10-Q 1 d90590e10-q.txt FORM 10-Q FOR QUARTER ENDED JULY 31, 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 July 31, 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. Employee 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 September 1, 2001 --------------------------------- ----------------------------------------- Common Stock, $.001 par value 9,237,952 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Consolidated Balance Sheets - July 31, 2001 and October 31, 2000 Consolidated Statements of Operations - For the Three and Nine months ended July 31, 2001 and 2000 Consolidated Statement of Shareholder's Equity - November 1, 2000 through July 31, 2001 Consolidated Statements of Cash Flows - For the Nine months ended July 31, 2001 and 2000 Notes to Consolidated Financial Statements
2 3 XETA TECHNOLOGIES, INC. CONSOLIDATED BALANCE SHEETS
ASSETS July 31, 2001 October 31,2000 -------------- --------------- (Unaudited) Current Assets: Cash and cash equivalents $ 372,057 $ 926,330 Current portion of net investment in sales-type leases and other receivables 2,325,353 2,609,976 Trade accounts receivable, net 19,925,249 30,139,623 Inventories, net 11,114,867 8,135,062 Deferred tax asset, net 769,526 1,133,487 Prepaid expenses and other assets 1,225,923 338,828 -------------- -------------- Total current assets 35,732,975 43,283,306 -------------- -------------- Noncurrent Assets: Goodwill, net of amortization 26,298,567 20,579,359 Net investment in sales-type leases, less current portion above 1,233,366 2,505,841 Property, plant & equipment, net 8,689,600 6,854,851 Capitalized software production costs, net of accumulated amortization of $828,066 & $693,066 462,956 597,956 Other assets 277,658 327,658 -------------- -------------- Total noncurrent assets 36,962,147 30,865,665 -------------- -------------- Total assets $ 72,695,122 $ 74,148,971 ============== ============== LIABILITIES & SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ 6,304,086 $ 6,820,754 Revolving line of credit 925,000 1,000,000 Accounts payable 9,952,730 11,750,607 Unearned revenue 2,941,336 4,513,029 Accrued liabilities 2,840,448 3,927,803 Accrued federal and state income taxes -- 125,942 -------------- -------------- Total current liabilities 22,963,600 28,138,135 -------------- -------------- Noncurrent liabilities: Long-term debt, less current portion above 17,413,621 17,983,011 Accrued long-term liabilities 1,299,114 1,299,114 Unearned service revenue 519,931 1,039,949 Noncurrent deferred tax liability, net 526,736 123,603 -------------- -------------- 19,759,402 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 July 31, 2001 and October 31, 2000 respectively 10,221 9,662 Paid-in capital 11,261,743 9,486,776 Retained earnings 20,944,815 18,313,380 Less treasury stock, at cost (2,244,659) (2,244,659) -------------- -------------- Total shareholders' equity 29,972,120 25,565,159 -------------- -------------- Total liabilities & shareholders' equity $ 72,695,122 $ 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 Nine Months Ending July 31, Ending July 31, 2001 2000 2001 2000 -------------- -------------- -------------- -------------- Commercial equipment sales $ 11,117,749 $ 13,637,639 $ 34,321,085 $ 38,610,237 Lodging systems sales 1,801,453 2,933,942 8,223,430 12,508,145 Installation and service revenues 8,006,346 8,951,256 25,230,740 22,291,770 Other revenues 38,897 57,094 908,716 192,838 -------------- -------------- -------------- -------------- Net sales and service revenues 20,964,445 25,579,931 68,683,971 73,602,990 -------------- -------------- -------------- -------------- Cost of commercial equipment 8,096,513 9,306,499 24,396,587 26,685,304 Cost of lodging systems 1,136,774 1,776,523 5,326,636 7,738,210 Installation and services costs 5,327,996 5,851,655 18,179,877 15,568,414 Cost of other revenues & corporate COGS 626,296 571,691 2,221,117 1,387,643 -------------- -------------- -------------- -------------- Total cost of sales and service 15,187,579 17,506,368 50,124,217 51,379,571 -------------- -------------- -------------- -------------- Gross profit 5,776,866 8,073,563 18,559,754 22,223,419 -------------- -------------- -------------- -------------- Operating expenses: Selling, general and administrative 3,343,455 4,773,454 11,581,036 11,994,653 Amortization 399,000 346,200 1,210,466 1,316,030 -------------- -------------- -------------- -------------- Total operating expenses 3,742,455 5,119,654 12,791,502 13,310,683 -------------- -------------- -------------- -------------- Income from operations 2,034,411 2,953,909 5,768,252 8,912,736 Interest expense (535,619) (672,671) (1,821,880) (1,683,893) Interest and other income 108,751 84,656 382,063 467,019 -------------- -------------- -------------- -------------- Subtotal (426,868) (588,015) (1,439,817) (1,216,874) Income before provision for income taxes 1,607,543 2,365,894 4,328,435 7,695,862 Provision for income taxes 630,000 930,000 1,697,000 3,014,000 -------------- -------------- -------------- -------------- Net income $ 977,543 $ 1,435,894 $ 2,631,435 $ 4,681,862 ============== ============== ============== ============== Earnings per share Basic $ 0.11 $ 0.17 $ 0.29 $ 0.57 ============== ============== ============== ============== Diluted $ 0.10 $ 0.15 $ 0.27 $ 0.48 ============== ============== ============== ============== Weighted average shares outstanding 9,202,952 8,380,035 9,003,302 8,285,005 ============== ============== ============== ============== Weighted average shares equivalents 9,795,292 9,804,028 9,729,176 9,782,277 ============== ============== ============== ==============
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 ---------------------------- ---------------------------- Retained Shares Issued Par Value Shares Amount Paid-in 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 -- -- -- -- 1,414,513 -- Net Income -- -- -- -- -- 2,631,435 ------------- ------------- ------------- ------------- ------------- ------------- Balance at July 31, 2001 10,221,740 $ 10,221 1,018,788 $ (2,244,659) $ 11,261,743 $ 20,944,815 ============= ============= ============= ============= ============= =============
The accompanying notes are an integral part of these consolidated statements. 5 6 XETA TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
For the Nine Months Ended July 31, 2001 2000 -------------- -------------- Cash flows from operating activities: Net Income $ 2,631,435 $ 4,681,862 -------------- -------------- Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation 745,030 574,179 Amortization 1,210,466 1,316,030 (Gain) loss on sale of assets 10,537 (3,611) Provision for returns & doubtful accounts receivable 230,000 139,000 Provision for excess and obsolete inventory 450,000 200,000 Change in assets and liabilities net of acquisition: (Increase) decrease in net investment in sales-type leases & other receivables 1,557,098 1,011,047 (Increase) decrease in trade receivables 11,128,989 (11,557,366) (Increase) decrease in inventories (3,804,805) 298,311 (Increase) in deferred tax asset (258,465) 123,527 (Increase) decrease in prepaid expenses and other assets 9,947 (156,391) (Increase) decrease in prepaid taxes (825,207) (344,614) Increase (decrease) in accounts payable (2,376,911) 2,828,468 Increase (decrease) in unearned revenue (2,315,183) (2,545,661) Increase (decrease) in accrued income taxes 1,288,571 932,822 Increase (decrease) in accrued liabilities (1,318,301) 99,647 Increase (decrease) in deferred tax liabilities (106,867) 34,648 -------------- -------------- Total adjustments 5,624,899 (7,049,964) -------------- -------------- Net cash provided by (used in) operating activities 8,256,334 (2,368,102) -------------- -------------- Cash flows from investing activities: Acquisitions, net of cash acquired (5,595,193) (26,477,656) Additions to capitalized software -- (58,550) Additions to property, plant & equipment (2,416,074) (1,706,139) Proceeds from sale of assets 700 82,325 -------------- -------------- Net cash used in investing activities (8,010,567) (28,160,020) -------------- -------------- Cash flows from financing activities: Proceeds from issuance of debt 5,500,000 26,020,432 Proceeds from draws on revolving line of credit 24,885,000 8,750,000 Principal payments on debt (6,586,053) (3,066,664) Payments on revolving line of credit (24,960,000) (5,600,000) Exercise of stock options 361,013 216,301 -------------- -------------- Net cash provided by (used in) financing activities (800,040) 26,320,069 -------------- -------------- Net increase (decrease) in cash and cash equivalents (554,273) (4,208,053) Cash and cash equivalents, beginning of period 926,330 4,556,212 -------------- -------------- Cash and cash equivalents, end of period $ 372,057 $ 348,159 ============== ============== Supplemental disclosure of cash flow information: Cash paid during the period for interest $ 1,982,124 $ 1,455,661 Cash paid during the period for income taxes $ 1,473,813 $ 2,294,031 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. July 31, 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 and 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 July 31, 2001, the Company had term loans of $22.7 million outstanding under the credit facility. In addition, the Company has an $8 million working capital revolving facility. At July 31, 2001, there was $7.08 million available under the revolver. On June 8, 2001, the credit facility was amended to reduce the amount available for future acquisitions to $1 million with the expectation that this amount will be used to retire the remaining balance of subordinated debt incurred in the purchase of U. S. Technologies Systems, Inc. Interest on all the funded portions of the facility accrues at either a) the London Interbank Offered Rate (which was 3.53% at July 31, 2001) plus a margin, 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 6.75% at July 31, 2001) plus a margin, 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 July 31, 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:
July 31, October 31, 2001 2000 --------------- --------------- (Unaudited) Raw materials $ 1,341,848 $ 1,235,842 Finished goods and spare parts 11,330,808 8,032,695 --------------- --------------- 12,672,656 9,268,537 Less reserve for excess and obsolete inventory (1,557,789) (1,133,475) --------------- --------------- $ 11,114,867 $ 8,135,062 =============== ===============
8 9 (5) PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consist of the following:
July 31, October 31, 2001 2000 --------------- --------------- (Unaudited) Data processing & computer field equipment $ 6,736,547 $ 4,244,213 Building 2,397,954 2,397,954 Land 611,582 611,582 Office furniture 1,084,117 958,385 Autos and trucks 259,345 266,668 Other 630,195 677,137 --------------- --------------- 11,719,740 9,155,939 Less accumulated depreciation (3,030,140) (2,301,088) --------------- --------------- $ 8,689,600 $ 6,854,851 =============== ===============
(6) UNEARNED INCOME Unearned income consists of the following:
July 31, October 31, 2001 2000 --------------- --------------- (Unaudited) Service contracts $ 1,698,270 $ 1,884,155 Warranty service 686,745 1,001,791 Systems shipped, but not installed 175,495 196,766 Customer deposits 317,628 1,309,159 Other deferred revenue 63,198 121,158 --------------- --------------- Total current deferred revenue 2,941,336 4,513,029 Noncurrent unearned service revenues 519,931 1,039,949 --------------- --------------- $ 3,461,267 $ 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:
July 31, October 31, 2001 2000 -------------- -------------- (Unaudited) Deferred tax assets: Nondeductible reserves $ 798,519 $ 1,630,311 Prepaid service contracts 211,162 337,559 Unamortized cost of service contracts 103,480 31,186 Other 85,773 29,224 -------------- -------------- Total deferred tax asset 1,198,934 2,028,280 -------------- -------------- Deferred tax liabilities: Tax income to be recognized on sales-type lease contracts 527,106 603,606 Unamortized capitalized software development costs 157,405 203,305 Other 271,633 211,485 -------------- -------------- Total deferred tax liability 956,144 1,018,396 -------------- -------------- Net deferred tax asset $ 242,790 $ 1,009,884 ============== ==============
(8) RECENTLY ISSUED ACCOUNTING PRINCIPALS In July, 2001, the Financial Accounting Standards Board (FASB) issued Statement No. 141, Business Combinations, Statement No. 142, Goodwill and Other Intangible Assets and Statement No. 143, Accounting for Asset Retirement Obligations. Statement No. 141 requires all business combinations initiated after June 30, 2001, to be accounted for using the purchase method of accounting. Under Statement No. 142, goodwill is no longer subject to amortization over its estimated useful life. Rather, goodwill will be subject to at least an annual assessment for impairment by applying a fair-value-based test. Additionally, an acquired intangible asset should be separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged, regardless of the acquirer's intent to do so. There will be more recognized intangible assets, such as unpatented technology and database content, being separated from goodwill. Those assets will be amortized over their useful lives, other than as assets that have an indefinite life. Statement No. 142 is required to be applied starting with fiscal years beginning after December 15, 2001. Early application is permitted for entities with fiscal years beginning after March 15, 2001, provided that the first interim financial statements have not been previously issued. Management has not determined the timing or impact of adopting Statement No. 142. As of July 31, 2001, the Company has unamortized goodwill in the amount of $26.3 million and had recorded amortization expense of $1.075 million related to goodwill for the nine-months ended July 31, 2001. Statement No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related long-lived asset. Statement No. 143 is effective for fiscal years beginning after June 15, 2002. The Company is currently assessing the impact of Statement No. 143 on its financial condition and results of operations. (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-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 filed on February 8, 2001. Accordingly, reference should be made to those statements for the following: 10 11
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
11 12 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 AND EARNINGS PER SHARE; 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 third quarter, the Company significantly improved its financial performance compared to the second quarter of the year, despite a 7% decline in revenues. Gross margins on total sales increased slightly compared to the first two quarters of fiscal 2001, net income improved 145% over the second quarter, operating expenses were reduced significantly, and cash flows from operations in the third quarter were a positive $5.2M. These improvements were largely the result of management's actions late in the second quarter to rapidly adjust its cost structure to the present revenue run-rates. The actions taken in the second quarter to re-size the cost structure of the Company included a workforce reduction of approximately 90 employees, a salary reduction of 10% to 25% for officers, and a 20% reduction in the fees paid to outside directors. By making these changes and through continued focus on the Company's balance sheet and cash management activities, management was able to significantly increase the Company's profitability and continue its investment in its transformation goals. These goals include: 1) complete the implementation of the Enterprise Resource Planning ("ERP") system, 2) integrate the recently acquired LAN, WAN, UM, Microsoft Exchange and IP consulting capabilities, and 3) redirect the sales and service teams toward faster growing applications and products. To that end, during the third quarter, the Company won contracts and installed systems in several of these high-end application environments including: call centers (CRM), ECLIPs(R) voice-over-IP systems, wireless networks, and multi-service network infrastructure (MSNI) systems. During the fourth quarter, management plans to cautiously add personnel to enhance the Company's capabilities in these areas. The third quarter revenue decline represents the third such quarter-over-quarter decline for the Company and reflects the continuing deterioration of the market for the Company's products. Presently, the visibility into the trend of future revenues continues to be murky and, as a result, management has not forecasted future results other than to say that, if the present level of revenues is maintained, earnings similar to those in the third quarter should be expected. FINANCIAL CONDITION For the first nine months of fiscal 2001, cash flows from operations were $8.3 million, reflecting the Company's emphasis on its cash management activities that began in the fourth quarter of fiscal 2000. Most of these cash flows were achieved through earnings and reductions of receivables. During fiscal 2001, the Company's receivables have been reduced by more than $11 million reflecting changes that have been implemented in the processing and collecting of billings. These efforts have resulted in a reduction in days sales outstanding (DSO) on billed receivables from 106 at July 31, 2000 to 77 at July 31, 2001. During the third quarter of this year, the Company saw a slight deterioration in its DSO's on billed receivables due to a significant cleanup effort at the end of the quarter to bill many systems orders that had been progressing through the installation process. The billing of these orders did not affect revenues as the revenue had been accrued upon shipment in prior months. 12 13 During the first nine months of the year, the Company has made investments of $8 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 July 31, 2001, the Company had total term debt outstanding of $23.7 million. In addition, $925,000 was outstanding on the working capital revolver. Management has maintained open and regular communications with its bank group since the inception of the credit facility in November 1999. These communications have continued throughout the current downturn in the market for the Company's products. Specifically, management of the Company has met regularly with its banks to keep them informed of the Company's response to the market conditions, and the operating results that management expects given various assumptions regarding future 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 obligations provided there is no further erosion in market conditions. 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 19% in the third quarter of fiscal 2001 compared to the third quarter of last year and have decreased 11% in total for the year-to-date period compared to the prior year. This decline is market related and reflects the continued decline in spending on technology by U.S. firms. Despite the declining sales, the Company did receive orders and install systems in its targeted product lines, including CRM and IP-based systems, reflecting increased acceptance of these new productivity-enhancing and cost-reducing technologies. Management expects sales of these advanced products to increase steadily over time, but can give no assurance as to a specific rate of growth in sales. Similarly, visibility into the overall market for the Company's Commercial products remains low and management is unable to predict with any confidence whether the current downturn will continue, stabilize, or recover in the near future. Lodging Systems Sales. Sales of lodging systems decreased 39% in the third quarter compared to last year and decreased 34% for the nine-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 is related to the market conditions. On a sequential basis, sales of lodging systems declined 13% in the third quarter compared to the 53% decline experienced between the first and second quarters of this year, reflecting some stabilization of the market. While no assurance can be given, management believes that based upon its experience in the industry, current order rates, and the current backlog of orders, the revenue run-rates earned in the third quarter can be sustained unless market conditions erode significantly. Installation and Service Revenues. Revenues earned from installation and service related activities ("Service") decreased 11% in the third quarter of fiscal 2001 compared to the prior year, but have increased 13% in the first nine months of fiscal 2001 compared to the period 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 the Commercial market decreased 25% in the third quarter compared to last year, but have increased 18% for the year-to-date period compared to a year ago. The third quarter is directly related to the decline in installation revenues associated with market-driven decline in sales of new systems. Other sources of service revenues earned from Commercial market customers, such as labor charges for moves, additions, and changes, and design services, have increased during fiscal 2001 as a result of management's continued focus on strengthening this segment of the business as a key differentiator in the marketplace driving customer satisfaction and retention. 13 14 Service revenues earned from Lodging related activities including maintenance contracts, installations and cabling projects decreased 7% in the third quarter, but increased 5% for the nine months ending July 31, 2001. The decrease in revenues in the third quarter reflects declining revenues earned from installation of new systems and the related cabling revenues. This decline is directly associated with the market declines in sales of new systems as discussed above. 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. Revenues from this portion of the Company's service offerings have been flat throughout the year, but management is pleased with the type of high-end projects being performed by its consultants and expects this portion of its business to grow once the overall technology market improves. Gross Margins. Gross margins earned on net sales and service revenues during the third quarter were 28% compared to 32% for the third quarter of fiscal 2000. Gross margins earned for the nine-month period ending July 31, 2001 were 27% compared to 30% for the same period a year ago. As a result of the actions taken at the end of the second quarter of this year, the Company was able to reverse the trend of severely declining gross margins earned on service revenues. As a result, gross margins earned on this revenue stream increased to 34% in the third quarter, up from 23% in the second quarter. This improvement was achieved largely through a workforce reduction program. Despite this 11 point improvement in quarter-over-quarter service gross margins, the margins in each major category of revenues has declined in fiscal 2001 compared to the prior year. Management attributes this decline largely to product mix as the downturn in the economy has reduced the number of more profitable, large systems orders, both in the commercial and lodging markets. Operating Expenses. Operating expenses, excluding amortization expenses, were 16% of revenues in the third quarter compared to 19% in the prior year. For the year-to-date periods, operating expenses, excluding amortization, were 17% in the current year compared to 16% in the prior year. The current quarter's results also represent a decrease of 3.6% from the second quarter of this year and additional cost reductions that were undertaken at the end of the second quarter. Most of these reductions were targeted toward sales expenses and were achieved primarily through workforce reductions. The results achieved in the third quarter were in line with management's expectations of 16% to 18% of revenues. Amortization expense was $399,000 for the third 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 $1,210,000 compared to $1,316,000 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 third quarter of the current year is approximately 20% lower than the same period in 2000 reflecting lower interest rates and slightly lower average debt outstanding. For the year-to-date period, interest expense is approximately 8% 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 Systems, 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 percentage of revenues was 4.7% in the third quarter compared to 5.6% in the prior year and was 3.8% for the nine-month period ending July 31, 2001, compared to 6.4% in the prior year. As discussed above, however, substantial improvement was made in profitability from the second quarter (1.8% profit margin) to the third quarter as a result of the adjustments made to the Company's cost structure at the end of the second quarter. The results in the third quarter are in line with management's current expectations for operating margins. 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", 14 15 "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. 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. Since August of 1999, the Company has pursued that vision through a strategy of acquisitions and organic growth. Since that time, the Company has closed four acquisitions and with strategic, organic growth has largely achieved its initial strategies of establishing itself in the Commercial market, creating a nationwide presence in that market, and developing competencies in its high-end application target markets such as Unified Messaging, CRM, LAN/WAN consulting, and data networking. Management believes that the acquisitions made to date provide all of the basic building blocks to achieve its vision. Therefore, future growth is more likely to be driven by organic growth as opposed to additional acquisitions. 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. 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 the Company's future operating results, except that management believes that if future revenues are consistent with those earned in the third quarter, then it is reasonable to expect diluted earnings per share to be within a range of $.08 to $.11. 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 ultimately 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 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. 15 16 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. 16 17 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. The Company continues to monitor the PHONOMETRICS' litigation. 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 Reports on Form 10-Q for the first quarter ended January 31, 2001 filed with the Commission on March 19, 2001. and for the second quarter ended April 30, 2001 filed with the Commission on June 14, 2001. ITEMS 2 - 5 have been omitted because they are 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 no reports on Form 8-K. 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: September 12, 2001 By: /s/ Jack R. Ingram ---------------------------------- Jack R. Ingram Chief Executive Officer Dated: September 12, 2001 By: /s/ Robert B. Wagner ---------------------------------- Robert B. Wagner Chief Financial Officer 17 18 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). 18 19 *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). 19 20 *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). 10.19 Second Amendment to Credit Agreement dated June 8, 2001 among XETA Technologies, Inc., the Lenders, the Agent and the Arranger (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 20