Executone Information Systems, Inc. 10-Q, June 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 June 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 July 31, 1997 was 49,639,043.
<PAGE>
INDEX
EXECUTONE Information Systems, Inc.
Page #
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
June 30, 1997 and December 31, 1996. 3
Consolidated Statements of Operations -
Three Months and Six Months Ended
June 30, 1997 and 1996. 4
Consolidated Statements of Cash Flows -
Six Months Ended June 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
June 30, December 31,
(In thousands, except for share amounts) 1997 1996
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 11,918 $ 27,696
Restricted cash 5,134 ---
Accounts receivable, net of
allowance of $1,800 and $2,106 30,385 38,992
Inventories 27,568 16,814
Prepaid expenses and other current assets 2,920 3,099
Total Current Assets 77,925 86,601
RESTRICTED CASH --- 5,031
PROPERTY AND EQUIPMENT, net 8,417 7,578
INTANGIBLE ASSETS, net 19,829 19,893
DEFERRED TAXES 19,669 18,434
OTHER ASSETS 18,509 14,472
$ 144,349 $ 152,009
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 1,089 $ 882
Accounts payable 32,879 31,416
Accrued payroll and related costs 2,711 3,398
Accrued liabilities 10,290 13,943
Deferred revenue and customer deposits 3,794 3,164
Total Current Liabilities 50,763 52,803
LONG-TERM DEBT 14,502 13,837
LONG-TERM DEFERRED REVENUE 307 22
TOTAL LIABILITIES 65,572 66,662
STOCKHOLDERS' EQUITY:
Common stock: $.01 par value; 80,000,000
shares authorized; 49,603,460 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 71,417 76,113
Retained earnings (deficit) (since July 1, 1988) (436) 1,422
Total Stockholders' Equity 78,777 85,347
$ 144,349 $ 152,009
</TABLE>
The accompanying notes are an integral part of these consolidated
balance sheets.
3
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EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
(In thousands, except for June 30, June 30,
per share amounts) 1997 1996 1997 1996
<S> <C> <C> <C> <C>
REVENUES $ 34,777 $ 51,982 $ 73,796 $ 118,948
COST OF REVENUES 24,878 33,013 49,777 73,459
Gross Profit 9,899 18,969 24,019 45,489
OPERATING EXPENSES:
Product development and eng. 3,437 3,611 6,737 7,375
Selling, general and admin. 10,197 22,593 20,244 48,849
13,634 26,204 26,981 56,224
OPERATING LOSS (3,735) (7,235) (2,962) (10,735)
INTEREST EXPENSE (503) (755) (937) (1,563)
GAIN ON SALE OF BUSINESSES (NOTE G) --- 47,495 --- 42,618
OTHER INCOME, net 296 315 811 531
INCOME (LOSS) BEFORE INCOME TAXES (3,942) 39,820 (3,088) 30,851
PROVISION (BENEFIT) FOR INCOME TAXES:
Cash 0 4,000 0 4,100
Noncash (Note C) (1,571) 11,960 (1,229) 8,249
(1,571) 15,960 (1,229) 12,349
NET INCOME (LOSS) $ (2,371) $ 23,860 $ (1,859) $ 18,502
EARNINGS (LOSS) PER SHARE $ (0.05) $ 0.45 $ (0.04) $ 0.35
WEIGHTED AVG. COMMON AND COMMON
EQUIVALENT SHARES OUTSTANDING 49,457 52,803 49,669 52,773
</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>
Six Months Ended
(In thousands) June 30,
1997 1996
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (1,859) $ 18,502
Adjustments to reconcile net income (loss)
to net cash used by operating activities:
Depreciation and amortization 1,512 2,807
Gain on sale of businesses (Note G) --- (42,618)
Provision/(benefit) for income taxes
not currently payable (1,229) 8,249
Noncash expenses, including noncash
interest expense, noncash provision
for losses on accounts receivable and
income from equity investment 112 (204)
Change in working capital items:
Accounts receivable 8,722 4,905
Inventories (10,783) (4,614)
Accounts payable and accruals (2,758) 2,096
Other working capital items 706 3,314
NET CASH USED BY OPERATING ACTIVITIES (5,577) (7,563)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (1,586) (2,164)
Proceeds from sale of businesses (Note G) --- 56,948
Investment in UniStar (2,373) ---
Other, net (948) 190
NET CASH PROVIDED/(USED) BY INVESTING ACTIVITIES (4,907) 54,974
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments under revolving credit facility --- (15,445)
Repayments of other long-term debt (585) (464)
Repurchase of stock (5,412) (1,983)
Proceeds from issuance of stock 703 546
Other borrowings --- 395
NET CASH USED BY FINANCING ACTIVITIES (5,294) (16,951)
INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS (15,778) 30,460
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 27,696 8,092
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 11,918 $ 38,552
</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.
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 six-month periods ended June 30, 1997 and 1996, the
Company made cash payments for income taxes of approximately
$389,000 and $779,000, 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 six-month periods ended June 30, 1997 had
been calculated in accordance with the new standard, it 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 June 30, 1997 and
December 31, 1996:
<TABLE>
<CAPTION>
(amounts in thousands) 6/30/97 12/31/96
<S> <C> <C>
Raw Materials $ 4,709 $ 3,493
Finished Goods 22,859 13,321
$27,568 $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 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)
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<PAGE>
upon conversion or redemption of the Series A and Series B
Preferred Stock or (iii) upon liquidation. As of June 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 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 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. The Company expects this ruling will be reviewed by
the U.S. Federal Courts as well, and believes, based on
consultation with and opinions rendered by outside legal counsel,
that the favorable rulings will be upheld on appeal. In 1995,
the Company accrued $1 million to cover estimated legal costs
through the possible appeal to the U.S. Federal Courts. If the
matter is appealed beyond the U.S. Federal Courts 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 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 will be deferred and
amortized over the life of the management agreement. The
guaranteed monthly advance 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. Total funding as described above totaled $5.0 million
through June 30, 1997 and is reflected in non-current other
assets.
Other than legal costs related to an appeal of the CDA Tribal
Court ruling or other actions by the states, the Company
estimates that the additional costs to become operational may
amount to between $5 million and $10 million. The 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 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. The cost estimate does not include a $4 million jackpot
reserve which could be required
8
<PAGE>
dependent upon certain conditions. If the Company ultimately
must fund a jackpot reserve, it will be repaid to UniStar solely
from NIL net revenues in equal installments over the term of the
agreement. 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. The
Company will acquire all hardware for the system without
financial obligation by either IGT or CWH. The Company estimates
that such hardware charges, which are included in the cost
estimates previously noted of $5 million to $10 million, will be
approximately $2 million to $3 million. Approximately $500,000
in hardware costs were incurred as of June 30, 1997.
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 June 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.
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 upheld 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.
9
<PAGE>
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 division 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. The proceeds
were used to repay the Company's bank borrowings, and the excess
was invested in short-term cash investments.
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.
10
<PAGE>
NOTE H - OTHER MATTERS
For the six-month periods ended June 30, 1997 and 1996,
respectively, the Company made cash payments of approximately
$0.8 million and $1.7 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 six-month periods ended June 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 $1.2 million and $0.3
million.
For both the three-month and six-month periods ended June 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 $3.5 million and $12.9 million for the
three-month and six-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 on-line 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 June 30, 1997, the Company
generated revenues of $34.8 million, an operating loss of $3.7
million and a net loss of $0.05 per common share compared to the
same period in 1996, which included revenues of $52.0 million, an
operating loss of $7.2 million, a pretax gain of $39.8 million
and a net gain of $.45 per share. For the six-month period ended
June 30, 1997, revenues were $73.8 million generating an
operating loss of $3.0 million and a net loss of $0.04 per share
compared to revenue of $118.9 million, an operating loss of $10.8
million, pretax profit of $30.9 million and net income of $0.35
per share. The 1997 results are not comparable to the three-
month and six-month periods in 1996, which included net gains on
the sales of businesses of $47.5 million and $42.6 million,
respectively. 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.
The revenue and profit shortfall during the three-month period
ended June 30, 1997 was primarily attributable to the Company's
largest distributor purchasing significantly less product at the
end of the quarter than it had in the past. This distributor had
previously purchased significant quantities of product at the end
of each quarter to meet expected needs for the following quarter.
In the belief that this practice was causing both excess and
unbalanced inventory, the distributor decided to change its
purchasing pattern to purchase product monthly as needed in the
future. The Company expects to benefit from this change in the
long term as the previous purchasing pattern resulted in extreme
pressure during the last week of each quarter and made it
difficult to plan effectively. However, in the short term, it
had a negative impact on both revenue and profit for the three-
month period ended June 30, 1997.
All of the Company's other businesses performed as anticipated
for the three-month period ended
June 30, 1997, including the balance of its independent
distribution channel, the National Accounts/Federal Systems
retail telephone group and the Healthcare business.
12
<PAGE>
Results of Operations
As a result of the business sales and dispositions consummated in
1996, the second quarter financial results for the three-month and
six-month periods ended June 30, 1997 are not comparable to the
same periods in 1996, other than on certain measures of overall
profitability. As previously noted, revenues from the Company's
largest distributor were significantly less than anticipated. As
a result, the Computer Telephony revenues for the three-month
period were $24.4 million compared to $30.2 million during the
previous quarter. This more than offset a strong performance from
the Healthcare Division, which had revenues of $10.4 million, an
18% increase compared to the previous quarter, and a record
backlog at June 30, 1997.
The Company expects its largest distributor's orders to normalize
over the last six months of 1997. However, this order level is
lower than the Company originally anticipated, as the distributor
has not yet increased its sales force to the levels originally
contemplated. In addition, the Company is in the process of
examining its cost structure to accommodate the lower anticipated
revenue.
Gross profit margin for the three-month period ended June 30, 1997
was $9.9 million or 28.5% of revenue, which was $4.2 million less
than the previous three-month period. The decline in gross profit
margin is a result of the lower revenue levels and a resulting
lower absorption of fixed costs. In addition, the margin
percentage was affected by a poor product mix resulting from the
shortfall in the distributor revenue during the quarter. The
distributor historically has purchased a higher level of software
and feature-rich hardware that typically produces higher margins.
Product development expenses were $3.4 million, which is slightly
higher than the previous quarter's spending levels. Selling,
general and administrative expenses were $10.2 million, which is
comparable to the previous quarter's spending level and in line
with the lower level of sales.
Operating losses for the three-month and six-month periods ended
June 30, 1997 were $3.7 million and $3.0 million, respectively.
Operating losses for the same periods in 1996 were $7.2 million
and $10.7 million, respectively.
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 via an 800 number 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 six-month period ended June 30, 1997, the Company
invested $2.9 million as part of the cost to develop the software
system, building and other costs related to the project. These
costs have been recorded as assets on the balance sheet. The
total UniStar investment cost on the balance sheet is $20.8
million at June 30, 1997, including $15.8 million in goodwill and
$5.0 million in other assets. In the opinion of the Company's
management, this investment is justified based upon the potential
returns.
The UniStar legal situation is proceeding forward. The Company
has received notice that the Tribal Appellate Court affirmed the
lower Tribal Court's May 1, 1996 ruling and analysis upholding
the CDA's right to conduct the telephone lottery on July 2, 1997.
The Company is awaiting the written opinion outlining the basis
for the court's conclusions. The Company remains hopeful that
this decision will accelerate a Federal Court decision on the
telephone-based lottery.
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, enabling the
telephone lottery to begin as soon as the legal issues are
resolved. As of July 21, 1997, the registered base of the US
Lottery was 1,800 people with about 200 active players. As part
of the test marketing program, the Company will be experimenting
with direct mail, print advertising, radio and other promotional
methods. It is anticipated that the national launch of the
Internet lottery will take place by the end of the year. The
Company estimates that an additional
$4 million to $5 million will be spent in 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 $32 million and $50 million
as of June 30, 1997 and December 31, 1996, respectively.
At June 30, 1997 and December 31, 1996, cash and cash equivalents
amounted to $11.9 million and $27.7 million, respectively, a
decrease of $15.8 million. During the six-month period ended
June 30,1997, the Company utilized $5.6 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 $2.4 million in UniStar-related activities, invest $0.5
million in an infrared communications company and fund $1.6
million in capital expenditures.
During the six-month period ended June 30, 1997, cash utilized by
operating activities was $2.0 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.
Total debt at June 30, 1997 was $15.6 million, an increase of
$0.9 million from $14.7 million at December 31, 1996. The
increase is primarily due to incurring $1.2 million in
capitalized lease obligations for equipment acquisitions during
the first six months of 1997. Outstanding debt at June 30, 1997
consists of $12.4 million in subordinated debt, due in 2011, with
the balance primarily capitalized lease obligations.
14
<PAGE>
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 vs. 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, and probably will be reviewed by the
United States federal courts as well. 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 upheld on appeal.
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, and the State has filed a motion to
remand it to the State court. UniStar and Tribe
are contesting the jurisdiction asserted by the
State of Missouri and intend to defend the right
of the Tribe to offer the Lottery on the Internet.
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, and it is impossible at
this time to predict when the NIL will commence
telephone 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.
16
<PAGE>
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
a) The Registrant's Annual Meeting of Shareholders was held on July 29,
1997.
b) Proxies were solicited by the Registrant's management pursuant to
Regulation 14 under the Securities Act of 1934; there was no solicitation
in opposition to management's nominees listed in the Proxy Statement dated
May 27, 1997, and all such nominees were elected pursuant to the vote of
the shareholders.
c) The amendment of the Registrant's 1986 Employee Stock Option Plan
described under "Proposal 2" in the Proxy Statement dated May 27, 1997,
which section is incorporated herein by reference, was approved by a vote
of the majority of the Registrant's outstanding Common and Preferred Stock
as follows:
For: 39,657,851
Against: 818,104
Abstain: 167,298
d) The total number of shares of the Registrant's Common Stock, $.01 par
value, and Preferred Stock, $.01 per value, outstanding as of May 27,
1997, the record date for the Annual Meeting, was 49,821,481, and
41,748,316 shares were represented in person or by proxy at the Meeting.
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: August 12, 1997 /s/ Alan Kessman
Alan Kessman
Chairman, President and
Chief Executive Officer
Dated: August 12, 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 Six Months Ended
June 30, June 30,
1997 1996 1997 1996
<S> <C> <C> <C> <C>
NET INCOME (LOSS) $ (2,371,000) $ 23,860,000 $ (1,859,000) $ 18,502,000
WEIGHTED AVERAGE NUMBER
OF COMMON SHARES
OUTSTANDING 49,457,000 51,878,000 49,669,000 51,865,000
COMMON STOCK EQUIVALENT
SHARES ASSUMED TO BE ISSUED
FOR DILUTIVE STOCK OPTIONS
AND WARRANTS 0 925,000 0 908,000
TOTAL WEIGHTED AVERAGE COMMON
AND COMMON EQUIVALENT SHARES
OUTSTANDING 49,457,000 52,803,000 49,669,000 52,773,000
EARNINGS (LOSS) PER
COMMON SHARE $ (0.05) $ 0.45 $ (0.04) $ 0.35
</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 June 30, 1997 and is qualified in it's entirety
by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> JUN-30-1997
<CASH> 17,052
<SECURITIES> 0
<RECEIVABLES> 32,185
<ALLOWANCES> 1,800
<INVENTORY> 27,568
<CURRENT-ASSETS> 77,925
<PP&E> 25,673
<DEPRECIATION> 17,256
<TOTAL-ASSETS> 144,349
<CURRENT-LIABILITIES> 50,763
<BONDS> 14,502
<COMMON> 496
0
7,300
<OTHER-SE> 70,981
<TOTAL-LIABILITY-AND-EQUITY> 144,349
<SALES> 73,796
<TOTAL-REVENUES> 73,796
<CGS> 49,777
<TOTAL-COSTS> 49,777
<OTHER-EXPENSES> 26,981
<LOSS-PROVISION> (262)
<INTEREST-EXPENSE> 937
<INCOME-PRETAX> (3,088)
<INCOME-TAX> (1,229)
<INCOME-CONTINUING> (1,859)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,859)
<EPS-PRIMARY> 0.04
<EPS-DILUTED> 0.04
</TABLE>
