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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2002
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Transition Period From _________to _________
Commission File Number 1-10346
MICROTEL INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0226211
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9485 HAVEN AVENUE, SUITE 100, RANCHO CUCAMONGA, CALIFORNIA 91730
(Address of principal executive offices) (Zip Code)
(909) 987-9220
(Registrant's telephone number, including area code)
Indicated 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 preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No | |
As of November 6, 2002, there were 21,513,366 shares of the registrant's
common stock, $0.0033 par value, outstanding.
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MICROTEL INTERNATIONAL, INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002
INDEX
PAGE
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2002 (unaudited)
and December 31, 2002............................................................F-1
Condensed Consolidated Statements of Operations for the Three and Nine Months
Ended September 30, 2002 and 2001 (unaudited)....................................F-2
Condensed Consolidated Statements of Other Comprehensive Income (Loss) for
the Three and Nine Months Ended September 30, 2002 and 2001 (unaudited)..........F-3
Consolidated Statements of Stockholders' Equity for the
Nine Months Ended September 30, 2002 (unaudited).................................F-4
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2002 and 2001 (unaudited)..........................................F-5
Notes to Condensed Consolidated Financial Statements (unaudited)........................F-6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations..................................................................... 2
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................ 15
Item 4. Controls and Procedures................................................................... 15
PART II - OTHER INFORMATION
Item 1. Legal Proceedings......................................................................... 16
Item 2. Changes in Securities and Use of Proceeds................................................. 16
Item 3. Defaults Upon Senior Securities........................................................... 16
Item 4. Submission of Matters to a Vote of Security Holders....................................... 16
Item 5. Other Information......................................................................... 17
Item 6. Exhibits and Reports on Form 8-K.......................................................... 17
Signatures .......................................................................................... 17
Certifications .......................................................................................... 18
Exhibits Filed with this Report on Form 10-Q.............................................................. 20
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 2002 AND DECEMBER 31, 2001
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
Sept. 30, December 31,
ASSETS 2002 2001
-------- --------
(unaudited)
Current assets:
Cash and cash equivalents $ 359 $ 604
Accounts receivable, net of allowance for doubtful
accounts of $209 and $226, respectively 4,748 5,627
Notes receivable 31 48
Inventories 7,257 7,433
Prepaid and other current assets 426 396
-------- --------
Total current assets 12,821 14,108
Property, plant and equipment, net 631 758
Goodwill, net 2,406 2,389
Other assets 466 433
-------- --------
$ 16,324 $ 17,688
======== ========
LIABILITIES, REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable, due on demand $ 2,138 $ 2,198
Notes payable 927 1,420
Current portion of long-term debt 412 550
Accounts payable 3,791 3,783
Accrued expenses 2,209 2,471
-------- --------
Total current liabilities 9,476 10,422
Long-term debt, less current portion 766 763
Other liabilities 356 371
-------- --------
Total liabilities 10,599 11,556
-------- --------
Convertible redeemable Series A Preferred Stock, $10,000
unit value. Authorized 200 shares; issued and outstanding
25 shares (aggregate liquidation preference of $250) 279 270
Stockholders' equity:
Preferred stock, authorized 10,000,000 shares; Convertible
Series B Preferred Stock, $0.01 par value; 65,733.7
and 150,000 shares issued and outstanding, respectively
(aggregate liquidation preferences of $421 and $960,
respectively) 411 938
Common stock, $0.0033 par value. Authorized 50,000,000
shares; and 21,513,000 and 20,671,000 shares issued and
outstanding, respectively 71 68
Additional paid-in capital 24,888 24,358
Accumulated deficit (19,242) (18,459)
Accumulated other comprehensive loss (682) (1,043)
-------- --------
Total stockholders' equity 5,446 5,862
-------- --------
$ 16,324 $ 17,688
======== ========
See accompanying notes to condensed consolidated financial statements.
F-1
MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ----------------------
2002 2001 2002 2001
-------- -------- -------- --------
(in thousands, except per share amounts)
Net sales $ 5,764 $ 6,345 $ 16,702 $ 20,893
Cost of sales 3,680 3,853 10,579 11,935
-------- -------- -------- --------
Gross profit 2,084 2,492 6,123 8,958
Operating expenses:
Selling, general and administrative 2,094 2,457 5,814 7,943
Engineering and product development 242 235 739 897
-------- -------- -------- --------
Income (loss) from operations (252) (200) (430) 118
Other income (expense):
Interest expense (119) (113) (303) (311)
Other income (loss) (56) 33 (33) 83
-------- -------- -------- --------
Loss before income taxes (427) (280) (766) (110)
Income tax expense (benefit) (97) 1 8 10
-------- -------- -------- --------
Net loss $ (330) $ (281) $ (774) $ (120)
======== ======== ======== ========
Loss per share:
Net loss:
Basic $ (0.02) $ (0.01) $ (0.04) $ (0.01)
======== ======== ======== ========
Diluted $ (0.02) $ (0.01) $ (0.04) $ (0.01)
======== ======== ======== ========
See accompanying notes to condensed consolidated financial statements.
F-2
MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME (LOSS)
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -----------------
2002 2001 2002 2001
----- ----- ----- -----
(in thousands)
Net loss $(330) $(281) $(774) $(120)
Other comprehensive income (loss) net of tax:
Foreign currency translation adjustment 17 230 $ 361 $ (96)
----- ----- ----- -----
Other comprehensive loss $(313) $ (51) $(413) $(216)
===== ===== ===== =====
See accompanying notes to condensed consolidated financial statements.
F-3
MICROTEL INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2002
(UNAUDITED)
(IN THOUSANDS)
Series B
Convertible Accumulated
Preferred Stock Common Stock Additional Other
------------------- ------------------- Paid-in Accumulated Comprehensive
Shares Amount Shares Amount Capital Deficit Income (Loss) Total
-------- -------- -------- -------- ------- ----------- --------------- --------
Balance at December 31, 2001 150 $ 938 20,671 $ 68 $ 24,358 $(18,459) $ (1,043) $ 5,862
Preferred Series B conversions (84) (527) 842 3 524 -- -- --
Foreign currency translation adjustment -- -- -- -- -- -- 361 361
Issuance of warrants for services -- -- -- -- 6 -- -- 6
Accretion of redeemable preferred stock -- -- -- -- -- (9) -- (9)
Net loss -- -- -- -- -- (774) -- (774)
-------- -------- -------- -------- -------- -------- -------- --------
Balance at September 30, 2002 66 $ 411 21,513 $ 71 $ 24,888 $(19,242) $ (682) $ 5,446
======== ======== ======== ======== ======== ======== ======== ========
See accompanying notes to condensed consolidated financial statements.
F-4
MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended Sept. 30,
2002 2001
------- -------
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (774) $ (120)
Adjustments to reconcile net loss to cash provided by operating activities:
Depreciation and amortization 230 272
Amortization of intangibles -- 303
Stock and warrants issued as compensation 6 10
Provision for doubtful account 102 144
Provision for obsolete/slow moving inventory 392 545
Changes in operating assets and liabilities:
Accounts receivable 665 1,674
Inventories (196) (1,750)
Other assets (23) 366
Accounts payable and accrued expenses (269) (903)
------- -------
Cash provided by operating activities 133 541
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net purchases of property, plant and equipment (107) (84)
Cash collected on note receivable 17 77
------- -------
Cash used in investing activities (90) (7)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in notes payable and long-term debt (688) (772)
------- -------
Cash used in financing activities (688) (772)
------- -------
Effect of exchange rate changes on cash 400 (81)
------- -------
Net decrease in cash and cash equivalents (245) (319)
------- -------
Cash and cash equivalents at beginning of period 604 756
------- -------
Cash and cash equivalents at end of period $ 359 $ 437
======= =======
Cash paid for:
Income tax $ 33 $ 34
======= =======
Interest $ 250 $ 304
======= =======
See accompanying notes to condensed consolidated financial statements.
F-5
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
(1) BASIS OF PRESENTATION
MicroTel International, Inc. (the "Company") is a worldwide
manufacturer of defense and aerospace electronic components and
telecommunications equipment. Formed in 1989, the Company operates through three
wholly-owned subsidiaries: XET Corporation ("XET"), CXR Telcom Corporation, and
CXR, S.A. The Company organizes itself in two product line segments: Electronic
Components and Telecommunications. The Company's electronic components group,
which includes XET and its international subsidiaries, provides to the
electronic components global market custom power conversion products and digital
switches that primarily are used for defense and aerospace applications. The
Company's telecommunications group, which comprises CXR Telcom Corporation and
CXR, S.A., provides testing, transmission and network access equipment to the
North American and European telecommunications industry. The Company operates
out of facilities in the United States, France, the United Kingdom and Japan.
The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with the rules and regulations of
the Securities and Exchange Commission and therefore do not include all
information and footnotes necessary for a complete presentation of financial
position, results of operations and cash flows in conformity with accounting
principles generally accepted in the United States of America.
The unaudited condensed consolidated financial statements do,
however, reflect all adjustments, consisting of only normal recurring
adjustments, which are, in the opinion of management, necessary to state fairly
the financial position as of September 30, 2002 and December 31, 2001 and the
results of operations and cash flows for the related interim periods ended
September 30, 2002 and 2001. However, these results are not necessarily
indicative of results for any other interim period or for the year. It is
suggested that the accompanying condensed consolidated financial statements be
read in conjunction with the Company's audited consolidated financial statements
included in its 2001 annual report on Form 10-K.
F-6
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
(2) EARNINGS (LOSS) PER SHARE
The following table illustrates the computation of basic and diluted
earnings (loss) per share (in thousands, except per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2002 2001 2002 2001
-------- -------- -------- --------
(in thousands, except per share amounts)
NUMERATOR:
Net loss $ (330) $ (281) $ (774) (120)
Less: accretion of the excess of the
redemption value over the carrying
value of redeemable preferred stock 3 3 9 9
-------- -------- -------- --------
Loss attributable to common
stockholders $ (333) $ (284) $ (783) (129)
======== ======== ======== ========
DENOMINATOR:
Weighted average number of common
shares outstanding during the period 21,506 20,571 21,104 20,570
Incremental shares from assumed
exercises or conversions of warrants,
options and preferred -- -- -- --
-------- -------- -------- --------
Adjusted weighted average shares 21,506 20,571 21,104 20,570
======== ======== ======== ========
Basic loss per share $ (0.02) $ (0.01) $ (0.04) $ (0.01)
======== ======== ======== ========
Diluted loss per share $ (0.02) $ (0.01) $ (0.04) $ (0.01)
======== ======== ======== ========
The computation of diluted loss per share for the nine month periods
ended September 30, 2002 and 2001 and for the three month periods ended
September 30, 2002 and 2001 excludes the effect of incremental common shares
attributable to the exercise of outstanding common stock options and warrants
because either their effect was antidilutive due to losses incurred by the
Company or such instruments had exercise prices greater than the average market
price of the common shares during the periods presented.
F-7
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
The following options and warrants were not included in the computation
of diluted income (loss) per share due to their antidilutive effect: September
30, 2002 September 30, 2001
September 30, 2002 September 30, 2001
------------------ ------------------
Options and warrants to purchase shares
of common stock 2,802,204 3,350,705
Exercise prices $0.20 - $3.44 $0.25 - $3.44
Expiration dates October 2002 - November 2001 -
February 2012 June 2011
The following shares of convertible preferred stock were not
included in the computation of diluted income (loss) per share due to their
antidilutive effect:
September 30, 2002 December 31, 2001
------------------ -----------------
Series A Preferred Stock 1,263,250 1,263,250
Series B Preferred Stock 657,337 1,500,000
--------- ---------
1,920,587 2,763,250
(3) INVENTORIES
Inventories consist of the following.
September 30, 2002 December 31, 2001
------------------ -----------------
Raw materials $2,422,000 $2,806,000
Work-in-process 3,269,000 2,879,000
Finished goods 1,566,000 1,748,000
---------- ----------
$7,257,000 $7,433,000
========== ==========
(4) NOTES PAYABLE
On April 17, 2002, the Company executed the Fourth Amendment to its
August 16, 2000 Credit and Security Agreement with Wells Fargo Business Credit,
Inc. The amendment increased the ceiling on the inventory portion of the
borrowing base to $400,000 during the months of January through April and
$300,000 through December for each year. The financial covenants were also
amended and the credit facility was extended through August 16, 2005.
F-8
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
(5) NOTES PAYABLE, DUE ON DEMAND
The Company's subsidiaries in France and in the U.K. have short-term
borrowing facilities with separate banks, which facilities are due on demand.
During 2002, one of the Company's U.K. subsidiaries exceeded the borrowing limit
on its overdraft credit facility and, as a result, that subsidiary's bank had
the right to charge penalty interest at the rate of 2% per month on the excess
borrowings but did not exercise that right.
Amounts owing under the U.K. overdraft credit facility were due and
payable no later than September 30, 2002. The Company's U.K. subsidiary obtained
a replacement overdraft credit facility as of November 12, 2002. The new
facility is for a maximum of $2,385,000 and includes a $556,500 cash flow loan,
a $127,000 term loan secured by fixed assets and a $1,701,500 loan secured by
accounts receivable. For purposes of this disclosure, the Company converted
these loan values using the exchange rate in effect at November 12, 2002 for the
conversion of British pound sterling into United States dollars. The interest
rate is 2% over the lender's base rate and is subject to a minimum rate of 4%
per annum. There are no financial performance covenants applicable to this
credit facility. However, the lender has the right to demand payment in full at
any time.
The Company's French subsidiary, CXR, S.A., has credit facilities
with several lenders totaling up to approximately $951,000 in the aggregate.
Each credit facility has a specified repayment term. However, each lender has
the right to demand payment in full at any time prior to the scheduled maturity
date of a particular credit facility. Although none of the lenders to CXR, S.A.
have indicated a desire to demand immediate payment of all outstanding principal
and interest balances on their respective credit facilities, CXR, S.A. has been
advised by its lenders that because CXR, S.A. has experienced a substantial
reduction in revenue, the lenders are contemplating a reduction in the total
available credit. As a result, the Company is in the process of seeking
alternative financing sources in France.
(6) INCOME TAXES
The Company recorded an income tax benefit during the three months
ended September 30, 2002, reversing the provision for U.K. income taxes recorded
in the prior two quarters of the year. This reversal was due to the
determination that U.K. net operating loss carryforwards can be used to offset
current tax liabilities. A 100% valuation allowance has been provided on the
total U.S. deferred income tax assets, as they are not more likely than not to
be realized.
(7) Reportable Segments
The Company has two reportable segments: Electronic Components and
Telecommunications. The Electronic Components segment operates in the United
States, European and Asian markets and designs, manufactures and markets
primarily digital switches and power supplies for the defense and aerospace
markets. The Telecommunications segment operates principally in the United
States and European markets and designs, manufactures and distributes
telecommunications test instruments and voice and data transmission and
networking equipment.
F-9
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
The Company evaluates performance based upon profit or loss from
operations before income taxes, exclusive of nonrecurring gains and losses.
The Company's reportable segments are comprised of operating
entities offering the same or similar products to similar customers. Each
segment is managed separately because each business has different customers,
design, manufacturing and marketing strategies.
There were no differences in the basis of segmentation or in the
basis of measurement of segment profit or loss from the amounts disclosed in the
Company's audited consolidated financial statements included in its 2001 annual
report on Form 10-K. Selected financial data for each of the Company's operating
segments is shown below:
Three months Three months Nine Months Nine Months
ended Sept. 30 ended Sept. 30 ended Sept. 30 ended Sept. 30
2002 2001 2002 2001
------------ ------------ ------------ ------------
Sales to external customers:
Electronic Components $ 3,397,000 $ 2,862,000 $ 9,899,000 $ 9,442,000
Telecommunications 2,367,000 3,483,000 6,803,000 11,451,000
------------ ------------ ------------ ------------
$ 5,764,000 $ 6,345,000 $ 16,702,000 $ 20,893,000
============ ============ ============ ============
Segment pretax profits (losses):
Electronic Components $ 570,000 $ 322,000 $ 1,942,000 $ 1,969,000
Telecommunications (442,000) 53,000 (1,211,000) 180,000
------------ ------------ ------------ ------------
$ 128,000 $ 375,000 $ 731,000 $ 2,149,000
============ ============ ============ ============
September 30, December 31,
2002 2001
----------- -----------
Segment assets:
Electronic Components $ 9,269,000 $ 9,060,000
Telecommunications 6,870,000 8,317,000
----------- -----------
$16,139,000 $17,377,000
=========== ===========
The following is a reconciliation of the reportable segment income
(loss) and assets to the Company's consolidated totals:
Three months Three months Nine Months Nine Months
ended Sept. 30 ended Sept. 30 ended Sept. 30 ended Sept. 30
2002 2001 2002 2001
------------ ------------ ------------ ------------
PRETAX INCOME
Total income for reportable segments $ 128,000 $ 375,000 $ 731,000 $ 2,149,000
Unallocated amounts:
Unallocated general corporate expenses 555,000 655,000 1,497,000 2,259,000
----------- ----------- ----------- -----------
Consolidated loss before income taxes $ (427,000) $ (280,000) $ (766,000) $ (110,000)
=========== =========== =========== ===========
F-10
MICROTEL INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
September 30, December 31,
2002 2001
------------ -----------
ASSETS
Total assets for reportable segments $ 16,139,000 $17,377,000
Other assets 185,000 311,000
------------ -----------
Total consolidated assets $ 16,324,000 $17,688,000
============ ===========
(8) GOODWILL - ADOPTION OF SFAS No. 142
Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets" ("SFAS No. 142") requires disclosure of what reported
income before extraordinary items and net income would have been in all periods
presented, exclusive of amortization expense (including any related tax effects)
recognized in those periods related to goodwill, intangible assets that are no
longer being amortized, any deferred credit related to an excess over cost,
equity method goodwill, and changes in amortization periods for intangible
assets that will continue to be amortized (including any related tax effects).
Similarly adjusted per-share amounts also must be disclosed for all periods
presented.
The Company initially applied SFAS No. 142 on January 1, 2002. The
amortization expense and net income of the Company for the initial nine-month
period of application ended September 30, 2002 and the comparable period in 2001
are included in the table below. The Company recognized no extraordinary items
in either of those periods.
Three months Three months Nine months Nine months
ended Sept 30, ended Sept. 30, ended Sept. 30, ended Sept. 30,
2002 2001 2002 2001
-------------- ---------------- ------------- --------------
Reported net loss: $ (330,000) $ (281,000) $ (774,000) $ (120,000)
Add back: goodwill
amortization -- 108,000 -- 303,000
-------------- ---------------- ----------- -----------
Adjusted net income (loss) excluding
amortization of goodwill $ (330,000) $ (173,000) $ (774,000) $ 183,000
============== ================ =========== ===========
Reported loss per share:
Basic $ (0.02) $ (0.01) $ (0.04) $ (0.01)
============== ================ =========== ===========
Diluted $ (0.02) $ (0.01) $ (0.04) $ (0.01)
============== ================ =========== -----------
Amortization of goodwill -
basic -- -- -- 0.02
Amortization of goodwill -
diluted -- -- -- 0.02
Adjusted earnings (loss) per
share
Basic $ (0.02) $ (0.01) $ (0.04) $ (0.01)
============== ================ =========== ===========
Diluted $ (0.02) $ (0.01) $ (0.04) $ (0.01)
============== ================ =========== ===========
F-11
(9) NEW ACCOUNTING PRONOUNCEMENTS
In October 2001, the FASB issued FASB Statement No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," or SFAS 144. SFAS No. 144
requires that those long-lived assets be measured at the lower of carrying
amount or fair value less cost to sell, whether reported in continuing
operations or in discontinued operations. Therefore, discontinued operations
will no longer be measured at net realizable value or include amounts for
operating losses that have not yet occurred. SFAS No. 144 is effective for the
Company's consolidated financial statements beginning January 1, 2002. The
implementation of SFAS No. 144 did not have a material impact on the Company's
consolidated financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(Including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires
that a liability for a cost associated with an exit or disposal activity be
recognized and measured initially at fair value when the liability is incurred.
SFAS No. 146 is effective for exit or disposal activities that are initiated
after December 31, 2002, with early application encouraged. The Company does not
expect the adoption of this statement to have a material effect on the Company's
financial statements.
F-12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
The following discussion and analysis should be read in conjunction
with our condensed consolidated financial statements and notes to financial
statements included elsewhere in this document. This report and our condensed
consolidated financial statements and notes to financial statements contain
forward-looking statements, which generally include the plans and objectives of
management for future operations, including plans and objectives relating to our
future economic performance and our current beliefs regarding revenues we might
earn if we are successful in implementing our business strategies. The
forward-looking statements and associated risks may include, relate to or be
qualified by other important factors, including, without limitation:
o the projected growth or contraction in the electronic
components and telecommunications markets;
o our business strategy for expanding, maintaining or
contracting our presence in these markets;
o anticipated trends in our financial condition and results of
operations; and
o our ability to distinguish ourselves from our current and
future competitors.
We do not undertake to update, revise or correct any forward-looking
statements.
The information contained in this document is not a complete
description of our business or the risks associated with an investment in our
common stock. Before deciding to buy or maintain a position in our common stock,
you should carefully review and consider the various disclosures we made in this
report, and in our other materials filed with the Securities and Exchange
Commission that discuss our business in greater detail and that disclose various
risks, uncertainties and other factors that may affect our business, results of
operations or financial condition. In particular, you should review our annual
report on Form 10-K for the year ended December 31, 2001, and the "Risk Factors"
we included in that report and in our quarterly report on Form 10-Q for the
quarter ended June 30, 2002.
Any of the factors described above or in the "Risk Factors" sections of
our earlier filings could cause our financial results, including our net income
(loss) or growth in net income (loss) to differ materially from prior results,
which in turn could, among other things, cause the price of our common stock to
fluctuate substantially.
OVERVIEW
Through our three direct wholly-owned operating subsidiaries, XET
Corporation, CXR Telcom Corporation, or CXR Telcom, and CXR, S.A., and through
the divisions and subsidiaries of our subsidiaries, we design, manufacture,
assemble, and market products and services in the following two material
business segments:
o Electronic Components
-- Digital Switches
-- Electronic Power Supplies
2
o Telecommunications
-- Telecommunications Test Instruments (analog and digital
test instruments used in the installation, maintenance,
management and optimization of public and private
communication networks)
-- Transmission and Network Access Products (range of
products for accessing public and private networks for
the transmission of data, voice and video)
Our sales are primarily in North America, Europe and Asia. Sales to
customers in the electronic components segment, primarily to aerospace
customers, military contractors and industrial customers, were 58.9% and 41.1%
respectively, of our total net sales during the nine month periods ended
September 30, 2002 and September 30, 2001. The remainder of our sales were to
telecommunications equipment customers. Revenues are recorded when products are
shipped if shipped FOB shipping point or when received by the customer if
shipped FOB destination.
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are described in Note 1 to our
audited consolidated financial statements included in Item 8 of our annual
report on Form 10-K for the year ended December 31, 2001. We believe our most
critical accounting policies include inventory valuation, goodwill impairment
and foreign currency translation.
INVENTORY VALUATION
We value our inventory at the lower of the actual cost to purchase or
manufacture the inventory or the current estimated market value of the
inventory. We regularly review inventory quantities on hand and record a
provision for excess and obsolete inventory based primarily on our estimated
forecast of product demand and production requirements for the next twelve
months. Demand for our products can fluctuate significantly. A significant
increase in the demand for our products could result in a short-term increase in
the cost of inventory purchases, while a significant decrease in demand could
result in an increase in the amount of excess inventory quantities on hand.
In addition, the telecommunications equipment industry is characterized
by rapid technological change, frequent new product development, and rapid
product obsolescence that could result in an increase in the amount of obsolete
inventory quantities on hand. Also, our estimates of future product demand may
prove to be inaccurate, in which case we may have understated or overstated the
provision required for excess and obsolete inventory. In the future, if our
inventory is determined to be overvalued, we would be required to recognize such
costs in our cost of goods sold at the time of such determination. Likewise, if
our inventory is determined to be undervalued, we may have over-reported our
costs of goods sold in previous periods and would be required to recognize
additional operating income at the time of sale. Therefore, although we make
every effort to ensure the accuracy of our forecasts of future product demand,
any significant unanticipated changes in demand or technological developments
could have a significant impact on the value of our inventory and our reported
operating results.
3
IMPAIRMENT OF GOODWILL
We periodically evaluate acquired businesses for potential impairment
indicators. Our judgments regarding the existence of impairment indicators are
based on legal factors, market conditions and operational performance of our
acquired businesses.
In assessing potential impairment of goodwill, we consider these
factors as well as forecasted financial performance of the acquired businesses.
If forecasts are not met, we may have to record additional impairment charges
not previously recognized. In assessing the recoverability of our goodwill and
other intangibles, we must make assumptions regarding estimated future cash
flows and other factors to determine the fair value of those respective assets.
If these estimates or their related assumptions change in the future, we may be
required to record impairment charges for these assets that were not previously
recorded. On January 1, 2002, we adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets," or SFAS No. 142, and
were required to analyze our goodwill for impairment issues by June 30, 2002,
and then periodically after that date. During the nine months ended September
30, 2002 and the year ended December 31, 2001, we did not record any impairment
losses related to goodwill and other intangible assets.
FOREIGN CURRENCY TRANSLATION
We have foreign subsidiaries that together accounted for 54.6% of our
net revenues, 66.3% of our assets and 68.4% of our total liabilities as of and
for the year ended December 31, 2001 and for 59.5% of our net revenues, 71.8% of
our assets and 72.9% of our total liabilities as of and for the nine months
ended September 30, 2002. In preparing our consolidated financial statements, we
are required to translate the financial statements of our foreign subsidiaries
from the currencies in which they keep their accounting records into United
States dollars. This process results in exchange gains and losses which, under
relevant accounting guidance, are either included within our statement of
operations or as a separate part of our net equity under the caption "cumulative
translation adjustment."
Under relevant accounting guidance, the treatment of these translation
gains or losses depends upon our management's determination of the functional
currency of each subsidiary. This determination involves consideration of
relevant economic facts and circumstances affecting the subsidiary. Generally,
the currency in which the subsidiary transacts a majority of its transactions,
including billings, financing, payroll and other expenditures, would be
considered the functional currency. However, management must also consider any
dependency of the subsidiary upon the parent and the nature of the subsidiary's
operations.
If management deems any subsidiary's functional currency to be its
local currency, then any gain or loss associated with the translation of that
subsidiary's financial statements is included in a cumulative translation
adjustment. However, if management deems the functional currency to be United
States dollars, then any gain or loss associated with the translation of these
financial statements would be included within our statement of operations.
If we dispose of any of our subsidiaries, any cumulative translation
gains or losses would be realized into our statement of operations. If we
determine that there has been a change in the functional currency of a
subsidiary to United States dollars, then any translation gains or losses
arising after the date of the change would be included within our statement of
operations.
4
Based on our assessment of the factors discussed above, we consider the
functional currency of each of our international subsidiaries to be each
subsidiary's local currency. Accordingly we hadcumulative translation losses of
$682,000 and $1,043,000 that were included as part of accumulated other
comprehensive loss within our balance sheets at September 30, 2002 and December
31, 2001, respectively. During the nine months ended September 30, 2002 and the
year ended December 31, 2001, we included translation adjustments of a gain of
approximately $361,000 and a loss of $312,000, respectively, under accumulated
other comprehensive income and loss.
If we had determined that the functional currency of our
subsidiaries was United States dollars, these gains or losses would have
decreased or increased our loss for the three and nine month periods ended
September 30, 2002 and 2001. The magnitude of these gains or losses depends upon
movements in the exchange rates of the foreign currencies in which we transact
business as compared to the value of the United States dollar. These currencies
include the euro, the British pound and the Japanese yen. Any future translation
gains or losses could be significantly higher than those we recorded for the
nine months ended September 30, 2002 and the year ended December 31, 2001.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO
THREE MONTHS ENDED SEPTEMBER 30, 2001
The following table sets forth, for the periods indicated, certain
statement of operations data expressed as a percentage of total net sales:
Three Months Ended
September 30,
----------------------
2002 2001
------- --------
Net sales ......................... 100.0% 100.0%
Cost of sales ..................... 63.9 60.7
------- -----
Gross profit ...................... 36.1 39.3
Selling, general and administrative
expenses ........................ 36.3 38.8
Engineering and product development
expenses ........................ 4.2 3.7
------- -----
Operating loss .................... (4.4) (3.2)
Interest expense .................. (2.0) (1.8)
Other income (expense) ............ (1.0) 0.6
------- -----
Loss before income tax benefit .... (7.4) (4.4)
Income tax benefit ................ (1.7) --
------- -----
Net loss .......................... (5.7)% (4.4)%
======= =====
NET SALES. Net sales for the three months ended September 30, 2002
decreased by $581,000 (9.2%) to $5,764,000 as compared to $6,345,000 for the
three months ended September 30, 2001.
Net sales of our electronic components increased by $535,000 (18.7%) to
$3,397,000 as compared to $2,862,000 for the three months ended September 30,
2001, mainly due to a $480,000 (38.6%) increase in sales of power supplies by
XCEL Corporation Ltd., or XCL, due to increased rate of products shipped under
long-term programs. Net sales of digital switches manufactured by
XET Corporation's Digitran Division declined by $97,000 (7.1%) to $1,260,000 as
compared to $1,357,000 for the three months ended September 30, 2001 but
increased by $266,000 (26.8%) over the dollar amount of digital switches sold in
the second quarter of 2002 due to increased sales volume. Sales of the Digitran
Division's subassemblies and other items increased by $264,000 (471.4%) to
$320,000 as compared to $56,000 for the three months ended September 30, 2001,
5
due to new contracts for electronic subsystems from a major aerospace company.
These contracts were executed beginning in January 2002, and the final shipments
under these contracts will be in November 2002.
Net sales of our telecommunications products and services for the three
months ended September 30, 2002 declined by $1,116,000 (32.0%) to $2,367,000 as
compared to $3,483,000 for the three months ended September 30, 2001. Test
equipment net sales for the three months ended September 30, 2002 decreased by
$806,000 (51.6%) to $755,000 as compared to $1,561,000 for the three months
ended September 30, 2001. The sales decline resulted from a $290,000 reduction
in sales of test equipment by CXR Telcom and a $516,000 reduction in resales of
test equipment by CXR, S.A., our French subsidiary. Management believes the
sales decline for CXR Telcom resulted primarily from reductions in capital
spending in the three months ended September 30, 2002 as compared to capital
spending in the three months ended September 30, 2001 by many of our
telecommunications customers due to generally weak telecommunications markets.
Management believes the sales decline for CXR, S.A. occurred primarily because
the exclusive distribution agreement that CXR, S.A. had with Sunrise Telecom,
Inc. terminated as of November 1, 2001, and CXR, S.A. has chosen not to remain
in the test instruments resale business except to support a limited number of
existing customers.
Net sales of our CXR HALCYON 704 series field test equipment decreased
by $231,000 (30.9%) to $517,000 as compared to $748,000 for the three months
ended September 30, 2001. Net sales of our T-Com central office test equipment
product line declined by $58,000 (28.0%) to $149,000 as compared to $207,000 for
the three months ended September 30, 2001, primarily due to continued weakening
in the market for test equipment used in central offices and by test equipment
manufacturers.
We believe that many of the United States telecom customers that CXR
Telcom serves built networks to handle an anticipated demand for voice and data
traffic that has not yet occurred. Consequently, many of these customers reduced
their purchasing budgets for 2002. This has had a negative impact on CXR
Telcom's sales.
CXR, S.A. produces all of our transmission products and networking
equipment. Net sales of transmission products and networking services provided
by CXR, S.A. decreased by $216,000 (12.8%) to $1,468,000 as compared to
$1,684,000 for the three months ended September 30, 2001. Total net sales by
CXR, S.A., including both test equipment and transmission and networking
equipment, decreased by $516,000 (28.0%) to $1,324,000 as compared to $1,840,000
for the three months ended September 30, 2001, primarily due to a lower sales
volume of test equipment. We believe that the decreases in CXR, S.A.'s and CXR
Telcom's sales relate to the overall slowdown in the telecom markets and the
termination of the Sunrise Telecom contract discussed above.
GROSS PROFIT. Gross profit as a percentage of total net sales decreased
to 36.2% for the three months ended September 30, 2002, as compared to 39.3% for
the comparable period in 2001. In dollar terms, total gross profit decreased by
$408,000 (16.4%) to $2,084,000 as compared to $2,492,000 for the three months
ended September 30, 2001.
Gross profit for our electronic components segment increased in dollar
terms by $255,000 (24.7%) to $1,288,000 as compared to $1,033,000 for the three
months ended September 30, 2001, andincreased as a percentage of related net
sales from 36.1% for the three months ended September 30, 2001 to 37.9% for the
three months ended September 30, 2002. This increase primarily was due to
increased sales of higher margin electronic components and subsystems by the
Digitran Division.
6
Gross profit for our telecommunications segment decreased in dollar
terms by $663,000 (45.4%) to $796,000 as compared to $1,459,000 for the three
months ended September 30, 2001, and decreased as a percentage of net sales from
41.9% for the three months ended September 30, 2001 to 33.6% for the three
months ended September 30, 2002. The decrease in gross profit as a percentage of
net sales primarily was due to the substantial reduction in sales volume that
increased overhead costs on a per unit basis.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased by $363,000 (14.8%) to $2,094,000 as compared
to $2,457,000 for the three months ended September 30, 2001. This decrease in
selling, general and administrative expenses was due to several factors. For
example, we incurred $156,000 in legal and accounting fees during the three
months ended September 30, 2001 in connection with amendments to a securities
registration statement and prior periodic reports but did not incur any of those
expenses during the three months ended September 30, 2002. Selling expenses were
reduced by $115,000, primarily due to staff reductions. Also, due to the new
accounting rules of SFAS No. 142, effective January 1, 2002 we no longer
amortize goodwill. Goodwill accounted for approximately $108,000 of our
amortization expense in the three months ended September 30, 2001.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product
development expenses consist primarily of research and product development
activities of our telecommunications segment. These expenses increased slightly
by $7,000 (3.0%) to $242,000 as compared to $235,000 for the three months ended
September 30, 2001, reflecting the cost savings from the closure of our St.
Charles, Illinois engineering facility in August 2001 and the relocation,
consolidation and downsizing of that engineering function into our Fremont,
California facility, as offset by increased engineering expenses of the Digitran
Division.
OTHER INCOME (EXPENSE). Interest expense increased slightly to $119,000
for the three months ended September 30, 2002 from $113,000 in the comparable
period in 2001. Other expense of $56,000 in the third quarter of 2002 primarily
resulted from foreign currency transaction losses.
INCOME TAX BENEFIT. Income tax benefit for the three months ended
September 30, 2002 was $97,000, as compared to an expense of $1,000 for the
comparable prior year period. The income tax benefit primarily was related to
the determination by our tax advisors that certain U.K. net operating losses
would be available and certain U.K. income taxes would be refundable.
NET LOSS. Net loss for the three months ended September 30, 2002 was
$330,000, as compared to net loss of $281,000 for the three months ended
September 30, 2001. The pretax loss for the three months ended September 30,
2002 was $427,000 as compared to the pretax loss of $280,000 for the prior year
period. The major contributing factor to the increase in pretax loss was the
lower sales volume of our telecommunications segment. We took in 2001, and
continue to take in 2002, various actions to reduce costs through staff
reductions in our telecommunications operations in the United States and France
and through various other methods. If these actions are not sufficient to reduce
cash outlays below revenue levels, then we may be required to restructure or
divest all or part of our telecommunications operations.
7
NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO
NINE MONTHS ENDED SEPTEMBER 30, 2001
The following table sets forth, for the periods indicated, certain
statement of operations data expressed as a percentage of total net sales:
Nine Months Ended
September 30,
--------------------
2002 2001
------- ------
Net sales ......................... 100.0% 100.0%
Cost of sales ..................... 63.3 57.1
------- -----
Gross profit ...................... 36.7 42.9
Selling, general and administrative
expenses ........................ 34.9 38.0
Engineering and product development
expenses ........................ 4.4 4.3
------- -----
Operating income (loss) ........... (2.6) 0.6
Interest expense .................. (1.8) (1.5)
Other income (expense) ............ (0.2) 0.3
------- -----
Loss before income tax expense .... (4.6) (0.6)
Income tax expense ................ -- --
------- -----
Net loss .......................... (4.6)% (0.6)%
======= =====
NET SALES. Net sales for the nine months ended September 30, 2002
decreased by $4,191,000 (20.1%) to $16,702,000 as compared to $20,893,000 for
the nine months ended September 30, 2001.
Net sales of our electronic components increased by $457,000 (4.8%) to
$9,899,000 as compared to $9,442,000 for the nine months ended September 30,
2001. Sales of power supplies by XCL increased by $984,000 (24.4%) to $5,011,000
as compared to $4,027,000 for the nine months ended September 30, 2001 due to an
increased rate of products shipped under long-term programs. Sales of digital
switches manufactured by the Digitran Division declined by $1,193,000 (24.9%) to
$3,597,000 as compared to $4,790,000 for the nine months ended September 30,
2001. The decline in sales of digital switches was a result of lower than
expected orders, which we believe is a temporary situation. However, XET
Corporation increased its sales of subassemblies by $787,000 (403.6%) to
$982,000 as compared to $195,000 for the nine months ended September 30, 2001
due to new contracts for electronic subsystems from a major aerospace company.
These contracts were executed beginning in January 2002, and the final shipments
under these contracts will be in November 2002. We believe that the Digitran
Division will have an opportunity to acquire new electronic subsystems contracts
in 2003.
Net sales of our telecommunications products and services for the nine
months ended September 30, 2002 declined by $4,648,000 (40.6%) to $6,803,000 as
compared to $11,451,000 for the nine months ended September 30, 2001. Test
equipment net sales for the nine months ended September 30, 2002 decreased by
$3,763,000 (61.5%) to $2,359,000 as compared to $6,122,000 for the nine months
ended September 30, 2001. The sales decline resulted from a $2,103,000 reduction
in sales of test equipment by CXR Telcom and a $1,660,000 reduction in resales
of test equipment by CXR, S.A. Management believes the sales decline for CXR
Telcom resulted primarily from reductions in capital spending in the nine months
ended September 30, 2002 as compared to capital spending in the nine months
ended September 30, 2001 by many of our telecommunications customers due to
generally weak telecommunications markets. Management believes the sales decline
for CXR, S.A. occurred primarily because the exclusive distribution agreement
that CXR, S.A. had with Sunrise Telecom, Inc. terminated as of November 1, 2001,
and CXR, S.A. has chosen not to remain in the test instruments resale business
except to support a limited number of existing customers.
8
Net sales of our CXR HALCYON 704 series field test equipment decreased
by $1,632,000 (51.2%) to $1,553,000 as compared to $3,185,000 for the nine
months ended September 30, 2001. Net sales of our T-Com central office test
equipment product line declined by $471,000 (54.3%) to $397,000 as compared to
$868,000 for the nine months ended September 30, 2001, primarily due to
continued weakening in the market for test equipment.
We believe that many of the United States telecom customers that CXR
Telcom serves built networks to handle an anticipated demand for voice and data
traffic that has not yet occurred. Consequently, many of these customers reduced
their purchasing budgets for 2002. This has had a negative impact on CXR
Telcom's sales.
CXR, S.A.produces all of our transmission products and networking
equipment. Net sales of transmission products and networking equipment produced
by CXR, S.A. decreased by $687,000 (14.4%) to $4,083,000 as compared to
$4,770,000 for the nine months ended September 30, 2001, primarily because of
the weak telecom market. Total net sales by CXR, S.A., including both test
equipment and transmission and networking equipment, decreased by $2,015,000
(33.2%) to $4,052,000 as compared to $6,067,000 for the nine months ended
September 30, 2001. We believe that the decreases in CXR, S.A.'s and CXR
Telcom's sales relate to the overall slowdown in the telecom markets and the
termination of the Sunrise Telecom contract discussed above, and that the French
national and local elections in April and May 2002 may have caused a delay in
purchases by major governmental customers of CXR, S.A.
GROSS PROFIT. Gross profit as a percentage of total net sales decreased
to 36.7% for the nine months ended September 30, 2002, as compared to 42.9% for
the comparable period in 2001. In dollar terms, total gross profit decreased by
$2,835,000 (31.6%) to $6,123,000 as compared to $8,958,000 for the nine months
ended September 30, 2001.
Gross profit for our electronic components segment decreased in dollar
terms by $202,000 (5.0%) to $3,820,000 as compared to $4,022,000 for the nine
months ended September 30, 2001, and decreased as a percentage of related net
sales from 42.6% for the nine months ended September 30, 2001 to 38.6% for the
nine months ended September 30, 2002. This decrease primarily was the result of
reduced profit margins on power supply sales by XCL due to a less profitable
product mix.
Gross profit for our telecommunications segment decreased in dollar
terms by $2,633,000 (53.3%) to $2,303,000 as compared to $4,936,000 for the nine
months ended September 30, 2001, and decreased as a percentage of net sales from
43.1% for the nine months ended September 30, 2001 to 33.8% for the nine months
ended September 30, 2002. The decrease in gross profit as a percentage of net
sales primarily was due to the substantial reduction in sales volume that
increased overhead costs on a per unit basis.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased by $2,129,000 (26.8%) to $5,814,000 as
compared to $7,943,000 for the nine months ended September 30, 2001. This
decrease in selling, general and administrative expenses was due to several
factors. For example, we incurred $608,000 in legal and accounting fees during
the nine months ended September 30, 2001 in connection with amendments to a
securities registration statement and prior periodic reports but did not incur
any of those expenses during the nine months ended September 30, 2002. Selling
expenses were reduced by $655,000 in our telecommunications segment and $115,000
in our electronic components segment primarily due to lower commissions on
9
reduced sales and reduced costs during the nine months ended September 30, 2002.
Administrative costs were reduced by $327,000 in our telecommunications segment
and $268,000 in our electronic components segment primarily due to staff
reductions at CXR Telcom and XCL. Also, due to the new accounting rules of SFAS
No. 142, effective January 1, 2002 we no longer amortize goodwill. Goodwill
accounted for $303,000 of our amortization expense in the nine months ended
September 30, 2001.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product
development expenses consist primarily of research and product development
activities of our telecommunications segment. These expenses decreased by
$158,000 (17.6%) to $739,000 as compared to $897,000 for the nine months ended
September 30, 2001, reflecting the cost savings from the closure of our St.
Charles, Illinois engineering facility in August 2001 and the relocation,
consolidation and downsizing of that engineering function into our Fremont,
California facility.
OTHER INCOME AND EXPENSE. Interest expense declined slightly to
$303,000 for the nine months ended September 30, 2002 from $311,000 in the
comparable period in 2001. Other expense was $33,000 in the first nine months of
2002 as compared to $83,000 of other income reported in the comparable period in
2001. The change primarily was caused by foreign currency transaction losses in
international transactions, most of which losses were incurred by our Japanese
subsidiary.
INCOME TAX EXPENSE. Income tax expense for the nine months ended
September 30, 2002 was $8,000, as compared to $10,000 for the comparable prior
year period. Income tax expense primarily comprised miscellaneous state income
taxes.
NET LOSS. Net loss for the nine months ended September 30,
2002 was $774,000, as compared to net loss of $120,000 for the nine months ended
September 30, 2001. The major cause of this change was the reduction in sales of
our telecommunications segment below the level needed to cover fixed costs. We
took in 2001, and continue to take in 2002, various actions to reduce costs
through staffing reductions in our telecommunications operations in the United
States and France and through various other methods. If these actions are not
sufficient to reduce cash outlays below revenue levels, then we may be required
to restructure or divest all or part of our telecommunications operations.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 2002 and the year ended
December 31, 2001, we funded our operations primarily through revenue generated
from our operations and through our lines of credit with Wells Fargo Business
Credit, Inc. and various foreign banks. As of September 30, 2002, we had working
capital of $3,346,000, an accumulated deficit of $19,242,000, an accumulated
other comprehensive loss of $682,000, $359,000 in cash and cash equivalents and
$4,748,000 of accounts receivable. As of December 31, 2001, we had working
capital of $3,686,000, an accumulated deficit of $18,459,000 an accumulated
other comprehensive loss of $1,043,000, $604,000 in cash and cash equivalents
and $5,627,000 of accounts receivable.
Cash provided by our operating activities totaled $133,000 for the nine
months ended September 30, 2002, as compared to $541,000 of cash provided by our
operating activities for the comparable period in 2001. This decrease in cash
provided by our operations during the nine months ended September 30, 2002
primarily resulted from lower collections of accounts receivable due to lower
sales.
10
Cash used in our investing activities totaled $90,000 for the nine
months ended September 30, 2002, as compared to $7,000 for the nine months ended
September 30, 2001. Cash used in our investing activities for the nine months
ended September 30, 2002 included $107,000 of costs associated with the
installation of our new Enterprise Resource Planning system, which system we
expect will improve the efficiency of our operations.
Cash used in financing activities totaled $688,000 for the nine months
ended September 30, 2002, as compared to $772,000 for the comparable period in
2001, primarily due to payments that reduced bank debt.
On August 16, 2000, our subsidiaries, CXR Telcom and XET Corporation,
together with MicroTel acting as guarantor, obtained a credit facility extension
and modification from Wells Fargo Business Credit, Inc. In April 2002, the
maturity date of the facility was extended by two years to August 16, 2005.
Since April 17, 2002, the facility has provided for a revolving loan of up to
$3,000,000 secured by inventory and accounts receivable and a term loan in
the amount of $687,000 secured by machinery and equipment. On September 30,
2002, the interest rate was the prime rate (then 4.75%) plus 1%, subject to a
minimum interest charge of $13,500 per month. The balance outstanding at
September 30, 2002 was $927,000 on the revolving loan and $129,000 on the term
loan, and we had available to us $80,000 of additional borrowings under the
revolving loan. The credit facility contains restrictive financial covenants
that are set by mutual agreement of us and our lender each year. At September
30, 2002, we were in compliance with such covenants.
Our foreign subsidiaries have credit facilities with Lloyds Bank in
England, Banc National du Paris, Societe General and Banque Hervet in France and
Johan Tokyo Credit Bank in Japan. The balances outstanding under our U.K.,
France and Japan credit facilities were $1,934,000, $951,000 and zero dollars,
respectively, on September 30, 2002. Of the total $1,934,000 balance owed to
Lloyds Bank, $1,320,000 was owed by XCL under a $1,600,000 overdraft credit
facility and $614,000 was owed by XCEL Power Systems Ltd., a subsidiary of XCL
("XPS"), under an $800,000 term facility. Due to a rapid expansion in sales, XCL
exceeded the borrowing limit contained in its overdraft credit facility with
Lloyds Bank at June 30, 2002. As a result, Lloyds Bank had the right to charge
penalty interest at the rate of 2% per month on the excess borrowings but did
not exercise that right. Amounts owing under the overdraft credit facility were
due and payable no later than September 30, 2002.
XPS has obtained an overdraft credit facility with Venture Financing
PLC, an affiliate of ABN AMRO Holdings N.V., which new facility replaced the
Lloyds Bank facility as of November 12, 2002. The new facility is for a maximum
of $2,385,000 and includes a $556,500 cash flow loan, a $127,000 term loan
secured by fixed assets and a $1,071,500 loan secured by accounts receivable.
For purposes of this discussion, we converted these loan values using the
exchange rate in effect at November 12, 2002 for the conversion of British pound
sterling into United States dollars. The interest rate is 2% over the base rate
of Venture Financing PLC and is subject to a minimum rate of 4% per annum. There
are no financial performance covenants applicable to this credit facility.
However, Venture Financing PLC has the right to demand payment in full at any
time.
CXR, S.A. has credit facilities with several lenders totaling up to
approximately $951,000 in the aggregate. Each credit facility has a specified
repayment term. However, each lender has the right to demand payment in full at
any time prior to the scheduled maturity date of a particular credit facility.
Although none of the lenders to CXR, S.A. have indicated a desire to demand
immediate payment of all outstanding principal and interest balances on their
respective credit facilities, CXR, S.A. has been advised by its lenders that
because CXR, S.A. has experienced a substantial reduction in revenue, the
lenders are contemplating a reduction in the total available credit. As a
result, we are in the process of seeking alternative financing sources in
France.
11
We cannot assure you that the various lenders to our U.K. and/or French
subsidiaries will not seek immediate payment of all amounts owed by them under
their respective credit facilities or seek to terminate any of the existing
credit facilities. Similarly, we cannot assure you that if either of these
events were to occur we would be successful in obtaining the required
replacement financing for our operations in the U.K. and/or France or, if we
were able to obtain such financing, that the financing would occur on a timely
basis, would be on acceptable terms and would be sufficient to allow us to
maintain our business operations in the U.K. and/or France. Accordingly, any of
these actions on the part of any of the lenders to our U.K. and/or French
subsidiaries could adversely impact our results of operations and cash flows.
Our backlog was $13,516,000 as of September 30, 2002, as compared to
$14,885,000 as of December 31, 2001. Our backlog as of September 30, 2002 was
96.7% related to our electronic components business, which business tends to
provide us with long lead times for our manufacturing processes due to the
custom nature of the products, and 3.3% related to our telecommunications
business, which business tends to deliver standard products from stock as orders
are received. The amount of backlog orders represents revenue that we anticipate
recognizing in the future, as evidenced by purchase orders and other purchase
commitments received from customers, but on which work has not yet been
initiated or with respect to which work is currently in progress. However, there
can be no assurance that we will be successful in fulfilling such orders and
commitments in a timely manner or that we will ultimately recognize as revenue
the amounts reflected as backlog.
During the nine months ended September 30, 2002 and the year ended
December 31, 2001, 40.7% and 53.9%, respectively, of our sales were to customers
in the telecommunications industry. We experienced 40.6% and 5.6% declines in
our telecommunications segment sales in the nine months ended September 30, 2002
and the year ended December 31, 2001, respectively, as compared to the
comparable prior year periods. We believe these declines primarily were due to a
general business decline experienced by many of our telecommunications
customers. We cannot predict the duration or severity of the telecommunications
market downturn or the extent to which the downturn will continue to negatively
affect our ability to sell our products and services to customers in the
telecommunications industry. A further reduction in sales would reduce our
accounts receivable balances, which in turn would have an adverse effect on our
financial position by reducing the amount of cash available under our lines of
credit.
We took various actions to reduce costs in 2001 and are reducing costs
further through staff reductions and other cost-reducing actions in 2002. These
actions are intended to reduce the cash outlays of our telecommunications
segment to match its revenue rate. If these actions are not sufficient to reduce
cash outlays below revenue levels, then we may restructure or divest all or part
of our telecommunications operations.
12
The following table outlines payments due from us or our subsidiaries
under our lines of credit and other significant contractual obligations over the
next five years, exclusive of interest:
PAYMENTS DUE BY PERIOD
CONTRACTUAL (IN THOUSANDS)
OBLIGATIONS AT
SEPT. 30, 2002 2002 2003 2004 2005 2006 THEREAFTER TOTAL
----------------------------------- ----------- ---------- -------- --------- -------- ------------- -------------
Line of Credit (Domestic) $ 927 $ $ $ $ $ $ 927
Line of Credit (U.K.) 1,320 1,320
Overdraft (France) 818 818
Term Loan (Domestic) 114 15 129
Term Loan (U.K.) 134 146 146 146 42 614
Term Loan (France) 22 56 56 134
Capitalized Lease Obligations 57 94 58 31 240
Other Promissory Notes 60 60
Operating Leases 196 158 97 1 452
----------- ---------- -------- --------- -------- ------------- -------------
$ 3,648 $ 469 $ 357 $ 178 $ 42 $ $ 4,694
In conjunction with our cost reductions, we believe that current and
future available capital resources, revenues generated from operations, and
other existing sources of liquidity, including the credit facilities we and our
subsidiaries have, will be adequate to meet our anticipated working capital and
capital expenditure requirements for at least the next twelve months. If,
however, our capital requirements or cash flow vary materially from our current
projections or if unforeseen circumstances occur, we may require additional
financing. Deteriorating global economic conditions may cause prolonged declines
in investor confidence in and accessibility to capital markets. Our failure to
raise capital, if needed, could restrict our growth, limit our development of
new products or hinder our ability to compete.
EFFECTS OF INFLATION
The impact of inflation and changing prices has not been significant on
the financial condition or results of operations of either our company or our
operating subsidiaries.
IMPACTS OF NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board, or the FASB,
finalized FASB Statements No. 141, "Business Combinations," or SFAS No. 141, and
No. 142, "Goodwill and Other Intangible Assets," or SFAS No. 142. SFAS No. 141
requires the use of the purchase method of accounting and prohibits the use of
the pooling-of-interests method of accounting for business combinations
initiated after June 30, 2001. SFAS No. 141 also requires that we recognize
acquired intangible assets apart from goodwill if the acquired intangible assets
meet certain criteria. SFAS No. 141 applies to all business combinations
initiated after June 30, 2001 and for purchase business combinations completed
on or after July 1, 2001. It also requires upon adoption of SFAS No. 142 that we
reclassify the carrying amounts of intangible assets and goodwill based on the
criteria in SFAS No. 141.
13
SFAS No. 142 requires, among other things, that companies no longer
amortize goodwill, but instead test goodwill for impairment at least annually.
In addition, SFAS No. 142 requires that we identify reporting units for the
purpose of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS No. 142. SFAS No. 142 is required to be
applied in fiscal years beginning after December 15, 2001 to all goodwill and
other intangible assets recognized at that date, regardless of when those assets
initially were recognized. SFAS No. 142 required us to complete a transitional
goodwill impairment test by June 30, 2002. We also were required to reassess the
useful lives of other intangible assets within the first interim quarter after
adoption of SFAS No. 142.
Our previous business combinations were accounted for using the
purchase method. As of September 30, 2002 and December 31, 2001, the net
carrying amount of goodwill was $2,345,000 and $2,389,000, respectively.
Amortization expense related to goodwill during the nine months ended September
30, 2002 and the year ended December 31, 2001 was zero dollars and $345,000,
respectively. Our adoption of SFAS No. 141 and SFAS No. 142 has not materially
impacted our financial position and results of operations.
In October 2001, the FASB issued FASB Statement No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," or SFAS 144. SFAS No. 144
requires that those long-lived assets be measured at the lower of carrying
amount or fair value less cost to sell, whether reported in continuing
operations or in discontinued operations. Therefore, discontinued operations
will no longer be measured at net realizable value or include amounts for
operating losses that have not yet occurred. SFAS No. 144 is effective for our
consolidated financial statements beginning January 1, 2002. The implementation
of SFAS No. 144 did not have a material impact on our consolidated financial
position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(Including Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires
that a liability for a cost associated with an exit or disposal activity be
recognized and measured initially at fair value when the liability is incurred.
SFAS No. 146 is effective for exit or disposal activities that are initiated
after December 31, 2002, with early application encouraged. We do not expect the
adoption of this statement to have a material effect on our financial
statements.
EURO CONVERSION
Our operating subsidiaries located in France and the U.K. had combined
net sales from operations approximating 56.0% of our total net sales for the
nine months ended September 30, 2002. Net sales from the French subsidiary
participating in the euro conversion were 24.3% of our net sales for the nine
months ended September 30, 2002. We continue to review the impact of the euro
conversion on our operations.
Our European operations took steps to ensure their capability of
entering into euro transactions. No material changes to information technology
and other systems are necessary to accommodate these multiple currency
transactions because such systems already were capable of using multiple
currencies.
14
While it is difficult to assess the competitive impact of the euro
conversion on our European operations, at this time we do not foresee any
material impediments to our ability to compete for orders from customers
requesting pricing using the new exchange rate. Since we have no significant
direct sales between our United States and European operations, we regard
exchange rate risk as nominal.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We have established and acquired international subsidiaries that
prepare their balance sheets in the relevant foreign currency. In order to be
included in our consolidated financial statements, these balance sheets are
converted, at the then current exchange rate, into United States dollars, and
the statements of operations are converted using weighted average exchange rates
for the applicable period. Accordingly, fluctuations of the foreign currencies
relative to the United States dollar could have an effect on our consolidated
financial statements. Our exposure to fluctuations in currency exchange rates
has increased as a result of the growth of our international subsidiaries.
However, because historically the majority of our currency exposure has related
to financial statement translation rather than to particular transactions, we do
not intend to enter into, nor have we historically entered into, forward
currency contracts or hedging arrangements in an effort to mitigate our currency
exposure.
A substantial portion of our notes payable and long-term debt have
variable interest rates based on the prime interest rate and/or the lender's
base rate, which exposes us to risk of earnings loss due to changes in such
interest rates. Our annual report on Form 10-K for the year ended December 31,
2001 contains information about our debt obligations that are sensitive to
changes in interest rates under "Item 7A. Quantitative and Qualitative
Disclosures About Market Risk." There have been no material changes in those our
market risks during the nine months ended September 30, 2002.
ITEM 4. CONTROLS AND PROCEDURES.
Our Chief Executive Officer and Chief Financial Officer (our principal
executive officer and principal financial officer, respectively) have concluded,
based on their evaluation as of October 24, 2002 ("Evaluation Date"), that the
design and operation of 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 ("Exchange Act")) are effective to ensure that information required to
be disclosed by us in the reports filed or submitted by us under the Exchange
Act is accumulated, recorded, processed, summarized and reported to our
management, including our principal executive officer and our principal
financial officer, as appropriate to allow timely decisions regarding whether or
not disclosure is required.
There were no significant changes in internal controls or in other
factors that could significantly affect internal controls subsequent to the
Evaluation Date, nor were there any significant deficiencies or material
weaknesses in our internal controls. As a result, no corrective actions were
required or undertaken.
15
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We are not a party to any material pending legal proceedings.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
RECENT SALES OF UNREGISTERED SECURITIES
In July 2002, we issued an aggregate of 46,293 shares of common stock
upon conversion of 4,629.3 shares of Series B Preferred Stock held by one
entity.
In September 2002, we issued to Jacque Moisset, former President of
CXR, S.A., for advice and consultation services valued at $6,000, three-year
warrants to acquire 120,000 shares of our common stock at an exercise price of
$0.50 per share.
Exemption from the registration provisions of the Securities Act of
1933 for the transactions described above is claimed under Section 4(2) of the
Securities Act of 1933, among others, on the basis that such transactions did
not involve any public offering and the purchasers were sophisticated with
access to the kind of information registration would provide.
DIVIDENDS
To date we have not paid dividends on our common stock. Our line of
credit with Wells Fargo Business Credit, Inc. prohibits the payment of cash
dividends on our common stock. The certificates of designations related to our
Series A Preferred Stock and Series B Preferred Stock provide that shares of
those series of preferred stock are not entitled to receive cash dividends. We
currently intend to retain future earnings to fund the development and growth of
our business and, therefore, do not anticipate paying cash dividends on our
common stock within the foreseeable future. Any future payment of dividends on
our common stock will be determined by our board of directors and will depend on
our financial condition, results of operations, contractual obligations and
other factors deemed relevant by the our board of directors.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On August 23, 2002, we held our 2002 annual meeting of stockholders.
The total number of outstanding votable shares was 21,513,366. Our stockholders
were asked to re-elect Carmine T. Oliva and Robert B. Runyon as Class III
directors to serve a three-year term on our board of directors. Results of the
vote are as follows:
NOMINEE FOR ABSTAIN WITHHELD TOTAL VOTED
------- --- ------- -------- -----------
Carmine T. Oliva 17,710,703 -- 69,959 17,780,662
Robert B. Runyon 17,709,066 -- 71,596 17,780,662
16
As a result, Messrs. Oliva and Runyon were re-elected to our board of
directors. In addition, Laurence P. Finnegan, Jr. continued to serve as a Class
II director following the meeting.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBITS
NUMBER DESCRIPTION
------ -----------
99.1 Certifications of Chief Executive Officer and Chief
Financial Officer Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act Of 2002
(b) REPORTS ON FORM 8-K
On July 2, 2002, we filed a report on Form 8-K for July 1, 2002 under
Item 5 -- Other Events to report an extension of stockholder proposal deadlines
for our 2002 annual meeting of stockholders.
On October 8, 2002, we filed a report on Form 8-K for September 24,
2002 under Item 4 -- Changes in Registrant's Certifying Accountant and Item 7 --
Financial Statements and Exhibits, disclosing our change in certifying
accountants and attaching the required letter from our former certifying
accountants.
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
MICROTEL INTERNATIONAL, INC.
Dated: November 13, 2002 By: /S/ CARMINE T. OLIVA
----------------------------------------------
Carmine T. Oliva, Chairman of the Board,
Chief Executive Officer (principal executive
officer) and President
By: /S/ RANDOLPH D. FOOTE
---------------------------------------------
Randolph D. Foote, Chief Financial Officer
(principal financial and accounting officer)
17
CERTIFICATIONS
I, Carmine T. Oliva, certify that:
1. I have reviewed this quarterly report on Form 10-Q of MicroTel
International, 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 officers 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 officers 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.
Date: November 13, 2002
/S/ CARMINE T. OLIVA
- -----------------------
Carmine T. Oliva,
Chief Executive Officer (principal executive officer)
18
I, Randolph D. Foote, certify that:
1. I have reviewed this quarterly report on Form 10-Q of MicroTel
International, 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 officers 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 officers 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.
Date: November 13, 2002
/S/ RANDOLPH D. FOOTE
- --------------------------------
Randolph D. Foote,
Chief Financial Officer
(principal financial officer)
19
EXHIBITS FILED WITH THIS REPORT ON FORM 10-Q
NUMBER DESCRIPTION
------ -----------
99.1 Certifications of Chief Executive Officer and Chief Financial
Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act Of 2002
20