10-Q 1 d88362e10-q.txt FORM 10-Q FOR QUARTER ENDED APRIL 30, 2001 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended April 30, 2001 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-16231 XETA Technologies, Inc. -------------------------------------------------------------------------------- (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.) 1814 W. Tacoma, Broken Arrow, OK 74012-1406 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) 918-664-8200 -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the 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 May 1, 2001 -------------------------------- -------------------------- Common Stock, $.001 par value 9,202,952 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Consolidated Balance Sheets - April 30, 2001 and October 31, 2000 Consolidated Statements of Operations - For the Three and Six months ended April 30, 2001 and 2000 Consolidated Statement of Shareholder's Equity - November 1, 2000 through April 30, 2001 Consolidated Statements of Cash Flows - For the Six months ended April 30, 2001 and 2000 Notes to Consolidated Financial Statements 2 3 XETA TECHNOLOGIES, INC. CONSOLIDATED BALANCE SHEETS
ASSETS April 30, 2001 October 31, 2000 --------------- ---------------- (Unaudited) Current Assets: Cash and cash equivalents $ 778,733 $ 926,330 Current portion of net investment in sales-type leases and other receivables 3,592,828 2,609,976 Trade accounts receivable, net 20,750,411 30,139,623 Inventories, net 13,645,154 8,135,062 Deferred tax asset, net 570,570 1,133,487 Prepaid expenses and other assets 1,834,618 338,828 --------------- --------------- Total current assets 41,172,314 43,283,306 --------------- --------------- Noncurrent Assets: Goodwill, net of amortization 26,651,069 20,579,359 Net investment in sales-type leases, less current portion above 1,457,915 2,505,841 Property, plant & equipment, net 8,080,675 6,854,851 Capitalized software production costs, net of accumulated amortization of $783,066 & $693,066 507,955 597,956 Other assets 298,352 327,658 --------------- --------------- Total noncurrent assets 36,995,966 30,865,665 --------------- --------------- Total assets $ 78,168,280 $ 74,148,971 =============== =============== LIABILITIES & SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 6,304,086 $ 6,820,754 Revolving line of credit 4,095,000 1,000,000 Accounts payable 11,553,531 11,750,607 Unearned revenue 3,475,461 4,513,029 Accrued liabilities 2,448,129 3,927,803 Accrued federal and state income taxes -- 125,942 --------------- --------------- Total current liabilities 27,876,207 28,138,135 --------------- --------------- Noncurrent liabilities: Long-term debt, less current portion above 18,989,642 17,983,011 Accrued long-term liabilities 1,299,114 1,299,114 Unearned service revenue 664,429 1,039,949 Noncurrent deferred tax liability, net 521,709 123,603 --------------- --------------- 21,474,894 20,445,677 --------------- --------------- Commitments Shareholders' equity: Preferred stock; $.10 par value; 50,000 shares authorized, 0 issued -- -- Common stock; $.001 par value; 50,000,000 shares authorized, 10,221,740 and 9,662,736 issued at April 30, 2001 and October 31, 2000 respectively 10,221 9,662 Paid-in capital 11,084,345 9,486,776 Retained earnings 19,967,272 18,313,380 Less treasury stock, at cost (2,244,659) (2,244,659) --------------- --------------- Total shareholders' equity 28,817,179 25,565,159 --------------- --------------- Total liabilities & shareholders' equity $ 78,168,280 $ 74,148,971 =============== ===============
The accompanying notes are an integral part of these consolidated statements. 3 4 XETA TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
For the Three Months For the Six Months Ending April 30, Ending April 30, 2001 2000 2001 2000 ------------ ------------ ------------ ------------ Commercial equipment sales $ 12,080,050 $ 15,886,795 $ 23,203,336 $ 24,972,598 Lodging systems sales 2,066,432 4,310,758 6,421,977 9,574,203 Installation and service revenues 8,284,048 7,242,302 17,224,394 13,340,514 Other revenues 166,184 33,178 869,819 135,744 ------------ ------------ ------------ ------------ Net sales and service revenues 22,596,714 27,473,033 47,719,526 48,023,059 ------------ ------------ ------------ ------------ Cost of commercial equipment 8,379,624 11,195,142 16,300,074 17,378,805 Cost of lodging systems 1,300,142 2,690,548 4,189,862 5,961,687 Installation and services costs 6,386,044 5,200,729 12,851,881 9,716,759 Cost of other revenues & corporate COGS 612,188 464,203 1,594,821 815,952 ------------ ------------ ------------ ------------ Total cost of sales and service 16,677,998 19,550,622 34,936,638 33,873,203 ------------ ------------ ------------ ------------ Gross profit 5,918,716 7,922,411 12,782,888 14,149,856 ------------ ------------ ------------ ------------ Operating expenses: Selling, general and administrative 4,407,482 4,241,250 8,237,581 7,221,199 Amortization 399,000 346,200 811,466 969,830 ------------ ------------ ------------ ------------ Total operating expenses 4,806,482 4,587,450 9,049,047 8,191,029 ------------ ------------ ------------ ------------ Income from operations 1,112,234 3,334,961 3,733,841 5,958,827 Interest expense (589,755) (645,222) (1,286,261) (1,011,222) Interest and other income 134,912 137,764 273,312 382,363 ------------ ------------ ------------ ------------ Subtotal (454,843) (507,458) (1,012,949) (628,859) Income before provision for income taxes 657,391 2,827,503 2,720,892 5,329,968 Provision for income taxes 258,000 1,102,000 1,067,000 2,084,000 ------------ ------------ ------------ ------------ Net income $ 399,391 $ 1,725,503 $ 1,653,892 $ 3,245,968 ============ ============ ============ ============ Earnings per share Basic $ 0.04 $ 0.21 $ 0.19 $ 0.39 ============ ============ ============ ============ Diluted $ 0.04 $ 0.17 $ 0.17 $ 0.33 ============ ============ ============ ============ Weighted average shares outstanding 9,101,093 8,219,336 8,901,823 8,236,968 ============ ============ ============ ============ Weighted average shares equivalents 9,741,886 9,918,042 9,674,935 9,897,906 ============ ============ ============ ============
The accompanying notes are an integral part of these consolidated statements. 4 5 XETA TECHNOLOGIES, INC. CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (Unaudited)
Common Stock Treasury Stock --------------------------- -------------------------- Number of Paid-in Retained Shares Issued Par Value Shares Amount Capital Earnings ------------- ----------- ----------- ----------- ----------- ----------- Balance-October 31, 2000 9,662,736 9,662 1,018,788 $(2,244,659) $ 9,486,776 $18,313,380 Stock options exercised $.001 par value 559,004 559 -- -- 360,454 -- Tax benefit of stock options -- -- -- -- 1,237,115 -- Net Income -- -- -- -- -- 1,653,892 ----------- ----------- ----------- ----------- ----------- ----------- Balance at April 30, 2001 10,221,740 $ 10,221 1,018,788 $(2,244,659) $11,084,345 $19,967,272 =========== =========== =========== =========== =========== ===========
5 6 XETA TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
For the Six Months Ended April 30, 2001 2000 ------------ ------------ Cash flows from operating activities: Net Income $ 1,653,892 $ 3,245,968 ------------ ------------ Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation 495,503 345,654 Amortization 811,466 969,830 (Gain) loss on sale of assets 9,814 (8,266) Provision for returns & doubtful accounts receivable 170,000 85,000 Provision for excess and obsolete inventory 300,000 125,000 Change in assets and liabilities net of acquisition: (Increase) decrease in net investment in sales-type leases & other receivables 65,074 379,048 (Increase) decrease in trade receivables 10,292,712 (7,217,426) (Increase) decrease in inventories (6,185,092) 1,909,601 (Increase) in deferred tax asset (59,509) 86,518 (Increase) decrease in prepaid expenses and other assets (103,942) (125,654) (Increase) decrease in prepaid taxes (1,269,592) (28,114) Increase (decrease) in accounts payable (776,110) (884,567) Increase (decrease) in unearned revenue (1,636,560) (1,960,401) Increase (decrease) in accrued income taxes 1,111,173 634,897 Increase (decrease) in accrued liabilities (1,710,620) (592,243) Increase (decrease) in deferred tax liabilities (111,894) (13,165) ------------ ------------ Total adjustments 1,402,423 (6,294,288) ------------ ------------ Net cash provided by (used in) operating activities 3,056,315 (3,048,320) ------------ ------------ Cash flows from investing activities: Acquisitions, net of cash acquired (5,593,695) (26,448,008) Additions to capitalized software -- (43,550) Additions to property, plant & equipment (1,556,597) (1,055,848) Proceeds from sale of assets 400 56,972 ------------ ------------ Net cash used in investing activities (7,149,892) (27,490,434) ------------ ------------ Cash flows from financing activities: Proceeds from issuance of debt 5,500,000 26,020,432 Proceeds from draws on revolving line of credit 18,420,000 4,650,000 Principal payments on debt (5,010,033) (1,916,665) Payments on revolving line of credit (15,325,000) (2,550,000) Exercise of stock options 361,013 57,551 ------------ ------------ Net cash provided by financing activities 3,945,980 26,261,318 ------------ ------------ Net decrease in cash and cash equivalents (147,597) (4,277,436) Cash and cash equivalents, beginning of period 926,330 4,556,212 ------------ ------------ Cash and cash equivalents, end of period $ 778,733 $ 278,776 ============ ============ Supplemental disclosure of cash flow information: Cash paid during the period for interest $ 1,713,853 $ 856,178 Cash paid during the period for income taxes $ 1,203,418 $ 1,404,967 Contingent consideration to be paid to target shareholder(s) $ -- $ 3,000,000 Contingent consideration paid to target shareholder(s) $ 2,000,000 Contingent liabilities acquired in acquisitions $ 1,300,000 $ 2,000,000 Treasury shares given in UST acquisition $ -- $ 3,300,000
The accompanying notes are an integral part of these consolidated statements. 6 7 XETA TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS April 30, 2001 (Unaudited) (1) BASIS OF PRESENTATION The consolidated financial statements herein include the accounts of XETA Technologies, Inc. (previously Xeta Corporation) and its wholly-owned subsidiaries, U.S. Technologies Systems, Inc. ("UST") and Xetacom, Inc. (the "Company" or "XETA"). Xetacom's operations have been insignificant to date. All significant intercompany accounts and transactions have been eliminated. On November 1, 2000, the Company purchased substantially all of the assets of PRO Networks Corporation ("PRO Net") and Key Metrology Integration, Inc. ("KMI") in separate transactions more fully described below. The results of operations from these acquisitions have been consolidated since November 1, 2000. The accompanying 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 annual financial statements prepared in accordance with accounting principles generally accepted in the United States, have been condensed or omitted pursuant to those rules and regulations. However, the Company believes that the disclosures made 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-K, 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. The results of operations for the interim periods are not necessarily indicative of the results for the entire fiscal year. The results of operations from the Company's new acquisitions were only consolidated since November 1, 2000 and the operating results of PRO Net and KMI have historically been subject to significant seasonal fluctuations. These statements should be read in conjunction with the audited financial statements and notes thereto of XETA included in the Company's Annual Report on Form 10-K, which was filed with the SEC on January 29, 2001, the Company's Form 10-K/A filing on February 8, 2001 reflecting the operating results of the Company. On June 26, 2000, the shareholders approved a reduction in the par value of the common stock to $.002 per share and an increase in the number of authorized common shares to 50 million. All share and per share amounts have been restated to reflect the effect of the two-for-one stock split on July 17, 2000. The stock split was effected through a reduction in the par value of the common stock to $.001 per share. 7 8 (2) ACQUISITIONS On November 1, 2000, the Company acquired substantially all of the assets of PRO Networks Corporation ("PRO Net") and Key Metrology Integration, Inc. ("KMI") in separate transactions. Both of these acquisitions were made to fulfill part of the Company's growth strategy to provide complex applications and professional services in addition to its traditional voice products and services. As a result of the acquisitions, the Company added approximately $5.3 million in goodwill to its balance sheet. (3) CREDIT FACILITY Financing for the acquisitions described above was provided through draws of $5.5 million on the Company's credit facility. At April 30,2001, the Company has term loans of $24.3 million outstanding and approximately $3.2 million available under the present facility for future acquisitions. In addition, the Company has an $8 million working capital revolving facility. At April 30, 2001, there was $3.91 million available under the revolver. Interest on all the funded portions of the facility accrues at either a) the London Interbank Offered Rate (which was 4.44% at April 30, 2001) plus 1.5% to 2.5%, as determined by the ratio of the Company's total funded debt to EBITDA (as defined in the credit facility) or b) the bank's prime rate (which was 7.5% at April 30, 2001) plus up to .75%, as determined by the ratio of the Company's total funded debt to EBITDA. Commitment fees of .20% to .45% (based on certain financial ratios) are due on any unused borrowing capacity under the credit facility. The Company makes monthly payments on the term loans of $525,341. Draws under the acquisition portion of the credit facility are converted annually into five-year term loans, except during the third year of the facility in which any draws are converted into a four-year term loan. The credit facility requires, among other things, that the Company maintain a minimum tangible net worth, working capital and debt to tangible net worth ratio, and debt service coverage, and it limits capital expenditures. At April 30, 2001, the Company was in compliance with the covenants of the revolving credit agreement or obtained the necessary covenant waiver. (4) INVENTORIES The following are the components of inventories:
April 30, October 31, 2001 2000 ------------ ------------ (Unaudited) Raw materials $ 1,367,137 $ 1,235,842 Finished goods and spare parts 13,960,714 8,032,695 ------------ ------------ 15,327,851 9,268,537 Less reserve for excess and obsolete inventory (1,682,697) (1,133,475) ------------ ------------ $ 13,645,154 $ 8,135,062 ============ ============
8 9 (5) PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consist of the following:
April 30, October 31, 2001 2000 ------------ ------------ (Unaudited) Data processing & computer field equipment $ 5,901,590 $ 4,244,213 Building 2,397,954 2,397,954 Land 611,582 611,582 Office furniture 1,085,564 958,385 Autos and trucks 259,345 266,668 Other 605,675 677,137 ------------ ------------ 10,861,710 9,155,939 Less accumulated depreciation (2,781,035) (2,301,088) ------------ ------------ $ 8,080,675 $ 6,854,851 ============ ============
(6) UNEARNED INCOME Unearned income consists of the following:
April 30, October 31, 2001 2000 ------------ ------------ (Unaudited) Service contracts $ 1,859,203 $ 1,884,155 Warranty service 829,138 1,001,791 Systems shipped, but not installed 70,165 196,766 Customer deposits 653,771 1,309,159 Other deferred revenue 63,184 121,158 ------------ ------------ Total current deferred revenue 3,475,461 4,513,029 Noncurrent unearned service revenues 664,429 1,039,949 ------------ ------------ $ 4,139,890 $ 5,552,978 ============ ============
9 10 (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:
April 30, October 31, 2001 2000 ------------ ------------ (Unaudited) Deferred tax assets: Nondeductible reserves $ 616,282 $ 1,630,311 Prepaid service contracts 255,835 337,559 Unamortized cost of service contracts 78,398 31,186 Other 46,224 29,224 ------------ ------------ Total deferred tax asset 996,739 2,028,280 ------------ ------------ Deferred tax liabilities: Tax income to be recognized on sales-type lease contracts 547,506 603,606 Unamortized capitalized software development costs 172,705 203,305 Other 227,667 211,485 ------------ ------------ Total deferred tax liability 947,878 1,018,396 ------------ ------------ Net deferred tax asset (liability) $ 48,861 $ 1,009,884 ============ ============
(10) 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-K, Commission File No. 0-16231, filed with the Securities and Exchange Commission on January 29, 2001, and the Company's Form 10-K/A filing on February 8, 2001. Accordingly, reference should be made to those statements for the following:
Note Description ---- ----------- 1 Business and Summary of Significant Accounting Policies 2 Acquisitions 3 Accounts Receivable 6 Accrued Liabilities 10 Stock Options 11 Earnings Per Share 12 Commitments 13 Major Customers and Concentration of Credit Risk 14 Employment Agreements 15 Contingencies 16 Retirement Plan 17 Subsequent Event 18 Selected Quarterly Financial Data
10 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS, WHICH ARE SUBJECT TO THE PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THESE STATEMENTS INCLUDE, WITHOUT LIMITATION, STATEMENTS CONCERNING EXPECTATIONS REGARDING: XETA TECHNOLOGIES' (THE "COMPANY'S") FINANCIAL POSITION INCLUDING REVENUES, EARNINGS PER SHARE, GROSS MARGINS, OPERATING EXPENSES, AND OPERATING MARGINS; THE IMPACT OF CERTAIN REDUCTIONS AND OTHER MEASURES TAKEN DURING THE QUARTER UPON THE COMPANY'S FUTURE RESULTS OF OPERATIONS; AND TRENDS AND CONDITIONS IN THE U.S. ECONOMY AND IN THE COMMUNICATIONS TECHNOLOGY INDUSTRY AND HOSPITALITY MARKETS. THESE AND OTHER FORWARD-LOOKING STATEMENTS (GENERALLY DEFINED BY SUCH WORDS AS "EXPECTS," "PLANS," "BELIEVES," "ANTICIPATES," "GUIDANCE," AND SIMILAR WORDS OR EXPRESSIONS) ARE NOT GUARANTEES OF PERFORMANCE BUT RATHER REFLECT MANAGEMENT'S CURRENT EXPECTATIONS, ASSUMPTIONS, AND BELIEFS BASED UPON INFORMATION CURRENTLY AVAILABLE TO MANAGEMENT. INVESTORS ARE CAUTIONED THAT ALL FORWARD-LOOKING STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES WHICH ARE DIFFICULT TO PREDICT AND THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED. THESE RISKS AND UNCERTAINTIES ARE DESCRIBED UNDER THE HEADING "OUTLOOK AND RISK FACTORS" BELOW. CONSEQUENTLY, ALL FORWARD-LOOKING STATEMENTS SHOULD BE READ IN CONJUNCTION WITH THE RISK FACTORS DISCUSSED HEREIN AND THROUGHOUT THIS REPORT TOGETHER WITH THE RISK FACTORS IDENTIFIED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K, WHICH WAS FILED ON JANUARY 29, 2001. GENERAL During its second quarter, the Company faced a continued, rapid decline in the market for its products. In the face of the decline in the overall U.S. economy, many U.S. firms have significantly deferred their capital spending on technology and productivity-enhancing products. The impact on the Company's revenues has been sudden and substantial, and most noticeable in the Lodging sector. As a result, the Company has taken several actions discussed below and throughout Item 2, to adjust the Company's operations to correspond to its current revenue levels. Management believes these actions will help the Company's operating results in the current economic climate. However, because of the general uncertainty as to the future trend of the U.S. economy and the duration of the current slow-down, it is difficult to predict whether additional such measures will be necessary in the future to maintain or protect current revenue levels. The Company's response to the current market conditions has been to rapidly adjust its cost structure to its current revenue run-rates and to continue to pursue, and in some cases, quicken the pace of its transformation strategies. Specifically, the Company implemented a workforce reduction of approximately 80 to 90 employees, a salary reduction for officers of 10% to 25%, and a 20% reduction in the fees paid to outside directors. Much of the workforce reduction represented an acceleration of the planned benefits of the implementation of the new Enterprise Resource Planning ("ERP") system and an acceleration of the integration of the Company's recent acquisitions in addition to sizing the Company appropriately for the current lower level of revenues. Despite having to take the actions above, management remains committed to the transformation of its business in fiscal 2001. This transformation includes executing the following tactics: (1) complete the 11 12 implementation of the digital operating model, (2) integrate our newly acquired LAN, WAN, UM, Microsoft Exchange and IP consulting and implementation competencies, and (3) redirect our sales and service teams from slower to faster growing application segments of the marketplace. Also, in response to the current market conditions, the Company has chosen to re-align the duties of its executive team in order to enable the Company to better respond to current market conditions in the areas of operating results and the Company's planned transformation. Jon Wiese, formerly Co-CEO and President, will assume the position of Chief Strategist and will be responsible for the Company's growth strategies and corporate transformation initiatives. Jack Ingram will remain as Chairman and CEO and will assume the duties and responsibilities of President responsible for all day-to-day activities. The Company believes that it can more effectively maximize its operating efficiencies and achieve its growth vision with this management structure. Management believes that as a result of the actions described above and pending no further deterioration in its markets, it can raise its profitability levels from the $.04 earnings per share level earned in the 2nd quarter to the $.08 to $.11 earnings per share level, while at the same time continuing to adequately serve the Company's customer base and preserve the ability to re-initiate the growth strategies once the market stabilizes. FINANCIAL CONDITION During the first half of fiscal 2001, the Company has continued to enjoy positive cash flows from operations as a result of the Company's profitability and the cash management project that began in the fourth quarter of fiscal 2000. Cash flows from operations were $3.1 million in the first half of 2001 generated substantially from the Company's efforts to reduce its accounts receivable balances through focusing on the processing and collecting of sales orders. These efforts have resulted in the reduction in days sales outstanding on billed receivables from 106 on July 31, 2000 to 71 for the quarter just ended. In the second quarter, the Company made a deliberate decision to increase its inventory balances to insure there would be adequate inventory balances available while the Company implemented a new warehouse strategy resulting in the elimination of six warehouses and the creation of an outsourced warehouse process. Also, the Company made these inventory purchases to take advantage of certain compensation programs available to the Company under the Avaya dealer program. During the first six months of the year, the Company has made investments of $7.1 million. Approximately $5.6 million of these investments represent the KMI and PRO Net acquisitions made at the beginning of the fiscal year, for which funding was provided by a draw on the Company's acquisition facility. The remaining investments made were primarily related to phase I of the implementation of the Company's ERP system. At April 30, 2001, the Company has total term debt outstanding of $25.3 million. In addition, $4.1 million was outstanding on the working capital revolver. As discussed above, management took several actions in the second quarter to adjust the cost structure of the Company to the current market conditions. While no assurance can be made, management believes that the cash flows of the Company will be sufficient to meet the Company's debt 12 13 obligations provided there is no further erosion in market conditions. Management has met with its bank group and discussed in detail these current market conditions, the actions taken in response, and the Company's current forecast for operating results and cash flows. Discussions are currently taking place regarding possible adjustments to some of the covenants and pricing under the Company's present credit facility. See additional discussion of the Company's Credit Facility under "Risk Factors" below. Management considers its relationship with its bank to be good. RESULTS OF OPERATIONS The Company is reporting its revenues and gross margins from three major sources: sales of equipment to the Commercial market, sales of systems to the Lodging market and installation and service activities derived from both markets. Also, the Company reports other revenues and costs of goods sold representing sales of equipment or services outside the Company's normal provisioning processes. Commercial Equipment Sales. Sales of equipment and systems to the Commercial market decreased 24% in the second quarter compared to last year and decreased 7% for the year-to-date period compared to last year. The Company attributes this decline directly to market conditions, and specifically to the slow-down in spending on new technology in the U.S. Management watches the order rates for its Commercial sales closely and those rates have not shown a clear trend in the first half of the year; therefore management is unable to predict with any confidence whether the current downturn will continue, stabilize, or recover during the balance of the year. Lodging Systems Sales. Sales of lodging systems decreased 52% in the second quarter compared to last year and decreased 33% for the six-month period compared to the previous year. Though lower lodging systems sales were expected in fiscal 2001, management believes that the severity of these results are related to the market conditions. Furthermore, the duration of the decline appears to be more severe as order rates for new lodging systems have consistently declined during the first half of the year. Given the likelihood of a more sustained downturn in this segment of the Company's business, more of the workforce reductions were targeted toward functional areas that supported this segment. Installation and Service Revenues. Revenues earned from installation and service ("Service") related activities increased 14% in the second quarter of fiscal 2001 compared to the prior year and increased 29% in the first half of fiscal 2001 compared to the first half of fiscal 2000. Service revenues are derived from activities related to the Company's Commercial and Lodging product offerings and from professional services provided by the Company's newly acquired professional consulting firm, KMI. Service revenues earned from Lodging related activities including maintenance contracts, installations and cabling projects increased 15% in the second quarter and 11% for the first six months of fiscal 2001. Despite these year-over-year increases, on a sequential basis Lodging related service revenues declined 11% in the second quarter (compared to the first quarter), especially revenues earned from Lodging cabling projects, reflecting the downturn in Lodging systems sales discussed above. 13 14 Service revenues earned from the Commercial market sources increased 3% in the second quarter compared to last year and 66% for the first half of 2001 compared to a year ago. Although this revenue stream has been adversely affected by the market conditions described above, the Company has offset those trends by continued focus on strengthening this segment of the business as a key differentiator in the marketplace driving customer satisfaction and retention. Service revenues earned from the Company's consulting business are not comparable to previous periods since this line of business was acquired in November of the current fiscal year. While management is pleased with the type of projects being performed by its consultants, this segment has also been negatively impacted by the general downturn in the economy as companies look for ways to decrease expenses and often defer consulting projects. Gross Margins. Gross margins in the second quarter of fiscal 2001 were 26% compared to 29% in the second quarter of fiscal 2000 and were 27% for the six month period ending April 30, 2001 compared to 29% for the same period in fiscal 2000. The major reason for the decline in overall gross margins was the decline in gross margins earned on service revenues which slipped to 23% from 28% in the three month period and to 25% from 27% for the sixth month period. Management believes that most of this erosion in margins was the result of an increase in manpower during the first half of the year which was made to support the Company's Lodging cabling and installation business and to a lesser extent the planned growth in the Commercial services segment. While no assurance can be given, management believes that the actions taken to reduce the size of the workforce supporting these revenue streams and a general focus on overall expenses will substantially improve the gross margins earned on Services. Gross margins earned on Commercial and Lodging equipment and systems sales were relatively flat in the second quarter of fiscal 2001 compared to the previous year and were up slightly compared to the first quarter of the current year reflecting favorable product mix and improved customer satisfaction despite the market conditions. Operating Expenses. Operating expenses, excluding amortization expenses, were 20% of revenues in the second quarter of fiscal 2001 compared to 15% in the same period of fiscal 2000 and were 17% for the first half of fiscal 2001 compared to 15% for the same period of fiscal 2000. These increases were the result of lower revenues and reduced reimbursement of marketing funds from the Company's principal supplier, Avaya. While no assurance can be given and provided that revenue levels remain at second quarter levels or improve, management believes that the cost reduction efforts implemented in April will result in operating expense levels more in line with its previously stated goal of 16% to 18% for these expenses. Amortization expense was $399,000 for the second quarter compared to $346,000 in the prior year reflecting additional goodwill added from recent acquisitions earlier in the year. For the year-to-date period, amortization expense was $811,000 compared to $970,000 in the prior year reflecting higher amortization of acquired goodwill in fiscal 2001 which was more than offset by an additional $208,000 in amortization in the first half of fiscal 2000 to complete the amortization of long distance service contracts purchased in 1997. Interest Expense and Other Income. Interest expense consists of interest on the Company's credit facility. Interest expense in the second quarter of the current year is approximately 9% lower than the same period in 2000 reflecting generally lower interest rates. For the year-to-date period, 14 15 interest expense is approximately 27% higher resulting from higher average debt outstanding in the current year and the fact that the Company did not incur debt until one month into fiscal 2000 when it acquired U.S. Technologies, Inc. Tax Expense. The Company has recorded a combined federal and state tax provision of 39% of income before taxes in all periods being presented. This rate reflects the effective federal tax rate plus the estimated composite state income tax rate. Operating Margins. Net income as a percent of revenues was 2% in the second quarter of fiscal 2001 compared to 6% in the prior year and was 3% in the first half of fiscal 2001 compared to 7% for the same period last year. The operating margins earned in 2001 to date are lower than the Company's target operating margins of 6% to 8% and reflect the current economic conditions that the Company is experiencing. Management believes that the changes that have been made to it's cost structure late in the Company's second quarter will restore operating margins to the 4% to 5% range for the balance of the year, provided there is no further deterioration in market conditions. OUTLOOK AND RISK FACTORS The following discussion is an update of the "Outlook and Risk Factors" discussed in the Company's Annual Report on Form 10-K for the year ended October 31, 2000. The discussions in that report regarding "Dealer Agreements", "Dependence Upon the Avaya 'Business Partner Program' and 'Incentive Programs'", "Competition", "Section 3389(h)(10) Election", and "General Risk Factors" are still considered current and should be given equal consideration together with the matters discussed below. Growth Strategy and Acquisitions. Management continues to strongly believe in its overall vision to become a nationwide integrator of voice and data technologies offering a full range of products and professional services and in its strategy to pursue that vision through a balanced growth strategy of acquisitions and organic growth. However, given the current market conditions, management has chosen to suspend its acquisition activity and will expand internally only as significant target geographic opportunities present themselves. Management believes that the cost containment measures taken to date will not hamper the Company's ability to quickly re-engage both its acquisition and internal growth strategies when market conditions and the Company's profitability improve. However, should additional cost reductions be needed in response to further weakening in the Company's markets, it is possible that such reductions could hamper the Company's ability to resume its expansion capabilities. U.S. Economy. Predicting the future of the U.S. economy and its impact on the Company's near and long-term results is treacherous. Management believes that its strategy to pursue becoming a nationwide integrator of voice and data technologies specializing in high-end, complex applications of those technologies, is still the correct vision. However, current market conditions have dictated the workforce and salary reductions discussed under "General" above as well as the implementation of other cost-containment measures. Also, in light of the uncertain economic conditions, the Company has temporarily suspended its acquisition activities. These actions, when considered together, will likely result in a delay in the Company's ability 15 16 to quickly reach the critical mass that management believes is necessary to ultimately be successful as a nationwide integrator. However, it is premature to determine whether these actions will ultimately result in a competitive disadvantage in the marketplace when the economy eventually recovers. Presently, there is little consensus regarding the duration or severity of the current downturn, especially as it relates to the Company's markets. Therefore, there can be no estimate given as to when the Company could resume its planned growth strategy. Credit Facility. As discussed under "Financial Condition" above, the Company has met with its bank group to fully discuss current economic conditions, their impact on the Company, and management's response to those conditions. Based on those actions and on generally flat revenues for the remainder of the fiscal year, the Company has forecasted that it can meet its debt obligations and continue to fund the implementation of its new ERP system. However, should the Company's financial condition deteriorate significantly in the future, it is possible that the cash flows from its operations would be insufficient to demonstrate an ability to meet its debt obligations. In such case, it might become necessary to restructure the debt or replace it through an equity offering. No assurance can be given that such a restructuring could be achieved at all and it is likely that the pricing of the restructured debt would be significantly higher than the Company's current senior debt credit facility. Technology Infrastructure and Information Systems. Management's ability to navigate the current market will depend heavily upon its ability to assemble the necessary information to make informed decisions and implement those decisions quickly and effectively. The Company is currently upgrading its technology infrastructure and its information systems. This upgrade will result in a consolidation from four critical legacy systems to one. The success of this conversion is critical to the Company attaining the planned productivity increases and operational efficiencies needed to improve the Company's operating results and provides the needed infrastructure for future growth. Attracting and Retaining Talented Employees. Despite the downturn in the economy, the Company continues to see a very tight market for the most talented labor, especially certified technicians and account executives with experience in the Company's markets. Management continues to believe that by providing opportunities for these individuals at the leading edge of technology and through appropriate compensation and training programs, the Company can effectively retain and attract the needed talent to support its business. However, should market conditions remain depressed, it is possible that the Company would have to defer or cancel needed training and certification programs necessary for these employees to maintain and advance their expertise. In addition, should the market demand for these individuals continue to remain strong in the face of an overall weaker economy, no assurance can be given that the Company could fashion sufficiently attractive cash and equity compensation packages to continue to retain or attract these important competencies. Stock Market Volatility. Historically, the Company's stock has not been widely followed by investment analysts and has been subject to price and volume trading volatility. This volatility is sometimes tied to overall market conditions and may or may not reflect the operating performance of the 16 17 Company. Due to the current negative perception of technology related stocks, the Company's declining revenues, and the relatively small size of the Company's market capitalization, the Company has seen the interest from the financial community and average trading volume of its stock decline further during fiscal 2001. As a result, there is increased risk that the Company's stock could experience even greater volatility from momentum trading by only a few stock market participants. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risks relating to the Company's operations result primarily from changes in interest rates. The Company did not use derivative financial instruments for speculative or trading purposes during the first half of fiscal 2001. Interest Rate Risk. The Company's cash equivalents, which consist of highly-liquid, short-term investments with an average maturity of less than 51 days, are subject to fluctuating interest rates. A hypothetical 10 percent change in such interest rates would not have a material effect upon the Company's consolidated results of operations or cash flows. The Company has a $43 million credit facility in place (see Note 3 to the Consolidated Financial Statements for details of the Company's long-term debt) to finance the expansion of its business pursuant to its balanced growth strategy of internal expansion and selective acquisitions. The Company is exposed to market risk from changes in interest rates related to this credit facility which is based upon either LIBOR or the bank's prime rate. 17 18 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. ASSOCIATED BUSINESS TELEPHONE SYSTEMS, INC., PLAINTIFF VS. XETA CORPORATION, DEFENDANT AND THIRD-PARTY PLAINTIFF, VS. D&P INVESTMENTS, INC., THIRD-PARTY DEFENDANT - On February 16, 2001, the parties entered into a Mutual Release and Settlement Agreement ("Agreement"), which terminated this matter. A complete description of the subject matter of this lawsuit is contained in the Company's Annual Report on Form 10-K for the 2000 fiscal year, filed with the Commission on January 29, 2001 and the Company's Quarterly Report on Form 10-Q filed with the Commission on March 19, 2001. Regarding the PHONOMETRICS' litigation, which the Company is monitoring, the Florida District Court entered an order in March, 2001 staying all of the Phonometrics' cases pending the outcome of an appeal by Phonometrics which is before the Federal Circuit Court of Appeals. A detailed description of the Phonometrics' cases is contained in the Company's Annual Report on Form 10-K for the fiscal year ended October 31, 2000 filed with the Commission on January 29, 2001, and the Company's Quarterly Report on Form 10-Q for the first quarter ended January 31, 2001, filed with the Commission on March 19, 2001. ITEMS 2 and 3 have been omitted because they are not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF THE SHAREHOLDERS. During the fiscal period for which this report is filed, the Company held its annual meeting of shareholders on March 20, 2001, at which the following two matters were submitted to a vote of the shareholders and approved. The first matter concerned the election of Directors. The following persons were elected to the Board of Directors without contest as follows:
NOMINEE FOR WITHHOLD ------- --- -------- Ron B. Barber 7,985,276 30,734 Donald T. Duke 7,985,276 30,734 Robert D. Hisrich 7,985,276 30,734 Jack R. Ingram 7,985,276 30,734 Ronald L. Siegenthaler 7,985,276 30,734 Robert B. Wagner 7,985,276 30,734 Jon A. Wiese 7,985,276 30,734
18 19 The second matter involved the ratification of the Board of Directors' selection of Arthur Andersen, LLP as the independent public accountants to audit the Company's financial statements for the fiscal year ending October 31, 2001. The selection was ratified by the shareholders as follows:
For Against Abstain --- ------- ------- 7,989,759 13,715 12,536
ITEM 5 has been omitted because it is not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits - See Exhibit Index page. (b) Reports on Form 8-K - During the quarter for which this report is filed, the Company filed a voluntary report on Form 8-K on March 26, 2001. 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 Technologies, Inc. (Registrant) Dated: June 14, 2001 By: /s/ JACK R. INGRAM ------------------------------------------- Jack R. Ingram Chief Executive Officer Dated: June 14, 2001 By: /s/ ROBERT B. WAGNER ------------------------------------------- Robert B. Wagner Chief Financial Officer 19 20 Exhibit Index SEC No. Description (2) PLAN OF ACQUISITION, REORGANIZATION, ARRANGEMENT, LIQUIDATION OR SUCCESSION - None. (3) (i) ARTICLES OF INCORPORATION - *(a) Amended and Restated Certificate of Incorporation of the Registrant -- Incorporated by reference to Exhibits 3.1 and 3.2 to the Registrant's Registration Statement on Form S-1, filed on June 17, 1987 (File No. 33-7841). *(b) Amendment No. 1 to Amended and Restated Certificate of Incorporation -- Incorporated by reference to Exhibit 4.2 to the Registrant's Post-Effective Amendment No. 1 to Registration Statement on Form S-8, filed on July 28, 1999 (File No. 33-62173). *(c) Amendment No. 2 to Amended and Restated Certificate of Incorporation - Incorporated by reference to Exhibit 3(i)(c) to the Registrant's Form 10-Q for the quarter ended April 30, 2000, filed on June 14, 2000 (File No. 0-16231). *(d) Amendment No. 3 to Amended and Restated Certificate of Incorporation - Incorporated by reference to Exhibit 4.4 to the Company's Post-Effective Amendment No. 2 to the Registration Statement Form S-8, filed on June 28, 2000 (File No. 33-62173). (ii) BYLAWS - (a) Amended and Restated Bylaws of the Registrant. (4) INSTRUMENTS DEFINING RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES - None other than the Amended and Restated Certificate of Corporation of the Registrant, as amended, and Amended and Restated Bylaws of the Registrant, as identified in Exhibit 3(i) and 3(ii) to this report. (10) MATERIAL CONTRACTS - *10.1 Dealer Agreement Among Lucent Technologies, Inc.; Distributor, Inacom Communications, Inc.; and XETA Corporation for Business Communications Systems--Incorporated by reference to Exhibit 10.1 to the Registrant's Form 10-Q for the quarter ended April 30, 1999, filed on June 11, 1999 (File No. 0-16231). *10.2 Stock Purchase Option dated June 17, 1999 granted to Jon A. Wiese --Incorporated by reference to Exhibit 10.2 to the Registrant's Form 10-Q for the quarter ended July 31, 1999, filed on September 14, 1999 (File No. 0-16231). *10.3 Stock Purchase Agreement dated as of August 1, 1999, between Mark A. Martin, individually, and Mark A. Martin, Trustee under Living Trust of Mark A. Martin dated April 4, 1994, and XETA Corporation -Incorporated by reference to Exhibit 2.1 to the Registrant's Form 8-K filed on December 15, 1999 (File No. 0-16231). 20 21 *10.4 Stock Purchase Agreement dated as of August 1, 1999, between Lawrence J. Hopp, individually, and Lawrence J. Hopp, Trustee under Living Trust of Lawrence J. Hopp dated October 13, 1994, and XETA Corporation -Incorporated by reference to Exhibit 2.2 to the Registrant's Form 8-K filed on December 15, 1999 (File No. 0-16231). *10.5 Credit Agreement dated as of November 30, 1999 among XETA Corporation, the Lenders, the Agent and the Arranger--Incorporated by reference to Exhibit 2.3 to the Registrant's Form 8-K filed on December 15, 1999 (File No. 16231). *10.6 Real Estate Mortgage on the Registrant's Broken Arrow, Oklahoma property--Incorporated by reference to Exhibit 2.5 to the Registrant's Form 8-K filed on December 15, 1999 (File No. 0-16231). *10.7 Pledge and Security Agreement relating to November 30, 1999 Credit Agreement - Incorporated by reference to Exhibit 2.4 to the Registrant's Form 8-K filed on December 15, 1999 (File No. 0-16231). *10.8 Subsidiary Guaranty by U.S. Technologies Systems, Inc. of November 30, 1999 Credit facility - Incorporated by reference to Exhibit 2.6 to the Registrant's Form 8-K filed on December 15, 1999 (File No. 0-16231). *10.9 Employment Agreement dated November 30, 1999 between Mark A. Martin and the Company - Incorporated by reference to Exhibit 99.1 to the Registrant's Form 8-K filed on December 15, 1999 (File No. 0-16231). *10.10 Stock Purchase Option dated February 1, 2000 granted to Larry N. Patterson - Incorporated by reference to Exhibit 10.9 to the Registrant's Form 10-Q for the quarter ended April 30, 2000, filed on June 14, 2000 (File No. 0-16231). *10.11 Amendment to Dealer Agreement Among Lucent Technologies, Inc. Distributor, Inacom Communications, Inc.; and XETA Corporation, for Business Communications Systems, dated effective March 19, 2000 - Incorporated by reference to Exhibit 10.10 to the Registrant's Form 10-Q for the quarter ended April 30, 2000, filed on June 14, 2000 (File No. 0-16231). *10.12 XETA Technologies 2000 Stock Option Plan - Incorporated by reference to Exhibit 10.11 to the Registrant's Form 10-Q for the quarter ended April 30, 2000, filed on June 14, 2000 (File No. 0-16231). *10.13 HCX 5000(R) Authorized Distributor Agreement dated April 1, 2000 between Hitachi Telecom (USA), Inc. and XETA Corporation--Omitted as substantially identical to the Authorized Distributor Agreement dated April 8, 1993 between Hitachi America, Ltd. and XETA Corporation which was previously filed as Exhibit 10.1 to the Company's Annual Report on Form 10-KSB for the fiscal year ended October 31, 1993 (File No. 0-16231). *10.14 Stock Purchase Option dated August 11, 2000 granted to Larry N. Patterson - Incorporated by reference to Exhibit 10.14 to the Registrant's Annual Report on Form 10-K for the year ended October 31, 2000, filed on January 29, 2001. (File No. 0-16231). *10.15 First Amendment to Credit Agreement dated August 21, 2000 among XETA Technologies, Inc., the Lenders, the Agent and the Arranger - Incorporated by reference to Exhibit 10.15 to the Registrant's Annual Report on Form 10-K for the year ended October 31, 2000, filed on January 29, 2001. (File No. 0-16231). 21 22 *10.16 Notice of Assignment by Lucent Technologies Inc. dated September 14, 2000 of all contracts with XETA Technologies, Inc. (including the Dealer Agreement) to Avaya Inc. - Incorporated by reference to Exhibit 10.16 to the Registrant's Annual Report on Form 10-K for the year ended October 31, 2000, filed on January 29, 2001. (File No. 0-16231). *10.17 Asset Purchase Agreement dated as of October 31, 2000, by and among Key Metrology Integration, Inc. as Seller, its principal shareholder The Douglas Wendell Myers Revocable Living Trust, XETA Technologies, Inc., as Purchaser, and Douglas Wendell Myers, individually - Incorporated by reference to Exhibit 10.17 to the Registrant's Annual Report on Form 10-K for the year ended October 31, 2000, filed on January 29, 2001. (File No. 0-16231). *10.18 Asset Purchase Agreement dated as of October 31, 2000, by and among PRO Networks Corporation, as Seller, its shareholders The John Gerard Sargent Revocable Living Trust and The Nancy Rhea Sargent Revocable Living Trust, XETA Technologies, Inc., as Purchaser, and John Gerard Sargent and Nancy Rhea Sargent, individually - Incorporated by reference to Exhibit 2.1 to the Registrant's Form 8-K filed on November 15, 2000 (File No. 0-16231). (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. * Previously filed 22