-----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, JvUIF1TRdaj6IPBUUhEI92+hDwpuRSRNcMxOUw076TmZb3Aa4tAydxkvxhE3md69 8o6VBUwehIJhmBIb8YVaXg== 0000725282-97-000027.txt : 19970813 0000725282-97-000027.hdr.sgml : 19970813 ACCESSION NUMBER: 0000725282-97-000027 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19970630 FILED AS OF DATE: 19970812 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: 97656273 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. 10-Q, June 30, 1997 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 June 30, 1997 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 July 31, 1997 was 49,639,043. INDEX EXECUTONE Information Systems, Inc. Page # PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets - June 30, 1997 and December 31, 1996. 3 Consolidated Statements of Operations - Three Months and Six Months Ended June 30, 1997 and 1996. 4 Consolidated Statements of Cash Flows - Six Months Ended June 30, 1997 and 1996. 5 Notes to Consolidated Financial Statements. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 PART II. OTHER INFORMATION 16 SIGNATURES 18 EXHIBIT 11. STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS 19 2 PART I - FINANCIAL INFORMATION Item 1. Financial Statements
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS June 30, December 31, (In thousands, except for share amounts) 1997 1996 (Unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 11,918 $ 27,696 Restricted cash 5,134 --- Accounts receivable, net of allowance of $1,800 and $2,106 30,385 38,992 Inventories 27,568 16,814 Prepaid expenses and other current assets 2,920 3,099 Total Current Assets 77,925 86,601 RESTRICTED CASH --- 5,031 PROPERTY AND EQUIPMENT, net 8,417 7,578 INTANGIBLE ASSETS, net 19,829 19,893 DEFERRED TAXES 19,669 18,434 OTHER ASSETS 18,509 14,472 $ 144,349 $ 152,009 LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of long-term debt $ 1,089 $ 882 Accounts payable 32,879 31,416 Accrued payroll and related costs 2,711 3,398 Accrued liabilities 10,290 13,943 Deferred revenue and customer deposits 3,794 3,164 Total Current Liabilities 50,763 52,803 LONG-TERM DEBT 14,502 13,837 LONG-TERM DEFERRED REVENUE 307 22 TOTAL LIABILITIES 65,572 66,662 STOCKHOLDERS' EQUITY: Common stock: $.01 par value; 80,000,000 shares authorized; 49,603,460 and 51,173,755 issued and outstanding 496 512 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 71,417 76,113 Retained earnings (deficit) (since July 1, 1988) (436) 1,422 Total Stockholders' Equity 78,777 85,347 $ 144,349 $ 152,009
The accompanying notes are an integral part of these consolidated balance sheets. 3 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended Six Months Ended (In thousands, except for June 30, June 30, per share amounts) 1997 1996 1997 1996 REVENUES $ 34,777 $ 51,982 $ 73,796 $ 118,948 COST OF REVENUES 24,878 33,013 49,777 73,459 Gross Profit 9,899 18,969 24,019 45,489 OPERATING EXPENSES: Product development and eng. 3,437 3,611 6,737 7,375 Selling, general and admin. 10,197 22,593 20,244 48,849 13,634 26,204 26,981 56,224 OPERATING LOSS (3,735) (7,235) (2,962) (10,735) INTEREST EXPENSE (503) (755) (937) (1,563) GAIN ON SALE OF BUSINESSES (NOTE G) --- 47,495 --- 42,618 OTHER INCOME, net 296 315 811 531 INCOME (LOSS) BEFORE INCOME TAXES (3,942) 39,820 (3,088) 30,851 PROVISION (BENEFIT) FOR INCOME TAXES: Cash 0 4,000 0 4,100 Noncash (Note C) (1,571) 11,960 (1,229) 8,249 (1,571) 15,960 (1,229) 12,349 NET INCOME (LOSS) $ (2,371) $ 23,860 $ (1,859) $ 18,502 EARNINGS (LOSS) PER SHARE $ (0.05) $ 0.45 $ (0.04) $ 0.35 WEIGHTED AVG. COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING 49,457 52,803 49,669 52,773
The accompanying notes are an integral part of these consolidated statements. 4 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Six Months Ended (In thousands) June 30, 1997 1996 CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (1,859) $ 18,502 Adjustments to reconcile net income (loss) to net cash used by operating activities: Depreciation and amortization 1,512 2,807 Gain on sale of businesses (Note G) --- (42,618) Provision/(benefit) for income taxes not currently payable (1,229) 8,249 Noncash expenses, including noncash interest expense, noncash provision for losses on accounts receivable and income from equity investment 112 (204) Change in working capital items: Accounts receivable 8,722 4,905 Inventories (10,783) (4,614) Accounts payable and accruals (2,758) 2,096 Other working capital items 706 3,314 NET CASH USED BY OPERATING ACTIVITIES (5,577) (7,563) CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (1,586) (2,164) Proceeds from sale of businesses (Note G) --- 56,948 Investment in UniStar (2,373) --- Other, net (948) 190 NET CASH PROVIDED/(USED) BY INVESTING ACTIVITIES (4,907) 54,974 CASH FLOWS FROM FINANCING ACTIVITIES: Repayments under revolving credit facility --- (15,445) Repayments of other long-term debt (585) (464) Repurchase of stock (5,412) (1,983) Proceeds from issuance of stock 703 546 Other borrowings --- 395 NET CASH USED BY FINANCING ACTIVITIES (5,294) (16,951) INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS (15,778) 30,460 CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 27,696 8,092 CASH AND CASH EQUIVALENTS - END OF PERIOD $ 11,918 $ 38,552
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 communications systems. Products and services include telephone systems, voice mail systems, inbound and outbound call center systems and specialized healthcare communications systems. The Company, through its UniStar Entertainment subsidiary, also has an exclusive five-year contract with the Coeur d'Alene Tribe of Idaho (CDA) to design, develop, finance and manage the National Indian Lottery (NIL) and its on-line US Lottery games. 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. 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 those 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 six-month periods ended June 30, 1997 and 1996, the Company made cash payments for income taxes of approximately $389,000 and $779,000, 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, the convertible preferred stock and the convertible debentures which are antidilutive have been excluded from the computations. In February 1997, the Financial Accounting Standards Board issued a new standard on earnings per share. The Company will adopt the new standard as of December 31, 1997. If earnings per share for the three-month and six-month periods ended June 30, 1997 had been calculated in accordance with the new standard, it would have been unchanged. NOTE E - INVENTORIES Inventories are stated at lower of first-in, first-out (FIFO) cost or market and consist of the following at June 30, 1997 and December 31, 1996:
(amounts in thousands) 6/30/97 12/31/96 Raw Materials $ 4,709 $ 3,493 Finished Goods 22,859 13,321 $27,568 $16,814
NOTE F - UNISTAR On December 19, 1995, the Company acquired 100% of the common stock of Unistar Gaming Corporation (Unistar Gaming) for 3.7 million shares of the Company's common stock and 350,000 shares of newly issued preferred stock. Unistar Gaming has an exclusive five-year contract to design, develop, finance and manage the National Indian Lottery through its wholly-owned subsidiary, UniStar Entertainment, Inc. (UniStar). The NIL will be a national telephone lottery authorized by Federal law and a compact between the State of Idaho and the CDA. In return for providing these management 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 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) 7 upon conversion or redemption of the Series A and Series B Preferred Stock or (iii) upon liquidation. As of June 30, 1997, 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 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 and a related order dated May 1, 1996 were subsequently appealed to the Tribal Appellate Court, which on July 2, 1997 affirmed the lower Tribal Court's May 1, 1996 ruling and analysis upholding the CDA's right to conduct the telephony lottery. The Company expects this ruling will be reviewed by the U.S. Federal Courts as well, and believes, based on consultation with and opinions rendered by outside legal counsel, that the favorable rulings will be upheld on appeal. In 1995, the Company accrued $1 million to cover estimated legal costs through the possible appeal to the U.S. Federal Courts. If the matter is appealed beyond the U.S. Federal Courts 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 million to $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 will be deferred and amortized over the life of the management agreement. The guaranteed monthly advance to the CDA, which began in January 1996, will be reimbursed when the NIL is operational and making profit distributions to UniStar. In addition, the Company has capitalized other fundings, consisting primarily of professional fees and other expenses, which the Company believes are reimbursable in accordance with the terms of the management agreement. Total funding as described above totaled $5.0 million through June 30, 1997 and is reflected in non-current other assets. Other than legal costs related to an appeal of the CDA Tribal Court ruling or other actions by the states, the Company estimates that the additional costs to become operational may amount to between $5 million and $10 million. The costs include capital expenditures for computers and software to build the telecommunications system, funds to complete the building on the CDA reservation which will be the operations center for the lottery, and various start-up expenses including personnel- related costs and advertising expenses. The Company is also required to make a guaranteed payment of $300,000 per year to the CDA. The cost estimate does not include a $4 million jackpot reserve which could be required 8 dependent upon certain conditions. If the Company ultimately must fund a jackpot reserve, it will be repaid to UniStar solely from NIL net revenues in equal installments over the term of the agreement. The Company expects it will be able to obtain additional financing for these costs, if necessary. In February 1997, the Company signed agreements with Virtual Gaming Technologies (formerly Internet Gaming Technologies (IGT)) and CasinoWorld Holdings, Ltd. (CWH). The agreements call for the Company to invest $700,000 in IGT common stock, which was done in September 1996 under a previous agreement. In addition, the Company was granted a 200,000-share, five-year option set at 15% more than the price per share on the initial investment, or $3.45 per share. CWH is to provide project management services overseeing the development of the software for the NIL, with the Company contracting independently for system software development. Such charges are not to exceed $2 million. The Company will acquire all hardware for the system without financial obligation by either IGT or CWH. The Company estimates that such hardware charges, which are included in the cost estimates previously noted of $5 million to $10 million, will be approximately $2 million to $3 million. Approximately $500,000 in hardware costs were incurred as of June 30, 1997. The investment in IGT is being accounted for under the cost method. All hardware costs incurred will be capitalized and depreciated over the useful life of the assets, beginning when the assets are placed in service. As of June 30, 1997, $1.3 million in progress payments have been made toward the software system. Such payments are being deferred until completion of the system and will be capitalized and depreciated over the term of the management agreement. On May 28, 1997, the State of Missouri brought an action in the Missouri Circuit Court in Kansas City against the Company's UniStar Entertainment subsidiary and the CDA to enjoin the US Lottery offered by the CDA on the Internet and managed by UniStar. The complaint alleges that the US Lottery violates Missouri anti-gaming laws and that the marketing and promotion of the US Lottery violate the Missouri Merchandising Practices Act. Based upon the ruling of the Tribal Appellate Court affirming the CDA's right to conduct the telephone lottery and the opinion of outside legal counsel, the Company believes that the US Lottery is legal. There are market and legal risks associated with the development of the NIL. The Company believes there is a national market for the NIL based upon research into the experience of other national lotteries and the growth of the overall lottery market. However, there is no assurance that there will be acceptance of a telephone or internet lottery. Based upon opinions from outside legal counsel, the Company also believes that the legal decision rendered by the CDA Tribal Court and affirmed by the Tribal Appellate Court will ultimately be upheld by the federal courts. However, there is no assurance of such a legal outcome. In the event that the telephone and internet lotteries do not attain the level of market acceptance anticipated by the Company or if the CDA Tribal Court rulings are not upheld on appeal, the Company would have to reevaluate its investment in UniStar. The Company periodically evaluates the recoverability of this investment in UniStar in accordance with the provisions of FAS No. 121, "Accounting for the Impairment of Long-Lived Assets" by projecting future undiscounted net cash flows for the telephone and internet lotteries. If the sum of such cash flows is not sufficient to recover the Company's investment in UniStar, projected cash flows would then be discounted and the Company's investment would be adjusted, accordingly. 9 NOTE G - SALE OF BUSINESSES On May 31, 1996, the Company sold its direct sales and service organization, including its network services division (DSOs), 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 the buyer also entered into a five-year exclusive distributor agreement pursuant to which Clarity sells and services EXECUTONE and INFOSTAR telephone products to business and commercial locations that require up to 400 telephones. 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 sale of the DSOs (including the separate sale of the Pittsburgh office) related primarily to the retail distribution channel of the Computer Telephony division and included the Network Services division. After the sale, the Computer Telephony division consists of telephony product sales to independent distributors, along with the National Accounts and Federal Systems marketing channels. The Company retains its Healthcare Communications and Call Center Management businesses and the UniStar business. During 1996, the Company recorded a pretax gain of $48.9 million on the sale to Clarity net of transaction, severance and other costs related to the sale, of which $47.5 million was recorded during the three-month 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 cash proceeds of $61.5 million included $5.0 million held in escrow. These funds, including interest, are classified as restricted cash and will be released to the Company in April 1998, subject to potential indemnity claims by Clarity. In 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 equipment inventory. During the three-month period ended March 31, 1996, the Company recorded a loss of $3.9 million on the transaction. The Company has filed a legal action against GPT Video Systems, with whom the Company terminated its distribution agreement for failure to deliver properly functioning videoconferencing products on a timely basis. In 1996, the Company also sold its inmate calling business for $0.5 million in cash and notes. During the three-month period ended March 31, 1996, the Company recorded a loss of $1.0 million on the transaction. This business was part of the Computer Telephony division. 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. 10 NOTE H - OTHER MATTERS For the six-month periods ended June 30, 1997 and 1996, respectively, the Company made cash payments of approximately $0.8 million and $1.7 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. During the six-month periods ended June 30, 1997 and 1996, respectively, noncash financing activities other than those related to the sale of certain of the Company's businesses (see Note G), included capital lease obligations incurred in connection with equipment acquisitions of $1.2 million and $0.3 million. For both the three-month and six-month periods ended June 30, 1997, more than 10% of the Company's revenues were derived from a single independent distributor. Revenues from the distributor, net of discounts, were $3.5 million and $12.9 million for the three-month and six-month periods, respectively. Refer to the Consolidated Statements of Cash Flows for information on all cash-related operating, investing and financing activities. 11 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction The Company develops, markets and supports voice and data communications systems. Products and services include telephone systems, voice mail systems, inbound and outbound call center systems, and specialized healthcare communications systems. The Company, through its UniStar Entertainment subsidiary, also has the exclusive right to design, develop and manage the National Indian Lottery, including the on-line US 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. 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. Overview During the three-month period ended June 30, 1997, the Company generated revenues of $34.8 million, an operating loss of $3.7 million and a net loss of $0.05 per common share compared to the same period in 1996, which included revenues of $52.0 million, an operating loss of $7.2 million, a pretax gain of $39.8 million and a net gain of $.45 per share. For the six-month period ended June 30, 1997, revenues were $73.8 million generating an operating loss of $3.0 million and a net loss of $0.04 per share compared to revenue of $118.9 million, an operating loss of $10.8 million, pretax profit of $30.9 million and net income of $0.35 per share. The 1997 results are not comparable to the three- month and six-month periods in 1996, which included net gains on the sales of businesses of $47.5 million and $42.6 million, respectively. In addition, the prior year data included the operating results of the direct sales offices and the network services division through the May 31, 1996 sale date. The revenue and profit shortfall during the three-month period ended June 30, 1997 was primarily attributable to the Company's largest distributor purchasing significantly less product at the end of the quarter than it had in the past. This distributor had previously purchased significant quantities of product at the end of each quarter to meet expected needs for the following quarter. In the belief that this practice was causing both excess and unbalanced inventory, the distributor decided to change its purchasing pattern to purchase product monthly as needed in the future. The Company expects to benefit from this change in the long term as the previous purchasing pattern resulted in extreme pressure during the last week of each quarter and made it difficult to plan effectively. However, in the short term, it had a negative impact on both revenue and profit for the three- month period ended June 30, 1997. All of the Company's other businesses performed as anticipated for the three-month period ended June 30, 1997, including the balance of its independent distribution channel, the National Accounts/Federal Systems retail telephone group and the Healthcare business. 12 Results of Operations As a result of the business sales and dispositions consummated in 1996, the second quarter financial results for the three-month and six-month periods ended June 30, 1997 are not comparable to the same periods in 1996, other than on certain measures of overall profitability. As previously noted, revenues from the Company's largest distributor were significantly less than anticipated. As a result, the Computer Telephony revenues for the three-month period were $24.4 million compared to $30.2 million during the previous quarter. This more than offset a strong performance from the Healthcare Division, which had revenues of $10.4 million, an 18% increase compared to the previous quarter, and a record backlog at June 30, 1997. The Company expects its largest distributor's orders to normalize over the last six months of 1997. However, this order level is lower than the Company originally anticipated, as the distributor has not yet increased its sales force to the levels originally contemplated. In addition, the Company is in the process of examining its cost structure to accommodate the lower anticipated revenue. Gross profit margin for the three-month period ended June 30, 1997 was $9.9 million or 28.5% of revenue, which was $4.2 million less than the previous three-month period. The decline in gross profit margin is a result of the lower revenue levels and a resulting lower absorption of fixed costs. In addition, the margin percentage was affected by a poor product mix resulting from the shortfall in the distributor revenue during the quarter. The distributor historically has purchased a higher level of software and feature-rich hardware that typically produces higher margins. Product development expenses were $3.4 million, which is slightly higher than the previous quarter's spending levels. Selling, general and administrative expenses were $10.2 million, which is comparable to the previous quarter's spending level and in line with the lower level of sales. Operating losses for the three-month and six-month periods ended June 30, 1997 were $3.7 million and $3.0 million, respectively. Operating losses for the same periods in 1996 were $7.2 million and $10.7 million, respectively. UniStar On December 19, 1995, the Company acquired 100% of the common stock of Unistar Gaming Corporation, a privately-held company which, through its wholly-owned subsidiary, UniStar Entertainment, Inc. (UniStar), has an exclusive five-year contract to design, develop, finance, and manage the National Indian Lottery (NIL). (See Note F of the Notes to Consolidated Financial Statements for the terms of the agreement.) The initial goal of this investment was to establish a telephone lottery that could be played by an individual of majority age, residing in one of 36 states or the District of Columbia that currently operates a state-run lottery. In the telephone-based NIL, calls via an 800 number will be processed with interactive voice response equipment or live agents located on the Coeur d'Alene Indian Tribe of Idaho (CDA) Reservation using ACD software to process nationwide lottery sales. The Company has made a significant investment in UniStar, which initially created 8% dilution to the Company's shareholders. 13 For the six-month period ended June 30, 1997, the Company invested $2.9 million as part of the cost to develop the software system, building and other costs related to the project. These costs have been recorded as assets on the balance sheet. The total UniStar investment cost on the balance sheet is $20.8 million at June 30, 1997, including $15.8 million in goodwill and $5.0 million in other assets. In the opinion of the Company's management, this investment is justified based upon the potential returns. The UniStar legal situation is proceeding forward. The Company has received notice that the Tribal Appellate Court affirmed the lower Tribal Court's May 1, 1996 ruling and analysis upholding the CDA's right to conduct the telephone lottery on July 2, 1997. The Company is awaiting the written opinion outlining the basis for the court's conclusions. The Company remains hopeful that this decision will accelerate a Federal Court decision on the telephone-based lottery. In February 1997, UniStar signed revised agreements with CasinoWorld Holdings, Ltd. relating to software development, system architecture and proprietary technology and a revised agreement for an equity investment in Virtual Gaming Technologies (formerly Internet Gaming Technologies). See Note F for the terms of these agreements. The architecture of the Internet Lottery, particularly the business system, data base structure and the banking interface, are critical building blocks in the process of developing the telephone lottery, enabling the telephone lottery to begin as soon as the legal issues are resolved. As of July 21, 1997, the registered base of the US Lottery was 1,800 people with about 200 active players. As part of the test marketing program, the Company will be experimenting with direct mail, print advertising, radio and other promotional methods. It is anticipated that the national launch of the Internet lottery will take place by the end of the year. The Company estimates that an additional $4 million to $5 million will be spent in 1997. 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 $32 million and $50 million as of June 30, 1997 and December 31, 1996, respectively. At June 30, 1997 and December 31, 1996, cash and cash equivalents amounted to $11.9 million and $27.7 million, respectively, a decrease of $15.8 million. During the six-month period ended June 30,1997, the Company utilized $5.6 million in cash to fund operating activities. Cash was also used to repurchase 2.1 million shares of the Company's common stock for $5.4 million, fund $2.4 million in UniStar-related activities, invest $0.5 million in an infrared communications company and fund $1.6 million in capital expenditures. During the six-month period ended June 30, 1997, cash utilized by operating activities was $2.0 million less than the cash used during the same period in 1996. The decrease is primarily due to the lower operating losses during the 1997 period. Total debt at June 30, 1997 was $15.6 million, an increase of $0.9 million from $14.7 million at December 31, 1996. The increase is primarily due to incurring $1.2 million in capitalized lease obligations for equipment acquisitions during the first six months of 1997. Outstanding debt at June 30, 1997 consists of $12.4 million in subordinated debt, due in 2011, with the balance primarily capitalized lease obligations. 14 Proceeds from the sale of the DSOs (see Note G) included $5.0 million of cash held in escrow and reported on the consolidated balance sheets as restricted cash. These funds, plus interest, will be released to the Company in April 1998, subject to potential indemnity claims by Clarity. 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. 15 PART II - OTHER INFORMATION Item 1. LEGAL PROCEEDINGS As previously reported, on October 16, 1995, the Coeur d'Alene Tribe filed an action entitled Coeur d'Alene Tribe vs. AT&T Corp. in the Tribal Court, located in Plummer, Idaho (Case No. C195-097), requesting a ruling that the Lottery to be developed and managed by the Company's UniStar Entertainment subsidiary is legal under IGRA, that IGRA preempts state and federal laws on the subject of Indian gaming, that Section 1084 is inapplicable and that the states lack authority to issue Section 1084 notification letters to any carrier, and an injunction preventing AT&T from refusing to provide telephone service to the NIL. This action was necessary because several network carriers have been sent Section 1084 letters under the Federal Communications Act by states opposed to the NIL. These letters state that the NIL is illegal under state and federal laws and prohibit the carriers from carrying network traffic for the NIL. On February 28, 1996, the Tribal Court ruled that all requirements of IGRA have been satisfied, that Section 1084 is inapplicable and the states lack jurisdiction to interfere with the NIL, and that AT&T cannot refuse service to the NIL based upon Section 1084, an allegation that the NIL is in violation of IGRA or the federal anti-lottery statutes. This ruling and a related order dated May 1, 1996 were appealed to the Tribal Appellate Court, which affirmed the lower court ruling on July 2, 1997, and probably will be reviewed by the United States federal courts as well. The Company has been advised by its outside counsel, Hunton & Williams, that based upon such firm's review of the applicable statutes, regulations and case law, it believes that the Lottery is authorized under IGRA and that the favorable rulings issued by the Coeur d'Alene Tribal Court on February 28 and May 1, 1996, and the Tribal Appellate Court on July 2, 1997, should be upheld on appeal. On May 28, 1997, the Attorney General of the State of Missouri brought an action in the Circuit Court of Jackson County, Missouri, against the Coeur d'Alene Tribe and UniStar seeking to enjoin Lottery games offered by the Tribe over the Internet and managed by UniStar. The complaint alleges that the US Lottery violates Missouri anti- gambling laws and that the marketing of the games violates the state's Merchandising Practices Act and also seeks restitution, a civil penalty, attorney's fees and court costs. The Company believes, based on the Tribal Court rulings and the opinion of its outside counsel referred to above, that the Missouri suit has no merit and that the Lottery activities are legal. UniStar and the Tribe have removed the case to the U.S. District Court for the Western District of Missouri, and the State has filed a motion to remand it to the State court. UniStar and Tribe are contesting the jurisdiction asserted by the State of Missouri and intend to defend the right of the Tribe to offer the Lottery on the Internet. This litigation, as well as other litigation which could be brought by states opposed to the NIL or its on-line US Lottery games, could prevent or delay full operations, and it is impossible at this time to predict when the NIL will commence telephone operations. The Company does not believe the outcome of this litigation will have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. 16 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 a) The Registrant's Annual Meeting of Shareholders was held on July 29, 1997. b) Proxies were solicited by the Registrant's management pursuant to Regulation 14 under the Securities Act of 1934; there was no solicitation in opposition to management's nominees listed in the Proxy Statement dated May 27, 1997, and all such nominees were elected pursuant to the vote of the shareholders. c) The amendment of the Registrant's 1986 Employee Stock Option Plan described under "Proposal 2" in the Proxy Statement dated May 27, 1997, which section is incorporated herein by reference, was approved by a vote of the majority of the Registrant's outstanding Common and Preferred Stock as follows: For: 39,657,851 Against: 818,104 Abstain: 167,298 d) The total number of shares of the Registrant's Common Stock, $.01 par value, and Preferred Stock, $.01 per value, outstanding as of May 27, 1997, the record date for the Annual Meeting, was 49,821,481, and 41,748,316 shares were represented in person or by proxy at the Meeting. 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 None. 17 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: August 12, 1997 /s/ Alan Kessman Alan Kessman Chairman, President and Chief Executive Officer Dated: August 12, 1997 /s/ Anthony R. Guarascio Anthony R. Guarascio Vice President, Finance and Administration Chief Financial Officer 18 EX-11 2 EXHIBIT 11 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
Three Months Ended Six Months Ended June 30, June 30, 1997 1996 1997 1996 NET INCOME (LOSS) $ (2,371,000) $ 23,860,000 $ (1,859,000) $ 18,502,000 WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING 49,457,000 51,878,000 49,669,000 51,865,000 COMMON STOCK EQUIVALENT SHARES ASSUMED TO BE ISSUED FOR DILUTIVE STOCK OPTIONS AND WARRANTS 0 925,000 0 908,000 TOTAL WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING 49,457,000 52,803,000 49,669,000 52,773,000 EARNINGS (LOSS) PER COMMON SHARE $ (0.05) $ 0.45 $ (0.04) $ 0.35
19 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 June 30, 1997 and is qualified in it's entirety by reference to such financial statements. 1000 6-MOS DEC-31-1997 JUN-30-1997 17,052 0 32,185 1,800 27,568 77,925 25,673 17,256 144,349 50,763 14,502 496 0 7,300 70,981 144,349 73,796 73,796 49,777 49,777 26,981 (262) 937 (3,088) (1,229) (1,859) 0 0 0 (1,859) 0.04 0.04
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