SecProbe.io

CORRESP
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corresp

    Corporate Administration

5949 Sherry Lane, Suite 1050

Dallas, Texas 75225

Main:       (214) 378-8992

Toll-free: (800) 222-9583

Fax:          (214) 378-8437

www.digrec.com

October 29, 2004

VIA EDGAR

Ms. O. Nicole Holden

Staff Accountant

Securities and Exchange Commission

Division of Corporation Finance

Mail Stop 0308

450 Fifth Street, N.W.

Washington, D.C. 20549

     Re:  Digital
Recorders, Inc. Form 8-K filed September 10, 2004

Dear Ms. Holden:

     This letter responds to your letter dated September 24, 2004, in which you
set forth comments of the Division of Corporation Finance’s staff relating to
Digital Recorders’ Current Report on Form 8-K filed
September 10, 2004. In
response to numbered paragraphs 1 and 2 of your letter, we filed an amendment
on Form 8-K/A on September 30, 2004, for the purpose of making the
clarifications requested by those paragraphs. Ow former accountants reviewed
the disclosure contained in the amendment and provided us with a supporting
letter regarding the disclosure, which we filed as Exhibit 16 to
the Form 8-K/A.

     We have
provided the supplemental information that you requested in
numbered paragraphs 3 and 4 and the second paragraph under the heading “Form
10-K Item 9A and Forms 10-Q Item 4” in your letter in a chart enclosed with
this letter as Exhibit A. For ease of reference, we have included, verbatim, in
the left column of the chart the language from your letter that asks us to
provide supplemental information. The information responsive to each item is
set forth in the right column opposite such item in the chart.

     Pursuant
to numbered paragraph 3 of your letter, you have requested
information about reportable events. In the report described in the following
paragraph, our former auditors identified certain items that they considered to
be “reportable conditions”. Although we described such items in Item 4.01 of
our Form 8-K, it is our opinion that the only “reportable event,” as defined in
Section 304(a)(l)(v) of Regulation S-K, was the identification by our former
auditors of a material weakness in our internal controls over financial
reporting, which is the subject of numbered paragraph 4 of your letter. We have
nevertheless provided the supplemental information you have requested regarding
those reportable conditions.

Ms. O. Nicole Holden

October 29, 2004

Page 2

     As requested in numbered paragraph 5 of your letter, I am enclosing with
this letter as Exhibit B the SAS 61 Report by Mr. McGladrey & Pullen, our
former auditors, to the Audit Committee dated April 13, 2004.

     I am also enclosing the following documents:

    •

    Exhibit C: Our former auditors’ Report to our Audit Committee dated
March 31, 2004;

    •

    Exhibit D: Memorandum dated April 8, 2004, from our former CFO, Mr.
Larry Taylor, to Mr. Colby Daughtry, engagement partner with
McGladrey & Pullen, relating to an item of disagreement between us
and our former auditors (deferred taxes and valuation allowance),
with attachment;

    •

    Exhibit E: Memorandum dated August 5, 2004, from Mr. Taylor and
Mr. Bedford Moss of the Company to Mr. Keith Wallace, a partner with
McGladrey & Pullen, briefly addressing two of the items of
disagreement between us and our former auditors (Series F accounting
treatment and deferred tax asset assessment); and

    •

    Exhibit F: A document containing a compilation of emails of various
dates between our management or Audit Committee members and our
former auditors, and certain related attachments, regarding the
matters identified by the former auditors in their April 13, 2004 SAS
61 Report to our Audit Committee as evidence of a material weakness
or reportable condition or as being the subject of a disagreement
with management.

     In determining which items of correspondence to include in response to
your request, we have included emails or other communications that contain
substantive discussion of the matters identified in our former auditors’ April
13, 2004 SAS 61 Report as evidence of a material weakness or reportable
condition or as the subject of a disagreement. We have omitted certain
correspondence that mentions those matters in an incidental or nonsubstantive
manner. As you have discussed with our counsel, we have also redacted language
from the enclosed correspondence that does not relate to items described in the
first sentence of this paragraph, as well as other extraneous information such
as certain worksheets delivered with emails and personal information (such as
individuals’ telephone extensions and email addresses).

     Also, we note that in the ordinary course of the relationship between a
company and its independent auditors, there may be communications in which
opinions (for example, regarding preliminary or alternative possible
interpretations or applications of accounting principles) are expressed,
discussed and resolved in due course prior to completion of the audit review
process. We have not included copies of any correspondence that may reflect
such an “ordinary course” exchange of opinions, unless the correspondence also
related to one of the disagreements noted by our former auditors in
their April 13, 2004 Report or to an item stated by our former auditors
in that Report to be evidence of a material weakness or reportable condition.
If you have any

Ms. O. Nicole Holden

October 29, 2004

Page 3

questions about our method for determining which documents to enclose with this
letter, I will be happy to discuss it with you.

     The undersigned, on behalf of the Company, acknowledges that:

    •

    the Company is responsible for the adequacy and accuracy of the
disclosure in its filings;

    •

    staff comments or changes to disclosure in response to staff
comments in the filings reviewed by the staff do not foreclose the
Commission from taking any action with respect to the filing; and

    •

    the Company may not assert staff comments as a defense in any
proceeding initiated by the Commission or any person under the
federal securities laws of the United States.

     If you have questions about any of our responses or require additional
information, please contact me at (214) 378-9429 or by telecopy at (214)
378-8437.

    Sincerely,

    David L. Turney

Chairman, CEO and President

Enclosures

Exhibit A

    3

    In detail, supplementally describe the nature of each reportable event and the amounts involved, if any. Also, tell us in what period the reportable event occurred and whether or not
you restated (or intend to restate) any prior period for any adjustment resulting from the reportable event; and if not, why not. Tell us in detail the steps you have taken (or plan
to take) and procedures you implemented (or plan to implement) to correct each reportable event.

    SEC Comment

    Company Response

    In detail, supplementally describe the nature of each reportable event and the amounts involved,
if any.

    In its reports to our Audit Committee dated March 31, 2004, and April 13, 2004 (the “Committee
Reports”), our former auditors identified three matters that they considered to be “reportable
conditions,” but were not considered to be material weaknesses. The following describes the reportable
conditions identified by our former auditors in the Committee Reports:

    (i) Segregation of employee duties: The former auditors noted an inadequate segregation of duties
relating to financial matters at two of our foreign subsidiaries, Mobitec AB and Transit-Media Mobitec.
The former auditors did not indicate that this condition related to any specific dollar amount.
During 2003, the gross revenues generated by those two subsidiaries represented approximately 20.3% and
11.2%, respectively, of our consolidated net sales.

    (ii) Capitalized Software: Our former auditors noted that we did not maintain documentation organized
in such a fashion as to support the capitalization of software development costs related to our DR 600
product. This product was developed internally at our Digital Recorders business unit. The lack of
organized documentation made it difficult to determine the establishment of technological feasibility
and to meet the requirements for capitalization of the software development costs. The aggregate
amount of capitalized software development costs in fiscal 2003 was $724,262, including $333,276
relating to the DR 600.

    (iii) Inter-Company Reconciliation and Translation Gains/Losses: Our former auditors noted that we did
not have a formal procedure in place to reconcile inter-company accounts and transactions in accordance
with FAS 52. Among other things, as described in the Committee Reports, the former auditors noted that
there were transactions between companies that did not agree and that some of the unpaid inter-company
transactions not deemed to be investments were not being adjusted for foreign currency fluctuations to
the income statement but instead to the equity adjustment account. No specific dollar amount was
related to this comment because all amounts were corrected in our Annual Report on Form 10-K/A. The
2003 financial statements reflect $4,684 of net inter-company transaction gains in net income and
$17,654 of net other comprehensive losses in equity from inter-company translation gains and losses.

The former auditors noted our determination to continue to treat certain 2003 and prior inter-company
transactions as investments between companies, based on our intention not to settle them in the
foreseeable

- 1 -

    SEC Comment

    Company Response

    future. The transactions to which this determination related were primarily transactions
not occurring in the ordinary course of business, principally advances to support long-term operations,
similar to equity investments. Settlement was, and continues to be, planned for transactions involving
sales and services in the ordinary course of business.

    Also, tell us in what period the reportable event occurred...

    Our former auditors identified the reportable conditions during the conduct of the 2003 annual audit,
and the conditions related to segregation of duties, software capitalization and inter-company
reconciliations during 2003. Our former auditors noted segregation of duties at our Transit Media GmbH
subsidiary, which subsequently merged with another subsidiary to form Transit-Media Mobitec, as a
reportable condition in connection with their audit of our 2002 financial statements.

    . . . and whether or not you restated (or intend to restate) any prior period for any adjustment
resulting from the reportable event; and if not, why not.

    None of the reportable conditions noted in connection with the 2003 annual audit required or require
restatement of our financial information for any prior period. No uncorrected misstatements identified
in connection with the 2003 annual audit, either individually or in aggregate, were material to our
financial statements taken as a whole. Similarly, there were no errors in any prior or subsequent
quarter that would require restatement of any of our financial statements. In the notes to the audited
financial statements for our fiscal year ended December 31, 2002, included in our Annual Report on Form
10-K for that year, we included restated unaudited interim financial information for each of the first
three quarters of that year and the associated year-to-date periods (1) to reclassify certain project
development costs to a capitalized software asset in the amount of $185,938, and (2) to reclassify
foreign currency translation gains of $379,984. (The reclassification of software development costs
did not relate to a reportable condition identified by our former auditors but, instead, to a
correction of a misapplication of FAS 86 in connection with the 2002 audit.) Those changes had no
impact on our reported cash flows provided by operations.

    Tell us in detail the steps you have taken (or plan to take) and procedures you implemented (or
plan to implement) to correct each reportable event.

    The Company is in the process of evaluating and improving its internal controls over financial
reporting and developing plans for further improvements in connection with its ongoing efforts to
comply with Section 404 of the Sarbanes-Oxley Act. These plans are described later in this document,
in response to the staff’s comment regarding steps taken and procedures implemented to correct the
material weakness. The specific steps that we have taken in
connection with each of the three reportable
conditions identified above are as follows:

    (i) Segregation of Employee Duties: Our Mobitec AB subsidiary has three accounting and clerical staff
members, and our Transit-Media Mobitec subsidiary has one accounting staff member. At Mobitec AB, the
larger of the two operations, we established procedures designed to improve segregation of duties
during the first quarter of 2004 by assigning primary responsibility for certain critical transactions
to the Accounting Supervisor and other staff, with back-up and review of these transactions by the
Finance Manager.

    Because of the small size of current operations at Transit-Media Mobitec, and because the number and
amount of cash transactions at this subsidiary are very small, we have not yet provided for additional
segregation of employee duties. Senior financial management of Mobitec AB, the business unit to which
Transmit-Media

- 2 -

    SEC Comment

    Company Response

    Mobitec reports, has been directed to provide additional oversight and review of the
operations and financial results of Transit-Media Mobitec. As our operations grow, we will add
additional staff at these subsidiaries to further segregate duties.

    (ii) Capitalized Software: We began implementing enhanced procedures at our Digital Recorders business
unit in the third quarter of 2004 that call for more detailed and organized documentation regarding the
progress of each development project and testing that occurs during the process. Specifically, the
procedures require that our technical personnel involved in the project submit reports to financial
management on a monthly basis. In addition, we will develop more detailed product design and business
plans at the time of commencement of each future project. The new procedures are now being used with
respect to five ongoing projects that we commenced during 2003 and 2004. During the first two quarters
of 2004, prior to the implementation of our enhanced procedures, we increased senior management reviews
of both the quarterly technical reports and the determinations by our accounting staff impacting
capitalization.

    (iii) Inter-Company Reconciliation and Translation Gains/Losses: We acknowledge that during the nine
months ended September 30, 2003, foreign currency transactions included in inter-company clearing
accounts were recorded as part of the accumulated other comprehensive income component of equity. The
majority of the inter-company transactions or sale of product occur between foreign subsidiaries,
rather than between the parent company or a domestic subsidiary and a foreign subsidiary. The
currencies involved were relatively stable, the transactions were settled in a relatively short time
and, therefore, any transaction gain or loss to be recognized was immaterial. Since that time,
including the fourth quarter of 2003 and all periods in 2004, foreign currency translation gains and
losses have been recorded as an equity adjustment and transaction gains and losses have been reflected
in the income statement in accordance with FAS 52.

    We have developed improved procedures relating to reconciliation of inter-company accounts, pursuant to
which we reconcile and balance on a monthly basis all accounts between entities in both the reporting
and functional currencies of the foreign subsidiary. We have also revi