FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-16231
XETA Technologies, Inc.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Oklahoma 73-1130045
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(State or other jurisdiction of (I.R.S. Employee
incorporation or organization) Identification No.)
1814 W. Tacoma, Broken Arrow, OK 74012-1406
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
918-664-8200
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Number of shares outstanding of each of the registrant's classes of common
stock, as of the latest practicable date.
Class Outstanding at May 31, 2003
- ------------------------------ ---------------------------------------
Common Stock, $.001 par value 9,752,952
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets - April 30, 2003 and October 31,
2002
Consolidated Statements of Operations - For the Three and six
months ended April 30, 2003 and 2002
Consolidated Statement of Shareholders' Equity - For the Six
Months Ended April 30, 2003
Consolidated Statements of Cash Flows - For the Six months
ended April 30, 2003 and 2002
Notes to Consolidated Financial Statements
2
XETA TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
April 30, 2003 October 31, 2002
-------------- ----------------
(Unaudited)
ASSETS
Current Assets:
Cash and cash equivalents $ 4,935,871 $ 1,966,734
Current portion of net investment in
sales-type leases and other receivables 615,278 1,015,096
Trade accounts receivable, net 7,489,328 9,478,706
Inventories, net 6,563,794 7,801,781
Deferred tax asset, net 740,466 592,643
Prepaid taxes - 1,195,539
Prepaid expenses and other assets 325,471 165,657
------------ ------------
Total current assets 20,670,208 22,216,156
------------ ------------
Noncurrent Assets:
Goodwill, net of accumulated amortization
prior to adoption of SFAS 142 25,754,674 25,782,462
Net investment in sales-type leases,
less current portion above 447,274 519,270
Property, plant & equipment, net 10,434,147 10,457,718
Capitalized software production costs, net of
accumulated amortization of $1,143,065 and $1,053,066 147,956 237,955
Other assets 148,619 170,424
------------ ------------
Total noncurrent assets 36,932,670 37,167,829
------------ ------------
Total assets $ 57,602,878 $ 59,383,985
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 3,288,337 $ 3,288,337
Revolving line of credit 2,000,000 -
Accounts payable 2,308,530 6,119,135
Unearned revenue 2,382,973 2,078,741
Accrued taxes 209,196 -
Accrued liabilities 1,962,573 1,968,771
Other Liabilities 174,702 181,501
------------ ------------
Total current liabilities 12,326,311 13,636,485
------------ ------------
Noncurrent liabilities:
Long-term debt, less current portion above 9,920,844 11,565,012
Accrued long-term liabilities 192,181 240,955
Unearned service revenue 216,375 233,859
Noncurrent deferred tax liability, net 1,567,362 1,186,680
------------ ------------
11,896,762 13,226,506
------------ ------------
Commitments and contingencies
Shareholders' equity:
Preferred stock; $.10 par value; 50,000 shares
authorized, 0 issued - -
Common stock; $.001 par value; 50,000,000
shares authorized, 10,771,740 and 10,721,740 issued at
April 30, 2003 and October 31, 2002, respectively 10,771 10,721
Paid-in capital 12,243,111 12,193,029
Retained earnings 23,476,801 22,672,256
Accumulated other comprehensive loss (106,219) (110,353)
Less treasury stock, at cost (2,244,659) (2,244,659)
------------ ------------
Total shareholders' equity 33,379,805 32,520,994
------------ ------------
Total liabilities and shareholders' equity $ 57,602,878 $ 59,383,985
============ ============
The accompanying notes are an integral part of these consolidated balance
sheets.
3
XETA TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED
For the Three Months For the Six Months
Ended April 30, Ended April 30,
2003 2002 2003 2002
---- ---- ---- ----
Systems sales $ 6,009,696 $ 6,172,320 $ 14,734,805 $ 13,517,361
Installation and service revenues 5,605,114 6,322,735 11,721,619 12,389,574
Other revenues 150,687 64,054 740,478 415,238
------------ ------------ ------------ ------------
Net sales and service revenues 11,765,497 12,559,109 27,196,902 26,322,173
------------ ------------ ------------ ------------
Cost of systems sales 3,965,590 4,410,582 10,393,802 9,445,968
Installation and services costs 3,970,932 4,822,877 8,331,339 9,549,927
Cost of other revenues & corporate COGS 392,322 411,220 1,116,013 1,152,472
------------ ------------ ------------ ------------
Total cost of sales and service 8,328,844 9,644,679 19,841,154 20,148,367
------------ ------------ ------------ ------------
Gross profit 3,436,653 2,914,430 7,355,748 6,173,806
------------ ------------ ------------ ------------
Operating expenses:
Selling, general and administrative 2,755,118 2,715,783 5,692,473 5,330,590
Amortization 45,000 45,000 90,000 90,000
------------ ------------ ------------ ------------
Total operating expenses 2,800,118 2,760,783 5,782,473 5,420,590
------------ ------------ ------------ ------------
Income from operations 636,535 153,647 1,573,275 753,216
Interest expense (160,895) (229,891) (340,572) (484,851)
Interest and other income 39,670 86,824 89,842 198,455
------------ ------------ ------------ ------------
Subtotal (121,225) (143,067) (250,730) (286,396)
Income before provision for income taxes 515,310 10,580 1,322,545 466,820
Provision for income taxes 202,000 4,000 518,000 184,000
------------ ------------ ------------ ------------
Net income $ 313,310 $ 6,580 $ 804,545 $ 282,820
============ ============ ============ ============
Earnings per share
Basic $ 0.03 $ 0.00 $ 0.08 $ 0.03
============ ============ ============ ============
Diluted $ 0.03 $ 0.00 $ 0.08 $ 0.03
============ ============ ============ ============
Weighted average shares outstanding 9,723,709 9,237,952 9,713,143 9,237,952
============ ============ ============ ============
Weighted average equivalent shares 9,936,926 9,917,943 9,940,279 9,883,122
============ ============ ============ ============
The accompanying notes are an integral part of these consolidated statements.
4
XETA TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
UNAUDITED
Common Stock Treasury Stock
-------------------------- ----------------------------
Shares
Issued Par Value Shares Amount Paid-in Capital
---------- ----------- --------- ------------ ---------------
Balance-October 31, 2002 10,721,740 $ 10,721 1,018,788 $(2,244,659) $12,193,029
Stock options exercised $.001 par value 50,000 50 - - 12,450
Tax benefit of stock options - - - - 37,632
Components of comprehensive income:
Net income - - - - -
Unrealized gain on hedge, net of tax of $2,665 - - - - -
Total comprehensive income
---------- ----------- --------- ----------- -----------
Balance-April 30, 2003 10,771,740 $ 10,771 1,018,788 $(2,244,659) $12,243,111
========== =========== ========= =========== ===========
Accumulated Other
Comprehensive Retained
Loss Earnings Total
----------------- -------- -----
Balance-October 31, 2002 $ (110,353) $22,672,256 $32,520,994
Stock options exercised $.001 par value - - 12,500
Tax benefit of stock options - - 37,632
Components of comprehensive income:
Net income - 804,545 804,545
Unrealized gain on hedge, net of tax of $2,665 4,134 - 4,134
-----------
Total comprehensive income 808,679
----------- ----------- -----------
Balance-April 30, 2003 $ (106,219) $23,476,801 $33,379,805
=========== =========== ===========
5
XETA TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months
Ended April 30,
2003 2002
------------ ------------
Cash flows from operating activities:
Net income $ 804,545 $ 282,820
------------ ------------
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 489,434 542,810
Amortization 90,000 90,000
Loss (gain) on sale of assets (750) 4,851
Provision for (reversal of) returns & doubtful accounts receivable - (48,200)
Provision for excess and obsolete inventory 81,082 105,709
Change in assets and liabilities, net of acquisitions:
Decrease in net investment in sales-type leases & other receivables 471,814 1,285,226
Decrease in trade receivables 1,989,378 7,904,321
Decrease in inventories 1,156,905 815,304
(Increase) decrease in deferred tax asset (147,823) 499,516
(Increase) decrease in prepaid expenses and other assets (138,009) 15,449
(Increase) decrease in prepaid taxes 1,195,539 (1,022,032)
Decrease in accounts payable (3,810,605) (1,204,076)
Increase (Decrease) in unearned revenue 286,748 (712,902)
Increase in accrued income taxes 228,306 92,375
Decrease in accrued liabilities (54,972) (902,716)
Increase in deferred tax liabilities 424,327 311,190
------------ ------------
Total adjustments 2,261,374 7,776,825
------------ ------------
Net cash provided by operating activities 3,065,919 8,059,645
------------ ------------
Cash flows from investing activities:
Additions to property, plant & equipment (467,682) (1,120,807)
Proceeds from sale of assets 2,568 -
------------ ------------
Net cash used in investing activities (465,114) (1,120,807)
------------ ------------
Cash flows from financing activities:
Proceeds from draws on revolving line of credit 2,000,000 14,250,000
Principal payments on debt (1,644,168) (2,644,171)
Payments on revolving line of credit - (18,750,000)
Exercise of stock options 12,500 -
------------ ------------
Net cash provided by (used in) financing activities 368,332 (7,144,171)
------------ ------------
Net increase (decrease) in cash and cash equivalents 2,969,137 (205,333)
Cash and cash equivalents, beginning of period 1,966,734 597,889
------------ ------------
Cash and cash equivalents, end of period $ 4,935,871 $ 392,556
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 486,003 $ 712,834
Cash paid during the period for income taxes $ 107,388 $ 300,163
Contingent consideration paid to target shareholder $ - $ 1,000,000
The accompanying notes are an integral part of these consolidated statements.
6
XETA TECHNOLOGIES, INC.
APRIL 30, 2003
(Unaudited)
1. BASIS OF PRESENTATION
The consolidated financial statements herein include the accounts of XETA
Technologies, Inc. and its wholly-owned subsidiaries, U.S. Technologies Systems,
Inc. and Xetacom, Inc. (the "Company" or "XETA"). Xetacom's operations have been
insignificant to date. All significant intercompany accounts and transactions
have been eliminated. Effective May 1, 2003, the Company effected a statutory
merger of UST into XETA. The purpose of the merger was to reduce costs
associated with the filing of income tax and other regulatory forms. There was
no effect on the operations of the Company associated with the merger.
The accompanying consolidated financial statements have been prepared by the
Company, without an audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote
disclosures, normally included in annual financial statements prepared in
accordance with accounting principles generally accepted in the United States,
have been condensed or omitted pursuant to those rules and regulations. However,
the Company believes that the disclosures made are adequate to make the
information presented not misleading when read in conjunction with the
consolidated financial statements and the notes thereto included in the
Company's latest financial statements filed as part of the Company's Annual
Report on Form 10-K, Commission File No. 0-16231. Management believes that the
financial statements contain all adjustments necessary for a fair statement of
the results for the interim periods presented. All adjustments made were of a
normal recurring nature. The results of operations for the interim period is not
necessarily indicative of the results for the entire fiscal year.
These statements should be read in conjunction with the audited financial
statements and notes thereto included in the Company's Annual Report on Form
10-K, which was filed with the SEC on January 29, 2003, reflecting the operating
results of the Company.
2. INVENTORIES:
Inventories are stated at the lower of cost (first-in, first-out or average) or
market and consist of the following components:
April 30, October 31,
2003 2002
------------ ----------
(Unaudited)
Finished goods and spare parts $ 7,218,897 $ 8,234,020
Raw materials 335,781 354,380
------------ ------------
7,554,678 8,588,400
Less- reserve for excess and obsolete inventories 990,884 786,619
------------ ------------
Total inventories, net $ 6,563,794 $ 7,801,781
============ ============
7
3. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment consist of the following:
Estimated
Useful April 30, October 31,
Lives 2003 2002
--------- ------------ ------------
(Unaudited)
Building 20 $ 2,397,954 $ 2,397,954
Data processing and computer field equipment 3-5 4,121,607 4,121,640
Land - 611,582 611,582
Office furniture 5 1,103,652 1,073,851
Auto 5 126,743 126,743
Other 3-7 620,810 634,213
------------ ------------
Total property, plant and equipment 8,982,348 8,965,983
Less- accumulated depreciation 4,835,413 4,397,821
------------ ------------
Net property, plant and equipment 4,146,935 4,568,162
Construction in progress 6,287,212 5,889,556
Total property, plant and equipment, net $ 10,434,147 $ 10,457,718
============ ============
Construction in progress includes capitalized interest of $572,000 and $408,000
for the periods ended April 30, 2003 and October 31, 2002, respectively. Upon
completion of the project, the total cost is expected to be depreciated over an
average life of 7 years.
4. ACCRUED LIABILITIES:
Accrued liabilities consist of the following:
April 30, October 31,
2003 2002
------------- -----------
(Unaudited)
Commissions $ 492,834 $ 428,460
Vacation 453,803 481,228
Payroll 421,817 417,171
Bonuses 205,416 213,735
Interest 12,064 11,265
Other 376,639 416,912
------------- -------------
Total current 1,962,573 1,968,771
Noncurrent liabilities 192,181 240,955
------------- -------------
Total accrued liabilities $ 2,154,754 $ 2,209,726
============= =============
5. UNEARNED REVENUE:
Unearned revenue consists of the following:
April 30, October 31,
2003 2002
------------ ------------
(Unaudited)
Customer deposits $ 1,036,442 $ 897,171
Service contracts 889,921 785,067
Warranty service 295,730 366,586
Systems shipped but not installed 118,071 28,866
Other 42,809 1,051
----------- -----------
Total current unearned revenue 2,382,973 2,078,741
Noncurrent unearned service contract revenue 216,375 233,859
----------- -----------
Total unearned revenue $ 2,599,348 $ 2,312,600
=========== ===========
8
6. INCOME TAXES:
Income tax expense is based on pretax financial accounting 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.
The tax effect of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are presented below:
April 30, October 31,
2003 2002
----------- -----------
(Unaudited)
Deferred tax assets:
Nondeductible reserves $ 636,935 $ 466,292
Prepaid service contracts 127,345 168,210
Unamortized cost of service contracts 33,995 52,788
Other 146,491 119,418
----------- -----------
Total deferred tax asset 944,766 806,708
----------- -----------
Deferred tax liabilities:
Intangible assets and other 1,667,064 1,257,404
Tax income to be recognized on sales-type lease contracts 46,600 50,062
Unamortized capitalized software development costs 57,998 93,279
----------- -----------
Total deferred tax liability 1,771,662 1,400,745
----------- -----------
Net deferred liability $ (826,896) $ (594,037)
=========== ===========
7. CREDIT AGREEMENTS:
On May 16, 2003, the Company and its banking partners executed a restructuring
of the Company's credit facility. Under the restructuring agreement, the line of
credit supported by a borrowing base of accounts receivables and inventories was
expanded to $7,500,000 and the term loan was reduced by $6,500,000. This
reduction in the term loan was effected by using $4,000,000 million in cash on
hand and borrowing an additional $2,500,000 under the expanded line of credit.
The Company will continue to make the same monthly principal payments on the
term loan. Also, certain financial covenants contained in the credit facility
were modified to reflect the adjustments in the structure of the facility and
the Company's current levels of profitability. Specifically, the debt service
coverage ratio was replaced with an EBIDA requirement of $700,000 per quarter.
After the restructuring, the Company's total debt was $11.2 million which
included $4.4 million in term debt, $2.3 million owed on a mortgage note, and
$4.5 million owed under the working capital revolver. The Company is currently
in compliance with all of the financial covenants contained in the new credit
agreement.
Prior to the restructuring discussed above, long-term debt consisted of the
following:
April 30, October 31,
2003 2002
----------- -----------
(Unaudited)
Bank line of credit, due December 31, 2003, secured by a borrowing
base of accounts receivable and inventories. $ 2,000,000 $ -
Term loan, payable in monthly installments of $259,861, due
December 31, 2003 collateralized by all assets of the Company. 10,914,181 12,473,349
Real estate term note, payable in monthly installments of $14,166, due
December 31, 2003, secured by a first mortgage on the Company's
headquarters building. 2,295,000 2,380,000
----------- -----------
15,209,181 14,853,349
Less-current maturities 5,288,337 3,288,337
----------- -----------
$ 9,920,844 $11,565,012
=========== ===========
9
Interest on all outstanding debt under the credit facility accrues at either a)
the London Interbank Offered Rate (which was 1.32% at April 30, 2003) plus 3.75%
or b) the bank's prime rate (which was 4.25% at January 31, 2003) plus 1%. The
credit facility requires, among other things, that the Company maintain a
minimum net worth, working capital and debt service coverage ratio and limits
capital expenditures. At April 30, 2003, the Company was either in compliance
with the covenants of the credit facility or had received the appropriate
waivers from its bank.
Based on 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.
8. STOCK OPTIONS:
Accounting for stock options issued to employees is governed by SFAS 123,
"Accounting for Stock Based Compensation." Generally, SFAS 123 requires
companies to record in their financial statements the compensation expense, if
any, related to stock options issued to employees. Under an alternative
accounting method adopted by the Company, SFAS 123 allows the Company to only
disclose the impact of issued stock options as if the expense had been recorded
in the financial statements. Had the Company recorded compensation expense
related to its stock option plans in accordance with SFAS 123, the Company's net
income and earnings per share would have been reduced to the pro forma amounts
indicated below:
For the Three Months For the Six Months
Ended April 30, Ended April 30,
--------------------------- ---------------------------
2003 2002 2003 2002
---- ---- ---- ----
Net income as reported $ 313,310 $ 6,580 $ 804,545 $ 282,820
Less: total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects 179,187 160,315 358,375 320,629
----------- ----------- -----------
Pro forma net income (loss) $ 134,123 $ (153,735) $ 446,170 $ (37,809)
=========== =========== =========== ===========
EARNINGS PER SHARE:
As reported - Basic $ .03 $ .00 $ .08 $ .03
As reported - Diluted $ .03 $ .00 $ .08 $ .03
Pro forma - Basic $ .01 $ (.02) $ .05 $ .00
Pro forma - Diluted $ .01 $ (.02) $ .04 $ .00
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 (4.46% to 5.78%), dividend yield (0.00%),
expected volatility (80.50% to 86.31%), and expected life (6 years).
9. FOOTNOTES INCORPORATED BY REFERENCE:
Certain footnotes are applicable to the consolidated financial statements, but
would be substantially unchanged from those presented in the Company's Annual
Report on Form 10-K, Commission File No. 0-16231, filed with the Securities and
Exchange Commission on January 29, 2003. Accordingly, reference should be made
to those statements for the following:
10
Note Description
- ---- -----------
1 Business and Summary of Significant Accounting Policies
2 Acquisitions
3 Accounts Receivable
8 Income Taxes
10 Stock Options
11 Earnings Per Share
12 Commitments
13 Major Customers and Concentrations of Credit Risk
14 Employment Agreements
15 Contingencies
16 Retirement Plan
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS, WHICH ARE SUBJECT
TO THE PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THESE
STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS CONCERNING EXPECTATIONS
REGARDING: OUR FINANCIAL POSITION INCLUDING SALES, REVENUES, GROSS MARGINS,
OPERATING MARGINS AND EXPENSES, AND EARNINGS FOR THE THIRD QUARTER; TRENDS AND
CONDITIONS IN THE U.S. ECONOMY AND IN THE COMMUNICATIONS TECHNOLOGY INDUSTRY;
AND OUR ABILITY TO IMPLEMENT OUR CURRENT BUSINESS PLAN. THESE AND OTHER
FORWARD-LOOKING STATEMENTS (GENERALLY IDENTIFIED BY SUCH WORDS AS "EXPECTS,"
"PLANS," "BELIEVES," "ANTICIPATES" "FORECASTS," "PREDICTS," AND SIMILAR WORDS OR
EXPRESSIONS) ARE NOT GUARANTEES OF PERFORMANCE BUT RATHER REFLECT OUR CURRENT
EXPECTATIONS, ASSUMPTIONS AND BELIEFS BASED UPON INFORMATION CURRENTLY AVAILABLE
TO US. INVESTORS ARE CAUTIONED THAT ALL FORWARD-LOOKING STATEMENTS ARE SUBJECT
TO CERTAIN RISKS AND UNCERTAINTIES WHICH ARE DIFFICULT TO PREDICT AND THAT COULD
CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED. MANY OF THESE
RISKS AND UNCERTAINTIES ARE DESCRIBED UNDER THE HEADING "OUTLOOK AND RISK
FACTORS" BELOW. CONSEQUENTLY, ALL FORWARD-LOOKING STATEMENTS SHOULD BE READ IN
CONJUNCTION WITH THE RISK FACTORS DISCUSSED HEREIN AND THROUGHOUT THIS REPORT
TOGETHER WITH THE RISK FACTORS IDENTIFIED IN THE COMPANY'S ANNUAL REPORT ON FORM
10-K, WHICH WAS FILED ON JANUARY 29, 2003.
GENERAL
For the quarter ending April 30, 2003, we earned $313,000 on revenues of $11.8
million compared to earnings of $7,000 on revenues of $12.6 million for the same
quarter a year ago. This dramatic increase in our earnings despite a 6% decrease
in revenues reflects the strict cost controls and improved efficiencies that we
have put in place over the past 24 months and improved profit margins earned on
all of our revenue streams. For the year to date period, we earned $805,000 on
revenues of $27.2 million in fiscal 2003 compared to earnings of $283,000 on
revenues of $26.3 million in the prior year.
The second quarter also included strong cash flows. We generated $4.5 million in
cash from operations through earnings and reductions in receivables and
inventories. We used these cash flows to reduce our debt by $822,000 in
scheduled principal reductions during the quarter. More significantly,
subsequent to the close of the second quarter, we signed an amendment to
restructure our credit facility which allowed us to reduce our total debt by an
additional $4 million and expand our available line of credit to $7.5 million.
The restructuring agreement is discussed further below under "Financial
Condition".
Despite the improvements in our earnings and cash flows, capital spending in the
U.S., especially in the technology sector, remains sluggish. A pall of pessimism
continues to mark most customers' attitudes despite recent signs of improvements
in consumer confidence and partial resolution of geopolitical concerns in the
Middle East, specifically with regards to the U.S.' confrontation with Iraq.
Nevertheless, we do not see any tangible signals of increased capital spending
that would significantly affect our near-term operating results. Therefore, we
will continue to operate cautiously and we expect our third quarter results to
be similar to the quarter just ended with earnings to fall in the 1 to 5 cent
range.
Notwithstanding the continuing macro-economic conditions, we continue to firmly
believe in the strategic vision that we began pursuing three and a half years
ago. That strategy was based in large part on the technological changes that
were emerging at the time, specifically the convergence of voice and data
technologies. We also believed that by expanding from our roots in the lodging
industry to the general commercial market, we were entering a larger market that
would provide us with large potential growth rates even if the overall market
grew only modestly. From a research and development viewpoint, the development
of convergence communications products has continued unabated despite slow
economic conditions during the past two years. During that time, Avaya has
released a raft of new products, all of which are Internet Protocol-based
technology. Customer acceptance of this technology is increasing as well. With
few exceptions, customers who are making purchasing decisions are opting for the
new technology in an effort to not be "left behind" with traditional voice
switches.
12
In summary, we believe that we are strategically positioned to take advantage of
the dramatic technological changes that are occurring in our industry. We
believe we have built an operating infrastructure that will provide us with both
a competitive advantage and a leveraged operating statement that will generate
higher rates of growth in earnings on lower revenue growth rates as our market
recovers. However, current macro-economic conditions present us with significant
short-term challenges. We believe that it is in the best long-term interest of
our shareholders to preserve the technical competence and market position that
we have built in the last three years. However, should the current economic
conditions continue or worsen in the short-term, we may be forced to take
actions which could set us back in the pursuit of our long-term strategy.
The following discussion presents additional information regarding our financial
condition and results of operations for the quarter ending April 30, 2003 and
should be read in conjunction with our comments above as well as the Outlook and
Risk Factors discussion contained at the end of this section of the report.
FINANCIAL CONDITION
During the first six months of the year, we generated cash from operations of
$3.1 million. These positive cash flows were primarily generated during the
quarter just completed as we continued to earn modest profits and reduced
receivables and inventories. Our receivables and inventories are near three-year
lows reflecting the close management of these balances coupled with the poor
economic conditions we are currently experiencing. We used these cash flows
primarily to reduce our debt. Through April 30, and prior to our debt
restructuring, we reduced our term debt and mortgage by a combined $1.6 million
dollars. Net borrowings on our line of credit have been $2 million and we have
spent $468,000 on capital expenditures in the first half of the year.
As discussed above, subsequent to the close of our second quarter, we closed on
a debt restructuring agreement with our banks. Under the agreement, our total
debt was reduced by $4 million, availability under our revolving line of credit
was increased to $7.5 million, and a new EBIDA requirement was instituted to
replace the debt service coverage ratio. Finally, the term debt that was
incurred to finance our expansion into the commercial market during fiscal 2000
and 2001 has been reduced by $6.5 million and is now expected to be retired in
18 months. This reduction was accomplished by using $4 million in cash on hand
plus drawing an additional $2.5 million under the line of credit. We will
continue the previous debt service requirements on the term loan which will
result in an acceleration of previous amortization period. We believe that this
restructuring is a significant and positive milestone as we seek to move to a
traditional capital structure in which our financing needs are supported
primarily by current assets and real estate. We are currently in compliance with
all of the financial covenants contained in our new credit agreement and while
no assurance can be given, we expect to continue to be in compliance the
remainder of the fiscal year under the restructured credit agreement.
RESULTS OF OPERATIONS
For the quarter ending April 30, 2003, our revenues were $11.8 million, compared
to $12.6 million in the second quarter of last year. Despite the decline in
revenues, however, a significant increase in our profit margins enabled us to
report net income of $313,000, a substantial increase over the $7,000 reported
in the second quarter of last year. Year-to-date revenues were $27.2 million,
compared to $26.3 million in the first half of last year. Year-to-date net
income was $805,000, compared to net income of $283,000 first half of fiscal
2002. This increase in net income was also largely fueled by improvements in
gross margins. Discussed below are the major revenue, gross margin, and
operating expense items that affected our financial results during the first
quarter of fiscal 2003.
Systems Sales. Systems sales for the second quarter were $6.0 million compared
to $6.2 million last year. Year-to-date systems revenues were $14.7 million
compared to $13.5 million last year. These mixed results reflect the continued
fragile economic conditions in which we operate. U.S. businesses continue to
demonstrate a strong aversion to capital spending commitments and we see no
significant signs that this trend will change in the near future. A bright spot
in our systems sales in the second quarter was our sales of systems to lodging
customers which were up 68% over last year and were nearly double first quarter
sales.
13
Our backlog of lodging customer orders remains strong beginning the third
quarter. However, we believe these increases represent isolated cases of capital
spending in this market sector as the lodging sector as a whole continues to
suffer as one of the hardest hit in the U.S. economy. Sales of systems to
commercial customers were down 18% in the second quarter compared to last year,
but are up 14% for the year-to-date period.
To combat the current capital spending environment, we will continue to operate
in a cautious manner with a primary goal of maintaining the personnel and
infrastructure that provides our competitive advantage in the market. In
addition, we have initiated a few, limited growth tactics. Specifically, we are
hiring additional sales personnel to focus on mid-market opportunities in
strategic cities in the United States. We define midmarket as a customer who
generally has more than 100 employees, but is not a large, multi-national or
"Fortune 500" type customer. Furthermore, our emphasis is on midmarket companies
that have a need for multi-site, networked communications systems that fit well
with our nationwide implementation capabilities. From a long-term perspective,
we believe that such customers are key to our success since we should have the
opportunity to sell our full-range of services, including recurring maintenance
services to them. Currently, much of our equipment sales in the commercial
segment are to Avaya "named" accounts. Many times, in these cases, Avaya invites
us into the account to provide the equipment and installation as part of their
Business Partner program. However, we are often not permitted to sell our own
service plans to these "named" customers and therefore our ability to generate
recurring revenue from this customer base is limited. By broadening our customer
focus through this Mid-market initiative, we expect to begin building a base of
recurring revenue. Our efforts to expand in this area are being funded largely
by cash incentives received from Avaya under market development programs
available to their certified dealers. Given our present low level of earnings
and limited access to working capital, these initiatives must gain traction and
quickly produce gross profit contributions for us to continue to pursue them.
Installation and Service Revenues. Installation and service revenues consist of
the following:
For the Three Months For the Six Months
Ended April 30, Ended April 30,
------------------------- --------------------------
2003 2002 2003 2002
---- ---- ---- ----
Contract & Time and Materials (T&M) $4,147,000 $4,714,000 $ 8,389,000 $ 9,257,000
Commercial installations 551,000 757,000 1,307,000 1,372,000
Lodging installations 483,000 373,000 908,000 795,000
Consulting 424,000 479,000 1,118,000 965,000
---------- ---------- ----------- -----------
Total installation and service revenue $5,605,000 $6,323,000 $11,722,000 $12,389,000
========== ========== =========== ===========
The decline in contract and T&M revenues resulted almost entirely from a decline
in T&M revenues. This revenue stream represents work orders from customers due
to equipment failures or adds, moves, and changes to systems originated by
customers. The overall demand for hourly services has declined as fewer
customers are expanding their employee bases or moving employees which generates
service billings for us. To ensure our competitive position, we re-instituted
lower hourly pricing for our services earlier in the fiscal year. By doing so,
our rates will compare favorably to smaller, regional service providers even
though we have nationwide capabilities. Contract revenues were relatively
unchanged for the three and six month periods.
Installation revenues tend to track in the same direction as our systems sales,
therefore the decline in commercial installation revenue in the second quarter
reflects the decline in commercial systems sales. The increase in lodging
installation revenues reflects the increases in the sales of those systems as
well. We recognize revenues from installation activities upon completion of the
installation, which for larger systems often means that the equipment is shipped
and systems revenues are recognized in one month and installation revenues on
that system are recognized in a subsequent month.
Consulting revenues decreased 11% in the second quarter compared to last year,
but were 16% higher for the year-to-date period comparison. These revenues
reflect professional design fees and project management fees associated with
complex, commercial systems implementations and the decline in the second
quarter reflects lower commercial systems sales in the quarter. Consulting
revenues also includes revenues earned from our boutique consulting firm which
specializes in Microsoft application implementations and network
14
administration. During the second quarter, a significant customer of this group
curtailed its spending, resulting in a decline in revenues. We expect revenues
from this portion of our consulting effort to remain at second quarter levels
for the near future as customers continue to strictly control nearly all
discretionary spending on IT related projects..
Gross Margins. The gross margin earned on total sales and service revenues in
the second quarter was 29.2% compared to 23.2% for the same period last year and
was 27.0% for the first half of fiscal 2003 compared to 23.5% for the first half
of fiscal 2002. These increases reflect improvements in gross margins for nearly
all major revenue streams and are discussed in more detail below.
The gross margins on systems sales were 34.0% in the second quarter compared to
28.5% for the second quarter of last year and were 29.5% for the first half of
the year, down slightly from 30.1% for the first half of fiscal 2002. The
improvements in second quarter systems gross margins reflect improved margins on
commercial systems sold and higher levels of manufacturer rebates received in
the quarter. The rebate levels are dependent upon product mix, sales volumes,
and specific programs being offered by the manufacturers and it is therefore
difficult to predict their impact on our gross margins with precision. These
improvements were partially offset by lower margins earned on systems sales to
lodging customers. These lower margins on sales to lodging customers were due
primarily to a lower mix of high margin products sold during the quarter
compared to last year.
The gross margins earned on service revenues were 29.2% in the second quarter
compared to 23.7% last year and was 28.9% for the first half of the year
compared to 22.9% for the same period last year. These improvements reflect cost
controls put in place in our professional services and installation departments
to more closely match their manpower levels and cost structures with our current
revenue levels for those activities. Throughout the current downturn in the
economy, we have strived to properly size our business to our revenue run-rates
without impairing our technical capabilities that are a key differentiator for
us in the market. This challenge has been most acute in the professional
services and installation areas as they house our key technical talent. We
believe that despite the cost containment measures we have initiated, we have
not handicapped our overall capabilities nor our ability to respond to a market
turnaround when it occurs.
A final component to our gross margins is the margins earned on other revenues
and its corporate cost of goods sold expenses. Other revenues typically
represent sales and cost of goods sold on equipment or services outside our
normal provisioning processes and was dominated by the sale of a large data
maintenance contract that occurred in the first quarter. In this transaction,
which is an annual contract directly between Avaya and the customer, the service
obligations are borne entirely by Avaya and we serve as a sales agent. Corporate
cost of goods sold represents our material logistics and purchasing functions
that support all of our revenue streams. These expenses have declined
approximately 10% in the first half of the year compared to last year reflecting
the effects of our tight cost controls.
Operating Expenses. Operating expenses increased 1% in the second quarter
compared to last year and 7% for the first half of the year compared to the
prior year. This increase is entirely related to the loss of certain financial
incentive programs previously offered by Avaya as actual expenditures for
selling expenses and G&A costs have declined during the year. These incentive
programs, which have been material to our operating results in the past, have
been curtailed and/or replaced by Avaya. Beginning in our second fiscal quarter,
we began receiving new financial incentives that have been approved and paid by
Avaya to support our sales expansion initiatives into a few new markets (see
discussion under "Systems Sales" above regarding these sales initiatives). Under
these new programs, Avaya grants specific requests for cost reimbursements based
on a business plan submitted by us. Previously, we earned financial incentives
based on a combination of the volume of our purchases and our marketing-related
expenditures. These new incentives, while substantially supporting this new
sales initiative, are less than the incentives received in prior years under the
old programs.
Interest Expense and Other Income. Interest and other expense was $121,000 in
the second quarter of this year compared to $143,000 in the second quarter of
last year and was $251,000 for the six months ending April 30, 2003 compared to
$286,000 in the same period last year. Interest expense is presented net of
interest capitalized on construction in progress. Interest costs capitalized in
the second quarter of this year were $83,000 compared to $66,000 last year.
Year-to-date interest costs capitalized were $165,000
15
compared to $125,000 for the year-to-date period last year. The decrease in
interest and other expenses reflects decreases in interest expense partially
offset by decreases in interest and other income. The decrease in interest
expense reflects lower average debt outstanding during the periods under
comparison. The lower interest income is due to a decrease in the average amount
of sales-type lease receivables outstanding. Both interest expense and interest
income are expected to continue to decline.
Tax Provision. The Company has recorded a combined federal and state tax
provision of 39% in all periods presented reflecting the effective federal tax
rate plus the estimated composite state income tax rate.
Operating Margins. Net income as a percent of revenues was 3% for the three and
six months ending April 30, 2003, respectively compared to 0% and 1% for the
same periods last year. We believe that our current business model and current
debt levels will support a target operating margin of 8%. However, we will have
to realize sustained growth in systems sales to reach that target.
OUTLOOK AND RISK FACTORS
The following discussion is an update to the "Outlook and Risk Factors"
discussed in the Company's Annual Report on Form 10-K for the year ended October
31, 2002. The discussions in the report regarding "Dealer Agreements",
"Dependence Upon Avaya", "Dependence Upon a Few Suppliers", "Hiring and
Retaining Key Personnel", "Competition", "Lodging Industry", and "Stock Market
Volatility" are still considered current and should be given equal consideration
together with the matters discussed below.
We continue to experience a lackluster capital spending environment and there
are no clear signals that this environment will improve for the balance of the
fiscal year.
Our systems sales and installation revenues are largely tied to capital spending
by our customers. Over the past 27 months, there have been a series of events
which have cast a pall of pessimism over the U.S. economy which has resulted in
an unwillingness by the general business community to make investments in new
technologies. We have met this challenge by operating in a very cautious and
cost-conscience manner which has enabled us to remain profitable and protect our
cash flows. We plan to continue to operate in this manner until we see reliable
signs of a recovery in capital spending.
We may not be able to meet our debt service requirements if present levels of
profitability continue.
Subsequent to the end of the second quarter, we completed the restructuring of
our debt agreement with our banks. This restructuring is discussed in detail
under "Financial Condition" above. The new agreement maintains the same debt
service requirements that we have met since November 2001. While we have never
missed or been late on our debt service obligations, we have generated much of
our cash available for debt service through reductions in working capital and to
a lesser degree through earnings and non-cash charges. Currently, our
receivables and inventory levels are at their lowest levels in three years, so
it is unlikely we will continue to generate similar levels of cash through these
sources. Therefore, it is important that our earnings be sufficient to provide
cash for our minimum debt service requirements. If we fail to earn approximately
$500,000 per quarter in earnings, we will likely have to meet our debt service
requirements through additional working capital improvements, borrowings on our
revolving line of credit, or reductions in capital spending.
Our sales initiative directed at the "mid-market" may not be successful and may
produce operating losses.
As discussed above, we are adding sales personnel in a few targeted cities to
focus on potential "midmarket" customers. In the short-term however, our ability
to fund the necessary operating and capital expenditures to expand our sales
force is largely dependent upon Avaya's financial support of this project. The
projected time frame of available funding is approximately six months. Therefore
if this initiative is not contributing to our profitability within six to eight
months, it is likely we will have to abandon this initiative.
16
Other Risk Factors.
In addition to the specific risk factors discussed above, the following general
factors can also impact our overall performance and results of operations: the
threat of additional acts of terrorism within the United States and the impact
of those threats on the overall economy, financial markets and customer spending
attitudes; future growth of the IP networking market; uncertainties inherent
with rapidly changing technologies and customer demand; the cost and effects of
legal claims and proceedings; and relationships with suppliers, vendors and
customers.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risks relating to our operations result primarily from changes in
interest rates. In November 2001, we entered into interest rate swap agreements
with each of its banking partners for the purpose of hedging against future
increases in interest rates. The interest rate swap agreements allow us to pay a
fixed interest rate of 3.32% (before application of the bank's pricing margin)
on a portion of its outstanding debt. At April 30, 2003, we had $6.2 million of
outstanding debt subject to interest rate fluctuations. A hypothetical 10
percent change in such interest rates would not have a material effect upon our
consolidated results of operations or cash flows.
ITEM 4. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures. Based on their
evaluation as of a date within 90 days of the filing date of this Quarterly
Report on Form 10-Q, our principal executive officer and principal financial
officer have concluded that our disclosure controls and procedures (as defined
in Rules 13a-14 (c) and 15d-14 (c) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")) are effective to ensure that information required
to be disclosed by the Company in reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in Securities and Exchange Commission rules and forms.
(b) Changes in Internal Controls. There were no significant changes in our
internal controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation. There were no significant
deficiencies or material weaknesses, and therefore there were no corrective
actions taken.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Phonometrics' litigation, which we are monitoring, appears to be winding
down, with orders finally dismissing the action with prejudice entered in
November, 2002 and awards of attorneys' fees having been granted in favor of
numerous hotel defendants in February, 2003. A detailed description of the
Phonometrics' cases is contained in our Annual Report on Form 10-K for the
fiscal year ended October 31, 2002 filed with the Commission on January 29,
2003.
ITEMS 2 - 5 have been omitted because they are not applicable.
17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits (filed herewith):
SEC Exhibit No. Description
- --------------- -----------
10(a) Fourth Amendment to Amended and Restated Credit Agreement dated effective as of March 1, 2003
among XETA Technologies, Inc., the Lenders and the Agent.
10(b) Fifth Amendment to Amended and Restated Credit Agreement dated effective as of May 1, 2003
among XETA Technologies, Inc., the Lenders and the Agent.
99.1 Certification of Chief Executive Officer Pursuant to Title 18, United States Code,
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certificate of Chief Financial Officer Pursuant to Title 18, United States Code, Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K - During the quarter for which this report is
filed, the Company filed no reports on Form 8-K.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
XETA Technologies, Inc.
(Registrant)
Dated: June 11, 2003 By: /s/ Jack R. Ingram
-------------------------
Jack R. Ingram
Chief Executive Officer
Dated: June 11, 2003 By: /s/ Robert B. Wagner
-------------------------
Robert B. Wagner
Chief Financial Officer
18
PRINCIPAL EXECUTIVE OFFICER CERTIFICATION
I, Jack R. Ingram, certify that:
1. I have reviewed this quarterly report on Form 10-Q of XETA
Technologies, Inc;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Dated: June 11, 2003
/s/ Jack R. Ingram
- --------------------------------
Jack R. Ingram
Chief Executive Officer
19
PRINCIPAL FINANCIAL OFFICER CERTIFICATION
I, Robert B. Wagner, certify that:
1. I have reviewed this quarterly report on Form 10-Q of XETA
Technologies, Inc;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Dated: June 11, 2003
/s/ Robert B. Wagner
- --------------------------------
Robert B. Wagner
Chief Financial Officer
20
EXHIBIT INDEX
SEC Exhibit No. Description
- --------------- -----------
10(a) Fourth Amendment to Amended and Restated Credit Agreement dated effective as of March 1, 2003
among XETA Technologies, Inc., the Lenders and the Agent.
10(b) Fifth Amendment to Amended and Restated Credit Agreement dated effective as of May 1, 2003
among XETA Technologies, Inc., the Lenders and the Agent.
99.1 Certification of Chief Executive Officer Pursuant to Title 18, United States Code,
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certificate of Chief Financial Officer Pursuant to Title 18, United States Code, Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.