-----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, Mm1GxTSVD3N7DaRXKGT8AQN+HE+qEQUAwC6+xJ5d/6vbvFKZyKSymHJJxMarUots 5dPDqVDwsEM+tDPJUbDYGQ== 0000950117-97-000238.txt : 19970222 0000950117-97-000238.hdr.sgml : 19970222 ACCESSION NUMBER: 0000950117-97-000238 CONFORMED SUBMISSION TYPE: 10-K405/A PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19951231 FILED AS OF DATE: 19970218 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-K405/A SEC ACT: SEC FILE NUMBER: 000-11551 FILM NUMBER: 97537770 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-K405/A 1 EXECUTONE INFORMATION SYSTEMS, INC. 10K405/A FORM 10-K/A SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For the fiscal year ended December 31, 1995 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from ____________ to ________________ Commission File Number: 0-11551 EXECUTONE INFORMATION SYSTEMS, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Virginia 86-0449210 - -------------------------------------------------------------- ----------------- (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 478 Wheelers Farms Road, Milford, Connecticut 06460 - -------------------------------------------------------------- ----------------- (Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (203)876-7600 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered ------------------- ------------------------------------------ N/A None Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR VALUE $.01 PER SHARE 7 1/2% CONVERTIBLE SUBORDINATED DEBENTURES, DUE MARCH 15, 2011 - -------------------------------------------------------------------------------- (Title of Class) - -------------------------------------------------------------------------------- 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 --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] The aggregate market value of the common stock held by nonaffiliates of the registrant (assuming for this purpose that all executive officers and directors of the registrant are affiliates) as of March 29, 1996 was $125,909,320, based on the last sale price for the common stock on that date. The number of shares outstanding of the registrant's only class of common stock, $.01 par value per share, as of March 29, 1996, was 51,865,163. DOCUMENTS INCORPORATED BY REFERENCE The following documents are incorporated by reference into the Part of this Form 10-K indicated below: Part II - 1995 Annual Report to Shareholders TABLE OF CONTENTS
Item Page PART I 1. Business 1 2. Properties 15 3. Legal Proceedings 15 4. Submission of Matters to a Vote of Security Holders 16 Executive Officers of the Registrant 17 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters 20 6. Selected Financial Data 20 7. Management's Discussion and Analysis of Financial Condition 20 and Results of Operations 8. Financial Statements and Supplementary Data 20 9. Changes in and Disagreements with Accountants on 20 Accounting and Financial Disclosure PART III 10. Directors and Executive Officers of the Registrant 20 11. Executive Compensation 22 12. Security Ownership of Certain Beneficial Owners and Management 28 13. Certain Relationships and Related Transactions 31 PART IV 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 32
PART I ITEM 1. BUSINESS General EXECUTONE Information Systems, Inc. ("EXECUTONE" or the "Company") designs, manufactures, sells, installs and supports voice processing systems and healthcare communications systems. EXECUTONE also provides cost-effective long-distance telephone service through its INFOSTAR'r'/LD+ program. Products are sold under the EXECUTONE'r', INFOSTAR'r', IDS'tm', LIFESAVER'tm' and INFOSTAR/ILS'tm' brand names through a worldwide network of direct sales and service offices and independent distributors. EXECUTONE's executive offices are located at 478 Wheelers Farms Road, Milford, Connecticut 06460, telephone (203) 876-7600. The Common Stock of EXECUTONE is traded on the NASDAQ National Market System under the symbol "XTON", and its Convertible Subordinated Debentures due 2011 trade on the NASDAQ system under the symbol "XTONG". Recent Developments On April 10, 1996, the Company entered into an agreement to sell the Company's direct sales and service organization, including its network services division, to a new acquisition company led by Bain Capital, Inc. and including Triumph Capital Group (the "Buyer"). The purchase price will consist of $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. The sale is expected to close on May 31, 1996, subject to the Buyer's financing and other conditions. The purchase and sale agreement also provides that the Company and the Buyer will enter into a five-year exclusive distributor agreement pursuant to which the Buyer will sell and service EXECUTONE'r' and INFOSTAR'r' telephone products to business and commercial locations that require up to 400 telephones. The sale will include the Company's National Service Center. The sale does not include the Pittsburgh direct sales and service office, which the Company has separately agreed to sell to one of its existing independent distributors for approximately $1.3 million in cash and notes. The sale of the Direct Sales and Service Group (including the separate sale of the Pittsburgh office) relates primarily to the retail distribution channel of the Computer Telephony division and includes the entire network services division. After the sale, the Computer Telephony division consists of telephony product sales to independent distributors, of which Clarity is the largest distributor, along with the National Accounts and Federal Systems marketing groups. The Company retains its Healthcare Communications and Call Center Management businesses and the Unistar business. On April 10, 1996, the Company also announced that it had given notice of its intention to terminate its distribution agreement with GPT Video Systems due to failures by GPT to deliver properly functioning videoconferencing products on a timely basis. In June 1996, the Company completed the sale of its videoconferencing division, including customer service contracts and certain inventory, to BT Visual Images LLC for approximatley $115,000, plus the assumption of certain liabilities relating to the business, of the division. 1 In April 1996, the Company also sold its inmate calling business, including certain equipment and customer contracts, for approximately $550,000 plus the assumption of certain obligations relating to the business. This business was part of the Computer Telephony division. On December 19, 1995, the Company acquired 100% of the common stock of Unistar Gaming Corp., a Delaware corporation ("Unistar"). Unistar, through its subsidiary Unistar Entertainment, Inc., has an exclusive five-year contract to design, develop, finance, and manage the National Indian Lottery (the "NIL" or "Lottery"). The NIL will be a national telephone lottery authorized by federal law and by a compact between the State of Idaho and the Coeur d'Alene Indian Tribe of Idaho ("Coeur d'Alene Tribe"). In return for providing these management services, Unistar will be paid a fee equal to 30% of the profits of the NIL. The Company acquired 100% of Unistar for 3.7 million shares of Common Stock, 250,000 shares of Cumulative Convertible Preferred Stock, Series A ("Series A Preferred Stock") and 100,000 shares of Cumulative Contingently Convertible Preferred Stock, Series B ("Series B Preferred Stock"). The Series A Preferred Stock has voting rights equal to one share of Common Stock and will earn dividends equal to 18.5% of the consolidated Retained Earnings of Unistar as of the end of a fiscal period, less any dividends paid to the holders of the Series A Preferred Stock prior to such date. The Series B Preferred Stock has voting rights equal to one share of Common Stock and will earn dividends equal to 31.5% of the consolidated Retained Earnings of Unistar as of the end of a fiscal period, less any dividends paid to the holders of the Series B Preferred Stock prior to such date. All dividends on Preferred Stock are payable (I) when and as declared by the Board of Directors, (ii) upon conversion or redemption of the Series A and Series B Preferred Stock or (iii) upon liquidation. 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. 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) if Unistar meets certain revenue and profit parameters. Shareholder approval is required before any of the Series B Preferred Stock can be converted or redeemed. The Company intends to submit the terms of the Series B Preferred Stock to its shareholders for approval at the 1996 Annual Meeting. The telephone operations of the NIL cannot begin until the resolution of a pending legal proceeding. Certain states have attempted to block the NIL by filing letters under 18 U.S.C. Section 1084 preventing long-distance carriers from providing telephone service to the NIL based on allegations that the NIL is not legal. The Coeur d'Alene Tribe has initiated legal action to argue that the Lottery is authorized by the Indian Gaming Regulatory Act ("IGRA") passed 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 Coeur d"Alene Tribal Court ruled that all requirements of IGRA have been satisfied, that the Section 1084 letters are invalid, and that the long distance carrier is obligated to provide telephone service for the NIL. This ruling and a related order dated May 1, 1996 are being appealed to the Tribal Appellate Court and probably will be appealed to 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 National Indian 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 should be upheld on appeal. 2 In July 1995, the Company reorganized its core business into five divisions: Computer Telephony, Healthcare Communication Systems, Call Center Management, Videoconferencing Products, and Network Services. The business of Executone, Inc. acquired by the Company in 1988 was a telephone equipment business that focused its direct selling effort on office sites with fewer than 20 phones, with an emphasis on selling additional hardware to generate revenues in the form of moves, adds and changes ("MAC") and service, mainly on a time and material basis. The average system size in the customer base at that time was in the 8-10 phone range. It was originally expected in 1988 that the MAC and service revenues generated by the customer base would be increasingly profitable as the base of customers grew. Since 1988, the Company has expanded its product line to the high-end user, with larger customers and more sophisticated products to serve customers' total communications needs. The strategy the Company is now pursuing is to focus on software solutions versus the hardware orientation of the business purchased in the 1988 acquisition. With the IDS product, a digital platform for various communications functions, which was developed after the acquisition, the Company's product lines now provide sophisticated software applications, including integrated voice mail, call center applications (ACD, IVR's and predictive dialers), infrared locator systems, nurse call systems and computer telephony interfaces that drive its telephony products. The development in the nature and complexity of our product lines has changed the way the Company has to market its products. Unlike many companies in its industry that focus on one particular product to one market, the Company provides multiple products and applications to its particular market niche. This requires the Company to have expertise in each particular market segment in which it competes because the Company's competitors are primarily one-product companies or divisions who are experts in their particular market niche. Therefore, the Company consolidated the sales, marketing and product development functions for each market segment under a divisional management structure, headed by a division president. The sales force has been restructured such that each sales person is assigned to a specific division and will sell only within that division's market segment. The specialization of the sales force included the addition of sales representatives with the necessary product and market expertise, as well as substantial retraining for the remaining sales representatives. Business Strategy EXECUTONE is a vertically integrated voice processing and healthcare communications company. The Company controls the major elements of its business, ranging from product design, manufacturing and marketing to distribution, installation, service and support. Revenues are derived from both from new installations and from the Company's existing customer base through additions, changes, upgrades or relocation of previously installed systems, maintenance contracts, service charges and sales of network services. The Company's products and services are marketed and sold through a worldwide network of Company direct sales and service offices and independent distributors. The Company is organized into five divisions focusing on different products and market segments: computer telephony, healthcare communication systems, call 3 center management, videoconferencing products, and network (voice, data and video) services. The objective of the computer telephony division is to offer value-added products and services. The Company's integrated digital telephone systems emphasize flexible software applications, such as data switching and computer telephone interface, designed to enhance the customer's ability to communicate, obtain and manage information. The Company's telephone systems provide the platform for its other voice processing software applications, such as automatic call distribution. The healthcare communications systems division provides to its healthcare facility customers integration of voice and data between nurse and patient communication systems and hospital information systems, resulting in increased flexibility and efficiency in hospital operations, and improved patient care. EXECUTONE has been a recognized name in this market for many years with its LIFESAVER'tm' and CARE/COM'r'II-E nurse call systems. The Company is also creating software applications specific to hospital and nursing homes to help resolve other labor intensive tasks. The healthcare communications division also markets the INFOSTAR/ILS'tm' locator system, released in early 1994. The INFOSTAR/ILS system can improve productivity, save time and expense for users and eliminate overhead paging by instantly locating staff and equipment in a facility. Each person or piece of equipment wears an individually coded badge that transmits infrared signals to sensors placed throughout the facility, which forward the location information to a central processing unit. The location data can be accessed on local display stations. The ILS'tm' system can be integrated with the Company's telephone systems and the LIFESAVER'tm' nurse call system to provide additional productivity improvements for hospital environments. The ILS system is also marketed by the computer telephony division for office environments. The call center management division develops and sells sophisticated telephony products that integrate a computerized digital telephone system platform with high-volume inbound, outbound and internal call processing systems. Such systems include automatic call distribution systems, predictive dialing systems, scripting software to assist agents handling calls, and interactive voice response systems. Certain of these systems also provide data interface with host or mainframe computers. These systems are sold to call center customers that have a need for systems to efficiently and cost-effectively receive or place their customer or prospect calls, distribute those calls to available live operators, obtain information from callers, record and distribute messages from callers, and produce management reports on call activity. The videoconferencing division is the exclusive distributor of products of GPT Video Systems ("GPT") in the United States. The division also provides videoconferencing network services such as multipoint conferencing, network bridging and network design to its videoconferencing customers. The network services division offers cost-effective voice, data and video 4 long-distance service, least-cost routing, network design and network support services, enabling customers to make more efficient and cost-effective use of their telecommunications systems. Services are sold primarily to telephony customers in the United States. In 1995, the Company acquired Unistar. Unistar, through its subsidiary Unistar Entertainment, Inc., has an exclusive five-year contract with the Coeur d'Alene Tribe of Idaho to design, develop, finance, and manage the National Indian Lottery (the "NIL" or the "Lottery"). The NIL will be a national telephone lottery authorized by the federal Indian Gaming Regulatory Act ("IGRA") and a compact between the State of Idaho and the Coeur d'Alene Tribe. In return for providing these management services to the NIL, Unistar will be paid a fee equal to 30% of the profits of the NIL. Through Unistar, the Company will provide development and management of the network design and call center applications for the Lottery's operations. It is anticipated that calls to purchase lottery tickets will be made via 800 number lines and processed by interactive voice response systems, as well as live agents located on the Coeur d'Alene Reservation using ACD software to manage a high volume of calls. The Lottery will require an extensive telephone network to handle the anticipated call volume. The telephone operations of the NIL cannot begin until resolution of a pending legal proceeding. See "Legal Proceedings." Computer Telephony Products The Company offers a complete line of applications-oriented computer telephony systems, ranging from those satisfying the basic voice communications needs of small businesses to those capable of meeting the complex voice and data communications demands of much larger business locations that need fully featured telecommunications systems. The Company markets the IDS'tm' Integrated Digital System, along with an expanding line of software applications and features operating on that platform. The Company's largest telephone platform is the IDS'tm'/System 648 digital system, which can accommodate up to 648 nonblocking voice ports and 648 nonblocking data ports. The Company believes its installed telephone equipment base exceeds 3 million desktops. In 1996, the Company introduced its TAPI telephone, designed to support any desktop application using the TAPI standard for computer-telephone integration, in order to speed inbound and outbound call handling and increase productivity. The TAPI telephone can eliminate time spent searching for telephone numbers, looking up PBX feature codes, misdialing or searching for information to handle a call. The Company's telephone systems are characterized by flexible software and a hardware design that makes them readily adaptable to evolving technology and customer requirements. The Company attributes the market acceptance of its systems to cost-effective design and to the sophistication of its software options. The software in each system provides such features as automatic dialing, add-on conferencing, call forwarding, last number redialing, message waiting, paging capability, internal diagnostic routines and other commonly used communications features. The Company's systems also include an integrated 5 automated attendant feature to answer and transfer calls quickly and efficiently without operator intervention, and a video display terminal and management reports that permit the monitoring of calls and improve the efficiency of directing calls to the appropriate extensions. The Company's telephone systems also support sophisticated applications such as voice mail and call center products as well as the Company's locator system. The Company also offers a voice mail system that can be integrated with the IDS'tm' telephone systems and with telephone systems manufactured by others. The voice message or voice mail system receives, records, stores, distributes, transfers and replays messages from both external and internal callers and can supplement other call center systems. The Company develops its application-specific software options using high-level programming languages to facilitate further enhancements and portability. EXECUTONE's software includes remote capabilities built into certain systems that enable the Company to customize and update selected features continuously, which increases the value of such systems and lengthens their useful lives. Certain of the Company's systems are capable of having service diagnostics, updates and modifications performed on a remote basis. The ability to provide such off-site servicing increases the efficiency of customer support and service. Healthcare Communication Products The Company develops, manufactures, markets and services a line of specialized internal communications systems that are used primarily in the healthcare industry. These internal communications systems are microprocessor-based patient-to-nurse communication systems, intercoms, paging and sound equipment, and room status indicators. The Company's LIFESAVER'tm' nurse call system is an advanced system integrating voice and data communication between nurse and patient and providing enhanced self-diagnostics. The LIFESAVER'tm' system is a state-of-the- art communications network that provides routine and emergency signaling, voice communications and data transmission. The nurse console offers menu-driven functions and step-by-step user prompts. The system is highly flexible, offering many programmable features that allow customization of its operations to the hospital's needs. A single system can serve more than 300 patient beds (150 rooms) and up to eight nurse control stations, and up to eight systems can be networked for centralized operation. The CARE/COM'r' II-E nurse call system represents the first step in EXECUTONE's plan to bring the benefits of a totally integrated communications system to the healthcare market on the Company's IDS digital platform. The CARE/COM'r' lI-E system provides patient-to-staff and staff-to-staff voice communication on an automatic three-level call priority basis. This new system can currently support 72 patient stations per system, with the ability to integrate three systems together and support 216 patient stations. A three-line LCD display Nurse Control Station allows simple call processing and system operation. The 6 system is highly flexible to meet the individually defined needs of today's hospitals and long-term care facilities. The LIFESAVER'tm' nurse call system integrates with the Company's locator system. The Healthcare Division also markets the INFOSTAR'r' /PRS patient reporting system, an automated voice storage system that allows the efficient transfer of patient information between nurses. Patient reports are password- protected for confidentiality and admission, discharge and transfer information are also supported. The system uses standard telephone instruments and provides full voice messaging capability. The INFOSTAR'r'/PRS system reduces report time, provides continuity at shift changes, and improves report quality. In 1995, the Healthcare Division began marketing the Communicator system manufactured by Dialogic Communications Corporation, in which the Company has an equity investment. The Communicator product is a P.C.-based, automated callout system that rapidly locates personnel to fulfill routine or emergency staffing needs, searching multiple locations until responses are sufficient to satisfy the staffing need. The system also provides real-time management reports of employee eligibility, availability, and responses. Using the Communicator system, hospitals can improve staffing efficiency, avoid miscommunication, and enhance productivity. Locator Systems The Company's INFOSTAR/ILS'tm' locator system is an integrated system using infrared transmitter badges to communicate location data to sensors installed throughout a facility. The badges transmit regularly at user-programmed intervals and can be worn by staff personnel or attached to equipment. The location data is collected by the sensors and forwarded to a central processing unit that organizes the data so it can be accessed at one or more display stations. The display of staff and equipment location information can be in the form of a list or in the form of a map of the facility using icons. The display can be filtered to show only particular staff members, groups of personnel, particular pieces of equipment or groups of equipment. The system can be integrated with either the IDS telephone systems, allowing the activation of features and display of information on the telephone set, or the Company's nurse call systems, allowing the activation of features and display of information at the nurse control station and patient stations. The INFOSTAR/VLS'tm' version of this product allows outside callers to locate personnel within a facility, find out who the person is with, complete the call, or leave a voice message. The ILS and VLS systems can also be integrated to other manufacturers' PBXs. Nortel has now made ILS available to its dealer network for sale by its dealers in conjunction with Nortel PBXs. Call Center Management Products The Company's call center management products consist of the following systems, which can be integrated with the Company's computer telephone systems and with each other to provide large-volume inbound, outbound and 7 internal call management. Computer-telephone integration ("CTI") technology integrates the IDS'tm' call processing function with information in a customer's computer database. Primarily used by large incoming call centers to automatically identify incoming callers and by outbound centers to contact and provide records of contacts, CTI limits the amount of time that an agent spends contacting or identifying the caller, thereby providing better customer service, reducing the number of required agents and reducing telephone line and transmission expense. Predictive Dialers and Scripting Products - The INFOSTAR'r'/Predictive Dialer is an automated call system designed to boost productivity in outbound call centers. The system integrates telephone, data collection and transaction processing functions for those customers who require high volume contact by telephone to transact business, such as sales, credit and collections, blood banks and fund-raising. Working with the host computer and the IDS'tm' telephone system platform, the dialer automatically dials telephone numbers pulled from the host computer database and detects "live" calls. Available representatives receive these calls and, through CTI, can view screen information about the customer from the database immediately after the customer answers the phone. The system predicts the availability of agents in order to reduce abandoned calls and increase agent productivity, and reduces agent contact with busy signals, no answers, wrong numbers and answering machines. Management reports provide instant and historical feedback on call distribution, list management, data input integrity and file maintenance. Scripting software allows the call center to create a script to guide its agents through various call scenarios and prompt the input of desired information. Automatic Call Distribution ("ACD") - ACD systems are designed to increase responsiveness to inbound callers and increase agent productivity. ACD systems provide the capability to distribute or route incoming calls to available agents based upon management's specifications, and allow the supervisor of the call processing group to monitor call traffic on-line via a computer terminal. The Company produces ACD software for call centers of up to 500 agents in multiple shifts (225 in any single shift), in five levels of sophistication, the highest of which is "Custom Plus ACD." Custom Plus ACD provides the capability to store and retrieve call data for a limited period, print out standard call traffic reports, customize reports to the needs of a specific application, monitor traffic with color screens and graphics, and greatly enhance the ability to store and retrieve historical call data. Interactive Voice Response - The Company's interactive voice response ("IVR") systems provide businesses with automated handling of routine calls. Voice response systems allow callers to input and retrieve information into or from computers by means of the dialpads on their telephones. The caller is guided by voice prompts to input data by dialing numbers, which the IVR system converts into computer keystrokes. The IVR system can also convert computer screen information into voice prompts, allowing callers to retrieve information from computers. The voice response product provides advanced computer access applications and advanced facilities, such as ISDN, that interface with the Company's IDS'tm' family of telephone systems and other advanced voice processing applications. 8 Videoconferencing Systems and Services The Videoconferencing Division markets videoconferencing equipment in the United States and provides video network services including video networking, network design, multipoint conferencing, and video network bridging. The Company provides its videoconferencing customers with a "turnkey" solution including equipment installation, network services, maintenance and customer support. Network Services The Company markets INFOSTAR'r'/LD+ long-distance telephone service to its customers. INFOSTAR'r'/LD+ provides a complete service to the Company's customers from the initial sale through billing and customer support. The Company has contracted with major carriers including Sprint, Worldcom and Teleport Communications to carry the long-distance traffic for both voice and data on their networks. The Company has also signed agreements to provide alternative local access in select cities throughout the U.S. This program offers many features including six-second billing rates, accounting codes, international service, 800 service, "T-1" access and specialized management reporting. The Company also provides the following network services: Network Designer - The Company can perform a computer-generated analysis of a customer's calling patterns in order to recommend the optimum configuration of its network. Recommendations would include the long-distance carriers and the number of lines needed. Least Cost Routing ("LCR") - LCR stores current tariff tables for the appropriate long-distance carriers employed by the customer and automatically selects the least expensive carrier for each specific call at the moment the call is placed. Data Switching - Data switching provides the capability to switch data between mainframe, minicomputers, personal computers, terminals and peripherals through the telephone systems. Centrex Capability and Applications - The Company's telephone systems can be programmed to function in conjunction with and enhance the features of Centrex services offered by the local telephone companies. Sales and Marketing Developing and maintaining a strong relationship with the end-user customer is the focus of the Company's marketing strategy. The Company's distribution network consists of (1) 70 Company-owned direct sales and service locations in the major markets in the United States; (2) domestic independent distributors with approximately 110 locations operating under exclusive and 9 nonexclusive agreements throughout the United States and Canada; (3) a National Accounts Division that uses the sales, installation, service and support capabilities of EXECUTONE's distribution network to serve multiple offices and departments of companies; (4) a Federal Systems Division that uses the distribution network to serve offices of the U. S. Government and its agencies; (5) vertical marketing organizations of the healthcare communications, call center, network and videoconferencing divisions; and (6) 20 independent distributors operating in sixteen other foreign countries. For those distributors that have exclusive distribution rights for specified products, retention of such rights is subject to satisfaction of established criteria for sales and service to customers on an ongoing basis. The divesting of or acquisition of customer bases to or from distributors in specific geographic territories may occur in the normal course of the Company's business. EXECUTONE's National Accounts Division provides uniformity in pricing, coordination, installation, billing and service for National Accounts Division customers such as Electronic Data Systems, Airborne Express, Paychex, Inc., W. W. Grainger, Home Quarters Warehouse, Inc., Bridgestone/Firestone, Carlson Companies, Fidelity Investments and TCI Cable. The Division coordinates the sales, installation, service and support functions of direct and independent sales offices to serve the multiple offices and departments of large companies. The Company's Federal Systems Division addresses the special procurement and administrative requirements of the U.S. Government. Sales are made through a combination of master contracts and competitively solicited proposals for large or complex telecommunications requirements. Federal Systems coordinates the installation, service and support activities of direct and independent sales offices to provide ongoing support to federal agency offices nationwide. Backlog consists primarily of products that have been ordered and that will be shipped or installed within 30 to 60 days of the order (other than call center and healthcare orders, which have a longer lead time), or systems the installation of which is not yet required by the customer. Backlog as of December 31, 1995, was $ 33,091,000 compared to $29,390,000 at December 31, 1994, and the Company expects virtually all of such backlog to be filled within the current fiscal year. Customer Support and Service The Company operates a National Service Center that diagnoses system problems for many of the end-user customers of its direct sales and service offices, coordinates field service personnel and programs certain corrections remotely from a centralized location at its corporate headquarters. The National Service Center helps the Company in providing consistent customer service and support while improving the productivity of the Company's technicians. All service calls received from customers are controlled from initial diagnosis to ultimate disposition through an internally-developed and maintained proprietary software package. The National Service Center maintains detailed customer records and also markets and monitors certain products and services such as maintenance 10 contracts. It is the primary point of contact for customer needs, questions or requests. Additionally, the National Service Center provides the Company with statistical data and reports regarding a product's performance, which can be used to make enhancements and improvements. This data is also available for each of the Company's locations and each of its technicians. EXECUTONE warrants parts and labor on its systems, typically for one year, and provides maintenance and service after warranty expiration either on a contract or time and materials basis. Most of the Company's products are repaired at its 56,000-square foot repair facility located in Poway, California. Product Development and Engineering As of March 1, 1996, EXECUTONE employed over 100 individuals engaged in product design and development. The Company's product development program is designed to anticipate and respond to customer needs through development of new products and enhancement of existing products. During 1995, the Company's engineering efforts focused on applications-oriented software products, including new releases of voice messaging, call center and healthcare communications software. EXECUTONE continually strives to reduce production costs by incorporating new technology into its design and manufacturing operations. For the years ended December 31, 1995, 1994, and 1993, Company-sponsored product development and engineering expenditures (including product management and testing) amounted to approximately $14.7 million, $12.2 million, and $9.9 million, respectively. Manufacturing Most of EXECUTONE's telephone products are manufactured by Wong's Electronics Company, Ltd. ("Wong's") in Hong Kong or China, by Quality Telecommunication Products, also referred to as Compania Dominicana de Telefonos ("Codetel"), in the Dominican Republic, and by the Company directly in Poway, California. Many of the printed circuit boards for the Company's products are manufactured, and many products are assembled into systems and system components, in the United States. The Company's Manufacturing Services Agreement with Wong's currently expires in February 1997 but is automatically extended each year for an additional one-year term unless either party gives notice of termination three months prior to expiration of the current term. The contract may be terminated earlier by either party in the event of a material breach by the other party. If the agreement between Wong's and EXECUTONE should be terminated for any reason, or if Wong's is unable to ship or has to reduce shipments, or if restrictions are imposed materially limiting the importation of products produced by foreign manufacturers, the Company could be affected adversely until satisfactory alternative sources are in place. The profitability of EXECUTONE's operations could be affected to the extent it is unable to reflect the direct and indirect costs of products purchased from Wong's in its pricing policies. The prices for products purchased by EXECUTONE from its suppliers are payable in U.S. 11 dollars. The majority of EXECUTONE's specialized healthcare and internal communication systems are produced in the United States at the Company's facility in Poway, California or at domestic subcontractors. The functions of repair, warehousing and distribution of the Company's products are performed at the Company's facilities in Poway. Trademarks, Patents and Copyrights Management believes that the continued success of EXECUTONE is dependent upon the ability to design, develop and market new products and new or enhanced applications. The patentability of such new products or applications is evaluated and patent applications are filed where necessary to protect unique developments. The Company currently holds eight utility patents, expiring at various times between 2007 and 2012, has 13 U.S. patent applications pending, and seven patent applications pending in numerous foreign countries. The Company has registered or applied to register its trademarks when it believes registration to be important to its ongoing business operations. The Company also generally claims copyright protection for software, circuit designs, schematics and technical documentation used in connection with its products, and relies upon trade secret, contract and copyright laws to protect its proprietary rights in its software, designs and documentation. Certain of EXECUTONE's products incorporate technology and software licensed from independent third parties. Generally, these licenses require payment of a royalty for each system sold that incorporates the licensed technology or require that the Company purchase the product from the licensor. Government Regulation Many of the Company's systems are designed to be connected to the public telecommunications network and as such are required to comply with certain rules of the Federal Communications Commission ("FCC") pertaining to telecommunications equipment. The Company's network services are generally required to be tariffed and are subject to regulation by the public utility commissions of the various states and by the FCC. The Company has not experienced any material adverse effect on its business or operations as a result of such regulation and compliance. Certain uses of outbound call processing systems are regulated by federal and state law. Among other things, the FCC has adopted rules pursuant to the Federal Telephone Consumer Protection Act to protect residential telephone subscribers' privacy rights to avoid receiving telephone solicitations to which they object. Certain states have enacted similar laws limiting access to telephone subscribers who object to receiving solicitations. Although compliance with these laws may limit the potential use of the Company's predictive dialer systems in some respects, the Company's systems can be programmed to operate 12 automatically in full compliance with these laws through the use of appropriate calling lists and calling campaign time parameters. To the extent the Company markets its products internationally, it is required to comply with applicable foreign law, including certification of its products by appropriate government regulatory organizations. Competition The market segments in which the Company offers its products and services are highly competitive. The under 300-desktop voice processing segment in the United States, the primary market for the Company's telephony division, is served by many domestic and foreign communications equipment manufacturers and distributors, including Lucent Technologies (the former equipment business of AT&T), Nortel (formerly named Northern Telecom), and the Regional Bell Operating Companies (the "RBOCs"), as well as numerous specialized software companies. The Company believes that it may be third in telephone system shipments to the under 300-desktop voice processing market, after AT&T/Lucent and Nortel, based on industry surveys of 1994 data. However, such information may not be sufficient to make an exact assessment of the Company's competitive position relative to its competitors. Similarly, the Company faces strong competition in network services, including AT&T, MCI, Sprint, and numerous long distance resellers. Although the Company can be competitive on price compared to several of these companies, many of EXECUTONE's competitors have substantially more capital, technology and marketing resources than the Company. Competition in the Company's market segments is expected to increase significantly with passage in February 1996 of the Telecommunications Act of 1996 (the "Act"). Under the Act, long-distance companies, cable companies and others will be permitted to compete with local telephone companies to offer local service. The RBOCs and other local telephone companies will be permitted to offer long-distance services if their local market meets certain criteria to measure the existence of local competition. The Company believes its call center division is in a good competitive position although to date it has not penetrated a significant portion of this market. The Company believes it is currently the only vendor that supplies inbound, outbound and administrative call processing integrated with a telephone system platform. The Company's principal competitors in healthcare communications are Hill-Rom Company, DuKane and Rauland-Borg. The Company believes it has a strong competitive position in nurse call and locator products. The Company believes that it has several competitors in videoconferencing but is not yet able to estimate its competitive position relative to such competitors. The Company competes by offering a full array of integrated 13 telecommunication products and services to its customers. The Company also competes on the basis of the quality of its products, its customer service, nationwide distribution and installation, and price. Employees As of March 1, 1996, EXECUTONE employed approximately 2,400 persons, directly and through its subsidiaries. Approximately 5% of the employees of the Company and its subsidiaries are represented by unions, all of which are represented by the International Brotherhood of Electrical Workers. Management believes that the Company's relations with its employees are good. 14 ITEM 2. PROPERTIES EXECUTONE's principal offices are located in two leased buildings in Milford, Connecticut. The Company has sales offices, warehouses, manufacturing and distribution facilities throughout the United States. As of December 31, 1995, the Company utilized 73 facilities in the United States with an aggregate of approximately 792,000 square feet for its ongoing operations. The Company's facilities are occupied under lease agreements except for one facility. This Company-owned building is approximately 15,000 square feet, and is used for a direct sales and service office. The current annual rent for the Company's facilities is approximately $9.2 million. The Company has one facility totaling approximately 14,000 square feet of space that is no longer used in ongoing operations and is subleased. The Company believes its facilities are adequate and generally suitable for its business requirements at the present time and for the immediate future. The following is a brief description of the primary facilities of the Company.
Use Location Approximate Size Corporate and Direct Sales Milford, Connecticut 150,000 square feet Headquarters; National Customer Service Center; and Research, Development and Engineering Facility Distribution, Production & Poway, California 115,000 square feet Repair Center and Warehouse Direct Sales and Service Major cities across U.S. 496,000 square feet Offices, including warehouses
ITEM 3. LEGAL PROCEEDINGS On October 16, 1995, the Coeur d 'Alene Tribe filed an action entitled Coeur d'Alene Tribe v. AT&T Corp. in the Tribal Court, located in Plummer, Idaho (Case No. C195-097), requesting a ruling that the NIL is legal under IGRA, that IGRA preempts state laws on the subject of Indian gaming, and the NIL cannot be blocked by state action, 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. The telephone operations of the NIL cannot begin until resolution of this proceeding and agreement of a network carrier to carry the network traffic of the NIL. On February 28, 1996, the Tribal Court ruled that all 15 requirements of IGRA have been satisfied, that the Section 1084 letters are invalid, and that AT&T is obligated to provide telephone service for the NIL. This ruling and a related order dated May 1, 1996 are being appealed to the Tribal Appellate Court and probably will be appealed to 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 National Indian 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 should be upheld on appeal. However, this litigation, as well as other litigation which could be brought by states opposed to the NIL, could delay commencement of operations, and it is impossible at this time to predict when the NIL will commence 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. The Company currently is a named defendant in a number of lawsuits and is a party to a number of other proceedings that have arisen in the normal course of its business. Those lawsuits and proceedings relate primarily to the collection of indebtedness owed to the Company, the performance of products sold by the Company, and various contract disputes. In the opinion of the Company, these proceedings are not expected to have a material adverse effect on the consolidated financial position, results of operations or liquidity of the Company and, to the extent they are not covered by insurance, reserves adequate to satisfy such liabilities have been established. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders in the fourth quarter of the fiscal year covered by this report. 16 EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company are as follows:
Name Age Position With Company Alan Kessman 49 Chairman of the Board, President and Chief Executive Officer Stanley M. Blau 58 Vice Chairman of the Board Michael W. Yacenda 44 Executive Vice President Barbara C. Anderson 44 Vice President, General Counsel and Secretary James E. Cooke III 47 Vice President, National Accounts Anthony R. Guarascio 42 Vice President, Finance and Chief Financial Officer Israel J. Hersh 42 Vice President, Software Engineering Elizabeth Hinds 54 Vice President, Human Resources Robert W. Hopwood 52 Vice President, Customer Care Andrew Kontomerkos 50 Senior Vice President, Hardware Engineering and Production David E. Lee 49 Vice President, Business Development John T. O'Kane 66 Vice President, MIS Frank J. Rotatori 53 Vice President, Healthcare Sales Shlomo Shur 46 Senior Vice President, Advanced Technology
Alan Kessman has served as Chairman and Chief Executive Officer of the Company since 1988. Prior to that, he had served as President and Chief Executive Officer of ISOETEC Communications, Inc., a predecessor of the Company ("ISOETEC"), since 1983. From 1978 to 1983, Mr. Kessman served as President of three operating subsidiaries of Rolm Corporation, and from 1981 to 1983, he served as a Corporate Vice President of Rolm Corporation, responsible for sales and service in the eastern United States. Stanley M. Blau has served as Vice Chairman of EXECUTONE since 1988. Prior thereto, from June 1987 to July 1988, Mr. Blau was the President and Chief Executive Officer of Vodavi Technology Corporation, a predecessor of the Company ("Vodavi"). Mr. Blau was formerly the President and Chairman of the Board of Consolidated Communications, Inc., a telecommunications products 17 supply company he founded in 1973. Michael W. Yacenda has served as Executive Vice President of EXECUTONE since January 1990. Prior to that time, he was Vice President, Finance and Chief Financial Officer of the Company from July 1988 to January 1990. He served as a Vice President of ISOETEC from 1983 to 1988. From 1974 to 1983, Mr. Yacenda was employed by Arthur Andersen & Co., a public accounting firm. Mr. Yacenda is a certified public accountant. Barbara C. Anderson has been Vice President, General Counsel and Secretary since 1990. From 1985 to 1989, she was Corporate Counsel of United States Surgical Corporation, a manufacturer of medical devices. James E. Cooke III has served as Vice President, National Accounts since February 1995. Prior to that time, from 1992 until 1995, Mr. Cooke served as Division Manager of Operations for the Company, and from 1988 through 1991, Mr. Cooke was a District Manager for the Company. From 1985 until 1988, Mr. Cooke was the President of an interconnect company, and from 1981 to 1985, he was a General Manager and a Regional Manager of the Jarvis Corporation. For eight years prior to that time, he worked at Xerox Corporation in various sales and management positions. Anthony R. Guarascio has been Vice President, Finance and Chief Financial Officer since January 1994, and prior thereto was Vice President and Corporate Controller since January 1990. From 1984 until 1990, Mr. Guarascio was the Corporate Controller of the Company and ISOETEC. Israel J. Hersh has been Vice President, Software Engineering since February 1995. Mr. Hersh joined the Company as Director of Software Development in 1984, and was promoted to Senior Director of Software Engineering in January 1994. Prior to his employment with the Company, Mr. Hersh was a manager of the software development department for T-Bar, Inc. Mr. Hersh has a B.S. in Electrical Engineering from Tel Aviv University and a MS in Electrical Engineering from Bridgeport University. Elizabeth Hinds has been Vice President, Human Resources since January 1995. Prior to joining the Company, Ms. Hinds was Vice President, Human Resources of Chilton Company, a wholly-owned subsidiary of Capital Cities/American Broadcasting Company, Inc. ("CC/ABC"), from February 1993 until January 1995. Ms. Hinds was the Director of Human Resources for CC/ABC from June 1987 until February 1993. Robert W. Hopwood has served as Vice President, Customer Care since January 1990. From 1983 until 1990, Mr. Hopwood was the Director of Technical Operations of the Company and ISOETEC. Andrew Kontomerkos has been Senior Vice President, Hardware Engineering and Production since January 1994, and prior thereto was Vice President, Hardware Engineering since 1988. He served as a Vice President of ISOETEC since 1983. From 1982 to 1983, he was a Vice President and founder 18 of SAM Communications, Inc., a telecommunications research and development company which was one of the predecessors to ISOETEC; that corporation was merged into ISOETEC in 1983. From 1979 to 1982, Mr. Kontomerkos was Director of Telecommunications Systems Development of TIE/communications, Inc., a manufacturer of telecommunications systems. David E. Lee has been Vice President, Business Development since February 1995. Prior thereto, from October 1990 to February 1995, Mr. Lee was Division Manager for the Network Services Division of the Company. From 1984 until 1990, Mr. Lee held various management positions within the Company. Mr. Lee served as Director, International Finance of GTE Corporation from 1983 to 1984 and prior thereto, he held various financial management positions within GTE Corporation. John T. O'Kane has served as Vice President, MIS since January 1990. From 1988 until 1990, Mr. O'Kane was Director of MIS for the Company. Prior to that time and since 1981, he was the Vice President of MIS for Executone, Inc., a predecessor of the Company. Frank J. Rotatori has been Vice President, Healthcare Sales since February 1995. Prior thereto he was Vice President, European Operations since February 1994, and prior thereto was Director of Call Center Management Products during 1992 and 1993, Vice President-Direct Sales from 1990 through 1991 and Vice President-Customer Service of the Company from 1988 to 1990. Mr. Rotatori joined ISOETEC in 1986 as a regional manager. From 1982 to 1986, he served as General Manager and Eastern Regional Manager for Rolm Corporation. For 13 years prior to that time, he worked at Xerox Corporation in various manufacturing, accounting, sales and service management positions. Shlomo Shur has been Senior Vice President, Advanced Technology since January 1994, and prior thereto was Vice President, Software Engineering since 1988. He served as a Vice President of ISOETEC from 1983 to 1988. From 1982 to 1983, he was Vice President and a founder of SAM Communications, Inc., a telecommunications research and development company which was one of the predecessors to ISOETEC; that corporation was merged into ISOETEC in 1983. From 1978 to 1982, Mr. Shur was Manager, Software Development for TIE/communications, Inc., a manufacturer of telecommunications systems. 19 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Incorporated by reference to "Stock Data" in the Registrant's 1995 Annual Report to Shareholders. ITEM 6. SELECTED FINANCIAL DATA Incorporated by reference to "Selected Financial Data" in the Registrant's 1995 Annual Report to Shareholders. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Incorporated by reference to "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Registrant's 1995 Annual Report to Shareholders. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Financial Statements are incorporated by reference to the Financial Statements in the Registrant's 1995 Annual Report to Shareholders. The Schedule appears at pages S-1 through S-2 of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Directors The following persons are currently serving as directors and have been nominated by the Board of Directors as candidates for re-election as directors at the Annual Meeting of Shareholders to be held on July 30, 1996. Certain information regarding each director is set forth below, including each individual's principal occupation and business experience during 20 at least the last five years, other directorships in other public companies, and the year in which the individual was elected a director of the Company or one of its predecessor companies.
Director Name Age Principal Occupation Since Alan Kessman 49 President, Chief Executive Officer and 1983 Chairman of the Board of the Company since 1988; formerly President, Chief Executive Officer and Chairman of the Board of ISOETEC Communications, Inc. ("ISOETEC"), one of the Company's predecessor corporations, since 1983. From 1981 to 1983, Mr. Kessman served as a Corporate Vice President of Rolm Corporation. Stanley M. Blau 58 Vice Chairman of the Company since 1983 1988; formerly President and Chief Executive Officer of Vodavi Technology Corporation ("Vodavi"), one of the Company's predecessor corporations, from 1987 until July 1988. Thurston R. Moore 49 Partner, Hunton & Williams (Attorneys), 1990 Richmond, Virginia, since 1981. Richard S. Rosenbloom 63 David Sarnoff Professor of Business 1992 Administration, Harvard Business School, since 1980. Mr. Rosenbloom is a director of Arrow Electronics, Inc. Jerry M. Seslowe 50 Managing Director of Resource Holdings 1996 Ltd., an investment and financial consulting firm, since prior to 1991. William R. Smart 75 Senior Vice President of Cambridge 1992 Strategic Management Group in Cambridge, Massachusetts since 1984. From 1984 to 1992, Chairman of the Board, Electronic Associates, Inc. Mr. Smart is a director of National Data Computer Company and American International Petroleum Company.
Executive Officers See Part 1 for information and identification of executive officers of the 21 Company. Compliance with Section 16(a) of the Securities Exchange Act of 1934 Section 16(a) of the Securities Exchange Act of 1934 requires that the Company's directors and executive officers, and persons who own more than 10% of a registered class of the Company's equity securities, file with the Securities and Exchange Commission initial reports of ownership and reports of change in ownership of Common Stock and other equity securities of the Company. Officers, directors and greater than 10% shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms that they file. To the Company's knowledge, based solely on review of the copies of such reports furnished to the Company, and written representations that no other reports were required, during the fiscal year ended December 31, 1995, all Section 16(a) filing requirements applicable to its officers, directors and greater than 10% beneficial owners were complied with. ITEM 11. EXECUTIVE COMPENSATION Director Compensation Each non-employee director receives an annual retainer of $10,000, payable in equal quarterly installments, plus a fee of $1,250 for each Board meeting attended. The Company also reimburses directors for their travel and accommodation expenses incurred in attending Board meetings. In addition, each non-employee director is granted annually an option to purchase shares of the Company's Common Stock under the terms and conditions of the Company's 1990 Directors' Stock Option Plan approved by the shareholders on June 20, 1990. During June 1995, each outside director was granted a five-year option for 3,000 shares at a per share exercise price of $2.50, the closing market price on the date of grant. Each non-employee director was also granted an additional five-year option ( for 12,300 shares at $3.15 per share in the case of Mr. Seslowe, and 13,300 shares at $3.00 per share in the case of the other non-employee directors) pursuant to an amendment to the Plan approved by the Board of Directors in November 1995, subject to approval by the shareholders of the Company at the 1996 Annual Meeting. These options were granted at a price equal to 120% of the closing market price of the Common Stock on the date of grant. The number of shares granted to each director under the amended Plan is determined by reference to an annual formula designed to award each 22 director five-year options having a value of $10,000 based on the Black-Scholes option valuation model and the current price of the Company's Common Stock. As of March 31, 1996, options to purchase 39,000 shares of Common Stock were outstanding under the 1990 terms of the Plan, and options to purchase an additional 52,200 shares were outstanding under the amendment to the Directors' Stock Option Plan subject to shareholder approval of the amendment at the 1996 Annual Meeting of Shareholders. Under the Plan as amended, subject to shareholder approval, options to purchase 140,800 shares were available for future grant under the Directors' Stock Option Plan. On February 1, 1996, June 23, 1992 and September 24, 1992, Jerry M. Seslowe, Richard S. Rosenbloom and William R. Smart were each granted warrants to purchase 25,000 shares of the Company's Common Stock at $2.63, $1.25 and $1.16, respectively, the closing market prices on those dates. The warrants vest ratably over a three-year period and expire on February 1, 2001, June 23, 1997 and September 24, 1997, respectively. Messrs. Seslowe, Rosenbloom and Smart received these warrants upon being elected to serve on the Company's Board of Directors. Executive Compensation Summary Compensation Table The following table sets forth the compensation by the Company of the Chief Executive Officer and the four most highly compensated other executive officers of the Company for services in all capacities to the Company and its subsidiaries during the past three fiscal years.
Annual Compensation Long-Term Compensation Other Awards Annual of All Name and Bonus ($) Compensa- Options/ Other(3) Principal Position Year Salary ($) (1) tion($) (2) SARs(#) Compensation ($) Alan Kessman 1995 400,000 -0- 1,100 -0- 10,328
23 Chairman of the Board, 1994 391,100 100,000 8,506 -0- 6,978 President and Chief 1993 374,850 150,764 -0- 50,000 263,491 Executive Officer Michael W. 1995 256,00 -0- 1,100 -0- 6,353 Yacenda Executive Vice 1994 243,154 39,600 10,000 -0- 55,597 President 1993 225,879 58,684 -0- 32,000 160,388 Stanley M. Blau 1995 197,789 -0- -0- 15,000 3,367 Vice Chairman 1994 201,738 7,713 -0- 15,000 3,276 1993 193,973 37,083 -0- 20,000 22,645 Shlomo Shur 1995 215,700 -0- -0- -0- 5,514 Senior Vice President 1994 211,539 23,088 10,000 -0- 4,199 Advanced Technology 1993 203,390 38,885 -0- 25,000 4,750 Andrew 1995 214,000 -0- -0- -0- 5,535 Kontomerkos Senior Vice 1994 205,888 28,025 10,000 -0- 4,899 President Hardware 1993 193,973 37,083 -0- 20,000 6,060 Engineering and Production (1) Includes special bonus awarded to certain Company employees following successful implementation of measures to overcome the effect of a fire at the facilities of one of the Company's major suppliers in China in December 1993. Special bonuses totalling $50,000, $30,000, $15,000 and $20,000 were awarded to Messrs. Kessman, Yacenda, Shur and Kontomerkos, respectively. 24 (2) This category represents employee stock option credits that could have been used after July 1, 1993 and prior to December 31, 1994 to pay the exercise price of employee stock options held by the employee. Stock purchased with the 1992 option credits must be held for one year. All credits shown in this column were used to exercise stock options in 1993 or 1994. See Note 3. (3) This category includes for 1994 stock option credits used to pay the exercise price of employee stock options exercised during 1994 by Mr. Yacenda in the amount of $50,549. This category includes for 1993 stock option credits used to pay the exercise price of employee stock options exercised during 1993 in the following amounts: Mr. Kessman $256,240; Mr. Yacenda, $155,250, and Mr. Blau, $19,200. The credits were granted in 1988, 1992 and 1994 (see note 2 above). The column does not include 1992 or 1994 credits used in 1993 or 1994 that were reported as "Other Annual Compensation" for 1992 or 1994. This category also includes for each individual a matching contribution by the Company under the Company's 401(k) plan in the amount of $660 each for each year. This column also includes premiums paid by the Company for long-term disability and life insurance for the individuals in the following amounts in 1995: Mr. Kessman, $9,668; Mr. Yacenda, $5,693; Mr. Shur, $4,854; Mr. Blau, $2,707; and Mr. Kontomerkos, $4,875; in the following amounts in 1994: Mr. Kessman, $7,424; Mr. Yacenda, $4,774; Mr. Shur, $4,196; Mr. Blau, $2,820; and Mr. Kontomerkos, $4,849; and in the following amounts in 1993: Mr. Kessman, $6,591; Mr. Yacenda, $4,478; Mr. Blau, $2,785; Mr. Shur, $4,090; 25 Mr. Kontomerkos, $5,400. Employment Agreement The Company and Mr. Kessman entered into an employment continuity agreement in January, 1995 that provides certain benefits to Mr. Kessman in the event of the termination of Mr. Kessman's employment following a change in control in the Company, including a lump sum payment equal to 2.99 times his then current base salary plus the average of any bonuses awarded to Mr. Kessman during the two fiscal years preceding the termination of his employment. Under the terms of the agreement, a change in control includes the acquisition of beneficial ownership of 20% of the Company's voting securities by any person or group. The agreement continues through the length of Mr. Kessman's employment with the Company. Option Grants in Last Fiscal Year The following table sets forth the individual grants of stock options made during the year ended December 31, 1995 to the Chief Executive Officer and the four most highly compensated 26 other executive officers of the Company. There were no grants of stock appreciation rights made to any officers during 1995, and there are no outstanding stock appreciation rights.
Potential Realized Value at Assumed Annual Rates of Stock Price Appreciation Individual Grants for Option Term - ------------------------------------------------------------------------------------------------ ------------------------------- % of Total Options Exercise Granted to or Base Options Employees in Price Expiration Name Granted (#) Fiscal Year ($/Sh) Date 5% ($) 10% ($) - ------------------------------------------------------------------------------------------------ ------------------------------- Alan Kessman 0 0 0 0 0 0 Michael W. Yacenda 0 0 0 0 0 0 Stanley M. Blau 15,000 2.5 $3.13 3/23/00 12,950 28,617 Shlomo Shur 0 0 0 0 0 0 Andrew Kontomerkos 0 0 0 0 0 0
The option reported in the above table expires in five years, and vests 25% per year over four years. Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values The following table sets forth each exercise of stock options made during the year ended December 31, 1995 by the Chief Executive Officer and the four most highly compensated other executive officers and the fiscal year-end value of unexercised options held by those individuals as of December 31, 1995. There were no exercises or holdings of stock appreciation rights by any officers during 1995, and there are no outstanding stock appreciation rights. 27
Value of Number of Unexercised Unexercised In-the-Money Options Options at Fiscal at Fiscal Year-End (#) Year-End ($) (1) --------------- ------------------- Shares Acquired Exercisable/ Exercisable/ Name on Exercise (#) Value Realized ($) Unexercisable Unexercisabl -------------- ------------------ -------------- Alan Kessman 137,500 262,500 65,688/35,000 74,097/18,438 Michael W. 158,273 302,697 66,000/27,000 60,313/16,688 Yacenda Stanley M. Blau 0 -0- 381,500/15,000 446,719/8,438 Shlomo Shur 286,930 495,854 62,500/17,500 59,219/9,219 Andrew Kontomerkos 296,425 578,660 45,250/13,750 42,078/7,109
(1) Based upon the last sale price on December 29, 1995 of $2.31 per share of Common Stock. Compensation Committee Interlocks and Insider Participation The members of the Compensation Committee in 1995 were Thurston Moore, Richard Rosenbloom, and William Smart. No member of the Committee is a former or current officer or employee of the Company or any subsidiary, except that Mr. Moore has acted as an Assistant Secretary of the Company. Mr. Moore is a partner in the law firm of Hunton & Williams, which regularly acts as counsel to the Company. 28 No executive officer of the Company served as a director or a member of the Compensation Committee or of the equivalent body of any entity, any one of whose executive officers serve on the Compensation Committee or the Board of Directors of the Company. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Ownership of Common Stock by Directors, Officers and Principal Shareholders The following table sets forth the number of shares of Common Stock beneficially owned as of March 31, 1996, by each current director of the Company, by all current directors and officers of the Company as a group and by each person known to the Company to be a beneficial owner of more than five percent of the Company's outstanding Common Stock. Unless otherwise noted, the owner has sole voting and dispositive power with respect to the securities.
Percentage Shares of Common Stock of Name of Beneficial Owner Beneficially Owned Common Stock (1) ------------------------ ----------------------- ---------------- Stanley M. Blau (2) . . . . . . . . . 753,846 1.4 Entities Associated with Hambrecht & Quist Group (3) . . . . . . . . . 4,822,989 9.3 One Bush Street San Francisco, CA 94104 Alan Kessman (4) . . . . . . . . . . 1,760,682 3.4 Thurston R. Moore (5) . . . . . . . . 108,635 * Entities Associated with Edmund H. Shea, Jr. (6). . . . . 3,249,895 6.3 655 Brea Canyon Road
29
Percentage Shares of Common Stock of Name of Beneficial Owner Beneficially Owned Common Stock (1) ------------------------ ----------------------- ---------------- Walnut Creek, CA 91789 Richard S. Rosenbloom (7) . . . . . . 50,300 * Jerry M. Seslowe (8) . . . . . . . . 69,444 * William R. Smart (9) . . . . . . . . 60,300 * All Directors and Officers as a Group (20 persons) (10) . . . . . . . . . 6,079,953 14.3
* Less than 1% (1) Based upon 51,865,163 shares of Common Stock outstanding as of March 31, 1996. In cases where the beneficial ownership of the individual or group includes options, warrants, or convertible securities, the percentage is based on the 51,865,163 shares actually outstanding plus the shares of Common Stock issuable upon exercise or conversion of any such options, warrants, or convertible securities held by the individual or group. The percentage does not reflect or assume the exercise or conversion of any options, warrants or convertible securities not owned by the individual or group in question. (2) Includes 362,750 shares subject to options exercisable within 60 days of June 3, 1996. Includes 16,250 shares subject to options not exercisable within 60 days of June 3, 1996. (3) The Hambrecht & Quist entities share power to vote and dispose of all of such shares. (4) Includes 62,500 shares subject to options exercisable within 60 days of June 3, 1996. Includes 12,500 shares subject to options not exercisable within 60 days of June 3, 1996. Includes 765,503 shares as to which voting and dispositive power is shared. Includes 187,500 shares held in a revocable trust for Mr. Kessman's children, over which Mr. Kessman has no control and as to which shares he disclaims any beneficial ownership. Includes 9,412 shares of Common Stock issuable upon conversion of the Company's Debentures (of which Mr. Kessman owns $100,000 principal amount or .5% of the principal amount outstanding). (5) Includes 28,300 shares subject to options, all of which are exercisable within 60 days of June 3, 1996. (6) Includes 11,935 shares of Common Stock issuable upon 30 conversion of the Company's Debentures, of which entities affiliated with Mr. Shea beneficially own less than 1% of the outstanding principal amount or $126,812 principal amount. The Shea entities share the power to vote and dispose of all of such shares. (7) Mr. Rosenbloom beneficially owns 50,300 shares subject to options and warrants, all of which are exercisable within 60 days of June 3, 1996. (8) Mr. Seslowe beneficially owns 37,300 shares of Common Stock subject to options and warrants, none of which are exercisable within 60 days of June 3, 1996. Includes 12,755 shares owned by Resource Holdings Associates, in which Mr. Seslowe has a greater than 10% ownership and of which he is a managing director. Does not include 203,756 shares of Common Stock contingently issuable upon conversion of the Series A Preferred Stock and the Series B Preferred Stock owned by Mr. Seslowe, or 45,874 shares of Common Stock contingently issuable upon conversion of Preferred Stock owned by Resource Holdings, none of which shares of Preferred Stock are or will become convertible within 60 days of June 3, 1996. (9) Mr. Smart beneficially owns 50,300 shares subject to options and warrants, of which 49,550 are exercisable within 60 days of June 3, 1996. (10) Includes 976,262 shares subject to options or warrants exercisable within 60 days of June 3, 1996. Includes 196,650 shares subject to options or warrants not exercisable within 60 days of June 3, 1996. Also includes 64,000 shares of Common Stock issuable upon conversion of the Company's Debentures (of which the group beneficially owns $680,000 principal amount, or 3.5% of the principal amount outstanding). Includes 924,978 shares as to which voting and dispositive power is shared and 289,445 shares as to which beneficial ownership is disclaimed. Ownership of Preferred Stock by Directors, Officers and Principal Shareholders The following table sets forth the number of shares of Convertible Cumulative Preferred Stock, Series A, and Contingently Convertible Cumulative Preferred Stock, Series B, beneficially owned as of March 31, 1996, by all current directors and officers of the Company who beneficially own any of such shares, and by each person known to the Company to be a beneficial owner of more than five percent of the Company's outstanding Preferred Stock. The table also shows 31 the percentage of each series beneficially owned, based upon 250,000 shares of Series A Stock and 100,000 shares of Series B Stock outstanding as of March 31, 1996. No other director, nominee for director or officer owns any shares of the Company's Preferred Stock. Unless otherwise noted, the owner has sole voting and dispositive power with respect to the securities.
Shares of Preferred Stock Beneficially Owned and Percent of Class Series A Stock Series B Stock Name of Beneficial Owner Cooper Life Sciences 78,819 (31.53%) 31,528 (31.53%) 160 Broadway New York, NY 10038 Jerry M. Seslowe 3,830 (1.53%) 1,532 (1.53%) James W. Spencer 26,625 (10.65%) 10,650 (10.65%) 8446 Bronze Lane Highlands Ranch, CO 80126 Watermark Investments 127,895 (51.16%) Limited 51,157 (51.16%) 730 Fifth Avenue New York, NY 10019 All Directors and Officers 3,830 (1.53%) as a Group (20 persons) 1,532 (1.53%)
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Hunton & Williams regularly acts as counsel to the Company. Mr. Moore, a director of the Company, is a 32 partner at Hunton & Williams. In connection with the Company's acquisition of Unistar, the Company paid or agreed to pay Resource Holdings Ltd, a former shareholder of Unistar, accrued investment banking fees incurred by Unistar prior to the acquisition of $105,000, and total finder's fees of $320,000 based on the value of the transaction. Mr. Seslowe was elected a director of the Company after the acquisition. Both Resource Holdings and Mr. Seslowe acquired Common Stock and Preferred Stock of the Company in exchange for their shares of Unistar. Mr. Seslowe is a managing director of and owns more than 10% of Resource Holdings. The Company's management believes that the transactions with Resource Holdings were on terms as favorable to the Company as could be expected from unaffiliated third parties. The Executive Stock Incentive Plan (the "Incentive Plan") approved by shareholders at the 1994 Annual Meeting was implemented in October 1994 with 30 employees participating. Under the terms of the Incentive Plan eligible employees were granted the right to purchase shares of the Company's Common Stock at a price of $3.1875 per share. Participating employees financed the purchases of these shares through loans by the Company's bank lenders at the prime rate less 1/4%. The loans are fully-recourse to the participating employees but are guaranteed by letters of credit from the Company to the lending banks. The Company holds the purchased Common Stock as security for the repayment of the loans. The following table contains information about borrowings in excess of $60,000 by executive officers that were outstanding during 1995 pursuant to the Incentive Plan that are guaranteed by the Company.
Unpaid Indebtedness Highest Amount of at Indebtedness Between 3/31/96 Name 1/1/95 and 3/31/96 (1) Including Accrued Interest - ----- ---------------------- -------------------------- Alan Kessman $1,912,500 $2,097,195 Michael W. Yacenda $1,115,625 $1,223,364 Shlomo Shur $ 557,813 $ 611,682 Andrew Kontomerkos $ 557,813 $ 611,682 Barbara C. Anderson $ 318,750 $ 349,533
33 James E. Cooke III $ 318,750 $ 349,533 Anthony R. $ 446,250 $ 489,345 Guarascio Israel J. Hersh $ 95,625 $ 104,860 Robert W. Hopwood $ 318,750 $ 348,912 David E. Lee $ 318,750 $ 349,533 Frank J. Rotatori $ 191,250 $ 209,720 - --------------------- (1) Amounts shown are exclusive of accrued interest. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1), (a)(2) and (d). The financial statements required by this item and incorporated herein by reference are as follows: Report of Independent Public Accountants Consolidated Balance Sheets - December 31, 1995 and 1994 Consolidated Statements of Operations - Years ended December 31, 1995, 1994 and 1993 Consolidated Statements of Changes in Stockholders' Equity - Three years ended December 31, 1995 Consolidated Statements of Cash Flows Years ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements The schedules to consolidated financial statements required by this item and included in this report are as follows: 34 Report of Independent Public Accountants on Schedule Schedule II - Valuation and Qualifying Accounts (a)(3) and (c). The exhibits required by this item and included in this report or incorporated herein by reference are as follows:
Exhibit No. 2-1 Agreement and Plan of Merger by and among EXECUTONE Information Systems, Inc., Executone Newco, Inc., and Unistar Gaming Corp., dated as of December 19, 1995. Incorporated by reference to the Registrant's Current Report on Form 8-K dated January 3, 1996. 2-2 Asset Purchase Agreement among V Technology Acquisition Corporation, EXECUTONE Information Systems, Inc. and Vodavi, Inc. dated November 5, 1993, and Amendment dated February 18, 1994. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993. 2-3 Asset Purchase Agreement by and among Tone Holdings, Inc. and Tone Acquisition Corporation, EXECUTONE Network Services, Inc. and EXECUTONE Information Systems, Inc. dated as of April 9, 1996, and Amendment No. 1 to Asset Purchase Agreement dated as of May 31, 1996, by and among Clarity Telecom Holdings, Inc. (formerly known as Tone Holdings, Inc.), Clarity Telecom, Inc. (formerly known as Tone Acquisition Corporation), EXECUTONE Network Services, Inc. and EXECUTONE Information Systems, Inc. (Confidential portions have been omitted and filed separately with the Commission pursuant to a request for confidential treatment.) Previously filed.
35 3-1 Articles of Incorporation, as amended through December 18, 1995 (restated for electronic filing). Previously filed. 3-2 Articles of Amendment dated and filed December 19, 1995, amending the Company's Articles of Incorporation. Incorporated by reference to the Registrant's Current Report on Form 8-K dated January 3, 1996. 3-3 Bylaws, as amended. Incorporated by reference to the Registrant's Registration Statement on Form S-3 (File No. 33-62257) filed August 30, 1995. 4-1 Second Amended and Restated Loan and Security Agreement dated as of August 30, 1994 and First Amendment thereto dated January 1, 1995, between EXECUTONE Information Systems, Inc., Continental Bank N.A. and the other Lenders named therein. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994. 4-2 Loan Agreement dated as of August 30, 1994, between EXECUTONE Information Systems, Inc., certain employees thereof, and the Lenders named therein. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994. 4-3 First Amendment dated January 1, 1995, Second Amendment dated September 29, 1995, and Third Amendment dated December 29, 1995, to the Second Amended and Restated Loan and Security Agreement by and among EXECUTONE Information Systems, Inc., the Financial Institutions Listed on the Signature Page Thereof, and Bank of America Illinois. Previously filed.
36 4-10 Indenture dated March 1, 1986 with United States Trust Company of New York relating to 7 1/2% Convertible Subordinated Debentures of Vodavi Technology Corporation due March 15, 2011. Incorporated by reference to Vodavi Technology Corporation's Registration Statement on Form S-1 (as amended) (Registration No. 33- 3827) filed on March 9, 1986 and amended April 1, 1986. 4-11 First Supplemental Indenture dated August 4, 1989 with United States Trust Company of New York relating to 7 1/2% Convertible Subordinated Debentures due March 15, 2011. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. 4-12 Specimen Certificate representing 7 1/2% Convertible Subordinated Debentures. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. 10-1 1984 Employee Stock Purchase Plan of EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 33-23294) declared effective by the Commission on August 23, 1988. 10-2 1986 Stock Option Plan of EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 33-23294) declared effective by the Commission on August 23, 1988. 10-3 1984 Stock Option Plan of EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31,
37 1990, as amended by Form 8 filed on August 20, 1991. 10-4 401(k) Savings Plan of Vodavi Technology Corporation dated December 27, 1985. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. 10-5 Stock Option Bonus Credit Plan of EXECUTONE Information Systems, Inc. dated December 31, 1988. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. 10-6 1990 Directors' Stock Option Plan. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed on August 20, 1991. 10-7 1994 Executive Stock Incentive Plan. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994. 10-9 Volume Purchase Agreement dated January 31, 1992, between U. S. Sprint Communications Company Limited Partnership and EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991, as amended by Form 8 filed on June 12, 1992. 10-10 Amendments dated as of April 1, 1995, and 1993 to Volume Purchase Agreement dated January 31, 1992, between U. S. Sprint Communications Company Limited Partnership and EXECUTONE Information Systems, Inc. (Confidential portions have been omitted and filed separately with the Commission pursuant to a request for confidential treatment.) Previously filed.
38 10-12 Warrant to Purchase 143,181 shares of Common Stock of the Registrant in favor of Continental Bank N. A. (now Bank of America Illinois) dated December 28, 1990. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed on August 20, 1991. 10-13 Warrant to Purchase 50,000 shares of Common Stock of the Registrant in favor of Continental Bank N. A. (now Bank of America Illinois) dated December 28, 1990. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed on August 20, 1991. 10-16 Manufacturing Services Agreement dated as of January 10, 1995, between EXECUTONE Information Systems, Inc. and Compania Dominicana de Telefonos, C por A (Codetel). Previously filed. 10-17 Manufacturing Services Agreement dated February 9, 1990 between Wong's Electronics Co., Ltd. and EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed on August 20, 1991. 10-19 Warrant to Purchase 25,000 Shares of Common Stock of EXECUTONE Information Systems, Inc. in favor of Richard S. Rosenbloom dated June 23, 1992. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. 10-20 Warrant to Purchase 25,000 Shares of Common Stock of EXECUTONE
39 Information Systems, Inc. in favor of William R. Smart dated September 24, 1992. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. 10-21 Management Agreement for the National Indian Lottery dated January 16,1995. Previously filed. 10-22 Distributor Agreement dated as of May 31, 1996, between EXECUTONE Information Systems, Inc. and Clarity Telecom, Inc. Previously filed. 11 Statement regarding computation of per share earnings. Previously filed. 13 1995 Annual Report to Shareholders of EXECUTONE Information Systems, Inc. Filed herewith. 21 Subsidiaries of EXECUTONE Information Systems, Inc. Previously filed. 23.1 Consent of Arthur Andersen LLP. Filed herewith. 23.2 Consent of Hunton & Williams. Filed herewith. 27 Financial Data Schedule. Previously filed.
Undertakings For the purposes of complying with the rules governing Form S-8 under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statements on the following Form S-8 filings: S-8 Reg. No. 2-91008 filed May 9, 1984 on 1983 Employee Stock Purchase Plan (650,000 shares) S-8 Reg. No. 33-959 filed October 17, 1985 on 1984 Stock Option Plan (390,000 shares) 40 S-8 Reg. No. 33-6604 filed June 19, 1986 on 1983 Stock Option Plan (350,000 shares) S-8 Reg. No. 33-16585 filed August 24, 1987 on 1986 and 1983 Stock Option Plans (800,000 shares) S-8 Reg. No. 33-23294 filed August 3, 1988 on 1986 Stock Option Plan (7,000,000 shares) and Employee Stock Purchase Plan (500,000 shares) S-8 Reg. No. 33-42561 filed September 4, 1991 on 1984 Employee Stock Purchase Plan (350,000 shares) and Directors' Stock Option Plan (100,000 shares) S-8 Reg. No. 33-45015 filed January 2, 1992 on 1984 Employee Stock Purchase Plan (400,000 shares) S-8 Reg. No. 33-57519 filed January 31, 1995 on 1984 Employee Stock Purchase Plan (1,000,000 shares). Insofar as indemnification arising under the Securities Act of 1933 (the "Act") may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to the court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. Reports on Form 8-K The Registrant filed no reports on Form 8-K during the quarter ended December 31, 1995. 41 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. By: /s/ Alan Kessman -------------------------- Alan Kessman, Chairman, President and Chief Executive Officer February 18, 1997 Milford, Connecticut Pursuant to the requirements of the Securities and Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. February 18, 1997 /s/ Alan Kessman ----------------------------- Alan Kessman Chairman, President and Chief Executive Officer (Principal Executive Officer) February 18, 1997 /s/ Stanley M. Blau ---------------------------- Stanley M. Blau Vice Chairman of the Board of Directors February 18, 1997 /s/ Anthony R. Guarascio ----------------------------- Anthony R. Guarascio Vice President-Finance and Chief Financial Officer (Principal Financial and Accounting Officer) February 18, 1997 /s/ Thurston R. Moore ------------------------------- 42 Thurston R. Moore Director February 18, 1997 /s/ Richard S. Rosenbloom -------------------------- Richard S. Rosenbloom Director February 18, 1997 /s/ Jerry M. Seslowe --------------------------- Jerry M. Seslowe Director February 18, 1997 /s/ William R. Smart ---------------------------- William R. Smart Director 43 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders of EXECUTONE Information Systems, Inc.: We have audited in accordance with generally accepted auditing standards, the financial statements included in EXECUTONE Information Systems, Inc. and subsidiaries' annual report to stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 26, 1996. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in Item 14 is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Stamford, Connecticut January 26, 1996 44 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS (Amounts in Thousands)
Additions Deductions --------------------------------------------- -------------- Charged Net Balance at (Credited) (Credited) Writeoffs of Balance at Beginning to Costs and to Other Uncollectible End of Description of Period Expenses Accounts Accounts Period ----------- --------- -------------- ---------- ------------- ----------- Year ended December 31, 1995 Deducted from asset accounts: Allowance for doubtful accounts $ 1,335 $ 1,872 -- ($1,492) $ 1,715 Allowance for uncollectible notes receivable 691 (432) -- -- 259 Year ended December 31, 1994 Deducted from asset accounts: Allowance for doubtful accounts 1,017 1,381 -- (1,063) 1,335 Allowance for uncollectible notes receivable 1,084 (393) -- -- 691 Year ended December 31, 1993 * Deducted from asset accounts: Allowance for doubtful accounts 1,046 1,285 -- (1,314) 1,017 Allowance for uncollectible notes receivable 1,604 (440) (80) -- 1,084
* Restated to reflect the disposition of the VCS Division, which was sold as of March 1994. S-2 EXECUTONE INFORMATION SYSTEMS, INC. EXHIBITS TO 1995 ANNUAL REPORT ON FORM 10-K
Exhibit No. 2-1 Agreement and Plan of Merger by and among EXECUTONE Information Systems, Inc., Executone Newco, Inc., and Unistar Gaming Corp., dated as of December 19, 1995. Incorporated by reference to the Registrant's Current Report on Form 8-K dated January 3, 1996. 2-2 Asset Purchase Agreement among V Technology Acquisition Corporation, EXECUTONE Information Systems, Inc. and Vodavi, Inc. dated November 5, 1993, and Amendment dated February 18, 1994. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993. 2-3 Asset Purchase Agreement by and among Tone Holdings, Inc. and Tone Acquisition Corporation, EXECUTONE Network Services, Inc. and EXECUTONE Information Systems, Inc. dated as of April 9, 1996, and Amendment No. 1 to Asset Purchase Agreement dated as of May 31, 1996, by and among Clarity Telecom Holdings, Inc. (formerly known as Tone Holdings, Inc.), Clarity Telecom, Inc. (formerly known as Tone Acquisition Corporation), EXECUTONE Network Services, Inc. and EXECUTONE Information Systems, Inc. (Confidential portions have been omitted and filed separately with the Commission pursuant to a request for confidential treatment.) Previously filed. 3-1 Articles of Incorporation, as amended through December 18, 1995 (restated for electronic filing). Preiously filed. 3-2 Articles of Amendment dated and filed December 19, 1995, amending the Company's Articles of Incorporation. Incorporated by reference to the Registrant's Current Report on Form 8-K dated January 3, 1996.
45 3-3 Bylaws, as amended. Incorporated by reference to the Registrant's Registration Statement on Form S-3 (File No. 33-62257) filed August 30, 1995. 4-1 Second Amended and Restated Loan and Security Agreement dated as of August 30, 1994 and First Amendment thereto dated January 1, 1995, between EXECUTONE Information Systems, Inc., Continental Bank N.A. and the other Lenders named therein. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994. 4-2 Loan Agreement dated as of August 30, 1994, between EXECUTONE Information Systems, Inc., certain employees thereof, and the Lenders named therein. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994. 4-3 First Amendment dated January 1, 1995, Second Amendment dated September 29, 1995, and Third Amendment dated December 29, 1995, to the Second Amended and Restated Loan and Security Agreement by and among EXECUTONE Information Systems, Inc., the Financial Institutions Listed on the Signature Page Thereof, and Bank of America Illinois. Previously filed. 4-10 Indenture dated March 1, 1986 with United States Trust Company of New York relating to 7 1/2% Convertible Subordinated Debentures of Vodavi Technology Corporation due March 15, 2011. Incorporated by reference to Vodavi Technology Corporation's Registration Statement on Form S-1 (as amended) (Registration No. 33- 3827) filed on March 9, 1986 and amended April 1, 1986.
46 4-11 First Supplemental Indenture dated August 4, 1989 with United States Trust Company of New York relating to 7 1/2% Convertible Subordinated Debentures due March 15, 2011. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. 4-12 Specimen Certificate representing 7 1/2% Convertible Subordinated Debentures. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. 10-1 1984 Employee Stock Purchase Plan of EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 33-23294) declared effective by the Commission on August 23, 1988. 10-2 1986 Stock Option Plan of EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 33-23294) declared effective by the Commission on August 23, 1988. 10-3 1984 Stock Option Plan of EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed on August 20, 1991. 10-4 401(k) Savings Plan of Vodavi Technology Corporation dated December 27, 1985. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. 10-5 Stock Option Bonus Credit Plan of EXECUTONE Information Systems, Inc. dated December 31, 1988.
47 Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. 10-6 1990 Directors' Stock Option Plan. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed on August 20, 1991. 10-7 1994 Executive Stock Incentive Plan. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994. 10-9 Volume Purchase Agreement dated January 31, 1992, between U. S. Sprint Communications Company Limited Partnership and EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991, as amended by Form 8 filed on June 12, 1992. 10-10 Amendments dated as of April 1, 1995, and 1993 to Volume Purchase Agreement dated January 31, 1992, between U. S. Sprint Communications Company Limited Partnership and EXECUTONE Information Systems, Inc. (Confidential portions have been omitted and filed separately with the Commission pursuant to a request for confidential treatment.) Previously filed. 10-12 Warrant to Purchase 143,181 shares of Common Stock of the Registrant in favor of Continental Bank N. A. (now Bank of America Illinois) dated December 28, 1990. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed on August 20, 1991. 10-13 Warrant to Purchase 50,000 shares of Common Stock of the Registrant in favor of Continental Bank N. A. (now
48 Bank of America Illinois) dated December 28, 1990. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed on August 20, 1991. 10-16 Manufacturing Services Agreement dated as of January 10, 1995, between EXECUTONE Information Systems, Inc. and Compania Dominicana de Telefonos, C por A (Codetel). Previously filed. 10-17 Manufacturing Services Agreement dated February 9, 1990 between Wong's Electronics Co., Ltd. and EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed on August 20, 1991. 10-19 Warrant to Purchase 25,000 Shares of Common Stock of EXECUTONE Information Systems, Inc. in favor of Richard S. Rosenbloom dated June 23, 1992. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. 10-20 Warrant to Purchase 25,000 Shares of Common Stock of EXECUTONE Information Systems, Inc. in favor of William R. Smart dated September 24, 1992. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. 10-21 Management Agreement for the National Indian Lottery dated January 16, 1995. Previously filed. 10-22 Distributor Agreement dated as of May 31, 1996, between EXECUTONE Information Systems, Inc. and Clarity Telecom, Inc. Previously filed.
49 11 Statement regarding computation of per share earnings. Previously filed. 13 1995 Annual Report to Shareholders of EXECUTONE Information Systems, Inc. Filed herewith. 21 Subsidiaries of EXECUTONE Information Systems, Inc. Previously filed. 23.1 Consent of Arthur Andersen LLP. Filed herewith. 23.2 Consent of Hunton & Williams. Filed herewith. 27 Financial Data Schedule. Previously filed.
50 STATEMENT OF DIFFERENCES The registered trademark symbol shall be expressed as .....'r' The trademark symbol shall be expressed as ............... 'tm' EX-13 2 EXHIBIT 13 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION The Company's revenues are primarily derived from sales of its products and services through a worldwide network of direct and independent sales and service offices. The Company's end-user revenues are derived from two primary sources: (1) sales of systems to new customers, which include sales of application-specific software options ("product revenues"), and (2) servicing the end-user base through the upgrade, expansion, enhancement (which includes sales of application-specific software options), and maintenance of previously installed systems, as well as revenues from the INFOSTAR'r'/LD+ program ("base revenues"). Base revenues usually generate higher operating income margin than initial sales of systems, since the Company's selling expenses for base revenues are lower than those for initial system sales. Sales of the Company's application-specific software options and related services generally produce a higher operating income margin than both system sales and base revenues due to the added performance value and relatively low production costs of such proprietary software and services. During the year, the Company reorganized its business into divisions, with each division focusing on different products and market segments. The discussion which follows under the heading "Company Restructuring" will detail the change in the Company's strategy which led to the restructuring, the resulting impairment of long-lived assets and other restructuring charges, along with an overview of each division's operating performance in 1995 (comparative data is not available on a divisional basis). COMPANY RESTRUCTURING Change in business strategy In July 1995, the Company reorganized its business into five divisions: Computer Telephony, Healthcare Communications Systems, Call Center Management ("CCM"), Videoconferencing Products, and Network Services. The current strategic focus is toward larger systems and software application-oriented products and away from hardware-oriented telephone systems. The business that was acquired in 1988 was a telephone equipment company that focused its direct selling effort on office sites with fewer than 20 phones with an emphasis on selling additional hardware to generate revenues in the form of move, adds and changes ("MAC") and service, mainly on a time and material basis. The average system size in the customer base at that time was in the 8-10 phone range. It was originally expected in 1988 that the MAC and service revenues generated by the customer base would be increasingly profitable as the base of customers grew. After the acquisition, the Company began to develop more advanced products which incorporated digital technology and more software-oriented applications and expanded its product line to the high-end user, with larger customers and more sophisticated products to serve customers' total communications needs. After a thorough review and analysis, it was determined that direct selling of the smaller, hardware-oriented portion of the telephony business was not profitable. This led to a definitive change in the Company's business strategy which was announced on July 11, 1995. As a result of the change in strategy and based upon the requirements of FAS No. 121 (see section entitled "Impairment of goodwill and related service stock" which follows), the Company recorded a $44.0 million provision for restructuring consisting of a $33.5 million goodwill impairment, an $8.8 million writedown of inventory, primarily service stock relating to the impaired assets and other non-recurring inventory adjustments, $0.9 million related to the shutdown of the Company's Scottsdale, Arizona facility and $0.8 million of other unusual items. The strategy the Company is now pursuing is to focus on software solutions. With the Integrated Digital System platform (Systems 108, 228, 432 and 648), which was developed post-acquisition, the Company's product lines now provide sophisticated software applications, including Integrated Voice Mail, Call Center Applications (ACD, IVR's and Predictive Dialers), Locating Devices, Nurse Call and Computer Telephony Interfaces which drive the computer telephony products, videoconferencing equipment and network services. The change in the nature and complexity of the Company's product lines has changed the way it has to market its products. Unlike many companies in this industry that focus on one particular product to one market, the Company provides multiple products and applications to its particular markets. This requires expertise in each particular market segment because the Company's competitors are primarily one-product companies who are experts in their particular market niche. Therefore, the Company has consolidated the sales, marketing and product development functions for each market segment under a divisional management structure, headed by a division president. The sales force has been restructured such that each sales person is assigned to a specific division and will sell only products associated with that division. The specialization of the sales force included the addition of sales representatives with the necessary product and market expertise, as well as substantial retraining for the remaining sales representatives. Impairment of goodwill and related service stock Once the Company decided to restructure and focus on sophisticated systems in the computer telephony division, it reevaluated the realizability of goodwill and the related service stock using the recently issued FAS No. 121, "Accounting for the Impairment of Long-Lived Assets," issued in March 1995. FAS No. 121 requires the Company to project the lowest level of identifiable future cash flows for purposes of determining whether there has been an impairment in long-lived assets. The business acquired in 1988 would not generate future cash flows sufficient to realize the goodwill and service stock on the Company's balance sheet. Prior to the second quarter of 1995 and the issuance of FAS No. 121, the Company periodically reviewed the realizability of goodwill on the basis of whether the goodwill was fully recoverable from projected, undiscounted net cash flows for the business as a whole, which included both the smaller hardware-oriented systems and the larger, sophisticated software-application telephony systems. Undiscounted cash flows for the business as a whole were used because the general rule under APB 17 was that goodwill and similar intangible assets could not be disposed of apart from the enterprise as a whole, unless the Company sold or otherwise liquidated a large segment or separable group of assets of the acquired company. Based upon this evaluation, goodwill was not determined to be impaired. The management decision discussed above to focus on the high end of the telephony market caused the impairment of long-lived assets, which was measured using the criteria of FAS No. 121. Computer Telephony The computer telephony division provides value-added products and services. The Company's integrated digital telephone systems emphasize flexible software applications, such as data switching and computer telephone interface, designed to enhance the customer's ability to communicate, obtain and manage information. The Company's telephone systems provide the platform for its other voice processing software applications, such as voice messaging systems and ACD. The computer telephony division remains the Company's largest contributor to revenues and profits. Revenues for 1995 were $233 million, unchanged from the prior year. The Company's base revenues, especially MAC and service, continued their historical growth offset by a lower level of new installations during the year. In addition, the division incurred transition costs related to the restructuring which increased its operating expenses in 1995. Healthcare Communications The healthcare communications division provides to its hospital customers integration of the flow of voice and data between nurse and patient, increased flexibility and efficiency in hospital operations, and the means to improve patient care. Healthcare division revenues increased almost 15% during 1995 to $29 million. Although there has been revenue growth due to the divisionalization of this business in the beginning of 1995, the introduction of new products lowered margins approximately $0.8 million due to higher introductory manufacturing costs. The Company has transitioned the nurse call product line in 1995 with the development of the LifeSaver'tm' and CareCom'r' IIE products. The higher 1995 manufacturing costs were due to the fact that offshore production was delayed due to the fire at the Company's production facility. These products were scheduled for transfer from the Company's pre-production facility in Poway, California, but the fire caused a delay in that transfer for almost one year. These products are now offshore and higher margins are anticipated, commencing in the first half of 1996. Although the nurse call product line was transitioned in 1995, the Company estimates that there is a customer base of approximately 8,500 systems. Taking into account historical usage, the Company believes it has appropriate levels of inventory on hand to support the servicing of the previously installed products. CCM The Call Center division develops and sells sophisticated telephony products that integrate a computerized digital telephone system platform with high-volume inbound, outbound and internal call processing systems. Such systems include automatic call distribution systems, predictive dialers, scripting software to assist agents handling calls, and interactive voice response systems. In 1995, the Company established the divisional management structure and made product improvements which are hoped to increase revenues in 1996 along with improving profit margins. During 1995, the Company issued the latest release of the predictive dialer product, which is a more competitive product from a price and feature standpoint than its predecessor. In addition, the Interactive Voice Response ("IVR") product, which had previously been produced by a third party, has been replaced with a Company-manufactured product which should result in higher gross profit margins. Backlog at the end of 1995 was at a record level which should translate into a strong first half of 1996. Videoconferencing Products The videoconferencing division provides videoconferencing network services such as multipoint conferencing, network bridging and network design to its customers. 1995 was a startup year for the videoconferencing division. In addition to the costs incurred to build a management team and sales force, divisional revenues did not grow as quickly as anticipated because of delays by suppliers in providing a competitively-priced product until the fourth quarter of 1995. The process of establishing demo sites and hiring a dedicated sales force has almost been completed. Network Services The network services division offers cost-effective voice and data long-distance service, least-cost routing, network design and network support services, enabling customers to make more efficient and cost-effective use of their telecommunications systems. Revenues were $24 million in 1995, a decrease from the previous year, but profits increased due to a negotiated rate reduction from the carrier. Revenues are down due to competitive pressures in the marketplace. The Company has met this challenge with a division president and, with changes to incentive compensation plans, has made long-distance sales as important to the Company's sales managers as selling equipment. There are now 35 dedicated sales representatives and 4 regional sales managers to work with the equipment sales representatives to package network and equipment sales properly. As a result, bookings at the end of 1995 were at their highest level for the entire year, which are expected to translate into higher revenues in 1996. 1995 COMPARED TO 1994 Results of Operations Total revenues for the year ended December 31, 1995 were $296.4 million, a $4.4 million increase over the comparable 1994 period. Base revenues increased 2% compared to 1994, primarily due to increases in system upgrades and expansions and increased revenue from maintenance contracts, partially offset by lower volume generated by the INFOSTAR'r'/LD+ program. Product revenues increased 1% compared to 1994, as the increase in new installations of healthcare products and in shipments to the independent sales and service offices were partially offset by a decrease in new telephony installations. Cost of revenues consists of direct manufacturing costs, indirect installation and service costs and other costs such as warehousing, software manufacturing and quality inspection. Direct manufacturing costs are the primary component of cost of revenues and are accounted for as direct costs related to specific base and product revenues. Those costs other than direct manufacturing costs are treated as fixed cost overhead and are not allocated specifically to base or product categories. Therefore, changes in gross profit can be measured based upon the pricing margin (revenue less direct manufacturing costs) on a product line basis and by the overall level of fixed cost overhead relative to total revenue. Gross profit, as a percentage of revenues, decreased slightly from 41.9% during 1994 to 41.5% during 1995 due to a combination of factors including product mix, higher introductory manufacturing costs for the healthcare products and a lower absorption of fixed cost overhead. Operating income, excluding the provision for restructuring, decreased $4.9 million compared to 1994 and, as a percentage of revenues, was 2.6% compared to 4.3% in 1994. The decrease in operating income is primarily due to increased operating expenses during 1995. Product development and engineering increased $2.5 million during 1995 as the Company continues to accelerate its investment in engineering for new product development and application-specific software products. Selling, general and administrative expenses increased $2.8 million during the year, primarily representing the full year cost impact of the divisional supporting management and sales structure. Interest expense increased during 1995 due to higher average borrowing levels on the revolving credit facility and increases in the Company's prime borrowing rate during 1995. Other income, net increased primarily as a result of the 1995 gains on the sales of the customer bases in Wisconsin and Iowa and the related direct sales offices, totaling $1.2 million. During the first quarter of 1995, the Company was involved in extensive negotiations to acquire the Dictaphone division of Pitney Bowes ("Dictaphone"). In April 1995, the acquisition was awarded to another bidder. The Company incurred approximately $1 million in fees and expenses related to the attempted acquisition which were recognized in the second and third quarters of 1995. The Company accounts for income taxes in accordance with FAS No. 109, "Accounting for Income Taxes." For the year ended December 31, 1995, the Company recorded a net tax benefit of $2.3 million. This is comprised of $4.2 million of tax benefit recognized as a result of the non-goodwill related portion of the restructuring provision, partially offset by the $1.9 million tax provision on earnings, excluding the restructuring provision. No tax benefit was recognized on the goodwill portion of the provision for restructuring since it is not deductible for tax purposes. The net tax benefit for the year was recorded as an increase to the deferred tax asset reflecting additional tax benefits to be utilized in the future. As of December 31, 1995, the deferred tax asset of $29.6 million represents the expected benefits to be received from the utilization of tax benefit carryforwards which will result in the payment of minimal taxes in the near future. The Company believes that the deferred tax asset will more likely than not be recognized in the carryforward period. The Company had no significant tax liability for the year ended December 31, 1995. In October 1995, the FASB issued Statement No. 123, "Accounting for Stock-Based Compensation." The Company will adopt the new pronouncement in fiscal year 1996 and has yet to decide whether it will record compensation cost or provide pro forma disclosure. Acquisition of Unistar Gaming Corporation On December 19, 1995, the Company acquired 100% of the common stock of Unistar Gaming Corporation ("Unistar") for 3.7 million shares of the Company's common stock and 350,000 shares of newly issued preferred stock. Unistar, privately-held prior to the acquisition, has an exclusive five-year contract to design, develop, finance, and manage the National Indian Lottery ("NIL"). See Note L of the Notes to Consolidated Financial Statements for the terms of the agreement. Management believes the Unistar business is a natural extension of its telephony and call center businesses. Calls via an 800 number will be processed with IVR equipment or live agents located on the Coeur d'Alene Indian Tribe of Idaho ("CDA") Reservation using ACD software to process nationwide wagering activity. The Company has made a significant investment in Unistar, which initially created 8% dilution to the Company's shareholders and will require possibly up to $2 million to $3 million of cash prior to the resolution of the pending legal issues discussed below. However, in the opinion of the Company's management, this investment is justified based upon the potential returns. In an attempt to block the NIL, certain states filed letters under 18 U.S.C. Section 1084 to prevent the long-distance carriers from providing telephone service to the NIL. 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. Any appeal of this ruling must be filed by May 31, 1996. The Company expects this ruling will be appealed, but believes that the CDA's position will be upheld. Other than legal costs related to an appeal of the CDA Tribal Court ruling or other actions by the states, if any, the Company estimates that the additional costs to become operational may amount to between $5-10 million. Operational capital includes 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 estimate of operating capital does not include a $4 million jackpot reserve which could be required 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 contract. The Company expects it will be able to obtain additional financing for these costs, if necessary. 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 lottery. Subsequent Events On April 9, 1996, the Company entered into an agreement to sell substantially all of the Direct Sales and Services Group, including its long-distance reseller business and National Service Center, for $67.4 million to an acquisition company led by Bain Capital, Inc. (See Note N of the Notes to Consolidated Financial Statements for the terms of the agreement.) The sale is expected to close on May 31, 1996, subject to the buyer's financing and other conditions. The agreement also provides that the Company and the buyer will enter into a five-year exclusive distribution agreement under which the buyer will sell and service the Company's telephony equipment to those businesses and commercial locations that require up to 400 telephones. The sale does not include the Pittsburgh direct sales and service office, which the Company has agreed to sell to one of its existing independent distributors for approximately $1.3 million in cash and notes. The sale of the direct Sales and Service Group (including the separate sale of the Pittsburgh office) relates primarily to the retail distribution channel of the Computer Telephony division and includes the entire network services division. After the sale, the Computer Telephony division will consist of telephony products sales to independent distributors, of which the newly-formed Bain company will be the largest distributor, along with the National Accounts and Federal Systems marketing groups. The Company will retain its Healthcare Communications and Call Center Management businesses and the recently acquired Unistar business. In 1995, the Direct Sales and Services Group, including the long-distance reseller business, had revenues of $191 million. On a pro forma basis, after giving effect to the transaction, the Company's 1995 revenues would be approximately $157 million. This includes $42 million in sales to the Direct Sales and Services Group which were eliminated in the 1995 Statement of Operations. On April 10, 1996, the Company announced that it had given notice of its termination of its distribution agreement with GPT Video Systems due to failures by GPT to deliver properly-functioning videoconferencing products on a timely basis. The Company is negotiating an agreement with a third party to sell its videoconferencing business. Terms of the contract have yet to be finalized. 1994 COMPARED TO 1993 Results of Operations Total revenues for the year ended December 31, 1994 were 7% higher than the comparable 1993 period. Base revenues for 1994 increased 12% over 1993 primarily due to volume increases generated by the INFOSTAR'r'/LD+ program, increased sales of system upgrades and expansions and increased revenue from maintenance contracts. Product revenues for 1994 increased 3% over 1993 primarily due to increased sales of voice processing products and sales decreases in non-voice processing applications and healthcare revenue. Gross profit increased $11.5 million compared to 1993, with the gross profit as a percentage of total revenues increasing to 41.9% from 40.9%. The increases were a result of the continuing favorable product mix of increased base revenue and voice processing products. Voice processing and base revenues in 1994 accounted for 71% of the sales volume compared to 64% in 1993, indicating the Company's shifting emphasis to market value-added products to the customer base and increase sales of application-specific software products. Operating income increased $1.4 million during 1994 and, as a percentage of total revenues, was 4.3% compared to 4.1% for 1993. The increase in operating income as a percentage of total revenues was primarily related to the increase in gross profit margin, partially offset by continuing investments in the sales force and sales support personnel, technical marketing support and product development and engineering expenses for the development and sale of the new higher margin products. The decrease in interest expense during 1994 was primarily due to the favorable impact of a lower level of bank borrowings. For the year ended December 31, 1994, the Company recorded a provision for income taxes of $3.3 million. Approximately 88% or $2.9 million of the total tax provision was recorded as a reduction of the deferred tax asset to reflect the utilization of tax benefits. As a result of the utilization of these benefits, the Company had no significant tax liability for the year ended December 31, 1994. In addition, the Company recorded a provision for income taxes of $0.5 million, relating to discontinued operations, which also reduced the deferred tax asset. During 1994, the Company adjusted its valuation allowance, resulting in an increase in the deferred tax asset of $6.5 million, $5.2 million of which was a reduction of goodwill as it related to pre-acquisition tax benefits and $1.3 million of which reduced the 1994 provision for income taxes. The basis for the adjustment of the valuation allowance was a significant increase in pre-tax income from $7.6 million in 1993 to $10.0 million in 1994. In December 1993, a fire occurred at the Company's main subcontractor's production facility in Shinzen, China, causing inventory shortages during the first six months of 1994. The production problems were largely alleviated by the Company's ability to increase its own production and find alternative manufacturing sources. In July 1994, the Company recovered $4 million from its insurance carrier for additional direct costs related to the emergency production situation. As of March 31, 1994, the Company sold its Vodavi Communications Systems Division ("VCS"), which sold telephone equipment to supply houses and dealers, a different class of customer from continuing operations, under the brand names STARPLUS'r' and INFINITE'tm', for approximately $10.9 million. Proceeds of the sale consisted of approximately $9.7 million in cash, received in April 1994, and a $1.2 million note, the proceeds of which were received in September 1995. The proceeds were used to reduce borrowings under the Company's revolving credit facility. The sale resulted in an after-tax gain of $604,000 (net of income tax provision of $403,000). Consolidated financial statements for the years ended December 31, 1994 and 1993 present VCS as a discontinued operation. Net revenues of the discontinued operation for 1994, through the date of sale, and 1993 were $8.6 million and $31.6 million, respectively. 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 $23 million, $30 million and $29 million as of December 31, 1995, 1994 and 1993, respectively. At December 31, 1995 and 1994, cash and cash equivalents amounted to $8.1 million and $7.8 million, respectively, or 8% of current assets. During the year ended December 31, 1995, net cash was used to fund $3.9 million of operating activities, purchase $3.5 million of capital equipment, repay $0.6 million of debt and for other payments of $0.8 million. Cash was generated through $5.2 million of additional borrowings, $1.6 million in proceeds from the issuance of stock, receipt of a $1.2 million note payment from the sale of VCS and $0.8 million in other proceeds. Cash used in operating activities during 1995 included $14.3 million in funding of working capital, primarily due to the high level of accounts payable at the end of 1994 generated by inventory purchases during the last quarter of 1994. The decrease in cash generated by operating activities compared to 1994 is primarily due to the decrease in operating income, excluding the provision for restructuring, the funding of $1.0 million in cash expenses relating to the attempted acquisition of Dictaphone and additional interest payments of $0.8 million. Total debt at December 31, 1995 was $30.8 million, an increase of $5.3 million from $25.5 million at December 31, 1994. The increase in debt is due to $4.5 million in higher bank borrowings, $0.8 million in other borrowings, a $0.4 million capital lease obligation incurred in connection with equipment acquisitions and an increase to the carrying value of the convertible subordinated debentures of $0.2 million due to accretion. The additional borrowings in 1995 were used to reduce the high level of accounts payable at the end of 1994 generated by inventory purchases during the last quarter of 1994. During the year, the Company made long-term debt and capital lease repayments of $0.6 million. The Company's secured credit facility (the "Credit Facility") was amended in December 1995. The $45 million Credit Facility expires in August 1999 and consists of a revolving line of credit providing for direct borrowings and up to $15 million in letters of credit. Direct borrowings and letter of credit advances are made available pursuant to a formula based on the levels of eligible accounts receivable and inventories. The Credit Facility agreement contains certain restrictive covenants which include, among other things, a prohibition on the declaration or payment of any cash dividends on common stock, minimum ratios of operating income to interest and fixed charges, and a maximum ratio of total liabilities to net worth as well as certain restrictions on start-up expenditures relating to Unistar and the NIL. Interest rates are also subject to adjustment based upon certain financial ratios. During 1995, the Company was in compliance with all such financial covenants. The Credit Facility is secured by substantially all of the assets of the Company. Refer to Note D of the Notes to Consolidated Financial Statements. As of February 16, 1996, there were $13.4 million of direct borrowings and $14.9 million of letters of credit outstanding and $15.2 million of additional borrowings available under the Credit Facility. Required principal payments for debt in 1996 are $0.9 million. The Company believes that borrowings under the Credit Facility and cash flow from operations will be sufficient to meet working capital and other requirements for 1996. SELECTED FINANCIAL DATA The following is selected financial data for EXECUTONE for the five years ended December 31, 1995. (In thousands, except for per share amounts)
Years Ended December 31, 1995 1994 (1) 1993 (1) 1992 (1) 1991 (1) -------------------------------------------------------------------------------- Revenues $296,393 $291,969 $271,765 $253,024 $243,616 ======== ======== ======== ======== ======== Income (Loss) Before Income Taxes From Continuing Operations $(39,221) $ 10,041 $ 7,580 $ 4,320 $ 2,327 ======== ========== ========== ========== ========== Income (Loss) From Continuing Operations $(36,934) $ 6,734 $ 4,903 $ 2,222 $ 1,146 Income (Loss) From Discontinued Operations, Net of Taxes --- 757 298 (157) (129) Extraordinary Item - Gain on Extinguishment of Debt, Net of Taxes (2) --- --- --- 1,267 --- ------------- ------------- ------------- ---------- ------------- Net Income (Loss) $(36,934) $ 7,491 $ 5,201 $ 3,332 $ 1,017 ======== ========== ========== ========== ========== EARNINGS (LOSS) PER SHARE: Continuing Operations $ (0.79) $ 0.14 $ 0.10 $ 0.05 $ 0.03 Discontinued Operations --- 0.02 0.01 --- --- Extraordinary Item --- --- --- 0.03 --- -------------- -------------- -------------- ------------ ------------- Net Income (Loss) $ (0.79) $ 0.16 $ 0.11 $ 0.08 $ 0.03 =========== =========== =========== =========== ========== Total Assets $167,844 $189,481 $175,555 $179,294 $177,602 ======== ======== ======== ======== ======== Long-Term Debt (3) $ 29,829 $ 24,698 $ 32,279 $ 43,752 $ 56,271 ========= ========= ========= ========= ========= Cash Dividends Declared Per Share (4) $ --- $ --- $ --- $ --- $ --- ============= ============= ============ ============= =============
(1) Discontinued operations are presented for VCS which was sold in March 1994. Refer to Note L of the Notes to Consolidated Financial Statements. (2) The extraordinary item relates to the 1992 exchange of debentures for Preferred Stock and Common Stock Purchase Warrants. Refer to Note D (b) of the Notes to Consolidated Financial Statements. (3) Includes capitalized leases. (4) The Company has not declared or paid any cash dividends on its Common Stock. Refer to "Stock Data". EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except for per share amounts)
Years Ended December 31, 1995 1994 1993 ---- ---- ---- REVENUES: Product $138,752 $137,752 $134,209 Base 157,641 154,217 137,556 --------- --------- --------- 296,393 291,969 271,765 COST OF REVENUES 173,536 169,497 160,745 --------- --------- --------- Gross Profit 122,857 122,472 111,020 --------- --------- --------- OPERATING EXPENSES: Product development and engineering 14,703 12,222 9,852 Selling, general and administrative 100,520 97,755 90,122 Provision for restructuring and unusual items (Note B) 44,042 --- --- ---------- -------------- -------------- 159,265 109,977 99,974 --------- --------- ---------- OPERATING INCOME (LOSS) (36,408) 12,495 11,046 INTEREST EXPENSE 3,920 3,089 3,556 OTHER INCOME, NET (2,129) (635) (90) ACQUISITION COSTS (Note L) 1,022 --- --- ---------- -------------- -------------- INCOME (LOSS) BEFORE INCOME TAXES FROM CONTINUING OPERATIONS (39,221) 10,041 7,580 PROVISION (BENEFIT) FOR INCOME TAXES: Cash 350 400 335 Noncash (Note E) (2,637) 2,907 2,342 ---------- ------------ ----------- (2,287) 3,307 2,677 ---------- ------------ ----------- INCOME (LOSS) FROM CONTINUING OPERATIONS (36,934) 6,734 4,903 Income from discontinued operations (net of income tax provision of $102 and $158 ) --- 153 298 Gain on disposal of discontinued operations (net of income tax provision of $403) --- 604 --- ------------- ----------- ------------- NET INCOME (LOSS) $ (36,934) $ 7,491 $ 5,201 ========= ========== ========== EARNINGS (LOSS) PER SHARE: CONTINUING OPERATIONS $ (0.79) $ 0.14 $ 0.10 DISCONTINUED OPERATIONS --- 0.02 0.01 -------------- ----------- ------------ NET INCOME (LOSS) $ (0.79) $ 0.16 $ 0.11 ========== ========== =========== WEIGHTED AVERAGE NUMBER OF SHARES OF COMMON STOCK AND EQUIVALENTS OUTSTANDING 46,919 47,697 48,283 =========== =========== ===========
The accompanying notes are an integral part of these consolidated statements. EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) Years Ended December 31, 1995 1994 1993 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Income (loss) from continuing operations $(36,934) $ 6,734 $ 4,903 Adjustments to reconcile net income (loss) to net cash (used) provided by operating activities: Depreciation and amortization 6,093 7,463 7,469 Deferred income tax provision (benefit) (2,637) 2,907 2,342 Provision for restructuring and unusual items (Note B) 44,042 --- --- Provision for losses on accounts receivable 1,440 893 725 Gains on sales of two direct sales offices (1,087) --- --- Other, net (521) 1,251 270 Changes in working capital items: Accounts receivable (4,205) (9,346) (4,337) Inventories (3,121) (13,049) 4,073 Accounts payable and accruals (9,131) 10,497 2,732 Other working capital items, net 2,177 (552) (1,440) ---------- ----------- --------- NET CASH (USED) PROVIDED BY CONTINUING OPERATIONS (3,884) 6,798 16,737 ---------- ---------- -------- Cash flows from discontinued operations --- (449) (209) ------------- ----------- --------- NET CASH (USED) PROVIDED BY OPERATING ACTIVITIES (3,884) 6,349 16,528 ---------- --------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (3,457) (6,091) (2,119) Dispositions (acquisitions) of direct sales offices 125 (1,298) (750) Proceeds from sale of VCS 1,200 9,700 --- Other, net 822 (436) 8 ---------- ---------- ----------- NET CASH (USED) PROVIDED BY INVESTING ACTIVITIES (1,310) 1,875 (2,861) --------- ---------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings (repayments) under revolving credit facility 4,478 (4,199) (3,524) Repayments of term note under credit facility --- (3,750) (1,250) Repayments of GTE/Contel promissory note --- --- (4,000) Repayments of other long-term debt (622) (1,781) (2,355) Repurchase of stock (810) (8,450) (3,100) Proceeds from issuance of stock 1,641 10,399 564 Other borrowings 750 --- --- -------- ------------ ----------- NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES 5,437 (7,781) (13,665) --------- --------- ------- INCREASE IN CASH AND CASH EQUIVALENTS 243 443 2 CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 7,849 7,406 7,404 --------- --------- --------- CASH AND CASH EQUIVALENTS - END OF YEAR $ 8,092 $ 7,849 $ 7,406 ========= ======== ========
The accompanying notes are an integral part of these consolidated statements. EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(In thousands, except for share amounts) December 31, December 31, 1995 1994 ---- ---- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 8,092 $ 7,849 Accounts receivable, net of allowance of $1,715 and $1,335 48,531 46,675 Inventories (Note B) 32,765 40,300 Prepaid expenses and other current assets 6,584 7,358 ---------- ----------- Total Current Assets 95,972 102,182 PROPERTY AND EQUIPMENT, net 18,462 18,967 INTANGIBLE ASSETS, net (Notes B and L) 20,022 38,415 DEFERRED TAXES 29,616 26,979 OTHER ASSETS 3,772 2,938 ----------- ----------- $167,844 $189,481 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of long-term debt $ 932 $ 777 Accounts payable 30,676 39,369 Accrued payroll and related costs 6,870 7,026 Accrued liabilities 11,851 9,192 Deferred revenue and customer deposits 19,781 18,757 ---------- ---------- Total Current Liabilities 70,110 75,121 LONG-TERM DEBT 29,829 24,698 LONG-TERM DEFERRED REVENUE 2,805 2,354 ----------- ----------- Total Liabilities 102,744 102,173 --------- --------- STOCKHOLDERS' EQUITY: Common stock: $.01 par value; 80,000,000 shares authorized; 51,658,492 and 45,647,894 issued and outstanding 517 456 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 --- Additional paid-in capital 79,668 72,303 Retained earnings (deficit) (since July 1, 1988) (22,385) 14,549 ---------- ---------- Total Stockholders' Equity 65,100 87,308 ---------- ---------- $167,844 $189,481 ======== ========
The accompanying notes are an integral part of these consolidated balance sheets. EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Common Stock Preferred Stock Additional Retained Total (In thousands, except for ----------------- ------------------- Paid-In Earnings Stockholders' share amounts) Shares Amount Shares Amount Capital (Deficit) Equity ------ ------ ------ ------ ------- --------- ------- Balance at December 31, 1992 30,873,495 $309 674,865 $6,149 $60,721 $1,857 $69,036 Proceeds from issuances of stock from employee stock plans 1,307,805 13 1,247 1,260 Proceeds from common stock purchase warrants exercised through bond conversion 1,418,300 14 971 985 Conversion of note payable into preferred stock 200,000 1,909 365 2,274 Conversion of preferred stock into common stock 8,748,650 88 (874,865) (8,058) 7,970 --- Repurchase of stock (1,142,752) (12) (3,088) (3,100) Amortization of deferred compensation 89 89 Net income 5,201 5,201 -------------------------------------------------------------------------------------- Balance at December 31, 1993 41,205,498 $412 --- $ --- $68,275 $7,058 $75,745 Proceeds from issuances of stock from employee stock plans 5,716,651 57 11,303 11,360 Proceeds from common stock purchase warrants exercised through bond conversion 1,507,000 15 1,056 1,071 Repurchase of stock (2,781,255) (28) (8,422) (8,450) Amortization of deferred compensation 91 91 Net income 7,491 7,491 -------------------------------------------------------------------------------------- Balance at December 31, 1994 45,647,894 $456 --- $ --- $72,303 $14,549 $87,308 Proceeds from issuances of stock from employee stock plans 1,934,492 19 1,613 1,632 Warrants exercised for common stock 363,549 4 (4) --- Common and preferred stock issued to acquire Unistar (Note L) 3,700,000 37 350,000 7,300 5,374 12,711 Common stock issued for investment in DCC (Note G) 353,118 4 1,100 1,104 Repurchase of stock (340,561) (3) (807) (810) Amortization of deferred compensation 89 89 Net loss (36,934) (36,934) ---------------------------------------------------------------------------------------- Balance at December 31, 1995 51,658,492 $517 350,000 $7,300 $79,668 $(22,385) $65,100 ======================================================================================
The accompanying notes are an integral part of these consolidated statements. EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - NATURE OF THE BUSINESS AND FORMATION OF THE COMPANY EXECUTONE Information Systems, Inc. (the "Company") designs, manufactures, sells, installs, supports and services voice processing systems and provides cost-effective long-distance telephone service and videoconferencing services. The Company is also a leading supplier of specialized hospital communications equipment. Products are sold under the EXECUTONE'r', INFOSTAR'r', IDS'tm', LIFESAVER'tm', and INFOSTAR/ILS'tm' brand names through a worldwide network of direct and independent sales and service offices. The Company's products are manufactured primarily in the United States, Hong Kong, China and the Dominican Republic. The Company was formed in July 1988 through the merger of ISOETEC Communications, Inc. ("ISOETEC") with Vodavi Technology Corporation ("Vodavi"). The merger of ISOETEC into Vodavi was accounted for under the purchase method of accounting and Vodavi was deemed to have undergone a quasi-reorganization for accounting purposes. As of July 1988, Vodavi's accumulated deficit of approximately $49.7 million was eliminated. Executone, Inc. was acquired in 1988 from Contel Corporation ("Contel") for promissory notes and cash. NOTE B - PROVISION FOR RESTRUCTURING In July 1995, the Company reorganized its business into five divisions: Computer Telephony, Healthcare Communications Systems, Call Center Management, Videoconferencing Products, and Network Services and changed its business strategy in the Computer Telephony division. The current strategic focus is on software applications in the communications market. The business that was acquired in 1988 was a telephone equipment hardware company focused on customers with small systems, with an emphasis on selling additional hardware and service to generate add-on revenue. Under the current strategy, the business acquired in 1988 is being de-emphasized. The Company adopted FAS No. 121, "Accounting for the Impairment of Long-Lived Assets," which was issued in March 1995, requiring impairment to be measured by projecting the lowest level of identifiable future cash flows. The Company concluded there was an impairment. As a result, the Company recorded a $44.0 million provision for restructuring consisting of a $33.5 million goodwill impairment, an $8.8 million writedown of inventory, primarily service stock relating to the impaired assets and other non-recurring inventory adjustments, $0.9 million related to the shutdown of the Company's Scottsdale, Arizona facility and $0.8 million of other unusual items. In accordance with the provisions of FAS No. 121, the Company prepared projections of future operating cash flows relating to the telephony business acquired in 1988 based upon the Company's new strategic direction. These projections indicated that this business would not generate sufficient operating cash flows to realize goodwill and the related service stock. The amount of impairment of the telephony goodwill was $33.5 million as of June 30, 1995. The write-off of inventory, primarily service stock, consisted of $1.3 million of raw materials inventory and $7.5 million of finished goods inventory. These amounts were determined based upon a review of specific inventory parts along with current and projected usage, incorporating the strategic direction of the Company. The Company will continue to maintain adequate levels of service stock for the telephony hardware customer base which will be amortized over the estimated product/service life of the related systems. NOTE C - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation. The 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 on the equity method. Certain prior year amounts have been reclassified to conform to the current year's presentation. Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Revenue Recognition. The Company recognizes revenue on equipment sales and software licenses to independent sales and service offices when shipped. Revenue from equipment, software and installation contracts with end-users is recognized when the contract or contract phase for major installations is substantially completed. Revenue derived from the sale of service contracts is amortized ratably over the service contract period on a straight-line basis. 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 period. Common stock equivalents and the convertible debentures which are antidilutive have been excluded from the computations. Cash Equivalents. Cash equivalents include short-term investments with original maturities of three months or less. Inventories. Inventories are stated at the lower of first-in, first-out ("FIFO") cost or market and consist of the following at December 31, 1995 and 1994:
(Amounts in thousands) 1995 1994 --------------------------- ---- ---- Raw Materials $ 4,783 $ 3,082 Finished Goods 27,982 37,218 -------- -------- $32,765 $40,300 ======= =======
Finished goods include service stock which is amortized over the estimated product/service life of the related systems. Intangible Assets. Intangible assets represent the excess of the purchase price of the predecessor companies acquired over the fair value of the net tangible assets acquired. Effective April 1, 1995, the carrying value of intangibles is evaluated periodically in accordance with the provisions of FAS No. 121 by projecting the lowest level of future undiscounted net cash flows of the underlying businesses. If the sum of such cash flows is less than the book value of the long-lived assets, including intangibles, projected future cash flows are discounted and intangibles are adjusted accordingly. Prior to April 1, 1995, the carrying value of intangibles was evaluated in accordance with the provisions of APB 17, and was based upon aggregate cash flows of the business as a whole. Amortization is provided over periods ranging from 10 to 40 years. Intangible assets at December 31, 1995 and 1994 are net of accumulated amortization of $0.8 million and $13.6 million, respectively. Property and Equipment. Property and equipment at December 31, 1995 and 1994 consist of the following:
(Amounts in thousands) 1995 1994 ---------------------- ---- ---- Land and building $ 1,364 $ 1,961 Furniture and fixtures 7,052 7,626 Leasehold improvements 2,828 2,620 Machinery and equipment 38,093 34,269 ------- -------- 49,337 46,476 Accumulated depreciation (30,875) (27,509) ------- -------- Property and equipment, net $18,462 $18,967 ======= =======
Depreciation is provided on a straight-line basis over the estimated economic useful lives of property and equipment which range from three to ten years for equipment and thirty years for a building. Amortization, principally of leasehold improvements, is provided over the life of the respective lease terms which range from three to ten years. Income Taxes. The Company utilizes the liability method of accounting for income taxes as set forth in FAS No. 109, "Accounting for Income Taxes." Under the liability method, deferred taxes are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Product Development and Engineering. Product development and engineering costs are expensed as incurred. Fair Value of Financial Instruments. The fair value of the Company's Convertible Subordinated Debentures at December 31, 1995 is approximately $14.3 million, based upon market quotes. The carrying value of all other financial instruments included in the accompanying financial statements approximate fair value as of December 31, 1995 based upon current interest rates. Noncash Investing and Financing Activities. The following noncash investing and financing activities took place during the three years ended December 31, 1995:
(Amounts in thousands) 1995 1994 1993 ---------------------- ---- ---- ---- Common and Preferred Stock issued to acquire Unistar (Note L) $12,711 $ --- $ --- Notes receivable for disposition of direct sales offices (Note L) 1,911 --- --- Equity investment in DCC (Note G) 1,505 --- --- Common shares exchanged to exercise options and warrants 1,137 455 8 Capital leases for equipment acquisitions 437 686 1,791 Note receivable for disposition of VCS division (Note L) --- 1,200 --- Common stock purchase warrants exercised through bond conversion --- 1,071 985 Utilization of credits under a special stock option incentive plan --- 737 696 Conversion of Preferred Stock into Common Stock --- --- 8,058 Conversion of note payable into Preferred Stock --- --- 2,274
Refer to the consolidated statements of cash flows for information on cash-related operating, investing and financing activities. NOTE D - DEBT The Company's debt is summarized below at December 31, 1995 and 1994:
(Amounts in thousands) 1995 1994 - --------------------------- ---- ---- Borrowings Under Revolving Credit Facility (a) $15,445 $10,967 Convertible Subordinated Debentures (b) 12,098 11,855 Capital Lease Obligations (c) 2,412 2,408 Other 806 245 ---------- ---------- Total Debt 30,761 25,475 Less: Current Portion of Long-Term Debt 932 777 ---------- ---------- Total Long-Term Debt $29,829 $24,698 ======= =======
(a) The Company's Credit Facility was amended in December 1995. The amended $45 million Credit Facility consists of a revolving line of credit providing for direct borrowings and up to $15 million in letters of credit. Direct borrowings and letter of credit advances are made available pursuant to a formula based on the levels of eligible accounts receivable and inventories. To minimize interest on the revolving line of credit, the Company has the option to borrow money based upon an adjusted prime borrowing rate (9.0% at December 31, 1995) or at an adjusted eurodollar rate (8.2% at December 31, 1995). The Company had $11.0 million and $8.0 million outstanding subject to the adjusted eurodollar rate at December 31, 1995 and 1994, respectively, with the balance at the adjusted prime borrowing rate. Prior to August 1994, interest on amounts outstanding under the revolving line of credit were based upon the lender's prime rate. The revolving line of credit expires in August 1999. Approximately $14.7 million was available at December 31, 1995 under the revolving line of credit, including approximately $14.9 million which was committed to cover outstanding letters of credit. The unused portion of the line of credit has a commitment fee of 0.375%. The Company's average outstanding indebtedness under the revolving line of credit for the years ended December 31, 1995 and 1994 was $17.4 million and $13.1 million, respectively, and the average interest rate on such indebtedness was 8.5% and 7.1%, respectively. The Credit Facility agreement contains certain restrictive covenants which include, among other things, a prohibition on the declaration or payment of any cash dividends on common stock, minimum ratios of operating income to interest and fixed charges, and a maximum ratio of total liabilities to net worth as well as certain restrictions on start-up expenditures relating to Unistar and the NIL (Refer to Note L). Interest rates are also subject to adjustment based upon certain financial ratios. The Company was in compliance with all covenants in 1995. The Credit Facility is secured by substantially all of the assets of the Company. (b) The Company's Convertible Subordinated Debentures (the "Debentures"), issued in April 1986, are due March 15, 2011 and bear interest at 7 1/2%, payable March 15th and September 15th. The face value of the outstanding Debentures at December 31, 1995 was $16.5 million. The face value of the Debentures was adjusted to fair value in connection with the Company's 1988 quasi-reorganization. The Debentures are convertible at the option of the holder into Common Stock of the Company at any time on or before March 15, 2011, unless previously redeemed, at a conversion price of $10.625 per share, subject to adjustment in certain events. Subject to certain restrictions, the Debentures are redeemable in whole or in part, at the option of the Company, at par in 1996. The Debentures are also subject to annual sinking fund payments of $1.5 million beginning March 15, 1997. In January 1992, $15 million principal amount of Debentures with a book value of $10.1 million was exchanged for 674,865 shares of Convertible Preferred Stock and 2,999,400 Common Stock Purchase Warrants. Debentures converted in the debt-for-equity exchange and in connection with Warrant exercises were delivered in lieu of cash in satisfying sinking fund requirements. Thus, no cash sinking fund payment will be due until March 2008. (c) The Company has entered into capital lease arrangements for office furniture and data processing and test equipment with a net book value of approximately $2.3 million and $2.4 million at December 31, 1995 and 1994, respectively. Such leases have been capitalized using implicit interest rates which range from 8% to 14%. The following is a schedule of future maturities of long-term debt at December 31, 1995:
Years Ending December 31: (Amounts in thousands) ------------------------- ----------------------- 1996 $ 932 1997 842 1998 640 1999 15,742 2000 155 Thereafter 12,450 ------- $30,761
(d) For the years ended December 31, 1995, 1994 and 1993, the Company made cash payments of approximately $3.6 million, $2.8 million and $4.2 million, respectively, for interest expense on indebtedness. NOTE E - INCOME TAXES The components of the provision (benefit) for income taxes applicable to income (loss) from continuing operations for the three years ended December 31, 1995 are as follows:
(Amounts in thousands) 1995 1994 1993 ---------------------- ---- ---- ---- Current - Federal $ 150 $ 200 $ 145 - State 200 200 190 --------- -------- -------- 350 400 335 --------- -------- --------
(Amounts in thousands) 1995 1994 1993 ---------------------- ---- ---- ---- Deferred - Federal (1,922) 2,363 1,842 - State (715) 544 500 --------- -------- -------- (2,637) 2,907 2,342 -------- ------- ------- $(2,287) $3,307 $2,677 ======== ====== ======
For the years ended December 31, 1994 and 1993, the Company recorded a deferred income tax provision of $505,000 and $158,000, respectively, related to discontinued operations. A reconciliation of the statutory federal income tax provision (benefit) to the reported income tax provision (benefit) on income (loss) from continuing operations for the three years ended December 31, 1995 is as follows:
(Amounts in thousands) 1995 1994 1993 - ---------------------- ---- ---- ---- Statutory income tax provision (benefit) $(13,335) $3,415 $2,577 State income taxes, net of federal income tax benefit (338) 676 526 Impairment of intangible assets 11,392 --- --- Amortization of intangible assets 171 457 476 Adjustment of valuation allowance --- (1,252) (800) Research and development credit (148) (250) (196) Other (29) 261 94 ----------- -------- --------- Reported income tax provision (benefit) $ (2,287) $3,307 $2,677 ======== ====== ======
The components of and changes in the net deferred tax asset are as follows:
Deferred December 31, (Expense) December 31, (Amounts in thousands) 1994 Benefit 1995 - ---------------------- ------------ ---------- ------------ Net operating loss and tax credit carryforwards $29,175 $(1,631) $27,544 Inventory reserves 5,405 2,800 8,205 Accrued liabilities and restructuring costs 1,446 (864) 582 Debenture revaluation (1,715) 90 (1,625) Other (2,540) 2,194 (346) --------- ------- --------- 31,771 2,589 34,360 Valuation allowance (4,792) 48 (4,744) -------- --------- --------- Deferred tax asset $26,979 $2,637 $29,616 ======= ====== =======
The deferred tax asset represents the benefits expected to be realized from the utilization of pre- and post-acquisition tax benefit carryforwards, which include net operating loss carryforwards ("NOLs"), tax credit carryforwards and the excess of tax bases over fair value of the net assets of the Company. The utilization of these tax benefits for financial reporting purposes will not be reflected in the statement of operations, but will be reflected as a reduction of the deferred tax asset. In order to fully realize the remaining deferred tax asset of $29.6 million as of December 31, 1995, the Company will need to generate future taxable income of approximately $80 million prior to the expiration of the NOLs and tax credit carryforwards. Although the Company believes that it is more likely than not that the deferred tax asset will be fully realized based on current projections of future pre-tax income, a valuation allowance has been provided for a portion of the deferred tax asset. There was no significant adjustment to the valuation allowance in 1995. During 1994, the Company adjusted its valuation allowance by $6.5 million, $5.2 million of which was a reduction of goodwill as it related to pre-acquisition tax benefits and $1.3 million of which reduced the 1994 provision for income taxes. During 1993, the Company adjusted its valuation allowance by $4.8 million, $4.0 million of which was a reduction of goodwill as it related to pre-acquisition tax benefits and $0.8 million of which reduced the 1993 provision for income taxes. The basis for the adjustments in 1994 and 1993 was a significant increase in pre-tax income from $4.3 million in 1992 to $10.0 million in 1994. Accordingly, historical earnings supported the realization of the larger deferred tax asset. The amount of the deferred tax asset considered realizable, however, could be reduced if estimates of future taxable income during the carryforward period are reduced. As of December 31, 1995, the Company has NOLs and tax credit carryforwards (subject to review by the Internal Revenue Service) available to offset future income for tax return purposes of approximately $69.3 million and $3.2 million, respectively. A portion of the NOLs and tax credit carryforwards were generated prior to the formation of the Company and their utilization is subject to certain limitations imposed by the Internal Revenue Code. The NOLs expire as follows:
(Amounts in millions) 2002 2003 2004 2005 2006 --------------------- ---- ---- ---- ---- ----- $0.5 $20.8 $26.0 $9.7 $12.3
A reconciliation of the Company's income (loss) before taxes for financial reporting purposes to taxable income for the three years ended December 31, 1995 is as follows:
(Amounts in thousands) 1995 1994 1993 - ---------------------- ---- ---- ---- Income (loss) before taxes from continuing operations $(39,221) $10,041 $7,580 Discontinued operations --- 1,262 456 ------------- --------- -------- Income (loss) before taxes for financial reporting purposes (39,221) 11,303 8,036 Differences between income (loss) before taxes for financial reporting purposes and taxable income: Permanent differences 28,587 1,070 1,570 --------- --------- ------- Book taxable income (loss) (10,634) 12,373 9,606 Net changes in temporary differences 11,113 (5,016) (7,830) --------- --------- ------- Taxable income $ 479 $ 7,357 $1,776 ========== ======== ======
The permanent differences relate to the write-off (in 1995) and amortization of goodwill, which are not deductible. Changes in temporary differences principally relate to the impairment in service stock inventory (in 1995), inventory reserves and other costs accrued for book purposes, but not deducted for tax purposes until subsequently paid. For the years ended December 31, 1995, 1994 and 1993, the Company made cash payments of approximately $214,000, $485,000 and $96,000, respectively, for income taxes. NOTE F - COMMITMENTS AND CONTINGENCIES Operating Leases. The Company conducts its business operations in leased premises under noncancellable operating lease agreements expiring at various dates through 2005. Rental expense under operating leases amounted to $9.6 million, $10.1 million and $9.7 million for the years ended December 31, 1995, 1994 and 1993, respectively. The following represents the future minimum rental payments due under noncancellable operating leases that have initial or remaining lease terms in excess of one year as of December 31, 1995:
Years Ending December 31, (Amounts in thousands) ------------------------- ---------------------- 1996 $ 8,761 1997 7,724 1998 7,025 1999 5,435 2000 3,941 Thereafter 3,374 --------- $36,260 =========
Litigation. The Company has various lawsuits, claims and contingent liabilities arising from the conduct of business; however, in the opinion of management, they are not expected to have a material adverse effect on the results of operations, cash flow or financial position of the Company. NOTE G - RELATED PARTY TRANSACTIONS During 1995, the Company acquired 43% of the common stock and certain other assets of Dialogic Communications Corporation ("DCC"), a vendor which supplies the Company with certain call center products, in exchange for 353,118 shares of the Company's common stock and $100,000 cash. This investment is included in Other Assets and the related equity income is included in Other Income, Net. NOTE H - STOCK OPTIONS AND WARRANTS Information relative to the Company's stock option plans at December 31, 1995 is as follows:
Shares Per Share Range ------ --------------- Total shares originally authorized 11,290,000 Options exercised/expired since inception of plans (7,074,104) ---------- Remaining shares reserved for issuance 4,215,896 Options outstanding 2,083,560 $0.69-3.25 ---------- Shares available for granting of future options 2,132,336 ========== Options exercisable 1,124,469 $0.69-3.19 Options exercised - Year ended December 31, 1995 1,970,760 $0.63-1.91 Year ended December 31, 1994 1,979,340 $0.63-2.88 Year ended December 31, 1993 1,144,395 $0.63-1.25
Option prices under the Company's plans are equal to the market value of the Common Stock on the dates the options are granted. The Company has non-plan options outstanding at December 31, 1995 for 357,030 shares at prices ranging from $1.13 to $20.43 per share. These include options for 300,000 shares granted to an officer by a predecessor company at a price of $1.13 per share. Deferred compensation of $0.9 million was recorded for the excess of the fair value over the exercise price at the date of grant and is being amortized over 10 years ending in 1997. At December 31, 1995, all of the non-plan options were exercisable. These options expire at various dates through November 2000. Certain options include registration rights for the shares issuable thereunder. As of December 31, 1995, the Company has warrants outstanding which permit the holder to purchase a total of 56,250 shares of Common Stock at prices ranging from $1.06 to $1.25 per share, expiring through September 1997. Warrants were exercised during the year ended December 31, 1994 for 860,919 shares of Common Stock at prices ranging from $0.01 to $1.00 per share. Warrants were exercised during the year ended December 31, 1993 for 9,700 shares of Common Stock at $1.00 per share. At December 31, 1995, 39,584 warrants were exercisable. In October 1995, the FASB issued Statement No. 123, "Accounting for Stock-Based Compensation." The Company will adopt the new pronouncement in fiscal year 1996 and has yet to decide whether it will record compensation cost or provide pro forma disclosure. NOTE I - EMPLOYEE STOCK PURCHASE PLAN A total of 2,750,000 shares of Common Stock are authorized for issuance under the Company's employee stock purchase plan. The plan permits eligible employees to purchase up to 1,000 shares of Common Stock at the lower of 85% of the fair market value of the Common Stock at the beginning or at the end of each six-month offering period. Pursuant to such plan, 229,636, 209,512 and 168,097 shares were sold to employees during the three years ended December 31, 1995, 1994 and 1993, respectively. In 1994, the Company's shareholders adopted the 1994 Executive Stock Incentive Plan, which enabled officers and other key employees to purchase a total of up to 3,000,000 shares of the Company's Common Stock. During 1995 and 1994, participants purchased 140,000 and 2,745,000 shares of Common Stock, respectively, at fair market value, which were financed through individual bank borrowings at market interest rates by each participant, payable over five years. The Company lends the employee 85% of the interest due to the bank, with $759,000 of such loans outstanding as of December 31, 1995. There were no amounts outstanding as of December 31, 1994. The Company guarantees the individual borrowings under a $9.4 million letter of credit which has a minimal impact on the Company's borrowing capability. Employee loans guaranteed by the Company with letters of credit as of December 31, 1995 and 1994 were $9.2 million and $8.7 million, respectively. These shares are held by the Company as security for the borrowings under a loan and pledge agreement. Sales of such shares by participants are subject to certain restrictions, and, generally, they may not be sold for five years. NOTE J - SAVINGS AND POST-RETIREMENT BENEFIT PLANS The Company has a 401(k) Savings Plan under which it matches employee contributions subject to the discretion of the Company's Board of Directors. The Company's matching contribution, consisting of shares of its Common Stock purchased in the open market, is equal to 25% of each employee's contribution, up to a maximum of $660 per employee. The expense for the matching contribution for the years ended December 31, 1995, 1994 and 1993 was approximately $687,000, $500,000 and $372,000, respectively. The Company has an obligation remaining from the acquisition of Executone, Inc. to provide post-retirement health and life insurance benefits for a group of fewer than 75 former Executone, Inc. employees, including seven current employees of the Company. The Company does not provide post-retirement health or life insurance benefits to any other employees. Effective January 1, 1993, the Company adopted FAS No. 106, a standard on accounting for post-retirement benefits other than pensions. This standard requires that the expected cost of these benefits must be charged to expense during the years that employees render services. The Company adopted the new standard prospectively and is amortizing the transition obligation over a 20-year period. Post-retirement benefit expense for the three years ended December 31, 1995 consists of the following:
(Amounts in thousands) 1995 1994 1993 - --------------------------- ---- ---- ---- Interest on accumulated benefit obligation $219 $217 $190 Amortization of transition obligation 116 116 116 Amortization of unrecognized actuarial loss 20 23 --- ------ ------ ------- $355 $356 $306 ==== ==== ====
The status of the plan at December 31, 1995 and 1994 is as follows:
(Amounts in thousands) 1995 1994 - ---------------------- ---- ---- Accumulated post-retirement benefit obligation ("APBO"): Retirees $2,779 $2,707 Active Employees 330 321 -------- -------- 3,109 3,028 Unamortized transition obligation (1,977) (2,093) Unrecognized net loss (486) (559) ------- ------- Accrued liability $ 646 $ 376 ====== ======
In determining the APBO as of December 31, 1995 and 1994, the weighted average discount rate used was 7%. The Company used a healthcare cost trend rate of approximately 11%, decreasing through 2006 and leveling off at 6% thereafter. A 1% increase in the healthcare trend rate would increase the APBO at December 31, 1995 by approximately 2% and increase the interest cost component of the post-retirement benefit expense for 1995 by less than $10,000. NOTE K - OTHER INCOME, NET Other Income, Net consists of the following for the three years ended December 31, 1995:
(Amounts in thousands) 1995 1994 1993 - ---------------------- ---- ---- ---- Interest income $ (285) $(287) $(252) Equity in earnings of DCC (Note G) (401) --- --- Gains on sales of direct sales offices (1,213) --- --- Other, net (230) (348) 162 --------- ------ ------ $(2,129) $(635) $ (90) ======= ===== ======
NOTE L - ACQUISITIONS/DISPOSITIONS During the fourth quarter of 1995, the Company sold its customer bases in Wisconsin and Iowa and the net assets of the related direct sales offices for a total of $2.1 million, consisting of $125,000 cash, a $1.8 million note, the proceeds of which were received in February 1996, and a $150,000 note due in installments by November 2001. These sales generated a gain of approximately $1.2 million, which is included in Other Income, Net for the year ended December 31, 1995. On December 19, 1995, the Company acquired 100% of the common stock of Unistar Gaming Corporation ("Unistar") for 3.7 million shares of the Company's common stock and 350,000 shares of newly issued preferred stock. Unistar, privately-held prior to the acquisition, has an exclusive five-year contract to design, develop, finance, and manage the National Indian Lottery ("NIL"). The NIL will be a national telephone lottery authorized by federal law and a compact between the State of Idaho and the Coeur d'Alene Indian Tribe of Idaho ("CDA"). In return for providing these management services to the NIL, Unistar will be paid a fee equal to 30% of the profits of the NIL. Unistar did not have any assets or operations other than the NIL contract prior to its acquisition by the Company. The purchase price was approximately $12.7 million and was based upon the determination by an investment banking firm of the value assigned to the common and preferred stock. The common stock valuation was based upon the value of the shares issued at the closing date, discounted for restrictions on the sale of the shares, which range from six to twenty-six months. The preferred stock was valued based upon the number of common shares which it was estimated that the preferred shares may be converted into at some future date. 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) upon conversion or redemption of the Series A and Series B Preferred Stock or (iii) upon liquidation. 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). Shareholder approval is required before any of the Series B Preferred Stock can be converted or redeemed. Liquidation preferences for all Series A and Series B preferred shares total $7.3 million as of December 31, 1995. Liquidation preference is based upon fair market value of the Series A and Series B preferred shares as determined by the investment banking firm engaged by the Company, plus any dividends in arrears. As of December 31, 1995, no dividends have accrued to the preferred stockholders. The preferred stock had no impact on earnings per share in 1995. 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 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. Any appeal of this ruling must be filed by May 31, 1996. The Company expects this ruling will be appealed but believes the CDA's position will be upheld. In recording the purchase, the Company has accrued $1 million to cover the legal costs which it anticipates are probable of being incurred to resolve these issues. Depending on the outcome of the litigation, it is possible that additional costs may be incurred. Other than legal costs related to an appeal of the CDA Tribal Court ruling or other actions by the states, if any, the Company estimates that the additional costs to become operational may amount to between $5-10 million. Operational capital includes 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 estimate of operating capital does not include a $4 million jackpot reserve which could be required 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 contract. The Company expects it will be able to obtain additional financing for these costs, if necessary. 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 lottery. During the first quarter of 1995, the Company was involved in extensive negotiations to acquire the Dictaphone division of Pitney Bowes. In April 1995, the acquisition was awarded to another bidder. The Company incurred approximately $1 million in fees and expenses related to the attempted acquisition which were recognized during the second and third quarters of 1995. In 1990, the Company acquired all the outstanding shares of Isoetec Texas, Inc., an independent distributor of the Company's products. The transaction has been accounted for by the purchase method. The purchase price was based upon a multiple of 1989 pre-tax earnings of Isoetec Texas, Inc., subject to adjustment. The purchase price originally recorded was based on cash payments to the former owners of approximately $900,000, $250,000 of notes, 325,000 shares of common stock and liabilities assumed of approximately $900,000. The Company brought an action against the former owners of Isoetec Texas, Inc. alleging breach of contract and fraud with respect to the calculation of 1989 pre-tax earnings and the purchase price. In November 1991, pursuant to the purchase contract, an arbitrator ruled that 1989 pre-tax earnings should be reduced by an amount that resulted in a reduction of the purchase price by approximately $2 million. This reduction was assumed in the original purchase price calculation and, as such, did not result in an adjustment to the recorded purchase price. However, the arbitrator also awarded damages of approximately $1.2 million to the former owners as additional purchase price. At that time, the Company did not adjust its purchase price calculation since it believed that the arbitrator went beyond its authority and decided to pursue the matter in court. In 1994, after an appeal to the Fifth Circuit U.S. Court of Appeals, the Company was required to pay $1.2 million as additional purchase price and interest of $400,000. In addition, the Company was required to issue an additional 78,866 shares of common stock to settle all remaining claims. These payments were adjustments to the recorded purchase price. As of March 31, 1994, the Company sold its Vodavi Communications Systems Division ("VCS"), which sold telephone equipment to supply houses and dealers, a different class of customer from continuing operations, under the brand names STARPLUS'r' and INFINITE'tm', for approximately $10.9 million. Proceeds of the sale consisted of approximately $9.7 million in cash, received in April 1994, and a $1.2 million note, the proceeds of which were received in September 1995. The proceeds were used to reduce borrowings under the Company's credit facility. The sale resulted in an after-tax gain of $604,000 (net of income tax provision of $403,000). Consolidated financial statements for the years ended December 31, 1994 and 1993 present VCS as a discontinued operation. Net revenues of the discontinued operation for the years ended December 31, 1994 (through the date of sale) and 1993 were $8.6 million and $31.6 million, respectively. NOTE M - SELECTED QUARTERLY FINANCIAL DATA The following is a summary of unaudited selected quarterly financial data for the years ended December 31, 1995 and 1994:
Three Months Ended March 31, June 30, September 30, December 31, (In thousands, except for per share amounts) 1995 1995 1995 1995 ------- --------- ------------ ------------ Revenues $70,808 $78,417 $74,164 $73,004 Gross Profit 28,349 32,021 30,504 31,983 Income (Loss) Before Income Taxes 200 (44,225) 2,205 2,599 Net Income (Loss) 120 (39,936) 1,323 1,559 Earnings (Loss) Per Share --- (0.86) 0.03 0.04
Three Months Ended March 31, June 30, September 30, December 31, (In thousands, except for per share amounts) 1994 1994 1994 1994 ---------- --------- ------------- ----------- Revenues $65,307 $76,612 $76,547 $73,503 Gross Profit 26,267 32,138 32,105 31,962 Income Before Income Taxes from Continuing Operations 143 4,024 3,312 2,562 Income from Continuing Operations 86 2,414 1,986 2,248 Discontinued Operations 757 --- --- --- Net Income 843 2,414 1,986 2,248 Earnings Per Share: Continuing Operations --- 0.05 0.04 0.05 Discontinued Operations 0.02 --- --- ---
The three months ended June 30, 1995 includes a provision for restructuring of $44,042 (see Note L) and acquisition expenses of $1.0 million (see Note L). The three months ended March 31, 1994 includes income of $757 from the discontinuance and sale of the VCS division (see Note L). NOTE N - SUBSEQUENT EVENTS On April 9, 1996, the Company entered into an agreement to sell substantially all of the Direct Sales and Services Group, including its long-distance reseller business and National Service Center, for $67.4 million to an acquisition company led by Bain Capital, Inc. The purchase price will consist of $61.5 million in cash, a $5.9 million note and warrants to purchase 8% of the common stock of the new company, issued as of the closing, for $1.1 million, exercisable for three years. The sale is expected to close on May 31, 1996, subject to the buyer's financing and other conditions. The agreement also provides that the Company and the buyer will enter into a five-year exclusive distribution agreement under which the buyer will sell and service the Company's telephony equipment to those businesses and commercial locations that require up to 400 telephones. The sale does not include the Pittsburgh direct sales and service office, which the Company has agreed to sell to one of its existing independent distributors for approximately $1.3 million in cash and notes. The sale of the direct Sales and Service Group (including the separate sale of the Pittsburgh office) relates primarily to the retail distribution channel of the Computer Telephony division and includes the entire network services division. After the sale, the Computer Telephony division will consist of telephony products sales to independent distributors, of which the newly-formed Bain company will be the largest distributor, along with the National Accounts and Federal Systems marketing groups. The Company will retain its Healthcare Communications and Call Center Management businesses and the recently acquired Unistar business. In 1995, the Direct Sales and Services Group, including the long-distance reseller business, had revenues of $191 million. On a pro forma basis, after giving effect to the transaction, the Company's 1995 revenues would be approximately $157 million. This includes $42 million in sales to the Direct Sales and Services Group which were eliminated in the 1995 Statement of Operations. On April 10, 1996, the Company announced that it had given notice of its termination of its distribution agreement with GPT Video Systems due to failures by GPT to deliver properly-functioning videoconferencing products on a timely basis. The Company is negotiating an agreement with a third party to sell its videoconferencing business. Terms of the contract have yet to be finalized. STOCK DATA The number of holders of record of the Company's Common Stock as of the close of business on January 31, 1996 was approximately 2,100. The Common Stock is traded on the NASDAQ National Market System under the symbol "XTON". As reported by NASDAQ on February 16, 1996, the closing sale price of the Common Stock on the NASDAQ National Market System was $2 7/16. The following table reflects in dollars the high and low closing sale prices for EXECUTONE's Common Stock as reported by the NASDAQ National Market System for the periods indicated:
Fiscal Period High Low ------------- ----- ---- 1995 First Quarter $3 7/16 $2 15/16 Second Quarter 3 3/8 2 1/8 Third Quarter 2 7/8 2 1/8 Fourth Quarter 2 7/8 2 1/8 1994 First Quarter $2 15/16 $2 3/16 Second Quarter 2 13/16 2 1/2 Third Quarter 3 5/16 2 1/2 Fourth Quarter 3 9/16 3
The Company's Debentures are quoted on the NASDAQ System under the symbol "XTONG". On February 16, 1996, the average of the closing bid and asked prices per $1,000 principal amount of Debentures, as reported on the NASDAQ System, was $850. The following table reflects in dollars the high and low average closing sale prices for the Debentures, as reported by the NASDAQ System, for the periods indicated:
Fiscal Period High Low ------------- ---- --- 1995 First Quarter $824 $808 Second Quarter 824 788 Third Quarter 815 805 Fourth Quarter 850 815 1994 First Quarter $900 $863 Second Quarter 854 786
Third Quarter 810 779 Fourth Quarter 815 775
It is the present policy of the Board of Directors to retain earnings for use in the business and the Company does not anticipate paying any cash dividends on the Common Stock in the foreseeable future. The Company's current bank credit agreement contains provisions prohibiting the payment of dividends on the Common Stock. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders of EXECUTONE Information Systems, Inc.: We have audited the accompanying consolidated balance sheets of EXECUTONE Information Systems, Inc. (a Virginia corporation) and subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of EXECUTONE Information Systems, Inc. and subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Stamford, Connecticut January 26, 1996 (except with respect to the matter discussed in Note N, as to which the date is April 10, 1996) STOCKHOLDER INFORMATION CORPORATE HEADQUARTERS INDEPENDENT PUBLIC ACCOUNTANTS EXECUTONE Information Systems, Inc. Arthur Andersen LLP 478 Wheelers Farms Road Champion Plaza Milford, Connecticut 06460 400 Atlantic Street (203) 876-7600 Stamford, Connecticut 06912-0021 STOCK AND WARRANT TRANSFER AGENT OUTSIDE COUNSEL American Stock Transfer and Trust Company Hunton & Williams 40 Wall Street Riverfront Plaza New York, New York 10005 951 East Byrd Street Richmond, Virginia 23219 BOND TRANSFER AGENT U.S. Trust Company of New York ADDITIONAL INFORMATION 114 West 47th Street A copy of EXECUTONE's Annual Report on Form 10-K, New York, New York 10036-1532 which is filed with the Securities and Exchange Commission, is available without charge by writing to: David Krietzberg Treasurer/Investor Relations Corporate Headquarters
DIRECTORS AND OFFICERS BOARD OF DIRECTORS Alan Kessman Jerry M. Seslowe 1, 2 Chairman of the Board Managing Director Resource Holdings, Ltd. Stanley M. Blau Vice Chairman William R. Smart 1 Senior Vice President Thurston R. Moore Cambridge Strategic Management Group Partner Hunton & Williams Richard S. Rosenbloom 1, 2 David Sarnoff Professor of Business Administration Harvard Business School 1 Compensation committee member 2 Audit committee member
OFFICERS Alan Kessman Anthony R. Guarascio David E. Lee President and Chief Executive Officer Vice President, Finance and Vice President, Business Chief Financial Officer Development Stanley M. Blau Vice Chairman Israel J. Hersh John T. O'Kane Vice President, Software Engineering Vice President, MIS Michael W. Yacenda Executive Vice President Elizabeth Hinds Frank J. Rotatori Vice President, Human Resources Vice President, Healthcare Sales Barbara C. Anderson Vice President, General Counsel and Robert W. Hopwood Shlomo Shur Secretary Vice President, Customer Care Senior Vice President, Advanced Technology James E. Cooke III Andrew Kontomerkos Vice President, National Accounts Senior Vice President, Hardware Engineering and Production
EX-23 3 EXHIBIT 23.1 EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included or incorporated by reference in this Form 10-K/A into the Company's previously filed Registration Statements File Nos. 33-45015, 33-57519, 33-42561, 33-62257, 33-23294, 33-16585, 33-3827, 33-6604, 33-959, 2-91008, 33-40623, 33-46874, 33-46875 and 33-50628. ARTHUR ANDERSEN LLP ---------------------------------- ARTHUR ANDERSEN LLP Stamford, Connecticut February 18, 1997 EX-23 4 EXHIBIT 23.2 Exhibit 23.2 February 17, 1997 EXECUTONE Information Systems, Inc. 478 Wheelers Farms Road Milford, CT 06460 ANNUAL REPORT ON FORM 10-K/A FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995 TO BE FILED FEBRUARY 18, 1997 (FILE NO. 000-11551) -------------------------------------------------- Gentlemen: This firm has reviewed the information set forth in the ninth paragraph under "Recent Developments" under Item 1., Business, and the information set forth in the first paragraph under Item 3, Legal Proceedings, of the Annual Report on Form 10-K/A for the fiscal year ended December 31, 1995 of EXECUTONE Information Systems, Inc. (the "Company"). We understand that the information set forth therein as it related to the issue of the authorization of the National Indian Lottery under 25 U.S.C. 2701 et seq. is based upon the advice provided to the Company by this firm. We consent to the summarization of such advice and the reference to us in the prospectus. Very truly yours, HUNTON & WILLIAMS -----END PRIVACY-ENHANCED MESSAGE-----