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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended January 31, 2003
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 (I.R.S. Employee
incorporation or organization) Identification No.)
1814 W. Tacoma, Broken Arrow, OK 74012-1406
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
918-664-8200
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since
last report)
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 whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes No X
----- -----
Number of shares outstanding of each of the registrant's classes of common
stock, as of the latest practicable date.
Class Outstanding at February 28, 2003
- ----------------------------- ----------------------------------------
Common Stock, $.001 par value 9,702,952
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets - January 31, 2003
and October 31, 2002
Consolidated Statements of Operations - For the
Three months ended January 31, 2003 and 2002
Consolidated Statement of Shareholders' Equity -
November 1, 2002 through January 31, 2003
Consolidated Statements of Cash Flows - For the
Three months ended January 31, 2003 and 2002
Notes to Consolidated Financial Statements
2
XETA TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
January 31, 2003 October 31, 2002
---------------- ----------------
(Unaudited)
Current Assets:
Cash and cash equivalents $ 1,448,458 $ 1,966,734
Current portion of net investment in
sales-type leases and other receivables 861,096 1,015,096
Trade accounts receivable, net 10,250,047 9,478,706
Inventories, net 7,187,714 7,801,781
Deferred tax asset, net 577,286 592,643
Prepaid taxes 896,628 1,195,539
Prepaid expenses and other assets 421,155 165,657
---------------- ----------------
Total current assets 21,642,384 22,216,156
---------------- ----------------
Noncurrent Assets:
Goodwill, net of accumulated amortization
prior to adoption of SFAS 142 25,768,568 25,782,462
Net investment in sales-type leases,
less current portion above 466,778 519,270
Property, plant & equipment, net 10,454,826 10,457,718
Capitalized software production costs, net of
accumulated amortization of $1,098,065 and $1,053,066 192,956 237,955
Other assets 158,525 170,424
---------------- ----------------
Total noncurrent assets 37,041,653 37,167,829
---------------- ----------------
Total assets $ 58,684,037 $ 59,383,985
================ ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 3,288,337 $ 3,288,337
Revolving line of credit 2,000,000 --
Accounts payable 3,903,049 6,119,135
Unearned revenue 1,991,590 2,078,741
Accrued liabilities 1,743,854 1,968,771
Other Liabilities 178,132 181,501
---------------- ----------------
Total current liabilities 13,104,962 13,636,485
---------------- ----------------
Noncurrent liabilities:
Long-term debt, less current portion above 10,742,928 11,565,012
Accrued long-term liabilities 196,783 240,955
Unearned service revenue 224,587 233,859
Noncurrent deferred tax liability, net 1,400,499 1,186,680
---------------- ----------------
12,564,797 13,226,506
---------------- ----------------
Commitments and contingencies
Shareholders' equity:
Preferred stock; $.10 par value; 50,000 shares
authorized, 0 issued -- --
Common stock; $.001 par value; 50,000,000
shares authorized, 10,721,740 and 10,721,740 issued at
January 31, 2003 and October 31, 2002, respectively 10,721 10,721
Paid-in capital 12,193,029 12,193,029
Retained earnings 23,163,491 22,672,256
Accumulated other comprehensive loss (108,304) (110,353)
Less treasury stock, at cost (2,244,659) (2,244,659)
---------------- ----------------
Total shareholders' equity 33,014,278 32,520,994
---------------- ----------------
Total liabilities and shareholders' equity $ 58,684,037 $ 59,383,985
================ ================
The accompanying notes are an integral part of these consolidated balance
sheets.
3
XETA TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED
For the Three Months
Ended January 31,
2003 2002
---------------- ----------------
Systems sales $ 8,725,109 $ 7,345,041
Installation and service revenues 6,116,505 6,066,839
Other revenues 589,791 351,184
---------------- ----------------
Net sales and service revenues 15,431,405 13,763,064
---------------- ----------------
Cost of systems sales 6,428,212 5,035,386
Installation and services costs 4,360,407 4,727,050
Cost of other revenues & corporate COGS 723,691 741,252
---------------- ----------------
Total cost of sales and service 11,512,310 10,503,688
---------------- ----------------
Gross profit 3,919,095 3,259,376
---------------- ----------------
Operating expenses:
Selling, general and administrative 2,937,355 2,614,807
Amortization 45,000 45,000
---------------- ----------------
Total operating expenses 2,982,355 2,659,807
---------------- ----------------
Income from operations 936,740 599,569
Interest expense (179,677) (254,960)
Interest and other income 50,172 111,631
---------------- ----------------
Subtotal (129,505) (143,329)
Income before provision for income
taxes 807,235 456,240
Provision for income taxes 316,000 180,000
---------------- ----------------
Net income $ 491,235 $ 276,240
================ ================
Earnings per share
Basic $ 0.05 $ 0.03
================ ================
Diluted $ 0.05 $ 0.03
================ ================
Weighted average shares outstanding 9,702,952 9,237,952
================ ================
Weighted average equivalent shares 9,941,968 9,880,989
================ ================
The accompanying notes are an integral part of these consolidated statements.
4
XETA TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
UNAUDITED
Common Stock Treasury Stock
------------------------------------- -------------------------------------
Shares Issued Par Value Shares Amount
---------------- ---------------- ---------------- ----------------
Balance-October 31, 2002 10,721,740 $ 10,721 1,018,788 $ (2,244,659)
Components of comprehensive income:
Net income -- -- -- --
Unrealized gain/loss on hedge, net
of tax of $1,320 -- -- -- --
Total comprehensive income
---------------- ---------------- ---------------- ----------------
Balance-January 31, 2003 10,721,740 $ 10,721 1,018,788 $ (2,244,659)
================ ================ ================ ================
Accumulated Other
Comprehensive Retained
Paid-in Capital Loss Earnings Total
---------------- ----------------- ---------------- ----------------
Balance-October 31, 2002 $ 12,193,029 $ (110,353) $ 22,672,256 $ 32,520,994
Components of comprehensive income:
Net income -- -- 491,235 491,235
Unrealized gain/loss on hedge, net
of tax of $1,320 -- 2,049 -- 2,049
----------------
Total comprehensive income 493,284
---------------- ----------------- ---------------- ----------------
Balance-January 31, 2003 $ 12,193,029 (108,304) $ 23,163,491 $ 33,014,278
================ ================= ================ ================
5
XETA TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months
Ended January 31,
2003 2002
--------------- ---------------
Cash flows from operating activities:
Net income $ 491,235 $ 276,240
--------------- ---------------
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation 245,259 266,627
Amortization 45,000 45,000
Loss on sale of assets -- 703
Provision for (reversal of) returns & doubtful accounts receivable -- (48,200)
Provision for excess and obsolete inventory 81,082 56,123
Change in assets and liabilities, net of acquisitions:
Decrease in net investment in sales-type leases & other receivables 206,492 993,166
(Increase) decrease in trade receivables (771,341) 5,242,559
(Increase) decrease in inventories 532,985 (7,610)
Decrease in deferred tax asset 15,357 225,422
(Increase) in prepaid expenses and other assets (243,599) (22,853)
(Increase) decrease in prepaid taxes 298,911 (354,954)
Increase (decrease) in accounts payable (2,216,086) 457,266
(Decrease) in unearned revenue (96,423) (278,825)
Increase in accrued income taxes 9,556 82,820
(Decrease) in accrued liabilities (269,089) (722,273)
Increase in deferred tax liabilities 216,837 164,636
--------------- ---------------
Total adjustments (1,945,059) 6,099,607
--------------- ---------------
Net cash provided by (used in) operating activities (1,453,824) 6,375,847
--------------- ---------------
Cash flows from investing activities:
Additions to property, plant & equipment (244,186) (562,752)
Proceeds from sale of assets 1,818 --
--------------- ---------------
Net cash used in investing activities (242,368) (562,752)
--------------- ---------------
Cash flows from financing activities:
Proceeds from draws on revolving line of credit 2,000,000 7,300,000
Principal payments on debt (822,084) (1,822,087)
Payments on revolving line of credit -- (11,622,000)
--------------- ---------------
Net cash provided by (used in) financing activities 1,177,916 (6,144,087)
--------------- ---------------
Net decrease in cash and cash equivalents (518,276) (330,992)
Cash and cash equivalents, beginning of period 1,966,734 597,889
--------------- ---------------
Cash and cash equivalents, end of period $ 1,448,458 $ 266,897
=============== ===============
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 240,338 $ 443,987
Cash paid during the period for income taxes $ 14,183 $ 62,078
Contingent consideration paid to target shareholder $ -- $ 1,000,000
The accompanying notes are an integral part of these consolidated statements.
6
XETA TECHNOLOGIES, INC.
JANUARY 31, 2003
(Unaudited)
1. BASIS OF PRESENTATION
The consolidated financial statements herein include the accounts of
XETA Technologies, Inc. and its wholly-owned subsidiaries, U.S. Technologies
Systems, Inc. ("UST") and Xetacom, Inc. (the "Company" or "XETA"). Xetacom's
operations have been insignificant to date. All significant intercompany
accounts and transactions have been eliminated.
The accompanying consolidated financial statements have been prepared
by the Company, without an audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote
disclosures, normally included in annual financial statements prepared in
accordance with accounting principles generally accepted in the United States,
have been condensed or omitted pursuant to those rules and regulations. However,
the Company believes that the disclosures made are adequate to make the
information presented not misleading when read in conjunction with the
consolidated financial statements and the notes thereto included in the
Company's latest financial statements filed as part of the Company's Annual
Report on Form 10-K, Commission File No. 0-16231. Management believes that the
financial statements contain all adjustments necessary for a fair statement of
the results for the interim periods presented. All adjustments made were of a
normal recurring nature. The results of operations for the interim period is not
necessarily indicative of the results for the entire fiscal year.
These statements should be read in conjunction with the audited financial
statements and notes thereto included in the Company's Annual Report on Form
10-K, which was filed with the SEC on January 29, 2003, reflecting the operating
results of the Company.
2. INVENTORIES:
Inventories are stated at the lower of cost (first-in, first-out or average) or
market and consist of the following components:
January 31, October 31,
2003 2002
-------------- --------------
(Unaudited)
Finished goods and spare parts $ 7,726,051 $ 8,234,020
Raw materials 358,627 354,380
-------------- --------------
8,084,678 8,588,400
Less- reserve for excess and obsolete inventories 896,964 786,619
-------------- --------------
Total inventories, net $ 7,187,714 $ 7,801,781
============== ==============
3. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment consist of the following:
Estimated
Useful January 31, October 31,
Lives 2003 2002
---------------- ---------------- ----------------
(Unaudited)
Building 20 $ 2,397,954 $ 2,397,954
Data processing and computer field equipment 3-5 10,237,176 10,011,196
Land -- 611,582 611,582
Office furniture 5 1,089,876 1,073,851
Auto 5 126,743 126,743
Other 3-7 634,213 634,213
---------------- ----------------
Total property, plant and equipment 15,097,544 14,855,539
Less- accumulated depreciation 4,642,718 4,397,821
---------------- ----------------
Total property, plant and equipment, net $ 10,454,826 $ 10,457,718
================ ================
7
4. ACCRUED LIABILITIES:
Accrued liabilities consist of the following:
January 31, October 31,
2003 2002
---------------- ----------------
(Unaudited)
Commissions $ 551,082 $ 428,460
Vacation 408,774 481,228
Payroll 188,306 417,171
Bonuses 111,981 213,735
Interest 13,221 11,265
Other 470,490 416,912
---------------- ----------------
Total current 1,743,854 1,968,771
Noncurrent liabilities 196,783 240,955
---------------- ----------------
Total accrued liabilities $ 1,940,637 $ 2,209,726
================ ================
5. UNEARNED REVENUE:
Unearned revenue consists of the following:
January 31, October 31,
2003 2002
---------------- ----------------
(Unaudited)
Customer deposits $ 957,844 $ 897,171
Service contracts 731,189 785,067
Warranty service 295,963 366,586
Systems shipped but not installed 4,750 28,866
Other 1,844 1,051
---------------- ----------------
Total current unearned revenue 1,991,590 2,078,741
Noncurrent unearned service contract revenue 224,587 233,859
---------------- ----------------
Total unearned revenue $ 2,216,177 $ 2,312,600
================ ================
6. 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.
8
The tax effect of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are presented below:
January 31, October 31,
2003 2002
---------------- ----------------
Deferred tax assets: (Unaudited)
Nondeductible reserves $ 511,613 $ 466,292
Prepaid service contracts 144,924 168,210
Unamortized cost of service contracts 42,381 52,788
Other 101,807 119,418
---------------- ----------------
Total deferred tax asset 800,725 806,708
---------------- ----------------
Deferred tax liabilities:
Intangible assets and other 1,489,939 1,257,404
Tax income to be recognized on sales-type lease contracts 58,360 50,062
Unamortized capitalized software development costs 75,639 93,279
---------------- ----------------
Total deferred tax liability 1,623,938 1,400,745
---------------- ----------------
Net deferred liability $ (823,213) $ (594,037)
================ ================
7. CREDIT AGREEMENTS:
At January 31, 2003, long-term debt consisted of the following:
January 31, October 31,
2003 2002
---------------- ----------------
(Unaudited)
Bank line of credit, due March 31, 2003, secured by a borrowing
base of accounts receivable and inventories $ 2,000,000 $ --
Term loan, payable in monthly installments of $259,861, due
November 30, 2003 collateralized by all assets of the Company 11,693,765 12,473,349
Real estate term note, payable in monthly installments of $14,166, due
November 30, 2003, secured by a first mortgage on the
Company's headquarters building 2,337,500 2,380,000
---------------- ----------------
16,031,265 14,853,349
Less-current maturities 5,288,337 3,288,337
---------------- ----------------
$ 10,742,928 $ 11,565,012
================ ================
Interest on all outstanding debt under the credit facility accrues at either a)
the London Interbank Offered Rate (which was 1.42% at January 31, 2003) plus
3.75% or b) the bank's prime rate (which was 4.75% at January 31, 2003) plus 1%.
The credit facility requires, among other things, that the Company maintain a
minimum net worth, working capital and debt service coverage ratio and limits
capital expenditures. At January 31, 2003, the Company was either in compliance
with the covenants of the credit facility or had received the appropriate
waivers from its bank.
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.
8. STOCK OPTIONS:
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
9
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 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 3 Months Ended January 31,
-------------------------------------
2003 2002
---------------- ----------------
Net income as reported $ 491,235 $ 276,240
Less: total stock-based employee
compensation expense determined
under fair value based method
for all awards, net of related
tax effects 179,187 160,315
---------------- ----------------
Pro forma net income $ 312,048 $ 115,925
EARNINGS PER SHARE:
As reported - Basic $ .05 $ .03
As reported - Diluted $ .05 $ .03
Pro forma - Basic $ .03 $ .01
Pro forma - Diluted $ .03 $ .01
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 (4.46% to 5.78%), dividend yield (0.00%),
expected volatility (80.50% to 86.31%), and expected life (6 years).
9. FOOTNOTES INCORPORATED BY REFERENCE:
Certain footnotes are applicable to the consolidated financial
statements, but would be substantially unchanged from those presented in the
Company's Annual Report on Form 10-K, Commission File No. 0-16231, filed with
the Securities and Exchange Commission on January 29, 2003. Accordingly,
reference should be made to those statements for the following:
Note Description
1 Business and Summary of Significant Accounting Policies
2 Acquisitions
3 Accounts Receivable
8 Income Taxes
10 Stock Options
11 Earnings Per Share
12 Commitments
13 Major Customers and Concentration of Credit Risk
14 Employment Agreements
15 Contingencies
16 Retirement Plan
10
ITEM 2. 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: OUR 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 OUR ABILITY
TO IMPLEMENT OUR CURRENT BUSINESS PLAN. THESE AND OTHER FORWARD-LOOKING
STATEMENTS (GENERALLY IDENTIFIED BY SUCH WORDS AS "EXPECTS," "PLANS,"
"BELIEVES," "ANTICIPATES" "FORECASTS," "PREDICTS," AND SIMILAR WORDS OR
EXPRESSIONS) ARE NOT GUARANTEES OF PERFORMANCE BUT RATHER REFLECT OUR CURRENT
EXPECTATIONS, ASSUMPTIONS AND BELIEFS BASED UPON INFORMATION CURRENTLY AVAILABLE
TO US. 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
TOGETHER WITH THE RISK FACTORS IDENTIFIED IN THE COMPANY'S ANNUAL REPORT ON FORM
10-K, WHICH WAS FILED ON JANUARY 29, 2003.
GENERAL
For the quarter ending January 31, 2003, we earned $491,000 on revenues of $15.4
million. These results represent an increase in earnings of 78% and an increase
in revenues of 12% compared to the first quarter of last year. Most of these
improvements came from the sale of communications products to our commercial
customers augmented by the steady revenues and gross profits derived from our
services activities. The percentage increase in earnings on a much lower
increase in revenues reflects the strict cost controls and improved efficiencies
that we have put in place over the past 21 months and demonstrates the leverage
that is now inherent in our operations such that incremental improvements in
revenues produce significant earnings improvements.
Despite these encouraging results, we continue to operate in the midst of very
fragile economic conditions marked by a high degree of pessimism by our
customers. Our customers' pessimism causes close scrutiny of nearly all capital
expenditures, resulting in lengthened sales cycles and greater competitive
pressures. Currently, we believe the single most important factor causing this
pessimism is geopolitical concerns centered on the situation in the Middle East,
specifically the U.S.' current confrontation with Iraq ("Iraqi situation").
Feedback from our customer base coupled with media reports and public statements
by economic pundits leads us to believe that capital spending in the United
States is unlikely to revert to a "normal" level until these geopolitical issues
are resolved. Until then, we will continue to cautiously implement growth
initiatives only to the extent that they can be supported by our current
revenues or through market development funding from Avaya or other suppliers.
Should economic conditions worsen, we will rapidly revert to a defensive posture
in an effort to remain profitable.
Notwithstanding the current macro-economic conditions, we continue to firmly
believe in the strategic vision that we began pursuing three years ago. That
strategy was based in large part on the technological changes that were emerging
at the time, specifically the convergence of voice and data technologies. We
also believed that by emerging from our roots in the lodging industry to the
general commercial market, we were entering a vastly larger market that would
provide us with large potential growth rates even if the overall market grew
only modestly. From a research and development viewpoint, the march toward
converged telecommunications products has continued unabated despite slow
economic conditions during the past two years. During that time, Avaya has
released a raft of new products, all of which are Internet Protocol-based
technology. Customer acceptance of this technology is gaining steam as well.
With few exceptions, customers who are making purchasing decisions are opting
for the new technology in an effort to not be "left behind" with traditional
voice switches.
In summary, we are facing a mixed bag of data. From a long-term view, we believe
that we are in a very large market that is poised at the beginning of a new
product cycle that is revolutionary in its scope. We also believe that our
company is well-positioned to capitalize on these factors as one of a handful of
national
11
providers of complex, converged technology solutions. However, current
macro-economic conditions coupled with the debt on our balance sheet present us
with significant short-term challenges. We believe that it is in the best
long-term interest of our shareholders to preserve the technical competence and
market position that we have built in the last three years. However, should the
current economic conditions continue or worsen in the short-term, we may be
forced to take actions which could set us back in the pursuit of our long-term
strategy.
The following discussion presents additional information regarding our financial
condition and results of operations for the quarter ending January 31, 2003 and
should be read in conjunction with our comments above as well as the Outlook and
Risk Factors discussion contained at the end of this section of the report.
FINANCIAL CONDITION
For the three months ending January 31, 2003, cash used by operations was $1.5
million. This cash consisted of positive cash flows from earnings and non-cash
charges of $863,000 and reductions in inventories of $533,000. Cash used in
operations consisted of reductions in accounts payable of $2.2 million and an
increase in trade accounts receivable of $771,000. Other working capital changes
contributed cash of $138,000. The negative cash flows from operations were
expected as a result of the surge in revenues experienced during the last month
of the 4th quarter of fiscal 2002 and the first quarter just ended. Most of
these orders were for larger systems, which generally have longer and more
complex implementation schedules and therefore also have longer cash cycles. At
the end of the quarter, our accounts payable balance had returned to more normal
levels reflecting the cash paid for equipment purchases. The quality of our
accounts receivable at January 31, 2003 remains within our targets as days sales
outstanding on billed receivables was 43 days and the percentage of outstanding
receivables beyond 60 days past due was 9%.
In addition to supporting our growth, cash was used in the quarter to make
scheduled principal payments on our term debt of $822,000 and to fund capital
expenditures of $242,000, most of which is related to the Company's ERP system
implementation.
We funded our cash needs during the quarter by drawing $2 million on our working
capital revolver. Presently, we do not have any further availability under the
revolver; therefore it is essential that we generate positive cash flows in the
second quarter from earnings and working capital in order to sustain our
operations. We expect our second quarter revenues to be at similar or lower
levels than our first quarter revenues, so we do not expect additional pressure
on our working capital in the immediate future. However, while no assurance can
be given, we believe that our banking partners would provide limited additional
working capital if we were able to demonstrate that our needs were driven by
increased revenues.
Although we have made all scheduled principal and interest payments on time, as
a result of our low levels of profitability caused by the economic conditions
discussed above and throughout this report, we have not been able to meet some
of the financial covenants contained in our credit facility. To date, our
banking partners have agreed to waive these defaults. It is likely that we will
continue to not be in full compliance with these financial covenants until
revenues and earnings improve for several consecutive quarters. Until that time,
we will likely have limited availability to additional working capital. See
"Outlook and Risk Factors" below for a further discussion of the risks
associated with the Company's credit facility.
RESULTS OF OPERATIONS
For the first quarter of fiscal 2003, our revenues were $15.4 million, an
increase of 12% over the first quarter of last year. This increase consisted of
a 19% increase in systems sales; a 1% increase in installation and service
revenues; and a 68% increase in other revenues. Our gross profit margins in the
first quarter improved to 25.4% compared to 23.7% in the prior year and our
operating expenses increased 12% compared to last year's levels. As a result of
these factors, our first quarter net income was $491,000, a 78% improvement over
last year. Discussed below are the major revenue, gross margin, and operating
expense items that affected our financial results during the first quarter of
fiscal 2003.
12
Systems Sales.
The increase in systems sales consisted of an increase in sales of equipment and
systems to commercial customers of $2.4 million or 44%, partially offset by a
decrease in sales of systems to lodging customers of $995,000 or 50%. The
increase in sales to commercial customers reflects our continued market
penetration in the commercial sector and excellent customer satisfaction with
our implementation of systems. We believe we are well-positioned to serve
customers who need to implement complex, networked, converged communications
systems for their businesses. However, despite the results of the first quarter
the rate of orders received for new systems declined dramatically beginning in
mid-December of last year and continued through the end of February.
Subsequently, and through the date of the filing of this report, order rates
have improved modestly. We believe, that order rates are likely to continue to
be depressed until the Iraqi situation is resolved. We believe that the decline
in the sale of systems to the lodging industry is also being affected by these
factors; however, the lodging industry also continues to suffer from the
after-effects of the September 11th tragedy and the resulting slump specific to
the travel industry.
To combat these issues, we are cautiously initiating a few, limited growth
tactics. Specifically, we are hiring additional sales personnel to focus on
mid-market opportunities in strategic cities in the United States. We define
mid-market as a customer who generally has more than 100 employees, but is not a
large, multi-national or "Fortune 500" type customer. Furthermore, our emphasis
is on mid-market companies that have a need for multi-site, networked
communications systems that fit well with our nation-wide implementation
capabilities. From a long-term perspective, we believe that such customers are
key to our success since we should have the opportunity to sell our full-range
of systems and services, including recurring maintenance services to them.
Currently, many of our sales of equipment are to Avaya customers. In these
cases, Avaya invites us into the account to provide the equipment and
installation as part of their Business Partner program. However, we are not
permitted to sell our own service plans to these customers and therefore our
ability to generate recurring revenue from this customer base is limited. By
locating and securing our own customers through this Mid-market initiative, we
expect to begin building a base of recurring revenue. Our efforts to expand in
this area are being funded largely by cash incentives received from Avaya under
their market development programs available to their dealer network. Given our
present low level of earnings and limited access to working capital, these
initiatives must gain traction and quickly produce gross profit contributions
for us to continue to pursue them.
Installation and Service Revenues.
Installation and service revenues consist of the following:
Three Months Ending January 31,
----------------- -----------------
2003 2002
----------------- -----------------
Contract & Time and Materials (T&M) revenues $ 4,242,000 $ 4,543,000
Commercial installations 756,000 615,000
Lodging installations 424,000 423,000
Consulting 695,000 486,000
----------------- -----------------
Total installation and service revenue $ 6,117,000 $ 6,067,000
================= =================
The 7% decline in contract and T&M revenues consisted of an increase of 7% to
contract revenues offset by a decrease of 39% in T&M revenues. The increase in
contract revenues came from a modest expansion of our lodging customer base in
both PBX and call accounting systems under contract. The decline in T&M revenues
came from both our commercial and lodging customer bases as customers either
chose different service providers or deferred routine maintenance of their
systems. In addition, the overall demand for hourly services has declined as
fewer customers are expanding their employee bases or moving employees which
generates service billings for us. To ensure our competitive position, we have
recently re-instituted lower hourly pricing for our services. By doing so, we
believe our rates will compare favorably to smaller, regional service providers
even though we have nationwide capabilities.
13
We recognize revenues from installation activities upon completion of the
installation, which for larger systems often means that the equipment is shipped
and systems revenues is recognized in one month and installation revenues on
that system are recognized in a subsequent month. In the first quarter of fiscal
2003, revenues earned from installations of systems for commercial customers
increased 23% which partially reflects the increase in commercial systems sales,
but also reflects the fact that installation of some larger systems which
shipped in the first quarter will be installed in the second quarter. Revenues
from installations of systems for lodging customers were unchanged despite the
decline in lodging systems sales reflecting installations of systems during the
first quarter which were shipped in the fourth quarter of last year.
Consulting revenues increased 43% and reflects professional design and project
management services provided to support the increase in sales of systems to
commercial customers.
Gross Margins. The gross margin earned on total sales and service revenues in
the first quarter was 25.4% compared to 23.7% for the same period last year.
This increase consisted of increases in gross margins for installation and
service revenues and an increase in the gross margins earned on Other revenues.
These improvements were partially offset by a decrease in the gross margins
earned on systems sales.
The gross margins earned on sales of systems was 26.3% down from 31.4% last
year. This decline reflects both a decline in gross margins earned on sales of
systems to commercial customers and a decrease in the percentage of total
systems sold to lodging customers, which generally earn a higher profit margin.
The decline in gross margins earned on sales to commercial customers reflects a
higher mix of larger systems sold which often carry lower gross profit margins
and the overall competitive pressures present in the market. The gross margin
earned on installation and service revenues was 28.7%, up from 22.1% last year.
This increase primarily reflects improvements in the gross margins earned in our
National Service Center which serves our lodging and commercial contract
customers. The continued integration of our commercial and lodging services
offerings and improved efficiencies in processes and systems have produced these
improvements. Gross margins earned on our other installation and service revenue
streams was relatively unchanged.
A final component to our gross margins are the margins earned on other revenues
and its corporate cost of goods sold expenses. Other revenues typically
represent sales and cost of goods sold on equipment or services outside our
normal provisioning processes and in the first quarter was dominated by the sale
of a large data maintenance contract. In this transaction, which is an annual
contract directly between Avaya and the customer, the service obligations are
borne entirely by Avaya and we serve as a sales agent. Corporate cost of goods
sold represents our material logistics and purchasing functions that supports
all of our revenue streams. These expenses declined 15% in the first quarter
compared to last year reflecting the effects of our tight cost controls.
Operating Expenses. Operating expenses increased 12% in the first quarter. This
increase is entirely related to the loss of certain financial incentive programs
previously offered by Avaya. These programs, which have been material to our
operating results in the past, have been curtailed and/or replaced by Avaya.
Beginning in our second fiscal quarter, we will be realizing new financial
incentives that have been approved and paid by Avaya to support our sales
expansion initiatives into a few new markets (see discussion under "Systems
Sales" above regarding these sales initiatives). Under these new programs, Avaya
grants specific requests for cost reimbursements based on a business plan
submitted by us. Previously, we earned financial incentives based on a
combination of the volume of our purchases and our marketing-related
expenditures. Our other sales and general and administrative expenses were
relatively unchanged between the two periods.
Interest Expense and Other Income. Interest and other expense was $130,000 in
the first quarter of this year compared to $143,000 in the first quarter of last
year. This improvement reflects a 29% decrease in interest expense partially
offset by a 55% decrease in interest and other income. The decrease in interest
expense reflects lower average debt outstanding during the two periods under
comparison. The lower interest income in the first period is due to a decrease
in the average amount of sales-type lease receivables outstanding. Both interest
expense and interest income are expected to continue to decline.
14
Tax Provision. The Company has recorded a combined federal and state tax
provision of 39% in all periods presented reflecting the effective federal tax
rate plus the estimated composite state income tax rate.
Operating Margins. Net income as a percent of revenues was 3% for the first
quarter compared to 2% for the same period last year. We believe that our
current business model and current debt levels will support a target operating
margin of 8%. However, we will have to realize sustained growth in systems sales
to reach that target.
OUTLOOK AND RISK FACTORS
The following discussion is an update to the "Outlook and Risk Factors"
discussed in the Company's Annual Report on Form 10-K for the year ended October
31, 2002. The discussions in the report regarding "Dealer Agreements",
"Dependence Upon Avaya", "Dependence Upon a Few Suppliers", "Hiring and
Retaining Key Personnel", "Competition", "Lodging Industry", and "Stock Market
Volatility" are still considered current and should be given equal consideration
together with the matters discussed below.
We believe the U.S. economy is being negatively impacted by concerns about the
Iraqi situation and those concerns are affecting our business.
Our order rates from our Commercial sector customers grew for six straight
months during the last half of 2002. However, beginning in mid-December, those
order rates for new equipment declined dramatically and have not recovered.
Initially, we believed the decline was due to holiday-related vacations, but we
now believe many customers are choosing not to make purchasing decisions until
there is a resolution regarding a potential war in the Middle East. The evidence
to support our belief is anecdotal and is based on discussions with customers
and public comments made by economists and other industry pundits. There is a
general consensus that if a war is begun, it is likely to do so during our
second quarter and that resolution should come within a few weeks or months.
After that, many believe the U.S. economy is poised for a rapid recovery.
However, if the start of a war is delayed or if perceptions develop that the war
is not going well, any recovery in our business would likely be delayed.
It is likely that we will continue to be in default of one or more of the
financial covenants in our credit facility and our banking partners may not
continue to grant waivers and/or provide working capital.
Based on the recent decline in order rates for new systems from our commercial
sector, it is likely that our operating results will be lower in the second
quarter than those presented in this report. If this occurs, we will continue to
not be in compliance with one or more of the financial covenants in our credit
facility. There can be no assurance given that our banking partners will waive
future defaults and continue to provide a working capital line of credit. They
may, in fact, request that we replace the current credit facility with one at
another financial institution. In the event this request is made, there can be
no assurance that we could move the credit facility to another lender on similar
terms or under any terms.
Our sales initiative directed at the "mid-market" may not be successful and may
produce operating losses.
As discussed above, we are adding sales personnel in a few targeted cities to
focus on potential "Mid-market" customers. In the short-term, however, our
ability to fund the necessary operating and capital expenditures to expand our
sales force is largely dependent upon Avaya's financial support of this project.
The projected time frame of available funding is approximately six months.
Therefore if this initiative is not contributing to our profitability within six
to nine months, it is likely we will have to abandon this initiative.
Other Risk Factors.
In addition to the specific risk factors discussed above, the following general
factors can also impact our overall performance and results of operations: the
threat of additional acts of terrorism within the United States and the impact
of those threats on the overall economy, financial markets and customer spending
attitudes; future 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.
15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risks relating to our operations result primarily from changes in
interest rates. In November 2001, we entered into interest rate swap agreements
with each of its banking partners for the purpose of hedging against future
increases in interest rates. The interest rate swap agreements allow us to pay a
fixed interest rate of 3.32% (before application of the bank's pricing margin)
on a portion of its outstanding debt. At January 31, 2003, we had $6.365 million
of outstanding debt subject to interest rate fluctuations. A hypothetical 10
percent change in such interest rates would not have a material effect upon our
consolidated results of operations or cash flows.
ITEM 4. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures. Based on their
evaluation as of a date within 90 days of the filing date of this Quarterly
Report on Form 10-Q, our principal executive officer and principal financial
officer have concluded that our disclosure controls and procedures (as defined
in Rules 13a-14 (c) and 15d-14 (c) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")) are effective to ensure that information required
to be disclosed by the Company in reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in Securities and Exchange Commission rules and forms.
(b) Changes in Internal Controls. There were no significant changes in
our internal controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation. There were no significant
deficiencies or material weaknesses, and therefore there were no corrective
actions taken.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
During the fiscal quarter for which this report is filed, there were no
material developments of which we are aware in the Phonometrics' litigation,
which we are monitoring. A detailed description of the Phonometrics' cases is
contained in our Annual Report on Form 10-K for the fiscal year ended October
31, 2002 filed with the Commission on January 29, 2003.
ITEMS 2 - 5 have been omitted because they are not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits (filed herewith):
SEC Exhibit No. Description
--------------- -----------
10.14 Third Amendment to Amended and Restated Credit
Agreement dated effective as of December 1, 2002
among XETA Technologies, Inc., the Lenders and the
Agent.
99.1 Certification of Chief Executive Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certificate of Chief Financial Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K - During the quarter for which this report is filed, the
Company filed no reports on Form 8-K.
16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
XETA Technologies, Inc.
(Registrant)
Dated: March 14, 2003 By: /s/ Jack R. Ingram
-----------------------------
Jack R. Ingram
Chief Executive Officer
Dated: March 14, 2003 By: /s/ Robert B. Wagner
-----------------------------
Robert B. Wagner
Chief Financial Officer
17
PRINCIPAL EXECUTIVE OFFICER CERTIFICATION
I, Jack R. Ingram, certify that:
1. I have reviewed this quarterly report on Form 10-Q of XETA
Technologies, Inc;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: March 14, 2003
/s/ Jack R. Ingram
- -----------------------
Jack R. Ingram
Chief Executive Officer
18
PRINCIPAL FINANCIAL OFFICER CERTIFICATION
I, Robert B. Wagner, certify that:
1. I have reviewed this quarterly report on Form 10-Q of XETA
Technologies, Inc;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5 The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: March 14, 2003
/s/ Robert B. Wagner
- -----------------------
Robert B. Wagner
Chief Financial Officer
19
INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
- ------- ---------------------------------------------------
10.14 Third Amendment to Amended and Restated Credit
Agreement dated effective as of December 1, 2002
among XETA Technologies, Inc., the Lenders and the
Agent.
99.1 Certification of Chief Executive Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certificate of Chief Financial Officer Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.