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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 JUNE 30, 2002
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period From _______ to _______
Commission File Number 1-10346
MICROTEL INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0226211
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9485 HAVEN AVENUE, SUITE 100, RANCHO CUCAMONGA, CALIFORNIA 91730
(Address of principal executive offices) (Zip Code)
(909) 987-9220
(Registrant's telephone number, including area code)
Indicated 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 preceding 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 | |
As of August 5, 2002, there were 21,513,366 shares of the registrant's
common stock, $0.0033 par value, outstanding.
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MICROTEL INTERNATIONAL, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
INDEX
PART I - FINANCIAL INFORMATION PAGE
----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2002 (unaudited)
and December 31, 2002........................................................ F-1
Condensed Consolidated Statements of Operations for the Three and Six Months
Ended June 30, 2002 and 2001 (unaudited)..................................... F-2
Condensed Consolidated Statements of Other Comprehensive Income for the
Three and Six Months Ended June 30, 2002 and 2001 (unaudited)................ F-3
Consolidated Statements of Stockholders' Equity for the
Six Months Ended June 30, 2002 (unaudited)................................... F-4
Condensed Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2002 and 2001 (unaudited)........................................... F-5
Notes to Condensed Consolidated Financial Statements (unaudited).................. F-6
Item 2. Management's Discussion and Analysis Of Financial Condition and
Results of Operations.............................................................. 2
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................... 25
PART II - OTHER INFORMATION
Item 1. Legal Proceedings................................................................. 26
Item 2. Changes in Securities and Use of Proceeds......................................... 26
Item 3. Defaults Upon Senior Securities................................................... 26
Item 4. Submission of Matters to a Vote of Security Holders............................... 26
Item 5. Other Information................................................................. 26
Item 6. Exhibits and Reports on Form 8-K.................................................. 27
Signatures .............................................................................. 27
Exhibits Filed with this Report on Form 10-Q................................................ 28
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2002 AND DECEMBER 31, 2001
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
June 30, December 31,
ASSETS 2002 2001
--------- ---------
Current assets: (unaudited)
Cash and cash equivalents $ 413 $ 604
Accounts receivable, net of allowance for doubtful
accounts of $154 and $226, respectively 5,640 5,627
Notes receivable 34 48
Inventories 7,516 7,433
Prepaid and other current assets 421 396
--------- ---------
Total current assets 14,024 14,108
Property, plant and equipment, net 677 758
Goodwill, net 2,438 2,389
Other assets 480 433
--------- ---------
$ 17,619 $ 17,688
========= =========
LIABILITIES, REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable, due on demand $ 2,441 $ 2,198
Notes payable 1,477 1,420
Current portion of long-term debt 507 550
Accounts payable 3,867 3,783
Accrued expenses 2,234 2,471
--------- ---------
Total current liabilities 10,526 10,422
Long-term debt, less current portion 694 763
Other liabilities 367 371
--------- ---------
Total liabilities 11,587 11,556
--------- ---------
Convertible redeemable Series A Preferred Stock, $10,000
unit value. Authorized 200 shares; issued and outstanding
25 shares (aggregate liquidation preference of $250) 276 270
Stockholders' equity:
Preferred stock, authorized 10,000,000 shares; Convertible
Series B Preferred Stock, $0.01 par value; 70,363
and 150,000 shares issued and outstanding, respectively
(aggregate liquidation preferences of $450 and $960,
respectively) 440 938
Common stock, $0.0033 par value. Authorized 50,000,000 shares;
and 21,467,000 and 20,671,000 shares issued and outstanding,
respectively 71 68
Additional paid-in capital 24,853 24,358
Accumulated deficit (18,909) (18,459)
Accumulated other comprehensive loss (699) (1,043)
--------- ---------
Total stockholders' equity 5,756 5,862
--------- ---------
$ 17,619 $ 17,688
========= =========
See accompanying notes to condensed consolidated financial statements.
F-1
MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(in thousands, except per share amounts)
Net sales $ 6,118 $ 7,083 $ 10,938 $ 14,548
Cost of sales 3,608 3,732 6,899 8,082
--------- --------- --------- ---------
Gross profit 2,510 3,351 4,039 6,466
Operating expenses:
Selling, general and administrative 1,855 2,905 3,720 5,486
Engineering and product development 259 303 497 662
--------- --------- --------- ---------
Income (loss) from operations 396 143 (178) 318
Other income (expense):
Interest expense (94) (105) (184) (198)
Other income 19 22 23 50
--------- --------- --------- ---------
Income (loss) before income taxes 321 60 (339) 170
Income tax expense 66 6 105 9
--------- --------- --------- ---------
Net income (loss) $ 255 $ 54 $ (444) $ 161
========= ========= ========= =========
Earnings (loss) per share:
Net income (loss):
Basic $ 0.01 $ 0.00 $ (0.02) $ 0.01
========= ========= ========= =========
Diluted $ 0.01 $ 0.00 $ (0.02) $ 0.01
========= ========= ========= =========
See accompanying notes to condensed consolidated financial statements.
F-2
MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME
THREE AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
----------------- ------------------
2002 2001 2002 2001
------ ------ ------ ------
(in thousands)
Net income (loss) $ 255 $ 54 $(444) $ 161
Foreign currency translation adjustment 382 (104) 344 (326)
------ ------ ------ ------
Other comprehensive income (loss) $ 637 $ (50) $(100) $(165)
====== ====== ====== ======
See accompanying notes to condensed consolidated financial statements.
F-3
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
SIX MONTHS ENDED JUNE 30, 2002
(UNAUDITED)
Series B
Convertible Accumulated
Preferred Stock Common Stock Additional Other
---------------- ------------------ Paid-in Accumulated Comprehensive
Shares Amount Shares Amount Capital Deficit Income (Loss) Total
------ ------ ------ ------ ------- ------- ------------- -----
Balance at December 31, 2001 150 $ 938 20,671 $ 68 $ 24,358 $ (18,459) $ (1,043) $ 5,862
Preferred Series B conversions (80) (498) 796 3 495 -- -- --
Foreign currency translation adjustment -- -- -- -- -- -- 344 344
Accretion of redeemable preferred stock -- -- -- -- -- (6) -- (6)
Net loss -- -- -- -- -- (444) -- (444)
------------------------------------------------------------------------------------------
Balance at June 30, 2002 70 $ 440 21,467 $ 71 $ 24,853 $ (18,909) $ (699) $ 5,756
==========================================================================================
See accompanying notes to condensed consolidated financial statements.
F-4
MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES
SIX MONTHS ENDED JUNE 30, 2002 AND 2001
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended June 30,
2002 2001
------ ------
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(444) $ 161
Adjustments to reconcile net income (loss) to cash provided by operating
activities:
Depreciation and amortization 149 168
Amortization of intangibles -- 195
Stock and warrants issued as compensation -- 10
Provision for doubtful account 24 --
Provision for obsolete/slow moving inventory 281 --
Changes in operating assets and liabilities:
Accounts receivable (52) 121
Inventories (292) (591)
Other assets (47) 219
Accounts payable and accrued expenses (157) (118)
------ ------
Cash provided by (used in) operating activities (538) 165
------ ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net purchases of property, plant and equipment (72) (123)
Cash collected on note receivable 14 50
------ ------
Cash (used in) investing activities (58) (73)
------ ------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in notes payable and long-term debt 188 102
------ ------
Cash provided by financing activities 188 102
------ ------
Effect of exchange rate changes on cash 217 (418)
------ ------
Net (decrease) in cash and cash equivalents (191) (224)
------ ------
Cash and cash equivalents at beginning of period 604 756
------ ------
Cash and cash equivalents at end of period $ 413 $ 532
====== ======
Cash paid for:
Income tax $ 13 $ 34
====== ======
Interest $ 181 $ 186
====== ======
See accompanying notes to condensed consolidated financial statements.
F-5
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002
(UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
MicroTel International, Inc. (the "Company") operates through three
wholly-owned subsidiaries: CXR Telcom Corporation, CXR, S.A. and XET
Corporation, formerly XIT Corporation ("XET"). CXR Telcom Corporation and CXR,
S.A. (collectively "CXR") design, manufacture and market electronic
telecommunication test equipment and transmission and network access products.
XET and its subsidiaries design, manufacture and market digital switches and
power supplies. The Company conducts its operations out of various facilities in
the United States, France, England and Japan and organizes itself in two product
line segments: Telecommunications and Electronic Components.
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with the rules and regulations of the
Securities and Exchange Commission and therefore do not include all information
and footnotes necessary for a complete presentation of financial position,
results of operations and cash flows in conformity with accounting principles
generally accepted in the United States of America.
The unaudited condensed consolidated financial statements do, however,
reflect all adjustments, consisting of only normal recurring adjustments, which
are, in the opinion of management, necessary to state fairly the financial
position as of June 30, 2002 and December 31, 2001 and the results of operations
and cash flows for the related interim periods ended June 30, 2002 and 2001.
However, these results are not necessarily indicative of results for any other
interim period or for the year. It is suggested that the accompanying condensed
consolidated financial statements be read in conjunction with the Company's
audited consolidated financial statements included in its 2001 annual report on
Form 10-K.
F-6
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2002
(UNAUDITED)
(2) EARNINGS (LOSS) PER SHARE
The following table illustrates the computation of basic and diluted
earnings (loss) per share (in thousands, except per share amounts):
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(in thousands, except per share amounts)
NUMERATOR:
Net income (loss) $ 255 $ 54 $ (444) $ 161
Less: accretion of the excess of the
redemption value over the carrying value
of redeemable preferred stock 3 3 6 6
--------- --------- --------- ---------
Income (loss) attributable to common
stockholders $ 252 $ 51 $ (450) $ 155
========= ========= ========= =========
DENOMINATOR:
Weighted average number of common
shares outstanding during the period 21,129 20,570 20,902 20,570
Incremental shares from assumed
exercises or conversions of warrants,
options and preferred stock 2,361 3,309 -- 3,277
--------- --------- --------- ---------
Adjusted weighted average shares 23,490 23,879 20,902 23,847
========= ========= ========= =========
Basic earnings (loss) per share $ 0.01 $ 0.00 $ (0.02) $ 0.01
========= ========= ========= =========
Diluted earnings (loss) per share $ 0.01 $ 0.00 $ (0.02) $ 0.01
========= ========= ========= =========
The computation of diluted loss per share for the six month period
ended June 30, 2002 excludes the effect of incremental common shares
attributable to the exercise of outstanding common stock options and warrants
because either their effect was antidilutive due to losses incurred by the
Company or such instruments had exercise prices greater than the average market
price of the common shares during the periods presented.
F-7
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2002
(UNAUDITED)
(3) INVENTORIES
Inventories consist of the following.
June 30, 2002 December 31, 2001
----------- -----------
Raw materials $2,448,000 $2,806,000
Work-in-process 3,346,000 2,879,000
Finished goods 1,722,000 1,748,000
----------- -----------
$7,516,000 $7,433,000
=========== ===========
(4) NOTES PAYABLE
On April 17, 2002, the Company executed the Fourth Amendment to its
August 16, 2000 Credit and Security Agreement with Wells Fargo Business Credit,
Inc. The amendment increased the ceiling on the borrowing base to $400,000
during the months of January through April and $300,000 through December for
each year. The financial covenants were also amended and the credit facility was
extended through August 16, 2005.
(5) NOTES PAYABLE, DUE ON DEMAND
The Company's subsidiaries in France and in the United Kingdom have
short term borrowing facilities with separate banks, which are due on demand. In
2002, one of the Company's United Kingdom subsidiaries exceeded its borrowing
limit with its bank and accordingly is now subject to penalty interest at a rate
of 2.0% per month on the excess borrowings. This note is due on or before
September 30, 2002. There can be no assurance that the Company will be
successful in extending either arrangement or finding a new source of financing.
(6) INCOME TAXES
The Company has recorded a provision for income taxes for the three and
six months ended June 30, 2002 for the U.K. subsidiaries only, because the
Company's domestic and other foreign operations have generated operating losses
for both financial reporting and income tax purposes. A 100% valuation allowance
has been provided on the total deferred income tax assets, as they are not more
likely than not to be realized.
(7) COMMITMENTS AND CONTINGENCIES
The Company and its subsidiaries from time to time become involved in
legal proceedings, claims and litigation arising in the ordinary course of
business. While the amounts claimed may be substantial, the ultimate liability
may not be predictable because of considerable uncertainties that may exist.
Therefore, it is possible the outcome of such legal proceedings, claims and
litigation could have a material effect on quarterly or annual operating results
or cash flows when resolved in a future period. However, based on facts
currently available, management believes such matters will not have a material
adverse affect on the Company's consolidated financial position, results of
operations or cash flows.
F-8
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2002
(UNAUDITED)
(8) Reportable Segments
The Company has two reportable segments: Telecommunications and
Electronic Components. The Telecommunications segment operates principally in
the United States and European markets and designs, manufactures and distributes
telecommunications test instruments and voice and data transmission and
networking equipment. The Electronic Components segment operates in the United
States, European and Asian markets and designs, manufactures and markets
primarily digital switches and power supplies.
The Company evaluates performance based upon profit or loss from
operations before income taxes, exclusive of nonrecurring gains and losses.
The Company's reportable segments are comprised of operating entities
offering the same or similar products to similar customers. Each segment is
managed separately because each business has different customers, design,
manufacturing and marketing strategies.
There were no differences in the basis of segmentation or in the basis
of measurement of segment profit or loss from the amounts disclosed in the
Company's audited consolidated financial statements included in its 2001 annual
report on Form 10-K. Selected financial data for each of the Company's operating
segments is shown below:
Six Months Ended Six Months Ended
June 30, 2002 June 30, 2001
------------- -------------
Sales to external customers:
Telecommunications $ 4,436,000 $ 7,968,000
Electronic Components 6,502,000 6,580,000
------------- -------------
$ 10,938,000 $ 14,548,000
============= =============
Segment pretax income (loss):
Telecommunications $ (770,000) $ 107,000
Electronic Components 1,372,000 1,613,000
------------- -------------
$ 602,000 $ 1,720,000
============= =============
June 30, 2002 December 31, 2001
------------- -------------
Segment assets:
Telecommunications $ 7,459,000 $ 8,317,000
Electronic Components 10,076,000 9,060,000
------------- -------------
$ 17,535,000 $ 17,377,000
============= =============
F-9
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2002
(UNAUDITED)
The following is a reconciliation of the reportable segment income
(loss) and assets to the Company's consolidated totals:
Six Months Ended Six Months Ended
June 30, 2002 June 30, 2001
------------- -------------
Pretax Income
-------------
Total income (loss) for reportable segments $ 602,000 $ 1,720,000
Unallocated amounts:
Unallocated general corporate expenses 941,000 1,550,000
------------- -------------
Consolidated income (loss) before
income taxes $ (339,000) $ 170,000
============= =============
June 30, 2002 December 31, 2001
------------- -------------
Assets
- ------
Total assets for reportable segments $ 17,535,000 $ 17,377,000
Other assets 84,000 311,000
------------- -------------
Total consolidated assets $ 17,619,000 $ 17,688,000
============= =============
F-10
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
JUNE 30, 2002
(UNAUDITED)
(9) GOODWILL - ADOPTION OF SFAS No. 142
Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets" ("SFAS No. 142") requires disclosure of what reported
income before extraordinary items and net income would have been in all periods
presented, exclusive of amortization expense (including any related tax effects)
recognized in those periods related to goodwill, intangible assets that are no
longer being amortized, any deferred credit related to an excess over cost,
equity method goodwill, and changes in amortization periods for intangible
assets that will continue to be amortized (including any related tax effects).
Similarly adjusted per-share amounts also must be disclosed for all periods
presented.
The Company initially applied SFAS No. 142 on January 1, 2002. The
amortization expense and net income of the Company for the initial six-month
period of application ended June 30, 2002 and the comparable period in 2001 are
included in the table below. The Company recognized no extraordinary items in
either of those periods.
Six Months Ended Six Months Ended
June 30, 2002 June 30, 2001
------------ ------------
Reported net income (loss): $ (444,000) $ 161,000
Add back: goodwill amortization -- 195,000
------------ ------------
Adjusted net income excluding amortization of goodwill $ (444,000) $ 356,000
============ ============
Reported earnings (loss) per share:
Basic $ (0.02) $ 0.01
============ ============
Diluted $ (0.02) $ 0.01
============ ============
Amortization of goodwill - basic $ -- $ 0.01
============ ============
Amortization of goodwill - diluted $ -- $ 0.01
============ ============
Adjusted earnings (loss) per share
Basic $ (0.02) $ 0.02
============ ============
Diluted $ (0.02) $ 0.02
============ ============
F-11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis should be read in conjunction
with our condensed consolidated financial statements and notes to financial
statements included elsewhere in this document. This report and our condensed
consolidated financial statements and notes to financial statements contain
forward-looking statements, which generally include the plans and objectives of
management for future operations, including plans and objectives relating to our
future economic performance and our current beliefs regarding revenues we might
earn if we are successful in implementing our business strategies. The
forward-looking statements and associated risks may include, relate to or be
qualified by other important factors, including, without limitation:
o the projected growth in the telecommunications and electronic
components markets;
o our business strategy for expanding our presence in these
markets;
o anticipated trends in our financial condition and results of
operations; and
o our ability to distinguish ourselves from our current and
future competitors.
We do not undertake to update, revise or correct any forward-looking
statements.
The information contained in this document is not a complete
description of our business or the risks associated with an investment in our
common stock. Before deciding to buy or maintain a position in our common stock,
you should carefully review and consider the various disclosures we made in this
report, and in our other materials filed with the Securities and Exchange
Commission that discuss our business in greater detail and that disclose various
risks, uncertainties and other factors that may affect our business, results of
operations or financial condition.
Any of the factors described above or in the "Risk Factors" section
below could cause our financial results, including our net income (loss) or
growth in net income (loss) to differ materially from prior results, which in
turn could, among other things, cause the price of our common stock to fluctuate
substantially.
OVERVIEW
We previously organized our operations in the following three business
segments:
o Instrumentation and Test Equipment;
o Components and Subsystem Assemblies; and
o Circuits.
In an effort to focus our attention and working capital on our
telecommunications test instruments and our transmission and network access
products, we sold substantially all of the assets of XCEL Arnold Circuits, Inc.
in April 1998 and sold substantially all of the assets of HyComp, Inc., a
manufacturer of hybrid circuits, in April 1999.
Effective August 1, 2000, we acquired the assets and business
operations of T-Com, a telecommunications test instruments manufacturer located
in Sunnyvale, California. T-Com produced central office equipment, which is
equipment that is typically employed in switching centers and network operating
centers.
2
In October 2000, we decided to discontinue our circuits segment. On
November 28, 2000, we sold XCEL Etch Tek, which was our only remaining material
circuit board business and was a division of our wholly-owned subsidiary, XET
Corporation. We retained our Monrovia, California circuit board manufacturing
facility as a captive supplier of circuit boards to XET Corporation's Digitran
Division in our electronic components segment.
Through our three direct wholly-owned operating subsidiaries, XET
Corporation, CXR Telcom Corporation, or CXR Telcom, and CXR, S.A., and through
the divisions and subsidiaries of our subsidiaries, we presently design,
manufacture, assemble, and market products and services in the following two
material business segments:
o Telecommunications
-- Telecommunications Test Instruments (analog and digital test
instruments used in the installation, maintenance, management
and optimization of public and private communication networks)
-- Transmission and Network Access Products (range of products
for accessing public and private networks for the transmission
of data, voice and video)
o Electronic Components
-- Digital Switches
-- Electronic Power Supplies
Our sales are primarily in North America, Europe and Asia. Sales to
customers in the telecommunications industry during the six month periods ended
June 30, 2002 and June 30, 2001 were 40.6% and 54.8%, respectively, of our total
net sales. The remainder of our sales were in the electronic components segment,
primarily to aerospace customers, military contractors and industrial customers.
Revenues are recorded when products are shipped if shipped FOB shipping point or
when received by the customer if shipped FOB destination.
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are described in Note 1 to our
audited consolidated financial statements included in Item 8 of our annual
report on Form 10-K for the year ended December 31, 2001. We believe our most
critical accounting policies include inventory valuation, goodwill impairment
and foreign currency translation.
INVENTORIES
We value our inventory at the lower of the actual cost to purchase or
manufacture the inventory or the current estimated market value of the
inventory. We regularly review inventory quantities on hand and record a
provision for excess and obsolete inventory based primarily on our estimated
forecast of product demand and production requirements for the next twelve
months. Demand for our products can fluctuate significantly. A significant
increase in the demand for our products could result in a short-term increase in
the cost of inventory purchases, while a significant decrease in demand could
result in an increase in the amount of excess inventory quantities on hand.
3
In addition, the telecommunications equipment industry is characterized
by rapid technological change, frequent new product development, and rapid
product obsolescence that could result in an increase in the amount of obsolete
inventory quantities on hand. Also, our estimates of future product demand may
prove to be inaccurate, in which case we may have understated or overstated the
provision required for excess and obsolete inventory. In the future, if our
inventory is determined to be overvalued, we would be required to recognize such
costs in our cost of goods sold at the time of such determination. Likewise, if
our inventory is determined to be undervalued, we may have over-reported our
costs of goods sold in previous periods and would be required to recognize
additional operating income at the time of sale. Therefore, although we make
every effort to ensure the accuracy of our forecasts of future product demand,
any significant unanticipated changes in demand or technological developments
could have a significant impact on the value of our inventory and our reported
operating results.
IMPAIRMENT OF GOODWILL
We periodically evaluate acquired businesses for potential impairment
indicators. Our judgments regarding the existence of impairment indicators are
based on legal factors, market conditions and operational performance of our
acquired businesses.
In assessing potential impairment for goodwill, we consider these
factors as well as forecasted financial performance of the acquired businesses.
If forecasts are not met, we may have to record additional impairment charges
not previously recognized. In assessing the recoverability of our goodwill and
other intangibles, we must make assumptions regarding estimated future cash
flows and other factors to determine the fair value of those respective assets.
If these estimates or their related assumptions change in the future, we may be
required to record impairment charges for these assets that were not previously
recorded. On January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets," or SFAS No. 142, and
are required to analyze our goodwill for impairment issues during the first six
months of 2002, and then periodically after that time. During the six months
ended June 30, 2002 and the year ended December 31, 2001, we did not record any
impairment losses related to goodwill and other intangible assets.
FOREIGN CURRENCY TRANSLATION
We have foreign subsidiaries that together accounted for 54.6% of our
net revenues, 66.3% of our assets and 68.4% of our total liabilities as of
December 31, 2001 and for 60.3% of our net revenues, 69.5% of our assets and
70.8% of our total liabilities as of and for the six months ended June 30, 2002.
In preparing our consolidated financial statements, we are required to translate
the financial statements of our foreign subsidiaries from the currencies in
which they keep their accounting records into United States dollars. This
process results in exchange gains and losses which, under relevant accounting
guidance, are either included within our statement of operations or as a
separate part of our net equity under the caption "cumulative translation
adjustment."
Under relevant accounting guidance, the treatment of these translation
gains or losses depends upon our management's determination of the functional
currency of each subsidiary. This determination involves consideration of
relevant economic facts and circumstances affecting the subsidiary. Generally,
the currency in which the subsidiary transacts a majority of its transactions,
including billings, financing, payroll and other expenditures, would be
considered the functional currency. However, management must also consider any
dependency of the subsidiary upon the parent and the nature of the subsidiary's
operations.
4
If management deems any subsidiary's functional currency to be its
local currency, then any gain or loss associated with the translation of that
subsidiary's financial statements is included in a cumulative translation
adjustment. However, if management deems the functional currency to be United
States dollars, then any gain or loss associated with the translation of these
financial statements would be included within our statement of operations.
If we dispose of any of our subsidiaries, any cumulative translation
gains or losses would be realized into our statement of operations. If we
determine that there has been a change in the functional currency of a
subsidiary to United States dollars, then any translation gains or losses
arising after the date of the change would be included within our statement of
operations.
Based on our assessment of the factors discussed above, we consider the
functional currency of each of our international subsidiaries to be each
subsidiary's local currency. Accordingly we had cumulative translation losses of
$699,000 and $1,043,000 that were included as part of accumulated other
comprehensive loss within our balance sheets at June 30, 2002 and December 31,
2001, respectively. During the six months ended June 30, 2002 and the year ended
December 31, 2001, we included translation adjustments of a gain of
approximately $344,000 and a loss of $312,000, respectively, under accumulated
other comprehensive income and loss.
If we had determined that the functional currency of our subsidiaries
was United States dollars, these losses would have increased our loss for the
six months ended June 30, 2002 and decreased our income for the three months
ended June 30, 2002 and the three and six months ended June 30, 2001. The
magnitude of these gains or losses depends upon movements in the exchange rates
of the foreign currencies in which we transact business as compared to the value
of the United States dollar. These currencies include the euro, the British
pound and the Japanese yen. Any future translation gains or losses could be
significantly higher than those we recorded for the six months ended June 30,
2002 and the year ended December 31, 2001.
5
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2002 COMPARED TO THREE MONTHS ENDED
JUNE 30, 2001
The following table sets forth, for the periods indicated, certain
statement of operations data expressed as a percentage of total net sales:
Three Months Ended
June 30,
-----------------------------------
2002 2001
-------------- --------------
Net sales.................................... 100.0% 100.0%
Cost of sales................................ 59.0 52.7
---------- ----------
Gross profit................................. 41.0 47.3
Selling, general and administrative
expenses................................... 30.3 41.0
Engineering and product development
expenses................................... 4.2 4.3
---------- ----------
Operating income............................. 6.5 2.0
Interest expense............................. (1.5) (1.5)
Other income................................. 0.2 0.3
---------- ----------
Income before income tax expense............. 5.2 0.8
Income tax expense........................... (1.0) --
---------- ----------
Net income................................... 4.2% 0.8%
========== ==========
NET SALES. Net sales for the three months ended June 30, 2002 decreased
by $965,000 (13.6%) to $6,118,000 as compared to $7,083,000 for the three months
ended June 30, 2001.
Net sales of our telecommunications products and services for the three
months ended June 30, 2002 declined by $1,715,000 (40.8%) to $2,481,000, as
compared to $4,196,000 for the three months ended June 30, 2001. Test equipment
net sales for the three months ended June 30, 2002 decreased by $1,589,000
(62.1%) to $969,000, as compared to $2,558,000 for the three months ended June
30, 2001. The sales decline resulted from a $1,081,000 reduction in sales of
test equipment by CXR Telcom and a $508,000 reduction in sales of test equipment
by CXR, S.A. Management believes these sales declines resulted primarily from
reductions in capital spending in the three months ended June 30, 2002, as
compared to capital spending in the three months ended June 30, 2001, by many of
our telecommunications customers due to generally weak telecommunications
markets in the United States and Europe. Also, the exclusive distribution
agreement that our French subsidiary, CXR, S.A., had with Sunrise Telecom, Inc.
terminated as of November 1, 2001. CXR, S.A. will continue to distribute Sunrise
products under an exclusive arrangement for select customers and under a
non-exclusive arrangement for other customers and also will continue to
distribute other manufacturers' products. Based on this revised relationship
with Sunrise Telecom, Inc., management estimates that net sales of Sunrise
products will be approximately $400,000 in 2002, as compared to $1,384,000 in
2001. Consequently, we have implemented personnel and other cost reductions to
reflect a plan to minimize sales efforts related to lower margin resale products
and focus on sales of our own internally-built products.
Net sales of our CXR HALCYON 704 series field test equipment decreased
by $854,000 (51.6%) to $802,000 for the three months ended June 30, 2002, as
compared to $1,656,000 for the three months ended June 30, 2001. Net sales of
our T-Com central office test equipment product line declined by $228,000
(71.9%) to $89,000 for the three months ended June 30, 2002, as compared to
$317,000 for the three months ended June 30, 2001, primarily due to continued
weakening in the market for test equipment used in central offices and by test
equipment manufacturers.
6
We believe that many of the United States telecom customers that CXR
Telcom serves built networks to handle an anticipated demand for voice and data
traffic that has not yet occurred. Consequently, many of these customers reduced
their purchasing budgets for 2002. This has had a negative impact on CXR
Telcom's sales.
CXR, S.A. produces all of our transmission products and networking
equipment. Despite a generally weak telecommunications market, net sales of
transmission products and networking equipment produced by CXR, S.A. increased
slightly by $54,000 (3.6%) to $1,540,000 for the three months ended March 31,
2002, as compared to $1,486,000 for the three months ended June 30, 2001. Total
net sales by CXR, S.A., including both test equipment and transmission and
networking equipment, decreased by $525,000 (27.3%) to $1,393,000 for the three
months ended June 30, 2002, as compared to $1,918,000 for the three months ended
June 30, 2001, primarily due to a lower sales volume of test equipment. We
believe that the decreases in CXR, S.A.'s and CXR Telcom's sales relate to the
overall slowdown in the telecom markets and the termination of the Sunrise
Telecom contract discussed above, and that the French national and local
elections in April and May 2002 may have caused a delay in purchases by major
governmental customers of CXR, S.A.
Net sales of our electronic components increased by $750,000 (26.0%) to
$3,637,000 for the three months ended June 30, 2002, as compared to $2,887,000
for the three months ended June 30, 2001, mainly due to a $689,000 (61.2%)
increase in sales of power supplies by XCEL Corporation Ltd., or XCL, due to
increased rate of completion of products shipped under long-term programs. Net
sales of digital switches by XET Corporation's Digitran Division declined by
$447,000 (31.0%) to $994,000 in the three months ended June 30, 2002, as
compared to $1,441,000 in the three months ended June 30, 2001. We expect this
lower level of digital switch sales to be a temporary timing issue of shipment
to orders and expect that digital switch sales will improve during the quarter
ended September 30, 2002. However, sales of Digitran's subassemblies and other
items increased by $523,000 (376.3%) to $662,000 for the quarter ended June 30,
2002, as compared to $139,000 in the prior year period, due to a new contract
for electronic sub systems from a major aerospace company.
GROSS PROFIT. Gross profit as a percentage of total net sales decreased
to 41.0% for the three months ended June 30, 2002, as compared to 47.3% for the
comparable period in 2001. In dollar terms, total gross profit decreased by
$841,000 (25.1%) to $2,510,000 for the three months ended June 30, 2002, as
compared to $3,351,000 for the comparable period in 2001.
Gross profit for our telecommunications segment decreased in dollar
terms by $1,071,000 (51.3%) to $1,017,000 for the three months ended June 30,
2002, as compared to $2,088,000 for the comparable period in 2001, and decreased
as a percentage of net sales from 49.8% for the three months ended June 30, 2001
to 40.1% for the three months ended June 30, 2002. The decrease in gross profit
as a percentage of net sales primarily was due to the substantial reduction in
sales volume that increased overhead costs on a per unit basis.
Gross profit for our electronic components segment increased in dollar
terms by $233,000 (18.5%) to $1,494,000 for the three months ended June 30,
2002, as compared to $1,261,000 for the three months ended June 30, 2001, and
decreased as a percentage of related net sales from 43.7% for the three months
ended June 30, 2001 to 41.1% for the three months ended June 30, 2002. This
increase primarily was due to increased sales of higher margin electronic
components and sub systems by the Digitran Division.
7
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased by $1,050,000 (36.1%) to $1,855,000 for the
three months ended June 30, 2002, as compared to $2,905,000 for the three months
ended June 30, 2001. This substantial decrease in selling, general and
administrative expenses was due to several factors. For example, we incurred
$312,000 in legal and accounting fees during the three months ended June 30,
2001 in connection with amendments to a securities registration statement and
prior periodic reports. Selling expenses were reduced by $386,000, primarily due
to lower commissions on reduced sales during the three months ended June 30,
2002. Administrative costs were reduced by $125,000 in our telecommunications
segment, primarily due to staff reductions at CXR Telcom. Also, due to the new
accounting rules of SFAS No. 142, effective January 1, 2002 we no longer
amortize goodwill. Goodwill accounted for approximately $100,000 of our
amortization expense in the three months ended June 30, 2001.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product
development expenses consist primarily of research and product development
activities of our telecommunications segment. These expenses decreased by
$44,000 (14.5%) to $259,000 for the three months ended June 30, 2002, as
compared to $303,000 for the comparable prior year period, reflecting the cost
savings from the closure of our St. Charles, Illinois engineering facility in
August 2001 and the relocation, consolidation and downsizing of that engineering
function into our Fremont, California facility.
OTHER INCOME AND EXPENSE. Interest expense was reduced slightly to
$94,000 for the three months ended June 30, 2002 from $105,000 in the comparable
period in 2001. Other income of $19,000 in the second quarter of 2002 declined
slightly from $22,000 in the second quarter of 2001.
INCOME TAX EXPENSE. Income tax expense for the three months ended June
30, 2002 was $66,000, as compared to $6,000 for the comparable prior year
period. The majority of the increase related to the recording by XCL of a
provision for U.K. income tax that was required because XCL is expected to
produce taxable income for 2002 and has consumed its currently available net
operating loss carryforwards. However, we are reviewing a possible legal
reorganization of our U.K. subsidiaries that may provide us with a means to
access additional U.K. tax net operating loss carryforwards.
NET INCOME. Net income for the three months ended June 30, 2002 was
$255,000, as compared to net income of $54,000 for the three months ended June
30, 2001. The major contributor to this change was the reduction in selling,
general and administrative expenses discussed above. Also, cost reductions
helped us to maintain our gross margins as a percentage of sales despite reduced
sales volume. We took in 2001, and continue to take in 2002, various actions to
reduce costs through staff reductions in our telecommunications operations in
the U.S. and France and through various other methods and to more aggressively
market our products. If these actions are not sufficient to reduce cash outlays
below revenue levels, then we may be required to restructure or divest all or
part of our telecommunications operations.
8
SIX MONTHS ENDED JUNE 30, 2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001
The following table sets forth, for the periods indicated, certain
statement of operations data expressed as a percentage of total net sales:
Six Months Ended
June 30,
--------------------------------------
2002 2001
----------------- ----------------
Net sales.................................... 100.0% 100.0%
Cost of sales................................ 63.1 55.6
---------- ----------
Gross profit................................. 36.9 44.4
Selling, general and administrative
expenses................................... 34.0 37.7
Engineering and product development
expenses................................... 4.5 4.5
---------- ----------
Operating income (loss)...................... (1.6) 2.2
Interest expense............................. (1.7) (1.4)
Other income................................. 0.2 0.4
---------- ----------
Income (loss) before income tax
expense.................................... (3.1) 1.2
Income tax expense........................... 1.0 0.1
---------- ----------
Net income (loss)............................ (4.1%) 1.1%
========== ==========
NET SALES. Net sales for the six months ended June 30, 2002 decreased
by $3,610,000 (24.8%) to $10,938,000 as compared to $14,548,000 for the six
months ended June 30, 2001.
Net sales of our telecommunications products and services for the six
months ended June 30, 2002 declined by $3,532,000 (44.3%) to $4,436,000, as
compared to $7,968,000 for the six months ended June 30, 2001. Test equipment
net sales for the six months ended June 30, 2002 decreased by $2,957,000 (64.8%)
to $1,604,000, as compared to $4,561,000 for the six months ended June 30, 2001.
The sales decline resulted from a $1,813,000 reduction in sales of test
equipment by CXR Telcom and a $1,144,000 reduction in sales of test equipment by
CXR, S.A. Management believes these sales declines resulted primarily from
reductions in capital spending in the six months ended June 30, 2002, as
compared to capital spending in the six months ended June 30, 2001, by many of
our telecommunications customers due to generally weak telecommunications
markets in the U.S. and Europe. Also, the exclusive distribution agreement that
CXR, S.A. had with Sunrise Telecom, Inc. terminated as of November 1, 2001. CXR,
S.A. will continue to distribute Sunrise products under an exclusive arrangement
for select customers and under a non-exclusive arrangement for other customers
and also will continue to distribute other manufacturers' products. Based on
this revised relationship with Sunrise Telecom, Inc., management estimates that
net sales of Sunrise products will be approximately $400,000 in 2002, as
compared to $1,384,000 in 2001. Consequently, we have implemented personnel and
other cost reductions to reflect a plan to minimize sales efforts related to
lower margin resale products and focus on sales of our own internally-built
products.
Net sales of our CXR HALCYON 704 series field test equipment decreased
by $1,399,000 (57.4%) to $1,038,000 for the six months ended June 30, 2002, as
compared to $2,437,000 for the six months ended June 30, 2001. Net sales of our
T-Com central office test equipment product line declined by $413,000 (62.5%) to
$248,000 for the six months ended June 30, 2002, as compared to $661,000 for the
six months ended June 30, 2001, primarily due to continued weakening in the
market for test equipment.
9
We believe that many of the U.S. telecom customers that CXR Telcom
serves built networks to handle an anticipated demand for voice and data traffic
that has not yet occurred. Consequently, many of these customers reduced their
purchasing budgets for 2002. This has had a negative impact on CXR Telcom's
sales.
CXR, S.A., our French subsidiary, produces all of our transmission
products and networking equipment. Net sales of transmission products and
networking equipment produced by CXR, S.A. decreased by $471,000 (15.3%) to
$2,615,000 for the six months ended March 31, 2002, as compared to $3,086,000
for the six months ended June 30, 2001, primarily because of the weak telecom
market. Total net sales by CXR, S.A., including both test equipment and
transmission and networking equipment, decreased by $1,499,000 (35.5%) to
$2,728,000 for the six months ended June 30, 2002, as compared to $4,227,000 for
the six months ended June 30, 2001. We believe that the decreases in CXR, S.A.'s
and CXR Telcom's sales relate to the overall slowdown in the telecom markets and
the termination of the Sunrise Telecom contract discussed above, and that the
French national and local elections in April and May 2002 may have caused a
delay in purchases by major governmental customers of CXR, S.A.
Net sales of our electronic components decreased slightly by $78,000
(1.2%) to $6,502,000 for the six months ended June 30, 2002, as compared to
$6,580,000 for the six months ended June 30, 2001. Sales of power supplies by
XCL increased by $504,000 (18.1%) to $3,287,000 in the six months ended June 30,
2002, as compared to $2,783,000 in the prior year period due to an increased
rate of completion of products shipped under long-term programs. Sales of
digital switches manufactured by the Digitran Division declined by $1,096,000
(31.9%) to $2,337,000 in the six months ended June 30, 2002, as compared to
$3,433,000 in the six months ended June 30, 2001. We expect this lower level of
digital switch sales to be a temporary timing issue of shipment to orders and
expect that digital switch sales will improve during the quarter ended September
30, 2002. However, XET Corporation increased its sales of subassemblies by
$523,000 to (376.3%) to $662,000 in the current period as compared to $139,000
in the first half of 2001 due to a new contract for electronic sub systems from
a major aerospace company Based on our backlog, we anticipate improvement in net
sales for both the Digitran Division and XCL in the third quarter of 2002.
GROSS PROFIT. Gross profit as a percentage of total net sales decreased
to 36.9% for the six months ended June 30, 2002, as compared to 44.4% for the
comparable period in 2001. In dollar terms, total gross profit decreased by
$2,427,000 (37.5%) to $4,039,000 for the six months ended June 30, 2002, as
compared to $6,466,000 for the comparable period in 2001.
Gross profit for our telecommunications segment decreased in dollar
terms by $1,970,000 (56.7%) to $1,507,000 for the six months ended June 30,
2002, as compared to $3,477,000 for the comparable period in 2001, and decreased
as a percentage of net sales from 43.6% for the six months ended June 30, 2001
to 34.0% for the six months ended June 30, 2002. The decrease in gross profit as
a percentage of net sales primarily was due to the substantial reduction in
sales volume that increased overhead costs on a per unit basis.
Gross profit for our electronic components segment decreased in dollar
terms by $457,000 (15.3%) to $2,532,000 for the six months ended June 30, 2002,
as compared to $2,989,000 for the six months ended June 30, 2001, and decreased
as a percentage of related net sales from 45.4% for the six months ended June
30, 2001 to 38.9% for the six months ended June 30, 2002. This decrease
primarily was the result of reduced profit margins in connection with lower
production volumes by XET Corporation's Digitran Division due to the completion
in the first quarter of 2001 of a product mix that carried a higher than average
gross profit margin.
10
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased by $1,766,000 (32.2%) to $3,720,000 for the
six months ended June 30, 2002, as compared to $5,486,000 for the six months
ended June 30, 2001. This substantial decrease in selling, general and
administrative expenses was due to several factors. For example, we incurred
$452,000 in legal and accounting fees during the six months ended June 30, 2002
in connection with amendments to a securities registration statement and prior
periodic reports. Selling expenses were reduced by $562,000 in our
telecommunications segment due to lower commissions on reduced sales and reduced
costs during the six months ended June 30, 2002. Administrative costs were
reduced by $265,000 in our telecommunications segment primarily due to staff
reductions at CXR Telcom. We reduced selling general and administrative expense
in our electronic components group by $196,000 due to cost reductions. Also, due
to the new accounting rules of SFAS No. 142, effective January 1, 2002 we no
longer amortize goodwill. Goodwill accounted for $195,000 of our amortization
expense in the six months ended June 30, 2001.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product
development expenses consist primarily of research and product development
activities of our telecommunications segment. These expenses decreased by
$165,000 (24.9%) to $497,000 for the six months ended June 30, 2002, as compared
to $662,000 for the comparable prior year period, reflecting the cost savings
from the closure of our St. Charles, Illinois engineering facility in August
2001 and the relocation, consolidation and downsizing of that engineering
function into our Fremont, California facility.
OTHER INCOME AND EXPENSE. Interest expense was reduced to $184,000 for
the six months ended June 30, 2002 from $198,000 in the comparable period in
2001 due to lower interest rates. Other income of $23,000 in the second quarter
of 2002 declined from $50,000 in the second quarter of 2001.
INCOME TAX EXPENSE. Income tax expense for the six months ended June
30, 2002 was $105,000, as compared to $9,000 for the comparable prior year
period. The majority of the increase related to the recording by XCL of a
provision for U.K. income tax that was required because XCL is expected to
produce taxable income for 2002 and has consumed its currently available net
operating loss carryforwards. However, we are reviewing a possible legal
reorganization of our U.K. subsidiaries that may provide us with a means to
access additional U.K. tax net operating loss carryforwards.
NET INCOME (LOSS). Net loss for the six months ended June 30, 2002 was
$444,000, as compared to net income of $161,000 for the six months ended June
30, 2001. The major cause of this change was the reduction in sales of our
telecommunications segment below the level needed to cover fixed costs. We took
in 2001, and continue to take in 2002, various actions to reduce costs through
staffing reductions in our telecommunications operations in the U.S. and France
and through various other methods and to more aggressively market our products.
If these actions are not sufficient to reduce cash outlays below revenue levels,
then we may be required to restructure or divest all or part of our
telecommunications operations.
LIQUIDITY AND CAPITAL RESOURCES
During the six months ended June 30, 2002 and the year ended December
31, 2001, we funded our operations primarily through revenue generated from our
operations and through our lines of credit with Wells Fargo Business Credit,
Inc. and various foreign banks. As of June 30, 2002, we had working capital of
$3,498,000, an accumulated deficit of $18,909,000, an accumulated other
comprehensive loss of $699,000, $413,000 in cash and cash equivalents and
$5,640,000 of accounts receivable. As of December 31, 2001, we had working
capital of $3,686,000, an accumulated deficit of $18,459,000 an accumulated
other comprehensive loss of $1,043,000, $604,000 in cash and cash equivalents
and $5,627,000 of accounts receivable.
11
Cash used in our operating activities totaled $538,000 for the six
months ended June 30, 2002, as compared to $165,000 of cash provided by our
operating activities for the comparable period in 2001. This decrease in cash
provided by our operations during the six months ended June 30, 2002 primarily
resulted from lower collections due to lower sales, especially during the first
three months of 2002.
Cash used in our investing activities totaled $58,000 for the six
months ended June 30, 2002, as compared to $73,000 for the six months ended June
30, 2001. Included in the results for the six months ended June 30, 2002 are
$72,000 of fixed asset purchases.
Cash provided by financing activities totaled $188,000 for the six
months ended June 30, 2002, as compared to $102,000 for the comparable period in
2001, primarily due to increases in bank debt.
On August 16, 2000, our subsidiaries, CXR Telcom and XET Corporation,
together with MicroTel acting as guarantor, obtained a credit facility extension
and modification from Wells Fargo Business Credit, Inc. In April 2002, the
maturity date of the facility was extended by two years to August 16, 2005. As
of April 17, 2002, the facility provides for a revolving loan of up to
$3,000,000 secured by our inventory and accounts receivable and a term loan in
the amount of $687,000 secured by our machinery and equipment. On June 30, 2002,
the interest rate was the prime rate (then 4.75%) plus 1%, subject to a minimum
interest charge of $13,500 per month. These figures reflect the reduction of the
annual interest rate from the prime rate plus 2% and the reduction of the
minimum interest charge from $15,000 per month that we achieved as of April 1,
2001 because we met or exceeded certain performance-based goals for 2000. The
balance outstanding at June 30, 2002 was $1,477,000 on the revolving loan and
$164,000 on the term loan, and we had available to us $142,000 of additional
borrowings under the revolving loan. The credit facility contains restrictive
financial covenants that are set by mutual agreement of us and our lender each
year. At June 30, 2002, we were in compliance with such covenants.
Our foreign subsidiaries have credit facilities with Lloyds Bank in
England, Banc National du Paris, Societe General and Banque Hervet in France and
Johan Tokyo Credit Bank in Japan. The balances outstanding under our U.K.,
France and Japan credit facilities were $2,378,000, $844,000 and zero dollars,
respectively, on June 30, 2002. Of the total $2,378,000 balance owed to Lloyds
Bank, $1,746,000 was owed by XCEL Corporation Limited under an overdraft credit
facility and $632,000 was owed by XCEL Power Systems Limited under a term
facility. Due to a rapid expansion in sales, XCEL Corporation Limited exceeded
the borrowing limit contained in its overdraft credit facility with Lloyds Bank
at June 30, 2002. As a result, at the election of Lloyds Bank the excess amount
will accrue interest at the rate of two percent (2%) per month.
XCEL Corporation Limited's overdraft credit facility is for an amount
up to approximately $1,600,000 and XCEL Power System Limited's term loan credit
facility is for an amount up to approximately $800,000. Although amounts owing
under the overdraft credit facility are due and payable no later than September
30, 2002, Lloyds Bank, as is typical in the U.K., has the right to demand
payment in full at any time prior to September 30, 2002. Our French subsidiary,
CXR, S.A., has credit facilities with several lenders totaling up to
approximately $844,000 in the aggregate. Each credit facility has a specified
repayment term. However, each lender, as is typical in France, has the right to
demand payment in full at any time prior to the scheduled maturity date of a
particular credit facility. Although neither Lloyds Bank nor any of the lenders
to CXR, S.A. have indicated a desire to demand immediate payment of all
outstanding principal and interest balances on their respective credit
facilities, Lloyds Bank has advised our U.K. subsidiaries that they no longer
wish to continue to finance our U.K. subsidiaries over the long term.
Accordingly, we are in the process of seeking alternative financing sources in
12
the U.K. Similarly, CXR, S.A. has been advised by its lenders that because CXR,
S.A. has experienced a substantial reduction in revenue, the lenders are
contemplating a reduction in the total available credit. As a result, we are in
the process of seeking alternative financing sources in France.
We cannot assure you that the various lenders to our U.K. and/or French
subsidiaries will not seek immediate payment of all amounts owed by them under
their respective credit facilities or seek to terminate any of the existing
credit facilities. Similarly, we cannot assure you that if either of these
events were to occur we would be successful in obtaining the required
replacement financing for our operations in the U.K. and/or France or, if we
were able to obtain such financing, that the financing would occur on a timely
basis, would be on acceptable terms and would be sufficient to allow us to
maintain our business operations in the U.K. and/or France. Accordingly, any of
these actions on the part of any of the lenders to our U.K. and/or French
subsidiaries could have a material adverse impact upon our results of operations
and cash flows.
Our backlog is substantial and was $14,886,000 as of June 30, 2002, up
from $14,885,000 as of December 31, 2001, despite higher shipments of our XCL
subsidiary. Our backlog as of June 30, 2002 was 95.1% related to our electronic
components business, which business tends to provide us with long lead times for
our manufacturing processes due to the custom nature of the products, and 4.9%
related to our telecommunications business, which business tends to deliver
standard products from stock as orders are received. The amount of backlog
orders represents revenue that we anticipate recognizing in the future, as
evidenced by purchase orders and other purchase commitments received from
customers, but on which work has not yet been initiated or with respect to which
work is currently in progress. However, there can be no assurance that we will
be successful in fulfilling such orders and commitments in a timely manner or
that we will ultimately recognize as revenue the amounts reflected as backlog.
During the six months ended June 30, 2002 and the year ended December
31, 2001, 40.6% and 53.9%, respectively, of our sales were to customers in the
telecommunications industry. We experienced 44.3% and 5.6% declines in our
telecommunications segment sales in the six months ended June 30, 2002 and the
year ended December 31, 2001, respectively, as compared to the comparable prior
year periods. We believe this decline primarily was due to a general business
decline experienced by many of our telecommunications customers. We anticipate a
decline in our telecommunications segment sales in 2002 as compared to 2001. We
cannot predict the duration or severity of the telecommunications market
downturn or the extent to which the downturn will continue to negatively affect
our ability to sell our products and services to customers in the
telecommunications industry. A further reduction in sales would reduce our
accounts receivable balances, which in turn would have an adverse effect on our
financial position by reducing the amount of cash available under our lines of
credit.
We took various actions to reduce costs in 2001 and are reducing costs
further through staff reductions and other cost-reducing actions in the first
half of 2002. These actions are intended to reduce the cash outlays of our
telecommunications segment to match its revenue rate. If these actions are not
sufficient to reduce cash outlays below revenue levels, then we may restructure
or divest all or part of our telecommunications operations.
13
The following table outlines payments due from us or our subsidiaries
under our lines of credit and other significant contractual obligations over the
next five years, exclusive of interest:
PAYMENTS DUE BY PERIOD
----------------------
CONTRACTUAL (IN THOUSANDS)
OBLIGATIONS AT
JUNE 30, 2002 2002 2003 2004 2005 2006 THERE-AFTER TOTAL
------------- ---- ---- ---- ---- ---- ----------- -----
Line of Credit
(Domestic) $ 1,477 $ $ $ $ $ $ 1,477
Line of Credit (U.K.) 1,746 1,746
Overdraft (France) 695 695
Term Loan (Domestic) 137 26 163
Term Loan (U.K.) 153 146 146 146 42 633
Term Loan (France) 37 56 56 149
Capitalized Lease
Obligations 62 56 20 138
Other Promissory Notes 118 118
Operating Leases 393 158 97 1 649
-------- ------ ------ ------ ------ ---------- --------
$ 4,818 $ 442 $ 319 $ 147 $ 42 $ $ 5,768
In conjunction with our cost reductions, we believe that current and
future available capital resources, revenues generated from operations, and
other existing sources of liquidity, including the credit facilities we and our
subsidiaries have, will be adequate to meet our anticipated working capital and
capital expenditure requirements for at least the next twelve months. If,
however, our capital requirements or cash flow vary materially from our current
projections or if unforeseen circumstances occur, we may require additional
financing. Deteriorating global economic conditions may cause prolonged declines
in investor confidence in and accessibility to capital markets. Our failure to
raise capital, if needed, could restrict our growth, limit our development of
new products or hinder our ability to compete.
14
EFFECTS OF INFLATION
The impact of inflation and changing prices has not been significant on
the financial condition or results of operations of either us or our operating
subsidiaries.
IMPACTS OF NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board, or the FASB,
finalized FASB Statements No. 141, "Business Combinations," or SFAS No. 141, and
No. 142, "Goodwill and Other Intangible Assets," or SFAS No. 142. SFAS No. 141
requires the use of the purchase method of accounting and prohibits the use of
the pooling-of-interests method of accounting for business combinations
initiated after June 30, 2001. SFAS No. 141 also requires that we recognize
acquired intangible assets apart from goodwill if the acquired intangible assets
meet certain criteria. SFAS No. 141 applies to all business combinations
initiated after June 30, 2001 and for purchase business combinations completed
on or after July 1, 2001. It also requires upon adoption of SFAS No. 142 that we
reclassify the carrying amounts of intangible assets and goodwill based on the
criteria in SFAS No. 141.
SFAS No. 142 requires, among other things, that companies no longer
amortize goodwill, but instead test goodwill for impairment at least annually.
In addition, SFAS No. 142 requires that we identify reporting units for the
purpose of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS No. 142. SFAS No. 142 is required to be
applied in fiscal years beginning after December 15, 2001 to all goodwill and
other intangible assets recognized at that date, regardless of when those assets
initially were recognized. SFAS No. 142 requires us to complete a transitional
goodwill impairment test six months from the date of adoption. We are also
required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS No. 142.
Our previous business combinations were accounted for using the
purchase method. As of June 30, 2002 and December 31, 2001, the net carrying
amount of goodwill was $2,438,000 and $2,389,000, respectively. Amortization
expense related to goodwill during the six months ended June 30, 2002 and the
year ended December 31, 2001 was zero dollars and $345,000, respectively. Our
adoption of SFAS No. 141 and SFAS No. 142 has not materially impacted our
financial position and results of operations.
In October 2001, the FASB issued FASB Statement No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," or SFAS 144. SFAS No. 144
requires that those long-lived assets be measured at the lower of carrying
amount or fair value less cost to sell, whether reported in continuing
operations or in discontinued operations. Therefore, discontinued operations
will no longer be measured at net realizable value or include amounts for
operating losses that have not yet occurred. SFAS No. 144 is effective for our
consolidated financial statements beginning January 1, 2002. The implementation
of SFAS No. 144 did not have a material impact on our consolidated financial
position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS 146 addresses accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (Including
Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
and measured initially at fair value when the liability is incurred. SFAS No.
146 is effective for exit or disposal activities that are initiated after
December 31, 2002, with early application encouraged. We do not expect the
adoption of this statement to have a material effect on our financial
statements.
15
EURO CONVERSION
Our operating subsidiaries located in France and the U.K. had combined
net sales from operations approximating 56.6% of our total net sales for the six
months ended June 30, 2002. Net sales from the French subsidiary participating
in the euro conversion were 24.9% of our net sales for the six months ended June
30, 2002. We continue to review the impact of the euro conversion on our
operations.
Our European operations took steps to ensure their capability of
entering into euro transactions. No material changes to information technology
and other systems are necessary to accommodate these multiple currency
transactions because such systems already were capable of using multiple
currencies.
While it is difficult to assess the competitive impact of the euro
conversion on our European operations, at this time we do not foresee any
material impediments to our ability to compete for orders from customers
requesting pricing using the new exchange rate. Since we have no significant
direct sales between our United States and European operations, we regard
exchange rate risk as nominal.
RISK FACTORS
AN INVESTMENT IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. IN
ADDITION TO THE OTHER INFORMATION IN THIS REPORT, YOU SHOULD CAREFULLY CONSIDER
THE FOLLOWING RISK FACTORS BEFORE DECIDING TO INVEST OR MAINTAIN AN INVESTMENT
IN SHARES OF OUR COMMON STOCK. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCURS, IT
IS LIKELY THAT OUR BUSINESS, FINANCIAL CONDITION AND OPERATING RESULTS WOULD BE
HARMED. AS A RESULT, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND
YOU COULD LOSE PART OR ALL OF YOUR INVESTMENT.
THE ECONOMIC DOWNTURN IN THE TELECOMMUNICATIONS EQUIPMENT MARKET CONTINUES
TO NEGATIVELY AFFECT OUR TELECOMMUNICATIONS SEGMENT SALES, WHICH SALES
ACCOUNTED FOR SUBSTANTIAL PORTIONS OF OUR REVENUES IN THE SIX MONTHS ENDED
JUNE 30, 2002 AND THE YEAR ENDED DECEMBER 31, 2001.
During the six months ended June 30, 2002 and the year ended December
31, 2001, 40.6% and 53.9% of our sales, respectively, were to customers in the
telecommunications industry. We experienced 44.3% and 5.6% declines in our
telecommunications segment sales in the six months ended June 30, 2002 and the
year ended December 31, 2001, respectively. We believe these declines primarily
were due to a general business decline experienced by many of our
telecommunications customers. We anticipate a decline in our telecommunications
segment sales in 2002 as compared to 2001. We cannot predict the duration or
severity of the telecommunications market downturn or the extent to which the
downturn will continue to negatively affect our ability to sell our products and
services to customers in the telecommunications industry. A further reduction in
sales would reduce our accounts receivable balances, which in turn would have an
adverse effect on our financial position by reducing cash availability under our
lines of credit. We are taking various actions, including staff reductions, to
reduce cash outlays of our telecommunications segment. However, if the downturn
is long-lasting and severe, we may need to continue to downsize or to
restructure, sell or discontinue all or part of our telecommunications
operations, which would negatively impact our business, prospects, financial
condition, results of operations and cash flows.
OUR LACK OF LONG-TERM PURCHASE ORDERS OR COMMITMENTS MAY ADVERSELY AFFECT
OUR BUSINESS IF DEMAND IS REDUCED.
During the six months ended June 30, 2002 and the year ended December
31, 2001, the sale of telecommunications equipment and related services
accounted for 40.6% and 53.9%, respectively, of our total sales, and the sale of
electronic components accounted for 59.4% and 46.1%, respectively, of our total
sales. In many cases we have long-term contracts with our telecommunications and
electronic components customers that cover the general terms and conditions of
our relationships with them but that do not include long-term purchase orders or
commitments. Rather, our customers issue purchase orders requesting the
16
quantities of telecommunications equipment they desire to purchase from us, and
if we are able and willing to fill those orders, then we fill them under the
terms of the contracts. Accordingly, we cannot rely on long-term purchase orders
or commitments to protect us from the negative financial effects of a reduced
demand for our products that could result from a general economic downturn, from
changes in the telecommunications and electronic components industries,
including the entry of new competitors into the market, from the introduction by
others of new or improved technology, from an unanticipated shift in the needs
of our customers, or from other causes.
MOST OF THE CREDIT FACILITIES OF OUR U.K. AND FRENCH SUBSIDIARIES ARE
PAYMENT-ON-DEMAND FACILITIES THAT MAY BE TERMINATED AT ANY TIME. IF ANY OF
THESE LENDERS WERE TO DEMAND IMMEDIATE PAYMENT OF ALL OUTSTANDING
OBLIGATIONS AND/OR TERMINATE THE EXISTING CREDIT FACILITY OR FACILITIES,
OUR BUSINESS WOULD SUFFER.
XCEL Corporation Limited has an overdraft credit facility of up to
approximately $1,600,000 and XCEL Power Systems Limited has a term loan credit
facility of up to approximately $800,000. Although amounts owing under the
overdraft credit facility are due and payable no later than September 30, 2002,
the lender has the right to demand payment in full at any time prior to
September 30, 2002. CXR, S.A. has credit facilities with several lenders
totaling up to approximately $844,000 in the aggregate. Each credit facility has
a specified repayment term. However, each lender has the right to demand payment
in full at any time prior to the scheduled maturity date of a particular credit
facility. The lender to our U.K. subsidiaries has advised our U.K. subsidiaries
that they no longer wish to continue to finance our U.K. subsidiaries over the
long term. Similarly, CXR, S.A. has been advised by its lenders that they are
contemplating a reduction in the total available credit. We cannot assure you
that the various lenders to our U.K. and/or French subsidiaries will not seek
immediate payment of all amounts owed by them under their respective credit
facilities or seek to terminate any of the existing credit facilities.
Similarly, we cannot assure you that if either of these events were to occur we
would be successful in obtaining the required replacement financing for our
operations in the U.K. and/or France or, if we were able to obtain such
financing, that the financing would occur on a timely basis, would be on
acceptable terms and would be sufficient to allow us to maintain our business
operations in the U.K. and/or France. Accordingly, any of these actions on the
part of any of the lenders to our U.K. and/or French subsidiaries could have a
material adverse impact upon our results of operations and cash flows.
OUR BUSINESS COULD SUFFER IF WE ARE UNABLE TO OBTAIN COMPONENTS OF OUR
PRODUCTS FROM OUTSIDE SUPPLIERS.
The major components of our products include circuit boards,
microprocessors, chipsets and memory components. Most of these components are
available from multiple sources. However, we currently obtain some components
used in our products from single or limited sources. Some modem chipsets used in
our data communications products have been in short supply and are frequently on
allocation by semiconductor manufacturers. We have, from time to time,
experienced difficulty in obtaining some components. We do not have guaranteed
supply arrangements with any of our suppliers, and there can be no assurance
that our suppliers will continue to meet our requirements. Further, disruption
in transportation services as a result of the terrorist attacks in the United
States on September 11, 2001 and further enhanced security measures in response
to the attacks may cause some increases in costs and timing for both our receipt
of components and shipment of products to our customers. If our existing
suppliers are unable to meet our requirements, we could be required to alter
product designs to use alternative components or, if alterations are not
feasible, we could be required to eliminate products from our product line.
17
Shortages of components could not only limit our product line and
production capacity but also could result in higher costs due to the higher
costs of components in short supply or the need to use higher cost substitute
components. Significant increases in the prices of components could have a
material adverse effect on our results of operations because our products
compete on price, and therefore we may not be able to adjust product pricing to
reflect the increases in component costs. Also, an extended interruption in the
supply of components or a reduction in their quality or reliability would have a
material adverse effect on our financial condition and results of operations by
impairing our ability to timely deliver quality products to our customers.
Delays in deliveries due to shortages of components or other factors may result
in cancellation by our customers of all or part of their orders. Although
customers who purchase from us products, such as many of our digital switches
and all of our custom power supplies, that are not readily available from other
sources would be less likely than other customers of ours to cancel their orders
due to production delays, we cannot assure you that cancellations will not
occur.
WE RELY HEAVILY ON OUR MANAGEMENT, AND THE LOSS OF THEIR SERVICES COULD
MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS.
Our success is highly dependent upon the continued services of key
members of our management, including our Chairman of the Board, President and
Chief Executive Officer, Carmine T. Oliva, our Executive Vice President, Graham
Jefferies and our Senior Vice President and Chief Financial Officer, Randolph
Foote. Mr. Oliva co-founded XET Corporation and has developed personal contacts
and other skills that we rely upon in connection with our financing, acquisition
and general business strategies. Mr. Jefferies is a long-time employee of
MicroTel who we have relied upon in connection with our United Kingdom
acquisitions and who fulfills significant operational responsibilities in
connection with our foreign and domestic operations. Mr. Foote joined us in
October 1999, and we have relied upon his skills in financial reporting,
accounting and tax matters in addition to his skills in the analysis of
potential acquisitions and general corporate administration. Consequently, the
loss of Mr. Oliva, Mr. Jefferies, Mr. Foote or one or more other key members of
management could have a material adverse effect on us. Although we have entered
into employment agreements with each of our executive officers, those agreements
are of limited duration and are subject to early termination by the officers
under some circumstances. We maintain key-man life insurance on Mr. Oliva and
Mr. Jefferies. However, we cannot assure you that we will be able to maintain
this insurance in effect or that the coverage will be sufficient to compensate
us for the loss of the services of Mr. Oliva or Mr. Jefferies.
MANY OF OUR COMPETITORS HAVE GREATER RESOURCES THAN US. IN ORDER TO COMPETE
SUCCESSFULLY, WE MUST KEEP PACE WITH OUR COMPETITORS IN ANTICIPATING AND
RESPONDING TO THE RAPID CHANGES INVOLVING THE ELECTRONIC COMPONENTS AND
TELECOMMUNICATIONS INDUSTRIES.
Our future success will depend upon our ability to enhance our current
products and services and to develop and introduce new products and services
that keep pace with technological developments, respond to the growth in the
telecommunications and electronic components markets in which we compete,
encompass evolving customer requirements, provide a broad range of products and
achieve market acceptance of our products. Many of our existing and potential
competitors have larger technical staffs, more established and larger marketing
and sales organizations and significantly greater financial resources than we
do. Our lack of resources relative to our competitors may cause us to fail to
anticipate or respond adequately to technological developments and customer
requirements or to experience significant delays in developing or introducing
new products and services. These failures or delays could reduce our
competitiveness, revenues, profit margins or market share.
18
IF WE ARE UNABLE TO FULFILL BACKLOG ORDERS DUE TO CIRCUMSTANCES INVOLVING
US OR ONE OR MORE OF OUR SUPPLIERS OR CUSTOMERS, OUR ANTICIPATED RESULTS OF
OPERATIONS AND CASH FLOWS WILL SUFFER.
As of June 30, 2002, we had $14,886,000 in backlog orders for our
products. These orders were due in large part to the long lead times associated
with our electronic components products. The amount of backlog orders represents
revenue that we anticipate recognizing in the future, as evidenced by purchase
orders and other purchase commitments received from customers, but on which work
has not yet been initiated or with respect to which work is currently in
progress. However, we cannot assure you that we will be successful in fulfilling
orders and commitments in a timely manner or that we will ultimately recognize
as revenue the amounts reflected as backlog.
FINANCIAL STATEMENTS OF OUR FOREIGN SUBSIDIARIES ARE PREPARED USING THE
RELEVANT FOREIGN CURRENCY THAT MUST BE CONVERTED INTO UNITED STATES DOLLARS
FOR INCLUSION IN OUR CONSOLIDATED FINANCIAL STATEMENTS. AS A RESULT,
EXCHANGE RATE FLUCTUATIONS MAY ADVERSELY IMPACT OUR REPORTED RESULTS OF
OPERATIONS.
We have established and acquired international subsidiaries that
prepare their balance sheets in the relevant foreign currency. In order to be
included in our consolidated financial statements, these balance sheets are
converted, at the then current exchange rate, into United States dollars, and
the statements of operations are converted using weighted average exchange rates
for the applicable period. Accordingly, fluctuations of the foreign currencies
relative to the United States dollar could have an effect on our consolidated
financial statements. Our exposure to fluctuations in currency exchange rates
has increased as a result of the growth of our international subsidiaries. Sales
of our products and services to customers located outside of the United States
accounted for approximately 55% of our net sales for the year ended December 31,
2001. We currently anticipate that foreign sales will account for a similar
proportion of our net sales for the year ended December 31, 2002. However,
because historically the majority of our currency exposure has related to
financial statement translation rather than to particular transactions, we do
not intend to enter into, nor have we historically entered into, forward
currency contracts or hedging arrangements in an effort to mitigate our currency
exposure.
IF WE ARE UNABLE TO SUCCESSFULLY IDENTIFY OR MAKE STRATEGIC ACQUISITIONS OR
ALLIANCES, OUR LONG-TERM COMPETITIVE POSITIONING MAY SUFFER.
Our business strategy includes growth through acquisitions, strategic
alliances and original equipment manufacturer resale agreements, among other
arrangements, that we believe will improve our competitive capabilities or
provide additional market penetration or business opportunities in areas that
are consistent with our business plan. Identifying and pursuing strategic
acquisition or other opportunities and integrating acquired products and
businesses requires a significant amount of management time and skill.
Acquisitions and alliances may also require us to expend a substantial amount of
cash or other resources, not only as a result of the direct expenses involved in
the acquisition transaction or the creation of the alliance, but also as a
result of ongoing research and development activities that may be required to
maintain or enhance the long-term competitiveness of acquired products,
particularly those products marketed to the rapidly evolving telecommunications
industry. If we are unable to make strategic acquisitions, alliances or other
arrangements due to our inability to identify appropriate targets, allies or
arrangements, to raise the necessary funds, particularly while our stock price
is low, or to manage the difficulties or costs involved in the acquisitions,
alliances or arrangements, our long-term competitive positioning could suffer.
19
OUR STOCK PRICE HAS BEEN VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES
FOR INVESTORS PURCHASING SHARES OF OUR COMMON STOCK.
The market prices of securities of technology-based companies,
especially telecommunications electronics companies, currently are highly
volatile. The market price of our common stock has fluctuated significantly in
the past. In fact, during the six months ended June 30, 2002, the high and low
closing sale prices of a share of our common stock were $0.40 and $0.16,
respectively. The market price of our common stock may continue to fluctuate in
response to the following factors, many of which are beyond our control:
o changes in market valuations of similar companies and stock
market price and volume fluctuations generally;
o economic conditions specific to the telecommunications
electronics industry;
o announcements by us or our competitors of new or enhanced
products, technologies or services or significant contracts,
acquisitions, strategic relationships, joint ventures or
capital commitments;
o regulatory developments;
o additions or departures of key personnel; and
o future sales of our common stock or other securities.
The price at which you purchase shares of common stock may not be
indicative of the price of our stock that will prevail in the trading market.
You may be unable to sell your shares of common stock at or above your purchase
price, which may result in substantial losses to you. Moreover, in the past,
securities class action litigation has often been brought against a company
following periods of volatility in the market price of its securities. We may in
the future be the target of similar litigation. Securities litigation could
result in substantial costs and divert management's attention and resources.
THE UNPREDICTABILITY OF OUR QUARTERLY OPERATING RESULTS MAY CAUSE THE PRICE
OF OUR COMMON STOCK TO FLUCTUATE OR DECLINE.
Our quarterly operating results have varied significantly in the past
and will likely continue to do so in the future due to a variety of factors,
many of which are beyond our control. Fluctuations in our operating results may
result from a variety of factors.
For example, the recent general decline in telecommunications market
activity and other changes affecting the telecommunications industry, including
consolidations and restructuring of United States and foreign telephone
companies, cause our sales to decrease or increase. Our sales may increase if we
obtain new customers as a result of the consolidations or restructurings.
However, our sales may decrease, either temporarily or permanently to the extent
our customers are acquired by or combined with companies that are and choose to
remain customers of our competitors.
In addition, the cyclical nature of the telecommunications business due
to the budgetary cycle of RBOCs has had and will continue to have for the
foreseeable future a significant impact on our quarterly operating results.
RBOCs generally obtain approval for their annual budgets during the first
quarter of each calendar year. If an RBOC's annual budget is not approved early
in the calendar year or is insufficient to cover its desired purchases for the
entire calendar year, we are unable to sell products to the RBOC during the
period of the delay or shortfall.
20
Due to these factors and other factors, including changes in general
economic conditions, we believe that period-to-period comparisons of our
operating results will not necessarily be meaningful in predicting future
performance. If our operating results do not meet the expectations of investors,
our stock price may fluctuate or decline.
IF OUR PRODUCTS FAIL TO COMPLY WITH EVOLVING GOVERNMENT AND INDUSTRY
STANDARDS AND REGULATIONS, WE MAY HAVE DIFFICULTY SELLING OUR PRODUCTS.
We design our products to comply with a significant number of industry
standards and regulations, some of which are evolving as new technologies are
deployed. In the United States, our telecommunications products must comply with
various regulations defined by the United States Federal Communications
Commission, or FCC, and Underwriters Laboratories as well as industry standards
established by Telcordia Technologies, Inc., formerly Bellcore, and the American
National Standards Institute. Internationally, our telecommunications products
must comply with standards established by the European Committee for
Electrotechnical Standardization, the European Committee for Standardization,
the European Telecommunications Standards Institute, telecommunications
authorities in various countries as well as with recommendations of the
International Telecommunications Union. The failure of our products to comply,
or delays in compliance, with the various existing and evolving standards could
negatively impact our ability to sell our products.
BECAUSE WE BELIEVE THAT PROPRIETARY RIGHTS ARE MATERIAL TO OUR SUCCESS,
MISAPPROPRIATION OF THESE RIGHTS COULD ADVERSELY IMPACT OUR FINANCIAL
CONDITION.
Our future success will be highly dependent on proprietary technology,
particularly in our telecommunications business. However, we do not hold any
patents and we currently rely on a combination of contractual rights,
copyrights, trademarks and trade secrets to protect our proprietary rights. Our
management believes that because of the rapid pace of technological change in
the industries in which we operate, the legal intellectual property protection
for our products is a less significant factor in our success than the knowledge,
abilities and experience of our employees, the frequency of our product
enhancements, the effectiveness of our marketing activities and the timeliness
and quality of our support services. Consequently, we rely to a great extent on
trade secret protection for much of our technology. However, there can be no
assurance that our means of protecting our proprietary rights will be adequate
or that our competitors or customers will not independently develop comparable
or superior technologies or obtain unauthorized access to our proprietary
technology. Our financial condition would be adversely impacted if we were to
lose our competitive position due to our inability to adequately protect our
proprietary rights as our technology evolves.
IF WE FAIL TO COMPLY WITH ENVIRONMENTAL REGULATIONS, WE COULD FACE
SIGNIFICANT LIABILITIES.
We are subject to a variety of environmental regulations relating to
the use, storage, discharge and disposal of hazardous chemicals used in our
circuit board manufacturing processes. Any failure to comply with present and
future regulations could subject us to future liabilities or the suspension of
production. These regulations could also require us to acquire costly equipment
or to incur other significant expenses to comply with environmental regulations.
We may also from time to time be subject to lawsuits with respect to
environmental matters. The extent of our liability under any suit is not
determinable and may have a material adverse affect on us.
21
THE LIMITATION ON OUR USE OF NET OPERATING LOSS CARRYFORWARDS MAY
NEGATIVELY IMPACT OUR RESULTS OF OPERATIONS AND CASH FLOWS.
We have substantial net operating loss, or NOL, carryforwards for
federal and state tax purposes. Because of our ownership changes resulting from
a merger in 1997, our use of these NOL carryforwards to offset future taxable
income will be limited. To the extent we are unable to fully use these NOL
carryforwards to offset future taxable income, we will be subject to income
taxes on future taxable income, which will negatively impact our results of
operations and cash flows.
BECAUSE WE MAY HAVE INADVERTENTLY FAILED TO COMPLY WITH THE FEDERAL TENDER
OFFER RULES, WE COULD FACE SIGNIFICANT LIABILITIES WHICH, IN TURN, COULD
ADVERSELY IMPACT OUR FINANCIAL CONDITION.
During 1998 and 1999 we modified the terms of some of our outstanding
warrants and the terms of our Series A Preferred Stock. These transactions may
have been subject to the federal tender offer rules which would have required us
to make filings with the Securities and Exchange Commission and to conduct our
activities in a manner prescribed by the tender offer rules. We did not make any
of these filings nor did we comply with the other requirements of the tender
offer rules. Although we believe that our activities surrounding the
modifications to our warrants and Series A Preferred Stock are not subject to
the federal tender offer rules, the Securities and Exchange Commission, as well
as those security holders who participated in the modification transactions, may
disagree with us. If that were to happen, we may be subject to fines by the
Securities and Exchange Commission and may be required by the Securities and
Exchange Commission and/or the security holders to rescind the transactions. The
dollar amount of any fines and the costs associated with rescission, including
the related legal and accounting costs, are difficult for us to quantify, yet
they could be significant. If they are significant, our financial condition
would be adversely impacted.
BECAUSE WE ARE SUBJECT TO THE "PENNY STOCK" RULES, THE LEVEL OF TRADING
ACTIVITY IN OUR STOCK MAY BE REDUCED.
Broker-dealer practices in connection with transactions in "penny
stocks" are regulated by penny stock rules adopted by the Securities and
Exchange Commission. Penny stocks, like shares of our common stock, generally
are equity securities with a price of less than $5.00 (other than securities
registered on some national securities exchanges or quoted on Nasdaq). The penny
stock rules require a broker-dealer, prior to a transaction in a penny stock not
otherwise exempt from the rules, to deliver a standardized risk disclosure
document that provides information about penny stocks and the nature and level
of risks in the penny stock market. The broker-dealer also must provide the
customer with current bid and offer quotations for the penny stock, the
compensation of the broker-dealer and its salesperson in the transaction, and,
if the broker-dealer is the sole market maker, the broker-dealer must disclose
this fact and the broker-dealer's presumed control over the market, and monthly
account statements showing the market value of each penny stock held in the
customer's account. In addition, broker-dealers who sell these securities to
persons other than established customers and "accredited investors" must make a
special written determination that the penny stock is a suitable investment for
the purchaser and receive the purchaser's written agreement to the transaction.
Consequently, these requirements may have the effect of reducing the level of
trading activity, if any, in the secondary market for a security subject to the
penny stock rules, and investors in our common stock may find it difficult to
sell their shares.
WE MAY NEED ADDITIONAL CAPITAL IN THE FUTURE, AND ADEQUATE FINANCING MAY
NOT BE AVAILABLE TO US ON ACCEPTABLE TERMS, OR AT ALL. IF WE OBTAIN
FINANCING THROUGH THE ISSUANCE OF EQUITY SECURITIES, FURTHER DILUTION TO
EXISTING STOCKHOLDERS MAY RESULT. WE MAY BE REQUIRED TO OBTAIN FINANCING
THROUGH ARRANGEMENTS THAT MAY REQUIRE US TO RELINQUISH RIGHTS OR CONTROL TO
SOME OF OUR PROPRIETARY TECHNOLOGIES.
Our future capital requirements will depend upon many factors,
including the magnitude of our sales and marketing efforts, the development of
new products and services, possible future strategic acquisitions, the progress
of our research and development efforts and the status of competitive products
and services. We believe that current and future available capital resources
22
will be adequate to fund our operations for the foreseeable future. However, to
the extent we are in need of any additional financing, there can be no assurance
that any additional financing will be available to us on acceptable terms, or at
all. Deteriorating global economic conditions may cause prolonged declines in
investor confidence in and accessibility to capital markets. If we raise
additional funds by issuing equity securities, further dilution to the existing
stockholders may result. If adequate funds are not available, we may be required
to delay, scale back or eliminate portions of our operations and product
development and marketing efforts or to obtain funds through arrangements with
partners or others that may require us to relinquish rights to some of our
technologies or potential products, services or other assets. Accordingly, the
inability to obtain financing could result in a significant loss of ownership
and/or control of our proprietary technology and other important assets and
could also adversely affect our ability to fund our continued operations and our
product development and marketing efforts that historically have contributed
significantly to our competitiveness.
SHARES OF OUR COMMON STOCK ELIGIBLE OR TO BECOME ELIGIBLE FOR PUBLIC SALE
COULD ADVERSELY AFFECT OUR STOCK PRICE AND MAKE IT DIFFICULT FOR US TO
RAISE ADDITIONAL CAPITAL THROUGH SALES OF EQUITY SECURITIES.
As of August 5, 2002, we had outstanding 21,513,366 shares of common
stock, substantially all of which shares were either unrestricted, registered
for resale under the Securities Act of 1933, or eligible for resale without
registration under Rule 144 of the Securities Act of 1933. As of August 5, 2002,
we also had outstanding options, warrants and preferred stock that were
exercisable for or convertible into 4,870,048 shares of common stock, nearly all
of which shares of common stock were registered for resale by the holders of the
options, warrants and preferred stock. Sales of a substantial number of shares
of our common stock in the public market, or the perception that sales could
occur, could adversely affect the market price for our common stock. Any adverse
effect on the market price for our common stock could make it difficult for us
to sell equity securities at a time and at a price that we deem appropriate.
BECAUSE OUR STOCK IS NOT LISTED ON A NATIONAL SECURITIES EXCHANGE, YOU MAY
FIND IT DIFFICULT TO DISPOSE OF OR OBTAIN QUOTATIONS FOR OUR COMMON STOCK.
Our common stock trades under the symbol "MCTL" on the NASD's OTC
Bulletin Board(R). Because our stock trades on the OTC Bulletin Board(R) rather
tHan on a national securities exchange, you may find it difficult to either
dispose of, or to obtain quotations as to the price of, our common stock.
OUR PREFERRED STOCK MAY DELAY OR PREVENT A TAKEOVER OF MICROTEL, POSSIBLY
PREVENTING YOU FROM OBTAINING HIGHER STOCK PRICES FOR YOUR SHARES.
Our board of directors has the authority to issue up to 10,000,000
shares of preferred stock and to fix the rights, preferences, privileges and
restrictions, including voting rights of those shares, without any further vote
or action by our stockholders. Of these shares, 200 have been designated as
Series A Preferred, of which 25 were outstanding as of August 5, 2002. In
addition, 150,000 shares have been designated as Series B Preferred Stock,
65,733.7 of which were outstanding as of August 5, 2002. The rights of the
holders of our common stock are subject to the rights of the holders of our
currently outstanding preferred stock and will be subject to, and may be
adversely affected by, the rights of the holders of any preferred stock that we
may issue in the future. The issuance of preferred stock, while providing
desired flexibility in connection with possible acquisitions and other corporate
23
purposes, could have the effect of making it more difficult for a third party to
acquire a majority of our outstanding voting stock, which would delay, defer or
prevent a change in control of MicroTel. Furthermore, preferred stock may have
other rights, including economic rights senior to the common stock, and, as a
result, the issuance of preferred stock could adversely affect the market value
of our common stock.
THE ANTI-TAKEOVER EFFECTS OF DELAWARE LAW COULD ADVERSELY AFFECT THE
PERFORMANCE OF OUR STOCK.
Section 203 of the General Corporation Law of Delaware prohibits us
from engaging in business combinations with interested stockholders, as defined
by statute. These provisions may have the effect of delaying or preventing a
change in control of MicroTel without action by our stockholders, even if a
change in control would be beneficial to our stockholders. Consequently, these
provisions could adversely affect the price of our common stock.
24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We have established and acquired international subsidiaries that
prepare their balance sheets in the relevant foreign currency. In order to be
included in our consolidated financial statements, these balance sheets are
converted, at the then current exchange rate, into United States dollars, and
the statements of operations are converted using weighted average exchange rates
for the applicable period. Accordingly, fluctuations of the foreign currencies
relative to the United States dollar could have an effect on our consolidated
financial statements. Our exposure to fluctuations in currency exchange rates
has increased as a result of the growth of our international subsidiaries.
However, because historically the majority of our currency exposure has related
to financial statement translation rather than to particular transactions, we do
not intend to enter into, nor have we historically entered into, forward
currency contracts or hedging arrangements in an effort to mitigate our currency
exposure.
A substantial portion of our notes payable and long-term debt have
variable interest rates based on the prime interest rate and/or the lender's
base rate, which exposes us to risk of earnings loss due to changes in such
interest rates.
The following table provides information about our debt obligations
that are sensitive to changes in interest rates. All dollars are in thousands.
The symbol "P" represents the prime rate. The symbol "B" represents lender's
base rate. The symbol "E" represents Euribor plus a variable margin. Balances
are as of December 31, 2001.
FAIR
THERE- VALUE
LIABILITIES 2002 2003 2004 2005 2006 AFTER TOTAL 12/31/01
----------- ---- ---- ---- ---- ---- ---- ----- --------
Line of Credit
(Domestic) $1,420 $1,420 $1,420
Average Interest
Rate P+1%
Line of Credit
(U.K.) $1,665 $1,665 $1,665
Average Interest
Rate B+2.5%
Overdraft (France) $ 533 $ 533 $ 533
Average Interest
Rate E
Term Loan (Domestic) $ 137 $ 95 $ 232 $ 232
Average Interest
Rate P+1% P+1%
Term Loan (U.K.) $ 146 $ 146 $ 146 $ 146 $ 81 $ 665 $ 665
Average Interest
Rate B+2.5% B+2.5% B+2.5% B+2.5% B+2.5%
Term Loan (France) $ 30 $ 30 $ 30 $ 90 $ 90
Average Interest
Rate 7.25%
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We are not a party to any material pending legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
RECENT SALES OF UNREGISTERED SECURITIES
In April and May 2002, we issued an aggregate of 756,742 shares of
common stock upon conversion of 75,674.2 shares of Series B Preferred Stock held
by four individuals and three entities.
Exemption from the registration provisions of the Securities Act of
1933 for the transactions described above is claimed under Section 4(2) of the
Securities Act of 1933, among others, on the basis that such transactions did
not involve any public offering and the purchasers were sophisticated with
access to the kind of information registration would provide.
DIVIDENDS
To date we have not paid dividends on our common stock. Our line of
credit with Wells Fargo Business Credit, Inc. prohibits the payment of cash
dividends on our common stock. The certificates of designations related to our
Series A Preferred Stock and Series B Preferred Stock provide that shares of
those series of preferred stock are not entitled to receive cash dividends. We
currently intend to retain future earnings to fund the development and growth of
our business and, therefore, do not anticipate paying cash dividends on our
common stock within the foreseeable future. Any future payment of dividends on
our common stock will be determined by our board of directors and will depend on
our financial condition, results of operations, contractual obligations and
other factors deemed relevant by the our board of directors.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
--- --------
Number Description
------ -----------
10.1 Fourth Amendment to Credit and Security Agreement
dated as of April 17, 2002 by and between CXR Telcom
Corporation, XET Corporation and Wells Fargo Business
Credit, Inc.
99.1 Certifications of Chief Executive Officer and Chief
Financial Officer Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act Of 2002
(b) Reports on Form 8-K
--- -------------------
None.
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
MICROTEL INTERNATIONAL, INC.
Dated: August 14, 2002 By: /s/ CARMINE T. OLIVA
--------------------------------------------
Carmine T. Oliva, Chairman of the Board,
Chief Executive Officer (principal executive
officer) and President
By: /s/ RANDOLPH D. FOOTE
--------------------------------------------
Randolph D. Foote, Chief Financial Officer
(principal financial and accounting officer)
27
EXHIBITS FILED WITH THIS REPORT ON FORM 10-Q
Number Description
------ -----------
10.1 Fourth Amendment to Credit and Security Agreement dated as of
April 17, 2002 by and between CXR Telcom Corporation, XET
Corporation and Wells Fargo Business Credit, Inc.
99.1 Certifications of Chief Executive Officer and Chief Financial
Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act Of 2002
28