UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
(Amendment No. 1)
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| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
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For the fiscal year ended October 31, 2005 | ||
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| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
Commission file number 0-16231
XETA Technologies, Inc.
(Exact name of registrant as specified in its charter)
Oklahoma |
| 73-1130045 |
(State or other jurisdiction of incorporation or |
| (I.R.S. Employer Identification No.) |
organization) |
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1814 West Tacoma Street, Broken Arrow, Oklahoma |
| 74012 |
(Address of principal executive offices) |
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Registrant’s telephone number including area code (918) 664-8200 | ||
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Securities registered pursuant to Section 12(g) of the Act: | ||
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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 ý
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 ý
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 ý No o
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. ý
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes o No ý
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes o No ý
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 29, 2005, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $23,966,520.
The number of shares outstanding of the registrant’s Common Stock as of December 22, 2005 was 10,178,237.
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 4, 2006 are incorporated by reference into Part III, Items 10 through 14 hereof.
EXPLANATORY NOTE
We are filing this Amendment No. 1 on Form 10-K/A solely to correct: (1) inadvertent errors in the long-term debt amounts and, consequently, the total amounts shown in the Contractual Obligations table contained in the Liquidity and Capital Resources section of Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) contained in Item 7 of our original Report on Form 10-K filed on January 9, 2006 (the “Original Report”); (2) a typographical error that appeared in Note 8 “Credit Agreements” of the Company’s Notes to Consolidated Financial Statements contained in Item 8 of our Original Report; specifically, the maturity date given for the revolving line of credit was incorrectly stated as “September 28, 2009,” and is being corrected to “September 28, 2006.” The correct maturity date of September 28, 2006 was used in our discussion of the revolving line of credit in the MD&A of our Original Report; and (3) the inadvertent omission of a check mark on the cover page of our Original Report in the box following the statement “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.”
In order to comply with certain technical requirements of the SEC’s rules in connection with the filing of this amendment on Form 10-K/A, we are including in this amendment (i) the complete text of Item 7 (Management’s Discussion and Analysis of Financial Condition and Results of Operations), (ii) the complete text of Item 8 (Financial Statements and Supplementary Data), and (iii) Item 15 (Exhibits and Financial Statement Schedules) to reflect the inclusion of the financial statements filed with this amendment, and the filing of updated certifications of our principal executive and principal financial officers and updated Consents of Independent Registered Public Accounting Firm.
This Amendment No. 1 to our Report on Form 10-K as originally filed on January 9, 2006 continues to speak as of the date of our Original Report, and we have not updated the disclosures contained in this Amendment No. 1 to reflect any events that occurred at a date subsequent to the filing of the Original Report.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
In fiscal 2005 we continued our strategies of rebalancing our sales efforts to support both the Avaya and Nortel product lines and to expand our services business. To execute this strategy, we continued to invest heavily in our sales department and technical forces. Over the past two years, we have increased our sales expenses to hire new personnel with experience selling Nortel products and to increase sales management to provide more accountability for revenue production. Similarly, in the services area we have acquired more technical expertise to support our Nortel service initiatives and to support certain geographical areas. These investments have been made with our long-term future in mind as we believe that it is important to quickly establish ourselves as a leading provider of enterprise-class communications solutions while this market continues to develop. These investments, coupled with flat revenues, reduced vendor incentives, and increased amortization and support costs associated with our technology infrastructure, produced lower income from operations in fiscal 2005. However, we believe we are on the right course to produce above-market, sustainable and profitable revenue growth in the future.
In July 2005 Greg Forrest was named President and Chief Operating Officer of the Company. Jack Ingram remains Chairman and Chief Executive Officer. Since Mr. Forrest’s appointment, the Company has focused heavily on revenue growth by establishing new structures and processes to support our existing sales organization and enable organic growth. Additionally, we have focused on selling services. This initiative, which is part of our “managed services” line of business, began to produce revenues in the fourth fiscal quarter and will continue to be
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a major emphasis in fiscal 2006. As part of the Managed Services initiative, we have begun to earn services revenues from major Nortel customers who need a nationwide vendor to provide on-site assistance for non-telephony communications, networking, and other technology related projects. By positioning the Company as on-site “hands and eyes” for these large customers, we are able to expand the range of services we can perform for them beyond telephony. Typically, these additional services, such as checking or upgrading security systems, fax machines, and networking components are performed at the direction of the customer’s in-house technical experts and may not require specific technical education beyond a basic understanding of wiring and technology.
We continue to be very optimistic about our long-term prospects. IP-based communications systems continue to gain market acceptance, the market for software applications to run on these systems is rapidly developing, and we believe we are well positioned in this market to be successful. In addition to selling products and related software applications, we believe our services business will continue to grow more rapidly than will our systems sales. We believe the initiatives discussed above represent substantial opportunities for new services growth independent of the growth in services that naturally follows from sales of systems to customers.
The discussion that follows provides more details regarding the factors and trends which affected our financial results, liquidity, and capital resources in fiscal 2005 when compared to the previous year.
Results of Operations
Year ending October 31, 2005 compared to October 31, 2004.
Net revenues for fiscal 2005 were $58.0 million compared to $58.8 million in fiscal 2004, a 1% decrease. Net income for fiscal 2005 was $0.494 million compared to $1.6 million in fiscal 2004. Discussed below are the major revenue, gross margin, and operating expense items that affected our financial results during fiscal 2005.
Systems Sales. Sales of systems and equipment were $27.9 million in fiscal 2005 compared to $31.3 million in fiscal 2004. These results include sales of systems to Commercial customers of $21.4 million in fiscal 2005 compared to $25.9 million in fiscal 2004 and sales of systems to Hospitality customers of $6.6 million in fiscal 2005 compared to $5.0 million in fiscal 2004. The decline in sales of systems to Commercial customers reflects the fewer number of large projects we received in fiscal 2005 compared to the prior year. Most of these larger projects were recognized as revenues in the first quarter of fiscal 2004 and 70% of the decline in systems sales to Commercial customers occurred in that quarter. In the fourth quarter of the fiscal year, our systems sales to Commercial customers had recovered to fourth quarter fiscal 2004 levels, reflecting both improved sales of Avaya systems and increased traction in our Nortel systems sales initiatives. The 24% improvement in year-over-year sales of systems to Lodging customers reflects improved financial conditions in that vertical market and significantly increased new construction activity by our largest customer in that segment.
Based upon the improvements we began to see in the fourth fiscal quarter, we believe that our sales of Nortel systems will continue to improve in fiscal 2006. Also, at the end of fiscal 2005 we expanded our Avaya sales force to resume expansion of that product line as well.
Services. Revenues earned from service related activities were $28.2 million in fiscal 2005 compared to $26.5 million in fiscal 2004. This increase consisted of increases in revenues from services provided by both the NSC and our installation department. The revenues earned by the NSC reflect higher sales of T&M services as discussed above, as well as higher revenues earned from cabling services sold during the year. As part of our acquisition of Bluejack in fiscal 2004, we launched a national cabling initiative to increase the market awareness of our capabilities in this area. These efforts were very successful and increases in cabling revenues represented approximately 28% of the total increase in services revenues in fiscal 2005. The other major component of our NSC revenues is our maintenance contract base. Revenues earned from maintenance contracts represented approximately 52% of total Services revenues and was relatively unchanged from the previous year.
Despite experiencing lower sales of systems during fiscal 2005, our installation services revenues were flat during the year. This was due to an installation contract we received at the beginning of the fiscal year to install a series of systems for the Metropolitan Transit Authority of Atlanta (“MARTA”) and due to improved sales of systems to lodging customers. Under the MARTA contract, we were engaged as a subcontractor to perform a series
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of installations of equipment upgrades to the MARTA communications network and provide training at the various upgrade locations. The majority of the services revenues from the MARTA project were recorded during the second quarter. There were no equipment revenues recorded by us under this contract as another dealer won that portion of the MARTA contract. As such, the MARTA contract represents an example of how we are positioning the services segment of our business to be less dependent on systems sales revenues to generate revenue growth. We believe that there is a substantial market available to earn revenues from installation related activities unrelated to sales of systems to our customers. Most of these installation opportunities would likely be Nortel related products.
Gross Margins. Gross margins were 24.2% in fiscal 2005 and in fiscal 2004.
Gross margins on systems sales were 24.9% in fiscal 2005 compared to 23.7% in fiscal 2004. This 1.2 point increase in gross margins on systems sales was achieved through careful focus and controls around contract acceptance and margin reviews and a mix of fewer large, low-margin projects. These factors more than offset the continued tightening of cost of goods sold rebate programs by our major vendors, primarily Avaya. In fiscal 2004 these programs, in which we receive rebates against our cost of goods sold for selling specific products, represented 3.6 points of margin improvement on systems sales. In fiscal 2005, these rebates represented only 1.9 points of margin enhancement, a 47% decrease. We believe that despite a highly competitive market, we can hold our gross margins on systems sales relatively stable, subject to various mix factors. However, we can give no assurance regarding possible changes in the cost of goods sold rebate programs that could either improve or further erode our margins.
The gross margins earned on services revenues were 25.9% in fiscal 2005 compared to 27.8% in fiscal 2004. This decrease reflects (i) our continued investment in hiring and training technical personnel for our Nortel initiative, (ii) higher materials costs to support our installed base of customers under maintenance contracts, and (iii) a higher usage of third-party service providers to support some of our managed services initiative. We are continuing to build up our technical competencies to install and support the products we sell. This includes hiring some new technical personnel; replacing some existing personnel with higher-priced certified staff; and additional training of existing staff. In addition to selling the Nortel product line, we also are working to become more proficient in contact management, unified messaging, and networking applications. We are also continuing to evaluate the geographic locations of our technical staff and have made reductions in some areas to be able to hire new or additional technical staff in other areas. In most of those instances, we hire experienced and certified technicians which has led to a slightly higher cost structure. Additionally, our materials costs were higher to support equipment under customer service contracts in fiscal 2005 than in previous years. In particular, in the fourth fiscal quarter of 2005 we experienced a string of equipment failures which were covered under our maintenance contracts. We have no reason to believe this trend will continue into the future. Finally, we service most of our customer locations through the use of XETA-employed service technicians. However, to serve remote locations and to maintain an efficient cost structure, we also utilize third-party technical vendors to perform some services for us on a subcontractor basis. These costs were higher than expected and our service management is reviewing our procedures and staffing plans to more effectively manage the balance between internal and external labor requirements in fiscal 2006. As a result of growth initiatives in the services area and more effective use of internal personnel, we expect services gross margins to improve in fiscal 2006.
A final component to our gross margins is the margins earned on other revenues and our corporate cost of goods sold expenses. Other revenues represent commissions earned on the sale of manufacturer service contracts and sales and cost of goods sold on equipment outside our normal provisioning processes. Corporate cost of goods sold represents the cost of our material logistics and purchasing functions. Corporate cost of goods sold declined 1% in fiscal 2005 compared to fiscal 2004.
Operating Expenses. Operating expenses were $13.3 million or 23% of revenues in fiscal 2005 compared to $11.7 million or 20% of revenues in fiscal 2004. This increase in operating expenses includes: our investment in sales resources to support the Nortel product line initiative of approximately $600,000, increased corporate expenses of approximately $250,000 related to increases in insurance costs, auditing and legal expenses, and the addition and relocation of a senior executive, reduced marketing incentive payments from our major vendors of $343,000, and increased expenses related to our Oracle implementation project of $455,000. Most of the increase in the Oracle upgrade project represented an increase in non-cash amortization expense of $348,000.
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Interest and Other Income. Interest expense consists of interest paid or accrued on our credit facility. Interest expense declined in fiscal 2005 by approximately $117,000, reflecting lower average debt levels in fiscal 2005. Also, during fiscal 2005, we capitalized interest costs of approximately $204,000 related to our Oracle implementation project compared to approximately $187,000 in fiscal 2004. During fiscal 2005, we reduced our term debt by $1.2 million through cash on hand and funds generated from operations.
Net other income in fiscal 2005 was approximately $171,000 compared to net other income of approximately $263,000 last year. The primary reason for the change in other income and expense relates to a $100,000 reversal of a legal contingency in 2004. There was no such unusual item of that magnitude in the current year and the legal matter in question was settled in 2005 for the amount remaining in the accrual.
Tax Expense. We have recorded a combined federal and state tax provision of approximately 39% in all years presented. This rate reflects 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 2005 was 0.8% compared to 2.7% in 2004. This decrease reflects slightly lower revenues and the increases in operating expenses discussed above. Our current business model targets an operating margin of 4%. However, we will have to realize sustained growth in our revenues, both commercial systems revenues and service revenues, and improve the gross margins in our services business to reach this target.
Year ending October 31, 2004 compared to October 31, 2003.
Net revenues for fiscal 2004 were $58.8 million compared to $52.7 million in fiscal 2003, a 12% increase. Net income for fiscal 2004 was $1.6 million compared to $1.6 million in fiscal 2003. Discussed below are the major revenue, gross margin, and operating expense items that affected our financial results during fiscal 2004.
Systems Sales. Sales of systems and equipment were $31.3 million in fiscal 2004 compared to $27.5 million in fiscal 2003, a 14% increase. These results reflect improved market conditions (while the overall U.S. economy showed signs of improvement, we continued to see mixed results as technology spending, especially on communications equipment, remained sluggish), and the addition of the Nortel product line in fiscal 2004. Market acceptance of IP-based telephony and related technologies improved during the year and nearly all new systems sold were either hybrid or IP-based systems.
Installation and Service Revenues. Revenues earned from installation and service related activities were $26.5 million for fiscal 2004, a 14% increase over fiscal 2003. All of our major service revenue streams showed increases in fiscal 2004 over fiscal 2003. These increases included increases in installation and consulting revenues that were driven by increases in systems sales and increases in revenues from maintenance contracts and services that were driven primarily by the addition of the Nortel product line.
The 14% increase in systems sales in fiscal 2004 resulted in improved installation, project management and programming revenues, all of which were directly associated with new systems sales. Our revenues earned from maintenance contracts increased 9% overall, but were mainly fueled by a 132% increase in revenues earned from service contracts with commercial (non-lodging) customers. This increase was directly related to the addition of the Nortel product line to our business. We also enjoyed a 27% increase in revenues earned from move, add, and change (MAC) and T&M service activities. A portion of these revenues were earned from customers who did not have service contracts, but called us regularly for services. The remaining portion of MAC and T&M revenues were earned from customers who did have service contracts with us, but needed non-covered services performed.
Gross Margins. Gross margins were 24.2% in fiscal 2004 compared to 27.2% in fiscal 2003. While we experienced a decline in gross margins on both systems sales and services, most of the decline in gross margins, 5.1 percentage points, was related to the gross margins on systems sales.
Gross margins on systems sales were 23.7% in fiscal 2004 compared to 28.8% in fiscal 2003. The gross margins we earned on systems sales were volatile and were affected by several factors including: 1) product mix; 2) sales to some customers who had pre-negotiated contracts with Avaya, which resulted in lower margins for us; and, 3) variety and changes in our suppliers and manufacturers’ financial incentives to their distributors. Approximately
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2.0 percentage points of the gross margin decline was expected as a result of dropping our exclusive representation of Avaya products to the commercial sector and adding the Nortel product line. The decrease in gross margins earned on systems sales occurred mostly during our first fiscal quarter and then was relatively stable the remainder of the year.
The gross margins earned on installation and service revenues were 27.8% in fiscal 2004 compared to 29.1% in fiscal 2003. This decrease was directly related to the cost of starting up our service offering for the Nortel product line.
A final component to our gross margins—the margins earned on other revenues and our corporate cost of goods sold expenses—declined 7% in fiscal 2004 compared to fiscal 2003, reflecting management’s continued focus on containment of administrative costs.
Operating Expenses. Operating expenses were $11.7 million or 19.8% of revenues in fiscal 2004 compared to $11.2 million or 21.3% of revenues in fiscal 2003. The decrease in operating expenses as a percent of sales reflects continued focus on controlling administrative costs and an increase in the sales and marketing incentive payments received from manufacturers.
Interest and Other Income. Interest expense declined in fiscal 2004 by approximately $243,000, reflecting lower average debt levels in fiscal 2004. Also, during fiscal 2004 we capitalized interest costs of approximately $187,000 related to our Oracle implementation project compared to approximately $337,000 in fiscal 2003. During fiscal 2004, we reduced our term debt by $1.2 million through cash on hand and funds generated from operations.
Net other income in fiscal 2004 was approximately $263,000 compared to net other expense of approximately $71,000 in fiscal 2003. The primary reason for the change in other income and expense related to the accrual of a contingent liability in 2003 and the partial reversal of that contingency in 2004 as more facts about the matter became available.
Tax Expense. We recorded a combined federal and state tax provision of approximately 39% in all years presented. 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 2004 was 2.7% compared to 3.0% in 2003. This decrease reflected lower gross margins earned in fiscal 2004.
Liquidity and Capital Resources
Our financial condition improved during fiscal 2005 as our working capital grew by 23%, our total assets grew by 6%, and our term debt was reduced by 30%. These improvements were the result of the $1.5 million in cash flows generated by operations. These cash flows included cash from earnings and non-cash charges such as depreciation and amortization of $1.5 million. Other changes in our working capital accounts netted to zero, but included increases in accounts receivable and inventories of $2.1 million and $1.0 million, respectively, both reflecting the growth in our revenues during the last quarter of the fiscal year. These changes were offset by a $2.4 million increase in accounts payable during the year, also reflecting the increased purchasing activity in the fourth fiscal quarter. We used these cash flows to fund capital expenditures of $793,000 and to reduce debt by $640,000. Approximately one-half of our capital expenditures were focused on supporting our Nortel growth initiatives such as acquiring vans for our new branch model operations and acquiring and upgrading computer hardware to support growth in personnel. The remaining capital expenditures were made to support our Oracle implementation project. At October 31, 2005 we had capitalized $7.7 million in this project. We have segregated the cost of this asset into four groups with estimated useful lives of three, five, seven and ten years. In fiscal 2005 we began amortizing the cost of those portions of the system that were ready for use. Our operating results for fiscal 2005 include $348,000 in amortization expense related to the project.
At October 31, 2005 the balance on our working capital revolver was $4.39 million, leaving $3.11 million available for additional borrowings. We believe that this available capacity is sufficient for our operating needs for the foreseeable future. The revolver is scheduled to expire on September 28, 2006, however we expect to renew it for another 12-month period prior to its expiration. At October 31, 2005, we were in compliance with the covenants
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of our debt agreements and we consider our relationship with our bank to be good. In addition to the available capacity under our working capital line of credit, we believe we 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, 2005 as well as payment obligations over the next five fiscal years:
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Contractual Obligations |
| Total |
| Less than |
| 2 – 3 |
| 4 – 5 |
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Long-term debt |
| $ | 3,186,047 |
| $ | 1,250,813 |
| $ | 514,384 |
| $ | 1,420,849 |
| $ | — |
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Operating leases |
| 814,028 |
| 252,885 |
| 413,820 |
| 147,323 |
| — |
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Total |
| $ | 4,000,075 |
| $ | 1,503,698 |
| $ | 928,204 |
| $ | 1,568,172 |
| $ | — |
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Recent Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 153, “Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29” (“SFAS No. 153”). This new standard is the result of a broader effort by the FASB to improve financial reporting by eliminating differences between generally accepted accounting principles (“GAAP”) in the US and GAAP developed by the International Accounting Standards Board (IASB). As part of this effort, the FASB and the IASB identified opportunities to improve financial reporting by eliminating certain narrow differences between their existing accounting standards. SFAS No. 153 amends Accounting Principles Board (“APB”) Opinion No. 29, “Accounting for Nonmonetary Transactions,” (“APB No. 29”) that was issued in 1973. The amendments made by SFAS No. 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have “commercial substance.” Previously, APB 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. The Company adopted SFAS No. 153 in the third quarter of fiscal 2005. There was no impact to the Company’s operating results or financial condition as a result of the adoption of the standard.
Application of Critical Accounting Policies
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 significant judgment about future events that affect the amounts reported throughout our financial statements. Actual events could unfold quite differently than our previous judgments had predicted. Therefore, the estimates and assumptions inherent in the financial statements included in this report could be materially different once those actual events are known. 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 sales of equipment 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 and customer acceptance, which sometimes requires judgment on our part. Revenues from maintenance contracts are recognized ratably over the term of the underlying contract.
Collectibility of Accounts Receivable. We must make judgments about the collectibility 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.
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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 in fiscal 2000, 2001, and 2004. We conduct an annual goodwill impairment review on November 1 of each year for the previous year just ended October 31 to determine the fair value of our reporting units. In fiscal years 2005 and 2004, we engaged an independent valuation consultant to assist us in this review. In order to make this assessment each year, we prepared a long-term forecast of the operating results and cash flows associated with the major reporting units of our business. We prepared this forecast to determine the net discounted cash flows associated with each of these units. The value of the discounted cash flows, less bank debt, 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, and the capital expenditures needed to support the projected growth in revenues. In those years in which a valuation consultant was engaged to assist in this evaluation, additional data regarding competitors and market valuations was also examined. 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 value and therefore no impairment had occurred.
We have recorded property, equipment, and capitalized software 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.
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, 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, from time-to-time we are a party to threatened litigation or actual litigation in the normal course of business. 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 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements |
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Consolidated Financial Statements |
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Consolidated Statements of Operations - For the Years Ended October 31, 2005, 2004 and 2003 |
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Consolidated Statements of Cash Flows - For the Years Ended October 31, 2005, 2004 and 2003 |
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Xeta Technologies, Inc.
We have audited the consolidated balance sheets of Xeta Technologies, Inc. (an Oklahoma Corporation) and subsidiary as of October 31, 2005, and the related consolidated statements of operations, shareholders’ equity and cash flows for the year then ended. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit 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 audit 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 audit provides 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, 2005, and the results of their operations and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles.
/s/ TULLIUS TAYLOR SARTAIN & SARTAIN LLP |
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December 16, 2005 |
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F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders of
XETA Technologies, Inc.
We have audited the accompanying consolidated balance sheet of XETA Technologies, Inc. (an Oklahoma corporation) and subsidiary as of October 31, 2004, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the two years in the period ended October 31, 2004. 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.
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, 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, 2004, and the results of their operations and their cash flows for each of the two years in the period ended October 31, 2004 in conformity with accounting principles generally accepted in the United States of America.
/s/ Grant Thornton LLP |
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Oklahoma City, Oklahoma | |
December 10, 2004 |
F-2
XETA TECHNOLOGIES, INC. AND SUBSIDIARY
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| ||
Current assets: |
|
|
|
|
| ||
Cash and cash equivalents |
| $ | 176,688 |
| $ | 141,054 |
|
Current portion of net investment in sales-type leases and other receivables |
| 533,114 |
| 439,026 |
| ||
Trade accounts receivable, net |
| 11,634,030 |
| 9,529,377 |
| ||
Inventories, net |
| 5,650,027 |
| 4,844,702 |
| ||
Deferred tax asset, net |
| 727,222 |
| 880,605 |
| ||
Prepaid taxes |
| 888,842 |
| 6,868 |
| ||
Prepaid expenses and other assets |
| 139,525 |
| 230,293 |
| ||
Total current assets |
| 19,749,448 |
| 16,071,925 |
| ||
|
|
|
|
|
| ||
Noncurrent assets: |
|
|
|
|
| ||
Goodwill |
| 26,476,245 |
| 26,196,806 |
| ||
Intangible assets, net |
| 179,709 |
| 217,542 |
| ||
Net investment in sales-type leases, less current portion above |
| 167,399 |
| 296,865 |
| ||
Property, plant & equipment, net |
| 10,411,329 |
| 10,726,855 |
| ||
Other assets |
| 34,411 |
| 46,358 |
| ||
Total noncurrent assets |
| 37,269,093 |
| 37,484,426 |
| ||
|
|
|
|
|
| ||
Total assets |
| $ | 57,018,541 |
| $ | 53,556,351 |
|
|
|
|
|
|
| ||
LIABILITIES AND SHAREHOLDERS’ EQUITY |
|
|
|
|
| ||
|
|
|
|
|
| ||
Current liabilities: |
|
|
|
|
| ||
Current portion of long-term debt |
| $ | 1,123,582 |
| $ | 1,209,645 |
|
Revolving line of credit |
| 4,394,727 |
| 3,850,282 |
| ||
Lease payable |
| 5,303 |
| 8,897 |
| ||
Accounts payable |
| 4,847,799 |
| 2,452,480 |
| ||
Current unearned services revenue |
| 1,505,609 |
| 1,558,510 |
| ||
Accrued liabilities |
| 2,392,846 |
| 2,522,343 |
| ||
Other liabilities |
| — |
| 4,986 |
| ||
Total current liabilities |
| 14,269,866 |
| 11,607,143 |
| ||
|
|
|
|
|
| ||
Noncurrent liabilities: |
|
|
|
|
| ||
Long-term debt, less current portion above |
| 1,697,039 |
| 2,820,357 |
| ||
Accrued long-term liability |
| 144,100 |
| 144,100 |
| ||
Noncurrent unearned services revenue |
| 64,895 |
| 140,172 |
| ||
Noncurrent deferred tax liability, net |
| 3,744,704 |
| 2,540,559 |
| ||
Total noncurrent liabilities |
| 5,650,738 |
| 5,645,188 |
| ||
|
|
|
|
|
| ||
Contingencies |
|
|
|
|
| ||
|
|
|
|
|
| ||
Shareholders’ equity: |
|
|
|
|
| ||
Preferred stock; $.10 par value; 50,000 shares authorized, 0 issued |
| — |
| — |
| ||
Common stock; $.001 par value; 50,000,000 shares authorized, 11,197,025 and 11,031,575 issued at October 31, 2005 and October 31, 2004, respectively |
| 11,197 |
| 11,031 |
| ||
Paid-in capital |
| 12,999,074 |
| 12,695,224 |
| ||
Retained earnings |
| 26,332,325 |
| 25,837,870 |
| ||
Accumulated other comprehensive income |
| — |
| 4,554 |
| ||
Less treasury stock, at cost (1,018,788 shares at October 31, 2005 and October 31, 2004) |
| (2,244,659 | ) | (2,244,659 | ) | ||
Total shareholders’ equity |
| 37,097,937 |
| 36,304,020 |
| ||
Total liabilities and shareholders’ equity |
| $ | 57,018,541 |
| $ | 53,556,351 |
|
The accompanying notes are an integral part of these consolidated balance sheets.
F-3
XETA TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
|
| For the Years |
| |||||||
|
| Ended October 31, |
| |||||||
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
|
|
|
|
|
|
| |||
Systems sales |
| $ | 27,942,695 |
| $ | 31,341,190 |
| $ | 27,549,876 |
|
Services |
| 28,241,316 |
| 26,492,810 |
| 23,338,915 |
| |||
Other revenues |
| 1,819,241 |
| 993,431 |
| 1,792,512 |
| |||
Net sales and services revenues |
| 58,003,252 |
| 58,827,431 |
| 52,681,303 |
| |||
|
|
|
|
|
|
|
| |||
Cost of equipment sales |
| 20,978,447 |
| 23,914,329 |
| 19,621,591 |
| |||
Services costs |
| 20,918,581 |
| 19,120,486 |
| 16,548,392 |
| |||
Cost of other revenues & corporate COGS |
| 2,072,931 |
| 1,529,938 |
| 2,192,967 |
| |||
Total cost of sales |
| 43,969,959 |
| 44,564,753 |
| 38,362,950 |
| |||
|
|
|
|
|
|
|
| |||
Gross profit |
| 14,033,293 |
| 14,262,678 |
| 14,318,353 |
| |||
|
|
|
|
|
|
|
| |||
Operating expenses |
|
|
|
|
|
|
| |||
Selling, general and administrative |
| 12,889,802 |
| 11,569,185 |
| 11,030,671 |
| |||
Amortization |
| 385,591 |
| 82,485 |
| 180,000 |
| |||
Total operating expenses |
| 13,275,393 |
| 11,651,670 |
| 11,210,671 |
| |||
|
|
|
|
|
|
|
| |||
Income from operations |
| 757,900 |
| 2,611,008 |
| 3,107,682 |
| |||
|
|
|
|
|
|
|
| |||
Interest expense |
| (113,523 | ) | (230,819 | ) | (473,979 | ) | |||
Interest and other income (expense) |
| 171,078 |
| 262,861 |
| (71,139 | ) | |||
Total interest and other income (expense) |
| 57,555 |
| 32,042 |
| (545,118 | ) | |||
|
|
|
|
|
|
|
| |||
Income before provision for income taxes |
| 815,455 |
| 2,643,050 |
| 2,562,564 |
| |||
Provision for income taxes |
| 321,000 |
| 1,035,000 |
| 1,005,000 |
| |||
|
|
|
|
|
|
|
| |||
Net income |
| $ | 494,455 |
| $ | 1,608,050 |
| $ | 1,557,564 |
|
|
|
|
|
|
|
|
| |||
Earnings per share |
|
|
|
|
|
|
| |||
Basic |
| $ | 0.05 |
| $ | 0.16 |
| $ | 0.16 |
|
|
|
|
|
|
|
|
| |||
Diluted |
| $ | 0.05 |
| $ | 0.16 |
| $ | 0.16 |
|
|
|
|
|
|
|
|
| |||
Weighted average shares outstanding |
| 10,087,279 |
| 10,008,507 |
| 9,827,884 |
| |||
|
|
|
|
|
|
|
| |||
Weighted average equivalent shares |
| 10,116,694 |
| 10,157,372 |
| 9,998,670 |
|
The accompanying notes are an integral part of these consolidated financial statements.
F-4
XETA TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED OCTOBER 31, 2005, 2004 AND 2003
|
| Common Stock |
| Treasury Stock |
|
|
| Accumulated Other |
| Retained |
|
|
| ||||||||||
|
| Shares Issued |
| Par Value |
| Shares |
| Amount |
| Paid-in Capital |
| Income (Loss) |
| Earnings |
| Total |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Balance-October 31, 2002 |
| 10,721,740 |
| $ | 10,721 |
| 1,018,788 |
| $ | (2,244,659 | ) | $ | 12,193,029 |
| $ | (110,353 | ) | $ | 22,672,256 |
| $ | 32,520,994 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Stock options exercised $.001 par value |
| 300,000 |
| 300 |
| — |
| — |
| 74,700 |
| — |
| — |
| 75,000 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Tax benefit of stock options |
| — |
| — |
| — |
| — |
| 413,952 |
| — |
| — |
| 413,952 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Components of comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Net income |
| — |
| — |
| — |
| — |
| — |
| — |
| 1,557,564 |
| 1,557,564 |
| ||||||
Unrealized gain on hedge, net of tax of $28,050 |
| — |
| — |
| — |
| — |
| — |
| 43,507 |
| — |
| 43,507 |
| ||||||
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 1,601,071 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Balance-October 31, 2003 |
| 11,021,740 |
| 11,021 |
| 1,018,788 |
| (2,244,659 | ) | 12,681,681 |
| (66,846 | ) | 24,229,820 |
| 34,611,017 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Stock options exercised $.001 par value |
| 9,835 |
| 10 |
| — |
| — |
| 9,535 |
| — |
| — |
| 9,545 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Tax benefit of stock options |
| — |
| — |
| — |
| — |
| 4,008 |
| — |
| — |
| 4,008 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Components of comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
Net income |
| — |
| — |
| — |
| — |
| — |
| — |
| 1,608,050 |
| 1,608,050 |
| ||||||
Unrealized gain on hedge, net of tax of $46,034 |
| — |
| — |
| — |
| — |
| — |
| 71,400 |
| — |
| 71,400 |
| ||||||
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 1,679,450 |
| ||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| 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 |
|
The accompanying notes are an integral part of these consolidated financial statements.
F-5
XETA TECHNOLOGIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
| For the Years |
| ||||||||||
|
| Ended October 31, |
| ||||||||||
|
| 2005 |
| 2004 |
| 2003 |
| ||||||
Cash flows from operating activities: |
|
|
|
|
|
|
| ||||||
Net income |
| $ | 494,455 |
| $ | 1,608,050 |
| $ | 1,557,564 |
| |||
|
|
|
|
|
|
|
| ||||||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
|
|
|
|
|
|
| ||||||
Depreciation |
| 710,435 |
| 822,300 |
| 971,499 |
| ||||||
Amortization |
| 385,591 |
| 82,485 |
| 180,000 |
| ||||||
(Gain) loss on sale of assets |
| (5,819 | ) | 2,465 |
| 48,521 |
| ||||||
Ineffectiveness of cash flow hedge |
| (12,476 | ) | 12,473 |
| — |
| ||||||
Provision (reversal) for returns & doubtful accounts receivable |
| 15,263 |
| — |
| (45,907 | ) | ||||||
Provision for excess and obsolete inventory |
| 242,730 |
| — |
| 280,431 |
| ||||||
Change in assets and liabilities, net of acquisitions: |
|
|
|
|
|
|
| ||||||
Decrease in net investment in sales-type leases & other receivables |
| 35,378 |
| 663,164 |
| 135,311 |
| ||||||
(Increase) decrease in trade account receivables |
| (2,119,916 | ) | (3,405,570 | ) | 3,963,230 |
| ||||||
(Increase) decrease in inventories |
| (1,048,055 | ) | 959,786 |
| 1,906,448 |
| ||||||
(Increase) decrease in deferred tax asset |
| 153,383 |
| 5,147 |
| (293,109 | ) | ||||||
(Increase) decrease in prepaid expenses and other assets |
| 102,715 |
| 172,357 |
| (99,146 | ) | ||||||
(Increase) decrease in prepaid taxes |
| (881,974 | ) | (6,868 | ) | 1,195,539 |
| ||||||
Increase (decrease) in accounts payable |
| 2,395,319 |
| (1,810,728 | ) | (2,190,257 | ) | ||||||
Decrease in unearned revenue |
| (128,178 | ) | (357,693 | ) | (462,367 | ) | ||||||
Increase (decrease) in accrued taxes |
| 38,216 |
| (19,918 | ) | 96,352 |
| ||||||
Increase (decrease) in accrued liabilities and lease payable |
| (133,091 | ) | 286,669 |
| (260,861 | ) | ||||||
Increase in deferred tax liability |
| 1,224,441 |
| 542,319 |
| 1,190,155 |
| ||||||
Total adjustments |
| 973,962 |
| (2,051,612 | ) | 6,615,839 |
| ||||||
|
|
|
|
|
|
|
| ||||||
Net cash provided by (used in) operating activities |
| 1,468,417 |
| (443,562 | ) | 8,173,403 |
| ||||||
|
|
|
|
|
|
|
| ||||||
Cash flows from investing activities: |
|
|
|
|
|
|
| ||||||
Acquisitions, net of cash acquired |
| (56,015 | ) | (597,791 | ) | — |
| ||||||
Additions to property, plant & equipment |
| (743,009 | ) | (1,059,623 | ) | (1,031,696 | ) | ||||||
Proceeds from sale of assets |
| 6,161 |
| 19,542 |
| 2,568 |
| ||||||
Net cash used in investing activities |
| (792,863 | ) | (1,637,872 | ) | (1,029,128 | ) | ||||||
|
|
|
|
|
|
|
| ||||||
Cash flows from financing activities: |
|
|
|
|
|
|
| ||||||
Proceeds from issuance of debt |
| — |
| — |
| 1,125 |
| ||||||
Proceeds from draws on revolving line of credit |
| 23,290,889 |
| 30,111,338 |
| 16,083,009 |
| ||||||
Principal payments on debt |
| (1,209,381 | ) | (1,209,384 | ) | (9,615,089 | ) | ||||||
Payments on revolving line of credit |
| (22,746,444 | ) | (26,980,129 | ) | (15,363,936 | ) | ||||||
Exercise of stock options |
| 25,016 |
| 9,545 |
| 75,000 |
| ||||||
Net cash (used in) provided by financing activities |
| (639,920 | ) | 1,931,370 |
| (8,819,891 | ) | ||||||
|
|
|
|
|
|
|
| ||||||
Net increase (decrease) in cash and cash equivalents |
| 35,634 |
| (150,064 | ) | (1,675,616 | ) | ||||||
|
|
|
|
|
|
|
| ||||||
Cash and cash equivalents, beginning of year |
| 141,054 |
| 291,118 |
| 1,966,734 |
| ||||||
Cash and cash equivalents, end of year |
| $ | 176,688 |
| $ | 141,054 |
| $ | 291,118 |
| |||
|
|
|
|
|
|
|
| ||||||
Supplemental disclosure of cash flow information: |
|
|
|
|
|
|
| ||||||
Cash paid during the period for interest, net of amount capitalized of $204,125 in 2005, $187,092 in 2004 and $337,200 in 2003 |
| $ | 124,250 |
| $ | 180,366 |
| $ | 446,786 |
| |||
Cash paid during the period for income taxes |
| $ | 41,511 |
| $ | 525,881 |
| $ | 132,011 |
| |||
Non-cash financing activities - Issuance of restricted stock |
| $ | 279,000 |
| $ | — |
| $ | — |
| |||
The accompanying notes are an integral part of these consolidated financial statements.
F-6
XETA TECHNOLOGIES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED OCTOBER 31, 2005
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Business
XETA Technologies, Inc. (“XETA” or the “Company”) is a leading provider of enterprise class communications solutions with sales and service locations nationwide, serving business clients in sales, consulting, engineering, project management, installation, and service support. The Company sells products that are manufactured by a variety of manufacturers including Avaya Inc. (“Avaya”) Nortel Networks Corporation (“Nortel”), and Spectralink Corporation. In addition, the Company provides XETA-manufactured call accounting systems to the hospitality industry. XETA is an Oklahoma corporation.
During fiscal 2003 U.S. Technologies Systems, Inc. (“USTI”) was merged into XETA for tax purposes. There was no impact on the Company’s financial statements. Formerly, USTI was a wholly-owned subsidiary of XETA, which was purchased on November 30, 1999 as part of the Company’s expansion into the commercial market. 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 Force (“EITF”) Issue No. 00-21 “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”) 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, revenue 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
F-7
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.
Service 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.”
Shipping and Handling Fees
In accordance with Emerging Issues Task Force Issue 00-10, “Accounting for Shipping and Handling Fees and Costs,” freight 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. 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. Incentive payments that are based on purchasing certain product lines exclusively from one manufacturer (“loyalty rebates”) are also recorded as a reduction in systems cost of goods sold. 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.
Interest and other income is primarily the recognition of interest income on the Company’s sales-type lease receivables and income earned on short-term cash investments. 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, agings of customer balances, and any specific disputes. The Company recorded bad debt expense of $15,263 and $0 for the years ended October 31, 2005 and 2004, respectively, and recorded a reversal of the provision for doubtful accounts of $45,907 for the year ended October 31, 2003.
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
F-8
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 $204,000, $187,000, and $337,000 in interest costs in fiscal years 2005, 2004 and 2003, respectively.
Research and Development and Capitalization of Software Production Costs
In the past, the Company developed proprietary telecommunications products targeted at the hospitality industry. The Company capitalized software production costs related to the product upon the establishment of technological feasibility in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, “Accounting for Costs of Computer Software to be Sold, Leased or Otherwise Marketed,” (“SFAS No. 86”). Amortization is provided on a product-by-product basis based upon the estimated useful life of the software (generally seven years). All other research and development costs (including those related to software for which technological feasibility has not been established) are expensed as incurred. Since the Company’s expansion into the general commercial market in fiscal 1999, the Company has ceased research and development of new products for the hospitality market.
Software Development Costs
The Company applies the provisions of Statement of Position (“SOP”) 98-1, “Accounting for the Cost of Computer Software Developed or Obtained for Internal Use” (“SOP 98-1”). Under SOP 98-1 external 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, the Company capitalized $7.7 million and $7.3 million related to the software development as of October 31, 2005 and 2004, respectively. The Company has segregated the cost of the developed software into four groups with estimated useful lives of three, five, seven and ten years. Beginning in fiscal 2005, the Company began implementing the developed software in its business and the operating results for fiscal 2005 include $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.
Derivative Instruments and Hedging Activities
The Company applies the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” 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.
Stock-based Compensation Plans
The Company accounts for its stock-based awards granted to officers, directors and key employees using Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees”. Options under these plans are granted at fair market value on the date of grant and thus no compensation cost has been recorded in the consolidated financial statements. Accordingly, the Company follows fixed plan accounting. XETA applies the disclosure only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”.
In December 2002 the Financial Accounting Standards Board (FASB) issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment of SFAS No. 123” (SFAS No. 148). This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure requirements of SFAS No.123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Until its adoption of SFAS No. 123 (Revised 2004), “Share-Based
F-9
Payments,” a revision of FASB Statement 123 (“SFAS No. 123R”) as described below, the Company accounted for stock-based employee compensation under the intrinsic value method, an alternative to the fair value method allowed by SFAS No. 123. Under this alternative method, the Company was only required to disclose the impact of issued stock options, as set forth below, as if the expense had been recorded in the consolidated financial statements.
|
| For the Year Ended |
| |||||||
Pro Forma Disclosures: |
| 2005 |
| 2004 |
| 2003 |
| |||
NET INCOME: |
|
|
|
|
|
|
| |||
As reported |
| $ | 494,455 |
| $ | 1,608,050 |
| $ | 1,557,564 |
|
Add (deduct): Total stock-based employee compensation recovered (expensed) determined under fair value based method for all awards, net of related tax effects |
| 1,203 |
| (103,583 | ) | (388,628 | ) | |||
Pro forma |
| $ | 495,658 |
| $ | 1,504,467 |
| $ | 1,168,936 |
|
|
|
|
|
|
|
|
| |||
EARNINGS PER SHARE: |
|
|
|
|
|
|
| |||
As reported – Basic |
| $ | 0.05 |
| $ | 0.16 |
| $ | 0.16 |
|
As reported – Diluted |
| $ | 0.05 |
| $ | 0.16 |
| $ | 0.16 |
|
|
|
|
|
|
|
|
| |||
Pro forma – Basic |
| $ | 0.05 |
| $ | 0.15 |
| $ | 0.12 |
|
Pro forma – Diluted |
| $ | 0.05 |
| $ | 0.15 |
| $ | 0.12 |
|
The fair value of the options granted was estimated at the date of grant using the Modified Black-Scholes European pricing model with the following assumptions: risk free interest rate (3.42% to 5.78%), dividend yield (0.00%), expected volatility (80.50% to 86.64%), and expected life (6 years).
In December 2004 the FASB issued SFAS No. 123R. This new statement supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related implementation guidance. The statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. This statement is effective as of the beginning of the first annual reporting period that begins after June 15, 2005 and the Company adopted the standard on November 1, 2005. Because option-holders are fully vested in all outstanding options at the present time, adoption of the new standard did not have a material impact on the Company’s consolidated financial position or results of operations.
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 Income Taxes,” and are provided on all temporary differences between the financial basis and the tax basis of the Company’s assets and liabilities.
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.
F-10
Most of the systems sold by the Company are manufactured by third parties. In these instances the Company passes on the manufacturer’s 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: commercial system sales, lodging system sales and services. The Company defines commercial system sales as sales to the non-hospitality industry. Services represent revenues earned from installing and maintaining systems for customers in both the commercial and hospitality segments.
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.
The following is a tabulation of business segment information for 2005, 2004, and 2003:
|
| Commercial |
| Lodging |
| Services |
| Other |
| Total |
| |||||
2005 |
|
|
|
|
|
|
|
|
|
|
| |||||
Sales |
| $ | 21,364,393 |
| $ | 6,578,302 |
| $ | 28,241,316 |
| $ | 1,819,241 |
| $ | 58,003,252 |
|
Cost of sales |
| 16,349,218 |
| 4,629,229 |
| 20,918,581 |
| 2,072,931 |
| 43,969,959 |
| |||||
Gross profit |
| 5,015,175 |
| 1,949,073 |
| 7,322,735 |
| (253,690 | ) | 14,033,293 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
2004 |
|
|
|
|
|
|
|
|
|
|
| |||||
Sales |
| $ | 25,897,343 |
| $ | 5,443,847 |
| $ | 26,492,810 |
| $ | 993,431 |
| $ | 58,827,431 |
|
Cost of sales |
| 20,180,498 |
| 3,733,831 |
| 19,120,486 |
| 1,529,938 |
| 44,564,753 |
| |||||
Gross profit |
| 5,716,845 |
| 1,710,016 |
| 7,372,324 |
| (536,507 | ) | 14,262,678 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
2003 |
|
|
|
|
|
|
|
|
|
|
| |||||
Sales |
| $ | 21,304,223 |
| $ | 6,245,653 |
| $ | 23,338,915 |
| $ | 1,792,512 |
| $ | 52,681,303 |
|
Cost of sales |
| 15,279,565 |
| 4,342,026 |
| 16,548,392 |
| 2,192,967 |
| 38,362,950 |
| |||||
Gross profit |
| 6,024,658 |
| 1,903,627 |
| 6,790,523 |
| (400,455 | ) | 14,318,353 |
|
Recently Issued Accounting Pronouncements
On December 16, 2004 the FASB issued FASB Statement No. 153, “Exchanges of Nonmonetary Assets - An Amendment of APB Opinion No. 29” (“SFAS No. 153”). This new standard is the result of a broader effort by the FASB to improve financial reporting by eliminating differences between generally accepted accounting principles (“GAAP”) in the United States and GAAP developed by the International Accounting Standards Board (IASB). As part of this effort, the FASB and the IASB identified opportunities to improve financial reporting by eliminating certain narrow differences between their existing accounting standards. SFAS No. 153 amends APB No. 29, Accounting for Nonmonetary Transactions, that was issued in 1973. The amendments made by SFAS No. 153 are based on the principle that exchanges of
F-11
nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have “commercial substance.” Previously, APB No. 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. The Company adopted SFAS No. 153 in the third quarter of fiscal 2005. There was no impact to the Company’s operating results or financial condition as a result of the adoption of the standard.
Acquisitions
On August 1, 2004, the Company acquired substantially all of the assets and liabilities of Bluejack Systems, LLC (Bluejack), a Seattle, Washington based Nortel dealer. The Company’s consolidated financial statements include the results of Bluejack’s operations since the date of the acquisition. The acquisition was made as part of the Company’s entry into the Nortel market and to establish a branch office in Seattle, a significant metropolitan area not previously served by the Company. Under the terms of the purchase agreement, the Company paid the owner of Bluejack $569,987. The Company recorded the acquisition according to the provisions of SFAS No. 141, “Business Combinations” (SFAS No. 141). Under SFAS No. 141, the acquired assets and liabilities were recorded on the Company’s books at their fair value. Included in the assets acquired was the customer list of Bluejack. The Company determined that the estimated fair value of the customer list was $227,000 and this amount was set up as a separate intangible asset on the Company’s consolidated balance sheet. This asset will be amortized over its expected useful life of 6 years. The remaining $498,000 difference between the cash paid and fair value of the net assets acquired plus approximately $27,000 in direct costs of the acquisition were recorded as goodwill. For tax purposes, the Company has recorded $1,088,000 in goodwill and other intangible assets, which will be deductible over 15 years on a straight-line basis. Certain other pro forma disclosures required by SFAS No. 141 have been omitted because they were not material to the Company’s consolidated financial statements.
Under the terms of the purchase agreement, the former owner of Bluejack was to receive additional purchase consideration over five years based upon the financial contribution, as defined, of the Seattle branch office. In July, 2005, the Company negotiated a purchase of this earn-out. Under the terms of the buyout, the former owner was paid $50,000 in cash and 100,000 shares of restricted stock. The restricted stock carries restrictions against transfer for two years as to 50,000 shares, three years as to 25,000 shares and four years as to 25,000 shares. As a result of these payments, the Company recorded additional goodwill of $329,000 in the third quarter of fiscal 2005.
Goodwill
The Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets” on November 1, 2001. Under SFAS No. 142, goodwill 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 November 1, 2005, 2004, and 2003 for the previous year just ended October 31. The results of these assessments have indicated that no impairment has existed in the value of recorded goodwill. Therefore, no impairment loss has been recognized.
The goodwill for tax purposes associated with the acquisition of USTI 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, 2005 and 2004.
The changes in the carrying value of goodwill for fiscal 2005 and 2004 are as follows:
F-12
|
| Commercial |
| Services |
| Other |
| Total |
| ||||
Balance, November 1, 2003 |
| $ | 17,566,586 |
| $ | 7,961,744 |
| $ | 198,556 |
| $ | 25,726,886 |
|
Amortization of book versus tax basis difference |
| (41,682 | ) | (13,338 | ) | (556 | ) | (55,576 | ) | ||||
Goodwill acquired |
| 368,898 |
| 143,460 |
| 13,138 |
| 525,496 |
| ||||
Balance, October 31, 2004 |
| 17,893,802 |
| 8,091,866 |
| 211,138 |
| 26,196,806 |
| ||||
Amortization of book versus tax basis difference |
| (41,680 | ) | (13,340 | ) | (556 | ) | (55,576 | ) | ||||
Goodwill acquired |
| 235,181 |
| 91,459 |
| 8,375 |
| 335,015 |
| ||||
Balance, October 31, 2005 |
| $ | 18,087,303 |
| $ | 8,169,985 |
| $ | 218,957 |
| $ | 26,476,245 |
|
Other Intangible Assets
|
| As of October 31, 2005 |
| As of October 31, 2004 |
| ||||||||
|
| Gross |
| Accumulated |
| Gross |
| Accumulated |
| ||||
Amortized intangible assets: |
|
|
|
|
|
|
|
|
| ||||
Software production costs |
| $ | 1,291,021 |
| $ | 1,291,021 |
| $ | 1,291,021 |
| $ | 1,291,021 |
|
Other |
| 402,710 |
| 223,001 |
| 402,710 |
| 185,168 |
| ||||
Total amortized intangible assets |
| $ | 1,693,731 |
| $ | 1,514,022 |
| $ | 1,693,731 |
| $ | 1,476,189 |
|
Aggregate amortization expense of intangible assets was $37,833, $124,105, and $220,525 for the years ended October 31, 2005, 2004, and 2003, respectively, which includes $0, $41,620, and $40,525 recorded as interest expense in the consolidated statements of operations for the years ended October 31, 2005, 2004, and 2003, respectively. The estimated aggregate amortization expense of intangible assets for each of the next five fiscal years is $37,833.
2. ACCOUNTS RECEIVABLE:
Trade accounts receivable consist of the following at October 31:
|
| 2005 |
| 2004 |
| ||
|
|
|
|
|
| ||
Trade receivables |
| $ | 11,932,173 |
| $ | 9,847,984 |
|
Less- reserve for doubtful accounts |
| 298,143 |
| 318,607 |
| ||
Net trade receivables |
| $ | 11,634,030 |
| $ | 9,529,377 |
|
Adjustments to the reserve for doubtful accounts consist of the following at October 31:
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
|
|
|
|
|
|
| |||
Balance, beginning of period |
| $ | 318,607 |
| $ | 335,541 |
| $ | 345,516 |
|
Provision (reversal) for doubtful accounts |
| 15,263 |
| — |
| (45,907 | ) | |||
Net (write-offs) recoveries |
| (35,727 | ) | (16,934 | ) | 35,932 |
| |||
Balance, end of period |
| $ | 298,143 |
| $ | 318,607 |
| $ | 335,541 |
|
F-13
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:
|
| 2005 |
| 2004 |
| ||
|
|
|
|
|
| ||
Raw materials |
| $ | 358,646 |
| $ | 395,539 |
|
Finished goods and spare parts |
| 5,831,560 |
| 5,320,972 |
| ||
|
| 6,190,206 |
| 5,716,511 |
| ||
Less- reserve for excess and obsolete inventories |
| 540,179 |
| 871,809 |
| ||
Total inventories, net |
| $ | 5,650,027 |
| $ | 4,844,702 |
|
F-14
Adjustments to the reserve for excess and obsolete inventories consist of the following:
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
|
|
|
|
|
|
| |||
Balance, beginning of period |
| $ | 871,809 |
| $ | 1,182,380 |
| $ | 786,619 |
|
Provision for excess and obsolete inventories |
| 242,730 |
| — |
| 280,431 |
| |||
Adjustments to inventories |
| (574,360 | ) | (310,571 | ) | 115,330 |
| |||
Balance, end of period |
| $ | 540,179 |
| $ | 871,809 |
| $ | 1,182,380 |
|
Adjustments to inventories in 2005, 2004 and 2003 included write-offs of obsolete inventory, corrections of vendor invoices, and adjustments to reduce certain items 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 |
|
|
|
|
| ||
|
| Useful |
| 2005 |
| 2004 |
| ||
Building |
| 20 |
| $ | 2,397,954 |
| $ | 2,397,954 |
|
Data processing and computer field equipment |
| 3-10 |
| 4,720,698 |
| 4,587,485 |
| ||
Software development costs, work-in-process |
| N/A |
| 5,410,558 |
| 7,280,461 |
| ||
Software development costs of components placed into service |
| 3-10 |
| 1,695,370 |
| — |
| ||
Hardware |
| 3-5 |
| 589,905 |
| — |
| ||
Land |
| — |
| 611,582 |
| 611,582 |
| ||
Office furniture |
| 5 |
| 1,114,073 |
| 1,110,729 |
| ||
Auto |
| 5 |
| 384,278 |
| 237,176 |
| ||
Other |
| 3-7 |
| 549,613 |
| 546,253 |
| ||
|
|
|
|
|
|
|
| ||
Total property, plant and equipment |
|
|
| 17,474,031 |
| 16,771,640 |
| ||
Less- accumulated depreciation |
|
|
| (7,062,702 | ) | (6,044,785 |
| ||
|
|
|
|
|
|
|
| ||
Total property, plant and equipment, net |
|
|
| $ | 10,411,329 |
| $ | 10,726,855 |
|
5. ACCRUED LIABILITIES:
Accrued liabilities consist of the following at October 31:
|
| 2005 |
| 2004 |
| ||
|
|
|
|
|
| ||
Commissions |
| $ | 597,811 |
| $ | 618,291 |
|
Interest |
| 23,246 |
| 21,494 |
| ||
Payroll |
| 554,506 |
| 520,397 |
| ||
Bonuses |
| 242,917 |
| 306,981 |
| ||
Vacation |
| 580,922 |
| 504,585 |
| ||
Other |
| 393,444 |
| 550,595 |
| ||
Total current |
| 2,392,846 |
| 2,522,343 |
| ||
Accrued long-term liability |
| 144,100 |
| 144,100 |
| ||
Total accrued liabilities |
| $ | 2,536,946 |
| $ | 2,666,443 |
|
F-15
6. UNEARNED SERVICES REVENUE:
Unearned service revenue consists of the following at October 31:
|
| 2005 |
| 2004 |
| ||
|
|
|
|
|
| ||
Service contracts |
| $ | 737,618 |
| $ | 845,550 |
|
Warranty service |
| 299,618 |
| 320,193 |
| ||
Customer deposits |
| 272,871 |
| 229,772 |
| ||
Systems shipped but not installed |
| 153,748 |
| 115,413 |
| ||
Other |
| 41,754 |
| 47,582 |
| ||
Total current unearned revenue |
| 1,505,609 |
| 1,558,510 |
| ||
Noncurrent unearned services revenue |
| 64,895 |
| 140,172 |
| ||
Total unearned revenue |
| $ | 1,570,504 |
| $ | 1,698,682 |
|
7. INCOME TAXES:
The income tax provision for the years ending October 31, 2005, 2004, and 2003, consists of the following:
|
| 2005 |
| 2004 |
| 2003 |
| |||
|
|
|
|
|
|
|
| |||
Current provision (benefit) – federal |
| $ | (725,730 | ) | $ | 266,490 |
| $ | 484,930 |
|
Current provision (benefit) – state |
| (95,930 | ) | 67,700 |
| 97,590 |
| |||
Deferred provision |
| 1,142,660 |
| 700,810 |
| 422,480 |
| |||
Total provision |
| $ | 321,000 |
| $ | 1,035,000 |
| $ | 1,005,000 |
|
The reconciliation of the statutory income tax rate to the effective income tax rate is as follows:
|
| Year Ended October 31, |
| ||||
|
| 2005 |
| 2004 |
| 2003 |
|
|
|
|
|
|
|
|
|
Statutory rate |
| 34 | % | 34 | % | 34 | % |
State income taxes, net of federal benefit |
| 5 | % | 5 | % | 5 | % |
Effective rate |
| 39 | % | 39 | % | 39 | % |
F-16
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:
|
| 2005 |
| 2004 |
| ||
Deferred tax assets: |
|
|
|
|
| ||
Currently nondeductible reserves |
| $ | 238,379 |
| $ | 351,059 |
|
Accrued liabilities |
| 300,255 |
| 393,760 |
| ||
Prepaid service contracts |
| 111,771 |
| 163,333 |
| ||
Unamortized cost of service contracts |
| 87,972 |
| 6,842 |
| ||
Other |
| — |
| 80,240 |
| ||
Total deferred tax assets |
| 738,377 |
| 995,234 |
| ||
|
|
|
|
|
| ||
Deferred tax liabilities: |
|
|
|
|
| ||
Intangible assets |
| 2,992,299 |
| 2,300,008 |
| ||
Depreciation and sale of assets |
| 734,394 |
| 343,726 |
| ||
Tax income to be recognized on sales-type lease contracts |
| 29,166 |
| 8,518 |
| ||
Other |
| — |
| 2,936 |
| ||
Total deferred tax liabilities |
| 3,755,859 |
| 2,655,188 |
| ||
Net deferred tax liability |
| $ | (3,017,482 | ) | $ | (1,659,954 | ) |
8. CREDIT AGREEMENTS:
The Company’s credit facility consists of a revolving credit and term loan agreement with a commercial bank. This agreement contains three separate notes: a term loan maturing on September 30, 2006, a mortgage agreement maturing on September 30, 2009 and amortizing based on an 11 year life, and a $7.5 million revolving credit agreement to finance growth in working capital. The revolving line of credit is collateralized by trade accounts receivable and inventories. At October 31, 2005 and 2004, the Company had approximately $4.395 million and $3.850 million, respectively, outstanding on the revolving line of credit. The weighted average interest rate on amounts outstanding under the line of credit during fiscal years 2005 and 2004 was 5.06% and 3.31%, respectively. The Company had approximately $3.1 million available under the revolving line of credit at October 31, 2005. 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 28, 2006. At October 31, long-term debt consisted of the following:
|
| October 31, |
| ||||
|
| 2005 |
| 2004 |
| ||
Term loan, payable in monthly installments of $86,524, due September 30, 2006 collateralized by all assets of the Company |
| $ | 952,459 |
| $ | 1,990,750 |
|
|
|
|
|
|
| ||
Real estate term note, payable in monthly installments of $14,257, plus a final payment of $1,198,061 on September 30, 2009, collateralized by a first mortgage on the Company’s building |
| 1,868,162 |
| 2,039,252 |
| ||
|
|
|
|
|
| ||
|
| 2,820,621 |
| 4,030,002 |
| ||
|
|
|
|
|
| ||
Less-current maturities |
| 1,123,582 |
| 1,209,645 |
| ||
|
|
|
|
|
| ||
|
| $ | 1,697,039 |
| $ | 2,820,357 |
|
F-17
Maturities of long-term debt for each of the years ended October 31, are as follows:
2006 |
| $ | 1,123,549 |
|
2007 |
| 171,090 |
| |
2008 |
| 171,090 |
| |
2009 |
| 1,354,892 |
|
Interest on all outstanding debt under the credit facility accrues at either a) the London Interbank Offered Rate (“LIBOR”) (which was 4.09% at October 31, 2005) plus 1.25% to 2.75% depending on the Company’s funded debt to cash flow ratio, or b) the bank’s prime rate (which was 6.75% at October 31, 2005) minus 0% to minus 1.125% also depending on the Company’s funded debt to cash flow ratio. At October 31, 2005, the Company was paying 6.375% on the revolving line of credit borrowings, 5.864% on the term loan and 5.614% on the mortgage note. 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, and debt service coverage requirements. At October 31, 2005, the Company was either in compliance with the covenants of the credit facility or had received the appropriate waivers from its bank.
9. DERIVATIVES AND RISK MANAGEMENT:
At October 31, 2004, the Company had an outstanding interest rate swap (“Swap”) in a notional amount of $4.2 million which expired in November 2004. Under the Swap contract, the Company paid a fixed interest rate of 3.32% and received a variable interest payment based on one-month LIBOR rates. SFAS No. 133, as amended, governs the accounting for derivative instruments such as Swaps. Under the provisions of SFAS No. 133, as long as the interest rate hedge is “effective”, as defined in the standard, the Company’s Swap is accounted for by recognizing an asset or liability at fair value with the offsetting entry to other comprehensive income or loss in Company’s stockholders’ equity section. Accordingly, the Company recorded a current liability and accumulated other comprehensive income of $4,554 at October 31, 2004, and recorded $12,473 of ineffectiveness during the year ended October 31, 2004, which is included in interest expense in the consolidated statement of operations. No material ineffective portion of the interest rate swap existed for 2003.
10. 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 2004 Plan is administered by the Compensation Committee of the Board of Directors. There have been no awards granted under the 2004 Plan.
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 options that have been granted under the 2000 Plan expire ten years from the date of grant, have three-year cliff-vesting, and are incentive stock 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. The following table summarizes information concerning options outstanding under the 2000 and 1988 Plans including the related transactions for the fiscal years ended October 31, 2003, 2004, and 2005:
F-18
|
| Number |
| Weighted |
| Weighted Average |
| ||
|
|
|
|
|
|
|
| ||
Balance, October 31, 2002 |
| 674,740 |
| $ | 7.66 |
|
|
| |
Granted |
| 5,000 |
| $ | 3.00 |
| $ | 1.26 |
|
Forfeited |
| (56,440 | ) | $ | 7.78 |
|
|
| |
Balance, October 31, 2003 |
| 623,300 |
| $ | 7.61 |
|
|
| |
Granted |
| 1,500 |
| $ | 6.35 |
| $ | 5.36 |
|
Exercised |
| (9,835 | ) | $ | 0.97 |
|
|
| |
Forfeited |
| (56,793 | ) | $ | 7.96 |
|
|
| |
Balance, October 31, 2004 |
| 558,172 |
| $ | 7.69 |
|
|
| |
Forfeited |
| (19,900 | ) | $ | 9.03 |
|
|
| |
Balance, October 31, 2005 |
| 538,272 |
| $ | 7.64 |
|
|
| |
|
|
|
|
|
|
|
| ||
Exercisable at October 31, 2005 |
| 538,272 |
| $ | 7.64 |
|
|
| |
Exercisable at October 31, 2004 |
| 330,772 |
| $ | 10.46 |
|
|
| |
Exercisable at October 31, 2003 |
| 310,123 |
| $ | 10.55 |
|
|
|
The Company has also granted options outside the 1988 Plan, 2000 Plan, and 2004 Plan to certain officers and directors. 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 including the related transactions for the fiscal years ended October 31, 2003, 2004, and 2005:
|
| Number |
| Weighted Average |
| |
|
|
|
|
|
| |
Balance, October 31, 2003 and 2004 |
| 685,400 |
| $ | 5.86 |
|
Exercised |
| (65,400 | ) | 0.38 |
| |
Balance, October 31, 2005 |
| 620,000 |
| $ | 6.44 |
|
|
|
|
|
|
| |
Exercisable at October 31, 2005 |
| 620,000 |
| $ | 6.44 |
|
Exercisable at October 31, 2004 |
| 685,400 |
| $ | 5.86 |
|
Exercisable at October 31, 2003 |
| 685,400 |
| $ | 5.86 |
|
The following is a summary of stock options outstanding as of October 31, 2005:
|
| Options Outstanding |
| Options Exercisable |
| ||||||||
Range of Exercise Prices |
| Number |
| Weighted |
| Weighted |
| Number |
| Weighted |
| ||
$1.64-1.82 |
| 36,504 |
| $ | 1.64 |
| 0.27 |
| 36,504 |
| $ | 1.64 |
|
$3.63-5.79 |
| 339,268 |
| $ | 4.04 |
| 5.09 |
| 339,268 |
| $ | 4.04 |
|
$5.81 |
| 580,000 |
| $ | 5.81 |
| 3.63 |
| 580,000 |
| $ | 5.81 |
|
$5.85-12.00 |
| 32,150 |
| $ | 9.90 |
| 4.92 |
| 32,150 |
| $ | 9.90 |
|
$15.53 |
| 40,000 |
| $ | 15.53 |
| 4.25 |
| 40,000 |
| $ | 15.53 |
|
$18.13 |
| 130,350 |
| $ | 18.13 |
| 4.47 |
| 130,350 |
| $ | 18.13 |
|
F-19
11. 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, 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 |
|
|
| For the Year Ended October 31, 2004 |
| ||||||
|
| Income |
| Shares |
| Per Share |
| ||
Basic EPS |
|
|
|
|
|
|
| ||
Net income |
| $ | 1,608,050 |
| 10,008,507 |
| $ | 0.16 |
|
Dilutive effect of stock options |
|
|
| 148,865 |
|
|
| ||
|
|
|
|
|
|
|
| ||
Diluted EPS |
|
|
|
|
|
|
| ||
Net income |
| $ | 1,608,050 |
| 10,157,372 |
| $ | 0.16 |
|
|
| For the Year Ended October 31, 2003 |
| ||||||
|
| Income |
| Shares |
| Per Share |
| ||
Basic EPS |
|
|
|
|
|
|
| ||
Net income |
| $ | 1,557,564 |
| 9,827,884 |
| $ | 0.16 |
|
Dilutive effect of stock options |
|
|
| 170,786 |
|
|
| ||
|
|
|
|
|
|
|
| ||
Diluted EPS |
|
|
|
|
|
|
| ||
Net income |
| $ | 1,557,564 |
| 9,998,670 |
| $ | 0.16 |
|
For the years ended October 31, 2005, 2004, and 2003, respectively, stock options for 1,121,668 shares at an average exercise price of $7.17, 843,017 shares at an average exercise price of $8.40, and 1,193,628 shares at an average exercise price of $7.22, were excluded from the calculation of earnings per share because they were antidilutive.
F-20
12. 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 ending October 31:
|
| Sales-Type |
| |
|
|
|
| |
2006 |
| $ | 312,413 |
|
2007 |
| 123,731 |
| |
2008 |
| 38,687 |
| |
|
| 474,831 |
| |
Less- imputed interest |
| 60,869 |
| |
Present value of minimum payments |
| $ | 413,962 |
|
13. 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 13%, 10%, and 11% of our total revenues in fiscal 2005, 2004, and 2003, 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, 2005.
The majority of the Company’s systems sales are derived from sales of equipment designed and marketed by Avaya or Nortel. 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.
14. EMPLOYMENT AGREEMENTS:
The Company has two incentive compensation plans: one for sales professionals and sales management and one 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 $309,424, $239,200 and $224,907 during 2005, 2004 and 2003, 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 management and the Board of Directors as key employees. The purpose of the EBP is to provide an
F-21
incentive for senior executives to reach Company-wide targeted financial objectives and to reward key employees for leadership and excellent performance. Those targeted results were not fully achieved in fiscal 2005, 2004 and 2003, however, the Company elected to pay partial bonuses of approximately $150,000, $240,000 and $240,000, respectively.
15. CONTINGENCIES:
Lease Commitments
Future minimum commitments under non-cancelable operating leases for office space and equipment are approximately $253,000, $212,000, $202,000, $92,000 and $55,000 in fiscal years 2006 through 2010, respectively.
Litigation
On June 15, 2005 the Company settled litigation with Software & Information Industry Association (“SIIA”). In 2003, SIIA, an association of software publishers, claimed that XETA had violated the Copyright Act, 17 U.S.C. § 501, et seq. by allegedly using unlicensed software in XETA’s business. In the settlement agreement reached with SIIA and eleven of its members, none of the parties admitted liability for any claims or causes of action, all pending matters were dismissed, and XETA made a $50,000 payment to the SIIA Copyright Protection Fund. XETA does not believe that it has any material liability to any SIIA member who was not a party to the settlement agreement and no such member has made any claim against the Company. The settlement of this matter did not have a material impact on XETA’s results of operations or financial position.
Since 1994, the Company has been monitoring numerous patent infringement lawsuits filed by Phonometrics, Inc., a Florida company, against certain telecommunications equipment manufacturers and hotels who use such equipment. While the Company was never named as a defendant in any of these cases, several of the Company’s call accounting customers were named defendants and notified the Company that they would seek indemnification under the terms of their contracts. Because there were other equipment vendors implicated along with the Company in the cases filed against the Company’s customers, the Company never assumed the outright defense of the customers in any of these actions. In October 1998, all of the cases filed against the hotels were dismissed by the court for failure to state a claim. After years of appeals by Phonometrics, all of which were lost on the merits, a final order dismissing the cases with prejudice was entered in November 2002, and the defendant hotels have been awarded attorney fees and costs, and in some cases sanctions, against Phonometrics and/or its legal counsel. Phonometrics continues to dispute the amount of fees awarded in some cases, and this issue continues to be litigated by Phonometrics in the United States Court of Appeals for the Federal Circuit.
16. RETIREMENT PLAN:
The Company has a 401(k) retirement plan (“Plan”). In addition to employee contributions, the Company makes discretionary matching and profit sharing contributions to the Plan based on percentages set by the Board of Directors. Contributions made by the Company to the Plan were approximately $547,000, $508,000 and $457,000 for the years ending October 31, 2005, 2004, and 2003, respectively.
F-22
17. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
The following quarterly financial data has been prepared from the financial records of the Company without an audit, and reflects all adjustments, which in the opinion of management were of a normal, recurring nature and necessary for a fair presentation of the results of operations for the interim periods presented.
|
| For the Fiscal Year Ended October 31, 2005 |
| ||||||||||
|
| Quarter Ended |
| ||||||||||
|
| January 31, |
| April 30, |
| July 31, |
| October 31, |
| ||||
|
| 2005 |
| 2005 |
| 2005 |
| 2005 |
| ||||
|
| (in thousands, except per share data) |
| ||||||||||
|
|
|
|
|
|
|
|
|
| ||||
Net sales |
| $ | 13,915 |
| $ | 14,204 |
| $ | 13,522 |
| $ | 16,362 |
|
Gross profit |
| 3,265 |
| 3,662 |
| 3,389 |
| 3,717 |
| ||||
Operating income |
| 17 |
| 286 |
| 122 |
| 333 |
| ||||
Net income |
| 78 |
| 164 |
| 64 |
| 188 |
| ||||
Basic EPS |
| $ | 0.01 |
| $ | 0.02 |
| $ | 0.01 |
| $ | 0.02 |
|
Diluted EPS |
| $ | 0.01 |
| $ | 0.02 |
| $ | 0.01 |
| $ | 0.02 |
|
|
| For the Fiscal Year Ended October 31, 2004 |
| ||||||||||
|
| Quarter Ended |
| ||||||||||
|
| January 31, |
| April 30, |
| July 31, |
| October 31, |
| ||||
|
| 2004 |
| 2004 |
| 2004 |
| 2004 |
| ||||
|
| (in thousands, except per share data) |
| ||||||||||
|
|
|
|
|
|
|
|
|
| ||||
Net sales |
| $ | 16,929 |
| $ | 13,189 |
| $ | 13,890 |
| $ | 14,819 |
|
Gross profit |
| 3,955 |
| 3,275 |
| 3,361 |
| 3,671 |
| ||||
Operating income |
| 954 |
| 595 |
| 607 |
| 455 |
| ||||
Net income |
| 562 |
| 410 |
| 371 |
| 265 |
| ||||
Basic EPS |
| $ | 0.06 |
| $ | 0.04 |
| $ | 0.04 |
| $ | 0.02 |
|
Diluted EPS |
| $ | 0.06 |
| $ | 0.04 |
| $ | 0.04 |
| $ | 0.02 |
|
|
| For the Fiscal Year Ended October 31, 2003 |
| ||||||||||
|
| Quarter Ended |
| ||||||||||
|
| January 31, |
| April 30, |
| July 31, |
| October 31, |
| ||||
|
| 2003 |
| 2003 |
| 2003 |
| 2003 |
| ||||
|
| (in thousands, except per share data) |
| ||||||||||
|
|
|
|
|
|
|
|
|
| ||||
Net sales |
| $ | 15,431 |
| $ | 11,765 |
| $ | 12,910 |
| $ | 12,575 |
|
Gross profit |
| 3,919 |
| 3,436 |
| 3,561 |
| 3,402 |
| ||||
Operating income |
| 937 |
| 637 |
| 742 |
| 792 |
| ||||
Net income |
| 491 |
| 313 |
| 376 |
| 378 |
| ||||
Basic EPS |
| $ | 0.05 |
| $ | 0.03 |
| $ | 0.04 |
| $ | 0.04 |
|
Diluted EPS |
| $ | 0.05 |
| $ | 0.03 |
| $ | 0.04 |
| $ | 0.04 |
|
F-23
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(a) |
| The following documents are filed as a part of this report: |
|
|
|
(1) |
| Financial Statements - See Index to Financial Statements at Page 8 of this Form 10-K/A. |
|
|
|
(2) |
| Financial Statement Schedule - None. |
|
|
|
(3) |
| Exhibits – The following exhibits are included with this report on Form 10-K/A: |
No. |
| Description |
|
|
|
23.1 |
| Consent of Tullius Taylor Sartain & Sartain LLP . |
|
|
|
23.2 |
| Consent of Grant Thornton LLP. |
|
|
|
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. |
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. | |
|
|
|
|
|
|
February 28, 2006 | By: | /s Robert B. Wagner |
|
| Robert B. Wagner, Chief Financial Officer |
9