Executone Information Systems, Inc. 10-Q, September 30, 1997
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, 1997
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, 1997 was 49,647,309.
<PAGE>
INDEX
EXECUTONE Information Systems, Inc.
Page #
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
September 30, 1997 and December 31, 1996. 3
Consolidated Statements of Operations -
Three Months and Nine Months Ended
September 30, 1997 and 1996. 4
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 1997 and 1996. 5
Notes to Consolidated Financial Statements. 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12
PART II. OTHER INFORMATION 16
SIGNATURES 18
EXHIBIT 11. STATEMENT REGARDING COMPUTATION
OF PER SHARE EARNINGS 19
2
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
<CAPTION>
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
(In thousands, except for share amounts) 1997 1996
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 7,021 $ 27,696
Restricted cash 5,021 ---
Accounts receivable, net of
allowance of $2,208 and $2,106 34,303 38,992
Inventories 22,385 16,814
Prepaid expenses and other current assets 3,772 3,099
Total Current Assets 72,502 86,601
RESTRICTED CASH --- 5,031
PROPERTY AND EQUIPMENT, net 8,256 7,578
INTANGIBLE ASSETS, net 19,797 19,893
DEFERRED TAXES 19,140 18,434
OTHER ASSETS 19,624 14,472
$ 139,319 $ 152,009
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 1,060 $ 882
Accounts payable 27,083 31,416
Accrued payroll and related costs 3,580 3,398
Accrued liabilities 10,149 13,943
Deferred revenue and customer deposits 2,898 3,164
Total Current Liabilities 44,770 52,803
LONG-TERM DEBT 14,685 13,837
LONG-TERM DEFERRED REVENUE 244 22
TOTAL LIABILITIES 59,699 66,662
STOCKHOLDERS' EQUITY:
Common stock: $.01 par value; 80,000,000
shares authorized; 49,647,309 and 51,173,755
issued and outstanding 496 512
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 71,467 76,113
Retained earnings 357 1,422
Total Stockholders' Equity 79,620 85,347
$ 139,319 $ 152,009
</TABLE>
The accompanying notes are an integral part of these
consolidated balance sheets.
3
<PAGE>
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
(In thousands, except for September 30, September 30,
per share amounts) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
REVENUES $ 42,936 $ 44,791 $116,732 $163,739
COST OF REVENUES 28,044 28,333 77,821 101,793
Gross Profit 14,892 16,458 38,911 61,946
OPERATING EXPENSES:
Product development and eng. 3,202 3,129 9,939 10,504
Selling, general and admin. 10,179 10,134 30,423 58,983
13,381 13,263 40,362 69,487
OPERATING INCOME/(LOSS) 1,511 3,195 (1,451) (7,541)
INTEREST EXPENSE (562) (550) (1,499) (2,113)
GAIN ON SALE OF BUSINESSES (Note G ) --- --- --- 42,618
OTHER INCOME, net 372 890 1,183 1,420
INCOME (LOSS) BEFORE INCOME TAXES 1,321 3,535 (1,767) 34,384
PROVISION (BENEFIT) FOR INCOME TAXES:
Cash 0 100 0 4,200
Noncash (Note C) 528 1,311 (701) 9,560
528 1,411 (701) 13,760
NET INCOME (LOSS) $ 793 $ 2,124 $ (1,066) $ 20,624
EARNINGS (LOSS) PER SHARE $ 0.02 $ 0.04 $ (0.02) $ 0.39
WEIGHTED AVG. COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING 49,648 52,176 49,657 52,558
</TABLE>
The accompanying notes are an integral part of these consolidated
statements.
4
<PAGE>
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
(In thousands) September 30,
1997 1996
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (1,066) $ 20,624
Adjustments to reconcile net income (loss)
to net cash used by operating activities:
Depreciation and amortization 2,248 3,484
Gain on sale of businesses (Note G) --- (42,618)
Provision/(benefit) for income taxes
not currently payable (701) 9,560
Noncash expenses, including noncash
interest expense, noncash provision
for losses on accounts receivable and
income from equity investment 439 (549)
Change in working capital items:
Accounts receivable 4,718 (3,868)
Inventories (5,812) 311
Accounts payable and accruals (7,651) (2,479)
Other working capital items (929) 3,104
NET CASH USED BY OPERATING ACTIVITIES (8,754) (12,431)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (1,295) (2,137)
Proceeds from sale of businesses (Note G) --- 56,948
Investment in UniStar (4,000) (2,938)
Other, net (1,082) 367
NET CASH PROVIDED/(USED) BY INVESTING ACTIVITIES (6,377) 52,240
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments under revolving credit facility --- (15,445)
Repayments of other long-term debt (890) (675)
Repurchase of stock (5,400) (2,894)
Proceeds from issuance of stock 746 801
Other borrowings --- 608
NET CASH USED BY FINANCING ACTIVITIES (5,544) (17,605)
INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS (20,675) 22,204
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 27,696 8,092
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 7,021 $ 30,296
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
5
<PAGE>
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 communications systems.
Products and services include telephone systems, voice mail
systems, inbound and outbound call center systems and
specialized healthcare communications systems. The Company,
through its UniStar Entertainment subsidiary, also has an
exclusive five-year contract with the Coeur d'Alene Tribe of
Idaho (CDA) to design, develop, finance and manage the National
Indian Lottery (NIL) and its on-line US Lottery games.
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 those 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, 1997 and 1996,
the Company made cash payments for income taxes of
approximately $424,000 and $869,000, respectively.
6
<PAGE>
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, the convertible
preferred stock and the convertible debentures which are
antidilutive have been excluded from the computations.
In February 1997, the Financial Accounting Standards Board
issued a new standard on earnings per share. The Company will
adopt the new standard as of December 31, 1997. If earnings
per share for the three-month and nine-month periods ended
September 30, 1997 had been calculated in accordance with the
new standard, the result would have been unchanged.
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,
1997 and December 31, 1996:
<TABLE>
<CAPTION>
(amounts in thousands) 9/30/97 12/31/96
<S> <C> <C>
Raw Materials $ 4,446 $ 3,493
Finished Goods 17,939 13,321
$22,385 $16,814
</TABLE>
NOTE F - UNISTAR
On December 19, 1995, the Company acquired 100% of the common
stock of Unistar Gaming Corporation (Unistar Gaming) for 3.7
million shares of the Company's common stock and 350,000 shares
of newly issued preferred stock. Unistar Gaming has an
exclusive five-year contract to design, develop, finance and
manage the National Indian Lottery through its wholly-owned
subsidiary, UniStar Entertainment, Inc. (UniStar). The NIL
will be a national telephone lottery authorized by Federal law
and a compact between the State of Idaho and the CDA. In return
for providing these management 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 CDA and
will be amortized over the 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.
7
<PAGE>
As of September 30, 1997, 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 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. In 1995,
the CDA initiated legal action against AT&T Corporation (AT&T)
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. This ruling and a related order dated May
1, 1996 were subsequently appealed to the Tribal Appellate
Court, which on July 2, 1997 affirmed the lower Tribal Court's
May 1, 1996 ruling and analysis upholding the CDA's right to
conduct the telephony lottery. On August 22, 1997, AT&T filed
a complaint for declaratory judgment against the CDA in the U.S.
District Court for the District of Idaho. The Company believes,
based on consultation with and opinions rendered by outside
legal counsel, that the favorable rulings will be affirmed by
the federal courts. In 1995, the Company accrued $1 million
to cover estimated legal costs through the possible appeal to
the U.S. District Court. If the matter is appealed beyond
the U.S. 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 million to $2 million.
Funding for UniStar capital expenditures, including the
building on the CDA reservation and the computers and software
to build the telecommunications system will be capitalized and
depreciated over the life of the management agreement. The
guaranteed monthly advance of $25,000 to the CDA, which began
in January 1996, will be reimbursed when the NIL is operational
and making profit distributions to UniStar. In addition, the
Company has capitalized other fundings, consisting primarily of
professional fees and other expenses, which the Company believes
are reimbursable in accordance with the terms of the management
agreement. Cumulative funding as described above totals
$6.1 million ($4.1 million for the nine-month period ended
September 30, 1997) and is reflected in non-current other assets.
The Company has also funded legal and other accrued liabilities
assumed as part of the acquisition of UniStar totaling, on a
cumulative basis, $2.6 million ($0.5 million for the nine-month
period ended September 30, 1997). Such cash flows, which were
previously reflected as part of the change in working capital
items, are now reflected as part of the investment in Unistar
in the statement of cash flows. Prior year amounts have been
reclassified to conform to the current year's presentation.
The investment in UniStar reflected on the statement of cash
flows includes the deferred charges and assumed liabilities
noted above (net of a $0.5 million capital lease) for a
cumulative total of $8.2 million ($4.0 million for
8
<PAGE>
the nine-month period ended September 30, 1997). Since
inception, the Company has also funded various UniStar expenses
totaling $1.4 million, which are reflected in the Company's
consolidated net income. Cumulative cash expenditures on
UniStar, including UniStar expenses, total $9.6 million.
Other than legal costs related to an appeal of the CDA Tribal
Court ruling or other actions by the states, the Company
estimates it will invest an additional $4 million to $5 million
by June 1998. These costs include capital expenditures for
computers and software to build the telecommunications system,
funds to complete the building on the CDA reservation which
will be the operations center for the lottery, and various
start-up and operating expenses including personnel-related
costs and advertising expenses. The Company is also required
to make a guaranteed payment of $300,000 per year to the CDA,
which is included in the above estimates. The Company expects
it will be able to obtain additional financing for these costs,
if necessary.
In February 1997, the Company signed agreements with Virtual
Gaming Technologies (formerly Internet Gaming Technologies
(IGT)) and CasinoWorld Holdings, Ltd. (CWH). The agreements
call for the Company to invest $700,000 in IGT common stock,
which was done in September 1996 under a previous agreement.
In addition, the Company was granted a 200,000-share, five-year
option set at 15% more than the price per share on the initial
investment, or $3.45 per share. CWH is to provide project
management services overseeing the development of the software
for the NIL, with the Company contracting independently for
system software development. Such charges are not to exceed $2
million, most of which has already been spent. The Company
will acquire all hardware for the system without financial
obligation by either IGT or CWH.. Approximately $500,000 in
hardware costs were incurred as of September 30, 1997.
All of these system development costs are included in the
above estimate for expenditures through June 1998.
The investment in IGT is being accounted for under the cost
method. All hardware costs incurred will be capitalized and
depreciated over the useful life of the assets, beginning when
the assets are placed in service. As of September 30, 1997,
$1.3 million in progress payments have been made toward the
software system. Such payments are being deferred until
completion of the system and will be capitalized and
depreciated over the term of the management agreement.
On May 28, 1997, the State of Missouri brought an action in the
Missouri Circuit Court in Kansas City against the Company's
UniStar Entertainment subsidiary and the CDA to enjoin the US
Lottery offered by the CDA on the Internet and managed by
UniStar. The complaint alleges that the US Lottery violates
Missouri anti-gaming laws and that the marketing and promotion
of the US Lottery violate the Missouri Merchandising Practices
Act. The CDA and UniStar have removed the case to the U.S.
District Court for the Western District of Missouri, which
denied the State's subsequent motion for remand back to the
state court. The State has moved the Court to certify its
denial of the motion for remand for interlocutory appeal to the
Circuit Court of Appeals and that motion is pending. Motions
to dismiss by CDA and UniStar based on sovereign immunity and
lack of personal jurisdiction are also currently pending before
the U.S. District Court. Based upon the ruling of the Tribal
Appellate Court affirming the CDA's right to conduct the
telephone lottery and the opinion of outside legal counsel, the
Company believes that the US Lottery is legal.
On September 15, 1997, the State of Wisconsin, by its Attorney
General, filed an action in the Wisconsin State Circuit Court
for Dane County against the Company, its UniStar Entertainment
subsidiary and the Coeur d'Alene Tribe of Idaho, to permanently
enjoin the US Lottery offered by the Tribe on the Internet and
managed by UniStar. The complaint alleges that the offering of
the US Lottery violates Wisconsin anti-gambling laws and that
legality of the US Lottery has been misrepresented to Wisconsin
residents in violation of state law. In addition to an injunction,
the suit seeks restitution, civil penalties, attorneys' fees
9
<PAGE>
and court costs. The Company, UniStar and the CDA have removed
the case to the U.S. District Court in Wisconsin. Based upon
the ruling of the Tribal Appellate Court affirming the CDA's
right to conduct the telephone lottery and the opinion of
outside legal counsel, the Company believes that the US Lottery
is legal.
There are market and legal risks associated with the
development of the NIL. The Company believes there is a
national market for the NIL based upon research into the
experience of other national lotteries and the growth of the
overall lottery market. However, there is no assurance that
there will be acceptance of a telephone or Internet lottery.
Based upon opinions from outside legal counsel, the Company
also believes that the legal decision rendered by the CDA
Tribal Court and affirmed by the Tribal Appellate Court will
ultimately be affirmed by the federal courts. However, there
is no assurance of such a legal outcome. In the event that
the telephone and Internet lotteries do not attain the level
of market acceptance anticipated by the Company or if the CDA
Tribal Court rulings are not upheld on appeal, the Company
would have to reevaluate its investment in UniStar.
The Company periodically evaluates the recoverability of this
investment in UniStar in accordance with the provisions of FAS
No. 121, "Accounting for the Impairment of Long-Lived Assets"
by projecting future undiscounted net cash flows for the
telephone and Internet lotteries. If the sum of such cash
flows is not sufficient to recover the Company's investment in
UniStar, projected cash flows would then be discounted and the
Company's investment would be adjusted accordingly.
NOTE G - SALE OF BUSINESSES
On May 31, 1996, the Company sold its direct sales and service
organization, including its network services division (DSOs),
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 the buyer also entered into a five-
year exclusive distributor agreement pursuant to which Clarity
sells and services EXECUTONE and INFOSTAR telephone products to
business and commercial locations that require up to 400
telephones.
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 sale
of the DSOs (including the separate sale of the Pittsburgh
office) related primarily to the retail distribution channel of
the Computer Telephony division and included the Network
Services division. After the sale, the Computer Telephony
business consists of telephony product sales to independent
distributors, along with the National Accounts and Federal
Systems marketing channels. The Company retains its Healthcare
Communications and Call Center Management businesses and the
UniStar business.
During 1996, the Company recorded a pretax gain of $48.9
million on the sale to Clarity net of transaction, severance
and other costs related to the sale, of which $47.5 million was
recorded during the three-month period ended June 30, 1996 and
$1.4 million was recorded in the three-month period ended
December 31, 1996. The proceeds were used to repay the
Company's bank borrowings, and the excess was invested in short-
term cash investments.
10
<PAGE>
The cash proceeds of $61.5 million included $5.0 million held
in escrow. These funds, including interest, are classified as
restricted cash and will be released to the Company in April
1998, subject to potential indemnity claims by Clarity.
In 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 equipment inventory.
During the three-month period ended March 31, 1996, the Company
recorded a loss of $3.9 million on the transaction. The
Company has filed a legal action against GPT Video Systems,
with whom the Company terminated its distribution agreement for
failure to deliver properly functioning videoconferencing
products on a timely basis.
In 1996, the Company also sold its inmate calling business for
$0.5 million in cash and notes. During the three-month period
ended March 31, 1996, the Company recorded a loss of $1.0
million on the transaction. This business was part of the
Computer Telephony division. 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 H - OTHER MATTERS
For the nine-month periods ended September 30, 1997 and 1996,
respectively, the Company made cash payments of approximately
$1.4 million and $2.5 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.
During the nine-month periods ended September 30, 1997 and
1996, respectively, noncash financing activities other than
those related to the sale of certain of the Company's
businesses (see Note G), included capital lease obligations
incurred in connection with equipment acquisitions of $1.6
million and $0.3 million.
For both the three-month and nine-month periods ended September
30, 1997, more than 10% of the Company's revenues were derived
from a single independent distributor. Revenues from the
distributor, net of discounts, were $10.0 million and $22.8
million for the three-month and nine-month periods,
respectively.
Refer to the Consolidated Statements of Cash Flows for
information on all cash-related operating, investing and
financing activities.
11
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Introduction
The Company develops, markets and supports voice and data
communications systems. Products and services include
telephone systems, voice mail systems, inbound and outbound
call center systems, and specialized healthcare communications
systems. The Company, through its UniStar Entertainment
subsidiary, also has the exclusive right to design, develop and
manage the National Indian Lottery, including the Internet-
based US 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.
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.
Overview
During the three-month period ended September 30, 1997,
the Company generated revenues of $42.9 million, operating income
of $1.5 million and net income of $0.02 per common share. For
the same period in 1996, revenues were $44.8 million, with
operating income of $3.2 million and net income of $0.04 per
common share. For the nine-month period ended September 30,
1997, revenues were $116.7 million, generating an operating
loss of $1.5 million and a net loss of $0.02 per common share,
compared to revenue of $163.7 million, an operating loss of
$7.5 million and net income of $0.39 per common share. The
1997 results for the nine-month period ended September 30, 1997
are not comparable to the ninemonth period in 1996, which
included a net gain on the sales of businesses of $42.6
million. In addition, the prior year data included the
operating results of the direct sales offices and the network
services division through the May 31, 1996 sale date.
Compared to the preceding quarter, the three-month period ended
September 30, 1997 showed increases of $8.2 million in revenues,
$5.2 million in operating profit and $3.2 million in net income.
This is primarily due to the recovery of sales to the Company's
largest independent distributor, which was the cause of the lower
revenue and profit levels in the previous quarter.
Results of Operations
As a result of the business sales and dispositions consummated
during the first half of 1996, the three-month period ended
September 30, 1997 is the first period for which the financial
results are comparable to the same period in 1996. The nine
month periods for 1997 and 1996 continue to not be comparable,
other than on certain measures of overall profitability.
Revenues for the three-month period ended September 30, 1997
decreased $1.9 million compared to the same period last year as
lower revenues from the Computer Telephony group more than
offset increases in Healthcare revenues. Computer Telephony
revenue was $32.6 million, a decrease of $4.2 million
12
<PAGE>
compared to the same period last year. The decrease was
primarily a result of lower sales to the Company's largest
distributor. Orders from this distributor normalized during
the quarter from the one-time adjustment in its purchasing
pattern which occurred in the second quarter. While the order
level during the quarter met the Company's revised
expectations, the new level of anticipated sales to this
distributor is lower than the sales levels achieved during the
last six months of 1996. Healthcare revenues for the three-
month period ended September 30, 1997 were $10.4 million, an
increase of 30% over the same period in 1996. Bookings for the
quarter increased 35% compared to the prior year. This is
attributable to the market acceptance of the healthcare
communications platform and its technological capabilities.
Gross profit margin for the three-month period ended September
30, 1997 was $14.9 million or 34.7% of revenue, which was $1.6
million or 2 percentage points less than the same period in
1996. The decline in gross profit margin is primarily a result
of the lower distributor revenue levels.
Product development expenses for the three-month period ended
September 30, 1997 were $3.2 million, a slight increase over the
prior year's spending levels. Selling, general and administrative
expenses were $10.2 million, which is comparable to the prior
year's spending level and appropriate to the Company's current
level of sales.
Operating income for the three-month period ended September 30,
1997 was $1.5 million compared to $3.2 million for the same
period in 1996. For the nine-month period ended September 30,
1997, the Company had an operating loss of $1.5 million,
compared to an operating loss of $7.5 million for the 1996
period.
Other income for the three-month period ended September 30, 1997
decreased from the same period in 1996 primarily due to lower
interest income generated from the declining cash balance over
the periods.
Net income for the three-month period ended September 30, 1997
was $0.8 million compared to $2.1 million for the same period in
1996. For the nine-month period ended September 30, 1997, the
Company had a net loss of $1.1 million, compared to net income
of $20.6 million for the 1996 period. The net income for the
1996 period includes a pretax gain on the sale of businesses of
$42.6 million. Excluding the gain on the sale of businesses,
the ninemonth period ended September 30, 1996 would have shown a
net loss of approximately $5.0 million.
UniStar
On December 19, 1995, the Company acquired 100% of the common
stock of Unistar Gaming Corporation, a privately-held company
which, through its wholly-owned subsidiary, UniStar
Entertainment, Inc. (UniStar), has an exclusive five-year
contract to design, develop, finance, and manage the National
Indian Lottery (NIL). (See Note F of the Notes to Consolidated
Financial Statements for the terms of the agreement.)
The initial goal of this investment was to establish a telephone
lottery that could be played by an individual of majority age,
residing in one of 36 states or the District of Columbia that
currently operates a state-run lottery. In the telephone-based
NIL, calls will be processed with interactive voice response
equipment or live agents located on the Coeur d'Alene Indian
Tribe of Idaho (CDA) Reservation using ACD software to process
nationwide lottery sales. The Company has made a significant
investment in UniStar, which initially created 8% dilution to
the Company's shareholders.
13
<PAGE>
For the nine-month period ended September 30, 1997, the Company
invested $4.7 million as part of the cost to develop the software
system, building and other costs related to the project. Of these
costs, $4.1 million have been recorded as assets on the balance
sheet. The total UniStar investment cost on the balance sheet
is $23.4 million at September 30, 1997, including $15.8 million
in goodwill and $6.1 million in other assets, with the remainder
consisting of funded UniStar expenses. In the opinion of the
Company's management, this investment is justified based upon the
potential returns.
Concerning the UniStar legal issues, AT&T, as expected, has
filed a complaint for declaratory judgment in the U.S. District
Court in Idaho against the CDA, seeking a federal court ruling
as to the enforceability of the Coeur d'Alene Tribal Court's
May 1 1996 order affirming the CDA's right to conduct the
telephone lottery. The CDA has answered that complaint. The
State of Wisconsin's suit against the US Lottery, filed on
September 15, 1997 in the Wisconsin State Circuit Court, has
been removed to the U.S. District Court in Wisconsin. The
Wisconsin case is similar to one filed in May by the State of
Missouri against the US Lottery, which is currently being
vigorously defended. The Missouri case has been removed to the
U.S. District Court in Missouri, which denied the State's
motion to remand the case to the state court. Motions to
dismiss by the CDA and UniStar based on sovereign immunity and
lack of personal jurisdiction are currently pending before the
U. S. District Court in Missouri. The Company continues to
believe, based upon consultations with and opinions rendered by
outside legal counsel, that the favorable rulings of the Tribal
Appellate Court will be affirmed by the federal courts.
In February 1997, UniStar signed revised agreements with
CasinoWorld Holdings, Ltd. relating to software development,
system architecture and proprietary technology and a revised
agreement for an equity investment in Virtual Gaming
Technologies (formerly Internet Gaming Technologies). See Note
F for the terms of these agreements. The architecture of the
Internet Lottery, particularly the business system, data base
structure and the banking interface, are critical building
blocks in the process of developing the telephone lottery. As
of October 21, 1997, the registered base of the US Lottery was
7,000 people with about 1,300 active players. Direct mail
advertising is currently scheduled to begin in mid-November
1997.
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 $27
million and $50 million as of September 30, 1997 and
December 31, 1996, respectively.
At September 30, 1997 and December 31, 1996, cash and cash
equivalents amounted to $7.0 million and $27.7 million,
respectively, a decrease of $20.7 million. During the nine-
month period ended September 30, 1997, the Company utilized
$8.8 million in cash to fund operating activities. Cash was
also used to repurchase 2.1 million shares of the Company's
common stock for $5.4 million, fund $4.0 million in
UniStar-related activities, invest $0.5 million in an infrared
communications company and fund $1.3 million in capital
expenditures.
During the nine-month period ended September 30, 1997, cash
utilized by operating activities was $3.7 million less than the
cash used during the same period in 1996. The decrease is
primarily due to the lower operating losses during the 1997
period.
14
<PAGE>
Total debt at September 30, 1997 was $15.7 million, an increase
of $1.0 million from $14.7 million at December 31, 1996. The
increase is primarily due to incurring $1.6 million in
capitalized lease obligations for equipment acquisitions during
the first nine months of 1997. Outstanding debt at September
30, 1997 consists of $12.5 million in subordinated debt, due in
2011, with the balance primarily capitalized lease obligations.
Proceeds from the sale of the DSOs (see Note G) included $5.0
million of cash held in escrow and reported on the consolidated
balance sheets as restricted cash. These funds, plus interest,
will be released to the Company in April 1998, subject to
potential indemnity claims by Clarity.
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.
15
<PAGE>
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
As previously reported, on October 16, 1995, the
Coeur d'Alene Tribe filed an action entitled Coeur
d'Alene Tribe v AT&T Corp. in the Tribal Court,
located in Plummer, Idaho (Case No. C195-097),
requesting a ruling that the Lottery to be developed
and managed by the Company's UniStar Entertainment
subsidiary is legal under IGRA, that IGRA preempts
state and federal laws on the subject of Indian
gaming, that Section 1084 is inapplicable and that
the states lack authority to issue Section 1084
notification letters to any carrier, and an
injunction preventing AT&T from refusing to provide
telephone service to the NIL. This action was
necessary because several network carriers have been
sent Section 1084 letters under the Federal
Communications Act by states opposed to the NIL.
These letters state that the NIL is illegal under
state and federal laws and prohibit the carriers
from carrying network traffic for the NIL. On
February 28, 1996, the Tribal Court ruled that all
requirements of IGRA have been satisfied, that
Section 1084 is inapplicable and the states lack
jurisdiction to interfere with the NIL, and that
AT&T cannot refuse service to the NIL based upon
Section 1084, an allegation that the NIL is in
violation of IGRA or the federal anti-lottery
statutes. This ruling and a related order dated May 1,
1996 were appealed to the Tribal Appellate Court,
which affirmed the lower court ruling on July 2, 1997.
On August 22, 1997, AT&T filed a complaint for
declaratory judgment against the CDA in the U.S.
District Courts for the District of Idaho. The
Company has been advised by its outside counsel,
Hunton & Williams, that based upon such firm's
review of the applicable statutes, regulations and
case law, it believes that the Lottery is authorized
under IGRA and that the favorable rulings issued by
the Coeur d'Alene Tribal Court on February 28 and
May 1, 1996, and the Tribal Appellate Court on July
2, 1997, should be affirmed by the federal courts.
On May 28, 1997, the Attorney General of the State
of Missouri brought an action in the Circuit Court
of Jackson County, Missouri, against the Coeur
d'Alene Tribe and UniStar seeking to enjoin Lottery
games offered by the Tribe over the Internet and
managed by UniStar. The complaint alleges that the
US Lottery violates Missouri anti gambling laws and
that the marketing of the games violates the state's
Merchandising Practices Act and also seeks restitution,
a civil penalty, attorney's fees and court costs.
The Company believes, based on the Tribal Court
rulings and the opinion of its outside counsel referred
to above, that the Missouri suit has no merit and that
the Lottery activities are legal. UniStar and the
Tribe have removed the case to the U.S. District Court
for the Western District of Missouri, which denied the
State's subsequent motion for remand back to the state
court. The State has moved the Court to certify its
denial of the motion for remand for interlocutory
appeal to the Circuit Court of Appeals and that
motion is pending. Motions to dismiss by CDA and
UniStar based on sovereign immunity and lack of
personal jurisdiction are also currently pending
before the U.S. District Court.
16
<PAGE>
On September 15, 1997, the State of Wisconsin, by
its Attorney General, filed an action in the
Wisconsin State Circuit Court for Dane County
against the Company, its UniStar Entertainment
subsidiary and the Coeur d'Alene Tribe of Idaho, to
permanently enjoin the US Lottery offered by the
Tribe on the Internet and managed by UniStar. The
complaint alleges that the offering of the US
Lottery violates Wisconsin anti-gambling laws and
that legality of the US Lottery has been
misrepresented to Wisconsin residents in violation
of state law. In addition to an injunction, the
suit seeks restitution, civil penalties, attorneys'
fees and court costs. The Company, UniStar and the
CDA have removed the case to the U.S. District
Court in Wisconsin. Based upon the ruling of the
Tribal Appellate Court affirming the CDA's right to
conduct the telephone lottery and the opinion of
outside legal counsel, the Company believes that
the US Lottery is legal.
UniStar and the CDA intend to defend the right of
the Tribe to offer the Lottery on the Internet.
However, this litigation, as well as other
litigation which could be brought by states opposed
to the NIL or its on-line US Lottery games, could
prevent or delay full operations. The Company does
not believe the outcome of this litigation will
have a material adverse effect on the Company's
consolidated financial position, results of
operations or liquidity.
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
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
None.
17
<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 13, 1997 /s/ Alan Kessman
Alan Kessman
Chairman, President and
Chief Executive Officer
Dated: November 13, 1997 /s/ Anthony R. Guarascio
Anthony R. Guarascio
Vice President, Finance and
Administration
Chief Financial Officer
18
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,
1997 1996 1997 1996
<S> <C> <C> <C> <C>
NET INCOME (LOSS) $ 793,000 $ 2,124,000 $ (1,066,000) $ 20,624,000
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES
OUTSTANDING 49,632,000 51,605,000 49,657,000 51,779,000
COMMON STOCK EQUIVALENT
SHARES ASSUMED TO BE ISSUED
FOR DILUTIVE STOCK OPTIONS
AND WARRANTS 16,000 571,000 0 779,000
TOTAL WEIGHTED AVERAGE COMMON
AND COMMON EQUIVALENT SHARES
OUTSTANDING 49,648,000 52,176,000 49,657,000 52,558,000
EARNINGS (LOSS) PER
COMMON SHARE $ 0.02 $ 0.04 $ (0.02) $ 0.39
</TABLE>
19
<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, 1997 and is qualified in it's
entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997
<CASH> 7,021
<SECURITIES> 0
<RECEIVABLES> 36,511
<ALLOWANCES> 2,208
<INVENTORY> 22,385
<CURRENT-ASSETS> 72,502
<PP&E> 19,282
<DEPRECIATION> 11,026
<TOTAL-ASSETS> 139,319
<CURRENT-LIABILITIES> 44,770
<BONDS> 14,685
0
7,300
<COMMON> 496
<OTHER-SE> 71,824
<TOTAL-LIABILITY-AND-EQUITY> 139,319
<SALES> 116,732
<TOTAL-REVENUES> 116,732
<CGS> 77,821
<TOTAL-COSTS> 77,821
<OTHER-EXPENSES> 40,362
<LOSS-PROVISION> 102
<INTEREST-EXPENSE> 1,499
<INCOME-PRETAX> (1,767)
<INCOME-TAX> (701)
<INCOME-CONTINUING> (1,066)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,066)
<EPS-PRIMARY> (0.02)
<EPS-DILUTED> (0.02)
</TABLE>
