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U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2003 or
| | TRANSITION REPORT UNDER 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)
NOT APPLICABLE
(Former Name, Former Address and Former Fiscal Year,
if Changed Since Last Report)
Indicate by check 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 | |
Indicate by check whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes | | No |X|
As of November 1, 2003, there were 23,433,250 shares of the issuer's common
stock, $0.0033 par value, outstanding.
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MICROTEL INTERNATIONAL, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
Condensed Consolidated Balance Sheets as of September 30, 2003
(unaudited) and December 31, 2002.......................... F-1
Condensed Consolidated Statements of Operations for the Three
and Nine Months Ended September 30, 2003 and 2002
(unaudited)................................................ F-2
Condensed Consolidated Statements of Other Comprehensive Income
for the Three and Nine Months Ended September 30, 2003
and 2002 (unaudited)....................................... F-3
Condensed Consolidated Statements of Stockholders' Equity for the
Nine Months Ended September 30, 2003 (unaudited)........... F-4
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended September 30, 2003 and 2002 (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...................................................... 17
ITEM 4. CONTROLS AND PROCEDURES.......................................... 17
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS................................................ 18
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS........................ 18
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.................................. 18
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............. 18
ITEM 5. OTHER INFORMATION................................................ 18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................. 19
SIGNATURES ............................................................ 20
EXHIBITS FILED WITH THIS FORM 10-Q........................................ 21
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2003 AND DECEMBER 31, 2002
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
September 30, December 31,
ASSETS 2003 2002
--------- ---------
Current assets: (unaudited)
Cash and cash equivalents $ 605 $ 254
Accounts receivable, net of allowance for doubtful
accounts of $128 and $130, respectively 4,923 5,356
Inventories 6,659 7,505
Prepaid and other current assets 522 343
--------- ---------
Total current assets 12,709 13,458
Property, plant and equipment, net 321 588
Goodwill, net of accumulated amortization of $1,056 and $1,050,
respectively 2,375 2,346
Other assets 583 394
--------- ---------
$ 15,988 $ 16,786
========= =========
LIABILITIES, REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ 2,505 $ 3,475
Current portion of long-term debt 248 318
Accounts payable 1,544 2,439
Accrued expenses 3,167 3,265
--------- ---------
Total current liabilities 7,464 9,497
Long-term debt, less current portion 917 927
Other liabilities 306 348
--------- ---------
Total liabilities 8,687 10,772
--------- ---------
Convertible redeemable Series A Preferred Stock, $10,000
unit value. Authorized 200 shares; issued and outstanding
0 shares and 25 shares, respectively (aggregate liquidation
preferences of $0 and $250, respectively) -- 282
Stockholders' equity:
Preferred stock, authorized 10,000,000 shares;
Convertible Series B Preferred Stock, $0.01 par value;
issued and outstanding 1,000 shares and 64,000 shares,
respectively (aggregate liquidation preferences of $4 and
$410, respectively) 4 400
Common stock, $0.0033 par value. Authorized 50,000,000 shares;
issued and outstanding 23,433,000 and 21,535,000,
respectively 77 71
Additional paid-in capital 25,597 24,900
Accumulated deficit (18,141) (19,042)
Accumulated other comprehensive loss (236) (597)
--------- ---------
Total stockholders' equity 7,301 5,732
--------- ---------
$ 15,988 $ 16,786
========= =========
See accompanying notes to condensed consolidated financial statements.
F-1
MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2003 2002 2003 2002
--------- --------- --------- ---------
(in thousands, except per share amounts)
Net sales $ 6,420 $ 5,764 $ 18,922 $ 16,702
Cost of sales 3,705 3,680 11,237 10,579
--------- --------- --------- ---------
Gross profit 2,715 2,084 7,685 6,123
Operating expenses:
Selling, general and administrative 1,916 2,094 5,532 5,814
Engineering and product development 230 242 697 739
--------- --------- --------- ---------
Income (loss) from operations 569 (252) 1,456 (430)
Other income (expense):
Interest expense (104) (119) (317) (303)
Other income (expense) 65 (56) 4 (33)
--------- --------- --------- ---------
Income (loss) before income taxes 530 (427) 1,143 (766)
Income tax expense (benefit) 26 (97) 236 8
--------- --------- --------- ---------
Net income (loss) $ 504 $ (330) $ 907 $ (774)
========= ========= ========= =========
Earnings (loss) per share:
Net income (loss):
Basic $ 0.02 $ (0.02) $ 0.04 $ (0.04)
========= ========= ========= =========
Diluted $ 0.02 $ (0.02) $ 0.04 $ (0.04)
========= ========= ========= =========
See accompanying notes to condensed consolidated financial statements.
F-2
MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
2003 2002 2003 2002
------- ------- ------- -------
(in thousands)
Net income (loss) $ 504 $ (330) $ 907 $ (774)
Other comprehensive income (loss) net of tax:
Foreign currency translation adjustment 109 17 361 361
------- ------- ------- -------
Comprehensive income (loss) $ 613 $ (313) $1,268 $ (413)
======= ======= ======= =======
See accompanying notes to condensed consolidated financial statements.
F-3
MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES
NINE MONTHS ENDED SEPTEMBER 30, 2003
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
(IN THOUSANDS)
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, 2002 64 $ 400 21,535 $ 71 $ 24,900 $ (19,042) $ (597) $ 5,732
Preferred Series A conversions -- -- 1,263 4 283 -- -- 287
Preferred Series B conversions (63) (396) 635 2 395 (1) -- --
Foreign currency translation adjustment -- -- -- -- -- -- 361 361
Accretion of redeemable preferred stock -- -- -- -- -- (5) -- (5)
Warrants issued for services -- -- -- -- 19 -- -- 19
Net profit -- -- -- -- -- 907 -- 907
--------------------------------------------------------------------------------------------
Balance at September 30, 2003 1 $ 4 23,433 $ 77 $ 25,597 $ (18,141) $ (236) $ 7,301
============================================================================================
See accompanying notes to condensed consolidated financial statements.
F-4
MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine months ended September 30,
2003 2002
-------- --------
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 907 $ (774)
Adjustments to reconcile net income (loss) to cash provided by operating
activities:
Depreciation and amortization 215 230
Provision for doubtful accounts 46 102
Provision for obsolete/slow moving inventory 628 392
Stock and warrants issued for services 19 6
Changes in operating assets and liabilities:
Accounts receivable 378 665
Inventories 182 (196)
Other assets (282) (23)
Accounts payable and accrued expenses (1,035) (269)
-------- --------
Cash provided by operating activities 1,058 133
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net purchases of property, plant and equipment (42) (107)
Cash received from sale of fixed assets 13 --
Cash collected on note receivable 12 17
-------- --------
Cash used in investing activities (17) (90)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in notes payable and long-term debt (1,050) (688)
-------- --------
Cash used in financing activities (1,050) (688)
-------- --------
Effect of exchange rate changes on cash 360 400
Net increase (decrease) in cash and cash equivalents 351 (245)
Cash and cash equivalents at beginning of period 254 604
-------- --------
Cash and cash equivalents at end of period $ 605 $ 359
======== ========
Cash paid for:
Income tax $ 61 $ 33
======== ========
Interest $ 288 $ 250
======== ========
See accompanying notes to condensed consolidated financial statements.
F-5
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003 AND 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 Telcom"), CXR Anderson
Jacobson, formerly CXR, S.A.S. ("CXR-AJ") and XET Corporation, formerly XIT
Corporation ("XET"). XET and its subsidiaries design, develop, manufacture and
market digital and rotary switches and power supplies and subsystem assemblies.
CXR Telcom and CXR-AJ design, develop, manufacture and market network access and
transmission products and communications test equipment. The Company conducts
its operations out of various facilities in the United States, England, France
and Japan and organizes itself in two product line segments: electronic
components and communications equipment.
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.
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 Company's
financial position as of September 30, 2003 and December 31, 2002 and the
Company's results of operations and cash flows for the related interim periods
ended September 30, 2003 and 2002. However, these results are not necessarily
indicative of results for any other interim period or for the year ending
December 31, 2003. 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 2002 annual report on Form
10-K.
STOCK-BASED COMPENSATION
In December 2002, the Financial Accounting Standards Board ("FASB")
issued FASB Statement of Financial Accounting Standards ("SFAS") No. 148,
"Accounting for Stock-Based Compensation-Transition and Disclosure-An Amendment
of SFAS 123." SFAS No. 148 amends SFAS No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for a voluntary
change to the fair value-based method of accounting for stock-based employee
compensation. In addition, this statement amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. The Company
has chosen to continue to account for stock-based compensation using the
intrinsic value method prescribed in Accounting Principles Bulletin Opinion No.
25, "Accounting for Stock Issued to Employees," and related interpretations.
Accordingly, compensation expense for stock options is measured as the excess,
if any, of the estimate of the market value of our stock at the date of the
grant over the amount an employee must pay to acquire the stock. The Company has
adopted the disclosure provisions of SFAS No. 148 for its financial reports.
F-6
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003 AND 2002
(UNAUDITED)
Because this standard involves disclosures only, the adoption of this standard
did not have a material impact on the Company's results of operations, financial
position or liquidity.
The following table sets forth the net income (loss), net income (loss)
available for common stockholders and earnings (loss) per share amounts for the
periods presented as if the Company had elected the fair value method of
accounting for stock options for all periods presented:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -----------------------
2003 2002 2003 2002
---- ---- ---- ----
(in thousands, except per share amounts)
Net income (loss)
As reported $ 504 $ (330) $ 907 $ (774)
Pro forma $ 494 $ (332) $ 873 $ (792)
Net income (loss) available for
common stockholders (less
accretion of preferred stock)
As reported $ 504 $ (333) $ 902 $ (783)
Pro forma $ 494 $ (335) $ 868 $ (801)
Basic earnings (loss) per share
As reported $ 0.02 $ (0.02) $ 0.04 $ (0.04)
Pro forma $ 0.02 $ (0.02) $ 0.04 $ (0.04)
Diluted earnings (loss) per share
As reported $ 0.02 $ (0.02) $ 0.04 $ (0.04)
Pro forma $ 0.02 $ (0.02) $ 0.04 $ (0.04)
The above calculations include the effects of all grants in the periods
presented. Because options often vest over several years and additional awards
are made each year, the results shown above may not be representative of the
effects on net income (loss) in future periods. The calculations were based on a
Black-Scholes pricing model with the following assumptions: no dividend yield;
expected volatility of 93%; risk-free interest rate of 2%-3%; expected lives of
7 years for all periods presented.
F-7
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003 AND 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 Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2003 2002 2003 2002
--------- --------- --------- ---------
(in thousands, except per share amounts)
NUMERATOR:
Net income (loss) $ 504 $ (330) $ 907 $ (774)
Less: accretion of the excess of the
redemption value over the
carrying value of redeemable
preferred stock -- 3 5 9
--------- --------- --------- ---------
Income (loss) attributable to common
stockholders $ 504 $ (333) $ 902 $ (783)
========= ========= ========= =========
DENOMINATOR:
Weighted average number of common shares
outstanding during the period 23,428 21,506 22,280 21,104
Incremental shares from assumed
exercises or conversions of warrants,
options and preferred stock 470 -- 1,324 --
--------- --------- --------- ---------
Adjusted weighted average shares 23,898 21,506 23,604 21,104
========= ========= ========= =========
Basic earnings (loss) per share $ 0.02 $ (0.02) $ 0.04 $ (0.04)
========= ========= ========= =========
Diluted earnings (loss) per share $ 0.02 $ (0.02) $ 0.04 $ (0.04)
========= ========= ========= =========
The computation of diluted loss per share for the three and nine-months
ended September 30, 2002 excludes the effect of incremental common shares
attributable to the exercise of outstanding common stock options and warrants
because their effect was antidilutive due to losses incurred by the Company or
because such instruments had exercise prices greater than the average market
price of the common shares during the periods presented. As of September 30,
2002, there were no shares of common stock underlying options and warrants that
were anti-dilutive and 6,000 shares of common stock underlying shares of
convertible preferred stock.
F-8
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003 AND 2002
(UNAUDITED)
(3) INVENTORIES
Inventories consist of the following.
September 30, 2003 December 31, 2002
------------------ -----------------
Raw materials $2,443,000 $2,904,000
Work-in-process 2,424,000 2,988,000
Finished goods 1,792,000 1,613,000
----------- -----------
$6,659,000 $7,505,000
=========== ===========
(4) REPORTABLE SEGMENTS
The Company has two reportable segments: electronic components and
communications equipment. The electronic components segment operates in the
United States, European and Asian markets and designs, manufactures and markets
digital and rotary switches, subsystem assemblies and power supplies. The
communications equipment segment operates principally in the United States and
European markets and designs, manufactures and distributes networking and voice
and data transmission equipment and communications test instruments.
The Company evaluates performance based upon profit or loss from
operations before income taxes, exclusive of nonrecurring gains and losses. The
Company accounts for intersegment sales at prices negotiated between the
individual segments. There were no intersegment sales during the nine-month
periods ended September 30, 2003 and 2002.
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 2002 annual
report on Form 10-K. Selected financial data for each of the Company's operating
segments is shown below:
Nine months ended Nine months ended
September 30, 2003 September 30, 2002
------------------ ------------------
Sales to external customers:
Electronic Components $ 12,251,000 $ 9,899,000
Communications Equipment 6,671,000 6,803,000
------------- -------------
$ 18,922,000 $ 16,702,000
============= =============
Segment pretax profits (losses)
Electronic Components $ 2,729,000 $ 1,942,000
Communications Equipment 34,000 (1,211,000)
------------- -------------
$ 2,763,000 $ 731,000
============= =============
F-9
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003 AND 2002
(UNAUDITED)
September 30, 2003 December 31, 2002
------------------ -----------------
Segment assets
Electronic Components $ 9,023,000 $ 9,445,000
Communications Equipment 6,725,000 6,773,000
------------ ------------
15,748,000 $16,218,000
============ ============
The following is a reconciliation of the reportable segment income
(loss) and assets to the Company's consolidated totals:
Nine months ended Nine months ended
September 30, 2003 September 30, 2002
------------------ ------------------
Pretax Income
Total income for reportable segments $ 2,763,000 $ 731,000
Unallocated amounts:
Unallocated general corporate expenses 1,620,000 1,497,000
------------ ------------
Consolidated income (loss) before
income taxes $ 1,143,000 $ (766,000)
============ ============
September 30, 2003 December 31, 2002
------------------ -----------------
Assets
Total assets for reportable segments $15,748,000 $16,218,000
Other assets 240,000 568,000
------------ ------------
Total consolidated assets $15,988,000 $16,786,000
============ ============
(5) NEW CXR-AJ CREDIT FACILITY
As of September 30, 2003, CXR-AJ, based in France, had credit
facilities with several lenders with balances totaling up to approximately
$852,000 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. Because CXR-AJ
experienced a substantial reduction in revenue in 2002, some of its lenders made
reductions in the total available credit. Banque Hervet reduced availability to
$78,000 from $159,000 effective December 31, 2002. On February 10, 2003, Societe
Generale notified CXR-AJ that CXR-AJ had to pay back its credit line balance by
April 30, 2003. Societe Generale agreed to an alternative pay back schedule for
the full balance owed as of March 31, 2003 so that $54,000 was due by May 31,
2003 and another $54,000 was due by June 30, 2003. The overdraft loan from
Societe Generale has been paid off in accordance with the bank's demand.
F-10
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2003 AND 2002
(UNAUDITED)
On April 8, 2003, CXR-AJ obtained a credit facility from IFN Finance, a
subsidiary of the global Dutch ABN AMRO Holdings N.V. financial institution. The
new credit line is for a maximum of $1,398,000, based on the exchange rate in
effect at September 30, 2003 for the conversion of euros into United States
dollars. This is an increase over the total of credit lines that CXR-AJ has with
its other banks. The IFN Finance facility will replace the several smaller
credit lines. The IFN Finance facility is secured by accounts receivable and
carries an annual interest rate of 1.6 percentage points above the French "T4M"
rate. The French T4M rate was 2.1% as of August 31, 2003. Funds that become
available under the new IFN Finance credit line as new accounts receivables
develop are being used to retire the existing CXR-AJ debt.
(6) NEW ACCOUNTING PRONOUNCEMENTS
New accounting pronouncements are discussed under the heading "Impacts
of New Accounting Pronouncements" beginning on page 15 of this report.
(7) INCOME TAXES
The effective tax rate for the three-month period ended September 30,
2003 differed from the United States federal statutory rate due to the fact that
the majority of taxes accrued were at U.K. tax rates on U.K. source income.
Also, the Company has domestic net operating losses to offset most of its 2003
United States tax liabilities. The Company previously provided a 100% valuation
allowance for the available domestic net operating losses.
(8) PREFERRED STOCK CONVERSIONS
During the three months ended September 30, 2003, holders of Series B
Preferred Stock converted 592.6 shares of Series B Preferred Stock into 5,926
shares of common stock. Each share of Series B Preferred Stock was convertible
into 10 shares of common stock.
(9) GOODWILL
The balance of goodwill on the Company's balance sheet fluctuates from
period to period due to the application of foreign currency translation to
United States dollars in calculating the balance of goodwill of our foreign
subsidiaries.
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 unaudited condensed consolidated financial statements and notes to
financial statements included elsewhere in this report. This report and our
unaudited 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 or contraction in the electronic
components and communications equipment markets in which we
operate;
o our business strategy for expanding, maintaining or
contracting 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. In particular, you should review our annual
report on Form 10-K for the year ended December 31, 2002, and the "Risk Factors"
we included in that report.
Any of the factors described above 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
Through our three wholly-owned operating subsidiaries, XET Corporation
("XET"), CXR Telcom Corporation ("CXR Telcom") and CXR Anderson Jacobson
("CXR-AJ"), and through the divisions and subsidiaries of those subsidiaries, we
design, develop, manufacture, assemble, and market products and services in the
following two material business segments:
o Electronic Components
-- digital and rotary switches
-- electronic power supplies
-- subsystem assemblies
2
o Communications Equipment
-- network access and transmission products
-- communications test instruments
Our sales are primarily in North America, Europe and Asia. Revenues are
recorded when products are shipped if shipped FOB shipping point or when
received by the customer if shipped FOB destination.
Sales to customers in the electronic components segment, primarily to
defense and aerospace customers, defense contractors and industrial customers,
were 59.1%, 46.1% and 44.1% of our total net sales for the years 2002, 2001 and
2000, respectively, and 64.7% of our total net sales during the nine months
ended September 30, 2003. Sales of communications equipment and related
services, primarily to telecommunications equipment customers, were 40.9%, 53.9%
and 55.8% of our total net sales during 2002, 2001 and 2000, respectively, and
35.3% of our total net sales during the nine months ended September 30, 2003.
We experienced a 37.2% decline in our communications equipment segment
sales during 2002. We believe this decline primarily was due to a general
business downturn experienced by many of our telecommunications customers, the
disruption caused by the French political elections in 2002 and our decision to
discontinue the resale in Europe of test equipment not manufactured by us. As a
result of the general business downturn, we experienced significant reductions
in sales and gross profit as well as changes in our product mix. Consequently,
we shifted our overall focus toward growing our electronic components business.
However, we also plan to continue working to improve the growth and performance
of our communications equipment business, particularly customer premises network
access and transmission products.
During the nine months ended September 30, 2003, our electronic
components segment improved its sales and profits as compared to the nine months
ended September 30, 2002. Our communications equipment segment reported an
operating profit in the nine months ended September 30, 2003 as compared to an
operating loss in the comparable prior year period. The improvement was related
to CXR-AJ, which serves mainly our telecommunications customer premises
equipment in Europe and the United States. CXR-AJ's 18.8% increase in sales was
more than completely offset by a 32.5% decline in sales at CXR Telcom in
Fremont, California. CXR Telcom mainly sells to telecommunications carrier
companies in the United States but also has begun marketing and selling to
non-telecommunications customers such as electric utilities, construction
contractors and government agencies. In the first half of 2003, we reduced costs
at CXR Telcom by laying off a substantial portion of its work force and began to
increase our sources of test equipment components from Asian manufacturers that
produce the components for lower prices than we previously paid to our former
suppliers.
We have reduced costs in our communications equipment segment and
lowered the breakeven point both in our United States and French operations
through various cost-cutting methods, such as using Asian contract
manufacturers, reducing facility rent expense and downsizing our administrative
office in Paris, France. These cost-cutting efforts have improved our bottom
line performance in this segment. However, 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
adversely affect our financial position by reducing cash availability under our
lines of credit.
3
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are described in the notes to the
audited consolidated financial statements that are included in our annual report
on Form 10-K for the year ended December 31, 2002. We believe our most critical
accounting policies include inventory valuation, foreign currency translation
and goodwill impairment.
INVENTORY VALUATION
We value our inventory at the lower of the actual cost to purchase or
manufacture the inventory and 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 quantity of inventory purchases, while a significant decrease in demand
could result in an increase in the amount of excess inventory quantities on
hand.
In addition, the communications 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.
FOREIGN CURRENCY TRANSLATION
We have foreign subsidiaries that together accounted for 62.1% of our
net revenues, 72.3% of our assets and 74.7% of our total liabilities as of and
for the year ended December 31, 2002, and 69.8% of our net revenues, 73.6% of
our assets and 73.9% of our total liabilities as of and for the nine months
ended September 30, 2003.
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 the
subsidiary's 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
$597,000 and $236,000 that were included as part of accumulated other
comprehensive loss within our balance sheets at December 31, 2002 and September
30, 2003, respectively. During the year ended December 31, 2002 and the nine
months ended September 30, 2003, we recorded translation adjustments of gains of
approximately $446,000 and $361,000, respectively.
If we had determined that the functional currency of our subsidiaries
was United States dollars, these gains or losses would have decreased or
increased our loss for the year ended December 31, 2002 and our net profit for
the nine months ended September 30, 2003. 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 year ended December 31, 2002 and the nine months ended September 30,
2003.
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 of 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
were required to analyze our goodwill for impairment issues by June 30, 2002,
and then at least annually after that date. At December 31, 2002 and September
30, 2003, we recorded goodwill of $2,346,000 and $2,375,000, respectively (net
of accumulated amortization of $1,050,000 and $1,056,000, respectively).
However, during the year ended December 31, 2002 and the nine months ended
September 30, 2003, we did not record any impairment losses related to goodwill
and other intangible assets.
5
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 2002
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
September 30,
----------------------------------
2003 2002
--------------- ---------------
Net sales........................................... 100.0% 100.0%
Cost of sales....................................... 57.7 63.9
--------------- ---------------
Gross profit........................................ 42.3 36.1
Selling, general and administrative
expenses.......................................... 29.8 36.3
Engineering and product development
expenses.......................................... 3.6 4.2
--------------- ---------------
Operating income.................................... 8.9 (4.4)
Interest expense.................................... (1.6) (2.0)
Other income (expense).............................. 1.0 (1.0)
--------------- ---------------
Income (loss) before income tax expense............. 8.3 (7.4)
Income tax expense.................................. 0.4 (1.7)
--------------- ---------------
Net income (loss) .................................. 7.9 (5.7)%
=============== ===============
NET SALES. Net sales for the three months ended September 30, 2003
increased by $656,000 (11.4%) to $6,420,000 as compared to $5,764,000 for the
three months ended September 30, 2002.
Net sales of our electronic components for the three months ended
September 30, 2003 increased by $1,005,000 (29.6%) to $4,402,000 as compared to
$3,397,000 for the three months ended September 30, 2002. Net sales of power
supplies by XCEL Corporation, Ltd., our U.K. subsidiary that manufactures power
supplies and wound components, for the three months ended September 30, 2003
increased by $853,000 (49.5%) to $2,577,000 as compared to $1,724,000 for the
three months ended September 30, 2002 due to an increase in the number of
products shipped under long-term programs. However, we anticipate that sales of
power supplies in 2004 will decline from 2003 levels based on expected timing of
shipments. Sales of digital switches manufactured by our Digitran Division for
the three months ended September 30, 2003 increased by $223,000 (17.7%) to
$1,483,000 as compared to $1,260,000 for the three months ended September 30,
2002. The increase in sales of digital switches was a result of increased
orders, which we believe was primarily due to increases in sales of spare parts
and increased demand due to the war in Iraq. XET's Digitran Division recently
introduced a new standard rotary switch and a Very Low Profile(R) rotary switch,
patent pending, that management expects to be additive to switch sales in 2004
and beyond. Sales of electronic subsystem assemblies were $156,000 as compared
to $320,000 in the quarter ended September 30, 2002 because of the completion of
a major contract.
Net sales of our communications equipment products and services for the
three months ended September 30, 2003 decreased by $349,000 (14.7%) to
$2,018,000 as compared to $2,376,000 for the comparable prior year period.
CXR-AJ produces all of our transmission products and network access equipment.
Net sales of transmission products and network access equipment produced by
CXR-AJ for the three months ended September 30, 2003 decreased by $120,000
(10.1%) to $1,069,000 as compared to $1,189,000 for the three months ended
September 30, 2002.
6
Test equipment net sales for the three months ended September 30, 2003
decreased by $92,000 (12.2%) to $663,000 as compared to $755,000 for the three
months ended September 30, 2002, which was primarily due to CXR-AJ's
discontinuation of its resales of test equipment in Europe in November 2002. Net
sales of our CXR HALCYON 704 series field test equipment decreased by $27,000
(4.1%) to $638,000 as compared to $665,000 for the three months ended September
30, 2002. We have begun to receive orders for our test equipment from certain
non-telecom customers, such as electric utilities, construction contractors and
government agencies, as a result of our efforts to expand our markets.
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 and 2003. Although we have seen recent
improvement in orders at CXR Telcom, we do not know if such improvement will be
a continuing trend or only a temporary change.
GROSS PROFIT. Gross profit as a percentage of total net sales increased
to 42.3% for the three months ended September 30, 2003 as compared to 36.2% for
the comparable period in 2002. In dollar terms, total gross profit increased by
$631,000 (30.3%) to $2,715,000 as compared to $2,084,000 for the three months
ended September 30, 2002.
Gross profit for our electronic components segment increased in dollar
terms by $479,000 (37.2%) to $1,767,000 for the three months ended September 30,
2003 as compared to $1,288,000 for the three months ended September 30, 2002,
and increased as a percentage of related net sales to 40.1% for the three months
ended September 30, 2003 from 37.9% for the three months ended September 30,
2002. This increase was primarily due to a higher margin product mix of digital
switch sales. However, gross profit as a percentage net sales of digital
switches by XET's Digitran Division improved to 67.0% during the third quarter
of 2003 as compared to 58.5% in the comparable prior year period. Power
supplies, which are produced by XCEL Power Systems Ltd. in the U.K., had a lower
gross margin of 25% in the current year period due to product mix as compared to
the 29% gross margin in the third quarter of 2002, although in dollars terms the
actual gross margin on these products increased to $682,000 in the current year
period as compared to $414,000 in the prior year period.
Gross profit for our communications equipment segment increased in
dollar terms by $153,000 (19.2%) to $949,000 for the three months ended
September 30, 2003 as compared to $796,000 for the comparable period in 2002,
and increased as a percentage of net sales to 47.0% for the three months ended
September 30, 2003 from 33.7% for the three months ended September 30, 2002. The
increase in gross profit as a percentage of net sales primarily was due to the
cost reductions at both CXR Telcom and CXR-AJ. These cost reductions were the
primary reason that both of our communications equipment subsidiaries had an
increase in gross margin in dollar terms and as percentages of net sales.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for the three months ended September 30, 2003 decreased
by $178,000 (8.5%) to $1,916,000 as compared to $2,094,000 for the three months
ended September 30, 2002. Selling, general and administrative expenses decreased
as a percentage of total net sales, to 29.8% of net sales during the three
7
months ended September 30, 2003 from 36.3% of net sales during the comparable
period in 2002. The decrease in these expenses was due primarily to
administrative staff reductions.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product
development expenses consist primarily of research and product development
activities of our communications equipment segment and XET's Digitran Division.
These expenses remained relatively constant at $230,000 for the three months
ended September 30, 2003 as compared to $242,000 for the three months ended
September 30, 2002.
OTHER INCOME AND EXPENSE. Interest expense decreased by $15,000 (12.6%)
to $104,000 for the three months ended September 30, 2003 from $119,000 for the
three months ended September 30, 2002 due to lower balances on our credit
facilities. Other income was $65,000 for the three months ended September 30,
2003 as compared to other expense of $56,000 for the three months ended
September 30, 2002 primarily due to gain on exchange rates.
INCOME TAX EXPENSE (BENEFIT). Income tax expense for the three months
ended September 30, 2003 was $26,000 as compared to a $97,000 tax benefit for
the comparable prior year period. The majority of the change related to the
recording by XCEL Power Systems of a provision for U.K. income tax that was
required because XCEL Power Systems is expected to produce greater taxable
income for 2003 than in 2002 and has consumed its net operating loss
carryforwards.
NET INCOME (LOSS). Net income improved by $834,000 (253%) to $504,000
for the three months ended September 30, 2003 as compared to a $330,000 net loss
for the comparable prior year period. The largest contributions to this positive
change were the increases in net sales of XCEL Power Systems, which improved its
operating profits by $282,000, and reduced operating costs at CXR Telcom, which
improved its profits by $252,000.
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 2002
The following table sets forth, for the periods indicated, certain
statement of operations data expressed as a percentage of total net sales:
Nine Months Ended
September 30,
--------------------------------------
2003 2002
----------------- ----------------
Net sales......................................... 100.0% 100.0%
Cost of sales..................................... 59.4 63.3
---------------- ----------------
Gross profit...................................... 40.6 36.7
Selling, general and administrative
expenses........................................ 29.2 34.9
Engineering and product development
expenses........................................ 3.7 4.4
---------------- ----------------
Operating income (loss)........................... 7.7 (2.6)
Interest expense.................................. (1.7) (1.8)
Other income (expense)............................ (0.2)
---------------- ----------------
Income (loss) before income tax expense........... 6.0 (4.6)
Income tax expense................................ 1.2 --
---------------- ----------------
Net income (loss)................................. 4.8 (4.6)%
================ ================
8
NET SALES. Net sales for the nine months ended September 30, 2003
increased by $2,220,000 (13.3%) to $18,922,000 as compared to $16,702,000 for
the nine months ended September 30, 2002.
Net sales of our electronic components for the nine months ended
September 30, 2003 increased by $2,353,000 (23.8%) to $12,251,000 as compared to
$9,899,000 for the nine months ended September 30, 2002. Net sales of power
supplies by XCEL Corporation, Ltd. for the nine months ended September 30, 2003
increased by $2,418,000 (48.3%) to $7,429,000 as compared to $5,011,000 for the
nine months ended September 30, 2002 due to an increase in the number of
products shipped under long-term programs. However, we anticipate that sales of
power supplies in 2004 will decline from 2003 levels based on expected timing of
shipments. Sales of digital switches manufactured by our Digitran Division for
the nine months ended September 30, 2003 increased by $583,000 (16.2%) to
$4,180,000 as compared to $3,597,000 for the nine months ended September 30,
2002. The increase in sales of digital switches was primarily a result of
increases in orders for spare parts that we believe was mainly due to the war in
Iraq. Sales of electronic subsystem assemblies were $266,000 in the current
period as compared to $982,000 in the first nine months of 2002 due to the
completion of a contract in 2002. XET's Digitran Division recently introduced a
new standard rotary switch and a patent pending Very Low Profile(R) rotary
switch that management expects will be additive to switch sales in 2004 and
beyond.
Net sales of our communications equipment products and services for the
nine months ended September 30, 2003 decreased slightly by $132,000 (1.9%) to
$6,671,000 as compared to $6,803,000 for the nine months ended September 30,
2002. The decrease was the result of a $763,000 improvement in sales by CXR-AJ
of network access and transmission equipment products and services, which was
offset by a $895,000 decline in sales of test equipment by CXR-AJ and CXR
Telcom. We decided to terminate the resale of test equipment by CXR-AJ in 2002
and now have only residual sales of these products. Network access and
transmission equipment sales for the nine months ended September 30, 2003
increased by $370,000 (9.1%) to $4,453,000 as compared to $4,083,000 for the
prior year period. Test equipment net sales for the nine months ended September
30, 2003 decreased by $788,000 (33.4%) to $1,571,000 as compared to $2,359,000
for the nine months ended September 30, 2002. The sales decrease resulted from a
reduction in orders from telecommunication customers in the United States, which
we believe was primarily due to the weak telecom market and CXR-AJ's
discontinuation of test equipment resales.
CXR-AJ produces all of our transmission products and network access
equipment. Total net sales by CXR-AJ, including both test equipment and
networking and transmission equipment, increased by $763,000 (18.8%) to
$4,815,000 as compared to $4,052,000 for the nine months ended September 30,
2002. This sales increase was achieved even though we terminated the resale of
test equipment in Europe at the end of 2002 and despite slower sales in 2002
that management believes were caused by the French business slowdown associated
with the French political elections.
Net sales of our CXR HALCYON 704 series field test equipment decreased
by $215,000 (13.8%) to $1,338,000 as compared to $1,553,000 for the nine months
ended September 30, 2002 primarily due to the poor telecom market. The CXR
HALCYON product line experienced a decrease in sales mainly due to the reduction
in the capital expenditures of telecommunications service providers. The service
providers released their capital budgets later in the year and at reduced
levels. We have responded to this industry downturn by reducing costs and
developing a strategy to seek new business in other industries that are not
suffering from the telecommunications downturn, such as utilities, construction
and government.
9
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 and 2003. This has had a negative impact on
CXR Telcom's sales. Although we have seen a recent improvement in orders at CXR
Telcom, we do not know if such improvement will be a continuing trend or only a
temporary change.
GROSS PROFIT. Gross profit as a percentage of total net sales increased
to 40.6% for the nine months ended September 30, 2003 as compared to 36.7% for
the comparable period in 2002. In dollar terms, total gross profit increased by
$1,562,000 (25.5%) to $7,685,000 as compared to $6,123,000 for the nine months
ended September 30, 2002.
Gross profit for our electronic components segment increased in dollar
terms by $1,043,000 (27.3%) to $4,863,000 for the nine months ended September
30, 2003 as compared to $3,820,000 for the nine months ended September 30, 2002,
and increased as a percentage of related net sales to 39.7% for the nine months
ended September 30, 2003 from 38.6% for the nine months ended September 30,
2002. This increase primarily was the result of increases in the profit margins
of both digital switches and power supplies due to changes in product mix for
XET's Digitran Division switch production operations and increased production
due to higher sales volumes lowering per unit costs and product mix for XCEL
Power Systems' U.K. power supply production operations.
Gross profit for our communications equipment segment increased in
dollar terms by $520,000 (22.6%) to $2,823,000 for the nine months ended
September 30, 2003 as compared to $2,303,000 for the comparable period in 2002,
and increased as a percentage of net sales to 42.3% for the nine months ended
September 30, 2003 from 33.8% for the nine months ended September 30, 2002. The
increase in gross profit as a percentage of net sales primarily was due to the
increase in sales due primarily to increased gross margins at both CXR-AJ and
CXR Telcom. CXR-AJ and CXR Telcom increased their gross margins as a percent of
sales to 43.1% and 40.3% from 33.3% and 34.6%, respectively due to cost
reductions and higher sales at CXR-AJ.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses for the nine months ended September 30, 2003 decreased
by $282,000 (4.9%) to $5,532,000 as compared to $5,814,000 for the nine months
ended September 30, 2002. Selling, general and administrative expenses also
decreased as a percentage of total net sales, to 29.2% of net sales during the
nine months ended September 30, 2003 from 34.8% of net sales during the
comparable period in 2002. Selling expenses were reduced by $215,000 in our
communications equipment segment due to lower commissions on lower sales and due
to cost reductions, and administrative costs were reduced by $378,000 in our
communications equipment segment primarily due to staff reductions at CXR Telcom
and CXR-AJ. These reductions were partially offset by a $185,000 increase in
sales and administrative expenses of the electronic components segment due to
support needed for higher sales volumes and a $125,000 increase in corporate
administrative expenses primarily due to increased wage accruals and investment
banker fees for acquisition services.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product
development expenses consist primarily of research and product development
activities of our communications equipment segment and XET's Digitran Division.
These expenses decreased by $42,000 (5.7%) to $697,000 for the nine months ended
September 30, 2003 as compared to $739,000 for the nine months ended September
30, 2002 due primarily to cost reductions in the communication equipment
segment.
10
OTHER INCOME (EXPENSE). Interest expense increased by $14,000 (4.6%) to
$317,000 for the nine months ended September 30, 2003 from $303,000 for the nine
months ended September 30, 2002 generally due to higher average debt balances at
XCEL Power Systems. Other income was $4,000 for the nine months ended September
30, 2003 as compared to other expense of $33,000 for the nine months ended
September 30, 2002 primarily due to foreign currency gains.
INCOME TAX EXPENSE. Income tax expense for the nine months ended
September 30, 2003 was $236,000 as compared to $8,000 for the comparable prior
year period. The majority of the increase related to the recording by XCEL Power
Systems of a provision for U.K. income tax that was required because XCEL Power
Systems is expected to produce greater taxable income for 2003 than in 2002 and
has consumed its net operating loss carryforwards.
NET INCOME (LOSS). The net income for the nine months ended September
30, 2003 was $907,000 as compared to the net loss of $774,000 for the nine
months ended September 30, 2002, an improvement of $1,681,000 or 217%. The
largest contributions to this positive change were the $1,190,000 and $821,000
increases in operating income of CXR-AJ and XCEL Power Systems, respectively,
due to increased sales and reduced costs of CXR-AJ and increased sales by XCEL
Power Systems. We continue to closely monitor costs throughout our operations
and have reduced costs through staffing reductions in our communications
equipment operations in the United States and France and through various other
cost-cutting methods, such as using contract manufacturers, reducing facility
rent expense and phasing out our administrative office in Paris, France. These
actions have substantially reduced the sales volume required to create
profitability at both CXR Telcom and CXR-AJ.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 2003 and the year ended
December 31, 2002, 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 September 30, 2003, we had working
capital of $5,245,000, which represented an increase of $1,284,000 (32.4%) over
working capital of $3,961,000 at December 31, 2002. Also, at September 30, 2003,
we had an accumulated deficit of $18,141,000, an accumulated other comprehensive
loss of $236,000, cash and cash equivalents of $605,000, and $4,923,000 of
accounts receivable. As of December 31, 2002, we had an accumulated deficit of
$19,042,000, an accumulated other comprehensive loss of $597,000, cash and cash
equivalents of $254,000, and $5,356,000 of accounts receivable.
Cash provided by our operating activities totaled $1,058,000 for the
nine months ended September 30, 2003, an improvement of $925,000 (695.5%) as
compared to cash provided by our operating activities of $133,000 for the nine
months ended September 30, 2002. This increase in cash provided by operations
during the nine months ended September 30, 2003 primarily resulted from
generation of net income as compared to our recording of a net loss in the
comparable prior year period, and the reduction of inventory levels, which were
partially offset with reductions in accounts payable
Cash used in our investing activities totaled $17,000 for the nine
months ended September 30, 2003 as compared to $90,000 used in our investing
activities for the nine months ended September 30, 2002. Included in the results
for the nine months ended September 30, 2003 are $42,000 of fixed asset
purchases.
Cash used in our financing activities totaled $1,050,000 for the nine
months ended September 30, 2003 as compared to $688,000 of cash used in our
11
financing activities for the nine months ended September 30, 2002, due to
repayments of bank debt in both the current and prior year periods.
On August 16, 2000, our subsidiaries, CXR Telcom and XET, together with
MicroTel acting as guarantor, obtained a credit facility extension from Wells
Fargo Business Credit, Inc. In April 2002, the maturity date of the facility was
extended by two years to August 16, 2005. Since April 17, 2002, the facility has
provided for a revolving loan of up to $3,000,000 secured by inventory and
accounts receivable and a term loan in the amount of $687,000 secured by
machinery and equipment. On September 30, 2003, the interest rate was the prime
rate (then 4%) plus 1%, subject to a minimum interest charge of $13,500 per
month. The balance outstanding at September 30, 2003 was $917,000 on the
revolving loan and $132,000 on the term loan, and we had available to us $4,000
of additional borrowings under the revolving loan. The credit facility contains
restrictive financial covenants that are set by mutual agreement each year. At
September 30, 2003, we were in compliance with these covenants, which include a
minimum net income covenant and a minimum debt service ratio to be measured
quarterly. The credit facility also contains an annual net worth covenant.
As of September 30, 2003, our foreign subsidiaries had credit
facilities, including lines of credit and term loans, with Venture Finance PLC,
a subsidiary of the global Dutch ABN AMRO Holdings N.V. financial institution,
in England, Banc National de Paris, Banque Hervet and IFN Finance, a subsidiary
of ABN AMRO Holdings, N.V., in France, and Johan Tokyo Credit Bank and Johnan
Shinkin Bank in Japan. At September 30, 2003, the balances outstanding under our
U.K., France and Japan credit facilities were $1,506,000, $852,000 and $76,000,
respectively.
XCEL Japan Ltd. , or XJL, obtained a term loan on November 29, 2002
from the Johnan Shinkin Bank. The loan is amortized over five years and carries
an annual interest rate of 3.25%. The balance of the loan as of September 30,
2003 was $76,000 using the exchange rate in effect at that date for conversion
of Japanese yen into United States dollars.
Our U.K. subsidiary, XCEL Power Systems, obtained a credit facility
with Venture Finance PLC as of November 12, 2002. This credit facility expires
on November 15, 2005. Using the exchange rate in effect at September 30, 2003
for the conversion of British pounds into United States dollars, the facility is
for a maximum of $2,490,000 and includes a $581,000 unsecured cash flow loan, a
$133,000 term loan secured by fixed assets and the remainder is a loan secured
by accounts receivable and inventory. The interest rate is the base rate of
Venture Finance PLC (4% at September 30, 2003) plus 2%, and is subject to a
minimum rate of 4% per annum. There are no financial performance covenants
applicable to this credit facility.
As of September 30, 2003, CXR-AJ had credit facilities with several
lenders with balances totaling up to approximately $852,000 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. Because CXR-AJ has experienced a
substantial reduction in revenue in 2002, some of its lenders have made
reductions in the total available credit. Banque Hervet reduced availability to
$78,000 from $159,000 effective December 31, 2002. On February 10, 2003, Societe
Generale notified CXR-AJ that CXR-AJ had to pay back its credit line balance by
April 30, 2003. Societe Generale agreed to an alternative pay back schedule for
the full balance owed as of March 31, 2003 so that $54,000 was due by May 31,
2003 and another $54,000 was due by June 30, 2003. The overdraft loan from
Societe Generale has been paid off in accordance with the bank's demand.
12
On April 8, 2003, CXR-AJ obtained a credit facility from IFN Finance, a
subsidiary of ABN AMRO Holdings N.V. The new credit line is for a maximum of
$1,398,000, based on the exchange rate in effect at September 30, 2003 for the
conversion of euros into United States dollars. This is an increase over the
total of credit lines that CXR-AJ has with its other banks. The IFN Finance
facility will replace the several smaller credit lines. The IFN Finance facility
is secured by accounts receivable and carries an annual interest rate of 1.6
percentage points above the French "T4M" rate. The French T4M rate was 2.1% as
of August 31, 2003. Funds that become available under the new IFN Finance credit
line as new accounts receivables develop are being used to retire the existing
CXR-AJ debt.
Our backlog was $8,785,000 as of September 30, 2003 as compared to
$13,516,000 as of September 30, 2002. The reduction in backlog was primarily due
to substantial shipments by XCEL Power Systems in the U.K. Our backlog as of
September 30, 2003 was 96.1% 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 3.9% related to our
communications equipment 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 nine months ended September 30, 2003, 64.7% and 35.3% of our
total net sales were generated by our electronic components segment and
communications equipment segment, respectively. We experienced a 1.9% decrease
in our communications equipment segment sales for the nine months ended
September 30, 2003 as compared to the nine months ended September 30, 2002. This
decrease was primarily composed of a 32.5% decline in sales of test equipment.
The test equipment decline was due to our discontinuation of test equipment
resales in Europe and the general telecommunications downturn in the United
States. Based on recent orders received, it appears to our management that the
worst of the telecommunication downturn and its effect on the test equipment
market has passed. However, a further reduction in sales could reduce our total
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 2002. These actions were
intended to reduce the cash outlays of our telecommunications equipment segment
to match its revenue rate. Also, in February 2003, we reduced the staffing level
by 50% at CXR Telcom, which we estimate has reduced costs at an annualized rate
of approximately $360,000. This savings is in addition to the approximate
$325,000 annualized savings we have begun to realize from moving CXR Telcom into
a lower cost facility in November 2002. We also have contracted with Asian
manufacturers for production of test equipment components at lower prices than
we previously paid to our former suppliers and have received shipments of
quality components from these new suppliers.
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. The symbol "P" represents the prime
rate, and the symbol "B" represents the lender's base rate.
13
PAYMENTS DUE BY PERIOD
----------------------
(IN THOUSANDS)
CONTRACTUAL
OBLIGATIONS AT THERE-
SEPTEMBER 30, 2003 2003 2004 2005 2006 2007 AFTER TOTAL
--------------------------- ------- ------- ------- ------- ------- ------- -------
Line of Credit (Domestic) $ 917 $ -- $ -- $ -- $ -- $ -- $ 917
Average Interest Rate P+1%
Line of Credit (U.K.) $ 826 $ -- $ -- $ -- $ -- $ -- $ 826
Average Interest Rate B+2%
Overdraft (France) $ 761 $ -- $ -- $ -- $ -- $ -- $ 761
Average Interest Rate 5.2%-7.2%
Term Loan (Domestic) $ 18 $ 72 $ 42 $ -- $ -- $ -- $ 132
Average Interest Rate P+1%
Term Loan (U.K.) $ 12 $ 46 $ 622 $ -- $ -- $ -- $ 680
Average Interest Rate B+2%
Term Loan (France) $ 24 $ 56 $ 10 $ -- $ -- $ -- $ 90
Average Interest Rate 5.2%-5.6%
Term Loan (Japan) $ 6 $ 18 $ 18 $ 18 $ 16 $ -- $ 76
Average Interest Rate 3.25%
Capitalized Lease
Obligations $ 128 $ 121 $ 35 $ 3 $ -- $ -- $ 287
Operating Leases $ 120 $ 562 $ 382 $ 6 $ -- $ -- $1,070
------- ------- ------- ------- ------- ------- -------
$2,812 $ 875 $1,109 $ 27 $ 16 $ -- $4,839
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.
EFFECTS OF INFLATION
The impact of inflation and changing prices has not been significant on
the financial condition or results of operations of either our company or our
operating subsidiaries.
14
IMPACTS OF NEW ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of
FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and
Technical Corrections." This statement rescinds SFAS No. 4, "Reporting Gains and
Losses from Extinguishment of Debt" and amends SFAS No. 64, "Extinguishments of
Debt Made to Satisfy Sinking Fund Requirements." Under SFAS No. 4, all gains and
losses from extinguishment of debt were required to be aggregated and, if
material, classified as an extraordinary item, net of the related income tax
effect. With the elimination of SFAS No. 4, gains and losses from extinguishment
of debt are to be classified as extraordinary items only if they meet the
criteria for extraordinary items in Accounting Principles Bulletin ("APB")
Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of
Disposal of a Segment of Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions." Applying the provisions of APB Opinion No.
30 will distinguish transactions that are part of an entity's recurring
operations from those that are unusual or infrequent or that meet the
classification of an extraordinary item. SFAS No. 145 also rescinds SFAS No. 44,
"Accounting for Intangible Assets of Motor Carriers," and amends SFAS No. 13,
"Accounting for Leases," to eliminate an inconsistency between the required
accounting for sale-leaseback transactions and the required accounting for
certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. SFAS No. 145 also amends other existing
authoritative pronouncements to make various technical corrections, clarify
meanings or describe their applicability under changed conditions. The adoption
of the provisions of SFAS No. 145 during 2002 did not have any impact on our
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 No. 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. The adoption of this
statement has not had a material effect on our financial statements.
In November 2002, the FASB issued FASB Interpretation No. ("FIN") 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, including
Indirect Guarantees of Indebtedness of Others." FIN 45 requires a guarantor to
recognize a liability, at the inception of the guarantee, for the fair value of
obligations it has undertaken in issuing the guarantee and also include more
detailed disclosures with respect to guarantees. FIN 45 is effective for
guarantees issued or modified after December 31, 2002 and requires the
additional disclosures for interim or annual periods ended after December 15,
2002. The initial recognition and measurement provisions of FIN 45 have not had
an impact on our results of operations or financial position.
In November 2002, the Emerging Issues Task Force ("EITF") reached a
consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables."
EITF Issue No. 00-21 provides guidance on how to account for arrangements that
involve the delivery or performance of multiple products, services and/or rights
to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. We
are currently evaluating the effect that the adoption of EITF Issue No. 00-21
but do not expect a material impact on our consolidated financial position or
results of operations.
15
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure-An Amendment of SFAS 123."
SFAS No. 148 amends SFAS No. 123 to provide alternative methods of transition
for a voluntary change to the fair value based method of accounting for
stock-based employee compensation. In addition, this statement amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. We have chosen to continue to account for stock-based compensation
using the intrinsic value method prescribed in Accounting Principles Bulletin
Opinion No. 25, "Accounting for Stock Issued to Employees" and related
interpretations. Accordingly, compensation expense for stock options is measured
as the excess, if any, of the estimate of the market value of our stock at the
date of the grant over the amount an employee must pay to acquire the stock. We
adopted the annual disclosure provisions of SFAS No. 148 for our financial
reports for the year ended December 31, 2002 and also adopted the interim
disclosure provisions for our financial reports beginning with the quarter ended
March 31, 2003. Because this standard involves disclosures only, the adoption of
SFAS No. 148 did not impact our results of operations, financial position or
liquidity.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities - An Interpretation of ARB No. 51." FIN 46 requires that if an
entity has a controlling financial interest in a variable interest entity, the
assets, liabilities and results of activities of the variable interest entity
should be included in the consolidated financial statements of the entity. FIN
46 requires that its provisions are effective immediately for all arrangements
entered into after January 31, 2003. For arrangements entered into prior to
January 31, 2003, the FIN 46 provisions are required to be adopted at the
beginning of the first interim or annual period beginning after June 15, 2003.
The provisions of FIN 46 have not had have a material impact on our results of
operations or financial position.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." This
statement establishes standards for how an issuer classifies and measures in its
statement of financial position certain financial instruments with
characteristics of both liabilities and equity. In accordance with the standard,
financial instruments that embody obligations for the issuer are required to be
classified as liabilities. SFAS No. 150 is effective for all financial
instruments created or modified after May 31, 2003, and otherwise shall be
effective at the beginning of the first interim period beginning after June 15,
2003. The adoption of SFAS No. 150 is not expected to have a material effect on
our consolidated financial condition or results of operations.
EURO CONVERSION
Our operating subsidiaries located in France and the U.K. had combined
net sales from operations approximating 66.5% and 58.7%, respectively, of our
total net sales for the nine months ended September 30, 2003 and the year ended
December 31, 2002. Net sales from the French subsidiary participating in the
euro conversion were approximately 25.5% and 25.8%, respectively, of our net
sales for the nine months ended September 30, 2003 and the year ended December
31, 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.
16
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. Our annual report on Form 10-K for the year ended December 31,
2002 contains information about our debt obligations that are sensitive to
changes in interest rates under "Item 7A. Quantitative and Qualitative
Disclosures About Market Risk." There were no material changes in those market
risks during the nine months ended September 30, 2003.
ITEM 4. CONTROLS AND PROCEDURES.
Our Chief Executive Officer and Chief Financial Officer (our principal
executive officer and principal financial officer, respectively) have concluded,
based on their evaluation as of September 30, 2003, that the design and
operation of our "disclosure controls and procedures" (as defined in Rule
13a-15(e) under the Securities Exchange Act of 1934, as amended ("Exchange
Act")) are effective to ensure that information required to be disclosed by us
in the reports filed or submitted by us under the Exchange Act is accumulated,
recorded, processed, summarized and reported to our management, including our
Chief Executive Officer and Chief Financial Officer, as appropriate to allow
timely decisions regarding whether or not disclosure is required.
During the quarter ended September 30, 2003, there were no changes in
our "internal controls over financial reporting" (as defined in Rule 13a-15(f)
under the Exchange Act) that have materially affected, or are reasonably likely
to materially affect, our internal controls over financial reporting.
17
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 September 2003, we issued an aggregate of 5,926 shares of common
stock to two investors upon conversion of 52.6 shares of our Series B Preferred
Stock. Exemption from the registration provisions of the Securities Act of 1933
for these transactions described above is claimed under Section 4(2) of the
Securities Act of 1933, among others, on the basis that such transaction did not
involve any public offering and the purchasers were accredited or 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 certificate of designations related to our
Series B Preferred Stock provides that shares of Series B 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 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.
18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
--------
Number Description
------ -----------
31 Certifications Required by Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32 Certification 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.
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MICROTEL INTERNATIONAL, INC.
Dated: November 5, 2003 By: /s/ CARMINE T. OLIVA
--------------------------------------------
Carmine T. Oliva, Chairman of the Board,
President and Chief Executive Officer
(principal executive officer)
By: /s/ RANDOLPH D. FOOTE
--------------------------------------------
Randolph D. Foote, Chief Financial Officer
(principal financial and accounting officer
20
EXHIBITS FILED WITH THIS REPORT ON FORM 10-Q
Number Description
------ -----------
31 Certifications Required by Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as Adopted Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
32 Certification 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
21