10-Q 1 microtel_10q.txt U. S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) |X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended JUNE 30, 2001 | | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ______________ to ______________ Commission File Number 1-10346 MICROTEL INTERNATIONAL, INC. (Exact Name of Registrant as Specified in Its Charter) DELAWARE 77-0226211 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 9485 HAVEN AVENUE, SUITE 100 RANCHO CUCAMONGA, CALIFORNIA 91730 (Address of Principal Executive Offices) (909) 987-9220 (Issuer's Telephone Number, Including Area Code) NOT APPLICABLE (Former Name, Former Address And Former Fiscal Year, if Changed Since Last Report) Indicated by check whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No | | As of August 10, 2001, there were 20,570,703 shares of the issuer's common stock, $.0033 par value, outstanding. ================================================================================
ITEM 1. FINANCIAL STATEMENTS. Consolidated Condensed Balance Sheets as of June 30, 2001 (unaudited) and December 31, 2000................................................................. 2 Consolidated Condensed Statements of Operations and Comprehensive Income for the three and six months ended June 30, 2001 and 2000 (unaudited)......................... 3 Consolidated Condensed Statements of Cash Flows for the six months ended June 30, 2001 and 2000 (unaudited).................................................... 4 Notes to Consolidated Condensed Financial Statements (unaudited)......................... 5 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................................................. 9 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.......................................................................... 24 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS.................................................................... 25 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS............................................ 25 ITEM 3. DEFAULTS UPON SENIOR SECURITIES...................................................... 25 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................................. 25 ITEM 5. OTHER INFORMATION.................................................................... 26 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K..................................................... 26 SIGNATURES .................................................................................. 27
1 ITEM 1. FINANCIAL STATEMENTS. MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) June 30, December 31, 2001 2000 --------- --------- ASSETS (unaudited) Cash and cash equivalents $ 532 $ 756 Accounts receivable - net 7,327 7,440 Notes receivable 80 130 Inventories 6,931 6,298 Other current assets 604 750 --------- --------- Total current assets 15,474 15,374 Property, plant and equipment-net 728 809 Goodwill-net 2,622 2,737 Other assets 490 564 --------- --------- $ 19,314 $ 19,484 ========= ========= LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY Notes payable $ 3,196 $ 3,661 Current portion of long-term debt 658 614 Accounts payable 5,136 5,222 Accrued expenses 3,196 3,082 Net liability of discontinued operations -- 15 --------- --------- Total current liabilities 12,186 12,594 Long-term debt, less current portion 805 282 Other liabilities 413 542 --------- --------- Total liabilities 13,404 13,418 Convertible redeemable preferred stock, $10,000 unit value. Authorized 200 shares; issued and outstanding 25 shares (aggregate liquidation preference of $250) 264 259 Stockholders' equity: Convertible Series B Preferred stock, $0.01 par value. Authorized 10,000,000 shares; 150,000 shares issued and outstanding (aggregate liquidation preference of $960) 938 938 Common stock, $.0033 par value. Authorized 50,000,000 shares; 20,570,000 shares issued and outstanding 68 68 Additional paid-in capital 24,317 24,307 Accumulated deficit (18,620) (18,775) Accumulated other comprehensive loss (1,057) (731) --------- --------- Total stockholders' equity 5,646 5,807 --------- --------- $ 19,314 $ 19,484 ========= ========= See accompanying notes to consolidated condensed financial statements. 2 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (UNAUDITED)
Three months ended Six months ended June 30, June 30, --------------------- --------------------- 2001 2000 2001 2000 --------- --------- --------- --------- (in thousands, except per share amounts) Net sales $ 7,083 6,828 $ 14,548 $ 12,688 Cost of sales 3,732 4,032 8,082 7,566 --------- --------- --------- --------- Gross profit 3,351 2,796 6,466 5,122 Operating expenses: Selling, general and administrative 2,905 2,248 5,486 4,395 Engineering and product development 303 253 662 496 --------- --------- --------- --------- Income (loss) from operations 143 295 318 231 Other income (expense): Interest expense (105) (98) (198) (195) Other income 22 108 50 205 --------- --------- --------- --------- Income from continuing operations before income taxes 60 305 170 241 Income tax expense 6 4 9 11 --------- --------- --------- --------- Income from continuing operations 54 301 161 230 --------- --------- --------- --------- Discontinued operations: Loss from operations of discontinued segment -- (95) -- (151) --------- --------- --------- --------- Net income 54 206 161 79 --------- --------- --------- --------- Other comprehensive loss: Changes in unrealized gain in marketable securities -- (383) -- 78 Foreign currency translation adjustment (104) (53) (326) (218) --------- --------- --------- --------- Total comprehensive loss $ (50) $ (230) $ (165) $ (61) ========= ========= ========= ========= Earnings (loss) per share: Continuing operations: Basic $ 0.00 $ 0.02 $ 0.01 $ 0.01 ========= ========= ========= ========= Diluted $ 0.00 $ 0.02 $ 0.01 $ 0.01 ========= ========= ========= ========= Discontinued operations: Basic $ -- $ (0.01) $ -- $ (0.01) ========= ========= ========= ========= Diluted $ -- $ (0.01) $ -- $ (0.01) ========= ========= ========= ========= Net income: Basic $ 0.00 $ 0.01 $ 0.01 $ 0.00 ========= ========= ========= ========= Diluted $ 0.00 $ 0.01 $ 0.01 $ 0.00 ========= ========= ========= =========
See accompanying notes to consolidated condensed financial statements. 3 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six months ended June 30, ------------------- 2001 2000 -------- -------- (in thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 161 $ 79 Adjustments to reconcile net income (loss) to cash provided by operating activities: Depreciation and amortization 168 206 Amortization of intangibles 195 130 Stock and warrants issued as compensation 10 110 Gain on sale of fixed assets -- (43) Other noncash items -- 221 Net change in operating assets of discontinued operations Changes in operating assets and liabilities: Accounts receivable 121 987 Inventories (591) (19) Other assets 219 (185) Accounts payable and accrued expenses (118) (2,245) -------- -------- Cash provided by (used in) operating activities 165 (759) -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from note receivable 50 -- Net purchases of property, plant and equipment (123) (9) Cash received for sale of DTS stock -- 520 Proceeds from sale of fixed assets -- 43 Investment in Belix Ltd. companies -- (592) -------- -------- Cash used in investing activities (73) (38) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in notes payable and long-term debt 102 852 Proceeds from exercise of employee stock options -- 73 -------- -------- Cash provided by financing activities 102 925 -------- -------- Effect Of Exchange Rate Changes (418) (218) -------- -------- Net Decrease In Cash and Cash Equivalents (224) (90) -------- -------- Cash and Cash Equivalents At Beginning Of Period 756 481 -------- -------- Cash and Cash Equivalents At End Of Period $ 532 $ 391 ======== ======== Cash paid for: Income taxes 34 11 ======== ======== Interest 186 219 ======== ======== See accompanying notes to consolidated condensed financial statements.
4 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND BUSINESS MicroTel International, Inc. (the "Company") operates through three wholly-owned subsidiaries: CXR Telcom Corporation, CXR, S.A. and XET Corporation, formerly XIT Corporation ("XET"). CXR Telcom Corporation and CXR, S.A. (collectively "CXR") design, manufacture and market electronic telecommunication test equipment and transmission and network access products. XET and its subsidiaries design, manufacture and market digital switches and power supplies. The Company conducts its operations out of various facilities in the U.S., France, England and Japan and organizes itself in two product line segments: telecommunications and electronic components. In October 2000, the Company decided to discontinue its circuits segment operations. At that time, the circuits segment operations consisted of XCEL Etch Tek, a wholly-owned subsidiary, and XCEL Circuits Division ("XCD"), a division of XET. XCEL Etch Tek was offered for sale and sold in November 2000. XCD, predominantly a captive supplier of printed circuit boards to the electronic components segment, has been retained and is now included in the electronic components segment. Accordingly, all prior financial information related to the circuits segment operations has been presented as discontinued operations in the accompanying consolidated condensed financial statements. BASIS OF PRESENTATION The accompanying unaudited consolidated condensed financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission and therefore do not include all information and footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with generally accepted accounting principles. The unaudited consolidated condensed financial statements do, however, reflect all adjustments, consisting of only normal recurring adjustments, which are, in the opinion of management, necessary to state fairly the financial position as of June 30, 2001 and December 31, 2000 and the results of operations and cash flows for the related interim periods ended June 30, 2001 and 2000. However, these results are not necessarily indicative of results for any other interim period or for the year. It is suggested that the accompanying consolidated condensed financial statements be read in conjunction with the Company's Consolidated Financial Statements included in Amendment No. 2 to its 2000 Annual Report on Form 10-K. 5 (2) EARNINGS PER SHARE The following table illustrates the computation of basic and diluted earnings per share (in thousands, except per share amounts):
Three months ended Six months ended June 30, June 30, ------------------ ------------------ 2001 2000 2001 2000 -------- -------- -------- -------- (in thousands, except per share amounts) NUMERATOR: Net income $ 54 $ 206 $ 161 $ 79 Less: accretion of the excess of the redemption value over the carrying value of redeemable preferred stock 3 23 6 46 -------- -------- -------- -------- Income attributable to common stockholders $ 51 $ 183 $ 155 $ 33 ======== ======== ======== ======== DENOMINATOR: Weighted average number of common shares outstanding during the period 20,570 18,712 20,570 18,443 Incremental shares from assumed conversions of warrants, options and preferred stock 3,309 2,076 3,277 2,250 -------- -------- -------- -------- Adjusted weighted average shares 23,879 20,788 23,847 20,693 ======== ======== ======== ======== Basic and diluted earnings per share $ 0.00 $ 0.01 $ 0.01 $ 0.00 ======== ======== ======== ========
(3) INVENTORIES Inventories consist of the following. June 30, 2001 December 31, 2000 ---------- ---------- Raw materials $3,130,000 $2,777,000 Work-in-process 2,457,000 1,914,000 Finished goods 1,344,000 1,607,000 ---------- ---------- $6,931,000 $6,298,000 ========== ========== (4) COMMITMENTS AND CONTINGENCIES The Company and its subsidiaries from time to time become involved in legal proceedings, claims and litigation arising in the ordinary course of business. While the amounts claimed may be substantial, the ultimate liability may not be predictable because of considerable uncertainties that may exist. Therefore, it is possible the outcome of such legal proceedings, claims and litigation could have a material effect on quarterly or annual operating results or cash flows when resolved in a future period. However, based on facts currently available, management believes such matters will not have a material adverse affect on the Company's consolidated financial position, results of operations or cash flows. 6 (5) REPORTABLE SEGMENTS The Company has two reportable segments: telecommunications and electronic components. The telecommunications segment operates principally in the U.S. and European markets and designs, manufactures and distributes telecommunications test instruments and voice and data transmission and networking equipment. The electronic components segment operates in the U.S., European and Asian markets and designs, manufactures and markets primarily digital switches and power supplies. The Company evaluates performance based upon profit or loss from operations before income taxes exclusive of nonrecurring gains and losses. The Company accounts for intersegment sales at prices negotiated between the individual segments. The Company's reportable segments are comprised of operating entities offering the same or similar products to similar customers. Each segment is managed separately because each business has different customers, design, manufacturing and marketing strategies. There were no differences in the basis of segmentation or in the basis of measurement of segment profit or loss from the amounts disclosed in the Company's consolidated financial statements included in Amendment No. 2 to its 2000 Annual Report on Form 10-K. Selected financial data for each of the Company's operating segments is shown below: Six months Six months ended June 30, ended June 30, 2001 2000 ------------ ------------ Sales to external customers: Telecommunications $ 7,968,000 $ 7,193,000 Electronic Components 6,580,000 5,495,000 ------------ ------------ $ 14,548,000 $ 12,688,000 ============ ============ Intersegment sales: Telecommunications $ -- $ -- Electronic Components -- -- ------------ ------------ $ -- $ -- ============ ============ Segment pretax profits: Telecommunications $ 107,000 $ 46,000 Electronic Components 1,613,000 1,095,000 ------------ ----------- $ 1,720,000 $ 1,141,000 ============ =========== June 30, December 31, 2001 2000 ------------ ------------ Segment assets: Telecommunications $ 8,725,000 $ 9,901,000 Electronic Components 9,811,000 8,876,000 ------------ ------------ $ 18,536,000 $ 18,777,000 ============ ============ 7 The following is a reconciliation of the reportable segment income and (loss) from continuing operations and assets to the Company's consolidated totals: Six months ended Six months ended June 30, 2001 June 30, 2000 ------------ ------------ Pretax income Total income for reportable segments $ 1,720,000 $ 1,141,000 Unallocated amounts: Unallocated general corporate expenses (1,550,000) (900,000) ------------ ------------ Consolidated income before income taxes $ 170,000 $ 241,000 ============ ============ June 30, December 31, 2001 2000 ------------ ------------ Assets Total assets for reportable segments $18,536,000 $18,777,000 Other assets 778,000 707,000 ------------ ------------ Total consolidated assets $19,314,000 $19,484,000 ============ ============ (6) NEW ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations," which eliminates the pooling method of accounting for business combinations initiated after June 30, 2001. In addition, SFAS 141 addresses the accounting for intangible assets and goodwill acquired in a business combination. This portion of SFAS 141 is effective for business combinations completed after June 30, 2001. The Company does not expect SFAS 141 to have a material impact on the Company's financial position or results of operations. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Intangible Assets," which revises the accounting for purchased goodwill and intangible assets. Under SFAS 142, goodwill and intangible assets with indefinite lives will no longer be amortized and will be tested for impairment annually. SFAS 142 is effective for fiscal years beginning after December 15, 2001, with earlier adoption permitted. The Company does not expect SFAS 142 to have a material impact on the Company's financial position or results of operations. 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion and analysis should be read in conjunction with our consolidated condensed financial statements and notes to financial statements included elsewhere in this report. This report and our consolidated condensed financial statements and notes to financial statements contain forward-looking statements, which generally include the plans and objectives of management for future operations, including plans and objectives relating to our future economic performance and our current beliefs regarding revenues we might earn if we are successful in implementing our business strategies. The forward-looking statements and associated risks may include, relate to or be qualified by other important factors, including, without limitation: o the projected growth in the telecommunications and electronic components markets; o our business strategy for expanding our presence in these markets; o anticipated trends in our financial condition and results of operations; and o our ability to distinguish ourselves from our current and future competitors. We do not undertake to update, revise or correct any forward-looking statements. The information contained in this report is not a complete description of our business or the risks associated with an investment in our common stock. Before deciding to buy or maintain a position in our common stock, you should carefully review and consider the various disclosures we made in this report, and in our other materials filed with the Securities and Exchange Commission that discuss our business in greater detail and that disclose various risks, uncertainties and other factors that may affect our business, results of operations or financial condition. Any of the factors described above or in the "Risk Factors" section below could cause our financial results, including our net income (loss) or growth in net income (loss) to differ materially from prior results, which in turn could, among other things, cause the price of our common stock to fluctuate substantially. OVERVIEW We previously organized our operations in three business segments: o Instrumentation and Test Equipment; o Components and Subsystem Assemblies; and o Circuits. In an effort to focus our attention and working capital on our telecommunications test instruments and our transmission and network access products, we sold substantially all of the assets of XCEL Arnold Circuits, Inc. in April 1998 and sold substantially all of the assets of HyComp, Inc., a manufacturer of hybrid circuits, in April 1999. In October 2000, we decided to discontinue our circuits segment. On November 28, 2000, we sold XCEL Etch Tek, which was our only remaining material circuit board business and was a division of our wholly-owned subsidiary, XET Corporation (formerly XIT Corporation). We intend to retain our small Monrovia, California circuit board manufacturing facility as a captive supplier of circuit boards to XET Corporation's Digitran Division. 9 Effective August 1, 2000, we acquired the assets and business operations of T-Com, LLC, or T-Com, a telecommunications test instruments manufacturer located in Sunnyvale, California. T-Com produced central office equipment, which is equipment that is typically employed in switching and network operating centers. Through our three direct wholly-owned operating subsidiaries, XET Corporation, CXR Telcom Corporation and CXR, S.A., and through the divisions and subsidiaries of our subsidiaries, we presently design, manufacture, assemble, and market products and services in the following two material business segments: o Telecommunications -- Telecommunications Test Instruments (analog and digital test instruments used in the installation, maintenance, management and optimization of public and private communication networks) -- Transmission and Network Access Products (range of products for accessing public and private networks for the transmission of data, voice and video) o Electronic Components (digital switches and electronic power supplies) Our sales are primarily in North America, Europe and Asia. In the first two quarters of 2001, approximately 55% of our sales were to customers in the telecommunications industry, and the remainder of our sales were to industrial, aerospace and military contractor customers. Revenues are recorded when products are shipped if shipped FOB shipping point or when received by the customer if shipped FOB destination. 10 RESULTS OF OPERATIONS THREE MONTHS ENDED JUNE 30, 2001 COMPARED TO THREE MONTHS ENDED JUNE 30, 2000 The following table sets forth, for the periods indicated, certain statement of operations data expressed as a percentage of total net sales:
THREE MONTHS ENDED JUNE 30, -------------------- 2001 2000 ---- ---- Net sales............................................. 100.0% 100.0% Cost of sales......................................... 52.7 59.1 ------ ------ Gross profit.......................................... 47.3 40.9 Selling, general and administrative expenses.......... 41.0 32.9 Engineering and product development expenses.......... 4.3 3.7 ------ ------ Operating income ..................................... 2.0 4.3 Interest expense...................................... (1.5) (1.4) Other expense......................................... 0.3 1.6 ------ ------ Income from continuing operations before income taxes. 0.8 4.5 Income taxes.......................................... 0.0 0.1 ------ ------ Income from continuing operations..................... 0.8 4.4 Loss from discontinued operations..................... 0.0 (1.4) ------ ------- Net income ........................................... 0.8% 3.0% ====== ======
CONTINUING OPERATIONS NET SALES. Net sales for the three months ended June 30, 2001 increased by $255,000 (3.7%) to $7,083,000, as compared to $6,828,000 for the three months ended June 30, 2000. Net sales of our telecommunications products for the three months ended June 30, 2001 increased by $556,000 (15.3%) to $4,196,000, as compared to $3,640,000 for the comparable period in 2000. Net sales of our U.S.-based telecom operation of CXR Telcom for the three months ended June 30, 2001 increased by $886,000 (63.7%) to $2,277,000, as compared to $1,391,000 for the comparable period in 2000. This increase was partially due to the addition of $384,000 of net sales of T-Com, LLC products and an increase in sales of our CXR HALCYON test equipment. CXR Telcom sales excluding sales of T-Com, LLC products increased by 36.0% in the current quarter as compared to the quarter ended June 30, 2000. Net sales of our French subsidiary, CXR, S.A., for the three months ended June 30, 2001 decreased by $330,000 (14.7%) to $1,918,000, as compared to $2,248,000 for the comparable prior year period. This decrease would have been 5% if not for the decline in the value of the French Franc in relation to the value of the U.S. dollar in the quarter ended June 30, 2001 as compared to their relative values for the quarter ended June 30, 2000. The majority of the decline in sales of CXR, S.A. is due to the closure of the Networking Division, which had sales of $327,000 in the three months ended June 30, 2000. Transmission sales in Europe increased $341,000 in the current quarter as compared to the quarter ended June 30, 2000, which increase was offset with a $343,000 decline in the resale of original equipment manufactured instruments in Europe. 11 Net sales of electronic components for the three months ended June 30, 2001 decreased by $301,000 (9.4%) to $2,887,000, as compared to $3,188,000 for the comparable period in 2000. The decrease was primarily due to a decline in sales of power supplies of our U.K. subsidiary, XCEL Corporation, Ltd., or XCL, as measured in U.S. dollars. The volume of sales was only down 2.9% as measured in XCL's functional currency, the British pound sterling, but because the British pound sterling has declined against the value of the U.S. dollar, the sales volume of XCL in the U.K. declined by $218,000 (14.6%) to $1,274,000 for the quarter ended June 30, 2001, as compared to $1,492,000 in the quarter ended June 30, 2000. GROSS PROFIT. Gross profit as a percentage of total net sales increased to 47.3% for the three months ended June 30, 2001, as compared to 40.9% for the comparable period in 2000. In dollar terms, total gross profit increased by $555,000 (19.8%) to $3,351,000 for the three months ended June 30, 2001, as compared to $2,796,000 for the comparable period in 2000. Gross profit for our telecommunications segment increased in dollar terms by $598,000 (40.2%) to $2,088,000 for the three months ended June 30, 2001, as compared to $1,490,000 for the comparable period in 2000, and increased as a percentage of net sales from 40.9% in 2000 to 49.8% in 2001. The increase in gross profit as a percentage of net sales was due primarily to the increased sales volume of the CXR HALCYON test instruments, which reduced per unit costs. Gross profit for our electronic components segment decreased in dollar terms by $45,000 (3.4%) to $1,261,000 for the three months ended June 30, 2001, as compared to $1,306,000 for the comparable period in 2000, and increased as a percentage of related net sales from 41.0% in 2000 to 43.7% in 2001. This percentage increase was primarily the result of improved gross margins at XCL in the U.K. as a result of an increase in sales of custom military power supplies, or PSUs, in relation to the PSUs sold in the commercial market. For the quarter ended June 30, 2001, custom PSU sales increased to 69.06% of the total PSUs sold, as compared to 39.6% in the three month period ended June 30, 2000. The custom military PSUs carry higher margins than the commercial PSUs. Also, the costs of integrating the acquisition of the Belix Ltd. companies reduced the gross margin in the prior year period. As a result of these matters, XCL's gross margin improved from 15.4% of net sales in the second quarter of 2000 to 32.5% of net sales in the current three-month period. The improvement in XCL's gross margins was partially offset with a decline in gross margins of digital switch products manufactured in Rancho Cucamonga, California at our XET Corporation subsidiary. These gross margins fell from 66.5% of net sales for the prior year period to 53.7% of net sales for the three-month period ended June 30, 2001. This reduction was primarily due to the lower volume caused by the completion of the BAE Systems, Canada contract during the first quarter of 2001. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased by $657,000 (29.2%) to $2,905,000 for the three-month period ended June 30, 2001, as compared to $2,248,000 for the comparable period in 2000. This increase was primarily due to increases of $307,000 in legal and accounting fees, $161,000 of compensation expenses and $171,000 of administrative expenses at CXR Telcom due to the initial consolidation of the business acquired with the acquisition of T-Com, LLC. These increases were partially offset with a reduction in administrative costs of $208,000 at XPS due to the completion of the integration of the Belix Ltd. companies that were acquired in April 2000. The legal and accounting fees in the three-month period ended June 30, 2001 include $312,000 incurred in connection with non-routine Securities and Exchange Commission filings. ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product development expenses consist primarily of research and product development activities of our telecommunications segment. These expenses increased by $50,000 (19.8%) to $303,000 for the three months ended June 30, 2001, as compared to $253,000 for the comparable prior year period. The increase primarily was due to the addition of engineering staff and related costs at CXR Telcom. 12 OTHER INCOME AND EXPENSE. Interest expense increased slightly to $105,000 for the three months ended June 30, 2001, from $98,000 in the comparable period in 2000. Other income of $22,000 in the second quarter of 2001 declined from $108,000 in the second quarter of 2000 primarily due to a $137,000 reduction in a warranty reserve in the second quarter of 2000. DISCONTINUED OPERATIONS As a result of our decision to discontinue our last remaining material circuits subsidiary in October 2000, our circuits segment has been accounted for as discontinued operations. We reported a net loss from discontinued operations of $95,000 for the three months ended June 30, 2000. Net sales, gross profit and selling, general and administrative expenses for our circuits business for the three months ended June 30, 2000 were $683,000, $17,000 and $57,000, respectively. SIX MONTHS ENDED JUNE 30, 2001 COMPARED TO SIX MONTHS ENDED JUNE 30, 2000 The following table sets forth, for the periods indicated, certain statement of operations data expressed as a percentage of total net sales:
SIX MONTHS ENDED JUNE 30, -------------------- 2001 2000 ---- ---- Net sales............................................. 100.0% 100.0% Cost of sales......................................... 55.6 59.6 ------ ------ Gross profit.......................................... 44.4 40.4 Selling, general and administrative expenses.......... 37.7 34.6 Engineering and product development expenses.......... 4.5 4.0 ------ ------ Operating income...................................... 2.2 1.8 Interest expense...................................... (1.4) (1.5) Other income......................................... 0.4 1.6 ------ ------ Income from continuing operations before income taxes. 1.2 1.9 Income taxes.......................................... 0.1 0.1 ------ ------ Income from continuing operations..................... 1.1 1.8 Loss from discontinued operations..................... 0.0 (1.2) ------ ------ Net income............................................ 1.1% 0.6% ====== =====
CONTINUING OPERATIONS NET SALES. Net sales for the six months ended June 30, 2001 increased by $1,860,000 (14.7%) to $14,548,000, as compared to $12,688,000 for the six months ended June 30, 2000. Net sales of our telecommunications products for the six months ended June 30, 2001 increased by $775,000 (10.8%) to $7,968,000, as compared to $7,193,000 for the comparable period in 2000. Net sales of our U.S.-based telecom operation of CXR Telcom for the six months ended June 30, 2001 increased by $1,033,000 (38.1%) to $3,741,000, as compared to $2,708,000 for the comparable period in 2000. This increase was mainly due to the addition of $815,000 of net sales of T-Com products that were acquired effective August 2000 with the acquisition of T-Com, LLC. Excluding sales of T-Com, LLC products, CXR Telcom sales increased by 8.0% in the first half of 2001 as compared to the comparable prior year period. Net sales of our transmission and original equipment manufactured test instruments by our French subsidiary, CXR, S.A., for the six months ended June 30, 2001 decreased by $258,000 (5.8%) to $4,227,000, 13 as compared to $4,485,000 for the comparable prior year period. This decrease would have been 4.3% if not for the decline in the value of the French Franc in relation to the value of the U.S. dollar in the six months ended June 30, 2001 as compared to their relative values for the six months ended June 30, 2000. The major reason for the decrease in sales of CXR, S.A. was the closure of the Networking Division, which had sales of $699,000 in the first six months of 2000 and negligible sales in the first six months of 2001. This decrease more than offset sales increases of transmission products and telecommunications test instruments, which increased by $455,000 (12.1%) in the first six months of 2001 to $4,202,000, as compared to $3,747,000 in the first six months of 2000. Net sales of our electronic components for the six months ended June 30, 2001 increased by $1,085,000 (19.7%) to $6,580,000, as compared to $5,495,000 for the comparable period in 2000, primarily due to a $655,000 increase in sales of XCL. This increase in net sales was primarily due to an increase in deliveries of outstanding contracts. Also contributing to the increase in sales of our electronic components segment was XET Corporation's Digitran Division in Rancho Cucamonga, California, which increased its sales in the six months ended June 30, 2001 by $411,000 (16.0%) to $2,985,000, as compared to $2,574,000 for the comparable prior year period. This increase was mainly due to shipments of digital switches under its contract with BAE Systems, Canada. Although shipments under this contract ended during the first quarter of 2001, we anticipate that higher revenues from our power conversion products will offset the reduction in sales caused by the completion of our contract with BAE Systems, Canada. GROSS PROFIT. Gross profit as a percentage of total net sales increased to 44.4% for the six months ended June 30, 2001, as compared to 40.4% for the comparable period in 2000. In dollar terms, total gross profit increased by $1,344,000 (26.2%) to $6,466,000 for the six months ended June 30, 2001, as compared to $5,122,000 for the comparable period in 2000. Gross profit for our telecommunications segment increased in dollar terms by $636,000 (22.3%) to $3,477,000 for the six months ended June 30, 2001, as compared to $2,841,000 for the comparable period in 2000, and increased as a percentage of net sales from 39.5% in 2000 to 43.6% in 2001. The increase in gross profit as a percentage of net sales was due primarily to the increased volume and efficiencies at CXR Telcom in Fremont, California and sales of higher margin products at CXR, S.A. in France. Gross profit for our electronic components segment increased in dollar terms by $708,000 (31.0%) to $2,989,000 for the six months ended June 30, 2001, as compared to $2,281,000 for the comparable period in 2000, and increased as a percentage of related net sales from 41.5% in 2000 to 45.4% in 2001. This increase was primarily the result of improved profit margins in connection with higher production volumes and a higher margin product mix at XCL in the U.K., which contributed $461,000 of the increase in gross profit. XIT's Digitran Division contributed $260,000 to the increase in gross profit primarily due to sales of higher margin products sold under the BAE Systems, Canada contract. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased by $1,091,000 (24.8%) to $5,486,000 for the six-month period ended June 30, 2001, as compared to $4,395,000 for the comparable period in 2000. The increase was due to increases of $460,000 in legal and accounting fees, $325,000 of compensation expenses and $330,000 of administrative expenses at CXR Telcom due to the consolidation of the business acquired with the acquisition of T-Com, LLC. This increase was partially offset with a reduction in administrative costs of $165,000 at XCL due to the completion of the integration of the Belix Ltd. companies that were acquired in April 2000. The legal and accounting fees in the first half of 2001 include $452,000 incurred in connection with non-routine Securities and Exchange Commission filings. 14 ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES. Engineering and product development expenses consist primarily of research and product development activities of our telecommunications segment. These expenses increased by $166,000 (33.5%) to $662,000 for the six months ended June 30, 2001, as compared to $496,000 for the comparable prior year period, reflecting new product development activities. This increase primarily was due to the addition of engineering staff. OTHER INCOME AND EXPENSE. Interest expense increased slightly to $198,000 for the six months ended June 30, 2001 from $195,000 in the comparable period in 2000. Other income of $50,000 in the first half of 2001 declined from $205,000 in the first half of 2000 primarily due to a $137,000 reduction in a warranty reserve in the second quarter of 2000. DISCONTINUED OPERATIONS As a result of our decision to discontinue our last remaining material circuits subsidiary in October 2000, our circuits segment has been accounted for as discontinued operations. We reported a net loss from discontinued operations of $151,000 for the six months ended June 30, 2000. Net sales, gross profit and selling, general and administrative expenses for our circuits business for the six months ended June 30, 2000 were $1,310,000, $64,000 and $215,000, respectively. LIQUIDITY AND CAPITAL RESOURCES During the six months ended June 30, 2001, we funded our operations primarily through revenue generated from our operations and through our line of credit with Wells Fargo Business Credit, Inc. During the latter part of 1999, we embarked on a cost reduction program in an effort to improve our cash flow position and profitability. This program included a significant reduction in personnel, the downsizing and relocation of our corporate headquarters and the sale of investments we had in other companies. As described below, these cost measures, together with our line of credit, have had a positive impact on MicroTel. As of December 31, 2000, we had working capital of $2,780,000 and an accumulated deficit of $18,775,000. As of that date, we had $756,000 in cash and cash equivalents and $7,440,000 of accounts receivable. As of June 30, 2001, we had working capital of $3,288,000, an accumulated deficit of $18,620,000 and an accumulated other comprehensive loss of $1,057,000. As of that date, we had $532,000 in cash and cash equivalents and $7,327,000 of accounts receivable. Cash provided by our operating activities totaled $165,000 for the six months ended June 30, 2001. Cash used by operations for the six months ended June 30, 2000 was $759,000. This increase in cash provided by operations during the six months ended June 30, 2001 resulted primarily from increased profitability in operations and a reduction in the pay down of accounts payable, partially offset by the reduction of cash collected from accounts receivable and the purchase of additional inventories. Cash used in our investing activities totaled $73,000 for the six months ended June 30, 2001 as compared to cash used in investing activities of $38,000 for the six months ended June 30, 2000. Included in the 2000 results is $520,000 from the sale of shares of common stock we held in Digital Transmission Systems, Inc. and a usage of $592,000 for the purchase of the Belix Ltd. companies in the U.K. 15 Cash provided by financing activities totaled $102,000 for the six months ended June 30, 2001, as compared to cash provided by financing activities of $925,000 for the six months ended June 30, 2000, primarily due to the increase in notes payable and long-term debt that was mainly incurred due to the acquisition of the Belix Ltd. companies in April 2000. On June 23, 2000, our credit facility with our previous lender, Congress Financial Corporation, or Congress Financial, expired while we were out of compliance with the adjusted net worth covenant of this facility. Congress Financial extended this facility through August 14, 2000. On August 16, 2000, our subsidiaries, CXR Telcom and XET Corporation, together with MicroTel acting as guarantor, obtained a credit facility from Wells Fargo Business Credit, Inc. This facility provides for a revolving loan of up to $3,000,000 secured by our inventory and accounts receivable and a term loan in the amount of $687,000 secured by our machinery and equipment. As a condition of extending this credit facility to our subsidiaries, Wells Fargo Business Credit, Inc. required our President and Chief Executive Officer, Carmine Oliva, to personally guaranty a portion of our indebtedness under the facility. On January 26, 2001, Mr. Oliva was released from this guaranty. The initial annual interest rate on both portions of the credit facility was the prime rate plus 2%. The facility contains a performance-based interest reduction feature. Based upon our 2000 financial performance, we obtained a reduction in the interest rate to the prime rate plus 1% effective April 1, 2001. The balance outstanding under this credit facility was $1,753,000 on June 30, 2001. There was $361,000 of additional borrowings available as of June 30, 2001. The credit facility expires on August 16, 2003. Our foreign subsidiaries have obtained credit facilities with Lloyds Bank in England, Banc National du Paris, Societe General and Banque Hervet in France and Johan Tokyo Credit Bank in Japan. The balances outstanding under our U.K. and France credit facilities were $1,236,000 and $508,000, respectively, on June 30, 2001. During the quarter ended June 30, 3001, our U.K. subsidiary converted $705,000 of its credit facility to a five-year term loan with a variable interest rate of the bank's base rate plus 2.5% and monthly payments of principal plus interest. We believe that current and future available capital resources, revenues generated from operations, and other existing sources of liquidity, including our credit facility with Wells Fargo Business Credit, Inc., will be adequate to meet our anticipated working capital and capital expenditure requirements for at least the next twelve months. If, however, our capital requirements or cash flow vary materially from our current projections or if unforeseen circumstances occur, we may require additional financing. Failure to raise such necessary capital could restrict our growth, limit our development of new products or hinder our ability to compete. LEGAL PROCEEDINGS There are no material legal proceedings pending against us (see Note 4 to the Consolidated Condensed Financial Statements included elsewhere in this report). EFFECTS OF INFLATION The impact of inflation and changing prices has not been significant on the financial condition or results of operations of either us or our operating subsidiaries. NEW ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards No. 141, or SFAS 141, "Business Combinations," which eliminates the pooling method of accounting for business combinations initiated after June 30, 2001. In addition, SFAS 141 addresses the accounting for intangible assets and goodwill acquired in a business combination. This portion of SFAS 141 is effective for business combinations completed after June 30, 2001. We do not expect SFAS 141 to have a material impact on our financial position or results of operations. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142, or SFAS 142, "Goodwill and Intangible Assets," which revises the accounting for purchased goodwill and intangible assets. Under SFAS 142, goodwill and intangible assets with indefinite lives will no longer be amortized and will be tested for impairment annually. SFAS 142 is effective for fiscal years beginning after December 15, 2001, with earlier adoption permitted. We do not expect SFAS 142 to have a material impact on our financial position or results of operations. 16 EURO CONVERSION Our operating subsidiaries located in France and the United Kingdom have combined net sales from operations approximating 50% of our total net sales for the six months ended June 30, 2001. Net sales from the French subsidiary participating in the Euro conversion were 29% of our net sales for the six months ended June 30, 2001. We continue to review the impact of the Euro conversion on our operations. In 1998, our European operations took steps to ensure their capability of entering into Euro transactions as of January 1, 1999. No material changes to information technology and other systems were necessary to accommodate these transactions because such systems already were capable of using multiple currencies. While it is difficult to assess the competitive impact of the Euro conversion on our European operations, at this time we do not foresee any material impediments to our ability to compete for orders from customers requesting pricing using the new exchange rate. Since we have no significant direct sales between our United States and European operations, we regard exchange rate as nominal. RISK FACTORS An investment in our common stock involves a high degree of risk. You should consider, among other things, the following factors carefully before deciding to purchase or hold any shares of our common stock. WE HAVE A HISTORY OF LOSSES AND AN ACCUMULATED DEFICIT THAT MAY CONTINUE IN THE FUTURE AND THAT MAY ADVERSELY IMPACT OUR BUSINESS AND OUR STOCKHOLDERS. We incurred significant net operating losses in each of the years ended December 31, 1999 and 1998 and incurred a net operating profit in the year ended December 31, 2000 and the six months ended June 30, 2001. We realized a net loss of approximately $4.6 million for the twelve months ended December 31, 1999, as compared to incurring a net loss of approximately $1.2 million for the twelve months ended December 31, 1998. For the twelve months ended December 31, 2000, we recorded net income of $1.0 million. For the six months ended June 30, 2001, we recorded net income of $161,000. Our accumulated deficit and accumulated other comprehensive loss through June 30, 2001 were approximately $18,620,000 and $1,057,000, respectively, and as of that date we had a total stockholders' equity of approximately $5,646,000. Although we recently reported profitable operations, there is no assurance that we will continue to maintain profitable operations in the future. If we are unable to do so, there may be a material adverse effect on our cash flows, which could cause us to violate covenants under our credit facility and could impede our ability to raise capital through debt or equity financing to the extent we may need it for our continued operations or for planned expansion. Consequently, future losses may have a material adverse effect on our business, prospects, financial condition, results of operations and cash flows. FINANCIAL STATEMENTS OF OUR FOREIGN SUBSIDIARIES ARE PREPARED USING THE RELEVANT FOREIGN CURRENCY THAT MUST BE CONVERTED INTO UNITED STATES DOLLARS FOR INCLUSION IN OUR CONSOLIDATED FINANCIAL STATEMENTS. AS A RESULT, EXCHANGE RATE FLUCTUATIONS MAY ADVERSELY IMPACT OUR REPORTED RESULTS OF OPERATIONS. We have established and acquired international subsidiaries that prepare their balance sheets in the relevant foreign currency. In order to be included in our consolidated financial statements, these balance sheets are converted, at the then current exchange rate, into United States dollars, and the statements of operations are converted using weighted average exchange rates for the applicable period. Accordingly, fluctuations of the foreign currencies relative to the United States dollar could have an effect on our consolidated financial statements. Our exposure to fluctuations in currency exchange rates has increased as a result of the growth of our international subsidiaries. Sales of our products and services to customers located outside of the United States accounted for approximately 53% of our net sales for the year ended December 31, 2000 and approximately 50% of our net sales for the six months ended June 30, 2001. We currently anticipate that foreign sales will account for a similar proportion of our net sales for the year ended December 31, 2001. However, because historically the majority of our currency exposure has related to financial statement translation rather than to particular transactions, we do not intend to enter into, nor have we historically entered into, forward currency contracts or hedging arrangements in an effort to mitigate our currency exposure. 17 MANY OF OUR COMPETITORS HAVE GREATER RESOURCES THAN US. IN ORDER TO COMPETE SUCCESSFULLY, WE MUST KEEP PACE WITH OUR COMPETITORS IN ANTICIPATING AND RESPONDING TO THE RAPID CHANGES INVOLVING THE ELECTRONIC COMPONENTS AND TELECOMMUNICATIONS INDUSTRIES. Our future success will depend upon our ability to enhance our current products and services and to develop and introduce new products and services that keep pace with technological developments, respond to the growth in the telecommunications and electronic components markets in which we compete, encompass evolving customer requirements, provide a broad range of products and achieve market acceptance of our products. Many of our existing and potential competitors have larger technical staffs, more established and larger marketing and sales organizations and significantly greater financial resources than we do. Our lack of resources relative to our competitors may cause us to fail to anticipate or respond adequately to technological developments and customer requirements or to experience significant delays in developing or introducing new products and services. These failures or delays could cause us to reduce our competitiveness, revenues, profit margins or market share. OUR LACK OF LONG-TERM PURCHASE ORDERS OR COMMITMENTS MAY ADVERSELY AFFECT OUR BUSINESS IF DEMAND IS REDUCED. During the year ended December 31, 2000 and the six months ended June 30, 2001, the sale of telecommunications equipment and related services accounted for approximately 56% and 55%, respectively, of our total sales, and the sale of electronic components accounted for approximately 44% and 45%, respectively, of our total sales. In many cases we have long-term contracts with our telecommunications and electronic components customers that cover the general terms and conditions of our relationships with them but that do not include long-term purchase orders or commitments. Rather, our customers issue purchase orders requesting the quantities of telecommunications equipment they desire to purchase from us, and if we are able and willing to fill those orders, then we fill them under the terms of the contracts. Accordingly, we cannot rely on long-term purchase orders or commitments to protect us from the negative financial effects of a reduced demand for our products that could result from a general economic downturn, from changes in the telecommunications and electronic components industries, including the entry of new competitors into the market, from the introduction by others of new or improved technology, from an unanticipated shift in the needs of our customers, or from other causes. OUR BUSINESS COULD SUFFER IF WE ARE UNABLE TO OBTAIN COMPONENTS OF OUR PRODUCTS FROM OUTSIDE SUPPLIERS. The major components of our products include circuit boards, microprocessors, chipsets and memory components. Most of these components are available from multiple sources. However, we currently obtain some components used in our products from single or limited sources. Some modem chipsets used in our data communications products have been in short supply and are frequently on allocation by semiconductor manufacturers. We have, from time to time, experienced difficulty in obtaining some components. We do not have guaranteed supply arrangements with any of our suppliers, and there can be no assurance that our suppliers will continue to meet our requirements. If our existing suppliers are unable to meet our requirements, we could be required to alter product designs to use alternative components or, if alterations are not feasible, we could be required to eliminate products from our product line. 18 Shortages of components could not only limit our product line and production capacity but also could result in higher costs due to the higher costs of components in short supply or the need to use higher cost substitute components. Significant increases in the prices of components could have a material adverse effect on our results of operations because our products compete on price, and therefore we may not be able to adjust product pricing to reflect the increases in component costs. Also, an extended interruption in the supply of components or a reduction in their quality or reliability would have a material adverse effect on our financial condition and results of operations by impairing our ability to timely deliver quality products to our customers. Delays in deliveries due to shortages of components or other factors may result in cancellation by our customers of all or part of their orders. Although customers who purchase from us products, such as many of our digital switches, that are not readily available from other sources would be less likely than other customers of ours to cancel their orders due to production delays, we cannot assure you that cancellations will not occur. IF WE ARE UNABLE TO SUCCESSFULLY IDENTIFY OR COMPLETE STRATEGIC ACQUISITIONS, OUR LONG-TERM COMPETITIVE POSITIONING MAY SUFFER. Our business strategy includes growth through acquisitions that we believe will improve our competitive capabilities or provide additional market penetration or business opportunities in areas that are consistent with our business plan. Identifying and pursuing strategic acquisition opportunities and integrating acquired products and businesses requires a significant amount of management time and skill. Acquisitions may also require us to expend a substantial amount of cash or other resources, not only as a result of the direct expenses involved in the acquisition transaction but also as a result of ongoing research and development activities that may be required to maintain or enhance the long-term competitiveness of acquired products, particularly those products marketed to the rapidly evolving telecommunications industry. If we are unable to complete strategic acquisitions due to our inability to identify appropriate targets or to manage the difficulties or costs involved in the acquisitions, our long-term competitive positioning could suffer. WE RELY HEAVILY ON OUR MANAGEMENT, AND THE LOSS OF THEIR SERVICES COULD MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS. Our success is highly dependent upon the continued services of key members of our management, including our Chairman of the Board, President and Chief Executive Officer, Carmine T. Oliva, and our Executive Vice President, Graham Jefferies. Mr. Oliva co-founded XET Corporation and has developed personal contacts and other skills that we rely upon in connection with our financing, acquisition and general business strategies. Mr. Jefferies is a long-time employee of MicroTel who we have relied upon in connection with our United Kingdom acquisitions and who fulfills significant operational responsibilities in connection with our foreign operations. Consequently, the loss of Mr. Oliva, Mr. Jefferies or one or more other key members of management could have a material adverse effect on us. Although we have entered into employment agreements with several key employees, we have not entered into any employment agreement with any of our executive officers other than with Mr. Oliva, Mr. Jefferies and our Senior Vice President and Chief Financial Officer, Randolph Foote. We maintain key-man life insurance on Mr. Oliva and Mr. Jefferies. However, we cannot assure you that we will be able to maintain this insurance in effect or that the coverage will be sufficient to compensate us for the loss of the services of Mr. Oliva or Mr. Jefferies. THE UNPREDICTABILITY OF OUR QUARTERLY OPERATING RESULTS MAY CAUSE THE PRICE OF OUR COMMON STOCK TO FLUCTUATE OR DECLINE. Our quarterly operating results have varied significantly in the past and will likely continue to do so in the future due to a variety of factors, many of which are beyond our control. Fluctuations in our operating results may result from a variety of factors. 19 For example, changes affecting the telecommunications industry, including consolidations and restructuring of United States and foreign telephone companies, can cause our sales to decrease or increase. Our sales may increase if we obtain new customers as a result of the consolidations or restructurings. However, our sales may decrease, either temporarily to the extent we have difficulty collecting monies due from our customers who are in the process of reorganizing, or permanently to the extent our customers are acquired by or combined with companies that are and choose to remain customers of our competitors. In addition, the cyclical nature of the telecommunications business due to the budgetary cycle of the regional Bell operating companies, or RBOCs, has had and will continue to have for the foreseeable future a significant impact on our quarterly operating results. RBOCs generally obtain approval for their annual budgets during the first quarter of each calendar year. If an RBOC's annual budget is not approved early in the calendar year or is insufficient to cover its desired purchases for the entire calendar year, we are unable to sell products to the RBOC during the period of the delay or shortfall. Due to these factors and other factors, including changes in general economic conditions, we believe that period-to-period comparisons of our operating results will not necessarily be meaningful in predicting future performance. If our operating results do not meet the expectations of investors, our stock price may fluctuate or decline. BECAUSE WE BELIEVE THAT PROPRIETARY RIGHTS ARE MATERIAL TO OUR SUCCESS, MISAPPROPRIATION OF THESE RIGHTS COULD ADVERSELY IMPACT OUR FINANCIAL CONDITION. Our future success will be highly dependent on proprietary technology, particularly in our telecommunications business. However, we do not hold any patents and we currently rely on a combination of contractual rights, copyrights, trademarks and trade secrets to protect our proprietary rights. Our management believes that because of the rapid pace of technological change in the industries in which we operate, the legal intellectual property protection for our products is a less significant factor in our success than the knowledge, abilities and experience of our employees, the frequency of our product enhancements, the effectiveness of our marketing activities and the timeliness and quality of our support services. Consequently, we rely to a great extent on trade secret protection for much of our technology. However, there can be no assurance that our means of protecting our proprietary rights will be adequate or that our competitors or customers will not independently develop comparable or superior technologies or obtain unauthorized access to our proprietary technology. Our financial condition would be adversely impacted if we were to lose our competitive position due to our inability to adequately protect our proprietary rights as our technology evolves. BECAUSE WE MAY HAVE INADVERTENTLY FAILED TO COMPLY WITH THE FEDERAL TENDER OFFER RULES, WE COULD FACE SIGNIFICANT LIABILITIES WHICH, IN TURN, COULD ADVERSELY IMPACT OUR FINANCIAL CONDITION. During 1998 and 1999 we modified the terms of some of our outstanding warrants and the terms of our Series A Preferred Stock. These transactions may have been subject to the federal tender offer rules which would have required us to make filings with the Securities and Exchange Commission and to conduct our activities in a manner prescribed by the tender offer rules. We did not make any of these filings nor did we comply with the other requirements of the tender offer rules. Although we believe that our activities surrounding the modifications to our warrants and Series A Preferred Stock are not subject to the federal tender offer rules, the Securities and Exchange Commission, as well as those security holders who participated in the modification transactions, may 20 disagree with us. If that were to happen, we may be subject to fines by the Securities and Exchange Commission and may be required by the Securities and Exchange Commission and/or the security holders to rescind the transactions. The dollar amount of any fines and the costs associated with rescission, including the related legal and accounting costs, are difficult for us to quantify, yet they could be significant. If they are significant, our financial condition would be adversely impacted. IF WE FAIL TO COMPLY WITH ENVIRONMENTAL REGULATIONS, WE COULD FACE SIGNIFICANT LIABILITIES. We are subject to a variety of environmental regulations relating to the use, storage, discharge and disposal of hazardous chemicals used in our circuit board manufacturing processes. Any failure to comply with present and future regulations could subject us to future liabilities or the suspension of production. These regulations could also require us to acquire costly equipment or to incur other significant expenses to comply with environmental regulations. We may also from time to time be subject to lawsuits with respect to environmental matters. The extent of our liability under any suit is not determinable and may have a material adverse effect on us. IF OUR PRODUCTS FAIL TO COMPLY WITH EVOLVING GOVERNMENT AND INDUSTRY STANDARDS AND REGULATIONS, WE MAY HAVE DIFFICULTY SELLING OUR PRODUCTS. We design our products to comply with a significant number of industry standards and regulations, some of which are evolving as new technologies are deployed. In the United States, our telecommunications products must comply with various regulations defined by the United States Federal Communications Commission, or FCC, and Underwriters Laboratories as well as industry standards established by Telcordia Technologies, Inc., formerly Bellcore, and the American National Standards Institute. Internationally, our telecommunications products must comply with standards established by the European Committee for Electrotechnical Standardization, the European Committee for Standardization, the European Telecommunications Standards Institute, telecommunications authorities in various countries as well as with recommendations of the International Telecommunications Union. The failure of our products to comply, or delays in compliance, with the various existing and evolving standards could negatively impact our ability to sell our products. THE LIMITATION ON OUR USE OF NET OPERATING LOSS CARRYFORWARDS MAY NEGATIVELY IMPACT OUR RESULTS OF OPERATION AND CASH FLOWS. We have substantial net operating loss, or NOL, carryforwards for federal and state tax purposes. Because of our ownership changes resulting from a merger in 1997, our use of these NOL carryforwards to offset future taxable income will be limited. To the extent we are unable to fully use these NOL carryforwards to offset future taxable income, we will be subject to income taxes on future taxable income, which will negatively impact our results of operations and cash flows. OUR STOCK PRICE HAS BEEN VOLATILE, WHICH COULD RESULT IN SUBSTANTIAL LOSSES FOR INVESTORS PURCHASING SHARES OF OUR COMMON STOCK. The market prices of securities of technology-based companies, including electronics hardware companies, currently are highly volatile. The market price of our common stock has fluctuated significantly in the past. The market price of our common stock may continue to exhibit significant fluctuations in response to the following factors, many of which are beyond our control: o variations in our quarterly operating results; o changes in market valuations of similar companies and stock market price and volume fluctuations generally; o economic conditions specific to the electronics hardware industry; 21 o announcements by us or our competitors of new or enhanced products, technologies or services or significant contracts, acquisitions, strategic relationships, joint ventures or capital commitments; o regulatory developments; o additions or departures of key personnel; and o future sales of our common stock or other securities. The price at which you purchase shares of common stock may not be indicative of the price of our stock that will prevail in the trading market. You may be unable to sell your shares of common stock at or above your purchase price, which may result in substantial losses to you. Moreover, in the past, securities class action litigation has often been brought against a company following periods of volatility in the market price of its securities. We may in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert management's attention and resources. BECAUSE WE ARE SUBJECT TO THE "PENNY STOCK" RULES, THE LEVEL OF TRADING ACTIVITIES IN OUR STOCK MAY BE REDUCED. Broker-dealer practices in connection with transactions in "penny stocks" are regulated by penny stock rules adopted by the Securities and Exchange Commission. Penny stocks, like shares of our common stock, generally are equity securities with a price of less than $5.00 (other than securities registered on some national securities exchanges or quoted on Nasdaq). The penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from the rules, to deliver a standardized risk disclosure document that provides information about penny stocks and the nature and level of risks in the penny stock market. The broker-dealer also must provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, and, if the broker-dealer is the sole market maker, the broker-dealer must disclose this fact and the broker-dealer's presumed control over the market, and monthly account statements showing the market value of each penny stock held in the customer's account. In addition, broker-dealers who sell these securities to persons other than established customers and "accredited investors" must make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser's written agreement to the transaction. Consequently, these requirements may have the effect of reducing the level of trading activity, if any, in the secondary market for a security subject to the penny stock rules, and investors in our common stock may find it difficult to sell their shares. WE MAY NEED ADDITIONAL CAPITAL IN THE FUTURE AND ADEQUATE FINANCING MAY NOT BE AVAILABLE TO US ON ACCEPTABLE TERMS OR AT ALL. IF WE OBTAIN FINANCING THROUGH THE ISSUANCE OF EQUITY SECURITIES, FURTHER DILUTION TO EXISTING STOCKHOLDERS MAY RESULT. WE MAY BE REQUIRED TO OBTAIN FINANCING THROUGH ARRANGEMENTS THAT MAY REQUIRE US TO RELINQUISH RIGHTS OR CONTROL TO SOME OF OUR PROPRIETARY TECHNOLOGIES. Our future capital requirements will depend upon many factors, including the magnitude of our sales and marketing efforts, the development of new products and services, possible future strategic acquisitions, the progress of our research and development efforts and the status of competitive products and services. We believe that current and future available capital resources will be adequate to fund our operations for the foreseeable future. However, to the extent we are in need of any additional financing, there can be no assurance that any additional financing will be available to us on acceptable terms, or at all. If we raise additional funds by issuing equity securities, further dilution to the existing stockholders may result. If adequate funds are not available, we may be required to delay, scale back or eliminate portions of our operations and product development and marketing efforts or to obtain funds through 22 arrangements with partners or others that may require us to relinquish rights to some of our technologies or potential products, services or other assets. Accordingly, the inability to obtain financing could result in a significant loss of ownership and/or control of our proprietary technology and other important assets and could also adversely affect our ability to fund our continued operations and our product development and marketing efforts that historically have contributed significantly to our competitiveness. SHARES OF OUR COMMON STOCK ELIGIBLE OR TO BECOME ELIGIBLE FOR PUBLIC SALE COULD ADVERSELY AFFECT OUR STOCK PRICE AND MAKE IT DIFFICULT FOR US TO RAISE ADDITIONAL CAPITAL THROUGH SALES OF EQUITY SECURITIES. As of August 10, 2001, we had outstanding 20,570,703 shares of common stock, all of which shares were either unrestricted, registered for resale under the Securities Act of 1933, or eligible for resale without registration under Rule 144 of the Securities Act of 1933. As of August 10, 2001, we also had outstanding options, warrants and preferred stock that were exercisable for or convertible into 6,643,930 shares of common stock. Of these, 1,673,924 shares of common stock underlying options, 1,712,305 shares of common stock underlying warrants and 2,763,250 shares of common stock underlying preferred stock were registered for resale. Sales of a substantial number of shares of our common stock in the public market, or the perception that sales could occur, could adversely affect the market price for our common stock. Any adverse effect on the market price for our common stock could make it difficult for us to sell equity securities at a time and at a price that we deem appropriate. BECAUSE OUR STOCK IS NOT LISTED ON A NATIONAL SECURITIES EXCHANGE, YOU MAY FIND IT DIFFICULT TO DISPOSE OF OR OBTAIN QUOTATIONS FOR OUR COMMON STOCK. Until May 12, 1999, our common stock was quoted on the Nasdaq SmallCap Market. We were unable to maintain the minimum bid price of $1.00 per share and our stock was delisted from that market. Since May 13, 1999, our common stock has been traded under the symbol "MCTL" on the NASD's OTC Bulletin Board. Because our stock trades on the OTC Bulletin Board rather than on a national securities exchange, you may find it difficult to either dispose of, or to obtain quotations as to the price of, our common stock. OUR PREFERRED STOCK MAY DELAY OR PREVENT A TAKEOVER OF MICROTEL, POSSIBLY PREVENTING YOU FROM OBTAINING HIGHER STOCK PRICES FOR YOUR SHARES. Our board of directors has the authority to issue up to 10,000,000 shares of preferred stock and to fix the rights, preferences, privileges and restrictions, including voting rights of those shares, without any further vote or action by our stockholders. Of these shares, 200 have been designated as Series A Preferred, of which 25 are currently outstanding. In addition, 150,000 shares have been designated as Series B Preferred Stock, all of which are currently outstanding. The rights of the holders of our common stock are subject to the rights of the holders of our currently outstanding preferred stock and will be subject to, and may be adversely affected by, the rights of the holders of any preferred stock that we may issue in the future. The issuance of preferred stock, while providing desired flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock, which would delay, defer or prevent a change in control of MicroTel. Furthermore, preferred stock may have other rights, including economic rights senior to the common stock, and, as a result, the issuance of preferred stock could adversely affect the market value of our common stock. 23 THE ANTI-TAKEOVER EFFECTS OF DELAWARE LAW COULD ADVERSELY AFFECT THE PERFORMANCE OF OUR STOCK. Section 203 of the General Corporation Law of Delaware prohibits us from engaging in business combinations with interested stockholders, as defined by statute. These provisions may have the effect of delaying or preventing a change in control of MicroTel without action by our stockholders, even if a change in control would be beneficial to our stockholders. Consequently, these provisions could adversely affect the price of our common stock. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. We have established and acquired international subsidiaries that prepare their balance sheets in the relevant foreign currency. In order to be included in our consolidated financial statements, these balance sheets are converted, at the then current exchange rate, into United States dollars, and the statements of operations are converted using weighted average exchange rates for the applicable period. Accordingly, fluctuations of the foreign currencies relative to the United States dollar could have an effect on our consolidated financial statements. Our exposure to fluctuations in currency exchange rates has increased as a result of the growth of our international subsidiaries. However, because historically the majority of our currency exposure has related to financial statement translation rather than to particular transactions, we do not intend to enter into, nor have we historically entered into, forward currency contracts or hedging arrangements in an effort to mitigate our currency exposure. A substantial portion of our notes payable and long-term debt have variable interest rates based on the prime interest rate and/or lender's base rate, which exposes us to risk of earnings loss due to changes in such interest rates. The following table provides information about our debt obligations that are sensitive to changes in interest rates. All dollars are in thousands. The symbol "P" represents the prime rate. The symbol "B" represents lender's base rate. Balances are as of December 31, 2000.
FAIR VALUE LIABILITIES 2001 2002 2003 2004 2005 THEREAFTER TOTAL 12/31/00 ----------- ---- ---- ---- ---- ---- ---------- ----- -------- Line of Credit $1,798 $1,798 $1,798 (domestic) Average Interest P+ 1% Rate Line of Credit $1,377 $1,377 $1,377 (Foreign) Average Interest B+ 2.5% Rate Term Loan $137 $137 $83 $8 $5 $370 $370 Average Interest P+ 2% P+ 2% P+ 2% P+ 2% P+ 2% Rate
24 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. We are not a party to any material pending legal proceedings. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS. Recent Sales of Unregistered Securities --------------------------------------- In April 2001, we issued warrants to purchase up to 35,000 shares of common stock at an exercise price of $0.39 per share to one entity in consideration for investor relations services. Exemption from the registration provisions of the Securities Act of 1933 for this transaction is claimed under Section 4(2) of the Securities Act of 1933, among others, on the basis that this transaction did not involve any public offering and the purchaser was sophisticated with access to the kind of information registration would provide. Dividends --------- To date we have not paid dividends on our common stock. Our line of credit with Wells Fargo Business Credit, Inc. prohibits the payment of cash dividends on our common stock. The certificates of designations related to our Series A Preferred Stock and Series B Preferred Stock provide that shares of those series of preferred stock are not entitled to receive cash dividends. We currently intend to retain future earnings to fund the development and growth of our business and, therefore, do not anticipate paying cash dividends on our common stock within the foreseeable future. Any future payment of dividends on our common stock will be determined by our board of directors and will depend on our financial condition, results of operations, contractual obligations and other factors deemed relevant by the our board of directors. ITEM 3. DEFAULTS UPON SENIOR SECURITIES. None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. On June 22, 2001, we held our 2001 annual meeting of stockholders. Our stockholders were asked: 1. To elect Laurence P. Finnegan, Jr. as a Class II director to serve a three-year term on our board of directors; and 2. To ratify the appointment of BDO Seidman, LLP as our independent auditors for fiscal 2001. 25 Results of the vote are as follows:
Proposal For Against Abstain Withheld Total Voted -------- --- ------- ------- -------- ----------- 1 16,062,162 0 0 38,774 16,100,936 2 16,075,543 7,786 17,607 0 16,100,936
The total number of outstanding votable shares was 20,570,415. The percentage of votable shares that was voted was 78.27%. ITEM 5. OTHER INFORMATION. None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits -------- 3.1 Amendments to Bylaws effective as of June 1, 2001 (1) ----------- (1) Incorporated by reference to the MicroTel International, Inc. Registration Statement on Form S-1 (Registration Statement No. 333-63024). (b) Reports on Form 8-K ------------------- We filed Amendment No. 3 to Form 8-K for September 22, 2000 on April 10, 2001 in connection with our acquisition of substantially all of the assets and our assumption of certain of the liabilities of T-Com, LLC, a Delaware limited liability company. The filing included "Item 2 - Acquisition or Disposition of Assets" and "Item 7 - Financial Statements and Exhibits." 26 SIGNATURES In accordance with the requirements of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MICROTEL INTERNATIONAL, INC. Dated: August 14, 2001 By: /S/ CARMINE T. OLIVA -------------------------------------------- Carmine T. Oliva, Chairman of the Board, Chief Executive Officer (principal executive officer) and President By: /S/ RANDOLPH D. FOOTE -------------------------------------------- Randolph D. Foote, Chief Financial Officer (principal financial and accounting officer) 27