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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 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 August 22, 2003
- ---------------------------------------- -----------------------------------
Common Stock, $.001 par value 10,002,952
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets - July 31, 2003
and October 31, 2002
Consolidated Statements of Operations - For the
Three and Nine Months Ended July 31, 2003 and 2002
Consolidated Statement of Shareholders' Equity - For the
Nine Months Ended July 31, 2003
Consolidated Statements of Cash Flows - For the
Nine Months Ended July 31, 2003 and 2002
Notes to Consolidated Financial Statements
2
XETA TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
July 31, 2003 October 31, 2002
------------- ----------------
(Unaudited)
Current Assets:
Cash and cash equivalents $ 604,332 $ 1,966,734
Current portion of net investment in
sales-type leases and other receivables 506,649 1,015,096
Trade accounts receivable, net 7,290,403 9,478,706
Inventories, net 5,706,358 7,801,781
Deferred tax asset, net 775,167 592,643
Prepaid taxes 102,205 1,195,539
Prepaid expenses and other assets 173,937 165,657
------------ ------------
Total current assets 15,159,051 22,216,156
------------ ------------
Noncurrent Assets:
Goodwill, net of accumulated amortization
prior to adoption of SFAS 142 25,740,780 25,782,462
Net investment in sales-type leases,
less current portion above 719,555 519,270
Property, plant & equipment, net 10,388,451 10,457,718
Capitalized software production costs, net of
accumulated amortization of $1,188,066 and $1,053,066 102,956 237,955
Other assets 125,024 170,424
------------ ------------
Total noncurrent assets 37,076,766 37,167,829
------------ ------------
Total assets $ 52,235,817 $ 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 1,800,000 --
Accounts payable 3,754,701 6,119,135
Unearned revenue 2,003,003 2,078,741
Accrued liabilities 2,263,820 1,968,771
Other liabilities 138,635 181,501
------------ ------------
Total current liabilities 13,248,496 13,636,485
------------ ------------
Noncurrent liabilities:
Long-term debt, less current portion above 2,598,759 11,565,012
Accrued long-term liabilities 179,348 240,955
Unearned service revenue 208,653 233,859
Noncurrent deferred tax liability, net 1,784,446 1,186,680
------------ ------------
4,771,206 13,226,506
------------ ------------
Contingencies
Shareholders' equity:
Preferred stock; $.10 par value; 50,000 shares
authorized, 0 issued -- --
Common stock; $.001 par value; 50,000,000
shares authorized, 11,021,740 and 10,721,740 issued at
July 31, 2003 and October 31, 2002, respectively 11,021 10,721
Paid-in capital 12,681,681 12,193,029
Retained earnings 23,852,362 22,672,256
Accumulated other comprehensive loss (84,290) (110,353)
Less treasury stock, at cost (2,244,659) (2,244,659)
------------ ------------
Total shareholders' equity 34,216,115 32,520,994
------------ ------------
Total liabilities and shareholders' equity $ 52,235,817 $ 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 For the Nine Months
Ended July 31, Ended July 31,
------------------------------- -------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
Systems sales $ 6,850,774 $ 6,626,397 $ 21,585,579 $ 20,143,758
Installation and service revenues 5,703,474 6,181,434 17,425,093 18,571,008
Other revenues 355,571 -- 1,096,049 415,238
------------ ------------ ------------ ------------
Net sales and service revenues 12,909,819 12,807,831 40,106,721 39,130,004
------------ ------------ ------------ ------------
Cost of systems sales 4,896,505 5,774,511 15,290,307 15,220,479
Installation and services costs 4,039,806 4,540,433 12,371,145 14,090,360
Cost of other revenues & corporate COGS 412,769 353,683 1,528,782 1,506,155
------------ ------------ ------------ ------------
Total cost of sales and service 9,349,080 10,668,627 29,190,234 30,816,994
------------ ------------ ------------ ------------
Gross profit 3,560,739 2,139,204 10,916,487 8,313,010
------------ ------------ ------------ ------------
Operating expenses:
Selling, general and administrative 2,773,359 2,160,934 8,465,832 7,491,524
Amortization 45,000 45,000 135,000 135,000
------------ ------------ ------------ ------------
Total operating expenses 2,818,359 2,205,934 8,600,832 7,626,524
------------ ------------ ------------ ------------
Income from operations 742,380 (66,730) 2,315,655 686,486
Interest expense (90,444) (220,544) (431,016) (705,395)
Interest and other income (34,375) 499,506 55,467 697,961
------------ ------------ ------------ ------------
Subtotal (124,819) 278,962 (375,549) (7,434)
Income before provision for income
taxes 617,561 212,232 1,940,106 679,052
Provision for income taxes 242,000 83,000 760,000 267,000
------------ ------------ ------------ ------------
Net income $ 375,561 $ 129,232 $ 1,180,106 $ 412,052
============ ============ ============ ============
Earnings per share
Basic $ 0.04 $ 0.01 $ 0.12 $ 0.04
============ ============ ============ ============
Diluted $ 0.04 $ 0.01 $ 0.12 $ 0.04
============ ============ ============ ============
Weighted average shares outstanding - Basic 9,878,495 9,379,963 9,768,886 9,285,809
============ ============ ============ ============
Weighted average equivalent shares - Diluted 10,002,656 9,844,573 9,932,006 9,883,830
============ ============ ============ ============
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)
Stock options exercised $.001 par value 300,000 300 -- --
Tax benefit of stock options -- -- -- --
Components of comprehensive income:
Net income -- -- -- --
Unrealized gain on hedge, net of tax of $16,803 -- -- -- --
Total comprehensive income
----------- ----------- ----------- -----------
Balance-July 31, 2003 11,021,740 $ 11,021 1,018,788 $(2,244,659)
=========== =========== =========== ===========
Comprehensive Retained
Paid-in Capital Loss Earnings Total
--------------- ------------- ----------- -----------
Balance-October 31, 2002 $12,193,029 $ (110,353) $22,672,256 $32,520,994
Stock options exercised $.001 par value 74,700 -- -- 75,000
Tax benefit of stock options 413,952 -- -- 413,952
Components of comprehensive income:
Net income -- -- 1,180,106 1,180,106
Unrealized gain on hedge, net of tax of $16,803 -- 26,063 -- 26,063
-----------
Total comprehensive income 1,206,169
----------- ----------- ----------- -----------
Balance-July 31, 2003 $12,681,681 $ (84,290) $23,852,362 $34,216,115
=========== =========== =========== ===========
5
XETA TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED
For the Nine Months
Ended July 31,
-------------------------------
2003 2002
------------ ------------
Cash flows from operating activities:
Net income $ 1,180,106 $ 412,052
------------ ------------
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 731,401 811,311
Amortization 135,000 135,000
Loss on sale of assets 48,521 44,589
Provision for (reversal of) returns & doubtful accounts receivable (45,907) (748,200)
Provision for excess and obsolete inventory 141,082 930,393
Change in assets and liabilities, net of acquisitions:
Decrease in net investment in sales-type leases & other receivables 308,162 1,761,067
Decrease in trade receivables 2,234,210 9,211,829
Decrease in inventories 1,954,341 1,156,943
(Increase) decrease in deferred tax asset (182,524) 533,724
Decrease in prepaid expenses and other assets 37,120 83,876
(Increase) decrease in prepaid taxes 1,093,334 (1,276,903)
Decrease in accounts payable (2,364,434) (1,273,927)
Decrease in unearned revenue (100,944) (997,554)
Increase in accrued income taxes 28,665 489,815
(Increase) decrease in accrued liabilities 233,442 (983,559)
Increase in deferred tax liabilities 1,007,933 484,024
------------ ------------
Total adjustments 5,259,402 10,362,428
------------ ------------
Net cash provided by operating activities 6,439,508 10,774,480
------------ ------------
Cash flows from investing activities:
Additions to property, plant & equipment (713,225) (1,627,315)
Proceeds from sale of assets 2,568 42,000
------------ ------------
Net cash used in investing activities (710,657) (1,585,315)
------------ ------------
Cash flows from financing activities:
Proceeds from draws on revolving line of credit 9,065,000 16,175,000
Principal payments on debt (8,966,253) (3,466,255)
Payments on revolving line of credit (7,265,000) (21,525,000)
Exercise of stock options 75,000 91,250
------------ ------------
Net cash used in financing activities (7,091,253) (8,725,005)
------------ ------------
Net increase (decrease) in cash and cash equivalents (1,362,402) 464,160
Cash and cash equivalents, beginning of period 1,966,734 597,889
------------ ------------
Cash and cash equivalents, end of period $ 604,332 $ 1,062,049
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 659,291 $ 989,253
Cash paid during the period for income taxes $ 128,237 $ 403,850
Contingent consideration paid to target shareholder $ -- $ 1,000,000
The accompanying notes are an integral part of these consolidated statements.
6
XETA TECHNOLOGIES, INC.
JULY 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. and Xetacom, Inc. (the "Company" or "XETA"). Xetacom's operations have been
insignificant to date. All significant intercompany accounts and transactions
have been eliminated. Effective May 1, 2003, the Company effected a statutory
merger of UST into XETA. The purpose of the merger was to reduce costs
associated with the filing of income tax and other regulatory forms. There was
no effect on the operations of the Company associated with the merger.
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 are
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:
July 31, October 31,
2003 2002
---------- ----------
Finished goods and spare parts $6,391,988 $8,234,020
Raw materials 298,882 354,380
---------- ----------
6,690,870 8,588,400
Less- reserve for excess and obsolete inventories 984,512 786,619
---------- ----------
Total inventories, net $5,706,358 $7,801,781
========== ==========
3. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment consist of the following:
Estimated
Useful July 31, October 31,
Lives 2003 2002
--------- ----------- -----------
Building 20 $ 2,397,954 $ 2,397,954
Data processing and computer field 3-5 4,167,911 4,121,640
equipment
Land -- 611,582 611,582
7
Office furniture 5 1,103,652 1,073,851
Auto 5 126,743 126,743
Other 3-7 511,320 634,213
----------- -----------
Total property, plant and equipment 8,919,162 8,965,983
Less- accumulated depreciation 5,017,161 4,397,821
----------- -----------
Net property, plant and equipment 3,902,001 4,568,162
Construction in progress 6,486,450 5,889,556
----------- -----------
Total property, plant and equipment, net $10,388,451 $10,457,718
=========== ===========
Construction in progress includes capitalized interest of $657,737 and $408,000
for the periods ended July 31, 2003 and October 31, 2002, respectively. Upon
completion of the project, the total cost is expected to be depreciated over an
average life of 7 years.
4. ACCRUED LIABILITIES:
Accrued liabilities consist of the following:
July 31, October 31,
2003 2002
---------- -----------
Commissions $ 447,730 $ 428,460
Vacation 498,833 481,228
Payroll 647,241 417,171
Bonuses 271,349 213,735
Interest 13,444 11,265
Other 385,223 416,912
---------- ----------
Total current 2,263,820 1,968,771
Noncurrent liabilities 179,348 240,955
---------- ----------
Total accrued liabilities $2,443,168 $2,209,726
========== ==========
5. UNEARNED REVENUE:
Unearned revenue consists of the following:
July 31, October 31,
2003 2002
---------- -----------
Customer deposits $ 751,492 $ 897,171
Service contracts 747,409 785,067
Warranty service 310,969 366,586
Systems shipped but not installed 142,928 28,866
Other 50,205 1,051
---------- ----------
Total current unearned revenue 2,003,003 2,078,741
Noncurrent unearned service contract revenue 208,653 233,859
---------- ----------
Total unearned revenue $2,211,656 $2,312,600
========== ==========
8
6. INCOME TAXES:
Income tax expense is based on pretax financial accounting income. Deferred
income taxes are computed using the asset-liability method and are provided on
all temporary differences between the financial basis and the tax basis of the
Company's assets and liabilities.
The tax effect of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are presented below:
July 31, October 31,
2003 2002
----------- -----------
Deferred tax assets:
Nondeductible reserves $ 655,002 $ 466,292
Prepaid service contracts 127,984 168,210
Unamortized cost of service contracts 25,326 52,788
Other 142,079 119,418
----------- -----------
Total deferred tax asset 950,391 806,708
----------- -----------
Deferred tax liabilities:
Intangible assets and other 1,882,512 1,257,404
Tax income to be recognized on sales-type lease
contracts 36,800 50,062
Unamortized capitalized software development costs
40,358 93,279
----------- -----------
Total deferred tax liability 1,959,670 1,400,745
----------- -----------
Net deferred liability $(1,009,279) $ (594,037)
=========== ===========
7. CREDIT AGREEMENTS:
On May 16, 2003, the Company and its banking partners executed a restructuring
of the Company's credit facility. Under the restructuring agreement, the line of
credit supported by a borrowing base of accounts receivables and inventories was
expanded to $7,500,000 and the term loan was reduced by $6,500,000. This
reduction in the term loan was effected by using $4,000,000 million in cash on
hand and borrowing an additional $2,500,000 under the expanded line of credit.
The monthly principal payments due on the term loan were not changed. On
September 2, 2003, the maturity date on all of the Company's debt was extended
to February 15, 2005.
Long-term debt consists of the following:
July 31, October 31,
2003 2002
----------- -----------
Bank line of credit, due February 15, 2005, $ 1,800,000
secured by accounts receivable and inventories $ -
Term loan, payable in monthly installments of
$259,861, due February 15, 2005
collateralized by all assets of the Company 3,634,596 12,473,349
Real estate term note, payable in monthly
installments of $14,166, due February 15,
2005, secured by a first mortgage on the
Company's building 2,252,500 2,380,000
----------- -----------
7,687,096 14,853,349
Less-current maturities 5,088,337 3,288,337
----------- -----------
$ 2,598,759 $11,565,012
=========== ===========
9
Interest on all outstanding debt under the credit facility accrues at either a)
the London Interbank Offered Rate (which was 1.1% at July 31, 2003) plus 3.75%
or b) the bank's prime rate (which was 4.00% at July 31, 2003) plus 1%. The
credit facility requires, among other things, that the Company generate a
certain level of EBIDA per quarter as well as maintain a minimum net worth,
maintain certain working capital ratios, and limits on capital expenditures. At
July 31, 2003, 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.
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 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 Three For the Nine
Months Ended July 31, Months Ended July 31,
------------------------------ --------------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
Net income as reported $ 375,561 $ 129,232 $ 1,180,106 $ 412,052
Less: total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax
effects 179,187 160,315 537,562 480,944
------------- ------------- ------------- -------------
Pro forma net income (loss) $ 196,374 $ (31,083) $ 642,544 $ (68,892)
============= ============= ============= =============
EARNINGS PER SHARE:
As reported - Basic $ .04 $ .01 $ .13 $ .04
As reported - Diluted $ .04 $ .01 $ .12 $ .04
Pro forma - Basic $ .02 $ .00 $ .07 $ (.01)
Pro forma - Diluted $ .02 $ .00 $ .07 $ (.01)
The fair value of the options granted was estimated at the date of grant using
the Black-Scholes 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. EARNINGS PER SHARE:
Basic and diluted earnings per common share were computed by dividing net income
(loss) by the weighted average number of shares of common stock outstanding
during the reporting periods. Options to purchase 994,268 shares of common stock
at an average exercise price of $8.09 and 913,000 shares of common stock at an
average exercise price of $8.62 were not included in the computation of diluted
earnings per share for the nine months ended July 31, 2003 and 2002,
respectively, because inclusion of these options would be anti-dilutive.
10
10. GOODWILL:
During fiscal years 2000 and 2001, the Company made four acquisitions, all using
the purchase method of accounting. To the extent that the purchase price of the
assets exceeded their fair value, the Company recorded the difference as
goodwill. Prior to the adoption of SFAS No. 142, the Company amortized goodwill
into its operating results over the estimated useful life of 20 years. Upon
adoption of SFAS No. 142, amortization was ended and replaced with periodic
evaluation of the fair value of goodwill compared to its recorded book value.
Management performs a review for impairment on an annual basis or earlier as
conditions warrant. For the nine months ended July 31, 2003, no impairment of
goodwill was recorded. In addition, the Company is reducing the carrying value
of goodwill each period to amortize the difference between the recorded value of
goodwill on the Company's tax return compared to the value recorded on the
Company's balance sheet, reflecting a difference in the valuation dates used for
common stock given in one of the acquisitions. During the nine months ended July
31, 2003, the Company has reduced goodwill by $41,682 to reflect this
difference.
11. DERIVATIVE INSTRUMENTS:
The Company uses derivative instruments to reduce its exposure to adverse
fluctuations in interest rate risks. At July 31, 2003 and 2002, the Company had
interest rate swaps on total notional/principal amounts of $6,666,666.67 and
$8,666,666.67, respectively, at a fixed rate of 3.32%. The interest rate swaps
have been properly documented and designated as qualifying hedges under the
provisions of SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities. No ineffective portion was recorded for the three- and nine-months
ended July 31, 2003 and 2002, respectively. The differential paid or received on
the interest rate swap agreements is recognized as an adjustment to interest
expense in the Company's Statement of Operations.
11
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, AND EARNINGS FOR THE FOURTH QUARTER; PLANS TO
RETIRE OUR ACQUISITION-RELATED DEBT; TRENDS AND CONDITIONS IN THE U.S. ECONOMY
AND IN THE COMMUNICATIONS TECHNOLOGY INDUSTRY; AND OUR ABILITY TO IMPLEMENT OUR
OVERALL BUSINESS PLAN AND IN PARTICULAR, OUR NEW MID-MARKET INITIATIVE AND OUR
NORTEL NETWORKS PRODUCT LINE . 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 July 31, 2003, we earned $376,000 on revenues of $12.9
million compared to earnings of $129,000 on revenues of $12.8 million for the
third quarter a year ago. For the nine months ending July 31, 2003 we earned
$1.2 million on revenues of $40.1 million compared to earnings of $412,000 on
revenues of $39.1 million in the same period last year. These earnings
improvements are consistent with our operating results throughout fiscal 2003 as
we continue to navigate the difficult business climate by carefully balancing
our investments in new growth engines against continued strict cost controls.
Our balance sheet continues to improve as well. During the quarter, we used
existing cash balances and cash from operations to reduce our debt by nearly
one-half to $7.7 million. Also, as discussed in our prior quarterly report, we
restructured our debt agreement early in the third quarter. This restructuring
transitions our debt to a traditional model that is supported primarily by the
assets of the Company. At the close of the quarter, our acquisition-related debt
has been reduced to $3.6 million and is expected to be retired in 14 months. Our
financial condition and cash flows are discussed more fully under "Financial
Condition" below.
During the quarter, we announced the addition of the Nortel Networks ("Nortel")
customer premise equipment to our product and service offerings. This addition
was effected through signing of a "Premium Partner" agreement with Nortel. This
agreement, the highest level of Nortel partnership, combined with our Avaya
Business Partner relationship, effectively doubles our market reach. In addition
to opening the door to "Nortel only" customers, many of our existing customers
have both Nortel and Avaya systems due to industry consolidation and distributed
purchasing organizations. We can now meet the needs of these multi-vendor
customers by providing them with system-wide service on all of their
communications systems. We believe that by adding the Nortel line of
communications systems to our product and services portfolio, we have added a
new dimension to our long term strategy to become the leading national provider
of these solutions. To implement the Nortel partnership, we have begun adding
personnel with previous Nortel sales, technical and design experience. We are
making these additions carefully by using a combination of market development
funds from Nortel and our own capital. We will continue to balance our growth
investments against our very slim operating margins until there are clear signs
of improved economic conditions. We expect to realize positive economic results
from our Nortel initiative in the first quarter of next year.
We are pleased with our third quarter operating results and financial condition
given the poor economic conditions that we have continued to face throughout
fiscal 2003. With our debt significantly reduced, our cost structure set for
efficient execution, and our market broadened, we believe we are poised for
excellent future growth when the market for communications equipment and
services recovers. As we enter our fourth quarter, there may be signs that a
recovery in overall capital spending is beginning to occur. However, we
12
have yet to see a rebound in the order rates for communications equipment.
Therefore, we will not change our operating strategy in the fourth quarter and
will continue to expect quarterly earnings to fall within the 1- to 5-cent
range.
The following discussion presents additional information regarding our financial
condition and results of operations for the quarter ending July 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
During fiscal 2003, our financial condition has improved dramatically. We have
generated $6.4 million in cash from operations, reduced our debt by $7.2 million
or nearly 50%, and have grown our equity by 5%. These improvements have all come
in a year in which revenues were flat compared to last year.
Cash generated from operations consisted of $2.2 million earned from net income
and non-cash charges, $2.2 million in reductions in receivables, $2.0 million in
reductions in inventories, $1.9 million in tax refunds and reductions in
deferred taxes, and $506,000 from other changes in working capital. Some of this
cash, $2.4 million, was used to reduce accounts payable, leaving net operating
cash flows of $6.4 million.
As discussed above, early in the third quarter, we restructured the debt with
our banks. As part of the restructuring, we used cash generated from operations
and increased availability under our revolving line of credit to reduce the term
debt. At July 31, 2003, our acquisition-related debt was $3.6; the mortgage on
our building was $2.3 million; and the amount drawn on our line of credit was
$1.8 million. The total available under the line of credit is $7.5 million. On
September 2, 2003, the maturity dates on all of our debt was extended to
February 15, 2005. However, the previous debt service requirements on the
acquisition debt will be maintained. According to this schedule, the acquisition
debt is expected to be retired in 14 months. In summary, we believe that the
restructuring is a significant and positive milestone as we seek to move to a
traditional capital structure in which our financing needs are supported
primarily by current assets and real estate.
RESULTS OF OPERATIONS
During fiscal 2003, our gross profits and net income have also improved despite
relatively flat revenues when compared to fiscal 2002. These results are due to
improved gross margins and a constant focus on our cost structure. We believe
that our operations and cost structure currently have excess capacity and that
as capital spending for telecommunications equipment recovers, we will enjoy a
measure of leverage in our operating statement producing further improvements in
operating margins. However, until such a recovery occurs, we will remain focused
on strict cost controls, maintaining our technical capabilities, and generating
positive cash flows from operations. Additionally, we will continue to make
careful investments in growth opportunities such as our mid-market initiative
and our expansion into the Nortel market. Discussed below in more detail are the
major revenue, gross margin, and operating expense items that affected our
financial results during the third quarter of fiscal 2003.
Systems Sales. Systems sales for the third quarter were $6.9 million, a 3%
increase over the third quarter of fiscal 2002. This increase consisted of
increases of approximately 3% in both our commercial and lodging sectors.
Systems sales for the year-to-date period ending July 31, 2003 were $21.6
million, a 7% increase compared to the prior year. This increase consisted of a
10% increase in sales to commercial sector customers partially offset by a 4%
decrease in sales to lodging sector customers. The modest increases in total
systems sales reflect the continued fragile economic conditions in which we
operate. Recently, some macro-economic indicators, including some related to
corporate capital spending, have shown signs of improvement. However, order
rates in our market sector have yet to see such improvements. We are augmenting
our traditional sales efforts with our mid-market and Nortel growth initiatives,
both of which are being partially funded through manufacturers' marketing
incentives and internally generated funds.
13
Installation and Service Revenues. Installation and service revenues consist of
the following:
For the Three Months Ended For the Nine Months
July 31, Ended July 31,
--------------------------- ---------------------------
2003 2002 2003 2002
----------- ----------- ----------- -----------
Contract & Time and Materials (T&M) $ 4,288,000 $ 4,731,000 $12,677,000 $13,989,000
Commercial installations 545,000 405,000 1,851,000 1,777,000
Lodging installations 500,000 299,000 1,409,000 1,095,000
Consulting 370,000 746,000 1,488,000 1,710,000
----------- ----------- ----------- -----------
Total installation and service revenue $ 5,703,000 $ 6,181,000 $17,425,000 $18,571,000
=========== =========== =========== ===========
The decline in contract and T&M revenues resulted almost entirely from a decline
in T&M revenues. This revenue stream represents work orders from customers due
to equipment failures or moves, adds, and changes to systems originated by
customers. 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 re-instituted
lower hourly pricing for our services earlier in the fiscal year. By doing so,
our rates compare favorably to smaller, regional service providers even though
we have nationwide capabilities. Contract revenues were relatively unchanged for
the three and nine month periods.
Installation revenues increased 48% in the third quarter and 14% for the year to
date period compared to those same periods last year. Generally, installation
revenues track in the same direction and proportion as the related systems
sales, but the timing of installations and the mix of installation revenue
compared to total project revenues vary on an order by order basis. 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 are recognized in one month and installation revenues on that system
are recognized in a subsequent month. While we are pleased with the current
operating efficiency of our installation department given the current level of
business, we believe there is excess capacity available. Therefore when our
order rates for new systems improve, we would expect to experience not only
increases in installation revenues, but also improvements in the profitability
of this activity.
Consulting revenues decreased 50% in the third quarter and 13% for the nine
month period compared to those same periods last year. Consulting revenues
reflect professional design fees and project management fees associated with
complex, commercial systems implementations as well as revenues earned from our
boutique consulting firm which specializes in Microsoft application
implementations and network administration. The declines in this revenue stream
primarily reflect lower revenues earned from our consulting operations which has
been negatively impacted by the overall poor economic conditions. This business
is located and derives most of its revenues from customers in the northwestern
U.S., which has experienced a very steep decline in demand for software
consulting business. Given the current economic outlook, we expect revenues from
this portion of our consulting business to remain at depressed levels for the
remainder of the year as customers continue to strictly control nearly all
discretionary spending on IT related projects..
Gross Margins.
The gross margin earned on total sales and service revenues in the third quarter
was 27.6% compared to 16.7% for the same period last year and was 27.2% for the
first nine months of fiscal 2003 compared to 21.2% for the same period in fiscal
2002. Note that in the third quarter of fiscal 2002, we increased our reserve
for obsolete and slow-moving inventory by $775,000. Without these adjustments,
overall gross margins would have been 23% in both the third quarter and the
year-to date periods in fiscal 2002.
The gross margins on systems sales were 28.5% in the third quarter compared to
12.9% for the third quarter of last year and were 29.2% for the first nine
months of the year compared to 24.4% for the first nine months of fiscal 2002.
The majority of the improvement in systems gross margins relates to the
inventory reserve adjustment discussed above which depressed systems gross
margins in the fiscal 2002 periods presented. The gross margins earned on
systems sales in fiscal 2003 are within our targets for these sales, but gross
margins can vary significantly based on customer and product mix. Also, as
discussed above, we recently added the Nortel product line to our business. By
doing so, we lost certain pricing advantages with Avaya related to their loyalty
program. For the first nine months of fiscal 2003, those pricing advantages were
equal to approximately 1.5% in gross margins earned on systems sales.
14
The gross margins earned on service revenues were 29.2% in the third quarter
compared to 26.5% last year and were 29.0% for the first nine months of the year
compared to 24.1% for the same period last year. These improvements reflect cost
controls put in place in our professional services and installation departments
to more closely match their manpower levels and cost structures with our current
revenue levels for those activities. Throughout the current downturn in the
economy, we have strived to properly size our business to our revenue run-rates
without impairing our technical capabilities that are a key differentiator for
us in the market. This challenge has been most acute in the professional
services and installation areas as they house our key technical talent. We
believe that despite the cost containment measures we have initiated, we have
not handicapped our overall capabilities nor our ability to respond to a market
turnaround when it occurs.
A final component to our gross margins is the margins earned on other revenues
and our 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. Corporate cost of goods sold represents our
material logistics and purchasing functions that support all of our revenue
streams. These expenses have declined approximately 7% in fiscal 2003 compared
to fiscal 2002 reflecting the effects of our tight cost controls.
Operating Expenses. Operating expenses increased 27.8% in the third quarter
compared to last year and 12.8% for the first nine months of fiscal 2003
compared to the prior year. In the third quarter of fiscal 2002, we decreased
the reserve for bad debts by $700,000 resulting in a large decrease in operating
expenses for the fiscal 2002 periods under comparison. Partially offsetting the
impact of this adjustment is the loss of certain financial incentive programs
previously offered by Avaya which were accounted for as contra selling expense
items. Actual expenditures for operating expenses are relatively unchanged
between fiscal 2003 and fiscal 2002. The discontinued incentive 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 began
receiving 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. These new incentives, while substantially supporting this new
sales initiative, are less than the incentives received in prior years under the
old programs.
Interest Expense and Other Income. Interest and other expense was $90,000 in the
third quarter of this year compared to $221,000 in the third quarter of last
year and was $431,000 for the nine months ending July 31, 2003 compared to
$705,000 in the same period last year. Interest expense is presented net of
interest capitalized on construction in progress. Interest costs capitalized in
the third quarter of this year were $85,000 compared to $72,000 last year.
Year-to-date interest costs capitalized were $250,000 compared to $197,000 for
the year-to-date period last year. The decrease in interest and other expenses
reflects decreases in interest expense partially offset by decreases in interest
and other income. The decrease in interest expense reflects lower average debt
outstanding during the periods under comparison. The lower interest income 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.
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 2.9% for the three
and nine months ending July 31, 2003, respectively compared to 1% for the same
periods 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 revenues 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
15
Agreements", "Dependence Upon Avaya", "Dependence Upon a Few Suppliers", "Hiring
and Retaining Key Personnel", "Competition", "Lodging Industry", "Stock Market
Volatility", and "Other Risk Factors" are still considered current and should be
given equal consideration together with the matters discussed below.
We continue to experience a lackluster capital spending environment and there
are no clear signals that this environment will improve for the balance of the
fiscal year.
Our systems sales and installation revenues are largely tied to capital spending
by our customers. Over the past 30 months, most U.S. companies have severely
curtailed their capital spending, especially spending related to new technology.
At several points during this period, including at the present time, there have
been improvements in macro economic indicators that have raised expectations for
growth in capital spending. While some market sectors have seen modest increases
in spending, our sector has not. As a result, we plan to continue to maintain
our cost conscience approach until there is more evidence of a recovery in our
business.
Our new sales initiatives may not be successful and may produce operating
losses.
As discussed above, we are adding personnel to support our Nortel and mid-market
sales initiatives. These investments are being made at a slower pace than we
would normally desire and our acceleration into these markets is being governed
by market development funds being received from Nortel and Avaya as well as the
limited capital provided by our operations. Should these vendor-supplied funds
dry up or if our profitability fails to improve, our ability to maintain these
efforts could be hampered and operating losses could occur.
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 our 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 our outstanding debt. At July 31, 2003, we had $1.2 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-15 (e) and 15d-15 (f) 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 period for which this report is filed, court filings in the
Phonometrics' litigation, which we continue to monitor, have dealt primarily
with the issue of attorneys' fees awarded to numerous hotel
16
defendants by the District Court for the Southern District of Florida, and the
amount of such fees. 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.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On April 2, 2003, at our Annual Meeting of Shareholders, all of the incumbent
directors were re-elected to the Board of Directors. The votes cast for each of
the nominees were as follows:
NOMINEE FOR WITHHOLD
------- --- --------
Ron B. Barber 8,704,918 222,842
Donald T. Duke 8,780,337 147,423
Robert D. Hisrich 8,779,837 147,923
Jack R. Ingram 8,764,030 163,730
Ronald L. Siegenthaler 8,781,741 146,019
Robert B. Wagner 8,764,430 163,330
The shareholders also voted to ratify the selection of Grant Thornton, LLP as
our independent auditors.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits (filed herewith):
SEC Exhibit No. Description
--------------- -----------
10.1 Nortel Networks Premium Partner U.S. Agreement
effective June 25, 2003 between Nortel Networks, Inc.
and XETA Technologies, Inc.
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief
Executive Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief
Financial Officer
17
32.1 Certification of Chief Executive Officer Pursuant to
Title 18, United States Code, Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2 Certificate of Chief Financial Officer Pursuant to
Title 18, United States Code, Section 1350, as
adopted 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 the following reports on Form 8-K:
1. Form 8-K filed May 20, 2003 (to furnish earnings release for
second quarter);
2. Form 8-K filed May 20, 2003 (regarding amendment to credit
facility); and
3. Form 8-K filed June 25, 2003 (regarding Nortel Networks
Premium Partner Agreement).
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: September 8, 2003 By: /s/ Jack R. Ingram
-----------------------
Jack R. Ingram
Chief Executive Officer
Dated: September 8, 2003 By: /s/ Robert B. Wagner
-----------------------
Robert B. Wagner
Chief Financial Officer
18
EXHIBIT INDEX
SEC Exhibit No. Description
- --------------- -----------
10.1 Nortel Networks Premium Partner U.S. Agreement
effective June 25, 2003 between Nortel Networks, Inc.
and XETA Technologies, Inc.
The Attachments to the foregoing Agreement, each of
which are listed below, have been omitted from this
Report and will be furnished to the Securities and
Exchange Commission upon request:
Attachment A: Affiliates of Premium Partner
Attachment B: Software License
Attachment C: Nortel Networks Services
Attachment D: Sales Agent Authorization
Attachment E: Service Standards
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief
Executive Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief
Financial Officer
32.1 Certification of Chief Executive Officer Pursuant to
Title 18, United States Code, Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2 Certificate of Chief Financial Officer Pursuant to
Title 18, United States Code, Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.