 million payments.Under the terms of the amendment, StorageTek paid us $17.8 million immediatelyin full settlement of the $20 million otherwise due to us to complete thesettlement.ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. 20 PART IIITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Our Class A common stock and Class B common stock are traded on the NasdaqNational Market under the symbols "ODETA" and "ODETB," respectively. Thefollowing table sets forth for the fiscal periods indicated the high and lowsales prices for the Class A common stock and Class B common stock as reportedby the Nasdaq National Market: Class A Class B Common Stock Common Stock ----------------- ----------------- High Low High Low -------- ------ ------- ------- Fiscal Year Ended March 31, 1999 First Quarter............................. $ 17 1/8 $ 8 3/8 $ 17 $ 9 Second Quarter............................ 13 5/8 4 5/8 14 1/4 5 Third Quarter............................. 8 3/4 4 1/16 9 5/8 4 Fourth Quarter............................ 10 5/8 7 1/16 10 3/4 7 3/8 Fiscal Year Ended March 31, 2000 First Quarter............................. 10 1/4 7 5/8 10 5/8 8 1/4 Second Quarter............................ 13 9 1/8 12 1/8 9 1/8 Third Quarter............................. 15 1/2 10 1/8 15 5/8 10 3/8 Fourth Quarter............................ 29 7/16 12 29 5/8 13 Fiscal Year Ending March 31, 2001 First Quarter (through June 26, 2000)..... 15 8 7/8 14 1/2 10 As of June 26, 2000, we had 627 holders of record of Class A common stockand 141 holders of record of Class B common stock according to informationfurnished by our transfer agent. Dividend Policy Pursuant to the terms of our Loan and Security Agreement with our lender,we are prohibited from paying any dividends on our common stock without ourlender's consent. We have never paid or declared cash dividends on either classof our common stock, and have no current plans to pay such dividends in theforeseeable future. We currently intend to retain any earnings for workingcapital and general corporate purposes. The payment of any future dividendswill be at the discretion of our Board of Directors, and will depend upon anumber of factors, including, but not limited to, future earnings, the successof our business, activities, our capital requirements, our general financialcondition and future prospects, general business conditions, the consent of ourlender and such other factors as the Board may deem relevant. 21 Recent Sales of Unregistered Securities During the last fiscal year, we have sold and issued the followingunregistered securities: In October, 1998, Iteris acquired Meyer, Mohaddes Associates, Inc. inexchange for 55,245 shares of our Class A common stock. Pursuant to the termsof the merger agreement, we issued an aggregate of 46,726 additional shares ofour Class A Common Stock in fiscal 1999 and an additional 20,181 shares of ourClass A Common Stock in April 2000 to the four former shareholders of Meyer,Mohaddes as a penalty for not completing the initial public offering of Iteris. The sale and issuance of securities set forth above were deemed to beexempt from registration under the Securities Act by virtue of Section 4(2)thereof. The recipients of the securities in each of the transactions set forthin above represented their intention to acquire such securities for investmentonly and not with a view to or for sale in connection with any distributionthereof, and appropriate legends were affixed to the share certificates andinstruments used in such transactions. Except as indicated above, there were nounderwriters, brokers or finders employed in connection with any of the foregoing transactions. 22 ITEM 6. SELECTED FINANCIAL DATA. The following selected consolidated financial data with respect to ourconsolidated statement of operations for each of the five fiscal years in theperiod ended March 31, 2000 and the consolidated balance sheet data at March 31,1996, 1997, 1998, 1999 and 2000 are derived from our audited consolidatedfinancial statements. The consolidated financial statements for the fiscalyears ended March 31, 1996 and 1997 and our consolidated balance sheet at March31, 1996, 1997 and 1998 are not included in this report. The followinginformation should be read in conjunction with "Management's Discussion andAnalysis of Financial Condition and Results of Operations" and with ourconsolidated financial statements and the related notes thereto includedelsewhere in this report. Fiscal Year Ended March 31, -------------------------------------------------- 1996 1997 1998 1999 2000 ------- ------- -------- -------- -------- (in thousands, except per share data) Consolidated Statement of Operations Data:Net sales...................... $65,056 $71,748 $ 79,552 $ 70,042 $ 62,041Contract revenues.............. 10,161 9,032 10,284 13,331 18,666 ------- ------- -------- -------- --------Total net sales and contract revenues...................... 75,217 80,780 89,836 83,373 80,707 Cost of sales.................. 44,535 48,507 55,227 49,816 50,883Cost of contract revenues...... 4,374 4,907 6,430 9,007 13,431Selling, general and administrative expense........ 15,620 19,831 26,010 31,670 38,173 Research and development expenses...................... 5,242 7,734 9,271 11,191 16,888 In process research and development................... -- -- 2,106 -- -- Restructuring charge........... -- -- 1,716 -- -- ------- ------- -------- -------- --------Income (loss) from operations.. 5,446 (199) (10,924) (18,311) (38,668)Non-operating income (expense) Royalty income................ -- -- -- -- 38,437 Interest expense, net......... (386) (183) (617) (1,807) (2,048) ------- ------- -------- -------- --------Income (loss) before taxes..... 5,060 (382) (11,541) (20,118) (2,279)Income taxes (benefit)......... 1,418 (181) (2,858) -- -- ------- ------- -------- -------- --------Income (loss) from continuing operations......... 3,642 (201) (8,683) (20,118) (2,279) Income (loss) from discontinued operations, net of income taxes............... (1,189) 3,931 2,089 -- -- ------- ------- -------- -------- --------Net income (loss).............. $ 2,453 $ 3,730 $ (6,594) $(20,118) $ (2,279) ======= ======= ======== ======== ========Diluted earnings (loss) per share(1): Continuing operations.......... $ 0.59 $ (0.03) $ (1.26) $ (2.57) $ (0.25)Discontinued operations........ (0.19) 0.62 0.31 -- -- ------- ------- -------- -------- --------Earnings (loss) per share...... $ 0.40 $ 0.59 $ (0.95) $ (2.57) $ (0.25) ======= ======= ======== ======== ========Shares used in calculating diluted earnings (loss) per share......................... 6,179 6,299 6,912 7,820 9,089 _____________________________(1) The earnings (loss) per share amounts prior to fiscal 1998 have been restated as required to comply with Statement of Financial Accounting Standards No. 128 Earnings per Share. 23 Fiscal Year Ended March 31, --------------------------------------------------- 1996 1997 1998 1999 2000 ------- ------- ------- -------- -------- Consolidated Balance Sheet Data: (in thousands) Working capital........................ $20,610 $21,903 $19,996 $ 15,216 $ 12,855Total assets........................... 73,013 85,805 88,790 81,355 81,850Long-term debt (less current portion).. 22,019 11,860 21,000 19,962 11,666Retained earnings (deficit)............ 8,481 12,211 (3,795) (23,913) (26,192)Total stockholders' equity............. 30,985 51,828 38,580 36,323 36,110 24 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.Results of Operations The following table sets forth certain income statement data as apercentage of total net sales and contract revenues for the periods indicatedand should be read in conjunction with Management's Discussion and Analysis ofFinancial Condition and Results of Operations: As of March 31, -------------------------- 1998 1999 2000 ----- ----- ----- Net sales....................................... 88.6% 84.0% 76.9%Contract revenues............................... 11.4 16.0 23.1 ----- ----- -----Total net sales and contract revenues........... 100.0% 100.0% 100.0%Cost of sales................................... 61.4 59.7 63.0Cost of contract revenues....................... 7.2 10.8 16.6Selling, general and administrative expenses.... 29.0 38.0 47.3Research and development expenses............... 10.3 13.4 20.9In process research and development............. 2.3 -- --Restructuring charge............................ 1.9 -- -- ----- ----- -----Loss from operations............................ (12.2) (22.0) (47.9)Non-operating income (expense) Royalty income................................. -- -- 47.6 Interest expense, net.......................... (0.7) (2.1) (2.5) ----- ----- -----Loss before taxes............................... (12.9) (24.1) (2.8)Income taxes (benefit).......................... (3.2) -- -- ----- ----- -----Loss from continuing operations................. (9.7) (24.1) (2.8)Income from discontinued operations, net of income taxes.................................... 2.4 -- -- ----- ----- -----Net loss........................................ (7.3)% (24.1)% (2.8)% ----- ----- ----- General. We define our business segments as video products, telecomproducts and ITS. The video products segment includes our wholly-ownedsubsidiaries, Broadcast, Inc. and Gyyr, Inc. The telecom products segmentincludes Zyfer, Inc., our wholly-owned subsidiary (formerly known as ourCommunications division) that manufactures timing and synchronization products,and Mariner Networks, Inc., our wholly-owned subsidiary. The ITS segmentincludes Odetics' 93% owned subsidiary, Iteris, Inc. On October 31, 1997, wecompleted the spin-off of our 82.9% interest in ATL Products, Inc. bydistributing our 8,005,000 shares of Class A common stock to our stockholders ofrecord on October 31, 1997. In connection with the spin-off, we restated ourfinancial statements to reflect continuing and discontinued operations.Discontinued operations reflect our interest in the operations of ATL for allperiods presented. All references to our subsidiaries in this report includethe prior business and results of operations of such subsidiaries as businessunits of Odetics prior to their incorporation. Net Sales and Contract Revenues. Net sales and contract revenues consist of(i) sales of products and services to commercial and municipal customers ("netsales") and (ii) revenues derived from contracts with state, county and municipal agencies for intelligent transportation systems projects ("contractrevenues"). Contract revenues also include revenue from contracts with agenciesof the United States Government and foreign entities for space-borne recorders 25 used for geographical information systems. Total net sales and contract revenuesdecreased 3.2% to $80.7 million for the fiscal year ended March 31, 2000("fiscal 2000") compared to $83.4 million for the fiscal year ended March 31,1999 ("fiscal 1999"), and decreased 7.2% in fiscal 1999 from $89.8 million forthe fiscal year ended March 31, 1998 ("fiscal 1998"). Net Sales. Net sales decreased 11.4% to $62.0 million in fiscal 2000compared to $70.0 million in fiscal 1999 as a result of declining sales inBroadcast, Mariner Networks and Gyyr. The decrease in Broadcast sales in fiscal2000 reflects delays in the delivery of our Roswell facility management system.We believe that the Roswell system represents key enabling software thatfacilitates the sale of Broadcast systems. The decline in Mariner Networks'sales reflects the loss in August 1999 of IBM as a significant OEM customer ofits Fraim Product family. Gyyr's revenues declined 6.1% in fiscal 2000 comparedto fiscal 1999 primarily as a result of declining sales of its analog basedtime-lapse recorder product families. Gyyr has made substantial investments inexpanding its product line to include a broad family of integrated securitysolutions, including the acquisition of a line of digital time-lapse recorders.This product line expansion was the result of our acquisition of the SecurityProducts Division of Digital Systems Processing, Inc. Contributions of revenuein fiscal 2000 from the expanded product offerings were not significant enoughto offset the declining revenues from analog-based time-lapse recorders. Net sales decreased 12.0% to $70.0 million in fiscal 1999 compared to $79.6million in fiscal 1998 as a result of a 10.2% decrease in Gyyr's sales and a58.6% decrease in Zypher's sales. The decrease in Gyyr's sales reflects reducedpurchases by certain of its OEM customers who sell to the banking industrysegment of the electronic security market. This market segment has undergonesubstantial consolidation in the current fiscal year that has negativelyimpacted demand for certain of our products including video multiplexers andtime-lapse video tape decks. The decrease in sales in our telecom productssegment reflects a decrease in sales by Zyfer of timing and synchronizationproducts to LGIC of Korea, a significant customer. The decline in sales to thiscustomer largely reflects adverse economic conditions in Asia. Sales by Iterisincreased 360.0% in fiscal 1999 compared to fiscal 1998 partially offsetting thedecline in sales of Gyyr and Zyfer. The increase in Iteris' sales was primarilythe result of increasing market acceptance of our Vantage line of video-basedtraffic intersection control systems. We also experienced a 140% increase inMariner Networks' sales in fiscal 1999 compared to fiscal 1998 primarily due toincreased sales of network interface products. Sales of Mariner Networksproducts represented 2.0% of our total net sales and contract revenues in fiscal1998 compared to 6.0% in fiscal 1999. During fiscal 1999, Broadcast sales wererelatively flat compared to fiscal 1998. Contract Revenues. Contract revenues increased 40.0% to $18.7 million infiscal 2000 compared to $13.3 million in fiscal 1999, and increased 29.6% infiscal 1999 from $10.3 million in fiscal 1998. The growth in contract revenuesin fiscal 2000 compared to fiscal 1999 primarily reflects increased contractvolume in our Iteris subsidiary. During fiscal 1999, Iteris completed theacquisition of Meyer Mohaddes Associates, Inc. and the assets of ViggenCorporation. In fiscal 2000 compared to fiscal 1999, Iteris experienced a 59%growth in contract revenues in Meyer Mohaddes Associates Inc., a 34% growth incontact revenues related to its acquisition of Viggen's assets, and a 37% growthin its base business of contracts. 26 Approximately one-half of the increase in contract revenues in fiscal 1999compared to fiscal 1998 resulted from the acquisition of Meyer Mohaddes. Thebalance of the increase in contract revenues in fiscal 1999 represents overallincreased contract volume in Iteris. The increases in Iteris' contract revenuesin both fiscal 2000 and fiscal 1999 were offset by continued declines incontract revenues derived from the sale of space-borne recorders and relatedservice and equipment to agencies of the United States Government. We havefocused our recent contract procurement efforts on commercial markets and themarkets for Iteris' products and services. Gross Profit. Total gross profit as a percent of net sales and contractrevenues decreased to 20.3% in fiscal 2000, compared to 29.4% in fiscal 1999,and 31.4% in fiscal 1998. Gross profit as a percent of net sales decreased to18.0% in fiscal 2000 compared to 28.9% in fiscal 1999. The decrease in grossprofit as a percent of net sales reflects lower sales levels and higherunabsorbed manufacturing costs in Video Products and Telecom Products. Grossprofit performance in fiscal 2000 was negatively impacted by pricing concessionsto certain customers in our Broadcast business. During fiscal 2000 gross profitwas impaired due to our adjustments to inventory reserves and capitalizedsoftware related to certain discontinued products and product options in ourMariner Networks, Broadcast and Gyyr businesses. As a result of increasingsales volume, we experienced improved gross profit performance during fiscal2000 on sales of Vantage Product by our Iteris subsidiary. Gross profit as a percent of contract revenues decreased to 28.0% in fiscal2000 compared to 32.4% in fiscal 1999. Contract revenue derived from our Iterissubsidiary comprised 83.5% of total contract revenue in fiscal 2000 compared to64.9% of total contract revenue in fiscal 1999. Gross profit earned on Iteris'contracts activity is generally lower than gross profit historically earned byOdetics on other government contract activities. The decrease in gross profit in fiscal 1999 compared to fiscal 1998reflects decreased gross profit performance in Broadcast and Zyfer. Thedecrease in gross profit in Broadcast resulted from an unfavorable sales mix oflow margin product sales in the fourth quarter of fiscal 1999, in addition to anincrease in charges for warranty liabilities that are included in cost of sales.Gross profit in Zyfer decreased from 46.5% of sales in fiscal 1998 to 36.7% ofsales in fiscal 1999, as a result of the decline in sales to LGIC of Korea. Selling, General and Administrative Expense. Selling, general andadministrative expense increased 20.5% to $38.2 million (or 47.2% of total netsales and contract revenues) in fiscal 2000 compared to $31.7 million (or 38.0%of total net sales and contract revenues) in fiscal 1999, and increased 21.8% infiscal 1999 compared to $26.0 million (or 29.0% of total net sales and contractrevenues) in fiscal 1998. During fiscal 2000, we increased expenditures forsales and marketing and general and administrative expenses in Mariner Networks,Iteris and Broadcast. Concurrent with the completion of development of MarinerNetworks' Dexter product and its progression to beta testing, we began buildingadditional sales and marketing and administrative functions to supportanticipated revenue growth. During fiscal 2000, we attempted to execute apublic offering of Iteris. As a result of the volatility of the public equitymarkets, we aborted the planned initial public offering and in May 2000,withdrew the Registration Statement on Form S-1. In preparation for the initialpublic offering of Iteris, we 27 increased expenditures for sales and marketing and general and administrativeexpenses to enable Iteris to execute on its aggressive growth plans and tofunction as an independent public company. As part of the process of filing aRegistration Statement on Form S-1 for Iteris with the Securities and ExchangeCommission, we adjusted the amortization periods for goodwill that arose uponthe acquisition of the assets of the Transportation Systems business ofRockwell, and Meyer, Mohaddes Associates, Inc. The effect of the adjustment wasan incremental charge to amortization expense of $887,000 during fiscal 2000.Iteris also experienced increased sales and marketing, and general andadministrative expenses as a result of its acquisitions of Meyer MohaddesAssociates in October 1998, and of certain assets of Viggen Corporation inJanuary 19, 1999. The increase in selling, general and administrative expense infiscal 2000 also reflects charges of approximately $500,000 for adjustment tothe allowance for doubtful accounts in Broadcast. During fiscal 1999, we increased sales and marketing expenditures $3.9million or 20.7% over fiscal 1998 levels. Sales and marketing expense increasedin our Iteris, Gyyr, Broadcast and Mariner Networks businesses in fiscal 1999.Approximately $514,000 of the increase in fiscal 1999 was attributable to MeyerMohaddes, which was acquired by Iteris in October 1998. The other increases inspending were incurred to support planned growth in sales and market share andwere incurred principally in the areas of labor and benefits, sales commissions,advertising and promotions, and charges related to support increased presence ininternational markets, particularly Europe. These increases were partiallyoffset by decreased spending in Zyfer, which enforced general spending cutbacksin response to the sharp reduction in sales in fiscal 1999 accompanying theAsian economic crisis. General and administrative expense increased $1.2 million in fiscal 1999 compared to fiscal 1998 primarily as a result of thewrite off of deferred costs associated with our delay in the initial publicoffering of Iteris, an increase in goodwill amortization as a result of theacquisitions of Meyer Mohaddes Associates and International Media IntegrationServices, and the administrative infrastructure that accompanied the acquisitionof Meyer Mohaddes Associates. Research and Development Expense. Research and development expenseincreased 50.9% to $16.9 million (or 20.9% of total net sales and contractrevenues) in fiscal 2000 compared to $11.2 million (or 13.4% of total net salesand contract revenues) in fiscal 1999, and increased 20.7% in fiscal 1999compared to $9.3 million (or 10.3% of total net sales and contract revenues) infiscal 1998. For competitive reasons, we closely guard the confidentiality ofspecific development projects. During fiscal 1999, $2.8 million of developmentcosts for Roswell and $2.1 million of development costs for Dexter werecapitalized as qualified software development costs. The increase in researchand development expense in fiscal 2000 also reflects increased expenditures byIteris, Broadcast and Mariner Networks. Iteris increased its developmentactivities 72.1% during fiscal 2000 to support its AutoVue product development.Broadcast continued to aggressively develop its Roswell facility managementsystem and completed the development of its MicroStation product offering. Allsoftware development activities for Broadcast during fiscal 2000 were charged asresearch and development expense. Mariner Networks capitalized $300,000 ofsoftware development costs in fiscal 2000, significantly expanded its productdevelopment team and increased research and development expenses 223.9% duringfiscal 2000 compared to fiscal 1999 to support the completion of its developmentschedule for Dexter in order to meet a targeted beta release of the product inthe first quarter of fiscal 2001. Gyyr reduced its expenses for productdevelopment 28 27.6% in fiscal 2000 compared to fiscal 1999 in response to its efforts toreduce overall operating expenses and because it had completed severaldevelopment initiatives as of the end of fiscal 1999. The change in Zyfer'sproduct development expenses in fiscal 2000 compared to fiscal 1999 was notsignificant. The increase in research and development expense in fiscal 1999 compared tofiscal 1998 principally reflects increased product development activity in Gyyr,Mariner Networks and Zyfer. Most of these increases represent engineering laborand related benefits, prototype material and consulting fees. Gyyr completed anaggressive product development schedule during fiscal 1999 intended to broadenits product family beyond time-lapse video recorders. During fiscal 1999, Gyyrintroduced its Vortex family of domes for facility monitoring, expanded itsvideo multiplexer product line, and launched a new Internet based securityproduct called Tango. Mariner Networks added substantial investment in thedevelopment of Dexter, a broadband wide area access concentrator. MarinerNetworks also invested development resources in FRAIM, an extension to itsfamily of products offering Frame Relay to ATM communications. Zyfer alsoexperienced increased development costs related to its high performance G.P.S.based synchronization product. Restructuring Charge. In March 1998, we recorded a nonrecurring charge of$1.7 million. This charge reflects severance costs related to retirement ofcertain of our founders and officers, and to a lesser extent, costs incurred toterminate a joint venture relationship in China. Royalty Income. In connection with the settlement of our action againstStorageTek, we received proceeds, net of expenses and fees, of approximately$38.4 million in October 1999. Under our revised settlement agreement withStorageTek, we received an additional $17.8 million in June 2000 in fullsettlement of the amounts due to us. See Item 3. Legal Proceedings. Interest Expense, Net. Interest expense, net reflects the net of interestexpense and interest income as follows: Year Ended March 31, ---------------------------------- 1998 1999 2000 ------- ------- ------- Interest expense......... $1,609 $1,928 $2,313 Interest income.......... 992 121 265 ------- ------- ------- Interest expense, net.... $ 617 $1,807 $2,048 ======= ======= ======= Interest expense increased 20.0% in fiscal 2000 compared to fiscal 1999,and decreased 19.8% in fiscal 1999 compared to fiscal 1998. Interest expenseprimarily reflects interest charges on Odetics line of credit borrowings andmortgage interest. The increase in fiscal 2000 represents increased averageoutstanding borrowings on our line of credit to fund negative operating cashflow. Interest income in fiscal 2000 primarily related to interest earned oninvested cash received from our settlement with StorageTek. Interest income infiscal 1999 and 29 fiscal 1998 was derived primarily from a note receivable due from ATL Products,Inc., our former subsidiary. ATL repaid in full the outstanding balance of itsnote receivable in July 1998. In-Process Research and Development. In the fourth quarter of fiscal 1998,we completed the purchase price allocation related to our acquisition ofIntelligent Controls and determined that $2.1 million of the purchase price wasattributable to the value of research and development activities in process atthe date of acquisition, constituting the development of an integrated buildingaccess and security system that Gyyr began selling in the latter part of fiscal1999 as the Access 202 product family. In accordance with the provisions ofFASB Statement No. 2, "Accounting for Research and Development Costs," werecorded a charge in fiscal 1998 for this in-process research and development.Subsequent to this acquisition, we incurred an additional $94,000 and $469,000of research and development expense in fiscal 1998 and 1999, respectively,related to this product development effort. Income Taxes. We have not provided income tax benefit for the lossesincurred in fiscal 2000 and 1999 due to the uncertainty as to the ultimaterealization of the benefit. We provided for a tax benefit from continuingoperations at an effective rate of (24.8)% in fiscal 1998. The tax benefitrecorded in 1998 was less than the statutory rate because no benefit wasrecorded in connection with $2.1 million write-off of purchased research anddevelopment expenses associated with the acquisition of Intelligent Controls, areduction in the benefit of general business credits on total expense, andforeign losses recorded in Singapore for which no tax benefit was recognized. Loss from Continuing Operations. In connection with the spin-off of our82.9% ownership interest in ATL on October 31, 1997, we restated our financialstatements to present the results of operations of ATL as discontinuedoperations for all periods presented. Loss from continuing operations reflectsour continuing operations including Gyyr, Broadcast, Zyfer, Mariner Networks andIteris.Liquidity and Capital Resources Odetics serves as an incubator of high technology companies, each with itsown marketplace, customers and products. The process of incubating companiesimplies a potentially high investment of cash as each entity moves through itsdevelopment stage in preparation for an initial public offering or a strategicsale. We generally fund the cash flow requirements of each entity by seekinginvestors who have both strategic and financial interests directly in thesubsidiaries of Odetics. We also fund our operations through the sale ofOdetics common stock and more traditional debt financing. During fiscal 2000, net cash provided by operating activities was $7.0million. Cash used to fund purchases of property plant and equipment was $2.2million, reflecting a decrease of 21.0% from fiscal 1999. Net cash provided byoperating activities in fiscal 2000 included the receipt of $38.4 million fromour settlement of litigation with Storage Technology Corporation ("StorageTek"). In October 1999, we settled litigation with StorageTek in exchange forlicense fees payable to us of $100 million, $80 million of which was paid on thesettlement date. The initial 30 payment of $80 million resulted in cash proceeds to us, net of expenses and fees, of approximately $38.4 million. We used a portion of the proceeds toretire outstanding borrowings on our line of credit with Transamerica BusinessCredit, and to reduce trade accounts payable. We retained the balance of thesefunds to support our general working capital requirements. Under the terms ofthe original settlement agreement, we were to receive two additional payments of$10 million each in September 2000 and 2001. In June 2000, we amended the settlement agreement with StorageTek toprovide for the acceleration of the two $10 million payments. Under the termsof the amendment, StorageTek paid us $17.8 million immediately in fullsettlement of the $20 million otherwise payable to us to complete thesettlement. We recognized non-operating income in the amount of $17.8 millionin the quarter ended June 30, 2000, and used the cash proceeds to pay downborrowings on our line of credit and retained the balance of the cash to fundour general working capital requirements. We currently have a $17.0 million line of credit with Transamerica BusinessCredit providing for borrowings at their prime rate plus 2.0% (11.0% at March31, 2000). At March 31, 2000, approximately $3.7 million of borrowings wereoutstanding under this line of credit. We anticipate that the cash flowavailable from our line of credit, proceeds from equity offerings of ourcommon stock and the stock of our subsidiaries, and amounts received from thelitigation settlement, and, if necessary, the sale of certain assets, will besufficient for us to execute our current operating plans and meet ourobligations on a timely basis for at least the next twelve months.ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK. We are exposed to changes in interest rates primarily from our long-termdebt arrangements. Under our current policies, we do not use interest ratederivative instruments to manage our exposure to interest rate changes. The following table provides information about our debt obligations thatare sensitive to changes in interest rates. Expected maturity date March 31, ----------------------------------------------------------------------- 2001 2002 2003 2004 2005 Total Fair value ------ ------ ------ ------ ------ ------- ---------- (dollars in thousands)Long-term debt: Fixed rate............ $3,102 $6,988 $1,813 $1,666 $1,199 $14,768 $14,768 Average interest rate. 8.67% 8.87% 9.18% 9.36% 9.36% 9.02% Variable rate......... $3,706 -- -- -- -- $ 3,706 $ 3,706 Average interest rate. 11.00% 11.00% 31 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The financial statements and supplementary data required by Regulation S-Xare included in this Form 10-K commencing on page F-1.ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. Not applicable. PART IIIITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. (a) Identification of Directors. The information under the heading"Election of Directors," appearing in our proxy statement, is incorporatedherein by reference. (b) Identification of Executive Officers. The information under theheading "Executive Compensation and Other Information," appearing in our proxystatement, is incorporated herein by reference. (c) Compliance with Section 16(a) of the Exchange Act. The informationunder the heading "Executive Compensation and Other Information," appearing inour proxy statement, is incorporated herein by reference.ITEM 11. EXECUTIVE COMPENSATION. The information under the heading "Executive Compensation," appearing inour proxy statement, is incorporated herein by reference.ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information under the heading "Principal Stockholders and Common StockOwnership of Certain Beneficial Owners and Management," appearing in our proxystatement, is incorporated herein by reference.ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information under the heading "Certain Transactions," appearing in ourproxy statement, is incorporated herein by reference. 32 PART IVITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) Documents filed as part of this report: 1. Financial Statements. The following financial statements ofOdetics are included in a separate section of this Annual Report on Form 10-Kcommencing on the pages referenced below: Page ---- Report of Independent Auditors...................................... F-2 Consolidated Balance Sheets as of March 31, 2000 and 1999........... F-3 Consolidated Statements of Operations for the years ended March 31, 2000, 1999 and 1998............................................... F-4 Consolidated Statements of Stockholders' Equity for the years ended March 31, 2000, 1999 and 1998..................................... F-5 Consolidated Statements of Cash Flows for the years ended March 31, 2000, 1999 and 1998............................................... F-6 Notes to Consolidated Financial Statements.......................... F-7 2. Financial Statement Schedules. Schedule II -- Valuation and Qualifying Accounts.................... S-1 All other schedules have been omitted because they are not required or therequired information is included in our consolidated financial statements andnotes thereto. 3. Exhibits. 3.1 Certificate of Incorporation of Odetics, as amended (incorporated by reference to Exhibit 19.2 to Odetics' Quarterly Report on Form 10-Q for the quarter ended September 30, 1987). 3.2 Bylaws of Odetics, as amended (incorporated by reference to Exhibit 4.2 to Odetics' Registration Statement on Form S-1 (Reg. No. 033- 67932) as filed with the SEC on July 6, 1993). 4.1 Specimen of Class A Common Stock and Class B Common Stock certificates (incorporated by reference to Exhibit 4.3 to Amendment No. 1 to Odetics' Registration Statement on Form S-1 (Reg. No. 033- 67932) as filed with the SEC on September 30, 1993). 4.2 Form of rights certificate for Odetics' preferred stock purchase rights (incorporated by reference to Exhibit A of Exhibit 4 to Odetics' Current Report on Form 8-K as filed with the SEC on May 1, 1998). 10.1 Profit Sharing Plan and Trust (incorporated by reference to Exhibit 10.3 to Odetics' Amendment No. 2 to the Registration Statement on Form S-8 (Reg. No. 002-98656) as filed with the SEC on May 5, 1988). 10.2 Form of Executive Deferral Plan between Odetics and certain employees of Odetics (incorporated by reference to Exhibit 10.4 to Odetics' Annual Report on Form 10-K for the year ended March 31, 1988). 10.3* Loan and Security Agreement dated December 28, 1998 among Transamerica Business Credit Corporation, Odetics and the subsidiaries of Odetics, and Schedule to Loan Agreement (incorporated by reference to the same exhibit number in Odetics' Annual Report on Form 10-K for the year ended March 31, 1999). 33 10.4* Amendment to Loan Agreement dated December 28, 1998 among Transamerica Business Credit Corporation, Odetics and the subsidiaries of Odetics, and related Schedule to Loan Agreement dated December 28, 1998 (incorporated by reference to the same exhibit number in Odetics' Annual Report on Form 10-K for the year ended March 31, 1999). 10.5* Revolving Credit Note dated December 28, 1998 payable to Transamerica Business Credit Corporation in the original principal amount of $17,000,000 (incorporated by reference to the same exhibit number in Odetics' Annual Report on Form 10-K for the year ended March 31, 1999). 10.6* Letter of Credit Agreement dated December 28, 1998 among Transamerica Business Credit Corporation, Odetics and the subsidiaries of Odetics (incorporated by reference to the same exhibit number in Odetics' Annual Report on Form 10-K for the year ended March 31, 1999). 10.7* Security Agreement in Copyrighted Works dated December 28, 1998 between Transamerica Business Credit Corporation and Odetics (incorporated by reference to the same exhibit number in Odetics' Annual Report on Form 10-K for the year ended March 31, 1999). 10.8* Patent and Trademark Security Agreement dated December 28, 1998 between Transamerica Business Credit Corporation and Odetics (incorporated by reference to the same exhibit number in Odetics' Annual Report on Form 10-K for the year ended March 31, 1999). 10.9* Cross-Corporate Continuing Guaranty dated December 28, 1998 among Transamerica Business Credit Corporation, Odetics and the subsidiaries of Odetics (incorporated by reference to the same exhibit number in Odetics' Annual Report on Form 10-K for the year ended March 31, 1999). 10.10 Form of Indemnity Agreement entered into by Odetics and certain of its officers and directors (incorporated by reference to Exhibit 19.4 to Odetics' Quarterly Report on Form 10-Q for the quarter ended September 30, 1988). 10.11 Schedule of officers and directors covered by Indemnity Agreement (incorporated by reference to Exhibit 10.9.2 to Amendment No. 1 to Odetics' Registration Statement on Form S-1 (Reg. No. 033-67932) as filed with the SEC on July 6, 1993). 10.12 Amendment Nos. 3 and 4 to the Profit Sharing Plan and Trust (incorporated by reference to Exhibits 4.3.1 and 4.3.2, respectively, to Amendment No. 3 to Odetics' Registration Statement on Form S-3 (Reg. No. 002-86220) as filed with the SEC on June 13, 1990). 10.13 Separation and Distribution Agreement dated March 1, 1997 between Odetics and ATL (incorporated by reference to Exhibit 10.13 to Odetics' Annual Report on Form 10-K for the year ended March 31, 1997) 10.14 Tax Allocation Agreement dated March 1, 1997 between Odetics and ATL (incorporated by reference to Exhibit 10.14 to Odetics' Annual Report on Form 10-K for the year ended March 31, 1997). 10.15 Services Agreement dated March 21, 1997 between Odetics and ATL (incorporated by reference to Exhibit 10.15 to Odetics' Annual Report on Form 10-K for the year ended March 31, 1997). 10.16 Promissory Note dated April 1, 1997 between Odetics and ATL (incorporated by reference to Exhibit 10.16 to Odetics' Annual Report on Form 10-K for the year ended March 31, 1997). 10.17 1997 Stock Incentive Plan of Odetics (incorporated by reference to Exhibit 99.1 to Odetics' Registration Statement on Form S-8 (File No. 333-44907) as filed with the SEC on January 26, 1998). 10.18 Form of Notice of Grant of Stock Option (incorporated by reference to Exhibit 99.2 to Odetics' Registration Statement on Form S-8 (File No. 333-44907) as filed with the SEC on January 26, 1998) 10.19 Form of Stock Option Agreement (incorporated by reference to Exhibit 99.3 to Odetics' Registration Statement on Form S-8 (File No. 333- 44907) as filed with the SEC on January 26, 1998). 10.20 Form of Addendum to Stock Option Agreement--Involuntary Termination Following Corporate Transaction/Change in Control (incorporated by reference to Exhibit 99.4 to Odetics' Registration Statement on Form S-8 (File No. 333-44907) as filed with the SEC on January 26, 1998). 34 10.21 Form of Addendum to Stock Option Agreement--Limited Stock Appreciation Rights (incorporated by reference to Exhibit 99.5 to Odetics' Registration Statement on Form S-8 (File No. 333-44907) as filed with the SEC on January 26, 1998). 10.23 Form of Stock Issuance Agreement (incorporated by reference to Exhibit 99.6 to Odetics' Registration Statement on Form S-8 (File No. 333-44907) as filed with the SEC on January 26, 1998) 10.24 Form of Addendum to Stock Issuance Agreement--Involuntary Termination Following Corporate Transaction/Change in Control (incorporated by reference to Exhibit 99.7 to Odetics' Registration Statement on Form S-8 (File No. 333-44907) as filed with the SEC on January 26, 1998). 10.25 Form of Notice of Grant of Automatic Stock Option--Initial Grant filed as Exhibit 99.8 filed as Exhibit (incorporated by reference to Exhibit 99.8 to Odetics' Registration Statement on Form S-8 (File No. 333-44907) as filed with the SEC on January 26, 1998). 10.26 Form of Notice of Grant of Automatic Stock Option--Annual Grant (incorporated by reference to Exhibit 99.9 to Odetics' Registration Statement on Form S-8 (File No. 333-44907) as filed with the SEC on January 26, 1998). 10.27 Form of Automatic Stock Option Agreement filed as Exhibit 99.10 to the (incorporated by reference to Exhibit 99.10 to Odetics' Registration Statement on Form S-8 (File No. 333-44907) as filed with the SEC on January 26, 1998). 10.28 Rights Agreement dated April 24, 1998 between Odetics and BankBoston, N.A., which includes the form of Certificate of Designation for the junior participating preferred stock as Exhibit A, the form of rights certificate as Exhibit B and the summary of rights to purchase Series A preferred shares as Exhibit C (incorporated by reference to Exhibit 4 to Odetics' Current Report on Form 8-K as filed with the SEC on May 1, 1998). 10.29 Promissory Note in the original principal amount of $15,000,000 payable to The Northwestern Mutual Life Insurance Company dated October 31, 1989 and related Deed of Trust, Security Agreement and Financing Statement between Odetics, Inc. and Northwestern Mutual dated October 31, 1989 (incorporated by reference to Exhibit 10.12 to Odetics' Registration Statement on Form S-1 (Reg. No. 033-67932) as filed with the SEC July 6, 1993). 10.30 1994 Long-Term Equity Plan of Odetics (incorporated by reference to Exhibit 4.3 to Odetics' Registration Statement on Form S-8 (File No. 333-05735) as filed with the SEC on June 11, 1996). 10.31 Subordinated Convertible Note Purchase Agreement between Iteris, Inc. and DaimlerChrysler GmbH, dated January 25, 2000. 10.32 Subordinated Convertible Note between Iteris, Inc. and DaimlerChrysler GmbH, dated January 25, 2000. 21 Subsidiaries of Odetics. 23.1 Consent of Independent Auditors. 27 Financial Data Schedule. 35 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the Registrant has duly caused this Report to be signed onits behalf by the undersigned, thereunto duly authorized, in the City ofAnaheim, State of California, on June 29, 2000. ODETICS, INC. By: /s/ JOEL SLUTZKY ---------------------------------- Joel Slutzky Chief Executive Officer, President and Chairman of the Board POWER OF ATTORNEY We, the undersigned officers and directors of Odetics, Inc., do herebyconstitute and appoint Joel Slutzky and Gregory A. Miner, and each of them, ourtrue and lawful attorneys-in-fact and agents, each with full power ofsubstitution and resubstitution, for him and in his name, place and stead, inany and all capacities, to sign any and all amendments to this report, and tofile the same, with exhibits thereto, and other documents in connectiontherewith, with the Securities and Exchange Commission, granting unto saidattorneys-in-fact and agents, and each of them, full power and authority to doand perform each and every act and thing requisite or necessary to be done inand about the premises, as fully to all intents and purposes as he might orcould do in person, hereby, ratifying and confirming all that each of saidattorneys-in-fact and agents, or his substitute or substitutes, may lawfully door cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, thisreport has been signed below by the following persons in the capacities and onthe dates indicated: Signature Title Date --------- ----- ---- /s/ JOEL SLUTZKY Chief Executive Officer, President and June 29, 2000--------------------------------------- Chairman of the Board (principal Joel Slutzky executive officer) /s/ CRANDALL GUDMUNDSON Director June 29, 2000--------------------------------------- Crandall Gudmundson /s/ JERRY MUENCH Director June 29, 2000--------------------------------------- Jerry Muench KEVIN C. DALY Director June 29, 2000--------------------------------------- Kevin C. Daly 36 Signature Title Date --------- ----- ---- /s/ GARY SMITH Vice President and Controller June 29, 2000--------------------------------------- (principal accounting officer) Gary Smith /s/ THOMAS L. THOMAS Director June 29, 2000--------------------------------------- Thomas L. Thomas /s/ JOHN SEAZHOLTZ Director June 29, 2000--------------------------------------- John Seazholtz /s/ PAUL E. WRIGHT Director June 29, 2000--------------------------------------- Paul E. Wright /s/ GREGORY A. MINER Vice President, Director and Chief June 29, 2000--------------------------------------- Operating Officer and Chief Financial Gregory A. Miner Officer (principal financial officer) 37 Odetics, Inc. Index to Consolidated Financial Statements Page ----Report of Independent Auditors........................................ F-2 Consolidated Balance Sheets as of March 31, 1999 and 2000............. F-3 Consolidated Statements of Operations for the years ended March 31, 1998, 1999 and 2000........................................ F-5 Consolidated Statements of Stockholders' Equity for the years ended March 31, 1998, 1999 and 2000........................................ F-6 Consolidated Statements of Cash Flows for the years ended March 31, 1998, 1999 and 2000........................................ F-7 Notes to Consolidated Financial Statements............................ F-8 F-1 Report of Independent AuditorsStockholders and Board of DirectorsOdetics, Inc.We have audited the accompanying consolidated balance sheets of Odetics, Inc. asof March 31, 1999 and 2000, and the related consolidated statements ofoperations, stockholders' equity, and cash flows for each of the three years inthe period ended March 31, 2000. Our audits also included the financialstatement schedule listed in Item 14(a). These financial statements and scheduleare the responsibility of the Company's management. Our responsibility is toexpress an opinion on these financial statements based on our audits.We conducted our audits in accordance with auditing standards generally acceptedin the United States. Those standards require that we plan and perform the auditto obtain reasonable assurance about whether the financial statements are freeof material misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An auditalso includes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for ouropinion.In our opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position ofOdetics, Inc. at March 31, 1999 and 2000, and the consolidated results of itsoperations and its cash flows for each of the three years in the period endedMarch 31, 2000, in conformity with accounting principles generally accepted inthe United States. Also, in our opinion, the related financial statementschedule, when considered in relation to the basic financial statements taken asa whole, presents fairly in all material respects the information set forththerein. /s/ ERNST & YOUNG LLPOrange County, CaliforniaMay 15, 2000,except for the last paragraph of Note 15,as to which the date is June 12, 2000 F-2 Odetics, Inc. Consolidated Balance Sheets (In thousands, except share and per share amounts) March 31 1999 2000 ------------------------------------- AssetsCurrent assets: Cash and cash equivalents $ 787 $ 4,880 Trade accounts receivable, net of allowance for doubtful accounts of $839 in 1999 and $2,068 in 2000 18,889 13,576 Costs and estimated earnings in excess of billings on uncompleted contracts 2,423 3,283 Inventories: Finished goods 1,101 1,203 Work in process 749 859 Materials and supplies 14,135 16,150 Prepaid expenses and other 2,202 1,978 -------------------------------------Total current assets 40,286 41,929 Property, plant and equipment: Land 2,060 2,060 Buildings and improvements 18,674 18,868 Equipment 28,618 30,652 Furniture and fixtures 2,685 2,676 Allowances for depreciation (29,561) (33,520) ------------------------------------- 22,476 20,736 Capitalized software costs, net 7,667 6,482Goodwill, net of accumulated amortization of $1,046 in 1999 and $2,723 in 2000 10,023 12,004Other assets 903 699 -------------------------------------Total assets $ 81,355 $ 81,850 ===================================== F-3 Odetics, Inc. Consolidated Balance Sheets (continued) (In thousands, except share and per share amounts) March 31 1999 2000 ------------------------------------ Liabilities and stockholders' equityCurrent liabilities: Trade accounts payable $ 10,454 $ 10,702 Accrued payroll and related 5,441 4,892 Accrued expenses 1,933 2,313 Contract reserve 3,892 3,056 Billings in excess of costs and estimated earnings on uncompleted contracts 1,276 1,303 Revolving line of credit - 3,706 Current portion of long-term debt 2,074 3,102 ------------------------------------Total current liabilities 25,070 29,074 Revolving line of credit 10,997 - Long-term debt, less current portion 8,965 11,666 Other liabilities - 5,000 Commitments and contingencies Stockholders' equity: Preferred stock: Authorized shares - 2,000,000 Issued and outstanding - none - - Common stock, $.10 par value: Authorized shares - 10,000,000 of Class A and 2,600,000 of Class B Issued and outstanding shares - 7,941,271 of Class A and 1,060,041 of Class B at March 31, 1999; 8,183,470 of Class A and 1,051,541 of Class B at March 31, 2000 901 923 Paid-in capital 59,579 61,200 Treasury stock, 50,093 and 4,564 shares in 1999 and 2000, respectively (240) (22) Notes receivable from employees (96) (61) Accumulated other comprehensive income 92 262 Accumulated deficit (23,913) (26,192) ------------------------------------Total stockholders' equity 36,323 36,110 ------------------------------------Total liabilities and stockholders' equity $ 81,355 $ 81,850 ====================================See accompanying notes. F-4 Odetics, Inc. Consolidated Statements of Operations (In thousands, except per share information) Year ended March 31 1998 1999 2000 ---------------------------------------- Net sales and contract revenues: Net sales $ 79,552 $ 70,042 $ 62,041 Contract revenues 10,284 13,331 18,666 ---------------------------------------- 89,836 83,373 80,707Costs and expenses: Cost of sales 55,227 49,816 50,883 Cost of contract revenues 6,430 9,007 13,431 Selling, general and administrative expenses 26,010 31,670 38,173 Research and development expenses 9,271 11,191 16,888 In process research and development 2,106 - - Restructuring charge 1,716 - - ---------------------------------------- 100,760 101,684 119,375 ----------------------------------------Loss from operations (10,924) (18,311) (38,668)Non-operating income (expense) Royalty income - - 38,437 Interest expense, net (617) (1,807) (2,048) ----------------------------------------Loss before taxes (11,541) (20,118) (2,279)Income tax benefit (2,858) - - ----------------------------------------Loss from continuing operations (8,683) (20,118) (2,279)Income from discontinued operations, net of income taxes 2,089 - - ----------------------------------------Net loss $ (6,594) $(20,118) $ (2,279) ========================================Basic and diluted loss per share: Continuing operations $(1.26) $(2.57) $(0.25) Discontinued operations .31 - - ---------------------------------------- Loss per share $ (.95) $(2.57) $(0.25) ========================================See accompanying notes. F-5 Odetics, Inc. Consolidated Statements of Stockholders' Equity (In thousands) Common stock ---------------------------------- Shares outstanding ------------------------ Notes Accumulative Class A Class B Additional receivable other Compre common common Paid-in Treasury from Comprehensive Accumulated -hensive stock stock Amount capital stock employees income deficit Total income ----------------------------------------------------------------------------------------------------- Balance at March 31, 1997 5,316 1,064 $638 $38,927 $ - $ - $ 52 $12,211 $ 51,828 $ 3,792 Issuances of common stock 885 - 88 7,968 - (3,377) - - 4,679 Conversion of Class B common stock 2 (2) - - - - - - - Spin-off of ATL Products, Inc. common stock - - - (1,655) - - - (9,412) (11,067) Purchase of treasury stock - - (239) - - - (239) Foreign currency translation adjustments - - - - - - (27) - (27) (27) Net loss - - - - - - - (6,594) (6,594) (6,594) -----------------------------------------------------------------------------------------------------Balance at March 31, 1998 6,203 1,062 726 45,240 (239) (3,377) 25 (3,795) 38,580 $ (6,621) Issuances of common stock 1,736 - 175 14,339 - - - - 14,514 Conversion of Class B common stock 2 (2) - - - - - - - Purchase of treasury stock - - - - (1) - - - (1) Payments on notes receivable - - - - - 3,281 - - 3,281 Foreign currency translation adjustments - - - - - - 67 - 67 67 Net loss - - - - - - - (20,118) (20,118) (20,118) -----------------------------------------------------------------------------------------------------Balance at March 31, 1999 7,941 1,060 901 59,579 (240) (96) 92 (23,913) 36,323 (20,051) Issuances of common stock 234 - 22 1,621 218 - - - 1,861 - Conversion of Class B common stock 8 (8) - - - - - - - - Payments on notes receivable - - - - - 35 - - 35 - Foreign currency translation 170 - 170 170 adjustments - - - - - - - - - - Net loss - - - - - - - (2,279) (2,279) (2,279) -----------------------------------------------------------------------------------------------------Balance at March 31, 2000 8,183 1,052 $923 $61,200 $ (22) $ (61) $262 $(26,192) $ 36,110 $ (2,109) =====================================================================================================See accompanying notes. F-6 Odetics, Inc. Consolidated Statements of Cash Flows (In thousands) Year ended March 31 1998 1999 2000 ----------------------------------------------------- Operating activitiesNet loss $ (6,594) $(20,118) $ (2,279)Adjustments to reconcile net loss to net cash used in operating activities: Income from discontinued operations (2,089) - - Depreciation and amortization 2,912 5,205 7,185 Write-off of in process research and development 2,106 - - Contribution to ASOP 511 - - Provision for losses on accounts receivable 155 332 745 Provision (benefit) for deferred income taxes (902) 915 - Other (11) - 213 Changes in operating assets and liabilities (Note 14) (1,462) 1,560 1,179 -----------------------------------------------------Net cash provided by (used in) operating activities (5,374) (12,106) 7,043 Investing activitiesPurchases of property, plant and equipment (3,829) (2,747) (2,169)Proceeds from option to sell real estate - - 5,000Software development costs (2,527) (4,944) (330)Purchase of net assets of acquired business (2,171) - (1,500)Net cash received from ATL 2,978 10,019 - -----------------------------------------------------Net cash provided by (used in) investing activities (5,549) 2,328 1,001 Financing activitiesProceeds from line of credit and long-term borrowings 49,176 44,527 23,966Principal payments on line of credit, long-term debt, and capital lease obligations (40,159) (45,089) (29,528)Proceeds from issuance of common stock 1,172 9,996 1,611 -----------------------------------------------------Net cash provided by (used in) financing activities 10,189 9,434 (3,951) ----------------------------------------------------- Increase (decrease) in cash (734) (344) 4,093Cash and cash equivalents at beginning of year 1,865 1,131 787 -----------------------------------------------------Cash and cash equivalents at end of year $ 1,131 $ 787 $ 4,880 =====================================================See accompanying notes. F-7 Odetics, Inc. and Subsidiary Notes to Consolidated Financial Statements March 31, 20001. Summary of Significant Accounting PoliciesPrinciples of ConsolidationThe consolidated financial statements of Odetics, Inc. (the Company) include theaccounts of the Company and its wholly-owned subsidiaries (Gyyr, Inc.,Broadcast, Inc., Mariner Networks, Inc., Zyfer, Inc., Odetics Europe Limited,Odetics Asia Pacific Pte. Ltd.) and its 93% owned subsidiary, Iteris, Inc.During fiscal 1990, the Company incorporated Odetics Europe Limited to developEuropean commercial sales. During fiscal 1995, the Company incorporated OdeticsAsia Pacific Pte. Ltd. to develop commercial sales for the Asian Market. Allsignificant intercompany accounts and transactions are eliminated inconsolidation.On October 31, 1997, the Company completed the spin-off of its 82.9% interest inATL Products, Inc. (ATL) by distributing the Company's 8,005,000 shares of ClassA Common Stock to the Company's stockholders of record on October 31, 1997. As aresult of the spin-off, the Company's financial statements have been restated toreflect the operations of ATL as discontinued operations.OperationsThe Company has initiated a business strategy known as its incubator strategywhereby its goal is to nurture and develop companies that can be spun-off to theCompany's stockholders. In pursuing this strategy, the Company has incurredlosses from continuing operations of $20.1 million and $2.3 million in fiscal1999 and 2000, respectively, due in part to making investments in its businessfor research and development as well as developing a separate infrastructure forcertain business units sufficient for these business units to functionultimately as independent public companies.The Company has obtained funds to pursue this strategy in fiscal 1999 and 2000from repayments of a note receivable, equity offerings, amounts received fromlitigation settlement and equipment financing. In fiscal 2001, it will benecessary either to obtain sufficient additional funding to continue thisstrategy or the Company will be required to curtail the incubator strategy inorder to reduce operating losses. Management believes cash available from itsrevolving line of credit, possible proceeds from additional equity offerings ofcommon stock of the Company or its subsidiaries, amounts received from F-8 Odetics, Inc. and Subsidiary Notes to Consolidated Financial Statements1. Summary of Significant Accounting Policies (continued)Operations (continued)litigation settlement and, if necessary, and the sale of certain assets, shouldbe sufficient to allow the Company to execute its current operating plans andmeet its obligations on a timely basis for at least the next twelve months.Additionally, management believes it is possible to obtain additional funds, ifrequired, through the sale or placing of additional financing on its facilitiesin Anaheim, California.Use of EstimatesThe preparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptions thataffect the amounts reported in the financial statements and accompanying notes.Actual results could differ from those estimates. Significant estimates made inpreparing the consolidated financial statements include the allowances fordoubtful accounts, deferred tax assets, inventory reserves, certain accruedliabilities and costs to complete long-term contracts and estimates of futurecash flows used to determine whether asset impairments exist.Revenue RecognitionProduct revenues and related cost of sales are recognized on the date ofshipment or, if required, upon acceptance by the customer, provided that theCompany believes collectibility of the net sales amount is probable.Accordingly, at the date revenue is recognized, the significant uncertaintiesconcerning the sale have been resolved.Contract revenues is derived primarily from long-term contracts withgovernmental agencies. Contract revenue includes costs incurred plus a portionof estimated fees or profits determined on the percentage of completion methodof accounting based on the relationship of costs incurred to total estimatedcosts. Any anticipated losses on contracts are charged to earnings whenidentified. Changes in job performance and estimated profitability, includingthose arising from contract penalty provisions and final contract settlementsmay result in revisions to cost and revenue and are recognized in the period inwhich the revisions are determined. Profit incentives are included in revenuewhen their realization is reasonably assured. F-9 Odetics, Inc. and Subsidiary Notes to Consolidated Financial Statements1. Summary of Accounting Policies (continued)Revenue Recognition (continued)Certain products sold by the Company include software which is integral to thefunctionality of the product. When such products do not require significantproduction, modification or customization of the software, revenue is recognizedupon delivery, assuming the fee is fixed and collectibility is probable. If anarrangement requires significant production, modification or customization ofthe software, the arrangement is accounted for on the percentage of completionmethod of accounting as costs are incurred.Revenues from follow-on service and support, for which the Company chargesseparately, are recognized when earned. Revenues from computer softwaremaintenance agreements are recognized ratably over the term of the agreements.When computer software maintenance is included in a software license agreement,an appropriate portion of the license fee is deferred and recognized over themaintenance period.Cash and Cash Equivalents Cash and cash equivalents consist of cash and short-term investments withmaturities of less than ninety days.Concentration of Credit RiskThe Company performs periodic credit evaluations of its customers' financialcondition and generally does not require collateral. Credit losses have beenwithin management's expectations and within amounts provided through theallowances for doubtful accounts. At March 31, 1999 and 2000, accountsreceivable from governmental agencies and prime government contractors wereapproximately $3,616,000 and $3,639,000, respectively.Fair Values of Financial InstrumentsFair values of cash and cash equivalents, and the current portion of long-termdebt approximate the carrying value because of the short period of time tomaturity. The fair value of long-term debt approximates carrying value becausethe related rates of interest approximate current market rates and has variablerates of interest. F-10 Odetics, Inc. and Subsidiary Notes to Consolidated Financial Statements1. Summary of Accounting Policies (continued)Inventory ValuationInventories are stated at the lower of cost or market. Cost is determined on thefirst-in, first-out method.Property, Plant and EquipmentProperty, plant and equipment are recorded at cost. Buildings are depreciatedusing the straight-line method over their estimated useful lives up to a periodof forty years. Equipment, furniture and fixtures, including assets recordedunder capital lease obligations, are depreciated principally by the decliningbalance method over their estimated useful lives ranging from four to eightyears.Long-Lived AssetsLong-lived assets and certain identifiable intangibles held and used by theCompany are reviewed for impairment whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable. Therecoverability test is performed at the lowest level based on undiscounted netcash flows. Based on its analysis, the Company believes that no impairment ofthe carrying value of its long-lived assets, inclusive of goodwill, existed atMarch 31, 2000. The Company's analysis was based on an estimate of futureundiscounted cash flows using forecasts contained in the Company strategic plan.It is at least reasonably possible that the Company's estimate of futureundiscounted cash flows may change during fiscal 2001. If the Company's estimateof future undiscounted cash flow should change or if the strategic plan is notachieved, future analyses may indicate insufficient future undiscounted cashflows to recover the carrying value of the Company's long-lived assets, in whichcase such assets would be written down to estimated fair value.GoodwillGoodwill, representing the excess of the purchase price over the fair value ofthe net assets of acquired entities, is being amortized using the straight-linemethod over the estimated useful lives ranging from ten to fifteen years. F-11 Odetics, Inc. and Subsidiary Notes to Consolidated Financial Statements1. Summary of Accounting Policies (continued) Research and Development ExpendituresSoftware development costs incurred subsequent to determination of technicalfeasibility are capitalized. Amortization of capitalized software costs isprovided on a product-by-product basis at the greater of the amount computedusing (a) the ratio of current gross revenues for the product to the total ofcurrent and anticipated future gross revenues or (b) the straight-line methodover the remaining estimated economic life of the product. Amortization beginswhen product is available for general release to customers. Generally, anoriginal estimated economic life of two to five years is assigned to capitalizedsoftware development costs.During fiscal 1998, 1999 and 2000, software development costs were amortized tocost of sales totaling $585,000, $1,063,000 and $1,515,000, respectively.All other research and development expenditures are charged to expense in theperiod incurred.WarrantyThe Company provides a warranty of one to two years on all products and recordsa related provision for estimated warranty costs at the date of the sale. Theestimated warranty liability at March 31, 1999 and 2000 was $411,000 and$596,000, respectively.Foreign Currency TranslationThe balance sheet accounts of Odetics Europe Limited and Odetics Asia PacificPte. Ltd. are translated at the current year-end exchange rate and incomestatement items are translated at the average exchange rate for the year.Resulting translation adjustments are made directly to a separate component ofstockholders' equity. Gains and losses resulting from transactions of theCompany and its subsidiaries which are made in currencies different from theirown are immaterial and are included in income as they occur.Income TaxesDeferred income tax assets and liabilities are computed for differences betweenfinancial statement and tax basis of assets and liabilities based on enacted taxlaws and rates applicable to the period in which differences are expected toaffect taxable income. Valuation allowances are established when necessary toreduce deferred tax assets to F-12 Odetics, Inc. and Subsidiary Notes to Consolidated Financial Statements1. Summary of Accounting Policies (continued)Income Taxes (continued)amounts which are more likely than not to be realized. The provision for incometaxes is the taxes payable or refundable for the period plus or minus the changeduring the period in deferred income tax assets and liabilities.Earnings (Loss) Per ShareBasic and diluted earnings (loss) per share is computed using the weightedaverage number of shares of common stock outstanding during the year andexcludes the anti-dilutive effects of options.The following table sets forth the computation of net income (loss) per share: Years ended March 31 1998 1999 2000 ---------------------------------------------------- (in thousands, except share and per share information)Numerator: Loss from continuing operation $ (8,683) $ (20,118) $ (2,279) Income from discontinued operations 2,089 - - ---------------------------------------------------- Net income (loss) $ (6,594) $ (20,118) $ (2,279) ==================================================== Denominator: Weighted-average shares outstanding 6,912,000 7,820,000 9,089,000 ==================================================== Basic and diluted earnings (loss) per share: Continuing operations $ (1.26) $ (2.57) $ (0.25) Discontinued operations .31 - - ---------------------------------------------------- Earnings (loss) per share $ (.95) $ (2.57) $ (0.25) ==================================================== F-13 Odetics, Inc. and Subsidiary Notes to Consolidated Financial Statements1. Summary of Accounting Policies (continued)Stock CompensationThe Company has elected to follow Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees (APB 25) and related Interpretations inaccounting for its employee stock options because the alternative fair valueaccounting provided for under FASB Statement No. 123, Accounting for Stock-BasedCompensation, requires use of option valuation models that were not developedfor use in valuing employee stock options. Under APB 25, if the exercise priceof the Company's employee stock options equals the market price of theunderlying stock on the date of grant, no compensation expense is recognized.To calculate the pro forma information required by Statement 123, the Companyuses the Black-Scholes option pricing model. The Black-Scholes model wasdeveloped for use in estimating the fair value of traded options which have novesting restrictions and are fully transferable. In addition, option valuationmodels require the input of highly subjective assumptions including the expectedstock price volatility. Because the Company's employee stock options havecharacteristics significantly different from those of traded options, andbecause changes in the subjective input assumptions can materially affect thefair value estimate, in management's option, the existing models do notnecessarily provide a reliable single measure of the fair value of its employeestock options.Advertising ExpensesThe Company expenses advertising costs as incurred. Advertising expense totaled$2,226,000, $2,622,000 and $2,488,000 in the years ended March 31, 1998, 1999and 2000, respectively.Recent Accounting PronouncementIn June 1998, FAS No. 133, Accounting for Derivative Instruments and HedgingActivities, was issued, which establishes new standards for recordingderivatives in financial statements. This statement requires recording allderivative instruments as assets or liabilities, measured at fair value.Statement No. 133, as amended, is effective for fiscal years beginning afterJune 15, 2000. Management does not anticipate the adoption of this statementwill have a significant impact on the consolidated results of operations orfinancial position of the Company. F-14 Odetics, Inc. and Subsidiary Notes to Consolidated Financial Statements 1. Summary of Accounting Policies (continued)Recent Accounting Pronouncement (continued)In March 2000, the Financial Accounting Standards Board issued InterpretationNo. 44, Accounting for Certain Transactions Involving Stock Compensation - aninterpretation of APB Opinion No. 25 ("FIN 44"). FIN 44 clarifies the definitionof employee for purposes of applying Accounting Practice Board Opinion No. 25,Accounting for Stock Issued to Employees, the criteria for determining whether aplan qualifies as a noncompensatory plan, the accounting consequence of variousmodifications to the terms of a previously fixed stock option or award, and theaccounting for an exchange of stock compensation awards in a businesscombination. FIN 44 is effective July 1, 2000, but certain conclusions coverspecific events that occur after either December 15, 1998, or January 12, 2000.The Company believes that FIN 44 will not have a material effect on itsfinancial position or results of operations.ReclassificationsCertain amounts in the 1998 and 1999 consolidated financial statements have beenreclassified to conform with the 2000 presentation.2. AcquisitionsOn June 20, 1997, the Company acquired certain assets and assumed certaincontracts from Rockwell Collins, Inc. (Rockwell). Revenues and costs related tocontracts assumed from Rockwell are included in the accompanying statement ofoperations since the date of assumption. The total payment to Rockwellassociated with the assumption of contracts was approximately $2.2 million incash. In the transaction, a total of $1.3 million of assets were acquired and a$5.0 million provision for anticipated losses on a contract with the MichiganDepartment of Transportation (MDOT) were assumed, which resulted in therecognition of approximately $6.0 million of goodwill. Also, Rockwell agreed toreimburse the Company for loses incurred on certain phases of the MDOT contract.At March 31, 2000, the remaining provision for contract losses totaled $3.1million, which the Company expects to incur over the next two years.On October 29, 1997, the Company acquired the net assets of Intelligent ControlsInc. (ICI). The total cost of the acquisition was approximately $2.7 millionwhich was paid in the Company's Class A common stock. A total of $1.0 million ofassets were acquired, primarily consisting of accounts receivable, inventoriesand property and equipment that were recorded by the Company at this historicalcarrying values, and $0.4 million of F-15 2. Acquisitions (continued)liabilities were assumed. In connection with the purchase, $2.1 million of inprocess research and development was written off, primarily related to softwareand hardware under development for an integrated building access and securitysystem that Gyyr began selling the latter part of fiscal 1999 as the Access 202product family. Subsequent to this acquisition, the Company incurred anadditional $94,000, $469,000 and $307,000 of research and development expense infiscal 1998, 1999 and 2000, respectively, related to this product developmenteffort.On September 12, 1998, the Company acquired International Media IntegrationServices Limited, a United Kingdom corporation (IMIS), pursuant to the terms ofa Sale and Purchase of Shares Agreement whereby the Company purchased all of theissued and outstanding shares of stock of IMIS for an aggregate purchase priceof $970,000 which was paid in 173,214 shares of the Company's Class A commonstock. The acquisition has been accounted for as a purchase, and the purchaseprice has been allocated to the fair value of the net assets acquired, primarilyacquire technology, which is being amortized over its useful life of 5 years.On October 16, 1998, the Company, through its subsidiary, Iteris, Inc., acquiredMeyer, Mohaddes Associates, Inc., a provider of transportation, engineering andplanning services (MMA). Pursuant to the terms of the merger agreement, theCompany purchased all of the issued and outstanding shares of stock of MMA for$4.3 million, by issuing 55,245 shares of the Company's Class A common stockvalued at $250,000 and 810,153 shares of Iteris, Inc.'s common stock aftergiving effect to the purchase price adjustment required by the merger agreement and a 1.874916-to-1 split of Iteris common stock. The results of operations ofMMA are included in the Company's consolidated results of operations from thedate of acquisition.The merger agreement provides for MMA shareholders to receive additional sharesof the Company's Class A common stock with a then market value of $250,000 ateach of April 16, 1999, October 16, 1999, April 16, 2000, October 16, 2000 andApril 16, 2001 in the event the Company does not consummate an initial publicoffering of the common stock of Iteris, Inc. by each and any of those dates. InApril and October 1999 and April 2000, Odetics issued an additional 25,740,20,986 and 20,181, respectively, shares of its Class A common stock to the MMAshareholders pursuant to this provision, which was recorded by the Company asadditional goodwill. In addition, if Iteris does not complete its initial publicoffering by October 2001, then the holders of the Iteris common stock issued inthis transaction will have the right to require Odetics to repurchase the Iteriscommon stock for a purchase price of $10 per share of Iteris. At any time priorto the F-16 Odetics, Inc. and Subsidiary Notes to Consolidated Financial Statements2. Acquisitions (continued)initial public offering of Iteris, Odetics has the right to require theseshareholders to sell all of their shares of Iteris common stock at a purchaseprice of $10 per share. Odetics has the option to pay the purchase price fortheses shares in cash or in Odetics' Class A common stock valued as of fivebusiness days prior to the date of the event triggering the payment.On January 19, 1999, the Company, through its subsidiary, Iteris, Inc., acquiredcertain assets and assumed certain liabilities of Viggen Corporation, a providerof transportation, engineering and planning services, for an aggregate purchaseprice of $275,000 evidenced by the issuance of 27,603 shares of the Company'sClass A common stock which were issued in April 1999. The acquisition has beenaccounted for as a purchase and the purchase price, including direct costs ofthe acquisition, has been allocated to the fair value of the net assets acquiredwith the excess approximating $746,000 allocated to goodwill. The results ofoperations of Viggen are included in the Company's consolidated results ofoperations from the date of acquisition.On December 1, 1999, the Company through its wholly owned subsidiary, Gyyr,Inc., acquired the security products division of Digital Processing Systems,Inc. (DPS), a manufacturer of digital security recorder products. Pursuant tothe terms of the Asset Purchase Agreement, the Company purchased certain assetsand assumed certain liabilities of DPS for an aggregate purchase price ofapproximately $3.5 million. The Company paid $1.5 million in cash during fiscal2000 and is obligated to pay $1 million at December 1, 2000 and 2001,respectively, in accordance with the terms of the agreement. This acquisitionwas accounted for as a purchase and accordingly, the result of operations forDPS are included in the Company's consolidated results of operations from thedate of acquisition. The excess of cost over the fair value of the net assets ofapproximately $3.4 million preliminarily has been recorded as goodwill while theCompany completes its identification and valuation of intangible assetsacquired.Pro forma information related to these acquisitions is not material to theCompany's historical consolidated results of operations.3. Sale of Stock of ATL Products, Inc.On March 13, 1997, ATL Products, Inc. (ATL), which at that time was a wholly-owned subsidiary of the Company, completed an initial public offering of1,650,000 shares of its Class A common stock, at an offering price of $11 pershare (the Offering). Following the Offering, the Company's beneficial ownershipinterest in the ATL totaled 82.9%. F-17 Odetics, Inc. and Subsidiary Notes to Consolidated Financial Statements3. Sale of Stock of ATL Products, Inc. (continued)On October 31, 1997, the Company completed a tax-free spin-off of its remaining82.9% interest in ATL to the Company's stockholders, pursuant to which eachholder of the Company's Class A and Class B Common as of October 31, 1997,received approximately 1.1 shares of Class A Common Stock of ATL for each shareof the Company's Common Stock then held.4. Related Party TransactionIn July 1999, the Company sold an option to an investment company incorporatedin Delaware, for an aggregate purchase price of $5.0 million to purchase certainreal property of Odetics. The option exercise price is equal to the lesser of(i) the appraised fair value of the property as determined as of November 1,1999, or (ii) at the option of the investment company, at the appraised fairvalue of the property as of November 1, 2000 or 2001. This investment companywas formed by an officer of Odetics and certain individuals. If the investmentcompany does not exercise the option, then the Company shall retain the optionpayment. If the option is exercised, the option payment will be applied as acredit against the option exercise price. Pursuant to the terms of the OptionAgreement, the Company may exercise a repurchase option at a repurchase pricespecified in the agreement at any time prior to August 1, 2002 if the investmentcompany has not previously exercised the option.5. Costs and Estimated Earnings on Uncompleted ContractsCosts incurred, estimated earnings and billings on uncompleted long-termcontracts are as follows: March 31 1999 2000 ------------------- (In thousands) Costs incurred on uncompleted contracts $19,204 $21,971 Estimated earnings 1,557 1,648 ------------------- 20,761 23,619 Less billings to date 19,614 21,639 ------------------- $ 1,147 $ 1,980 =================== Included in accompanying balance sheets: Costs and estimated earnings in excess of billings on uncompleted contracts $ 2,423 $ 3,283 Billings in excess of costs and estimated earnings on uncompleted contracts 1,276 1,303 ------------------- $ 1,147 $ 1,980 =================== F-18 Odetics, Inc. Notes to Consolidated Financial Statements5. Costs and Estimated Earnings on Uncompleted Contracts (continued)Costs and estimated earnings in excess of billings at March 31, 1999 and 2000include $320,000 and $150,000, respectively, that were not billable as certainmilestone objectives specified in the contracts had not been attained.Substantially all costs and estimated earnings in excess of billings at March31, 2000 are expected to be billed and collected during the year ending March31, 2001.6. Revolving Line of Credit and Long-Term Debt The Company has a $17.0 million revolving line of credit which provides forborrowings at the prime rate plus 2.0% (11.0% at March 31, 2000). Borrowings areavailable for general working capital purposes, and at March 31, 2000,approximately $13.3 million was available for borrowing under the line. The lineexpires December 31, 2000.The revolving line of credit is collateralized by substantially all of theCompany's assets. Under the terms of the loan and security agreement, theCompany is required to comply with certain covenants, maintain certain debt tonet worth ratios, working capital current ratios and minimum net worthrequirements, and prohibits the payment of dividends without the lender'sconsent. The Company was in compliance with the financial covenants at March 31,2000.Included within the borrowing limits of the loan and security agreement, theCompany has available approximately $2,000,000 in letters of credit at March 31,2000.On January 25, 2000, the Company through its subsidiary, Iteris, Inc., enteredinto a joint venture agreement, pursuant to which the Company obtained aSubordinated Convertible Promissory Note in the amount of $3.75 million. Thenote is convertible into Iteris' common stock either at the option of the jointventure partner at any time prior to the maturity, or automatically upon aninitial public offering of Iteris' common stock or a change in control event, asdefined in the agreement. The number of shares issuable upon conversion issubject to the fair value of the Iteris's common stock on the date ofconversion. The note matures on January 25, 2002 and bears interest at 8% perannum. All accrued interest will be forgiven if the conversion feature istriggered. F-19 Odetics, Inc. Notes to Consolidated Financial Statements6. Revolving Line of Credit and Long-Term Debt (continued)Long-term debt consisted of the following: March 31 1999 2000 --------------------- (In thousands) Note payable, accruing interest at 9.36%, collateralized by deed of trust on land and buildings with a net book value of approximately $11,000,000, payable in monthly installments through December 2004. $ 8,173 $ 7,027 Notes payable, accruing interest at 8.00%, payable upon maturity in January 2002 - 3,750 Note payable, in two equal annual installments in December 2001 and 2002 - 2,000 Notes payable, accruing interest at 7.55% to 8.89%, collateralized by equipment, payable in monthly installments through 2003. 2,866 1,991 --------------------- 11,039 14,768 Less current portion 2,074 3,102 --------------------- $ 8,965 $11,666 =====================The annual maturities of long-term debt through March 31, 2005 are as follows: (In thousands) 2001 $ 3,102 2002 6,988 2003 1,813 2004 1,666 2005 1,199 ----------- $14,768 =========== F-20 Odetics, Inc. Notes to Consolidated Financial Statements7. Restructuring ChargeIn the fourth quarter of fiscal 1998, the Board of Directors approved an earlyretirement plan for certain founders, senior officers and employees of theCompany. The Company recorded a charge of approximately $1.5 million related tothis plan that is expected to be paid out over a four year period. In addition,the Company recorded a charge of approximately $200,000 to write down itsinvestment in connection with the termination of its joint venture in China.8. Income TaxesThe reconciliation of the income tax benefit from continuingoperations to taxes computed at U.S. federal statutory rates is as follows: Year ended March 31 1998 1999 2000 ----------------------------------------------------- (In thousands) Income tax benefit at statutory rates $(3,915) $(6,840) $ (775) Acquired in process research and development 715 - - State income taxes, net of federal tax benefit 189 - - Increase (decrease) of valuation allowance associated with federal deferred tax assets (175) 5,373 (773) Foreign losses recorded without benefit 118 1,061 1,258 Foreign income at lower tax rate 15 Nondeductible goodwill amortization 11 31 191 Other 184 375 99 ----------------------------------------------------- $(2,858) $ - $ - =====================================================United States and foreign loss from continuing operations before income taxesare as follows: Year ended March 31 1998 1999 2000 ----------------------------------------------------- (In thousands) Pretax (income) loss: Domestic $ (9,726) $(16,997) $ 1,317 Foreign (1,815) (3,121) (3,596) ----------------------------------------------------- $(11,541) $(20,118) $(2,279) ===================================================== F-21 Odetics, Inc. Notes to Consolidated Financial Statements8. Income Taxes (continued) Significant components of the income taxes benefit from continuing operationsare as follows: Year ended March 31 1998 1999 2000 --------------------------------------------- (In thousands) Current: Federal $(1,143) $(915) $ - State (328) - - Tax benefit from stock option exercises (300) - - Foreign (485) - - --------------------------------------------- Total current (2,256) (915) - Deferred: Federal (1,516) 915 - State 614 - - --------------------------------------------- Total deferred (902) 915 - Charge in lieu: Credit to additional paid-in capital attributable to stock option exercises 300 - - --------------------------------------------- $(2,858) $ - $ - =============================================The components of deferred tax assets and liabilities are as follows: 1999 2000 ------------------------------------- (In thousands) Deferred tax assets: Inventory reserves $ 780 $ 730 Deferred compensation and other payroll accruals 1,133 1,016 Acquired net operating loss carryforwards 217 217 Net operating loss carryover 6,120 4,200 General business tax credit carryforwards 958 975 Alternative minimum tax credit carryforwards 404 463 State tax credits 81 Bad debt reserve 307 865 Other reserves 178 255 Other, net 314 400 ------------------------------------- Total deferred tax assets 10,411 9,202 Valuation allowance for deferred tax assets (6,575) (6,145) ------------------------------------- Net deferred tax assets 3,836 3,057 ------------------------------------- F-22 Odetics, Inc. Notes to Consolidated Financial Statements8. Income Taxes (continued) 1999 2000 ------------------------------------ (In thousands) Deferred tax liabilities: Tax over book depreciation 2,777 1,973 Capitalized interest and taxes 468 451 Cash to accrual adjustment 556 347 Other, net 35 286 Total deferred tax liabilities 3,836 3,057 ------------------------------------ Net deferred taxes $ - $ - ====================================At March 31, 2000, for federal income tax purposes, the Company hadapproximately $975,000 in general business credit carryforwards and $463,000 ofalternative minimum tax credit carryforwards. The Company also has $9,900,000 ofnet operating loss carryforwards for federal income tax purposes which begin toexpire in 2019, and $640,000 of net operating loss carryfowards which wereacquired as part of the ICI acquisition. For financial reporting purposes, avaluation allowance has been recorded to offset the deferred tax asset relatedto these credits and net operating losses. Any future benefits recognized fromthe reduction of the valuation allowance related to these carryforwards willresult in a reduction of income tax expense, other than the ICI operating losscarryforwards whose realization will result in an adjustment of assets acquiredin this acquisition. The credit carryforwards expire at various dates beginningin 2001 and the acquired net operating losses begin to expire in 2003.Because of the "change of ownership" provision of the Tax Reform Act of 1986,utilization of the Company's net operating loss carryforwards may be subject toan annual limitation against taxable income in future periods. As a result ofthe annual limitation, a portion of these carryforwards may expire beforeultimately becoming available to reduce future income tax liabilities.9. Associate Incentive ProgramsUnder the terms of a Profit Sharing Plan, the Company contributes to a trustfund such amounts as are determined annually by the Board of Directors. Nocontributions were made in 1998, 1999 or 2000. F-23 Odetics, Inc. Notes to Consolidated Financial Statements 9. Associate Incentive Programs (continued)In May 1990, the Company adopted a 401(k) Plan as an amendment and replacementof the former Associate Stock Purchase Plan that was an additional feature ofthe Profit Sharing Plan. Under the 401(k) Plan, eligible associates voluntarilycontribute to the plan up to 15% of their salary through payroll deductions. TheCompany matches 50% of contributions up to a stated limit. Under the provisionsof the 401(k) Plan, associates have four investment choices, one of which is thepurchase of Odetics, Class A common stock at market price. Company matchingcontributions were approximately $548,000, $644,000 and $677,000 in 1998, 1999and 2000, respectively.Effective April 1, 1987, the Company established a noncontributoryAssociate Stock Ownership Plan (ASOP) for all associates with more than sixmonths of eligible service. The ASOP provides that Company contributions, whichare determined annually by the Board of Directors, may be in the form of cash orshares of Company stock. The Company contributions to the ASOP wereapproximately $511,000, $55,000 and $69,000 in 1998, 1999 and 2000,respectively. Shares distributed through the ASOP Plan were included in totaloutstanding shares used in the earnings per share calculation.10. Deferred Compensation PlansDuring 1986, the Company adopted an Executive Deferral Plan under which certainexecutives may defer a portion of their annual compensation. All deferredamounts earn interest, generally with no guaranteed rate of return. Compensationcharged to operations and deferred under the plan totaled $302,000, $377,000 and$110,000 for 1998, 1999 and 2000, respectively.11. Stock Option PlansThe Company has adopted an Associate Stock Option Plan which provides thatoptions for shares of the Company's unissued Class A common stock may be grantedto directors and associates of the Company. Options granted enable the optionholder to purchase one share of Class A common stock at prices which are equalto or greater than the fair market value of the shares at the date of grant.Options expire ten years after date of grant or 90 days after termination ofemployment and vest ratably at 33% on each of the first three anniversaries ofthe grant date. F-24 Odetics, Inc. Notes to Consolidated Financial Statements 11. Stock Option Plans (continued)A summary of all Company stock option activity is as follows: Year ended March 31 1998 1999 2000 ---------------------------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price ---------------------------------------------------------------------------------------- (In thousands, except per share data)Options outstanding at beginning of year 640 $6.41 563 $4.67 628 5.27 Granted 502 4.63 149 7.36 358 10.36 Exercised (578) 4.79 (59) 4.63 (152) 4.65 Canceled (1) 5.99 (25) 4.63 (33) 4.65 ----------------------------------------------------------------------------------------Options outstanding at end of year 563 $4.67 628 $5.27 801 7.68 ======================================================================================== Exercisable at end of year 165 219 ========================================================================================Available for grant at end of year 157 37 114 ========================================================================================Weighted average fair value of options granted $2.43 $3.81 $ 5.25 ========================================================================================The exercise price for options outstanding as of March 31, 2000, $4.50 to$11.00. The weighted-average renewing contractual life of those options is 8.0years.In connection with the completed spin-off of the Company's interest in ATL, theCompany made secured loans to option holders in amounts up to the exercise priceof their options, which totaled $3.4 million. These notes are full recourse, aresecured by the shares of stock of the Company and ATL are interest bearing witha rate of 5.7% and are due five years from the exercise date. Loans must berepaid upon sale of the underlying shares of stock or upon termination ofemployment. F-25 Odetics, Inc. Notes to Consolidated Financial Statements 11. Stock Option Plans (continued)Pro Forma Disclosures of the Effect of Stock-Based Compensation PlansIn calculating pro forma information regarding net income and earning per share,as required by Statement No. 123, the fair value was estimated at the date ofgrant using a Black-Scholes option pricing model with the following assumption: Years ended March 31 1998 1999 2000 ---------------------------------------------------- Dividend rate 0.0 0.0 0.0 Expected life - years 7.0 7.0 7.0 Risk-free interest rate 6.0 6.0 6.0 Volatility of common stock 0.4 0.4 0.4For purposes of pro forma disclosures, the estimated fair value of the optionsis amortized to expense over the options' vesting period. The Company's proforma information for the year ended March 31, 1998, 1999 and 2000 follows (in thousands, except per share data): 1998 1999 2000 ------------------------------------------------------- Pro forma: Net loss $(7,084) $(20,555) $(2,969) Basic and diluted loss per share $ (1.03) $ (2.63) $ (0.33)Iteris, Inc.'s Stock OptionsIn September 1997, Iteris granted options to purchase up to 899,960 shares ofits common stock to certain members of its senior management at an exerciseprice of $1.07 per share. The options granted vested ratably at 25% on each ofthe first four anniversaries of the grant date. F-26 Odetics, Inc. Notes to Consolidated Financial Statements 11. Stock Option Plans (continued)Iteris, Inc.'s Stock Options (continued)Subsequently, Iteris' Board of Directors adopted and approved the 1998 StockIncentive Plan (the "Plan"), as amended in February 2000, authorized 3,000,000shares of Iteris' common stock for issuance under the Plan, and grantedthereunder options to purchase 1,731,485 shares of common stock at exerciseprices ranging from $1.60 to $9.07 per share, the fair value of the underlyingcommon stock as of the date of grant as determined by the Board of Directors.Options expire ten years after date of grant or 90 days after termination ofemployment. The options granted vested ratably at 25% on each of the first fouranniversaries of the grant date.Mariner Networks, Inc.'s Stock OptionsIn March 2000, Mariner's Board of Directors adopted a Special Executive StockOption Plan which provides for the granting of stock options for shares ofMariner's unissued common stock to certain officers, key employees, non-employeemembers of the Board of Directors, consultants and independent contractors. Atotal of 1,176,500 shares of Mariner's common stock are reserved for issuanceunder this plan. Options expire ten years after date of grant or 90 days aftertermination of employment and vest upon the optionee's completion of five yearsof service measured from the vesting commencement date as specified on the stockoption agreements. The vesting of these options will accelerate upon initialpublic offering of Mariner's common stock. Options to purchase 800,500 shares ofMariner's common stock were outstanding at March 31, 2000.In March 2000, Mariner's Board of Directors also adopted the 1999 Employee StockOption Plan which provides options for shares of Mariner's common stock toassociates, non-employee members of the Board of Directors of Mariner, Odeticsor other Odetics' subsidiaries and independent consultants. A total of 588,500shares of Mariner's common stock are reserved for issuance under this plan.Options expire ten years after date of grant or 90 days after termination ofemployment and vest upon the optionee's completion of five years of servicemeasured from the vesting commencement date as specified on the stock optionagreements. The vesting of these options will accelerate upon initial publicoffering of Mariner's common stock. Options to purchase 328,000 shares ofMariner's common stock were outstanding at March 31, 2000. F-27 Odetics, Inc. Notes to Consolidated Financial Statements 12. Commitments and ContingenciesThe Company has lease commitments for facilities in various locations throughout the United States. The annual commitment under these noncancelable operatingleases at March 31, 2000 is as follows: Fiscal Year (in thousands) ----------- 2001 $ 626 2002 508 2003 17 -------------------- $1,151 ====================Rent expense under operating leases totaled $258,000, $725,000 and $973,000,respectively for the years ended March 31, 1998, 1999 and 2000.13. Business Segment and Geographic InformationThe Company operates in three reportable segments: intelligent transportationsystems, video products which includes products for the television broadcast andvideo security markets, and telecommunications. The accounting policies of thereportable segments are the same as those described in the summary ofsignificant accounting policies except that certain expenses, such as interest,amortization of certain intangibles and certain F-28 Odetics, Inc. Notes to Consolidated Financial Statements 13. Business Segment and Geographic Information (continued)corporate expenses are not allocated to the segments. In addition, certainassets including cash and cash equivalents, deferred taxes and certain long-lived and intangible assets are not allocated to the segments. Intersegmentsales are recorded at the selling segment's cost plus profit.The reportable segments are each managed separately because they manufacture anddistribute distinct products or provide services with different processes.Selected financial information for the Company's reportable segments as of andfor the years ended March 31, 1998, 1999 and 2000 follows: Intelligence Video Products Telecom Product(In thousands) Transportation Total------------------------------------------------------------------------------------------------------------ Year ended March 31, 1998 Revenue from external customers $ 5,841 $ 54,161 $23,613 $ 83,615Intersegment revenues - 4,163 53 4,216Depreciation and amortization 514 1,362 589 2,465Segment income (loss) (5,445) (2,240) 3,527 (4,158)Segment assets 11,614 37,913 7,943 57,470Expenditure for long-lived assets 7,384 4,003 1,001 12,388 Year ended March 31, 1999 Revenue from external customers $14,580 $ 46,755 $13,974 $ 75,309Intersegment revenues - 5,351 94 5,445Depreciation and amortization 765 2,282 1,199 4,246Segment income (loss) (3,865) (5,381) (2,617) (11,863)Segment assets 17,943 38,831 8,954 65,728Expenditure for long-lived assets 4,924 3,457 3,084 11,465 Year ended March 31, 2000 Revenue from external customers $23,411 $ 38,958 $ 9,664 $ 72,033Intersegment revenues - 6,001 84 6,085Depreciation and amortization 1,962 2,637 1,182 5,781Segment income (loss) (4,407) (16,350) (7,824) (28,581)Segment assets 19,240 38,831 8,954 67,025Expenditure for long-lived assets 470 760 1,108 2,338 F-29 Odetics, Inc. Notes to Consolidated Financial Statements13. Business Segment and Geographic Information (continued)The following reconciles segment income to consolidated income before incometaxes and segment assets and deprecation and amortization to consolidated assetsand consolidated depreciation and amortization: (In thousands) 1998 1999 2000------------------------------------------------------------------------------------------------------- RevenueTotal revenues for reportable segments $ 87,832 $ 80,754 $ 78,118Non reportable segment revenues 6,220 8,064 8,673Elimination of Intersegment sales (4,216) (5,445) (6,084) ----------------------------------------------- Total consolidated revenues $ 89,836 $ 83,373 $ 80,707 =============================================== Segment Profit or LossTotal profit or loss for reportable segments $ (4,158) $(11,863) $(28,581)Other profit or loss (273) (1,201) (3,618)Unallocated amounts:Corporate and other expenses (4,777) (5,247) (6,469)Special income or charge (1,716) 38,437Interest expense (617) (1,807) (2,048) ----------------------------------------------- Loss from continuing operations before income taxes $(11,541) $(20,118) $ (2,279) =============================================== AssetsTotal assets for reportable segments $ 57,470 $ 65,728 $ 67,025Assets held at Corporate 31,320 15,627 14,825 ----------------------------------------------- Total assets $ 88,790 $ 81,355 $ 81,850 =============================================== Depreciation and AmortizationDepreciation and amortization for reportable segments $ 2,465 $ 4,246 $ 5,781Other 447 959 1,404 ----------------------------------------------- Total depreciation and amortization $ 2,912 $ 5,205 $ 7,185 =============================================== F-30 Odetics, Inc. Notes to Consolidated Financial Statements 13. Business Segment and Geographic Information (continued)Selected financial information for the Company's operations by geographicsegment is as follows: (In thousands) 1998 1999 2000----------------------------------------------------------------------------------------------------- Geographic Area RevenueUnited States $60,502 $61,171 $65,285Europe 5,538 7,582 8,509Asia Pacific Rim 17,842 6,287 2,821Other 5,954 8,333 4,092 --------------------------------------------- Total net revenue $89,836 $83,373 $80,707 ============================================= Geographic Area Long-Lived AssetsUnited States $32,929 $39,424 $38,805Europe 504 1,612 1,101Asia Pacific Rim 24 33 15 --------------------------------------------- Total long-lived assets $33,457 $41,069 $39,921 =============================================14. Supplemental Cash Flow Information Year ended March 31 1998 1999 2000 ---------------------------------- (In thousands) Net cash used in changes in operating assets and liabilities, net of acquisitions: (Increase) decrease in accounts receivable $ 1,136 $(2,706) $ 4,568 (Increase) decrease in net costs and estimated earnings in excess of billings (1,771) 276 (833) (Increase) decrease in inventories (4,604) 4,825 (2,227) Increase in prepaids and other assets (951) 111 428 Increase (decrease) in accounts payable and accrued expenses 4,728 (946) (757) ---------------------------------- Net cash used in changes in operating assets and liabilities $(1,462) $ 1,560 $ 1,179 ================================== Cash paid during the year: Interest $ 1,526 $ 1,997 $ 1,995 Income taxes paid (refunded) 365 (463) (1,144) Noncash transactions during the year: Purchase of subsidiary for stock $ 2,734 $ 5,845 $ - Acquisition of business for note payable - - 2,000 MMA purchase price adjustment - - 251 F-31 Odetics, Inc. Notes to Consolidated Financial Statements 15. Legal ProceedingsOn October 11, 1999, the Company settled a patent infringement case it hadbrought against Storage Technology Corporation (StorageTek). Through anagreement, StorageTek agreed to pay the Company a license fee totaling $100.0million for use of the Company's United States Patent No. 4,779,151. Under theagreement, the license fee was payable in three installments: $80.0 million uponsigning of the agreement, and two annual installments of $10.0 million payablein each of October 2000 and 2001. In connection with the initial payment, theCompany received $38.4 million, net of legal fees and other direct expenses,which is reflected in the accompanying consolidated statement of operations asroyalty income.On June 12, 2000, the Company and StorageTek amended the agreement, wherebyStorageTek agreed to pay a final discounted payment of $17.8 million immediatelyin full settlement of the $20.0 million otherwise due to complete thesettlement. Accordingly, the Company will recognize non-operating income in thatamount in its quarter ended June 30, 2000. F-32 ODETICS, INC. Schedule II - VALUATION AND QUALIFYING ACCOUNTS Column A Column B Column C Column D Column E-------------------------------------------------------------------------------------------------------------------------- Balance at Charged Balance Beginning of to Costs Charged to Deductions at End Description Period and Expenses Accounts Describe of Period-------------------------------------------------------------------------------------------------------------------------- Year ended March 31, 1998: Deducted from asset accounts: Allowance for doubtful accounts........ $ 350,000 $ 155,000 $ 0 $ (73,000) $ 432,000 Reserve for inventory obsolescence..... 2,437,000 1,240,000 0 $ (796,000) 2,881,000 -------------------------------------------------------------------------- Total............................... $2,787,000 $1,395,000 $ 0 $ (869,000) $3,313,000 ========== ========== ======== =========== ==========Year ended March 31, 1999: Deducted from asset accounts: Allowance for doubtful accounts........ $ 432,000 $ 332,000 $125,000 $ (50,000) $ 839,000 Reserve for inventory obsolescence..... 2,881,000 1,590,000 0 $(1,300,000) 3,171,000 -------------------------------------------------------------------------- Total............................... $3,313,000 $1,922,000 $125,000 $(1,350,000) $4,010,000 ========== ========== ======== =========== ==========Year ended March 31, 2000: Deducted from asset accounts: Allowance for doubtful accounts........ $ 839,000 $1,293,000 $ 0 $ (64,000) $2,068,000 Reserve for inventory obsolescence..... 3,171,000 $1,438,000 0 $(1,123,000) 3,486,000 -------------------------------------------------------------------------- Total............................... $4,010,000 $2,731,000 $ 0 $(1,187,000) $5,554,000 ========== ========== ======== =========== ========== S-1 EXHIBIT 10.31 ITERIS,INC. SUBORDINATED CONVERTIBLE NOTE PURCHASE AGREEMENT January 25, 2000 ITERIS, INC. SUBORDINATED CONVERTIBLE NOTE PURCHASE AGREEMENT This Agreement is made as of January 25, 2000 by and between Iteris, Inc.,a Delaware corporation (the "Company"), and DaimlerChrysler Venture GmbH, aGerman limited liability company ("Purchaser"). RECITALS A. Purchaser is not a U.S. Person as defined in Rule 902(k) of RegulationS (`Regulation S"), as promulgated under the Securities Act of 1933, as amended(the "Securities Act"). B. The Company desires to sell to Purchaser and Purchaser desires topurchase from the Company the subordinated convertible promissory note describedherein, the offer and sale of which is being made in reliance upon theprovisions of Regulation S. AGREEMENT SECTION 1. AUTHORIZATION AND SALE OF NOTE 1.1 Authorization. The Company has authorized the sale and issuance ------------- of an 8% subordinated convertible promissory note in the principal amount of$3.75 million (the "Note"), substantially in the form attached hereto as ExhibitA. 1.2 Sale of Note. Subject to the terms and conditions hereof, the ------------ Company will issue and sell to the Purchaser and the Purchaser will buy from theCompany the Note for an amount of $3.75 million. Such purchase price shall bepaid in the manner set forth in Section 2.2. The number of shares of CommonStock into which the Note is convertible shall be subject to certain adjustmentprovisions. 1.3 Company Records and Use of Proceeds. Upon issuance, the Note will -----------------------------------be registered in the Purchaser's name in the Company's records. The proceedsfrom the sale and issuance of the Note shall be used for general corporatepurposes and not for the retirement of any shareholder debt, except asauthorized in this Agreement. Section 2. CLOSING DATE & DELIVERY 2.1 Closing. The closing of the purchase and sale of the Note ------- hereunder (the "Closing") shall be held at the offices of DaimlerChryslerVenture GmbH, Stuttgart, Germany, promptly after the execution of this Agreementor at such other time and place upon which the Company and the Purchaser shallagree (the date of the Closing is hereinafter referred to as the "ClosingDate"). 1 2.2 Payment and Delivery. At the Closing, the Company will deliver to --------------------Purchaser the Note, against payment of the purchase price therefor, by checkpayable to the Company, or by wire transfer per the Company's instructions. Section 3. REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company represents and warrants to the Purchaser as follows as of theexecution of this Agreement and the Closing: 3.1 Organization and Standing: Certificate and Bylaws. The Company is ------------------------- a corporation duly organized, validly existing and in good standing under thelaws of the state of Delaware. The Company has all requisite corporate power andauthority to own and operate its properties and assets, and to carry on itsbusiness as presently conducted and as proposed to be conducted. The Company isqualified to do business as a foreign corporation in each jurisdiction wherefailure to be so qualified would have a material adverse effect on the Company'sbusiness as presently conducted and as currently proposed to be conducted. TheCompany has made available to the Purchaser copies of the Company's Certificateof Incorporation and Bylaws, as amended to date. Said copies are true, correctand complete and contain all amendments through the date hereof. 3.2 Corporate Power. The Company has all requisite corporate power ---------------and authority to execute and deliver the Registration Rights Agreement (asdefined in Section 5.10 hereof) and this Agreement, to sell and issue the Notehereunder, to issue the Common Stock issuable upon conversion of the Note (the"Conversion Stock"), and to carry out and perform its obligations under theterms of this Agreement and the Registration Rights Agreement. 3.3 Capitalization. The authorized capital stock of the Company --------------consists of 40,000,000 shares of Common Stock, $0.01 par value (the "CommonStock"), of which 6,432,100 shares are issued and outstanding as of the ClosingDate, and 5,000,000 shares of Preferred Stock, $0.01 par value, none of whichare outstanding. The Company has reserved a sufficient number of shares ofCommon Stock for issuance upon conversion of the Note. Shares of the ConversionStock have the rights, preferences, privileges and restrictions set forth in theCertificate of Incorporation. Except as set forth above and options to purchase[1,400,000] shares of Common Stock, there are no options, warrants, conversionprivileges or other rights to purchase or otherwise acquire any of the Company'sauthorized and unissued capital stock. The outstanding shares of the capitalstock of the Company are duly and validly issued, fully paid and nonassessable,and such shares have been issued in compliance with the Securities Act and anyapplicable state securities law, or in compliance with applicable exemptionstherefrom. 3.4 Subsidiaries. Except for Meyer, Mohaddes Associates, Inc., a ------------wholly owned subsidiary of the Company, the Company has no subsidiaries. 3.5 Financial Statements. The Company has delivered at or prior tothe Closing to the Purchaser the Company's unaudited financial statements forthe fiscal period ended December 31, 1999 (the "Financial Statements"). TheFinancial Statements are complete and correct in all material respects and havebeen prepared in accordance with 2 generally accepted accounting principles ("GAAP") applied on a basis consistentwith prior accounting periods, except to the extent that the unaudited financialstatements are subject to normal and recurring year-end adjustments. TheFinancial Statements present fairly the financial condition and operatingresults of the Company as of the date and during the periods indicated therein.Except to the extent reflected or reserved against or disclosed in the FinancialStatements, the Company as of the date of the Financial Statements had nomaterial liabilities or obligations of any kind, whether accrued, absolute,contingent or otherwise, which under GAAP should have been reflected or reservedagainst or disclosed. 3.6 Absence of Certain Changes. Since December 31, 1999, and at all --------------------------times up to the Closing, there has not been, nor, so far as reasonably can be foreseen at this time, is there reasonably likely to be, any event or conditionof any character which has materially adversely affected, or is likely tomaterially affect, the Company's consolidated business operations, assets,condition (financial or otherwise), liabilities, earnings or prospects includingbut not limited to: (a) any event which materially, adversely affects the Company'sbusiness as it is currently being conducted; (b) any declaration, setting aside or payment or otherdistribution in respect of any of the Company's capital stock, or any direct orindirect redemption, purchase or other acquisition of any of such stock by theCompany, other than the repurchase of unvested shares of Common Stock of theCompany issued to employees, officers or directors of or consultants to theCompany; (c) any waiver by the Company of a valuable right or of amaterial debt owed to it; (d) any material change or amendment to a material contract orarrangement by which the Company or any of its assets or properties is bound orsubject; (e) any material commitment, transaction or other action by theCompany other than in the ordinary course of business and consistent with pastpractice; (f) any amendment or other change to the Certificate ofIncorporation or Bylaws of the Company (except as contemplated by thisAgreement); (g) any sale or other disposition of any right, title orinterest in or to any material assets or properties of the Company or anyrevenues derived therefrom other than in the ordinary course of business andconsistent with past practice; (h) any creation, incurrence or assumption of any indebtednessfor money borrowed by the Company exceeding $50,000 (not including net increasesin accounts payable or intercompany debt incurred in the ordinary course of theCompany's business); (i) any material capital expenditures by the Company not in theordinary course of business; 3 (j) any material change in any accounting principle or method orelection for federal income tax purposes used by the Company; (k) any change in the assets, liabilities, prospects, financialcondition or operations of the Company from those reflected in the FinancialStatements, except changes in the ordinary course of business which have notbeen, either in any case or in the aggregate, materially adverse; (l) any material change in the outstanding indebtedness owed bythe Company; (m) any material change in the contingent obligations of theCompany by way of guaranty, endorsement, indemnity, warranty or otherwise; (n) any damage, destruction or loss, whether or not covered byinsurance, materially and adversely affecting the properties or business of theCompany; (o) any loans made by the Company to its employees, officers ordirectors other than advances of expenses made in the ordinary course ofbusiness; (p) any agreements made with any affiliates of the Company,other than agreements relating to or contemplated by the Separation andDistribution Agreement between the Company and Odetics, Inc. dated December 31,1999; or (q) any authorization, approval, agreement or commitment to do any of the foregoing. 3.7 Absence of Undisclosed Liabilities. The Company does not have any ---------------------------------- material obligation or material liability arising out of any transaction enteredinto at or prior to the Closing, or any act or omission to act at or prior tothe Closing, except (a) to the extent set forth or reserved against in theFinancial Statements, (b) as disclosed in the Disclosure Schedule, and (c)current liabilities incurred and obligations under agreements entered into inthe usual and ordinary course of business since December 31, 1999, none of which(individually or in the aggregate) materially and adversely affects thebusiness, properties, finances or prospects (financial or otherwise) of theCompany. 3.8 Authorization, No Breach. The execution, delivery and performance ------------------------of this Agreement and the Registration Rights Agreement and the consummation ofall transactions contemplated hereby or thereby, including but not limited tothe offering, sale and issuance of the Note pursuant to this Agreement has beenduly authorized by all required corporate actions of the Company and itsshareholders and the Company has taken all corporate acts necessary for the dueand valid authorization, execution, issuance and performance of the Agreement,the Registration Rights Agreement, the Note and the Conversion Stock. ThisAgreement, the Registration Rights Agreement and the Note constitute valid andbinding obligations of the Company enforceable in accordance with theirrespective terms, except as the indemnification provisions of Section 2.7 of theRegistration Rights Agreement may be limited by principles of public policy, andsubject to laws of general application relating to bankruptcy, insolvencyreorganization, moratorium and the relief of debtors and rules of law governingspecific performance, injunctive relief or 4 other equitable remedies. The Note, when issued in compliance with theprovisions of this Agreement, will be validly issued, fully paid andnonassessable, and will have the rights, preferences and privileges describedtherein; the Conversion Stock has been duly and validly reserved and, whenissued in compliance with the provisions of this Agreement and the Certificateof Incorporation, will be duly and validly authorized, validly issued andoutstanding, fully paid and nonassessable; and the Note and such ConversionStock will be free of any liens or encumbrances, other than any liens orencumbrances created by or imposed upon the holders; provided, however, that theNote and the Conversion Stock may be subject to restrictions on transfer understate and/or federal securities laws as set forth herein. 3.9 Material Contracts and Commitments. A list of and copies of the ----------------------------------contracts, mortgages, indentures, agreements, instruments, leases andtransactions to which the Company is a party or by which it is bound whichinvolve obligations of, or payments to, the Company in excess of Two HundredThousand Dollars ($200,000) and all agreements between the Company and itsofficers, directors, consultants and employees (the "Material Contracts"), havebeen delivered to the Purchaser. All of the Material Contracts are valid,binding and in full force and effect in all material respects and enforceable bythe Company in accordance with their respective terms in all material respects,subject to the effect of applicable bankruptcy, insolvency, reorganization,moratorium or other laws of general application relating to or affectingenforcement of creditors' fights and rules or laws concerning equitableremedies. To the Company's knowledge, the Company is not in material defaultunder any of such Material Contracts and no other party to any of the MaterialContracts is in material default thereunder. 3.10 Litigation, etc. There are no actions, suits, proceedings or --------------- investigations pending or claims asserted (or, to the Company's knowledge, anybasis therefor or threat thereof), to which the Company is a party or itsproperty is subject or, to the Company's knowledge, against any officer,director or employee of the Company in connection with such person'srelationship with or actions taken on behalf of the Company or which questionthe validity or enforceability of this Agreement, the Registration RightsAgreement or the Note which might result in (i) any material adverse change inthe business, prospects or financial condition of the Company or any of itsproperties or assets, (ii) any material impairment of the right or ability ofthe Company to carry on its business as now conducted or as proposed to be conducted or to pay amounts under the Note as they become due or (iii) in anymaterial liability on the part of the Company, and none which question thevalidity of this Agreement or any action taken or to be taken in connectionherewith. 3.11 Consents. No consent, approval, qualification, order or -------- authorization of, or filing with, any governmental authority is required inconnection with the Company's valid execution, delivery or performance of thisAgreement or the Registration Rights Agreement, or the offer, sale or issuanceof the Note by the Company, the issuance of Conversion Stock, or theconsummation of any other transaction contemplated on the part of the Companyhereby, except such filings as may be required under the applicable securitieslaws. 3.12 Title to Properties; Liens and Encumbrances. The Company has -------------------------------------------good and marketable title to its properties and assets and, with respect to theproperty and assets leased by the Company, holds valid leasehold intereststherein, in each case subject to 5 no mortgage, pledge, lien, security interest, conditional sale agreement,encumbrance or charge or other equitable interest, except (i) tax, materialmens'or like liens for obligations not yet due or payable or being contested in goodfaith by appropriate proceedings, (ii) security interests granted toTransamerica Business Credit Corporation pursuant to that certain Loan andSecurity Agreement to which the Company is a party dated December 28, 1998, andrelated documentation, or (iii) liens or encumbrances which do not individuallyor the aggregate in any case materially impair the Company's use thereof ormaterially detract from the value of the Company and which have arisen in theordinary course of business. 3.13 Proprietary Information and Other Rights. The Company uses ----------------------------------------patents, trade secrets, including know-how, concepts, computer programs andother technical data (the "Proprietary Information") for the development,manufacture and sale of its products. The Company owns or has the right to useall such Proprietary Information necessary for its business as now conductedand, to the knowledge of the Company, the Proprietary Information underdevelopment or intended to be used by the Company in its business as currentlyproposed, will not infringe upon the proprietary rights of third parties.Reasonable security measures have been taken by the Company to protect thesecrecy, confidentiality and value of the Proprietary Information referred to inthis Section 3.13. Each officer of the Company or subsidiary has executed aproprietary information agreement, copies of which have been provided toPurchaser. The Company, after reasonable investigation, is not aware that any ofits officers is in violation thereof, and the Company will use its best effortsto prevent any such violation. 3.14 Insurance. The Company maintains insurance of the types and in --------- the amounts generally deemed adequate for its business and consistent withinsurance coverage maintained by similar companies in similar businesses,including but not limited to, insurance covering real and personal propertyowned or leased by the Company against theft, damage, destruction, acts ofvandalism and all other risks customarily insured against, all of whichinsurance is in full force and effect and all premiums with respect thereto arecurrently paid. 3.15 Brokers or Finders. The Company has not incurred, and will not ------------------ incur, directly or indirectly, as a result of any action taken by the Company,any liability for brokerage or finders' fees or agents' commissions or anysimilar charges in connection with this Agreement. 3.16 Compliance With Other Instruments. --------------------------------- (a) The Company is not in violation or default of anyprovisions of its Certificate of Incorporation or Bylaws or of any judgment,order, writ, decree or Material Contract to which it is a party or by which itis bound or, to its knowledge, of any provision of federal or state statute, rule or regulation applicable to the Company or its subsidiaries, except to theextent that such violation or default would not have a material adverse effecton the Company, its business or its operations. The execution, delivery andperformance of this Agreement, the Registration Rights Agreement or the Note andthe consummation of the transactions contemplated herein will not result in anysuch violation nor be in conflict with or constitute, with or without thepassing of time and giving of notice, either a default under any such provision,judgment, order, writ, decree or Material Contract or any event which results inthe creation of any lien, charge or encumbrance upon any assets of the Companyor any of its subsidiaries (other than such liens as are contemplated hereby). 6 (b) The Company has avoided every condition, and has notperformed any act, the occurrence of which would result in its loss of any rightgranted under any license, distribution or other agreement. The Company believesthat has received fair value for all licenses assigned or transferred to thirdparties. 3.17 Registration Rights. Except as set forth in the Registration ------------------- Rights Agreement and the Registration Rights Agreement dated October 16, 1998,among the Company, Michael P. Meyer, Abbas Mohaddes, Viggen Davidian and GaryHamrick, the Company is not under any contractual obligation to register any ofits securities which are outstanding or any of its securities which mayhereafter be issued. 3.18 Offering. Subject to the accuracy of the Purchaser's -------- representations in Section 4 hereof, the offer, sale and issuance of the Noteand the issuance of the Conversion Stock, constitute transactions exempt fromthe registration requirement of Section 5 of the Securities Act and applicablestate securities laws. 3.19 Disclosure. There is no fact known to the Company that has not ----------been disclosed to the Purchaser which the Company reasonably expects will have amaterial adverse effect upon the financial condition, operating results orassets of the Company, taken as a whole. The Company has fully provided thePurchaser with all the information which the Purchaser has requested fordeciding whether to purchase the Note and, to the extent applicable, theConversion Stock and all information which the Company believes is reasonablynecessary to enable the Purchaser to make such decision. 3.20 Minute Books. The minute books of the Company contain copies of ------------ minutes for all meetings of directors and shareholders since the time ofincorporation. The Purchaser (or its counsel) has been provided with anopportunity to review the minute books or copies of such minutes. 3.21 Employees; Proprietary Information Agreement. To the best of the -------------------------------------------- Company's knowledge, no employee of the Company is in violation of any term ofany employment contract, patent disclosure agreement or any other contract,agreement, order or decree relating to the relationship of such employee withthe Company or any other party because of the nature of the business conductedor to be conducted by the Company. To the best of the Company's knowledge, noneof its employees is obligated under any contact, agreement or judgment thatwould interfere with such employee exercising his or her best efforts to promotethe interests of the Company or that would conflict with the Company's businessas currently proposed. 3.22 Dividends. The Company has not declared or paid any dividends, --------- or authorized or made any distribution upon or with respect to any class orseries of its capital stock. 3.23 Intellectual Property Rights. The Company (a) owns or has the ---------------------------- right to use, free and clear of all liens, charges, claims and restrictions(except for those disclosed in Section 3.13), all patents, trademarks, servicemarks, trade names, copyrights, computer software programs, databases, domainnames, licenses, trade secrets and rights and any other intellectual propertynecessary to its business as now conducted and, to the Company's knowledge, is not infringing upon or otherwise acting adversely to the right or 7 claimed right of any person under or with respect to any of the foregoing and(b) is not obligated or under any liability whatsoever to make any payments byway of royalties, fees or otherwise to any owner of, licensor of, other claimantto, any patent, trademark, trade name, copyright, database, domain name, orother intangible asset, except pursuant to the Cooperative Development Agreementfor a Lane Departure Detection and Warning System between the Company andDaimlerChrysler Corporation dated July 22, 1998, and the Asset Sale Agreementbetween the Company and Rockwell Collins, Inc. dated June 20, 1997 (the "LicenseAgreements"). There are no outstanding options, licenses, or agreements of anykind relating to the foregoing nor, is the Company bound by or a party to anyoptions, licenses or agreements of any kind with respect to the patents,trademarks, service marks, trade names, copyrights, databases, domain names,trade secrets, licenses, information, computer software programs, proprietaryrights and processes of any other person or entity, except for the LicenseAgreements the Agreement between Freightliner Corporation and the Company datedJanuary 11, 1999,confidential nondisclosure agreements and the like. 3.24 Operating Rights. The Company has all operating authority, ---------------- licenses, franchises, permits, certificates, consents, rights and privileges asare necessary or appropriate to the operation of its business as now or asproposed to be conducted, the absence of which would have a material and adverseeffect on the business of the Company ("collectively, the "Permits"). SuchPermits are in full force and effect, no violations have been or are expected tohave been recorded in respect of any such Permits, and no proceeding is pendingor, to the Company's knowledge, threatened that could result in the revocationor limitation of any of such Permits. The Company has conducted its business soas to comply in all material respects with all such Permits. 3.25 Related Party Transactions. Except for officers or directors of -------------------------- the Company who are also officers or directors of Odetics, Inc., no officer ordirector of the Company (a) is an officer, director or general partner of, ordirectly or indirectly owns beneficially more than 5% of the equity of, anybusiness which (i) furnishes or sells services or products which compete withservices or products furnished or sold by the Company or (ii) purchases from orsells or furnishes to the Company any goods or services, or (b) has a beneficialinterest in any contract or agreement to which the Company is a party or bywhich it may be bound or affected involving the payment or receipt of in excessof $50,000, other than any agreements governing the purchase of shares of theCompany's Common Stock and agreements relating to the employment of suchpersons, copies of which agreements have been delivered to the Purchaser'counsel. The Company is not a guarantor or indemnitor of an indebtedness of anyother person, firm or corporation. 3.26 Environmental Regulations. The Company has met, and continues to ------------------------- meet in all material respects, all applicable local, state and federalenvironmental regulations. The Company has disposed of its waste products andeffluents, and has used reasonable efforts to cause others to dispose of wasteproducts and effluents for the Company, in accordance with, in all materialrespects, all applicable state, local and federal environmental regulations andin such a manner that, to the best of the Company's knowledge, no harm hasresulted or will result to any of the employees or properties of the Company orto any other persons or entities or their properties. 3.27 Taxes. The Company believes that it has accurately prepared in ----- all material respects and has filed all tax returns that are required to havebeen filed on or before 8 the Closing with appropriate federal, state, county and local governmentalagencies or instrumentalities. The Company has paid or established adequatereserves for all material income, franchise and other taxes, assessments,governmental charges, penalties, interest and fines due and payable by it on orbefore the Closing. There is no pending dispute with any taxing authorityrelating to any of such returns, and the Company has no knowledge of any proposed liability for any tax to be imposed upon the properties or assets ofthe Company. 3.28 Inventory. All inventory is of a quality and quantity usable in --------- the ordinary course of business, except for obsolete items, or materials belowstandard quality, which, in the aggregate, are not material in amount and havebeen written off or written down to net realizable value on the books of theCompany. 3.29 Returns and Complaints. The Company has not received any ----------------------customer complaints concerning its products or services that have not beenresolved and which are indicative of a problem that is reasonably likely toresult in a material adverse effect on the Company, its business or itsoperations. 3.30 Foreign Corrupt Practices Act. The Company has not made, offered -----------------------------or agreed to offer anything of value to any governmental official, politicalparty or candidate for political office (or any person that the Company knows orhas reason to know will offer anything of value to any such person) in violationof the Foreign Corrupt Practices Act of 1977, as amended. 3.31 No Cancelled Contracts. No Material Contracts or purchase orders ---------------------- have been cancelled, rescinded, continued or modified in any material respectwhich would have a material adverse effect on the Company, its business or itsoperations. Section 4. REPRESENTATIONS AND WARRANTIES OF THE PURCHASER Purchaser hereby represents and warrants to the Company with respect to thepurchase of the Note as follows: 4.1 Accredited Investor. It is an "accredited investor" as such term ------------------- is defined in Rule 501(a) of Regulation D of the Securities Act. 4.2 Experience. It has substantial experience in evaluating and ---------- investing in private placement transactions of securities in companies similarto the Company so that it is capable of evaluating the merits and risks of itsInvestment in the Company and has the capacity to protect its own interests. 4.3 Economic Risk. It understands that the purchase of the Note -------------hereunder is a speculative investment which involves a high degree of risk ofloss of its investment therein. It is able to bear the economic risk of itsinvestment in the Note for an indefinite period of time, including the risk of acomplete loss of its investment in such securities. It acknowledges that suchNote and the Conversion Stock have not been registered under the Securities Actand, therefore, cannot be sold unless subsequently registered under theSecurities Act or an exemption from such registration is available. Theforegoing does 9 not, however, limit or modify the representations and warranties of the Companyset forth in Section 3 of this Agreement or the fight of the Purchaser to relythereon. 4.4 Strategic Investment. It is acquiring the Note and the underlying --------------------Common Stock for investment for its own account, not as a nominee or agent, notfor the account or benefit of any U.S. Person and not with the view to, or forresale in connection with, any distribution thereof. It understands that theNote and the underlying Common Stock have not been, and will not be, registeredunder the Securities Act by reason of a specific exemption from the registrationprovisions of the Securities Act, the availability of which depends upon, amongother things, the bona fide nature of the investment intent and the accuracy ofits representations as expressed herein. 4.5 Execution, Delivery and Performance. It has full right, power and -----------------------------------authority to execute and deliver this Agreement and the Registration RightsAgreement and to perform its obligations hereunder and thereunder. At or beforethe Closing hereunder, it will execute and deliver to the Company theRegistration Rights Agreement, and it acknowledges and agrees that the Notepurchased will be subject to the terms and provisions of the Registration RightsAgreement, and the Company's Certificate of Incorporation and Bylaws. ThisAgreement and the Registration Rights Agreement, when so executed and deliveredby the Purchaser, will constitute valid and binding obligations of eachPurchaser enforceable in accordance with their respective terms, except as theindemnification provisions of the Registration Rights Agreement may be limitedby principles of public policy, and subject to laws of general applicationrelating to bankruptcy, insolvency and the relief of debtors and rules of lawgoverning specific performance, injunctive relief or other equitable remedies.No consent, approval, authorization, order, filing, registration orqualification of or with any court, governmental authority or third person isrequired to be obtained by the Purchaser in connection with the execution anddelivery of this Agreement or the Registration Rights Agreement or theperformance of each Purchaser's obligations hereunder or thereunder. 4.6 Regulation S and Rule 144. Purchaser acknowledges that the Note -------------------------and the underlying Common Stock are being purchased in reliance upon RegulationS and that the Note and the Conversion Stock must be held indefinitely unlesssubsequently transferred in accordance with Regulation S, registered under theSecurities Act or an exemption from such registration is available. Purchaser isaware of the provisions of Regulation S, which prohibits the offer or sale ofthe Note and the Conversion Stock to or for the benefit or account of any U.S.Person for a period of one year following the Closing, and Rule 144 promulgatedunder the Securities Act ("Rule 144") which permit limited resale of securitiespurchased in a private placement subject to the satisfaction of certainconditions, including, among other things, the existence of a public market forthe securities, the availability of certain current public information about theCompany, the resale occurring not less than one year after a party has purchasedand paid for the security to be sold, the sale being effected through a"broker's transaction" or in transactions directly with a "market maker" and thenumber of securities being sold during any three (3) month period not exceedingspecified limitations. 4.7 No Public Market. Purchaser understands that no public market now ----------------exists for any of the securities issued by the Company and that the Company hasmade no assurances that a public market will ever exist for the Company'ssecurities. 10 4.8 Access to Data. Purchaser acknowledges that it has had a full --------------opportunity to ask questions and receive answers concerning the terms andconditions of the offering of the Note and has had full access to the Company'sofficers and such other information concerning the Company as it has requested. 4.9 Brokers or Finders. Purchaser has not incurred and will not ------------------incur, directly or indirectly, as a result of any action taken by the Purchaser,any liability for brokerage or finder's fees or agent's commissions or anysimilar charges in connection with this Agreement. 4.10 Tax Liability. Purchaser has reviewed with its own tax advisors -------------the federal, state, local and foreign tax consequences of this investment andthe transactions contemplated by this Agreement. It relies solely on suchadvisors and not on any statements or representations of the Company or any ofits agents. It understands that it (and not the Company) shall be responsiblefor any of its own tax liability that may arise as a result of this investmentor the transactions contemplated by this Agreement. 4.11 Investor Counsel. Purchaser acknowledges that it has had the ----------------opportunity to review this Agreement, the exhibits attached hereto and thetransaction contemplated by this Agreement with its own legal counsel. It isrelying solely on such counsel and not on any statements or representations of the Company, Stradling Yocca Carlson & Rauth (counsel solely to the Company) orany of its agents for legal advice with respect to this investment or thetransactions contemplated by this Agreement. 4.12 Foreign Investor. Purchaser is a German limited liability company ----------------with its principal place of business in Stuttgart, Germany, has no branch orother operations within the United States and is not a U.S. Person. Alldecisions concerning the purchase of the Note and the acquisition, if any, ofthe Conversion Stock, have been and will be made at Purchaser's principal placeof business where this Agreement and the Registration Rights Agreement will beexecuted and delivered and where the Note will be received. The Note was notoffered to Purchaser in the United States and at the time of execution of thisAgreement and the time of any offer to Purchaser to purchase the Note, thePurchaser was physically outside of the United States. Section 5. CONDITIONS TO CLOSING OF THE PURCHASER The Purchaser's obligations to purchase the Note at the Closing are, at theoption of the Purchaser, subject to the fulfillment on or prior to the ClosingDate of the following conditions: 5.1 Representations and Warranties Correct. The representations and --------------------------------------warranties made by the Company in Section 3 hereof shall be true and correct asof the Closing Date with the same force and effect as if made on such date. 5.2 Covenants. All covenants, agreements and conditions contained in ---------this Agreement to be performed by the Company on or prior to the Closing Dateshall have been performed or complied with. 11 5.3 Compliance Certificate. The Company shall have delivered to the ----------------------Purchaser a certificate of the Company, executed by the President of theCompany, dated the Closing Date, and certifying as to the fulfillment of theconditions specified in Sections 5.1 and 5.2 of this Agreement. 5.4 Good Standing Certificates. The Company shall have delivered to --------------------------the Purchaser certificates dated as of the most recent practicable date prior tothe Closing Date issued by the Delaware Secretary of State to the effect thatthe Company is legally existing and in good standing, and similar good standingcertificates from the state of incorporation for each of the subsidiaries. 5.5 Secretary's Certificate. The Company shall have delivered to the -----------------------Purchaser a certificate executed by the Secretary of the Company dated as of theClosing, certifying the following matters: (a) resolutions adopted by the Boardapproving the transactions contemplated by this Agreement; (b) Certificate ofIncorporation of the Company; (c) Bylaws of the Company; (d) incumbency of thoseofficers of the Company signing the various agreements; and (e) such othermatters as the Purchaser may reasonably request. 5.6 Note. A Note substantially in the form of Exhibit A shall have ----been executed and delivered by the Company and the Purchaser and shall be infull force and effect as of the Closing. 5.7 Registration Rights Agreement. An Registration Rights Agreement ----------------------------- substantially in the form of Exhibit B (the "Registration Rights Agreement")shall have been executed and delivered by the Company and the Purchaser andshall be in full force and effect as of the Closing. 5.8 Legal Opinion. The Purchaser shall have received from Stradling -------------Yocca Carlson & Rauth, counsel to the Company, a legal opinion addressed to themsubstantially in the form of Exhibit C. 5.9 Debt Conversion. Odetics, Inc. shall have agreed to contribute to ---------------the capital of the Company a portion of the amount of debt owed by the Companyto Odetics, Inc. Section 6. CONDITIONS TO CLOSING OF COMPANY The Company's obligation to sell and issue the Note at the Closing is, atthe option of the Company, subject to the fulfillment as of the Closing Date ofthe following conditions with the same force and effect as if made on such date: 6.1 Representations. The representations and warranties made by the ---------------Purchaser in Section 4 hereof shall be true and correct as of the Closing Date. 6.2 Registration Rights Agreement. The Purchaser shall have executed -----------------------------and delivered the Registration Rights Agreement. 12 6.3 Payment of Purchase Price. The Purchaser shall have delivered to -------------------------the Company the purchase price for the Note being purchased at such Closing. 6.4 Forms W-9 or W-8. Each Purchaser shall have delivered to the ----------------Company a complete and executed Internal Revenue Service Form W-8 or Form W-9,as applicable. Section 7. AFFIRMATIVE COVENANTS OF THE COMPANY AND THE PURCHASER 7.1 Compliance with Documents. The Company will perform and observe -------------------------all of its obligations to the holders of the Note (and the Conversion Stock) setforth in this Agreement, the Certificate of Incorporation, the Bylaws, and allof its obligations set forth in the Investor Rights Agreement. 7.2 Observation of Board of Directors. For as long as the Note ---------------------------------remains outstanding or Purchaser holds at least 200,000 shares of Common Stock,if Purchaser so requests, the Company will permit a representative of Purchaserto receive notice of and attend all Board meetings and to receive all documentsprovided generally to the Board at the same time as such materials are providedto the Board. Purchaser's representative shall be capable of discussingstrategic objectives and implementation relating to the Company's business andshall be permitted to attend portions of any Board meeting related specificallyto operations or financial matters. Purchaser's representative shall be able toattend any other portions of Board meeting at the sole discretion of the Board.Notwithstanding the foregoing, Purchaser acknowledges and agrees that theCompany's management will have the right to exclude any such representative fromall or portions of meetings of the Board, or omit to provide such representativewith certain information, if the Company's management believes it is necessaryin order to preserve the attorney-client privilege, or fulfill the Company'sobligations with respect to confidential or proprietary information of thirdparties, or if such meeting or information involves matters where a directorwould customarily not participate in a meeting or be provided such information.In addition, Purchaser acknowledges and agrees that any such representative willmaintain the confidentiality of all information obtained through suchrepresentative's position and will be bound by the same obligations ofconfidentiality as Purchaser is bound. 7.3 Information Rights. In addition to the rights set forth in the ------------------Investor Rights Agreement, the Company hereby covenants and agrees to thefollowing with Purchaser: (a) The Company shall provide to Purchaser (i) as soon asavailable and in any event within ninety (90) days after the end of each fiscalyear of the Company, a balance sheet of the Company as of the end of such fiscalyear and the related statements of income, retained earnings and changes infinancial position for such fiscal year, setting forth in each case incomparative form the figures for the previous fiscal year, all reported on by a firm of independent public accountants of nationally recognized standing, (ii)as soon as available and in any event within 30 days after the end of each ofmonth, internal balance sheet and income statement as are produced in theordinary course of business by the Company. 13 (b) The Company will permit representatives of the Purchaser tovisit and inspect any of its properties and to examine and make copies of any ofits books and records and to discuss its affairs, finances and accounts with itsofficers, employees and agents all at such reasonable times and as often as mayreasonably be desired, provided Purchaser provides the Company with reasonablenotice in advance of such visit. (c) The information rights under this Section 7.3 shallterminate upon the closing of the Company's initial public offering registeredunder the Securities Act. 7.4 Advancement of Strategic Relationship. The parties intend to -------------------------------------cooperate in the following areas: (a) Purchaser will support and use its international networks tofacilitate the adoption of the AutoVue product in DaimlerChrysler commercialvehicles and passenger cars. (b) Purchaser will support and use its international networks tofacilitate joint initiatives between DaimlerChrysler and the Company to bringeBusiness solutions, such as Personalized Traveler Information, to mobileinternet users in DaimlerChrysler commercial vehicles and passenger cars. 7.5 Publicity. Purchaser and the Company agree that neither shall ---------publicly disclose, whether by a press release or otherwise, the existence of orthe terms and conditions of this Agreement until the Closing, at which time thePurchaser and the Company shall cooperate in the drafting and issuance of pressreleases in the United States and Europe. Neither party shall issue a pressrelease without the prior consent of the other party. Purchaser acknowledgesthat the company may be required to file this Agreement and the agreementscontemplated hereby with the Securities Exchange Commission in connection withits initial Public Offering, and Purchaser hereby consents to such filing. Section 8. RESTRICTIONS ON TRANSFERABILITY OF SECURITIES; COMPLIANCE WITH SECURITIES ACT 8.1 Restrictions on Transferability. In addition to the restrictions -------------------------------set forth in Section 8.2, Purchaser agrees that all offers and sales of the Noteand the Conversion Stock prior to the expiration of a period commencing on theClosing Date and ending one year thereafter shall not be made to U.S. Persons orfor the account or benefit of any U.S. Person and shall otherwise be made incompliance with Regulation S. Purchaser will cause any proposed purchaser,assignee, transferee, or pledgee of the Note or the Conversion Stock held bysuch Purchaser to agree to take and hold such securities subject to theprovisions and upon the conditions specified in this Section 8. 8.2 Lock Up Agreement. For the period commencing on the Closing Date -----------------and ending fifteen (15) months following the Closing Date (the "Lock UpPeriod"), Purchaser will not, without the prior written consent of the Company,(which consent may be withheld in its sole discretion), directly or indirectly,issue, sell, offer or agree to sell, grant any option for the sale of, pledge,make any short sale or maintain any short position, establish or maintain a "putequivalent position" (within the meaning of Rule 16-a-1(h) under 14 the Securities Exchange Act of 1934, as amended), enter into any swap,derivative transaction or other arrangement that transfers to another, in wholeor in part, any of the economic consequences of ownership of the Note or theConversion Stock; provided, however, that in the event the Company has notconsummated an initial public offering of its Common Stock prior to nine (9) months following the Closing Date, the Lock Up Period shall be extended suchthat the Lock Up Period extends to a date that is 180 days following the date ofthe Company's final prospectus delivered in connection with its initial publicoffering. Notwithstanding the foregoing, Purchaser may transfer the Note or theConversion Stock, subject to applicable securities laws, to any entity directlyor indirectly controlling or controlled by or under common control with, thePurchaser. 8.3 Restrictive Legend. Each certificate or instrument representing ------------------(i) the Note, (ii) the Conversion Stock, and (iii) any other securities issuedin respect of the Note or the Conversion Stock upon a stock split, stockdividend, stock exchange or similar event (collectively the "RestrictedSecurities"), shall (unless otherwise permitted by the provisions of Rule 144)be stamped or otherwise imprinted with a legend in the following form (inaddition to any legend required under applicable state securities laws): "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR INVESTMENT AND NOT WITH A VIEW TO, OR IN CONNECTION WITH, THE SALE OR DISTRIBUTION THEREOF. NO SUCH SALE OR DISPOSITION MAY BE EFFECTED WITHOUT AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO OR AN OPINION OF COUNSEL REASONABLY SATISFACTORY TO THE CORPORATION THAT SUCH REGISTRATION IS NOT REQUIRED UNDER THE SECURITIES ACT OF 1933, AS AMENDED. THESE SECURITIES HAVE NOT BEEN REGISTERED WITH THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR THE SECURITIES COMMISSION OF ANY STATE UNDER ANY STATE SECURITIES LAW. THEY ARE BEING OFFERED PURSUANT TO A SAFE HARBOR FROM REGISTRATION UNDER REGULATION S ("REGULATION S") PROMULGATED UNDER THE ACT. THE SECURITIES MAY NOT BE OFFERED, SOLD OR OTHERWISE TRANSFERRED IN THE UNITED STATES OR TO U. S. PERSONS (AS SUCH TERM IS DEFINED IN REGULATION S) UNLESS THE SECURITIES ARE REGISTERED UNDER THE ACT AND APPLICABLE STATE SECURITIES LAWS, OR SUCH OFFERS, SALES AND TRANSFERS ARE MADE PURSUANT TO AN AVAILABLE EXEMPTION OR SAFE HARBOR FORM THE REGISTRATION REQUIREMENTS OF THOSE LAWS. THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO CERTAIN RESTRICTIONS ON TRANSFER AND CERTAIN MARKET STAND-OFF PROVISIONS WHICH ARE CONTAINED IN A SUBORDINATED CONVERTIBLE NOTE PURCHASE AGREEMENT, DATED AS OF JANUARY 25, 2000, COPIES 15 OF WHICH ARE ON FILE AT THE PRINCIPAL OFFICE OF THE CORPORATION." Purchaser consents to the Company making a notation on its records andgiving instructions to any transfer agent of the Note or the Conversion Stock inorder to implement the restrictions on transfer established in this Section 8. 8.4 Notice of Proposed Transfers. The holder of each certificate ----------------------------representing Restricted Securities by acceptance thereof agrees to comply in allrespects with the provisions of this Section 8.3. Prior to any proposed sale,assignment, transfer or pledge of any Restricted Securities (other than atransfer not involving a change in beneficial ownership), the holder thereofshall give written notice to the Company of such Purchaser's intention to effectsuch transfer, sale, assignment or pledge. Each such notice shall describe themanner and circumstances of the proposed transfer, sale, assignment or pledge insufficient detail, and shall be accompanied, at such holder's expense, by either(i) a written opinion of legal counsel, who shall be and whose legal opinionshall be reasonably satisfactory to the Company, addressed to the Company, tothe effect that the proposed transfer of the Restricted Securities may beeffected without registration under the Securities Act or (ii) a "no action"letter from the Commission to the effect that the transfer of such securitieswithout registration will not result in a recommendation by the staff of theCommission that action be taken with respect thereto, whereupon the holder ofsuch Restricted Securities shall be entitled to transfer such RestrictedSecurities in accordance with the terms of the notice delivered by the holder tothe Company. Each certificate evidencing the Restricted Securities transferredas above provided shall bear, except if such transfer is made pursuant to Rule144, the appropriate restrictive legend set forth in Section 8.2 above, exceptthat such certificate shall not bear such restrictive legend if in the opinion of counsel for such holder and the Company such legend is not required in orderto establish compliance with any provision of the Securities Act. Section 9. MISCELLANEOUS 9.1 Governing Law. This Agreement shall be governed and construed in -------------all respects in accordance with the laws of the State of California so appliedto agreements made and performed in California by residents of the State ofCalifornia. 9.2 Survival. The representations, warranties, covenants and --------agreements made herein shall survive any investigation made by the Purchaser andthe closing of the transactions contemplated hereby for a period of two (2)years. 9.3 Successors and Assigns. Except as otherwise expressly provided ----------------------herein, all covenants and agreements contained in this Agreement by or on behalfof any of the parties hereto will bind and inure to the benefit of therespective successors and assigns of such parties whether so expressed or not.In addition, and whether or not any express assignment has been made, theprovisions of this Agreement which are for the Purchaser's benefit as thepurchaser or holder of Note or the Conversion Stock are also for the benefit ofand enforceable by any subsequent holder of Note or the Conversion Stock. 16 9.4 Entire Agreement; Amendment. This Agreement and the other ---------------------------documents delivered pursuant hereto at the Closing constitute the full andentire understanding and agreement between the parties with regard to thesubjects hereof and thereof, and no party shall be liable or bound to any otherparty in any manner by any warranties, representations or covenants except asspecifically set forth herein or therein. Except as expressly provided herein,neither this Agreement nor any term hereof may be amended, waived, discharged orterminated other than by a written instrument signed by the party against whomenforcement of any such amendment, waiver, discharge or termination is sought. 9.5 Notices, etc. All notices and other communications required or ------------permitted hereunder shall be in writing, including facsimile, or electroniccommunications and shall be effective upon receipt. 9.6 Delays or Omissions. Except as expressly provided herein, no -------------------delay or omission to exercise any right, power or remedy accruing to any holderof any Note, upon any breach or default of the Company under this Agreement,shall impair any such right, power or remedy of such holder nor shall it beconstrued to be a waiver of any such breach or default, or an acquiescencetherein, or of or in any similar breach or default thereafter occurring; norshall any waiver of any single breach or default be deemed a waiver of any otherbreach or default theretofore or thereafter occurring. Any waiver, permit,consent or approval of any kind or character on the part of any holder of anybreach or default under this Agreement, or any waiver on the part of any holderof any provisions or conditions of this Agreement, must be in writing and shallbe effective only to the extent specifically set forth in such writing. Allremedies, either under this Agreement or by law or otherwise afforded to anyholder, shall be cumulative and not alternative. 9.7 Remedies. Purchaser will have all of the rights and remedies set --------forth in this Agreement, the Investor Rights Agreement and the Certificate ofIncorporation, as the case may be, and all of the rights and remedies whichPurchaser may have under any law. The Purchaser, having any rights under anyprovision of this Agreement or the Investor Rights Agreement, will be entitledto enforce such rights specifically, to recover damages by reason of any breachof any provision of this Agreement or the Investor Rights Agreement and toexercise all other rights granted by law. 9.8 Severability. If any provision of this Agreement becomes or is ------------ declared by a court of competent jurisdiction to be illegal, invalid,unenforceable or void, this Agreement shall continue in full force and effectwithout said provision. In such event, the parties shall negotiate, in goodfaith, a legal, valid and enforceable substitute provision which most nearlyeffects the intent of the parties in entering into this Agreement. 9.9 Expenses. The Company shall pay all of Purchaser's expenses in --------connection with the transactions contemplated hereby, provided that the Closingand the Company's initial public offering of Common Stock registered under theSecurities Act have occurred, including the fees and disbursements of thePurchaser's counsel, Baker & McKenzie. Total expenses shall not exceed theamount of $25,000 in the aggregate. 17 Dated this 25th of January 2000 Dated this 25th of January 2000At Anaheim, California At Stuttgart, GermanyITERIS, INC. DAIMLERCHRYSLER VENTURE GMBHBy: /S/ Jack Johnson By: /s/ Dr. Marianne Tumpen ---------------- ----------------------- Jack Johnson, Dr. Marianne Tumpen, President Managing Director 18 EXHIBIT 10.32 "THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE BEEN ACQUIRED FOR INVESTMENT AND NOT WITH A VIEW TO, OR IN CONNECTION WITH, THE SALE OR DISTRIBUTION THEREOF. NO SUCH SALE OR DISPOSITION MAY BE EFFECTED WITHOUT AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO OR AN OPINION OF COUNSEL REASONABLY SATISFACTORY TO THE CORPORATION THAT SUCH REGISTRATION IS NOT REQUIRED UNDER THE SECURITIES ACT OF 1933, AS AMENDED. THESE SECURITIES HAVE NOT BEEN REGISTERED WITH THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), OR THE SECURITIES COMMISSION OF ANY STATE UNDER ANY STATE SECURITIES LAW. THEY ARE BEING OFFERED PURSUANT TO A SAFE HARBOR FROM REGISTRATION UNDER REGULATION S ("REGULATION S") PROMULGATED UNDER THE ACT. THE SECURITIES MAY NOT BE OFFERED, SOLD OR OTHERWISE TRANSFERRED IN THE UNITED STATES OR TO U. S. PERSONS (AS SUCH TERM IS DEFINED IN REGULATION S) UNLESS THE SECURITIES ARE REGISTERED UNDER THE ACT AND APPLICABLE STATE SECURITIES LAWS, OR SUCH OFFERS, SALES AND TRANSFERS ARE MADE PURSUANT TO AN AVAILABLE EXEMPTION OR SAFE HARBOR FORM THE REGISTRATION REQUIREMENTS OF THOSE LAWS. THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO CERTAIN RESTRICTIONS ON TRANSFER AND CERTAIN MARKET STAND-OFF PROVISIONS WHICH ARE CONTAINED IN A SUBORDINATED CONVERTIBLE NOTE PURCHASE AGREEMENT, DATED AS OF JANUARY 25, 2000, COPIES OF WHICH ARE ON FILE AT THE PRINCIPAL OFFICE OF THE CORPORATION." ITERIS, INC. Subordinated Convertible Promissory Note$3,750,000 January 25, 2000 Anaheim, California FOR VALUE RECEIVED, Iteris, Inc., a Delaware corporation ("Company"),promises to pay to DaimlerChrysler Venture GmbH ("Holder"), or its registeredassigns, the principal sum of Three Million Seven Hundred and Fifty ThousandDollars ($3,750,000.00), or such lesser amount as shall equal the outstandingprincipal amount hereof, together with interest from the date of thissubordinated convertible promissory note ("Note") on the unpaid principalbalance calculated in accordance with Section 2 hereof. All unpaid principal, --------- together with any then unpaid and accrued interest and other amounts payablehereunder, shall be due and payable on the earlier of (i) the second anniversary of the date of this Note, or (ii)when, upon or after the occurrence of an Event of Default (as defined below),such amounts are declared due and payable by Holder. This Note is issuedpursuant to the Note Purchase Agreement (as defined below). 1. Definitions. As used in this Note, the following capitalized terms ----------- have the following meanings: (a) "Affiliate," with respect to any Person, means (i) any director,officer or employee of such Person, (ii) any Person directly or indirectlycontrolling or controlled by or under direct or indirect common control withsuch Person, and (iii) any Person beneficially owning or holding 10% or more ofany class of voting securities of such Person or any corporation of which suchPerson beneficially owns or holds, in the aggregate, 10% or more of any class ofvoting securities The term "control" means the possession, directly orindirectly, of the power to direct or cause the direction of the management andpolicies of a Person, whether through the ownership of voting securities, bycontract or otherwise. The term "Affiliate," when used herein without referenceto any Person, shall mean an Affiliate of Company. (b) "Company" includes the corporation initially executing this Noteand any Person which shall succeed to or assume the obligations of Company under this Note. (c) "Certificate" shall mean the Certificate of Incorporation ofCompany as amended and/or restated and effective immediately prior to theredemption or conversion of all of this Note. (d) "Equity Securities" of any Person shall mean (a) all commonstock, preferred stock, participations, shares, partnership interests or otherequity interests in and of such Person (regardless of how designated and whetheror not voting or non-voting) and (b) all warrants, options and other rights toacquire any of the foregoing. (e) "Event of Default" has the meaning given in Section 5 hereof. --------- (f) "GAAP" shall mean generally accepted accounting principles as ineffect in the United States of America from time to time. (g) "Holder" shall mean the Person specified in the introductoryparagraph of this Note or any Person who shall at the time be the registeredholder of this Note. (h) "Indebtedness" shall mean and include the aggregate amount of,without duplication (i) all obligations for borrowed money, (ii) all obligationsevidenced by bonds, debentures, notes or other similar instruments, (iii) allobligations to pay the deferred purchase price of property or services (otherthan accounts payable incurred in the ordinary course of business determined inaccordance with GAAP), (iv) all obligations with respect to capital leases, (v)all obligations created or arising under any conditional sale or other titleretention agreement with respect to property acquired by such Person, (vi) allreimbursement and other payment obligations, contingent or otherwise, in respectof letters of credit and similar surety instruments; and (vii) all guarantyobligations with respect to the types of Indebtedness listed in clauses (i)through (vi) above. (i) [Intentionally Omitted] 2 (j) "Material Adverse Effect" shall mean a material adverse effect on(a) the business, assets, operations, or financial condition of Company; or (b)the ability of Company to pay or perform the Obligations in accordance with theterms of this Note and the other Transaction Documents and to avoid an Event ofDefault, or an event which, with the giving of notice or the passage of time orboth, would constitute an Event of Default, under any Transaction Document. (k) "Note Purchase Agreement" shall mean the Note Purchase Agreementdated January 25, 2000 between Company and the Holder (as amended, modified orsupplemented from time to time). (l) "Obligations" shall mean and include all loans, advances, debts,liabilities and financial obligations, howsoever arising, owed by Company toHolder of every kind and description (whether or not evidenced by any note orinstrument and whether or not for the payment of money), now existing orhereafter arising under or pursuant to the terms of the Transaction Documents,including, all interest, fees, charges, expenses, attorneys' fees and costs andaccountants' fees and costs chargeable to and payable by Company hereunder andthereunder, in each case, whether direct or indirect, absolute or contingent,due or to become due, and whether or not arising after the commencement of aproceeding under Title 11 of the United States Code (11 U. S. C. Section 101 et -- seq.), as amended from time to time (including post-petition interest) and---whether or not allowed or allowable as a claim in any such proceeding. (m) "Person" shall mean and include an individual, a partnership, acorporation (including a business trust), a joint stock company, a limitedliability company, an unincorporated association, a joint venture or otherentity or a governmental authority. (n) "Senior Indebtedness" shall mean, unless expressly subordinatedto or made on a parity with the amounts due under this Note, the principal of(and premium, if any), unpaid interest on and amounts reimbursable, fees,expenses, costs of enforcement and other amounts due in connection with, (i) indebtedness of Company, to banks, commercial finance lenders, insurancecompanies, leasing or equipment financing institutions or other lendinginstitutions regularly engaged in the business of lending money (excluding debtthat is convertible or exercisable into equity through venture capital,investment banking or similar institutions which sometimes engage in lendingactivities but which are primarily engaged in investments in equity securities),which is for money borrowed, or purchase or leasing of equipment in the case oflease or other equipment financing, whether or not secured, and (ii) any suchindebtedness or any debentures, notes or other evidence of indebtedness issuedin exchange for such Senior Indebtedness, or any indebtedness arising from thesatisfaction of such Senior Indebtedness by a guarantor. (o) "Subsidiary" shall mean (a) any corporation of which more than50% of the issued and outstanding equity securities having ordinary voting powerto elect a majority of the Board of Directors of such corporation is at the timedirectly or indirectly owned or controlled by Company, (b) any partnership,joint venture, or other association of which more than 50% of the equityinterest having the power to vote, direct or control the management of suchpartnership, joint venture or other association is at the time directly orindirectly owned and controlled by Company, (c) any other entity included in thefinancial statements of Company on a consolidated basis. (p) "Transaction Documents" shall mean this Note and the NotePurchase Agreement and any other documents that may be exchanged between Companyand Holder in connection with the issuance of the Note. 3 2. Interest. The interest rate to be applied to the unpaid principal -------- balance of this Note shall be eight percent per annum. The interest rate on thisNote shall be increased in accordance with Section 15 upon the occurrence of anEvent of Default. In the event this Note is automatically converted into CommonStock in accordance with Section 8(b), all interest accrued under this Noteshall be forgiven and Holder shall not be entitled to receive interest in cashor in the form of Common Stock upon such conversion. 3. Prepayment. Upon fifteen days prior written notice to Holder, Company ---------- may prepay this Note in whole or in part, unless Holder elects to convert theNote in accordance with Section 8(a) of this Note; provided that any suchprepayment will be applied first to the payment of expenses due under this Note,second to interest accrued on this Note and third, if the amount of prepaymentexceeds the amount of all such expenses and accrued interest, to the payment ofprincipal of this Note. 4. Certain Covenants. While any amount is outstanding under the Note, ----------------- without the prior written consent of Holder: (a) Dividends, Redemptions, Etc. Neither Company nor any of itsSubsidiaries shall (i) pay any dividends or make any distributions on its EquitySecurities; (ii) purchase, redeem, retire, defease or otherwise acquire forvalue any of its equity securities, other than the repurchase of shares ofcommon stock under option agreements or restricted stock purchase agreementswith employees, directors or consultants; (iii) return any capital to any holderof its equity securities; (iv) make any distribution of assets, EquitySecurities, obligations or securities to any holder of its Equity Securities; or(v) set apart any sum for any such purpose; provided, however, that anySubsidiary may pay cash dividends to Company. (b) Indebtedness Payments. Neither Company nor any of itsSubsidiaries shall as to any Indebtedness which is not Senior Indebtedness (i)prepay, redeem, purchase, defease or otherwise satisfy in any manner prior tothe scheduled repayment thereof any Indebtedness for borrowed money (other thanamounts due under this Note or the other Notes issued under the Note PurchaseAgreement) or lease obligations, (ii) amend, modify or otherwise change theterms of any Indebtedness for borrowed money (other than the Obligations) orlease obligations so as to accelerate the scheduled repayment thereof or (iii)repay any principal or interest on any notes to officers, directors orshareholders, including, without limitation, obligations to Odetics, Inc. (c) Affiliate Transactions. Neither Company nor any of itsSubsidiaries shall enter into any contractual obligation with any Affiliate or engage in any other transaction with any Affiliate except upon terms at least asfavorable to Company or such Subsidiary as an arms-length transaction withunaffiliated Persons. Holder acknowledges and agrees that the Separation andDistribution Agreement and the agreements contemplated thereby are on terms atleast as favorable to the Company as arms-length transactions with unaffiliatedPersons. 5. Events of Default. The occurrence of any of the following shall ----------------- constitute an "Event of Default" under this Note and the other TransactionDocuments. Promptly upon the occurrence thereof, the Company shall provideHolder with written notice of the occurrence of any Event of Default hereunderor any event of default with respect to any Senior Indebtedness. (a) Failure to Pay. Company shall fail to pay (i) when due anyprincipal payment on the due date hereunder or (ii) any interest or otherpayment required under the terms of 4 this Note or any other Transaction Document on the date due and such paymentshall not have been made within five (5) days of Company's receipt of Holder'swritten notice to Company of such failure to pay; or (b) Other Payment Obligations. Company or any of its Subsidiariesshall (i) fail to make any payment when due under the terms of any bond,debenture, note or other evidence of Indebtedness, including the SeniorIndebtedness, to be paid by such Person (excluding this Note and the otherTransaction Documents but including any other evidence of Indebtedness ofCompany or any of its Subsidiaries to Holder) and such failure shall continuebeyond any period of grace provided with respect thereto or thirty (30) days,whichever is longer, or (ii) default in the observance or performance of anyother agreement, term or condition contained in any such bond, debenture, noteor other evidence of Indebtedness, and the effect of such failure or default isto cause, or permit the holder or holders thereof to cause, Indebtedness in anaggregate amount of One Hundred Thousand Dollars ($100,000) or more to becomedue prior to its stated date of maturity; or (c) Voluntary Bankruptcy or Insolvency Proceedings. Company or any ofits Subsidiaries shall (i) apply for or consent to the appointment of areceiver, trustee, liquidator or custodian of itself or of all or a substantialpart of its property, (ii) be unable, or admit in writing its inability, to payits debts generally as they mature, (iii) make a general assignment for thebenefit of its or any of its creditors, (iv) be dissolved or liquidated, (v)become insolvent (as such term may be defined or interpreted under anyapplicable statute), (vi) commence a voluntary case or other proceeding seekingliquidation, reorganization or other relief with respect to itself or its debtsunder any bankruptcy, insolvency or other similar law now or hereafter in effector consent to any such relief or to the appointment of or taking possession ofits property by any official in an involuntary case or other proceedingcommenced against it, or (vii) take any action for the purpose of effecting anyof the foregoing; or (d) Involuntary Bankruptcy or Insolvency Proceedings. Proceedings forthe appointment of a receiver, trustee, liquidator or custodian of Company orany of its Subsidiaries or of all or a substantial part of the property thereof,or an involuntary case or other proceedings seeking liquidation, reorganizationor other relief with respect to Company or any of its Subsidiaries or the debtsthereof under any bankruptcy, insolvency or other similar law now or hereafterin effect shall be commenced and an order for relief entered or such proceedingshall not be dismissed or discharged within thirty (30) days of commencement; or (e) Judgments. A final judgment or order for the payment of money inexcess of One Hundred Thousand Dollars ($100,000) (exclusive of amounts coveredby insurance issued by an insurer not an Affiliate of Company) shall be renderedagainst Company or any of its Subsidiaries and the same shall remainundischarged for a period of thirty (30) days during which execution shall notbe effectively stayed, or any judgment, writ, assessment, warrant of attachment,or execution or similar process shall be issued or levied against a substantialpart of the property of Company or any of its Subsidiaries and such judgment,writ, or similar process shall not be released, stayed, vacated or otherwisedismissed within thirty (30) days after issue or levy. 6. Rights of Holder upon Default. Upon the occurrence or existence of any ----------------------------- Event of Default (other than an Event of Default referred to in Sections 5(c) -------------and 5(d)) and at any time thereafter during the continuance of such Event of-------- Default, Holder may, by written notice to Company, declare all outstandingObligations payable by Company hereunder to be immediately due and payablewithout presentment, demand, protest or any other notice of any kind, all ofwhich are 5 hereby expressly waived, anything contained herein or in the other TransactionDocuments to the contrary notwithstanding. In addition to the foregoingremedies, upon the occurrence or existence of any Event of Default, Holder mayexercise any other right power or remedy granted to it by the TransactionDocuments or otherwise permitted to it by law, either by suit in equity or byaction at law, or both. 7. Subordination. The indebtedness evidenced by this Note is hereby ------------- expressly subordinated, to the extent and in the manner hereinafter set forth,in right of payment to the prior payment in full of all of Company's SeniorIndebtedness. (a) Insolvency Proceedings. If there shall occur any receivership,insolvency, assignment for the benefit of creditors, bankruptcy, reorganization,or arrangements with creditors (whether or not pursuant to bankruptcy or otherinsolvency laws), sale of all or substantially all of the assets, dissolution,liquidation, or any other marshaling of the assets and liabilities of Company,(i) no amount shall be paid by Company in respect of the principal of, intereston or other amounts due with respect to this Note at the time outstanding,unless and until the principal of and interest on the Senior Indebtedness thenoutstanding shall be paid in full, and (ii) no claim or proof of claim shall befiled with Company by or on behalf of Holder of this Note which shall assert anyright to receive any payments in respect of the principal of and interest onthis Note except subject to the payment in full of the principal of and intereston all of the Senior Indebtedness then outstanding. (b) Default on Senior Indebtedness. If there shall occur an event ofdefault which has been declared in writing with respect to any SeniorIndebtedness, as defined therein, or in the instrument under which it isoutstanding, permitting the holder to accelerate the maturity thereof and Holdershall have received written notice thereof from the holder of such SeniorIndebtedness, then, unless and until such event of default shall have been curedor waived or shall have ceased to exist, or all Senior Indebtedness shall havebeen paid in full, no payment shall be made in respect of the principal of orinterest on this Note, unless within one hundred eighty (180) days after thehappening of such event of default, the maturity of such Senior Indebtednessshall not have been accelerated. Not more than one notice may be given to Holderpursuant to the terms of this Section 7(b) during any 360 day period. ------------ (c) Further Assurances. By acceptance of this Note, Holder agrees toexecute and deliver customary forms of subordination agreements requested fromtime to time by holders of Senior Indebtedness, and as a condition to Holder'srights hereunder, Company may require that Holder execute such forms ofsubordination agreements; provided that such forms shall not impose on Holderterms less favorable than those provided herein. (d) Other Indebtedness. No indebtedness which does not constituteSenior Indebtedness shall be senior in any respect to the indebtednessrepresented by this Note. (e) Subrogation. Subject to the payment in full of all SeniorIndebtedness, Holder shall be subrogated to the rights of the holder(s) of suchSenior Indebtedness (to the extent of the payments or distributions made to theholder(s) of such Senior Indebtedness pursuant to the provisions of this Section -------7) to receive payments and distributions of assets of Company applicable to the-Senior Indebtedness. No such payments or distributions applicable to the SeniorIndebtedness shall, as between Company and its creditors, other than the holdersof Senior Indebtedness and Holder, be deemed to be a payment by Company to or on account of this Note; and for purposes of such subrogation, no payments ordistributions to the holders of Senior Indebtedness to which Holder 6 would be entitled except for the provisions of this Section 7 shall, as betweenCompany and its creditors, other than the holders of Senior Indebtedness andHolder, be deemed to be a payment by Company to or on account of the SeniorIndebtedness. (f) No Impairment. Subject to the rights, if any, of the holders ofSenior Indebtedness under this Section 7 to receive cash, securities or otherproperties otherwise payable or deliverable to Holder, nothing contained in thisSection 7 shall impair, as between Company and Holder, the obligation ofCompany, subject to the terms and conditions hereof, to pay to Holder theprincipal hereof and interest hereon as and when the same become due andpayable, or shall prevent Holder, upon default hereunder, from exercising allrights, powers and remedies otherwise provided herein or by applicable law. (g) Reliance of Holders of Senior Indebtedness. Holder, by itsacceptance hereof, shall be deemed to acknowledge and agree that the foregoingsubordination provisions are, and are intended to be, an inducement to and aconsideration of each holder of Senior Indebtedness, whether such SeniorIndebtedness was created or acquired before or after the creation of theindebtedness evidenced by this Note, and each such holder of Senior Indebtednessshall be deemed conclusively to have relied on such subordination provisions inacquiring and holding, or in continuing to hold, such Senior Indebtedness. 8. Conversion. ---------- (a) Voluntary Conversion. Holder has the right, at Holder's option,at any time prior to payment in full of this Note or conversion pursuant toSection 8(b) below, to convert the Note at the office of the Company or anytransfer agent for the shares of Common Stock, into the number of shares ofCommon Stock which is equal to the quotient obtained by dividing (A) the entireunpaid amount of this Note, together with all accrued but unpaid interest andother fees due under the Note, by (B) the Note Conversion Price. For purposes ofthis Section 8(a), the "Note Conversion Price" shall be the fair market value ofthe Common Stock at the time of conversion multiplied by .75. The fair marketvalue of the Common Stock at the time of conversion shall be determined bymutual agreement of the Holder and the Company, and if no such agreement can bereached in good faith, by Bear, Stearns & Co., Inc. If the fair market value isdetermined by Bear, Stearns & Co. Inc., the Holder and the Company shall sharethe burden of expenses incurred in making such determination equally. (b) Automatic Conversion. The entire unpaid principal amount of thisNote, shall be automatically converted into Common Stock (subject to subsection(c), below), immediately prior to (i) any consolidation or merger of Companywith or into any Person, any corporate reorganizations in which the Companyshall not be the continuing or surviving entity of such consolidation, merger orreorganization and in which the holders of the outstanding voting capital stockof the Company immediately prior to such consolidation, merger or reorganizationhold less than 50% of the outstanding voting capital stock of the survivingcompany immediately following such transaction, any transaction or series ofrelated transactions by Company in which in excess of 50% of Company's votingpower is transferred or a sale of all or substantially all of the assets ofCompany (each, a "Sale Transaction"); or (ii) the closing of a firmlyunderwritten public offering pursuant to a registration statement filed byCompany under the Securities Act of 1933, as amended (the "Act"), with aggregategross proceeds in excess of $20 million and at a price of not less than $10.00per share of Common Stock (as presently constituted, subject to proportionateadjustment in the event of any stock split, stock dividend, reverse stock split,combination, consolidation, reclassification or 7 similar event) (a "Qualified Public Offering"). The number of shares into whichthis Note shall be converted in the event of an automatic conversion pursuant tothis Section 8(b) shall be equal to the product of (A) .025 multiplied by (B)the number of issued and outstanding shares of Common Stock of the Company atthe time of conversion, including shares of Common Stock issued upon conversionof this Note and shares issued in a Qualified Public Offering, plus the number of shares of Common Stock purchasable pursuant to outstanding options topurchase Common Stock that are vested at the time of conversion. (c) Adjustments for Valuation. In the event the Acquisition Value ofthe Company is less than $200 million, Holder shall elect at the time ofconversion to either (1) receive a cash payment, representing a return ofprincipal, equal to an amount calculated under the following formula (the "CashPayment"): Outstanding principal amount under this Note - [.75 * (AcquisitionValue * .025)]; or(2) receive such number of additional shares of Common Stock equal to the numberof shares calculated under the following formula: Cash Payment ------------ Per Share Value * $.75In the event the Acquisition Value of the Company is more than $200 million,Holder shall either (1) pay an additional amount of cash to the Company on thedate of conversion equal to an amount calculated under the following formula(the "Additional Payment"): [.75 * (Acquisition Value * .025)] - Outstanding principal amountunder this Note; or(2) reduce the number of shares otherwise issuable under 8(b) by such number ofshares equal to the number of shares calculated under the following formula: Additional Payment ------------------ Per Share Value * $.75 For purposes of this Section 8, the following terms shall have the meaningsset forth below: "Acquisition Value" means (a) in the event of a Qualified Public Offering,the Total Market Capitalization of the Company plus the aggregate exercise priceof all options outstanding and that are vested on the date of conversion, and(b) in the event of a Sale Transaction, the aggregate consideration being paid,assuming the purchase of 100% of the capital stock or assets of the Company,less liabilities not assumed in the Sale Transaction, and plus the aggregateexercise price of all options outstanding and that are vested on the date ofconversion. "Per Share Value" means, in the event of a Qualified Public Offering, theinitial public offering price, and in the event of a Sale Transaction, theAcquisition Value divided by the total number of shares of Common Stockoutstanding after giving effect to this conversion and including the totalnumber of shares issuable pursuant to options to purchase Common Stock of theCompany that are vested at the time of conversion. 8 (d) Adjustment for Stock Splits and Combinations. If the Company atany time or from time to time after the date of this Note (the "Effective Date")effects a division of the outstanding shares of Common Stock, then the NoteConversion Price shall be proportionately decreased and, conversely, if thisCompany at any time, or from time to time, after the Effective Date combines theoutstanding shares of Common Stock, then the Note Conversion Price shall beproportionately increased. Any adjustment under this Section 8(d) shall be ------------ effective on the close of business on the date such division or combinationbecomes effective. (e) Adjustment for Certain Dividends and Distributions. If theCompany at any time or from time to time after the Effective Date pays or fixesa record date for the determination of holders of shares of Common Stockentitled to receive a dividend or other distribution in the form of shares ofCommon Stock, or rights or options for the purchase of, or securitiesconvertible into, Common Stock, then in each such event the Note ConversionPrice shall be decreased, as of the time of such payment or, in the event arecord date is fixed, as of the close of business of such record date, by multiplying the Note Conversion Price by a fraction (i) the numerator of whichshall be the total number of shares of Common Stock outstanding immediatelyprior to the time of such payment or the close of business on such record date,as the case may be, and (ii) the denominator of which shall be the sum of (A) ---------- the total number of shares of Common Stock outstanding immediately prior to thetime of such payment or the close of business on such record date, as the casemay be, plus (B) the number of shares of Common Stock issuable in payment of ---- such dividend or distribution or upon exercise of such option or right ofconversion; provided, however, that if a record date is fixed and such dividendis not fully paid or such other distribution is not fully made on the date fixedtherefor, then the Note Conversion Price shall not be decreased as of the closeof business on such record date as hereinabove provided as to the portion notfully paid or distributed and thereafter the Note Conversion Price shall bedecreased pursuant to this Section 8(e) as of the date or dates of actual ------------payment of such dividend or distribution. (f) Adjustments for Other Dividends and Distributions. If the Companyat any time or from time to time after the Effective Date pays, or fixes arecord date for the determination of holders of shares of Common Stock entitledto receive, a dividend or other distribution in the form of securities of theCompany other than shares of Common Stock or rights or options for the purchaseof, or securities convertible into, Common Stock, then in each such eventprovision shall be made so that the Holder shall receive upon conversionthereof, in addition to the number of shares of Common Stock receivablethereupon, the amount of securities of the Company which they would havereceived had the Note been converted into shares of Common Stock on the date oneday before such event (adjusted to account for any additional accrued by unpaidinterest and other fees due under the Note) and had Holder thereafter, from thedate of such event to and including the actual date of conversion of theirshares, retained such securities, subject to all other adjustments called forduring such period under this Section 8 with respect to the rights of the --------- Holder. (g) Adjustment for Reclassification, Exchange and Substitution. If atany time or from time to time after the Effective Date the number of shares ofCommon Stock issuable upon conversion of the Note, is changed into the same or adifferent number of shares of any other class or classes of stock or othersecurities, whether by recapitalization, reclassification or otherwise (otherthan a recapitalization, division or combination of shares or a stock dividend,or a reorganization, merger, consolidation or sale of assets provided forelsewhere in this Section 8), then in any such event the Holder shall have theright thereafter to convert the Note into the same kind and amount of stock andother securities receivable upon such recapitalization, reclassification orother change, as the maximum number of shares of Common Stock into which theNote, could have been converted 9 immediately prior to such recapitalization (adjusted to account for anyadditional accrued but unpaid interest and other fees due under the Note),reclassification or change, all subject to further adjustment as providedherein. (h) Reorganizations, Mergers, Consolidations or Sales of Assets. Ifat any time or from time to time after the Effective Date there is a capitalreorganization of the Common Stock (other than a recapitalization, division,combination, reclassification or exchange of shares provided for elsewhere inthis Section 8) or a merger or consolidation of this Company into or withanother corporation (except as provided for in section 8(b)), then, as a part ofsuch capital reorganization, merger or consolidation, provision shall be made sothat the Holder shall thereafter receive upon conversion thereof the number ofshares of stock or other securities or property of this Company, or of thesuccessor corporation resulting from such merger or consolidation or sale, towhich a holder of the number of shares of Common Stock into which the Note wouldhave been entitled on such capital reorganization, merger, consolidation or sale(adjusted to account for any additional accrued but unpaid interest and otherfees due under the Note). In any such case, appropriate adjustment shall be madein the application of the provisions of this Section 8 with respect to the --------- rights of the Holder after such capital reorganization, merger, consolidation, or sale. The provisions of this Section 8 (including adjustment of the Note --------- Conversion Price and the number of shares into which the Note may be converted)shall be applicable after that event and be as nearly equivalent to suchConversion Prices and number of shares as may be practicable. (i) Conversion Procedure. (i) Conversion Pursuant to Section 8(a). Before Holder shall be ----------------------------------- entitled to convert this Note into Common Stock, it shall surrender this Note, duly endorsed, at the office of Company and shall give written notice by registered or certified mail, postage prepaid, to Company at its principal corporate office, of the election to convert the same pursuant to Section 8(a), and shall state therein the name or names in which the ------------ certificate or certificates for the Common Stock are to be issued. Company shall, as soon as practicable thereafter, issue and deliver at such office to Holder of this Note a certificate or certificates for the Common Stock to which Holder shall be entitled upon conversion (bearing such legends as are required by the Note Purchase Agreement and applicable state and federal securities laws in the opinion of counsel to Company), and any other securities and property to which Holder is entitled upon such conversion under the terms of this Note. The conversion shall be deemed to have been made immediately prior to the close of business on the date of the surrender of this Note, and the Person or Persons entitled to receive the Common Stock upon such conversion shall be treated for all purposes as the record holder or holders of such shares of Common Stock as of such date. (ii) Conversion Pursuant to Section 8(b). If this Note is ----------------------------------- automatically converted, written notice shall be delivered to Holder at the address last shown on the records of Company for Holder or given by Holder to Company for the purpose of notice or, if no such address appears or is given, at the place where the principal executive office of Company is located, notifying Holder of the conversion to be effected, the amount and kind of Common Stock to be issued upon conversion, the date on which such conversion is expected to occur and calling upon such Holder to surrender to Company, in the manner and at the place designated, the Note. Upon such conversion of this Note, Holder shall surrender this Note, duly endorsed, at the principal office of Company. At its expense, Company shall, as soon as practicable thereafter, issue and deliver to such Holder at such principal office a 10 certificate or certificates for the Common Stock to which Holder shall be entitled upon such conversion (bearing such legends as are required by the Note Purchase Agreement and applicable state and federal securities laws in the opinion of counsel to Company), together with any other securities and property to which Holder is entitled upon such conversion under the terms of this Note. Any conversion of this Note pursuant to Section 8(b) shall be ------------ deemed to have been made immediately prior to the closing of the issuance and sale of Common Stock as described in Section 8(b) and on and after such date the Persons entitled to receive the Common Stock issuable upon such conversion shall be treated for all purposes as the record Holder of such Common Stock and a purchaser of such Common Stock under the Note Purchase Agreement and shall be bound by the terms of the Note Purchase Agreement. (j) Fractional Shares; Effect of Conversion. The Company may, butshall not be obligated to, issue any fractional shares upon conversion of thisNote. In the event that Company elects not to issue fractional shares, Companyshall round the number of shares to the nearest whole share of each type ofCommon Stock, provided that if such rounding would result in holder receivingless than 99.9% of the amount of such Common Stock to which he is entitled,pursuant to this Section 8, such fraction shall be rounded up to the next whole --------- share of Common Stock. (k) Reservation of Stock Issuable Upon Conversion. The Company shallat all times reserve and keep available out of its authorized but unissuedshares of Common Stock, solely for the purpose of effecting the conversion of this Note, such number of shares of Common Stock as shall from time to time besufficient to effect the conversion of the Note. 9. Successors and Assigns. Subject to the restrictions on transfer ---------------------- described in the Note Purchase Agreement, the rights and obligations of Companyand Holder of this Note shall be binding upon and benefit the successors,assigns, heirs, administrators and transferees of the parties. 10. Assignment by Company. Neither this Note nor any of the rights, ---------------------interests or obligations hereunder may be assigned, by operation of law orotherwise, in whole or in part, by Company without the prior written consent ofHolder. 11. Waiver. Company hereby waives presentment, demand, or protest and any ------ notice of any kind in connection with the delivery, acceptance, performance,default, acceleration, or collection of this Note. 12. Notices. Any notice, request or other communication required or -------permitted hereunder shall be in writing and shall be deemed to have been dulygiven if personally delivered or mailed by recognized overnight courier orpersonal delivery at the respective addresses of the parties as set forth in theNote Purchase Agreement or on the register maintained by Company. Any partyhereto may by notice so given change its address for future notice hereunder.Notice shall conclusively be deemed to have been given when received. 13. No Intent of Usury. It is the express intentions of the parties that ------------------ the payments under this Note are based upon the success and profitability of aspeculative venture, and are therefore exempt from applicable usuryrestrictions. Holder understands and acknowledges that all payments under thisNote are contingent upon the profitability of the Company. Nothing contained inthis Note or in the Agreement shall be deemed to require the payment by theCompany or the retention by Holder of interest in excess of the maximum legalrate (the "Maximum Legal Rate"). All agreements between Holder and Companypertaining to the obligation evidenced hereby (the "Loan") are expressly limited 11 so that in no contingency or event, whether by reason of acceleration of thematurity of the Loan or otherwise, shall the amount paid or agreed to be paid toHolder for the use, forbearance, or detention of money to be loaned hereunderexceed the Maximum Legal Rate. If, under any circumstance whatsoever, thefulfillment of any provision of this Note or the Agreement shall involvetranscending the limits of validity prescribed by law, then, ipso facto, the ---- ----- obligation to be fulfilled by Company shall be reduced to the limit of suchvalidity. This provision shall control every provision of all agreements betweenCompany and Holder. In the event at any time the interest paid shall exceed theMaximum Legal Rate, the excess amount shall be deemed to be held in trust byHolder for the exclusive use and benefit of Company; provided, however, thatsuch amounts held in trust may be applied to interest or other lawfulconsideration payable under the terms of this Note and the Agreement if suchamounts can be so applied without violating applicable laws and withoutexceeding the Maximum Legal Rate. Holder may commingle any such amounts with itsown funds. If at the time the Note is paid, the total amount deemed to beinterest under applicable laws exceeds the Maximum Legal Rate, the maximumliability of Company shall be expressly limited to the legal maximum amounts,and in the event any excess sums have been paid or are payable such amountsshall be promptly repaid or credited to Company. In the event the interest orother consideration payable by Company hereunder is exempt from applicable usurystatutes, or for any other reason is not limited by law, none of the provisionsof this paragraph shall be construed so as to limit the interest or otherconsideration payable under the terms of this Note or the Agreement. 14. Payment. Payment shall be made in lawful tender of the United States. ------- 15. Default Rate, Usury. In the event that any payment of principal or ------------------- interest provided for herein is not paid by Company when due (including the entire unpaid balance of this Note in the event such amount is made immediatelydue and payable pursuant to the terms hereof), then Company shall pay interestafter the date of default on such amounts not paid when due at a rate per annumequal to the rate otherwise applicable hereunder plus four percent (4%). In theevent any interest is paid on this Note which is deemed to be in excess of thethen legal maximum rate, then that portion of the interest payment representingan amount in excess of the then legal maximum rate shall be deemed a payment ofprincipal and applied against the principal of this Note. 16. Expenses. If action is instituted to collect this Note, Company --------promises to pay all costs and expenses, including, without limitation,reasonable attorneys' fees and costs, incurred in connection with such action ifHolder prevails. 17. Governing Law. This Note and all actions arising out of or in ------------- connection with this Note shall be governed by and construed in accordance withthe laws of the State of California, without regard to the conflicts of lawprovisions of the State of California, or of any other state. 12 IN WITNESS WHEREOF, Company has caused this Note to be issued as ofthe date first written above. ITERIS, INC. a Delaware corporation By: /s/ Jack Johnson ---------------- Jack Johnson, President 13 EXHIBIT 21 List of Subsidiaries -------------------- State or Other Jurisdiction Name of Subsidiary of Incorporation or Organization ------------------ -------------------------------- Broadcast, Inc. Delaware Gyyr Incorporated California Iteris, Inc., formerly known as Odetics ITS, Inc. (93% subsidiary of Delaware Mariner Networks, Inc. Delaware Meyer, Mohaddes Associates, Inc. (100% owned subsidiary of Iteris, Inc.) California Odetics Europe Limited England and Wales Odetics Asia Pacific Pte. Ltd Singapore Zyfer, Inc. Delaware EXHIBIT 23.1 Consent of Independent AuditorsWe consent to the incorporation by reference in the Registration Statements(Form S-3 Nos. 033-63983, 333-40555, 333-63911, 333-66717, 333-69677, 333-74509and 333-91903) of Odetics, Inc. and in the related Prospectuses, and in theRegistration Statements (Form S-8 Nos. 333-05735, 333-44907 and 333-30396) ofour report dated May 15, 2000, except for the last paragraph of Note 15, as towhich the date is June 12, 2000, with respect to the consolidated financialstatements and schedule of Odetics, Inc. included in this Annual Report (Form10-K) for the year ended March 31, 2000. /s/ ERNST & YOUNG LLPOrange County, CaliforniaJune 27, 2000
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