-----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, MNIhlLNLeK8fVfLqTq9hrUcIKiSV8i7TdptKO7j4zooOnib+twgff6TODAcP1a16 OC0XJAINuDvHEea4xvIjAA== 0000950134-98-007560.txt : 19980915 0000950134-98-007560.hdr.sgml : 19980915 ACCESSION NUMBER: 0000950134-98-007560 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980731 FILED AS OF DATE: 19980914 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: XETA CORP CENTRAL INDEX KEY: 0000742550 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE & TELEGRAPH APPARATUS [3661] IRS NUMBER: 731130045 STATE OF INCORPORATION: OK FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: 10QSB SEC ACT: SEC FILE NUMBER: 000-16231 FILM NUMBER: 98708908 BUSINESS ADDRESS: STREET 1: 4500 S GARNETT STE 1000 CITY: TULSA STATE: OK ZIP: 74146 BUSINESS PHONE: 9186648200 MAIL ADDRESS: STREET 1: 4500 S GARNETT SUITE 1000 CITY: TULSA STATE: OK ZIP: 74146 10QSB 1 FORM 10QSB FOR QUARTER ENDED JULY 31, 1998 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB [X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR QUARTER ENDED JULY 31, 1998 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-16231 XETA Corporation - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Oklahoma 73-1130045 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 4500 S. Garnett, Suite 1000, Tulsa, Oklahoma 74146 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) 918-664-8200 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Not Applicable - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Check whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 . ---- --- Number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.
Class Outstanding at September 1, 1998 - -------------------------------- -------------------------------- Common Stock, $.10 par value 2,028,737
Page 1 of 22 consecutive pages Exhibit Index appears on Page 21. 2 PART I. FINANCIAL INFORMATION
Page No. -------- ITEM 1. FINANCIAL STATEMENTS Consolidated Balance Sheets - July 31, 1998 3 and October 31, 1997 Consolidated Statements of Operations - For the 4 Nine months ending July 31, 1998 and 1997 Consolidated Statements of Shareholder's Equity - 5 November 1, 1997 through July 31, 1998 Consolidated Statements of Cash Flows - For the 6 Nine months ending July 31, 1998 and 1997 Notes to Consolidated Financial Statements 7
2 3 XETA CORPORATION CONSOLIDATED BALANCE SHEETS
July 31, 1998 October 31,1997 ------------- --------------- (Unaudited) ASSETS ------ Current Assets: Cash and cash equivalents $ 5,214,986 $ 6,011,841 Current portion of net investment in sales-type leases 1,741,056 2,122,405 Other receivables, net 2,644,185 1,501,843 Inventories, net (Note 4) 2,338,329 1,498,748 Deferred tax asset, net (Note 7) 467,483 61,743 Prepaid expenses and other assets 84,496 75,827 ------------ ------------ Total current assets 12,490,535 11,272,407 ------------ ------------ Noncurrent Assets: Net investment in sales-type leases, less current portion above 1,185,991 1,381,818 Purchased long distance contracts, net (Note 2) 785,310 938,958 Property, plant & equipment, net (Note 5) 1,921,518 634,905 Capitalized software production costs, net of accumulated amortization of $423,066 at July 31, 1998 and $333,066 at October 31, 1997 626,586 537,578 Other assets 78,174 54,197 ------------ ------------ Total noncurrent assets 4,597,579 3,547,456 ------------ ------------ Total assets $ 17,088,114 $ 14,819,863 ============ ============ LIABILITIES & SHAREHOLDERS' EQUITY ---------------------------------- Current liabilities: Accounts payable $ 1,171,379 $ 591,822 Unearned revenue (Note 6) 3,170,267 2,877,785 Accrued liabilities 768,240 739,696 Accrued federal and state income taxes 132,522 118,874 ------------ ------------ Total current liabilities 5,242,408 4,328,177 ------------ ------------ Unearned service revenue (Note 6) 662,714 603,433 ------------ ------------ Noncurrent deferred tax liability, net (Note 7) 504,060 551,720 ------------ ------------ Commitments (Note 2) Shareholders' equity: Common stock; $.10 par value; 10,000,000 shares authorized, 2,286,284 and 2,207,285 issued at July 31, 1998 and October 31, 1997, respectively 228,628 220,728 Paid-in capital 5,135,818 4,859,340 Retained earnings 6,796,039 4,516,205 ------------ ------------ 12,160,485 9,596,273 Less treasury stock, at cost (1,481,553) (259,740) ------------ ------------ Total shareholders' equity 10,678,932 9,336,533 ------------ ------------ Total liabilities & shareholders' equity $ 17,088,114 $ 14,819,863 ============ ============
The accompanying notes are an integral part of these statements. 3 4 XETA CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
For the Three Months For the Nine Months Ending July 31, Ending July 31, 1998 1997 1998 1997 ----------- ----------- ----------- ----------- Installation and service revenues $ 3,432,990 $ 2,594,940 $ 9,564,188 $ 6,658,807 Sales of systems 3,438,804 2,644,044 8,475,713 6,676,694 Long distance services 310,444 60,241 759,508 60,241 ----------- ----------- ----------- ----------- Net sales and service revenues 7,182,238 5,299,225 18,799,409 13,395,742 ----------- ----------- ----------- ----------- Installation and service cost 2,185,549 1,638,130 5,986,941 4,229,097 Cost of sales 2,486,024 1,857,779 5,766,507 4,429,782 Cost of long distance services 151,653 19,927 315,024 19,927 ----------- ----------- ----------- ----------- Total cost of sales and service 4,823,226 3,515,836 12,068,472 8,678,806 ----------- ----------- ----------- ----------- Gross profit 2,359,012 1,783,389 6,730,937 4,716,936 ----------- ----------- ----------- ----------- Operating expenses: Selling, general and administrative 1,121,156 915,044 3,233,424 2,586,568 Engineering, research and development, and amortization of capitalized software production costs 126,299 104,170 376,885 308,834 ----------- ----------- ----------- ----------- Total operating expenses 1,247,455 1,019,214 3,610,309 2,895,402 ----------- ----------- ----------- ----------- Income from operations 1,111,557 764,175 3,120,628 1,821,534 Interest and other income 171,341 159,301 505,206 494,671 ----------- ----------- ----------- ----------- Income before provision for income taxes 1,282,898 923,476 3,625,834 2,316,205 Provision for income taxes 477,000 332,000 1,346,000 829,000 ----------- ----------- ----------- ----------- Net income $ 805,898 $ 591,476 $ 2,279,834 $ 1,487,205 =========== =========== =========== =========== Earnings per share Basic $ 0.39 $ 0.29 $ 1.12 $ 0.74 =========== =========== =========== =========== Diluted $ 0.34 $ 0.25 $ 0.96 $ 0.63 =========== =========== =========== =========== Weighted average shares outstanding 2,044,876 2,010,326 2,030,898 2,002,830 =========== =========== =========== =========== Weighted average shares equivalents 2,360,603 2,373,982 2,369,203 2,354,147 =========== =========== =========== ===========
The accompanying notes are an integral part of these statements. 4 5 XETA CORPORATION CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY NOVEMBER 1, 1997 THROUGH July 31, 1998 (Unaudited)
Common Stock Treasury Stock ------------------------------ ------------------------------- Number of Shares Issued Paid-in Retained & Outstanding Par Value Shares Amount Capital Earnings ------------- ------------ ------------ ------------ ------------ ------------ Balance - October 31, 1997 2,207,285 $ 220,728 (189,747) $ (259,740) $ 4,859,340 $ 4,516,205 Stock options exercised 78,999 7,900 85,000 Tax benefit of stock options 191,478 Treasury stock acquired (58,900) (1,221,813) Net Income 2,279,834 ------------ ------------ ------------ ------------ ------------ ------------ Balance - July 31, 1998 2,286,284 $ 228,628 (248,647) $ (1,481,553) $ 5,135,818 $ 6,796,039 ============ ============ ============ ============ ============ ============
The accompanying notes are an integral part of these statements. 5 6 XETA CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
For the Nine Months Ending July 31, 1998 1997 ----------- ----------- Cash flows from operating activities: Net Income $ 2,279,834 $ 1,487,205 ----------- ----------- Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 220,234 141,356 Amortization of capitalized software production costs and long distance contracts 243,648 81,796 (Gain) loss on sale of assets 14,517 -- Provision for doubtful accounts receivable 67,000 27,000 Change in assets and liabilities: (Increase) decrease in net investment in sales-type leases 577,176 1,297,301 (Increase) in other receivables (1,209,342) (405,343) (Increase) decrease in inventories (839,581) (477,720) Decrease in prepaid income taxes -- 173,785 (Increase) decrease in deferred tax asset (405,740) 4,541 (Increase) decrease in prepaid expenses and other assets (32,646) 8,422 Increase (decrease) in accounts payable 579,557 315,360 Increase (decrease) in unearned revenue 351,763 (193,955) Increase in accrued income taxes 205,125 269,624 Increase (decrease) in accrued liabilities 28,544 99,229 Increase (decrease) in deferred tax liabilities (47,660) (95,714) ----------- ----------- Total adjustments (247,405) 1,245,682 ----------- ----------- Net cash provided by operating activities 2,032,429 2,732,887 ----------- ----------- Cash flows from investing activities: Purchases of long distance contracts (1,024,318) Additions to capitalized software (178,998) (218,849) Additions to property, plant & equipment (1,522,225) (295,643) Proceeds from sale of assets 852 3,827 ----------- ----------- Net cash used in investing activities (1,700,371) (1,534,983) ----------- ----------- Cash flows from financing activities: Purchase of treasury stock (1,221,813) -- Exercise of stock options 92,900 34,058 ----------- ----------- Net cash provided by financing activities (1,128,913) 34,058 ----------- ----------- Net increase in cash and cash equivalents (796,855) 1,231,962 Cash and cash equivalents, beginning of period 6,011,841 3,549,101 ----------- ----------- Cash and cash equivalents, end of period $ 5,214,986 $ 4,781,063 =========== =========== Supplemental disclosure of cash flow information: Cash paid during the period for interest $ 19,051 $ 855 Cash paid during the period for income taxes $ 1,572,799 $ 726,328
The accompanying notes are an integral part of these statements. 6 7 XETA CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS July 31, 1998 (Unaudited) (1) BASIS OF PRESENTATION The consolidated financial statements included herein include the accounts of XETA Corporation and its wholly-owned subsidiary, Xetacom, Inc. Xetacom's operations have been insignificant to date. All significant intercompany accounts and transactions have been eliminated. The consolidated financial statements have been prepared by the Company, without an audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The Company believes that the disclosures made in these financial statements are adequate to make the information presented not misleading when read in conjunction with the consolidated financial statements and the notes thereto included in the Company's latest financial statements filed as part of the Company's Annual Report on Form 10-KSB, Commission File No. 0-16231. Management believes that the financial statements contain all adjustments necessary for a fair statement of the results for the interim periods presented. All adjustments made were of a normal recurring nature. (2) COMMITMENT In April 1997, the Company entered the long distance services market through a sales sub-agency agreement with MCI and through a marketing alliance with Americom Communications Services, Inc. ("Americom"). Simultaneously, the Company purchased Americom's interest in existing long distance contracts at 71 hotels. Previous to the Company's purchase of these contracts, Americom had obtained loans from the long distance carrier, which were secured by future commissions to be earned. To effect the transfer of ownership in these contracts, the Company guaranteed Americom's indebtedness. At July 31, 1998, the amount of the guarantee was $229,919. (3) REVOLVING CREDIT AGREEMENT The company maintains a $1,000,000 revolving line of credit with its bank. There are no outstanding advances under the credit agreement. 7 8 (4) INVENTORIES The following are the components of inventories:
July 31, October 31, 1998 1997 ----------- ----------- (Unaudited) Raw materials $ 962,068 $ 712,546 Finished goods and spare parts 1,591,261 1,001,202 ----------- ----------- 2,553,329 1,713,748 Less reserve for excess and obsolete inventory (215,000) (215,000) ----------- ----------- $ 2,338,329 $ 1,498,748 =========== ===========
(5) PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consist of the following:
July 31, October 31, 1998 1997 ----------- ----------- (Unaudited) Computer field equipment $ 1,308,447 $ 1,105,379 Land 611,582 10,000 Construction in Progress 661,754 10,500 Office furniture 136,143 127,527 Other 261,583 232,828 ----------- ----------- 2,979,509 1,486,234 Less accumulated depreciation (1,057,991) (851,329) ----------- ----------- $ 1,921,518 $ 634,905 =========== ===========
(6) UNEARNED INCOME Unearned income consists of the following:
July 31, October 31, 1998 1997 ---------- ---------- (Unaudited) Service contracts $1,280,982 $1,522,597 Warranty service 869,308 685,955 Systems shipped, but not installed 12,153 42,825 Customer deposits 947,960 508,359 Other deferred revenue 59,864 118,049 ---------- ---------- Total current deferred revenue 3,170,267 2,877,785 Noncurrent unearned service revenues 662,714 603,433 ---------- ---------- $3,832,981 $3,481,218 ========== ==========
8 9 (7) INCOME TAXES The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below:
July 31, October 31, 1998 1997 --------- --------- (Unaudited) Deferred tax assets: Prepaid service contracts $ 318,780 $ 32,305 Nondeductible reserves 278,888 207,502 Other (39,352) 20,559 --------- --------- Total deferred tax asset 558,316 260,366 --------- --------- Deferred tax liabilities: Unamortized capitalized software development costs (213,039) (182,777) Tax income to be recognized on sales-type lease contracts (315,894) (501,606) Other (65,960) (65,960) --------- --------- Total deferred tax liability (594,893) (750,343) --------- --------- Net deferred tax liability $ (36,577) $(489,977) ========= =========
(8) INTEREST AND OTHER INCOME Interest and other income recorded in the accompanying financial statements, consists primarily of interest income earned from sales-type leases and cash investments. 9 10 (9) FOOTNOTES INCORPORATED BY REFERENCE Certain footnotes are applicable to the consolidated financial statements, but would be substantially unchanged from those presented in the Company's Annual Report on Form 10-KSB, Commission File No. 0-16231, filed with the Securities and Exchange Commission on January 29, 1998. Accordingly, reference should be made to those statements for the following:
Note Description ---- ----------- 1 Business and summary of significant accounting policies 3 Operator services business and purchased long distance contracts 4 Income taxes 6 Accrued liabilities 8 Stock options 9 Commitments 10 Major customers and concentrations of credit risk 11 Employment agreements 12 Contingency 13 Earnings per share 15 Retirement plan
10 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Throughout fiscal 1998, XETA Corporation ("the Company") has posted record net income and sales as the Company continues to penetrate the rapidly expanding hospitality market with its products and services. Although all of the Company's major revenue sources have shown increases for the year to date period, the Company's PBX product and service offering continues to be its fastest growing revenue stream. Management intends to continue to focus the Company on its present course of expanding the Company's base of hospitality customers by maintaining the Company's reputation for service quality, introducing new products, and enhancing existing products. In addition, the Company is actively evaluating possible synergistic acquisitions both inside and outside the hospitality sector. For the quarter ending July 31, 1998, the Company earned net income of $806,000 or $.34 per share (diluted) on net sales of $7.182 million compared to net income of $591,000 or $.25 per share (diluted) on net sales of $5.299 million for the third quarter of fiscal 1997. For the nine months ending July 31, 1998, the Company earned net income of $2.280 million or $.96 per share (diluted) on net sales of $18.799 million compared to net income of $1.487 million or $.63 per share (diluted) on net sales of $13.396 million. The discussion which follows provides further analysis of the major factors and trends which management believes had the most significant impact on the financial condition of the Company as of July 31, 1998 and the results of operations for the quarter and nine month periods then ended as compared to those same periods a year ago. Also included in this discussion are the major factors, trends and risks which management believes will affect the outlook for the Company. This analysis should be read in conjunction with the Consolidated Financial Statements and Notes thereto contained in this report. FINANCIAL CONDITION The Company's financial condition remains strong. Cash balances at July 31, 1998 were $5.215 million, which represented 31% of total assets and 49% of book value. The Company's working capital on July 31, 1998 was $7.248 million and there was no debt. Cash balances have decreased $797,000 during fiscal 1998. Most of this decrease was associated with the Company's common stock repurchase program during the year as well as acquisition of land and the initial construction costs associated with the Company's relocation to a new, larger facility. Repurchases of stock totaled $1.222 million during the first nine months of the year representing the purchase of 58,900 shares. These repurchases were made pursuant to a previously announced stock buy-back program. The Company has begun construction of a 37,000 square foot facility that will house all of the current Tulsa operations. The total cost of the project is expected to be $3 million and the Company's relocation should be complete by the end of the second quarter of fiscal 1999. During fiscal 1998, the Company has spent $1.253 million on the new facility, including $.602 million on the acquisition of land. Partially offsetting the effect of the expenditures for the stock repurchases and the construction of the new facility was cash earned from operations of 11 12 $2.032 million. This included net income of $2.280 million less adjustments to net income of negative $.247 million. These adjustments included significant increases in both accounts receivable and inventories, both of which are primarily the result of the Company's rapid expansion during the year. Management believes that cash flows from operations and existing working capital will be sufficient to meet the Company's working capital needs in the immediate future and to fund the remaining estimated construction and relocation costs associated with the Company's move to a new facility. Management is continually evaluating opportunities to expand the Company's operations in the hospitality market as well as other opportunities that would diversify the Company's operations into other markets. In addition to synergistic acquisitions, the Company also regularly evaluates the formation of new alliances or distribution agreements to expand the Company's distribution of its own products or to add additional products to the Company's current product and service offerings. Management believes additional sources of working capital, either debt, equity, or both, would be available to the Company should existing cash balances be insufficient to finance the consummation of a viable project that might result from these evaluations. RESULTS OF OPERATIONS Revenues increased 36% and 40% for the three and nine month periods ending July 31, 1998, respectively, compared to those same periods in fiscal 1997. The increases in the third quarter of fiscal 1998 compared to the third quarter of fiscal 1997 included an increase in installation and service revenues of $838,000 or 32%, an increase in systems sales of $795,000 or 30%, and an increase in long distance services of $250,000 or 415%. For the nine month period ending July 31, 1998 compared to the same period in fiscal 1997, installation and service revenues increased $2.905 million or 44%, systems sales increased $1.799 million or 27%, and long distance revenues increased $699,000 or 1161%. Note that the increases in long distance revenues experienced during fiscal 1998 are not indicative of a future trend as this is a new revenue source for the Company which did not begin until the third quarter of fiscal 1997. The Company's revenues can also be examined by product line. Revenues generated by sales and services of PBX systems increased 42% during the third quarter compared to the third quarter of fiscal 1997 and increased 44% for the nine month period ending July 31, 1998 compared to the same period in fiscal 1997. Revenues from call accounting related activities, including both sales of systems and services, were relatively unchanged in the third quarter of the current year compared to the third quarter of last year, but have increased 13% during the year to date periods. A discussion of these changes by product line is presented more fully below. PBX Systems Sales. Sales of PBX systems increased $819,000 or 36% in the third quarter and increased $1.544 million or 28% for the first nine months of fiscal 1998. The growth in the sales of new PBX systems has been fueled by two major factors, the continued broad acceptance of the Company's PBX product and service offering and the robust growth of the overall hotel industry. The Company continues to gain market share in this portion of its business by 12 13 providing competitive pricing of its PBX package and a high quality, non-disruptive installation program. In addition, the Company is enjoying the fruits of a very healthy and expanding hotel industry. Construction of new hotels, primarily in the smaller, extended-stay segment of the market, is helping to generate a general expansion of the market. PBX Service Revenues. Service revenues from PBX related activities grew $812,000 or 50% during the third quarter and $2.659 million or 68% during the first nine months of fiscal 1998. This growth reflects the high level of retention of PBX service customers and the Company's success in securing new service contracts from customers with previously installed Hitachi PBX systems. The growth in revenues derived from PBX service customers has been a major factor in the Company's success during the past three years. Management is committed to ensuring that this growing base of recurring revenues is supported with trained personnel and adequate administrative support to maintain the Company's reputation for high quality service. Maintaining that reputation and consequently, the base of customers enjoying the Company's service offering, will be the key to the Company's success whether or not the current expansion in the hospitality market continues. Call Accounting Systems Sales. Sales of call accounting systems decreased $18,000 or 5% in the third quarter, but have increased $268,000 or 24% for the year to date period. Sales of call accounting systems have exceeded management's expectations this year. This growth is being fueled by two factors: the expansion of the hospitality market and the Company's long distance service offering. As part of the long distance offering, customers have the option to receive a call accounting system as part of the service. To compensate the Company for the use of the system and service on it, a monthly fee approximately equal to the price of a turnkey service agreement for their system is deducted from the hotel's commissions. The Company allocates this monthly fee to call accounting system sales and to service revenues to properly reflect the nature of these revenues. Call accounting revenues earned from the Company's long distance service offering are not expected to expand further. See further discussion below under "Long Distance Services". Call Accounting Service Revenues. Call accounting service revenues increased $26,000 or 3% during the third quarter and $247,000 or 9% for the year to date period. This increase reflects the growth in new customers from increased sales of systems as discussed above and the Company's ability to consistently maintain and increase its base of call accounting customers under service contracts. Long Distance Services. Revenues earned from long distance services were $310,000 in the third quarter and $760,000 for the first nine months of the year. As noted above, revenues from the Company's long distance service offering began during the third quarter of fiscal 1997 and were still "ramping-up" at that time. The majority of the Company's long distance revenues are derived from commissions earned from 71 contracts purchased from Americom Communications Services, Inc. in April 1997. Additions to this beginning base of accounts has not met management's expectations. Management does not expect future revenues or gross profits to be significantly different from those currently being earned. Gross Margins. Gross margins earned on total revenues were 33% in the third quarter of fiscal 1998 compared to 34% in the third quarter of fiscal 1997. Gross margins earned on total revenues for the nine month period ending July 31, 1998 were 36% compared to 35% for the same period in fiscal 1997. The gross margins earned on systems sales declined slightly in both the third 13 14 quarter comparison (from 30% in 1997 to 28% in 1998) and the nine month comparison (from 34% in 1997 to 32% in 1998). These lower margins reflect the greater portion of smaller PBX systems sold during the third quarter of fiscal 1998. Most of these systems are being sold to the extended-stay market which is highly price-driven and is very competitive. Gross margins earned on service revenues decreased slightly during the third quarter, but has shown a slight increase for the year to date period. The margins earned on service revenues during these periods are within the historical range of 36% to 38% and management believes these margins will be sustained for the remainder of the current fiscal year. The gross margins earned on long distance services were 51% during the third quarter of fiscal 1998 and were 58% for the nine month period ending July 31, 1998. Comparisons to the previous year's long distance gross margins are not meaningful due to the startup nature of those revenues in fiscal 1997. Operating Expenses. Operating expenses increased $206,000 or 23% during the third quarter of fiscal 1998 compared to the third quarter of fiscal 1997 and increased $647,000 or 25% for the nine months ending July 31, 1998 compared to the same period in fiscal 1997. These increases primarily reflect increases in expenses that are directly related to the growth in revenues and profitability, such as commissions and executive bonuses. However, they also reflect additional sales and administrative personnel expense required to support the Company's growth. Also reflected in these increases are accruals the Company has made associated with the Company's relocation to a new facility. Interest and Other Income. Interest and other income increased $12,000 or 8% in the third quarter and $11,000 or 2% during the year-to-date period. The majority of interest income earned by the Company is from interest on XETAPLAN receivables. The Company's portfolio of these leases has been maturing at a rapid rate, but during the second and third quarters of fiscal 1998 a significant portion of the Company's call accounting sales were made through the XETAPLAN program, either through new sales or through renewals of expiring XETAPLANS. These new XETAPLANs are helping to reverse the decline in interest income from this source. The Company also earns interest income on its idle cash balances. The Company invests these balances in money market accounts. Tax Expense. The Company has recorded a combined federal and state tax provision of 37% of income before taxes throughout fiscal 1998 compared to a combined provision of 36% used throughout fiscal 1997. The increase in the tax rate reflects primarily the estimation of state taxes, which fluctuates based on the Company's sales volumes in each state. OUTLOOK AND RISK FACTORS The statements contained in this section are based on current expectations. The statements are forward-looking in nature and actual results may differ materially. The Company's Form 10-KSB for the year ended October 31, 1997 contains an expanded discussion of risk factors that should be read in conjunction with this report. The Company continues to expand its market share in the hospitality industry, which is currently a rapidly expanding and healthy market. In the near term, management believes the Company will continue to enjoy strong sales of its products and rapid growth of its customer base, especially for its PBX product line. Throughout the first nine months of the year and up to the filing of 14 15 this report, the Company's backlog of sales orders remained very strong. Currently, a slow-down in the growth of the hospitality sector of the economy is not predicted in the near-term; however, such a slow-down would likely negatively impact the growth rate of the Company. Nevertheless, it is important to note that as the Company's customer base is expanding, so is its recurring base of service revenues. Historically, the Company has a very high customer retention rate and the majority of those customers produce regular, monthly service revenues for the Company. This base of recurring service revenues should help cushion the effects of a slow-down in orders for new systems, if such a slow-down should occur. Recently, there has been a surge in consolidation of ownership of hotel properties, particularly by real estate investment trusts ("REITS"), some of which have tax-advantaged corporate structures. This consolidation has produced some risks to the Company as industry personnel are shuffled and consolidated as well. To date, the impact on the Company has been positive, but the ultimate potential impact of these changes to the Company is still unknown. Recently, changes to IRS regulations have been proposed that would significantly reduce the tax-favored status enjoyed by several of the REITS. There is a general consensus that these changes will be enacted into law. In response, one of the largest hotel REITS, and a significant customer to the Company, has recently announced that it will be converting to C-Corp status. Press reports speculate that the other major hotel REITS, which have enjoyed the same tax-advantaged status, will also make similar changes to their structure. While no assurance can be given, at the present time management does not expect that these changes will have a material, adverse impact on the Company. The Company continues to invest significant resources into the development of its XPANDER(R) system. The initial phase of the XPANDER(R) system is in production; however, development continues on additional features and on other XPANDER(R)-based products. To date, all installed XPANDER(R) systems are operating satisfactorily. The market for XPANDER(R) is continuing to develop, but the timing of its development has been slower than hoped. Management continues to believe very strongly that a majority of business oriented hotels will eventually convert to multiple telephone line access and that the XPANDER(R) system will be the solution chosen by many hoteliers. During the third quarter, the Company announced a new call accounting product, the Virtual XL(TM) Series. This product, which consists of four new models of the Company's XL(R) Series call accounting systems, enables the Company's customers to access the system's screens and reports utilizing an Internet browser. This access can be performed either on site through the hotel LAN or remotely via an Internet or Intranet connection. The VIRTUAL XL(TM), which was an offshoot from the development of the XPANDER(R) system, is a timely answer to the trend toward centralized ownership and management of hotels as well as the trend toward connectivity of hotel information systems. The Company has installed several VIRTUAL XL(TM) systems that are operating satisfactorily. While no assurance can be given as to future sales levels, management is enthused with market reaction to this product to date. Since the middle of 1997, the Company has been assessing the potential effect of the year 2000 on its business. This evaluation is on-going and will continue up to and through the beginning of that year. The issues surrounding the year 2000 ("Y2k") are extremely complex for any supplier of personal computer ("PC") products. PC motherboards and the internal software on those 15 16 boards, called BIOS, can contain innumerable variations, which could affect performance after December 31, 1999. In addition, the Company's proprietary software is also susceptible to potential Y2k problems. The Company has addressed these issues as described below. For its PC-based product lines, which include the XL(R) and VIRTUAL XL(TM) Call Accounting Series, XPERT(R) Answer Detection Systems and BUFFY+ call buffering systems, the Company has developed a - - software upgrade which includes patches designed to compensate for all Y2k issues for which the Company has become aware. This upgrade is available to all of the Company's customers with XL(R) and VIRTUAL XL(TM) systems. For those customers with service contracts on their systems, the upgrade will be provided with their regular rate table update. Customers not under service contracts will be required to pay a nominal fee to receive the upgrade. All of the Company's customers are being contacted to make them aware of the software upgrade. In addition to the upgrade for the Company's proprietary software, the Company will be providing its customers with a test disk to enable the customer to test their specific version of motherboard and BIOS to determine if they have additional Y2k issues not addressed by the Company's software patch. Due to the extreme complexity of this issue, there can be no assurance given that the Company's response to these issues will be sufficient to prevent disruption in its business on January 1, 2000. The Company's other major systems that are not PC-based, such as the XD(R), XDM(R), XACT(R), and XXAM(R) systems, are not expected to be affected by Y2k. The Company distributes Hitachi PBX systems and Centigram voice mail systems as well as other micro-processor based ancillary products which may be affected by Y2k issues as well. Currently, management is satisfied that manufacturers of these systems are addressing this issue. However, as with its own products, the Company cannot provide any assurances that Centigram's and Hitachi's response to these issues will be sufficient to prevent disruption of the Company's business on January 1, 2000. The Company is involved in two matters of pending litigation (See "Legal Proceedings" under Part II below). In one of these matters (Phonometrics), the Company is only indirectly involved and based on the current status of the litigation, management expects this matter to be resolved with no material impact to the Company's financial statements. In the ABTS matter, the trial that was previously scheduled for July was postponed and currently is not firmly scheduled. There are several pre-trial matters still pending before the court and although management desires very strongly to bring this matter to a resolution, it will continue to work through the legal process to resolve and further clarify as many of the issues as possible prior to the trial. No loss contingencies, other than the estimated cost of bringing the ABTS matter to trial, have been recorded in the financial statements. Should the ABTS case be resolved unfavorably, the Company may have to record additional expenses that could cause operating results to be materially lower than those expected. 16 17 PART II. OTHER INFORMATION Item 1. Legal Proceedings ABTS In June, 1995, Associated Business Telephone Systems ("ABTS") initiated an action against the Company which is currently pending in the United States District Court for the Northern District of Oklahoma. ABTS claims' are based upon allegations of breach of contract including alleged violations of certain exclusivity rights held by ABTS, and tortious interference with ABTS' relationships with certain of its customers, arising in connection with (i) a Distributor's Agreement entered into between the Company and D & P Investments in 1986, pursuant to which the Company sold to D & P Investments certain call accounting systems (D & P has allegedly assigned its claims under this agreement to ABTS), and (ii) a Maintenance Agreement between the Company and ABTS pursuant to which the Company furnished maintenance services for such systems. Other claims raised by ABTS, including a breach of warranty claim, have been dismissed by the Court on summary judgment motion or during a pretrial hearing held in June, 1998. The Company has filed a counterclaim against ABTS and a third-party claim against D & P Investments based upon breach of contract. ABTS originally sought damages on its claims against the Company in the aggregate amount of approximately $1,000,000. This damage claim has been reduced as the Court has dismissed some of ABTS' claims. At present, ABTS seeks damages on its remaining claims in the approximate amount of $809,000. The Company seeks damages on its counterclaims against ABTS in excess of $3,000,000. On August 19, 1998, the Court re-opened discovery on the limited issue of damages. Such discovery is presently being conducted by both sides in this matter. The previously scheduled July 20th trial date was postponed by the Court on its own motion due to the Court's problems with scheduling. A new trial date has not been scheduled and likely will not be until the additional discovery on damages has been concluded. The Company intends to continue to vigorously defend ABTS' claims against it and to vigorously pursue all of its counterclaims against ABTS. PHONOMETRICS For the past several years, the Company has been monitoring the progress of numerous patent infringement lawsuits filed by Phonometrics, Inc., a Florida corporation, against certain telecommunications equipment manufacturers and hotels who use such equipment. While the Company has not been named as a defendant in any of these cases, several of its customers are named defendants and have notified the Company that they seek indemnification under the terms of their contracts with the 17 18 Company. Because there are other equipment vendors implicated along with the Company in the cases filed against its customers, the Company has not assumed the outright defense of its customers in any of these actions. The cases filed by Phonometrics against the Company's customers are pending in the Southern District of Florida (the "Florida litigation") and the Northern District of California (the "California litigation"). In each of the lawsuits, Phonometrics is seeking damages of an unspecified amount, based upon a reasonable royalty of the hotels' profits derived from use of the allegedly infringing equipment during a period commencing six years prior to the filing of the lawsuit and ending October 30, 1990. Phonometrics is barred from seeking an injunction against continued use of the equipment since the patent expired in October, 1990. With regard to the Florida litigation, the Florida court heard the cases filed by Phonometrics against the equipment manufacturers, and ruled against Phonometrics and in favor of the equipment manufacturers, including Northern Telecom. The court then stayed the cases filed against the hotels (which includes the cases involving the Company's customers), pending the outcome of Phonometrics' appeal of the court's decision in favor of Northern Telecom. In its order staying the hotel cases, the Florida court stated that it would enter final judgment in favor of all of the hotels in the event the appeals court upholds the Florida court's decision against Phonometrics in the Northern Telecom case. The California litigation was also stayed pending the outcome of the Florida litigation. On January 15, 1998, the United States Court of Appeals for the Federal Circuit affirmed the Florida court's decision against Phonometrics and in favor of Northern Telecom, finding that as a matter of law the accused products cannot infringe Phonometrics' patent. Subsequently, on February 17, 1998 Phonometrics sought to revive its case against Northern Telecom by filing a motion with the Florida court seeking leave to amend (for the second time) its complaint against Northern Telecom. This motion was denied by the Florida Court on April 17, 1998 and on May 15, 1998 Phonometrics filed a notice of intent to appeal the Court's decision denying its motion seeking leave to amend its complaint. On August 11, 1998, the Court of Appeals dismissed Phonometrics' notice of appeal for failure to prosecute. While it appears that this latest defeat for Phonometrics will clear the way for the lower Florida Court to follow through with its stated intention of dismissing the hotel cases once the Northern Telecom matter is finally concluded in favor of Northern Telecom, as of August 27, 1998, the docket sheet for the Florida hotel cases did not reflect any recent activity and these cases remain stayed. 18 19 Items 2, 3, 4, and 5 of Part II have been omitted because they are inapplicable or the response thereto is negative. Item 6. (a) Exhibits - See the Exhibit Index. (b) Reports on Form 8-K - During the quarter for which this report is filed, the Registrant did not file any reports with the Securities and Exchange Commission on Form 8-K. 19 20 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. XETA CORPORATION (Registrant) Dated: September 10, 1998 By: /s/ JACK R. INGRAM ------------------------------- Jack R. Ingram President Dated: September 10, 1998 By: /s/ ROBERT B. WAGNER ------------------------------- Robert B. Wagner Vice President of Finance 20 21 EXHIBIT INDEX
SEC. NO. DESCRIPTION - -------- ----------- (2) Plan of acquisition, reorganization, arrangement, liquidation or succession - None. (3) Articles of Incorporation and Bylaws - previously filed as Exhibits 3.1, 3.2, and 3.3 to the Registrant's Registration Statement on Form 5.1, Registration No. 33-7841. (4) Instruments defining rights of security holders, including indentures - previously filed as Exhibits 3.1, 3.2 and 3.3 to the Registrant's Registration Statement on Form S-1, Registration No. 33-7841. (10) Material Contracts - none (11) Statement re: computation of per share earnings - Inapplicable. (15) Letter re: unaudited interim financial information - Inapplicable. (18) Letter re: change in accounting principles - Inapplicable. (19) Report furnished to security holders - None. (22) Published report regarding matters submitted to a vote of security holders - None. (23) Consents of experts and counsel 23.1 Consent of Arthur Andersen LLP (24) Power of attorney - None. (27) Financial Data Schedule (99) Additional exhibits - None.
EX-23.1 2 CONSENT OF ARTHUR ANDERSEN LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the use of our report and to all references to our Firm included in or made a part of the Form S-8 made by Xeta Corporation on August 28, 1995. It should be noted that we have not audited any financial statements of the Company subsequent to October 31, 1997 or performed any audit procedures subsequent to the date of our report. ARTHUR ANDERSEN LLP Tulsa, Oklahoma September 9, 1998 EX-27 3 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON PAGES 3 AND 4 OF THE COMPANY'S 10 QSB FOR THE YEAR TO DATE AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1 9-MOS OCT-31-1998 JUL-31-1998 5,214,986 0 2,644,185 0 2,338,329 12,490,535 1,921,518 0 17,088,114 5,242,408 0 0 0 228,628 10,450,304 17,088,114 7,182,238 7,182,238 4,823,226 4,823,226 0 0 0 1,282,898 477,000 805,898 0 0 0 805,898 .39 .34
-----END PRIVACY-ENHANCED MESSAGE-----