MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The Company's revenues are primarily derived from sales of its products and
services through a worldwide network of direct and independent sales and service
offices. The Company's end-user revenues are derived from two primary sources:
(1) sales of systems to new customers, which include sales of
application-specific software options ("product revenues"), and (2) servicing
the end-user base through the upgrade, expansion, enhancement (which includes
sales of application-specific software options), and maintenance of previously
installed systems, as well as revenues from the INFOSTAR`r'/LD+ program ("base
revenues"). Base revenues usually generate higher operating income margin than
initial sales of systems, since the Company's selling expenses for base revenues
are lower than those for initial system sales. Sales of the Company's
application-specific software options and related services generally produce a
higher operating income margin than both system sales and base revenues due to
the added performance value and relatively low production costs of such
proprietary software and services.
During the year, the Company reorganized its business into divisions, with each
division focusing on different products and market segments. The discussion
which follows under the heading "Company Restructuring" will detail the change
in the Company's strategy which led to the restructuring, the resulting
impairment of long-lived assets and other restructuring charges, along with an
overview of each division's operating performance in 1995 (comparative data is
not available on a divisional basis).
COMPANY RESTRUCTURING
Change in business strategy
In July 1995, the Company reorganized its business into five divisions: Computer
Telephony, Healthcare Communications Systems, Call Center Management ("CCM"),
Videoconferencing Products, and Network Services. The current strategic focus is
toward larger systems and software application-oriented products and away from
hardware-oriented telephone systems.
The business that was acquired in 1988 was a telephone equipment company that
focused its direct selling effort on office sites with fewer than 20 phones with
an emphasis on selling additional hardware to generate revenues in the form of
move, adds and changes ("MAC") and service, mainly on a time and material basis.
The average system size in the customer base at that time was in the 8-10 phone
range. It was originally expected in 1988 that the MAC and service revenues
generated by the customer base would be increasingly profitable as the base of
customers grew. After the acquisition, the Company began to develop more
advanced products which incorporated digital technology and more
software-oriented applications and expanded its product line to the high-end
user, with larger customers and more sophisticated products to serve customers'
total communications needs. After a thorough review and analysis, it was
determined that the smaller, hardware-oriented portion of the telephony business
was not profitable. This led to a definitive change in the Company's business
strategy which was announced on July 11, 1995.
The strategy the Company is now pursuing is to focus on software solutions. With
the Integrated Digital System platform (Systems 108, 228, 432 and 648), which
was developed post-acquisition, the Company's product lines now provide
sophisticated software applications, including Integrated Voice Mail, Call
Center Applications (ACD, IVR's and Predictive Dialers), Locating Devices, Nurse
Call and Computer Telephony Interfaces which drive the computer telephony
products, videoconferencing equipment and network services.
The change in the nature and complexity of the Company's product lines has
changed the way it has to market its products. Unlike many companies in this
industry that focus on one particular product to one market, the Company
provides multiple products and applications to its particular markets. This
requires expertise in each particular market segment because the Company's
competitors are primarily one-product companies who are experts in their
particular market niche. Therefore, the Company has consolidated the sales,
marketing and product development functions for each market segment under a
divisional management structure, headed by a division president. The sales force
has been restructured such that each sales person is assigned to a specific
division and will sell only products associated with that
division. The specialization of the sales force included the addition of sales
representatives with the necessary product and market expertise, as well as
substantial retraining for the remaining sales representatives.
Impairment of goodwill and related service stock
Once the Company decided to restructure and focus on sophisticated systems in
the computer telephony division, it reevaluated the realizability of goodwill
and the related service stock using the recently issued FAS No. 121, "Accounting
for the Impairment of Long-Lived Assets," issued in March 1995. FAS No. 121
requires the Company to project the lowest level of identifiable future cash
flows for purposes of determining whether there has been an impairment in
long-lived assets. The business acquired in 1988 would not generate future cash
flows sufficient to realize the goodwill and service stock on the Company's
balance sheet.
Prior to the second quarter of 1995 and the issuance of FAS No. 121, the Company
periodically reviewed the realizability of goodwill on the basis of whether the
goodwill was fully recoverable from projected, undiscounted net cash flows for
the business as a whole, which included both the smaller hardware-oriented
systems and the larger, sophisticated software-application telephony systems.
Undiscounted cash flows for the business as a whole were used because the
general rule under APB 17 was that goodwill and similar intangible assets could
not be disposed of apart from the enterprise as a whole, unless the Company sold
or otherwise liquidated a large segment or separable group of assets of the
acquired company. Based upon this valuation, goodwill was not determined to be
impaired. The management decision discussed above to focus on the high end of
the telephony market caused the impairment of long-lived assets, which was
measured using the criteria of FAS No. 121.
Computer Telephony
The computer telephony division provides value-added products and services. The
Company's integrated digital telephone systems emphasize flexible software
applications, such as data switching and computer telephone interface, designed
to enhance the customer's ability to communicate, obtain and manage information.
The Company's telephone systems provide the platform for its other voice
processing software applications, such as voice messaging systems and ACD.
The computer telephony division remains the Company's largest contributor to
revenues and profits. Revenues for 1995 were $233 million, unchanged from the
prior year. The Company's base revenues, especially MAC and service, continued
their historical growth offset by a lower level of new installations during the
year. In addition, the division incurred transition costs related to the
restructuring which increased its operating expenses in 1995.
Healthcare Communications
The healthcare communications division provides to its hospital customers
integration of the flow of voice and data between nurse and patient, increased
flexibility and efficiency in hospital operations, and the means to improve
patient care.
Healthcare division revenues increased almost 15% during 1995 to $29 million.
Although there has been revenue growth due to the divisionalization of this
business in the beginning of 1995, the introduction of new products lowered
margins due to higher introductory manufacturing costs. The Company has
transitioned the nurse call product line in 1995 with the development of the
LifeSaver`tm' and CareCom`r' IIE products. The higher 1995 manufacturing costs
were due to the fact that offshore production was delayed due to the fire at the
Company's production facility. These products were scheduled for transfer from
the Company's pre-production facility in Poway, California, but the fire caused
a delay in that transfer for almost one year. These products are now offshore
and higher margins are anticipated, commencing in the first quarter of 1996.
CCM
The CCM division develops and sells sophisticated telephony products that
integrate a computerized digital telephone system platform with high-volume
inbound, outbound and internal call processing systems. Such systems include
automatic call distribution systems, predictive dialers, scripting software to
assist agents handling calls, and interactive voice response systems.
In 1995, the Company established the divisional management structure and made
product improvements which are hoped to increase revenues in 1996 along with
improving profit margins. During 1995, the Company issued the latest release of
the predictive dialer product, which is a more competitive product from a price
and feature standpoint than its predecessor. In addition, the IVR product, which
had previously been produced by a third party, has been replaced with a
Company-manufactured product which should result in higher gross profit margins.
Backlog at the end of 1995 was at a record level which should translate into a
strong first half of 1996.
Videoconferencing Products
The videoconferencing division provides videoconferencing network services such
as multipoint conferencing, network bridging and network design to its
customers.
1995 was a startup year for the videoconferencing division. In addition to the
costs incurred to build a management team and sales force, divisional revenues
did not grow as quickly as anticipated because of delays by suppliers in
providing a competitively-priced product until the fourth quarter of 1995. The
process of establishing demo sites and hiring a dedicated sales force has almost
been completed.
Network Services
The network services division offers cost-effective voice, data and video
long-distance service, least-cost routing, network design and network support
services, enabling customers to make more efficient and cost-effective use of
their telecommunications systems.
Revenues were $24 million in 1995, a decrease from the previous year, but
profits increased due to a negotiated rate reduction from the carrier. Revenues
are down due to competitive pressures in the marketplace. The Company has met
this challenge with a division president and, with changes to incentive
compensation plans, has made long-distance sales as important to the Company's
sales managers as selling equipment. There are now 35 dedicated sales
representatives and 4 regional sales managers to work with the equipment sales
representatives to package network and equipment sales properly. As a result,
bookings at the end of 1995 were at their highest level for the entire year,
which are expected to translate into higher revenues in 1996.
1995 COMPARED TO 1994
Results of Operations
Total revenues for the year ended December 31, 1995 were $296.4 million, a $4.4
million increase over the comparable 1994 period. Base revenues increased 2%
compared to 1994, primarily due to increases in system upgrades and expansions
and increased revenue from maintenance contracts, partially offset by lower
volume generated by the INFOSTAR`r'/LD+ program. Product revenues increased 1%
compared to 1994, as the increase in new installations of healthcare products
and in shipments to the independent sales and service offices were partially
offset by a decrease in new telephony installations.
Gross profit, as a percentage of revenues, decreased slightly from 41.9% during
1994 to 41.5% during 1995 due to a combination of factors including product mix,
higher introductory manufacturing costs for the healthcare products and a lower
absorption of fixed cost overhead.
Operating income, excluding the provision for restructuring, decreased $4.9
million compared to 1994 and, as a percentage of revenues, was 2.6% compared to
4.3% in 1994. The decrease in operating income is primarily due to increased
operating expenses during 1995. Product development and engineering increased
$2.5 million during 1995 as the Company continues to accelerate its investment
in engineering for new product development and application-specific software
products. Selling, general and administrative expenses increased $2.8 million
during the year, primarily representing the full year cost impact of the
divisional supporting management and sales structure.
Interest and other expenses, net decreased $0.7 million during 1995. The net
decrease is primarily a result of the 1995 gains on the sales of the customer
bases in Wisconsin and Iowa and the related direct sales offices, totaling $1.2
million.
This was partially offset by an increase in interest expense during 1995 due to
higher average borrowing levels on the revolving credit facility and increases
in the Company's prime borrowing rate during 1995.
During the first quarter of 1995, the Company was involved in extensive
negotiations to acquire the Dictaphone division of Pitney Bowes ("Dictaphone").
In April 1995, the acquisition was awarded to another bidder. The Company
incurred approximately $1 million in fees and expenses related to the attempted
acquisition which were recognized during the second and third quarters of 1995.
The Company accounts for income taxes in accordance with FAS No. 109,
"Accounting for Income Taxes." For the year ended December 31, 1995, the Company
recorded a net tax benefit of $2.3 million. This is comprised of $4.2 million of
tax benefit recognized as a result of the non-goodwill related portion of the
restructuring provision, partially offset by the $1.9 million tax provision on
earnings, excluding the restructuring provision. No tax benefit was recognized
on the goodwill portion of the provision for restructuring since it is not
deductible for tax purposes. The net tax benefit for the year was recorded as an
increase to the deferred tax asset reflecting additional tax benefits to be
utilized in the future. As of December 31, 1995, the deferred tax asset of $29.6
million represents the expected benefits to be received from the utilization of
tax benefit carryforwards which will result in the payment of minimal taxes in
the near future. The Company believes that the deferred tax asset will more
likely than not be recognized in the carryforward period. The Company had no
significant tax liability for the year ended December 31, 1995.
In October 1995, the FASB issued Statement No. 123, "Accounting for Stock-Based
Compensation." The Company will adopt the new pronouncement in fiscal year 1996
and has yet to decide whether it will record compensation cost or provide pro
forma disclosure.
Acquisition of Unistar Gaming Corporation
On December 19, 1995, the Company acquired 100% of the common stock of Unistar
Gaming Corporation ("Unistar") for 3.7 million shares of the Company's common
stock and 350,000 shares of newly issued preferred stock. Unistar,
privately-held prior to the acquisition, has an exclusive five-year contract to
design, develop, finance, and manage the National Indian Lottery ("NIL"). See
Note L of the Notes to Consolidated Financial Statements for the terms of the
agreement.
Management believes the Unistar business is a natural extension of its telephony
and call center business. Calls via an 800 number will be processed with
Interactive Voice Response ("IVR") equipment or live agents located on the Coeur
d'Alene Indian Tribe of Idaho ("CDA") Reservation using ACD software to process
nationwide wagering activity. The Company has made a significant investment in
Unistar, which initially creates 8% dilution to the Company's shareholders and
will require possibly $2 million to $3 million of cash prior to the resolution
of the pending legal issues discussed below. However, in the opinion of the
Company's management, this investment is justified based upon the potential
returns.
In an attempt to block the NIL, certain states filed Section 1084 letters to
prevent the long-distance carriers from providing telephone service to the NIL.
The CDA initiated legal action to compel the long-distance carriers to provide
telephone service to the NIL. The CDA's position is that the lottery is
authorized by the Indian Gaming Regulatory Act ("IGRA") passed by Congress in
1988, that the IGRA preempts state and federal statutes, and that the states
lack authority to issue the Section 1084 notification letters to any carrier. On
February 28, 1996, the NIL was ruled lawful by the CDA Tribal Court. The CDA
Tribal Court found that all requirements of the IGRA have been satisfied and the
Section 1084 letters issued by certain state attorneys general in an effort to
interfere with the lawful operation of the NIL are invalid. In addition, the
Court found that the long-distance carriers are obligated to provide the service
requested in the action. The Company expects this ruling will be appealed, but
believes that the CDA's position will be upheld.
Other than legal costs related to an appeal of the CDA Tribal Court ruling or
other actions by the states, if any, the Company estimates that the additional
costs to become operational may run between $5-10 million. The Company believes
it will be able to obtain additional financing for these costs.
The Company believes there is a national market for the NIL based upon research
into the experience of other national lotteries and the growth of the overall
lottery market. However, there is no assurance that there will be acceptance of
a telephone lottery.
Subsequent Events
On April 10, 1996, the Company entered into an agreement to sell substantially
all of the Direct Sales and Services Group, including its long-distance reseller
business and National Service Center, for $67.4 million to an acquisition
company led by Bain Capital, Inc. The purchase price will consist of $61.5
million in cash, a $5.9 million note and warrants to purchase 8% of the common
stock of the new company, issued as of the closing, for $1.1 million,
exercisable for three years. The sale is expected to close on May 31, 1996,
subject to the buyer's financing and other conditions. The Company expects a
gain on the sale. The agreement also provides that the Company and the buyer
will enter into a five-year exclusive distribution agreement under which the
buyer will sell and service the Company's telephony equipment to those
businesses and commercial locations that require up to 400 telephones.
The sale does not include the Pittsburgh direct sales and service office, which
the Company has separately agreed to sell to one of its existing independent
distributors for approximately $1.3 million in cash and notes. The Company will
retain its Healthcare Communications and Call Center Management businesses,
along with its National Accounts and Federal Systems marketing groups. In
addition, the Company will continue to make telephony product sales to its
independent distributors, along with retaining the recently acquired Unistar
business.
In 1995, the Direct Sales and Services Group, including the long-distance
reseller business, had revenues of $191 million. On a pro forma basis, after
giving effect to the transaction, the Company's 1995 revenues would be
approximately $157 million. This includes $42 million in sales to the Direct
Sales and Services Group which were eliminated in the 1995 Statement of
Operations.
On April 10, 1996, the Company also announced that it had given notice of its
intention to terminate its distribution agreement with GPT Video Systems due to
failures by GPT to deliver properly-functioning videoconferencing products on a
timely basis. The Company has not yet finalized its plans for its
videoconferencing division.
1994 COMPARED TO 1993
Results of Operations
Total revenues for the year ended December 31, 1994 were 7% higher than the
comparable 1993 period. Base revenues for 1994 increased 12% over 1993 primarily
due to volume increases generated by the INFOSTAR`r'/LD+ program, increased
sales of system upgrades and expansions and increased revenue from maintenance
contracts. Product revenues for 1994 increased 3% over 1993 primarily due to
increased sales of voice processing products and sales decreases in non-voice
processing applications and healthcare revenue.
Gross profit increased $11.5 million compared to 1993, with the gross profit as
a percentage of total revenues increasing to 41.9% from 40.9%. The increases
were a result of the continuing favorable product mix of increased base revenue
and voice processing products. Voice processing and base revenues in 1994
accounted for 71% of the sales volume compared to 64% in 1993, indicating the
Company's shifting emphasis to market value-added products to the customer base
and increase sales of application-specific software products.
Operating income increased $1.4 million during 1994 and, as a percentage of
total revenues, was 4.3% compared to 4.1% for 1993. The increase in operating
income as a percentage of total revenues was primarily related to the increase
in gross profit margin, partially offset by continuing investments in the sales
force and sales support personnel, technical marketing support and product
development and engineering expenses for the development and sale of the new
higher margin products.
Interest and other expenses, net for the year ended December 31, 1994 was $1.0
million lower than the corresponding 1993 period, primarily due to the favorable
impact of a lower level of bank borrowings.
For the year ended December 31, 1994, the Company recorded a provision for
income taxes of $3.3 million. Approximately 88% or $2.9 million of the total tax
provision was recorded as a reduction of the deferred tax asset to reflect the
utilization of tax benefits. As a result of the utilization of these benefits,
the Company had no significant tax liability for the year ended December 31,
1994. In addition, the Company recorded a provision for income taxes of $0.5
million, relating to discontinued operations, which also reduced the deferred
tax asset. During 1994, the Company adjusted its valuation allowance, resulting
in an increase in the deferred tax asset of $6.5 million, $5.2 million of which
was a reduction of goodwill as it related to pre-acquisition tax benefits and
$1.3 million of which reduced the 1994 provision for income taxes. The basis for
the adjustment of the valuation allowance was a significant increase in pre-tax
income from $7.6 million in 1993 to $10.0 million in 1994.
In December 1993, a fire occurred at the Company's main subcontractor's
production facility in Shinzen, China, causing inventory shortages during the
first six months of 1994. The production problems were largely alleviated by the
Company's ability to increase its own production and find alternative
manufacturing sources. In July 1994, the Company recovered $4 million from its
insurance carrier for additional direct costs related to the emergency
production situation.
As of March 31, 1994, the Company sold its Vodavi Communications Systems
Division ("VCS"), which sold telephone equipment to supply houses and dealers, a
different class of customer from continuing operations, under the brand names
STARPLUS`r' and INFINITE`tm', for approximately $10.9 million. Proceeds of the
sale consisted of approximately $9.7 million in cash, received in April 1994,
and a $1.2 million note, the proceeds of which were received in September 1995.
The proceeds were used to reduce borrowings under the Company's revolving credit
facility. The sale resulted in an after-tax gain of $604,000 (net of income tax
provision of $403,000). Consolidated financial statements for the years ended
December 31, 1994 and 1993 present VCS as a discontinued operation.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity is represented by cash, cash equivalents and cash
availability under its existing credit facilities. The Company's liquidity was
$23 million, $30 million and $29 million as of December 31, 1995, 1994 and 1993,
respectively.
At December 31, 1995 and 1994, cash and cash equivalents amounted to $8.1
million and $7.8 million, respectively, or 8% of current assets. During the year
ended December 31, 1995, net cash was used to fund $3.9 million of operating
activities, purchase $3.5 million of capital equipment, repay $0.6 million of
debt and for other payments of $0.8 million. Cash was generated through $5.2
million of additional borrowings, $1.6 million in proceeds from the issuance of
stock, receipt of a $1.2 million note payment from the sale of VCS and $0.8
million in other proceeds. Cash used in operating activities during 1995
included $14.3 million in funding of working capital, primarily due to the high
level of accounts payable at the end of 1994 generated by inventory purchases
during the last quarter of 1994. The decrease in cash generated by operating
activities compared to 1994 is primarily due to the decrease in operating
income, excluding the provision for restructuring, the funding of $1.0 million
in cash expenses relating to the attempted acquisition of Dictaphone and
additional interest payments of $0.8 million.
Total debt at December 31, 1995 was $30.8 million, an increase of $5.3 million
from $25.5 million at December 31, 1994. The increase in debt is due to $4.5
million in higher bank borrowings, $0.8 million in other borrowings, a $0.4
million capital lease obligation incurred in connection with equipment
acquisitions and an increase to the carrying value of the convertible
subordinated debentures of $0.2 million due to accretion. The additional
borrowings in 1995 were used to reduce the high level of accounts payable at the
end of 1994 generated by inventory purchases during the last quarter of 1994.
During the year, the Company made long-term debt and capital lease repayments of
$0.6 million.
The Company's secured credit facility (the "Credit Facility") was amended in
December 1995. The $45 million Credit Facility expires in August 1999 and
consists of a revolving line of credit providing for direct borrowings and up to
$15 million in letters of credit. Direct borrowings and letter of credit
advances are made available pursuant to a formula based on the levels of
eligible accounts receivable and inventories. The Credit Facility agreement
contains certain restrictive covenants which include, among other things, a
prohibition on the declaration or payment of any cash dividends on common stock,
minimum ratios of operating income to interest and fixed charges, and a maximum
ratio of total liabilities to net worth as well as certain restrictions on
start-up expenditures relating to Unistar and the NIL. Interest rates are also
subject to adjustment based upon certain financial ratios. During 1995, the
Company was in
compliance with all such financial covenants. The Credit Facility is secured by
substantially all of the assets of the Company. Refer to Note D of the Notes to
Consolidated Financial Statements.
As of February 16, 1996, there were $13.4 million of direct borrowings and $14.9
million of letters of credit outstanding and $15.2 million of additional
borrowings available under the Credit Facility. Required principal payments for
debt in 1996 are $0.9 million. The Company believes that borrowings under the
Credit Facility and cash flow from operations will be sufficient to meet working
capital and other requirements for 1996.
SELECTED FINANCIAL DATA
The following is selected financial data for EXECUTONE for the five years ended
December 31, 1995.
(In thousands, except for per share amounts)
Years Ended December 31,
------------------------------------------------------------------
1995 1994 (1) 1993 (1) 1992 (1) 1991 (1)
------------------------------------------------------------------
Revenues $296,393 $291,969 $271,765 $253,024 $243,616
======== ======== ======== ======== ========
Income (Loss) Before
Income Taxes From
Continuing Operations $(39,221) $ 10,041 $ 7.580 $ 4,320 $ 2,327
======== ======== ======== ======== ========
Income (Loss) From
Continuing Operations $(36,934) $ 6,734 $ 4,903 $ 2,222 $ 1,146
Income (Loss) From
Discontinued Operations,
Net of Taxes --- 757 298 (157) (129)
Extraordinary Item - Gain on
Extinguishment of Debt,
Net of Taxes (2) --- --- --- 1,267 ---
-------- -------- -------- -------- --------
Net Income (Loss) $(36,934) $ 7,491 $ 5,201 $ 3,332 $ 1,017
======== ======== ======== ======== ========
EARNINGS (LOSS) PER SHARE:
Continuing Operations$ (0.79) $ 0.14 $ 0.10 $ 0.05 $ 0.03
Discontinued Operations --- 0.02 0.01 --- ---
Extraordinary Item --- --- --- 0.03 ---
-------- -------- -------- -------- --------
Net Income (Loss) $ (0.79) $ 0.16 $ 0.11 $ 0.08 $ 0.03
======== ======== ======== ======== ========
Total Assets $167,844 $189,481 $175,555 $179,294 $177,602
======== ======== ======== ======== ========
Long-Term Debt (3) $ 29,829 $ 24,698 $ 32,279 $ 43,752 $ 56,271
======== ======== ======== ======== ========
Cash Dividends Declared
Per Share (4) $ --- $ --- $ --- $ --- $ ---
======== ======== ======== ======== ========
(1) Discontinued operations are presented for VCS which was sold in March 1994.
Refer to Note L of the Notes to Consolidated Financial Statements.
(2) The extraordinary item relates to the 1992 exchange of debentures for
Preferred Stock and Common Stock Purchase Warrants. Refer to Note D (b) of
the Notes to Consolidated Financial Statements.
(3) Includes capitalized leases.
(4) The Company has not declared or paid any cash dividends on its Common
Stock. Refer to "Stock Data".
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except for per share amounts)
Years Ended December 31,
1995 1994 1993
---- ---- ----
REVENUES:
Product $138,752 $137,752 $134,209
Base 157,641 154,217 137,556
--------- --------- ---------
296,393 291,969 271,765
COST OF REVENUES 173,536 169,497 160,745
--------- ---------- ----------
Gross Profit 122,857 122,472 111,020
--------- ---------- ----------
OPERATING EXPENSES:
Product development and engineering 14,703 12,222 9,852
Selling, general and administrative 100,520 97,755 90,122
Provision for restructuring and unusual items
(Note B) 44,042 --- ---
--------- ---------- ----------
159,265 109,977 99,974
--------- ---------- ----------
OPERATING INCOME (LOSS) (36,408) 12,495 11,046
INTEREST AND OTHER EXPENSES,
NET 1,791 2,454 3,466
ACQUISITION COSTS (Note L) 1,022 --- ---
--------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAXES
FROM CONTINUING OPERATIONS (39,221) 10,041 7,580
PROVISION (BENEFIT) FOR INCOME TAXES:
Cash 350 400 335
Noncash (Note E) (2,637) 2,907 2,342
--------- ---------- ----------
(2,287) 3,307 2,677
--------- ---------- ----------
INCOME (LOSS) FROM CONTINUING
OPERATIONS (36,934) 6,734 4,903
Income from discontinued operations
(net of income tax provision of $102 and $158 ) --- 153 298
Gain on disposal of discontinued operations
(net of income tax provision of $403) --- 604 ---
--------- ---------- ----------
NET INCOME (LOSS) $ (36,934) $ 7,491 $ 5,201
========= ========== ==========
EARNINGS (LOSS) PER SHARE:
CONTINUING OPERATIONS $ (0.79) $ 0.14 $ 0.10
DISCONTINUED OPERATIONS --- 0.02 0.01
--------- ---------- ----------
NET INCOME (LOSS) $ (0.79) $ 0.16 $ 0.11
======== ========== ==========
WEIGHTED AVERAGE NUMBER OF
SHARES OF COMMON STOCK AND
EQUIVALENTS OUTSTANDING 46,919 47,697 48,283
=========== =========== ===========
The accompanying notes are an integral part of these consolidated statements.
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) Years Ended December 31,
1995 1994 1993
---- ----- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Income (loss) from continuing operations $(36,934) $ 6,734 $ 4,903
Adjustments to reconcile net income (loss) to net
cash (used) provided by operating activities:
Depreciation and amortization 6,093 7,463 7,469
Deferred income tax provision (benefit) (2,637) 2,907 2,342
Provision for restructuring and unusual items
(Note B) 44,042 --- ---
Provision for losses on accounts receivable 1,440 893 725
Gains on sales of two direct sales offices (1,087) --- ---
Other, net (521) 1,251 270
Changes in working capital items:
Accounts receivable (4,205) (9,346) (4,337)
Inventories (3,121) (13,049) 4,073
Accounts payable and accruals (9,131) 10,497 2,732
Other working capital items, net 2,177 (552) (1,440)
-------- --------- --------
NET CASH (USED) PROVIDED BY CONTINUING
OPERATIONS (3,884) 6,798 16,737
-------- --------- --------
Cash flows from discontinued operations --- (449) (209)
-------- --------- --------
NET CASH (USED) PROVIDED BY OPERATING
ACTIVITIES (3,884) 6,349 16,528
-------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment, net (3,457) (6,091) (2,119)
Dispositions (acquisitions) of direct sales offices 125 (1,298) (750)
Proceeds from sale of VCS 1,200 9,700 ---
Other, net 822 (436) 8
-------- --------- --------
NET CASH (USED) PROVIDED BY
INVESTING ACTIVITIES (1,310) 1,875 (2,861)
-------- --------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings (repayments) under revolving credit facility 4,478 (4,199) (3,524)
Repayments of term note under credit facility --- (3,750) (1,250)
Repayments of GTE/Contel promissory note --- --- (4,000)
Repayments of other long-term debt (622) (1,781) (2,355)
Repurchase of stock (810) (8,450) (3,100)
Proceeds from issuance of stock 1,641 10,399 564
Other borrowings 750 --- ---
-------- --------- --------
NET CASH PROVIDED (USED) BY FINANCING
ACTIVITIES 5,437 (7,781) (13,665)
-------- --------- --------
INCREASE IN CASH AND CASH EQUIVALENTS 243 443 2
CASH AND CASH EQUIVALENTS - BEGINNING
OF YEAR 7,849 7,406 7,404
-------- --------- --------
CASH AND CASH EQUIVALENTS - END
OF YEAR $ 8,092 $ 7,849 $ 7,406
======== ========= ========
The accompanying notes are an integral part of these consolidated statements.
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except for share amounts) December 31, December 31,
1995 1994
----------- -----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 8,092 $ 7,849
Accounts receivable, net of allowance
of $1,715 and $1,335 48,531 46,675
Inventories (Note B) 32,765 40,300
Prepaid expenses and other current assets 6,584 7,358
-------- --------
Total Current Assets 95,972 102,182
PROPERTY AND EQUIPMENT, net 18,462 18,967
INTANGIBLE ASSETS, net (Notes B and L) 20,022 38,415
DEFERRED TAXES 29,616 26,979
OTHER ASSETS 3,772 2,938
-------- --------
$167,844 $189,481
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 932 $ 777
Accounts payable 30,676 39,369
Accrued payroll and related costs 6,870 7,026
Accrued liabilities 11,851 9,192
Deferred revenue and customer deposits 19,781 18,757
-------- --------
Total Current Liabilities 70,110 75,121
LONG-TERM DEBT 29,829 24,698
LONG-TERM DEFERRED REVENUE 2,805 2,354
-------- --------
Total Liabilities 102,744 102,173
-------- --------
STOCKHOLDERS' EQUITY:
Common stock: $.01 par value; 80,000,000 shares
authorized; 51,658,492 and 45,647,894 issued and
outstanding 517 456
Preferred stock: $.01 par value; Cumulative Convertible
Preferred Stock (Series A), 250,000 shares authorized,
issued and outstanding; Cumulative Contingently
Convertible Preferred Stock (Series B), 100,000 shares
authorized, issued and outstanding 7,300 ---
Additional paid-in capital 79,668 72,303
Retained earnings (deficit) (since July 1, 1988) (22,385) 14,549
-------- --------
Total Stockholders' Equity 65,100 87,308
-------- --------
$167,844 $189,481
======== ========
The accompanying notes are an integral part of these consolidated balance
sheets.
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock Preferred Stock Additiona Retained Total
(In thousands, except for ------------- --------------- Paid-In Earnings Stockholders'
share amounts) Shares Amount Shares Amount Capital (Deficit) Equity
------ ------ ------ ------ ------- ------- --------
Balance at December 31, 1992 30,873,495 $309 674,865 $6,149 $60,721 $1,857 $69,036
Proceeds from issuances of stock
from employee stock plans 1,307,805 13 1,247 1,260
Proceeds from common stock
purchase warrants exercised
through bond conversion 1,418,300 14 971 985
Conversion of note payable
into preferred stock 200,000 1,909 365 2,274
Conversion of preferred stock
into common stock 8,748,650 88 (874,865) (8,058) 7,970 ---
Repurchase of stock (1,142,752) (12) (3,088) (3,100)
Amortization of deferred
compensation 89 89
Net income 5,201 5,201
------------------------------------------------------------------------
Balance at December 31, 1993 41,205,498 $412 --- $ --- $68,275 $7,058 $75,745
Proceeds from issuances of stock
from employee stock plans 5,716,651 57 11,303 11,360
Proceeds from common stock
purchase warrants exercised
through bond conversion 1,507,000 15 1,056 1,071
Repurchase of stock (2,781,255) (28) (8,422) (8,450)
Amortization of deferred
compensation 91 91
Net income 7,491 7,491
------------------------------------------------------------------------
Balance at December 31, 1994 45,647,894 $456 --- $ --- $72,303 $14,549 $87,308
Proceeds from issuances of stock
from employee stock plans 1,934,492 19 1,613 1,632
Warrants exercised for common
stock 363,549 4 (4) ---
Common and preferred stock issued
to acquire Unistar (Note L) 3,700,000 37 350,000 7,300 5,374 12,711
Common stock issued for
investment in DCC (Note G) 353,118 4 1,100 1,104
Repurchase of stock (340,561) (3) (807) (810)
Amortization of deferred
compensation 89 89
Net loss (36,934) (36,934)
------------------------------------------------------------------------
Balance at December 31, 1995 51,658,492 $517 350,000 $7,300 $79,668 $(22,385) $65,100
========================================================================
The accompanying notes are an integral part of these consolidated statements.
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - NATURE OF THE BUSINESS AND FORMATION OF THE COMPANY
EXECUTONE Information Systems, Inc. (the "Company") designs, manufactures,
sells, installs, supports and services voice processing systems and provides
cost-effective long-distance telephone service and videoconferencing services.
The Company is also a leading supplier of specialized hospital communications
equipment. Products are sold under the EXECUTONE`r', INFOSTAR`r', IDS`tm',
LIFESAVER`tm' and INFOSTAR/ILS`tm' brand names through a worldwide network of
direct and independent sales and service offices. The Company's products are
manufactured primarily in the United States, Hong Kong, China and the Dominican
Republic.
The Company was formed in July 1988 through the merger of ISOETEC
Communications, Inc. ("ISOETEC") with Vodavi Technology Corporation ("Vodavi").
The merger of ISOETEC into Vodavi was accounted for under the purchase method of
accounting and Vodavi was deemed to have undergone a quasi-reorganization for
accounting purposes. As of July 1988, Vodavi's accumulated deficit of
approximately $49.7 million was eliminated. Executone, Inc. was acquired in 1988
from Contel Corporation ("Contel") for promissory notes and cash.
NOTE B - PROVISION FOR RESTRUCTURING
In July 1995, the Company reorganized its business into five divisions: Computer
Telephony, Healthcare Communications Systems, Call Center Management,
Videoconferencing Products, and Network Services and changed its business
strategy in the Computer Telephony division. The current strategic focus is on
software applications in the communications market. The business that was
acquired in 1988 was a telephone equipment hardware company focused on customers
with small systems, with an emphasis on selling additional hardware and service
to generate add-on revenue. Under the current strategy, the business acquired in
1988 is being de-emphasized. The Company adopted FAS No. 121, "Accounting for
the Impairment of Long-Lived Assets," which was issued in March 1995, requiring
impairment to be measured by projecting the lowest level of identifiable future
cash flows. The Company concluded there was an impairment. As a result, the
Company recorded a $44.0 million provision for restructuring consisting of a
$33.5 million goodwill impairment, an $8.8 million writedown of inventory,
primarily service stock relating to the impaired assets and other non-recurring
inventory adjustments, $0.9 million related to the shutdown of the Company's
Scottsdale, Arizona facility and $0.8 million of other unusual items.
In accordance with the provisions of FAS No. 121, the Company prepared
projections of future operating cash flows relating to the telephony business
acquired in 1988 based upon the Company's new strategic direction. These
projections indicated that this business would not generate sufficient operating
cash flows to realize goodwill and the related service stock. The amount of
impairment of the telephony goodwill was $33.5 million as of June 30, 1995.
The write-off of inventory, primarily service stock, consisted of $1.3 million
of raw materials inventory and $7.5 million of finished goods inventory. These
amounts were determined based upon a review of specific inventory parts along
with current and projected usage, incorporating the strategic direction of the
Company. The Company will continue to maintain adequate levels of service stock
for the telephony hardware customer base which will be amortized over the
estimated product/service life of the related systems.
NOTE C - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation. The consolidated financial statements include the
accounts of the Company and its subsidiaries. In consolidating the accompanying
financial statements, all significant intercompany transactions have been
eliminated. Investments in affiliated companies owned more than 20%, but not in
excess of 50%, are recorded on the equity method. Certain prior year amounts
have been reclassified to conform to the current year's presentation.
Use of Estimates. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities,
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 these estimates.
Revenue Recognition. The Company recognizes revenue on equipment sales and
software licenses to independent sales and service offices when shipped. Revenue
from equipment, software and installation contracts with end-users is recognized
when the contract or contract phase for major installations is substantially
completed.
Revenue derived from the sale of service contracts is amortized ratably over the
service contract period on a straight-line basis.
Earnings Per Share. Earnings per share is based on the weighted average number
of shares of common stock and dilutive common stock equivalents (which include
stock options and warrants) outstanding during the period. Common stock
equivalents and the convertible debentures which are antidilutive have been
excluded from the computations.
Cash Equivalents. Cash equivalents include short-term investments with original
maturities of three months or less.
Inventories. Inventories are stated at the lower of first-in, first-out ("FIFO")
cost or market and consist of the following at December 31, 1995 and 1994:
(Amounts in thousands) 1995 1994
---------------------- ---- ----
Raw Materials $ 4,783 $ 3,082
Finished Goods 27,982 37,218
------- -------
$32,765 $40,300
======= =======
Finished goods include service stock which is amortized over the estimated
product/service life of the related systems.
Intangible Assets. Intangible assets represent the excess of the purchase price
of the predecessor companies acquired over the fair value of the net tangible
assets acquired. Effective April 1, 1995, the carrying value of intangibles is
evaluated periodically in accordance with the provisions of FAS No. 121 by
projecting the lowest level of future undiscounted net cash flows of the
underlying businesses. If the sum of such cash flows is less than the book value
of the long-lived assets, including intangibles, projected future cash flows are
discounted and intangibles are adjusted accordingly. Prior to April 1, 1995, the
carrying value of intangibles was evaluated in accordance with the provisions of
APB 17, and was based upon aggregate cash flows of the business as a whole.
Amortization is provided over periods ranging from 10 to 40 years. Intangible
assets at December 31, 1995 and 1994 are net of accumulated amortization of $0.8
million and $13.6 million, respectively.
Property and Equipment. Property and equipment at December 31, 1995 and 1994
consist of the following:
(Amounts in thousands) 1995 1994
---------------------- ---- ----
Land and building $ 1,364 $ 1,961
Furniture and fixtures 7,052 7,626
Leasehold improvements 2,828 2,620
Machinery and equipment 38,093 34,269
--------- ---------
49,337 46,476
Accumulated depreciation (30,875) (27,509)
--------- ---------
Property and equipment, net $ 18,462 $ 18,967
========= =========
Depreciation is provided on a straight-line basis over the estimated economic
useful lives of property and equipment which range from three to ten years for
equipment and thirty years for a building. Amortization, principally of
leasehold improvements, is provided over the life of the respective lease terms
which range from three to ten years.
Income Taxes. The Company utilizes the liability method of accounting for income
taxes as set forth in FAS No. 109, "Accounting for Income Taxes." Under the
liability method, deferred taxes are determined based on the difference between
the financial statement and tax bases of assets and liabilities using enacted
tax rates in effect in the years in which the differences are expected to
reverse.
Product Development and Engineering. Product development and engineering costs
are expensed as incurred.
Fair Value of Financial Instruments. The fair value of the Company's Convertible
Subordinated Debentures at December 31, 1995 is approximately $14.3 million,
based upon market quotes. The carrying value of all other financial instruments
included in the accompanying financial statements approximate fair value as of
December 31, 1995 based upon current interest rates.
Noncash Investing and Financing Activities. The following noncash investing and
financing activities took place during the three years ended December 31, 1995:
(Amounts in thousands) 1995 1994 1993
---------------------- ---- ---- ----
Common and Preferred Stock issued to
acquire Unistar (Note L) $12,711 $ --- $ ---
Notes receivable for disposition of direct sales
offices (Note L) 1,911 --- ---
Equity investment in DCC (Note G) 1,505 --- ---
Capital leases for equipment acquisitions 437 686 1,791
Note receivable for disposition of VCS
division (Note L) --- 1,200 ---
Common stock purchase warrants exercised
through bond conversion --- 1,071 985
Utilization of credits under a special
stock option incentive plan --- 737 696
Conversion of Preferred Stock into
Common Stock --- --- 8,058
Conversion of Note Payable into
Preferred Stock --- --- 2,274
Refer to the consolidated statements of cash flows for information on
cash-related operating, investing and financing activities.
NOTE D - DEBT
The Company's debt is summarized below at December 31, 1995 and 1994:
(Amounts in thousands) 1995 1994
- ---------------------- ---- ----
Borrowings Under Revolving Credit Facility (a) $15,445 $10,967
Convertible Subordinated Debentures (b) 12,098 11,855
Capital Lease Obligations (c) 2,412 2,408
Other 806 245
------- -------
Total Debt 30,761 25,475
Less: Current Portion of Long-Term Debt 932 777
------- -------
Total Long-Term Debt $29,829 $24,698
======= =======
(a) The Company's Credit Facility was amended in December 1995. The amended $45
million Credit Facility consists of a revolving line of credit providing for
direct borrowings and up to $15 million in letters of credit. Direct borrowings
and letter of credit advances are made available pursuant to a formula based on
the levels of eligible accounts receivable and inventories. To minimize interest
on the revolving line of credit, the Company has the option to borrow money
based upon an adjusted prime borrowing rate (9.0% at December 31, 1995) or at an
adjusted eurodollar rate (8.2% at December 31, 1995). The Company had $11.0
million and $8.0 million outstanding subject to the adjusted eurodollar rate at
December 31, 1995 and 1994, respectively, with the balance at the adjusted prime
borrowing rate. Prior to August 1994, interest on amounts outstanding under the
revolving line of credit were based upon the lender's prime rate. The revolving
line of credit expires in August 1999. Approximately $14.7 million was available
at December 31, 1995 under the revolving line of credit, including approximately
$14.9 million which was committed to cover outstanding letters of credit. The
unused portion of the line of credit has a commitment fee of 0.375%. The
Company's average outstanding
indebtedness under the revolving line of credit for the years ended December 31,
1995 and 1994 was $17.4 million and $13.1 million, respectively, and the average
interest rate on such indebtedness was 8.5% and 7.1%, respectively.
The Credit Facility agreement contains certain restrictive covenants which
include, among other things, a prohibition on the declaration or payment of any
cash dividends on common stock, minimum ratios of operating income to interest
and fixed charges, and a maximum ratio of total liabilities to net worth as well
as certain restrictions on start-up expenditures relating to Unistar and the NIL
(Refer to Note L). Interest rates are also subject to adjustment based upon
certain financial ratios. The Company was in compliance with all covenants in
1995. The Credit Facility is secured by substantially all of the assets of the
Company.
(b) The Company's Convertible Subordinated Debentures (the "Debentures"), issued
in April 1986, are due March 15, 2011 and bear interest at 7 1/2%, payable March
15th and September 15th. The face value of the outstanding Debentures at
December 31, 1995 was $16.5 million. The face value of the Debentures was
adjusted to fair value in connection with the Company's 1988
quasi-reorganization. The Debentures are convertible at the option of the holder
into Common Stock of the Company at any time on or before March 15, 2011, unless
previously redeemed, at a conversion price of $10.625 per share, subject to
adjustment in certain events. Subject to certain restrictions, the Debentures
are redeemable in whole or in part, at the option of the Company, at par in
1996. The Debentures are also subject to annual sinking fund payments of $1.5
million beginning March 15, 1997. In January 1992, $15 million principal amount
of Debentures with a book value of $10.1 million was exchanged for 674,865
shares of Convertible Preferred Stock and 2,999,400 Common Stock Purchase
Warrants. Debentures converted in the debt-for-equity exchange and in connection
with Warrant exercises were delivered in lieu of cash in satisfying sinking fund
requirements. Thus, no cash sinking fund payment will be due until March 2008.
(c) The Company has entered into capital lease arrangements for office furniture
and data processing and test equipment with a net book value of approximately
$2.3 million and $2.4 million at December 31, 1995 and 1994, respectively. Such
leases have been capitalized using implicit interest rates which range from 8%
to 14%.
The following is a schedule of future maturities of long-term debt at December
31, 1995:
Years Ending December 31: (Amounts in thousands)
------------------------ ---------------------
1996 $ 932
1997 842
1998 640
1999 15,742
2000 155
Thereafter 12,450
-------
$30,761
=======
NOTE E - INCOME TAXES
The components of the provision (benefit) for income taxes applicable to income
(loss) from continuing operations for the three years ended December 31, 1995
are as follows:
(Amounts in thousands) 1995 1994 1993
---------------------- ---- ---- ----
Current - Federal $ 150 $ 200 $ 145
- State 200 200 190
------- ------ ------
350 400 335
------- ------ ------
Deferred - Federal (1,922) 2,363 1,842
- State (715) 544 500
------- ------ ------
(2,637) 2,907 2,342
------- ------ ------
$(2,287) $3,307 $2,677
======== ====== ======
For the years ended December 31, 1994 and 1993, the Company recorded a deferred
income tax provision of $505,000 and $158,000, respectively, related to
discontinued operations.
A reconciliation of the statutory federal income tax provision (benefit) to the
reported income tax provision (benefit) on income (loss) from continuing
operations for the three years ended December 31, 1995 is as follows:
(Amounts in thousands) 1995 1994 1993
- ---------------------- ---- ---- ----
Statutory income tax provision (benefit) $(13,335) $3,415 $2,577
State income taxes, net of
federal income tax benefit (338) 676 526
Impairment of intangible assets 11,392 --- ---
Amortization of intangible assets 171 457 476
Adjustment of valuation allowance --- (1,252) (800)
Research and development credit (148) (250) (196)
Other (29) 261 94
-------- ------ ------
Reported income tax provision (benefit) $ (2,287) $3,307 $2,677
======== ====== ======
The components of and changes in the net deferred tax asset are as follows:
Deferred
December 31, (Expense) December 31,
(Amounts in thousands) 1994 Benefit 1995
- ---------------------- ----------- ---------- ---------
Net operating loss and tax credit carryforwards $29,175 $(1,631) $27,544
Inventory reserves 5,405 2,800 8,205
Accrued liabilities and restructuring costs 1,446 (864) 582
Debenture revaluation (1,715) 90 (1,625)
Other (2,540) 2,194 (346)
------- ------- -------
31,771 2,589 34,360
Valuation allowance (4,792) 48 (4,744)
------- ------- -------
Deferred tax asset $26,979 $ 2,637 $29,616
======= ====== =======
The deferred tax asset represents the benefits expected to be realized from the
utilization of pre- and post-acquisition tax benefit carryforwards, which
include net operating loss carryforwards ("NOLs"), tax credit carryforwards and
the excess of tax bases over fair value of the net assets of the Company. The
utilization of these tax benefits for financial reporting purposes will not be
reflected in the statement of operations, but will be reflected as a reduction
of the deferred tax asset.
In order to fully realize the remaining deferred tax asset of $29.6 million as
of December 31, 1995, the Company will need to generate future taxable income of
approximately $80 million prior to the expiration of the NOLs and tax credit
carryforwards. Although the Company believes that it is more likely than not
that the deferred tax asset will be fully realized based on current projections
of future pre-tax income, a valuation allowance has been provided for a portion
of the deferred tax asset. There was no significant adjustment to the valuation
allowance in 1995. During 1994, the Company adjusted its valuation allowance by
$6.5 million, $5.2 million of which was a reduction of goodwill as it related to
pre-acquisition tax benefits and $1.3 million of which reduced the 1994
provision for income taxes. During 1993, the Company adjusted its valuation
allowance by $4.8 million, $4.0 million of which was a reduction of goodwill as
it related to pre-acquisition tax benefits and $0.8 million of which reduced the
1993 provision for income taxes. The basis for the adjustments in 1994 and 1993
was a significant increase in pre-tax income from $4.3 million in 1992 to $10.0
million in 1994. Accordingly, historical earnings supported the realization of
the larger deferred tax asset. The amount of the deferred tax asset considered
realizable, however, could be reduced if estimates of future taxable income
during the carryforward period are reduced.
As of December 31, 1995, the Company has NOLs and tax credit carryforwards
(subject to review by the Internal Revenue Service) available to offset future
income for tax return purposes of approximately $69.3 million and $3.2 million,
respectively. A portion of the NOLs and tax credit carryforwards were generated
prior to the formation of the
Company and their utilization is subject to certain limitations imposed by the
Internal Revenue Code. The NOLs expire as follows:
(Amounts in millions) 2002 2003 2004 2005 2006
- --------------------- ---- ---- ---- ---- ----
$0.5 $20.8 $26.0 $9.7 $12.3
A reconciliation of the Company's income (loss) before taxes for financial
reporting purposes to taxable income for the three years ended December 31, 1995
is as follows:
(Amounts in thousands) 1995 1994 1993
- ---------------------- ---- ---- ----
Income (loss) before taxes from continuing operations $(39,221) $10,041 $ 7,580
Discontinued operations --- 1,262 456
-------- ------- -------
Income (loss) before taxes for financial
reporting purposes (39,221) 11,303 8,036
Differences between income (loss) before taxes for
financial reporting purposes and taxable income:
Permanent differences 28,587 1,070 1,570
-------- ------- -------
Book taxable income (loss) (10,634) 12,373 9,606
Net changes in temporary differences 11,113 (5,016) (7,830)
-------- ------- -------
Taxable income $ 479 $ 7,357 $ 1,776
======== ======= =======
The permanent differences relate to the write-off (in 1995) and amortization of
goodwill, which are not deductible. Changes in temporary differences principally
relate to the impairment in service stock inventory (in 1995), inventory
reserves and other costs accrued for book purposes, but not deducted for tax
purposes until subsequently paid.
For the years ended December 31, 1995, 1994 and 1993, the Company made cash
payments of approximately $214,000, $485,000 and $96,000, respectively, for
income taxes.
NOTE F - COMMITMENTS AND CONTINGENCIES
Operating Leases. The Company conducts its business operations in leased
premises under noncancellable operating lease agreements expiring at various
dates through 2005. Rental expense under operating leases amounted to $9.6
million, $10.1 million and $9.7 million for the years ended December 31, 1995,
1994 and 1993, respectively.
The following represents the future minimum rental payments due under
noncancellable operating leases that have initial or remaining lease terms in
excess of one year as of December 31, 1995:
Years Ending December 31, (Amounts in thousands)
------------------------- ---------------------
1996 $ 8,761
1997 7,724
1998 7,025
1999 5,435
2000 3,941
Thereafter 3,374
-------
$36,260
Litigation. The Company has various lawsuits, claims and contingent liabilities
arising from the conduct of business; however, in the opinion of management,
they are not expected to have a material adverse effect on the results of
operations, cash flow or financial position of the Company.
NOTE G - RELATED PARTY TRANSACTIONS
During 1995, the Company acquired 43% of the common stock and certain other
assets of Dialogic Communications Corporation ("DCC"), a vendor which supplies
the Company with certain call center products, in exchange for 353,118 shares of
the Company's common stock and $100,000 cash. This investment is included in
Other Assets and the related equity income is included in Interest and Other
Expenses, Net.
NOTE H - STOCK OPTIONS AND WARRANTS
Information relative to the Company's stock option plans at December 31, 1995 is
as follows:
Shares Per Share Range
-------- ---------------
Total shares originally authorized 11,290,000
Options exercised/expired since inception of plans (7,074,104)
----------
Remaining shares reserved for issuance 4,215,896
Options outstanding 2,083,560 $0.69-3.25
----------
Shares available for granting of future options 2,132,336
==========
Options exercisable 1,124,469 $0.69-3.19
Options exercised -
Year ended December 31, 1995 1,970,760 $0.63-1.91
Year ended December 31, 1994 1,979,340 $0.63-2.88
Year ended December 31, 1993 1,144,395 $0.63-1.25
Option prices under the Company's plans are equal to the market value of the
Common Stock on the dates the options are granted.
The Company has non-plan options outstanding at December 31, 1995 for 357,030
shares at prices ranging from $1.13 to $20.43 per share. These include options
for 300,000 shares granted to an officer by a predecessor company at a price of
$1.13 per share. Deferred compensation of $0.9 million was recorded for the
excess of the fair value over the exercise price at the date of grant and is
being amortized over 10 years ending in 1997. At December 31, 1995, all of the
non-plan options were exercisable. These options expire at various dates through
November 2000. Certain options include registration rights for the shares
issuable thereunder.
As of December 31, 1995, the Company has warrants outstanding which permit the
holder to purchase a total of 56,250 shares of Common Stock at prices ranging
from $1.06 to $1.25 per share, expiring through September 1997. At December 31,
1995, 39,584 warrants were exercisable. Certain options and warrants have been
exercised using pyramiding during the years ended December 31, 1995, 1994 and
1993.
In October 1995, the FASB issued Statement No. 123, "Accounting for Stock-Based
Compensation." The Company will adopt the new pronouncement in fiscal year 1996
and has yet to decide whether it will record compensation cost or provide pro
forma disclosure.
NOTE I - EMPLOYEE STOCK PURCHASE PLAN
A total of 2,750,000 shares of Common Stock are authorized for issuance under
the Company's employee stock purchase plan. The plan permits eligible employees
to purchase up to 1,000 shares of Common Stock at the lower of 85% of the fair
market value of the Common Stock at the beginning or at the end of each
six-month offering period. Pursuant to such plan, 229,636, 209,512 and 168,097
shares were sold to employees during the three years ended December 31, 1995,
1994 and 1993, respectively.
In 1994, the Company's shareholders adopted the 1994 Executive Stock Incentive
Plan, which enabled officers and other key employees to purchase a total of up
to 3,000,000 shares of the Company's Common Stock. During 1995 and 1994,
participants purchased 140,000 and 2,745,000 shares of Common Stock,
respectively, at fair market value, which were financed through individual bank
borrowings at market interest rates by each participant, payable over five
years. The
Company lends the employee 85% of the interest due to the bank, with $759,000 of
such loans outstanding as of December 31, 1995. There were no amounts
outstanding as of December 31, 1994. The Company guarantees the individual
borrowings under a $9.4 million letter of credit which has a minimal impact on
the Company's borrowing capability. Employee loans guaranteed by the Company
with letters of credit as of December 31, 1995 and 1994 were $9.2 million and
$8.7 million, respectively. These shares are held by the Company as security for
the borrowings under a loan and pledge agreement. Sales of such shares by
participants are subject to certain restrictions, and, generally, they may not
be sold for five years.
NOTE J - SAVINGS AND POST-RETIREMENT BENEFIT PLANS
The Company has a 401(k) Savings Plan under which it matches employee
contributions subject to the discretion of the Company's Board of Directors. The
Company's matching contribution, consisting of shares of its Common Stock
purchased in the open market, is equal to 25% of each employee's contribution,
up to a maximum of $660 per employee. The expense for the matching contribution
for the years ended December 31, 1995, 1994 and 1993 was approximately $687,000,
$500,000 and $372,000, respectively.
The Company has an obligation remaining from the acquisition of Executone, Inc.
to provide post-retirement health and life insurance benefits for a group of
fewer than 75 former Executone, Inc. employees, including seven current
employees of the Company. The Company does not provide post-retirement health or
life insurance benefits to any other employees. Effective January 1, 1993, the
Company adopted FAS No. 106, a standard on accounting for post-retirement
benefits other than pensions. This standard requires that the expected cost of
these benefits must be charged to expense during the years that employees render
services. The Company adopted the new standard prospectively and is amortizing
the transition obligation over a 20-year period.
Post-retirement benefit expense for the three years ended December 31, 1995
consists of the following:
(Amounts in thousands) 1995 1994 1993
- ---------------------- ---- ---- ----
Interest on accumulated benefit obligation $219 $217 $190
Amortization of transition obligation 116 116 116
Amortization of unrecognized actuarial loss 20 23 ---
---- ---- ----
$355 $356 $306
==== ==== ====
The status of the plan at December 31, 1995 and 1994 is as follows:
(Amounts in thousands) 1995 1994
- ---------------------- ---- ----
Accumulated post-retirement benefit obligation ("APBO"):
Retirees $2,779 $2,707
Active Employees 330 321
------ ------
3,109 3,028
Unamortized transition obligation (1,977) (2,093)
Unrecognized net loss (486) (559)
------ ------
Accrued liability $ 646 $ 376
====== ======
In determining the APBO as of December 31, 1995 and 1994, the weighted average
discount rate used was 7%. The Company used a healthcare cost trend rate of
approximately 11%, decreasing through 2006 and leveling off at 6% thereafter. A
1% increase in the healthcare trend rate would increase the APBO at December 31,
1995 by approximately 2% and increase the interest cost component of the
post-retirement benefit expense for 1995 by less than $10,000.
NOTE K - INTEREST AND OTHER EXPENSES, NET
Interest and other expenses, net consists of the following for the three years
ended December 31, 1995:
(Amounts in thousands) 1995 1994 1993
- ---------------------- ---- ---- ----
Interest expense $3,920 $3,089 $3,556
Interest income (285) (287) (252)
Equity in earnings of DCC (Note G) (401) --- ---
Gains on sales of direct sales offices (1,213) --- ---
Other, net (230) (348) 162
------ ------ ------
$1,791 $2,454 $3,466
====== ====== ======
For the years ended December 31, 1995, 1994 and 1993, the Company made cash
payments of approximately $3.6 million, $2.8 million and $4.2 million,
respectively, for interest expense on indebtedness.
NOTE L - ACQUISITIONS/DISPOSITIONS
During the fourth quarter of 1995, the Company sold its customer bases in
Wisconsin and Iowa and the net assets of the related direct sales offices for a
total of $2.1 million, consisting of $125,000 cash, a $1.8 million note, the
proceeds of which were received in February 1996 and a $150,000 note due in
installments by November 2001. These sales generated a gain of approximately
$1.2 million, which is included in Interest and Other Expenses, Net for the year
ended December 31, 1995.
On December 19, 1995, the Company acquired 100% of the common stock of Unistar
Gaming Corporation ("Unistar") for 3.7 million shares of the Company's common
stock and 350,000 shares of newly issued preferred stock. Unistar,
privately-held prior to the acquisition, has an exclusive five-year contract to
design, develop, finance, and manage the National Indian Lottery ("NIL"). The
NIL will be a national telephone lottery authorized by federal law and a compact
between the State of Idaho and the Coeur d'Alene Indian Tribe of Idaho ("CDA").
In return for providing these management services to the NIL, Unistar will be
paid a fee equal to 30% of the profits of the NIL.
The purchase price was approximately $12.7 million. The excess of the purchase
price over the value of the net liabilities assumed has been allocated to the
management agreement with the CDA and will be amortized over the five-year term
of the contract commencing with the first significant lottery revenues.
The preferred stock consists of 250,000 shares of Cumulative Convertible
Preferred Stock, Series A ("Series A Preferred Stock") and 100,000 shares of
Cumulative Contingently Convertible Preferred Stock, Series B ("Series B
Preferred Stock"). The Series A Preferred Stock has voting rights equal to one
share of common stock and will earn dividends equal to 18.5% of the consolidated
retained earnings of Unistar as of the end of a fiscal period, less any
dividends paid to the holders of the Series A Preferred Stock prior to such
date. The Series B Preferred Stock has voting rights equal to one share of
common stock and will earn dividends equal to 31.5% of the consolidated retained
earnings of Unistar as of the end of a fiscal period, less any dividends paid to
the holders of the Series B Preferred Stock prior to such date. All dividends on
Preferred Stock are payable (i) when and as declared by the Board of Directors,
(ii) upon conversion or redemption of the Series A and Series B Preferred Stock
or (iii) upon liquidation. The Series A and Series B Preferred Stock is
redeemable for a total of 13.3 million shares of common stock (Series A
Preferred Stock for 4.925 million shares and Series B Preferred Stock for 8.375
million shares) at the Company's option. In the event that Unistar meets certain
revenue and profit parameters, the Series A Preferred Stock is convertible for
up to 4.925 million shares of common stock and the Series B Preferred Stock is
contingently convertible for up to 8.375 million shares of common stock (a total
of an additional 13.3 million shares of common stock). Shareholder approval is
required before any of the Series B Preferred Stock can be converted or
redeemed. Liquidation preferences for all Series A and Series B preferred shares
total $7.3 million as of December 31, 1995. As of December 31, 1995, no
dividends have accrued to the preferred stockholders. The preferred stock had no
impact on earnings per share in 1995.
In an attempt to block the NIL, certain states filed Section 1084 letters to
prevent the long-distance carriers from providing telephone service to the NIL.
The CDA initiated legal action to compel the long-distance carriers to provide
telephone service to the NIL. The CDA's position is that the lottery is
authorized by the Indian Gaming Regulatory Act ("IGRA") passed by Congress in
1988, that the IGRA preempts state and federal statutes, and that the states
lack authority to issue the Section 1084 notification letters to any carrier. On
February 28, 1996, the NIL was ruled lawful by the CDA Tribal Court. The CDA
Tribal Court found that all requirements of the IGRA have been satisfied and the
Section 1084 letters issued by certain state attorneys general in an effort to
interfere with the lawful operation of the NIL
are invalid. In addition, the Court found that the long-distance carriers are
obligated to provide the service requested in the action. The Company expects
this ruling will be appealed but believes the CDA's position will be upheld.
Other than legal costs related to an appeal of the CDA Tribal Court ruling or
other actions by the states, if any, the Company estimates that the additional
costs to become operational may run between $5-10 million. The Company believes
it will be able to obtain additional financing for these costs.
The Company believes there is a national market for the NIL based upon research
into the experience of other national lotteries and the growth of the overall
lottery market. However, there is no assurance that there will be acceptance of
a telephone lottery.
During the first quarter of 1995, the Company was involved in extensive
negotiations to acquire the Dictaphone division of Pitney Bowes. In April 1995,
the acquisition was awarded to another bidder. The Company incurred
approximately $1 million in fees and expenses related to the attempted
acquisition which were recognized during the second and third quarters of 1995.
In 1990, the Company acquired all the outstanding shares of Isoetec Texas, Inc.,
an independent distributor of the Company's products. The transaction has been
accounted for by the purchase method. The purchase price was based upon a
multiple of 1989 pre-tax earnings of Isoetec Texas, Inc., subject to adjustment.
The purchase price originally recorded was based on cash payments to the former
owners of approximately $900,000, $250,000 of notes, 325,000 shares of common
stock and liabilities assumed of approximately $900,000.
The Company brought an action against the former owners of Isoetec Texas, Inc.
alleging breach of contract and fraud with respect to the calculation of 1989
pre-tax earnings and the purchase price. In November 1991, pursuant to the
purchase contract, an arbitrator ruled that 1989 pre-tax earnings should be
reduced by an amount that resulted in a reduction of the purchase price by
approximately $2 million. This reduction was assumed in the original purchase
price calculation and, as such, did not result in an adjustment to the recorded
purchase price. However, the arbitrator also awarded damages of approximately
$1.2 million to the former owners as additional purchase price. At that time,
the Company did not adjust its purchase price calculation since it believed that
the arbitrator went beyond its authority and decided to pursue the matter in
court. In 1994, after an appeal to the Fifth Circuit U.S. Court of Appeals, the
Company was required to pay $1.2 million as additional purchase price and
interest of $400,000. In addition, the Company was required to issue an
additional 78,866 shares of common stock to settle all remaining claims. These
payments were adjustments to the recorded purchase price.
As of March 31, 1994, the Company sold its Vodavi Communications Systems
Division ("VCS"), which sold telephone equipment to supply houses and dealers, a
different class of customer from continuing operations, under the brand names
STARPLUS(R) and INFINITE(TM), for approximately $10.9 million. Proceeds of the
sale consisted of approximately $9.7 million in cash, received in April 1994,
and a $1.2 million note, the proceeds of which were received in September 1995.
The proceeds were used to reduce borrowings under the Company's credit facility.
The sale resulted in an after-tax gain of $604,000 (net of income tax provision
of $403,000). Consolidated financial statements for the years ended December 31,
1994 and 1993 present VCS as a discontinued operation. Net revenues of the
discontinued operation for the years ended December 31, 1994 (through the date
of sale) and 1993 were $8.6 million and $31.6 million, respectively.
NOTE M - SELECTED QUARTERLY FINANCIAL DATA
The following is a summary of unaudited selected quarterly financial data for
the years ended December 31, 1995 and 1994:
Three Months Ended
---------------------------------------------------------
March 31, June 30, September 30, December 31,
(In thousands, except for per share amounts) 1995 1995 1995 1995
-------- --------- ------------- -------------
Revenues $70,808 $78,417 $74,164 $73,004
Gross Profit 28,349 32,021 30,504 31,983
Income (Loss) Before Income Taxes 200 (44,225) 2,205 2,599
Net Income (Loss) 120 (39,936) 1,323 1,559
Earnings (Loss) Per Share --- (0.86) 0.03 0.04
Three Months Ended
--------------------------------------------------------------
March 31, June 30, September 30, December 31,
(In thousands, except for per share amounts) 1994 1994 1994 1994
---------- --------- ------------ -------------
Revenues $65,307 $76,612 $76,547 $73,503
Gross Profit 26,267 32,138 32,105 31,962
Income Before Income Taxes
from Continuing Operations 143 4,024 3,312 2,562
Income from Continuing Operations 86 2,414 1,986 2,248
Discontinued Operations 757 --- --- -----
Net Income 843 2,414 1,986 2,248
Earnings Per Share:
Continuing Operations --- 0.05 0.04 0.05
Discontinued Operations 0.02 --- --- -----
The three months ended June 30, 1995 includes a provision for restructuring of
$44,042 (See Note L) and acquisition expenses of $1.0 million (See Note L). The
three months ended March 31, 1994 includes income of $757 from the
discontinuance and sale of the VCS division (See Note L).
NOTE N - SUBSEQUENT EVENTS
On April 10, 1996, the Company entered into an agreement to sell substantially
all of the Direct Sales and Services Group, including its long-distance reseller
business and National Service Center, for $67.4 million to an acquisition
company led by Bain Capital, Inc. The purchase price will consist of $61.5
million in cash, a $5.9 million note and warrants to purchase 8% of the common
stock of the new company, issued as of the closing, for $1.1 million,
exercisable for three years. The sale is expected to close on May 31, 1996,
subject to the buyer's financing and other conditions. The Company expects a
gain on the sale. The agreement also provides that the Company and the buyer
will enter into a five-year exclusive distribution agreement under which the
buyer will sell and service the Company's telephony equipment to those
businesses and commercial locations that require up to 400 telephones.
The sale does not include the Pittsburgh direct sales and service office, which
the Company has separately agreed to sell to one of its existing independent
distributors for approximately $1.3 million in cash and notes. The Company will
retain its Healthcare Communications and Call Center Management businesses,
along with its National Accounts and Federal Systems marketing groups. In
addition, the Company will continue to make telephony product sales to its
independent distributors, along with retaining the recently acquired Unistar
business.
In 1995, the Direct Sales and Services Group, including the long-distance
reseller business, had revenues of $191 million. On a pro forma basis, after
giving effect to the transaction, the Company's 1995 revenues would be
approximately $157 million. This includes $42 million in sales to the Direct
Sales and Services Group which were eliminated in the 1995 Statement of
Operations.
On April 10, 1996, the Company also announced that it had given notice of its
intention to terminate its distribution agreement with GPT Video Systems due to
failures by GPT to deliver properly-functioning videoconferencing products on a
timely basis. The Company has not yet finalized its plans for its
videoconferencing division.
STOCK DATA
The number of holders of record of the Company's Common Stock as of the close of
business on January 31, 1996 was approximately 2,100. The Common Stock is traded
on the NASDAQ National Market System under the symbol "XTON". As reported by
NASDAQ on February 16, 1996, the closing sale price of the Common Stock on the
NASDAQ National Market System was $2 7/16. The following table reflects in
dollars the high and low closing sale prices for EXECUTONE's Common Stock as
reported by the NASDAQ National Market System for the periods indicated:
Fiscal Period High Low
------------- ---- ---
1995
First Quarter $3 7/16 $2 15/16
Second Quarter 3 3/8 2 1/8
Third Quarter 2 7/8 2 1/8
Fourth Quarter 2 7/8 2 1/8
1994
First Quarter $2 15/16 $2 3/16
Second Quarter 2 13/16 2 1/2
Third Quarter 3 5/16 2 1/2
Fourth Quarter 3 9/16 3
The Company's Debentures are quoted on the NASDAQ System under the symbol
"XTONG". On February 16, 1996, the average of the closing bid and asked prices
per $1,000 principal amount of Debentures, as reported on the NASDAQ System, was
$850. The following table reflects in dollars the high and low average closing
sale prices for the Debentures, as reported by the NASDAQ System, for the
periods indicated:
Fiscal Period High Low
------------- ---- ----
1995
First Quarter $824 $808
Second Quarter 824 788
Third Quarter 815 805
Fourth Quarter 850 815
1994
First Quarter $900 $863
Second Quarter 854 786
Third Quarter 810 779
Fourth Quarter 815 775
It is the present policy of the Board of Directors to retain earnings for use in
the business and the Company does not anticipate paying any cash dividends on
the Common Stock in the foreseeable future. The Company's current bank credit
agreement contains provisions prohibiting the payment of dividends on the Common
Stock.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
EXECUTONE Information Systems, Inc.:
We have audited the accompanying consolidated balance sheets of EXECUTONE
Information Systems, Inc. (a Virginia corporation) and subsidiaries as of
December 31, 1995 and 1994, and the related consolidated statements of
operations, changes in stockholders' equity and cash flows for each of the three
years in the period ended December 31, 1995. 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 generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of EXECUTONE Information Systems,
Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1995, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Stamford, Connecticut
January 26, 1996 (except with respect to the matter discussed in
Note N, as to which the date is April 10, 1996)
STOCKHOLDER INFORMATION
CORPORATE HEADQUARTERS INDEPENDENT PUBLIC ACCOUNTANTS
EXECUTONE Information Systems, Inc. Arthur Andersen LLP
478 Wheelers Farms Road Champion Plaza
Milford, Connecticut 06460 400 Atlantic Street
(203) 876-7600 Stamford, Connecticut 06912-0021
STOCK AND WARRANT TRANSFER AGENT OUTSIDE COUNSEL
American Stock Transfer and Trust Company Hunton & Williams
40 Wall Street Riverfront Plaza
New York, New York 10005 951 East Byrd Street
Richmond, Virginia 23219
BOND TRANSFER AGENT
U.S. Trust Company of New York ADDITIONAL INFORMATION
114 West 47th Street A copy of EXECUTONE's Annual
New York, New York 10036-1532 Report on Form 10-K, which is
filed with the Securities and
Exchange Commission, is available
without charge by writing to:
DAVID KRIETZBERG
Treasurer/Investor Relations
Corporate Headquarters
DIRECTORS AND OFFICERS
BOARD OF DIRECTORS
- --------------------------------------------------------------------------------
ALAN KESSMAN JERRY M. SESLOWE 1, 2
Chairman of the Board Managing Director
Resource Holdings, Ltd.
STANLEY M. BLAU
Vice Chairman WILLIAM R. SMART 1
Senior Vice President
THURSTON R. MOORE Cambridge Strategic Management
Partner Group
Hunton & Williams
RICHARD S. ROSENBLOOM 1, 2
David Sarnoff Professor of Business Administration
Harvard Business School
1 COMPENSATION COMMITTEE MEMBER
2 AUDIT COMMITTEE MEMBER
OFFICERS
- -----------------------------------------------------------------------------------------------------------------------------------
ALAN KESSMAN ANTHONY R. GUARASCIO DAVID E. LEE
President and Chief Executive Officer Vice President, Finance and Vice President, Business
Chief Financial Officer Development
STANLEY M. BLAU ISRAEL J. HERSH JOHN T. O'KANE
Vice Chairman Vice President, Software Engineering Vice President, MIS
MICHAEL W. YACENDA ELIZABETH HINDS FRANK J. ROTATORI
Executive Vice President Vice President, Human Resources Vice President, Healthcare Sales
BARBARA C. ANDERSON ROBERT W. HOPWOOD SHLOMO SHUR
Vice President, General Counsel and Vice President, Customer Care Senior Vice President, Advanced Technology
Secretary
JAMES E. COOKE III ANDREW KONTOMERKOS
Vice President, National Accounts Senior Vice President, Hardware
Engineering and Production