-----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, BujBX47FcQDQ0erEhuguawF9Hi++zE+B2OeZp+bZbC1wLv87E78d1yu7W7rSTV5a DPLTA6frM/LvgsUghWPP6w== 0000725282-99-000014.txt : 19990430 0000725282-99-000014.hdr.sgml : 19990430 ACCESSION NUMBER: 0000725282-99-000014 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990429 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: SEC FILE NUMBER: 000-11551 FILM NUMBER: 99604384 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 (3/31/99) FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1999 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 (I.R.S. 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 April 28, 1999 was 62,848,347. INDEX EXECUTONE Information Systems, Inc. Page # PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets - March 31, 1999 and December 31, 1998. 3 Consolidated Statements of Operations - Three Months Ended March 31, 1999 and 1998. 4 Consolidated Statements of Cash Flows - Three Months Ended March 31, 1999 and 1998. 5 Notes to Consolidated Financial Statements. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14 PART II. OTHER INFORMATION 21 SIGNATURES 22 2 PART I - FINANCIAL INFORMATION Item 1. Financial Statements EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
March 31, December 31, (In thousands, except for share amounts) 1999 1998 (Unaudited) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 911 $ 1,482 Accounts receivable, net of allowance of $1,563 and $1,720 24,006 25,531 Inventories 23,610 24,753 Prepaid expenses and other current assets 4,869 4,966 Total Current Assets 53,396 56,732 PROPERTY AND EQUIPMENT, net 10,327 10,604 INTANGIBLE ASSETS, net 3,763 3,795 DEFERRED TAXES 22,811 22,811 OTHER ASSETS 8,747 16,363 $ 99,044 $ 110,305 LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of long-term debt $ 1,038 $ 856 Accounts payable 13,184 18,093 Accrued payroll and related costs 4,140 3,969 Accrued liabilities 13,760 15,046 Deferred revenue and customer deposits 2,344 2,439 Total Current Liabilities 34,466 40,403 LONG-TERM DEBT 22,641 23,693 OTHER LONG-TERM LIABILITIES 2,245 2,445 TOTAL LIABILITIES 59,552 66,541 STOCKHOLDERS' EQUITY: Common stock: $.01 par value; 80,000,000 shares authorized; 49,438,578 and 49,834,807 issued and outstanding 494 498 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 70,386 71,624 Accumulated deficit (38,688) (35,658) Total Stockholders' Equity 39,492 43,764 $ 99,044 $ 110,305 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 (In thousands, except for per share amounts) March 31, 1999 1998 REVENUES $ 31,749 $ 33,903 COST OF REVENUES 21,376 23,065 Gross Profit 10,373 10,838 OPERATING EXPENSES: Product development and engineering 2,365 2,513 Selling, general and administrative 11,468 9,625 Provision for special charges --- 2,344 13,833 14,482 OPERATING LOSS (3,460) (3,644) INTEREST EXPENSE (753) (508) OTHER INCOME, net 1,183 23 LOSS BEFORE INCOME TAXES (3,030) (4,129) INCOME TAX BENEFIT --- (1,651) NET LOSS $ (3,030) $ (2,478) LOSS PER SHARE $ (0.06) $ (0.05) AVERAGE DILUTED COMMON SHARES 49,529 49,698 The accompanying notes are an integral part of these consolidated statements.
4 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three Months Ended (In thousands) March 31, 1999 1998 CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (3,030) $ (2,478) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 874 877 Income tax benefit not currently receivable --- (1,651) Noncash items, including noncash interest expense, noncash provision for losses on accounts receivable and income from equity investment 117 152 Gain on distributor note and warrant redemption (1,161) --- Change in working capital items: Accounts receivable 1,610 3,808 Inventories 1,115 (3,115) Accounts payable and accruals (5,065) 1 Restricted cash --- 5,084 Other working capital items 80 1,169 NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES (5,460) 3,847 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (210) (241) Investment in eLottery (1,404) (2,428) Proceeds from distributor note and warrant redemption 9,261 --- Other, net 120 (230) NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES 7,767 (2,899) CASH FLOWS FROM FINANCING ACTIVITIES: Repayments under revolving credit facility (1,313) --- Repayments of other long-term debt (263) (291) Repurchase of stock (1,341) --- Proceeds from issuance of stock 39 86 NET CASH USED BY FINANCING ACTIVITIES (2,878) (205) INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (571) 743 CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 1,482 7,727 CASH AND CASH EQUIVALENTS - END OF PERIOD $ 911 $ 8,470 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 AND FORMATION OF THE COMPANY EXECUTONE Information Systems, Inc. (the Company) develops, markets and supports voice and data communications and information systems. Products and services include telephone systems, voice mail systems, inbound and outbound call center systems and specialized healthcare communications and workflow management systems. Products and services are sold under the EXECUTONE, INFOSTAR, IDS, LIFESAVER and INFOSTAR/ILS brand names through a national network of independent distributors and direct sales and service employees. The Company's products are manufactured primarily in the United States, Malaysia, China and the Dominican Republic. The Company's eLottery subsidiary (formerly named Unistar Gaming Corp.) develops, provides and maintains Internet, intranet and telephone communications, accounting, database and other applications and services for use by the domestic and international lottery market. eLottery's UniStar Entertainment subsidiary has the exclusive right to design, develop and manage the National Indian Lottery (NIL) of the Coeur d'Alene Tribe of Idaho (CDA). The NIL was operational beginning in January 1998. However, in response to an adverse legal opinion on December 17, 1998, eLottery and the CDA terminated the operations of the NIL and the US Lottery telephone and Internet operations managed by eLottery. NOTE B - BASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. In consolidating the accompanying financial statements, all significant intercompany transactions have been eliminated. Investments in affiliated companies owned more than 20%, but not in excess of 50%, are recorded under the equity method. 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. 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 three-month periods ended March 31, 1999 and 1998, the Company made cash payments for income taxes of approximately $51,000 and $54,000, 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. A reconciliation of the Company's loss per share calculations for the three-month periods ended March 31, 1999 and 1998, respectively, is as follows:
Per Share (in thousands, except for per share amounts) Loss Shares Amount For the three months ended March 31, 1999: Basic and Diluted Loss Per Share: Net Loss $(3,030) 49,529 $(0.06) For the three months ended March 31, 1998: Basic and Diluted Loss Per Share: Net Loss $(2,478) 49,698 $(0.05)
The Company's Convertible Subordinated Debentures are convertible into approximately 1.5 million shares of common stock as of March 31, 1999. The shares issuable upon conversion of the Debentures were not included in the computation of diluted earnings per share because they would be antidilutive for each of the periods presented. Incremental common shares assumed to be issued for stock options totaling 540,000 and 61,000 shares as of March 31, 1999 and 1998, respectively, were not included in the computation of diluted earnings per share due to the net losses for both periods. Options to purchase 783,000 and 1.2 million shares of common stock as of March 31, 1999 and 1998, respectively, were not included in the computation of diluted earnings per share because the exercise price was greater than the average market price of the shares of common stock. The convertible preferred stock issued in connection with the acquisition of eLottery was antidilutive, at issuance, and has been excluded from the above calculations. On April 13, 1999, the convertible preferred stock was redeemed (See Note G). NOTE E - INVENTORIES Inventories are stated at lower of first-in, first-out (FIFO) cost or market and consist of the following at March 31, 1999 and December 31, 1998:
(amounts in thousands) 3/31/99 12/31/98 Raw Materials $ 3,138 $ 2,527 Finished Goods 20,472 22,226 $ 23,610 $ 24,753
7 NOTE F - eLOTTERY Acquisition On December 19, 1995, EXECUTONE Information Systems, Inc. ("Executone') acquired 100% of the common stock of Unistar Gaming Corp. for common and preferred stock with a combined value of $12.7 million. In January 1999, Unistar Gaming Corp. changed its name to eLottery, Inc. ("eLottery"). Any reference herein to eLottery shall be deemed to include business conducted under the name Unistar Gaming Corp. eLottery's wholly-owned subsidiary, UniStar Entertainment, Inc. ("UniStar Entertainment") has an exclusive five-year management agreement with the CDA, which was the primary asset acquired, to provide design, development, financial and management services to the NIL. The NIL was operational beginning in January 1998. However, in response to an adverse legal opinion on December 17, 1998, eLottery and the CDA terminated the operations of the NIL and the US Lottery telephone and Internet operations managed by eLottery. 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, as originally issued, was to earn dividends equal to 18.5% of the consolidated retained earnings of eLottery 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, as originally issued, was to earn dividends equal to 31.5% of the consolidated retained earnings of eLottery 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 were 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 March 31, 1999, no dividends had accrued to the preferred stockholders. The Series A and Series B Preferred Stock were 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 eLottery met certain revenue and profit parameters, the Series A Preferred Stock was convertible for up to 4.925 million shares of common stock and the Series B Preferred Stock was convertible for up to 8.375 million shares of common stock (a total of 13.3 million shares of common stock). On April 7, 1999, the Company reached agreement with the preferred shareholders to accelerate redemption of the Series A and Series B preferred shares, with such shares actually being redeemed effective April 13, 1999 (see Note G). Legal and Other Risks On October 16, 1995, the CDA filed an action entitled Coeur d'Alene Tribe v. AT&T Corp. in the Tribal Court, located in Plummer, Idaho (Case No. C195-097): (i) requesting a ruling that the NIL is legal under the federal Indian Gaming Regulatory Act of 1988 ("IGRA"), that IGRA preempts state laws on the subject of Indian gaming, that Section 1084 is inapplicable and that therefore the states lack authority to issue Section 1084 notification letters to any long-distance carrier; and (ii) seeking an injunction preventing AT&T from refusing to provide telephone service to the NIL. The CDA took the position that all NIL gaming activity was occurring on "Indian lands" as required by IGRA. On February 28, 1996, the Tribal Court ruled: (i) that all requirements of IGRA have been satisfied; (ii) that Section 1084 is inapplicable and the states lack jurisdiction to interfere with the NIL; and (iii) that AT&T cannot refuse service to the NIL. On July 2, 1997, the Tribal Appellate Court affirmed the lower Tribal Court's May 1, 1996 ruling and analysis upholding the CDA's right to conduct the NIL telephone lottery. On 8 August 22, 1997, AT&T filed a complaint for declaratory judgment against the CDA in the U. S. District Court for the District of Idaho, to obtain a federal court ruling on the validity and enforceability of the Tribal Court ruling. On December 17, 1998, that Court issued an opinion and order denying the motions and counter-claims of the CDA and granting declaratory judgment in favor of AT&T upholding the position of AT&T and overruling the decisions of the Tribal Courts. In response to that decision, eLottery and the CDA terminated operations of the NIL and the US Lottery in every state where it had been offered. The CDA has filed a notice of appeal of the District Court decision; however, eLottery will not participate in or fund any appeal of this ruling. On September 14, 1998, the CDA, eLottery and representatives of the U.S. Department of Justice had discussions regarding a declaratory judgment to be sought jointly from the U.S. District Court for the District of Idaho as to whether the operation of the NIL is legal under 18 U.S.C. Sections 1952 and 1955. eLottery was informed that the Department of Justice views such operation to be in violation of such statutes. The Department of Justice proposed that the parties file a joint stipulation of facts and cross-motions for summary judgment in the declaratory judgment action. On December 17, 1998, the Idaho Federal District Court issued an opinion and order granting declaratory judgment in favor of the action styled AT&T v. Coeur d' Alene Tribe. In response to that decision, eLottery and the CDA terminated operation of the NIL and the US Lottery. In light of the ruling of the U.S. District Court of Idaho and the termination of the NIL and the US Lottery, eLottery has requested confirmation from the Department of Justice that no further action will be taken. 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 CDA and UniStar Entertainment seeking to enjoin the NIL games offered by the CDA over the Internet and managed by UniStar Entertainment. The complaint also sought civil penalties, attorneys fees and court costs. The complaint alleged that the NIL violates Missouri anti-gambling laws and that the marketing of the games violates the Missouri Merchandising Practices Act. UniStar Entertainment and the CDA removed the case to the U.S. District Court for the Western District of Missouri, which denied the State's subsequent motion to remand back to the state court. The court also subsequently granted a motion to dismiss the CDA from this case based on sovereign immunity. The court preliminarily denied a motion to dismiss UniStar Entertainment based on sovereign immunity, although the court indicated it might reconsider that decision. UniStar Entertainment filed a motion for reconsideration of its motion for dismissal. The State of Missouri has appealed the dismissal of the CDA to the Eighth Circuit Court of Appeals. On January 28, 1998, the State of Missouri sought to dismiss voluntarily the existing federal case against UniStar Entertainment and the next day filed a new action against Executone, UniStar Entertainment and two tribal officials, with essentially the same allegations, in state court. The State obtained a temporary restraining order from a state judge against Executone, UniStar Entertainment and two tribal officials enjoining the marketing of the NIL Internet and telephone lotteries in the State of Missouri. On February 5, 1998, the U.S. District Court for the Eastern District of Missouri ruled that this second case also should be heard in federal court, transferred the second case to the Western District of Missouri where the original case had been filed, and dissolved the state court's temporary restraining order. A motion to dismiss the second case based on the sovereign immunity of all the defendants and a motion to abstain in favor of the jurisdiction of the Coeur d'Alene Tribal Court are pending. The State of Missouri has appealed to the Eighth Circuit the denial of its motion to remand the case to state court or, in the alternative, to seek a preliminary injunction. On January 6, 1999, the Eighth Circuit dismissed Missouri's appeal from the Eastern District of Missouri. In the same opinion, the Eight Circuit vacated the decisions from the Western District of 9 Missouri as to the CDA and remanded that case to the Western District for a hearing on whether the Internet games of the NIL are gaming activities "on Indian lands." The Eighth Circuit also held valid Missouri's voluntary dismissal of UniStar Entertainment from the Western District lawsuit. In light of the termination of the NIL and the US Lottery, eLottery anticipates seeking dismissal of the Missouri actions. On September 15, 1997, the State of Wisconsin, by its Attorney General, filed an action in the Wisconsin State Circuit Court for Dane County against Executone, UniStar Entertainment and the CDA, to permanently enjoin the NIL offered by the CDA on the Internet. The complaint alleged that the offering of the NIL violates Wisconsin anti-gambling laws and that legality of the NIL has been misrepresented to Wisconsin residents in violation of state law. In addition to an injunction, the suit sought restitution, civil penalties, attorneys' fees and court costs. Executone, UniStar Entertainment and the CDA have removed the case to the U.S. District Court in Wisconsin. On February 18, 1998, the District Court dismissed the CDA from the case based on sovereign immunity and dismissed Executone based on the State's failure to state a claim against Executone. The State of Wisconsin appealed the dismissal of the CDA to the Seventh Circuit Court of Appeals. A motion to dismiss the case against UniStar Entertainment on the basis of sovereign immunity was denied. UniStar Entertainment appealed the denial of its motion to dismiss to the Seventh Circuit Court of Appeals. In light of the termination of the NIL and the US Lottery, eLottery anticipates seeking dismissal of this action. Investment in eLottery The Company periodically evaluates the recoverability of its investment in eLottery 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 underlying businesses. If the sum of such cash flows is not sufficient to recover the Company's investment in eLottery, projected cash flows would then be discounted and the carrying value of Company's investment would be adjusted accordingly. On December 17, 1998, the United States District Court for the District of Idaho ruled in the case of AT&T vs. Coeur d'Alene Tribe that the orders previously issued by the Tribal Court upholding the legality of the US Lottery were erroneous (see Legal and Other Risks for a description of the litigation). In response to this legal decision, eLottery and the CDA terminated operation of the NIL and the US Lottery in every state where it had been offered. Management determined that all of eLottery's assets related to the NIL were impaired and were written down to zero during the fourth quarter of 1998. All of the Company's remaining investment in eLottery relates to its business as an Internet retailer of lottery products for legally authorized entities. In February 1997, the Company signed agreements with Virtual Gaming Technologies (formerly Internet Gaming Technologies (IGT)) and CasinoWorld Holdings, Ltd. (CWH). The agreements required the Company to invest $700,000 in IGT common stock 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 provided project management services overseeing the development of the software for the NIL, with the Company contracting independently for system software development. The Company acquired all hardware for the system without financial obligation by either IGT or CWH. Approximately $800,000 in hardware costs were incurred as of March 31, 1999. The investment in IGT is being accounted for under the cost method. All hardware costs incurred are being capitalized and depreciated over the useful life of the assets. As of March 31, 1999, approximately $3.3 million has been spent on software development. Such payments are being capitalized and depreciated over a five-year period. 10 NOTE G - DIVESTITURE OF CORE BUSINESSES On March 29, 1999, the Company announced that it planned to divest its core telephone and healthcare businesses and change the name of the Company to eLottery, Inc. At the same time, the Executone Board of Directors announced it had received an offer for those businesses from a group to be led by Stanley J. Kabala, Chairman and Chief Executive Officer of Executone, and that it has formed a special committee of the Board to accomplish that divestiture. The offer from management is approximately $70 million and is subject to a number of conditions including negotiation of a definitive agreement, financing, the waiver or expiration of a pre-existing right of first offer, and approval of the Executone shareholders. A final decision as to the method of divesting this business has not been made by the Board. The Company expects to recognize a gain on the transaction, which may be deferred over some undetermined future period, dependent upon the final terms. The proceeds of any sale will remain in the Company to help it accelerate the achievement of eLottery's business plans. At the conclusion of the transaction and subject to shareholder approval, Executone would be renamed eLottery, Inc. eLottery's activities to date have been primarily related to the organization of the company, developing the business and gaming systems necessary to operate a national telephone lottery and the USlottery.com Internet site and preparing a marketing plan for selling its technology to entities licensed to sell lottery tickets. With the termination of operations of the NIL and the divestiture of the core telephony and healthcare businesses, eLottery expects to derive its future revenues from acting as an Internet retailer of lottery products for legally authorized entities and the sale or licensing of the technology it has developed and advertising on its Internet web site, eLotteryWorld.com. eLottery has yet to record any revenue. On April 13, 1999, as part of its plan to separate its telephony and healthcare businesses from eLottery, the Company accelerated the redemption of its Series A and Series B preferred stock. Upon redemption, the preferred shares were redeemed for 13.3 million shares of common stock, or approximately 21% of eLottery's common stock, and will no longer be entitled to receive a total of 50% of eLottery's retained earnings as preferred dividends. NOTE H - SEGMENTS The Company's reportable business segments provide products and services, which are marketed through both retail and independent distribution channels. These businesses are managed and reported separately because they serve distinct markets. Three-month period ended March 31,1999 Computer (amounts in thousands) Telephony Healthcare eLottery Corporate Totals Revenue from External Customers $ 23,255 $ 8,494 $ -- $ -- $ 31,749 Intersegment Revenues 1,830 2,220 -- -- 4,050 Segment Income (Loss) 560 (1,833) (653) (1,534) (3,460) 11 Three-month period ended March 31,1998 Computer (amounts in thousands) Telephony Healthcare eLottery Corporate Totals Revenue from External Customers $ 24,708 $ 9,195 $ -- $ -- $ 33,903 Intersegment Revenues 1,911 2,138 -- -- 4,049 Segment Income (Loss) (362) (744) (194) -- (1,300)
The following reconciles the Company's segment loss to the reported net loss for the three-month periods ended March 31, 1999 and 1998:
(Amounts in thousands) 1999 1998 Total segment income (loss) $(3,460) $(1,300) Special charges -- (2,344) Interest expense (753) (508) Other income, net 1,183 23 Income tax benefit -- 1,651 $(3,030) $(2,478)
Corporate assets were reduced by approximately $8.0 million during the first quarter of 1999 due to the repayment of the note receivable from Claricom and the redemption of Claricom warrants issued to the Company (See Note I). NOTE I - OTHER MATTERS For the three-month periods ended March 31, 1999 and 1998, respectively, the Company made cash payments of approximately $0.8 million and $0.5 million for interest expense on indebtedness. During the three-month period ended March 31, 1999, noncash financing activities included capital lease obligations incurred in connection with computer software and equipment acquisitions of $0.6 million. For the quarters ended March 31, 1999 and 1998, the Company had two individual customers, each of which generated in excess of 10% of the Company's revenues. Both customers are included in the Computer Telephony segment. One customer accounted for $4.1 million and $4.5 million in sales for the 1999 and 1998 periods, respectively. The second customer accounted for $4.2 million and $3.3 million for the same periods, respectively. On February 26, 1999, the Company received $9.3 million from Claricom as payment in full for Claricom's outstanding $5.9 million junior subordinated note plus interest, along with the redemption of the warrants issued to the Company as part of the sale of the direct offices in 1996. As a result, the Company recorded a gain of $1.2 million during the first quarter of 1999. The gain is included in Other Income, net. 12 The Company recorded a total of $9.0 million in reorganization and other special charges during year ended December 31, 1998, of which $2.3 million was recorded during the first quarter of 1998. At March 31, 1999, the remaining reserve balance associated with these charges was $4.9 million. These amounts will be paid during 1999, with the exception of $1.5 million related to the patent litigation settlement, which will be paid subsequent to December 31, 1999. On March 30, 1998, the Company entered into an Amended and Restated Distributor Agreement (the "Amended Agreement") with Claricom, purchaser of the direct sales offices and the Company's largest distributor. The Amended Agreement, effective April 1,1998 and continuing through December 31, 2001, provides, among other things, that Claricom will be a non-exclusive distributor of the Company's telephony products and that Claricom can market products competing with those sold by the Company. Upon execution of the Amended Agreement, Claricom released to the Company the $5 million plus interest being held in escrow to satisfy potential indemnity claims under the 1996 Asset Purchase Agreement and waived all potential contract claims under the prior distributor agreement. 13 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis explains trends in the Company's financial condition and results of operations for the three-month periods ended March 31, 1999 compared with the same period last year. It is intended to help shareholders and other readers understand the dynamics of the Company's business and the key factors underlying its financial results. This discussion should be read in conjunction with the consolidated financial statements and notes included elsewhere in this Form 10-Q, and with the Company's audited consolidated financial statements and notes thereto for the year ended December 31, 1998. Management believes that certain statements in this management's discussion and analysis constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995 that are based on current expectations, estimates and projections about the industries in which the Company operates, management's beliefs and assumptions made by management. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance, or achievements expressed or implied by such forward- looking statements. Such risks, uncertainties and assumptions include, among others, the following: general economic and business conditions; demographic changes; import protection and regulation; rapid technology development and changes; timing of product introductions; the mix of products/services; industry capacity and other industry trends; and the ability of the Company to attract and retain key employees. OVERVIEW The Company develops, markets and supports voice and data communications and information systems. Products and services include telephone systems, voice mail systems, inbound and outbound call center systems and specialized healthcare communications and workflow management systems. The Company's products are sold under the EXECUTONE, INFOSTAR, IDS, LIFESAVER and INFOSTAR/ILS brand names through a national network of independent distributors and company direct sales and service employees. The Company's eLottery subsidiary (formerly named Unistar Gaming Corp.) develops, provides and maintains Internet, intranet and telephone communications, accounting, database and other applications and services for use by the domestic and international lottery market. eLottery's UniStar Entertainment subsidiary has the exclusive right to design, develop and manage the National Indian Lottery (NIL) of the Coeur d'Alene Tribe of Idaho (CDA). The NIL was operational beginning in January 1998. However, in response to an adverse legal opinion on December 17, 1998, eLottery and the CDA terminated the operations of the NIL and US Lottery telephone and Internet operations managed by eLottery. Revenues are derived from product sales to distributors, direct sales of healthcare products, and direct sales to national accounts and 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, national account and government customers. DIVESTITURE OF CORE TELEPHONY AND HEALTHCARE BUSINESSES On March 29, 1999, the Company announced that it planned to divest its core telephony and healthcare businesses and change the name of the Company to eLottery, Inc. At the same time, the Executone Board of Directors announced it had received an offer for those businesses from a group to be led by 14 Stanley J. Kabala, Chairman and Chief Executive Officer of Executone, and that it has formed a special committee of the Board to accomplish that divestiture. The offer from management is in the range of $70 million and is subject to a number of conditions including negotiation of a definitive agreement, financing, the waiver or expiration of a pre-existing right of first offer, and approval of the Executone shareholders. A final decision as to the method of divesting this business has not been made by the Board. Under the management offer, the proceeds of the sale will remain in the public company, eLottery, to help it accelerate the achievement of its business plans. The Board believes this transaction creates more value for the Company's shareholders than the spin off of the eLottery common stock, which had potentially significant corporate and individual tax consequences. As a result, the Company has terminated its previously filed registration statement. On April 13, 1999, as part of its plan to separate its telephony and healthcare businesses from eLottery, the Company accelerated the redemption of its Series A and Series B preferred stock. All of the Company's preferred shares were redeemed for approximately 13.3 million common shares. The Company believes this transaction will simplify its capital structure and align the interests of the former preferred and current common shareholders. RESULTS OF OPERATIONS In the first quarter of 1999, the Company continued its efforts to make significant changes in its business practices. These changes, which began in the second half of 1998, are intended to improve the Company's performance in future periods. Revenues for the first quarter of 1999 were $31.7 million, with an operating loss of $3.5 million and a net loss of $3.0 million or ($.06) per common share. Revenues for the first quarter of 1998 were $33.9 million, with an operating loss of $3.6 million and a net loss of $2.5 million or ($.05) per common share. The 1998 results include a $2.3 million special charge, covering severance and benefits continuation costs. The decrease in revenue was primarily attributable to lower revenues generated by the Company's independent distribution channel, including Claricom, the Company's largest distributor, and the Healthcare Communications group. The increase in the net loss compared to the first quarter of 1998 is due to several factors; the $2.2 million decrease in revenue, $1.5 million in professional fees incurred during the quarter to help identify and initiate the changes in business processes now underway, and the Company's more conservative treatment of its pretax loss, for which no tax benefit was taken in the first quarter of 1999 compared to a tax benefit of $1.7 million taken in the same period in 1998. REVENUE Revenues were $31.7 million during the three month period ended March 31, 1999, compared to $33.9 million for the same period in 1998. Revenue, by business, was distributed as follows (in millions):
Inc (Dec) Three-month period ended 1999 1998 $ % Computer Telephony $ 23.2 $ 24.7 ($ 1.5) (6.1%) Healthcare 8.5 9.2 ( 0.7) (7.6%) $ 31.7 $ 33.9 ($ 2.2) (6.5%)
15 Computer Telephony Computer telephony products range from PBXs for small to medium- sized businesses to standards-compliant computer telephony applications, LAN and Internet-based applications, including voice mail, unified messaging, automatic call distribution (ACD), predictive dialing and wireless communications. This business targets the under-400-extension market segment. Customers range from small companies with fewer than ten employees to large national accounts and government agencies with fewer than 400 extensions at any individual location. These products are marketed through independent distribution and direct sales, with the direct sales effort focused on product and service sales to National and Government Accounts. In the first quarter of 1999, Computer Telephony revenues decreased $1.5 million, or 6%, compared to the same quarter last year. In the wholesale channel, the Company no longer offers distributor-focused sales incentives at the end of each quarter. In the past, this often resulted in inflated distributor inventory and excessive receivables. Incentives are now being directed at stimulating end user demand, with the intent of creating value for both the end user and the distributor. With these changes in business practice, the Company believes that these distributors have reduced most of their excess inventory that had accumulated over several years of supply push incentive programs. Purchases by Claricom, the Company's largest independent distributor, were approximately $0.4 million lower in the first quarter of 1999 compared to the same period in 1998, which was the last quarter when Claricom purchases were influenced by the old distributor contract. Management believes that the recent acquisition or Claricom by Staples is a very positive development for the Company, given their increased financial strength and Staples' marketing and product distribution strength. Healthcare Healthcare products range from traditional nurse call systems, intercoms and room status indicators to more sophisticated patient reporting systems, infrared locating systems and wireless technologies. All of these products can be seamlessly integrated to enhance a facility's communications and information networking. Healthcare customers include hospitals, surgical centers, nursing homes and assisted living centers. Healthcare reported $0.7 million lower sales for the first quarter of 1999 compared to the same period in 1998, but almost $1.0 million higher than the fourth quarter of 1998. Compared to the prior year, the lower revenue reflects the negative effects of increased sales force turnover that resulted from the Company's efforts to offer the business for sale during 1998 and the change in business practice away from supply push distributor incentive programs. With the changes this business continues to make in its installation process and the end of distributor- focused sales incentives, the Company believes that the revenue increase from the previous sequential quarter is indicative of a return to growth. Healthcare has a record backlog of almost $18 million as of March 31, 1999. GROSS PROFIT Gross profit for the first quarter of 1999 was $10.4 million or 32.7 % of revenue, compared to $10.8 million or 32.0% of revenue for the same quarter last year. The decrease in gross profit of only $0.4 million is due to the lower volume. The volume decrease has been largely offset by higher pricing margins in the Computer Telephony business, resulting from the discontinuance of the Company's old pricing practices, along with lower fixed costs, resulting from the Company's cost reduction efforts. 16 OPERATING EXPENSES Product development expenses were $2.4 million for the first quarter of 1999, a decrease of approximately $0.1 million from the same quarter last year. The decrease is a result of cost reduction efforts and lower headcount. Product development costs are expected to remain at approximately the current level for the remainder of 1999. Selling, general and administrative expenses were $11.5 million, or 36.1% of revenue for the first quarter of 1999, compared to $9.6 million or 28.4% of revenue for the same period in 1998. The increase is primarily due to $1.5 million in professional fees incurred to help the Company evaluate its business practices, determine the necessary changes and implement those changes. While the changes that have been generated by this process are beginning to reduce costs in other parts of the business, the full impact will not be felt until the fourth quarter of 1999. The Company expects to pay an additional $2.0 million in fees to complete this process during the second and third quarters of 1999. eLottery expenses increased approximately $0.5 million during the first quarter of 1999 compared to the same period last year due to the Company's efforts to develop and market eLottery's products, along with the Company's practice in the first quarter of 1998 of charging the NIL for personnel expenses which, with the termination of the NIL, are now included in the Company's expenses. On a comparable basis, excluding the special charges in 1998 and the professional fees in 1999, selling, general and administrative expenses for the core businesses declined approximately $0.2 million, primarily as a result of reduced headcount. SPECIAL CHARGES As a result of actions taken by the Company to improve its business processes, including significant changes in its senior management structure, along with a provision for a patent litigation settlement, the Company recorded a total of $9.0 million in reorganization and other special charges during year ended December 31, 1998, of which $2.3 million was recorded during the first quarter of 1998. At March 31, 1999, the remaining reserve balance associated with these charges was $4.9 million. These amounts will be paid during 1999, with the exception of $1.5 million related to the patent litigation settlement, which will be paid subsequent to December 31, 1999. INTEREST AND OTHER EXPENSE Interest expense for the first quarter of 1999 increased $0.2 million compared to the same period in 1998 due to higher levels of bank borrowings in 1999. Other income, net, for the first quarter of 1999 increased $1.2 million compared to the same period in 1998 due to a nonrecurring $1.2 million gain on the receipt of payment from Claricom on the $5.9 million junior subordinated note plus interest, along with the redemption of the warrants held by the Company. eLOTTERY On December 19, 1995, EXECUTONE Information Systems, Inc. ("Executone') acquired 100% of the common stock of Unistar Gaming Corp. for common and preferred stock with a combined value of $12.7 million. In January 1999, Unistar Gaming Corp. changed its name to eLottery, Inc. ("eLottery"). Any reference herein to eLottery shall be deemed to include business conducted under the name Unistar Gaming Corp. eLottery's wholly-owned subsidiary, UniStar Entertainment, Inc. ("UniStar Entertainment") has an exclusive five-year management agreement with the CDA, which was the primary asset acquired, to provide design, development, financial and management services to the National Indian Lottery. The NIL was operational beginning in January 1998. However, in response to an adverse legal opinion on December 17, 1998, eLottery and the CDA terminated the operations of the NIL and the US Lottery telephone and Internet operations managed by eLottery. 17 eLottery's original mission was to develop, install and manage a National Indian Lottery accessible by telephone. eLottery developed a state-of-the-art Internet and telephone-based system providing both instant and draw lottery games, full player accounting and tracking and automatic credit or debit card clearance. In early 1998, as a hedge against potential adverse legal and political decisions, eLottery began investigating alternative applications and markets for its technology. eLottery is now pursuing opportunities to become a web-based retailer of lottery services and to license its systems and services to state and international lotteries. The Company has developed and operated systems software that enables the electronic distribution of lottery tickets over the Internet, Intranet and via telephone. The Company believes that the electronic distribution of lottery tickets through these systems will increase lottery sales because they make the purchase of tickets more easily accessible and because they make use of technology to enhance and enliven the lottery gaming experience. With its unique and proven ability to offer lottery operators its new Internet and Intranet-based lottery products worldwide, the Company believes it is well positioned to capitalize on the growth in non-traditional lottery sales. During the first quarter of 1999, the Company incurred approximately $1.8 million in cash expenditures related to eLottery. Of that amount, approximately $1.0 million related to the termination of NIL operations, including payment of outstanding invoices, shutdown costs and severance and other charges. The Company estimates an additional $0.6 million remaining in NIL-related charges, all of which should be paid during the second quarter of 1999. eLottery had a net loss during the quarter of $0.7 million, incurring expenses for the development and marketing of its products. With the termination of the NIL and US Lottery, the Company continues to face certain legal and other risks. See the Notes to Consolidated Financial Statements for a discussion of the legal issues and legislative proposals, which could impact the Company and its eLottery business. YEAR 2000 Status The Company has completed a review of its computer systems to identify systems that could be affected by the "Year 2000" issue. Systems that do not properly recognize information after December 31, 1999 could generate erroneous data or fail. Although the Company estimated the cost to resolve the Year 2000 issue through its current software system would have been less than $0.5 million, it decided as part of its long-term information systems plan to convert to a new and more comprehensive software system for its information technology (IT) infrastructure. The new system will cost approximately $2.3 million, including installation and data conversion costs. The Company expects the new system to be operational by the end of the second quarter of 1999. The costs for the new system will be capitalized and depreciated over the expected service life of the system beginning in the third quarter of 1999. Implementation of the new system began during the third quarter of 1998. The Company has incurred approximately $1.7 million through March 31, 1999, primarily for the purchase of software licenses and certain system hardware, along with installation costs. The system configuration has been completed, along with documentation of the Company's business process procedures as they will be used in the new system. The Company has also completed and tested the data conversion processes. As of March 31, 1999, it is estimated that the installation process is 70% to 80% complete. Management believes that the conversion to new software will resolve the Year 2000 issue as it relates to its IT infrastructure. There are several peripheral systems that will not be replaced by the new software. These systems are 18 being made compliant using the Company's internal resources, which have been redeployed from other projects. The remedial effort is approximately 90% complete and is scheduled to be 100% complete by the end of the second quarter of 1999. The total remedial cost for these systems is approximately $50,000, substantially all of which has been incurred as of March 31, 1999. For non-IT systems (non-information technology that typically includes imbedded technology such as micro-controllers), the Company has reviewed its production and other equipment and determined that there are no significant Year 2000 issues. The Company has also begun seeking representations and assurances from its key vendors regarding timely Year 2000 compliance. Other than such surveys of its vendors, the Company has not made an assessment as to whether any of its suppliers or service providers will be affected by the date change. Risk Assessment Although the Company believes that internal Year 2000 compliance will be achieved by December 31, 1999, there can be no assurance that the Year 2000 problem will not have a material adverse affect on the Company's business, financial condition and results of operations. The failure by the Company to correct a material Year 2000 problem could result in an interruption in, or a failure of, certain normal business activities or operations. Presently, the Company perceives that the most reasonably likely worst case scenario related to the Year 2000 issue is associated with potential concerns with the ability of third party vendors to provide products used in the manufacturing process. A significant disruption in the product manufacturing process could prevent or delay the Company from completing new installations or system upgrades and enhancements for its customers. This would adversely affect the Company's results of operations, liquidity and financial condition. The Company is not presently aware of any vendor-related Year 2000 issue that is likely to result in such a disruption. Contingency Plan The Company does not yet have a contingency plan in place to deal with unforeseen conversion failures. Such a plan is currently being developed and will include the identification of a team of employees to be on call during the millennium change to monitor key systems, providing for backup power sources, data retention and recovery procedures for critical business data and operational plans to address potential delays in product supply from vendors. The contingency plan is expected to be in place by June 1999. OTHER On March 30, 1998, the Company entered into an Amended and Restated Distributor Agreement with Claricom (the "Amended Agreement"). The Amended Agreement, effective April 1, 1998 and continuing through December 31, 2001, provides, among other things, that Claricom will be a non-exclusive distributor of the Company's telephony products andthat Claricom can market products competing with those sold by the Company. Upon execution of the Amended Agreement, Claricom released to the Company the $5 million plus interest being held in escrow to satisfy potential indemnity claims under the 1996 Asset Purchase Agreement and waived all potential contract claims under the prior distributor agreement. 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 $10 million as of March 31, 1999 and December 31, 1998. 19 At March 31, 1999 and December 31, 1998, cash and cash equivalents amounted to $0.9 million and $1.5 million, respectively, a decrease of $0.6 million. The decrease was mainly due to the funding of the Company's operating losses, along with additional expenditures to fund the termination of NIL operations, the repayment of debt and the repurchase of stock, all of which was largely offset by a nonrecurring cash receipt from Claricom (see below). The Company used $5.5 million in its operating activities during the first quarter of 1999 compared to $3.8 million in cash provided by operations for the same period in 1998. Excluding the March 1998 release of $5.1 million held in escrow since the sale of the direct offices in 1996, $1.2 million in funds were used in operating activities for the first quarter of 1998. The increase in funds used by operating activities is primarily due to the funding of the 1999 operating loss and the reduction in the Company's accounts payable during the first quarter of 1999. Cash provided by investing activities totaled $7.8 million for the first quarter of 1999, compared to $2.9 million of cash used during the same period last year. The increase in cash provided by investing activities is due to a nonrecurring cash receipt from Claricom. On February 26, 1999, the Company received $9.3 million from Claricom as payment in full for Claricom's outstanding $5.9 million junior subordinated note plus interest, along with the redemption of the warrants issued to the Company as part of the sale of the direct offices in 1996. The Company used the proceeds to reduce outstanding bank borrowings and accounts payable. The Company used $2.9 million in cash from financing activities during the first quarter of 1999. Cash was used to repay $1.6 million in borrowings, along with $1.3 million to repurchase 420,000 of the Company's common stock. During the same period in 1998, the Company used $0.2 million in cash in its financing activities, primarily for debt repayment. Total debt as of March 31, 1999 was $23.7 million, a decrease of $0.8 million from $24.5 million at December 31, 1998. The decrease is a result of a reduction in the Company's bank borrowings by $1.3 million and the repayment of $0.2 million in capital lease obligations. Debt was increased by $0.6 million in connection with the acquisition of a new computer software system, along with an increase to the carrying value of the convertible subordinated debentures of $0.1 million due to accretion. The Company believes that borrowings available under the credit facility and cash flow from operations will be sufficient to meet working capital and other requirements for the next twelve months. 20 PART II - OTHER INFORMATION Item 1. LEGAL PROCEEDINGS See Note F of the Notes to Consolidated Financial Statements in Part I, Item 1 for details on legal proceedings. 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 Not applicable. 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 (see Note D of Notes to Consolidated Financial Statements in Part I, Item 1). b) Reports on Form 8-K On April 29, 1999, with the withdrawal of the eLottery Registration Statement on Form S-1 on April 14, 1999 and the impending sale of the Company's core businesses (see Note G of Notes to Consolidated Financial Statements in Part I, Item 1), the Company filed a Current Report on Form 8-K to disclose the risk factors that could materially adversely affect the performance of eLottery. 21 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: April 29, 1999 /s/ Stanley J. Kabala Stanley J. Kabala Chairman, President and Chief Executive Officer Dated: April 29, 1999 /s/ Edward W. Stone Edward W. Stone Senior Vice President and Chief Financial Officer 22 EX-27 2
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 March 31, 1999 and is qualified in its entirety by reference to such financial statements. 1000 3-MOS DEC-31-1999 MAR-31-1999 911 0 25,569 1,563 23,610 53,396 23,540 13,213 99,044 34,466 22,641 0 7,300 494 31,698 99,044 31,749 31,749 21,376 21,376 13,833 38 753 (3,030) 0 (3,030) 0 0 0 (3,030) (0.06) (0.06)
-----END PRIVACY-ENHANCED MESSAGE-----