-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Td3sDP8tAGyoDBu4lNaaxIWOGs0aQyHdda/YtcZuqtNgV3TR6C5pZH6n++aBa5MD /IfBcYU7N/KQZhsLa1jsAw== 0001047469-99-013042.txt : 19990402 0001047469-99-013042.hdr.sgml : 19990402 ACCESSION NUMBER: 0001047469-99-013042 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MICROTEL INTERNATIONAL INC CENTRAL INDEX KEY: 0000854852 STANDARD INDUSTRIAL CLASSIFICATION: INSTRUMENTS FOR MEAS & TESTING OF ELECTRICITY & ELEC SIGNALS [3825] IRS NUMBER: 770226211 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-10346 FILM NUMBER: 99583283 BUSINESS ADDRESS: STREET 1: 4290 E BRICKELL ST STREET 2: STE 102 CITY: ONTARIO STATE: CA ZIP: 91761-1511 BUSINESS PHONE: 9094564321 MAIL ADDRESS: STREET 1: 4290 E BRICKELL STREET STREET 2: STE 102 CITY: ONTARIO STATE: CA ZIP: 91761-1511 FORMER COMPANY: FORMER CONFORMED NAME: CXR CORP DATE OF NAME CHANGE: 19920703 10-K 1 10-K - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998, OR / / TRANSITION REPORT PURSUANT TO 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 Identification incorporation or organization) No.) 4290 E. BRICKELL STREET, ONTARIO, (909) 456-4321 CALIFORNIA 91761 (Registrant's telephone number, (Address of principal executive offices) including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH Common Stock, $.0033 par value REGISTERED None SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None TITLE OF CLASS ------------------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such a shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Indicate by check mark if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. / / The aggregate market value of the voting stock at March 26, 1999 held by nonaffiliates was approximately $8,218,000. As of March 26, 1999 there were 16,435,546 shares of Common Stock, Par Value $.0033, outstanding. DOCUMENTS INCORPORATED BY REFERENCE. The definitive proxy statement in respect of the 1999 Annual Meeting of Shareholders of the Company is incorporated by reference into Part III of this Form 10-K. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART I ITEM 1. BUSINESS WHEN USED ANYWHERE IN THE DISCUSSION OF "BUSINESS" BELOW, THE WORDS "MAY," "WILL," "EXPECT," "ANTICIPATE," "CONTINUE," "ESTIMATE," "PROJECT," "INTEND," "SHOULD," "BELIEVE," AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934 REGARDING EVENTS, CONDITIONS AND FINANCIAL TRENDS THAT MAY AFFECT THE COMPANY'S FUTURE PLANS OF OPERATIONS, BUSINESS STRATEGY, OPERATING COSTS AND FINANCIAL POSITION. SPECIFICALLY, FORWARD-LOOKING STATEMENTS ARE INCLUDED IN THE FOLLOWING SECTIONS BELOW: "OVERVIEW;" "INSTRUMENTATION AND TEST EQUIPMENT SECTOR;" "COMPONENTS AND SUBSYSTEM ASSEMBLIES SECTOR;" "CIRCUITS SECTOR;" "PRODUCT DEVELOPMENT AND ENGINEERING;" "COMPETITION;" "REGULATION;" AND "EMPLOYEES." PROSPECTIVE INVESTORS ARE CAUTIONED THAT ANY FORWARD-LOOKING STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND ARE SUBJECT TO RISKS AND UNCERTAINTIES AND THAT ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE INCLUDED WITHIN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS. OVERVIEW MicroTel International, Inc. (the "Company") is a holding company which, through its various direct and indirect operating subsidiaries, designs, manufactures and distributes a wide range of electronics hardware products and provides related services primarily to the telecommunications industry. Approximately 55% of the Company's product sales are to customers in the telecommunications industries, including AT&T and the Regional Bell Operating Companies ("RBOCs") domestically, and France Telecom in Europe. The foregoing excludes the product sales of the Company's 41% owned affiliate company, Digital Transmission Systems, Inc. ("DTS"), which sells principally to wireless telephone service providers, as such sales are not included in the Company's consolidated financial statements. The remainder of the sales are various information technology products for industrial, medical, military and aerospace applications. The Company does not market the products manufactured and distributed by its subsidiaries in connection with the "MicroTel" name but rather such products are distributed under each subsidiary's market-recognized brand-names. The Company's objective is to become a leader in quality, cost effective solutions to meet the global requirements of telecommunications and information technology customers. The Company believes that it can achieve this objective through customer-oriented product development, superior product solutions, and excellence in local market service and support in North America, Europe and Asia. In 1984, MicroTel International, Inc. began operations as CXR Telcom Corporation. In 1989, a holding company, CXR Corporation, a Delaware corporation, was formed with two operating subsidiaries, CXR Telcom Corporation, based in the United States, and CXR, S.A., based in France (collectively, "CXR"). CXR manufactures and distributes telecommunications testing and transmission equipment. In 1995, CXR Corporation changed its name to MicroTel International, Inc. On March 26, 1997, the Company consummated a merger pursuant to which XIT Corporation ("XIT") became a wholly-owned subsidiary of the Company, with XIT as the surviving subsidiary (the "Merger"). Because the Merger was accounted for as a reverse acquisition, historical financial information referred to herein as that of the Company shall refer to the historical financial information of XIT. Prior to 1991, XIT produced video display products, bare printed circuit boards, digital switches, keyboards, keypads and other components primarily for military, aerospace and medical applications. In 2 1991, XIT began a fundamental transition of its business operations by divesting $1.5 million in unprofitable bare printed circuit board volume and $3.5 million in low margin standard keyboards. During that year, XIT relocated its corporate headquarters, its Digitran Division's input and display component business, and its circuit division to Ontario and Monrovia, California from Pasadena, California and focused its circuits manufacturing on low volume, high margin double-sided and multi-layer circuit boards. Commencing in that year, XIT also began investing heavily in research and development in order to diversify its information technology product line and reduce its dependence on military and aerospace sales. Commencing in 1994, XIT began to implement a business strategy of acquiring strategically complementary businesses and product lines. In July 1994, XIT acquired approximately 85% of HyComp, Inc. through a share exchange with the majority shareholders. HyComp, formed in 1969, designs and manufactures hybrid circuits, resistor networks, and thin film components. HyComp's products are for high-reliability applications where they must withstand extremes of temperature, humidity or environment. These products have a variety of uses in communications electronics, military, aerospace, medical, computer and industrial controls. Subsequently, XIT acquired an additional approximate 7% of HyComp Common Stock through an exchange of XIT common stock for HyComp common shares. As a result of the exercise of certain HyComp stock options in 1997, the Company's ownership of the common shares outstanding of HyComp was reduced to 88.5%. As part of the Company's strategic plan to focus on telecommunications product sales only and exit the circuits business, on March 1, 1999 the Company accepted an offer to sell substantially all the assets and liabilities of HyComp to a public corporation. The sale is expected to close on or about March 31, 1999. In May 1995, XIT acquired certain work in process from a bankrupt printed circuit board and contract manufacturing company and established XCEL Contract Manufacturing Division (XCMD) temporarily located in Philadelphia, Pennsylvania. The Company continues to service certain of the XCMD customers from its Ontario and Monrovia facilities, but has since closed its Philadelphia operation. In May 1995, XIT sold its Computron Display Systems Division ("Computron") based in Illinois, a manufacturer of higher cost custom color and monochrome display monitors, for approximately $1.8 million. Computron was sold based on XIT management's determination that the demand for its monochrome product lines was declining and its custom color product was too high in cost. Further, XIT's growth in the monitor product area was then expected to be derived from its low cost standard color cathode ray tube ("CRT") product line, branded XCEL-Lite, as well as a full range of flat panel products manufactured at its Digitran Division. As part of the Company's strategic plan, the Company sold its XCEL-Lite product line to a private company in December 1998. In September 1995, through a newly established wholly-owned subsidiary XCEL Arnold Circuits, Inc. ("XCEL Arnold"), XIT completed the acquisition of Arnold Circuits, Inc., a La Habra, California manufacturer of complex multi-layer, surface mount circuit boards used in sophisticated electronic equipment for the communications, computer, instrumentation and industrial controls industries. XCEL Arnold's circuit boards are used principally in cellular telephone transmission products. Due to a decline in its major customer's business and as part of the Company's strategic plan, management decided to exit this business. On April 9, 1998, the Company sold certain of the assets of XCEL Arnold to a private corporation which also assumed certain liabilities (see Note 3 to the Consolidated Financial Statements included elsewhere herein). In April 1996, XCEL Arnold completed the acquisition of Etch-Tek, Inc. ("Etch-Tek"), a manufacturer of quick turn and prototype quantities of double sided and high multi-layer count printed circuit boards. Etch-Tek, located in Concord, California, was originally established as a division of XCEL Arnold and operated as the XCEL Etch Tek Division of XCEL Arnold. The assets of Etch Tek were not included in the sale of XCEL Arnold and, following such sale, Etch-Tek operates as a division of XIT Corporation and will be retained as part of the Company primarily to supply printed circuits to its other operating business units and affiliated company, DTS. 3 In September 1996, XCEL Corporation, Ltd. ("XCEL UK"), the Company's United Kingdom subsidiary, acquired Abbott Electronics, Ltd. ("Abbott"). XCEL UK operates Abbott as a wholly-owned subsidiary of XCEL UK trading as XCEL Power Systems, Ltd ("XPS"). XPS designs and manufactures high and low voltage, high specification, compact and micro-electronic power supplies to meet rugged environmental and high tolerance electrical requirements for telecommunications, aerospace and military applications. In accordance with its strategic plan to focus on the sale of telecommunication products, in the fall of 1996, XIT began negotiations with MicroTel with respect to the Merger. Management believes that the Merger enhanced the Company's ability to service its telecommunications and information technology customers, created additional marketing opportunities both geographically and across product lines, and provided cost savings by the internal sourcing of components by MicroTel's subsidiaries formerly purchased from outside third-party vendors. In October 1997, the Company acquired all the capital stock of Critical Communications Incorporated ("Critical"), a manufacturer of telecommunication test instruments located in St. Charles, Illinois. The Company has transferred manufacturing of Critical's products to its CXR Telcom subsidiary in Fremont, California and has maintained the remaining operation as a product engineering and development, customer service and mid-west sales office where it previously lacked a presence. In January 1999, the Company acquired approximately 41% of the common stock of Digital Transmission Systems, Inc., a public company (OTC BB-- DTSX), thus expanding the Company's range of products to include wireless voice and data transmission products. Within the electronics industry, the Company now manufactures and distributes three product lines and is organized into three related business sectors which are discussed below. 1. INSTRUMENTATION AND TEST EQUIPMENT SECTOR The Company's Instrumentation and Test Equipment products are manufactured by CXR, CXR, S.A. and DTS. In addition, CXR, S.A. performs network integration services and distributes test equipment and data, voice and video transmission products manufactured by third parties. Their customers include AT&T, France Telecom, the RBOCs, Nextel, Altel, interconnect carriers, independent telephone operating companies, private communications networks, banks, brokerage firms and Government agencies. TELECOM TEST INSTRUMENTS. The CXR line of test instruments measure the transmission characteristics of telephone circuits. In the United States, the market for this test equipment has expanded as a result of the AT&T divestiture of the RBOCs and the trend towards user ownership of equipment. As a result of the AT&T divestiture, local telephone operating companies have been forced to develop their own internal capacity to identify and isolate troubles in the network transmission facilities in both telephone company owned or subscriber owned equipment. In October 1997, the Company acquired all the capital stock of Critical Communications Incorporated ("Critical") of St. Charles, Illinois in a stock-for-stock exchange. Founded in 1991, Critical is a provider of sophisticated, state-of-the-art, portable telephone test instruments used by both long-distance carriers and local telephone service providers as well as by corporate and government telecommunications end users. The Company incorporated the manufacturing operations of Critical into those of CXR Telcom and distributes its products through both existing CXR and Critical sales channels. This acquisition expanded the previous CXR product offering to include additional software-driven, user-friendly and cost-competitive hand-held products. These products have broadened CXR's penetration of the Installation and Maintenance ("I&M") segment of the telecommunications marketplace--i.e. that segment in which corporate service installations and maintenance are provided by the various telephone companies. While CXR's existing I&M products were used extensively in the Central Office testing environment (which necessitates the use of a multi-function, all-in-one test instrument), Critical's products are primarily 4 designed to service the test instrument needs at outside plant service installations, where lightweight, portable products requiring fewer functional testing features are required. It is particularly in this market segment, where CXR presently competes with only one, outdated product, that the Critical product line has begun to have significant impact. The current line of test equipment manufactured and sold by CXR consists primarily of the new 700 Series of Transmission test sets acquired from Critical Communications which are a modular, rugged, lightweight and hand-held line of products which are principally used by telephone companies to qualify and certify the service offerings to end users. These sets are configured in a variety of models designed to perform analog and digital measurements on voice grade and wide band circuit applications. Testing of the physical copper pair and qualifying it for the new wide band digital services applications is becoming the primary concern on the part of telephone companies. These services include the Digital Data Service (DDS), High Capacity Digital Subscriber loops (HDSL) and Asymmetrical Digital Subscriber loops (ADSL). Additionally, the modular nature of the equipment's design provides an upgrade path for optional testing of the signaling parameters over the telephony network, simulation of the Central Office (CO) and simulation of the Private Branch Exchange (PBX). The 700 series can also be equipped with the modules necessary to perform the digital tests required to qualify the data transmission rates for service offered to ultimate users. These rates range from basic modem rates to the higher speeds of the Pulse Coded Modulation (PCM) network (1.5 million bits per second (Mb/s)). DATACOM TEST INSTRUMENTS. Datacom test instruments are used to test and monitor the performance of computers and communications equipment to ensure proper function in receiving or transmitting data over wide area or local area networks. Datacom instruments monitor, emulate and perform digital tests on protocol, code and transmission functions of computers, terminals, modems, multiplexers, front-end processors and other computer and communications equipment. The CXR Telcom Series 840 and 804 products address this market. TRANSMISSION PRODUCTS. CXR develops, manufactures, and sells a broad line of Anderson Jacobson ("AJ") modem products. These include modem models operating at data rates from 2400 bits per second (bps) through 56,000 bps. These are sold as rackmount modems for use at central communication/ computer sites, or as stand-alone modems for use at remote sites. All of the AJ models are "feature rich" modems that generally offer more capabilities and flexibility than competing products. The ability to transmit digital data to and from computers is an important element in the computer industry. Communications and data interconnect capabilities are fundamental requirements for maximization of computer systems uses. The large volume of information to be exchanged between computer networks in geographically disperse locations require rapid, accurate and economical communications capabilities and the AJ product line is designed to meet and satisfy such needs. The AJ 1456/2853 Series of products are a true V.90 compatible product line designed to accommodate the newly standardized high speed of 56Kb/s and its sub-rates standard of V.34, V.32 ter and V.32. These products operate on a full duplex basis, using standard dial-up lines or on 2-wire and 4-wire leased lines. The series features trellis coded modulation and local and remote echo cancellation, with capabilities to cope with satellite delay of multiple hops in long distance transmission. Also, the series is equipped with multiple number storage capacity via a V.25 bis synchronous dialer for computer controlled application. In leased line operation, the series features unattended automatic dial backup using the dial-up network in the event of lease line failures. The series is also available in either stand alone desktop applications or as a card for chassis rackmount configuration. The AJ Smart Rack is a modem management enclosure that accommodates 16 modular card modems that allow data center managers to keep track of configurations, diagnostics, alarms and system status at all times through a menu driven user interface. The main advantage of the Smart Rack is the simplicity of keeping track of all activities with real time monitoring and reporting using simple easy to read display 5 screens. Also an on-board modem allows access from remote locations and the ability to dial a predefined sequence of numbers for alarm reporting. The AJ 5900 series offers intelligent T-1 Channel Service Units which provide access to D4 and Extended Super Frame (ESF) on High Capacity Digital Service (HCDS), in either a single line or rack mount configuration. The AJ 5900 series offers a single termination interface to the Data Terminal Equipment (DTE), providing continuous monitoring for bipolar violations and multiple error events. The user can select thresholds for error rates, with separate levels for the network and the equipment. The series provides complete access to both the network side and the user side, along with the appropriate diagnostic tests in order to maintain network integrity. In March 1997, CXR introduced a new product line, the AJ 6900 series for T-1 and fractional T-1 CSU-DSU applications. These products provide for the direct interface between the customer's equipment and the T-1 facilities. The AJ 6900 series operates at any multiple 56K or 64K b/s, including current Frame Relay data rates. Built-in multiplexer ports allow simultaneous connections to a PBX or channel bank which shares the same T-1 facility. The AJ 6900 series has an integrated Simple Network Management Protocol (SNMP) and therefore can easily be used by any compatible network management system using SNMP. With the acquisition of an interest in DTS, the Company plans to offer its own transmission products in the United States and Europe together with DTS's scaleable network access products to wireless service companies that provide low cost, high quality voice and data services. The integrated solutions provided by DTS combine voice signals from cell site base stations, control signals such as alarms and high speed data from other digital service and transmits them to switching centers of the wireless service provider. The innovative form factor of the DTS equipment, together with advanced diagnostic features allow wireless carriers to troubleshoot and manage their networks in a non-intrusive manner. DTS provides products to a number of domestic wireless service customers including Nextel, Altel, AirTouch and GTE MobilNet. NETWORK SERVER PRODUCTS. In 1998, CXR developed and introduced to field trial a new product offering, a Remote Access Server (RAS), to address the Internet Service Provider (ISP) market and corporate communication users. The RAS-248, RAS-496 and RAS 3096+ products provide high density communication to accommodate the incoming traffic from high speed Modems (56Kb/s), ISDN Terminal Adapters (TA), Primary rate ISDN and at the PCM rates for both the US and the International standards. The product implements a secure 128 bit encryption, which operates using the Windows NT operating system platform. Also, the product line features an adaptability to Web Caching with application server options, built-in protocol analysis and is compatible with the Local Area Network (LAN) infrastructures and its various topologies. Like all of the AJ data transmission products, the RAS family uses the SNMP management Protocol and therefore can be very easily configured and managed from any location capable of using SNMP system. These products were formally introduced to the market in the third quarter of 1998. NETWORKING SYSTEMS. In 1996, CXR, S.A. formed a new business unit to market several lines of products used to build data and voice networks. All of these products are sourced from third-party vendors under distributorship or OEM arrangements. The "product" marketed to its customers is a turn-key solution using these products and includes network design, installation and maintenance. The product lines marketed consist of four primary types as follows: (i) multiplexing equipment used to transport data, voice and local area network traffic over point-to-point leased lines and frame relay networks; (ii) statistical multiplexers, terminal servers and routers for local area network interconnections; (iii) data compression equipment used to compress and encrypt data streams prior to network access to maximize transmission speed and secure the transmission and to decompress and decipher upon transmission receipt; and (iv) ISDN routers used to link remote offices to corporate office local area networks. 6 2. COMPONENTS AND SUBSYSTEM ASSEMBLIES SECTOR Components and Subsystem Assemblies products are produced and/or sold by XIT's Digitran Division, based in Ontario, California, XCEL UK and XPS, wholly-owned subsidiaries of XIT based in England, and another wholly-owned subsidiary, XCEL Japan, Ltd. The Company has downsized these businesses throughout 1998 and is currently producing only those products with relatively higher margins. The Company will not attempt to expand these businesses but rather will operate them so as to maximize their profitability or sell them in order to support the Company's expansion into the telecommunications hardware business sector. COMPONENTS XIT's Digitran Division manufactures and sells digital switch products serving aerospace, military, communications, industrial and commercial applications. Thumbwheel, push button, and lever modules, together with assemblies, are manufactured in 16 different model families. The Digitran Division also offers a wide variety of custom keypads. The Digitran Division previously produced the XCEL-Lite display color monitor product which was sold in December 1998. Color and monochrome monitors (including XCEL-Lite) continue to be sold in Europe through XCEL UK. XPS, located in Ashford, Kent, England, produces a range of high and low voltage, high specification, compact and microelectronic power supplies for an international customer base, including telecommunications, aerospace and military customers. SUBSYSTEMS The Company's Digitran division discontinued the manufacture of subsystem assemblies for outside customers and now concentrates on assembling components and products for several other of the Company's other business operations including DTS. However, the Company's XCEL UK subsidiary does continue to offer complete manufacturing solutions to OEMs, outside and internal divisions and subsidiaries, including concurrent engineering, assembly of printed circuit boards and front panel assemblies incorporating its input and display components, assembly of subsystems, test engineering, software development and accessory packaging. The Company's XCEL UK subsidiary believes its ability to manufacture various electronic components, combined with its engineering integration capability, provides it with a number of competitive advantages in providing custom contract assembled subsystem assemblies. By integrating the Company's printed circuit boards and components, XCEL UK is able to engineer and manufacture communications, medical, industrial, and military weapons input and display subsystems and other subsystem assemblies. 3. CIRCUITS SECTOR The Company's printed circuit boards are produced by the XCEL Etch Tek and XCEL Circuits divisions of XIT, located in Concord and Monrovia, California respectively, and HyComp, Inc. ("HyComp"), an approximately 89% owned subsidiary of XIT based in Marlborough, Massachusetts, the assets of which are currently anticipated to be sold on March 31, 1999. Until March 31, 1998, the Company produced printed circuits at its XCEL Arnold Circuits, Inc. subsidiary ("XCEL Arnold") located in La Habra, California. On April 9, 1998, the Company completed the sale, effective as of March 31, 1998, of substantially all of the assets of XCEL Arnold to Arnold Circuits, Inc., a newly formed entity formed to consummate the purchase. With the sale of the HyComp business, the Company will have effectively exited the circuits business. The Company has downsized XCEL Etch Tek and combined the XCEL Circuits division under the management structure of XCEL Etch Tek and plans to maintain these operations as predominantly captive suppliers to its other operating divisions, subsidiaries and affiliate. 7 CUSTOMERS AND MARKETING Customers for the Company's Instrumentation and Test product line include AT&T, the RBOCs, international telephone companies--including France Telecom--and private communications networks. Datacom test equipment and modem equipment are purchased by telecommunications equipment manufacturers and used in the design, manufacture, installation and maintenance of the electronic equipment they provide. Telecom test instruments are purchased by the major long distance and local loop carriers. During the periods presented in this report, the customers for the Circuits Sector included GenRad, Raytheon, Lockheed Martin, Tektronics, Teradyne, Holland Signal, Racal, EFW and Loral, among others. The principal customers for Components and Subsystems are OEMs in the electronics industry and include manufacturers of communications equipment, industrial computers, automatic teller machines, medical devices, industrial instruments and test equipment, and aerospace and military products. Such customers include Boeing, Lockheed Martin, Raytheon, Litton, Rockwell, Teledyne, Honeywell, NCR, Eastman Kodak, British Aerospace, Aerospatiale, Pilkington, Sagem, Toshiba and Hyundai, among many others. The Company's largest customer was Motorola which accounted for approximately 3%, 14%, 34% and 41% of the net sales for the year ended December 31, 1998 and 1997, the three months ended December 31, 1996 and the year ended September 30, 1996, respectively. These sales were made by XCEL Arnold, the assets of which were sold by the Company effective March 31, 1998. No other customer accounted for more than 10% of the Company's net sales for these periods. The Company markets its products through a combination of direct sales engineers, distributors and independent sales representatives primarily in the United States, Europe and Japan (See Note 15 to the Consolidated Financial Statements included elsewhere in this Report). BACKLOG The Company's business is not generally seasonal, with the exception that the printed circuit board industry generally slows in the last calendar quarter of each year and capital equipment purchases are lower than average during the first quarter of each year, impacting the Instrumentation and Test Equipment sector. The Company's backlog of firm, unshipped orders was as follows by business sector at December 31, 1998, 1997 and 1996, and September 30, 1996, respectively.
DEC. 31, DEC. 31, SEPT. 30, DEC. 31, 1998 1997 1996 1996 ------------- ------------ ------------ ------------- (IN THOUSANDS) Instrumentation and Test Equipment..................... $ 1,861 $ 985 $ -- $ -- Components and Subsystem Assemblies.................... 7,137 6,452 8,888 9,187 Circuits............................................... 993 5,397 5,880 11,019 ------ ------------ ------------ ------------- $ 9,991 $ 12,834 $ 14,768 $ 20,206 ------ ------------ ------------ ------------- ------ ------------ ------------ -------------
The backlog for the Instrumentation and Test Equipment Sector at December 31, 1998 and 1997 is that of CXR, acquired on March 26, 1997, and, while historically the backlog for this Sector has been nominal, the substantial increase as of December 31, 1998 results from the acquisition of purchase agreements with certain RBOC's in the fourth quarter of 1998. Backlog for CXR is not deemed a significant measure of its business, as its customers generally order on a just-in-time basis. The increase in backlog for the Components and Subsystem Assemblies Sector at December 31, 1998 resulted from an increase of approximately $1,060,000 at XPS principally in the fourth quarter of 1998 and an increase in the orders for the remainder of the Sector from programs which did not order in 1997, thus contributing to the decline from December 31, 1996 to December 31, 1997. The Sector's backlog at September 30, 1996 was principally due to the backlog of XPS, acquired in September 1996, of $5,992,000. Order backlog for 8 XPS is volatile and the decline from September 30, 1996 to December 31, 1997 did not indicate an adverse trend. The Company's order backlog at December 31, 1998 will be mostly shipped during 1999, with the exception of approximately $908,000 of orders at XIT (Components) whose fulfillment will extend beyond 1999. The overall decline in backlog for the Circuits Sector from December 31, 1997 to December 31, 1998 was principally the result of the sale of XCEL Arnold, which had a backlog of approximately $3,400,000 at December 31, 1997. The decline in backlog for this sector in 1996 resulted from XCEL Arnold's major customer, Motorola, changing its ordering pattern, compounded in 1997 by a deferral of orders by this customer pending correction of late delivery problems. Motorola, as a matter of policy, reduced its order quantities from a 12 month supply in the September 30, 1995 time frame to a 3 to 6 month supply beginning in the September 30, 1996 time frame and thereafter. The backlog of DTS is not included in the foregoing. MANUFACTURING The Company purchases the electronic components required for the manufacture of its various product lines from a number of vendors and has experienced no significant difficulties in obtaining timely delivery of components. In addition, the Company has begun internal sourcing of certain electronic components following the Merger. Management has determined that there would be little, if any, cost savings from outside manufacturing. PRODUCT DEVELOPMENT AND ENGINEERING The Company's product development and engineering is critical in view of rapid technological innovation in the electronics hardware industry. Current research and development efforts are concentrated in the Instrumentation and Test Equipment Sector (CXR) and at HyComp. For the year ended December 31, 1998 and 1997, the three months ended December 31, 1996 and the year ended September 30, 1996, engineering and product development costs of the Company were $2,454,000, $2,046,000, $69,000 and $309,000, respectively. The product development costs of CXR were $2,202,000, $1,797,000 and $2,612,000 during the years ended December 31, 1998, 1997 and 1996, respectively. These product development costs were related primarily to development of new telecommunications test equipment, trunk testing system products and data communications equipment. Current research expenditures are directed principally towards enhancements to the current test instrument product line and development of increased band width (faster speed) transmission products. These expenditures are intended to improve market share and gross profit margins, although no assurances may be given that such improvements will be achieved. CXR also makes use of the latest CAD (Computer Aided Design) equipment to design and package its products. This puts CXR in the position to take full advantage of the latest CAE (Computer Aided Engineering), and EDA (Engineering Design Automation) workstation tools to design, simulate and test its advanced product features or product enhancements for custom circuits and miniaturization purposes. With the above mentioned tools, product developments are turned around quickly, keeping the highest quality and reliability integrated as part of the overall development process. This kind of capability also allows CXR to offer custom featured designs for the potentially expanding Original Equipment Manufacturer (OEM) customers, whose needs require the integration of CXR's products with their own. PATENTS AND TRADEMARKS The Company regards its software, hardware and manufacturing processes as proprietary and relies on a combination of patent, copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions, including employee and third-party nondisclosure agreements, to protect its proprietary rights. The Company seeks to protect its software, documentation and other written materials under trade secret and copyright laws, which afford some limited protection. The laws of some foreign 9 countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. The Company requires that its employees enter into confidentiality agreements as a condition of employment. COMPETITION The Instrumentation and Test Equipment Sector has numerous competitors with greater technological, financial and marketing resources than those possessed by the Company. The ability of the Company to compete in the Instrumentation and Test product lines is dependent on several factors including price, technology, product performance, service and its ability to attract and retain qualified management and technical personnel. The market for printed circuit boards in the United States is fragmented and very competitive. The Company believes there are over 700 companies producing circuit boards in the United States. XIT competes primarily against other independent manufacturers. While there are no dominant manufacturers in the segment of the industry served by XIT, the Company also faces competition in this sector from certain captive circuit board manufacturers who seek orders in the open market to fill excess capacity, thereby increasing price competition. A number of the Company's competitors are larger than the Company and have greater financial, marketing and other resources. It is for these reasons in combination with the Company's strategic plan that the Company has effectively exited this market. The Company's Components and Subsystem Assemblies Sector competes in a highly fragmented market composed of a diverse group of manufacturers. The Company believes that the primary bases of competition in this market segment are capability, price, manufacturing quality, advanced manufacturing technology and reliable delivery. The Company believes that by focusing on low to medium-volume production, and by manufacturing subsystems using its in-house manufactured components, the Company can compete, particularly in Europe. Additionally, by taking on a wider range of systems than its larger competitors and by having access to a diversified customer base, the Company believes it is able to diversify its workload and is not as dependent as some of its competitors on individual contracts, customers or industries. REGULATION The Federal Communication Commission ("FCC") has adopted regulations with respect to the interconnection of communications equipment with telephone lines and radiation emanations of certain equipment. CXR has complied with these regulations and received all necessary FCC approvals for its line of trunk testing equipment. As additional products require certification, CXR believes it will be able to satisfy all such future requirements. The Company believes it complies with environmental regulations since it assembles, rather than manufactures, electronic components and therefore discharges into the environment are believed to be negligible. The Company's product lines are subject to certain federal and state statutes governing safety and environmental protection. The Company believes that it is in substantial compliance with all such regulations and is not aware of any proposed or pending safety or environmental rule or regulation which, if adopted, would have a material impact on its business or financial condition. EMPLOYEES As of December 31, 1998, the Company employed 303 persons. Of these employees, 201 employees are employed in the United States and 102 are employed in Europe and Japan. None of the Company's employees are represented by unions and there have not been any work stoppages at any of the Company's facilities. The Company believes that its relationship with its employees is good. 10 ITEM 2. PROPERTIES The Company leases or owns approximately 205,000 square feet of administrative, production, storage and shipping space. All of these facilities are leased other than the Abondant, France facility. The Ontario facility is owned by Capital Source Partners, a California real estate partnership in which XIT holds a 50% ownership interest.
BUSINESS UNIT LOCATION FUNCTION - --------------------------------------------------- -------------------------------- --------------------------- XCEL Information Technologies/Digitran Ontario, California Corporate headquarters/ (Components and subsystem assemblies) Manufacturing XCEL Circuit Division Monrovia, California Manufacturing (Circuits) XCEL Etch Tek Concord, California Administrative/ (Circuits) Manufacturing XCEL Power Systems Ashford, United Kingdom Administrative/ (Components and subsystem assemblies) Manufacturing XCEL Japan, Ltd. Tokyo, Japan Administrative/ (Components and subsystem assemblies) Assembly HyComp, Inc. Marlborough, Massachusetts Administration/ (Circuits) Manufacturing CXR, S.A Paris, France Administrative (Instrumentation and test equipment) CXR, S.A. Abondant, France Manufacturing (Instrumentation and test equipment) CXR Fremont, California Administrative/ (Instrumentation and test equipment) Manufacturing
The lease for the Fremont facility will expire in or about September 2002, with one five-year renewal option. The lease for the Paris, France facility expires in April 2007. The Ontario facility is covered by a lease that expires in September 2006, with options to extend until September 2010. The Monrovia facility is covered by a lease that expires in October 1999. The Concord facility is subject to a lease that expires in September 2001, with options to renew until April 2016. The Marlborough facility is subject to a lease which expires in October 2000, and the Tokyo facility is subject to a lease which expires in March 2000. The Ashford facility is subject to a fifteen-year lease which expires in September 2011, subject to the right of the Company to terminate the lease after five years, and the rights of the Company or the landlord to terminate the lease after ten years. The Company believes that these facilities are adequate for the current business operations. ITEM 3. LEGAL PROCEEDINGS SCHEINFELD V. MICROTEL INTERNATIONAL, INC. In October 1996, David Scheinfeld brought an action in the Supreme Court of the State of New York, County of New York, to recover monetary damages in the amount of $300,000 allegedly sustained by the failure of the Company, its stock transfer agent and its counsel to timely deliver and register 40,000 shares of Common Stock purchased by Mr. Scheinfeld. The Company was informed by Mr. Scheinfeld that in order to settle his claims, the Company would have to issue him unrestricted shares of common stock. Since, in the absence of registrations, the Company could not issue unrestricted shares, the Company answered Mr. Scheinfeld's motion and sought to compel him to serve a complaint upon the defendants. On June 30, 1997, the complaint was served, and the Company has subsequently answered, denying the 11 material allegations of the complaint. In August 1997, the Company served discovery requests on Mr. Scheinfeld, who was initially obligated to respond by September 12, 1997. Several court scheduling and preliminary settlement conferences were held during 1998 with no definitive outcome. Discovery is presently scheduled to be completed during April 1999. Although the ultimate outcome of this matter cannot be predicted with certainty, pending actual resolution, management believes the disposition of this matter will not have a material adverse affect on the consolidated financial position, results of operations or cash flows. DANIEL DROR & ELK INTERNATIONAL, INC. V. MICROTEL INTERNATIONAL, INC. In November 1996, the Company entered into an agreement (the "Agreement") with the former Chairman of the Company, which involved certain mutual obligations. In December 1997, the former Chairman defaulted on the repayment of the first installment of a debt obligation which was an obligation set forth in the Agreement. Also in December 1997, the former Chairman of the Company, filed suit in the District Court for Galveston County, Texas alleging the Company had breached an alleged oral modification of the Agreement. In January 1998, the Company answered the complaint denying the allegation and litigation commenced in Texas. In April 1998, the Company brought an action in California against the former Chairman for breach of the Agreement and sought recovery of all stock, warrants and debt due the Company. The Company obtained a judgement against the former Chairman in this litigation. In December 1997, Elk International Corporation Limited ("Elk"), a stockholder of the Company, brought an action in Texas against the Company's current Chairman and an unrelated party, alleging certain misrepresentations during the merger discussions between XIT and the Company. In February 1999, Elk filed suit against the Company and the current Chairman in connection with a stop transfer placed by the Company on certain common shares held by Elk. On March 1, 1999, the parties entered into a settlement agreement which terminated all of the actions discussed in the previous three paragraphs. The agreement calls for the Company to issue to Elk, Dror and other parties a combination of cash, stock and warrants which have an aggregated fair value of approximately $130,000. The cash portion of the settlement is $60,000 and is payable over a six month period. The Company has properly accrued for this settlement in the accompanying 1998 consolidated financial statements. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. (A) MARKET INFORMATION. Since September 11, 1996, the Company's common stock has been trading on the NASDAQ SmallCap Market under the symbol MCTL, until February 19, 1999 when the symbol changed to MCTLC (see below). Prior to that date, the shares of the Company's common stock had been listed on the American Stock Exchange under the symbol MOL. Accordingly, the tables below reflect the high and low sales prices for a share of the Company's common stock during the period they were listed on the AMEX, and the high and low bid information for the period during which they were listed on the Nasdaq SmallCap(SM) Market ("Nasdaq"). The quotations below for dates commencing September 11, 1996 reflect inter-dealer prices, without retail mark-ups, mark-downs or commissions, and may not represent actual transactions. 12 On August 13, 1998, the Company received notice from Nasdaq that the closing bid price of the Company's common stock had fallen below Nasdaq's minimum requirement of $1.00 for the prior 30 consecutive trading days and that unless the closing bid price could be maintained at or above $1.00 for ten consecutive trading days prior to November 13, 1998, the Company's common stock would be delisted by Nasdaq. By November 12, 1998, the closing bid price of the Company's common stock had not traded at or above $1.00 as required and, on that date, the Company requested that Nasdaq conduct a hearing to review the Company's plans for compliance with the minimum bid requirement. The hearing was conducted on January 22, 1999 and on February 17, 1999, Nasdaq advised the Company that, in Nasdaq's view, "...the Company had presented a definitive plan which [would] enable it to regain compliance with the bid price requirement..." and accordingly, Nasdaq elected to continue the listing of the Company's common stock under an exception which required that (i) prior to May 17, 1999, the Company evidence a closing bid price of at least $1.00 per share and thereafter maintain such bid price for a minimum of ten (10) consecutive trading days and (ii) prior to March 31, 1999, the Company obtain shareholder approval for the issuance by the Company in July 1998 of 200 shares of convertible preferred stock. On March 16, 1999, Nasdaq extended the date for the Company to obtain shareholder approval to May 17, 1999. The Company is presently preparing to solicit shareholder approval for the convertible preferred stock issuance as soon as practicable following the filing of this report and has commenced execution of its plan to comply with Nasdaq's minimum bid price requirement. On August 15, 1996, the shareholders of the Company ratified a one-for-five reverse stock split effective for holders of record on August 29, 1996. The sales prices below have been restated to give effect to the reverse split.
CALENDAR YEAR HIGH LOW - ------------------------------------------------------------------------ --------- --------- 1998 Fourth Quarter.......................................................... $ 0.875 $ 0.375 Third Quarter........................................................... 1.063 0.438 Second Quarter.......................................................... 1.25 0.938 First Quarter........................................................... 1.625 1.00 1997 Fourth Quarter.......................................................... $ 2.4375 $ 1.1563 Third Quarter........................................................... 2.625 2.375 Second Quarter.......................................................... 2.8125 1.875 First Quarter........................................................... 3.4375 1.4375 1996 Fourth Quarter.......................................................... $ 3.25 $ 1.0625 Third Quarter........................................................... 5.625 3.125 Second Quarter.......................................................... 8.75 4.6875 First Quarter........................................................... 9.375 5.3125
(B) SHAREHOLDERS As of March 18, 1999, the Company had 3,709 stockholders of record, of which 437 were round lot stockholders, and approximately 3,400 beneficial stockholders. (C) DIVIDENDS No dividends on the Common Shares have been paid by the Company to date. The Company's Loan and Security Agreement with Congress Financial Corporation prohibits the payment of cash dividends. The Company currently intends to retain future earnings to fund the development and growth of its business and, therefore, does not anticipate paying cash dividends on the Common Shares within the foreseeable future. Any future payment of dividends on the Common Shares will be determined by the 13 Company's Board of Directors and will depend on the Company's financial condition, results of operations and other factors deemed relevant by its Board of Directors. ITEM 6. SELECTED FINANCIAL DATA. The following table summarizes selected consolidated financial data for the Company for the years ended December 31, 1998 and 1997, the three months ended December 31, 1996 and the years ended September 30, 1996, 1995 and 1994. The data has been derived from and should be read in conjunction with the Company's Consolidated Financial Statements, the related Notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations. The financial data as of and for the three months ended December 31, 1996 are not necessarily indicative of results that may be expected for the full year. MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE YEAR YEAR MONTHS YEAR ENDED SEPTEMBER 30, ENDED DEC ENDED DEC ENDED DEC ------------------------------- 31, 1998 31, 1997 31, 1996 1996 1995 1994 --------- --------- --------- --------- --------- --------- Net sales....................................... $ 37,261 $ 43,098 $ 7,886 $ 31,249 $ 19,602 $ 14,237 Net income (loss)............................... $ (1,185) $ (9,693) $ (905) $ 1,083 $ 337 $ (672) Income (loss) available to common stockholders.................................. $ (1,245) $ (9,753) $ (924) $ 1,003 $ 327 $ (672) Basic and diluted earnings (loss) per share..... $ (.10) $ (.96) $ (.15) $ .17 $ .07 $ (.14) Total assets.................................... $ 21,242 $ 25,440 $ 20,564 $ 19,613 $ 15,955 $ 11,137 Long-term obligations, less current portion..... $ 2,384 $ 3,319 $ 3,549 $ 2,678 $ 1,524 $ 740 Redeemable preferred stock...................... $ 1,516 $ 714 $ 794 $ 775 $ 835 $ -- Stockholders' equity............................ $ 5,482 $ 6,015 $ 5,047 $ 5,845 $ 4,464 $ 3,263 Shares outstanding at period end................ 12,622 11,926 6,064 6,064 5,814 4,886
No cash dividends on the Company's common stock were declared during any of the periods presented. Shares outstanding and earnings (loss) per share have been restated to give effect to the recapitalization of XIT Corporation (the accounting acquiror) in the "reverse acquisition" of MicroTel International, Inc. by XIT Corporation on March 26, 1997. As discussed previously, the historical financial data above prior to the Merger is that of XIT Corporation (the "Accounting Acquiror"). In conjunction with the reverse acquisition accounting treatment, XIT changed its fiscal year end from September 30 to December 31 to adopt the fiscal year end of MicroTel International, Inc. The three month period ended December 31, 1996 represents the "transition" period between XIT's fiscal year ended September 30, 1996 and the beginning of its new fiscal year, January 1, 1997. 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. WHEN USED IN THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, THE WORDS "MAY," "WILL," "EXPECT," "ANTICIPATE," "CONTINUE," "ESTIMATE," "PROJECT," "INTEND," "SHOULD," "BELIEVE" AND SIMILAR EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934 REGARDING EVENTS, CONDITIONS AND FINANCIAL TRENDS THAT MAY AFFECT THE COMPANY'S FUTURE PLANS OF OPERATIONS, BUSINESS STRATEGY, OPERATING COSTS AND FINANCIAL POSITION. SPECIFICALLY, FORWARD-LOOKING STATEMENTS ARE INCLUDED IN THE FOLLOWING SECTIONS BELOW: LIQUIDITY AND CAPITAL RESOURCES, OUTLOOK, AND NEW ACCOUNTING PRONOUNCEMENTS. PROSPECTIVE INVESTORS, READERS OR OTHER USERS OF THIS REPORT ARE CAUTIONED THAT ANY FORWARD-LOOKING STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND ARE SUBJECT TO RISKS AND UNCERTAINTIES AND THAT ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THOSE INCLUDED WITHIN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS. As discussed previously herein and in the notes to the accompanying consolidated financial statements, the consolidated financial statements presented are those of XIT Corporation and its wholly and majority-owned subsidiaries and beginning March 26, 1997, include the Company and its subsidiaries CXR Telcom Corporation and CXR, S.A. (the "Former Company"). This is the result of the reverse acquisition by XIT of MicroTel International, Inc. (the Registrant) and its subsidiaries in a merger on March 26, 1997 (the "Merger"). The Former Company and "accounting acquiree" is described as "CXR" in the discussion below. XIT Corporation is referred to as "XIT." The Company conducts its operations out of various facilities in the U.S., France, England, and Japan and organizes itself in three product line sectors-Circuits, Components and Subsystem Assemblies, and Instrumentation and Test Equipment. The Circuits Sector operates principally in the U.S. market, the Components and Subsystems Assemblies Sector operates in the U.S., European and Asian markets, and the Instrumentation and Test Equipment Sector operates principally in the U.S. and European markets. The Instrumentation and Test Equipment Sector and the Components and Subsystems Assembly Sector are referred to as "the Test Equipment Sector" and "the Components Sector" in the discussion below for brevity. In conjunction with the merger of XIT and CXR, XIT changed its fiscal year end from September 30 to December 31 to conform to the fiscal year of CXR. Consequently, the consolidated financial statements discussed herein are for the years ended December 31, 1998 and 1997, the three months ended December 31, 1996 (the transition period), and the year ended September 30, 1996. The Company's Instrumentation and Test Equipment Sector business is conducted solely by CXR and accordingly its results of operations are not included in the results of operations for the three months ended December 31, 1996 or the year ended September 30, 1996. 15 RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1998 VERSUS YEAR ENDED DECEMBER 31, 1997 NET SALES Consolidated net sales decreased by $5,837,000 or 13.5% in 1998 compared with 1997. This decrease in sales was due in large part to the sale of the Company's XCEL Arnold Circuits, Inc. subsidiary ("XCEL Arnold") as of March 31, 1998. The table below sets forth the composition of consolidated net sales by business sector, separately identifying the operations of XCEL Arnold during the years ended December 31, 1998 and 1997 (dollars in thousands).
INCREASE/(DECREASE) -------------------- 1998 1997 VARIANCE PERCENT --------- --------- --------- --------- Sector Test Equipment........................................................ $ 17,532 $ 15,054 $ 2,478 16.5% Components............................................................ 12,412 12,197 215 1.8% Circuits.............................................................. 5,807 6,817 (1,010) (14.8%) XCEL Arnold (sold 3/31/98)............................................ 1,510 9,030 (7,520) (83.3%) --------- --------- --------- Total Sales........................................................... $ 37,261 $ 43,098 $ (5,837) (13.5%) --------- --------- --------- --------- --------- ---------
During 1998, the Test Equipment Sector experienced a substantial increase in net sales in that Sector's French business operation, CXR, S.A, which increased sales by $2,668,000 or 31.5% over its sales levels in 1997. The Sector's CXR Telcom business unit experienced a slight decline in sales of $190,000 or 2.8% compared with prior year as the growth in the sales of new test instruments substantially replaced products which are reaching the end of their life. The growth in the French business operation resulted from increased sales of both internally produced and third party resale products. The sales growth rate for this Sector is expected to increase in 1999 as both new and existing customers of the CXR Telcom subsidiary place orders under purchasing agreements finalized during the last quarter of 1998 and as a result of the French operation's expanded product offerings. Net sales in the Component Sector increased only slightly as sales of digital switch products increased in 1998 to offset a decline in sales of custom engineered subsystem component and display products, both of which have now been discontinued as part of the Company's strategic decision to focus its attention and resources on only higher margin products and core instrumentation and test products. The backlog for this Sector rose approximately 11% or $685,000 from December 31, 1997 to December 31, 1998 indicating a continued demand for both digital switch products, despite the aging of the product line, and custom power supply products which are manufactured and distributed in the Sector's United Kingdom operations. Overall Circuits Sector sales, excluding XCEL Arnold, decreased as sales for XIT's XCEL Etch-Tek division ("Etch-Tek") decreased approximately $1 million from 1997 levels, particularly in the latter half of 1998, as insufficient working capital was available to enable Etch-Tek to acquire the necessary raw materials and process supplies to accept higher levels of "quick-turn" (short manufacturing time) order commitments. The sales of Etch-Tek are not expected to return to former levels in the foreseeable future and the Company has instituted significant cost reduction measures to bring the operation's overhead expenses into line with anticipated internal requirements and outside customer sales levels. 16 GROSS PROFIT The composition of consolidated gross profit by business sector and the percentages of related net sales are as follows for the years ended December 31, 1998 and 1997.
1998 1997 -------------------- -------------------- (DOLLARS IN THOUSANDS) Sector Test Equipment........................................................... $ 8,052 45.9% $ 6,319 42.0% Components............................................................... 4,650 37.5% 2,863 23.5% Circuits................................................................. 688 9.4% 1,246 7.9% --------- --------- Total Gross Profit....................................................... $ 13,390 35.9% $ 10,428 24.2% --------- --------- --------- ---------
Consolidated gross profit as a percentage of net sales increased 11.7% percentage points in 1998 from 1997, as the impact of the higher margin sales in the Test Equipment Sector represented a larger component of the consolidated sales mix for 1998. Gross profit margin percentages in the Test Equipment Sector increased in 1998 from 1997 and the Sector's net sales as a percent of total net sales increased to 47.1% in 1998 from 34.9% in 1997. Additionally, gross profit margins as a percent of net sales rose substantially in the Components Sector where net sales remained stable. Accordingly, the Company generated an increase of approximately $3.0 million in gross profit on $5.8 million less in net sales. The improvement in gross profit percentage for the Test Equipment Sector resulted from the introduction in early 1998 of a new line of test instruments at the Company's CXR Telcom subsidiary. These new, software-intensive test instruments were designed to replace aging, hardware-intensive products which had comparatively lower margins. Additionally, sales mix at the Company's CXR, S.A subsidiary shifted to higher margin, internally manufactured products in 1998. Also, management at CXR, S.A. sought to improve profits through the addition of new third-party products. The improvement in gross profit percentage for the Components Sector was the combined result of (i) a favorable product mix shift to higher margin digital switch products noted above under Net Sales and (ii) relatively higher margins for products sold by XCEL Power Systems, Inc., located in the U.K. ("XPS"), in 1998 which also experienced a shift in product mix as management focused sales efforts on more desirable custom power supply products with associated higher gross profit margins. The increase in gross profit for the Circuits Sector was principally the result of the sale of XCEL Arnold and the associated avoidance of continued negative margins at that operation in 1998 as compared with 1997, the effect of which was partially offset by relatively higher costs for the Sector's Etch Tek division's product sales in 1998 compared with 1997 due to the underabsorption of fixed manufacturing costs related to declining sales levels. 17 OPERATING EXPENSES Operating expenses for the years ended December 31, 1998 and 1997 were comprised of the following:
1998 1997 --------- --------- (IN THOUSANDS) Commissions............................................................. $ 1,167 $ 1,511 Other selling........................................................... 4,230 3,690 --------- --------- Total selling expense................................................... 5,397 5,201 General & administrative expense........................................ 6,429 6,160 --------- --------- Total selling, general & administrative................................. $ 11,826 $ 11,361 --------- --------- --------- --------- Engineering & product development....................................... $ 2,454 $ 2,046 --------- --------- --------- ---------
Total selling expense as a percentage of net sales was 14.5% and 12.1% for the years ended December 31, 1998 and 1997, respectively. Commissions as a percentage of sales decreased slightly from 3.5% in 1997 to 3.1% in 1998 as a result of and in direct relation to the decrease in Circuits Sector sales. In contrast to Components Sector sales which are primarily achieved through direct selling, the majority of Circuits Sector sales are made through manufacturer representatives. The increase in other selling expense, which consists of sales and marketing departmental costs, from 1997 to 1998, occurred principally in the Test Equipment Sector as the other Sectors remained relatively stable. This increase in the Test Equipment Sector was the result of the inclusion of CXR's operations for the entire twelve months in 1998 versus nine months in 1997 subsequent to the Merger on March 26, 1997. General and administrative expense increased by $269,000 in 1998 from 1997. This increase occurred in the Test Equipment Sector and was the result of the inclusion of CXR's operations for the entire twelve months in 1998 versus nine months in 1997. General and administrative expenses represent not only those costs associated with general corporate overhead but also reflects the dispersion of the Company's business operations onto three continents as well as the broad diversity of products which are produced in each of the local markets served by those business operations. Additionally, included in this category are expenses associated with legal matters which, although resolved in late 1998 and early 1999, pre-date the Merger (see Item 3--Legal Proceedings and Note 14 to the Consolidated Financial Statements included elsewhere in this report). Engineering and product development costs originated principally from the research and product development activities of the Test Equipment Sector and increased by $408,000 in 1998 from 1997 as additional engineering staff associated with the introduction of new test instruments was added. OTHER INCOME AND EXPENSE The decrease in interest expense of $220,000 in 1998 from 1997 resulted principally from decreased average borrowings during the respective periods. Fluctuations in other expense (income), net resulted principally from differences in foreign currency exchange gains and losses incurred during the respective periods. Other income in 1998 also included the gain on the sale of XCEL Arnold of $580,000. INCOME TAXES Income taxes, while nominal in both respective periods, consists primarily of foreign taxes as the Company is in a loss carryforward position for Federal income tax purposes. 18 FISCAL YEAR ENDED DECEMBER 31, 1997 VERSUS FISCAL YEAR ENDED SEPTEMBER 30, 1996 The following discussion relates to the comparison of the results of operations for the twelve months ended December 31, 1997 ("Fiscal 1997") versus the twelve months ended September 30, 1996 ("Fiscal 1996"), excluding the results of CXR which are discussed separately below.
FISCAL 1997 ------------------------------------- CONSOLIDATED CXR COMPARATIVE FISCAL 1996 ------------ --------- ------------ ----------- (IN THOUSANDS) Net sales..................................................... $ 43,098 $ 15,054 $ 28,044 $ 31,249 Cost of sales................................................. 32,670 8,735 23,935 23,057 ------------ --------- ------------ ----------- Gross profit.................................................. 10,428 6,319 4,109 8,192 Selling expense............................................... 5,201 2,562 2,639 2,409 General & administrative...................................... 6,160 1,196 4,964 3,970 Engineering & product development............................. 2,046 1,797 249 309 Write-down of goodwill........................................ 5,693 4,000 1,693 -- Interest expense.............................................. 895 110 785 507 Other expense (income)........................................ 29 106 (77) (108) Income taxes.................................................. 97 6 91 22 ------------ --------- ------------ ----------- Net income (loss)............................................. $ (9,693) $ (3,458) $ (6,235) $ 1,083 ------------ --------- ------------ ----------- ------------ --------- ------------ -----------
NET SALES Net sales for Fiscal 1997 declined by $3,205,000 or 10.3% from Fiscal 1996. This decline was comprised of lower sales for the Company's Circuits Sector of $3,019,000 and a decrease in the sales for the Components Sectors of $186,000. The decrease for Fiscal 1997 in the Circuits Sector was comprised of an increase in Sector sales of $2,212,000 due to the inclusion of Etch Tek's operations for the entire twelve months in Fiscal 1997 versus five months in Fiscal 1996 subsequent to its acquisition on May 1, 1996, and a decline in sales for the remainder of the Sector of $5,231,000 which primarily occurred in the XCEL Arnold subsidiary. This latter decline was due principally to lower demand from the major customer of the group, Motorola. Lower demand in the first quarter of 1997 was based on reduced customer requirements and the effects on the Sector were compounded by an inability to ship the orders received as a result of material sourcing problems caused by cash flow constraints during the same quarter. Although it is believed that customer requirements increased in the second quarter of 1997, the Sector continued to experience lower demand due to order cutbacks by Motorola resulting from the previous shipment performance problems. The decrease in net sales in the Components Sector was the net result of an increase in Sector sales of $4,248,000 due to the inclusion of the operating results of XCEL Power Systems, Ltd ("XPS") for the entire twelve months in 1997 versus one month in Fiscal 1996 subsequent to its acquisition on September 1, 1996 which was more than offset by: (i) the loss in July 1996 of a major account for display monitors, (ii) a significant digital switch program in place in the first half of 1996 which did not repeat in 1997 and (iii) a general decline in sector product sales due to the aging of related customer programs. 19 GROSS PROFIT The composition of consolidated gross profit by business sector and the percentages of related net sales for Fiscal 1997 and Fiscal 1996 are as follows.
FISCAL 1997 FISCAL 1996 -------------------- -------------------- (DOLLARS IN THOUSANDS) Circuits Sector............................................................... $ 1,246 7.9% $ 3,570 18.9% Components Sector............................................................. 2,863 23.4% 4,622 37.3% --------- --------- Total Gross Profit............................................................ $ 4,109 14.7% $ 8,192 26.2% --------- --------- --------- ---------
Consolidated gross profit, as a percentage of sales, declined from 26.2% in Fiscal 1996 to 14.7% in Fiscal 1997 as the result of decreases in gross profit of 11.0 and 13.9 percentage point decreases in gross profit percentage for the Circuits and Components Sectors, respectively. The decrease for the Components Sector was the combined result of (i) the lower sales volume, net of the inclusion of XPS, for the reasons noted above and the consequential decline in absorption of the Company's fixed manufacturing costs, and (ii) higher than average margins on a Fiscal 1996 digital switch program that did not repeat in Fiscal 1997. The decline in gross profit for the Circuits Sector was caused by higher costs for XCEL Arnold's product sales due to the lower absorption of fixed manufacturing costs related to declining sales levels and manufacturing inefficiencies from a product mix change to higher technical content circuit boards, and despite improved margins at Etch-Tek in Fiscal 1997 over those achieved in Fiscal 1996. OPERATING EXPENSES Operating expenses (selling, general and administrative; engineering and product development; and write-down of goodwill) increased by approximately $2,857,000 from $6,688,000 in Fiscal 1996 to $9,545,000 in Fiscal 1997. The primary component of this change was a write-down of goodwill of $1,693,000 (see Note 11 to the Consolidated Financial Statements included elsewhere herein). This write-down resulted from the Company's reassessment of the anticipated impact of current industry and economic factors on the Company's operations. Net realizable value was based on estimated undiscounted future cash flows from the related assets. Selling expenses as a percentage of sales increased from 7.7% in Fiscal 1996 to 9.4% in Fiscal 1997, despite the fact that they include significant commissions and are therefore largely variable. The increase was due to a higher mix of house account to manufacturer's representative sales, principally in the second quarter of 1996 versus the second quarter of 1997, and to the effects on the 1997 percentage of spreading fixed departmental costs over the lower sales volume for the year. General and administrative expenses increased by $994,000 or 25.0% in Fiscal 1997 over Fiscal 1996 as the positive effects of the streamlining of the administrative structure in the Circuits Sector in the second half of 1996, which approximated $601,000 for Fiscal 1997, were more than outweighed by the inclusion of XPS for the entire twelve months in 1997 versus only one month in 1996 and increased corporate administrative costs. The latter corporate cost increases relate principally to incremental legal fees associated with public reporting and integration matters following and resulting from the merger of XIT and CXR, and secondarily to higher personnel costs and the implementation of a new computer system in 1997. Engineering and product development expenses declined by $60,000 from Fiscal 1996 to Fiscal 1997 due principally to an increase in the amount of such costs billable to specific contracts. Interest expense increased by $278,000 in Fiscal 1997 versus Fiscal 1996 principally reflecting higher average borrowings during the respective periods. Other expense (income) is principally comprised of foreign currency exchange gains and losses incurred during the respective periods. Income taxes, while nominal in both respective periods, increased $69,000 resulting from an income tax payable by the Company's U.K. subsidiary related to debt forgiveness in connection with the XPS 20 subsidiary acquisition. The Company's domestic income tax obligation primarily consists of minimum state tax payments as the Company is in a loss carryforward position for Federal income tax purposes. RESULTS OF CXR The table following summarizes the incremental results of CXR for Fiscal 1997.
(IN THOUSANDS) Net sales...................................................................... $ 15,054 ------------- ------------- Gross profit $ 6,319 ------------- ------------- Operating expenses............................................................. 5,555 Write-down of goodwill......................................................... 4,000 Other expenses................................................................. 222 ------------- Net loss....................................................................... $ 3,458 ------------- -------------
CXR's results of operations above consist of the nine months and five days ended December 31, 1997 subsequent to the merger on March 26, 1997. CXR's results of operations for Fiscal 1997, shown above include net earnings of $105,000 on net sales of $500,000 for the five day period ended March 31, 1997, including amortization of goodwill originating in the merger of $5,000. For the entire three months ended March 31, 1997, however, CXR incurred a net loss of $1,904,000 on net sales of $3,496,000. Included in these quarterly results prior to March 26, 1997, CXR incurred certain significant charges as follows: (i) $462,000 of compensation expense related to certain officers and directors whose corporate capacities would terminate or change at the date of the merger with XIT and (ii) $287,000 of asset write-downs and severance costs related to the reassessment of the impact on asset realizable values and certain cutbacks in personnel, respectively, necessitated by the continuing sluggishness of its business volume. These charges directly impacted the net loss of CXR for the quarter as there are no tax effects because CXR is in a net operating loss carryforward position. Even considering these charges, CXR's results for the first quarter of 1997 exhibited a significant deterioration from the first quarter of 1996, in which it incurred a net loss of $715,000 on net sales of $4,134,000. This deterioration resulted from the continuing and worsening impact on CXR of the industry and economic factors discussed below. Through the majority of 1997, domestic sales for CXR were generally negatively impacted by delays in purchasing by its principal customers, as a result of the consolidation and/or restructuring of these companies in the wake of the passage of the Telecommunications Bill of 1996. One notable exception was the receipt in April 1997 of an order totaling $2,340,000 from AT&T for customized test instruments. European sales of CXR, S.A. were negatively impacted by a decline in sales to France Telecom during its pre-privatization reorganization and a generally weak French economy in which unemployment continued to be at peak levels. Additionally, sales for both operating subsidiaries have been negatively impacted by the rapid obsolescence of the analog-based components of their product lines, particularly older transmission products and further, both sales and margins have been impacted by extreme price competition for transmission products in general. Compared to the first quarter of 1997, CXR's results improved significantly in the second, third and fourth quarters as the result of substantially increased net sales, a favorable impact on margins resulting from the shipment of a high-margin product on an order received from AT&T in April 1997, and the positive effects of personnel cutbacks made in the first quarter. Of the total AT&T order of $2,340,000, CXR Telcom shipped approximately $241,000, $650,000 and $1,449,000 in the second, third and fourth quarters, respectively. As a result of declining demand for certain of its test instruments, the aging of its transmission product line and other economic and market factors, the Company wrote down the carrying value of the goodwill originating from the reverse acquisition with XIT to its net realizable value (see Note 11 to the Consolidated Financial Statements included elsewhere herein). Exclusive of the write-down 21 of goodwill, for the full twelve month period ended December 31, 1997, CXR incurred a net loss of $1,862,000 on net sales of $18,050,000 versus a net loss of $4,597,000 on net sales of $16,303,000 in the same period of 1996. Although not necessarily indicative of the results that would have occurred or of results which may occur in the future, a summary of the unaudited pro forma results as if the merger had taken place at the beginning of 1997 is presented in Note 2 to the Consolidated Financial Statements included elsewhere herein. THREE MONTHS ENDED DECEMBER 31, 1996 VERSUS THREE MONTHS ENDED DECEMBER 31, 1995 EFFECTS OF ACQUISITIONS ON THE THREE MONTHS ENDED DECEMBER 31, 1996 The consolidated results of operations for the three months ended December 31, 1996 include the results of operations of two companies acquired since December 31, 1995. They include the full quarterly results of both Etch-Tek, a manufacturer of printed circuit boards acquired on May 1, 1996, and Abbott, a British manufacturer of power supplies acquired on September 1, 1996. The table below separates the results of the acquired entities from the consolidated totals for the three months ended December 31, 1996 in order to provide a more meaningful basis for a comparative discussion of these results versus the three months ended December 31, 1995.
THREE MONTHS ENDED DECEMBER 31, ---------------------------------------------------- 1996 ----------------------------------------- CONSOLIDATED ACQUISITIONS COMPARATIVE 1995 ------------- ----------- ------------- --------- (IN THOUSANDS) Net sales..................................................... $ 7,886 $ 2,200 $ 5,686 $ 6,796 Cost of sales................................................. 6,680 1,668 5,012 5,073 ------ ----------- ------ --------- Gross profit.................................................. 1,206 532 674 1,723 Selling expense............................................... 556 105 451 554 General & administrative...................................... 1,260 425 835 817 Engineering & product development............................. 69 -- 69 76 Interest expense.............................................. 183 72 111 98 Other expense (income)........................................ 13 (1) 14 27 Income taxes.................................................. 30 -- 30 -- ------ ----------- ------ --------- Net income (loss)............................................. $ (905) $ (69) $ (836) $ 151 ------ ----------- ------ --------- ------ ----------- ------ ---------
As can be seen from the table, the consolidated results of operations for the three months ended December 31, 1996 were significantly impacted by the results of the acquired companies. Net sales, gross profit, and operating expenses (selling, general and administrative, and engineering and product development) of these companies represented 27.9%, 44.1%, and 28.1%, respectively, of the consolidated totals. 22 The table following summarizes by company the incremental results related to the acquired companies for the three months ended December 31, 1996 (in thousands):
ETCH-TEK XPS TOTAL ----------- --------- --------- Net sales....................................................... $ 1,013 $ 1,187 $ 2,200 ----------- --------- --------- ----------- --------- --------- Gross profit.................................................... $ 124 $ 408 $ 532 ----------- --------- --------- ----------- --------- --------- Operating expenses.............................................. 182 348 530 Interest expense................................................ 16 56 72 Other expense (income).......................................... (1) -- 1 ----------- --------- --------- Net income(loss)................................................ $ (73) $ 4 $ (69) ----------- --------- --------- ----------- --------- ---------
COMPARATIVE RESULTS OF OPERATIONS--THREE MONTHS ENDED DECEMBER 31, 1996 VERSUS THREE MONTHS ENDED DECEMBER 31, 1995 The following discussion relates to the comparison of the results of operations for the three months ended December 31, 1996, excluding the results of the acquired companies, to the results for the same period of the prior year (see the first table above under Effects of Acquisitions on the Three Months Ended December 31, 1996). Net sales for the three months ended December 31, 1996 declined by $1,110,000 or 16.3% from those in the same period of the prior year. The decline was principally in the Components Sector, whose sales declined $1,183,000 or 37%. Approximately $640,000 of the decline in the Components Sector's sales was due to the loss of a major account for display monitors, and the remaining decline resulted principally from the timing of orders from a significant subsystem assembly customer. Gross profit, as a percentage of sales, declined from 25.4% in the three months ended December 31, 1995 to 11.9% for the three months ended December 31, 1996. This decline was the combined result of (i) the lower sales volume for the Components Sector noted above and the consequential decline in absorption of fixed manufacturing costs and (ii) manufacturing inefficiencies incurred by the Circuits Sector because of a product mix change to higher technical content circuit boards. Operating expenses (selling, general and administrative, and engineering and product development) decreased by $92,000 in total from $1,447,000 in the three months ended December 31, 1995 to $1,355,000 in the three months ended December 31, 1996. Selling expense, as a percentage of sales, was 7.9% in 1996 versus 8.2% in 1995. Selling expense consists principally of commissions for Circuits Sector sales and fixed departmental costs for Components Sector sales. The decrease in percentage in 1996 is consequently due to the decline in sales for the Components Sector noted above. General and administrative and engineering and product development expenses were relatively comparable between the periods. The apparent flat level of general and administrative expenses, however, was the combined result of the positive effects in 1996 of the streamlining of the administrative structure in the Circuits Sector being offset by the inclusion in 1995 of a reversal of an accrual of $176,000 related to the favorable disposition of certain long-disputed administrative costs. Interest expense increased by only $13,000, as a result of significantly higher average borrowings in 1996 being mitigated by lower interest rates due to the refinancing of the Company's bank facilities in January 1996. Other expense (income), net is principally comprised of foreign currency exchange gains and losses incurred during the respective periods, and in 1996, includes equity in the loss of a real estate partnership of $13,000. Income taxes are nominal in the respective periods as the Company is in a loss carryforward position for Federal income tax purposes (see Note 12 to the Consolidated Financial Statements included elsewhere in this report). 23 LIQUIDITY AND CAPITAL RESOURCES OPERATING ACTIVITIES Cash provided by (used in) operations was $(3,133,000), $(1,668,000), $(564,000) and $789,000 for the year ended December 31, 1998 and 1997, the three months ended December 31, 1996 and the year ended September 30, 1996. The principal non-cash items contributing to these cash flows are: (i) depreciation and amortization which was $858,000, $1,281,000, $276,000 and $799,000 in the respective periods, with the increasing trend due principally to acquired operations, partially offset by the sale of XCEL Arnold during 1998; (ii) the write-down of goodwill in fiscal 1997 of $5,693,000; and (iii) the provision for obsolete inventory of $885,000 and $3,134,000 in fiscal 1998 and fiscal 1997, respectively. The increase in cash used in operations in 1998 compared with 1997 arises principally from the increase in accounts receivable of $1,101,000 which resulted from substantially increased shipments of the Company's telecommunications test instruments in December 1998 compared with those of the same period in 1997 and the absence of the accounts receivable of XCEL Arnold at December 31, 1998. The increase in accounts receivable is not reflective of a change in the rate of accounts receivable turnover but rather increased demand for the Company's products in general, coupled with traditional increased capital spending by the Company's customer just before year-end. Additionally, excluding the effect of the sale of XCEL Arnold, inventories increased primarily at CXR due to increased orders and backlog in 1998 from 1997. The substantial increase in cash used in operations in fiscal 1997 versus the cash provided by operations in fiscal 1996 was the result of a decline in results from operations, principally at XCEL Arnold, and the increase in inventory levels. Cash used in operations of $564,000 in the three months ended December 31, 1996 resulted from the decline in results of operations, coupled with changes in working capital management during the period. During the three months ended December 31, 1996, the Company had reduced inventory levels and elongated its payables cycle due to cash flow constraints. INVESTING AND FINANCING ACTIVITIES During 1997, the Company developed a corporate finance strategy designed to (i) dispose of XCEL Arnold; (ii) obtain an expanded and consolidated domestic credit facility to provide substantial additional working capital and replace the Company's existing fragmented and limited domestic debt structure; (iii) obtain additional capital through an equity financing; and, (iv) sell one of the Company's profitable but non-strategic subsidiaries. Effective March 31, 1998, the Company sold its XCEL Arnold subsidiary and received $1,350,000 in cash and a note for $650,000. The cash was utilized to extinguish revolving bank debt associated with the XCEL Arnold business operations and a term loan secured by XCEL Arnold's fixed assets. On July 8, 1998, the Company finalized a $10.5 million credit facility with a commercial asset-based lender which provided a term loan of approximately $1.5 million and a revolving line of credit of up to $8 million based upon assets available from either existing or future-acquired operations, of which the Company has utilized approximately $2.5 million at December 31, 1998, and a capital equipment expenditure credit line of up to $1 million. This credit facility replaced the existing credit facilities of the Company's domestic operating companies, which included the XIT credit facility, of which the Company had defaulted on certain provisions, and CXR Telcom Corporation's line of credit, both of which were paid in full at the closing, and provides expanded borrowing capability based upon available assets. Based upon the Company's eligible collateral at December 31, 1998, approximately $566,000 of additional borrowings were available under the line of credit. The Domestic Facility agreement contains one financial requirement with which the Company was in compliance at December 31, 1998. The agreement also contains other restrictive covenants with which the Company was in compliance or for which it had obtained waivers at December 31, 1998. 24 Also in conjunction with the foregoing strategy, in June 1998, the Company sold 50 shares of convertible redeemable preferred stock (the "New Preferred Shares") at $10,000 per share to one institutional investor. In July 1998, the Company sold an additional 150 New Preferred Shares at the same per share price to two other institutional investors. Included with the sale of such New Preferred Shares were a total of one million warrants to purchase the Company's common stock exercisable at $1.25 per share and expiring May 22, 2001. In total, the Company received net proceeds of approximately $1,843,000 after deduction of commissions and transaction-related expenses and utilized such proceeds for working capital. The Preferred Shares are convertible into the common stock of the Company (see Note 9 to the Consolidated Financial Statements included elsewhere in this report). On March 1, 1999, the Company accepted an offer to sell substantially all the assets (excluding accounts receivable and cash) and liabilities of its HyComp, Inc. subsidiary in exchange for $750,000 in cash and a royalty on the net sales of the acquiring company during the twelve months following the closing of the transaction. The offer was accepted subject to negotiation of a definitive sale agreement and approval by HyComp's board of directors. The transaction is expected to close on or about April 2, 1999 and to result in a gain of approximately $350,000. Capital expenditures were $182,000, $424,000, $155,000 and $786,000 in the years ended December 31, 1998 and 1997, the three months ended December 31, 1996 and the year ended September 30, 1996, respectively, with the substantial increase in fiscal 1996 and the three months ended December 31, 1996 due principally to purchases by the capital intensive Circuits Sector. There are currently no formal commitments for future capital expenditures. While the Company has been successful in implementing its strategy, specific needs for and timing of any subsequent financing arrangements will depend upon results of operations, acquisition opportunities, and other unforeseen factors which cannot presently be predicted. There can be no assurance that such financing arrangements will either be available or be available on terms and conditions acceptable to the Company. If available, any additional equity financing arrangements may be dilutive to the Company's stockholders and any debt financing may contain restrictive covenants and additional debt service requirements which could adversely affect the Company's operating results. LEGAL PROCEEDINGS In March 1999, the Company entered into a settlement agreement with the Company's former chairman and a corporate shareholder resulting in the termination of two suits filed in 1997 and a third filed in early 1999 (see "Legal Proceedings" and Note 14 to the Consolidated Financial Statements included elsewhere herein). Following this settlement, there remains one significant legal proceeding pending against the Company. Management believes that the outcome of this proceeding will not have a material adverse effect on the financial position, results of operations or cash flows of the Company. YEAR 2000 The Company continues to assess the impact, if any, of the Year 2000 issue on its computer applications and operating systems, equipment which uses embedded software, its products and interactions with third parties in order to determine the Company's state of readiness; costs to address the Company's Year 2000 issues; risks of the Company's Year 2000 issues; and any necessary contingency plans. Certain of the Company's telephone test and transmission software-driven products utilize computer calendar/clock data and are presently Year 2000 compliant. Additionally, information regarding available upgrades necessary enable previous versions of such products to be made Year 2000 compliant have been made available to purchasers. The majority of the products produced by the Company do not utilize computer calendar/clock data and consequently have no potential Year 2000 problems. At certain of its domestic facilities, the Company is currently installing accounting and operations management computer applications which are Year 2000 compliant and which operate on computer 25 operating systems which are also Year 2000 compliant. The Company estimates that the completion of its conversion to such computer systems will be completed in the first half of 1999. The Company did not initiate such changes in application and operating software systems in order to accommodate the Year 2000 issue but rather to upgrade and enhance its management information systems capability. As a part of its selection criteria, the Company considered the impact of the Year 2000 issue. The Company is currently developing assessment processes to finalize its review of internal Year 2000 issues and expects to shortly begin an evaluation of any potential Year 2000 issues related to third parties. While the Company currently believes that the impact of the Year 2000 issue will not have a material effect on the Company's operations or financial condition, its assessment of this issue is not yet complete and therefore uncertainty exists as to whether material Year 2000 issues exist. EFFECTS OF INFLATION The impact of inflation and changing prices has not been significant on the financial condition or results of operations of either the Company or its various operating subsidiaries. OUTLOOK FOR THE COMPANY Since the Merger at the end of March 1997 through early July 1998, the Company directed its attention to stabilizing its financial condition and improving its operating results. In addition, during the second half of 1997 and the first quarter of 1998, the Company expended considerable management time and effort to divest itself of the XCEL Arnold operation which, due to its substantial operating losses, severely constricted the Company's cash position. The Company's failure to maintain the requisite financial position and consequential default on its major bank debt financing agreement, which was eliminated in early July 1998 by the consolidated credit facility referenced above, resulted principally from the operating losses incurred at XCEL Arnold. The time and effort to manage that situation coupled with efforts to obtain a replacement credit facility absorbed considerable management attention. Nonetheless, with two exceptions, all operating units experienced positive operating income, before interest and miscellaneous expense/(income), in the second quarter of 1998. Additionally, the Company added $1.8 million in cash from the private equity placement referenced above. Although there can be no assurances, the Company intends to raise additional working capital through the sale of one of its non-strategic and previously profitable subsidiaries. On March 1, 1999, the Company accepted an offer to sell substantially all the assets (excluding accounts receivable and cash) and liabilities of its HyComp, Inc. subsidiary subject to negotiation of a definitive sale agreement and approval by HyComp's board of directors. Also, the sale of the real property owned by the partnership for which the Company holds a 50% interest is planned for 1999. The Company believes these achievements position it to continue to improve its operating results in 1999. The Company's overall strategy is to expand its Test Equipment sector through the acquisition and/or development of new products, product lines and/or separate operating companies, such as its recent acquisition of 41% of DTS in January 1999, while concurrently continuing to evaluate existing lower-margin or loss operations elsewhere throughout the Company, with a view toward divestment and downsizing so as to redirect capital to the higher margin Test Equipment sector. In addition, the Company will continue to seek to maximize short to intermediate term profitability on existing maturing product lines in all sectors through price increases and lower operating costs. Over the last year, the Test Equipment sector in the United States market has successfully acquired and integrated the products of a state-of-the-art, customer-premises hand-held test equipment manufacturer located in St. Charles, Illinois. The acquired products have replaced existing, aged products and, in a short period of time, have become a significant portion of the net sales of the CXR US operation. Production of this product line has been transferred to and consolidated with the CXR Telcom facility in Fremont, California and the St. Charles facility has been repositioned as an engineering, R&D and customer support center. Additionally, the French Test Equipment subsidiary has begun to market a broader range of test, transmission and 26 networking products sourced through licensing, reseller and other agreements. These actions, in conjunction with the reduction of lower margin Circuits sector business, the sale of the domestic display business, and the restructured marketing focus in the Components sector on higher margin products, has resulted in the Company reducing its net loss in the first quarter of 1998 from approximately $950,000 to a profit of approximately $180,000 in the fourth quarter of 1998, excluding the non-recurring expense associated with the settlement of three lawsuits (see Legal Proceedings and Note 14 to the Consolidated Financial Statements contained elsewhere herein). Although there are no assurances, the Company believes continued improvement in operating results will continue throughout 1999. In the US Test Equipment Sector, the recent completion of mergers of various Regional Bell Operating Companies is beginning to produce new opportunities. The consolidation of Southwest Bell and Pacific Bell is now complete and release of equipment purchases has once again returned to traditional levels. Although the NYNEX and Bell Atlantic merger had initially created some uncertainty and delayed capital equipment purchases, this merger now affords the Company the opportunity to provide the combined entity with the Company's newer test equipment products. Domestic sales of transmission products are expected to improve with the introduction of Remote Access Server products for Internet applications as well as trial systems for other transmission products which are currently in place at SBC Communications and GTE. Additionally, in-house efforts are being directed toward developing software which will allow the recently acquired test equipment products to be marketed in both Europe and Latin America. NEW ACCOUNTING PRONOUNCEMENTS Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Financial Instruments and Hedging Activities" ("SFAS 133") issued by the FASB is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. SFAS 133 provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. The Company does not expect adoption of SFAS 133 to have a material effect on its financial position or results of operations. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not applicable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. This information appears in a separate section of this Report following Part IV. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEMS 10 - 13. The information required by Items 10 - 13 will either be set forth in the definitive proxy statement in respect of the 1999 Annual Meeting of Stockholders of the Company to be filed within 120 days of December 31, 1998 pursuant to Regulation 14A under the Securities Exchange Act of 1934, which is incorporated herein by reference, or the required information will be included as an amendment to this Form 10-K Annual Report on or before April 30, 1999. 27 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a)(1) and (2) Reference is made to the Index to Consolidated Financial Statements and Financial Statement Schedule appearing in a separate section of this Report following this Part IV. (a)(3) Exhibits. See attached Exhibit Index. (b) None. (c) The exhibits required by this portion of Item 14 are submitted as a separate section of this Report. (d) None.
28 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. MICROTEL INTERNATIONAL INC. By: /s/ CARMINE T. OLIVA ----------------------------------------- Carmine T. Oliva CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE CAPACITY DATE - ------------------------------ -------------------------- ------------------- Chairman of the Board, /s/ CARMINE T. OLIVA President and Chief - ------------------------------ Executive Officer March 31, 1999 Carmine T. Oliva (Principal Executive Officer) /s/ DAVID A. BARRETT - ------------------------------ Director March 31, 1999 David A. Barrett /s/ LAURENCE P. FINNEGAN, JR. - ------------------------------ Director March 31, 1999 Laurence P. Finnegan, Jr. /s/ ROBERT B. RUNYON - ------------------------------ Director March 31, 1999 Robert B. Runyon /s/ JAMES P. BUTLER Chief Financial Officer - ------------------------------ (Principal Accounting and March 31, 1999 James P. Butler Financial Officer)
29 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION - ----------- -------------------------------------------------------------------------------------------------------- 2. Merger Agreement dated December 31, 1996 between XIT Corporation, XIT Acquisition, Inc. and MicroTel International, Inc.(1) 3.1 Certificate of Incorporation of MicroTel International, Inc. as amended to date.(2) 3.2 Bylaws of MicroTel International, Inc.(3) 3.3 Amended Certificate of Incorporation of MicroTel International, Inc.(7) 4.1 Certificate of Designations, Preferences and Rights of Preferred Stock of MicroTel International Inc., a Delaware Corporation.(12) 4.2 Warrant to Purchase Common Stock of MicroTel International, Inc. Issued to DDC.(4) 4.3 Form of Warrant to Purchase Common Stock of MicroTel International, Inc. issued to Yorkton Securities, Inc.(7) 4.4 Form of Warrant to Purchase Common Stock of MicroTel International, Inc. issued to entrenet Group, L.L.C.(7) 4.5 Form of Warrant to Purchase Common Stock of MicroTel International, Inc. issued to various subscribers.(7) 10.1 1986 Incentive Stock Option Plan.(3) 10.2 Form of Officers Deferred Compensation Agreement by and between Raymond E. Jacobson and CXR Corporation.(5) 10.3 Agreement from San Jose National Bank for CXR Telcom Corporation dated May 19, 1995.(2) 10.4 Qualified Employee Stock Purchase Plan.(3) 10.5 1993 Incentive Stock Option Plan.(6) 10.6 Stock Purchase Agreement with DDC.(4) 10.7 First Amendment to Stock Purchase Agreement with DDC.(4) 10.8 Agreement between MicroTel International, Inc. and Elk International Corporation, Ltd. dated November 15, 1996 (without Exhibits).(8) 10.9 Settlement Agreement between MicroTel International, Inc. and Daniel Dror dated December 3, 1996 (without Exhibits).(8) 10.10 Agency Agreement between MicroTel International, Inc. and Yorkton Securities, Inc.(7) 10.11 Form of Subscription Agreement between MicroTel International, Inc. and various subscribers.(7) 10.12 Employment Arrangement between Henry Mourad and Registrant (without Exhibits).(7) 10.13 Employment Arrangement between Barry Reifler and Registrant (without Exhibits).(7) 10.14 Employment Agreement dated January 1, 1996 between XIT and Carmine T. Oliva.(8) 10.15 Lease Agreement between XIT Corporation and P&S Development.(8) 10.16 Lease Agreement between XIT Corporation and Don Mosco.(8) 10.17 General Partnership Agreement between XIT Corporation and P&S Development.(8) 10.18 Lease Agreement between XCEL Arnold Circuits, Inc. and RKR Associates.(8)
30
EXHIBIT NUMBER DESCRIPTION - ----------- -------------------------------------------------------------------------------------------------------- 10.19 Option Agreement between MicroTel International, Inc. and Elk International Corporation dated November 15, 1996.(8) 10.20 Amendment to Option Agreement between MicroTel International, Inc. and Daniel Dror dated November 15, 1996.(8) 10.21 Option Agreement between MicroTel International, Inc. and Elk International Corporation dated December 3, 1996.(8) 10.22 Warrant to Purchase Common Stock of MicroTel International, Inc. issued to Elk International Corporation.(8) 10.23 Agreement of Settlement and Mutual Release between MicroTel International, Inc. and Francis John Gorry dated June 28, 1996.(8) 10.24 Amended Agreement of Settlement and Mutual Release between MicroTel International, Inc. and Francis John Gorry dated November 30, 1996.(8) 10.25 Promissory Note between MicroTel International, Inc. and Jack Talan dated February, 1997.(8) 10.26 Lease Agreement between SCI Limited Partnership-I and CXR Telcom Corporation, Dated July 28, 1997. (9) 10.27 Share Exchange Agreement among CXR Telcom Corporation, MicroTel International, Inc. and Eric P. Bergstrom, Steve T. Robbins and Mike B. Peterson, Dated October 17, 1997. (10) 10.28 Indemnity Escrow Agreement among CXR Telcom Corporation, MicroTel International, Inc., Eric P. Bergstrom, Steve T. Robbins and Mike B. Peterson and Gallagher, Briody & Butler, Dated October 17, 1997. (10) 10.29 Form of Contingent Stock Agreement among CXR Telcom Corporation, MicroTel International, Inc., Critical Communications Incorporated, Mike B. Peterson, Eric P. Bergstrom and Steve T. Robbins, Dated October 17, 1997. (10) 10.30 Form of Severance Agreement among CXR Telcom Corporation, Critical Communications Incorporated, Mike B. Peterson, Eric P. Bergstrom and Steve T. Robbins, Dated October 17, 1997. (10) 10.31 Asset Purchase Agreement, among Arnold Circuits, Inc, BNZ Incorporated, Robert Bertrand, XCEL Arnold Circuits, Inc., XIT Corporation and Mantalica & Treadwell (without exhibits), Dated January 9, 1998. (10) 10.32 Addendum No. 1 to Asset Purchase Agreement, among Arnold Circuits, Inc, BNZ Incorporated, Robert Bertrand, XCEL Arnold Circuits, Inc., XIT Corporation and Mantalica & Treadwell, Dated March 31, 1998. (10) 10.33 Bill of Sale and Assignment and Assumption Agreement between XCEL Arnold Circuits, Inc.and Arnold Circuits, Inc., Dated March, 31 1998. (10) 10.34 Warrant to Purchase Common Stock of MicroTel International, Inc. issued to BNZ Incorporated. (10) 10.35 Guaranty of Robert Bertrand in favor of XCEL Arnold Circuits, Inc., Dated March 31, 1998. (10) 10.36 Guaranty of BNZ Incorporated in favor of XCEL Arnold Circuits, Inc., Dated March 31, 1998. (10) 10.37 Pledge and Escrow Agreement between BNZ Incorporated and XCEL Arnold Circuits, Inc., Dated March 31, 1998. (10)
31
EXHIBIT NUMBER DESCRIPTION - ----------- -------------------------------------------------------------------------------------------------------- 10.38 Promissory Note between Arnold Circuits, Inc. and XCEL Arnold Circuits, Inc. Dated March 31, 1998. (10) 10.39 Promissory Note between XIT Corporation and Arnold Circuits, Inc. Dated March 31, 1998. (10) 10.40 Security Agreement between Arnold Circuits, Inc and XCEL Arnold Circuits, Inc. Dated March 31, 1998. (10) 10.41 Joint Marketing and Supply Agreement between Arnold Circuits, Inc and XCEL Etch Tek, Dated March 31, 1998. (10) 10.42 Loan and Security Agreement between Congress Financial Corporation (Western) and MicroTel International, Inc., XIT Corporation, CXR Telcom Corporation and HyComp, Inc. dated June 23, 1998. (11) 10.43 Security Agreement between Congress Financial Corporation (Western) and XIT Corporation dated June 23, 1998. (11) 10.44 Subscription Agreement for the sale of Series A Convertible Preferred Stock of MicroTel International, Inc. to Fortune Fund Limited Seeker III. (11) 10.45 Subscription Agreement for the sale of Series A Convertible Preferred Stock of MicroTel International, Inc. to Rana General Holding, Ltd. (110) 10.46 Subscription Agreement for the sale of Series A Convertible Preferred Stock of MicroTel International, Inc. to Resonace Ltd. (11) 10.47 Form of Warrant to purchase the Common Stock of MicroTel International, Inc. issued in connection with the sale of Series A Convertible Preferred Stock. (11) 10.48 Amended Certificate of Designations, Preferences and Rights of Preferred Stock of MicroTel International, Inc. a Delaware Corporation. (11) 10.49 Employment Agreement between MicroTel International, Inc. and James P. Butler dated May 1, 1998. (11) 21.1 List of Subsidiaries of MicroTel International, Inc.(7) 23.1 Consent of BDO Seidman, LLP. (#) 23.2 Consent of KPMG LLP. (#) 23.3 Consent of Hardcastle Burton. (#) 27. Financial Data Schedule. (#)
- ------------------------ (#) Filed herewith. (1) Incorporated by reference to MicroTel International, Inc. report on Form 8-K filed as Exhibit 1 to Item 2 of the Report on January 21, 1997 (File No. 1-10346). (2) Incorporated by reference to MicroTel International, Inc. annual report on Form 10-K for the year ended December 31, 1995 (File No. 1-10346). (3) Incorporated by reference to CXR Corporation Registration Statement on Form S-4 No. 33-30818. (4) Incorporated by reference to CXR Corporation annual report on Form 10-K for the year ended June 30, 1994 (File No. 1-10346). (5) Incorporated by reference to CXR Telecom Corporation annual report on Form 10-K for the year ended June 30, 1993 (File No. 1-10346). 32 (6) Incorporated by reference to CXR Corporation Registration Statement on Form S-8 No. 33-77926. (7) Incorporated by reference to MicroTel International, Inc. annual report on Form 10-K for the year ended December 31, 1996 (File No. 1-10346). (8) Incorporated by reference to MicroTel International, Inc. annual report on Form 10-K/A for the year ended December 31, 1996 (File No. 1-10346). (9) Incorporated by reference to MicroTel International, Inc. Registration Statement on Form S-8 No. 333-29925. (10) Incorporated by reference to MicroTel International, Inc. annual report on Form 10-K for the year ended December 31, 1997 (File No. 1-10346). (11) Incorporated by reference to MicroTel International, Inc. interim report on Form 10-Q for the six months ended June 30, 1998 (File No. 1-10346). (12) Incorporated by reference to MicroTel International, Inc. Registration Statement on Form S-1 No. 333-64695. 33 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
PAGE --------- Report of Independent Certified Public Accountants (BDO Seidman, LLP)..................................... F-2 Independent Auditors' Report (KPMG LLP)................................................................... F-3 Independent Auditors' Report (Hardcastle Burton).......................................................... F-4 Consolidated Balance Sheets............................................................................... F-5 Consolidated Statements of Operations and Comprehensive Income............................................ F-6 Consolidated Statements of Stockholders' Equity........................................................... F-7 Consolidated Statements of Cash Flows..................................................................... F-9 Notes to Consolidated Financial Statements................................................................ F-11 Consolidated Financial Statement Schedule II--Valuation and Qualifying Accounts........................... F-36
F-1 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors MicroTel International, Inc. We have audited the accompanying consolidated balance sheets of MicroTel International, Inc. as of December 31, 1998 and 1997, and the related consolidated statements of operations and comprehensive income, stockholders' equity and cash flows for the years ended December 31, 1998 and 1997 and the three months ended December 31, 1996. We have also audited the information for the years ended December 31, 1998 and 1997 and the three months ended December 31, 1996 in the financial statement schedule listed in the accompanying index. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial statement schedule are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial statement schedule. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements and financial statement schedule. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MicroTel International, Inc. at December 31, 1998 and 1997, and the results of its operations and its cash flows for the years ended December 31, 1998 and 1997 and the three months ended December 31, 1996 in conformity with generally accepted accounting principles. Also, in our opinion, the financial statement schedule referred to above presents fairly, in all material respects, the information set forth therein. BDO Seidman, LLP Orange County, California February 19, 1999, except as to the penultimate paragraph of Note 14 and the second paragraph of Note 16, which are as of March 1, 1999 F-2 INDEPENDENT AUDITORS' REPORT The Board of Directors MicroTel International, Inc. We have audited the accompanying consolidated statements of operations and comprehensive income, stockholders' equity and cash flows of MicroTel International, Inc. and subsidiaries (formerly known as XCEL Corporation and subsidiaries) for the year ended September 30, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We did not audit the consolidated financial statements of XCEL Corporation Ltd. and subsidiaries, which statements reflect total revenues constituting 7% of the related consolidated totals. Those consolidated financial statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for XCEL Corporation Ltd. and subsidiaries, is based solely on the report of the other auditors. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit and the report of the other auditors provide a reasonable basis for our opinion. In our opinion, based on our audit and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of MicroTel International, Inc. and subsidiaries (formerly known as XCEL Corporation and subsidiaries) for the year ended September 30, 1996 in conformity with generally accepted accounting principles. KPMG LLP Orange County, California December 13, 1996 F-3 XCEL CORPORATION LIMITED REPORT OF THE AUDITORS TO THE SHAREHOLDERS OF XCEL CORPORATION LIMITED We have audited the financial statements on pages four to fifteen which have been prepared under the historical cost convention, as modified by the revaluation of certain fixed assets, and the accounting policies set out on page seven. RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITORS As described on page two the company's directors are responsible for the preparation of financial statements. It is our responsibility to form an independent opinion, based on our audit, on those statements and to report our opinion to you. BASIS OF OPINION We conducted our audit in accordance with Auditing Standards issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements. It also includes an assessment of the significant estimates and judgments made by the directors in the preparation of the financial statements, and of whether the accounting policies are appropriate to the company's circumstances, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the financial statements. OPINION In our opinion the financial statements give a true and fair view of the state of the company's affairs as at 30 September 1996 and of its profit for the year then ended and have been properly prepared in accordance with the provisions of the Companies Act 1985 applicable to small companies. /s/ Hardcastle Burton Hardcastle Burton Chartered Accountants Registered Auditor Lake House Market Hill Royston Herts SGB 9JN Dated: 22 November 1996 F-4 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
DECEMBER 31, DECEMBER 31, 1998 1997 ------------ ------------ ASSETS (NOTES 7 AND 8) Current assets: Cash and cash equivalents.......................................................... $ 572 $ 1,921 Accounts receivable, net of allowance for doubtful accounts of $275 and $241....... 7,337 6,749 Current portion of notes receivable (Notes 3 and 6)................................ 291 501 Inventories (Note 4)............................................................... 6,426 7,087 Prepaid and other current assets................................................... 926 869 ------------ ------------ Total current assets................................................................. 15,552 17,127 Property, plant and equipment, net (Note 5).......................................... 1,939 4,968 Goodwill, net of accumulated amortization of $249 and $44 (Notes 2, 3 and 11)........ 1,701 1,906 Notes receivable, less current portion (Notes 3 and 6)............................... 533 124 Other assets (Note 6)................................................................ 1,517 1,315 ------------ ------------ $ 21,242 $ 25,440 ------------ ------------ ------------ ------------ LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable (Note 7)............................................................. $ 3,379 $ 3,630 Current portion of long-term debt (Note 8)......................................... 805 1,216 Accounts payable................................................................... 4,269 6,621 Accrued expenses................................................................... 3,312 3,837 ------------ ------------ Total current liabilities............................................................ 11,765 15,304 Long-term debt, less current portion (Note 8)........................................ 1,430 2,530 Other liabilities.................................................................... 954 789 Minority interest (Note 3)........................................................... 95 88 ------------ ------------ Total liabilities.................................................................... 14,244 18,711 ------------ ------------ Convertible redeemable preferred stock, $10,000 unit value. Authorized 200 shares; issued and outstanding 161 shares in 1998 (aggregate liquidation preference of $1,610) (Note 9)................................................................... 1,516 -- Series A redeemable preferred stock, no par value. Authorized, issued and outstanding 1,000 shares in 1997 (Note 9)................... -- 306 Series B redeemable preferred stock, no par value. Authorized, issued and outstanding 1,000 shares in 1997 (Note 9)................... -- 408 Commitments and contingencies (Note 14) Subsequent events (Notes 14 and 16) Stockholders' equity (Notes 2, 3, 9 and 10): Preferred stock, $0.01 par value. Authorized 10,000,000 shares; no shares issued and outstanding.................................................................. -- -- Common stock, $.0033 par value. Authorized 25,000,000 shares; issued and outstanding 12,622,000 and 11,926,000 shares..................................... 42 39 Additional paid-in capital......................................................... 20,463 19,960 Accumulated deficit................................................................ (15,122) (13,877) Accumulated other comprehensive income (loss)...................................... 99 (107) ------------ ------------ Total stockholders' equity......................................................... 5,482 6,015 ------------ ------------ $ 21,242 $ 25,440 ------------ ------------ ------------ ------------
See accompanying notes to consolidated financial statements. F-5 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS YEAR ENDED YEAR ENDED ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, 1998 1997 1996 1996 ------------ ------------ ------------- ------------- Net sales (Note 15)................................... $ 37,261 $ 43,098 $ 7,886 $ 31,249 Cost of sales......................................... 23,871 32,670 6,680 23,057 ------------ ------------ ------------- ------------- Gross profit.......................................... 13,390 10,428 1,206 8,192 Operating expenses: Selling, general and administrative................. 11,826 11,361 1,816 6,379 Engineering and product development................. 2,454 2,046 69 309 Write-down of goodwill (Note 11).................... -- 5,693 -- -- ------------ ------------ ------------- ------------- Income (loss) from operations......................... (890) (8,672) (679) 1,504 Other expense (income): Interest expense.................................... 675 895 183 507 Gain on sale of subsidiary (Note 3)................. (580) -- -- -- Minority interest in net income of consolidated subsidiary (Note 3)............................... 7 20 4 4 Other, net.......................................... 92 9 9 (112) ------------ ------------ ------------- ------------- Income (loss) before income taxes..................... (1,084) (9,596) (875) 1,105 Income taxes (Note 12)................................ 101 97 30 22 ------------ ------------ ------------- ------------- Net income (loss)..................................... $ (1,185) $ (9,693) $ (905) $ 1,083 ------------ ------------ ------------- ------------- Other comprehensive income (loss): Foreign currency translation adjustment............. 206 (260) 126 (89) ------------ ------------ ------------- ------------- Total comprehensive income (loss)..................... $ (979) $ (9,953) $ (779) $ 994 ------------ ------------ ------------- ------------- ------------ ------------ ------------- ------------- Basic and diluted earnings (loss) per share (Note 13)................................................. $ (.10) $ (.96) $ (.15) $ .17 ------------ ------------ ------------- ------------- ------------ ------------ ------------- -------------
See accompanying notes to consolidated financial statements. F-6 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
ACCUMULATED COMMON STOCK ADDITIONAL OTHER ---------------------- PAID-IN ACCUMULATED COMPREHENSIVE SHARES AMOUNT CAPITAL DEFICIT INCOME (LOSS) TOTAL --------- ----------- ----------- ------------ --------------- --------- Balance at September 30, 1995............ 5,814 $ 19 $ 8,532 $ (4,203) $ 116 $ 4,464 Stock issued in connection with acquisition of minority interest (Note 3)..................................... 71 -- 344 -- -- 344 Stock issued for debt conversion (Note 10).................................... 179 1 122 -- -- 123 Foreign currency translation adjustment............................. -- -- -- -- (89) (89) Accretion of preferred stock............. -- -- -- (80) -- (80) Net income............................... -- -- -- 1,083 -- 1,083 --------- --- ----------- ------------ ----- --------- Balance at September 30, 1996............ 6,064 20 8,998 (3,200) 27 5,845 Comprehensive income (loss).............. -- -- -- (19) 126 107 Net loss................................. -- -- -- (905) -- (905) --------- --- ----------- ------------ ----- --------- Balance at December 31, 1996............. 6,064 20 8,998 (4,124) 153 5,047 Stock issued in connection with reverse acquisition (Note 2)................... 3,186 10 5,235 -- -- 5,245 Stock issued in connection with private placement (Note 10).................... 2,000 7 4,251 -- -- 4,258 Stock issued in connection with acquisition (Note 3)................... 500 2 1,123 -- -- 1,125 Stock issued for debt conversion (Note 10).................................... 55 -- 44 -- -- 44 Stock issued upon exercise of stock options................................ 30 -- 97 -- -- 97 Stock issued in connection with settlement of dispute (Note 10)........ 80 -- 190 -- -- 190 Stock issued as compensation and under stock purchase plan.................... 11 -- 22 -- -- 22 Foreign currency translation adjustment............................. -- -- -- -- (260) (260) Accretion of preferred stock............. -- -- -- (60) -- (60) Net loss................................. -- -- -- (9,693) -- (9,693) --------- --- ----------- ------------ ----- --------- Balance at December 31, 1997............. 11,926 39 19,960 (13,877) (107) 6,015
See accompanying notes to consolidated financial statements. F-7 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS)
ACCUMULATED COMMON STOCK ADDITIONAL OTHER ---------------------- PAID-IN ACCUMULATED COMPREHENSIVE SHARES AMOUNT CAPITAL DEFICIT INCOME (LOSS) TOTAL --------- ----------- ----------- ------------ --------------- --------- Stock issued upon conversion of preferred stock (Note 9)......................... 770 $ 3 $ 364 $ -- $ -- $ 367 Repurchase of stock issued in connection with settlement of dispute (Note 10)... (80) -- (168) -- -- (168) Stock issued under stock purchase plan... 7 -- 7 -- -- 7 Warrants issued in connection with issuance of preferred stock (Note 9)... -- -- 163 -- -- 163 Warrants issued for services............. -- -- 85 -- -- 85 Repricing of warrants issued in connection with issuance of preferred stock (Note 9)......................... -- -- 52 -- -- 52 Foreign currency translation adjustment............................. -- -- -- -- 206 206 Accretion of preferred stock............. -- -- -- (60) -- (60) Net loss................................. -- -- -- (1,185) -- (1,185) --------- --- ----------- ------------ ----- --------- Balance at December 31, 1998............. 12,622 $ 42 $ 20,463 $ (15,122) $ 99 $ 5,482 --------- --- ----------- ------------ ----- --------- --------- --- ----------- ------------ ----- ---------
See accompanying notes to consolidated financial statements. F-8 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
THREE MONTHS YEAR ENDED YEAR ENDED ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, 1998 1997 1996 1996 ------------ ------------ ------------ ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)...................................... $ (1,185) $ (9,693) $ (905) $ 1,083 Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities: Depreciation and amortization...................... 409 923 209 589 Amortization of intangible assets.................. 449 358 67 210 Gain on the sale of subsidiary..................... (580) -- -- -- Allowance for doubtful accounts.................... 97 251 16 17 Provision for inventory obsolescence............... 885 3,134 416 211 Write-down of goodwill............................. -- 5,693 -- -- Repricing of warrants and warrants issued for services......................................... 137 -- -- -- Minority interest.................................. 7 20 4 (4) Stock issued as compensation....................... -- 22 -- -- Equity in earnings (loss) of unconsolidated partnership...................................... (24) 21 5 -- Changes in operating assets and liabilities: Accounts receivable................................ (1,101) (554) (158) (5) Inventories........................................ (1,017) (1,011) (169) (421) Prepaids and other assets.......................... (411) 413 (145) 145 Accounts payable................................... (339) (755) (367) (296) Accrued expenses and other liabilities............. (460) (490) 463 (740) ------------ ------------ ------------ ------------- Cash provided by (used in) operating activities........ (3,133) (1,668) (564) 789 ------------ ------------ ------------ ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Net purchases of property, plant and equipment....... (182) (424) (155) (786) Cash paid for purchase of subsidiaries............... -- -- -- (1,163) Cash received on sale of subsidiary.................. 1,350 -- -- -- Cash acquired in acquisition/merger.................. -- 273 -- -- Investment in and loan to real estate partnership.... -- -- (868) -- Cash collected on notes receivable................... 451 125 -- -- ------------ ------------ ------------ ------------- Cash provided by (used in) investing activities...... 1,619 (26) (1,023) (1,949) ------------ ------------ ------------ -------------
See accompanying notes to consolidated financial statements. F-9 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
THREE MONTHS YEAR ENDED YEAR ENDED ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, 1998 1997 1996 1996 ------------- ------------- ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in notes payable............. (251) (3) 628 249 Proceeds from long-term debt......................... 1,542 163 1,326 2,000 Repayments of long-term debt......................... (2,916) (1,606) (294) (1,055) Preferred stock dividends paid....................... -- (140) -- (140) Proceeds from sale of preferred stock................ 2,000 -- -- -- Payment of preferred stock and debt issuance costs... (423) -- -- -- Proceeds from sale of common stock................... 7 4,258 -- -- ------------- ------------- ------------- ------------- Cash provided by (used in) financing activities........ (41) 2,672 1,660 1,054 ------------- ------------- ------------- ------------- Effect of exchange rate changes on cash................ 206 57 28 (87) ------------- ------------- ------------- ------------- Net increase (decrease) in cash and cash equivalents... (1,349) 1,035 101 (193) Cash and cash equivalents at beginning of period....... 1,921 886 785 978 ------------- ------------- ------------- ------------- Cash and cash equivalents at end of period............. $ 572 $ 1,921 $ 886 $ 785 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest........................................... $ 652 $ 827 $ 183 $ 490 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Income taxes....................................... $ 138 $ 58 $ -- $ 12 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Note receivable received upon sale of subsidiary..... $ 650 $ -- $ -- $ -- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Warrants issued in connection with issuance of preferred stock.................................... $ 163 $ -- $ -- $ -- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Common stock issued upon conversion of preferred stock.............................................. $ 367 $ -- $ -- $ -- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Accretion of preferred stock......................... $ 60 $ 60 $ 19 $ 80 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Issuance of common stock in connection with settlement of dispute.............................. $ -- $ 190 $ -- $ -- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Repurchase of common stock issued in connection with settlement of dispute in exchange for payable...... $ 168 $ -- $ -- $ -- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Issuance of common stock, preferred stock and notes in connection with acquisitions.................... $ -- $ 6,370 $ -- $ 539 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Issuance of common stock upon exercise of stock options............................................ $ -- $ 97 $ -- $ -- ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- Issuance of common stock upon conversion of debt to equity............................................. $ -- $ 44 $ -- $ 123 ------------- ------------- ------------- ------------- ------------- ------------- ------------- -------------
See accompanying notes to consolidated financial statements. F-10 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND BUSINESS MicroTel International, Inc. (the "Company") is a holding company for its three wholly-owned subsidiaries: CXR Telcom Corporation, CXR, S.A. and, effective March 26, 1997, XIT Corporation ("XIT"). CXR Telcom Corporation and CXR, S.A. (collectively "CXR") design, manufacture and market electronic telecommunication test equipment and data communications equipment. XIT designs, manufactures and markets information technology products, including displays and input components, subsystem assemblies, printed circuits and hybrid microelectronic circuits. The Company conducts its operations out of various facilities in the U. S., France, England and Japan and organizes itself in three product line sectors: Circuits, Components and Subsystem Assemblies, and Instrumentation and Test Equipment. BASIS OF PRESENTATION As discussed more fully in Note 2, the Company merged with XIT on March 26, 1997. The merger was accounted for as a purchase of the Company by XIT in a "reverse acquisition" because the existing stockholders of the Company prior to the merger did not have voting control of the combined entity after the merger. In a reverse acquisition, the accounting treatment differs from the legal form of the transaction, as the continuing legal parent company is not assumed to be the acquirer and the financial statements of the combined entity are those of the accounting acquirer (XIT), including any comparative prior year financial statements presented by the combined entity after the business combination. Consequently, the consolidated financial statements include the accounts of XIT and its wholly and majority-owned subsidiaries, and beginning March 26, 1997, include the Company and its other subsidiaries, CXR Telcom Corporation and CXR, S.A. (the "Former Company"). In connection with the reverse acquisition, the Company assumed the number of authorized common shares of 25,000,000 and $.0033 par value per share of the Former Company. Furthermore, the former stockholders of XIT were issued approximately 6,199,000 shares of common stock, which resulted in a common share exchange ratio of 1.451478. Accordingly, all references to the number of shares and to the per share information in the accompanying consolidated financial statements have been adjusted to reflect these changes on a retroactive basis. During 1998 and 1997, the Company experienced significant operating losses and negative cash flows from operations. Management has taken certain steps in an effort to generate net income and positive cash flows from operations in the future. These steps include selling an unprofitable subsidiary (see Note 3), reducing cost structures and improving operating efficiencies. The Company has made certain improvements during the year ended December 31, 1998, which have significantly reduced its loss from operations. There can be no assurance that management will be able to continue to improve its results of operations, nor that future plans will be successful. The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. XIT's 50% investment in a real estate partnership (see Note 6) is accounted for using the equity method. All significant intercompany balances and transactions have been eliminated in consolidation. F-11 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) FISCAL YEARS In connection with the reverse acquisition accounting treatment described above, XIT changed its fiscal year end from September 30 to December 31 to adopt the fiscal year end of the Former Company. REVENUE RECOGNITION Revenues are recorded when products are shipped. CASH AND CASH EQUIVALENTS Cash and cash equivalents consist of all highly liquid investments with an original maturity of three months or less when purchased. INVENTORIES Inventories are stated at the lower of cost (first-in, first-out) or market (net realizable value). PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed principally using the straight-line method over the useful lives of the assets (or lease term, if shorter) as follows:
Buildings............................................................... 50 years Machinery, equipment and fixtures....................................... 3-7 years Leasehold improvements.................................................. 5 years
Maintenance and repairs are expensed as incurred while renewals and betterments are capitalized. GOODWILL Goodwill represents the excess of purchase price over the fair value of net assets acquired through business combinations accounted for as purchases and is amortized on a straight-line basis over its estimated useful life. During 1997, the Company wrote-down the value of goodwill by approximately $5.7 million and reduced the estimated useful lives from 15-20 years to 10 years (see Note 11). SOFTWARE DEVELOPMENT COSTS Software development costs, including purchased technology, are capitalized beginning when technological feasibility has been established or when purchased from third parties and continues through the date of commercial release. Amortization commences upon commercial release of the product and is calculated using the greater of the straight-line method over three years or the ratio of the products' current revenues divided by the anticipated total product revenues. The carrying value of capitalized software development costs aggregates $412,000 and $592,000 (net of accumulated amortization of $417,000 and $248,000) at December 31, 1998 and 1997, respectively, and is included in other assets in the accompanying consolidated balance sheets. Amortization relating to the remaining capitalized software of F-12 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) $169,000 and $248,000 was charged to cost of sales during the years ended December 31, 1998 and 1997, respectively. DEBT ISSUANCE COSTS The costs related to the issuance of debt and the redeemable preferred stock are capitalized and amortized over the life of the instrument. LONG-LIVED ASSETS The Company reviews the carrying amount of its long-lived assets and identifiable intangible assets for possible impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. PRODUCT WARRANTIES The Company provides warranties for certain of its products for periods of generally one year. Estimated warranty costs are recognized at the time of the sale. INCOME TAXES The Company uses the liability method of accounting for income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." Deferred income taxes are recognized based on the differences between financial statement and income tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. The provision for income taxes represents the tax payable for the period and the change during the period in deferred tax assets and liabilities. STOCK-BASED COMPENSATION The Company applies APB Opinion 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its employee stock-based compensation plans. Accordingly, no compensation cost is recognized for its employee stock option plans, unless the exercise price of options granted is less than fair market value on the date of grant. The Company has adopted the disclosure provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." EARNINGS (LOSS) PER SHARE Earnings (loss) per share is calculated pursuant to Statement of Financial Accounting Standards No. 128, "Earnings per Share." Basic earnings (loss) per share includes no dilution and is computed by dividing income (loss) available to common shareholders by the weighted average number of shares F-13 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) outstanding during the period. Diluted earnings (loss) per share reflects the potential dilution of securities that could share in the earnings of the Company. FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments" requires all entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized on the balance sheet, for which it is practicable to estimate fair value. This statement defines fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. As of December 31, 1998 and 1997, the fair value of all financial instruments approximated carrying value. The carrying amount of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses are reasonable estimates of their fair value because of the short maturity of these items. The Company believes the carrying amounts of its notes payable and long-term debt approximate fair value because the interest rates on these instruments are subject to change with, or approximate, market interest rates. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. CONCENTRATION OF CREDIT RISK Financial instruments, which potentially expose the Company to concentration of credit risk, consist primarily of cash and accounts receivable. The Company places its cash with high quality financial institutions. At times, cash balances may be in excess of the amounts insured by the Federal Deposit Insurance Corporation. The Company's accounts receivable results from sales to a broad customer base. The Company extends credit to its customers based upon an evaluation of the customer's financial condition and credit history and generally does not require collateral. Credit losses are provided for in the financial statements and consistently have been within management's expectations. FOREIGN CURRENCY TRANSLATION The accounts of foreign subsidiaries have been translated using the local currency as the functional currency. Accordingly, foreign currency denominated assets and liabilities have been translated to U.S. dollars at the current rate of exchange on the balance sheet date. The effects of translation are recorded as a separate component of stockholders' equity in accumulated other comprehensive income (loss). Exchange gains and losses arising from transactions denominated in foreign currencies are translated at average exchange rates and included in operations. Such amounts are not material to the accompanying consolidated financial statements. F-14 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) COMPREHENSIVE INCOME Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 established new rules for the reporting and display of comprehensive income (loss) and its components in a full set of general-purpose financial statements. All prior period data presented has been restated to conform to the provisions of SFAS 130. REPORTABLE SEGMENTS Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 requires public business enterprises to report certain information about operating segments in complete sets of financial statements and in condensed financial statements of interim periods issued to shareholders. It also establishes standards for disclosures regarding products and services, geographic areas and major customers. All prior period data presented has been restated to conform to the provisions of SFAS 131. The Company has determined that it operates in three reportable segments: Instrumentation and Test Equipment, Components and Subsystem Assemblies, and Circuits. NEW ACCOUNTING PRONOUNCEMENT Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Financial Instruments and Hedging Activities" ("SFAS 133") issued by the FASB is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. SFAS 133 provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. The Company does not expect adoption of SFAS 133 to have a material effect on its financial position or results of operations. RECLASSIFICATIONS Certain reclassifications have been made to the prior year financial statements to be consistent with the 1998 presentation. (2) MERGER WITH XIT CORPORATION On March 26, 1997, privately-held XIT merged with a wholly-owned, newly formed subsidiary of the Company, with XIT as the surviving subsidiary. Pursuant to the transaction, the former stockholders of XIT were issued approximately 6,119,000 shares of common stock of the Company, or approximately 66% of the issued and outstanding common stock. In addition, holders of XIT stock options and warrants at the date of the merger collectively had the right to acquire an additional 2,153,000 shares of common stock. Collectively, then the former XIT stockholders owned, or had the right to acquire, approximately 65% of the common stock of the Company on a fully-diluted basis as of the date of the transaction. As described in Note 1, the merger has been accounted for as a purchase of the Company by XIT. Accordingly, the purchase price, consisting of the value of the common stock outstanding of the Company at the date of the merger of $5,011,000 plus the direct costs of the acquisition of $730,000, and the acquired assets and liabilities of MicroTel were recorded at their estimated fair values at the date of the merger. The F-15 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (2) MERGER WITH XIT CORPORATION (CONTINUED) excess of $4,998,000 of the purchase price over the fair value of the net assets acquired was recorded as goodwill and thereafter was amortized on a straight-line basis over 15 years. In September 1997, the Company wrote-down the goodwill associated with the merger to $998,000. Thereafter, the remaining goodwill is being amortized on a straight-line basis over ten years (see Note 11). The following represents the unaudited pro forma results of operations as if the merger had occurred at the beginning of the respective periods presented below. The presentation for the year ended September 30, 1996 combines the Company's results of operations for that year with the former MicroTel results of operations for the year ended December 31, 1996, with adjustments to reflect amortization of the excess purchase price over the fair value of the net assets acquired.
YEAR ENDED YEAR ENDED DECEMBER 31, 1997 SEPTEMBER 30, 1996 ----------------- ------------------ Net sales.............................................. $ 46,094,000 $ 47,552,000 ----------------- ------------------ ----------------- ------------------ Net loss............................................... $ (12,097,000) $ (3,514,000) ----------------- ------------------ ----------------- ------------------ Basic and diluted loss per share....................... $ (1.12) $ (.40) ----------------- ------------------ ----------------- ------------------
The pro forma results of operations above do not purport to be indicative of the results that would have occurred had the merger taken place at the beginning of the respective period presented or of results which may occur in the future. (3) ACQUISITIONS AND DISPOSITIONS OF BUSINESSES ACQUISITIONS On October 17, 1997, the Company's CXR Telcom subsidiary acquired all the capital stock of Critical Communications Incorporated ("Critical") of St. Charles, Illinois in exchange for 500,000 shares of the Company's common stock. Founded in 1991, Critical is a provider of sophisticated, state-of-the-art, portable telephone test instruments used by both long-distance carriers and local telephone service providers as well as by corporate and government telecommunications end users. The acquisition of Critical has been accounted for as a purchase, and accordingly, the results of operations of Critical since the date of the acquisition are included in the Company's consolidated statements of operations. The 500,000 shares of common stock were valued at $1,125,000 based on the fair value of the common stock on the acquisition date. The Company acquired $9,000 in cash in the acquisition and the cost in excess of net assets acquired was $1,123,000 which is being amortized on a straight-line basis over ten years. The pro forma effect of this acquisition was not material to the results of operations for 1997 or 1996. On May 1, 1996, the Company acquired all of the assets and assumed all of the liabilities of Etch-Tek, Inc. ("Etch-Tek") for $460,000 in cash and a $195,000 promissory note. Etch-Tek is a manufacturer of quick turn prototype quantity and medium production printed circuit boards. The acquisition of Etch-Tek has been accounted for as a purchase, and accordingly, the results of operations of Etch-Tek since the date F-16 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (3) ACQUISITIONS AND DISPOSITIONS OF BUSINESSES (CONTINUED) of acquisition are included in the Company's consolidated statements of operations. Supplementary information related to the acquisition of Etch-Tek for the year ended September 30, 1996 is as follows:
Assets acquired................................................................. $ 1,401,000 Liabilities assumed............................................................. (746,000) Promissory note................................................................. (195,000) ------------ Cash paid to sellers............................................................ 460,000 Cash acquired................................................................... (32,000) ------------ Net cash paid................................................................... $ 428,000 ------------ ------------
On September 1, 1996, the Company acquired all of the common stock of Abbott Electronics Ltd. ("Abbott"), a British manufacturer of power supplies, for approximately $735,000, including transaction expenses. On July 6, 1994, the Company acquired 84.6% of the common shares outstanding of HyComp, Inc. ("HyComp"), a public company, by means of an exchange of the Company's common stock for HyComp common stock held by Metraplex Corporation and various other officers and directors of HyComp. HyComp is a manufacturer of thin film hybrid circuits for industrial, medical and military customers. In May 1996, the Company acquired additional common shares of HyComp, which increased the Company's ownership percentage to 90.7%. Also in May 1996, the Company acquired 96.1% of the preferred shares outstanding of HyComp. Each of these transactions was an exchange of the Company's common stock for the respective HyComp stock at recorded amounts that approximate fair value. As the result of the exercise of certain HyComp stock options in 1997, the Company's ownership of the common shares outstanding of HyComp was reduced to 88.5%. For financial reporting purposes, HyComp's assets, liabilities and earnings are consolidated with those of the Company. Ownership interest in HyComp, other than that of the Company's, is included in the accompanying consolidated financial statements as minority interest, and includes amounts applicable to HyComp's preferred stock of $6,000 at December 31, 1998 and 1997. Dividends on the preferred stock are cumulative at 8% per year, and minority interest at December 31, 1998 and 1997 includes cumulative dividends in arrears of $8,000. In March 1999, the Company accepted an offer to sell substantially all of the assets and liabilities of HyComp (see Note 16). DISPOSITIONS On January 9, 1998, the Company entered into a definitive agreement to sell certain of the assets of its Xcel Arnold Circuits, Inc. subsidiary ("XACI"), a manufacturer of multi-layer bare printed circuit boards. On April 9, 1998, the Company completed the sale and received $1,350,000 in cash and a note receivable aggregating $650,000, which is payable over three years. The balance due under the note receivable is $650,000 at December 31, 1998 of which $144,000 is included in current portion of notes receivable in the accompanying 1998 consolidated balance sheet. The sale resulted in a gain of approximately $580,000. F-17 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (3) ACQUISITIONS AND DISPOSITIONS OF BUSINESSES (CONTINUED) Summarized below is the unaudited pro forma financial information of the Company as though the assets had been sold at the beginning of the respective period presented below:
1998 1997 ------------- ------------- Net sales...................................................... $ 35,752,000 $ 34,068,000 ------------- ------------- ------------- ------------- Net loss....................................................... $ (715,000) $ (7,327,000) ------------- ------------- ------------- ------------- Basic and diluted loss per share............................... $ (.06) $ (.73) ------------- ------------- ------------- ------------- Total assets................................................... $ 21,242,000 $ 21,021,000 ------------- ------------- ------------- -------------
(4) INVENTORIES Inventories are summarized as follows:
DECEMBER 31, DECEMBER 31, 1998 1997 ------------ ------------ Raw materials.................................................... $2,926,000 $3,044,000 Work-in-process.................................................. 2,375,000 2,333,000 Finished goods................................................... 1,125,000 1,710,000 ------------ ------------ $6,426,000 $7,087,000 ------------ ------------ ------------ ------------
Included in the amounts above is an allowance for inventory obsolesence of $1,856,000 and $1,766,000 at December 31, 1998 and 1997, respectively. (5) PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consists of the following:
DECEMBER 31, DECEMBER 31, 1998 1997 ------------- ------------- Land and buildings.............................................. $ 348,000 $ 642,000 Machinery, equipment and fixtures............................... 3,971,000 7,634,000 Leasehold improvements.......................................... 1,022,000 736,000 ------------- ------------- 5,341,000 9,012,000 Accumulated depreciation and amortization....................... (3,402,000) (4,044,000) ------------- ------------- $ 1,939,000 $ 4,968,000 ------------- ------------- ------------- -------------
Included in the amounts above is $200,000 and $192,000 of assets held under capital lease as of December 31, 1998 and 1997, respectively. Accumulated amortization related to the assets held under capital lease was $36,000 and $14,000 at December 31, 1998 and 1997, respectively. F-18 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (6) INVESTMENT IN PARTNERSHIP On December 19, 1996, the Company's XIT subsidiary invested $100,000 and formed an equal partnership with P&S Development, a California general partnership. The partnership, "Capital Source Partners, A Real Estate Partnership," obtained ownership rights to a 93,000 square foot facility in, Ontario, California. The Company presently occupies 63,000 square feet of this facility as a corporate headquarters and as an administrative and factory facility for XIT's Digitran Division under a long-term lease from the partnership. Immediately following the formation of the partnership, XIT obtained a loan from a bank for $750,000 (Note 8), and in turn, loaned such funds to the partnership under a note receivable with the same terms and conditions. Such funds were utilized to reduce the existing debt secured by the real estate. XIT's original investment in the partnership is adjusted for the income (loss) attributable to XIT's portion of the partnership's results of operations using the equity method of accounting. The carrying value of the investment in the partnership of $150,000 and $126,000 is included in other assets in the accompanying consolidated balance sheets at December 31, 1998 and 1997, respectively. The balance due under the note receivable is $124,000 and $625,000 at December 31, 1998 and 1997, respectively, of which $124,000 and $501,000 is included in current portion of notes receivable in the accompanying consolidated balance sheets at December 31, 1998 and 1997, respectively. (7) NOTES PAYABLE A summary of notes payable is as follows:
DECEMBER 31, DECEMBER 31, 1998 1997 ------------ ------------ Line of credit with a commercial lender.......................... $2,485,000 $ -- Line of credit with a bank....................................... -- 2,377,000 Factoring line of credit with a bank............................. -- 185,000 Foreign subsidiary lines of credit with banks.................... 77,000 292,000 Foreign subsidiary line of credit with a bank.................... 317,000 289,000 Notes payable to related parties................................. -- 387,000 Other notes payable.............................................. 500,000 100,000 ------------ ------------ $3,379,000 $3,630,000 ------------ ------------ ------------ ------------
The Company's XIT subsidiary had a line of credit with a bank (the "XIT Debt") which provided for maximum borrowings of $3,500,000 collateralized by substantially all assets of XIT and its domestic subsidiaries with interest at the bank's prime rate plus 1%. The Company's CXR Telcom subsidiary had a factoring line of credit with a bank which provided for borrowing based on an advance rate of 85% of eligible accounts receivable with no maximum. On July 8, 1998, the Company finalized a $10.5 million credit facility (the "Domestic Facility") with a commercial lender for a term of two years which provided for (i) a term loan of approximately $1.5 million (see Note 8); (ii) a revolving line of credit of up to $8 million based upon assets available from either existing or future-acquired operations; and (iii) a capital equipment expenditure credit line of up to $1 million. This credit facility replaced the existing credit facilities of the Company's domestic operating companies, which included the XIT Debt and CXR Telcom Corporation's line of credit, both of which were paid in full at the closing. Borrowings under the revolving line of credit provision of the Domestic Facility totaled $2,485,000 at December 31, 1998. The line of credit is collateralized by substantially all assets of the Company's domestic F-19 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (7) NOTES PAYABLE (CONTINUED) subsidiaries, bears interest at the lender's prime rate (7.75% at December 31, 1998) plus 1% and is payable on demand. Based upon the Company's eligible collateral at December 31, 1998, approximately $566,000 of additional borrowings were available under the line of credit. No borrowings were outstanding under the $1 million capital equipment expenditure credit line at December 31, 1998, all of which remained available. There are no restrictions on unborrowed amounts. The Domestic Facility agreement requires maintenance of certain financial ratios and contains other restrictive covenants. The Company was in compliance with, or had obtained waivers for, all such covenants at December 31, 1998. The Company's loan agreement prohibits the payment of cash dividends. The Company's French subsidiary has a bank line of credit aggregating $77,000 at December 31, 1998. Borrowings under the related agreement bear interest at 5.05% to 5.55% at December 31, 1998 and are based on eligible accounts receivable. Approximately $370,000 of additional borrowings were available under the line at December 31, 1998. The Company's UK subsidiary has a bank line of credit with $317,000 outstanding at December 31, 1998. Borrowings under the related agreement bear interest at the bank's base rate (6.25% at December 31, 1998) plus 2.5% and are based on eligible accounts receivable. Approximately $440,000 of additional borrowings were available under the line at December 31, 1998. The Company has an outstanding note with a balance of $250,000 at December 31, 1998 in connection with the sale of its XCEL Arnold Circuits, Inc. subsidiary (Note 3). This loan bears no interest and is payable on demand. Additionally, the Company borrowed $250,000 from a third party on a short-term basis on December 31, 1998. This loan bears interest at 10%, is payable in full on April 30, 1999 or earlier upon the occurrence of certain events. As of December 31, 1997, the Company had non-interest bearing short-term borrowings due to a stockholder and an officer of a subsidiary aggregating $387,000. Additionally, the Company had borrowed $100,000 from a third party which it had invested in a real estate partnership (see Note 6). Such short-term borrowings were repaid during 1998. (8) LONG-TERM DEBT A summary of long-term debt follows:
DECEMBER 31, DECEMBER 31, 1998 1997 ------------ ------------- Term notes payable to commercial lender (a)..................... $1,526,000 $ 2,087,000 Term note payable to bank (b)................................... 135,000 568,000 Term notes payable to foreign banks (c)......................... 101,000 124,000 Capitalized lease obligations (d)............................... 380,000 714,000 Other promissory notes.......................................... 93,000 253,000 ------------ ------------- 2,235,000 3,746,000 Current portion................................................. (805,000) (1,216,000) ------------ ------------- $1,430,000 $ 2,530,000 ------------ ------------- ------------ -------------
(a) Three term notes payable to commercial lender bearing interest at the lender's prime rate (7.75% at December 31, 1997) plus 1.25%. The notes are collateralized by machinery and equipment and are F-20 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (8) LONG-TERM DEBT (CONTINUED) payable in aggregate monthly principal installments of approximately $28,000 plus interest through final maturity dates in fiscal 2003. (b) The term note payable to bank is unsecured and bears interest at the lender's prime rate (7.75% at December 31, 1997) plus 1.25%. The note is payable in equal monthly installments through December 31, 1999. (c) The Company has agreements with several foreign banks which include term borrowings which mature at various dates through 2001. Interest rates on the borrowings bear interest at rates ranging from 2.0% to 2.8% and are payable in monthly installments. Included in the other term notes is a $101,000 note, which is guaranteed by Tokyo Credit Guarantee Corporation on behalf of the Company's Japanese subsidiary. The term borrowings are collateralized by the assets of the respective subsidiary. (d) Capital lease agreements are calculated using interest rates appropriate at the inception of the lease and range from 12% to 22%. Lease liabilities are amortized over the lease term using the effective interest method. The leases all contain bargain purchase options and expire through 2002. Principal maturities related to long-term debt as of December 31, 1998 are as follows:
YEAR ENDING DECEMBER 31, AMOUNT - -------------------------------------------------------------------------------- ------------ 1999............................................................................ $ 805,000 2000............................................................................ 507,000 2001............................................................................ 386,000 2002............................................................................ 342,000 2003............................................................................ 195,000 ------------ $ 2,235,000 ------------ ------------
(9) REDEEMABLE PREFERRED STOCK SERIES A AND SERIES B REDEEMABLE PREFERRED STOCK In connection with the Arnold Circuits, Inc. acquisition in 1995, XCEL Arnold Circuits, Inc. issued 1,000 shares each of Series A redeemable preferred stock (Series A) and Series B redeemable preferred stock (Series B). In preference to common shares of stock, each Series A and Series B share was entitled to a cumulative cash dividend of $120 and $160 per year commencing in June 1996, respectively. The Series A and B shares had a liquidation preference of and were subject to mandatory redemption by the Company on December 15, 1999 at a value of $30 and $40 per share, respectively, plus all accrued and unpaid dividends, whether or not declared, to the date of redemption. The redeemable preferred stock was recorded at fair value on the date of issuance using an imputed market rate dividend of 9.5%. The excess of the redemption value over the carrying value was being accreted by periodic charges to retained earnings over the original life of the issue. The Series A and Series B redeemable preferred stock was retired as part of the sale of the XCEL Arnold Circuits subsidiary in March 1998 (see Note 3). F-21 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (9) REDEEMABLE PREFERRED STOCK (CONTINUED) The following table reflects the Series A and Series B redeemable preferred stock activity:
SERIES A REDEEMABLE SERIES B REDEEMABLE PREFERRED STOCK PREFERRED STOCK ------------------------ ------------------------ NUMBER OF NUMBER OF SHARES AMOUNT SHARES AMOUNT ----------- ----------- ----------- ----------- Balance at September 30, 1995.................................... 1,000 $ 358,000 1,000 $ 477,000 Accretion of preferred stock..................................... -- 34,000 -- 46,000 Preferred stock dividends paid................................... -- (60,000) -- (80,000) ----------- ----------- ----------- ----------- Balance at September 30, 1996.................................... 1,000 332,000 1,000 443,000 Accretion of preferred stock..................................... -- 8,000 -- 11,000 ----------- ----------- ----------- ----------- Balance at December 31, 1996..................................... 1,000 340,000 1,000 454,000 Accretion of preferred stock..................................... -- 26,000 -- 34,000 Preferred stock dividends paid................................... -- (60,000) -- (80,000) ----------- ----------- ----------- ----------- Balance at December 31, 1997..................................... 1,000 306,000 1,000 408,000 Accretion of preferred stock..................................... -- 7,000 -- 7,000 Cancellation of stock upon sale of subsidiary.................... (1,000) (313,000) (1,000) (415,000) ----------- ----------- ----------- ----------- Balance at December 31, 1998..................................... -- $ -- -- $ -- ----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
CONVERTIBLE REDEEMABLE PREFERRED STOCK In June 1998, the Company sold 50 shares of convertible redeemable preferred stock (the "New Preferred Shares") at $10,000 per share to one institutional investor. In July 1998, the Company sold an additional 150 New Preferred Shares at the same per share price to two other institutional investors. Included with the sale of such New Preferred Shares were a total of one million warrants to purchase the Company's common stock exercisable at $1.25 per share and expiring May 22, 2001. The Company has ascribed an estimated fair value to these warrants aggregating $163,000 and accordingly has reduced the convertible redeemable preferred stock balance as of the date of issuance. The Company received net proceeds totaling approximately $1,843,000 after deduction of commissions and transaction-related expenses. The New Preferred Shares were originally convertible into common stock of the Company at the option of the holder thereof at any time after the ninetieth (90th) day of issuance thereof at the conversion rate per share of New Preferred Share equal to $10,000 divided by the lesser of (x) $1.25 and (y) One Hundred Percent (100%) of the arithmetic average of the three lowest closing bid prices over the forty (40) trading days prior to the exercise date of any such conversion. No more than 20% of the aggregate number of New Preferred Shares originally purchased and owned by any single entity may be converted in any thirty (30) day period after the ninetieth (90th) day from issuance. In the event of any liquidation, dissolution or winding up of the Company, the holders of shares of New Preferred Shares are entitled to receive, prior and in preference to any distribution of any assets of the Company to the holders of the Company's common stock, an amount per share equal to $10,000 for each outstanding New Preferred Share. Any unconverted New Preferred Shares may be redeemed at the option of the Company for cash at a per share price equal to $11,500 per New Preferred Share and any New Preferred Shares which remain outstanding as of May 22, 2003 are subject to mandatory redemption by the F-22 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (9) REDEEMABLE PREFERRED STOCK (CONTINUED) Company at the same per-share redemption price. The excess of the redemption value over the carrying value is being accreted by periodic charges to retained earnings over the original life of the issue. In November 1998, the holders of the New Preferred Shares agreed to modify the conversion rate to $10,000 divided by $0.50 (the fair value of the underlying shares of common stock) in exchange for a reduction in the exercise price of the Warrants to $0.75 per share. In connection with the repricing of the warrants, the Company recognized $52,000 of expense in 1998. This expense represents the excess of the fair value of the warrants after repricing over the value of the warrants immediately before the repricing. The following table reflects the convertible redeemable preferred stock activity:
NUMBER OF SHARES AMOUNT ------------- ------------ Balance at December 31, 1997......................................... -- $ -- Preferred stock issued............................................... 200 1,837,000 Conversion to common stock........................................... (39) (367,000) Accretion of preferred stock......................................... -- 46,000 --- ------------ Balance at December 31, 1998......................................... 161 $ 1,516,000 --- ------------ --- ------------
(10) STOCKHOLDERS' EQUITY In April 1997, the Company sold 2,000,000 investment units at $2.50 per unit. The units consist of one share of common stock and one quarter of a warrant to purchase one share of common stock. The warrants have an exercise price of $3.45. The proceeds to the Company were $4,258,000 (net of $600,000 of commissions and $142,000 for other expenses). In connection with this transaction, 200,000 warrants were issued to the placement agents at an exercise price of $2.66. STOCK OPTIONS AND WARRANTS The Company has the ability to issue options to purchase its common stock under the following arrangements: - Employee Stock and Stock Option Plan, effective July 1, 1994, providing for non-qualified stock options as well as restricted and non-restricted stock awards to both employees and outside consultants. Up to 520,000 shares may be granted or optioned under this plan. Terms of related grants under the plan are at the discretion of the Board of Directors. - Stock Option Plan adopted in 1993, providing for the granting of up to 300,000 incentive stock options to purchase stock at not less than the current market value on the date of grant. Options granted under this plan vest ratably over three years and expire 10 years after date of grant. - The MicroTel International Inc. 1997 Stock Incentive Plan (the "1997 Plan") provides that options granted may be either qualified or nonqualified stock options and are required to be granted at fair market value on the date of grant. Subject to termination of employment, options may expire up to ten years from the date of grant and are nontransferable other than in the event of death, disability or certain other transfers that the committee of the Board of Directors administering the 1997 Plan may permit. Up to 1,600,000 stock options may be granted under the 1997 Plan. All outstanding F-23 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (10) STOCKHOLDERS' EQUITY (CONTINUED) options of former optionholders under the XIT 1987 Employee Stock Option Plan were converted to options under the 1997 Plan as of the date of the merger between the Company and XIT at the exchange rate of 1.451478 (see Note 2). The Company accounts for stock-based compensation under the "intrinsic value" method. Under this method, no compensation expense is recorded for these plans and arrangements for current employees whose grants provide for exercise prices at or above the market price on the date of grant. Compensation or other expense is recorded based on intrinsic value (excess of market price over exercise price on date of grant) for employees, and fair value of the option awards for others. The following table shows activity in the outstanding options:
THREE MONTHS YEAR YEAR ENDED WEIGHTED YEAR ENDED ENDED ENDED DEC. 31, AVERAGE DEC. 31, DEC. 31, SEP. 30, 1998 EXERCISE 1997 1996 1996 SHARES PRICE SHARES SHARES SHARES ---------- ----------- ---------- --------- --------- Outstanding at beginning of period..................... 1,999,000 $ 2.32 842,000 874,000 874,000 Granted................................................ 200,000 1.13 96,000 41,000 -- XIT/MicroTel merger.................................... -- -- 1,146,000 _ -- Exercised.............................................. -- -- (30,000) _ -- Canceled............................................... (152,000) 3.15 (55,000) (73,000) -- ---------- ----- ---------- --------- --------- Outstanding at end of period........................... 2,047,000 $ 2.13 1,999,000 842,000 874,000 ---------- ----- ---------- --------- --------- ---------- ----- ---------- --------- ---------
The following table summarizes information with respect of stock options at December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------------------- ------------------------- NUMBER WEIGHTED AVG. NUMBER OUTSTANDING REMAINING EXERCISABLE RANGE OF DECEMBER 31, CONTRACTUAL LIFE WEIGHTED DECEMBER 31, WEIGHTED EXERCISE PRICE 1998 (YEARS) AVG. PRICE 1998 AVG. PRICE - ---------------- ------------ ------------------- ----------- ------------ ----------- $1.00 to $2.00 1,050,00 7.0 $ 1.73 919,000 $ 1.57 $2.01 to $3.01 811,000 3.2 $ 2.40 811,000 $ 2.40 $3.01 to $4.00 186,000 5.0 $ 3.20 162,000 $ 3.21 ------------ ------------ 2,047,000 5.3 $ 2.13 1,892,000 $ 2.26 ------------ ------------ ------------ ------------
Options exercisable as of December 31, 1998, 1997 and 1996 and September 30, 1996 are as follows:
DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, 1998 1997 1996 1996 ------------ ------------ ------------ ------------- Exercisable............................................ 1,892,000 1,843,000 821,000 874,000 ------------ ------------ ------------ ------------- ------------ ------------ ------------ ------------- Weighted Average Exercise Price........................ $ 2.26 $ 2.32 $ 1.91 $ 1.89 ------------ ------------ ------------ ------------- ------------ ------------ ------------ -------------
Weighted average exercise prices for 1998 are calculated at prices effective as of December 31, 1998. The fair value of options granted during 1998 was $112,000, at a weighted average value of $0.56 per share. Exercise prices for options outstanding as of December 31, 1998 generally ranged from $1.13 to $3.45 per F-24 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (10) STOCKHOLDERS' EQUITY (CONTINUED) share and the weighted average remaining contractual life for these options was 5.3 years. The fair value of options granted during the year ended December 31, 1997 and the three months ended December 31, 1996 were $132,000 and $29,000, at weighted average prices of $1.37 and $.72 per share, respectively. If the Company had instead elected the fair value method of accounting for stock-based compensation, compensation cost would be accrued at the estimated fair value of all stock option grants over the service period, regardless of later changes in stock prices and price volatility. The fair value at date of grant for options granted in 1998 and 1997 has been estimated based on a modified Black-Scholes pricing model with the following assumptions: no dividend yield; expected volatility ranging between approximately 25% to 57% in 1998 and 73% in 1997, based on historical results; risk-free interest rate of 5.1%; and average expected lives of approximately ten years. The fair value at date of grant for options granted in 1996 has been estimated using the minimum value method with the following assumptions: no dividend yield; risk-free interest rate of 6.0% and the actual remaining life of the option. The following table sets forth the net income (loss), net income (loss) available for common stockholders and earnings (loss) per share amounts for the periods presented as if the Company had elected the fair value method of accounting for stock options.
YEAR ENDED YEAR ENDED THREE MONTHS YEAR ENDED DEC. 31, DEC. 31, ENDED DEC. 31, SEP. 30, 1998 1997 1996 1996 ----------- ----------- --------------- ----------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) NET INCOME (LOSS) As reported.............................................. $ (1,185) $ (9,693) $ (905) $ 1,083 Pro forma................................................ $ (1,297) $ (9,825) $ (934) $ 1,083 NET INCOME (LOSS) AVAILABLE FOR COMMON STOCKHOLDERS As reported.............................................. $ (1,245) $ (9,753) $ (924) $ 1,003 Pro forma................................................ $ (1,357) $ (9,885) $ (953) $ 1,003 BASIC AND DILUTED EARNINGS (LOSS) PER SHARE As reported.............................................. $ (.10) $ (.96) $ (.15) $ .17 Pro forma................................................ $ (.11) $ (.98) $ (.16) $ .17
Additional incremental compensation expense includes the excess of fair values of options granted during the year over any compensation amounts recorded for options whose exercise prices were less than market value at date of grant, and for any expense recorded for non-employee grants. Additional incremental compensation expense also includes the excess of the fair value at modification date of options repriced or extended over the value of the old options immediately before modification. All such incremental compensation is amortized over the related vesting period, or expensed immediately if fully vested. The above calculations include the effects of all grants in the periods presented. Because options often vest over several years and additional awards are made each year, the results shown above may not be representative of the effects on net income (loss) in future years. F-25 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (10) STOCKHOLDERS' EQUITY (CONTINUED) The Board of Directors has also authorized the issuance of common stock purchase warrants to certain officers, directors, stockholders, key employees and other parties as follows:
WARRANT PRICE NUMBER OF ---------------------------- SHARES PER SHARE TOTAL ---------- -------------- ------------ Balance outstanding, September 30, 1995............................... 908,000 $ 1.21 to 3.79 $ 2,435,000 Warrants issued....................................................... 363,000 3.44 1,248,000 Warrants canceled..................................................... (73,000) 3.44 to 3.79 (252,000) ---------- ------------ Balance outstanding, September 30, 1996 and December 31, 1996......... 1,198,000 1.21 to 3.79 3,431,000 Warrant - MicroTel merger............................................. 122,000 2.50 305,000 Warrants issued....................................................... 1,170,000 2.13 to 3.45 3,410,000 ---------- ------------ Balance outstanding, December 31, 1997................................ 2,490,000 1.21 to 3.79 7,146,000 Warrants issued....................................................... 1,802,000 0.66 to 1.25 1,588,000 ---------- ------------ Balance outstanding, December 31, 1998................................ 4,292,000 $ .66 to 3.79 $ 8,734,000 ---------- ------------ ---------- ------------
The Company has an Employee Stock Purchase Plan allowing eligible employees to purchase shares of the Company's common stock at 85% of market value. During 1998 and 1997, 7,000 and 6,000 shares, respectively, had been issued pursuant to the plan with 32,000 shares reserved for future issuance. At December 31, 1998, the total number of shares reserved for issuance upon exercise of stock options and warrants, direct grants and the conversion of preferred stock was 9,966,000 shares. DEBT TO EQUITY CONVERSION In March 1997, the Company converted $44,000 in various promissory notes to 55,000 shares of common stock. In September 1996, the Company converted $123,000 in various promissory notes to 179,000 shares of common stock. SETTLEMENT OF DISPUTE During 1997, the Company entered into an amendment to an agreement with a former officer in settlement of a claim made by such officer for certain amounts purportedly owed to him by the Company. In connection with the amended agreement, the Company issued the former officer 80,000 shares of its common stock valued at $190,000, the fair market value of the common stock on the date of issuance. In November 1998, the Company entered into a further amended agreement pursuant to which the former officer returned the 80,000 shares previously issued in exchange for the Company's agreement to pay $168,000 over the next two years. The Company cancelled the returned shares. (11) NON-RECURRING CHARGES; IMPAIRMENT OF GOODWILL The Company assesses the recoverability of its goodwill whenever adverse events or changes in circumstances or business climate indicate that expected future cash flows (undiscounted and without interest charges) for individual business units may not be sufficient to support recorded goodwill. During the third quarter ended September 30, 1997 the Company, due to declines in profit margins and continuing F-26 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (11) NON-RECURRING CHARGES; IMPAIRMENT OF GOODWILL (CONTINUED) operating losses, wrote-off the carrying value of goodwill originating with certain acquisitions. The Company also wrote-down the carrying value of goodwill originating from the reverse acquisition with XIT (see Note 2) to its net realizable value. These write-downs totaled $5,693,000 and were charged to operations. (12) INCOME TAXES The Company files a consolidated U.S. federal income tax return. This return includes all domestic companies 80% or more owned by the Company and the proportionate share of its interest in partnership investments. State tax returns are filed on a consolidated, combined or separate basis depending on the applicable laws relating to the Company and its domestic subsidiaries. Income (loss) before income taxes was taxed under the following jurisdictions:
YEAR ENDED YEAR ENDED THREE MONTHS ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, 1998 1997 1996 1996 ------------- ------------- ------------------- ------------- Domestic........................................ $ (2,247,000) $ (9,721,000) $ (882,000) $ 870,000 Foreign......................................... 1,163,000 125,000 7,000 235,000 ------------- ------------- ---------- ------------- Total........................................... $ (1,084,000) $ (9,596,000) $ (875,000) $ 1,105,000 ------------- ------------- ---------- ------------- ------------- ------------- ---------- -------------
Income tax expense consists of the following:
YEAR ENDED YEAR ENDED THREE MONTHS ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, 1998 1997 1996 1996 ------------ ------------ ------------------- ------------- CURRENT: Federal....................................... $ -- $ -- $ -- $ 6,000 State......................................... 8,000 17,000 16,000 11,000 Foreign....................................... 93,000 80,000 14,000 5,000 ------------ ------------ ------- ------------- $ 101,000 $ 97,000 $ 30,000 $ 22,000 ------------ ------------ ------- ------------- ------------ ------------ ------- -------------
F-27 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (12) INCOME TAXES (CONTINUED) Income tax expense (benefit) differs from the amount obtained by applying the statutory federal income tax rate of 34% to income (loss) before income taxes as follows:
YEAR ENDED YEAR ENDED THREE MONTHS ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, 1998 1997 1996 1996 ------------ ------------- ------------------- ------------- Tax at U. S. federal statutory rate............. $ (368,000) $ (3,263,000) $ (297,000) $ 296,000 State taxes, net of federal income tax benefit....................................... 8,000 17,000 16,000 7,000 Foreign income taxes............................ 93,000 80,000 14,000 5,000 Net operating losses utilized................... -- -- -- (62,000) Write-down of goodwill.......................... -- 1,936,000 -- -- Losses with no current benefit.................. 270,000 1,096,000 283,000 (307,000) Permanent differences........................... 98,000 157,000 15,000 54,000 Other........................................... -- 74,000 (1,000) 29,000 ------------ ------------- ---------- ------------- $ 101,000 $ 97,000 $ 30,000 $ 22,000 ------------ ------------- ---------- ------------- ------------ ------------- ---------- -------------
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are as follows:
DECEMBER 31, DECEMBER 31, 1998 1997 ------------- ------------- Deferred tax assets: Allowance for doubtful accounts.............................. $ 90,000 $ 61,000 Inventory reserves and uniform capitalization................ 387,000 449,000 Accrued vacation............................................. 154,000 174,000 Warranty reserve............................................. 49,000 45,000 Other accrued liabilities.................................... 76,000 103,000 Deferred compensation........................................ 537,000 588,000 Research credit carryforwards................................ 256,000 256,000 Alternative Minimum Tax credit carryforwards................. 134,000 134,000 Net operating loss carryforwards............................. 15,423,000 15,167,000 ------------- ------------- Total deferred tax assets.................................... 17,106,000 16,977,000 Valuation allowance for deferred tax assets.................. (16,591,000) (16,644,000) ------------- ------------- Net deferred tax assets...................................... 515,000 333,000 Deferred tax liabilities-depreciation.......................... (515,000) (333,000) ------------- ------------- Net deferred taxes......................................... $ -- $ -- ------------- ------------- ------------- -------------
As of December 31, 1998, the Company has a federal net operating loss carryforward of approximately $45,000,000 which expires at various dates between 2001 and 2018 and a state net operating loss carryforward of approximately $2,700,000 which expires at various dates through 2003. F-28 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (12) INCOME TAXES (CONTINUED) As a result of the merger with XIT (Note 2), the Company experienced a more than 50% ownership change for federal income tax purposes. As a result, an annual limitation will be placed upon the Company's ability to realize the benefit of its net operating loss and credit carryforwards. The amount of this annual limitation, as well as the impact of the application of other possible limitations under the consolidated return regulations, has not been definitively determined at this time. Management believes sufficient uncertainty exists regarding the realizability of the deferred tax asset items and that a valuation allowance, equal to the net deferred tax asset amount, is required. (13) EARNINGS (LOSS) PER SHARE The following table illustrates the computation of basic and diluted earnings (loss) per share:
YEAR ENDED YEAR ENDED THREE MONTHS ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, 1998 1997 1996 1996 ------------- ------------- ------------------- ------------- NUMERATOR: Net income (loss)............................ $ (1,185,000) $ (9,693,000) $ (905,000) $ 1,083,000 Less: accretion of the excess of the redemption value over the carrying value of redeemable preferred stock................. 60,000 60,000 19,000 80,000 ------------- ------------- ---------- ------------- Income available for common stockholders....... $ (1,245,000) $ (9,753,000) $ (924,000) $ 1,003,000 ------------- ------------- ---------- ------------- ------------- ------------- ---------- ------------- DENOMINATOR: Weighted average number of common shares outstanding during the period................ 11,952,000 10,137,000 6,064,000 5,841,000 ------------- ------------- ---------- ------------- Basic and diluted earnings (loss) per share $ (.10) $ (.96) $ (.15) $ .17 ------------- ------------- ---------- ------------- ------------- ------------- ---------- -------------
The computation of diluted earnings (loss) per share excludes the effect of incremental common shares attributable to the exercise of outstanding common stock options and warrants because their effect was antidilutive due to losses incurred by the Company or such instruments had exercise prices greater than the average market price of the common shares during periods presented. See summary of outstanding stock options and warrants in Note 10. (14) COMMITMENTS AND CONTINGENCIES LEASES The Company conducts most of its operations from leased facilities under operating leases which expire at various dates through 2007. The leases generally require the Company to pay all maintenance, insurance and property tax costs and contain provisions for rent increases. Total rent expense for the years ended December 31, 1998 and 1997, the three months ended December 31, 1996 and the year ended September 30, 1996 was $2,091,000, $2,477,000, $595,000 and $1,135,000, respectively. F-29 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (14) COMMITMENTS AND CONTINGENCIES (CONTINUED) The future minimum rental payments required under operating leases that have initial or remaining noncancellable lease terms in excess of one year are as follows:
YEAR ENDING DECEMBER 31, AMOUNT - -------------------------------------------------------------------------------- ------------ 1999............................................................................ $ 1,868,000 2000............................................................................ 1,603,000 2001............................................................................ 1,163,000 2002............................................................................ 1,062,000 2003............................................................................ 1,026,000 Thereafter...................................................................... 1,231,000 ------------ $ 7,953,000 ------------ ------------
Included in the above amounts is annual rent of $456,000 payable under a lease to a real estate partnership which is 50% owned by the Company (Note 6). The lease expires in September 2006. LITIGATION The Company and its subsidiaries are, from time to time, involved in legal proceedings, claims and litigation arising in the ordinary course of business. While the amounts claimed may be substantial, the ultimate liability cannot presently be determined because of considerable uncertainties that 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. SCHEINFELD V. MICROTEL INTERNATIONAL, INC. In October 1996, David Scheinfeld brought an action in the Supreme Court of the State of New York, County of New York, to recover monetary damages in the amount of $300,000 allegedly sustained by the failure of the Company, its stock transfer agent and its counsel to timely deliver and register 40,000 shares of common stock purchased by Mr. Scheinfeld. The Company was informed by Mr. Scheinfeld that in order to settle his claims, the Company would have to issue him unrestricted shares of common stock. Since, in the absence of registrations, the Company could not issue unrestricted shares, the Company answered Mr. Scheinfeld's motion and sought to compel him to serve a complaint upon the defendants. On June 30, 1997, the complaint was served, and the Company has subsequently answered, denying the material allegations of the complaint. In August 1997, the Company served discovery requests on Mr. Scheinfeld, who was initially obligated to respond by September 12, 1997. Several court scheduling and preliminary settlement conferences were held during 1998 with no definitive outcome. Discovery is presently scheduled to be completed during April 1999. Although the ultimate outcome of this matter cannot be predicted with certainty, pending actual resolution, management believes the disposition of this matter will not have a material adverse affect on the Company's consolidated financial position, results of operations or cash flows. F-30 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (14) COMMITMENTS AND CONTINGENCIES (CONTINUED) DANIEL DROR & ELK INTERNATIONAL, INC. V. MICROTEL INTERNATIONAL, INC. In November 1996, the Company entered into an agreement (the "Agreement") with the former Chairman of the Company, which involved certain mutual obligations. In December 1997, the former Chairman defaulted on the repayment of the first installment of a debt obligation which was an obligation set forth in the Agreement. Also in December 1997, the former Chairman of the Company, filed suit in the District Court for Galveston County, Texas alleging the Company had breached an alleged oral modification of the Agreement. In January 1998, the Company answered the complaint denying the allegation and litigation commenced in Texas. In April 1998, the Company brought an action in California against the former Chairman for breach of the Agreement and sought recovery of all stock, warrants and debt due the Company. The Company obtained a judgement against the former Chairman in this litigation. In December 1997, Elk International Corporation Limited ("Elk"), a stockholder of the Company, brought an action in Texas against the Company's current Chairman and an unrelated party, alleging certain misrepresentations during the merger discussions between XIT and the Company. In February 1999, Elk filed suit against the Company and the current Chairman in connection with a stop transfer placed by the Company on certain common shares held by Elk. On March 1, 1999, the parties entered into a settlement agreement which terminated all of the actions discussed in the previous three paragraphs. The agreement calls for the Company to issue to Elk, Dror and other parties a combination of cash, stock and warrants which have an aggregated fair value of approximately $130,000. The cash portion of the settlement is $60,000 and is payable over a six month period. The Company has properly accrued for this settlement in the accompanying 1998 consolidated financial statements. EMPLOYEE BENEFIT PLANS Through September 30, 1998, the Company sponsored several defined contribution plans ("401(k) Plans") covering the majority of its U.S. domestic employees. Effective October 1, 1998, these plans were terminated and a new plan was instituted covering the same employees. Participants may make voluntary pretax contributions to such plans up to the limit as permitted by law. Annual contributions to any plan by the Company is discretionary. The Company made contributions of $22,000, $43,000 and $46,000 to the 401(k) Plans for the calendar years ended December 31, 1998, 1997 and 1996, respectively. (15) SEGMENT, GEOGRAPHIC AREAS, AND MAJOR CUSTOMERS INFORMATION The Company has three reportable segments: Instrumentation and Test Equipment, Components and Subsystem Assemblies, and Circuits. The Instrumentation and Test Equipment 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 Components and Subsystems Assemblies segment operates in the U.S., European and Asian markets and designs, manufactures and markets information technology products, including input and display components, subsystem assemblies, and power supplies. The Circuits Sector operates principally in the U.S. market and designs, manufactures and markets hybrid microelectronic and other circuits. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. 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. F-31 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (15) SEGMENT, GEOGRAPHIC AREAS, AND MAJOR CUSTOMERS INFORMATION (CONTINUED) 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, and different design, manufacturing, and marketing strategies. Selected financial data for each of the Company's operating segments is shown below.
THREE MONTHS YEAR ENDED YEAR ENDED ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, 1998 1997 1996 1996 ------------- ------------- ------------- ------------- SALES FROM EXTERNAL CUSTOMERS: Instruments....................................... $ 17,532,000 $ 15,054,000 $ -- $ -- Components........................................ 12,412,000 12,197,000 3,641,000 12,383,000 Circuits.......................................... 7,317,000 15,847,000 4,245,000 18,866,000 ------------- ------------- ------------- ------------- $ 37,261,000 $ 43,098,000 $ 7,886,000 $ 31,249,000 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- INTERSEGMENT SALES: Instruments....................................... $ 17,000 $ 133,000 $ -- $ -- Components........................................ 635,000 957,000 234,000 805,000 Circuits.......................................... 699,000 819,000 103,000 726,000 ------------- ------------- ------------- ------------- $ 1,351,000 $ 1,909,000 $ 337,000 $ 1,531,000 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- INTEREST EXPENSE: Instruments....................................... $ 79,000 $ 109,000 $ -- $ -- Components........................................ 323,000 396,000 65,000 59,000 Circuits.......................................... 168,000 346,000 80,000 242,000 ------------- ------------- ------------- ------------- $ 570,000 $ 851,000 $ 145,000 $ 301,000 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- DEPRECIATION AND AMORTIZATION: Instruments....................................... $ 265,000 $ 164,000 $ -- $ -- Components........................................ 91,000 284,000 46,000 263,000 Circuits.......................................... 312,000 607,000 63,000 477,000 ------------- ------------- ------------- ------------- $ 668,000 $ 1,055,000 $ 109,000 $ 740,000 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- SEGMENT PROFITS: Instruments....................................... $ 367,000 $ 536,000 $ -- $ -- Components........................................ 2,473,000 794,000 156,000 3,057,000 Circuits.......................................... (786,000) (1,055,000) (482,000) (226,000) ------------- ------------- ------------- ------------- $ 2,054,000 $ 275,000 $ (326,000) $ 2,831,000 ------------- ------------- ------------- ------------- ------------- ------------- ------------- ------------- SEGMENT ASSETS: Instruments....................................... $ 10,234,000 $ 5,691,000 $ -- $ -- Components........................................ 7,193,000 5,312,000 11,505,000 13,956,000 Circuits.......................................... 2,737,000 7,907,000 9,059,000 5,657,000 ------------- ------------- ------------- ------------- $ 20,164,000 $ 18,910,000 $ 20,564,000 $ 19,613,000 ------------- ------------- ------------- ------------- ------------- ------------- ------------- -------------
F-32 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (15) SEGMENT, GEOGRAPHIC AREAS, AND MAJOR CUSTOMERS INFORMATION (CONTINUED) The following is a reconciliation of the reportable segment revenues, profit or loss and assets to the Company's consolidated totals.
YEAR ENDED YEAR ENDED THREE MONTHS ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, 1998 1997 1996 1996 ------------- ------------- ------------------- ------------- Net sales Total sales for reportable segments.......... $ 38,612,000 $ 45,007,000 $ 8,223,000 $ 32,780,000 Elimination of intersegment sales............ (1,351,000) (1,909,000) (337,000) (1,531,000) ------------- ------------- ------------------- ------------- Total consolidated net sales................... $ 37,261,000 $ 43,098,000 $ 7,886,000 $ 31,249,000 ------------- ------------- ------------------- ------------- ------------- ------------- ------------------- ------------- Profit (loss) Total profit (loss) for reportable segments.... $ 2,054,000 $ 275,000 $ (326,000) $ 2,831,000 Write-down of goodwill......................... -- (5,693,000) -- -- Unallocated amounts: General corporate expenses................... (3,138,000) (4,178,000) (549,000) (1,726,000) ------------- ------------- ------------------- ------------- Consolidated profit (loss) before income taxes........................................ $ (1,084,000) $ (9,596,000) $ (875,000) $ 1,105,000 ------------- ------------- ------------------- ------------- ------------- ------------- ------------------- ------------- Assets Total assets for reportable segments......... $ 20,164,000 $ 18,910,000 $ 20,564,000 $ 19,613,000 Other assets................................. 1,078,000 6,530,000 -- -- Other unallocated amounts.................... -- -- -- -- ------------- ------------- ------------------- ------------- Total consolidated assets...................... $ 21,242,000 $ 25,440,000 $ 20,564,000 $ 19,613,000 ------------- ------------- ------------------- ------------- ------------- ------------- ------------------- ------------- Interest expense Interest expense for reportable segments..... $ 570,000 $ 851,000 $ 145,000 $ 301,000 Other interest expense....................... 105,000 44,000 38,000 206,000 ------------- ------------- ------------------- ------------- Total interest expense......................... $ 675,000 $ 895,000 $ 183,000 $ 507,000 ------------- ------------- ------------------- ------------- ------------- ------------- ------------------- ------------- Depreciation and amortization Depreciation and amortization expense for reportable segments........................ $ 668,000 $ 1,055,000 $ 109,000 $ 740,000 Other depreciation and amortizaiton expense.................................... 190,000 226,000 167,000 59,000 ------------- ------------- ------------------- ------------- Total depreciation and amortization............ $ 858,000 $ 1,281,000 $ 276,000 $ 799,000 ------------- ------------- ------------------- ------------- ------------- ------------- ------------------- -------------
F-33 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (15) SEGMENT, GEOGRAPHIC AREAS, AND MAJOR CUSTOMERS INFORMATION (CONTINUED) A summary of the Company's net sales, operating income (loss) and identifiable assets by geographical area follows:
YEAR ENDED YEAR ENDED THREE MONTHS ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, SEPTEMBER 30, 1998 1997 1996 1996 ------------- ------------- ------------------- ------------- Net sales: United States................................ $ 19,965,000 $ 28,098,000 $ 6,012,000 $ 27,854,000 Asia......................................... 706,000 857,000 333,000 1,211,000 Europe....................................... 16,590,000 14,143,000 1,541,000 2,184,000 ------------- ------------- ------------------- ------------- $ 37,261,000 $ 43,098,000 $ 7,886,000 $ 31,249,000 ------------- ------------- ------------------- ------------- ------------- ------------- ------------------- ------------- Operating income (loss) (1): United States................................ $ (1,972,000) $ (9,196,000) $ (603,000) $ 1,047,000 Asia......................................... (50,000) (80,000) 16,000 (54,000) Europe....................................... 1,132,000 604,000 (92,000) 511,000 ------------- ------------- ------------------- ------------- $ (890,000) $ (8,672,000) $ (679,000) $ 1,504,000 ------------- ------------- ------------------- ------------- ------------- ------------- ------------------- ------------- Identifiable assets: United States................................ $ 12,179,000 $ 16,779,000 $ 15,219,000 $ 14,848,000 Asia......................................... 813,000 678,000 1,110,000 937,000 Europe....................................... 8,250,000 7,983,000 4,235,000 3,828,000 ------------- ------------- ------------------- ------------- $ 21,242,000 $ 25,440,000 $ 20,564,000 $ 19,613,000 ------------- ------------- ------------------- ------------- ------------- ------------- ------------------- -------------
- ------------------------ (1) Operating loss for United States for the year ended December 31, 1997 includes a write-down of goodwill of $5,693,000 (see Note 11). In determining operating income (loss) for each geographic area, sales and purchases between geographic areas have been accounted for on the basis of prices set between the geographic areas, generally at cost plus 5%. Identifiable assets by geographic area are those assets that are used in the Company's operations in each location. Export sales included in the United States amounts shown in the summary table by geographic area above were not significant. The Company had sales to one customer which accounted for approximately 14%, 34% and 41% of net sales for year ended December 31, 1997, the three months ended December 31, 1996 and the year ended September 30, 1996, respectively. The accounts receivable balance from this customer was approximately 4% of total accounts receivable at December 31, 1997. No one customer accounted for more than 10% of net sales for the year ended December 31, 1998. (16) SUBSEQUENT EVENTS On January 31, 1999, the Company exercised an option to purchase 1,738,159 shares or 41.4% of the outstanding common stock of Digital Transmission Systems, Inc. ("DTS") from a private company in exchange for 1,000,000 shares of common stock of the Company. This option was granted to the Company F-34 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1998, 1997 AND 1996 AND SEPTEMBER 30, 1996 (16) SUBSEQUENT EVENTS (CONTINUED) on December 31, 1998 in exchange for warrants (with a fair value of approximately $55,000) to purchase 152,381 shares of the Company's common stock at $0.66 per share for five years. On March 1, 1999, the Company accepted an offer to sell substantially all the assets (excluding accounts receivable and cash) and liabilities of its HyComp, Inc. subsidiary in exchange for $750,000 in cash and a royalty on the net sales of the acquiring company during the twelve months following the closing of the transaction. The offer was accepted subject to negotiation of a definitive sale agreement and approval by HyComp's board of directors. The transaction is expected to close on or about April 2, 1999 and to result in a gain of approximately $350,000 (unaudited). Summarized below is the unaudited pro forma financial information of the Company as though the assets had been sold at the beginning of the year ended December 31, 1998.
Net sales...................................................................... $ 34,435,000 ------------- ------------- Net loss....................................................................... $ (1,469,000) ------------- ------------- Basic and diluted loss per share............................................... $ (.13) ------------- ------------- Total assets................................................................... $ 19,125,000 ------------- -------------
F-35 MICROTEL INTERNATIONAL, INC. AND SUBSIDIARIES SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1998 AND 1997, THREE MONTHS ENDED DECEMBER 31, 1996 AND YEAR ENDED SEPTEMBER 30, 1996
ADDITIONS BALANCE AT CHARGED TO DEDUCTIONS BALANCE AT BEGINNING OF COSTS AND WRITE OFFS END OF DESCRIPTION PERIOD EXPENSES OF ACCOUNTS PERIOD - ----------------------------------------------------------- ------------ ---------- ------------ ------------ Allowance for doubtful accounts: Year ended December 31, 1998............................. $ 241,000 97,000 (63,000) $ 275,000 Year ended December 31, 1997............................. 63,000 251,000 (73,000) 241,000 Three months ended December 31, 1996..................... 47,000 16,000 -- 63,000 Year ended September 30, 1996............................ 57,000 17,000 (27,000) 47,000 ------------ ---------- ------------ ------------ ------------ ---------- ------------ ------------ Allowance for inventory obsolescence: Year ended December 31, 1998............................. $ 1,856,000 885,000 (975,000) $ 1,766,000 Year ended December 31, 1997............................. 685,000 3,134,000 (1,963,000) 1,856,000 Three months ended December 31, 1996..................... 322,000 416,000 (53,000) 685,000 Year ended September 30, 1996............................ 419,000 211,000 (308,000) 322,000 ------------ ---------- ------------ ------------ ------------ ---------- ------------ ------------
F-36 EX-23.1 2 EXHIBIT 23.1 Exhibit 23.1 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors MicroTel International, Inc. We hereby consent to the incorporation by reference in the Registration Statements (Nos. 333-74281, 333-71035, 333-69571, 33-22518, 33-72926 and 333-12567) on Form S-8 of our report dated February 19, 1999, except as to the penultimate paragraph of Note 14 and the second paragraph of Note 16 which are as of March 1, 1999, relating to the consolidated financial statements and financial statement schedule of MicroTel International, Inc. appearing in the Company's Annual Report on Form 10-K for the year ended December 31, 1998. BDO Seidman, LLP Orange County, California March 30, 1999 EX-23.2 3 EXHIBIT 23.2 Exhibit 23.2 CONSENT OF INDEPENDENT AUDITORS The Board of Directors MicroTel International, Inc.: We consent to incorporation by reference in the registration statements (Nos. 333-74281, 333-71035, 333-69571, 33-22518, 33-72926 and 333-12567) on Form S-8 of MicroTel International, Inc. (formerly XCEL Corporation and subsidiaries) of our report dated December 13, 1996, relating to the consolidated statements of operations, stockholders' equity, and cash flows for the year ended September 30, 1996, which report appears in the December 31, 1998 annual report on Form 10-K of MicroTel International, Inc. (formerly XCEL Corporation and subsidiaries). KPMG LLP Orange County, California March 29, 1999 EX-23.3 4 EXHIBIT 23.3 [LETTERHEAD] BY FAX J P Burder Esq Microtel International Inc 4290 E Brickell Street Ontario CA 91761-1511 23 February 1999 Dear Sir: XCEL CORPORATION LIMITED As requested, we hereby enclose an original signed audit report on the above company's financial statements for the year ended 30 September 1996. Furthermore, we hereby consent to this audit report being included with your filing with the US Securities and Exchange Commission on Form 10-K for the period ended 31 December 1998. Yours faithfully HARDCASTLE BURTON /s/ Hardcastle Burton EX-27 5 EXHIBIT 27
5 0000854852 MICROTEL INTERNATIONAL, INC. 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1999 572 0 7,612 275 6,426 15,552 5,341 3,402 21,242 11,765 1,430 1,619 0 42 5,337 21,242 37,261 37,261 23,871 23,871 0 97 675 (1,084) 101 (1,185) 0 0 0 (1,185) (.10) (.10)
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