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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended October 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 0-16231
XETA Technologies, Inc.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1130045
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification No.)
organization)
1814 West Tacoma, Broken Arrow, Oklahoma 74012
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (918) 664-8200
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant as of December 31, 2001 (based upon the
average bid and asked prices of such shares) was approximately $39,252,374.
The number of shares outstanding of the registrant's Common Stock as of
December 31, 2001 was 9,237,952 (excluding 1,018,788 treasury shares). Exhibit
Index appears at Page 23.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement to be filed with the Securities and
Exchange Commission in connection with the Annual Meeting of Shareholders to be
held March 28, 2002 are incorporated into Part III, Items 11 through 13 hereof.
PART I
ITEM 1. BUSINESS
DEVELOPMENT AND DESCRIPTION OF BUSINESS
XETA Technologies, Inc. (the "Company"), an Oklahoma corporation formed in
1981, is in the midst of a planned three-year effort to transform itself from a
niche player in the hospitality market to a nation-wide leader of integrated
communications solutions. In fiscal 2001, the Company continued to execute on
this vision while at the same time battled rapidly deteriorating market
conditions that forced adjustments to some of the short-term tactics employed to
reach that vision.
In late 1999, the Company initiated its expansion strategy through a
balanced approach of organic growth and strategic acquisitions. The immediate
goals of this strategy were to: 1) establish a nation-wide presence delivering
traditional voice solutions to commercial customers; 2) add more complex
communications applications to the product mix such as call centers, unified
messaging, and voice-over-Internet Protocol ("VoIP"); and 3) begin introducing
professional and consulting services. Between November 1999 and November 2000,
the Company made 4 acquisitions and established 6 new sales offices. The
acquisitions included one large, nation-wide dealer of Avaya, Inc. ("Avaya")
products, a smaller regional Avaya dealer, a data networking company located in
the Midwest, and a professional services firm located in the northwestern U.S.
With the strategic pieces in place, the Company approached fiscal 2001 as a
year of transformation. Specifically, management focused its attention on three
areas: 1) transforming the Company's product lines from slower growing voice
oriented products to faster growing segments such as data, Microsoft Exchange,
and IP capabilities, including LAN/WAN network consulting and implementation; 2)
transforming the sales and service teams to prospect and serve these
faster-growing product segments; and 3) transforming the Company's information
technology systems through the implementation of a new enterprise resource
planning ("ERP") system.
However, shortly after the beginning of the fiscal year, the Company
encountered the rapidly declining market conditions that have plagued the
technology sector of the U.S. economy throughout the year. While not altering
its overall expansion strategy or its transformation activities for fiscal 2001,
in April 2001 the Company positioned itself for the changing market conditions
by implementing a workforce reduction of approximately 20% and reducing
officers' salaries between 10% and 25%. Also, the fees paid to outside directors
were reduced 20%. As a result of these actions, the Company remained profitable
and generated positive cash flows despite market driven quarter-over-quarter
revenue declines in every quarter of the year. Simultaneously, the Company
largely achieved its transformation initiatives with the most significant
remaining item being the final implementation of the new ERP platform.
On October 31, 2001, the Company completed a restructuring of its credit
facility with its bank group. The restructuring was in response to the overall
market conditions, which have lowered the profitability of the Company. The
effects of the restructuring, which is more fully described under "Liquidity and
Capital Resources" in the "Management Discussion and Analysis" below, are to
expand the Company's available credit under its working capital revolver, reduce
the monthly principal payments by approximately 50%, and lower the threshold for
some of the financial covenants contained in the credit facility.
COMMERCIAL PRODUCTS
The Company sells Avaya telecommunications and converged products to
commercial customers. The Company sells a wide range of communications servers
offered by Avaya, including DEFINITY(R) Solutions, MERLIN MAGIX(TM) Systems
and the PARTNER(R) Communications Systems products, which are designed to
meet the needs of large, medium and small users, respectively. The Company also
sells Avaya voice mail, unified messaging and customer relationship management
("CRM") systems. Each of the products listed above have various models available
depending on the feature set and size of the customer's application. In addition
to selling Avaya systems, the Company enjoys a strong business selling
aftermarket components such as additional phone sets, headsets, circuit packs,
etc.
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In addition to traditional voice products, the Company also sells converged
network solutions combining voice and data traffic over the same network through
product offerings from Avaya and Cisco. By using a single network for all
traffic, customers can achieve significant cost savings by cutting duplication,
simplifying administration and getting more value from their existing data
network. The Avaya VoIP solutions are marketed under the name Enterprise Class
IP Solutions (ECLIPS) and Office IP and are full VoIP solutions designed to
replace existing circuit-based PBX's. The Company can also provide a migration
path from existing PBX's to "IP-enabled" switches to preserve a customer's
investment and comfort in its existing and proven technology while still gaining
most of the cost and feature advantages of VoIP. During fiscal 2001, one of the
Company's major transformation initiatives was to train the Company's sales and
service staffs to prospect, design and install these new IP-based products. By
the end of fiscal 2001, fully 50% of all new, large systems being sold were
IP-enabled or fully IP based systems.
HOSPITALITY PRODUCTS
Communications Systems. The Company distributes Avaya's DEFINITY(R)
Guestworks(TM) Systems and Hitachi's 5000(R) Series Digital Communications
Systems to the hospitality industry under nationwide, non-exclusive dealer
agreements with both vendors. Both of these systems are equipped with lodging
specific software, which integrates with nearly all aspects of the hotel's
operations. The Company also offers a variety of related products such as voice
mail systems, analog telephones, uninterruptible power supplies, announcement
systems, and others, most of which also have lodging specific software features.
Most of these products are sold in conjunction with the sale of new
communications systems and, with the exception of voice mail systems, are
purchased from regional and national suppliers. Sales of communications systems
to the lodging industry represented 12%, 13%, and 35% of total revenues in
fiscal 2001, 2000, and 1999, respectively.
Call Accounting Products. The Company markets a line of proprietary call
accounting systems under the Virtual XL(R) ("VXL") series name. Introduced in
1998, the VXL is a PC-based system designed to operate on a hotel's local or
wide area network, and if that network is connected to the Internet, the VXL can
also be accessed via an Internet connection. The VXL systems are the Company's
latest technology in a series of call accounting products the Company has
successfully marketed since its inception. Many of the Company's earlier
products remain in the field and are supported by the Company's service and
technical staff.
INSTALLATION AND SERVICES
Since the Company's inception, installation and service of the Company's
products has been the key differentiator between the Company and its
competitors. The Company has had nationwide, 24 hour-per-day service
capabilities for over 15 years and utilizes extensive remote servicing
capabilities to help quickly diagnose technical problems. As the Company has
expanded during the past two years in accordance with its overall growth vision,
the installation and service capabilities that have long been established in the
lodging sector have been overlayed to the Company's new commercial operations.
As such, the Company can provide consistent installation and service standards
to large, complex, multi-location customer applications.
For its distributed products, the Company typically passes on the
manufacturer's limited warranty, which is generally one year in length. Labor
costs associated with fulfilling the warranty requirements are generally borne
by the Company. For proprietary call accounting products sold to the lodging
industry, the Company provides its customers with a limited one-year warranty
covering parts and labor. Subsequent to the expiration of the warranty, the
Company offers a wide range of after-market service contracts to both its
lodging and commercial customers under one year and multi-year service
contracts. The Company earns a significant portion of recurring service revenues
from lodging customers who maintain service contracts on their systems. To date,
the Company has had limited success in selling these service contracts to its
commercial customer base, primarily because many of the Company's customers have
existing relationships with Avaya. While the Company intends to continue to
offer its own post-warranty maintenance contracts to commercial customers, there
can be no assurance given as to the success of this service offering. See a
further discussion of the Company's partnering relationship with Avaya under
"Marketing" below.
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NETWORKING PRODUCTS AND PROFESSIONAL SERVICES
As a result of acquisitions, training and strategic hiring of personnel,
the Company has developed expertise in a wide range of networking and consulting
applications. These services include LAN/WAN assessments, enterprise network
design and implementation, Microsoft exchange customizations, Virtual Private
Networks ("VPN"), Unified Messaging (UM), network security audits, and wireless
networking solutions. In addition to Avaya products, the Company also provides
Cisco, Novell, and Microsoft products in implementing these solutions.
SOFTWARE AND PRODUCT DEVELOPMENT
The Company has traditionally developed proprietary telecommunications
products specifically for the lodging industry. However, as a result of the
Company's expansion into the general commercial market, the Oracle ERP system
implementation project, and other various changes in technology which have
decreased the importance of call accounting systems in the lodging industry, the
Company has redirected its development resources toward internal IT needs.
Management does not expect a significant change in this strategy in the near
future.
MARKETING
The Company's target markets in the commercial sector are mid-sized to
large, multi-location customers with complex applications, which enables the
Company to leverage its nation-wide presence and its ability to deliver
consistent implementations at multiple customer locations. The Company markets
its products and services to the commercial market through its direct sales
force and through relationships with Avaya's direct sales force under Avaya's
Business Partner program. This program is part of Avaya's announced corporate
strategy of moving significant portions of its equipment sales revenues into its
dealer channels. As such, the Company markets its implementation abilities to
Avaya's direct sales force as well as directly to end-users. When partnering
with Avaya to provide design, equipment and installation of communications
solutions to customers, the Company usually works directly with the customer,
takes title to the inventory prior to its shipment to the customer and is
responsible for the entire implementation project.
In marketing its products and services to the hospitality industry, the
Company relies heavily on its experience and reputation in the industry to build
long-term relationships with the wide range of personnel (corporate hotel chain
personnel, property management officials, industry consultants, hotel owners,
and on-site financial or operating officers) that can be the key decision makers
for the purchase of hotel telecommunications equipment. The Company has
relationships with nearly all hotel chains and major property management
companies. These relationships are one of the keys to the Company's past and
future success. Typically, the Company focuses its marketing expenditures on
efforts to continue to strengthen these relationships rather than broad
promotional efforts that are employed in the commercial market. However, the
Company does offer a variety of sales programs to the lodging industry, the most
significant of which is the XETAPLAN program. Under the XETAPLAN program,
customers are provided one of the Company's call accounting products for a
period of three to five years in exchange for a monthly fee paid to the Company.
Service on the products is also included in the contract. For communications
systems it sells to the lodging industry, the Company offers a package of
value-added services including a call accounting system and a service package
with a specified number of free labor hours and weekly appointments with
certified technicians to correct minor malfunctions or to perform routine
maintenance. The Company does not anticipate expanding its hospitality-market
sales force in fiscal 2001.
MAJOR CUSTOMERS
During fiscal 2001, the Company did not have any single customer that
comprised more than 10% of its revenues.
COMPETITION
Commercial. The Company faces intense competition in the commercial market
from other Avaya dealers as well as other manufacturers and their respective
distribution channels. However, while acquisition cost will always be a
4
competitive factor, increasingly, the ability to design communications systems
to maximize worker productivity and minimize the administration costs for the
customer's IT department are of increasing importance and is a key
differentiator between the Company and its competition. As a result of
acquisitions as well as strategic hiring and training programs, the Company can
provide the full range of products and services required to meet the needs of
multi-location customers. This range of products and services includes: 1)
traditional product offerings (voice and data systems, messaging servers,
aftermarket components), 2) traditional services (maintenance, installation,
time and materials services), 3) network consulting (architecture, design,
integration, and project management), and 4) emerging applications (voice over
IP telephony, unified messaging, call centers, and virtual private networks).
Management believes that by having this full range of product and service
offerings, the Company can provide a one-stop solution to customers needs while
maintaining consistent quality of service. Also, the Company is able to prospect
for customers on a variety of fronts, address the customer's needs, and then
introduce them to other product and service capabilities.
Hospitality. The Company believes that its most effective weapon in
competing in the hospitality market is its commitment to differentiate itself by
concentrating on the performance and reliability of its systems and by providing
the highest level of service possible. Competition in this market is fierce and
competitors range from large, well-known, well-financed companies to small,
regional or local distributors, many of whom do not concentrate on the
hospitality market but are simply located near the prospective customer. While
the Company believes that its reputation and nation-wide presence contribute
significantly to its success, there can be no assurance given that the Company
will be able to continue to expand its market share in the future.
MANUFACTURING
The Company assembles all of its proprietary products, which include the
Virtual XL(R), XPERT(R) and XPANDER(R) systems, from an inventory of
components, parts and sub-assemblies obtained from various suppliers. These
components are purchased from a variety of regional and national distributors at
prices which fluctuate based on demand and volumes purchased. Some components,
although widely distributed, are manufactured by a single, usually foreign,
source and are therefore subject to shortages and price fluctuations if
manufacturing is interrupted. The Company maintains adequate inventories of
components to mitigate short-term shortages and believes the ultimate risk of
long-term shortages is minimal. The Company's proprietary products are based on
PC technology, which is continually and rapidly changing. As a result, some of
the components originally designed for use in the Company's systems have been
phased out of production and replaced by more advanced technology. To date,
these substitutions have not forced the Company to substantially redesign its
systems and there has been minimal effect on the overall system cost. There can
be no assurance given, however, that future obsolescence of key components would
not result in unanticipated delays in shipments of systems due to redesign and
testing of assemblies.
The Company uses outside contractors to assemble its proprietary printed
circuit boards. The components and blank circuit boards are purchased and
inventoried by the Company and supplied to the outside contractor for assembly
and quality control testing. The Company performs various quality control
procedures, including powering up completed systems and allowing them to
"burn-in" before being assembled into a final unit for a specific customer
location, and performing final testing prior to shipment.
EMPLOYEES
At December 31, 2001, the Company employed 299 employees, including 1
part-time employee.
5
COPYRIGHTS, PATENTS AND TRADEMARKS
The Company has never applied for patent protection on its hardware or
software technology with the exception of the technology for XPANDER(R), for
which the Company has a patent pending. The Company claims copyrights on all of
its proprietary circuit boards and software.
While the Company believes that the ownership of patents, copyrights and
registered trademarks is less significant to its success than its proprietary
technology, quality and type of service and technical expertise, the Company
recognizes that its reputation for quality products and services gives value to
its product names. Therefore, the Company has registered as United States
domestic trademarks the names "XETA," "XETAXCEL," "XACT," "XPERT," "XPERT+,"
"XL," "XPANDER," and "Virtual XL" for use in the marketing of its services and
systems. All of these marks are registered on the principal register of the
United States Patent and Trademark Office ("PTO"), with the exception of
XPANDER(R), which is registered on the supplemental register.
GOVERNMENT REGULATION
The Federal Communications Commission (the "FCC") and state governments
regulate the telecommunications industry. None of the Company's business
activities, however, are directly regulated by the FCC or the states. None of
the Company's products or services require approval from any governmental
agency.
The Company's computer products are subject to radio frequency emanation
and electrical safety standards imposed by the FCC. The cost of complying with
such standards, as well as with any applicable environmental laws, is
immaterial.
ITEM 2. PROPERTIES
The Company's principal executive office and Service Center are located in
a 37,000 square foot, Company-owned, single story building located in a suburban
business park near Tulsa, Oklahoma. This facility also houses the Company's
warehouse and assembly areas to support its hospitality sales channel. The
building is located on a 13-acre tract of land. The property is subject to a
mortgage held by Bank One, Oklahoma, NA, to secure the Company's credit
facility.
The Company's commercial channel shipping operations are primarily located
in leased facilities in St. Louis, Missouri. In addition to the warehouse, this
facility houses sales staff, technical design, professional services, and
installation support personnel. The Company leases other office space throughout
the U.S. for sales, consulting, and technical staff. Additionally, the Company
has informal office arrangements with its regional technicians to allow for some
storage of spare parts.
ITEM 3. LEGAL PROCEEDINGS
Since 1994, the Company has been monitoring numerous patent infringement
lawsuits filed by PHONOMETRICS, INC., a Florida company, against certain
telecommunications equipment manufacturers and hotels who use such equipment.
While the Company has not been named as a defendant in any of these cases,
several of its call accounting customers are named defendants. These customers
have notified the Company that they will seek indemnification under the terms of
their contracts with the Company. However, because there are other equipment
vendors implicated along with the Company in the cases filed against its
customers, the Company has never assumed the outright defense of its customers
in any of these actions.
All of the cases filed by Phonometrics against the Company's customers were
originally filed in, or transferred to, the United States District Court for the
Southern District of Florida. In October 1998 the Florida Court dismissed all of
the cases filed against the hotels for failure to state a claim, relying on the
precedent established in Phonometrics' unsuccessful patent infringement lawsuit
against Northern Telecom. Phonometrics appealed the Florida court's order and
the United States Court of Appeals for the Federal Circuit reversed the District
Court's dismissal of the cases, but did so solely upon the basis of a procedural
matter. The Appeals Court made no ruling with respect to the merits of
Phonometrics' case and
6
remanded the cases back to the Florida court for further proceedings. These
cases were reopened in April 2000. Thereafter Phonometrics filed motions to
disqualify the District Court judge hearing the cases. These motions were denied
by the District Court and Phonometrics appealed the denial. The cases were
stayed by the District Court pending the outcome of this appeal. In November
2001 several defendant hotels filed motions for summary judgment. The District
Court issued an order lifting the stay on the cases only for purposes of hearing
motions for summary judgment. The Company will continue to monitor proceedings
in these actions.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
7
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
The Company's Common Stock, $.001 par value, is currently traded on the
over-the-counter market and is reported in the National Association of
Securities Dealers Automated Quotation ("NASDAQ") System under the symbol
"XETA."
The high and low bid prices for the Company's Common Stock, as reported by
the National Association of Securities Dealers through its NASDAQ System, for
each of the quarters during the Company's two most recent fiscal years are set
forth below. These prices reflect inter-dealer prices, without adjustment for
retail mark-ups, mark-downs or commissions and may not necessarily represent
actual transactions.
2001 2000
---- ----
High Low High Low
---- --- ---- ---
Quarter Ending:
January 31 12.00 8.31 22.06 9.66
April 30 11.63 5.01 33.94 15.53
July 31 6.40 4.26 23.75 10.88
October 31 6.02 3.49 19.00 8.00
The Company has never paid cash dividends on its Common Stock. Payment of
cash dividends is dependent upon the Company's earnings, capital requirements,
overall financial condition and other factors deemed relevant by its Board of
Directors. The Company is currently prohibited from paying cash dividends by its
credit facility.
As of December 31, 2001, the latest practicable date for which such
information is available, the Company had 173 shareholders of record. In
addition, based upon information received annually from brokers holding stock in
the Company on behalf of beneficial owners, the Company has approximately 8,113
beneficial shareholders.
8
ITEM 6. SELECTED FINANCIAL DATA.
For the Year Ending October 31 2001 2000 1999 1998 1997
--------- --------- --------- --------- ---------
Results of Operations
Commercial equipment sales $ 41,964 $ 54,199 $ 0 $ 0 $ 0
Installation and Service sales 33,105 31,220 18,766 13,220 9,355
Lodging systems sales 10,064 16,032 17,857 11,232 9,238
Other revenues 921 968 640 995 167
--------- --------- --------- --------- ---------
Total Revenues 86,054 102,419 37,263 25,447 18,760
Cost of commercial equipment sales 29,812 37,403 -- -- --
Cost of installation and services 23,512 21,627 12,206 8,536 5,884
Cost of Lodging systems 6,449 10,077 10,412 7,141 5,674
Cost of other revenues and corporate COGS 2,759 2,482 655 775 400
--------- --------- --------- --------- ---------
62,532 71,589 23,273 16,452 11,958
Gross Profit 23,522 30,830 13,990 8,995 6,802
Operating expenses 16,173 18,452 7,622 4,757 4,139
Income from operations 7,349 12,378 6,368 4,238 2,663
Interest and other income (1,623) (1,761) 665 671 667
--------- --------- --------- --------- ---------
Income before taxes 5,726 10,617 7,033 4,909 3,330
Provisions for taxes 2,245 4,156 2,750 1,855 1,190
--------- --------- --------- --------- ---------
Net income $ 3,481 $ 6,461 $ 4,283 $ 3,054 $ 2,140
========= ========= ========= ========= =========
Earnings per share - Basic $ 0.38 $ 0.77 $ 0.53 $ 0.38 $ 0.27
Earnings per share - Diluted $ 0.36 $ 0.66 $ 0.46 $ 0.33 $ 0.23
Weighted Average Common Shares 9,061 8,350 8,021 8,120 8,024
Outstanding
Weighted Average Common Share Equivalents 9,698 9,762 9,254 9,372 9,460
As of October 31 2001 2000 1999 1998 1997
--------- --------- --------- --------- ---------
Balance Sheet Data:
Working Capital $ 11,214 $ 15,145 $ 8,021 $ 5,122 $ 6,944
Total Assets 67,285 74,149 25,316 18,292 14,820
Long Term Debt 14,853 17,983 -- -- --
Shareholders' Equity 31,197 25,565 14,551 11,185 9,337
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS, WHICH ARE
SUBJECT TO THE PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995. THESE STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS CONCERNING
EXPECTATIONS REGARDING: THE COMPANY'S FINANCIAL POSITION INCLUDING SALES,
REVENUES, GROSS MARGINS, OPERATING MARGINS AND EXPENSES; TRENDS AND CONDITIONS
IN THE U.S. ECONOMY AND IN THE COMMUNICATIONS TECHNOLOGY INDUSTRY AND
HOSPITALITY MARKETS; AND THE COMPANY'S ABILITY TO IMPLEMENT ITS CURRENT BUSINESS
PLAN. THESE AND OTHER FORWARD-LOOKING STATEMENTS (GENERALLY IDENTIFIED BY SUCH
WORDS AS "EXPECTS," "PLANS," BELIEVES," "ANTICIPATES" AND SIMILAR WORDS OR
EXPRESSIONS) ARE NOT GUARANTEES OF PERFORMANCE BUT RATHER REFLECT MANAGEMENT'S
CURRENT EXPECTATIONS, ASSUMPTIONS AND BELIEFS BASED UPON INFORMATION CURRENTLY
AVAILABLE TO MANAGEMENT. INVESTORS ARE CAUTIONED THAT ALL FORWARD-LOOKING
STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES WHICH ARE DIFFICULT TO
PREDICT AND THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
PROJECTED. MANY OF THESE RISKS AND UNCERTAINTIES ARE DESCRIBED UNDER THE HEADING
"OUTLOOK AND RISK FACTORS" BELOW. CONSEQUENTLY, ALL FORWARD-LOOKING STATEMENTS
SHOULD BE READ IN CONJUNCTION WITH THE RISK FACTORS DISCUSSED HEREIN AND
THROUGHOUT THIS REPORT.
For the fiscal year ending October 31, 2001, the Company reported net
income of $3.5 million on revenues of $86 million. These results reflect the
deteriorating market conditions experienced by the Company throughout fiscal
2001. Although first quarter revenues were 22% higher on a year-over-year basis,
the Company reported sequential quarterly revenue declines for the remainder of
the year. These declines were primarily due to overall market conditions as
customers deferred spending decisions to conserve capital and evaluate economic
developments. The Company responded to these market conditions by intently
focusing on its cost structure and by improving its operational efficiencies.
Despite the current recession in the U.S. economy as a whole and
particularly in the technology sector, management remains fully confident in its
overall vision to dramatically expand the Company and capitalize on the
converging world of voice and data technology. To this end, the Company
continued its transformation efforts during fiscal 2001 by continuing to
integrate its acquired capabilities in LAN/WAN, Unified Messaging, Microsoft
Exchange and IP technologies, re-direct its sales and service employees from
slower to faster growing segments of the market (i.e. from traditional voice
products to converged application products), and work on the implementation of
its new ERP system.
Near-term economic conditions remain too murky to predict, however
management is cautiously optimistic regarding fiscal 2002 as a whole and
therefore, in the fourth quarter, a careful expansion of its sales force was
begun. Management believes that the first step toward a future expansion of its
business is to prove that it can maintain constant quarter-over-quarter revenues
in the current business climate. From there, management believes that, with its
new cost structure, revenues can be expanded at a faster rate than operating
expenses when the overall market conditions improve.
RESULTS OF OPERATIONS
Year ending October 31, 2001 compared to October 31, 2000. Net revenues for
fiscal 2001 were $86.1 million compared to $102.4 million for fiscal 2000, a 16%
decline. Net income for fiscal 2001 was $3.5 million compared to $6.5 million
for the previous year, a 46% decline. Discussed below are the major revenue,
gross margin, and operating expense items that affected the Company's financial
results during fiscal 2001 as well as management's current expectation for those
items for the coming year.
Commercial Equipment Sales. Sales of equipment to commercial customers in
fiscal 2001 were $41.96 million representing a 23% decrease from the previous
year. This decrease is the result of overall market conditions that deteriorated
throughout the year. Beginning late in the Company's first quarter, order rates
for new equipment became erratic. By the end of the Company's second quarter, a
clear decline in order rates was apparent and visibility into the near-term was
murky. That condition has continued to the present, as customers perceive the
need to use their available capital cautiously until a clear economic recovery
is underway. Management believes that its customers have deferred buying
decisions temporarily rather than canceling capital spending.
A significant portion of the Company's commercial equipment sales are
derived from its "Business Partner" relationship with Avaya Communications, Inc.
("Avaya"). Avaya is pursuing a strategy of moving a greater portion of its
10
revenues through its dealer sales channel. The Company, with its nation-wide
sales and implementation capabilities, is well positioned to take advantage of
this strategy. As such, the Company carefully cultivates relationships with the
Avaya sales team. Under these arrangements, the Company takes title to the
equipment and then sells it directly to the end-user customer. The Company bears
the collection and warranty risks. Management believes that revenues from these
"partnering" activities will continue to represent a significant portion of its
business in the future.
Lodging Systems Sales. Sales of communications systems to the lodging
industry (including "other revenues") were $10.98 million for fiscal 2001,
representing a decline in revenues of $6.0 million or 35%. This decline reflects
the recession being experienced in the overall U.S. economy and, more
particularly, in the lodging sector. Also, the decline reflects the fact that
many hotels upgraded their communications systems during the Year 2000 ("Y2K")
upgrade cycle and, therefore, do not perceive a need for new systems at this
time. Finally, the events of September 11th had an immediate and negative impact
on the lodging industry, but it is still unclear what the long-term impact will
be. Management believes that it is likely that sales of lodging systems will
remain at depressed levels until the economy has sufficiently recovered to spur
new construction and major renovation programs.
Installation and Service Revenues. Revenues derived from installation and
service activities increased $1.9 million or 6% to $33.1 million in fiscal 2001.
This increase consists of sales of professional services from the Company's
acquired networking and professional services organizations, partially offset by
decreased revenues from installation activities due to lower equipment and
systems sales as discussed above. Revenues earned from maintenance contracts
were relatively constant. The addition of data networking and consulting
capabilities is a key component in the Company's overall vision for expansion.
As voice and data technologies have converged and as more advanced applications
of those technologies are being developed, the complexity of communications
systems design and implementation has increased significantly. The Company's
acquisition of Pro Networks, Inc., a data networking company, and KMI, Inc., a
professional consulting company, in November of 2000 were important pieces of
the Company's overall strategy and represent the nucleus from which the Company
is building its expertise in the design and implementation of these new,
complex, converged systems. Furthermore, management believes that the quality of
the Company's implementation and service capabilities will ultimately be the key
differentiator that drives customer satisfaction and retention. Management
believes that the outlook for this revenue stream in fiscal 2002 is dependent
upon its ability to increase sales of new systems.
Gross Margins. Gross margins earned in 2001 were 27.3% compared to 30% in
fiscal 2000. This decline in gross margins consisted of declines in margins on
each of the Company's major revenue streams. In general, these declines can be
attributed to the overall decline in higher margin large systems projects in
both the commercial and lodging market sectors as economic conditions have
resulted in lower capital spending by customers. The gross margins earned on
commercial equipment sales was 29% in fiscal 2001 compared to 31% for the prior
year. The target margins for this revenue stream are 28% to 30%. The gross
margins earned on lodging systems sales were 35.9% in fiscal 2001 compared to
37.1% in fiscal 2000. Management's target margin for this revenue stream is 33%
to 35%. The gross margins earned on installation and service revenues for fiscal
2001 were 29% compared to 30.7% in the prior year. The target margin for
installation and service revenues is 28% to 30%. In the second quarter of fiscal
2001, the Company experienced a sudden and significant downturn in its business,
which resulted in a dramatic decline in the margins earned on installation and
service revenues due to their sensitivity to labor costs. In response,
management implemented a workforce reduction. A significant portion of this
reduction was targeted toward the installation and service workforce to restore
the gross margins in this area to the expected targets. Management believes that
gross margins earned in fiscal 2002 should be within the targeted ranges
discussed above and that overall margins, after deducting corporate level costs
for purchasing, shipping and warehousing, should be in the range of 28% to 30%.
Operating Expenses. Operating expenses, excluding amortization expense,
were 16.9% of total revenues in fiscal 2001 compared to 16.5% in the year
earlier. This relatively consistent expense level was maintained through the
workforce and other cost reductions in sales expenses and through efficiencies
gained through continued integration of general and administrative activities of
the acquired companies. The expense levels for fiscal 2001 were in line with
management's target of 16% to 18% of total sales. Amortization expense reflects
primarily the amortization of goodwill acquired in the four acquisitions done by
the Company in the past two fiscal years.
The Company has adopted Financial Accounting Standard No. 142 as of
November 1, 2001. Under this standard, the Company will no longer amortize
against earnings the goodwill on its balance sheet. Instead, management will, at
least annually, compare the net book value of its acquired businesses against
the fair value of those businesses and determine
11
whether the value on the Company's balance sheet has become impaired. If such an
impairment has occurred, a write-down of the impaired asset, most likely
goodwill, is required. In accordance with the implementation guidance in the
standard, the Company has engaged an independent expert to make the initial
evaluation of the fair value of the acquired businesses. In so doing, the
Company and the expert agreed that the acquired businesses should be viewed as
one business, the commercial business. The expert found that the fair value of
the commercial business exceeded its book value as of October 31, 2001 and,
therefore, no impairment charge has been recorded.
Interest and Other Income. Interest expense consists of interest paid or
accrued on the Company's credit facility. Interest expense declined in fiscal
2001 by $259,000 or 11%, primarily reflecting lower average interest rates
experienced during the year. Other income and expense consists primarily of
interest income earned from the Company's sales-type lease receivable portfolio.
Interest income declined by $122,000 or 21% in fiscal 2001 reflecting the
maturing of the lease portfolio.
Tax Expense. The Company has recorded a combined federal and state tax
provision of 39% in all years presented. This rate reflects the effective
federal tax rate plus the estimated composite state income tax rate.
Operating Margins. Net income as a percent of revenues for fiscal 2001 was
4% compared to 6.3% in the prior year. This decline primarily reflects lower
gross margins earned in fiscal 2001 as discussed above and also relatively
constant amortization expense between the two years. While management was able
to adjust most of its cost structure of the Company to reflect the reduced
revenues earned, the amortization charge from goodwill is not dependent upon
revenues.
Year ending October 31, 2000 compared to October 31, 1999. Net revenues for
fiscal 2000 were $102.4 million, an increase of $65.1 million or 175% over the
previous year. Of this increase, approximately $63.9 million represented
revenues earned from acquired companies during the year.
Commercial Equipment Sales. Fiscal 2000 represented the first year of the
Company's planned expansion into the commercial market. This expansion was
largely initiated through two acquisitions of Avaya voice product dealers. Sales
of products to commercial customers were $54.2 million in fiscal 2000 and
represented revenues earned from the acquired operations of U.S. Technologies
Systems, Inc. ("USTI") and Advanced Communications Technology, Inc. ("ACT")
since the date of their acquisition (11 months and 8 months, respectively).
Lodging Systems Sales. Sales of lodging systems declined $1.8 million or
10%. This decline consisted of a decrease in sales of call accounting systems of
$2.4 million or 51% and an increase in sales of communications systems (PBX's)
to the lodging market of $582,000 or 4%. Sales of call accounting products in
fiscal 2000 returned to more normal levels after the surge in orders experienced
in 1999, as many customers upgraded or replaced their systems in preparation for
Y2K. In addition, the capital available to the lodging industry for new
construction, remodeling, and investments in technology shrunk considerably in
2000, resulting in extended sales cycles and fierce competition. The Company was
able to offset some of the impact of these trends through its offering of the
Avaya Guestworks(TM) PBX system. The Avaya system enabled the Company to break
into new customer accounts that were not previously receptive to the Company's
Hitachi PBX offering.
Installation and Service Revenues. Installation and service revenues
increased $12.5 million or 66% during fiscal 2000. Approximately $9.7 million of
this increase was earned from the expansion of the Company's service
capabilities into the commercial market. During fiscal 2000, the Company hired
and trained additional technicians and implemented new provisioning processes
and pricing strategies to address the needs of the commercial market. Revenues
earned from the Company's traditional lodging installation and service
activities grew approximately $2.7 million or 15%. This growth was fueled by
increases in revenues earned from maintenance contracts and billable services on
call accounting systems and PBX's, partially offset by decreases in installation
revenues.
12
Other Revenues. Other revenues consisted of revenues earned from the
remaining long distance services contracts still in force and from
non-recurring, low margin, sale of after-market products in which the Company
acts as a "broker" to facilitate the transaction for its customers. The sale of
after-market products included in this revenue caption involved transactions in
which the Company procured large quantities of after-market components,
typically telephone sets, for end-user customers.
Gross Margins. Total gross margins earned in 2000 were 30% compared to 38%
in 1999. This decline was expected as a result of a dramatic and planned change
in product mix toward the commercial market for voice and data products. As the
Company executed its growth strategy through acquiring companies operating in
the commercial market, the percentage of its business earned from higher-margin,
specialized lodging products and services declined as a portion of total
revenues.
The gross margins earned on commercial equipment sales in fiscal 2000 were
31%. The margins earned on these sales were highly impacted by the percentage of
these sales generated through the Avaya business partner arrangements in which
the Company partners with Avaya to sell and install equipment to Avaya's larger
customers. These customers, which are often large, Fortune 500 sized companies,
have the buying power to drive lower prices and therefore lower margins for the
Company.
The gross margins earned on lodging systems sales were 37% in fiscal 2000
compared to 42% in fiscal 1999. This decline represented a change in product mix
in 2000 toward sales of more PBX systems and fewer call accounting systems as a
portion of total lodging systems sales. As a proprietary product, the Company's
call accounting systems earn a higher gross margin than the distributed PBX
product line.
The gross margins earned on installation and service revenues in fiscal
2000 were 31% compared to 35% in fiscal 1999. This decline was somewhat expected
as the installation of commercial PBX systems is more complex than in the
lodging sector and, as such, the costs to design and implement these systems is
higher than the Company experienced previously. Furthermore, in the commercial
sector, the Company has not built up a base of recurring revenues from
maintenance contracts, which tends to smooth out the margins earned on this
revenue stream.
Operating Expenses. Total operating expenses, including selling, general
and administrative ("SGA"), and amortization were 18% of total revenues in
fiscal 2000 compared to 20.5% of total fiscal 1999 revenues. SGA costs
represented 16.5% of revenues in 2000 compared to 15% in 1999. These levels were
satisfactory to management given the rapid growth of the Company and the
complexity of its operations compared to the previous year. Amortization expense
between the two years consisted of different components and was therefore not
comparable. The majority of amortization expense in fiscal 1999 related to the
amortization of the purchase price of the PBX service contracts purchased from
Williams Communications Solutions in late 1998, while the majority of
amortization expense recorded in fiscal 2000 was related to the acquisitions of
USTI and ACT.
Interest Expense. Interest expense consisted of interest on the Company's
credit facility that was used to fund the acquisitions of USTI and ACT, interest
on a working capital revolver, and various commitment fees paid on the unused
portion of the credit facility. Prior to the establishment of this credit
facility, the Company did not have any outstanding debt.
Interest and Other Income. Interest and other income consisted primarily of
interest income earned on XETAPLAN sales-type leases. Under these lease
arrangements, the Company provides a call accounting system to its lodging
customers and service on the system for a period of three to five years in
exchange for a monthly or quarterly fee. Under the accounting rules followed by
the Company, a portion of these payments were imputed as interest income. In
fiscal 1999, interest income also included interest earned on cash investments.
The decline in interest income reflected the decline in available cash balances
for investments.
Income Taxes. The Company recorded a provision for federal and state income
taxes of $4.2 million or 39% of pre-tax income compared to $2.75 million or 39%
of pre-tax income in fiscal 1999. This rate reflected the effective federal tax
rate plus the estimated composite state income tax rate.
13
Operating Margins. Net income as a percent of sales was 6.3% in fiscal 2000
compared to 11.5% in fiscal 1999. This lower operating margin reflected the
Company's transition from a niche company in the small hospitality sector to a
voice and data integrator in a larger and faster growing commercial voice and
data integration market.
LIQUIDITY AND CAPITAL RESOURCES
At the beginning of fiscal 2000, the Company established a new credit
facility to provide capital for its planned expansion into the commercial
market. This credit facility was tapped for $31.5 million in long-term debt
between November 30, 1999 and November 1, 2000 to fund the acquisition of four
companies. Despite the difficult economic conditions experienced during the past
year, the Company has been able to reduce this debt 43% to $18.1 million.
As a result of the rapidly and negatively changing market conditions
experienced in fiscal 2001, the Company's earnings levels, which were the
primary basis of support for the credit facility, began to deteriorate
dramatically. In response to these conditions, the Company made substantial
reductions in its cost structure at the end of its second fiscal quarter and
began negotiations with its bank to restructure its credit facility to reflect
the Company's current earnings levels and to more fully collateralize the
facility to the Company's assets rather than to cash flows. On October 31, 2001
the Company closed on a restructuring of the credit facility which included the
following significant changes: 1) the amount available under the revolving line
of credit was expanded $1 million to a total of $9 million and it was secured
with a borrowing base of receivables and inventory; 2) the outstanding term debt
was reduced by $5.55 million by transferring $3 million to the revolver and the
remaining $2.55 million to a 15 year mortgage collateralized by the Company's
headquarters building; 3) the remaining term loan of $15.59 million, after the
reductions mentioned above, was put on a new 5 year amortization schedule; and
4) the debt service coverage ratio required under the agreement was temporarily
reduced. As a result of the restructuring, the Company's monthly principal
payments were reduced nearly in half to $274,000. Management is pleased with the
restructuring and believes that the agreement reflects a strong vote of
confidence by the Company's banking partners as to the actions that have been
taken in response to the downturn in market conditions.
Although the Company has access to a variety of capital sources such as
additional bank debt, private placements of subordinated debt, and public or
private sales of additional equity, the availability of those sources at
acceptable prices is currently limited. Management is currently focused on
overriding the effects of the current downturn in the economy and returning the
Company to higher levels of profitability and previous growth rates. As such, it
is carefully managing its balance sheet with a view toward reducing inventories
and receivables. The Company has a long-standing policy of paying its vendors
promptly and has maintained that policy while carefully managing its cash flows.
Management believes its most likely source of immediate, additional capital, if
needed, will be its banking partners. While the Company believes that its
relationship with its banks remains very positive, there can be no assurance
given as to the availability of additional debt should the Company's earnings
deteriorate further.
For the year ending October 31, 2001, the Company generated $9.8 million in
cash from operations. This amount consisted of $7.7 million earned from earnings
and non-cash charges and $15.1 from reductions in accounts receivables offset by
reductions in accounts payable and accrued liabilities of $9.9 million and
reductions in other working capital items of $3.1 million. Other sources of cash
included additional long-term borrowings of $5.5 million and net borrowings on
the Company's working capital revolver of $4.4 million. This cash was used to
fund acquisitions totaling $5.6 million and implementation of the Company's new
ERP system of $2.9 million.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". This statement addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. In August 2001, the FASB
issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets." This statement supercedes SFAS 121, "Accounting for the Impairment of
Long-Lived Assets to be Disposed of" and amends Accounting Principals Board
Opinion No. 30, "Reporting the Results of Operation - Reporting the Effects of
Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions." The Statement retains the basic framework of
SFAS No. 121, resolves certain implementation issues of SFAS 121, extends
applicability to discontinued operations, and broadens the presentation of
discontinued operations to include a component of an entity. The effect of
implementing both of these new standards on the Company's results of operations
and financial position is not expected to be material.
14
OUTLOOK AND RISK FACTORS
The statements in this section entitled "Outlook and Risk Factors," as well
as other statements throughout this report regarding trends or future
performance or events, are based on management's current expectations. These
statements are forward-looking and actual results may differ materially. All
such statements should be read in conjunction with the risk factors discussed
herein and elsewhere in this report.
U.S. Economy. The Company's business is subject to the effects of general
economic conditions in the United States and, in particular, market conditions
for telecommunications and networking equipment and services. In recent
quarters, the Company's operating results have been adversely affected as a
result of unfavorable economic conditions and reduced capital spending in the
United States. If the economic conditions in the United States do not improve,
or continue to deteriorate, the Company may continue to experience material
adverse impacts on its business, operating results, and financial condition.
Credit Facility and Working Capital. Management believes that its
relationship with its banking partners is good and that the recently
restructured credit facility adequately addresses both principal payment and
financial covenant requirements for the present market conditions. However,
there can be no assurance given that the Company will have adequate working
capital available should market conditions continue to deteriorate. Under the
restructured credit facility, the Company's access to working capital borrowings
is restricted by a borrowing base of accounts receivables and inventory. As the
Company's revenues have declined, availability under the facility has been
reduced accordingly. Should the Company's need for working capital temporarily
exceed its borrowing limits, the Company might be forced to delay payments to
its bank or other vendors. Such delays could materially and negatively impact
the Company's operating results. Conversely, should the Company's revenues
expand rapidly in the near future, it is also possible that demand for
additional working capital could be in excess of that allowed under the credit
facility. However, in this scenario, management is more confident that it could
successfully demonstrate the positive need for additional capital.
Dealer Agreements. The Company sells communications systems under dealer
agreements with Avaya, Inc. (formerly Lucent Technologies) and Hitachi Telecom,
(USA), Inc. The Company is a major dealer for both manufacturers and considers
its relationship with both to be good. Nevertheless, if the Company's strategic
relationship with Avaya, and to a lesser degree with Hitachi, were to be
terminated prematurely or unexpectedly, the Company's operating results would be
adversely impacted. Furthermore, in both the separate agreements that the
Company has with Avaya for distribution of products to the commercial and
lodging markets and the agreement with Hitachi, the Company must meet certain
volume commitments to earn the pricing structure provided in the dealer
agreements. In addition, the Company's relationship with Avaya is administered
through a joint agreement between the Company, Avaya, and one of Avaya's "super
distributors", Voda One (formerly Inacom) through which the Company receives
specified pricing from Voda One based on certain volume requirements. Should the
Company fail to meet any of these requirements, future profit margins could
suffer.
Dependence upon Avaya. The Company is one of the largest dealers of Avaya
products in the U.S. While the Company's agreement with Avaya is non-exclusive
and the Company can and does represent other manufacturer's products in the
marketplace, the Company is heavily dependent upon the quality and continued
development of technologically advanced products to compete effectively. Avaya
is a leading provider of communications systems and software for enterprises,
including businesses, government agencies and other organizations. The Company
offers Avaya's voice, converged voice and data, customer relationship
management, messaging, multi-service networking and structured cabling products
and services. Multi-service networking products are those products that support
network infrastructures which carry voice, video and data traffic over any of
the protocols, or set of procedures, supported by the Internet on local area and
wide area data networks. A structured cabling system is a flexible cabling
system designed to connect phones, workstations, personal computers, local area
networks and other communications devices through a building or across one or
more campuses. Avaya is a market-leader in messaging, structured cabling
systems, enterprise voice communications and call center systems, but is
relatively new to the converged voice and data products and multi-service
networking products markets.
Most industry analysts expect the growth rate for traditional voice
products to be very low, while higher growth rates are expected for those
products focused on networked communications tools such as converged voice and
data
15
applications. Avaya is not a leader in multi-service networking products or
in converged voice and data products. The Company's long-term growth strategy is
built upon being a nationwide integrator of these converged voice and data
applications as well as other high-end applications and as such is dependent
upon Avaya's success in developing these products in a timely manner.
Also, Avaya, like many major manufacturers, provides various incentive
programs to support the advertising and sale of its products. The Company
receives substantial rebates through these common incentive programs to offset
both costs of goods sold and marketing expenses. These amounts are material to
the Company's operating results. These rebates are based on a combination of the
dollar volumes of purchases of certain products, the number of units of certain
products purchased, and the year-over-year growth in purchases of certain
products. Historically, the requirements of these incentive programs are changed
annually. While the Company does not expect such programs to be altered to the
Company's detriment, there can be no assurance given that a change in these
programs won't negatively impact the Company's profit margins and operating
results.
Dependence Upon a Few Suppliers. The Company's growth and ability to meet
customer demands also depend in part on its capability to obtain timely
deliveries of parts from suppliers. The Company's agreement with Avaya specifies
the use of a single distributor from which it purchases most Avaya products.
While this supplier has performed effectively and has been relatively flexible
to date, there is no assurance that the present general economic conditions or
other specific conditions unique to the supplier will not cause an interruption
in the supply of products in the future. In addition, Avaya has recently
outsourced its manufacturing operations to a third party company. During the
initial months of the outsourcing agreement, there have been periodic shortages
of equipment. Although the Company works closely with its suppliers to avoid
these types of shortages, there can be no assurance that the Company will not
encounter these problems in the future.
Hiring and Retaining Key Personnel. The Company's ability to attract,
train, motivate and retain highly skilled and qualified technical and sales
personnel is critical to the Company's success. Competition for such employees
in the rapidly changing telecommunications industry is typically intense,
although the current economic conditions have temporarily eased some of this
pressure. As the Company has transformed itself into an integrated
communications solutions provider, it has invested heavily the in the hiring and
training of personnel to sell and service the Company's new products and service
offerings. If the Company is unable to retain its skilled employees or to hire
additional qualified personnel as needed, it could adversely impact the
Company's ability to implement its business strategies efficiently and
effectively.
Competition. The market for the Company's products and services is highly
competitive and subject to rapidly changing technologies. As the industry itself
evolves and new technologies and products are introduced into the marketplace,
new participants enter the market and existing competitors seek to strengthen
their positions and expand their product/service offerings. There has been a
trend toward industry consolidation, which can lead to the creation of stronger
competitors who may be better able to compete as a sole-source vendor for
customers. While the Company believes that through its expansion and
transformation of the last few years, it has positioned itself well to compete
effectively in the marketplace, its failure to maintain or enhance its
competitive position could adversely affect its business and results of
operations.
Lodging Industry. As a result of the overall downturn in the economy in
general and the recession in the lodging industry in particular as a result of
the September 11th attacks, there is deepened uncertainty to the near-term
health of many of the Company's customers. While the Company has substantially
divested itself from its previous dependence on this sector, it remains an
important part of the Company's business and the financial failure of one or
more of the Company's significant lodging customers could have a material,
negative impact on the Company's financial results.
Technology Infrastructure and Information Systems. Management's ability to
navigate the current market will depend heavily upon its ability to assemble the
necessary information to make informed decisions and implement those decisions
quickly and effectively. The Company is currently upgrading its technology
infrastructure and its information systems. This upgrade will result in a
consolidation from four critical legacy systems to one. The success of this
conversion is critical to the Company ultimately attaining the planned
productivity increases and operational efficiencies needed to improve the
Company's operating results and provides the needed infrastructure for future
growth.
16
Stock Market Volatility. Historically, the Company's stock has not been
widely followed by investment analysts and has been subject to price and volume
trading volatility. This volatility is sometimes tied to overall market
conditions and may or may not reflect the operating performance of the Company.
Due to the current negative perception of technology related stocks, the
Company's declining revenues, and the relatively small size of the Company's
market capitalization, the Company has seen the interest from the financial
community and average trading volume of its stock decline further during fiscal
2001. As a result, there is increased risk that the Company's stock could
experience even greater volatility from momentum trading by only a few stock
market participants.
Other Risk Factors. In addition to the specific factors discussed above,
the following general factors can also impact the Company's overall performance
and results of operations: the continued growth of the IP networking market,
uncertainties inherent with rapidly changing technologies and customer demand,
the cost and effects of legal claims and proceedings, and relationships with
suppliers, vendors and customers.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risks relating to the Company's operations result primarily from
changes in interest rates. The Company did not use derivative financial
instruments for speculative or trading purposes during the 2001 fiscal year.
Interest Rate Risk. The following table provides information regarding
the company's financial instruments that are sensitive to changes in interest
rates. The table presents the company's debt obligations and weighted-average
interest rates by expected maturity dates. The variable average interest rates
reflect the rates in effect at October 31, 2001. A hypothetical 10 percent
change in such interest rates would not have a material effect upon the
company's consolidated results of operations or cash flows. At October 31, 2001,
the company had not entered into any interest rate swap agreements to manage
interest rate risk. Subsequent to October 31, 2001, the company entered into an
interest rate swap agreement, which was in conjunction with the company's
finance facility restructuring.
Expected Maturity Date Fair Value
---------------------- ----------
2002 2003 10/31/01
---- ---- --------
Fixed rate $ 1,000 -- $ 1,000
Average interest rate 7.12% --
Variable rate $ 8,638 $14,853
Average interest rate 5.4% 5.4%
17
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
INDEX TO FINANCIAL STATEMENTS OF THE COMPANY PAGE
- -------------------------------------------- ----
Report of Independent Public Accountants F-1
Consolidated Financial Statements
Consolidated Balance Sheets - October 31, 2001 and 2000 F-2
Consolidated Statements of Operations - For
the Years Ended October 31, 2001, 2000 and 1999 F-3
Consolidated Statements of Shareholders' Equity -
For the Years Ended October 31, 2001, 2000 and 1999 F-4
Consolidated Statements of Cash Flows - For the
Years Ended October 31, 2001, 2000 and 1999 F-5
Notes to Consolidated Financial Statements F-6
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
18
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS; COMPLIANCE WITH SECTION 16(a) OF THE
EXCHANGE ACT.
The directors, executive officers and significant employees of the Company
are set forth below. All officers and members of the Board of Directors serve
for a term of one year or until their successors are duly elected and qualified.
Directors may be removed by holders of 66 2/3% of the Company's outstanding
voting shares.
NAME AND AGE POSITIONS WITH COMPANY
------------ ----------------------
Jack R. Ingram Chairman of the Board, Chief Executive
Age 58 Officer, and President
Robert B. Wagner Chief Financial Officer, Vice President of
Age 40 Finance, Secretary, Treasurer, and
Director
Larry N. Patterson Senior Vice President, Sales and Service
Age 45
Donald E. Reigel Regional Vice President, Sales - Central
Age 47
James J. Burke Regional Vice President, Sales - Western
Age 57
Sandra J. Connor Regional Vice President, Sales - Eastern
Age 37
Ron B. Barber Director
Age 47
Donald T. Duke Director
Age 52
Dr. Robert D. Hisrich Director
Age 57
Ronald L. Siegenthaler Director
Age 58
A brief account of the business experience for the past five years of the
individuals listed above follows.
MR. INGRAM has been the Company's Chief Executive Officer since July 1990.
He also served as the Company's President from July 1990 until August 1999 and
re-assumed that position in June 2001. He has been a director of the Company
since March 1989. Mr. Ingram's business experience prior to joining the Company
was concentrated in the oil and gas industry. Mr. Ingram holds a Bachelor of
Science Degree in Petroleum Engineering from the University of Tulsa.
MR. WAGNER has been the Company's Vice President of Finance and Chief
Financial Officer since March 1989. He has been with the Company since July 1988
and became a member of the Board of Directors in March 1996. Mr. Wagner is a
Certified Public Accountant licensed in Oklahoma and received his Bachelor of
Science Degree in Accounting from Oklahoma State University.
19
MR. PATTERSON joined the Company in March 2000 and serves as Senior Vice
President, Sales and Service. Prior to his employment with the Company, Mr.
Patterson worked for Exxon Corporation and held various executive positions in
Europe, Asia and Latin America with Exxon Company, International. He is a member
of the American Management Association and is active in Organizational
Development, Leadership Development and Investment Management activities. Mr.
Patterson received his Bachelor of Science Degree in Engineering from Oklahoma
State University.
MR. REIGEL joined the Company in June 1993 as PBX Product Sales Manager. He
was promoted to Vice President of Marketing and Sales in June 1995; became Vice
President of Hospitality Sales in December, 1999; and is currently Regional Vice
President, Sales - Central. Prior to his employment with the Company, Mr. Reigel
served as a national accounts sales manager for WilTel Communications Systems.
Mr. Reigel received his Bachelor of Science Degree in Business from the
University of Colorado.
MR. BURKE joined the Company in November 1999 in conjunction with the
acquisition of USTI and is currently Regional Vice President, Sales - Western.
Prior to his employment with the Company, he had been employed by USTI since
August 1990 and served as the Western Region Sales Director and National Sales
Director. Mr. Burke received his Bachelor of Science Degree in Business from
Niagara University.
MS. CONNOR joined the Company in September 2000, and is currently Vice
President, Sales-Eastern. Prior to her employment with the Company, Ms. Connor
served in various sales and sales operations assignments at Lucent Technologies,
most recently as Area Sales Vice President for the New England Region -
Enterprise Networks Division. Ms. Connor received her Bachelor of Science Degree
in Management from the University of Massachusetts, Lowell.
MR. BARBER has been a director of the Company since March 1987. He has been
engaged in the private practice of law since October 1980 and is a shareholder
in the law firm of Barber & Bartz, a Professional Corporation, in Tulsa,
Oklahoma, which serves as counsel to the Company. Mr. Barber is also a Certified
Public Accountant licensed in Oklahoma. He received his Bachelor of Science
Degree in Business Administration (Accounting) from the University of Arkansas
and his Juris Doctorate Degree from the University of Tulsa.
MR. DUKE has been a director of the Company since March 1991. He is
President of Duke Energy Co. L.L.C., an oil and gas consulting and investment
firm. Mr. Duke has been in senior management in the oil and gas industry since
1980, including time as President and Chief Operating Officer of Hadson
Petroleum (USA), Inc., a domestic oil and gas subsidiary of Hadson Corporation,
where he was responsible for all phases of exploration and production, land,
accounting, operations, product marketing and budgeting and planning. Mr. Duke
has a Bachelor of Science Degree in Petroleum Engineering from the University of
Oklahoma.
DR. HISRICH has been a director of the Company since March 1987. He
occupies the A. Malachi Mixon III Chair in Entrepreneurial Studies and is
Professor of Marketing and Policy Studies at the Weatherhead School of
Management at Case Western Reserve University in Cleveland, Ohio. Prior to
assuming such positions, he occupied the Bovaird Chair of Entrepreneurial
Studies and Private Enterprise and was Professor of Marketing at the College of
Business Administration for the University of Tulsa. He is also a marketing and
management consultant. He is a member of the Board of Directors of Jameson Inn,
Inc., and Noteworthy Medical Systems, Inc., a member of the Editorial Boards of
the Journal of Venturing and the Journal of Small Business Management, and a
member of the Board of Directors of Enterprise Development, Inc. Dr. Hisrich
received his Bachelor of Arts Degree in English and Science from DePauw
University and his Master of Business Administration Degree (Marketing) and
Ph.D. in Business Administration (Marketing, Finance, and Quantitative Methods)
from the University of Cincinnati.
MR. SIEGENTHALER has been a director of the Company since its
incorporation. He also served as its Executive Vice President from July 1990
until March, 1999. Since 1974, through SEDCO Investments, a partnership in which
Mr. Siegenthaler is a partner, and as an individual, Mr. Siegenthaler has been
involved as partner, shareholder, officer, director, or sole proprietor of a
number of business entities with significant involvement in fabrication and
marketing of steel, steel products and other raw material, real estate, oil and
gas, and telecommunications. Mr. Siegenthaler received his Bachelor's Degree in
Liberal Arts from Oklahoma State University.
20
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Based solely upon a review of (i) Forms 3 and 4 and amendments thereto
furnished to the Company during its most recent fiscal year, (ii) Forms 5 and
amendments thereto furnished to the Company with respect to its most recent
fiscal year, and (iii) written representations made to the Company by its
directors and officers, the Company knows of no director, officer, or beneficial
owner of more than ten percent of the Company's Common Stock who has failed to
file on a timely basis reports of beneficial ownership of the Company's Common
Stock as required by Section 16(a) of the Securities Exchange Act of 1934, as
amended, except as follows: Mr. Hisrich was late in filing his Statements of
Changes in Beneficial Ownership on Form 4 for the month of February 2001. Mr.
Jon Wiese, former President and Co-CEO of the Company, was late in filing his
Statement of Changes in Beneficial Ownership on Form 4 for the month of August
2001.
ITEM 11. EXECUTIVE COMPENSATION.
That portion of the Company's definitive Proxy Statement appearing under
the caption "Executive Compensation," to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A on or before February 28, 2002
and to be used in connection with the Company's Annual Meeting of Shareholders
to be held March 28, 2002 is hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
That portion of the Company's definitive Proxy Statement appearing under
the caption "Security Ownership of Certain Beneficial Owners and Management," to
be filed with the Securities and Exchange Commission pursuant to Regulation 14A
on or before February 28, 2002 and to be used in connection with the Company's
Annual Meeting of Shareholders to be held March 28, 2002 is hereby incorporated
by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
That portion of the Company's definitive Proxy Statement appearing under
the caption "Related Transactions," to be filed with the Securities and Exchange
Commission pursuant to Regulation 14A on or before February 28, 2002 and to be
used in connection with the Company's Annual Meeting of Shareholders to be held
March 28, 2002 is hereby incorporated by reference.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) (1) Financial Statements - See Index to Financial Statements at Page
18 of this Form 10-K.
(2) Financial Statement Schedule - None.
(3) Exhibits - See Exhibit Index at Page 23 of this Form 10-K.
(b) The Company filed no report on Form 8-K during the last quarter of the
fiscal year ended October 31, 2001.
(c) See Exhibit Index at Page 23 of this Form 10-K.
(d) See Index to Financial Statements at Page 18 of this Form 10-K.
21
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
XETA TECHNOLOGIES, INC.
JANUARY 29, 2002 BY: /s/ JACK R. INGRAM
--------------------------------------
JACK R. INGRAM, CHIEF EXECUTIVE
OFFICER AND PRESIDENT
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
JANUARY 29, 2002 /s/ JACK R. INGRAM
-----------------------------------------
JACK R. INGRAM, CHIEF EXECUTIVE OFFICER,
PRESIDENT AND DIRECTOR
JANUARY 29, 2002 /s/ ROBERT B. WAGNER
-----------------------------------------
ROBERT B. WAGNER, VICE PRESIDENT OF
FINANCE, CHIEF FINANCIAL OFFICER, AND
DIRECTOR
JANUARY 29, 2002 /s/ DONALD T. DUKE
-----------------------------------------
DONALD T. DUKE, DIRECTOR
JANUARY 29, 2002 /s/ RONALD L. SIEGENTHALER
-----------------------------------------
RONALD L. SIEGENTHALER, DIRECTOR
22
EXHIBIT INDEX
SEC No. Description
------- -----------
(2) PLAN OF ACQUISITION, REORGANIZATION, ARRANGEMENT, LIQUIDATION OR
SUCCESSION - None.
(3) (i) ARTICLES OF INCORPORATION -
*(a) Amended and Restated Certificate of Incorporation
of the Registrant -- Incorporated by reference to
Exhibits 3.1 and 3.2 to the Registrant's
Registration Statement on Form S-1, filed on June
17, 1987 (File No. 33-7841).
*(b) Amendment No. 1 to Amended and Restated
Certificate of Incorporation -- Incorporated by
reference to Exhibit 4.2 to the Registrant's
Post-Effective Amendment No. 1 to Registration
Statement on Form S-8, filed on July 28, 1999
(File No. 33-62173).
*(c) Amendment No. 2 to Amended and Restated
Certificate of Incorporation - Incorporated by
reference to Exhibit 3(i)(c) to the Registrant's
Form 10-Q for the quarter ended April 30, 2000,
filed on June 14, 2000 (File No. 0-16231).
*(d) Amendment No. 3 to Amended and Restated
Certificate of Incorporation - Incorporated by
reference to Exhibit 4.4 to the Company's
Post-Effective Amendment No. 2 to the
Registration Statement Form S-8, filed on June
28, 2000 (File No. 33-62173).
(ii) BYLAWS -
*(a) Amended and Restated Bylaws of the Registrant -
Incorporated by reference to Exhibit 3(ii)(a) to
the Registrant's Form 10-Q for the quarter ended
April 30, 2001, filed on July 14, 2001 (File No.
0-16231).
(4) INSTRUMENTS DEFINING RIGHTS OF SECURITY HOLDERS, INCLUDING
INDENTURES - None other than the Amended and Restated Certificate of
Corporation of the Registrant, as amended, and Amended and Restated
Bylaws of the Registrant, as identified in Exhibit 3(i) and 3(ii) to
this report.
(10) MATERIAL CONTRACTS -
*10.1 Dealer Agreement Among Lucent Technologies, Inc.;
Distributor, Inacom Communications, Inc.; and XETA
Corporation for Business Communications Systems --
Incorporated by reference to Exhibit 10.1 to the
Registrant's Form 10-Q for the quarter ended April 30,
1999, filed on June 11, 1999 (File No. 0-16231).
*10.2 Real Estate Mortgage on the Registrant's Broken Arrow,
Oklahoma property -- Incorporated by reference to
Exhibit 2.5 to the Registrant's Form 8-K filed on
December 15, 1999 (File No. 0-16231).
*10.3 Pledge and Security Agreement relating to November 30,
1999 Credit Agreement - Incorporated by reference to
Exhibit 2.4 to the Registrant's Form 8-K filed on
December 15, 1999 (File No. 0-16231).
*10.4 Subsidiary Guaranty by U.S. Technologies Systems, Inc.
of November 30, 1999 Credit facility - Incorporated by
reference to Exhibit 2.6 to the Registrant's Form 8-K
filed on December 15, 1999 (File No. 0-16231).
23
*10.5 Stock Purchase Option dated February 1, 2000 granted to
Larry N. Patterson - Incorporated by reference to
Exhibit 10.9 to the Registrant's Form 10-Q for the
quarter ended April 30, 2000, filed on June 14, 2000
(File No. 0-16231).
*10.6 Amendment to Dealer Agreement Among Lucent Technologies,
Inc. Distributor, Inacom Communications, Inc.; and XETA
Corporation, for Business Communications Systems, dated
effective March 19, 2000 - Incorporated by reference to
Exhibit 10.10 to the Registrant's Form 10-Q for the
quarter ended April 30, 2000, filed on June 14, 2000
(File No. 0-16231).
*10.7 XETA Technologies 2000 Stock Option Plan - Incorporated
by reference to Exhibit 10.11 to the Registrant's Form
10-Q for the quarter ended April 30, 2000, filed on June
14, 2000 (File No. 0-16231).
*10.8 HCX 5000(R) Authorized Distributor Agreement dated
April 1, 2000 between Hitachi Telecom (USA), Inc. and
XETA Corporation -- Omitted as substantially identical
to the Authorized Distributor Agreement dated April 8,
1993 between Hitachi America, Ltd. and XETA Corporation
which was previously filed as Exhibit 10.1 to the
Company's Annual Report on Form 10-KSB for the fiscal
year ended October 31, 1993 (File No. 0-16231).
*10.9 Stock Purchase Option dated August 11, 2000 granted to
Larry N. Patterson - Incorporated by reference to
Exhibit 10.14 to the Registrant's Annual Report on Form
10-K for the year ended October 31, 2000, filed on
January 29, 2001. (File No. 0-16231).
*10.10 First Amendment to Credit Agreement dated August 21,
2000 among XETA Technologies, Inc., the Lenders, the
Agent and the Arranger - Incorporated by reference to
Exhibit 10.15 to the Registrant's Annual Report on Form
10-K for the year ended October 31, 2000, filed on
January 29, 2001. (File No. 0-16231).
*10.11 Notice of Assignment by Lucent Technologies Inc. dated
September 14, 2000 of all contracts with XETA
Technologies, Inc. (including the Dealer Agreement) to
Avaya Inc. - Incorporated by reference to Exhibit 10.16
to the Registrant's Annual Report on Form 10-K for the
year ended October 31, 2000, filed on January 29, 2001.
(File No. 0-16231).
*10.12 Asset Purchase Agreement dated as of October 31, 2000,
by and among Key Metrology Integration, Inc. as Seller,
its principal shareholder The Douglas Wendell Myers
Revocable Living Trust, XETA Technologies, Inc., as
Purchaser, and Douglas Wendell Myers, individually -
Incorporated by reference to Exhibit 10.17 to the
Registrant's Annual Report on Form 10-K for the year
ended October 31, 2000, filed on January 29, 2001. (File
No. 0-16231).
*10.13 Asset Purchase Agreement dated as of October 31, 2000,
by and among PRO Networks Corporation, as Seller, its
shareholders The John Gerard Sargent Revocable Living
Trust and The Nancy Rhea Sargent Revocable Living Trust,
XETA Technologies, Inc., as Purchaser, and John Gerard
Sargent and Nancy Rhea Sargent, individually -
Incorporated by reference to Exhibit 2.1 to the
Registrant's Form 8-K filed on November 15, 2000 (File
No. 0-16231).
*10.14 Second Amendment to Credit Agreement dated June 8, 2001
among XETA Technologies, Inc., the Lenders, the Agent
and the Arranger - Incorporated by reference to exhibit
10.19 to the Registrant's Form 10-Q for the quarter
ended July 31, 2001, filed on September 14, 2001 (File
No. 0-16231).
24
10.15 Amended and Restated Audit Agreement dated October 31,
2001 among XETA Technologies, Inc., the Lenders and the
Agent.
(11) STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS - Inapplicable.
(15) LETTER RE: UNAUDITED INTERIM FINANCIAL INFORMATION - Inapplicable.
(18) LETTER RE: CHANGE IN ACCOUNTING PRINCIPLES - Inapplicable.
(19) REPORT FURNISHED TO SECURITY HOLDERS - None.
(22) PUBLISHED REPORT REGARDING MATTERS SUBMITTED TO A VOTE OF SECURITY
HOLDERS - None.
(23) CONSENTS OF EXPERTS AND COUNSEL
23.1 Consent of Arthur Andersen LLP
(24) POWER OF ATTORNEY - None.
(99) ADDITIONAL EXHIBITS - None.
* Previously filed.
25
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Xeta Technologies, Inc.:
We have audited the accompanying consolidated balance sheets of Xeta
Technologies, Inc. (formerly Xeta Corporation, an Oklahoma corporation) and
subsidiaries as of October 31, 2001 and 2000, and the related consolidated
statements of operations, shareholders' equity and cash flows for each of the
three years in the period ended October 31, 2001. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Xeta Technologies,
Inc. and subsidiaries as of October 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
October 31, 2001, in conformity with accounting principles generally accepted in
the United States.
ARTHUR ANDERSEN LLP
Tulsa, Oklahoma
December 11, 2001
F-1
XETA TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
October 31, 2001 October 31,2000
---------------- ---------------
Current Assets:
Cash and cash equivalents $ 597,889 $ 926,330
Current portion of net investment in
sales-type leases and other receivables 2,534,692 2,609,976
Trade accounts receivable, net 15,907,101 30,139,623
Inventories, net 9,008,965 8,135,062
Deferred tax asset, net 1,013,748 1,133,487
Prepaid expenses and other assets 916,461 338,828
------------ ------------
Total current assets 29,978,856 43,283,306
------------ ------------
Noncurrent Assets:
Goodwill, net of amortization 25,944,567 20,579,359
Net investment in sales-type leases,
less current portion above 1,092,917 2,505,841
Property, plant & equipment, net 9,599,249 6,854,851
Capitalized software production costs, net of
accumulated amortization of $873,066 & $693,066 417,955 597,956
Other assets 251,333 327,658
------------ ------------
Total noncurrent assets 37,306,021 30,865,665
------------ ------------
Total assets $ 67,284,877 $ 74,148,971
============ ============
LIABILITIES & SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 4,288,337 $ 6,820,754
Revolving line of credit 5,350,000 1,000,000
Accounts payable 4,547,347 11,750,607
Unearned revenue 2,528,103 4,513,029
Accrued liabilities 2,051,152 3,927,803
Accrued federal and state income taxes -- 125,942
------------ ------------
Total current liabilities 18,764,939 28,138,135
------------ ------------
Noncurrent liabilities:
Long-term debt, less current portion above 14,853,349 17,983,011
Accrued long-term liabilities 1,299,114 1,299,114
Unearned service revenue 454,166 1,039,949
Noncurrent deferred tax liability, net 715,883 123,603
------------ ------------
17,322,512 20,445,677
------------ ------------
Commitments
Shareholders' equity:
Preferred stock; $.10 par value; 50,000 shares
authorized, 0 issued -- --
Common stock; $.001 par value; 50,000,000
shares authorized, 10,256,740 and 9,662,736
issued at October 31, 2001 and 2000
respectively 10,256 9,662
Paid-in capital 11,637,812 9,486,776
Retained earnings 21,794,017 18,313,380
Less treasury stock, at cost (2,244,659) (2,244,659)
------------ ------------
Total shareholders' equity 31,197,426 25,565,159
------------ ------------
Total liabilities & shareholders' equity $ 67,284,877 $ 74,148,971
============ ============
The accompanying notes are an integral part of these consolidated statements.
F-2
XETA TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Twelve Months
Ending October 31,
2001 2000 1999
------------- ------------- -------------
Commercial equipment sales $ 41,964,072 $ 54,198,673 $ --
Lodging systems sales 10,063,623 16,032,612 17,857,086
Installation and service revenues 33,105,152 31,219,629 18,766,095
Other revenues 921,182 967,987 639,871
------------- ------------- -------------
Net sales and service revenues 86,054,029 102,418,901 37,263,052
------------- ------------- -------------
Cost of commercial equipment 29,811,902 37,403,184 --
Cost of lodging systems 6,449,040 10,076,638 10,412,029
Installation and services costs 23,511,694 21,627,342 12,206,057
Cost of other revenues & corporate COGS 2,758,651 2,481,864 654,606
------------- ------------- -------------
Total cost of sales and service 62,531,287 71,589,028 23,272,692
------------- ------------- -------------
Gross profit 23,522,742 30,829,873 13,990,360
------------- ------------- -------------
Operating expenses:
Selling, general and administrative 14,564,120 16,864,374 5,686,350
Amortization 1,609,466 1,587,230 1,936,057
------------- ------------- -------------
Total operating expenses 16,173,586 18,451,604 7,622,407
------------- ------------- -------------
Income from operations 7,349,156 12,378,269 6,367,953
Interest expense (2,095,331) (2,354,793) --
Interest and other income 471,812 594,143 664,903
------------- ------------- -------------
Subtotal (1,623,519) (1,760,650) 664,903
Income before provision for income
taxes 5,725,637 10,617,619 7,032,856
Provision for income taxes 2,245,000 4,156,000 2,750,000
------------- ------------- -------------
Net income $ 3,480,637 $ 6,461,619 $ 4,282,856
============= ============= =============
Earnings per share
Basic $ 0.38 $ 0.77 $ 0.53
============= ============= =============
Diluted $ 0.36 $ 0.66 $ 0.46
============= ============= =============
Weighted average shares outstanding 9,061,105 8,350,299 8,021,248
============= ============= =============
Weighted average shares equivalents 9,698,048 9,761,703 9,254,442
============= ============= =============
The accompanying notes are an integral part of these consolidated statements.
F-3
XETA TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Stock Treasury Stock
-------------------------- -------------------
Shares Issued Par Value Shares Amount Paid-in Capital Retained Earnings
------------- --------- ------ ------ --------------- -----------------
Balance-October 31, 1998 2,286,284 $ 228,628 264,547 $(1,748,116) $ 5,135,818 $ 7,568,905
Stock options exercised $.10 par value 32,067 3,207 -- -- 49,469
Tax benefit of stock options -- -- -- -- 188,568
Treasury stock purchased -- -- 65,150 (1,158,043)
Two-for-one stock split 2,318,351 329,697
Net income 4,282,856
----------- ----------- ----------- ----------- ----------- -----------
Balance-October 31, 1999 4,636,702 231,835 659,394 (2,906,159) 5,373,855 11,851,761
Treasury stock issued in acquisition (150,000) 661,500 2,638,500
Stock options exercised $.05 par value 72,166 3,607 182,693
Change in par value of common stock (226,025) 226,025
Two-for-one stock split 4,708,868 509,394
Stock options exercised $.001 par value 245,000 245 61,007
Tax benefit of stock options 1,004,696
Net income 6,461,619
----------- ----------- ----------- ----------- ----------- -----------
Balance-October 31, 2000 9,662,736 9,662 1,018,788 (2,244,659) 9,486,776 18,313,380
Stock options exercised $.001 par value 594,004 594 -- -- 369,169 --
Tax benefit of stock options -- -- -- -- 1,781,867 --
Net income -- -- -- -- -- 3,480,637
----------- ----------- ----------- ----------- ----------- -----------
Balance-October 31, 2001 10,256,740 $ 10,256 1,018,788 $(2,244,659) $11,637,812 $21,794,017
=========== =========== =========== =========== =========== ===========
The accompanying notes are an integral part of these consolidated statements.
F-4
XETA TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Twelve Months
Ended October 31,
2001 2000 1999
------------ ------------ ------------
Cash flows from operating activities:
Net income $ 3,480,637 $ 6,461,619 $ 4,282,856
------------ ------------ ------------
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation 1,004,518 819,439 430,599
Amortization 1,609,466 1,587,230 1,936,057
Loss on sale of assets 10,693 17,665 --
Provision for returns & doubtful accounts receivable 290,000 191,000 36,000
Provision for excess and obsolete inventory 1,300,000 325,000 496,170
Change in assets and liabilities net of acquisitions:
(Increase) decrease in net investment in sales-type leases &
other receivables 1,488,208 1,559,228 (3,709,850)
(Increase) decrease in trade receivables 15,111,338 (9,072,384) (907,446)
(Increase) decrease in inventories (2,548,903) 1,392,523 (1,723,570)
(Increase) in deferred tax asset (502,687) 111,533 (47,008)
(Increase) decrease in prepaid expenses and other assets 159,284 (116,751) (391,144)
(Increase) decrease in prepaid taxes (662,958) 18,700 --
Increase (decrease) in accounts payable (7,782,294) 1,104,108 379,645
Increase (decrease) in unearned revenue (2,794,181) (2,834,396) 2,667,239
Increase (decrease) in accrued income taxes 1,655,925 1,130,639 6,692
Increase (decrease) in accrued liabilities (2,107,597) (97,501) 670,283
Increase (decrease) in deferred tax liabilities 82,280 (16,421) 123,143
------------ ------------ ------------
Total adjustments 6,313,092 (3,880,388) (33,190)
------------ ------------ ------------
Net cash provided by operating activities 9,793,729 2,581,231 4,249,666
------------ ------------ ------------
Cash flows from investing activities:
Acquisitions, net of cash acquired (5,595,193) (26,556,154) --
Purchase of long distance contracts (156,500)
Additions to capitalized software -- (68,550) (114,036)
Additions to property, plant & equipment (3,585,867) (2,720,054) (1,555,769)
Proceeds from sale of assets 1,200 82,325 --
------------ ------------ ------------
Net cash used in
investing activities (9,179,860) (29,262,433) (1,826,305)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from issuance of debt 5,500,000 26,020,432
Proceeds from draws on revolving line of credit 40,035,000 23,750,000
Principal payments on debt (11,162,073) (4,216,664)
Payments on revolving line of credit (35,685,000) (22,750,000)
Purchase of treasury stock (1,158,043)
Exercise of stock options 369,763 247,552 52,676
------------ ------------ ------------
Net cash provided by (used in)
financing activities (942,310) 23,051,320 (1,105,367)
------------ ------------ ------------
Net decrease in cash and cash equivalents (328,441) (3,629,882) 1,317,994
Cash and cash equivalents, beginning of period 926,330 4,556,212 3,238,218
------------ ------------ ------------
Cash and cash equivalents, end of period $ 597,889 $ 926,330 $ 4,556,212
============ ============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 2,760,516 $ 1,620,462 $ 18,296
Cash paid during the period for income taxes $ 1,645,414 $ 2,956,054 $ 2,675,135
Treasury shares given in UST acquisition $ -- $ 3,300,000 $ --
The accompanying notes are an integral part of these consolidated statements.
F-5
XETA TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED OCTOBER 31, 2001
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Business
XETA Technologies, Inc. (XETA or the Company) is a nationwide integrator of
voice and data technologies. The Company provides consulting, sales,
engineering, project management, installation and service of voice, data, IP
networking solutions, Microsoft Exchange applications, unified messaging
systems, call centers, and telephony over IP solutions to the commercial market.
These products are manufactured by a variety of manufacturers including Avaya,
Cisco, and Hitachi. In addition, the Company provides voice systems and
XETA-manufactured call accounting systems to the hospitality industry. XETA is
an Oklahoma corporation.
U.S. Technologies Systems, Inc. (USTI) is a wholly-owned subsidiary of XETA and
was purchased on November 30, 1999 as part of the Company's expansion into the
commercial market. Xetacom, Inc. (Xetacom), is a wholly-owned, but dormant,
subsidiary of the Company.
Cash and Cash Equivalents
Cash and cash equivalents at October 31, 2001, consist of money market accounts
and commercial bank accounts.
Lease Accounting
A portion of the Company's revenues has been generated using sales-type leases.
The Company sells some of its call accounting systems to the lodging industry
under these sales-type leases to be paid over three, four and five-year periods.
Because the present value (computed at the rate implicit in the lease) of the
minimum payments under these sales-type leases equals or exceeds 90 percent of
the fair market value of the systems and/or the length of the lease exceeds 75
percent of the estimated economic life of the equipment, the Company recognizes
the net effect of these transactions as a sale, as required by accounting
principles generally accepted in the United States.
Interest and other income is primarily the recognition of interest income on the
Company's sales-type lease receivables and income earned on short-term cash
investments. Interest income from a sales-type lease represents that portion of
the aggregate payments to be received over the life of the lease, which exceeds
the present value of such payments using a discount factor equal to the rate
implicit in the underlying leases.
Revenue Recognition
The Company recognizes revenue from sales-type leases as discussed above under
the caption "Lease Accounting." Service revenue is recognized monthly over the
life of the related sales-type lease or service agreement on a straight-line
basis. In fiscal year 2000, the Company changed its revenue recognition policy
related to equipment sales, in order to provide better matching of revenues and
expenses under the Company's new method. Equipment revenues from call accounting
and PBX systems sales are recognized upon shipment of the system and
installation revenue from system sales is recognized upon installation. Under
the prior method, call accounting system sales were recognized 75 percent upon
shipment with
F-6
the remaining 25 percent recognized upon installation. PBX system sales were
recognized 100 percent upon installation. The accounting change was not material
to the financial statements.
Property, Plant and Equipment
The Company capitalizes the cost of all significant property, plant and
equipment additions including equipment manufactured by the Company and
installed at customer locations under PBX service agreements. Depreciation is
computed over the estimated useful life of the asset or the terms of the lease
for leasehold improvements, whichever is shorter, on a straight-line basis. When
assets are retired or sold, the cost of the assets and the related accumulated
depreciation is removed from the accounts and any resulting gain or loss is
included in income. Maintenance and repair costs are expensed as incurred.
Research and Development and Capitalization of Software Production Costs
The Company capitalizes software production costs related to a product upon the
establishment of technological feasibility as defined by accounting principles
generally accepted in the United States. Amortization is provided on a
product-by-product basis based upon the estimated useful life of the software
(generally seven years). All other research and development costs (including
those related to software for which technological feasibility has not been
established) are expensed as incurred.
Income Taxes
Several items of income and expense, including certain sales revenues under
sales-type leases, are included in the financial statements in different years
than they are included in the income tax returns. Deferred income taxes are
recorded for the tax effect of these differences.
Warranty and Unearned Revenue
The Company typically provides a one-year warranty from the date of installation
of its systems. The Company defers a portion of each system sale to be
recognized as service revenue during the warranty period. The amount deferred is
generally equal to the sales price of a maintenance contract for the type of
system under warranty and the length of the warranty period.
The Company also records deposits received on sales orders and prepayments for
maintenance contracts as unearned revenues.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Segment Information
In the first quarter of 2000, the Company adopted Statement of Financial
Accounting Standards No. 131 (SFAS 131), "Disclosures about Segments of an
Enterprise and Related Information," in conjunction with its acquisition of USTI
and the Company's internal realignment. The Company divided its operations into
three reportable segments: commercial system sales, lodging system sales and
installation and service. The Company defines commercial system sales as sales
to the non-lodging industry. Installation and service revenues represent
revenues earned from installing and maintaining systems for customers in both
the commercial and lodging segments.
The reporting segments follow the same accounting policies used for the
Company's consolidated financial statements and described in the summary of
significant accounting policies. Company
F-7
management evaluates a segment's performance based upon gross margins. Assets
are not allocated to the segments. Sales to customers located outside of the
United States are immaterial.
The following is tabulation of business segment information for 2001, 2000 and
1999. Segment information for 2000 and 1999 has been restated to conform to the
current presentation.
Commercial Lodging Installation
Equipment Systems and Service Other
SALES Sales REVENUES Revenue Total
------------ ------------ ------------ ------------ ------------
2001
Sales $ 41,964,072 $ 10,063,623 $ 33,105,152 $ 921,182 $ 86,054,029
Cost of sales 29,811,902 6,449,040 23,511,694 2,758,651 62,531,287
Gross profit 12,152,170 3,614,583 9,593,458 (1,837,469) 23,522,742
2000
Sales 54,198,673 16,032,612 31,219,629 967,987 102,418,901
Cost of sales 37,403,184 10,076,638 21,627,342 2,481,864 71,589,028
Gross profit 16,795,489 5,955,974 9,592,287 (1,513,877) 30,829,873
1999
Sales -- 17,857,086 18,766,095 639,871 37,263,052
Cost of sales -- 10,412,029 12,206,057 654,606 23,272,692
Gross profit -- 7,445,057 6,560,038 (14,735) 13,990,360
Recently Issued Accounting Pronouncements
In June 2001, the FASB issued Statements of Financial Accounting Standards
("SFAS") No.'s 141 and 142, "Business Combinations" and "Goodwill and Other
Intangible Assets", respectively. SFAS 141 requires all business combinations
initiated after June 30, 2001 to be accounted for using the purchase method.
Under SFAS 142, goodwill recorded as part of a business combination is no longer
amortized, but instead will be subject to at least annual assessment for
impairment by applying a fair-value-based test. Also, SFAS 142 requires that in
future business combinations, all acquired intangible assets should be
separately stated on the balance sheet if the benefit of the intangible asset is
obtained through contractual or other legal rights, or if the intangible asset
can be sold, transferred, licensed, rented, or exchanged, regardless of the
acquirer's intent to do so. These intangible assets will then be amortized over
their useful lives, resulting in amortization expense. The new rule does not
require that companies evaluate existing goodwill on their books for allocation
into separately recognized intangible assets. However, companies, at the time of
adoption of the new standard, are required to conduct an initial
fair-value-based goodwill impairment test to determine if the carrying value of
the goodwill on their balance sheet is impaired. The Company has elected to
early adopt SFAS 142 on November 1, 2001. In conjunction with the adoption of
the standard, the Company engaged an independent valuation expert to conduct the
initial assessment. The results of that assessment indicated that no impairment
existed in the value of recorded goodwill on the Company's books as of November
1, 2001. As a result of the adoption of SFAS 142, the Company will no longer
record goodwill amortization in its operating results. Amortization of goodwill
from acquisitions was $1.5 million, $1.1 million, and $1.8 million for the years
ending October 31, 2001, 2000, and 1999, respectively. Based on goodwill amounts
at October 31, 2001, amortization expense of $1.4 million would have been
recorded for the year ending October 31, 2002.
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations". This statement addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. The statement amend SFAS 19, "Financial
Accounting and Reporting by Oil and Gas Producing Companies." SFAS 143 requires
that the fair value of a liability for an asset retirement obligation be
recognized in the period in which it is incurred if a reasonable estimate of
fair value can be made, and that the associated asset
F-8
retirement costs be capitalized as part of the carrying amount of the long-lived
asset. The Statement is effective for financial statements issued for fiscal
years beginning after June 15, 2002. The effect of this new standard on the
Company's results of operations and financial position is not expected to be
material.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement supercedes SFAS
121, "Accounting for the Impairment of Long-Lived Assets to be Disposed of" and
amends Accounting Principals Board Opinion No. 30, "Reporting the Results of
Operation - Reporting the Effects of Disposal of a Segment of a Business and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions." The
Statement retains the basic framework of SFAS No. 121, resolves certain
implementation issues of SFAS 121, extends applicability to discontinued
operations, and broadens the presentation of discontinued operations to include
a component of an entity. The Statement will be applied prospectively and is
effective for financial statements issued for fiscal years beginning after
December 15, 2001. Adoption of the Statement is not expected to have any initial
impact on the Company's results of operations or financial position.
RECLASSIFICATIONS
Certain reclassifications have been made to the 2000 and 1999 income statements
to conform with the 2001 presentation. These reclassifications had no effect on
net income or retained earnings.
CHANGE IN PAR VALUE AND STOCK SPLIT
On June 26, 2000, the Company reduced the par value of its common stock to
$.001 and increased the authorized shares to 50 million.
The Company declared a two-for-one stock split which was effective on July 17,
2000. All share and per share amounts contained in these financial statements
and footnotes have been restated to reflect the stock split.
2. ACQUISITIONS:
The accompanying balance sheet and statements of operations represent the
financial condition and results of operations of the Company after consolidating
the operating results of each of the transactions discussed below since the date
of acquisition.
On November 1, 2000, the Company acquired substantially all of the assets
of Pro Networks Corporation (Pro Net) and Key Metrology, Inc. (KMI) in separate
transactions. Both of these acquisitions were made to fulfill part of the
Company's growth strategy to provide complex applications and professional
services in addition to its traditional voice products and services. Both of
these transactions were accounted for using the purchase method of accounting.
The combined purchase price was $5.6 million resulting in approximately $5.3
million in goodwill. Prior to November 1, 2001, the Company amortized goodwill
over 20 years unless circumstances indicated a shorter life was appropriate.
Both transactions contained earn-out provisions, which could have resulted in
additional purchase price being paid to the sellers; however, management
anticipates that the provisions will expire unearned.
On February 29, 2000, the Company acquired substantially all of the properties
and assets (the Assets) of Advanced Communications Technologies, Inc. (ACT)
pursuant to the terms of an Asset Purchase Agreement (the Purchase Agreement)
dated February 22, 2000, entered into among the Company and ACT, its parent
corporation, Noram Telecommunications, Inc., an Oregon corporation, and its
parent corporation, Quanta Services, Inc., a Delaware corporation. The Company
also assumed all of ACT's existing liabilities as disclosed on ACT's balance
sheet with the exception of inter-company liabilities and income taxes payable
by ACT. The purchase price of the Assets was $3 million which included the book
value (as defined in the Purchase Agreement) of ACT plus $250,000. In
conjunction with the purchase, the Company recorded $874,000 of goodwill.
F-9
On November 30, 1999, the Company acquired USTI, a Missouri Subchapter S
corporation. The Company purchased all of the outstanding common stock of USTI
for $26 million in cash, inclusive of $3 million in hold-backs, plus 300,000
shares of XETA common stock held in treasury with a market value of $3.3 million
on the date of issuance. At October 31, 2001, there remained $1 million in
hold-backs subject to various indemnity provisions in the purchase agreement.
This amount was paid in full according to the terms of the purchase agreement on
November 30, 2001. The transaction was accounted for using the purchase method
of accounting and goodwill of $22,000,000 was added to the Company's balance
sheet.
The unaudited proforma information presented below consists of statement of
operations data as presented if USTI's results had been consolidated from the
first day of the period reported.
Proforma
Year ended October 31,
2000 1999
------------ -------------
Revenues $106,462,887 $ 75,213,052
Net income $ 6,869,101 $ 6,694,856
Basic earnings per share $ 0.82 $ 1.27
Diluted earnings per share $ 0.70 $ 1.10
Please see Note 1 above regarding the Company's adoption of SFAS 142 and the
related accounting for goodwill beginning November 1, 2001.
3. ACCOUNTS RECEIVABLE:
Trade accounts receivable consist of the following at October 31:
2001 2000
-------------- -------------
Trade receivables $ 17,205,346 $ 32,003,881
Less- reserve for doubtful accounts 1,298,245 1,864,258
-------------- -------------
Net trade receivables $ 15,907,101 $ 30,139,623
============== =============
Adjustments to the reserve for doubtful accounts consist of the following at
October 31:
2001 2000
-------------- ------------
Balance, beginning of period $ 1,864,258 $ 185,168
Acquired at acquisition - 1,642,771
Provision for doubtful accounts 290,000 191,000
Net write-offs (856,013) (154,681)
------------- ------------
Balance, end of period $ 1,298,245 $ 1,864,258
============= ============
4. INVENTORIES:
Inventories are stated at the lower of cost (first-in, first-out or average) or
market and consist of the following components at October 31:
2001 2000
-------------- ------------
Raw materials $ 1,236,411 $ 1,235,842
Finished goods and spare parts 9,459,787 8,032,695
------------ ------------
10,696,198 9,268,537
Less- reserve for excess and obsolete inventories 1,687,233 1,133,475
------------ ------------
Total inventories, net $ 9,008,965 $ 8,135,062
============ ============
F-10
Adjustments to the reserve for excess and obsolete inventories consist of the
following:
2001 2000
------------- ------------
Balance, beginning of period $ 1,133,475 $ 821,170
Provision for excess and obsolete inventories 1,300,000 325,000
Adjustments to inventories (746,242) (12,695)
------------- ------------
Balance, end of period $ 1,687,233 $ 1,133,475
============= ============
5. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment consist of the following at October 31:
Estimated
Useful
Lives 2001 2000
----------- ------------ ------------
Building 20 $ 2,397,954 $ 2,397,954
Data processing and computer field equipment 3-5 7,862,996 4,244,213
Land - 611,582 611,582
Office furniture 5 1,084,117 958,385
Auto 5 251,477 266,668
Other 3-7 673,538 677,137
------------ ------------
Total property, plant and equipment 12,881,664 9,155,939
Less- accumulated depreciation 3,282,415 2,301,088
------------ ------------
Total property, plant and equipment, net $ 9,599,249 $ 6,854,851
============ ============
6. ACCRUED LIABILITIES:
Accrued liabilities consist of the following at October 31:
2001 2000
------------- -------------
Commissions $ 493,915 $ 1,608,576
Interest 144,138 708,750
Payroll 416,406 401,632
Bonuses 541,382 334,476
Vacation 398,100 294,905
Other 57,211 579,464
------------- -------------
Total current 2,051,152 3,927,803
Noncurrent liabilities 1,299,114 1,299,114
------------- -------------
Total accrued liabilities $ 3,350,266 $ 5,226,917
============= =============
F-11
7. UNEARNED REVENUE:
Unearned revenue consists of the following at October 31:
2001 2000
-------------- --------------
Service contracts $ 1,375,018 $ 1,884,155
Warranty service 578,964 1,001,791
Customer deposits 370,714 1,309,159
Systems shipped but not installed 139,247 196,766
Other 64,160 121,158
-------------- --------------
Total current unearned revenue 2,528,103 4,513,029
Noncurrent unearned service contract revenue 454,166 1,039,949
-------------- --------------
Total unearned revenue $ 2,982,269 $ 5,552,978
============== ==============
8. INCOME TAXES:
Income tax expense is based on pretax financial accounting income. Deferred
income taxes are computed using the asset-liability method in accordance with
SFAS No. 109, "Accounting for Income Taxes" and are provided on all temporary
differences between the financial basis and the tax basis of the Company's
assets and liabilities.
The income tax provision for the years ending October 31, 2001, 2000 and 1999,
consists of the following:
2001 2000 1999
------------- ------------- ----------
Current provision - federal $ 1,630,630 $ 4,440,000 $ 2,176,000
Current provision - state 350,800 753,000 498,000
------------- ------------- -------------
Deferred provision (benefit) 263,570 (1,037,000) 76,000
Total provision $ 2,245,000 $ 4,156,000 $ 2,750,000
============= ============= =============
The reconciliation of the statutory income tax rate to the effective income tax
rate is as follows:
Year Ended
October 31,
----------------------
2001 2000 1999
---- ---- ----
Statutory rate 34 % 34 % 34 %
State income taxes 7 % 7 % 7 %
Other (2)% (2)% (2)%
---- ---- ----
Effective rate 39 % 39 % 39 %
==== ==== ====
F-12
The tax effect of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities as of October 31 are
presented below:
2001 2000
---------- ----------
Deferred tax assets:
Prepaid service contracts $ 247,423 $ 337,559
Nondeductible reserves 925,917 1,630,311
Unamortized cost of service contracts 102,412 31,186
Other 95,599 29,224
---------- ----------
Total deferred tax asset 1,371,351 2,028,280
---------- ----------
Deferred tax liabilities:
Tax income to be recognized on sales-type lease contracts 394,624 603,606
Unamortized capitalized software development costs 160,495 203,305
Other 518,367 211,485
---------- ----------
Total deferred tax liability 1,073,486 1,018,396
---------- ----------
Net deferred tax asset $ 297,865 $1,009,884
========== ==========
9. CREDIT AGREEMENTS:
Financing for the acquisitions described in Note 2 was provided through an
amended and restated credit facility with a bank. The credit facility consists
of term loans that were used to finance most of the cash purchase price for each
of the acquisitions and a revolving line of credit. On October 31, 2001, the
credit facility was restructured to reflect the Company's current earnings
levels, expand the revolving line of credit to $9 million, and to more fully
collateralize the outstanding debt. At October 31, 2001, long-term debt
consisted of the following:
October 31,
2001 2000
----------- -----------
$9 million bank line of credit, due October 31, 2002, secured by a
borrowing base of accounts receivable and inventories
$ 5,350,000 $ 1,000,000
Term loan, payable in monthly installments of $259,861 at October 31,
2001 and $433,674 at October 31, 2000, due October 31, 2003
15,591,686 21,803,765
Real estate term note, payable in monthly installments of $14,166, due
October 31, 2003, secured by a first mortgage on the
Company's headquarters building 2,550,000 --
Acquisition hold-back, payable on November 30, 2001 1,000,000 3,000,000
----------- -----------
24,491,686 25,803,765
Less-current maturities 9,638,337 7,820,754
----------- -----------
$14,853,349 $17,983,011
Maturities of long-term debt for each of the years ended October 31, are as
follows:
2002 $ 9,638,337
2003 14,853,349
Interest on all outstanding debt under the credit facility accrues at either a)
the London Interbank Offered Rate (which was 2.34% at October 31, 2001) plus
1.25% to 3.25%, as determined by the collateral underlying the loan and the
ratio of the Company's total funded debt to EBITDA (as defined in the credit
facility) or b) the bank's prime rate (which was 5.5% at October 31, 2001) minus
0% to 1.5%. The credit facility requires, among other things, that the Company
maintains a minimum net
F-13
worth, working capital and debt service coverage ratio and limits capital
expenditures. At October 31, 2001, the Company was in compliance with the
covenants of the credit facility.
Based on the borrowing rates currently available to the Company for bank loans
with similar terms and average maturities, the fair value of the long-term debt
approximates the carrying value.
10. STOCK OPTIONS:
During fiscal 2000, the Company adopted a new stock option plan (2000 Plan) for
officers, directors and key employees. The 2000 Plan replaces the previous 1988
Plan, which had expired. Under the 2000 Plan, the Board of Directors or a
committee thereof determine the option price, not to be less than fair market
value, the date of the grant, number of options granted, and the vesting period.
Although there are exceptions, generally options that have been granted under
the 2000 Plan expire 10 years from the date of grant, have 3-year cliff-vesting
and are incentive stock options as defined under the applicable IRS tax rules.
Options granted under the previous 1988 Plan generally vested 33 1/3% per year
after a 1-year waiting period.
Outstanding Options
(1988 and 2000 Plans)
---------------------
Price Per
Number Share
------ -----
Balance, October 31, 1999 337,076 $ 0.25 - 4.38
Granted 258,400 $ 9.06 - 18.13
Exercised (99,732) $ 0.25 - 4.38
Forfeited (21,100) $11.00 - 18.13
--------- --------------
Balance, October 31, 2000 474,644 $ 0.25 - 18.13
Granted 119,350 $ 5.31 - 11.63
Exercised (94,004) $ 0.25 - 4.38
Forfeited (-58,650) $ 9.06 - 18.13
---------- --------------
Balance, October 31, 2001 441,140 $ 0.31 - 18.13
========= ==============
At October 31, 2001 and 2000, options to purchase 170,840 and 341,804 shares,
respectively, are exercisable.
The Company has also granted options outside the Plan to certain officers
and directors. These options generally expire ten years from the date of grant
and are exercisable over the period stated in each option. The table below
presents information regarding options granted outside the Plan.
Outstanding Options
Price Per
Number Share
------ -----
Balance, October 31, 1999 2,400,000 $ 0.25- 5.94
Granted 40,000 $ 15.53
Exercised (289,600) $ 0.25
--------- ------------
Balance, October 31, 2000 2,150,400 $ .25-15.53
Granted -- $ --
Exercised (500,000) $ 0.25- 5.81
Forfeited (200,000) $ 5.81
---------- ------------
Balance, October 31, 2001 1,450,400 $ 0.25-15.53
========= =============
Accounting for stock options issued to employees is governed by SFAS 123,
"Accounting for Stock Based Compensation." Generally, SFAS 123 requires
companies to record in their financial statements the compensation expense, if
any, related to stock options issued to employees. Under an alternative
accounting method adopted by the Company, SFAS 123 allows the Company to only
F-14
disclose the impact of issued stock options as if the expense had been recorded
in the financial statements. Had the Company recorded compensation expense
related to its stock option plans in accordance with SFAS 123, the Company's net
income and earnings per share would have been reduced to the pro forma amounts
indicated below:
For the Year Ended
October 31,
-------------------------------------------------
2001 2000 1999
------------- ------------- -------------
NET INCOME:
As reported $ 3,480,637 $ 6,461,619 $ 4,282,856
Pro forma $ 2,796,612 $ 5,797,629 $ 4,088,298
EARNINGS PER SHARE:
As reported - Basic $ .38 $ .77 $ .53
As reported - Diluted $ .36 $ .66 $ .46
Pro forma - Basic $ .31 $ .69 $ .51
Pro forma - Diluted $ .29 $ .59 $ .44
The fair value of the options granted was estimated at the date of grant using
the Modified Black-Scholes European pricing model with the following
assumptions: risk free interest rate (4.82% to 5.78%), dividend yield (0.00%),
expected volatility (81.11% to 81.32%), and expected life (6 years).
11. EARNINGS PER SHARE:
All Basic earnings per common share were computed by dividing net income by the
weighted average number of shares of common stock outstanding during the
reporting period. A reconciliation of net income and weighted average shares
used in computing basic and diluted earnings per share is as follows:
For the Year Ended October 31, 2001
-----------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS
Net income $3,480,637 9,061,105 $ .38
========== =====
Dilutive effect of stock options 636,943
------------
Diluted EPS
Net income $3,480,637 9,698,048 $ .36
========== ============ =====
For the Year Ended October 31, 2000
-----------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS
Net income $ 6,461,619 8,350,299 $ .77
============ =====
Dilutive effect of stock options 1,411,404
------------
Diluted EPS
Net income $ 6,461,619 9,761,703 $ .66
============ =========== =====
F-15
For the Year Ended October 31, 1999
-----------------------------------
Income Shares Per Share
(Numerator) (Denominator) Amount
----------- ------------- ------
Basic EPS
Net income $4,282,856 8,021,248 $ .53
=========== =====
Dilutive effect of stock options 1,233,194
------------
Diluted EPS
Net income $4,282,856 9,254,442 $ .46
========== =========== =====
12. SALES-TYPE LEASES:
------------------
Minimum future annual payments to be received under various leases are as
follows:
Sales-Type
Lease Payments
RECEIVABLE
2002 $2,231,108
2003 785,080
2004 291,432
2005 2,264
------------
3,309,884
Less- imputed interest 324,329
------------
Present value of minimum payments $ 2,985,555
============
13. MAJOR CUSTOMERS AND CONCENTRATIONS OF CREDIT RISK:
Marriott International/Marriott Host (Marriott) is a major customer of the
Company. The Company has systems installed at various Marriott owned or managed
hotels under the brands "Marriott," "Residence Inn by Marriott," "Courtyard by
Marriott," and "Fairfield Inn by Marriott." Revenues from Marriott represented
22 percent of the Company's revenues for the year 1999. Marriott has been a
major customer of the Company since 1986 and management considers its
relationship with Marriott to be good.
During fiscal 2000 and 2001, no single customer represented 10 percent or more
of revenues.
The Company extends credit to its customers in the normal course of business,
including under its sales-type lease program. As a result, the Company is
subject to changes in the economic and regulatory environments or other
conditions, which, in turn, may impact the Company's overall credit risk.
However, the Company sells to a wide variety of customers, and except for its
hospitality customers, does not focus its sales and marketing efforts on any
particular industry. Management considers the Company's credit risk to be
satisfactorily diversified and believes that the allowance for doubtful accounts
is adequate to absorb estimated losses at October 31, 2001 and 2000.
14. EMPLOYMENT AGREEMENTS:
The Board of Directors adopted a new bonus plan in fiscal 2000 to replace the
plan previously in place. Under the new plan, bonuses were to be paid to
executives and key employees based on targeted financial results, which
reflected the Company's annual operating plan. Those targeted results were not
fully achieved in fiscal 2001 or 2000; however, the Company elected to pay
partial bonuses to key employees of approximately $157,500 and $120,000,
respectively.
In fiscal year 1999, $1,114,000 was paid under the previous bonus plan.
F-16
15. CONTINGENCIES:
LITIGATION
Since 1994, the Company has been monitoring numerous patent infringement
lawsuits filed by PHONOMETRICS, INC., a Florida company, against certain
telecommunications equipment manufacturers and hotels who use such equipment.
While the Company has not been named as a defendant in any of these cases,
several of its call accounting customers are named defendants. These customers
have notified the Company that they will seek indemnification under the terms of
their contracts with the Company. However, because there are other equipment
vendors implicated along with the Company in the cases filed against its
customers, the Company has never assumed the outright defense of its customers
in any of these actions.
All of the cases filed by Phonometrics against the Company's customers were
originally filed in, or transferred to, the United States District Court for the
Southern District of Florida. In October 1998 the Florida Court dismissed all of
the cases filed against the hotels for failure to state a claim, relying on the
precedent established in Phonometrics' unsuccessful patent infringement lawsuit
against Northern Telecom. Phonometrics appealed the Florida Court's order and
the United States Court of Appeals for the Federal Circuit reversed the Florida
Court's dismissal of the cases, but did so solely upon the basis of a procedural
matter. The Appeals Court made no ruling with respect to the merits of
Phonometrics' case and remanded the cases back to the Florida Court for further
proceedings. These cases were reopened in April 2000. Thereafter, Phonometrics
filed motions to disqualify the Florida Court judge hearing the cases. These
motions were denied by the Florida Court and Phonometrics appealed the denial.
The cases were stayed by the Florida Court pending the outcome of this appeal.
In November 2001, several defendant hotels filed motions for summary judgment.
The Florida Court issued an order lifting the stay on the cases only for
purposes of hearing motions for summary judgment. The Company will continue to
monitor proceedings in these actions.
16. RETIREMENT PLAN:
The Company has a 401(k) retirement plan (Plan). In addition to employee
contributions, the Company makes discretionary matching and profit sharing
contributions to the Plan based on percentages set by the Board of Directors.
Contributions made by the Company to the Plan were approximately $534,000,
$355,000 and $168,000 for the years ending October 31, 2001, 2000, and 1999,
respectively.
17. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
The following quarterly financial data has been prepared from the financial
records of the Company without an audit, and reflects all adjustments which, in
the opinion of management, were of a normal, recurring nature and necessary for
a fair presentation of the results of operations for the interim periods
presented.
For the Fiscal Year Ended October 31, 2001
----------------------------------------------
Quarter Ended
----------------------------------------------
January 31, April 30, July 31, October 31,
2001 2001 2001 2001
------- ------- ------- -------
(in thousands, except per share data)
Net sales $25,123 $22,597 $20,964 $17,370
Gross profit 6,864 5,919 5,777 4,963
Operating income 2,622 1,112 2,034 1,581
Net income 1,255 399 978 849
Basic EPS $ 0.14 $ 0.04 $ 0.11 $ 0.09
Diluted EPS $ 0.13 $ 0.04 $ 0.10 $ 0.09
F-17
For the Fiscal Year Ended October 31, 2000
----------------------------------------------------
Quarter Ended
----------------------------------------------------
January 31, April 30, July 31, October 31,
2000 2000 2000 2000
------- ------- ------- -------
(in thousands, except per share data)
Net sales $20,550 $27,473 $25,580 $28,816
Gross profit 6,227 7,922 8,074 8,606
Operating income 2,624 3,335 2,954 3,465
Net income 1,520 1,726 1,436 1,780
Basic EPS $ 0.19 $ 0.21 $ 0.17 $ 0.20
Diluted EPS $ 0.16 $ 0.17 $ 0.15 $ 0.18
F-18
INDEX TO EXHIBITS
SEC No. Description
------- -----------
(2) PLAN OF ACQUISITION, REORGANIZATION, ARRANGEMENT, LIQUIDATION OR
SUCCESSION - None.
(3) (i) ARTICLES OF INCORPORATION -
*(a) Amended and Restated Certificate of Incorporation
of the Registrant -- Incorporated by reference to
Exhibits 3.1 and 3.2 to the Registrant's
Registration Statement on Form S-1, filed on June
17, 1987 (File No. 33-7841).
*(b) Amendment No. 1 to Amended and Restated
Certificate of Incorporation -- Incorporated by
reference to Exhibit 4.2 to the Registrant's
Post-Effective Amendment No. 1 to Registration
Statement on Form S-8, filed on July 28, 1999
(File No. 33-62173).
*(c) Amendment No. 2 to Amended and Restated
Certificate of Incorporation - Incorporated by
reference to Exhibit 3(i)(c) to the Registrant's
Form 10-Q for the quarter ended April 30, 2000,
filed on June 14, 2000 (File No. 0-16231).
*(d) Amendment No. 3 to Amended and Restated
Certificate of Incorporation - Incorporated by
reference to Exhibit 4.4 to the Company's
Post-Effective Amendment No. 2 to the
Registration Statement Form S-8, filed on June
28, 2000 (File No. 33-62173).
(ii) BYLAWS -
*(a) Amended and Restated Bylaws of the Registrant -
Incorporated by reference to Exhibit 3(ii)(a) to
the Registrant's Form 10-Q for the quarter ended
April 30, 2001, filed on July 14, 2001 (File No.
0-16231).
(4) INSTRUMENTS DEFINING RIGHTS OF SECURITY HOLDERS, INCLUDING
INDENTURES - None other than the Amended and Restated Certificate of
Corporation of the Registrant, as amended, and Amended and Restated
Bylaws of the Registrant, as identified in Exhibit 3(i) and 3(ii) to
this report.
(10) MATERIAL CONTRACTS -
*10.1 Dealer Agreement Among Lucent Technologies, Inc.;
Distributor, Inacom Communications, Inc.; and XETA
Corporation for Business Communications Systems --
Incorporated by reference to Exhibit 10.1 to the
Registrant's Form 10-Q for the quarter ended April 30,
1999, filed on June 11, 1999 (File No. 0-16231).
*10.2 Real Estate Mortgage on the Registrant's Broken Arrow,
Oklahoma property -- Incorporated by reference to
Exhibit 2.5 to the Registrant's Form 8-K filed on
December 15, 1999 (File No. 0-16231).
*10.3 Pledge and Security Agreement relating to November 30,
1999 Credit Agreement - Incorporated by reference to
Exhibit 2.4 to the Registrant's Form 8-K filed on
December 15, 1999 (File No. 0-16231).
*10.4 Subsidiary Guaranty by U.S. Technologies Systems, Inc.
of November 30, 1999 Credit facility - Incorporated by
reference to Exhibit 2.6 to the Registrant's Form 8-K
filed on December 15, 1999 (File No. 0-16231).
*10.5 Stock Purchase Option dated February 1, 2000 granted to
Larry N. Patterson - Incorporated by reference to
Exhibit 10.9 to the Registrant's Form 10-Q for the
quarter ended April 30, 2000, filed on June 14, 2000
(File No. 0-16231).
*10.6 Amendment to Dealer Agreement Among Lucent Technologies,
Inc. Distributor, Inacom Communications, Inc.; and XETA
Corporation, for Business Communications Systems, dated
effective March 19, 2000 - Incorporated by reference to
Exhibit 10.10 to the Registrant's Form 10-Q for the
quarter ended April 30, 2000, filed on June 14, 2000
(File No. 0-16231).
*10.7 XETA Technologies 2000 Stock Option Plan - Incorporated
by reference to Exhibit 10.11 to the Registrant's Form
10-Q for the quarter ended April 30, 2000, filed on June
14, 2000 (File No. 0-16231).
*10.8 HCX 5000(R) Authorized Distributor Agreement dated
April 1, 2000 between Hitachi Telecom (USA), Inc. and
XETA Corporation -- Omitted as substantially identical
to the Authorized Distributor Agreement dated April 8,
1993 between Hitachi America, Ltd. and XETA Corporation
which was previously filed as Exhibit 10.1 to the
Company's Annual Report on Form 10-KSB for the fiscal
year ended October 31, 1993 (File No. 0-16231).
*10.9 Stock Purchase Option dated August 11, 2000 granted to
Larry N. Patterson - Incorporated by reference to
Exhibit 10.14 to the Registrant's Annual Report on Form
10-K for the year ended October 31, 2000, filed on
January 29, 2001. (File No. 0-16231).
*10.10 First Amendment to Credit Agreement dated August 21,
2000 among XETA Technologies, Inc., the Lenders, the
Agent and the Arranger - Incorporated by reference to
Exhibit 10.15 to the Registrant's Annual Report on Form
10-K for the year ended October 31, 2000, filed on
January 29, 2001. (File No. 0-16231).
*10.11 Notice of Assignment by Lucent Technologies Inc. dated
September 14, 2000 of all contracts with XETA
Technologies, Inc. (including the Dealer Agreement) to
Avaya Inc. - Incorporated by reference to Exhibit 10.16
to the Registrant's Annual Report on Form 10-K for the
year ended October 31, 2000, filed on January 29, 2001.
(File No. 0-16231).
*10.12 Asset Purchase Agreement dated as of October 31, 2000,
by and among Key Metrology Integration, Inc. as Seller,
its principal shareholder The Douglas Wendell Myers
Revocable Living Trust, XETA Technologies, Inc., as
Purchaser, and Douglas Wendell Myers, individually -
Incorporated by reference to Exhibit 10.17 to the
Registrant's Annual Report on Form 10-K for the year
ended October 31, 2000, filed on January 29, 2001. (File
No. 0-16231).
*10.13 Asset Purchase Agreement dated as of October 31, 2000,
by and among PRO Networks Corporation, as Seller, its
shareholders The John Gerard Sargent Revocable Living
Trust and The Nancy Rhea Sargent Revocable Living Trust,
XETA Technologies, Inc., as Purchaser, and John Gerard
Sargent and Nancy Rhea Sargent, individually -
Incorporated by reference to Exhibit 2.1 to the
Registrant's Form 8-K filed on November 15, 2000 (File
No. 0-16231).
*10.14 Second Amendment to Credit Agreement dated June 8, 2001
among XETA Technologies, Inc., the Lenders, the Agent
and the Arranger - Incorporated by reference to exhibit
10.19 to the Registrant's Form 10-Q for the quarter
ended July 31, 2001, filed on September 14, 2001 (File
No. 0-16231).
10.15 Amended and Restated Audit Agreement dated October 31,
2001 among XETA Technologies, Inc., the Lenders and the
Agent.
(11) STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS - Inapplicable.
(15) LETTER RE: UNAUDITED INTERIM FINANCIAL INFORMATION - Inapplicable.
(18) LETTER RE: CHANGE IN ACCOUNTING PRINCIPLES - Inapplicable.
(19) REPORT FURNISHED TO SECURITY HOLDERS - None.
(22) PUBLISHED REPORT REGARDING MATTERS SUBMITTED TO A VOTE OF SECURITY
HOLDERS - None.
(23) CONSENTS OF EXPERTS AND COUNSEL
23.1 Consent of Arthur Andersen LLP
(24) POWER OF ATTORNEY - None.
(99) ADDITIONAL EXHIBITS - None.
* Previously filed.