-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DGjevL/pX9F+IimwqmrkrgQkmaNL6EMQmkjU2vQHzTR0QGs9F8EtHWkdAgvTvOK/ RVBmv2466bBWEX81qGLNbA== 0000725282-96-000033.txt : 19961115 0000725282-96-000033.hdr.sgml : 19961115 ACCESSION NUMBER: 0000725282-96-000033 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19960930 FILED AS OF DATE: 19961113 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: EXECUTONE INFORMATION SYSTEMS INC CENTRAL INDEX KEY: 0000725282 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-TELEPHONE INTERCONNECT SYSTEMS [7385] IRS NUMBER: 860449210 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-11551 FILM NUMBER: 96661432 BUSINESS ADDRESS: STREET 1: 478 WHEELERS FARMS RD CITY: MILFORD STATE: CT ZIP: 06460 BUSINESS PHONE: 2038767600 MAIL ADDRESS: STREET 1: 478 WHEELERS FARMS RD CITY: MILFORD STATE: CT ZIP: 06460-1847 FORMER COMPANY: FORMER CONFORMED NAME: VODAVI TECHNOLOGY CORP DATE OF NAME CHANGE: 19880802 10-Q 1 EXECUTONE INFORMATION SYSTEMS, INC. 9/30/96 10-Q FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File No. 0-11551 EXECUTONE Information Systems, Inc. (Exact name of registrant as specified in its charter) Virginia 86-0449210 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 478 Wheelers Farms Road, Milford, Connecticut 06460 (Address of principal executive offices) (Zip Code) (203) 876-7600 (Registrant's telephone number, including area code) N/A (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 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 The number of shares outstanding of registrant's Common Stock, $.01 par value per share, as of October 31, 1996 was 51,647,630. INDEX EXECUTONE Information Systems, Inc. Page # PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets - September 30, 1996 and December 31, 1995. 3 Consolidated Statements of Operations - Three Months and Nine Months Ended September 30, 1996 and 1995. 4 Consolidated Statements of Cash Flows - Nine Months Ended September 30, 1996 and 1995. 5 Notes to Consolidated Financial Statements. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 PART II. OTHER INFORMATION 16 SIGNATURES 17 EXHIBIT 11. STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS 18 2 PART I - FINANCIAL INFORMATION Item 1. Financial Statements EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
September 30, December 31, (In thousands, except for share amounts) 1996 1995 (Unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 35,296 $ 8,092 Accounts receivable, net of allowance of $1,537 and $1,715 35,140 48,531 Inventories 17,283 32,765 Prepaid expenses and other current assets 2,242 5,290 Total Current Assets 89,961 94,678 PROPERTY AND EQUIPMENT, net 7,528 18,462 INTANGIBLE ASSETS, net 19,925 20,022 DEFERRED TAXES 20,056 29,616 OTHER ASSETS 12,158 5,066 $ 149,628 $ 167,844 LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of long-term debt $ 1,027 $ 932 Accounts payable 28,090 30,676 Accrued payroll and related costs 3,307 6,870 Accrued liabilities 16,190 11,851 Deferred revenue and customer deposits 3,019 19,781 Total Current Liabilities 51,633 70,110 LONG-TERM DEBT 14,034 29,829 LONG-TERM DEFERRED REVENUE 156 2,805 TOTAL LIABILITIES 65,823 102,744 STOCKHOLDERS' EQUITY: Common stock: $.01 par value; 80,000,000 shares authorized; 51,584,935 and 51,658,492 issued and outstanding 516 517 Preferred stock: $.01 par value; Cumulative Convertible Preferred Stock (Series A), 250,000 shares authorized, issued and outstanding; Cumulative Contingently Convertible Preferred Stock (Series B), 100,000 shares authorized, issued and outstanding 7,300 7,300 Additional paid-in capital 77,748 79,668 Accumulated deficit (since July 1, 1988) (1,759) (22,385) Total Stockholders' Equity 83,805 65,100 $ 149,628 $ 167,844 The accompanying notes are an integral part of these consolidated balance sheets.
3 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands, except for Three Months Ended Nine Months Ended per share amounts) September 30, September 30, 1996 1995 1996 1995 REVENUES $ 44,791 $ 74,164 $ 163,739 $ 223,390 COST OF REVENUES 28,333 43,660 101,793 132,515 Gross Profit 16,458 30,504 61,946 90,875 OPERATING EXPENSES: Product development and engineering 3,129 3,553 10,504 10,980 Selling, general and administrative 10,134 24,040 58,983 74,298 Provision for restructuring (Note H) 0 0 0 44,042 13,263 27,593 69,487 129,320 OPERATING INCOME/(LOSS) 3,195 2,911 (7,541) (38,445) INTEREST EXPENSE (550) (1,044) (2,113) (3,002) GAIN ON SALE OF BUSINESSES (NOTE F) 0 0 42,618 0 ACQUISITION COSTS 0 (16) 0 (1,022) OTHER INCOME, NET 890 354 1,420 646 INCOME (LOSS) BEFORE INCOME TAXES 3,535 2,205 34,384 (41,823) PROVISION (BENEFIT) FOR INCOME TAXES: Cash 100 100 4,200 300 Noncash (Note C) 1,311 782 9,560 (3,627) 1,411 882 13,760 (3,327) NET INCOME (LOSS) $ 2,124 $ 1,323 $ 20,624 $ (38,496) EARNINGS (LOSS) PER SHARE $ 0.04 $ 0.03 $ 0.39 $ (0.83) WEIGHTED AVG. COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING 52,176 49,014 52,558 46,478 The accompanying notes are an integral part of these consolidated statements.
4 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Nine Months Ended (In thousands) September 30, 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 20,624 $ (38,496) Adjustments to reconcile net income (loss) to net cash used by operating activities: Depreciation and amortization 3,484 4,701 Gain on sale of businesses (Note F) (42,618) --- Provision for restructuring (Note H) --- 44,042 Provision/(benefit) for income taxes not currently payable 9,560 (3,627) Noncash expenses, including noncash interest expense, noncash provision for losses on accounts receivable and income from equity investment (549) 124 Change in working capital items: Accounts receivable (3,868) 445 Inventories 311 (1,347) Accounts payable and accruals (4,617) (11,050) Other working capital items 3,104 1,947 NET CASH USED BY OPERATING ACTIVITIES (14,569) (3,261) CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (2,137) (2,950) Proceeds from sale of businesses (Note F) 61,948 1,200 Investment in IGT and CWH (Note G) (800) --- Other, net 367 518 NET CASH PROVIDED/(USED) BY INVESTING ACTIVITIES 59,378 (1,232) CASH FLOWS FROM FINANCING ACTIVITIES: (Repayments)/borrowings under revolving credit facility (15,445) 3,033 Repayments of other long-term debt (675) (380) Repurchase of stock (2,894) (192) Proceeds from issuance of stock 801 1,250 Other borrowings 608 750 NET CASH (USED)/PROVIDED BY FINANCING ACTIVITIES (17,605) 4,461 INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS 27,204 (32) CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 8,092 7,849 CASH AND CASH EQUIVALENTS - END OF PERIOD $ 35,296 $ 7,817 The accompanying notes are an integral part of these consolidated statements.
5 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE A - NATURE OF THE BUSINESS EXECUTONE Information Systems, Inc. (the "Company") develops, markets and supports voice and data systems and healthcare communications systems. Products and services include telephone systems, voice mail systems, in-bound and out-bound call center systems, specialized healthcare communications systems and application consulting services. The Company, through its Unistar Entertainment subsidiary, also has the exclusive right to design, develop and manage the National Indian Lottery. Products and services are sold under the EXECUTONE, INFOSTAR, IDS, LIFESAVER, INFOSTAR/ILS and UNISTAR brand names through a worldwide network of direct sales and service employees and independent distributors. NOTE B - BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In the opinion of management, all adjustments, which include normal recurring adjustments, considered necessary for a fair presentation of the results for the interim periods presented have been included. Certain prior year amounts have been reclassified to conform to the current year's presentation. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. As of July 1, 1988, an accumulated deficit of approximately $49.7 million was eliminated. NOTE C - INCOME TAXES The Company accounts for income taxes in accordance with FAS No. 109, "Accounting for Income Taxes." The deferred tax asset represents the benefits that are more likely than not to be realized from the utilization of pre- and post-acquisition tax benefit carryforwards, which include net operating losses, tax credits and the excess of tax bases over the fair value of the net assets of the Company. For the nine-month periods ended September 30, 1996 and 1995, the Company made cash payments for income taxes of approximately $869,000 and $138,000, respectively. 6 NOTE D - EARNINGS PER SHARE Earnings per share is based on the weighted average number of shares of common stock and dilutive common stock equivalents (which include stock options and warrants) outstanding during the periods. Common stock equivalents and the convertible debentures which are antidilutive have been excluded from the computations. NOTE E - INVENTORIES Inventories are stated at lower of first-in, first-out ("FIFO") cost or market and consist of the following at September 30, 1996 and December 31, 1995:
(amounts in thousands) 9/30/96 12/31/95 Raw Materials $ 3,915 $ 4,783 Finished Goods 13,368 27,982 $ 17,283 $ 32,765
NOTE F - SALE OF BUSINESSES On May 31, 1996, the Company sold its direct sales and service organization, including its network services division and National Service Center, to Clarity Telecom Holdings, Inc. d/b/a Executone Business Solutions (Clarity), a new acquisition company formed for the acquisition by Bain Capital, Inc. The Company received $61.5 million in cash, a $5.9 million junior subordinated note due July 1, 2004, with interest at 7.5% per year, and warrants to purchase 8% of the equity issued as of the closing in the new company for $1.1 million, exercisable for three years. After recording the notes and the warrants at their fair market value, the total value of the consideration received was $69.6 million. The Company and Clarity also entered into a five-year exclusive distributor agreement pursuant to which Clarity will sell and service EXECUTONE and INFOSTAR telephone products to business and commercial locations that require up to 400 telephones. The Company retained the healthcare communications division, the call center management division, the National Accounts and Federal Systems marketing groups as well as the recently acquired Unistar business. The sale did not include the Pittsburgh direct sales and service office, which the Company sold to one of its existing independent distributors for approximately $1.3 million in cash and notes in May 1996, resulting in no gain or loss. The Company recorded a pretax gain of $47.5 million on the sale to Clarity net of transaction, severance and other costs related to the sale. The proceeds were used to repay the Company's bank borrowings, and the excess was invested in short-term cash investments. The final proceeds from this sale are subject to adjustment based upon the closing balance sheets of the businesses sold to Clarity. In October 1996, the Company and Clarity reached an agreement on the amount of the adjustment, subject to the drafting and execution of the written documents. The Company does not expect the adjustment to have a material adverse effect on its results of operations, cash flow or financial position. 7 In June 1996, the Company sold its videoconferencing division to BT Visual Images LLC for a $0.2 million note, royalties on videoconferencing revenue through June 1998 and contingent consideration related to the sale of inventory. The Company recorded a pretax reserve for loss of $3.9 million on the transaction. In April 1996, the Company also sold its inmate calling business for $0.5 million in cash and notes and recorded a pretax loss of $1.0 million. Neither the Pittsburgh direct sales office, the videoconferencing division, nor the inmate calling business constituted a material portion of the Company's assets, revenues or net income prior to sale. NOTE G - UNISTAR ACQUISITION On December 19, 1995, the Company acquired 100% of the common stock of Unistar Gaming Corporation ("Unistar") for 3.7 million shares of the Company's common stock and 350,000 shares of newly issued preferred stock. Unistar has an exclusive five-year contract to design, develop, finance and manage the National Indian Lottery (NIL). In return for providing the services, Unistar will be paid a fee equal to 30% of the profits of the NIL. The excess of the purchase price over the value of the net liabilities assumed has been allocated to the management agreement with the Coeur d'Alene Tribe of Idaho (CDA) and will be amortized over the five-year term of the contract commencing with the first significant lottery revenues. The preferred stock consists of 250,000 shares of Cumulative Convertible Preferred Stock, Series A ("Series A Preferred Stock") and 100,000 shares of Cumulative Contingently Convertible Preferred Stock, Series B ("Series B Preferred Stock"). The Series A Preferred Stock has voting rights equal to one share of common stock and will earn dividends equal to 18.5% of the consolidated retained earnings of Unistar as of the end of a fiscal period, less any dividends paid to the holders of the Series A Preferred Stock prior to such date. The Series B Preferred Stock has voting rights equal to one share of common stock and will earn dividends equal to 31.5% of the consolidated retained earnings of Unistar as of the end of a fiscal period, less any dividends paid to the holders of the Series B Preferred Stock prior to such date. All dividends on Preferred Stock are payable (i) when and as declared by the Board of Directors, (ii) upon conversion or redemption of the Series A and Series B Preferred Stock or (iii) upon liquidation. As of September 30, 1996, no dividends have accrued to the preferred stockholders. The Series A and Series B Preferred Stock is redeemable for a total of 13.3 million shares of common stock (Series A Preferred Stock for 4.925 million shares and Series B Preferred Stock for 8.375 million shares) at the Company's option. In the event that Unistar meets certain revenue and profit parameters, the Series A Preferred Stock is convertible for up to 4.925 million shares of common stock and the Series B Preferred Stock is contingently convertible for up to 8.375 million shares of common stock (a total of an additional 13.3 million shares of common stock). In an attempt to block the NIL, certain states filed letters under 18 U.S.C. Section 1084 to prevent the long-distance carriers from providing telephone service to the NIL. The CDA initiated legal action to compel the long-distance carriers to provide telephone service to the NIL. The CDA's position is that the lottery is authorized by the Indian Gaming Regulatory Act ("IGRA") passed by Congress in 1988, that IGRA preempts state and federal statutes, and that the states lack authority to issue the Section 1084 notification letters to any carrier. On February 28, 1996, the NIL was ruled lawful by the CDA Tribal Court. The CDA Tribal Court found that all requirements of IGRA have been satisfied and that the 8 Section 1084 letters issued by certain state attorneys general in an effort to interfere with the lawful operation of the NIL are invalid. In addition, the Court found that the long-distance carriers cannot refuse to provide the service requested in the action based upon 18 U.S.C. Section 1084. This ruling is currently being appealed to the CDA Tribal Supreme Court with a hearing date currently anticipated for the first quarter of 1997. Although the Company also anticipates an appeal in the U.S. Federal District Court, the Company believes, based on consultation with and opinions rendered by outside legal counsel, that the CDA's position will be upheld on appeal. The Company has accrued $1 million to cover estimated legal costs through the possible appeal to the U.S. Federal District Court. If the matter is appealed beyond the U.S. Federal District Court or if additional court challenges are brought by states opposed to the NIL, the Company estimates that additional legal costs could be in the range of $1-2 million. Funding for Unistar capital expenditures, including the computers and software to build the telecommunications system will be capitalized and depreciated over the life of the management agreement. Funding by Unistar on behalf of the NIL to complete the building on the CDA reservation, which will be the operations center for the lottery, will be deferred and amortized over the life of the management agreement. The guaranteed monthly advance to the CDA of $25,000, which began in January 1996, and other reimbursable expenses, will be reflected as a non-current receivable and will be reimbursed when the NIL is operational and making profit distributions to Unistar. Unistar's expenditures will be expensed as incurred. The Company expects it will be able to obtain additional financing for these costs, if necessary. On September 9, 1996, the Company announced a series of agreements with Internet Gaming Technologies, Inc. (IGT) and CasinoWorld Holdings, Ltd. (CWH). IGT and CWH have agreed to deliver to Unistar a turnkey system for use in the NIL, including hardware and a fully-paid software license from CWH for its system architecture and proprietary technology. The technology is currently in use in an Internet and telephony-based wagering system in Monaco and will be incorporated in a turnkey system for Unistar. The Company has agreed to pay a maximum of $5 million, of which $800,000 was paid through September 30, 1996, for the turnkey wagering system and the software license. As part of the consideration paid, the Company has obtained an equity interest of 2.2% of IGT (up to a maximum of 9.6%) and warrants to obtain up to 4% of CWH. Future payments are based on certain milestones being achieved by CWH in delivering a turnkey lottery system to include the computer hardware, on-site central office type telephone switch, interactive voice response and other equipment necessary for Unistar to establish and run the National Indian Lottery, as well as a mirror backup site for IGT. The software includes the gaming system, the business system and the banking interface. The investment in IGT shares will be accounted for under the cost method. The payments to IGT and CWH for the turnkey lottery system will be capitalized and amortized over the life of the management agreement. The Company believes there is a national market for the NIL based upon research into the experience of other multi-state lotteries and the growth of the overall lottery market. However, there is no assurance that there will be acceptance of a telephone lottery or the NIL generally. NOTE H - PROVISION FOR RESTRUCTURING In July 1995, the Company reorganized its then-existing businesses into five divisions: Computer Telephony, Healthcare Communications Systems, Call Center Management, Videoconferencing Products, and Network Services and changed its business strategy in the Computer Telephony division to 9 focus on software applications in the communications market. The Videoconferencing and Network Services Divisions have since been sold (see Note F). The business that was acquired in 1988 was a telephone equipment hardware company focused on customers with small systems, with an emphasis on selling additional hardware and service to generate add-on revenue and was de-emphasized. The Company adopted FAS No. 121, "Accounting for the Impairment of Long-Lived Assets," which was issued in March 1995, requiring impairment to be measured by projecting the lowest level of identifiable future cash flows. The Company concluded there was an impairment. As a result, the Company recorded a $44.0 million provision for restructuring consisting of a $33.5 million goodwill impairment, an $8.8 million writedown of inventory, primarily service stock relating to the impaired assets and other non- recurring inventory adjustments, $0.9 million related to the shutdown of the Company's Scottsdale, Arizona facility and $0.8 million of other unusual items. NOTE I - OTHER MATTERS For the nine-month periods ended September 30, 1996 and 1995, respectively, the Company made cash payments of approximately $2.5 million and $3.0 million for interest expense on indebtedness. In February 1996, the Company received the proceeds of the $1.8 million note from the sale of the Wisconsin direct sales office in December 1995. In September 1995, the Company received the proceeds of the $1.2 million note from the sale of its Vodavi Communications Systems Division. During the nine-month period ended September 30, 1996, noncash investing and financing activities, other than those related to the sale of certain of the Company's businesses (see Note F), included a capital lease obligation incurred in connection with an equipment acquisition of $0.3 million. The only non-cash financing activities for the nine-month period ended September 30, 1995, related to a capital lease obligation incurred in connection with equipment acquisitions of $0.3 million. Refer to the Consolidated Statements of Cash Flows for information on all cash-related operating, investing and financing activities. 10 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction The Company develops, markets and supports voice and data systems and healthcare communications systems. Products and services include telephone systems, voice mail systems, in-bound and out- bound call center systems, specialized healthcare communications systems and application consulting services. The Company, through its Unistar Entertainment subsidiary, also has the exclusive right to design, develop and manage the National Indian Lottery. Products are sold under the EXECUTONE, INFOSTAR, IDS, LIFESAVER, INFOSTAR/ILS and UNISTAR brand names through a worldwide network of direct sales and service employees and independent distributors. Revenues are derived from product sales to distributors, direct sales of healthcare and call center products, and direct sales to national accounts and federal government customers, as well as installations, additions, changes, upgrades or relocation of previously installed systems, maintenance contracts, and service charges to the existing base of healthcare, call center, national account and federal government customers. Results of Operations On May 31, 1996, the Company sold substantially all of its direct sales and services group, including its long-distance reseller business and National Service Center, for consideration valued at $69.6 million to Clarity Telecom Holdings, Inc. d/b/a Executone Business Solutions (Clarity). The Company believes that the transfer of this business to new ownership, with its increased resources and dedicated focus on sales and service, will grow and increase the market share of the sales and service business, resulting in increased equipment sales to the former direct sales offices. The Company retains the Healthcare, Call Center Management ("CCM"), National Accounts and Federal Systems groups, as well as telephony equipment sales to the independent distributors, of which Clarity is the largest distributor. For the first six months of 1996, the primary mission of the Company was to complete the sale of the direct sales and service organization while transitioning to a more focused Company. The Company devoted much of its management resources during that period toward efforts to finalize the agreement to sell the direct sales and service organization, adversely affecting the Company's financial results on a year-to-date basis. The three- month period ended September 30, 1996 was the Company's first standalone quarter since the sale. The Company was able to achieve its forecasted revenue, maintain solid order levels, convert inventory into receivables and resolve numerous transitional issues. As a result of the sale, financial results for the three-month and nine-month periods ended September 30, 1996 are not comparable to same prior year period, other than on certain measures of overall profitability. Revenues for the three-month period ended September 30, 1996 totaled $44.8 million. Gross profit margin for the three-month period ended September 30, 1996 was 36.7%. This was slightly higher than the Company's forecasted expectations due to improved pricing margins from favorable product mix in the Computer Telephony division. Product development expenses were $3.1 million or 7% of revenues which was in line with the Company's spending projections. Selling and G&A expenses for the three-month period ended September 30, 1996 were $10.1 million or 22.6% of revenues. These expenses were higher than originally planned, as the Company incurred certain one-time charges. 11 Operating income for the three-month period ended September 30, 1996 was $3.2 million or 7.1% of revenue versus an operating profit of $2.9 million or 3.9% of revenue for the prior year period. For the nine-month period ended September 30, 1996, the Company reported an operating loss of $7.5 million. For the comparable nine-month period in 1995, the Company reported an operating profit (before the provision for restructuring) of $5.6 million. The change is attributable to two factors. First, as previously noted, the process of negotiating and closing the sale during the first half of the year had an adverse impact on operating results. Second, the closing of the sale on May 31, 1996 excluded the revenue and profit related to the direct offices for the month of June 1996, traditionally the strongest direct revenue month, from the Company's operating results. During the month of June 1995, the Company generated operating profits of almost $9 million. Net income for the three-month period ended September 30, 1996 was $2.1 million or $0.04 per share on 52.2 million shares outstanding compared to net income of $1.3 million or $0.03 per share on 49.0 million shares outstanding for the same period in 1995. Included in results for the nine-month period ended September 30, 1996 is a net gain on the sale of businesses of $42.6 million. This includes a net pretax gain of $47.5 million on the sale of the direct sales, service and long distance businesses partially offset by losses from the sale of the videoconferencing division and the inmate calling business of $4.9 million. The comparable period in 1995 included a $44.0 million provision for restructuring consisting primarily of a goodwill impairment based on the adoption of FAS No. 121. Sale of Businesses On May 31, 1996, the Company sold its direct sales and service organization, including its network services division, to Clarity Telecom Holdings, Inc. (Clarity), a new acquisition company led by Bain Capital, Inc., for consideration valued at $69.6 million. The Company recorded a pretax gain of $47.5 million net of transaction, severance and other related costs during the period ended June 30, 1996. The proceeds were used to repay the Company's bank borrowings and the excess was invested in short- term cash investments. The final proceeds from this sale are subject to adjustment based upon the closing balance sheets of the businesses sold to Clarity. In October 1996, the Company and Clarity reached agreement on the amount of the adjustment, subject to the drafting and execution of the written documents. The Company does not expect the adjustment to have a material adverse effect on its results of operations, cash flow or financial position. The Company retains its healthcare communications and CCM businesses, its National Accounts and Federal Marketing groups and the Unistar business. Within these businesses are the Company's high-end applications and the most productive sales representatives, those which carry $1 million per year sales quotas. Management believes this sale will be good for both companies. Clarity will be able to focus on sales and service and the expansion of market share. The Company will benefit from that expansion through increased product sales. Telephony product sales through existing independent distributors and through Clarity will continue to represent a substantial portion of the Company's revenues. The sale will also allow the Company to dedicate more of its resources to telephony product development, particularly relating to the IDS platform, the development and marketing of the Healthcare and CCM product lines and the Unistar business. 12 In June 1996, the Company sold its videoconferencing division to BT Visual Images LLC for a $0.2 million note, royalties on videoconferencing revenue through June 1998 and contingent consideration related to the sale of inventory transferred to the buyer as part of the sale. The Company recorded a reserve for loss of $3.9 million on the transaction during the three-month period ended June 30, 1996. The Company is currently negotiating issues regarding the close of the business with GPT Video Systems, with whom the Company terminated its distribution agreement for failure to deliver properly functioning videoconferencing products on a timely basis. Unistar Acquisition On December 19, 1995, the Company acquired 100% of the common stock of Unistar Gaming Corporation ("Unistar"), a privately-held company that has an exclusive five-year contract to design, develop, finance, and manage the National Indian Lottery ("NIL"). (See Note G of the Notes to Consolidated Financial Statements for the terms of the agreement.) Management believes the Unistar business is a natural extension of its telephony and call center businesses. Calls via an 800 number will be processed with Interactive Voice Response ("IVR") equipment or live agents located on the Coeur d'Alene Indian Tribe of Idaho ("CDA") Reservation using ACD software to process nationwide wagering activity. The Company has made a significant equity investment in Unistar, initially creating 8% dilution to the Company's shareholders. In the opinion of the Company's management, this investment is justified based upon the potential returns. In an attempt to block the NIL, certain states filed letters under 18 U.S.C. Section 1084 to prevent the long-distance carriers from providing telephone service to the NIL based upon allegations that the NIL is not legal. The CDA initiated legal action to compel the long-distance carriers to provide telephone service to the NIL. The CDA's position is that the lottery is authorized by the Indian Gaming Regulatory Act ("IGRA") passed by Congress in 1988, that IGRA preempts state and federal statutes, and that the states lack authority to issue the Section 1084 notification letters to any carrier. On February 28, 1996, the NIL was ruled lawful by the CDA Tribal Court. The CDA Tribal Court found that all requirements of IGRA have been satisfied and that the Section 1084 letters issued by certain state attorneys general in an effort to interfere with the lawful operation of the NIL are invalid. In addition, the Court found that the long- distance carriers cannot refuse to provide the service requested in the action based upon 18 U.S.C. Section 1084. The Company has accrued $1 million to cover estimated legal costs through the possible appeal to the U.S. Federal District Court. If the matter is appealed beyond the U.S. Federal District Court or if additional court challenges are brought by states opposed to the NIL, the Company estimates that additional legal costs could be in the range of $1-2 million. The Company estimates that the additional funds to become operational may amount to between $7- 12 million. As announced on September 9, 1996, Unistar has signed agreements with Internet Gaming Technologies and CasinoWorld Holdings, Ltd. for software licenses and development, system architecture and proprietary technology (see Note G of the Notes to Consolidated Financial Statements for the terms of the agreement). The development of these systems is a critical step in the process of developing the telephone lottery, enabling the telephone lottery to begin as soon as the legal issues are resolved. The National Indian Lottery is scheduled to be live on the Internet, including a new Home Page that will field trial the lottery-type games and allow people to register and play without wagering, by December 31, 1996. 13 Provision for Restructuring In July 1995, the Company reorganized its then-existing businesses into five divisions: Computer Telephony, Healthcare Communications Systems, Call Center Management, Videoconferencing Products, and Network Services and changed its business strategy in the Computer Telephony division to focus on software applications in the communications market. The Videoconferencing and Network Services Divisions have since been sold (see Note F). The business that was acquired in 1988 was a telephone equipment hardware company focused on customers with small systems, with an emphasis on selling additional hardware and service to generate add-on revenue and the business was de-emphasized. The Company adopted FAS No. 121, "Accounting for the Impairment of Long-Lived Assets," which was issued in March 1995, requiring impairment to be measured by projecting the lowest level of identifiable future cash flows. The Company concluded there was an impairment. As a result, the Company recorded a $44.0 million provision for restructuring consisting of a $33.5 million goodwill impairment, an $8.8 million writedown of inventory, primarily service stock relating to the impaired assets and other non- recurring inventory adjustments, $0.9 million related to the shutdown of the Company's Scottsdale, Arizona facility and $0.8 million of other unusual items. In accordance with the provisions of FAS No. 121, the Company prepared projections of future operating cash flows relating to the telephony business acquired in 1988 based upon the Company's new strategic direction. These projections indicated that this business would not generate sufficient operating cash flows to realize goodwill and the related service stock. The amount of impairment of the telephony goodwill was $33.5 million as of June 30, 1995. The write-off of inventory, primarily service stock, consisted of $1.3 million of raw materials inventory and $7.5 million of finished goods inventory. These amounts were determined based upon a review of specific inventory parts along with current and projected usage, incorporating the strategic direction of the Company. Liquidity and Capital Resources The Company's liquidity is represented by cash, cash equivalents and cash availability under its existing credit facilities. The Company's liquidity was approximately $61 million and $23 million as of September 30, 1996 and December 31, 1995, respectively. At September 30, 1996 and December 31, 1995, cash and cash equivalents amounted to $35.3 million and $8.1 million, respectively, an increase of $27.2 million generated primarily by $61.9 million in cash proceeds for the sale of the Company's direct sales and service organization. During the nine-month period ended September 30, 1996, cash was used to repay $16.1 million of debt, including all of the Company's bank borrowings, repurchase $2.9 million of the Company's common stock and to fund the $14.6 million in cash used by operating activities. The remainder of the proceeds were invested in short-term cash securities. Cash used by operating activities was $14.6 million for the nine months ended September 30, 1996 compared to the use of cash by operations of $3.2 million for the same period in 1995. The increase in cash used by operating activities is primarily due to the operating losses generated during the transition period in the first six months of 1996. In addition, during the three-month period ended September 30, 1996, the Company experienced a one-time growth in trade receivables of $5.0 million due to the 60-day terms extended to Clarity per the sale contract. 14 Total debt at September 30, 1996 was $15.0 million, a decrease of $15.8 million from $30.8 million at December 31, 1995. Outstanding debt at September 30, 1996 consists of $12.3 million in subordinated debt, due in 2011, with the balance primarily capitalized lease obligations. The Company believes that its existing cash balances and cash flow from operations will be sufficient to meet working capital and other requirements for the next twelve months. Forward-Looking Statements The Company's financial operations before and after the sale of the direct sales and service organization are very different. There are significant changes in certain components which have been highlighted in the Company's previously-filed quarterly report on Form 10-Q for the period ended June 30, 1996. 15 PART II - OTHER INFORMATION Item 1. LEGAL PROCEEDINGS Not applicable. Item 2. CHANGES IN SECURITIES Not applicable. Item 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The 1996 Annual Meeting of Shareholders was held on July 30, 1996 and the votes at that meeting were reported in the Company's quarterly report on Form 10-Q for the period ended June 30, 1996. Item 5. OTHER INFORMATION Not applicable. Item 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits 11 - Statement Regarding Computation of Per Share Earnings. b) Reports on Form 8-K On September 24, 1996, the Company filed an amended Current Report on Form 8-K/A reporting the closing of the sale of the direct sales and service organization, including the network services division, and pro forma financial information. 16 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. EXECUTONE Information Systems, Inc. Dated: November 14, 1996 /s/ Alan Kessman Alan Kessman Chairman, President and Chief Executive Officer Dated: November 14, 1996 /s/ Anthony R. Guarascio Anthony R. Guarascio Vice President Finance and Chief Financial Officer 17 EX-11 2 EXHIBIT 11 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
Three Months Ended Nine Months Ended September 30, September 30, 1996 1995 1996 1995 NET INCOME (LOSS) $ 2,124,000 $ 1,323,000 $ 20,624,000 $(38,496,000) WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 51,605,000 46,898,000 51,779,000 46,478,000 COMMON STOCK EQUIVALENT SHARES ASSUMED TO BE ISSUED FOR DILUTIVE STOCK OPTIONS AND WARRANTS 571,000 2,116,000 779,000 --- TOTAL WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING 52,176,000 49,014,000 52,558,000 46,478,000 EARNINGS (LOSS) PER COMMON SHARE $ 0.04 $ 0.03 $ 0.39 $ (0.83) 18
EX-27 3
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS INCLUDED IN THE REGISTRANT'S FILING ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996 AND IS QUALIFIED IN IT'S ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 9-MOS DEC-31-1996 SEP-30-1996 35,296 0 36,677 1,537 17,283 89,961 23,334 15,806 149,628 51,633 14,034 516 0 7,300 75,989 149,628 163,739 163,739 101,793 101,793 10,504 887 2,113 34,384 13,760 20,624 0 0 0 20,624 0.39 0.39
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