##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended September 30, 2008
 Commission File Number 000-28539
 DRI CORPORATION
 Exact name of Registrant as specified in its Charter)
 North Carolina
    
    56-1362926(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification Number)
 13760 Noel Road, Suite 830
Dallas, Texas 75240  (Address of principal executive offices, Zip Code)
 (214) 378-8992
 þ o
  Large accelerated filer oAccelerated filer oNon-accelerated filer o(Do not check if a smaller reporting company)Smaller reporting company þ o þ
  Common Stock, par value $.10 per share
    
    11,466,606(Class of Common Stock)
    
    Number of Shares




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##### 



DRI CORPORATION AND SUBSIDIARIES
 INDEX
    
    Page No.PART I  FINANCIAL INFORMATIONItem 1.
    
    Financial StatementsConsolidated Balance Sheets  September 30, 2008 (Unaudited) and December 31, 2007
    
    
    3Consolidated Statements of Operations  Three and Nine Months Ended September 30,
2008 and 2007 (Unaudited)
    
    
    4Consolidated Statements of Cash Flows  Nine Months Ended September 30, 2008 and
2007 (Unaudited)
    
    
    5Notes to Unaudited Consolidated Financial Statements
    
    
    7Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    16Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    23Item 4T.
    
    Controls and Procedures
    
    
    23PART II  OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    25Item 1A.
    
    Risk Factors
    
    
    25Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    26Item 3.
    
    Defaults Upon Senior Securities
    
    
    26Item 4.
    
    Submission of Matters to a Vote of Securityholders
    
    
    26Item 5.
    
    Other Information
    
    
    26Item 6.
    
    Exhibits
    
    
    26SIGNATURES
    
    
    32EX-10.22.1EX-31.1EX-31.2EX-32.1EX-32.2
  2




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1. FINANCIAL STATEMENTS
 
 
 December 31, 2007September 30, 2008
    
    
    (Note 1)ASSETSCurrent AssetsCash and cash equivalents
    
    $
    1,937
    
    
    $
    729Trade accounts receivable, net
    
    
    14,160
    
    
    
    11,919Current portion of note receivable
    
    
    86
    
    
    
    86Other receivables
    
    
    563
    
    
    
    465Inventories
    
    
    11,785
    
    
    
    9,603Prepaids and other current assets
    
    
    934
    
    
    
    495Total current assets
    
    
    29,465
    
    
    
    23,297Property and equipment, net
    
    
    3,535
    
    
    
    2,890Long-term portion of note receivable
    
    
    172
    
    
    
    258Goodwill
    
    
    10,442
    
    
    
    11,033Intangible assets, net
    
    
    935
    
    
    
    1,097Deferred tax assets, net
    
    
    52
    
    
    
    56Other assets
    
    
    1,206
    
    
    
    283Total assets
    
    $
    45,807
    
    
    $
    38,914LIABILITIES AND SHAREHOLDERS EQUITYCurrent LiabilitiesLines of credit
    
    $
    3,376
    
    
    $
    6,043Notes payable, net
    
    
    
    
    
    
    500Loans payable
    
    
    695
    
    
    
    391Current portion of long-term debt
    
    
    223
    
    
    
    254Current portion of foreign tax settlement
    
    
    474
    
    
    
    499Accounts payable
    
    
    7,658
    
    
    
    6,246Accrued expenses
    
    
    5,197
    
    
    
    3,681Preferred stock dividends payable
    
    
    16
    
    
    
    18Total current liabilities
    
    
    17,639
    
    
    
    17,632Long-term debt and capital leases, net
    
    
    5,099
    
    
    
    14Foreign tax settlement, long-term
    
    
    732
    
    
    
    1,043Liability for uncertain tax positions
    
    
    566
    
    
    
    311Minority interest in consolidated subsidiary
    
    
    938
    
    
    
    422Commitments and contingencies (Notes 7, 8 and 14)Shareholders EquitySeries E Redeemable, Nonvoting, Convertible Preferred Stock, $.10 par value,
liquidation preference of $5,000 per share; 500 shares authorized; 80 and 85
shares issued and outstanding at September 30, 2008, and December 31, 2007,
respectively; redeemable at the discretion of the Company at any time.
    
    
    337
    
    
    
    355Series G Redeemable, Convertible Preferred Stock, $.10 par value,
liquidation preference of $5,000 per share; 600 shares authorized; 435 and 410
shares issued and outstanding at September 30, 2008, and December 31, 2007,
respectively; redeemable at the discretion of the Company after five years
from date of issuance.
    
    
    1,893
    
    
    
    1,768Series H Redeemable, Convertible Preferred Stock, $.10 par value,
liquidation preference of $5,000 per share; 600 shares authorized; 63 and 59
shares issued and outstanding at September 30, 2008, and December 31, 2007,
respectively; redeemable at the discretion of the Company after five years
from date of issuance.
    
    
    267
    
    
    
    247Series J Redeemable, Convertible Preferred Stock, $.10 par value,
liquidation preference of $5,000 per share; 250 shares authorized; 90 shares
issued and outstanding at September 30, 2008, and December 31, 2007;
redeemable at the discretion of the Company at any time.
    
    
    388
    
    
    
    388Series AAA Redeemable, Nonvoting, Convertible Preferred Stock, $.10 par value,
liquidation preference of $5,000 per share; 20,000 shares authorized; 166 and 172
shares issued and outstanding at September 30, 2008, and December 31, 2007,
respectively; redeemable at the discretion of the Company at any time.
    
    
    830
    
    
    
    860Common stock, $.10 par value, 25,000,000 shares authorized; 11,457,515 and
11,187,993 shares issued and outstanding at September 30, 2008 and
December 31, 2007, respectively.1,146
    
    
    
    1,119Additional paid-in capital
    
    
    32,687
    
    
    
    32,079Accumulated other comprehensive income  foreign currency translation
    
    
    3,050
    
    
    
    4,570Accumulated deficit
    
    
    (19,765
    )
    
    
    (21,894
    )Total shareholders equity
    
    
    20,833
    
    
    
    19,492Total liabilities, minority interest and shareholders equity
    
    $
    45,807
    
    
    $
    38,914
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Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Net sales
    
    $
    18,794
    
    
    $
    13,929
    
    
    $
    55,222
    
    
    $
    40,814Cost of sales
    
    
    12,294
    
    
    
    9,388
    
    
    
    35,938
    
    
    
    28,063Gross profit
    
    
    6,500
    
    
    
    4,541
    
    
    
    19,284
    
    
    
    12,751Operating expensesSelling, general and administrative
    
    
    4,798
    
    
    
    3,174
    
    
    
    13,921
    
    
    
    10,383Research and development
    
    
    199
    
    
    
    329
    
    
    
    723
    
    
    
    1,024Total operating expenses
    
    
    4,997
    
    
    
    3,503
    
    
    
    14,644
    
    
    
    11,407Operating income
    
    
    1,503
    
    
    
    1,038
    
    
    
    4,640
    
    
    
    1,344Other income (loss)
    
    
    (32
    )
    
    
    4
    
    
    
    (54
    )
    
    
    43Foreign currency gain
    
    
    125
    
    
    
    130
    
    
    
    289
    
    
    
    151Interest expense
    
    
    (390
    )
    
    
    (276
    )
    
    
    (1,051
    )
    
    
    (924
    )Total other income and expense
    
    
    (297
    )
    
    
    (142
    )
    
    
    (816
    )
    
    
    (730
    )Income from continuing operations before income tax expense
    
    
    1,206
    
    
    
    896
    
    
    
    3,824
    
    
    
    614Income tax expense
    
    
    (291
    )
    
    
    (200
    )
    
    
    (1,179
    )
    
    
    (177
    )Income from continuing operations before minority interest in
income of consolidated subsidiary
    
    
    915
    
    
    
    696
    
    
    
    2,645
    
    
    
    437Minority interest in income of consolidated subsidiary
    
    
    (176
    )
    
    
    (120
    )
    
    
    (516
    )
    
    
    (99
    )Income from continuing operations
    
    
    739
    
    
    
    576
    
    
    
    2,129
    
    
    
    338Loss from discontinued operations (Note 2)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (219
    )Net income
    
    
    739
    
    
    
    576
    
    
    
    2,129
    
    
    
    119Provision for preferred stock dividends
    
    
    (77
    )
    
    
    (76
    )
    
    
    (226
    )
    
    
    (220
    )Net income (loss) applicable to common shareholders
    
    $
    662
    
    
    $
    500
    
    
    $
    1,903
    
    
    $
    (101
    )Net income (loss) per share  basicContinuing operations
    
    $
    0.06
    
    
    $
    0.04
    
    
    $
    0.17
    
    
    $
    0.01Discontinued operations
    
    $
    0.00
    
    
    $
    0.00
    
    
    $
    0.00
    
    
    $
    (0.02
    )Income (loss) per share applicable to common shareholders
    
    $
    0.06
    
    
    $
    0.04
    
    
    $
    0.17
    
    
    $
    (0.01
    )Net income (loss) per share  dilutedContinuing operations
    
    $
    0.06
    
    
    $
    0.04
    
    
    $
    0.16
    
    
    $
    0.01Discontinued operations
    
    $
    0.00
    
    
    $
    0.00
    
    
    $
    0.00
    
    
    $
    (0.02
    )Income (loss) per share applicable to common shareholders
    
    $
    0.06
    
    
    $
    0.04
    
    
    $
    0.16
    
    
    $
    (0.01
    )Weighted average number of common shares and common
share equivalent outstandingBasic
    
    
    11,453,588
    
    
    
    11,131,248
    
    
    
    11,290,217
    
    
    
    10,606,347Diluted
    
    
    13,052,316
    
    
    
    11,702,461
    
    
    
    13,018,961
    
    
    
    11,020,059
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Nine Months Ended September 30,2008
    
    
    2007Cash flows from operating activitiesNet income
    
    $
    2,129
    
    
    $
    119Loss from discontinued operations
    
    
    
    
    
    
    (219
    )Income from continuing operations
    
    
    2,129
    
    
    
    338Adjustments to reconcile net income to net cash
provided by operating activitiesDeferred income taxes
    
    
    
    
    
    
    (124
    )Liability for uncertain tax positions
    
    
    297
    
    
    
    87Depreciation and amortization of property and equipment
    
    
    721
    
    
    
    810Amortization of intangible assets
    
    
    118
    
    
    
    100Amortization of deferred financing costs
    
    
    231
    
    
    
    216Amortization of the fair value of warrants
    
    
    143
    
    
    
    188Amortization of beneficial conversion feature
    
    
    54
    
    
    
    Bad debt expense
    
    
    100
    
    
    
    22Stock issued in lieu of cash compensation
    
    
    64
    
    
    
    57Stock-based compensation expense
    
    
    111
    
    
    
    28Write-down of inventory for obsolescence
    
    
    81
    
    
    
    119Loss (gain) on sale of fixed assets
    
    
    4
    
    
    
    (3
    )Other, primarily effect of foreign currency gain
    
    
    (347
    )
    
    
    (275
    )Minority interest in income of consolidated subsidiary
    
    
    516
    
    
    
    99Changes in operating assets and liabilitiesIncrease in trade accounts receivable
    
    
    (2,944
    )
    
    
    (312
    )Increase in other receivables
    
    
    (52
    )
    
    
    (301
    )(Increase) decrease in inventories
    
    
    (2,686
    )
    
    
    443Increase in prepaids and other current assets
    
    
    (478
    )
    
    
    (34
    )Decrease in other assets
    
    
    4
    
    
    
    Increase (decrease) in accounts payable
    
    
    1,567
    
    
    
    (729
    )Increase in accrued expenses
    
    
    1,716
    
    
    
    1,063Decrease in foreign tax settlement
    
    
    (263
    )
    
    
    (128
    )Net cash provided by continuing operations
    
    
    1,086
    
    
    
    1,664Net cash used in discontinued operations
    
    
    
    
    
    
    (68
    )Net cash provided by operating activities
    
    
    1,086
    
    
    
    1,596Cash flows from investing activitiesProceeds from sale of fixed assets
    
    
    5
    
    
    
    65Purchases of property and equipment
    
    
    (390
    )
    
    
    (195
    )Investments in software development
    
    
    (1,075
    )
    
    
    (472
    )Proceeds from sale of DAC
    
    
    
    
    
    
    1,100Net cash (used in) provided by investing activities
    
    
    (1,460
    )
    
    
    498Cash flows from financing activitiesProceeds from bank borrowings and lines of credit
    
    
    68,641
    
    
    
    48,267Principal payments on bank borrowings and lines of credit
    
    
    (65,702
    )
    
    
    (51,264
    )Issuance of common stock
    
    
    3
    
    
    
    173Proceeds from issuance of Preferred stock, net of costs
    
    
    
    
    
    
    411Payments of debt issuance costs
    
    
    (1,193
    )
    
    
    Payment of dividends on Preferred stock
    
    
    (83
    )
    
    
    (92
    )Net cash provided by (used in) financing activities
    
    
    1,666
    
    
    
    (2,505
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    (84
    )
    
    
    38Net increase (decrease) in cash and cash equivalents
    
    
    1,208
    
    
    
    (373
    )Cash and cash equivalents at beginning of period
    
    
    729
    
    
    
    611Cash and cash equivalents at end of period
    
    $
    1,937
    
    
    $
    238
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Nine Months Ended September 30,2008
    
    
    2007Supplemental disclosures of non-cash investing and financing activities:Conversion of preferred stock to common stock
    
    $
    55
    
    
    $
    1,010Fair value of warrants issued in connection with new term loan
    
    $
    333
    
    
    $
    Fair value of warrants issued in connection with sale of preferred stock
    
    $
    
    
    
    $
    23Note receivable in connection with sale of DAC
    
    $
    
    
    
    $
    344Conversion of convertible subordinated debenture
    
    $
    250
    
    
    $
    Amortization of convertible subordinated debenture beneficial conversion feature
    
    $
    54
    
    
    $
    Purchase of equipment under capital lease obligation
    
    $
    21
    
    
    $
    Preferred stock dividends
    
    $
    145
    
    
    $
    135
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DRI CORPORATION AND SUBSIDIARIES
 
 NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 (TM)
  (1) BASIS OF PRESENTATION AND DISCLOSURE
    Product Warranties
  Nine Months ended September 30,2008
    
    
    2007Balance at beginning of period
    
    $
    491
    
    
    $
    384Additions charged to costs and expenses
    
    
    119
    
    
    
    474Deductions
    
    
    (137
    )
    
    
    (351
    )Foreign exchange translation (gain) loss
    
    
    (21
    )
    
    
    15Balance at end of period
    
    $
    452
    
    
    $
    522
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Recent Accounting Pronouncements
        8




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(2) DISCONTINUED OPERATIONS
    Accounting for the Impairment or Disposal of Long-Lived
Assets
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2007
    
    2007(In thousands)
    
    (In thousands)Net sales
    
    $
    
    
    
    $
    239Loss before income tax expense
    
    
    
    
    
    
    (219
    )
 (3) GOODWILL AND OTHER INTANGIBLE ASSETS
  (4) INVENTORIES
 September 30,
    
    
    December 31,2008
    
    
    2007(In thousands)Raw materials and system components
    
    $
    7,681
    
    
    $
    6,496Work in process
    
    
    319
    
    
    
    176Finished goods
    
    
    3,785
    
    
    
    2,931Total inventories
    
    $
    11,785
    
    
    $
    9,603
 9




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(5) PROPERTY AND EQUIPMENT
 EstimatedDepreciable
    
    
    September 30,
    
    
    December 31,Lives (years)
    
    
    2008
    
    
    2007(In thousands)Leasehold improvements
    
    
    5 - 9
    
    
    $
    287
    
    
    $
    278Automobiles
    
    
    5
    
    
    
    13
    
    
    
    16Computer and telecommunications equipment
    
    
    3
    
    
    
    968
    
    
    
    857Software
    
    
    3 - 5
    
    
    
    4,550
    
    
    
    4,434Test equipment
    
    
    3 - 5
    
    
    
    125
    
    
    
    123Furniture and fixtures
    
    
    3 - 7
    
    
    
    2,706
    
    
    
    2,730Software projects in progress
    
    
    
    
    
    
    1,421
    
    
    
    66810,070
    
    
    
    9,106Less accumulated depreciation and amortization
    
    
    
    
    
    
    6,535
    
    
    
    6,216Total property and equipment, net
    
    
    
    
    
    $
    3,535
    
    
    $
    2,890
 (6) ACCRUED EXPENSES
 September 30,
    
    
    December 31,2008
    
    
    2007(In thousands)Salaries, commissions, and benefits
    
    $
    1,635
    
    
    $
    1,429Taxes  payroll, sales, income, and other
    
    
    1,259
    
    
    
    1,020Warranties
    
    
    452
    
    
    
    491Current portion of capital leases
    
    
    25
    
    
    
    23Interest payable
    
    
    315
    
    
    
    172Deferred revenue
    
    
    740
    
    
    
    303Other
    
    
    771
    
    
    
    243Total accrued expenses
    
    $
    5,197
    
    
    $
    3,681
 (7) LINES OF CREDIT, NOTES PAYABLE AND LOANS PAYABLE
 (a) Domestic line of credit and loan payable
  10




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b) International lines of credit and loans payable
  11




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September 30,
    
    
    December 31,2008
    
    
    2007(In thousands)Line of credit with Laurus Master Fund dated March 16, 2006; replaced by line of
credit with PNC Bank, National Association in June 2008
    
    $
    
    
    
    $
    3,796Line of credit with PNC Bank, National Association dated June 30, 2008; payable in
full June 30, 2008; secured by all tangible and intangible U.S. assets of the
Company; bears average interest rate of 6.75% in 2008
    
    
    2,157
    
    
    
    Line of credit with Handelsbanken dated December 31, 2007, expires on December
31, 2008; secured by certain assets of the Swedish subsidiary, Mobitec AB; bears
average interest rate of 6.43% and 4.92% in 2008 and 2007, respectively.
    
    
    11
    
    
    
    1,057Line of credit with Handelsbanken dated December 31, 2007; expires on December
31, 2008; secured by accounts receivable of the Swedish subsidiary, Mobitec AB;
bears average interest rate of 6.83% and 5.36% in 2008 and 2007, respectively.
    
    
    605
    
    
    
    1,087Line of credit with Handelsbanken dated June 23, 2004; open-ended term; secured
by accounts receivable and inventory of the German subsidiary, Mobitec GmbH;
bears average interest rate of 5.73% and 5.30% in 2008 and 2007, respectively.
    
    
    603
    
    
    
    103Total lines of credit
    
    $
    3,376
    
    
    $
    6,043
 12




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(8) LONG-TERM DEBT
   September 30,
    
    
    December 31,2008
    
    
    2007(In thousands)Term loan with BHC Interim Funding III, L.P., dated June 30, 2008;
payable in full June 30, 2011; secured by substantially all tangible
and intangible assets of the Company; bears interest rate of 12.75%.
    
    $
    5,000
    
    
    $
    Term loan with Svenska Handelsbanken AB, dated June 30, 2008;
payable in quarterly installments of $55,000; secured by accounts
receivable and inventory of the Swedish subsidiary, Mobitec AB;
bears average interest rate of 7.33%.
    
    
    611
    
    
    
    Convertible debenture to a director dated August 26, 2002,
converted on June 30, 2008
    
    
    
    
    
    
    250Other long-term debt
    
    
    
    
    
    
    4Total long-term debt
    
    
    5,611
    
    
    
    254Less current portion
    
    
    223
    
    
    
    254Less debt discount
    
    
    304
    
    
    
    5,084
    
    
    
    Long-term portion of capital leases
    
    
    15
    
    
    
    14Total long-term debt and capital leases, less current portion
    
    $
    5,099
    
    
    $
    14
 (9)
    
    PREFERRED STOCK
   (10) PER SHARE AMOUNTS
  13




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Three
months ended September 30,
    
    

Nine
months ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(Unaudited)(In thousands, except share amounts)Net income (loss) applicable to common shareholders
    
    $
    662
    
    
    $
    500
    
    
    $
    1,903
    
    
    $
    (101
    )Effect of dilutive securities on net income (loss):Convertible debt
    
    
    
    
    
    
    5
    
    
    
    10
    
    
    
    Convertible preferred stock
    
    
    66
    
    
    
    
    
    
    
    194
    
    
    
    Net income (loss) applicable to common shareholders, assuming conversions
    
    $
    728
    
    
    $
    505
    
    
    $
    2,107
    
    
    $
    (101
    )Weighted average shares oustanding  Basic
    
    
    11,453,588
    
    
    
    11,131,248
    
    
    
    11,290,217
    
    
    
    10,606,347Effect of dilutive securities on shares outstanding:Options
    
    
    53,451
    
    
    
    188,268
    
    
    
    49,812
    
    
    
    41,623Warrants
    
    
    77,223
    
    
    
    176,333
    
    
    
    58,344
    
    
    
    372,089Convertible debt
    
    
    
    
    
    
    206,612
    
    
    
    150,133
    
    
    
    Convertible preferred stock
    
    
    1,468,054
    
    
    
    
    
    
    
    1,470,455
    
    
    
    Weighted average shares outstanding  Diluted
    
    
    13,052,316
    
    
    
    11,702,461
    
    
    
    13,018,961
    
    
    
    11,020,059
  (11) COMPREHENSIVE INCOME (LOSS)
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(Unaudited)
    
    
    (Unaudited)(In thousands)
    
    
    (In thousands)Net income
    
    $
    739
    
    
    $
    576
    
    
    $
    2,129
    
    
    $
    119Foreign currency translation adjustment
    
    
    (2,648
    )
    
    
    843
    
    
    
    (1,520
    )
    
    
    1,007Total comprehensive income (loss)
    
    $
    (1,909
    )
    
    $
    1,419
    
    
    $
    609
    
    
    $
    1,126
 (12) SEGMENT AND GEOGRAPHIC INFORMATION
  14




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##### Table of Contents



Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(Unaudited)
    
    
    (Unaudited)(In thousands)
    
    
    (In thousands)Net sales  continuing operationsNorth America
    
    $
    8,005
    
    
    $
    6,580
    
    
    $
    22,760
    
    
    $
    20,951Europe
    
    
    4,580
    
    
    
    3,446
    
    
    
    15,639
    
    
    
    10,387Asia-Pacific
    
    
    2,304
    
    
    
    1,103
    
    
    
    6,991
    
    
    
    3,219Middle East
    
    
    74
    
    
    
    481
    
    
    
    676
    
    
    
    1,448South America
    
    
    3,831
    
    
    
    2,319
    
    
    
    9,156
    
    
    
    4,809$
    18,794
    
    
    $
    13,929
    
    
    $
    55,222
    
    
    $
    40,814
 September 30,2008
    
    
    December 31,(Unaudited)
    
    
    2007(In thousands)Long-lived assets  continuing operationsNorth America
    
    $
    2,870
    
    
    $
    1,345Europe
    
    
    1,591
    
    
    
    1,538Asia-Pacific
    
    
    48
    
    
    
    44South America
    
    
    232
    
    
    
    246$
    4,741
    
    
    $
    3,173
 (13) INCOME TAXES
    (14) LEGAL PROCEEDINGS
  15




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
  Business  General
   Critical Accounting Policies and Estimates
  
    
    Allowance for doubtful accounts;
    
    Inventory valuation;
    
    Warranty reserve;
    
    Intangible assets and goodwill;
    
    Income taxes, including deferred tax assets;
    
    Revenue recognition; and
    
    Stock-based compensation.
   16




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##### Table of Contents



Results of Operations
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Net sales
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    65.4
    
    
    
    67.4
    
    
    
    65.1
    
    
    
    68.8Gross profit
    
    
    34.6
    
    
    
    32.6
    
    
    
    34.9
    
    
    
    31.2Operating expenses:Selling, general and administrative
    
    
    25.5
    
    
    
    23.0
    
    
    
    25.2
    
    
    
    25.4Research and development
    
    
    1.1
    
    
    
    2.4
    
    
    
    1.3
    
    
    
    2.5Total operating expenses
    
    
    26.6
    
    
    
    25.4
    
    
    
    26.5
    
    
    
    27.9Operating income
    
    
    8.0
    
    
    
    7.3
    
    
    
    8.4
    
    
    
    3.3Other income and expense
    
    
    (1.6
    )
    
    
    (1.0
    )
    
    
    (1.5
    )
    
    
    (1.8
    )Income from continuing operations before
income tax expense
    
    
    6.4
    
    
    
    6.3
    
    
    
    6.9
    
    
    
    1.4Income tax expense
    
    
    (1.5
    )
    
    
    (1.4
    )
    
    
    (2.1
    )
    
    
    (0.4
    )Income from continuing operations before minority
interest in income of consolidated subsidiary
    
    
    4.9
    
    
    
    4.9
    
    
    
    4.8
    
    
    
    1.1Minority interest in income of consolidated subsidiary
    
    
    (0.9
    )
    
    
    (0.9
    )
    
    
    (0.9
    )
    
    
    (0.2
    )Income from continuing operations
    
    
    4.0
    
    
    
    4.1
    
    
    
    3.9
    
    
    
    0.8Loss from discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.5
    )Net income
    
    
    4.0
    %
    
    
    4.1
    %
    
    
    3.9
    %
    
    
    0.3
    %
 COMPARISON OF OUR RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
 Net Sales and Gross Profit.
     17




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Selling, General and Administrative.
 Research and Development Expenses.
 Operating Income.
 Other Income (Loss), Foreign Currency Gain, and Interest Expense.
 18




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##### Table of Contents



Income Tax Expense.
 Net Income Applicable to Common Shareholders.
 COMPARISON OF OUR RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
 Net Sales and Gross Profit.
     19




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Selling, General and Administrative.
 Research and Development Expenses.
 Operating Income.
 Other Income, Foreign Currency Gain, and Interest Expense.
 Income Tax Benefit (Expense).
 20




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##### Table of Contents



Discontinued Operations.
 Net Income (Loss) Applicable to Common Shareholders.
 Industry and Market Overview
    OUR LIQUIDITY AND CAPITAL RESOURCES
 Cash Flows for the Nine Months Ended September 30, 2008 and 2007
  21




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##### Table of Contents



Significant Financing Arrangements
  (1)
    
    The existing line of credit with Laurus, which matured June 30, 2008, was replaced with
a new line of credit under the PNC Agreement which increased borrowing capacity from $6.0
million to $8.0 million. The line of credit under the PNC Agreement matures June 30, 2011.(2)
    
    An additional $5.0 million in working capital was provided by the Term Loan under the
BHC Agreement. The Term Loan matures June 30, 2011.(3)
    
    Borrowing capacity on Mobitec ABs lines of credit under agreements with Handelsbanken
was increased from approximately $2.4 million to approximately $3.6 million (based on
September 30, 2008 currency exchange rates) and the basis on which borrowings are made
under these credit agreements was increased to a maximum of 90% of total invoiced sales of
Mobitec AB. These credit agreements renew annually on a calendar-year basis.(4)
    
    An additional $667,000 (based on September 30, 2008 currency exchange rates) in working
capital was provided by the Mobitec Loan. The Mobitec Loan matures June 30, 2011.(5)
    
    Borrowing capacity on Mobitec GmbHs line of credit under an agreement with
Handelsbanken was increased from approximately $740,000 to approximately $1.3 million
(based on September 30, 2008 currency exchange rates). This credit agreement has an
open-ended term.
 Management Conclusion
  Impact of Inflation
  22




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FORWARD-LOOKING STATEMENTS
   
    
    our ability to meet our capital requirements;
    
    our ability to meet and maintain our existing debt obligations, including obligations to
make payments under such debt instruments;
    
    the sufficiency of our liquidity and capital resources to support current operations for
the remainder of 2008;
    
    our future cash flow position;
    
    recent legislative action affecting the transportation and/or security industry;
    
    future legislative action affecting the transportation and/or security industry;
    
    the likelihood of current transit funding legislation being extended through current
resolutions or future legislation;
    
    changes in federal or state funding for transportation and/or security-related funding;
    
    our opinion that mass transit projects and funding approved by voters in recent elections
are a positive indicator of future business opportunities;
    
    our future outlook with respect to the domestic and international markets for our products;
and
    
    our opinion that increased funding for transit security establishes a positive trend.
   
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4T. CONTROLS AND PROCEDURES
 Disclosure Controls and Procedures
   23




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Changes in Internal Control over Financial Reporting
  24




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##### Table of Contents



PART II  OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
  
 ITEM 1A. RISK FACTORS
  Risks Related to Indebtedness, Financial Condition and Results of Operations
 Our substantial debt could adversely affect our financial position, operations and ability to
grow.
 
    
    we could be required to dedicate a substantial portion of our cash flow from operations
to payments on our debt, which would reduce amounts available for working capital, capital
expenditures, research and development and other general corporate purposes;
    
    our flexibility in planning for, or reacting to, changes in our business and the
industries in which we operate could be limited;
    
    we may be more vulnerable to general adverse economic and industry conditions;
    
    we may be at a disadvantage compared to our competitors that may have less debt than we
do;
    
    it may be more difficult for us to obtain additional financing that may be necessary in
connection with our business;
    
    it may be more difficult for us to implement our business and growth strategies; and
    
    we may have to pay higher interest rates on future borrowings.
 Difficult conditions in the global capital markets and the economy generally may materially
adversely affect our business and results of operations.
  25




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##### Table of Contents



ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
   
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES
  
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS
  
 ITEM 5. OTHER INFORMATION
  Fiscal Quarter Ending:
    
    Leverage Ratio:September 30, 2008
    
    3.50 to 1.0December 31, 2008
    
    3.50 to 1.0March 31, 2009
    
    4.25 to 1.0June 30, 2009
    
    3.00 to 1.0September 30, 2009
    
    3.00 to 1.0December 31, 2009
    
    3.00 to 1.0March 31, 2010 and each fiscal quarter ending thereafter
    
    2.50 to 1.0
 
 ITEM 6. EXHIBITS
  Exhibit No.
    
    Document3.1
    
    Amended and Restated Articles of Incorporation of the Company
(incorporated herein by reference from the Companys
Registration Statement on Form S-3, filed with the SEC on
December 23, 2003)3.2
    
    Articles of Amendment to Articles of Incorporation of the
Company containing Certificate of Designation of Series E
Redeemable Nonvoting Convertible Stock (incorporated herein by
reference from the Companys Report on Form 8-K, filed with
the SEC on November 12, 2003)
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##### Table of Contents



Exhibit No.
    
    Document3.3
    
    Articles of Amendment to Articles of Incorporation of the
Company containing Amended and Restated Certificate of
Designation of Series F Convertible Preferred Stock
(incorporated herein by reference from the Companys Report on
Form 8-K, filed with the SEC on April 14, 2004)3.4
    
    Articles of Amendment to the Articles of Incorporation of the
Company containing Series AAA Preferred Stock Change in
Quarterly Dividend Accrual and Conversion Price (incorporated
herein by reference to the Companys Report on Form 10-K for
the year ended December 31, 2004)3.5
    
    Articles of Amendment to Articles of Incorporation of the
Company containing Amended and Restated Certificate of
Designation of Series G Redeemable Convertible Preferred Stock
(incorporated herein by reference to the Companys Report on
Form 8-K filed on June 28, 2005)3.6
    
    Articles of Correction of Articles of Amendment to the
Articles of Incorporation of the Company containing a
correction to an error in the Amended Certificate of
Designation of Series G Redeemable Convertible Preferred Stock
(incorporated herein by reference to the Companys Report on
Form 10-Q for the quarter ended June 30, 2005)3.7
    
    Articles of Amendment to the Articles of Incorporation of the
Company containing an amendment to eliminate a staggered
election of Board members (incorporated herein by reference to
the Companys Report on Form 10-Q for the quarter ended June
30, 2005)3.8
    
    Articles of Amendment to Articles of Incorporation of the
Company containing Amended and Restated Certificate of
Designation of Series H Convertible Preferred Stock
(incorporated herein by reference to the Companys Report on
Form 8-K filed on November 4, 2005)3.9
    
    Articles of Amendment to Articles of Incorporation of the
Company containing Certificate of Designation of Series I
Convertible Preferred Stock (incorporated herein by reference
to the Companys Report on Form 8-K filed on March 23, 2006)3.10
    
    Amended and Restated Bylaws of the Company (incorporated
herein by reference from the Companys Registration Statement
on Form SB-2)3.11
    
    Amendment to Amended and Restated Bylaws of the Company
(incorporated herein by reference from the Companys Proxy
Statement for the Annual Meeting of Shareholders for fiscal
year 2000, filed with the SEC on June 6, 2001)3.12
    
    Amended and Restated Bylaws of the Company (incorporated
herein by reference to the Companys Report on Form 8-K filed
on September 18, 2006)3.13
    
    Amendment No. 1 to the Companys Certificate of Designation
with respect to its Series D Junior Participating Preferred
Stock (incorporated herein by reference to the Companys
Report on Form 8-K filed with the SEC on September 28, 2006)3.14
    
    Amendment to Bylaws of DRI Corporation, dated as of September
12, 2007 (incorporated herein by reference to the Companys
Report on Form 8-K filed with the SEC on September 14, 2007)4.5
    
    Rights Agreement, dated as of September 22, 2006, between the
Company and American Stock Transfer & Trust Company, as Rights
Agent, together with the following exhibits thereto: Exhibit A
 Certificate of Designation of Series D Junior Participating
Preferred Stock of Digital Recorders, Inc. and the Amendment
to Certificate of Designation of Series D Junior Participating
Preferred Stock of Digital Recorders, Inc.; Exhibit B  Form
of Right Certificate; and Exhibit C  Summary of Rights to
Purchase Shares (incorporated herein by reference to the
Companys Registration Statement on Form 8-A filed with the
Securities and Exchange Commission on October 2, 2006)4.6
    
    Omnibus Amendment dated as of January 10, 2007, effective
December 31, 2006, by and among the Company, TwinVision of
North America, Inc., Digital Audio Corporation,
Robinson-Turney International, Inc., and Laurus Master Fund,
Ltd. (incorporated herein by reference to the Companys report
on Form 8-K filed with the SEC on January 16, 2007)
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##### Table of Contents



Exhibit No.
    
    Document4.7
    
    Amended and Restated Secured Term Note dated as of January 10,
2007, effective December 31, 2006, by and between the Company,
TwinVision of North America, Inc., Digital Audio Corporation,
Robinson-Turney International, Inc., and Laurus Master Fund,
Ltd. (incorporated herein by reference to the Companys Report
on Form 8-K filed with the SEC on January 16, 2007)4.8
    
    Second Amended and Restated Registration Rights Agreement
dated as of January 10, 2007, effective December 31, 2006, by
and between the Company and Laurus Master Fund, Ltd.
(incorporated herein by reference to the Companys Report on
Form 8-K filed with the SEC on January 16, 2007)4.9
    
    Certificate of Designation of Series J Convertible Preferred
Stock of Digital Recorders, Inc. (incorporated herein by
reference to the Companys Report on Form 10-Q for the quarter
ended June 30, 2007)4.10
    
    Warrant, dated as of June 30, 2008, issued by DRI Corporation
to BHC Interim Funding III, L.P. (incorporated herein by
reference to the Companys report on Form 8-K/A filed with the
SEC on August 13, 2008)10.1
    
    Secured Non-Convertible Revolving Note between the Company and
Laurus Master Fund, Ltd., dated March 16, 2006 (incorporated
herein by reference to the Companys Report on Form 8-K filed
on March 21, 2006)10.2
    
    Security Agreement (with Schedules) between the Company and
Laurus Master Fund, Ltd. dated March 16, 2006 (incorporated
herein by reference to the Companys Report on Form 8-K filed
on March 21, 2006)10.3
    
    Grant of Security Interest in Patents and Trademarks (with
Schedules) between the Company and Laurus Master Fund, Ltd.,
dated March 16, 2006 (incorporated herein by reference to the
Companys Report on Form 8-K filed on March 21, 2006)10.4
    
    Stock Pledge Agreement (with Schedules) between the Company
and Laurus Master Fund, Ltd., dated March 16, 2006
(incorporated herein by reference to the Companys Report on
Form 8-K filed on March 21, 2006)10.5
    
    Registration Rights Agreement between the Company and Laurus
Master Fund, Ltd., dated March 16, 2006 (incorporated herein
by reference to the Companys Report on Form 8-K filed on
March 21, 2006)10.6
    
    Common Stock Purchase Warrant between the Company and Laurus
Master Fund, Ltd., dated March 16, 2006 (incorporated herein
by reference to the Companys Report on Form 8-K filed on
March 21, 2006)10.7
    
    Share Purchase Agreement between the Company and Transit
Vehicle Technology Investments, Inc., dated March 21, 2006
(incorporated herein by reference to the Companys Report on
Form 8-K filed on March 23, 2006)10.8
    
    Stock Purchase Warrant between the Company and Transit Vehicle
Technology Investments, Inc., dated March 21, 2006
(incorporated herein by reference to the Companys Report on
Form 8-K filed on March 23, 2006)10.9
    
    Registration Rights Agreement between the Company and Transit
Vehicle Technology Investments, Inc., dated March 21, 2006
(incorporated herein by reference to the Companys Report on
Form 8-K filed on March 23, 2006)10.10
    
    Securities Purchase Agreement dated as of April 28, 2006, by
and between Digital Recorders, Inc., TwinVision of North
America, Inc., Digital Audio Corporation, and Robinson-Turney
International, Inc., and Laurus Master Fund, Ltd.
(incorporated herein by reference to the Companys Report on
Form 8-K filed on May 4, 2006)
 28




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##### Table of Contents



Exhibit No.
    
    Document10.11
    
    Secured Term Note by Digital Recorders, Inc., TwinVision of
North America, Inc., Digital Audio Corporation, and
Robinson-Turney International, Inc., issued to Laurus Master
Fund, Ltd., in the original principal amount of $1,600,000
(incorporated herein by reference to the Companys Report on
Form 8-K filed on May 4, 2006)10.12
    
    Common Stock Purchase Warrant dated as of April 28, 2006
(incorporated herein by reference to the Companys Report on
Form 8-K filed on May 4, 2006)10.13
    
    Amended and Restated Registration Rights Agreement dated as of
April 28, 2006, by and between Digital Recorders, Inc. and
Laurus Master Fund, Ltd. (incorporated herein by reference to
the Companys Report on Form 8-K filed on May 4, 2006)10.14
    
    Share Purchase Agreement, dated as of April 30, 2007, entered
into by and among Dolphin Direct Equity Partners, LP, Digital
Audio Corporation and Digital Recorders, Inc. (incorporated
herein by reference to the Companys Report on Form 10-Q for
the quarter ended March 31, 2007)10.15
    
    Waiver and Consent, dated as of April 30, 2007, entered into
by and between Digital Recorders, Inc., TwinVision of North
America, Inc., Digital Audio Corporation, Robinson-Turney
International, Inc. and Laurus Master Fund, Ltd. (incorporated
herein by reference to the Companys Report on Form 10-Q for
the quarter ended March 31, 2007)10.16
    
    Form of Share Purchase Agreement, dated June 11, 2007, between
Digital Recorders, Inc. and buyer of Series J Convertible
Preferred Stock of Digital Recorders, Inc. with Schedule of
Differences (incorporated herein by reference to the Companys
Report on Form 10-Q for the quarter ended June 30, 2007)10.17
    
    Form of Registration Rights Agreement, dated June 11, 2007,
between Digital Recorders, Inc. and holder of Series J
Convertible Preferred Stock of Digital Recorders, Inc.
(incorporated herein by reference to the Companys Report on
Form 10-Q for the quarter ended June 30, 2007)10.18
    
    Promissory Note, dated April 30, 2007, by Dolphin Direct
Equity Partners, LP issued to Digital Recorders, Inc. in the
principal sum of $344,184.50 (incorporated herein by reference
to the Companys Report on Form 10-Q for the quarter ended
June 30, 2007)10.19
    
    Executive Employment Agreement, effective July 1, 2007, by and
between Mobitec GmbH and Mobitec AB and Oliver Wels
(incorporated herein by reference to the Companys Report on
Form 10-Q for the quarter ended March 31, 2008)10.20
    
    Extension Agreement, dated as of April 30, 2008 by and between
DRI Corporation and Digital Audio Corporation. (incorporated
herein by reference to the Companys Report on Form 8-K filed
on May 6, 2008)10.21
    
    Agreement, dated as of June 30, 2008, by and between DRI
Corporation and John D. Higgins (incorporated herein by
reference to the Companys current report on Form 8-K/A filed
with the SEC on August 14, 2008)10.22
    
    Revolving Credit and Security Agreement, dated as of June 30,
2008, by and among, PNC Bank, National Association, and
Digital Recorders, Inc., TwinVision of North America, Inc. and
DRI Corporation (incorporated herein by reference to the
Companys current report on Form 8-K/A filed with the SEC on
August 14, 2008)10.22.1
    
    Amendment No. 2 to Revolving Credit and Security Agreement,
dated as of September 29, 2008, by and between, PNC Bank,
National Association, and Digital Recorders, Inc., TwinVision
of North America, Inc. and DRI Corporation (filed herewith)10.23
    
    Revolving Credit Note, dated as of June 30, 2008, issued by
Digital Recorders, Inc., TwinVision of North America, Inc. and
DRI Corporation to PNC Bank, National Association
(incorporated herein by reference to the Companys current
report on Form 8-K/A filed with the SEC on August 14, 2008)
 29




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##### Table of Contents



Exhibit No.
    
    Document10.24
    
    Loan and Security Agreement, dated as of June 30, 2008, by and
among Digital Recorders, Inc., TwinVision of North America,
Inc. and DRI Corporation, and BHC Interim Funding III, L.P.
(incorporated herein by reference to the Companys current
report on Form 8-K/A filed with the SEC on August 14, 2008)10.24.1
    
    First Amendment to the Loan and Security Agreement, dated as
of July 30, 2008, by and among Digital Recorders, Inc.,
TwinVision of North America, Inc. and DRI Corporation, and BHC
Interim Funding III, L.P. (incorporated herein by reference to
the Companys current report on Form 8-K/A filed with the SEC
on August 14, 2008)10.25
    
    Senior Secured Term Note, dated as of June 30, 2008, issued by
Digital Recorders, Inc. and TwinVision of North America, Inc.
to BHC Interim Funding III, L.P. (incorporated herein by
reference to the Companys current report on Form 8-K/A filed
with the SEC on August 14, 2008)10.26
    
    Continuing Unconditional Guaranty, dated as of June 30, 2008,
granted by DRI Corporation in favor of BHC Interim Funding
III, L.P. (incorporated herein by reference to the Companys
current report on Form 8-K/A filed with the SEC on August 14,
2008)10.27
    
    Stock Pledge Agreement, dated as of June 30, 2008, by and
between DRI Corporation and BHC Interim Funding III, L.P.
(incorporated herein by reference to the Companys current
report on Form 8-K/A filed with the SEC on August 14, 2008)10.28
    
    Trademark Security Agreement, dated as of June 30, 2008, by
and between DRI Corporation and BHC Interim Funding III, L.P.
(incorporated herein by reference to the Companys current
report on Form 8-K/A filed with the SEC on August 14, 2008)10.29
    
    Trademark Security Agreement, dated as of June 30, 2008, by
and between Digital Recorders, Inc. and BHC Interim Funding
III, L.P. (incorporated herein by reference to the Companys
current report on Form 8-K/A filed with the SEC on August 14,
2008)10.30
    
    Trademark Security Agreement, dated as of June 30, 2008, by
and between TwinVision of North America, Inc. and BHC Interim
Funding III, L.P. (incorporated herein by reference to the
Companys current report on Form 8-K/A filed with the SEC on
August 14, 2008)10.31
    
    Copyright Security Agreement, dated as of June 30, 2008, by
and between Digital Recorders, Inc. and BHC Interim Funding
III, L.P. (incorporated herein by reference to the Companys
current report on Form 8-K/A filed with the SEC on August 14,
2008)10.32
    
    Copyright Security Agreement, dated as of June 30, 2008, by
and between TwinVision of North America, Inc. and BHC Interim
Funding III, L.P. (incorporated herein by reference to the
Companys current report on Form 8-K/A filed with the SEC on
August 14, 2008)10.33
    
    Patent Security Agreement, dated as of June 30, 2008, by and
between Digital Recorders, Inc. and BHC Interim Funding III,
L.P. (incorporated herein by reference to the Companys
current report on Form 8-K/A filed with the SEC on August 14,
2008)10.34
    
    Undertaking Concerning Loan Payment  for purposes other than
personal consumption, by and between Handelsbanken and Mobitec
AB (English translation). (incorporated herein by reference to
the Companys current report on Form 8-K/A filed with the SEC
on August 14, 2008)10.35
    
    Instrument for Debt A  Loan for purposes other than personal
consumption, by and between Handelsbanken, Mobitec AB (English
translation). (incorporated herein by reference to the
Companys current report on Form 8-K/A filed with the SEC on
August 14, 2008)10.36
    
    Factoring Agreement by and between Handelsbanken and Mobitec
AB (English translation). (incorporated herein by reference to
the Companys current report on Form 8-K/A filed with the SEC
on August 14, 2008)10.37
    
    EURO Short Term Loan Facility by and between Handelsbanken and
Mobitec GmbH (incorporated herein by reference to the
Companys current report on Form 8-K/A filed with the SEC on
August 14, 2008)
 30




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##### Table of Contents



Exhibit No.
    
    Document31.1
    
    Section 302 Certification of David L. Turney (filed herewith)31.2
    
    Section 302 Certification of Stephen P. Slay (filed herewith)32.1
    
    Section 906 Certification of David L. Turney (filed herewith)32.2
    
    Section 906 Certification of Stephen P. Slay (filed herewith)
 31




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##### Table of Contents



SIGNATURES
  DRI CORPORATIONSignature: 
By:
    
    /s/ Stephen P. Slay
Stephen P. SlayTitle:
    
    Chief Financial Officer
(Principal Financial and Accounting Officer)
 Date:
 32