UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended October 31, 20072009
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934
Commission file number 0-16231
XETA Technologies, Inc.
(Exact name of registrant as specified in its charter)
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Oklahoma |
| 73-1130045 |
(State or other jurisdiction of |
| (I.R.S. |
incorporation or organization) |
| Identification No.) |
1814 |
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(Address of principal executive offices) |
| (Zip Code) |
918-664-8200
(Registrant’s telephone number, including area code (918) 664-8200code)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value |
(Title of Class) |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No x
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a non-accelerated filer.smaller reporting company. See definition of “large accelerated filer, “accelerated filerfiler” and large accelerated filer”“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer o | |
Non-accelerated filer o | Smaller reporting company x |
Large accelerated filer o Accelerated filer o Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes o No x
The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the Nasdaq closing price on April 28, 2007,30, 2009, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $33,442,994.$16,206,170.
The number of shares outstanding of the registrant’s Common Stock as of December 19, 200718, 2009 was 10,231,646.10,262,430.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement to be filed with the Securities and Exchange Commission in connection with the Annual Meeting of Shareholders to be held April 8, 20086, 2010 are incorporated by reference into Part III, Items 10 through 14 hereof.
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements relating to future events and our future performance and results. Many of these statements appear in the discussions under the headings “Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” All statements other than those that are purely historical may be forward-looking statements. Forward-looking statements can generally be identified by words such as “expects,” “anticipates,” “may”, “plans,” “believes,” “intends,” “projects,” “estimates,” and similar words or expressions. Forward-looking statements are not guarantees of performance, but rather reflect our current expectations, estimates, and forecasts about the industry and markets in which we operate, and our assumptions and beliefs based upon information currently available to us. These statements are subject to risks and uncertainties which are difficult to predict or which we are unable to control, including but not limited to such factors as customer demand for advanced communications products,the condition of the U.S. economy and its impact on capital spending trends withinin our market,markets, the financial condition of our suppliers and changes by them in their distribution strategies and support, technological changes,Nortel’s bankruptcy proceedings, unpredictable revenue levels from quarter to quarter, inconsistent gross profit margins, continuing acceptance and success of the Mitel product mix,and services offering, availability of credit to finance growth, intense competition and industry consolidation, dependence upon a few large wholesale customers in our Managed Services offering, the ability to attractavailability and retain highly skilled personnel, competitionretention of revenue professionals and certified technicians, and other risks and uncertainties specifically discussed under the heading “Risk Factors” under Part I of this report. As a result of these risks and uncertainties, actual results may differ materially and adversely from those expressed in forward-looking statements. Consequently, investors are cautioned to read and consider all forward-looking statements in conjunction with such risk factors and uncertainties. The Private Securities Litigation Reform Act of 1995 provides a safe-harbor for forward-looking statements made by the Company.
PART I
Development and Description of Business
XETA Technologies, Inc. (“XETA”, the “Company”, “we”, “us”, or “our”), an Oklahoma corporation formed in 1981, is a leading providerintegrator of advanced communications technologies with nationwide sales and service. XETA provides sales, design, project management, implementation, and maintenance services in support of the products it represents. The Company sells products produced by several manufacturers including Avaya, Inc. (“Avaya”), Nortel Networks Corporation (“Nortel”), Mitel Corporation (“Mitel”), and Samsung Business Communications Systems (“Samsung”). In addition, the Company manufactures and markets a comprehensive arrayline of proprietary call accounting systems to the hospitality industry.
We market our products and services available from market leaders. Our market focus is on enterprise-class communications solutions and managed services in the emerging, highly-technical worldto a variety of converged communications. We specialize in helping our customers transition from traditional voice telephony to Internet Protocol (“IP”) based telephony, IP-based telephony enables our customers to reduce their total communications costs and more effectively serve their own customers through advanced applicationscompanies such as contact centers, message management systems, and integrated multi-media applications. We provide these solutions and services toenterprise-class multi-location, mid market and large sized enterprisescompanies located throughout the United States. We also market our solutions and services to several vertical markets such as the hospitality, industry, the federaleducation, Federal government, and the healthcare industry. healthcare.
We providedeliver services through our nationwide network of Company-employed design engineers, and service technicians as well as our 24-hour, 7-days-per-week call center locatedand qualified third party service providers. Our service delivery is coordinated in our contact center, which operates 24-hours per day, 7-days-per-week and is located at our headquarters building in Broken Arrow, Oklahoma. Our contact center and national technical footprint are well-suited to address the communication needs of large, multi-location, national, or super-regional customers.
We maintainLarge enterprises often have a combination of manufacturer platforms in their communications equipment portfolios. As such our ability to sell and service three of the industry’s highest certifications asleading communication platforms is an Avaya Platinum National Business Partner, a Nortel Elite Advantage Partner, and a Mitel Premium PARTNER. We distributeimportant competitive advantage. Because of our extensive array of products and services, we enjoy multiple sales opportunities with these customers. These include new equipment installations, implementation of advanced applications, and various service relationships.
An important element of our sales strategy is to continually search for these manufacturers under nationwide, non-exclusive dealer agreements. All three of the manufacturers provide us with important volume incentives and marketing expense reimbursements to carry their products. We purchase their products from large distributors who also provide pricing and volume incentives. We have distributed Avaya products since 1998 and Nortel products since 2004. In October, 2007 we added the Mitel product line to our product mix in response to market demand in the lodging industry. Mitel is a market-leader in voice communications for the lodging industry and, like Avaya and Nortel, has transitioned its product line to server-based systems that work effectively in converged voice and data environments. With the addition of Mitel products, we believe we will be ableopportunities to expand business relationships with current customers. Our sales teams continually monitor and assess our already strong market position incustomer’s communications needs, proposing appropriate technologies to address those needs, establishing or expanding the lodging industry.service relationship, and proposing equipment and service solutions to other divisions or subsidiaries.
Our primary operating strategies in fiscal 2007 were to focus onUnder our target customers, expand our wholesaleswholesale services offerings, and create further alignment with our major business partners. We target our products and services at large enterprises with multiple locations and often with multiple technology platforms. Larger enterprises fit our key market advantages such as nation-wide coverage, 24-hour operations, and ability to support both Avaya and Nortel products, capabilities that most regional and local integrators do not possess. Our wholesale service strategy is based on partneringoffering, we collaborate with manufacturers, network service providers and largesystems integrators (“wholesale customers”) to provide services to their end-user customers. Typically,In many instances, we provide field resources to carry out on-site service activities. Under a full outsourcing arrangement we may provide a broader range of services. These services or specificinclude call center support, remote technical expertisesupport, on-site labor and spare parts. Our wholesale services business initiative has succeeded because we provide excellent service to supplement core services provided by our wholesale customers. Our abilityend-user customers, and are willing to support multiple platforms is also often a key factor in this market as well. Ourcreate and execute flexible service programs and billing arrangements. The continued success in expandingof our wholesale services revenues wasinitiative is a key factor invital component of our long-term goal of shifting our revenue growth in fiscal 2007 and is discussedmix toward more fully below. Finally, we improved our alignment with our major business partners, Avaya and Nortel, in fiscal 2007. This strategy is focused on approaching the market in the manner which best fits each manufacturer. For Avaya, this means partnering with them to sell equipment to the enterprise market and selling their service capabilities and maintenance contracts. For Nortel, this means approaching the market with a regional focus and aligning with Nortel’s regional sales management. To accomplish significant progress toward this initiative, we dedicated senior sales management to each product line and have shaped each sales organization as well as their go-to-market strategies to more closely match their respective product lines.services revenues.
In fiscal 2007,April, 2009, we completedsigned a transitionthree year services collaboration and dealer agreement with Samsung. Under the agreement, our professional services team supports Samsung’s North American channel partners and customers. The Samsung delivery team utilizes a “Center of Excellence” model that encourages knowledge sharing and ongoing review of best practices. The model ensures the highest level of service to dealers and end-users alike.
We strive to align our Company’s sales, marketing, and services programs with those of our manufacturing partners. As the composition of the market evolves in response to Avaya’s acquisition of Nortel, our cogent and well crafted sales plan is of even greater importance. We have developed sales and service programs to assist customers in supporting their existing investments or migrating their portfolios to alternative technologies. Our sales teams will continue to search for market opportunities resulting from the consolidation of Avaya and Nortel. Uncertainties in the market may also result in acceleration in our executive management ranks. In June, our previous Chief Executive Officer (“CEO”), Jack Ingram, stepped down and Greg Forrest, previously our President and Chief Operating Officer, was named CEO. Additionally, we separatedacquisitions particularly in the roles of Chairman of the Board of Directors and CEO and named Don Duke, a long-time director of the Company, as non-executive Chairman.Nortel partner community.
We sell communications solutions to the general commercial market, federalschool districts, the Federal government, and to the healthcare market. These solutions are aimed at maximizingdesigned to maximize the effectiveness of our customers’ communications systems through the use of advanced technologies. By deploying advanced communications technologies such as IP-based telephony. Through the use of these systems,and consolidating voice and data traffic on a common infrastructure our customers can reduce their total communications costs by establishing their voice communications as an application on their data networks and can increase
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the productivity of their employeescosts. In addition, through the use of other voiceintegrated applications that integrate with their data networks. Such applications include message management systems that integrate voicemail and fax messages with existing email systems, speech recognition systems, and multimediathey can also improve employee productivity. With the adoption of IP telephony by most enterprise level customers, new, advanced applications such as streaming audioUnified Communications systems and collaboration software are widely available. These advanced applications combine voice, voice mail, presence, instant messaging, and video systems. applications and seamlessly integrates them on the desktop with other data applications such as MS Outlook™.
We sell these systems under dealer agreements with Avaya, Nortel and Nortel. Both of theseMitel. These manufacturers have significant installed bases in the communications equipment market and are migrating their customers from traditional telephony systems to new IP-basedserver based platforms. WeTo support our sales efforts we receive incentive payments from boththe manufacturers whichto offset certain product costs, training expenses, and certainspecific sales and marketing expenses. We purchase theseAvaya and Nortel products through major distributors and receive additional price incentives from these distributors. These incentive payments are material to our business. We purchase Mitel systems directly from Mitel to receive additional discounts. We sell data networking products to the commercial market under non-exclusive dealer agreements with Avaya, Nortel, Samsung, Juniper Systems, Cisco Systems Inc., and Hewlett-Packard Company.
Sales of systems to commercial customers were $23.8 million in fiscal 2007 compared to $22.5 million and $21.4 million in 2006 and 2005, respectively. These sales represented 34%, 37%, and 37% of total revenues during fiscal years 2007, 2006, and 2005, respectively.
Communications Systems. We sell communications systems to the hospitality industry through nationwide, non-exclusive dealer agreements with Avaya, Nortel, and Mitel. In addition to most of the features available on the commercial systems, above, the systems sold to hospitality customers are equipped withinclude hospitality-specific software, which integrates with nearly all aspects of the hotel’sproperty’s operations. We also offer a variety of related products such as voice mail systems, analog telephones, uninterruptible power supplies, announcement systems, and others, most of which also have hospitality-specific software features. MostThe majority of these additional products are sold in conjunction with the sale of new communications systems and, with the exception of voice mailvoicemail systems, are purchased from regional and national suppliers. All of our sales of communications systems in fiscal 2007 were either Avaya or Nortel products. We expect Mitel product sales to begin in our second quarter of fiscal 2008 and to become material to our hospitality revenues in fiscal 2009.
Call Accounting Products. We marketsell a line of proprietary call accounting products under the Virtual XLÒ® and Virtual XL.2™XL.2™ product names. Introduced in 1998, the VXL“VXL” series is a PC-based system designed to operate on a hotel’sproperty’s local or wide area network. If that network is connected to the Internet, the VXL can also be accessed via an Internet connection. The original VXL was upgraded to a rack-mounted, server-style system in 2004 and is marketed under the name Virtual XL.2™XL.2™ (“VXL”). The VXL systems are our latest technology in a series of call accounting products we have successfully marketed since the Company’s inception. Many of those earlier products remain in operation at customer locations and are under maintenance contracts with us or generate time and materialstime-and-materials (“T&M”) revenues for us.revenues. These revenues and the related gross profits are material to our business.
Sales of communications systems and products to the hospitality industry represented 13%, 10%, and 11% of total revenues in fiscal 2009, 2008 and 2007, 2006 and 2005.respectively. Marriott International, Host Marriott, and other Marriott-affiliated companies (“Marriott”) represent a single customer relationship for our Company and are a major customercontributor to our hospitality business.revenues. Revenues earned from sales of hospitality systems sold to Marriott represented 32%20%, 21%, and 52%32% of our sales of hospitality systems in fiscal 2007, 2006,2009, 2008, and 2005,2007, respectively.
Services
Services revenue is our largest revenue stream. Due to itsBecause a majority of these revenues are recurring nature and produce generally higher profitability,margins, this portion of our business is of vital importance to our operating results. Our services product offeringofferings includes nation-wide customer service, project management, professional services, installation, consulting, and structured cabling implmentation to support our customers.implementation. The geographic reach and technical breadth of our services organization are key differentiators between us and our competitors.
Our services organization includes our National Service Center (“NSC”) housedlocated at our headquarters in Broken Arrow, Oklahoma. The NSC supports our commercial and hospitality customers who have purchased maintenance contracts on their systems, as well as other customers who engage us on a T&Mhourly time-and-material or per occurrence basis. We employ a network of highly trained technicians who are strategically located in major metropolitan areas and can be dispatched by the NSC to support our customers in the fieldcustomer locations or to install new systems. We also employ design and implementation engineers, (which we referreferred to as our Professional Services Organization or “PSO”(“PSO”), to design voice, data, and converged networkssolutions to meet specific customer applications.requirements. Much of the work done by the PSO representsis pre-sales workdesign and is often not recovered in revenues, representingrevenues. While this activity represents a
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significant investment. Weinvestment, we believe however, that by hiring the most qualified personnel possible and keeping their talents in-house,to provide these services we create a competitive advantage in the marketplace.advantage.
To our non-hospitality end-users of Nortel equipment, we sell our own maintenance contracts. Additionally, we aggressively market our Nortel services capabilities to existing and potential wholesale customers. By providing national coverage at competitive hourly rates, the NSC is a valuable resource to wholesale customers by providing geographic coverage or technical capabilities to service their customers directly. Our largest wholesale customer opportunities are with the Regional Bell Operating Companies (“RBOCs”). RBOCs are the largest Nortel dealers in the U.S. and as such have large installed bases of customers with Nortel systems. Under a wholesale customer agreement, the RBOCs use the NSC to service customers out of the RBOCs’ regional service area and/or handle overflow work during peak periods. Another significant wholesale customer is Nortel itself. Nortel has maintenance contracts with many large, “Fortune 1000”-type customers. Nortel out-sources much of the on-site service work for these customers to its authorized service providers, including us.4
For Avaya products sold to non-hospitality customers, we sell Avaya’s post-warranty maintenance contracts, for which we earn a commission. These commissions are recorded as other revenues in our financial statements.
For Avaya, Nortel, and Mitel communications systems sold to hospitality customers, we sell our ownXETA maintenance agreements.contracts. For our proprietary products, we offer post-warranty service contracts to our hospitality customers under one-year and multi-year service contracts. The revenues earned from the sale of our maintenance contracts are an important part of our business model as they provide a predictable stream of profitable recurring revenue. We earn a significant portion of our recurring servicerepair and maintenance services revenues from hospitality customers who maintain service contracts on their systems.
To our non-hospitality end-users of Nortel equipment, we sell XETA maintenance contracts. Additionally, we aggressively market our services capabilities to existing and potential wholesale customers. Our largest wholesale customer is Nortel. Nortel has maintenance contracts with many “Fortune 1000” customers and outsources much of the on-site service work to authorized service providers, such as XETA.
For Avaya products sold to non-hospitality customers, we sell Avaya’s post-warranty maintenance contracts, for which we earn a commission. These commissions are recorded as “Other Revenues” in our financial statements and are material to our gross profits and net income.
For our distributed products, we typically pass on the manufacturer’s limited warranty, which is generally one year in length. Labor costs associated with fulfilling the warranty requirements are generally borne by us. For our proprietary call accounting products sold to the hospitality industry, we provide our customers with a limited one-year warranty covering parts and labor.labor warranty.
Services revenues represented 53%, 50%, and 49% of total revenues for fiscal years 2007, 2006 and 2005, respectively. Marriott is a significant customer and services revenues earned from Marriott represented 13%, 15%, and 15% of total services revenues in fiscal years 2007, 2006, and 2005, respectively.
We market our products and services primarily through our direct sales force to a wide variety of customers including large national companies, mid-size companies, hospitality industry, education market, Federal government, agencies, and the hospitalityhealthcare industry.
Because the technology we sell is now typically an application running on an existing data network, the focus of our marketing efforts has had to adjust toward data networking decision makers, many of whom are at the executive level of their organization. These executives may have long-standing relationships with their data products and services dealers. Furthermore, because most customers are making the decision
In addition to convert their traditional voice networksmarketing directly to IP-based platforms for the first time, the decisionend-users, we also have a significant sales and marketing effort dedicated to do so is often considered riskierour wholesale services. This area of our business has experienced significant growth in recent years and is therefore being made at higher levels within the organization. As a result,key contributor to our increase in services revenues. Under these offerings we have also adjusted our marketing effortspartner with manufacturers, network services companies, and systems integrators to provide assurancesa variety of technical services to customers thatour partners’ end-user customers. We make considerable investments in sales and technical resources to create relationships with current and potential wholesale partners. Once those relationships are established, we jointly market our capabilities with our partners to end-users who have requested bids for new services or are capable of designing and implementing these new systems effectively.renewing existing contracts.
We hold specific events to support our direct marketing to customers. Additionally, a significantAnother important aspect of our marketing effort centers on our relationships with Avaya and Nortel.our manufacturers. As a national dealer, for both manufacturers, we have certain technical and geographical capabilities that help differentiate us in the marketplace. Wemarketplace and we aggressively market these capabilities to Avaya, Nortel, and Nortel. BothMitel. The manufacturers utilize us in a variety of ways, from fulfilling certain customer orders to handling entire customer relationships. We have carefully positioned ourselves as a leading dealer for both manufacturers by achieving the highest level of certification with each manufacturer, building our in-house engineering capabilities, providing nationwide implementation services, and through access to our 24-hour, 7 days-per-week service center.
Our marketing efforts to the hospitality industry rely heavily on our experience and reputation in that industry. Over the course of serving this market for more than 2528 years, we have built strong long-term relationships with a wide range of personnel (corporate hotel chain personnel, property management officials, industry consultants, hotel owners, and on-site financial and/or operating officers) that are the key decision makers responsible for the purchase of hotel communications technology. We have relationships with nearly all hotel chains and major hospitality property management companies. These relationships are key to our past and future success andWe target our hospitality marketing efforts are targeted at strengthening and deepening those relationships rather thanthese relationships. The addition of the more broad promotional efforts sometimes employed inMitel product line has also allowed us to expand our marketing effortsalready leading market position by providing us an opportunity to talk with hospitality industry buying channels that have previously standardized on the commercial sector.Mitel product line and were not previously potential customers for us. It has also given us the opportunity to approach existing customers about additional hotel segments that require a lower price point communications server.
Backlog
At December 1, 2007 our backlog of orders for systems sales was $12.7 million compared to $2.6 million at the same time last year. Approximately $10 million of this backlog is from a single customer. Based on current installation schedules, we expect the revenue from this customer’s orders to be recognized as revenue ratably over fiscal 2008. We expect the remainder of our backlog to also ship and be recognized as revenue by October 31, 2008, with the majority of these orders being shipped in the first half of the year. However, our customers frequently change their installation plans which can significantly disrupt the timing of our revenue recognition. Therefore no assurance can be given that our current expectations will be realized regarding the full recognition of revenues currently in our backlog. Additionally, we currently have approximately $21 million in contracted maintenance revenues which we expect to recognize over the next fiscal year. Most of the contracts are cancelable upon thirty days notice by the customer or us.
Commercial. The market for Commercial communications systems, applications and services is rapidly evolving at a rapid pace due to the convergence of voice and data networks and the speed at which new applications are being introduced. Our market has always been highly competitive, as both Avaya and Nortel have extensive dealer organizations, including the Regional Bell Operating Companies, nationwide dealers likesimilar to us, and smaller regionally-focusedregional dealers. In addition to other Avaya and Nortel dealers, we also face competition from dealers of other largecommunications’ technology manufacturers such as Cisco Systems, Inc., Siemens Aktiengesellschaft, Alcatel S.A.ShorTel, Inc., and NEC Corporation, as well as from a number of other companies, some of which focus on particular segments of the market such as call centers or message management.Corporation. With the addition of data products dealers, particularly Cisco dealers, the competition has been heightened.increased. Many of our new competitors have long-standing relationships with the information technologyInformation Technology (“IT”) decision makers of our customers, increasing the fiercenessferocity of the competition.
Hospitality. , We face similar competitive pressures in our hospitality business to those discussed above under “Commercial” competition.in our hospitality business. However, since the hospitality market is a small niche market, we believe our most effective competitive strengthsadvantages are the performance and reliability of our proprietary hospitalitycall accounting systems and our high level of service commitment to this niche market. Despite these strengths, we expect to experience a period of testing as we begin distributing the Mitel product line to the hospitality industry, including to long-term customers. In all previous new product line introductions, customers have required us to prove our capabilities in installing and maintaining the product prior to releasing significant orders to us. We expect this period of proving to last most of fiscal 2008 with material Mitel orders beginning late in the year or in fiscal 2009. While we are confident that we will successfully establish ourselves as a Mitel dealer and that our reputation and nationwide presence will continue to contribute significantly to our success in the hospitality market, there can be no assurance given that we will be able to continue to expand our market share in the future.
Manufacturing
We assemble the Virtual XL™® and Virtual XL.2™XL.2™ systems, our proprietary call accounting systems, which are sold exclusively to the hospitality industry. The sale of these systems comprise less than 1% of our total revenues. We assemble these systems from an inventory of components, parts and sub-assemblies obtained from various suppliers. These components are purchased from a variety of regional and national distributors at prices that fluctuate based on demand and volumes purchased. Some components, although widely distributed, are manufactured by a single, usually foreign, source and are therefore subject to shortages and price fluctuations if manufacturing is interrupted. We maintain adequate inventories of components to mitigate short-term shortages and believe the ultimate risk of long-term shortages is minimal.
We use outside contractors to assemble our proprietary printed circuit boards that are part of our proprietary call accounting systems. The components and blank circuit boards are purchased, inventoried, and supplied to the outside contractors for assembly and quality-control testing. We perform various quality-control procedures, including powering up completed systems and allowing them to “burn in” before being assembled into a final unit for a specific customer location, and performing final testing prior to shipment.
All of the other products we sell are purchased as finished goods from the manufacturers’ distributors.
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Employees
We employed 364372 and 309361 employees at December 1, 20072009 and 2006,2008, respectively.
We own registered United States trademarks on the following names for use in the marketing of our hospitality services and systems: “XETA,” “XPERT,” “XL,” and “Virtual XL,” and “XTRAMILE”XL”. All of these trademarks are registered on the principal register of the United States Patent and Trademark Office.
Our business and prospects are subject to many risks and uncertainties. The following items are representative of the risks, uncertainties and assumptions that could affect our business, our future performance and the outcome of our forward-looking statements.
Nortel’s Chapter 11 Bankruptcy filing and subsequent sale of its enterprise solution business to Avaya may negatively impact our revenues and/or financial condition.
Nortel filed a voluntary petition for Chapter 11 bankruptcy protection on January 14, 2009. To date Nortel has not filed its plan of reorganization. In the forward-looking statementsmeantime the administrators of the bankruptcy have adopted a business disposal strategy, pursuant to which they have sold the Nortel enterprise solution business (“NES”) to Avaya. All of the foregoing developments pose a variety of risks to our business, as follows:
·Throughout fiscal 2009 uncertainty surrounding Nortel’s bankruptcy significantly dampened demand for equipment in this product line. Until Nortel files it plan of reorganization, this uncertainty is likely to continue. Nortel has until February 1, 2010 to file its plan of reorganization unless such date is further extended by the court. Although Avaya’s acquisition of Nortel’s enterprise division may help to reduce the uncertainly in the market over the course of fiscal 2010, in the near term we make.anticipate continued weakness in demand for Nortel equipment.
·We are owed approximately $700,000 in pre-petition accounts receivable less approximately $116,000 in approved offsets for amounts we owed to Nortel at the time of the filing. If our pre-petition claims are not collectible either in whole or in large part, we could experience material, negative operating results in the near term.
·Nortel has filed a statement of financial affairs under which it shows payments to the Company against multiple invoices of approximately $1.6 million which were made during the 90-day statutory “preference period” under bankruptcy law. As such, these payments are considered “preference payments” and are subject to a “preference claim” which can be asserted by Nortel. Bankruptcy law allows the debtor to recover these payments unless the creditor successfully establishes that the payments were made in the ordinary course of business between the debtor and creditor. If Nortel elects to assert a preference claim against the Company for this amount or any portion thereof and the Company is unable to successfully defend the claim, the Company would have to return any such amounts to Nortel.
·Avaya’s purchase of NES—which is one of our major suppliers, is an important customer, and whose product line represents a significant portion of our business—may result in a significant disruption and/or material decline in our revenues and gross profits. Avaya and NES are large, complex companies with global operations. They have had very different marketing strategies and both have long, deep cultural traditions. The integration of these two companies will be challenging and disruptive to the market. There can be no assurance given that the combination of Avaya and NES will not have near-term and/or long-term material, negative impact on our operating results, financial position, market position, and overall reputation.
Our business is affected by capital spending. Economic conditions and the continued difficulty for our customers to access affordable credit may inhibit capital spending over the next twelve months and beyond.
The U.S. economy is still struggling to emerge from a severe recessionary contraction. Despite efforts by the Federal Government to stabilize the banking and financial systems, credit availability remains limited for nearly all enterprises. Hence the outlook for corporate capital investment is uncertain. These factors contribute to a high degree of uncertainty concerning capital spending. Because our business relies on capital spending for technology and equipment, we may continue to experience declining demand for our products. This could have a material, negative impact on our operating results and financial condition.
We may experience higher than normal bad debt losses as a result of economic conditions and may experience lower revenues as a result of limiting our extension of credit to customers.
The recent economic downturn and tight credit markets have resulted in some of our customers experiencing difficulty in paying their obligations to us, particularly obligations related to the purchase of new systems. While we monitor credit reports and payment histories carefully, we cannot eliminate all of the risks associated with the extension of credit. As a result, we may experience higher rates of bad debt in the near future and we may also experience lower revenues as a result of tightening our credit standards.
Our revenue for a particular period is difficult to predict, and a shortfall in revenue can harm our operating results.
Our systems sales, implementation, cabling, and other revenues for a particular quarter are difficult to predict. Our total revenues may decline or grow at a slower rate than in past periods. We have experienced periods during which shipments have exceeded net bookings, or manufacturing issues have delayed shipments, resulting in erratic revenues. The timing of orders, primarily in our systems sales, can also impact our quarter to quarter business and operating results. As a result, our operating results could vary materially from quarter to quarter based on the receipt of orders, and the ultimate recognition of revenue. We set our operating expenses based primarily on forecasted revenues. An unexpected shortfall in revenues could lead to lower than expected operating results if we are unable to quickly reduce these fixed expenses in response to short-term business changes. Any of these factors could have a material adverse impact on our operations and financial results.
The lack of available credit beyond our current credit facility may impair our ability to fully execute our acquisition growth strategies.
Our growth strategy includes the acquisition of businesses that either increase our market share in traditional voice or converged communications systems or expand our competencies and presence in advanced technologies such as Unified Communications and collaboration applications. The economic downturn, the cost of entry into these new communications applications businesses, and the acquisition of NES by Avaya has increased the number of potential acquisition opportunities for us. However, because of the continued uncertainty in the credit markets and the lack of credit available through traditional lending institutions, it may be difficult for us to finance the acquisition opportunities available with senior debt. Despite our strong cash flows and low debt, our ability to secure senior debt financing is subject to the same limitations and costs affecting the market as a whole. There is no assurance that alternative sources of capital will be sufficient to pursue all the acquisition opportunities considered in the best interest of the Company. As a result we may be unable to pursue certain reasonably priced, synergistic opportunities.
The value of our product and services offerings to the hospitality market is declining and our repair and maintenance revenues associated with this line of business are under significant pressure.
Increasing use of cell phones by guests has caused a rapid decline in hotels’ revenues and gross profits earned from long distance and other telephone-related fees. This development has severely reduced the importance of PBX and call accounting systems in hotels. Additionally, many of the new voice applications have limited value in the hospitality market. As a result, there is not be successfula compelling financial reason or guest-driven need to replace existing equipment. The primary uses of guest room phones are to access hotel amenities such as the front desk or room service or to call other guests. Additionally, guest room phones are necessary to satisfy laws mandating access to 911 services in all guest rooms. Manufacturers who enjoy a significant share of the installed base of systems in the hospitality market are in competition with startup firms to develop low cost, shared, network dial tone that will meet the needs of hotel properties at prices that will produce a sufficient return on their investment. While we are carefully monitoring these developments, there is no assurance that hotels spending on PBX and call accounting systems and associated maintenance services will not drop dramatically resulting in a material, negative impact on our operating results.
Success in our overall strategy, a key component of which is to focus on the marketing of advanced communications products and applications and related services.services, may be difficult or even prevented by a variety of factors.
Our operating results may be adversely affected if we are not ableExpansion of our net profit margins and increasing our shareholders’ return on investment over the long term is highly dependent upon our ability to successfully position ourselves asbecome a leader in the sale, implementation, and ongoing maintenance of advanced communications. Because of their sophistication and complex integration with both network and desktop software applications, including Microsoft Office products such as Outlook, these new advanced communications technologies.products are expected to earn higher margins than our current products. To be successful,succeed in these dynamic markets, we must continue to: train our sales employees on the capabilities and technical specifications of these new technologies; train our services employeestechnicians to servicesupport these new products and applications; develop relationships with new types of qualified service providers to supplement our internal capabilities; and develop new relationships with different disciplines, and at higher management levels, within our customers’ organizations.
Additionally, because many of these technologies are still in the early stages of their development,market acceptance, we cannot predict whether: (i) the demand for advanced communications products, applications, and services, including IP telephony systems and UC, will grow as fast as we anticipate;anticipated; (ii) other new technologies may cause the market to evolve in a manner different than we expect; or (iii) technologies developed by manufacturers that we do not represent may become more accepted oras the standard in our industry.industry standard.
Our significant investment of resources into the launch of our Mitel product and services offering may not produce satisfactory results.8
Beginning in the first quarter of fiscal 2008, we are training our technical workforce, our PSO organization, and our hospitality sales team to design, sell, install and maintain Mitel products. These investments may not produce the revenues and gross profits that we expect.
If we incur delays in our anticipated installation schedule, significant installation challenges, product performance issues, or weather-related catastrophes, our expected revenues and gross profits in fiscal 2008 from the sale of equipment and installation services to the Miami-Dade County Public School (“MDCPS”) system could be materially less than expected.
In November, 2007, we announced the award of a series of orders from MDCPS totaling in excess of $10 million to provide and install communications equipment. The equipment for ten of the schools was shipped prior to the end of fiscal 2007 to support initial installations. We expect the remaining revenues and gross profits to be recognized in fiscal 2008 based on current installation schedules. However, we may experience delays in the installation schedule due to circumstances out of our control as we are reliant on MDCPS personnel to assist us in coordinating each installation. Furthermore, we could experience delays or a halt in installations due to a variety of other factors including catastrophic weather conditions such as hurricanes which are prone to the Miami area. Additionally, unexpected technical installation challenges or product performance issues could occur, also resulting in delays in the recognition of revenues or erosion of gross profits from these orders.
7
Finally, we cannot predict the impact of economic conditions on the adoption of these technologies. We believe that most customers will likely limit their capital investments to those with anticipated paybacks of one year or less until it is clearer that an economic recovery is underway and competitive pressures begin to drive technology decision-making again. While UC and other collaboration-oriented voice applications are predicted to enhance user productivity and improve the security of certain intra-company communications, the return rate on these investments is yet unproven, therefore customers may choose to delay investment.
We may experience severe declines in our services revenues from the loss of a major wholesale services customer.
Our wholesale services revenues are generated from a few large customers who contract with us to provide a variety of services for specific end-user customers. Typically, the end-user customer is a large corporation as well. Our experience to date in these arrangements indicates that we may experience severe reductions in service revenues in the event that either the end-user or our customer selects a different service provider or changes their operating strategy regarding the delivery of these services. The loss of one of our wholesale managed service customers could have a sudden, material, adverse effect on our operating results.
Avaya was recently acquired by private investors who may materially alter Avaya’s strategies, includinghas announced a significant change in their vendorpricing structure and incentive programs, which might be detrimental tomay affect our operating results.
Avaya has been acquired by a consortium of private equity firmsrecently announced significant changes in its pricing structure and is no longer a public company. Avaya’s goals, focusincentive programs. According to Avaya these changes, which are being made to simplify its pricing structure and strategies may change materially aseliminate the new owners’ influence on Avaya’s operations increases. The changes could be detrimentalneed to our own strategiesrequest special discounts and goals and could negatively impact our short-term and or long-term operating results.
Additionally, Avaya has historically provided various financialadminister complex incentive programs, should be neutral to support increasing the market share, promotion, and sale of its products. The sumprofit margins. Our initial review of these changes contradicts Avaya’s statements regarding the neutrality of these changes on our profit margins. As a large business partner of Avaya we receive substantial discounts off of list price and the payments we receive under Avaya’s various incentive amountsprograms are material to our operating results. Typically,We are continuing to evaluate these changes which are scheduled to take effect on February 1, 2010. Avaya announcesmay make additional adjustments to the announced changes before that date and/or may delay the implementation of some or all of the changes as it continues to these programs at least annually,receive feedback from its business partners. At this time, no assurance can be given that the pricing and in some years thoseincentive program changes eventually implemented by Avaya will not have had a negativematerial, adverse impact on the incentive payments we have received. It is possible that as a result of strategic decisions by Avaya’s new owners, future changes could be more frequent and more adverse to our business model and, therefore, we may experience difficulty in maintaining the level of incentive payments which we have enjoyed in prior years.operating results.
The financial conditionAvaya’s strategies regarding the provision of Nortel is uncertainequipment and actions they may takeservices to their customers are changing and could hurthave a material impact on our operating results.
In recent years, Nortel has endured severe financial difficulties, made significant senior managementAvaya is repositioning itself as a hardware and software manufacturer providing a wide range of voice communications hardware and applications to its customers. As part of this strategy, Avaya is segmenting its hardware maintenance and software support. The new software support offerings include technical support for specific voice applications and upgrade services to ensure customers can access all software patches and upgrades. Currently, we earn revenues from some of our customers, particularly hospitality customers, to provide the products and services now being included by Avaya in its new software support offerings. These changes and restated its financial results numerous times. Recent developments indicate that these financial and accounting difficulties may be subsiding. However, substantial litigation and government investigations continue to be unresolved and it is possible that unfavorable outcomes or settlements of these matters might require Nortel to take actions that could be detrimental tohave a material, negative impact on our operating results if our revenues or financial condition.
Microsoft Corporation has announced it is entering the unified communications market, which could resultmargins are reduced in significant disruptionresponse to the current communications market landscape.
Microsoft Corporation (“Micrsosoft”) has announced several new products that will compete directly with existing Avaya and Nortel applications. Microsoft represents a significant entrant into the converged communications market and may cause a significant disruption to our strategy of aligning our efforts with current market leaders Avaya and Nortel. The timing and quality of our reaction to Microsoft’s entrance into the market, the quality of these new products, and the market acceptance of these products will dictate the potential positive or negative impact to us.mandated changes by Avaya.
We are faced withface intense competition fueled by rapid changes in the technologies and markets in which we operate.
The market for our products and services is highly competitive and subject to rapidly changing technologies. As the industry evolves and new technologies and products are introduced, into the marketplace, new participants enter the market and existing competitors seeksearch for ways to strengthen their positions and expand their product/service offerings. There has beenis a developing trend toward industry consolidation, which can lead tocould result in the creation of stronger competitors who may be better able to compete as a sole-source vendor for customers. While we believe that through our transformation and expansion during the last few years, we are well-positionedwell positioned to compete effectively in the marketplace,marketplace; our failure to maintain or enhance this position could adversely affect our business and results of operations.
Revenues and gross profits earned by hotels from guest calls continue to decline, which may result in hotels canceling their call accounting maintenance agreements with us.
Increasing use of cell phones by guests has caused a rapid decline in hotels’ revenues and gross profits earned from long distance and other telephone-related fees. This development has severely reduced the importance of call accounting systems in hotels. As a result, we have experienced some erosion in our base of maintenance contracts as customers cancelled their call accounting maintenance contracts with us. In fiscal 2007 we earned $3.0 million in revenues associated with these maintenance contracts compared with $3.7 in fiscal 2006. The additional loss of or reduction in these revenues could materially and negatively impact our operating results.
The success of our business depends significantly uponon our ability to retainrecruit and recruitretain highly skilled personnel.
Our ability to attract, train, motivate and retain highly skilled and qualified technical and sales personnel is critical to our success. Competition for such employees in the rapidly changing communications industry is fierce. As we have transformed our company into an integratedintegrator of advanced communications solutions provider, we have invested heavily in the hiring and training of personnel to sell and service our portfolio of products and services. If we are unable to retain our skilled employees or to hire additional qualified personnel aswhen needed, it could adversely impact our ability to implement our strategies efficiently and effectively.strategies.
The technology we sell is highly complex and changes rapidly, increasing our reliance upon the manufacturers for technical assistance and increasing the risk that our inventories on hand will become obsolete.
The communications equipment we sell is highly complex and requires significant technical resources to design, install, and maintain. This complexity may require us to rely heavily upon the manufacturers’ technical staff to support the installation and maintenance of communications systems. This reliance may result in lower services revenue or lower profit margins earned on our services revenue. In addition to their complexity, the systems are evolving rapidly as product enhancements are introduced by the manufacturers. These rapid changes present risks that our inventory on hand will become obsolete, resulting in the need to reduce sales margins to sell the equipment or in direct write-offs in the value of the equipment. Any of these results would be detrimental to our profitability.
Our business is directly affected by capital spending trends in the United States and, in particular, market conditions for communications and networking equipment and services.
The direction and relative strength of the U.S. economy has recently been increasingly uncertain due to softness in the housing market, rising oil prices, and continuing geopolitical uncertainties. Because our business is directly affected by capital spending on technology equipment in the U.S., our business would be directly and negatively impacted if these concerns continue to grow to the point that large enterprises begin curtailing their capital spending,.
The loss of either our Elite designation or Platinum Level statushighest level dealer certifications with Nortel and Avaya, respectively,any of our manufacturers could negatively impact our ability to differentiate our products and services in the market.market and could negatively impact our operating results.
BothWe hold the highest level of dealer certifications with Avaya, Nortel, and Avaya have different status levels for their business partnersMitel. These certifications are based on technical and sales capabilities and purchasing volumes. Currently, we hold the highest level of status with each manufacturer.volumes and are reviewed annually. We emphasize the fact that we are one of the few providers in our market to have the highest statuscertification level with each manufacturer and we believe that this is a significant differentiator with some customers.customers who have two or more of the manufacturers’ products in their installed base. Additionally, as a result of these certifications we receive enhanced manufacturer incentive payments which are material to our operating results. While we expect to be able to maintain the technical capabilities, sales skill sets, and purchasing volumes to maintainsecure our statuses,certifications, a downgrade in our status with either manufacturer or both could have a material impact on our reputation in the market which in turn couldand negatively impact our operating results.
The introduction of new products could result in reduced revenues, reduced gross margins, reduced customer satisfaction, and longer collection periods.
We are sellingsell a variety of new, highly complex products that incorporate leading-edge technology, including both hardware and software. The earlysoftware technology. Early versions of these products, which we are selling currently, can contain software defects or “bugs” and other defects that can cause the products to not function as intended. We will be dependent upon Avaya and Nortelour suppliers of these technologies to fix these problems as they occur. Anproblem. The inability of the manufacturer to quickly correct these problems quickly could result in damage to our reputation, reduced revenues, reduced customer satisfaction, delays in payments from customers for products purchased, and potential liabilities.
Compliance with new corporate governance and accounting regulations may require a material increase in our operating expenses beginning in fiscal 2008.2010.
We are required to comply with a host of new government-mandated corporate governance and accounting regulations, the most significant of which is section 404 of the Sarbanes-Oxley Act of 2002. Under the current guidelines issued by the Securities and Exchange Commission, our managementauditors must attest on our report on internal controls over financial reporting must be complete by our fiscal year ended October 31, 2008 and our auditor’s attestation report on internal control over financial reporting will be initially required for our fiscalbeginning in the year ended October 31, 2010. We believe, based onIn addition, the Financial Accounting Standards Board (“FASB”) has issued new guidance providedaccounting standards related to small public companies from the Public Companies Accounting Oversight Boardfair value and discussions withbusiness combination accounting. These rules require significantly different accounting treatment for some items that are common in business combinations and as such, our external auditors and consultants in this field that expenditures required to comply with these regulations will notfinancial results could be material to our overall operating results. However, since we have not completed our work in this area and will not complete it until the end of the fiscal year, we cannot provide assurance that significant unexpected costs might be incurred which could materially impact our operating results.different for future acquisitions.
A significant portion of our expected growth in services revenues is dependent upon our relationship with a few wholesale customers.
Much of the current growth in our services businessrevenue is coming from Nortel and Verizon as they usea few wholesale service customers using us as a subcontractor to service many of their high profile end-user customers. While weWe believe our relationship with these companies is strong future changesand our performance ratings have been excellent. However, our experience is that end-users’ decisions to maintain their service agreements with our wholesale service customers depends on factors which are beyond our control. Therefore we can provide no assurance that we will not experience sudden declines in Nortel personnel, negative service events,our maintenance and competitive factors could jeopardize this revenue stream.repair services revenues due to the loss of large contracts by our wholesale customers.
9
Hitachi’s decision to cease manufacturing communications systems for the hospitality market has caused some uncertainty with respect to our future relationship with our Hitachi installed base of hospitality customers.
Hitachi, once one of the leading suppliers of traditional PBX systems to the hospitality market, ceased selling systems forto this market in March 2005. We have many long-time hospitality customers with significant portfolios of Hitachi systems in their hotels. Weproperties. In addition, we have several hundred Hitachi systems under service contracts producinggenerating recurring contract revenues and gross profits for our business.profits. Over the next sevenfour to eightsix years, allmost of these customers will have to transition their communications systems to new platforms, presentingplatforms. The transition presents a risk to us that another vendor may be selected to install and service their communications systems. Our entry intoIn response we have added the Mitel product line is in part a responseto mitigate the impact to our operating results due to Hitachi’s exit offrom the hospitality market.
While Hitachi’s exit from the market created some uncertainty in our relationship with existing customers, we believe our relationship with our Hitachi customers is strong. Consequently, we believe that in most instances we will be in a favorable position to supply a new system to our customers when they decide to replace their Hitachi system. Additionally, during the third quarter of fiscal 2006 we acquired the remaining assets and liabilities of Hitachi’s U.S. hospitality market. Included in the acquired assets acquired was a substantial supplyinventory of new and refurbished inventory that enablesparts and equipment enabling us to serve our Hitachi customers. Despite these mitigating factors, no assurance can be given that Hitachi’s exit from this market will not negatively impact our financial results in the future.
We are connecting our products to our customers’customer’s computer networks and problemsintegrating these products to other customer-owned software applications such as the Microsoft Office Suite. In most cases, we are integrating our products to mission-critical networks and systems such as contact centers owned by the customer. Problems with the implementation of these products could cause operational disruption, toloss of revenues and gross profits for our customers’ entire operations.customers.
Unlike traditional stand-alone voice systems, our new IP-based products and advanced voice applications are typically are connected to our customers’ existing local and wide area networks. While we believe the risk of our products disrupting other traffic or operations onaffecting performance of these networks is low, such problems could occur, whichoccur. Such an event could cause significant disruption to our customers’ operations. Theseoperations, including loss of revenue, or the inability to access critical services such as 911 emergency services. In turn, these disruptions in turn, could result in reduced customer satisfaction, delays in payments from customers for products and services purchased, damage to our reputation, and potential liabilities.
We expect our gross margins to vary over time.
Our gross margins are impactedaffected by a variety of factors, including changes in customer and product mix, increased price competition, changes in vendor incentive programs, and changes in shipment volume. We expect these factors to cause our gross margins to be inconsistent as we makein quarter-to-quarter and year-to-year comparisons.
If our dealer agreements with the original equipment manufacturers are terminated prematurely or unexpectedly, our business could be adversely affected.
We sell communications systems under dealer agreements with various manufacturers such as Avaya, Nortel, and Mitel. We are a major dealer for Avayamany manufacturers and Nortel andwe consider our relationship with boththem to be good. Nevertheless, if our strategic relationship with our manufacturers were to be terminated prematurely or unexpectedly, our operating results would be adversely impacted. Furthermore, these agreements require that we meet certain volume commitments to earn the pricing structureincentives provided in the dealer agreements. Failure to meet these requirements could causehave material adverse consequences toon our gross margins and overall operating results.
We are dependent upon a few suppliers.
Our growth and ability to meet customer demand depends in part on our capability to obtain timely deliveries of products from suppliers. All of our manufacturersBoth Avaya and Nortel utilize a two-tier distribution model in whichwhereby a few third-party companies (super distributors) distribute their products to their respective dealer communities. In the case of one such distributor, they distribute both Avaya and Nortel products. The limited amount of distribution available for each of these product lines increases our risk of interruptions in the supply of products in the future.these products.
We might have to record a significantmay incur additional goodwill impairment loss in the event our business was to suffer a severe decline.and other asset impairments.
Under SFAS No. 142, “GoodwillOur business has been, and Other Intangible Assets”,may continue to be, materially adversely affected by macro-economic conditions. During the fiscal year we are required to evaluatehave experienced a significant decline in revenues in our commercial equipment reporting unit and a sustained decline in our market capitalization. After completing the fair valueannual impairment test, management determined that goodwill associated with our commercial equipment sales reporting unit was impaired. As such we recorded an impairment charge of each$14.8 million in fiscal year 2009. We could experience further deterioration in this area of our reporting units annually to determine if the fair value is less than the carrying valuebusiness or other areas of those reporting units. If we determine that is the case, then anour business, which might result in additional impairment loss will be recorded inof our statementremaining goodwill balances. Additional impairment charges could have a material adverse effect on our financial condition and results of operations. The determinationSee Part II Item 7 of fair value is a highly subjective exercisethis report “Application of Critical Accounting Policies, Goodwill and can produce significantly different results based on the assumptions usedother Long-Lived Assets” for additional information regarding our goodwill and methodologies employed. It is likely that if our financial results were to decline substantially and if macroeconomic conditions eroded, we would have to record a non-cashother asset impairment loss in our statement of operations.charges.
If our business grows significantly over the next three years, the successful completion of our Oracle implementation project will be critical to our ability to effectively and efficiently operate our business in the future; implementation of the system will significantly increase our amortization expense.
As XETA approaches the threshold of $100 million in revenues, timely and accurate business information will be increasingly important. Implementing our business plan and monitoring progress depends on the efficient accumulation and distribution and analysis of business intelligence. We have been working on a major upgrade to our technology infrastructure and information systems to consolidate our mission-critical legacy systems from four to one. From fiscal 2001 through fiscal 2006 we purposely imposed constraints on capital spending and slowed the development of this system and the consolidation.. Furthermore, at current revenue and transaction levels, conversion to this new system is not essential to our near-term success. However, we have proceeded with the project while our revenues are at lower levels, in anticipation of future growth, which will require upgraded and consolidated infrastructure. While we are taking great care to properly plan this implementation and to fully test the solution prior to the conversion, we cannot guarantee that the conversion will not disrupt our operations. We recognized $619,000 and $429,000 in amortization expense in fiscal 2007 and 2006, respectively reflecting the fact that certain functions of the system were available and used in our business operations. When fully implemented we estimate that the annual amortization expense will increase to $1.2 million. Although a non-cash charge, this expense will have a material, negative impact on our operating results.
If industry consolidation continues, it may become more difficult to compete in our market.
Recently there has been significant merger and acquisition activity in our industry which has created larger and stronger competitors. If consolidation continues, XETA may become one of the smaller national dealers of the products and services we sell. This could negatively impact our ability to market our services to national customers.
Our stock price may continue to be volatile.
Historically, our stock is not widely followed by investment analysts and is subject to price and trading volume volatility. This volatility is sometimes tied to overall market conditions and may or may not reflect our financial performance. It is likely that this volatility will continue.
Our business is subject to the risks of tornadoes and other natural catastrophic events and to interruptions caused by man-made problems such as computer viruses or terrorism.
Our corporate headquarters and NSC are located in northeastern Oklahoma, a region known as “tornado alley”. The region is also frequently the victim of significant ice storms. A significant natural disaster, such as a tornado or prolonged ice storm could have a material adverse impact on our business, operating results, and financial condition. In addition, despite our implementation of network security measures, our servers are vulnerable to computer viruses, hacking, and similar disruptions from unauthorized tampering of our computer systems. Any such event could also cause a similar material adverse impact. In addition, acts of war or terrorism could have a material adverse impact on our business, operating results and financial condition. The continued threat of terrorism and associated security and military response, or any future acts of terrorism may further disrupt ourthe national economy and create furtheradditional uncertainties. To the extent that such disruptions or uncertainties might result in delays or cancellations of customer orders, or impact the assembly or shipment of our products, our business, operating results and financial condition could be materially and adversely affected.
We may be subject to infringement claims and litigation, which could cause us to incur significant expenses or prevent us from selling certain products and services.
Third parties, including customers, may assert claims or initiate legal action against our manufacturers, suppliers, customers or us, alleging that the products we sell infringe on another’s proprietary rights. Regardless of merit, such claims can be time-consuming, expensive, and/or require us to enter into costly license agreements. In some instances, a successful claim could prevent us from selling a particular product or service. We have not conducted patent searches on the third party-products we distribute to independently determine if they infringe upon another’son another party’s proprietary rights; norrights. Nor would it be practical or cost-effective for us to do so. Rather, we rely on infringement indemnities provided by the equipment manufacturers. However, because these indemnities are not absolute and in some instances have limits of coverage, no assurance can be given that in the event of a claim our indemnification by the equipment manufacturer will be adequate to hold us harmless, or that we are entitled to indemnification by the equipment manufacturer.
11
If any infringement or other intellectual property claim is brought against us, and succeeds, whether it is based uponon a third-party manufacturer’sthird-party’s equipment that we distribute or uponon our own proprietary products, our business, operating results and financial condition could be materially and adversely affected.
We are subject to a variety of other general risks and uncertainties inherent in doing business.
In addition to the specific factors discussed above, we are subject to risks that are inherent to doing business.Thesebusiness. These include growth rates, general economic and political conditions, customer satisfaction with the quality of our services, costs of obtaining insurance, unexpected death of key employees, changes in employment laws and regulations, changes in tax laws and regulations, and other events that can impact revenues and the cost of doing business.
Not Applicable.
Our principal executive offices and the NSC are located in a 37,000 square foot, Company-owned, single story building located on a 13-acre tract of land in a suburban business park near Tulsa, Oklahoma. This facility also houses a warehouse and assembly area. TheAt October, 31, 2009 the building is located on a 13-acre tract of landwas subject to a mortgage held by Bank of Oklahoma, NA to secure ourNA. In November 2009, the Company retired the mortgage and entered into a credit facility.facility with a new banking institution.
We have additional leased facilities located near St. Louis, Missouri. In addition to our primary warehouse and shipping operation, this facility houses sales staff, technical design, professional services and installation support personnel. Our Seattle branch office is located in leasedWe lease office space for branch offices in Bellevue, Washington, a suburb of Seattle. This facility housesWashington; Richardson, Texas; and Southborough, Massachusetts. These facilities primarily house sales and technical personnel.
We also lease other office space throughout the U.S. for sales, consulting, and technical staff and have informal office arrangements with our regional technicians to allow for storage of spare parts inventory.staff.
ITEM 3. LEGAL PROCEEDINGS
None.On November 10, 2009, the Company was named as an additional defendant in a lawsuit originally filed on March 16, 2009 by Pangaia Partners against two of Pangaia’s former employees who subsequently went to work for the Company. The lawsuit was filed in Superior Court of New Jersey Law Division, Bergen County. Pangaia’s claims against the Company are made in relation to a Nortel account to which the employee defendants were assigned when they worked for Pangaia and which they now service as employees of the Company. Pangaia’s claims against the Company and the individual defendants include unfair competition, tortuous interference with prospective economic advantage, tortuous interference with contract, misappropriation of trade secrets, conversion and unjust enrichment. In its original claim against its former employees, Pangaia sought but was denied a preliminary injunction to enforce non-competition agreements. Pangaia now seeks monetary damages against all defendants, but has not alleged a specific dollar amount. A preliminary investigation indicates the claims are without merit and the Company expects to mount a vigorous defense.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Market Information
Our common stock is traded on the Nasdaq Global Market under the symbol “XETA.” The following table sets forth, for the periods indicated, the high and low sales prices of our common stock as reported on the Nasdaq National Market.
|
| 2007 |
| 2006 |
| ||||||||
Quarter Ended: |
| High |
| Low |
| High |
| Low |
| ||||
January 31 |
| $ | 4.00 |
| $ | 2.76 |
| $ | 2.57 |
| $ | 2.15 |
|
April 30 |
| $ | 3.80 |
| $ | 2.79 |
| $ | 2.61 |
| $ | 1.86 |
|
July 31 |
| $ | 3.78 |
| $ | 2.99 |
| $ | 2.75 |
| $ | 2.20 |
|
October 31 |
| $ | 4.00 |
| $ | 2.64 |
| $ | 3.35 |
| $ | 2.01 |
|
Dividends
|
| 2009 |
| 2008 |
| ||||||||
Quarter Ended: |
| High |
| Low |
| High |
| Low |
| ||||
January 31 |
| $ | 2.21 |
| $ | 1.25 |
| $ | 4.89 |
| $ | 3.70 |
|
April 30 |
| $ | 2.05 |
| $ | 1.06 |
| $ | 4.59 |
| $ | 3.03 |
|
July 31 |
| $ | 3.00 |
| $ | 1.66 |
| $ | 4.12 |
| $ | 2.90 |
|
October 31 |
| $ | 2.98 |
| $ | 2.05 |
| $ | 3.50 |
| $ | 1.19 |
|
We have never paid cash dividends on our Common Stock. Payment of cash dividends is dependent upon our earnings, capital requirements, overall financial condition and other factors deemed relevant by the Board of Directors. Currently, we are prohibited by our credit facility from paying cash dividends.
In October 2008 the Board of Directors approved a stock repurchase program in which up to $1,000,000 could be used to repurchase our Common Stock in open market. The timing and amount of any repurchases is based on various factors, including general market conditions, the market price of our Common Stock, Company-imposed black-out periods during which the Company and its insiders are prohibited from trading in XETA common stock and management’s assessment of our financial position and liquidity. The program can be modified, suspended, extended or terminated by the Company at any time without prior notice. The program does not have an expiration date. Since the inception of the program, we have repurchased a total of 30,796 shares of our common stock for a total cash investment of $58,157. There was no repurchase activity for the fourth quarter of fiscal 2009.
12
Holders of Stock
As of December 11, 2007,January 4, 2010, there were approximately 167 shareholders of record. Since many of the Company’s shareholders hold their shares in “street name,” meaning that their shares are held in the name of their brokerage firms for the account of the individual shareholder, we estimate the actual number of shareholders to be at least over 3,000.
Securities Authorized for Issuance under Equity Compensation Plans2,000.
EQUITY COMPENSATION PLAN INFORMATION
Plan Category |
| Number of securities to be |
| Weighted-average |
| Number of securities |
|
| Number of securities to be |
| Weighted-average |
| Number of securities |
| ||
|
| (a) |
| (b) |
| (c) |
| |||||||||
Equity compensation plans approved by security holders |
| 658,568 |
| $ | 6.50 |
| 1,518,406 | (1) |
| 677,099 |
| $ | 5.81 |
| 2,290,243 | (1) |
Equity compensation plans not approved by security holders |
| 580,000 | (2) | $ | 5.81 |
| 0 |
|
| 450,000 | (2) | $ | 6.75 |
| 0 |
|
Total |
| 1,238,567 |
| $ | 6.18 |
| 529,433 |
|
| 1,127,099 |
| $ | 6.18 |
| 2,290,243 |
|
(1)Includes 1,252,1732,252,109 and 266,23338,134 shares available under the 2004 Plan and 2000 Plan, respectively. The 2004 Plan includes an evergreen feature in which 3% of the total outstanding shares are added to the total shares available for issuance. The evergreen feature does not apply to incentive stock options. Consequently, there are 389,656530,000 and 266,23338,134 shares available to be issued as incentive stock options under the 2004 Plan and 2000 Plan, respectively.
(2)All of these options were granted as part of an initial compensation package to an officer upon his hiring. These options vested over three years, and are exercisable until June 16, 2009.
Stock Performance Graph
The following graph shows the Company’s stock prices as an index assuming $100 invested on November 1, 2002 along with the composite prices of companies listed in the SIC Code (Telephone, Telegraph Apparatus) Index and the Nasdaq Market Index.February 28, 2013.
|
| 2002 |
| 2003 |
| 2004 |
| 2005 |
| 2006 |
| 2007 |
|
XETA TECHNOLOGIES, INC. |
| 100.00 |
| 532.71 |
| 335.51 |
| 220.56 |
| 313.08 |
| 368.22 |
|
NASDAQ MARKET INDEX |
| 100.00 |
| 145.24 |
| 148.44 |
| 159.81 |
| 179.95 |
| 217.22 |
|
SIC CODE INDEX |
| 100.00 |
| 198.60 |
| 239.78 |
| 247.74 |
| 249.39 |
| 320.10 |
|
13
ITEM 6. SELECTED FINANCIAL DATA
For the Year Ended October 31, |
| 2007 |
| 2006 |
| 2005 |
| 2004 |
| 2003 |
| |||||
|
| (Amounts in thousands, except per share data) |
| |||||||||||||
Results of Operations |
|
|
|
|
|
|
|
|
|
|
| |||||
Systems sales |
| $ | 31,846 |
| $ | 29,249 |
| $ | 27,943 |
| $ | 31,341 |
| $ | 27,550 |
|
Services |
| 37,297 |
| 29,894 |
| 28,241 |
| 26,493 |
| 23,339 |
| |||||
Other revenues |
| 950 |
| 822 |
| 1,819 |
| 993 |
| 1,792 |
| |||||
Net Sales and Services Revenues |
| 70,093 |
| 59,965 |
| 58,003 |
| 58,827 |
| 52,681 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Cost of systems sales |
| 24,216 |
| 22,162 |
| 20,978 |
| 23,914 |
| 19,622 |
| |||||
Services costs |
| 25,877 |
| 21,645 |
| 20,008 |
| 19,120 |
| 16,548 |
| |||||
Cost of other revenues and corporate COGS |
| 1,792 |
| 1,424 |
| 2,073 |
| 1,530 |
| 2,193 |
| |||||
Total Cost of Sales |
| 51,885 |
| 45,231 |
| 43,059 |
| 44,564 |
| 38,363 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Gross Profit |
| 18,208 |
| 14,734 |
| 14,944 |
| 14,263 |
| 14,318 |
| |||||
Operating expenses |
| 15,791 |
| 13,398 |
| 14,186 |
| 11,652 |
| 11,210 |
| |||||
Income from operations |
| 2,417 |
| 1,336 |
| 758 |
| 2,611 |
| 3,108 |
| |||||
Interest and other income (expense) |
| (44 | ) | (128 | ) | 57 |
| 32 |
| (545 | ) | |||||
Income before taxes |
| 2,373 |
| 1,208 |
| 815 |
| 2,643 |
| 2,563 |
| |||||
Provision for taxes |
| 941 |
| 490 |
| 321 |
| 1,035 |
| 1,005 |
| |||||
Net Income |
| $ | 1,432 |
| $ | 718 |
| $ | 494 |
| $ | 1,608 |
| $ | 1,558 |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Earnings per share – Basic |
| $ | 0.14 |
| $ | 0.07 |
| $ | 0.05 |
| $ | 0.16 |
| $ | 0.16 |
|
Earnings per share – Diluted |
| $ | 0.14 |
| $ | 0.07 |
| $ | 0.05 |
| $ | 0.16 |
| $ | 0.16 |
|
Weighted Average Common Shares Outstanding |
| 10,215 |
| 10,180 |
| 10,087 |
| 10,009 |
| 9,828 |
| |||||
Weighted Average Common Share Equivalents |
| 10,215 |
| 10,210 |
| 10,117 |
| 10,157 |
| 9,999 |
| |||||
As of October 31, |
| 2007 |
| 2006 |
| 2005 |
| 2004 |
| 2003 |
| |||||
Balance Sheet Data: |
|
|
|
|
|
|
|
|
|
|
| |||||
Working capital |
| $ | 8,502 |
| $ | 6,311 |
| $ | 4,668 |
| $ | 4,465 |
| $ | 4,204 |
|
Total assets |
| 60,096 |
| 55,913 |
| 56,207 |
| 53,556 |
| 50,673 |
| |||||
Long term debt, less current portion |
| 1,355 |
| 1,526 |
| 1,697 |
| 2,820 |
| 4,030 |
| |||||
Shareholders’ equity |
| 39,439 |
| 37,885 |
| 37,098 |
| 36,304 |
| 34,611 |
| |||||
14
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
In fiscal 2007,2009 we recorded a net loss of $10.3 million. This loss included $17.8 million in impairment charges to goodwill and our operating results improved significantly over the prior year due primarilyERP system. Net of these non-cash charges our after-tax net income would have been $506,000 on revenues of $71.6 million compared to increased revenues and improved services gross margins. We achieved these results by successfully executing our strategies to focus on our target customers, increase our services revenues, and align our sales efforts with our manufacturers’ go-to-market strategies. To increase services revenues we expanded our wholesale services offering through by penetrating existing accounts and developing new relationships. Both elements proved successful in fiscal 2007. Our wholesale service strategy is based on partnering with manufacturers, network service providers, and large integrators (“wholesale customers”) to provide services to their end-user customers. Typically, we provide field services or specific technical expertise to supplement core services to the end-user provided by our wholesale customers. Our ability to support multiple manufacturer platforms is also often a key consideration in this market. Our success in expanding our wholesale services revenues was an important contributor to our revenue growth in fiscal 2007. This is discussed more fully below. In fiscal 2007 we also improved our alignment with Avaya and Nortel, our major business partners. Our business strategy emphasized approaching the market in a manner that best capitalized on each manufacturer’s portfolio of products and services. For Avaya, this meant partnering with them to sell equipment to the enterprise market and selling their service capabilities and maintenance contracts. For Nortel, this meant approaching the market with a regional focus and aligning our sales efforts with Nortel’s regional sales management. Additionally, we assigned senior sales management to each product line to maximize progress on these initiatives.
We plan to build on our successes$2.1 million in fiscal 2008 by continuing to focus on the above strategies, particularly our wholesale services strategy. We are targeting a mix of revenues of approximately 66% services revenues$84.3 million. These declines primarily reflect two factors: difficult macro-economic conditions which depressed capital spending, and 33% systems sales. We expect to achieve this targetuncertainty concerning the Nortel product line created by Nortel’s bankruptcy filing in the next three to five fiscal years. Traditionally, our revenue mix has been approximately 50%/50%. By increasing the mix of recurring, higher gross margin services revenues to a greater proportion of total revenues; we will improve the predictability of our results and increase our blended gross margins. Also in fiscal 2008, we expect slower growth in our operating expenses as we increase administrative efficiencies. We believe our efforts will produce continued improvement in both revenues and profitability in fiscal 2008.January 2009.
In November 2007,response to the difficult market conditions experienced throughout fiscal 2009, management developed and executed a cost reduction plan designed to aggressively reduce costs while preserving the key resources necessary to fully realize growth opportunities as the market recovers. Underlying the plan was management’s belief that the challenging economic environment will present growth opportunities in our service business as customers choose to maintain rather than replace their existing communication systems. In addition we announcedanticipate customers in all segments will give stronger consideration to outsourcing the support of their communications networks to reduce costs. To support these trends, management focused cost reduction on elements of our operations that we had been awardedwould not affect our ability to meet the needs of our customers in these areas.
Increasing our recurring revenues through both direct and wholesale services offerings is one of our key strategies. We continue to invest in this area of our business and expect improved growth rates in fiscal 2010 based on three factors: a series of orders from Miami-Dade County Public Schools (“MDCPS”) to sell and install new communications systems at certain schoolsmodest economic recovery will likely create a more favorable overall marketplace; disruption in the MDCPS district.market created by Avaya’s acquisition of Nortel should create opportunities to increase our base of Nortel repair and maintenance revenues; and the growing trend of end users to outsource additional elements of their communications services should create growth opportunities to provide managed services to new customers.
Macro-economic conditions negatively impacted our commercial systems business beginning in the first quarter of fiscal 2009. Those conditions worsened significantly in the third fiscal quarter. Also, uncertainty regarding the ultimate disposition of the Nortel product line grew as Nortel began divesting its assets, including assets which are strategic to the Company’s operations. Finally, the Company’s sustained decline in market capitalization continued, reflecting market uncertainty regarding the value of the Company’s operations. This combination of factors prompted the Company to conduct an interim test for impairment as of July 31, 2009. The Company engaged a consultant to assist in the valuation of the commercial systems sales and services reporting units. The Company used a combination of evaluations to estimate the fair value of its reporting units, including the following: a) an income approach by which forecasted future cash flows are discounted to present value; b) a market approach by which comparable companies values are compared to the applicable reporting unit’s values; and c) a market approach by which the Company’s own market capitalization is applied to the applicable reporting unit. Based on current installation schedules, we expect to recognize mostthe results of this revenuework, the Company determined that the carrying value of the commercial systems sales reporting unit was impaired, and the services reporting unit was not impaired. The Company recorded an impairment charge of $11 million against its commercial systems sales reporting unit as an initial estimate at the end of the third quarter. The Company completed its evaluation of the fair value of this reporting unit including performing the step II analysis required by ASC 350 during the fourth quarter and increased the total goodwill impairment charge to $14.8 million.
Also, in the third quarter of fiscal 2008. As such, these orders should have2009, management determined that its Oracle Enterprise Resource Planning (“ERP”) system and the related investment were over-adequate for its current and near-term operating needs. The ERP system was originally purchased in 2001 during a material positive impact on our fiscal 2008 results (see comments regardingperiod of hyper-growth and the risks associated with these orders under “Risk Factors” above). DueCompany expected to be significantly larger within three-to-five years. Those growth expectations did not materialize. Furthermore, the economic downturn presented another setback to the magnitudeCompany’s growth. As a result, management determined that it was likely the investment in the ERP system would not be realized within a reasonable time frame and was therefore impaired. At the time of these orders, the proportionimpairment charge, the net book value of equipment revenuesCompany’s ERP system was $6.5 million. The Company used various outside sources and its current vendor to services revenues,estimate the cost of a replacement ERP system adequate for the Company’s current and near-term operating needs. This research yielded an estimated replacement cost of $3.5 million. As a result of this finding an impairment charge of $3.0 million was recorded in the relatively compressed installation schedule,third fiscal quarter of the mix of our revenues in fiscal 2008 may not reflect our targeted long-term mix.year.
The discussion that follows provides more details regarding the factors and trends that affected our financial results, liquidity, and capital resources in fiscal 20072009 when compared to the previous year.
FISCAL YEAR 20072009 COMPARED TO FISCAL YEAR 2006.2008.
Net revenuesRevenues for fiscal 20072009 were $70.1$71.6 million compared to $59.9$84.3 million in fiscal 2006,2008, a 17% increase. Net income15% decrease. The net loss for fiscal 20072009 was $1,432,000$10.3 million compared to $718,000net income of $2.1 million in fiscal 2006.2008. Discussed below are the major revenue, gross margin, and operating expense items that affected our financial results during fiscal 2007.2009.
Services Revenues. Revenues earned from our services business were $37.3$41.1 million in fiscal 20072009 compared to $29.9$43.5 million in fiscal 2006,2008, a 25% increase.6% decrease. This growthdecline reflects continued successa 1% or $228,000 decrease in all three major services revenue streams including our recurring services,maintenance and repair revenues, a 15% or $1.6 million decrease in implementation services,revenues, and our nationala 17% or $538,000 decrease in structured cabling business.revenues.
RecurringThe decreases in our maintenance and repair services business, which consists ofincludes revenues earned from maintenance contracts and time and materialstime-and-materials (“T&M”) based charges, increased $4.0 million or 18%consisted of relatively flat contract maintenance revenues and a decrease in T&M revenues of 5%. We believe the decline in T&M revenues was primarily influenced by general economic conditions as customers reduced spending on non-critical services. Contract revenues in fiscal 2007 compared to last year, primarily reflecting our success2009 were lower than expected because of several contract losses and a reduction in the expansionsize of ourone major wholesale services initiative. Revenues from our wholesaleprogram. These reductions offset program wins with other customers. In each case, the loss of revenues was due to divestures of assets or strategic changes by end-users that moved the services programs are in the form of contract maintenance fees and/to other vendors. We did not experience a significant program loss or time charges for services provided. Some accounts provide additional revenues from minimum monthly charges. A key aspectreduction due to our success with these programs has been our flexibility in structuring the service delivery model to meet the unique needs or demands of our customers’ end users. We believe that expansion of these
15
revenues represents a critical success factor for us in the future as we seek to increase the mix of these recurring revenues as a percentage of our overall revenues.quality.
Our implementationefforts to increase services revenues were $8.2 millioncenter on our wholesale services offerings. Under these offerings we partner with manufacturers, network services companies, and systems integrators to provide a variety of technical services to our partners’ end-user customers. We have invested heavily in sales and technical resources to create relationships with current and potential wholesale partners. Once those relationships are established, we jointly market our capabilities with our partners to end-users who have requested bids for new services or are renewing existing contracts. The wholesale services segment is a highly competitive market and end-users because of their size and prominence can demand both favorable pricing and high service levels. In most cases, our service performance is measured monthly, quarterly and/or annually by our partner. To date, our service ratings have been excellent. However, our experience indicates that end-users expect excellent service ratings, and pricing drives most purchase decisions. As a result, we have limited influence in contract negotiations between our wholesale partners and end-users. This is a key difference between the direct and wholesale services offerings. As we experienced in fiscal 2007, an increase2009, growth in our wholesale services business will likely be choppy and include large contract wins that are partially offset by the occasional loss of $2.6 million or 47% compared to the prior year. a large wholesale services contract.
The growthdecrease in our implementation revenues was a key factor in our success in fiscal 2007 as higher levels2009 reflects the difficult comparison to fiscal 2008 which provided over $3 million in implementation revenues associated with the Miami-Dade County Public School’s (“M-DCPS”) orders. The rate of decline in these revenues resulted in better absorptionwas lower than the corresponding rate of the significant fixed cost structure in this portion of our services organization. The 47% growth rate is significantly greater than our growthdecline in systems sales, traditionally the historicalprimary driver of these revenues. The additionalWe attribute this to increasing demand for more complex communications systems requiring significant fee-generating design and engineering services provided by our Professional Services Organization (“PSO”). In the near term Implementation revenues will continue to closely align with the sale of new systems. From a long term perspective, however, as customers displace conventional communications platforms and adopt more complex systems, we anticipate growth came from several large installation and professional services contracts sold separately from systems sales. Additionally, the proportionin this area of installation and professional services fees continues to increase in comparison to the total project price as the complexity of the applications we sell increases. Allour business through fee-based utilization of these increased revenues improved our utilization of our resources and contributed to the overall increase in our services gross profits which are discussed below.highly skilled technical resources.
Our structured cabling revenues grew 40% to $2.6 milliondecreased 17% in fiscal 2007 compared2009. This decline is a difficult comparison to our structured cabling revenues in fiscal 2006. The increase in2008 due to the significant contribution to these revenues isby the result of our continued success in establishing a national structured cabling business that markets our cabling services to existing and new customers. With this product and service offering, we are better able to compete for projects where structured cabling is wrapped into an overall communications infrastructure purchase. We are also able to compete for stand-alone structured cabling business often associated with new construction.M-DCPS orders.
Systems Sales. Sales of systems were $31.9$30.1 million in fiscal 20072009 compared to $29.2$38.9 million in fiscal 2006,2008, a 9% increase.23% decrease. Sales of systems to commercial customers were $23.8$21.1 million in fiscal 2007,2009, a 6%30% decrease compared to fiscal 2008. Sales of systems to hospitality customers were $9.0 million in fiscal 2009, a 5% increase compared to fiscal 2006. the prior year.
The increasedecrease in sales of systems to commercial customers is primarily attributable to the resultcompletion of the M-DCPS contract which produced $1.7 million in equipment revenues during fiscal 2009 compared to $9.4 million during fiscal 2008. Additionally, macro-economic conditions and uncertainty around the Nortel bankruptcy dampened capital spending on technology.
The increased sales of systems to hospitality customers in fiscal 2009 reflects our continued success ofin this relatively mature niche market despite considerable economic challenges in the hospitality segment. In addition, our success confirms successful execution on our strategy to focusexpand into the Mitel product offering. Mitel has provided us with the opportunity to work with hotel chains and property management companies that have previously standardized on our manufacturers’ lines of business, particularly the NortelMitel product line. As discussed above, we have receivedMitel provides us the opportunity to approach existing customers about opportunities in other hospitality segments requiring a series of orders from MDCPS to sell and install over $10 million of Avaya communications systems to the school district. About 75% of the value of each of these orders will be recognized as systems sales and if current shipping schedules hold, we expect this revenue to be recognizedlower price point.
Other Revenues. Other revenues were $396,000 in fiscal 2008. Sales of systems2009 compared to Hospitality customers were $8.0$1.9 million in fiscal 2007, an 18% increase compared to the prior year. This increase reflects our strong market position in the growing hospitality market and the acceptance of our Nortel product line to hospitality customers. While we expect to continue to have success in this market, we expect our growth rates in fiscal 2008 to be lower than this year.
Other revenues were $951,000 in fiscal 2007 compared to $822,000 in fiscal 2006.2008. Other revenues consist of commissions earned on the sale of Avaya maintenance contracts and sales of equipment and/or services made outside of our normal provisioning processes. The increasedecrease in other revenues is attributable to an increasea decrease in the sales of Avaya post-warranty maintenance contracts. Under our dealer agreement with Avaya, we are incentivized to market their maintenance contracts to the Avaya customer base. We are paid a commission on these contracts based on the size and length of the contract and the underlying equipment covered under the agreement.
We expected a decline in this segment as we benefited throughout 2008 when many customers accelerated their purchases or renewals of Avaya service contracts in anticipation of manufacturer-driven changes in the structure of these service programs. This is an unpredictable revenue stream that depends on the expiration dates of existing contracts, installation dates of new systems, the customer type as defined by Avaya, and the number of years that customers contract for services. While no assurance can be given, we expect sales of Avaya service contracts to return to pre-fiscal 2008 levels. Sales of products provisioned outside of our normal processes generally reflects sales of phone sets to hospitality customers in which we earn a small, flat, per-phone profit on the transaction. Other revenues also include restocking fees earned on canceled orders.
Gross Margins. Gross margins were 26.0%27.2% in fiscal 20072009 compared to 24.6%26.4% in fiscal 2006.2008.
The gross margins earned on Servicesservices revenues were 30.6%31.1% in fiscal 20072009 compared to 27.6%28.3% in fiscal 2006. This increase reflects improvements in gross2008. Gross margins earned on recurringServices revenues reflect mixed results between improved margins earned on maintenance and repair services and implementation revenues, whilestructured cabling, which were offset by lower margins on implementations.
As a result of improved cost controls, revised procedures, and reduced headcounts, we earned higher gross margins on our maintenance and repair and structured cabling services revenues. Implementation gross margins were impacted by the significant decline in revenues were relatively flat compared to last year. The margins on recurring services improved slightly due to better utilization of our care center and field services personnel, lower materials costs and improved utilization of qualified third party service providers. The profitability of implementation and professional services was the largest contributorrelated to the significant increaseM-DCPS contract. However cost reductions and on-boarding the new Samsung service program dampened the impact of lower revenues in overallthis area. Similar to the Samsung program, developing additional billable consulting services profitability. As discussed above under services revenues, increased implementation revenues resulted in improved absorption of the fixed costs of this elementthat are not directly associated with new system installations is an important aspect of our services organization. Thestrategy to create more predictability and higher gross margins earned on cabling revenues were consistent with fiscal 2006 and with our expectations.in this area.
Gross margins on systems sales were 24.0%26.6% in fiscal 20072009 compared to 24.2%26.2% in fiscal 2006.2008. These margins are consistent withslightly higher than our expectations for systems sales. We maintain a highand reflect our continued focus on systems sales margins through controls around contract acceptance and margin reviews. We also work closely with both our manufacturers and our product distributors to maximize vendor support through their rebate, promotion, and competitive discount programs. These programs werehave been relatively unchanged allowing us to maximize these discounts and rebates. The Systems sales market is highly competitive and downward pressure on margins is a constant in fiscal 2007 compared to fiscal 2006.this segment of our business. We believe that despite a highly competitive market,the techniques and disciplines we canemploy around contract acceptance and margin reviews will enable us to maintain our gross margins on systems sales. However, we can give no assurance regarding possible changes in our vendor support programs or other market factors that could either increase or lower margins.
A final component to our gross margins is the margins earned on other revenues. These include costs incurred to market and administer the Avaya post-warranty maintenance contracts that we sell and our corporate cost of goods sold expenses. While we earn a commission on the sale of Avaya post-warranty maintenance contracts which has no direct cost
16
of goods sold, we incur costs in marketing and administration of these contracts before submitting them to Avaya. Corporate cost of goods sold represents the cost of our material logistics, warehousing, advance replacement of service spare parts, and purchasing functions. Corporate cost of goods sold decreased 0.3%was 2.0% of revenues in fiscal 20072009 compared to 1.8% of revenues in fiscal 2006.2008.
Operating Expenses. Operating expenses, including $17.8 million in impairment charges, were $15.8$36.4 million or 23%50.8% of revenues in fiscal 20072009 compared to $13.4$18.6 million or 22%22.0% of revenues in fiscal 2006. The2008. Excluding the impairment charges, operating expenses were 25.9% of revenues in fiscal 2009. Apart from the impairment, the increase in operating expenses is duereflects the following factors:
· A bad debt provision of $350,000 in specific response to increased sales expensesthe Nortel bankruptcy filing
· Increased legal fees to support our wholesale services sales initiative, increased gross profit-litigation and net income-based incentive payments to employees due to improved profitability, increased FAS 123(R) compensation expense dueboard governance activities
· Increased amortization of: the ERP system platform prior to the issuanceimpairment entry made in the third fiscal quarter; and intangible assets associated with recent acquisitions of stock optionsservice contracts and customer lists
The level of operating expenses as a percentage of revenues is above our targets and we took steps in fiscal 2007 and 2006, increased amortization expense from the expanded utilizationthird quarter to bring these costs more in line with our expectations. These steps included reductions of our enterprise technology platform,sales force and increased marketingsales support staffs, a company-wide suspension of the matching contribution on our 401k Plan, and a mandatory week of unpaid leave for each employee in the company during the last 4 months of the fiscal year. Although rapidly declining systems sales make it difficult to meet our targets for operating expenses relatedas a percent of revenues, we consider it tactically appropriate, given our strong cash flows, to a major marketing event held aroundsupport operating expenses above our targets in the PGA Championship during our fourth fiscal quarter.near term so we are positioned for faster than market growth when economic conditions improve.
Interest Expense and Other Income. Interest expense consists primarily of interest paid or accrued on our credit facility. Interest expense decreasedwas $100,000 in fiscal 2007 by approximately $77,000. This change primarily reflects lower overall borrowing costs in 20072009 compared to last year due to less outstanding debt. During$334,000 in fiscal 2007, we reduced our mortgage debt by $171,000 through cash on hand2008. This reduction reflects both lower interest rates and funds generated from operations and enjoyed lower average amounts outstanding underborrowing during the year. The cash cycle on the M-DCPS project was extremely long and forced us to borrow heavily on our revolving line of credit.
credit in fiscal 2008 to meet working capital needs. Net other income in fiscal 20072009 was approximately $50,000$28,000 compared to net other income of approximately $42,000$24,000 in 2006.fiscal 2008.
Tax Expense. We have recorded a combined federalFederal and state tax provision of approximately 39.6%39.2% in fiscal 2007 compared to 40.5% in2009 and fiscal 2006.2008. This rate reflects the effective federalFederal tax rate plus the estimated composite state income tax rate.
Operating Margins. Our net loss as a percent of revenues in fiscal 2009 was a negative 14.4%. Excluding the impact of the non-cash impairment charges in fiscal 2009, our net income as a percentage of revenues was 0.7% compared to net income as a percent of revenues of 2.4% in fiscal 2007 was 2.0% compared to 1.2% in 2006.2008. This increasedecrease reflects improved gross profit margins partially offset by higherrelatively flat operating expenses as discussed above.on decreased revenues in fiscal 2009. Our current business model targets an operating margin of 4% to 6% to be reached in the next three to five years. However, we will have to realize sustained growth in our revenues, continued improvements in total gross margins, primarily in our service gross margins, and a significantly slower growth rate in operating expenses to meet this target.
FISCAL YEAR 20062008 COMPARED TO FISCAL YEAR 2005.2007.
Net revenuesRevenues for fiscal 20062008 were $59.9$84.3 million compared to $58.0$70.1 million in fiscal 2005,2007, a 3%20% increase. Net income for fiscal 20062008 was $718,000$2,056,000 compared to $494,000$1,432,000 in fiscal 2005.2007. Discussed below are the major revenue, gross margin, and operating expense items that affected our financial results during fiscal 2006.2008.
Services Revenues. Revenues earned from our services business were $43.5 million in fiscal 2008 compared to $37.3 million in fiscal 2007, a 17% increase. This growth reflects a 10% or $2.7 million increase in maintenance and repair services revenues, a 35% or $2.8 million increase in implementation revenues, and a 24% or $619,000 increase in structured cabling revenues.
The increases in our maintenance and repair services consisted of growth in our contract maintenance revenues of 18%, partially offset by lower T&M revenues of 9%. The growth rate in contract revenues in fiscal 2008 was lower than expected due to lower growth in commercial contract revenues.
The growth in our implementation revenues in fiscal 2008 was due to the M-DCPS contract, which provided over $3 million in implementation revenues.
About one-half of the growth in structured cabling revenues related to the M-DCPS contract. The remainder of the growth in structured cabling was due to increased new construction and remodeling that occurred prior to the economic downturn and continued market acceptance of our nationwide structured cabling service offering.
Systems Sales. Sales of systems were $29.2$38.9 million in fiscal 20062008 compared to $27.9$31.9 million in fiscal 2005,2007, a 5%22% increase. Sales of systems to commercial customers were $22.5$30.3 million in fiscal 2006,2008, a 5%27% increase compared to fiscal 2005. We experienced very weak demand for systems in our first quarter of fiscal 2006 which severely impacted our annual results. However, our average quarterly sales of systems to commercial customers in the second through fourth quarters was 45% higher than our first quarter sales to commercial customers. The first quarter weakness in systems sales was due primarily to customer-driven shipping and installation schedules on some of our larger orders received in the first quarter. These orders were recorded as revenues upon shipment primarily in the second and third fiscal quarters.2007. Sales of systems to hospitality customers were $6.8$8.6 million in fiscal 2006, a 3%2008, an 8% increase compared to the prior yearyear. The increase in sales of systems to commercial customers was attributable to the M-DCPS contract which produced $9.4 million in equipment revenues during fiscal 2008 compared to $2.0 million in fiscal 2007. The increase in hospitality equipment sales was due to improved penetration into existing accounts, new customer acquisitions and were consistent with our expectations for this portionthe introduction of our business in 2006.the Mitel product line.
Services Revenues.Other Revenues Revenues earned from our services business were $29.9 million in fiscal 2006 compared to $28.2 million in fiscal 2005, a 6% increase. This increase consisted of an increase in recurring revenues partially offset by a decrease in installation revenues. Recurring revenues earned from maintenance contracts and time and materials (“T&M”) relationships with commercial customers represented the fastest growing part of our business in fiscal 2006 as these revenues grew by 29% compared to the prior year. This increase was primarily related to the Nortel product line and represented our initial success in developing our strategies to sell Nortel services. Our recurring revenues earned from hospitality customers grew modestly in fiscal 2006, also reflecting penetration into the Nortel market. We experienced a slight decline in revenues earned from contracts to maintain our proprietary call accounting systems as some customers declined to renew service contracts for this product, reflecting the impact of cell phones and internet communications on the usage of hotel-provided phone transmission. Our installation revenues declined substantially in fiscal 2006 as these revenues returned to their historical dependence on systems sales. In fiscal 2005, we received a large “installation-only” contract from the Metropolitan Atlanta Rapid Transit Authority (“MARTA”) which positively skewed our installation
17
revenues. We did not receive a similar contract in fiscal 2006 which resulted in a decline in these revenues and a negative impact to the overall gross margins earned on our services revenues.
. Other revenues were $822,000$1,937,000 in fiscal 20062008 compared to $1.8 million$951,000 in fiscal 2005.2007. The declineincrease in other revenues was attributable to declinesan increase in the sales of Avaya post-warranty maintenance contracts and in sales of equipment made outside our normal provisioning processes.contracts.
Gross Margins. Gross margins were 24.6%26.4% in fiscal 20062008 compared to 25.8%26.0% in fiscal 2005.
Gross margins on systems sales were 24.2% in fiscal 2006 compared to 24.9% in fiscal 2005 and were consistent with our expectations for systems sales at that time. The support payments we received from our relationships with manufacturers and vendors were relatively unchanged in fiscal 2006 from fiscal 2005.2007.
The gross margins earned on services revenues were 27.6%28.3% in fiscal 20062008 compared to 29.2%30.6% in fiscal 2005. These margins consisted of improvements2007 and were negatively affected by the slow-down in the growth rate of maintenance and repair services revenues. Gross margins on systems sales were 26.2% in fiscal 2008 compared to 24.0% in fiscal 2007.
A final component to our gross margins earned on recurring revenues that were more than offset by declines inis the margins earned on installationother revenues. The(See discussion of gross margins earned on recurring revenues returned to their historical levels as the revenues earned from our Nortel service initiatives grew sufficiently to absorb the investments we made in hiring and training of technical personnel in the Nortel product line. Gross margins earned on installation revenues declined dramatically due to the decline in revenues as discussed above.
The gross margins earned on other revenues in fiscal 2006 reflected the costcaption “Gross Margins” under “FISCAL YEAR 2009 COMPARED TO FISCAL YEAR 2008” above for an explanation of marketing and administering the program to sell Avaya post-warranty maintenance contracts and the costcomposition of our material logistics and purchasing functions.these margins). Corporate cost of goods sold increased 5%was 1.8% of revenues in fiscal 20062008 compared to 2% of revenues in fiscal 2005 primarily due to increases in personnel related expenses.2007.
Operating Expenses. Operating expenses were $13.4$18.6 million or 22%22.0% of revenues in fiscal 20062008 compared to $14.2$15.8 million or 24%22.5% of revenues in fiscal 2005. This decrease reflected decreases2007. Increases in bothoperating expenses included increased selling expenses primarily in the form of increased sales expenses and general and administrative expenses in 2006 over 2005. Salespersonnel targeted at selling our wholesale services initiative. Other significant increases were increased costs associated with the support of our Oracle platform, increased compensation expense reductions consisted of decreased personnel costs due to reduced sales management expenses and lower consulting fees. The reductions in general and administrative expenses were duethe issuance of incentive stock options, increased legal fees related to a decrease in legal expenses, lower depreciation expense,higher levels of litigation, and increased reimbursementsamortization expense driven by manufacturersexpanded utilization of our enterprise technology platform and distributorsthe amortization of market development and marketing costs.intangible assets from small acquisitions.
Interest Expense and Other Income. Interest expense increased in fiscal 20062008 by approximately $57,000,$241,000 compared to fiscal 2007 reflecting higher average borrowing during the year and the fact that we ceased capitalization of interest ratescosts on the ERP implementation project at the end of fiscal 2007. The cash cycle on the M-DCPS project was extremely long and forced us to borrow heavily on our revolving line of credit in fiscal 2006. During fiscal 2006, we reduced our term debt by $1.1 million through cash on hand and funds generated from operations.
2008 to meet working capital needs. Net other income in fiscal 20062008 was approximately $42,000$24,000 compared to net other income of approximately $171,000 last year. In the first quarter of fiscal 2005, we collected $87,000 on a customer receivable that had previously been written off. There was not a transaction of similar magnitude$50,000 in fiscal 2006.2007.
Tax Expense. We recorded a combined federalFederal and state tax provision of approximately 40.5%39.2% in fiscal 20062008 compared to 39%39.6% in fiscal 2005.2007. This rate reflected the effective Federal tax rate plus the estimated composite state income tax rate.
Operating Margins. Our net income as a percent of revenues in fiscal 20062008 was 1.2%2.4% compared to 0.8%2.0% in 2005. This increasefiscal 2007 which reflected reduced operating expenses as discussed above.improved gross profit margins on the sale of equipment in fiscal 2008.
Our financial condition improved during fiscal 20072009 as our working capital grew by 35%23% to $8.5$11.5 million and we generated $2.1$10.0 million in cash flows from operations. These cash flows included cash from earnings and non-cash chargesa decrease in accounts receivable of $2.9$6.1 million, a reductiondecrease in inventory of $544,000, increases$343,000 and an increase in unearned revenue of $1.5 million. These positive cash flows were partially offset by a decrease in accounts payable of $1.3 million, and increases$956,000; a decrease in deferred taxaccrued liabilities of $1.1 million. These increases were partially offset by an increase in accounts receivable of $4.0 million$399,000; and other changes in working capital items, which netted to an increasea decrease in cash of $174,000.$390,000. The impairment charge to goodwill and other assets of $17.8 million and the related $6.8 million decrease in deferred tax liabilities did not impact cash flows in the period. Other non-cash charges included amortization of $1.2 million; depreciation of $1.0 million; provisions for doubtful accounts receivable and obsolete inventories of $562,000; stock-based compensation of $284,000; and a loss on the sale of assets of $4,000. We used these positive cash flows to reduce borrowings on our working capital line of credit by $361,000,$2.5 million; to make asset purchases of capitalized hospitality service contracts as well as certain net assets of Summatis, together totaling $1.55 million; acquire capital assets of $896,000; reduce our mortgage balance through scheduled principal payments by $171,000,$171,000; and to fund other financing and investing activities of $201,000. The acquisition of capital expendituresassets included $607,000 spent as part of $1.3 million. Of these capital expenditures, $535,000normal replacement of our information technology infrastructure and headquarters facility improvements. The remaining $288,000 was spent on our Oracle implementation and approximately $765,000 was spent on capital equipment. Non-cash charges included depreciation expense of $552,000, amortization expense of $657,000, stock-based compensation expense of $122,000, and a provision for obsolete inventory of $102,000. At October 31, 2007 we had capitalized $8.7 million on the Oracle project. We have segregated the cost of this asset into four classifications with estimated useful lives of three,ERP implementation.
five, sevenAs noted above, our deferred tax liabilities decreased $6.8 million during fiscal 2009 and tenthe balance of our noncurrent deferred tax asset was $739,000 at October 31, 2009. Most of this balance and the annual change in this account is due to the difference in accounting for Goodwill between generally accepted accounting principles (“GAAP”) and the U.S. tax code. Under GAAP, Goodwill is not amortized, but instead is evaluated for impairment. This evaluation is conducted as conditions warrant, but not less than annually. The deferred tax liability associated with Goodwill accounting will not be reduced unless the Company records an additional impairment charge to Goodwill. In Fiscal year 2009, goodwill impairment charges of $14.8 million were recorded. For tax purposes, Goodwill is amortized on a straight-line basis over 15 years. In fiscal 2005 we began amortizingAs a result, the costCompany receives a tax deduction of those portionsapproximately 1/15th of its Goodwill balance each year in its tax return. Deductions taken on the tax return of approximately $1.8 million annually for amortization is recognized in the balance sheet as a reduction to the deferred tax asset. The amount recorded in the noncurrent deferred taxes is the difference between the impairment recorded for book purposes and the tax amortization multiplied by the effective tax rate. This difference is recorded as a non current item because under GAAP deferred taxes are recorded as current or noncurrent based on the classification of the system that were ready for use. Our operating results for fiscal years 2007 and 2006 include $619,000 and $391,000, respectively, in amortization expense related toasset or liability which generated the project.deferred tax item.
At October 31, 2007 the balance2009 there were no outstanding draws on our working capital revolver was $2.8 million, leaving $4.7 million available for additional borrowings.revolver. We believe that thisour cash balances and available borrowing capacity isare sufficient forto support our operating needsrequirements for the foreseeable future. On November 6, 2009 we replaced our previous credit facility with a new loan agreement with a new banking institution. The revolver is scheduled to mature on September 23, 2008, however we expect to renew it for another 12-month period prior to its expiration. At October 31, 2007, we were in compliance with the covenantsnew loan agreement consists of our debt agreements except for a requirement to not exceed $900,000 in capital expenditures. As discussed above, our capital expenditures were $1.3an $8.5 million in fiscal 2007. Our bank has granted a waiver of this technical violation of therevolving credit agreement and we consider our relationship with our bank to be good.finance growth in working capital. In addition to the available capacity under our working capital line of credit, to finance investments beyond our current operating needs we believe we may have access to a variety of capital sources such as additional bank debt, private placements of subordinated debt, and public or private sales of additional equity. However, there are currently no plans to issue such securities.
The table below presents our contractual obligations at October 31, 2007 as well as payment obligations over the next five fiscal years:
|
|
|
| Payments due by period |
| |||||||||||
Contractual Obligations |
| Total |
| Less than |
| 2 – 3 |
| 4 – 5 |
| More than |
| |||||
Long-term debt |
| $ | 1,699,392 |
| $ | 266,961 |
| $ | 1,432,431 |
| $ | — |
| $ | — |
|
Operating leases |
| 490,281 |
| 262,465 |
| 216,947 |
| 10,869 |
| — |
| |||||
Total |
| $ | 2,189,673 |
| $ | 529,426 |
| $ | 1,649,378 |
| $ | 10,869 |
| $ | — |
|
In June 2006, the FASB issued Interpretation No. 48 (“FIN 48”),See Notes to Consolidated Financial Statements, Note 1: Business and Summary of Significant Accounting Policies for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, to clarify certain aspects of accounting for uncertain tax positions, including issues related to the recognition and measurement of those tax positions. This interpretation is effective for fiscal years beginning after December 15, 2006, and therefore we adopted the statement in the first quarter of fiscal 2008. We have concluded a preliminary reviewdiscussion of the impact of FIN 48 and we do not expect it to have a material impact on our consolidated financial statements.
In September 2006, the FASB issued Statement of Financial Standards No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance withnew accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. This statement does not require any new fair value measurements; rather, it applies under other accounting pronouncements that require or permit fair value measurements. The provisions of SFAS 157 are effective for fiscal years beginning after November 15, 2007. The Company does not expect the adoption of SFAS 157 to have a material impactstandards on the Company’s consolidated financial position or results of operations.statements.
In February 2007, the FASB issued Statement of Financial Standards, No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). This Statement permits companies to choose to measure many financial instruments and certain other items at fair value to improve their financial reporting and mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Under SFAS 159, companies may elect to use the fair value option at specified election dates on an instrument by instrument basis. The provisions of SFAS 159 are effective for fiscal years beginning on or before November 15, 2007, although early adoption is permitted. The Company expects to adopt the standard on November 1, 2008 and is currently evaluating the potential impact of any election to use the fair value option.
Our financial statements are prepared based on the application of generally accepted accounting principles in the U.S. These accounting principles require us to exercise considerable judgment about future events that affect the amounts reported throughout our financial statements. Actual events could unfold quite differently than our judgments predicted. Therefore, the estimates and assumptions inherent in the financial statements included in this report could be materially
19
different once actual events unfold. We believe the following policies may involve a higher degree of judgment and complexity in their application and represent critical accounting policies used in the preparation of our financial statements. If different assumptions or estimates were used, our financial statements could be materially different from those included in this report.
Revenue Recognition. We recognize revenues from equipment sales based on shipment of the equipment, which is generally easily determined. Revenues from installation and service activities are recognized based upon completion of the activity, which sometimes requires judgment on our part. Revenues from maintenance contracts are recognized ratably over the term of the underlying contract.
CollectibilityCollectability of Accounts Receivable. We must make judgments about the collectibilitycollectability of our accounts receivable to be able to present them at their net realizable value on the balance sheet. To do this, we carefully analyze the aging of our customer accounts, try to understand why accounts have not been paid, and review historical bad debt problems. From this analysis, we record an estimated allowance for receivables that we believe will ultimately become uncollectible. We actively manage our accounts receivable to minimize our credit risks and believe that our current allowance for doubtful accounts is fairly stated.
Realizability of Inventory Values. We make judgments about the ultimate realizability of our inventory in order to record our inventory at its lower of cost or market. These judgments involve reviewing current demand for our products in comparison to present inventory levels and reviewing inventory costs compared to current market values. We maintain a significant inventory of used and refurbished parts for which these assessments require a high degree of judgment.
Goodwill and Other Long-lived Assets. We have a significant amount of goodwill on our balance sheet resulting from the acquisitions made inbetween fiscal 2000 2001, and 2004. We are responsible2009. The Company accounts for reviewing goodwill under the provisions of Accounting Standards Codification (“ASC”) 350, “Intangibles — Goodwill and Other”. Goodwill recorded as a part of a business combination is not amortized, but instead is subject to at least an annual assessment for impairment at least annually. We conducted theseby applying a fair-value-based test. The test for goodwill impairment tests on August 1, 2007 for fiscal year 2007 and on November 1 for eachis a two-step analysis process. The first step of the prioranalysis is to determine if a potential impairment exists for a reporting unit by comparing the fair value of the unit with the carrying value of the unit. The goodwill of the reporting unit is not considered to have a potential impairment if the fair value of a reporting unit exceeds its carrying amount and the second step of the impairment test is not necessary. If the carrying amount of a reporting unit exceeds the fair value of the unit, the second step is performed to determine if goodwill is impaired and to measure the amount, if any, of impairment loss to recognize. The second step of the analysis compares the implied fair value of goodwill with the carrying amount of goodwill. The implied fair value of goodwill is determined by allocating all the assets and liabilities, including any unrecognized intangible assets, to the reporting unit. If the implied fair value of goodwill exceeds the carrying amount, then goodwill is not considered impaired. If the carrying amount of goodwill exceeds the implied fair value, goodwill is considered impaired and an impairment loss is recognized in an amount equal to the excess of the carrying amount over the implied fair value.
Macro-economic conditions negatively impacted our commercial systems business beginning in the first quarter of fiscal years. In2009. Those conditions worsened significantly in the third fiscal years 2007 and 2006, wequarter. Also, uncertainty regarding the ultimate disposition of the Nortel product line grew as Nortel began divesting its assets, including assets which are strategic to the Company’s operations. Finally, the Company’s sustained decline in market capitalization continued, reflecting market uncertainty regarding the value of the Company’s operations. This combination of factors prompted the Company to conduct an interim test for impairment as of July 31, 2009. The Company engaged an independent valuationa consultant to assist us in this review. In order to make this assessment each year, we prepared a long-term forecastthe valuation of the operating resultscommercial systems sales and services reporting units. The Company used a combination of evaluations to estimate the fair value of its reporting units, including the following: a) an income approach by which forecasted future cash flows associated withare discounted to present value; b) a market approach by which comparable companies values are compared to the majorapplicable reporting unitsunit’s values; and c) a market approach by which the Company’s own market capitalization is applied to the applicable reporting unit. Based on the results of our business. We prepared this forecast to determinework, the net discounted cash flows associated with each of these units. TheCompany determined that the carrying value of the discounted cash flows, less bank debt,commercial systems sales reporting unit was then compared to the book value of each of those units. There is a great deal of judgment involved in making this assessment, including the growth rates of our various business lines, gross margins, operating margins, discount rates,impaired, and the capital expenditures needed to supportservices reporting unit was not impaired. The Company recorded an impairment charge of $11 million against its commercial systems sales reporting unit as an initial estimate at the projected growth in revenues.end of the third quarter. The valuation consultant engaged to assist in thisCompany completed its evaluation also examines additional data regarding competitors and market valuations. This examination also requires a great amount of subjectivity and assumptions. Based on the work performed, we determined that the fair value was greater than our carrying valueof this reporting unit including performing the step II analysis required by ASC 350 during the fourth quarter and therefore noincreased the total goodwill impairment had occurred.charge to $14.8 million.
We have recorded property equipment, and capitalized softwareequipment costs at historical cost less accumulated depreciation or amortization. The determination of useful economic lives and whether or not these assets are impaired involves significant judgment.
In accordance with ASC 360, “Impairment or Disposal of Long-Lived Assets”, an impairment loss on long-lived assets used in operations is recorded when events and circumstances indicate that the carrying amount of the asset may not be recoverable. During the third fiscal quarter, it was determined that certain identifiable assets related to our ERP platform were impaired because the Company estimates that full cost of the system cannot be reasonably recovered based on near-term projected financial results. An impairment charge of $3.0 million was recorded to reduce the Company’s carrying value of this asset to the mid-point of management’s estimate of the replacement cost of an ERP system that would be adequate for the Company’s current and near-term operating needs.
Accruals for Contractual Obligations and Contingent Liabilities. On products assembled or installed by us, we have varying degrees of warranty obligations. We use historical trends and make other judgments to estimate our liability for such obligations. We also must record estimated liabilities for many forms of federal,Federal, state, and local taxes. Our ultimate liability for these taxes depends upon a number of factors, including the interpretation of statutes and the mix of our taxable income between higher and lower taxing jurisdictions. In addition, in the pastnormal course of business, we have beencan be a party to threatened litigation or actual litigation in the normal course of business.litigation. In such cases, we evaluate our potential liability, if any, and determine if an estimate of that liability should be recorded in our financial statements. Estimating both the probability of our liability and the potential amount of the liability are highly subjective exercises and are evaluated frequently as the underlying circumstances change.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK20
Market risks relating to our operations result primarily from changes in interest rates. We did not use derivative financial instruments for speculative or trading purposes during the 2007 fiscal year.
Interest Rate Risk. We are subject to the risk of fluctuation in interest rates in the normal course of business due to our utilization of variable debt. Our credit facility bears interest at a floating rate at either the London Interbank Offered Rate (“LIBOR”) (4.71% at October 31, 2007) plus 1.25 to 2.75% depending on the Company’s funded debt to cash flow ratio or the bank’s prime rate (7.5% at October 31, 2007) less 0.0% to 1.125% also depending on the Company’s funded debt to
20
cash flow ratio. A hypothetical 10% increase in interest rates would have increased our interest expense by approximately $9,000 in fiscal 2007 and would not have had a material impact on our financial position or cash flows.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial information required by this Item is incorporated by reference to the financial statements listed in Items 15(a)(1) and 15(a)(2), which financial statements appear at Pages F-1 through F-21 at the end of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.9A(T). CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We carried out, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, an evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of our fiscal year ended October 31, 2007.2009. Based upon our evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission (“Commission”) rules and forms and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.forms.
Changes in Internal Controls
There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. There were no significant deficiencies or material weaknesses, and therefore, there were no corrective actions taken.
Management Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Securities Exchange Act of 1934, as amended, as a process designed by, or under the supervision of, a company’s principal executive and principal financial officers and effected by a company’s board, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP and includes those policies and procedures that:
· Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of a company;
· Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of a company are being made only in accordance with authorizations of management and directors of a company; and
· Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of a company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. Our management assessed the effectiveness of our internal control over financial reporting as of October 31, 2009. In making this assessment, our management used criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on its assessment, our management believes that, as of October 31, 2009, our internal control over financial reporting was effective based on those criteria.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this Annual Report.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information required by this Item relating to directors is incorporated by reference to our definitive proxy statement to be filed with the Securities and Exchange Commission (the “Commission”) not later than 120 days after the close of our fiscal year ended October 31, 20072009 (the “Proxy Statement”), under the section “Proposal 1—Election of Directors.”
Information relating to executive officers required by this Item is incorporated by reference to the Proxy Statement under the section “Executive Officers.”
Other information required by this Item is incorporated by reference to the Proxy Statement under the section “Section 16(a) Beneficial Ownership Reporting Compliance,” and to the discussions “Code of Ethics,” “Nominating and Governance Committee” and “Audit“Audit/Finance Committee” under the section “Corporate Governance.”
We have adopted a financial code of ethics that applies to our CEO, CFO, controller, principal accounting officercontrollers and any other employee performing similar functions. This financial code of ethics is posted on our website. The Internet address for our website is www.xeta.com, and the financial code of ethics may be found on the Investor Relations page under “Governance.”
We will satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding any amendment to, or waiver from, a provision of this code of ethics by posting such information on our website, at the address and location specified above.
21
ITEM 11. EXECUTIVE COMPENSATION
Information required by this Item is incorporated by reference to the Proxy Statement under the sections “Executive Compensation” and “Director Compensation,” and to the discussion “Compensation Committee Interlocks” under the section “Corporate Governance”.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Information relating to Equity Compensation Plans required by this Item is included in Part II of this Report in the table entitled “Equity Compensation Plan Information” under the caption “Market for the Registrant’s Common Stock and Related Stockholder Matters.”
Other information required by this Item is incorporated by reference to the Proxy Statement under the section “Security Ownership of Certain Beneficial Owners and Management.”
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Information required by this Item is incorporated by reference to the Proxy Statement under the section “Certain Relationships and Related Transaction” and to the discussion “Director Independence” under the section “Corporate Governance.”
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Information required by this Item is incorporated by reference to the discussion in the Proxy Statement “Fees and Independence” under the section “Proposal 2—Independent Public Accountants.”
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
The following documents are filed as a part of this report:
(a)(1) Financial Statements - The following financial statements are included with this report:repo rt:
| Page | |
F-1 | ||
|
| |
Consolidated Financial Statements |
| |
|
| |
2008 | F-2 | |
|
| |
2007 | F-3 | |
|
| |
2007 | F-4 | |
|
| |
2007 | F-5 | |
|
| |
F-6 |
(a)(2) Financial Statement Schedules - None.
(a)(3) Exhibits –— The following exhibits are included with this report or incorporated herein by reference:
No. |
| Description |
|
|
|
3(i) |
| Restated Certificate of Incorporation (incorporated by reference to Exhibit 3(i) to XETA’s Annual Report on Form 10-K for the year ended October 31, 2004). |
|
|
|
3(ii) |
| Amended and Restated Bylaws as adopted January 23, 2008 (incorporated by reference to Exhibit 3(ii) to XETA’s |
|
|
|
10.1† |
| XETA Technologies, Inc. 2004 Omnibus Stock Incentive Plan as amended |
10.2*† |
| Form of Restricted Stock |
|
|
|
10.3† |
| Form of Stock Option Award Agreement |
|
|
|
|
| |
|
| XETA Technologies 2000 Stock Option Plan as amended and restated December 30, 2008 (the “2000 Plan”) (incorporated by reference to Exhibit |
|
| |
10.5† | Form of Stock Purchase Option Agreement under the 2000 Plan (incorporated by reference to Exhibit 99(d)(2) to XETA’s SC TO-I filed September 17, 2009). | |
|
|
|
|
| Nortel Networks Premium Partner U. S. Agreement effective June 25, 2003 between Nortel Networks, Inc. and XETA Technologies, Inc. (incorporated by reference to Exhibit 10.1 to XETA’s Quarterly Report on Form 10-Q for the quarter ended July 31, 2003). |
23
| Avaya Inc. Reseller Master Terms and Conditions effective as of August 6, 2003 between Avaya Inc. and XETA Technologies, Inc. | |
|
| |
|
| Mitel authorizedPARTNER Agreement dated |
|
| |
|
| |
| ||
|
| Loan Agreement |
|
| |
|
| Promissory Note payable to |
|
| |
| Promissory Note ($7,500,000 payable to BOK) dated | |
|
| |
|
| |
|
| |
|
| |
| ||
21* | Subsidiaries of XETA Technologies, Inc. | |
|
| |
23.1* | Consent of | |
|
| |
31.1* | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
|
| |
31.2* | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
|
| |
32.1* | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
|
| |
32.2* | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* Indicates Exhibits filed with this report.
† Indicates management contract or compensatory plan or arrangement.
(b) See Item 15(a)(3) above.
(c) See Item 15(a)(2) above.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
XETA TECHNOLOGIES, INC. | ||
| ||
January | By: |
|
| Greg D. Forrest, Chief Executive Officer | |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
January |
|
Greg D. Forrest, Chief Executive Officer, President and | |
|
|
January |
|
Robert B. Wagner, Chief Financial Officer and Executive Director of Operations | |
|
|
January |
|
Donald T. Duke, Director | |
| |
| |
| /s/ Ronald L. Siegenthaler |
Ronald L. Siegenthaler, Director | |
| |
January |
|
|
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
XETA Technologies, Inc.
We have audited the accompanying consolidated balance sheets of XETA Technologies, Inc. and subsidiary as of October 31, 20072009 and 2006,2008, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended October 31, 2007.2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. Tullius Taylor Sartain & Sartain LLP audited the financial statements of XETA Technologies, Inc. for the year ended October 31, 2007, and merged with Hogan & Slovacek P.C. to form HoganTaylor LLP effective January 7, 2009.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of XETA Technologies, Inc. and subsidiary as of October 31, 20072009 and 2006,2008, and the results of their operations and their cash flows for each of the three years in the period ended October 31, 2007,2009, in conformity with U.S. generally accepted accounting principles.
/s/ | |
| |
| |
Tulsa, Oklahoma | |
|
XETA TECHNOLOGIES, INC. AND SUBSIDIARY
|
| October 31, 2007 |
| October 31, 2006 |
| ||
ASSETS |
|
|
|
|
| ||
Current assets: |
|
|
|
|
| ||
Cash and cash equivalents |
| $ | 402,918 |
| $ | 174,567 |
|
Current portion of net investment in sales-type leases and other receivables |
| 490,033 |
| 329,619 |
| ||
Trade accounts receivable, net |
| 16,236,137 |
| 12,245,507 |
| ||
Inventories, net |
| 4,296,574 |
| 4,942,973 |
| ||
Deferred tax asset, net |
| 916,259 |
| 709,343 |
| ||
Prepaid taxes |
| 19,737 |
| 22,622 |
| ||
Prepaid expenses and other assets |
| 517,757 |
| 300,738 |
| ||
Total current assets |
| 22,879,415 |
| 18,725,369 |
| ||
|
|
|
|
|
| ||
Noncurrent assets: |
|
|
|
|
| ||
Goodwill |
| 26,365,093 |
| 26,420,669 |
| ||
Intangible assets, net |
| 104,042 |
| 141,875 |
| ||
Net investment in sales-type leases, less current portion above |
| 136,493 |
| 128,708 |
| ||
Property, plant & equipment, net |
| 10,610,820 |
| 10,485,018 |
| ||
Other assets |
| — |
| 11,124 |
| ||
Total noncurrent assets |
| 37,216,448 |
| 37,187,394 |
| ||
|
|
|
|
|
| ||
Total assets |
| $ | 60,095,863 |
| $ | 55,912,763 |
|
|
|
|
|
|
| ||
LIABILITIES AND SHAREHOLDERS’ EQUITY |
|
|
|
|
| ||
|
|
|
|
|
| ||
Current liabilities: |
|
|
|
|
| ||
Current portion of long-term debt |
| $ | 171,123 |
| $ | 171,123 |
|
Revolving line of credit |
| 2,758,660 |
| 3,119,445 |
| ||
Accounts payable |
| 5,670,240 |
| 4,325,758 |
| ||
Current unearned revenue |
| 2,212,247 |
| 1,802,665 |
| ||
Accrued liabilities |
| 3,565,031 |
| 2,994,641 |
| ||
Total current liabilities |
| 14,377,301 |
| 12,413,632 |
| ||
|
|
|
|
|
| ||
Noncurrent liabilities: |
|
|
|
|
| ||
Long-term debt, less current portion above |
| 1,354,530 |
| 1,525,950 |
| ||
Accrued long-term liability |
| 211,300 |
| 436,850 |
| ||
Noncurrent unearned service revenue |
| 81,650 |
| 79,132 |
| ||
Noncurrent deferred tax liability, net |
| 4,631,917 |
| 3,572,089 |
| ||
Total noncurrent liabilities |
| 6,279,397 |
| 5,614,021 |
| ||
|
|
|
|
|
| ||
Contingencies |
|
|
|
|
| ||
|
|
|
|
|
| ||
Shareholders’ equity: |
|
|
|
|
| ||
Preferred stock; $.10 par value; 50,000 shares authorized, 0 issued |
| — |
| — |
| ||
Common stock; $.001 par value; 50,000,000 shares authorized, 11,233,529 issued at October 31, 2007 and October 31, 2006 |
| 11,233 |
| 11,233 |
| ||
Paid-in capital |
| 13,189,311 |
| 13,067,676 |
| ||
Retained earnings |
| 28,483,280 |
| 27,050,860 |
| ||
Less treasury stock, at cost (1,018,788 shares at October 31, 2007 and 2006) |
| (2,244,659 | ) | (2,244,659 | ) | ||
Total shareholders’ equity |
| 39,439,165 |
| 37,885,110 |
| ||
Total liabilities and shareholders’ equity |
| $ | 60,095,863 |
| $ | 55,912,763 |
|
The accompanying notes are an integral part of these consolidated balance sheets.
F-2
XETA TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
|
| For the Years |
| |||||||
|
| 2007 |
| 2006 |
| 2005 |
| |||
|
|
|
|
|
|
|
| |||
Systems sales |
| $ | 31,845,671 |
| $ | 29,249,004 |
| $ | 27,942,695 |
|
Services |
| 37,296,596 |
| 29,894,230 |
| 28,241,316 |
| |||
Other revenues |
| 950,887 |
| 821,730 |
| 1,819,241 |
| |||
Net sales and service revenues |
| 70,093,154 |
| 59,964,964 |
| 58,003,252 |
| |||
|
|
|
|
|
|
|
| |||
Cost of systems sales |
| 24,215,941 |
| 22,161,682 |
| 20,978,447 |
| |||
Services costs |
| 25,876,839 |
| 21,645,086 |
| 20,007,601 |
| |||
Cost of other revenues & corporate COGS |
| 1,792,620 |
| 1,423,927 |
| 2,072,931 |
| |||
Total cost of sales and service |
| 51,885,400 |
| 45,230,695 |
| 43,058,979 |
| |||
|
|
|
|
|
|
|
| |||
Gross profit |
| 18,207,754 |
| 14,734,269 |
| 14,944,273 |
| |||
|
|
|
|
|
|
|
| |||
Operating expenses |
|
|
|
|
|
|
| |||
Selling, general and administrative |
| 15,133,757 |
| 12,969,071 |
| 13,800,782 |
| |||
Amortization |
| 656,828 |
| 428,785 |
| 385,591 |
| |||
Total operating expenses |
| 15,790,585 |
| 13,397,856 |
| 14,186,373 |
| |||
|
|
|
|
|
|
|
| |||
Income from operations |
| 2,417,169 |
| 1,336,413 |
| 757,900 |
| |||
|
|
|
|
|
|
|
| |||
Interest expense |
| (93,397 | ) | (170,044 | ) | (113,523 | ) | |||
Interest and other income |
| 49,648 |
| 42,166 |
| 171,078 |
| |||
Total interest and other income (expense) |
| (43,749 | ) | (127,878 | ) | 57,555 |
| |||
|
|
|
|
|
|
|
| |||
Income before provision for income taxes |
| 2,373,420 |
| 1,208,535 |
| 815,455 |
| |||
Provision for income taxes |
| 941,000 |
| 490,000 |
| 321,000 |
| |||
|
|
|
|
|
|
|
| |||
Net income |
| $ | 1,432,420 |
| $ | 718,535 |
| $ | 494,455 |
|
|
|
|
|
|
|
|
| |||
Earnings per share |
|
|
|
|
|
|
| |||
Basic |
| $ | 0.14 |
| $ | 0.07 |
| $ | 0.05 |
|
|
|
|
|
|
|
|
| |||
Diluted |
| $ | 0.14 |
| $ | 0.07 |
| $ | 0.05 |
|
|
|
|
|
|
|
|
| |||
Weighted average shares outstanding |
| 10,214,741 |
| 10,208,250 |
| 10,087,279 |
| |||
|
|
|
|
|
|
|
| |||
Weighted average equivalent shares |
| 10,214,741 |
| 10,210,246 |
| 10,116,694 |
| |||
|
| October 31, 2009 |
| October 31, 2008 |
| ||
|
|
|
|
|
| ||
ASSETS |
| ||||||
Current assets: |
|
|
|
|
| ||
Cash and cash equivalents |
| $ | 4,731,926 |
| $ | 63,639 |
|
Current portion of net investment in sales-type leases and other receivables |
| 470,025 |
| 353,216 |
| ||
Trade accounts receivable, net |
| 13,832,452 |
| 19,995,498 |
| ||
Inventories, net |
| 5,036,198 |
| 5,236,565 |
| ||
Deferred tax asset |
| 1,136,351 |
| 588,926 |
| ||
Prepaid taxes |
| 39,784 |
| 64,593 |
| ||
Prepaid expenses and other assets |
| 2,057,514 |
| 1,608,113 |
| ||
Total current assets |
| 27,304,250 |
| 27,910,550 |
| ||
|
|
|
|
|
| ||
Noncurrent assets: |
|
|
|
|
| ||
Goodwill |
| 12,031,975 |
| 26,825,498 |
| ||
Intangible assets, net |
| 570,740 |
| 828,825 |
| ||
Net investment in sales-type leases and other receivables, less current portion above |
| 335,413 |
| 103,037 |
| ||
Property, plant & equipment, net |
| 6,825,916 |
| 10,722,539 |
| ||
Deferred tax asset |
| 739,216 |
| — |
| ||
Other assets |
| — |
| 2,271 |
| ||
Total noncurrent assets |
| 20,503,260 |
| 38,482,170 |
| ||
|
|
|
|
|
| ||
Total assets |
| $ | 47,807,510 |
| $ | 66,392,720 |
|
|
|
|
|
|
| ||
LIABILITIES AND SHAREHOLDERS’ EQUITY |
| ||||||
|
|
|
|
|
| ||
Current liabilities: |
|
|
|
|
| ||
Current portion of long-term debt |
| $ | 1,183,475 |
| $ | 1,354,565 |
|
Revolving line of credit |
| — |
| 2,524,130 |
| ||
Accounts payable |
| 5,785,225 |
| 6,691,550 |
| ||
Current portion of obligations under capital lease |
| 154,072 |
| 148,225 |
| ||
Current unearned services revenue |
| 5,194,601 |
| 3,237,296 |
| ||
Accrued liabilities |
| 3,444,396 |
| 4,593,725 |
| ||
Total current liabilities |
| 15,761,769 |
| 18,549,491 |
| ||
|
|
|
|
|
| ||
Noncurrent liabilities: |
|
|
|
|
| ||
Accrued long-term liability |
| 144,100 |
| 144,100 |
| ||
Long-term portion of obligations under capital lease |
| 106,076 |
| 260,148 |
| ||
Noncurrent unearned services revenue |
| 36,691 |
| 56,393 |
| ||
Noncurrent deferred tax liability |
| — |
| 5,545,692 |
| ||
Total noncurrent liabilities |
| 286,867 |
| 6,006,333 |
| ||
|
|
|
|
|
| ||
Contingencies |
|
|
|
|
| ||
|
|
|
|
|
| ||
Shareholders’ equity: |
|
|
|
|
| ||
Preferred stock; $.10 par value; 50,000 shares authorized, 0 issued |
| — |
| — |
| ||
Common stock; $.001 par value; 50,000,000 shares authorized, 11,256,193 issued at October 31, 2009 and October 31, 2008 |
| 11,255 |
| 11,255 |
| ||
Paid-in capital |
| 13,704,460 |
| 13,493,395 |
| ||
Retained earnings |
| 20,223,169 |
| 30,539,714 |
| ||
Less treasury stock, at cost (994,695 shares at October 31, 2009 and 1,001,883 shares at October 31, 2008) |
| (2,180,010 | ) | (2,207,468 | ) | ||
Total shareholders’ equity |
| 31,758,874 |
| 41,836,896 |
| ||
Total liabilities and shareholders’ equity |
| $ | 47,807,510 |
| $ | 66,392,720 |
|
The accompanying notes are an integral part of these consolidated financial statements.
XETA TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
|
| Common Stock |
| Treasury Stock |
|
|
| Accumulated Other |
|
|
|
|
| ||||||||||
|
| Shares Issued |
| Par Value |
| Shares |
| Amount |
| Paid-in Capital |
| Income |
| Retained Earnings |
| Total |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Balance- October 31, 2004 |
| 11,031,575 |
| $ | 11,031 |
| 1,018,788 |
| $ | (2,244,659 | ) | $ | 12,695,224 |
| $ | 4,554 |
| $ | 25,837,870 |
| $ | 36,304,020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Stock options exercised $.001 par value |
| 65,450 |
| 66 |
| — |
| — |
| 24,950 |
| — |
| — |
| 25,016 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Restricted shares issued $.001 par value |
| 100,000 |
| 100 |
| — |
| — |
| 278,900 |
| — |
| — |
| 279,000 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Components of comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Net income |
| — |
| — |
| — |
| — |
| — |
| — |
| 494,455 |
| 494,455 |
| ||||||
Unrealized loss on hedge |
| — |
| — |
| — |
| — |
| — |
| (4,554 | ) | — |
| (4,554 | ) | ||||||
Total comprehensive income |
| — |
| — |
| — |
| — |
| — |
| (4,554 | ) | 494,455 |
| 489,901 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Balance- October 31, 2005 |
| 11,197,025 |
| 11,197 |
| 1,018,788 |
| (2,244,659 | ) | 12,999,074 |
| — |
| 26,332,325 |
| 37,097,937 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Stock options exercised $.001 par value |
| 36,504 |
| 36 |
| — |
| — |
| 52,548 |
| — |
| — |
| 52,584 |
| ||||||
Tax benefit of stock options |
| — |
| — |
| — |
| — |
| 12,966 |
| — |
| — |
| 12,966 |
| ||||||
Stock based compensation |
| — |
| — |
| — |
| — |
| 3,088 |
| — |
| — |
| 3,088 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Net Income |
| — |
| — |
| — |
| — |
| — |
| — |
| 718,535 |
| 718,535 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Balance- October 31, 2006 |
| 11,233,529 |
| 11,233 |
| 1,018,788 |
| (2,244,659 | ) | 13,067,676 |
| — |
| 27,050,860 |
| 37,885,110 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Stock based compensation |
| — |
| — |
| — |
| — |
| 121,635 |
| — |
| — |
| 121,635 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Net Income |
| — |
| — |
| — |
| — |
| — |
| — |
| 1,432,420 |
| 1,432,420 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Balance- October 31, 2007 |
| 11,233,529 |
| $ | 11,233 |
| 1,018,788 |
| $ | (2,244,659 | ) | $ | 13,189,311 |
| $ | — |
| $ | 28,483,280 |
| $ | 39,439,165 |
|
The accompanying notes are an integral part of this consolidated financial statement.
F-4
XETA TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWSOPERATIONS
|
| For the Years |
| |||||||
|
| 2007 |
| 2006 |
| 2005 |
| |||
Cash flows from operating activities: |
|
|
|
|
|
|
| |||
Net income |
| $ | 1,432,420 |
| $ | 718,535 |
| $ | 494,455 |
|
|
|
|
|
|
|
|
| |||
Adjustments to reconcile net income to net cash provided by operating activities: |
|
|
|
|
|
|
| |||
Depreciation |
| 551,715 |
| 507,672 |
| 710,435 |
| |||
Amortization |
| 656,828 |
| 428,785 |
| 385,591 |
| |||
Stock based compensation |
| 121,635 |
| 3,088 |
|
|
| |||
(Gain) loss on sale of assets |
| (5,000 | ) | 6,208 |
| (5,819 | ) | |||
Ineffectiveness of cash flow hedge |
| — |
| — |
| (12,476 | ) | |||
Provision for returns and doubtful accounts receivable |
| — |
| — |
| 15,263 |
| |||
Provision for excess and obsolete inventory |
| 102,000 |
| 102,000 |
| 242,730 |
| |||
Increase in deferred tax liability |
| 1,115,404 |
| 669,662 |
| 412,490 |
| |||
Change in assets and liabilities, net of acquisitions: |
|
|
|
|
|
|
| |||
(Increase) decrease in net investment in sales-type leases & other receivables |
| (168,199 | ) | 242,186 |
| 35,378 |
| |||
(Increase) in trade account receivables |
| (3,990,630 | ) | (611,477 | ) | (2,119,916 | ) | |||
Decrease (increase) in inventories |
| 544,399 |
| 605,054 |
| (1,048,055 | ) | |||
(Increase) decrease in deferred tax asset |
| (206,916 | ) | 17,879 |
| 153,383 |
| |||
(Increase) decrease in prepaid expenses and other assets |
| (205,895 | ) | (137,926 | ) | 102,715 |
| |||
Decrease (increase) in prepaid taxes |
| 2,885 |
| 54,269 |
| (70,023 | ) | |||
Increase (decrease) in accounts payable |
| 1,344,482 |
| (522,041 | ) | 2,395,319 |
| |||
Increase (decrease) in unearned revenue |
| 412,100 |
| 311,293 |
| (128,178 | ) | |||
Increase in accrued taxes |
| — |
| 38,216 |
| 38,216 |
| |||
Increase (decrease) in accrued liabilities |
| 344,840 |
| 889,242 |
| (133,091 | ) | |||
Total adjustments |
| 619,648 |
| 2,604,110 |
| 973,962 |
| |||
|
|
|
|
|
|
|
| |||
Net cash provided by operating activities |
| 2,052,068 |
| 3,322,645 |
| 1,468,417 |
| |||
|
|
|
|
|
|
|
| |||
Cash flows from investing activities: |
|
|
|
|
|
|
| |||
Acquisitions, net of cash acquired |
|
|
|
|
| (56,015 | ) | |||
Additions to property, plant & equipment |
| (1,296,512 | ) | (996,152 | ) | (743,009 | ) | |||
Proceeds from sale of assets |
| 5,000 |
| 17,632 |
| 6,161 |
| |||
Net cash used in investing activities |
| (1,291,512 | ) | (978,520 | ) | (792,863 | ) | |||
|
|
|
|
|
|
|
| |||
Cash flows from financing activities: |
|
|
|
|
|
|
| |||
Net Proceeds from (payments on) revolving line of credit |
| (360,785 | ) | (1,275,282 | ) | 544,445 |
| |||
Principal payments on debt |
| (171,420 | ) | (1,123,548 | ) | (1,209,381 | ) | |||
Exercise of stock options |
| — |
| 52,584 |
| 25,016 |
| |||
Net cash used in financing activities |
| (532,205 | ) | (2,346,246 | ) | (639,920 | ) | |||
|
|
|
|
|
|
|
| |||
Net increase (decrease) in cash and cash equivalents |
| 228,351 |
| (2,121 | ) | 35,634 |
| |||
|
|
|
|
|
|
|
| |||
Cash and cash equivalents, beginning of period |
| 174,567 |
| 176,688 |
| 141,054 |
| |||
Cash and cash equivalents, end of period |
| $ | 402,918 |
| $ | 174,567 |
| $ | 176,688 |
|
|
|
|
|
|
|
|
| |||
Supplemental disclosure of cash flow information: |
|
|
|
|
|
|
| |||
Cash paid during the period for interest, net of amount capitalized of $199,544 in 2007, $302,613 in 2006, and $204,125 in 2005 |
| $ | 100,412 |
| $ | 164,377 |
| $ | 124,250 |
|
Cash paid during the period for income taxes |
| $ | 29,659 |
| $ | 34,304 |
| $ | 41,511 |
|
|
| For the Years |
| |||||||
|
| Ended October 31, |
| |||||||
|
| 2009 |
| 2008 |
| 2007 |
| |||
|
|
|
|
|
|
|
| |||
Systems sales |
| $ | 30,095,844 |
| $ | 38,900,301 |
| $ | 31,845,671 |
|
Services |
| 41,080,689 |
| 43,483,939 |
| 37,296,596 |
| |||
Other revenues |
| 395,878 |
| 1,936,639 |
| 950,887 |
| |||
Net sales and services revenues |
| 71,572,411 |
| 84,320,879 |
| 70,093,154 |
| |||
|
|
|
|
|
|
|
| |||
Cost of systems sales |
| 22,079,858 |
| 28,719,969 |
| 24,215,941 |
| |||
Services costs |
| 28,291,495 |
| 31,178,401 |
| 25,876,839 |
| |||
Cost of other revenues & corporate COGS |
| 1,720,115 |
| 2,166,374 |
| 1,792,620 |
| |||
Total cost of sales and services |
| 52,091,468 |
| 62,064,744 |
| 51,885,400 |
| |||
|
|
|
|
|
|
|
| |||
Gross profit |
| 19,480,943 |
| 22,256,135 |
| 18,207,754 |
| |||
|
|
|
|
|
|
|
| |||
Operating expenses |
|
|
|
|
|
|
| |||
Selling, general and administrative |
| 17,370,765 |
| 17,547,088 |
| 15,133,757 |
| |||
Amortization |
| 1,201,176 |
| 1,018,186 |
| 656,828 |
| |||
Impairment of goodwill & other assets |
| 17,800,000 |
| — |
| — |
| |||
Total operating expenses |
| 36,371,941 |
| 18,565,274 |
| 15,790,585 |
| |||
|
|
|
|
|
|
|
| |||
(Loss) income from operations |
| (16,890,998 | ) | 3,690,861 |
| 2,417,169 |
| |||
|
|
|
|
|
|
|
| |||
Interest expense |
| (99,657 | ) | (334,072 | ) | (93,397 | ) | |||
Interest and other income |
| 28,110 |
| 23,645 |
| 49,648 |
| |||
Net interest and other expense |
| (71,547 | ) | (310,427 | ) | (43,749 | ) | |||
|
|
|
|
|
|
|
| |||
(Loss) income before (benefit) provision for income taxes |
| (16,962,545 | ) | 3,380,434 |
| 2,373,420 |
| |||
(Benefit) provision for income taxes |
| (6,646,000 | ) | 1,324,000 |
| 941,000 |
| |||
|
|
|
|
|
|
|
| |||
Net (loss) income |
| $ | (10,316,545 | ) | $ | 2,056,434 |
| $ | 1,432,420 |
|
|
|
|
|
|
|
|
| |||
(Loss) earnings per share |
|
|
|
|
|
|
| |||
Basic |
| $ | (1.01 | ) | $ | 0.20 |
| $ | 0.14 |
|
|
|
|
|
|
|
|
| |||
Diluted |
| $ | (1.01 | ) | $ | 0.20 |
| $ | 0.14 |
|
|
|
|
|
|
|
|
| |||
Weighted average shares outstanding |
| 10,223,626 |
| 10,249,671 |
| 10,214,741 |
| |||
|
|
|
|
|
|
|
| |||
Weighted average equivalent shares |
| 10,223,626 |
| 10,249,671 |
| 10,214,741 |
| |||
The accompanying notes are an integral part of these consolidated financial statements.
XETA TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
|
| Common Stock |
| Treasury Stock |
|
|
|
|
|
|
| |||||||||
|
| Shares Issued |
| Par Value |
| Shares |
| Amount |
| Paid-in Capital |
| Retained Earnings |
| Total |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Balance- October 31, 2006 |
| 11,233,529 |
| $ | 11,233 |
| 1,018,788 |
| $ | (2,244,659 | ) | $ | 13,067,676 |
| $ | 27,050,860 |
| $ | 37,885,110 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Stock based compensation |
| — |
| — |
| — |
| — |
| 121,635 |
| — |
| 121,635 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Net Income |
| — |
| — |
| — |
| — |
| — |
| 1,432,420 |
| 1,432,420 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Balance- October 31, 2007 |
| 11,233,529 |
| $ | 11,233 |
| 1,018,788 |
| $ | (2,244,659 | ) | $ | 13,189,311 |
| $ | 28,483,280 |
| $ | 39,439,165 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Stock options exercised $.001 par value |
| 22,664 |
| 22 |
| — |
| — |
| 90,193 |
| — |
| 90,215 |
| |||||
Issuance of restricted common stock from treasury |
| — |
| — |
| (16,905 | ) | 37,191 |
| (37,191 | ) | — |
| — |
| |||||
Tax benefit of stock options |
| — |
| — |
| — |
| — |
| 4,032 |
| — |
| 4,032 |
| |||||
Stock based compensation |
| — |
| — |
| — |
| — |
| 247,050 |
| — |
| 247,050 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Net Income |
| — |
| — |
| — |
| — |
| — |
| 2,056,434 |
| 2,056,434 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Balance- October 31, 2008 |
| 11,256,193 |
| $ | 11,255 |
| 1,001,883 |
| $ | (2,207,468 | ) | $ | 13,493,395 |
| $ | 30,539,714 |
| $ | 41,836,896 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Purchase of treasury stock, at cost |
| — |
| — |
| 30,796 |
| (58,157 | ) | — |
| — |
| (58,157 | ) | |||||
Issuance of restricted common stock from treasury |
| — |
| — |
| (38,916 | ) | 85,615 |
| (85,615 | ) | — |
| — |
| |||||
Stock based compensation |
| — |
| — |
| — |
| — |
| 296,680 |
| — |
| 296,680 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Net loss |
| — |
| — |
| — |
| — |
| — |
| (10,316,545 | ) | (10,316,545 | ) | |||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Balance- October 31, 2009 |
| 11,256,193 |
| $ | 11,255 |
| 993,763 |
| $ | (2,180,010 | ) | $ | 13,704,460 |
| $ | 20,223,169 |
| $ | 31,758,874 |
|
The accompanying notes are an integral part of these consolidated financial statements.
XETA TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
| For the Years |
| |||||||
|
| Ended October 31, |
| |||||||
|
| 2009 |
| 2008 |
| 2007 |
| |||
Cash flows from operating activities: |
|
|
|
|
|
|
| |||
Net (loss) income |
| $ | (10,316,545 | ) | $ | 2,056,434 |
| $ | 1,432,420 |
|
|
|
|
|
|
|
|
| |||
Adjustments to reconcile net (loss) income to net cash provided by operating activities: |
|
|
|
|
|
|
| |||
Depreciation |
| 1,026,069 |
| 744,003 |
| 551,710 |
| |||
Amortization |
| 1,201,174 |
| 1,018,189 |
| 656,833 |
| |||
Impairment of goodwill & other assets |
| 17,800,000 |
| — |
| — |
| |||
Stock based compensation |
| 283,909 |
| 247,050 |
| 121,635 |
| |||
Loss (gain) on sale of assets |
| 3,764 |
| 425 |
| (5,000 | ) | |||
Provision for returns & doubtful accounts receivable |
| 460,000 |
| 22,924 |
| — |
| |||
Provision for excess and obsolete inventory |
| 102,000 |
| 102,000 |
| 102,000 |
| |||
(Decrease) increase in deferred taxes |
| (6,776,757 | ) | 1,300,716 |
| 908,488 |
| |||
Change in assets and liabilities: |
|
|
|
|
|
|
| |||
(Increase) decrease in net investment in sales-type leases & other receivables |
| (89,400 | ) | 170,273 |
| (168,199 | ) | |||
Decrease (increase) in trade accounts receivable |
| 6,114,067 |
| (3,748,230 | ) | (3,990,630 | ) | |||
Decrease (increase) in inventories |
| 343,114 |
| (962,714 | ) | 544,399 |
| |||
Increase in prepaid expenses and other assets |
| (325,375 | ) | (1,092,627 | ) | (205,895 | ) | |||
Decrease (increase) in prepaid taxes |
| 24,809 |
| (44,856 | ) | 2,885 |
| |||
(Decrease) increase in accounts payable |
| (956,376 | ) | 1,021,231 |
| 1,344,482 |
| |||
Increase in unearned revenue |
| 1,517,735 |
| 925,638 |
| 412,100 |
| |||
(Decrease) increase in accrued liabilities |
| (398,628 | ) | (88,289 | ) | 344,840 |
| |||
Total adjustments |
| 20,330,105 |
| (384,267 | ) | 619,648 |
| |||
|
|
|
|
|
|
|
| |||
Net cash provided by operating activities |
| 10,013,560 |
| 1,672,167 |
| 2,052,068 |
| |||
|
|
|
|
|
|
|
| |||
Cash flows from investing activities: |
|
|
|
|
|
|
| |||
Additions to property, plant & equipment |
| (895,848 | ) | (1,294,415 | ) | (1,296,512 | ) | |||
Proceeds from sale of assets |
| 5,064 |
| — |
| 5,000 |
| |||
Acquisitions, net of cash acquired |
| (802,887 | ) | — |
| — |
| |||
Investment in capitalized service contracts |
| (750,000 | ) | (353,481 | ) | — |
| |||
Net cash used in investing activities |
| (2,443,671 | ) | (1,647,896 | ) | (1,291,512 | ) | |||
|
|
|
|
|
|
|
| |||
Cash flows from financing activities: |
|
|
|
|
|
|
| |||
Principal payments on debt |
| (171,090 | ) | (171,088 | ) | (171,420 | ) | |||
Net payments on revolving line of credit |
| (2,524,130 | ) | (234,530 | ) | (360,785 | ) | |||
Payments on capital lease obligations |
| (148,225 | ) | (48,147 | ) | — |
| |||
Payments to acquire treasury stock |
| (58,157 | ) | — |
| — |
| |||
Exercise of stock options |
| — |
| 90,215 |
| — |
| |||
Net cash used in financing activities |
| (2,901,602 | ) | (363,550 | ) | (532,205 | ) | |||
|
|
|
|
|
|
|
| |||
Net increase (decrease) in cash and cash equivalents |
| 4,668,287 |
| (339,279 | ) | 228,351 |
| |||
|
|
|
|
|
|
|
| |||
Cash and cash equivalents, beginning of period |
| 63,639 |
| 402,918 |
| 174,567 |
| |||
Cash and cash equivalents, end of period |
| $ | 4,731,926 |
| $ | 63,639 |
| $ | 402,918 |
|
|
|
|
|
|
|
|
| |||
Supplemental disclosure of cash flow information: |
|
|
|
|
|
|
| |||
Cash paid during the period for interest, net of amount capitalized of $0 in 2009 and 2008 and $199,544 in 2007 |
| $ | 101,276 |
| $ | 346,045 |
| $ | 100,412 |
|
Cash paid during the period for income taxes |
| $ | 110,210 |
| $ | 68,108 |
| $ | 29,659 |
|
Capital lease obligations incurred |
| $ | — |
| $ | 456,520 |
| $ | — |
|
Non-collateralized obligation to purchase service contracts |
| $ | — |
| $ | 750,000 |
| $ | — |
|
The accompanying notes are an integral part of these consolidated financial statements.
XETA TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED OCTOBER 31, 20072009
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Business
XETA Technologies, Inc. (“XETA” or the “Company”) is a leading providerintegrator of advanced communications technologies with nationwide sales and service. XETA serves a diverse group of business clients in sales, engineering, project management, installation,implementation, and service support. The Company sells products produced by a variety of manufacturers including Avaya, Inc. (“Avaya”), Nortel Networks Corporation (“Nortel”), and Mitel Corporation (“Mitel”), and Spectralink Corporation.. In addition, the Company manufactures and markets a line of proprietary call accounting systems to the hospitality industry. XETA is an Oklahoma corporation.
Xetacom, Inc. is a wholly-owned dormant subsidiary of the Company.
Cash and Cash Equivalents
Cash and cash equivalents consist of money-market accounts and commercial bank accounts.
Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate the value:
The carrying value of cash and cash equivalents, customer deposits, trade accounts receivable, sales-type leases, accounts payable and short-term debt approximate their respective fair values due to their short maturities.
Based upon the borrowing rates currently available to the Company for bank loans with similar terms and average maturities, the fair value of the long-term debt approximates the carrying value.
Revenue Recognition
The Company earns revenues from the sale and installation of communications systems, the sale of maintenance contracts, and the sale of services on a time-and-materials (“T&M”) basis. The Company typically sells communications systems under single contracts to provide the equipment and the installation services; however, the installation and any associated professional services and project management services are priced independently from the equipment based on the market price for those services. The installation of the systems sold by the Company can be outsourced to a third party either by the Company under a subcontractor arrangement or by the customer under arrangements in which vendors bid separately for the provision of the equipment from the installation and related services. Emerging Issues Task ForceAccounting Standards Codification (“EITF”ASC”) Issue No. 00-21 “Revenue Arrangements with Multiple Delieverables” (“EITF 00-21”)605-25, “Revenue Recognition - Multiple-Element Arrangements”, addresses certain aspects of accounting by a vendor for arrangements with multiple revenue-generating elements, such as those including products with installation. Under EITF 00-21, revenueRevenue is recognized for each element of the transaction based on its relative fair value. The revenue associated with each delivered element should be recognized separately if it has stand-alone value to the customer, there is evidence of the fair value of the undelivered element, the delivery or performance of the undelivered element is considered probable and performance is substantially under the Company’s control and is not essential to the functionality of the delivered element. Under these guidelines, the Company recognizes systems sales revenue upon shipment of the equipment and installation services revenues upon completion of the installation of the system.
Services revenues earned from maintenance contracts are recognized ratably over the term of the underlying contract on a straight-line basis. Revenues earned from services provided on a T&M basis are recognized as those services are provided. The Company recognizes revenue from sales-type leases as discussed below under the caption “Lease Accounting.” Revenues are reported net of applicable sales and use tax imposed on the related transaction.
Shipping and Handling Fees
In accordance with Emerging Issues Task Force Issue 00-10, “Accounting for Shipping and Handling Fees and Costs,” freightFreight billed to customers is included in net sales and service revenues in the consolidated statements of operations, while freight billed by vendors is included in cost of sales in the consolidated statements of operations.
Accounting for Manufacturer Incentives
The Company receives various forms of incentive payments, rebates, and negotiated price discounts from the manufacturers of the products they sell.sold. Rebates and negotiated price discounts directly related to specific customer sales are recorded as a reduction in the cost of goods sold on those systems sales. Rebates and other incentives designed to offset marketing expenses and certain growth initiatives supported by the manufacturer are recorded as contra expense to the related expenditure. All incentive payments are recorded when earned under the specific rules of the incentive plan.
Lease Accounting
A small portion (less than 1%) of the Company’s revenues has been generated using sales-type leases. The Company sells some of its call accounting systems to the hospitality industry under sales-type leases to be paid over three, four and five-year periods. Because the present value (computed at the rate implicit in the lease) of the minimum payments under these sales-type leases equals or exceeds 90 percent of the fair market value of the systems and/or the length of the lease exceeds 75 percent of the estimated economic life of the equipment, the Company recognizes the net effect of these transactions as a sale.
The Company records interest income from its sales-type lease receivables. Interest income from a sales-type lease represents that portion of the aggregate payments to be received over the life of the lease that exceeds the present value of such payments using a discount factor equal to the rate implicit in the underlying lease.
Accounts Receivable
Accounts receivable are recorded at amounts billed to customers less an allowance for doubtful accounts. Management monitors the payment status of all customer balances and considers an account to be delinquent once it has aged sixty days past the due date. The allowance for doubtful accounts is adjusted based on management’s assessment of collection trends, agingsaging of customer balances, and any specific disputes. TheFor the year ended October 31, 2009, the Company recorded no bad debt expense of $460,000 which included $350,000 provided for the years ending October 31, 2007 and 2006.potential uncollectible amounts associated with Nortel’s bankruptcy filing. This matter is discussed more fully in Note 2. The Company recorded bad debt expense of $15,263 for the year ended October 31, 2005..$22,924 and $0 in fiscal years 2008 and 2007, respectively.
Property, Plant and& Equipment
The Company capitalizes the cost of all significant property, plant and equipment additions including equipment manufactured by the Company and installed at customer locations under certain system service agreements. Depreciation is computed over the estimated useful life of the asset or the terms of the lease for leasehold improvements, whichever is shorter, on a straight-line basis. When assets are retired or sold, the cost of the assets and the related accumulated depreciation is removed from the accounts and any resulting gain or loss is included in other income. Maintenance and repair costs are expensed as incurred. Interest costs related to an investment in long-lived assets are capitalized as part of the cost of the asset during the period the asset is being prepared for use. The Company capitalized $200,000, $303,000, and $204,000 indid not capitalize any interest costs in fiscal years 2007, 20062009 and 2005, respectively.2008 and capitalized $200,000 in fiscal year 2007.
Software Development Costs
The Company applies the provisions of Statement of Position 98-1, “Accounting for the Cost of Computer Software Developed or Obtained for Internal Use” (“SOP 98-1”). Under SOP 98-1 externalExternal direct costs of software development, payroll and payroll-related costs for time spent on the project by employees directly associated with the development, and interest costs incurred during the development as provided under the provisions of SFAS No. 34, “Capitalization of Interest Costs,” should be capitalized after the “preliminary project stage” has been completed. Accordingly,completed are capitalized. The capitalized value of software at October 31, 2009 was $3.5 million which reflects an impairment charge of $3.0 million recorded in fiscal 2009. In the third fiscal quarter of fiscal 2009, management determined that its ERP system and the related investment were over-adequate for its current and near-term operating needs. The ERP system was originally purchased in 2001 during a period of hyper-growth and the Company had capitalized $8.7expected to be significantly larger within three-to-five years. Those growth expectations did not materialize. Furthermore, the economic downturn represented another setback in the Company’s growth curve. As a result, management determined that it was likely the investment in the ERP system would not be realized within a reasonable time-frame and was therefore impaired. At the time of the impairment charge, the net book value of the Company’s ERP investment was $6.5 million. The Company used various outside sources and its current vendor to estimate the replacement cost of an ERP system that
would be adequate for the Company’s current and near-term operating needs. This research yielded an estimated replacement cost of $3.5 million and $8.2an impairment charge of $3.0 million related towas recorded in the software development asthird fiscal quarter of October 31, 2007 and 2006, respectively.the year. The Company has segregated the cost of the developed software into four groups with estimated useful lives of three, five, seven and ten years. BeginningAmortization costs of $931,000, $906,000, and $619,000 were recognized in fiscal 2005, the Company began implementing the developed software in its businessyears 2009, 2008 and the operating results include $619,000, $391,000, and $348,000 in amortization costs calculated based on the estimated useful lives of those functions of the software which are ready for their intended use for fiscal years 2007, 2006 and 2005, respectively.
F-7
Derivative Instruments and Hedging Activities
The Company applies the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (“SFAS 133”) as amended. SFAS No. 133 requires companies to recognize all derivative instruments as either assets or liabilities in the consolidated balance sheets at fair value. At October 31, 2007 and 2006, the Company had no derivative instruments.
Stock-Based Compensation Plans
In December 2004,The Company applies the Financial Accounting Standards Board (“FASB”) issued Statementprovisions of Financial Accounting Standards No. 123 (revised 2004)ASC 718, “Compensation — Stock Compensation”, “Share-Based Payment” (“SFAS 123(R)”). SFAS 123(R)which requires companies to measure all employee stock-based compensation awards using a fair value method and recognize compensation cost in its financial statements. The valuation provisions of SFAS 123(R) apply to new awards and to awards that are outstanding at the effective date and subsequently modified or cancelled. The Company adopted on a prospective basis SFAS 123(R) beginning November 1, 2005 for stock-based compensation awards granted after that date and for unvested awards outstanding at that date using the modified prospective application method. The Company recognizes the fair value of stock-based compensation awards as selling, general and administrative expense in the consolidated statements of operations on a straight-line basis over the vesting period. We recognized compensation expense of $284,000, $247,000, and $122,000 and 3,000 for the twelve months ended October 31, 2009, 2008, and 2007, and 2006, respectively..respectively.
Income Taxes
Income tax expense is based on pretax income. Deferred income taxes are computed using the asset-liability method in accordance with SFAS No. 109, “Accounting for ASC 740, ���Income Taxes,”Taxes”, and are provided on all temporary differences between the financial basis and the tax basis of the Company’s assets and liabilities. The Company accounts for any uncertain tax positions, including issues related to the recognition and measurement of those tax positions, in accordance with the tax position guidance in ASC 740.
Unearned Revenue and Warranty
For proprietary systems sold, the Company typically provides a one-year warranty from the date of installation of the system. The Company defers a portion of each system sale to be recognized as service revenue during the warranty period. The amount deferred is generally equal to the sales price of a maintenance contract for the type of system under warranty and the length of the warranty period. The Company also records deposits received on sales orders and prepayments for maintenance contracts as unearned revenues.
Most of the systems sold by the Company are manufactured by third parties. In these instances the Company passes on the manufacturer’smanufacturers’ warranties to its customers and therefore does not maintain a warranty reserve for this equipment. The Company maintains a small reserve for occasional labor costs associated with fulfilling warranty requests from customers.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Segment Information
The Company has three reportable segments: services, commercial system sales, and lodginghospitality system sales. Managed Services revenues represent revenues earned from installing and maintaining systems for customers in both the commercial and lodginghospitality segments. The Company defines commercial system sales as sales to the non-lodgingnon-hospitality industry.
The reporting segments follow the same accounting policies used for the Company’s consolidated financial statements and are described in the summary of significant accounting policies. Company management evaluates a segment’s performance based upon gross margins. Assets are not allocated to the segments. Sales to customers located outside of the U.S. are immaterial.
F-8
The following is a tabulation of business segment information for 2007, 20062009, 2008 and 2005:2007:
|
| Services |
| Commercial |
| Lodging |
| Other |
| Total |
| |||||
2007 |
|
|
|
|
|
|
|
|
|
|
| |||||
Sales |
| $ | 37,296,596 |
| $ | 23,841,340 |
| $ | 8,004,331 |
| $ | 950,887 |
| $ | 70,093,154 |
|
Cost of sales |
| 25,876,839 |
| 18,218,088 |
| 5,997,853 |
| 1,792,620 |
| 51,885,400 |
| |||||
Gross profit |
| $ | 11,419,757 |
| $ | 5,623,252 |
| $ | 2,006,478 |
| $ | (841,733 | ) | $ | 18,207,754 |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
2006 |
|
|
|
|
|
|
|
|
|
|
| |||||
Sales |
| $ | 29,894,230 |
| $ | 22,462,789 |
| $ | 6,786,215 |
| $ | 821,730 |
| $ | 59,964,964 |
|
Cost of sales |
| 21,645,086 |
| 17,206,738 |
| 4,954,944 |
| 1,423,927 |
| 45,230,695 |
| |||||
Gross profit |
| $ | 8,249,144 |
| $ | 5,256,051 |
| $ | 1,831,271 |
| $ | (602,197 | ) | $ | 14,734,269 |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
2005 |
|
|
|
|
|
|
|
|
|
|
| |||||
Sales |
| $ | 28,241,316 |
| $ | 21,364,393 |
| $ | 6,578,302 |
| $ | 1,819,241 |
| $ | 58,003,252 |
|
Cost of sales |
| 20,007,601 |
| 16,349,218 |
| 4,629,229 |
| 2,072,931 |
| 43,058,979 |
| |||||
Gross profit |
| $ | 8,233,715 |
| $ | 5,015,175 |
| $ | 1,949,073 |
| $ | (253,690 | ) | $ | 14,944,273 |
|
|
| Services |
| Commercial |
| Hospitality |
| Other |
| Total |
| |||||
2009 |
|
|
|
|
|
|
|
|
|
|
| |||||
Sales |
| $ | 41,080,689 |
| $ | 21,062,073 |
| $ | 9,033,771 |
| $ | 395,878 |
| $ | 71,572,411 |
|
Cost of sales |
| 28,291,495 |
| 15,675,673 |
| 6,404,185 |
| 1,720,115 |
| 52,091,468 |
| |||||
Gross profit |
| $ | 12,789,194 |
| $ | 5,386,400 |
| $ | 2,629,586 |
| $ | (1,324,237 | ) | $ | 19,480,943 |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
2008 |
|
|
|
|
|
|
|
|
|
|
| |||||
Sales |
| $ | 43,483,939 |
| $ | 30,266,493 |
| $ | 8,633,808 |
| $ | 1,936,639 |
| $ | 84,320,879 |
|
Cost of sales |
| 31,178,401 |
| 22,536,512 |
| 6,183,457 |
| 2,166,374 |
| 62,064,744 |
| |||||
Gross profit |
| $ | 12,305,538 |
| $ | 7,729,981 |
| $ | 2,450,351 |
| $ | (229,735 | ) | $ | 22,256,135 |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
2007 |
|
|
|
|
|
|
|
|
|
|
| |||||
Sales |
| $ | 37,296,596 |
| $ | 23,841,340 |
| $ | 8,004,331 |
| $ | 950,887 |
| $ | 70,093,154 |
|
Cost of sales |
| 25,876,839 |
| 18,218,088 |
| 5,997,853 |
| 1,792,620 |
| 51,885,400 |
| |||||
Gross profit |
| $ | 11,419,757 |
| $ | 5,623,252 |
| $ | 2,006,478 |
| $ | (841,733 | ) | $ | 18,207,754 |
|
Recently Issued Accounting Pronouncements
In May 2005,June 2009 the Financial Accounting Standards Board (“FASB”) issued SFAS No. 154, “Accounting Changes and Error Corrections—a replacementAccounting Standards Codification (“ASC”) 105, “Generally Accepted Accounting Principles”. ASC 105 establishes the Codification as the sole source of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS No. 154”). SFAS No. 154 requires retrospective applicationauthoritative accounting principles to prior periods’be applied in the preparation of financial statements for changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 also requires that retrospective application of a change in accounting principle be limited to the direct effects of the change. Indirect effects of a change in accounting principle should be recognized in the period of the accounting change. SFAS No. 154 also requires that a change in depreciation, amortization, or depletion method for long-lived non-financial assets be accounted for as a change in accounting estimate affected by a change in accounting principle. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Ourconformity with GAAP. The adoption of SFAS No. 154this statement did not have a material effectimpact on our consolidatedthe Company’s financial statements.position or results of operations.
In October 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-13, “Revenue Recognition - Multiple-Deliverable Revenue Arrangements”. The guidance in ASU 2009-13 amends the criteria for separating consideration in multiple-deliverable arrangements and expands required disclosures related to a company’s multiple-deliverable revenue arrangements. ASU 2009-13 is effective prospectively for fiscal years beginning on or after June 15, 2010. The Company is currently assessing the impact that adoption will have on its financial position or results of operations.
In June 2006,2009 the FASB issued Interpretation No. 48 (“FIN 48”)Company adopted ASC 855, “Subsequent Events”, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, to clarify certain aspectswhich establishes the general standards of accounting for uncertain tax position, including issues relatedand disclosures required for events occurring after the balance sheet date but before financial statements are issued or are available to be issued. Under ASC 855 the recognition and measurementeffects of those tax positions. This interpretation is effective for fiscal years beginning after December 15, 2006, and therefore we adoptedall subsequent events that provide additional evidence about conditions that existed at the statement on November 1, 2007. We have concluded a preliminary reviewdate of the impactbalance sheet, including the estimates inherent in the process of FIN 48 and we dopreparing financial statements, are required to be recognized in the financial statements. Subsequent events that provide evidence about conditions that did not expect itexist at the date of the balance sheet but arose after the balance sheet date but before financial statements are issued or are available to be issued should not be recognized in the financial statements but may need to be disclosed to prevent the financial statements from being misleading. The adoption did not have a material impact on the subsequent events that we report, either through recognition or disclosure, in our consolidated financial statements.statement.
In September 2006,November 2008 the FASB issued Statement of Financial Standards No. 157,Company adopted ASC 820, “Fair Value Measurements” (“SFAS 157”). SFAS 157Measurements and Disclosures”, which defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. This statement does not require any new fair value measurements; rather, it applies under other accounting pronouncements that require or permit fair value measurements. The provisions of SFAS 157 are effective for fiscal years beginning after November 15, 2007. The Company does not expect the adoption of SFAS 157 toASC 820 did not have a material impact on the Company’s consolidated financial position or results of operations.
In FebruaryDecember 2007 the FASB issued Statement of Financial Standards, No. 159, “The Fair Value Option for Financial AssetsASC 805, “Business Combinations”. Under ASC 805, an entity is required to recognize the assets acquired, liabilities assumed, contractual contingencies, and Financial Liabilities” (“SFAS 159”). This Statement permits companies to choose to measure many financial instruments and certain other itemscontingent consideration at their fair value on the acquisition date. It further requires that acquisition-related costs are recognized separately from the acquisition and expensed as incurred, restructuring costs generally expensed in periods subsequent to the acquisition date, and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period impact income tax expense. The adoption of ASC 805 will change the accounting treatment for business combinations on a prospective basis beginning in the first quarter of fiscal year 2010.
In December 2007 the FASB issued ASC 810, “Consolidation”. ASC 810 changes the accounting and reporting for minority interests, which will be recharacterized as non-controlling interests and classified as a component of equity. ASC 810 is effective for us on a prospective basis for business combinations with an acquisition date beginning in the first quarter of fiscal year 2010. As of October 31, 2009, the Company did not have any minority interests; therefore the adoption of this statement is not expected to have an impact on the Company’s consolidated financial statements.
In April 2008 the FASB issued guidance which was primarily codified into ASC 350 “Intangibles — Goodwill and Other”. The guidance amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of intangible assets. The intent of the guidance is to improve their financial reportingthe consistency between the useful life of a recognized intangible asset under the accounting standards and mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without havingthe period of the expected cash flows used to apply complex hedge accounting provisions. Under SFAS 159, companies may elect to usemeasure the fair value option at specified election dates on an instrument by instrument basis. The provisions of SFAS 159 are effective for fiscal years beginning on or before November 15, 2007, although early adoption is permitted.the asset. The Company expectswill adopt in the first quarter of fiscal 2010 and will apply the guidance prospectively to adopt the standard on November 1, 2008 and is currently evaluating the potential impact of any election to use the fair value option.intangible assets acquired after adoption.
F-9Other accounting standards that have been issued or proposed that do not require adoption until a future date are not expected to have a material impact on our consolidated financial statements upon adoption.
Goodwill
The Company accounts for goodwill under the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). Under SFAS 142, goodwillGoodwill recorded as a part of a business combination is not amortized, but instead is subject to at least an annual assessment for impairment by applying a fair-value-based test. Such impairment tests have been performed by management on August 1, 2007, November 1, 2006 and 2005 for
Macro-economic conditions negatively impacted our commercial systems business beginning in the years ending October 31, 2007, 2006 and 2005, respectively. The resultsfirst quarter of these assessments have indicated that no impairment has existedfiscal 2009. Those conditions worsened significantly in the third fiscal quarter. Also, uncertainty regarding the ultimate disposition of the Nortel product line grew as Nortel began divesting its assets, including assets which are strategic to the Company’s operations. Finally, the Company’s sustained decline in market capitalization continued, reflecting market uncertainty regarding the value of the Company’s operations. This combination of factors prompted the Company to conduct an interim test for impairment as of July 31, 2009. The Company engaged a consultant to assist in the valuation of the commercial systems sales and services reporting units. The Company used a combination of evaluations to estimate the fair value of its reporting units, including the following: a) an income approach by which forecasted future cash flows are discounted to present value; b) a market approach by which comparable companies values are compared to the applicable reporting unit’s values; and c) a market approach by which the Company’s own market capitalization is applied to the applicable reporting unit. Based on the results of this work, the Company determined that the carrying value of the commercial systems sales reporting unit was impaired, and the services reporting unit was not impaired. The Company recorded goodwill. Therefore, noan impairment loss has been recognized.charge of $11 million against its commercial systems sales reporting unit as an initial estimate at the end of the third quarter. The Company completed its evaluation of the fair value of this reporting unit including performing the step II analysis required by ASC 350 during the fourth quarter and increased the total goodwill impairment charge to $14.8 million.
Impairment tests were conducted as of August 1 for fiscal years 2008 and 2007 and did not reflect impairment in either the commercial systems or services reporting units.
The goodwill for tax purposes associated with the acquisition of U.S. Technologies, Inc. (which occurred November 30, 1999) exceeded the goodwill recorded on the financial statements by $1,462,000. The Company is reducing the carrying value of goodwill each accounting period to record the tax benefit realized due to the excess of tax-deductible goodwill over the reported amount of goodwill, resulting from a difference in the valuation dates used for common stock given in the acquisition. Accrued income taxes and deferred tax liabilities are being reduced as well. The Company reduced the carrying value of goodwill by $55,576 for the impact of the basis difference for both the years ended October 31, 20072009 and 2006.2008.
The changes in the carrying value of goodwill for fiscal 20072009 and 20062008 are as follows:
|
| Commercial |
| Services |
| Other |
| Total |
| ||||
Balance, November 1, 2005 |
| $ | 18,087,303 |
| $ | 8,169,985 |
| $ | 218,957 |
| $ | 26,476,245 |
|
Amortization of book versus tax basis difference |
| (41,680 | ) | (13,340 | ) | (556 | ) | (55,576 | ) | ||||
Balance, October 31, 2006 |
| 18,045,623 |
| 8,156,645 |
| 218,401 |
| 26,420,669 |
| ||||
Amortization of book versus tax basis difference |
| (41,680 | ) | (13,340 | ) | (556 | ) | (55,576 | ) | ||||
Balance, October 31, 2007 |
| $ | 18,003,943 |
| $ | 8,143,305 |
| $ | 217,845 |
| $ | 26,365,093 |
|
|
| Commercial |
| Services |
| Other |
| Total |
| ||||
Balance, November 1, 2007 |
| $ | 18,003,943 |
| $ | 8,143,305 |
| $ | 217,845 |
| $ | 26,365,093 |
|
Goodwill acquired |
| — |
| 515,981 |
| — |
| 515,981 |
| ||||
Amortization of book versus tax basis difference |
| (41,680 | ) | (13,340 | ) | (556 | ) | (55,576 | ) | ||||
Balance, October 31, 2008 |
| 17,962,263 |
| 8,645,946 |
| 217,289 |
| 26,825,498 |
| ||||
Goodwill acquired |
| 37,232 |
| 24,821 |
| — |
| 62,053 |
| ||||
Amortization of book versus tax basis difference |
| (41,680 | ) | (13,340 | ) | (556 | ) | (55,576 | ) | ||||
Impairment of Goodwill |
| (14,800,000 | ) | — |
| — |
| (14,800,000 | ) | ||||
Balance, October 31, 2009 |
| $ | 3,157,815 |
| $ | 8,657,427 |
| $ | 216,733 |
| $ | 12,031,975 |
|
Other Intangible Assets
|
| As of October 31, 2007 |
| As of October 31, 2006 |
| ||||||||
|
| Gross |
| Accumulated |
| Gross |
| Accumulated |
| ||||
Acquired customer list and other |
| $ | 227,000 |
| $ | 122,958 |
| $ | 227,000 |
| $ | 85,125 |
|
�� |
| As of October 31, 2009 |
| As of October 31, 2008 |
| ||||||||
|
| Gross |
| Accumulated |
| Gross |
| Accumulated |
| ||||
Acquired customer list and other |
| $ | 1,076,352 |
| $ | 505,612 |
| $ | 1,064,283 |
| $ | 235,458 |
|
Amortization expense of intangible assets was $270,155, $112,501 and $37,833 for the years ended October 31, 2007, 20062009, 2008 and 2005,2007, respectively. The estimated amortization expense of intangible assets is $37,833, $37,833,$214,719, $146,760, $125,927, $83,334 and $28,376$0 for fiscal years ended October 31, 2008, 20092010, 2011, 2012, 2013 and 2010,2014, respectively.
2. ACCOUNTS RECEIVABLE:
Trade accounts receivable consist of the following at October 31:
|
| 2007 |
| 2006 |
|
| 2009 |
| 2008 |
| ||||
|
|
|
|
|
|
|
|
|
|
| ||||
Trade receivables |
| $ | 16,411,981 |
| $ | 12,499,407 |
|
| $ | 14,393,681 |
| $ | 20,188,378 |
|
Less- reserve for doubtful accounts |
| 175,844 |
| 253,900 |
|
| 561,229 |
| 192,880 |
| ||||
Net trade receivables |
| $ | 16,236,137 |
| $ | 12,245,507 |
|
| $ | 13,832,452 |
| $ | 19,995,498 |
|
Adjustments to the reserve for doubtful accounts consist of the following at October 31:
|
| 2007 |
| 2005 |
| 2005 |
|
| 2009 |
| 2008 |
| 2007 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Balance, beginning of period |
| $ | 253,900 |
| $ | 298,143 |
| $ | 318,607 |
|
| $ | 192,880 |
| $ | 175,844 |
| $ | 253,900 |
|
Provision for doubtful accounts |
| — |
| — |
| 15,263 |
|
| 460,000 |
| 22,924 |
| — |
| ||||||
Net write-offs |
| (78,056 | ) | (44,243 | ) | (35,727 | ) |
| (91,651 | ) | (5,888 | ) | (78,056 | ) | ||||||
Balance, end of period |
| $ | 175,844 |
| $ | 253,900 |
| $ | 298,143 |
|
| $ | 561,229 |
| $ | 192,880 |
| $ | 175,844 |
|
F-10On January 14, 2009 Nortel Networks Corporation filed for bankruptcy protection in the United States Bankruptcy Court for the District of Delaware. The administrators of the bankruptcy have adopted a business disposal strategy. Under this strategy, the administrators have segmented Nortel into three business units: Virtual Service Switches, CDMA businesses and Enterprise Solutions. We conduct all of our Nortel business through the Enterprise Solutions unit. On December 18, 2009, Avaya completed the purchase of Nortel’s enterprise solutions business unit. Nortel is one of our major suppliers, is an important customer, and its product line represents a significant portion of our business. At the time of filing this Form 10-K, our post-petition relationship with Nortel continues without interruption. However, management recognizes the potential impact of Nortel’s filing on the Company’s financial performance. Nortel owes XETA approximately $700,000 in pre-petition accounts receivable. On July 17, 2009 the bankruptcy court granted our request for offset of $116,000 in charges we owed Nortel at the time of the filing. As of October 31, 2009 we have recorded $350,000 as a reserve against possible Nortel bad debts. Nortel has until February 1, 2010 to file its reorganization plan; however, this date is subject to further extension. Until a plan of reorganization is filed, our ability to assess the probability of recovering pre-petition amounts due is limited.
We are following developments in the bankruptcy case and will assert our legal rights and defenses as appropriate.
3. INVENTORIES:
Inventories are stated at the lower of cost (first-in, first-out or weighted-average) or market and consist of the following components at October 31:
|
| 2007 |
| 2006 |
|
| 2009 |
| 2008 |
| ||||
|
|
|
|
|
|
|
|
|
|
| ||||
Finished goods and spare parts |
| $ | 5,068,227 |
| $ | 5,565,484 |
|
| $ | 5,977,703 |
| $ | 6,084,830 |
|
Less- reserve for excess and obsolete inventories |
| 771,653 |
| 622,511 |
|
| 941,505 |
| 848,265 |
| ||||
Total inventories, net |
| $ | 4,296,574 |
| $ | 4,942,973 |
|
| $ | 5,036,198 |
| $ | 5,236,565 |
|
Adjustments to the reserve for excess and obsolete inventories consist of the following:
|
| 2007 |
| 2006 |
| 2005 |
|
| 2009 |
| 2008 |
| 2007 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Balance, beginning of period |
| $ | 622,511 |
| $ | 540,179 |
| $ | 871,809 |
|
| $ | 848,265 |
| $ | 771,653 |
| $ | 622,511 |
|
Provision for excess and obsolete inventories |
| 102,000 |
| 102,000 |
| 242,730 |
|
| 102,000 |
| 102,000 |
| 102,000 |
| ||||||
Adjustments to inventories |
| 47,142 |
| (19,668 | ) | (574,360 | ) |
| (8,760 | ) | (25,388 | ) | 47,142 |
| ||||||
Balance, end of period |
| $ | 771,653 |
| $ | 622,511 |
| $ | 540,179 |
|
| $ | 941,505 |
| $ | 848,265 |
| $ | 771,653 |
|
Adjustments to inventories in 2007, 20062009, 2008 and 20052007 included write-offs of obsolete inventory and adjustments to certain inventory values to lower of cost or market.
4. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment consist of the following at October 31:
|
| Estimated |
| 2007 |
| 2006 |
|
| Estimated |
| 2009 |
| 2008 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Building and building improvements |
| 3-20 |
| $ | 2,686,753 |
| $ | 2,397,954 |
|
| 3-20 |
| $ | 3,253,693 |
| $ | 3,054,563 |
|
Data processing and computer field equipment |
| 2-7 |
| 2,556,878 |
| 2,469,671 |
|
| 1-7 |
| 3,248,126 |
| 3,351,229 |
| ||||
Software development costs, work-in-process |
| N/A |
| 3,792,567 |
| 5,274,299 |
|
| N/A |
| 197,097 |
| 2,069,234 |
| ||||
Software development costs of components placed into service |
| 3-10 |
| 4,355,953 |
| 2,339,644 |
|
| 3-10 |
| 2,697,806 |
| 6,631,805 |
| ||||
Hardware |
| 3-5 |
| 599,751 |
| 599,751 |
|
| 3-5 |
| 643,635 |
| 615,657 |
| ||||
Land |
| - |
| 611,582 |
| 611,582 |
|
| — |
| 611,582 |
| 611,582 |
| ||||
Office furniture |
| 5-7 |
| 947,094 |
| 932,252 |
|
| 5-7 |
| 779,588 |
| 944,048 |
| ||||
Auto |
| 5 |
| 539,184 |
| 428,214 |
|
| 5 |
| 537,300 |
| 516,185 |
| ||||
Other |
| 3-7 |
| 239,533 |
| 252,780 |
|
| 3-7 |
| 149,484 |
| 239,533 |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total property, plant and equipment |
|
|
| 16,329,295 |
| 15,306,147 |
|
|
|
| 12,118,311 |
| 18,033,836 |
| ||||
Less- accumulated depreciation and amortization |
|
|
| (5,718,475 | ) | (4,821,129 | ) |
|
|
| (5,292,395 | ) | (7,311,297 | ) | ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Total property, plant and equipment, net |
|
|
| $ | 10,610,820 |
| $ | 10,485,018 |
|
|
|
| $ | 6,825,916 |
| $ | 10,722,539 |
|
Interest costs related to an investment in long-lived assets are capitalized as part of the cost of the asset during the period the asset is being prepared for use. The Company capitalized $200,000, $303,000$0, $0 and $204,000$200,000 in interest costs in fiscal years 2009, 2008 and 2007, 2006respectively. Amortization expense of software placed in service was approximately $931,000, $906,000 and 2005,$619,000 for the years ended October 31, 2009, 2008 and 2007, respectively. The estimated amortization expense of the software currently placed in service is approximately $545,000 annually for fiscal years ended October 31, 2010, 2011, 2012, 2013 and 2014.
F-11
5. ACCRUED LIABILITIES:
AccruedCurrent accrued liabilities consist of the following at October 31:
|
| 2007 |
| 2006 |
|
| 2009 |
| 2008 |
| ||||
|
|
|
|
|
|
|
|
|
|
| ||||
Vacation |
| $ | 792,958 |
| $ | 890,986 |
| |||||||
Commissions |
| $ | 1,170,749 |
| $ | 841,654 |
|
| 789,184 |
| 747,668 |
| ||
Contingent payment |
| 85,916 |
| 906,298 |
| |||||||||
Bonuses |
| 283,467 |
| 517,057 |
| |||||||||
Sales taxes |
| 71,072 |
| 314,000 |
| |||||||||
Payroll |
| 187,066 |
| 141,147 |
| |||||||||
Interest |
| 21,898 |
| 28,914 |
|
| 8,308 |
| 9,928 |
| ||||
Payroll |
| 91,039 |
| 598,077 |
| |||||||||
Bonuses |
| 469,648 |
| 280,042 |
| |||||||||
Vacation |
| 795,012 |
| 693,281 |
| |||||||||
Other |
| 1,016,685 |
| 551,863 |
|
| 1,226,425 |
| 1,066,641 |
| ||||
Total current |
| 3,565,031 |
| 2,993,831 |
| |||||||||
Accrued long-term liability |
| 211,300 |
| 436,850 |
| |||||||||
Total accrued liabilities |
| $ | 3,776,331 |
| $ | 3,430,681 |
| |||||||
Total current accrued liabilities |
| $ | 3,444,396 |
| $ | 4,593,725 |
| |||||||
6. UNEARNED SERVICES REVENUE:
Unearned services revenue consists of the following at October 31:
|
| 2007 |
| 2006 |
|
| 2009 |
| 2008 |
| ||||
|
|
|
|
|
|
|
|
|
|
| ||||
Service contracts |
| $ | 1,491,359 |
| $ | 951,683 |
|
| $ | 2,465,485 |
| $ | 1,939,247 |
|
Warranty service |
| 279,579 |
| 223,442 |
|
| 1,158,102 |
| 797,541 |
| ||||
Customer deposits |
| 399,555 |
| 572,397 |
|
| 1,529,260 |
| 458,754 |
| ||||
Other |
| 41,754 |
| 55,143 |
|
| 41,754 |
| 41,754 |
| ||||
Total current unearned revenue |
| 2,212,247 |
| 1,802,665 |
| |||||||||
Total current unearned services revenue |
| 5,194,601 |
| 3,237,296 |
| |||||||||
Noncurrent unearned services revenue |
| 81,650 |
| 79,132 |
|
| 36,691 |
| 56,393 |
| ||||
Total unearned revenue |
| $ | 2,293,897 |
| $ | 1,881,797 |
| |||||||
Total unearned services revenue |
| $ | 5,231,292 |
| $ | 3,293,689 |
| |||||||
7. INCOME TAXES:
The income tax provision for the years ended October 31, 2007, 2006,2009, 2008, and 2005,2007, consists of the following:
|
| 2007 |
| 2006 |
| 2005 |
| |||
|
|
|
|
|
|
|
| |||
Current provision (benefit) – federal |
| $ | 31,941 |
| $ | (182,005 | ) | $ | (223,285 | ) |
Current provision (benefit) – state |
| 17,886 |
| (19,203 | ) | (30,904 | ) | |||
Deferred provision |
| 891,173 |
| 691,208 |
| 575,189 |
| |||
Total provision |
| $ | 941,000 |
| $ | 490,000 |
| $ | 321,000 |
|
|
| 2009 |
| 2008 |
| 2007 |
| |||
|
|
|
|
|
|
|
| |||
Current provision — Federal |
| $ | — |
| $ | 28,034 |
| $ | 31,941 |
|
Current provision — State |
| 80,000 |
| 23,161 |
| 17,886 |
| |||
Deferred (benefit) provision |
| (6,726,000 | ) | 1,272,805 |
| 891,173 |
| |||
Total (benefit) provision |
| $ | (6,646,000 | ) | $ | 1,324,000 |
| $ | 941,000 |
|
The reconciliation of the statutory income tax rate to the effective income tax rate is as follows:
|
| Year Ended |
| ||||
|
| 2007 |
| 2006 |
| 2005 |
|
|
|
|
|
|
|
|
|
Statutory rate |
| 34 | % | 34 | % | 34 | % |
State income taxes, net of federal benefit |
| 6 | % | 7 | % | 5 | % |
Effective rate |
| 40 | % | 41 | % | 39 | % |
F-12
|
| Year Ended |
| ||||
|
| 2009 |
| 2008 |
| 2007 |
|
|
|
|
|
|
|
|
|
Statutory rate |
| 34 | % | 34 | % | 34 | % |
State income taxes, net of Federal benefit |
| 5 | % | 5 | % | 6 | % |
Effective rate |
| 39 | % | 39 | % | 40 | % |
The tax effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of October 31 are presented below:
|
| 2007 |
| 2006 |
|
| 2009 |
| 2008 |
| ||||
Deferred tax assets: |
|
|
|
|
|
|
|
|
|
| ||||
Net operating loss carryforward |
| $ | 1,285,170 |
| $ | 1,156,913 |
| |||||||
Net operating loss carry forward |
| $ | 1,183,015 |
| $ | 1,158,195 |
| |||||||
Currently nondeductible reserves |
| 320,983 |
| 256,764 |
|
| 569,871 |
| 353,000 |
| ||||
Accrued liabilities |
| 428,972 |
| 392,449 |
|
| 566,305 |
| 172,258 |
| ||||
Prepaid service contracts |
| 141,687 |
| 30,770 |
|
| 40,651 |
| 43,547 |
| ||||
Stock based compensation expense |
| 47,681 |
| — |
|
| 255,816 |
| 144,525 |
| ||||
Other |
| 35,276 |
| 40,436 |
|
| 51,302 |
| 29,488 |
| ||||
Total deferred tax asset |
| 2,259,769 |
| 1,877,332 |
|
| 2,666,960 |
| 1,901,013 |
| ||||
|
|
|
|
|
|
|
|
|
|
| ||||
Deferred tax liabilities: |
|
|
|
|
|
|
|
|
|
| ||||
Intangible assets |
| 4,379,071 |
| 3,686,779 |
|
| 68,483 |
| 5,051,498 |
| ||||
Depreciation |
| 1,576,618 |
| 1,032,788 |
|
| 701,034 |
| 1,788,933 |
| ||||
Tax income to be recognized on sales-type lease contracts |
| 19,738 |
| 20,511 |
|
| 21,876 |
| 17,348 |
| ||||
Total deferred tax liability |
| 5,975,427 |
| 4,740,078 |
|
| 791,393 |
| 6,857,779 |
| ||||
Net deferred tax liability |
| $ | (3,715,658 | ) | $ | (2,862,746 | ) | |||||||
Net deferred tax asset (liability) |
| $ | 1,875,567 |
| $ | (4,956,766 | ) | |||||||
|
| 2007 |
| 2006 |
| ||
Net deferred liability as presented on the balance sheet: |
|
|
|
|
| ||
Current deferred tax asset |
| $ | 916,259 |
| $ | 709,343 |
|
Noncurrent deferred tax liability |
| (4,631,917 | ) | (3,572,089 | ) | ||
Net deferred tax liability |
| $ | (3,715,658 | ) | $ | (2,862,746 | ) |
|
| 2009 |
| 2008 |
| ||
Net deferred tax asset (liability) as presented on the balance sheet: |
|
|
|
|
| ||
Current deferred tax asset |
| $ | 1,136,351 |
| $ | 588,926 |
|
Noncurrent deferred tax asset (liability) |
| 739,216 |
| (5,545,692 | ) | ||
Net deferred tax asset (liability) |
| $ | 1,875,567 |
| $ | (4,956,766 | ) |
The tax effect of impairment charges recognized in fiscal year 2009 resulted in a decrease in noncurrent deferred tax liabilities of approximately $7.0 million. For tax purposes the Company is amortizing its goodwill balances over a statutory life of 15 years. The combination of these tax deductions and lower levels of taxable income generated from operations in recent years has created net operating losses that are reflected in the Company’s balance sheet as deferred tax assets. Management believes that future operating income will be sufficient to realize these loss carry forwards and that no valuation allowance is required.
The Company has net operating losses of approximately $3.6 million which begin expiring in 2025.
8. CREDIT AGREEMENTS:
TheAt October 31, 2009 the Company’s credit facility consistsconsisted of a revolving credit and term loan agreement with a commercial bank including a mortgage agreement maturing on September 30, 2009 and amortizing based on a 13 year life and a $7.5 million revolving credit agreement to finance growth in working capital. The revolving line of credit iswas collateralized by trade accounts receivable and inventories. At October 31, 2007 and 2006,2009 the Company had approximately $2.759 million and $3.119 million, respectively,did not have an outstanding balance on the revolving line of credit. The Companycredit and had approximately $4.7$2.524 million available under the revolving line of creditoutstanding at October 31, 2007. Advance rates are defined in the agreement, but are generally at the rate of 80% on qualified trade accounts receivable and 40% of qualified inventories. The revolving line of credit matures on September 23, 2008. Long-term debt consisted of the following at October 31:
|
| 2007 |
| 2006 |
|
| 2009 |
| 2008 |
| ||||
|
|
|
|
|
|
|
|
|
|
| ||||
Real estate term note, payable in monthly installments of $14,257 plus interest, plus a fixed payment of $1,198,061 due September 30, 2009, collateralized by a first mortgage on the Company’s building |
| $ | 1,525,653 |
| $ | 1,697,073 |
| |||||||
Real estate term note, payable with a fixed payment of $1,183,475 due November 30, 2009, collateralized by a first mortgage on the Company’s building |
| $ | 1,183,475 |
| $ | 1,354,565 |
| |||||||
|
|
|
|
|
|
|
|
|
|
| ||||
Less-current maturities |
| 171,123 |
| 171,123 |
|
| 1,183,475 |
| 1,354,565 |
| ||||
|
|
|
|
|
|
|
|
|
|
| ||||
Total long-term debt, less current maturities |
| $ | 1,354,530 |
| $ | 1,525,950 |
|
| $ | — |
| $ | — |
|
Maturities of long-term debt for each of the years ended October 31, are as follows:
2008 | 171,123 |
|
2009 | 1,354,530 |
|
2010 | $ | 1,183,475 |
Interest on all outstanding debt under the credit facility accrues at either a) the London Interbank Offered Rate (“LIBOR”) (4.71% at October 31, 2007) plus 1.25% to 2. 5% depending on the Company’s funded debt to cash flow ratio, or b) the bank’s prime rate (7.5% at October 31, 2007) minus 0% to minus 1.125% also depending on the Company’s funded debt to cash flow ratio. At October 31, 2007,2009 the Company was paying 6.375%6.24% on the revolving line of credit borrowings and 6.621% on the mortgage note.
In November 2009, the Company entered into a one year loan agreement with a new financial institution, replacing the previous credit facility which was scheduled to mature on November 30, 2009. The new loan agreement consists of an $8.5 million revolving credit agreement collateralized by trade accounts receivable, inventories, and real estate. Advance rates are defined in the agreement, but are generally at the rate of 75% on qualified trade accounts receivable and 50% of qualified inventories and real estate. The credit facility contains several financial covenants common in such agreements including tangible net worth requirements, limitations on the amount of funded debt to annual earnings before interest, taxes, depreciation and amortization, limitations on capital spending,cash dividends, and debt service coverage requirements. AtInterest on the new loan agreement accrues at the greater of either a) the London Interbank Offered Rate (“LIBOR”) (0.24% at October 31, 2007, the Company was either in compliance with the covenants of the credit facility2009) plus 3.00% or had received the appropriate waivers from its bank.b) 4.5%.
9. STOCK-BASED INCENTIVE AWARDS:
In fiscal 2004 the Company’s stockholders approved the “2004 Omnibus Stock Incentive Plan” (“2004 Plan”) for officers, directors and employees. The 2004 Plan authorizes the grant of up to 600,000 shares of common stock and includes an evergreen feature so that such number will automatically increase on November 1 of each year during the term of the 2004 Plan by three percent of the total number of outstanding shares of common stock outstanding on the previous October 31. Awards available for issuance under the 2004 Plan include nonqualified and incentive stock options, restricted stock, and other stock-based incentive awards such as stock appreciation rights or phantom stock. The evergreen feature does not apply to incentive stock options. The 2004 Plan is administered by the Compensation Committee of the Board of Directors.
In fiscal 2000 the Company’s shareholders approved a stock option plan (“2000 Plan”) for officers, directors and key employees. The 2000 Plan replaced the previous 1988 Plan, which had expired. Under the 2000 Plan, the Board of Directors, or a committee thereof, determine the option price, not to be less than fair market value at the date of grant, number of options granted, and the vesting period. Although there are exceptions, generally
During the fourth quarter of fiscal 2009, the Company made a tender offer to holders of certain underwater options that have been grantedwhich had an exercise price greater than $2.95, but not higher than $4.14, in exchange for a new option with an exercise price of $2.54, a term of 6 years, and a vesting schedule of 50% after one year of service and 25% after two and three years of service, respectively. The exchange ratio, the number of old options surrendered for each new option, was calculated based on the fair values of the options surrendered and issued under a value-for-value exchange. No additional compensation expense was recognized as a result of the 2000 Plan expire ten years fromoption exchange. Under the dateprogram 292,100 options were surrendered out of grant, have three-year cliff-vesting, and are incentive stocka total eligible number of 386,800 options as defined under the applicable Internal Revenue Service tax rules. Options granted under the previous 1988 Plan generally vested 33 1/3% per year after a one-year waiting period. in exchange for 198,999 new options with terms outlined above.
The following table summarizes information concerning options outstanding under the 2004, 2000 and 1988 Plans including the related transactions for the fiscal years ended October 31, 2005, 2006,2007, 2008, and 2007:2009:
|
| Number |
| Weighted |
| Weighted Average |
|
| Number |
| Weighted |
| Weighted Average |
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Balance, October 31, 2004 |
| 558,172 |
| $ | 7.69 |
|
|
| ||||||||||
Forfeited |
| (19,900 | ) | $ | 9.03 |
|
|
| ||||||||||
Balance, October 31, 2005 |
| 538,272 |
| $ | 7.64 |
|
|
| ||||||||||
Granted |
| 160,000 |
| $ | 2.95 |
| $ | 2.95 |
| |||||||||
Exercised |
| (36,504 | ) | $ | 1.64 |
|
|
| ||||||||||
Forfeited |
| (16,200 | ) | $ | 6.60 |
|
|
| ||||||||||
Balance, October 31, 2006 |
| 645,568 |
| $ | 6.84 |
|
|
|
| 635,268 |
| $ | 6.80 |
|
|
| ||
Granted |
| 100,000 |
| $ | 3.24 |
| $ | 2.20 |
|
| 100,000 |
| $ | 3.24 |
| $ | 2.29 |
|
Exercised |
| — |
| — |
|
|
|
| — |
| — |
|
|
| ||||
Forfeited |
| (86,800 | ) | $ | 5.28 |
|
|
|
| (76,900 | ) | $ | 4.79 |
|
|
| ||
Balance, October 31, 2007 |
| 658,768 |
| $ | 6.50 |
|
|
|
| 658,368 |
| $ | 6.50 |
|
|
| ||
Granted |
| 80,000 |
| $ | 4.08 |
| $ | 2.45 |
| |||||||||
Exercised |
| (22,664 | ) | $ | 3.98 |
|
|
| ||||||||||
Forfeited |
| (52,604 | ) | $ | 6.43 |
|
|
| ||||||||||
Balance, October 31, 2008 |
| 663,100 |
| $ | 6.41 |
|
|
| ||||||||||
Granted |
| 120,000 |
| $ | 1.76 |
| $ | 1.10 |
| |||||||||
Issued under Option Exchange |
| 198,999 |
| $ | 2.54 |
| $ | 1.18 |
| |||||||||
Forfeited |
| (12,900 | ) | $ | 4.59 |
|
|
| ||||||||||
Cancelled in Option Exchange |
| (292,100 | ) | $ | 3.44 |
|
|
| ||||||||||
Balance, October 31, 2009 |
| 677,099 |
| $ | 5.81 |
|
|
| ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Exercisable at October 31, 2009 |
| 338,100 |
| $ | 9.28 |
|
|
| ||||||||||
Exercisable at October 31, 2008 |
| 335,600 |
| $ | 9.53 |
|
|
| ||||||||||
Exercisable at October 31, 2007 |
| 398,768 |
| $ | 8.74 |
|
|
|
| 398,768 |
| $ | 8.74 |
|
|
| ||
Exercisable at October 31, 2006 |
| 485,568 |
| $ | 8.12 |
|
|
| ||||||||||
Exercisable at October 31, 2005 |
| 538,272 |
| $ | 7.64 |
|
|
| ||||||||||
The 338,100 options outstanding and exercisable at October 31, 2009 under the 2004 Plan and the 2000 Plan had no intrinsic value. The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option. Exercise prices for options outstanding at October 31, 2009, ranged from $1.59 to $18.13. The weighted-average fair value of options vested in fiscal 2009 and 2008 was $1.86 and $2.24 per share, respectively. No shares vested in fiscal 2007.
The Company has also granted options outside the 1988 Plan, 2000 Plan, and 2004 Plan to certain officers and directors.directors typically as an inducement to accept employment or a seat on the Board. These options generally expire ten years from the date of grant and are exercisable over the period stated in each option. The following table summarizes information
concerning options outstanding under various Officer and Director Plans (“O&D Plans”) including the related transactions for the fiscal years ended October 31, 2005, 2006,2007, 2008, and 2007:2009:
|
| Number |
| Weighted Average |
| |
|
|
|
|
|
| |
Balance, October 31, 2005 and 2006 |
| 620,000 |
| $ | 6.44 |
|
Forfeited |
| (40,000 | ) | 15.53 |
| |
Balance, October 31, 2007 |
| 580,000 |
| $ | 5.81 |
|
|
|
|
|
|
| |
Exercisable at October 31, 2007 |
| 580,000 |
| $ | 5.81 |
|
Exercisable at October 31, 2006 |
| 620,000 |
| $ | 6.44 |
|
Exercisable at October 31, 2005 |
| 620,000 |
| $ | 6.44 |
|
|
| Number |
| Weighted Average |
| |
|
|
|
|
|
| |
Balance, October 31, 2007, 2008 |
| 630,000 |
| $ | 6.48 |
|
Forfeited |
| (180,000 | ) | $ | 5.81 |
|
Balance, October 31, 2009 |
| 450,000 |
| $ | 6.75 |
|
|
|
|
|
|
| |
Exercisable at October 31, 2009 |
| 450,000 |
| $ | 6.75 |
|
Exercisable at October 31, 2008 |
| 630,000 |
| $ | 6.48 |
|
Exercisable at October 31, 2007 |
| 630,000 |
| $ | 6.48 |
|
F-14The 450,000 options outstanding and exercisable at October 31, 2009 under the O&D Plans had no intrinsic value. Exercise prices for options outstanding at October 31, 2009, ranged from $5.82 to $15.53. All the shares issued under the O&D Plans were vested prior to fiscal 2007.
The following is a summary of all stock options outstanding as of October 31, 2007:2009:
|
| Options Outstanding |
| Options Exercisable |
| |||||||||
Range of |
| Number |
| Weighted |
| Weighted |
| Number |
| Weighted |
| |||
$2.95 |
|
| 160,000 |
| $ | 2.95 |
| 3.97 |
| — |
| $ | 2.95 |
|
$3.12-3.25 |
|
| 100,000 |
| $ | 3.24 |
| 6.46 |
| — |
| 3.24 |
| |
$3.63-5.79 |
|
| 249,568 |
| $ | 3.82 |
| 3.04 |
| 249,568 |
| $ | 3.82 |
|
$ 5.81 |
|
| 580,000 |
| $ | 5.81 |
| 1.63 |
| 580,000 |
| $ | 5.81 |
|
$5.85-12.00 |
|
| 21,850 |
| $ | 10.26 |
| 2.98 |
| 21,850 |
| $ | 10.26 |
|
$ 18.13 |
|
| 127,350 |
| $ | 18.13 |
| 2.47 |
| 127,350 |
| $ | 18.13 |
|
|
| Options Outstanding |
| Options Exercisable |
| ||||||||
Range of |
| Number |
| Weighted |
| Weighted |
| Number |
| Weighted |
| ||
$1.59 |
| 10,000 |
| $ | 1.59 |
| 9.47 |
| — |
| — |
| |
$1.77 |
| 110,000 |
| $ | 1.77 |
| 5.63 |
| — |
| — |
| |
$2.54 |
| 198,999 |
| $ | 2.54 |
| 5.96 |
| — |
| — |
| |
$2.95-3.25 |
| 95,000 |
| $ | 3.03 |
| 2.68 |
| 95,000 |
| $ | 3.03 |
|
$3.63 |
| 95,600 |
| $ | 3.63 |
| 2.20 |
| 95,600 |
| $ | 3.63 |
|
$4.30 |
| 10,000 |
| $ | 4.30 |
| 4.26 |
| — |
| — |
| |
$5.81 |
| 400,000 |
| $ | 5.81 |
| 1.25 |
| 400,000 |
| $ | 5.81 |
|
$9.05-11.64 |
| 31,650 |
| $ | 9.88 |
| 0.92 |
| 31,650 |
| $ | 9.88 |
|
$15.53 |
| 40,000 |
| $ | 15.53 |
| 3.33 |
| 40,000 |
| $ | 15.53 |
|
$18.13 |
| 125,850 |
| $ | 18.13 |
| 0.46 |
| 125,850 |
| $ | 18.13 |
|
Restricted Stock
Shares of restricted stock have been granted out of the 2004 Plan to certain key employees and executives to provide long-term incentive compensation opportunities. The restricted shares vest in equal portions over three years. The fair value of our restricted shares is determined based on the closing price of our stock on the date of grant and is recognized straight line over the vesting period. Restricted shares issued to key employees were 14,500 and 16,905 in fiscal years 2009 and 2008, respectively. In late fiscal 2008, the Compensation Committee of the Board of Directors established equity ownership targets for senior executives and designated a portion of any annual bonuses to be paid in shares restricted stock if the executive has not met his targets. Restricted shares issued in fiscal 2009 to executives in lieu of cash bonuses were 24,416.
A summary of restricted stock activity under the 2004 Plan is as follows:
|
| Number of |
| Weighted |
| Aggregate |
| ||
|
|
|
|
|
|
|
| ||
Balance, October 31, 2007 |
| — |
|
|
|
|
| ||
Granted |
| 16,905 |
| $ | 4.03 |
| $ | 28,739 |
|
Balance, October 31, 2008 |
| 16,905 |
| $ | 4.03 |
|
|
| |
Granted |
| 38,916 |
| $ | 1.75 |
| $ | 97,290 |
|
Balance, October 31, 2009 |
| 55,821 |
| $ | 2.44 |
|
|
| |
|
|
|
|
|
|
|
| ||
Vested at October 31, 2009 |
| 5,635 |
| $ | 4.03 |
| $ | 14,088 |
|
Vested at October 31, 2008 |
| — |
|
|
|
|
| ||
At October 31, 2009 there was $73,249 of unrecognized compensation expense related to restricted stock that is expected to be recognized over a weighted-average period of 1.8 years.
10. EARNINGS PER SHARE:
All basic earnings per common share were computed by dividing net income by the weighted average number of shares of common stock outstanding during the reporting period. A reconciliation of net income and weighted average shares used in computing basic and diluted earnings per share is as follows:
|
| For the Year Ended October 31, 2007 |
|
| For the Year Ended October 31, 2009 |
| ||||||||||||
|
| Income |
| Shares |
| Per Share |
|
| Income |
| Shares |
| Per Share |
| ||||
Basic EPS |
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net income |
| $ | 1,432,420 |
| 10,214,741 |
| $ | 0.14 |
| |||||||||
Net loss |
| $ | (10,316,545 | ) | 10,223,626 |
| $ | (1.01 | ) | |||||||||
Dilutive effect of stock options |
|
|
| — |
|
|
|
|
|
| — |
|
|
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Diluted EPS |
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net income |
| $ | 1,432,420 |
| 10,214,741 |
| $ | 0.14 |
| |||||||||
Net loss |
| $ | (10,316,545 | ) | 10,223,626 |
| $ | (1.01 | ) | |||||||||
|
| For the Year Ended October 31, 2006 |
|
| For the Year Ended October 31, 2008 |
| ||||||||||||
|
| Income |
| Shares |
| Per Share |
|
| Income |
| Shares |
| Per Share |
| ||||
Basic EPS |
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net income |
| $ | 718,535 |
| 10,208,250 |
| $ | 0.07 |
|
| $ | 2,056,434 |
| 10,249,671 |
| $ | 0.20 |
|
Dilutive effect of stock options |
|
|
| 1,996 |
|
|
|
|
|
| — |
|
|
| ||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Diluted EPS |
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||
Net income |
| $ | 718,535 |
| 10,210,246 |
| $ | 0.07 |
|
| $ | 2,056,434 |
| 10,249,671 |
| $ | 0.20 |
|
|
| For the Year Ended October 31, 2005 |
| ||||||
|
| Income |
| Shares |
| Per Share |
| ||
Basic EPS |
|
|
|
|
|
|
| ||
Net income |
| $ | 494,455 |
| 10,087,279 |
| $ | 0.05 |
|
Dilutive effect of stock options |
|
|
| 29,415 |
|
|
| ||
|
|
|
|
|
|
|
| ||
Diluted EPS |
|
|
|
|
|
|
| ||
Net income |
| $ | 494,455 |
| 10,116,694 |
| $ | 0.05 |
|
F-15
|
| For the Year Ended October 31, 2007 |
| ||||||
|
| Income |
| Shares |
| Per Share |
| ||
Basic EPS |
|
|
|
|
|
|
| ||
Net income |
| $ | 1,432,420 |
| 10,214,741 |
| $ | 0.14 |
|
Dilutive effect of stock options |
|
|
| — |
|
|
| ||
|
|
|
|
|
|
|
| ||
Diluted EPS |
|
|
|
|
|
|
| ||
Net income |
| $ | 1,432,420 |
| 10,214,741 |
| $ | 0.14 |
|
For the years ended October 31, 2007, 2006,2009, 2008, and 2005,2007, respectively, stock options for 1,333,880 shares at an average exercise price of $6.16, 1,016,940 shares at an average exercise price of $7.33, and 1,111,441 shares at an average exercise price of $7.16, 1,121,668 shares at an average exercise price of $7.17, and 843,017 shares at an average exercise price of $8.40, were excluded from the calculation of earnings per share because they were antidilutive.
11. FINANCING RECEIVABLES:
A small portion of the Company’s systems sales are made under sales-type lease agreements with the end-users of the
equipment. These receivables are secured by the cash flows under the leases and the equipment installed at the customers’ premises. Minimum future annual payments to be received under various leases are as follows for years ended October 31:
|
| Sales-Type |
| |
|
|
|
| |
2008 |
| $ | 169,280 |
|
2009 |
| 108,047 |
| |
2010 |
| 33,033 |
| |
|
| 310,360 |
| |
Less- imputed interest |
| 37,603 |
| |
Present value of minimum payments |
| $ | 272,757 |
|
12. MAJOR CUSTOMERS, SUPPLIERS AND CONCENTRATIONS OF CREDIT RISK:
Marriott International, Host Marriott, and other affiliated companies (“Marriott”) represent a single customer relationship for our Company and are a major customer. Revenues earned from Marriott represented 8%10%, 10%8%, and 13%11% of our total revenues in fiscal 2009, 2008 and 2007, 2006respectively. Miami-Dade County Public School systems (“M-DCPS”) is a major customer and 2005,revenues earned from M-DCPS represented 5%, 16%, and 5% of our total revenues in fiscal years 2009, 2008, and 2007, respectively.
The Company extends credit to its customers in the normal course of business, including under its sales-type lease program. As a result, the Company is subject to changes in the economic and regulatory environments or other conditions, which in turn may impact the Company’s overall credit risk. However, the Company sells to a wide variety of customers and, except for its hospitality customers, does not focus its sales and marketing efforts on any particular industry. Management considers the Company’s credit risk to be satisfactorily diversified and believes that the allowance for doubtful accounts is adequate to absorb estimated losses at October 31, 2007.2009.
The majority of the Company’s systems sales are derived from sales of equipment designed and marketed by Avaya, Nortel, or Nortel.Mitel. As such, the Company is subject to the risks associated with these companies’ financial condition, ability to continue to develop and market leading-edge technology systems, and the soundness of their long-term product strategies. Both Avaya and Nortel have outsourced their manufacturing operations to single, separate manufacturers. Thus, the Company is subject to certain additional risks such as those that might be caused if the manufacturers incur financial difficulties or if man-made or natural disasters impact their manufacturing facilities. The Company purchases most of its Avaya and Nortel products from two distributors who have common ownership. Avaya has one other distributor that could quickly supply the Company’s business. Nortel products can be purchased from several distributors and the Company makes frequent purchases from those other distributors. The Company believes that both its Avaya and Nortel purchases could be quickly converted to the other available distributors without a material disruption to its business. Mitel products are purchased directly from Mitel to receive certain additional pricing advantages, but the products can be purchased from a variety of distributors as well.
13. EMPLOYMENT AGREEMENTS:
The Company has two incentive compensation plans: one for sales professionals and sales management and onethe Employee Bonus Plan (“EBP”) for all other employees. The bonus plan for sales personnel is based on either gross profit generated or a percentage of their “contribution”, defined as the gross profit generated less their direct and allocated sales expenses. The Company paid $366,397, $474,634 and $422,930 $256,626during 2009, 2008 and $309,424 during 2007, 2006 and 2005, respectively, under the sales professionals’ bonus plan. The Employee Bonus Plan (“EBP”) provides an annual incentive compensation opportunity for senior executives and other employees designated by senior managementexecutives and the Board of Directors as key employees. The purpose of the EBP is to provide an incentive for senior executives and to reward key employees for leadership and excellent performance. In fiscal 2007, 20062009, 2008 and 2005,2007, the Company accrued bonuses of approximately $151,000, $418,000 and $350,000, $197,000 and $150,000, respectively.
F-16
14. CONTINGENCIES:
In addition to potential losses related to Nortel’s pre-petition receivables, the Company may be subject to preference payment claims asserted by Nortel. It is routine in bankruptcy proceedings for the debtor in possession or bankruptcy trustee to assert a statutory “preference claim” to seek to recover payments made by the bankrupt entity to creditors during the 90-day period immediately preceding the filing of the bankruptcy petition. This period is known as the “preference period.” Although the debtor is entitled to make a claim based solely upon when the payments were made, the payments are not recoverable if they were made in the debtor’s ordinary course of dealings with the creditor. Nortel has filed a schedule showing approximately $1.6 million in payments made to the Company during the preference period, but to date has not asserted a preference claim against the Company. The Company has good defenses to any such potential claim against it, including that the subject payments were made in the ordinary course of the Company’s business dealings with Nortel. If a preference claim is brought, these defenses must be argued as to each individual invoice for which the Company received payment during the preference period. In light of the fact that a claim has not been asserted and the Company has not fully evaluated its potential defenses as against each individual invoice, the Company is unable at this time to determine the extent, if any, of any material loss that might occur if a claim to recover preference payments was asserted. Therefore, no provision for loss has been made beyond the amount discussed above related to unpaid invoices at
the time of the bankruptcy filing.
Operating Lease Commitments
Future minimum commitments under non-cancelable operating leases for office space and equipment are approximately $262,000, $131,000, $86,000$483,000, $202,000 $117,000, $47,000 and $11,000$3,000 in fiscal years 2010 through 2014, respectively.
Capital Lease Commitments
During 2008 through 2011, respectively.the Company leased software licenses under an agreement that is classified as a capital lease. The book value of the licenses is included in the balance sheet as property, plant, and equipment and was $253,622 at October 31, 2009. Accumulated amortization of the licenses at October 31, 2009 was $202,898. Amortization of assets under the capital lease is included in depreciation expense. The future minimum lease payments required under the capital lease and the present value of the net minimum lease payments as of October 31, 2009, are as follows:
|
| Capital |
| |
|
|
|
| |
2010 |
| $ | 161,435 |
|
2011 |
| 107,624 |
| |
Total minimum lease payments |
| 269,059 |
| |
Less- imputed interest |
| 8,911 |
| |
Present value of minimum payments |
| 260,148 |
| |
Less-current maturities of capital lease obligation |
| 154,072 |
| |
Long-term capital lease obligation |
| $ | 106,076 |
|
15. RETIREMENT PLAN:
The Company has a 401(k) retirement plan (“Plan”). In addition to employee contributions, the Company makesmade discretionary matching and profit sharing contributions to the Plan based on percentages set by the Board of Directors. The company’s discretionary matching contributions were suspended as part of a cost reduction plan that was executed in the third fiscal quarter. Contributions made by the Company to the Plan were approximately $621,000, $564,000$521,000, $712,000 and $547,000$621,000 for the years ended October 31, 2007, 2006,2009, 2008, and 2005,2007, respectively.
16. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):SUBSEQUENT EVENTS:
The following quarterly financial data has been prepared from the financial recordsIn connection with preparation of the Consolidated Financial Statements for fiscal year ended October 31, 2009, the Company withouthas evaluated subsequent events for potential recognition and disclosures through January 5, 2010, the date of financial statement issuance.
On November 6, 2009, the Company entered into loan agreement with a new banking institution, replacing the previous credit facility which was scheduled to mature on November 30, 2009. The new credit facility is more fully described in Note 8 above.
On November 10, 2009, the Company was named as an audit,additional defendant in a lawsuit originally filed on March 16, 2009 by Pangaia Partners against two of Pangaia’s former employees who subsequently went to work for the Company. The lawsuit was filed in Superior Court of New Jersey Law Division, Bergen County. Pangaia’s claims against the Company are made in relation to a Nortel account to which the employee defendants were assigned when they worked for Pangaia and reflects all adjustments, which in the opinion of management were of a normal, recurring nature and necessary for a fair presentationthey now service as employees of the resultsCompany. Pangaia’s claims against the Company and the individual defendants include unfair competition, tortuous interference with prospective economic advantage, tortuous interference with contract, misappropriation of operations fortrade secrets, conversion and unjust enrichment. In its original claim against its former employees, Pangaia sought but was denied a preliminary injunction to enforce non-competition agreements. Pangaia now seeks monetary damages against all defendants, but has not alleged a specific dollar amount. A preliminary investigation indicates the interim periods presented.claims are without merit and the Company expects to mount a vigorous defense.
|
| For the Fiscal Year Ended October 31, 2007 |
| ||||||||||
|
| Quarter Ended |
| ||||||||||
|
| January 31, |
| April 30, |
| July 31, |
| October 31, |
| ||||
|
| (in thousands, except per share data) |
| ||||||||||
|
|
|
|
|
|
|
|
|
| ||||
Net sales |
| $ | 16,051 |
| $ | 16,689 |
| $ | 18,248 |
| $ | 19,105 |
|
Gross profit |
| 3,952 |
| 4,199 |
| 4,529 |
| 5,528 |
| ||||
Operating income |
| 283 |
| 339 |
| 641 |
| 1,154 |
| ||||
Net income |
| 170 |
| 208 |
| 377 |
| 677 |
| ||||
Basic EPS |
| $ | 0.02 |
| $ | 0.02 |
| $ | 0.04 |
| $ | 0.06 |
|
Diluted EPS |
| $ | 0.02 |
| $ | 0.02 |
| $ | 0.04 |
| $ | 0.06 |
|
|
| For the Fiscal Year Ended October 31, 2006 |
| ||||||||||
|
| Quarter Ended |
| ||||||||||
|
| January 31, |
| April 30, |
| July 31, |
| October 31, |
| ||||
|
| (in thousands, except per share data) |
| ||||||||||
|
|
|
|
|
|
|
|
|
| ||||
Net sales |
| $ | 12,683 |
| $ | 14,894 |
| $ | 15,660 |
| $ | 16,728 |
|
Gross profit |
| 2,776 |
| 3,536 |
| 4,160 |
| 4,262 |
| ||||
Operating income |
| (152 | ) | 118 |
| 482 |
| 888 |
| ||||
Net income |
| (141 | ) | 57 |
| 286 |
| 516 |
| ||||
Basic EPS |
| $ | (0.01 | ) | $ | 0.01 |
| $ | 0.02 |
| $ | 0.05 |
|
Diluted EPS |
| $ | (0.01 | ) | $ | 0.01 |
| $ | 0.02 |
| $ | 0.05 |
|
