EXECUTONE INFORMATION SYSTEMS, INC. 9/30/96 10-Q
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
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 No. 0-11551
EXECUTONE Information Systems, Inc.
(Exact name of registrant as specified in its charter)
Virginia 86-0449210
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
478 Wheelers Farms Road, Milford, Connecticut
06460
(Address of principal executive offices)
(Zip Code)
(203) 876-7600
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
The number of shares outstanding of registrant's Common Stock,
$.01 par value per share, as of October 31, 1996 was 51,647,630.
<PAGE>
INDEX
EXECUTONE Information Systems, Inc.
Page #
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
September 30, 1996 and December 31, 1995. 3
Consolidated Statements of Operations -
Three Months and Nine Months Ended
September 30, 1996 and 1995. 4
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 1996 and 1995. 5
Notes to Consolidated Financial Statements. 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 11
PART II. OTHER INFORMATION 16
SIGNATURES 17
EXHIBIT 11. STATEMENT REGARDING COMPUTATION
OF PER SHARE EARNINGS 18
2
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
(In thousands, except for share amounts) 1996 1995
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 35,296 $ 8,092
Accounts receivable, net of
allowance of $1,537 and $1,715 35,140 48,531
Inventories 17,283 32,765
Prepaid expenses and other current assets 2,242 5,290
Total Current Assets 89,961 94,678
PROPERTY AND EQUIPMENT, net 7,528 18,462
INTANGIBLE ASSETS, net 19,925 20,022
DEFERRED TAXES 20,056 29,616
OTHER ASSETS 12,158 5,066
$ 149,628 $ 167,844
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 1,027 $ 932
Accounts payable 28,090 30,676
Accrued payroll and related costs 3,307 6,870
Accrued liabilities 16,190 11,851
Deferred revenue and customer deposits 3,019 19,781
Total Current Liabilities 51,633 70,110
LONG-TERM DEBT 14,034 29,829
LONG-TERM DEFERRED REVENUE 156 2,805
TOTAL LIABILITIES 65,823 102,744
STOCKHOLDERS' EQUITY:
Common stock: $.01 par value; 80,000,000 shares
authorized; 51,584,935 and 51,658,492 issued
and outstanding 516 517
Preferred stock: $.01 par value; Cumulative
Convertible Preferred Stock (Series A),
250,000 shares authorized, issued and
outstanding; Cumulative Contingently
Convertible Preferred Stock (Series B),
100,000 shares authorized, issued and
outstanding 7,300 7,300
Additional paid-in capital 77,748 79,668
Accumulated deficit (since July 1, 1988) (1,759) (22,385)
Total Stockholders' Equity 83,805 65,100
$ 149,628 $ 167,844
The accompanying notes are an integral part of these consolidated
balance sheets.
</TABLE>
3
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EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
(In thousands, except for Three Months Ended Nine Months Ended
per share amounts) September 30, September 30,
1996 1995 1996 1995
<S> <C> <C> <C> <C>
REVENUES $ 44,791 $ 74,164 $ 163,739 $ 223,390
COST OF REVENUES 28,333 43,660 101,793 132,515
Gross Profit 16,458 30,504 61,946 90,875
OPERATING EXPENSES:
Product development and
engineering 3,129 3,553 10,504 10,980
Selling, general and
administrative 10,134 24,040 58,983 74,298
Provision for restructuring
(Note H) 0 0 0 44,042
13,263 27,593 69,487 129,320
OPERATING INCOME/(LOSS) 3,195 2,911 (7,541) (38,445)
INTEREST EXPENSE (550) (1,044) (2,113) (3,002)
GAIN ON SALE OF BUSINESSES (NOTE F) 0 0 42,618 0
ACQUISITION COSTS 0 (16) 0 (1,022)
OTHER INCOME, NET 890 354 1,420 646
INCOME (LOSS) BEFORE INCOME TAXES 3,535 2,205 34,384 (41,823)
PROVISION (BENEFIT) FOR INCOME TAXES:
Cash 100 100 4,200 300
Noncash (Note C) 1,311 782 9,560 (3,627)
1,411 882 13,760 (3,327)
NET INCOME (LOSS) $ 2,124 $ 1,323 $ 20,624 $ (38,496)
EARNINGS (LOSS) PER SHARE $ 0.04 $ 0.03 $ 0.39 $ (0.83)
WEIGHTED AVG. COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING 52,176 49,014 52,558 46,478
The accompanying notes are an integral part of these consolidated
statements.
</TABLE>
4
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EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
(In thousands) September 30,
1996 1995
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 20,624 $ (38,496)
Adjustments to reconcile net income (loss)
to net cash used by operating activities:
Depreciation and amortization 3,484 4,701
Gain on sale of businesses (Note F) (42,618) ---
Provision for restructuring (Note H) --- 44,042
Provision/(benefit) for income taxes
not currently payable 9,560 (3,627)
Noncash expenses, including noncash
interest expense, noncash provision
for losses on accounts receivable and
income from equity investment (549) 124
Change in working capital items:
Accounts receivable (3,868) 445
Inventories 311 (1,347)
Accounts payable and accruals (4,617) (11,050)
Other working capital items 3,104 1,947
NET CASH USED BY OPERATING ACTIVITIES (14,569) (3,261)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (2,137) (2,950)
Proceeds from sale of businesses (Note F) 61,948 1,200
Investment in IGT and CWH (Note G) (800) ---
Other, net 367 518
NET CASH PROVIDED/(USED) BY INVESTING ACTIVITIES 59,378 (1,232)
CASH FLOWS FROM FINANCING ACTIVITIES:
(Repayments)/borrowings under revolving
credit facility (15,445) 3,033
Repayments of other long-term debt (675) (380)
Repurchase of stock (2,894) (192)
Proceeds from issuance of stock 801 1,250
Other borrowings 608 750
NET CASH (USED)/PROVIDED BY FINANCING ACTIVITIES (17,605) 4,461
INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS 27,204 (32)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 8,092 7,849
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 35,296 $ 7,817
The accompanying notes are an integral part of these consolidated statements.
</TABLE>
5
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EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE A - NATURE OF THE BUSINESS
EXECUTONE Information Systems, Inc. (the "Company") develops,
markets and supports voice and data systems and healthcare
communications systems. Products and services include telephone
systems, voice mail systems, in-bound and out-bound call center
systems, specialized healthcare communications systems and
application consulting services. The Company, through its
Unistar Entertainment subsidiary, also has the exclusive right to
design, develop and manage the National Indian Lottery. Products
and services are sold under the EXECUTONE, INFOSTAR, IDS,
LIFESAVER, INFOSTAR/ILS and UNISTAR brand names through a
worldwide network of direct sales and service employees and
independent distributors.
NOTE B - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have
been prepared in accordance with generally accepted accounting
principles for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In
the opinion of management, all adjustments, which include normal
recurring adjustments, considered necessary for a fair
presentation of the results for the interim periods presented
have been included. Certain prior year amounts have been
reclassified to conform to the current year's presentation.
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, 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 these estimates.
As of July 1, 1988, an accumulated deficit of approximately $49.7
million was eliminated.
NOTE C - INCOME TAXES
The Company accounts for income taxes in accordance with FAS No.
109, "Accounting for Income Taxes." The deferred tax asset
represents the benefits that are more likely than not to be
realized from the utilization of pre- and post-acquisition tax
benefit carryforwards, which include net operating losses, tax
credits and the excess of tax bases over the fair value of the
net assets of the Company.
For the nine-month periods ended September 30, 1996 and 1995, the
Company made cash payments for income taxes of approximately
$869,000 and $138,000, respectively.
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NOTE D - EARNINGS PER SHARE
Earnings per share is based on the weighted average number of
shares of common stock and dilutive common stock equivalents
(which include stock options and warrants) outstanding during the
periods. Common stock equivalents and the convertible debentures
which are antidilutive have been excluded from the computations.
NOTE E - INVENTORIES
Inventories are stated at lower of first-in, first-out ("FIFO")
cost or market and consist of the following at September 30, 1996
and December 31, 1995:
<TABLE>
<CAPTION>
(amounts in thousands) 9/30/96 12/31/95
<S> <C> <C>
Raw Materials $ 3,915 $ 4,783
Finished Goods 13,368 27,982
$ 17,283 $ 32,765
</TABLE>
NOTE F - SALE OF BUSINESSES
On May 31, 1996, the Company sold its direct sales and service
organization, including its network services division and
National Service Center, to Clarity Telecom Holdings, Inc. d/b/a
Executone Business Solutions (Clarity), a new acquisition company
formed for the acquisition by Bain Capital, Inc. The Company
received $61.5 million in cash, a $5.9 million junior
subordinated note due July 1, 2004, with interest at 7.5% per
year, and warrants to purchase 8% of the equity issued as of the
closing in the new company for $1.1 million, exercisable for
three years. After recording the notes and the warrants at their
fair market value, the total value of the consideration received
was $69.6 million. The Company and Clarity also entered into a
five-year exclusive distributor agreement pursuant to which
Clarity will sell and service EXECUTONE and INFOSTAR telephone
products to business and commercial locations that require up to
400 telephones.
The Company retained the healthcare communications division, the
call center management division, the National Accounts and
Federal Systems marketing groups as well as the recently acquired
Unistar business. The sale did not include the Pittsburgh direct
sales and service office, which the Company sold to one of its
existing independent distributors for approximately $1.3 million
in cash and notes in May 1996, resulting in no gain or loss.
The Company recorded a pretax gain of $47.5 million on the sale
to Clarity net of transaction, severance and other costs related
to the sale. The proceeds were used to repay the Company's bank
borrowings, and the excess was invested in short-term cash
investments. The final proceeds from this sale are subject to
adjustment based upon the closing balance sheets of the
businesses sold to Clarity. In October 1996, the Company and
Clarity reached an agreement on the amount of the adjustment,
subject to the drafting and execution of the written documents.
The Company does not expect the adjustment to have a material
adverse effect on its results of operations, cash flow or
financial position.
7
<PAGE>
In June 1996, the Company sold its videoconferencing division to
BT Visual Images LLC for a $0.2 million note, royalties on
videoconferencing revenue through June 1998 and contingent
consideration related to the sale of inventory. The Company
recorded a pretax reserve for loss of $3.9 million on the
transaction.
In April 1996, the Company also sold its inmate calling business
for $0.5 million in cash and notes and recorded a pretax loss of
$1.0 million. Neither the Pittsburgh direct sales office, the
videoconferencing division, nor the inmate calling business
constituted a material portion of the Company's assets, revenues
or net income prior to sale.
NOTE G - UNISTAR ACQUISITION
On December 19, 1995, the Company acquired 100% of the common
stock of Unistar Gaming Corporation ("Unistar") for 3.7 million
shares of the Company's common stock and 350,000 shares of newly
issued preferred stock. Unistar has an exclusive five-year
contract to design, develop, finance and manage the National
Indian Lottery (NIL). In return for providing the services,
Unistar will be paid a fee equal to 30% of the profits of the
NIL. The excess of the purchase price over the value of the net
liabilities assumed has been allocated to the management
agreement with the Coeur d'Alene Tribe of Idaho (CDA) and will be
amortized over the five-year term of the contract commencing with
the first significant lottery revenues.
The preferred stock consists of 250,000 shares of Cumulative
Convertible Preferred Stock, Series A ("Series A Preferred
Stock") and 100,000 shares of Cumulative Contingently Convertible
Preferred Stock, Series B ("Series B Preferred Stock"). The
Series A Preferred Stock has voting rights equal to one share of
common stock and will earn dividends equal to 18.5% of the
consolidated retained earnings of Unistar as of the end of a
fiscal period, less any dividends paid to the holders of the
Series A Preferred Stock prior to such date. The Series B
Preferred Stock has voting rights equal to one share of common
stock and will earn dividends equal to 31.5% of the consolidated
retained earnings of Unistar as of the end of a fiscal period,
less any dividends paid to the holders of the Series B Preferred
Stock prior to such date. All dividends on Preferred Stock are
payable (i) when and as declared by the Board of Directors, (ii)
upon conversion or redemption of the Series A and Series B
Preferred Stock or (iii) upon liquidation. As of September 30,
1996, no dividends have accrued to the preferred stockholders.
The Series A and Series B Preferred Stock is redeemable for a
total of 13.3 million shares of common stock (Series A Preferred
Stock for 4.925 million shares and Series B Preferred Stock for
8.375 million shares) at the Company's option. In the event that
Unistar meets certain revenue and profit parameters, the Series A
Preferred Stock is convertible for up to 4.925 million shares of
common stock and the Series B Preferred Stock is contingently
convertible for up to 8.375 million shares of common stock (a
total of an additional 13.3 million shares of common stock).
In an attempt to block the NIL, certain states filed letters
under 18 U.S.C. Section 1084 to prevent the long-distance
carriers from providing telephone service to the NIL. The CDA
initiated legal action to compel the long-distance carriers to
provide telephone service to the NIL. The CDA's position is that
the lottery is authorized by the Indian Gaming Regulatory Act
("IGRA") passed by Congress in 1988, that IGRA preempts state and
federal statutes, and that the states lack authority to issue the
Section 1084 notification letters to any carrier. On February
28, 1996, the NIL was ruled lawful by the CDA Tribal
Court. The CDA Tribal Court found that all requirements of IGRA
have been satisfied and that the
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Section 1084 letters issued by certain state attorneys general in
an effort to interfere with the lawful operation of the NIL are
invalid. In addition, the Court found that the long-distance
carriers cannot refuse to provide the service requested in the
action based upon 18 U.S.C. Section 1084. This ruling is
currently being appealed to the CDA Tribal Supreme Court with a
hearing date currently anticipated for the first quarter of 1997.
Although the Company also anticipates an appeal in the U.S.
Federal District Court, the Company believes, based on
consultation with and opinions rendered by outside legal counsel,
that the CDA's position will be upheld on appeal. The Company
has accrued $1 million to cover estimated legal costs through the
possible appeal to the U.S. Federal District Court. If the
matter is appealed beyond the U.S. Federal District Court or if
additional court challenges are brought by states opposed to the
NIL, the Company estimates that additional legal costs could be
in the range of $1-2 million.
Funding for Unistar capital expenditures, including the computers
and software to build the telecommunications system will be
capitalized and depreciated over the life of the management
agreement. Funding by Unistar on behalf of the NIL to complete
the building on the CDA reservation, which will be the operations
center for the lottery, will be deferred and amortized over the
life of the management agreement. The guaranteed monthly advance
to the CDA of $25,000, which began in January 1996, and other
reimbursable expenses, will be reflected as a non-current
receivable and will be reimbursed when the NIL is operational and
making profit distributions to Unistar. Unistar's expenditures
will be expensed as incurred. The Company expects it will be
able to obtain additional financing for these costs, if
necessary.
On September 9, 1996, the Company announced a series of
agreements with Internet Gaming Technologies, Inc. (IGT) and
CasinoWorld Holdings, Ltd. (CWH). IGT and CWH have agreed to
deliver to Unistar a turnkey system for use in the NIL, including
hardware and a fully-paid software license from CWH for its
system architecture and proprietary technology. The technology
is currently in use in an Internet and telephony-based wagering
system in Monaco and will be incorporated in a turnkey system for
Unistar. The Company has agreed to pay a maximum of $5 million,
of which $800,000 was paid through September 30, 1996, for the
turnkey wagering system and the software license. As part of the
consideration paid, the Company has obtained an equity interest
of 2.2% of IGT (up to a maximum of 9.6%) and warrants to obtain
up to 4% of CWH. Future payments are based on certain milestones
being achieved by CWH in delivering a turnkey lottery system to
include the computer hardware, on-site central office type
telephone switch, interactive voice response and other equipment
necessary for Unistar to establish and run the National Indian
Lottery, as well as a mirror backup site for IGT. The software
includes the gaming system, the business system and the banking
interface. The investment in IGT shares will be accounted for
under the cost method. The payments to IGT and CWH for the
turnkey lottery system will be capitalized and amortized over the
life of the management agreement.
The Company believes there is a national market for the NIL based
upon research into the experience of other multi-state lotteries
and the growth of the overall lottery market. However, there is
no assurance that there will be acceptance of a telephone lottery
or the NIL generally.
NOTE H - PROVISION FOR RESTRUCTURING
In July 1995, the Company reorganized its then-existing
businesses into five divisions: Computer Telephony, Healthcare
Communications Systems, Call Center Management, Videoconferencing
Products, and Network Services and changed its business strategy
in the Computer Telephony division to
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focus on software applications in the communications market. The
Videoconferencing and Network Services Divisions have since been
sold (see Note F). The business that was acquired in 1988 was a
telephone equipment hardware company focused on customers with
small systems, with an emphasis on
selling additional hardware and service to generate add-on
revenue and was de-emphasized. The Company adopted FAS No. 121,
"Accounting for the Impairment of Long-Lived Assets," which was
issued in March 1995, requiring impairment to be measured by
projecting the lowest level of identifiable future cash flows.
The Company concluded there was an impairment. As a result, the
Company recorded a $44.0 million provision for restructuring
consisting of a $33.5 million goodwill impairment, an $8.8
million writedown of inventory, primarily service stock relating
to the impaired assets and other non- recurring inventory
adjustments, $0.9 million related to the shutdown of the
Company's Scottsdale, Arizona facility and $0.8 million of other
unusual items.
NOTE I - OTHER MATTERS
For the nine-month periods ended September 30, 1996 and 1995,
respectively, the Company made cash payments of approximately
$2.5 million and $3.0 million for interest expense on
indebtedness.
In February 1996, the Company received the proceeds of the $1.8
million note from the sale of the Wisconsin direct sales office
in December 1995. In September 1995, the Company received the
proceeds of the $1.2 million note from the sale of its Vodavi
Communications Systems Division.
During the nine-month period ended September 30, 1996, noncash
investing and financing activities, other than those related to
the sale of certain of the Company's businesses (see Note F),
included a capital lease obligation incurred in connection with
an equipment acquisition of $0.3 million.
The only non-cash financing activities for the nine-month period
ended September 30, 1995, related to a capital lease obligation
incurred in connection with equipment acquisitions of $0.3
million.
Refer to the Consolidated Statements of Cash Flows for
information on all cash-related operating, investing and
financing activities.
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Introduction
The Company develops, markets and supports voice and data systems
and healthcare communications systems. Products and services
include telephone systems, voice mail systems, in-bound and out-
bound call center systems, specialized healthcare communications
systems and application consulting services. The Company,
through its Unistar Entertainment subsidiary, also has the
exclusive right to design, develop and manage the National Indian
Lottery. Products are sold under the EXECUTONE, INFOSTAR, IDS,
LIFESAVER, INFOSTAR/ILS and UNISTAR brand names through a
worldwide network of direct sales and service employees and
independent distributors.
Revenues are derived from product sales to distributors, direct
sales of healthcare and call center products, and direct sales to
national accounts and federal government customers, as well as
installations, additions, changes, upgrades or relocation of
previously installed systems, maintenance contracts, and service
charges to the existing base of healthcare, call center, national
account and federal government customers.
Results of Operations
On May 31, 1996, the Company sold substantially all of its
direct sales and services group, including its long-distance
reseller business and National Service Center, for consideration
valued at $69.6 million to Clarity Telecom Holdings, Inc. d/b/a
Executone Business Solutions (Clarity). The Company believes
that the transfer of this business to new ownership, with its
increased resources and dedicated focus on sales and service,
will grow and increase the market share of the sales and service
business, resulting in increased equipment sales to the former
direct sales offices. The Company retains the Healthcare, Call
Center Management ("CCM"), National Accounts and Federal Systems
groups, as well as telephony equipment sales to the independent
distributors, of which Clarity is the largest distributor.
For the first six months of 1996, the primary mission of the
Company was to complete the sale of the direct sales and service
organization while transitioning to a more focused Company. The
Company devoted much of its management resources during that
period toward efforts to finalize the agreement to sell the
direct sales and service organization, adversely affecting the
Company's financial results on a year-to-date basis. The three-
month period ended September 30, 1996 was the Company's first
standalone quarter since the sale. The Company was able to
achieve its forecasted revenue, maintain solid order levels,
convert inventory into receivables and resolve numerous
transitional issues.
As a result of the sale, financial results for the three-month
and nine-month periods ended September 30, 1996 are not
comparable to same prior year period, other than on certain
measures of overall profitability. Revenues for the three-month
period ended September 30, 1996 totaled $44.8 million. Gross
profit margin for the three-month period ended September 30, 1996
was 36.7%. This was slightly higher than the Company's
forecasted expectations due to improved pricing margins from
favorable product mix in the Computer Telephony division.
Product development expenses were $3.1 million or 7% of revenues
which was in line with the Company's spending projections.
Selling and G&A expenses for the three-month period ended
September 30, 1996 were $10.1 million or 22.6% of revenues.
These expenses were higher than originally planned, as the
Company incurred certain one-time charges.
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Operating income for the three-month period ended September 30,
1996 was $3.2 million or 7.1% of revenue versus an operating
profit of $2.9 million or 3.9% of revenue for the prior year
period. For the nine-month period ended September 30, 1996, the
Company reported an operating loss of $7.5 million. For the
comparable nine-month period in 1995, the Company reported an
operating profit (before the provision for restructuring) of $5.6
million. The change is attributable to two factors. First, as
previously noted, the process of negotiating and closing the sale
during the first half of the year had an adverse impact on
operating results. Second, the closing of the sale on May 31,
1996 excluded the revenue and profit related to the direct
offices for the month of June 1996, traditionally the strongest
direct revenue month, from the Company's operating results.
During the month of June 1995, the Company generated operating
profits of almost $9 million.
Net income for the three-month period ended September 30, 1996
was $2.1 million or $0.04 per share on 52.2 million shares
outstanding compared to net income of $1.3 million or $0.03 per
share on 49.0 million shares outstanding for the same period in
1995.
Included in results for the nine-month period ended September 30,
1996 is a net gain on the sale of businesses of $42.6 million.
This includes a net pretax gain of $47.5 million on the sale of
the direct sales, service and long distance businesses partially
offset by losses from the sale of the videoconferencing division
and the inmate calling business of $4.9 million. The comparable
period in 1995 included a $44.0 million provision for
restructuring consisting primarily of a goodwill impairment based
on the adoption of FAS No. 121.
Sale of Businesses
On May 31, 1996, the Company sold its direct sales and service
organization, including its network services division, to Clarity
Telecom Holdings, Inc. (Clarity), a new acquisition company led
by Bain Capital, Inc., for consideration valued at $69.6 million.
The Company recorded a pretax gain of $47.5 million net of
transaction, severance and other related costs during the period
ended June 30, 1996. The proceeds were used to repay the
Company's bank borrowings and the excess was invested in short-
term cash investments. The final proceeds from this sale are
subject to adjustment based upon the closing balance sheets of
the businesses sold to Clarity. In October 1996, the Company and
Clarity reached agreement on the amount of the adjustment,
subject to the drafting and execution of the written documents.
The Company does not expect the adjustment to have a material
adverse effect on its results of operations, cash flow or
financial position.
The Company retains its healthcare communications and CCM
businesses, its National Accounts and Federal Marketing groups
and the Unistar business. Within these businesses are the
Company's high-end applications and the most productive sales
representatives, those which carry $1 million per year sales
quotas.
Management believes this sale will be good for both companies.
Clarity will be able to focus on sales and service and the
expansion of market share. The Company will benefit from that
expansion through increased product sales. Telephony product
sales through existing independent distributors and through
Clarity will continue to represent a substantial portion of the
Company's revenues. The sale will also allow the Company to
dedicate more of its resources to telephony product development,
particularly relating to the IDS platform, the development and
marketing of the Healthcare and CCM product lines and the Unistar
business.
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In June 1996, the Company sold its videoconferencing division to
BT Visual Images LLC for a $0.2 million note, royalties on
videoconferencing revenue through June 1998 and contingent
consideration related to the sale of inventory transferred to the
buyer as part of the sale. The Company recorded a reserve for
loss of $3.9 million on the transaction during the three-month
period ended June 30, 1996. The Company is currently negotiating
issues regarding the close of the business with GPT Video
Systems, with whom the Company terminated its distribution
agreement for failure to deliver properly functioning
videoconferencing products on a timely basis.
Unistar Acquisition
On December 19, 1995, the Company acquired 100% of the common
stock of Unistar Gaming Corporation ("Unistar"), a privately-held
company that has an exclusive five-year contract to design,
develop, finance, and manage the National Indian Lottery ("NIL").
(See Note G of the Notes to Consolidated Financial Statements for
the terms of the agreement.)
Management believes the Unistar business is a natural extension
of its telephony and call center businesses. Calls via an 800
number will be processed with Interactive Voice Response ("IVR")
equipment or live agents located on the Coeur d'Alene Indian
Tribe of Idaho ("CDA") Reservation using ACD software to process
nationwide wagering activity. The Company has made a significant
equity investment in Unistar, initially creating 8% dilution to
the Company's shareholders. In the opinion of the Company's
management, this investment is justified based upon the potential
returns.
In an attempt to block the NIL, certain states filed letters
under 18 U.S.C. Section 1084 to prevent the long-distance
carriers from providing telephone service to the NIL based upon
allegations that the NIL is not legal. The CDA initiated legal
action to compel the long-distance carriers to provide telephone
service to the NIL. The CDA's position is that the lottery is
authorized by the Indian Gaming Regulatory Act ("IGRA") passed by
Congress in 1988, that IGRA preempts state and federal statutes,
and that the states lack authority to issue the Section 1084
notification letters to any carrier. On February 28, 1996, the
NIL was ruled lawful by the CDA Tribal Court. The CDA Tribal
Court found that all requirements of IGRA have been satisfied and
that the Section 1084 letters issued by certain state attorneys
general in an effort to interfere with the lawful operation of
the NIL are invalid. In addition, the Court found that the long-
distance carriers cannot refuse to provide the service requested
in the action based upon 18 U.S.C. Section 1084. The Company has
accrued $1 million to cover estimated legal costs through the
possible appeal to the U.S. Federal District Court. If the
matter is appealed beyond the U.S. Federal District Court or if
additional court challenges are brought by states opposed to the
NIL, the Company estimates that additional legal costs could be
in the range of $1-2 million. The Company estimates that the
additional funds to become operational may amount to between $7-
12 million.
As announced on September 9, 1996, Unistar has signed agreements
with Internet Gaming Technologies and CasinoWorld Holdings, Ltd.
for software licenses and development, system architecture and
proprietary technology (see Note G of the Notes to Consolidated
Financial Statements for the terms of the agreement). The
development of these systems is a critical step in the process of
developing the telephone lottery, enabling the telephone lottery
to begin as soon as the legal issues are resolved. The National
Indian Lottery is scheduled to be live on the Internet, including
a new Home Page that will field trial the lottery-type games and
allow people to register and play without wagering, by
December 31, 1996.
13
<PAGE>
Provision for Restructuring
In July 1995, the Company reorganized its then-existing
businesses into five divisions: Computer Telephony, Healthcare
Communications Systems, Call Center Management, Videoconferencing
Products, and Network Services and changed its business strategy
in the Computer Telephony division to focus on software
applications in the communications market. The Videoconferencing
and Network Services Divisions have since been sold (see Note F).
The business that was acquired in 1988 was a telephone equipment
hardware company focused on customers with small systems, with an
emphasis on selling additional hardware and service to generate
add-on revenue and the business was de-emphasized. The Company
adopted FAS No. 121, "Accounting for the Impairment of Long-Lived
Assets," which was issued in March 1995, requiring impairment to
be measured by projecting the lowest level of identifiable future
cash flows. The Company concluded there was an impairment. As a
result, the Company recorded a $44.0 million provision for
restructuring consisting of a $33.5 million goodwill impairment,
an $8.8 million writedown of inventory, primarily service stock
relating to the impaired assets and other non- recurring
inventory adjustments, $0.9 million related to the shutdown of
the Company's Scottsdale, Arizona facility and $0.8 million of
other unusual items.
In accordance with the provisions of FAS No. 121, the Company
prepared projections of future operating cash flows relating to
the telephony business acquired in 1988 based upon the Company's
new strategic direction. These projections indicated that this
business would not generate sufficient operating cash flows to
realize goodwill and the related service stock. The amount of
impairment of the telephony goodwill was $33.5 million as of June
30, 1995.
The write-off of inventory, primarily service stock, consisted of
$1.3 million of raw materials inventory and $7.5 million of
finished goods inventory. These amounts were determined based
upon a review of specific inventory parts along with current and
projected usage, incorporating the strategic direction of the
Company.
Liquidity and Capital Resources
The Company's liquidity is represented by cash, cash equivalents
and cash availability under its existing credit facilities. The
Company's liquidity was approximately $61 million and $23 million
as of
September 30, 1996 and December 31, 1995, respectively.
At September 30, 1996 and December 31, 1995, cash and cash
equivalents amounted to $35.3 million and $8.1 million,
respectively, an increase of $27.2 million generated primarily by
$61.9 million in cash proceeds for the sale of the Company's
direct sales and service organization. During the nine-month
period ended September 30, 1996, cash was used to repay $16.1
million of debt, including all of the
Company's bank borrowings, repurchase $2.9 million of the
Company's common stock and to fund the $14.6 million in cash used
by operating activities. The remainder of the proceeds were
invested in short-term cash securities. Cash used by operating
activities was $14.6 million for the nine months ended September
30, 1996 compared to the use of cash by operations of $3.2
million for the same period in 1995. The increase in cash used
by operating activities is primarily due to the operating losses
generated during the transition period in the first six months of
1996. In addition, during the three-month period ended September
30, 1996, the Company experienced a one-time growth in trade
receivables of $5.0 million due to the 60-day terms extended to
Clarity per the sale contract.
14
<PAGE>
Total debt at September 30, 1996 was $15.0 million, a decrease of
$15.8 million from $30.8 million at December 31, 1995.
Outstanding debt at September 30, 1996 consists of $12.3 million
in subordinated debt, due in 2011, with the balance primarily
capitalized lease obligations.
The Company believes that its existing cash balances and cash
flow from operations will be sufficient to meet working capital
and other requirements for the next twelve months.
Forward-Looking Statements
The Company's financial operations before and after the sale of
the direct sales and service organization are very different.
There are significant changes in certain components which have
been highlighted in the Company's previously-filed quarterly
report on Form 10-Q for the period ended June 30, 1996.
15
<PAGE>
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Not applicable.
Item 2. CHANGES IN SECURITIES
Not applicable.
Item 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The 1996 Annual Meeting of Shareholders was held on July 30,
1996 and the votes at that meeting were reported in the
Company's quarterly report on Form 10-Q for the period ended
June 30, 1996.
Item 5. OTHER INFORMATION
Not applicable.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
11 - Statement Regarding Computation of Per Share Earnings.
b) Reports on Form 8-K
On September 24, 1996, the Company filed an amended Current
Report on Form 8-K/A reporting the closing of the sale of
the direct sales and service organization, including the
network services division, and pro forma financial
information.
16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this Report to be signed on
its behalf by the undersigned thereunto duly authorized.
EXECUTONE Information Systems, Inc.
Dated: November 14, 1996 /s/ Alan Kessman
Alan Kessman
Chairman, President and
Chief Executive Officer
Dated: November 14, 1996 /s/ Anthony R. Guarascio
Anthony R. Guarascio
Vice President Finance and
Chief Financial Officer
17
<PAGE>
EXHIBIT 11
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1996 1995 1996 1995
<S> <C> <C> <C> <C>
NET INCOME (LOSS) $ 2,124,000 $ 1,323,000 $ 20,624,000 $(38,496,000)
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING 51,605,000 46,898,000 51,779,000 46,478,000
COMMON STOCK EQUIVALENT SHARES
ASSUMED TO BE ISSUED FOR
DILUTIVE STOCK OPTIONS AND
WARRANTS 571,000 2,116,000 779,000 ---
TOTAL WEIGHTED AVERAGE COMMON
AND COMMON EQUIVALENT SHARES
OUTSTANDING 52,176,000 49,014,000 52,558,000 46,478,000
EARNINGS (LOSS) PER COMMON
SHARE $ 0.04 $ 0.03 $ 0.39 $ (0.83)
18
<PAGE>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS INCLUDED IN THE REGISTRANT'S FILING ON FORM 10-Q FOR THE
QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996 AND IS QUALIFIED IN IT'S ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> SEP-30-1996
<CASH> 35,296
<SECURITIES> 0
<RECEIVABLES> 36,677
<ALLOWANCES> 1,537
<INVENTORY> 17,283
<CURRENT-ASSETS> 89,961
<PP&E> 23,334
<DEPRECIATION> 15,806
<TOTAL-ASSETS> 149,628
<CURRENT-LIABILITIES> 51,633
<BONDS> 14,034
<COMMON> 516
0
7,300
<OTHER-SE> 75,989
<TOTAL-LIABILITY-AND-EQUITY> 149,628
<SALES> 163,739
<TOTAL-REVENUES> 163,739
<CGS> 101,793
<TOTAL-COSTS> 101,793
<OTHER-EXPENSES> 10,504
<LOSS-PROVISION> 887
<INTEREST-EXPENSE> 2,113
<INCOME-PRETAX> 34,384
<INCOME-TAX> 13,760
<INCOME-CONTINUING> 20,624
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 20,624
<EPS-PRIMARY> 0.39
<EPS-DILUTED> 0.39
</TABLE>
