FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from to
Commission File Number: 0-11551
EXECUTONE Information Systems, Inc.
(Exact name of registrant as specified in its charter)
Virginia 86-0449210
(State or other jurisdiction of (I.R.S. Employeer
incorporation or organization) Identification No.)
478 Wheelers Farms Road, Milford, Connecticut 06460
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (203)876-7600
Securities registered pursuant to Section 12(b) of the
Act:
Title of each class Name of each exchange
on which registered
N/A None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
72% Convertible Subordinated Debentures, Due March 15, 2011
(Title of Class)
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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 ___
Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not
be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. []
The aggregate market value of the common stock held by
non-affiliates of the registrant (assuming for this
purpose that all executive officers and directors of the registrant
are affiliates) as of March 24, 1997 was $117,323,737, based on the
last sale price for the common stock on that date.
The number of shares outstanding of the registrant's only class
of common stock, $.01 par value per share, as of March 24, 1996,
was 49,471,481.
DOCUMENTS INCORPORATED BY REFERENCE
The following documents are incorporated by reference
into the Part of this Form 10-K indicated below:
Part II 1996 Annual Report to Shareholders
Part III 1997 Proxy Statement for Annual Meeting of
Shareholders scheduled to be held June 10, 1997.
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TABLE OF CONTENTS
Item Page
PART I
1. Business 1
2. Properties 11
3. Legal Proceedings 11
4. Submission of Matters to a Vote of Security Holders 12
Executive Officers of the Registrant 13
PART II
5. Market for Registrant's Common Equity and Related
Stockholder Matters 16
6. Selected Financial Data 16
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
8. Financial Statements and Supplementary Data 16
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 16
PART III
10. Directors and Executive Officers of the Registrant 17
11. Executive Compensation 17
12. Security Ownership of Certain Beneficial Owners
and Management 17
13. Certain Relationships and Related Transactions 17
PART IV
14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K 18
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PART I
ITEM 1. BUSINESS
General
EXECUTONE Information Systems, Inc. ("EXECUTONE" or the
"Company") develops, markets and supports voice and data
communications systems. Products and services include
telephone systems, voice mail systems, in-bound and out-bound
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
(the "NIL" or the "Lottery"). Products are sold under
the EXECUTONE'r', INFOSTAR'r', IDS'tm', LIFESAVER'tm',
INFOSTAR/ILS'tm' and UNISTAR'tm' brand names through a
worldwide network of direct sales and service employees
and independent distributors.
EXECUTONE's executive offices are located at
478 Wheelers Farms Road, Milford, Connecticut 06460,
telephone (203) 876-7600. The Common Stock of EXECUTONE
is traded on the NASDAQ National Market System
under the symbol "XTON", and its Convertible Subordinated
Debentures due 2011 trade on the NASDAQ system under the
symbol "XTONG".
Recent Developments
In 1996, the Company sold its direct sales and service
organization, including its network services division and the
national service center, to Clarity Telecom Holdings, Inc.
d/b/a/ Executone Business Solutions ("Clarity") for consideration
valued at $69.6 million. The Company and Clarity also entered
into a five-year exclusive distributor agreement pursuant to which
Clarity sells and services EXECUTONE'r' and INFOSTAR'r'
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 separately sold to one of its existing
independent distributors.
After the sale, the Computer Telephony business consists of
telephone products sales to independent distributors, of which
Clarity is the largest distributor, along with the National Accounts
and Federal Systems marketing groups. The Company retains its
Healthcare Communications and Call Center Management businesses
and the Unistar business.
In April 1996, the Company rescinded its distribution
agreement with GPT Video Systems due to failures by GPT to
deliver properly functioning videoconferencing
products on a timely basis. The Company has also
commenced a legal action against GPT to recover its
damages. In June 1996, the Company completed the sale
of its videoconferencing division, including customer
service contracts and certain inventory.
On December 19, 1995, the Company acquired 100% of the
common stock of Unistar Gaming Corp., a Delaware
corporation ("Unistar Gaming"). Unistar Gaming, through
its subsidiary Unistar Entertainment, Inc. ("Unistar"), has
an exclusive five-year contract to design, develop, finance,
and manage the Lottery, a national lottery authorized by
federal law and by a compact between the State of Idaho and
the Coeur d'Alene Indian Tribe of Idaho ("Coeur d'Alene Tribe"
or the "Tribe"). In return for providing these management
services, Unistar will be paid a fee equal to 30% of the profits
of the Lottery.
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The Company acquired 100% of Unistar for 3.7 million
shares of Common Stock, 250,000 shares of its Cumulative
Convertible Preferred Stock, Series A ("Series A Preferred Stock")
and 100,000 shares of its Cumulative Contingently Convertible
Preferred Stock, Series B ("Series B Preferred Stock").
The telephone operations of the Lottery may not begin
until the resolution of a pending legal proceeding.
Certain states have attempted to block the NIL by
filing letters under 18 U.S.C. Section 1084 preventing
long-distance carriers from providing telephone service
to the NIL based on allegations that the NIL is not legal.
The Coeur d'Alene Tribe has initiated legal action to
argue that the Lottery is authorized by the Indian Gaming
Regulatory Act ("IGRA") passed 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 Coeur d'Alene Tribal
Court ruled that all requirements of IGRA have been satisfied,
that the Section 1084 letters are
invalid, and that the long distance carrier is obligated
to provide telephone service for the NIL. This ruling and a
related order dated May 1, 1996 are being appealed to the Tribal
Appellate Court and probably will be appealed ultimately to
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 National Indian 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 should be upheld on appeal.
Overview of Business
The Company's revenues are derived from both from product
sales to distributors, direct sales of healthcare
communications 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. The Company's products and
services are marketed and sold through a national network
of Company direct sales and service employees and independent
distributors.
The Computer Telephony business offers value-added
products and services to the small to medium-sized
business customer. The Company's integrated digital
telephone systems emphasize flexible software
applications, such as data switching and computer
telephone interface, designed to enhance the customer's
ability to communicate, obtain and manage information.
The Company's telephone systems provide the platform for
its other voice and data software applications, such as
automatic call distribution.
The Healthcare Communications business provides to its
healthcare facility customers integration of voice and
data between nurse and patient communication systems
and hospital information systems, resulting in increased
flexibility and efficiency in hospital operations, and
improved patient care. EXECUTONE has been a recognized
name in this market for many years with its LIFESAVER'tm' and
CARE/COM'r'II-E nurse call systems. The Company markets software
applications specific to hospital and nursing homes to help
resolve other labor intensive tasks.
The Healthcare Communications business also markets the
INFOSTAR/ILS'tm' locator system, which can improve
productivity, save time and expense for users and
eliminate overhead paging by instantly locating staff
and equipment in a facility. Each person or piece of
equipment wears an individually coded badge that
transmits infrared signals to sensors placed throughout
the facility, which forward the location information to
a central processing unit. The ILS system can be integrated
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with the Company's telephone systems and nurse call systems
to provide additional productivity improvements for hospital environments.
The Call Center Management business develops and sells
sophisticated telephony products that integrate a
computerized digital telephone system platform with high-volume
inbound, outbound and internal call processing systems. Such
systems include automatic call distribution systems, predictive
dialing systems, and scripting software to assist agents
handling calls. Certain of these systems also provide data interface
with host or mainframe computers. These systems are sold to
call center customers that have a need for systems to efficiently
and cost-effectively receive or place their customer or prospect calls,
distribute those calls to available live operators, obtain information
from callers, record and distribute messages from callers,
and produce management reports on call activity.
In 1995, the Company acquired Unistar. Unistar has an
exclusive five-year contract with the Coeur d'Alene Tribe
to design, develop, finance, and manage the Lottery, a national
lottery authorized by IGRA and a compact between the State of Idaho
and the Tribe. Unistar provides development and management of
the software, network design and call center applications for
the Lottery's operations.
The telephone operations of the Lottery may not begin
until resolution of a pending legal proceeding. See
"Legal Proceedings." Although the Unistar legal
situation is essentially unchanged, management is
hopeful that the Tribe will receive a positive decision
early this year in the Tribal Appellate Court, affirming
the Tribal Court's rulings last year on the legality of
the National Indian Lottery, and that such a decision will
accelerate a federal court decision. In the meantime, Unistar
is developing the business and gaming systems needed to conduct
the Lottery, and plans to test these systems at an Internet test
site between April and June 1997. Assuming the successful completion
of these tests, Unistar plans a controlled expanded test from July to
September, and assuming continued successful results, a
national launch over the Internet in the fourth quarter of 1997.
Computer Telephony Products
The Company develops and distributes a complete line of
applications-oriented computer telephony products that are
easy to install, easy to maintain and easy to use, and that
create visible value for our customers. The Company's complete
portfolio of applications are built upon the Integrated Digital
System (IDS) family of digital telephone systems. Products range
from PBXs to satisfy the basic voice communications needs of small-
to medium-sized businesses to standards-compliant CT applications,
standalone and LAN-based applications including voice mail, unified
messaging, Automatic Call Distribution (ACD) and wireless communications.
The Company's telephone systems are characterized by
flexible software and a hardware design that makes them
readily adaptable to evolving technology and customer requirements.
The Company attributes the market acceptance of its systems to
standards-based, cost-effective design and to the sophistication of its
software options. The Company's systems include an
integrated automated attendant feature to answer and
transfer calls quickly and efficiently without operator
intervention. The Integrated Operator Terminal and management
reports capabilities permit the monitoring of calls and improve
the efficiency of directing calls to the appropriate extensions.
The Company's latest achievement in call processing, the Ultimate
Operator, takes the operator's console to a new level by delivering
superior call handling and reporting capabilities in a Windows
environment. The IDS systems also support sophisticated call center
and healthcare applications in addition to the Company's Integrated
Locator System. The recent introduction of the Company's LAN card
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allows users with access to their organization's network to manage
the IDS through their desktop PCs.
The Company has steadily introduced a portfolio of
products fully compliant with the latest industry
standards (TAPI, TSAPI, CSTA) and incorporating the
most advanced elements of computer telephony integration.
The TAPI telephones support any desktop application using
the TAPI standard for computer-telephone integration. Unified
Messaging and Voice Activated Speed Dial further increase
productivity by speeding the calling process.
The Company also offers a voice mail system that can be integrated
with the IDS telephone systems and with telephone systems
manufactured by others. The INFOSTAR/VX2 voice mail system
receives, records, stores, distributes, transfers and replays
messages from both external and internal callers and can
supplement other call center systems. In 1996 the Company
introduced the INFOSTAR/VXC Voice Exchange Card, a complete
voice processing system built on a card that integrates directly
into the IDS switch, eliminating the need for a standalone voice
mail system. In 1997, the Company signed an agreement to distribute
the Active Voice line of voice processing and unified messaging products.
The Company develops its application-specific software
options using high-level programming languages to
facilitate further enhancements and portability.
enhancements and portability.
EXECUTONE's software includes remote capabilities built
into certain systems that enable the Company to customize
and update selected features continuously, which increases
the value of such systems and lengthens their useful lives.
Certain of the Company's systems are capable of having service
diagnostics, updates and modifications performed on a remote basis.
The ability to provide such off-site servicing increases the efficiency
of customer support and service.
Healthcare Communication Products
The Company develops, manufactures, markets and services
a line of specialized internal communications systems that
are used primarily in the healthcare industry. These internal
ommunications systems are microprocessor-based patient to nurse
communication systems, intercoms, paging and sound equipment, and
room status indicators.
Platform Systems. Released on January 17, 1997, the Healthcare
Communications Platform (HCP) is the communications solution dedicated to
a single platform technology for complete systems integration. The
HCP exemplifies the Company's commitment to provide total communciation
capability. With the HCP system, the nurse call function is now
integrated with an IDS phone system to provide the dual function at one master
control center. Nurse call, locator, wireless phones, pocket pagers, patient
reports, and management reports can all integrate seamlessly using a single
platform fully utilizing all product benefits.
Nurse Call Systems. The Company's LIFESAVER'tm' nurse call system is an
advanced system integrating voice and data communication between nurse and
patient and providing enhanced self-diagnostics. The LIFESAVER system is
a state-of-the-art communications network that provides routine and
emergency signaling, voice communications and data transmission. The
nurse console offers menu-driven functions and step-by-step user prompts.
The system is highly flexible, offering many programmable features that
allow customization of its operations to the hospital's needs. A single
system can serve more than 300 patient beds (150 rooms) and up to eight
nurse control stations, and up to eight systems can be networked for
centralized operation. The LIFESAVER integrates with the Company's
locator system.
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The CARE/COM II-E nurse call system represents the first step in
EXECUTONE's plan to bring the benefits of a totally integrated
communications system to the healthcare market on the Company's
IDS digital platform. The CARE/COM II-E system provides patient-to-staff
and staff-to-staff communication on an automatic three-level call
priority basis. This new system can currently support 72 patient
stations per system, with the ability to integrate three systems
together and support 216 patient stations. A five-line LCD
display Nurse Control Station allows simple call processing and system
operation. The system is highly flexible to meet the individually
defined needs of today's hospitals and long-term care facilities.
Patient Reporting Systems. The Healthcare Division also markets
the INFOSTAR /PRS patient reporting system, an automated voice
storage system that allows the efficient transfer of patient
information between nurses. Patient reports are password-protected
for confidentiality and admission, and discharge and transfer
information are also supported. The system uses standard telephone
instruments and provides full voice messaging capability. The
INFOSTAR/PRS system reduces report time, provides continuity at shift
changes, and improves report quality.
Locator Systems. The Company's INFOSTAR/ILS'tm' locator
system is an integrated system using infrared transmitter badges
to communicate location data to sensors installed throughout a
facility. The badges transmit regularly at user-programmed intervals
and can be worn by staff personnel or attached to equipment. The
location data is collected by the sensors and forwarded to a central
processing unit that organizes the data so it can be accessed at one
or more display stations. The display of staff and equipment location
information can be in the form of a list or in the form of a map of
the facility using icons. The display can be filtered to show only
particular staff members, groups of personnel,
particular pieces of equipment or groups of equipment.
The system can be integrated with either the IDS telephone systems,
allowing the activation of features and display of information on the
telephone set, or the Compaby's nurse call system, allowing the
activation of features and display of information at the nurse control
station and patient stations. The INFOSTAR/VLS version of this product
allows outside callers using non-IDS based products to locate personnel
within a facility, find out who the person is with, complete the call,
or leave a voice message. The ILS and VLS systems can also be integrated
to other manufacturers' PBXs. Nortel has now made ILS available to its
dealer network for sale by its dealers in conjunction with Nortel PBXs.
The ILS system is also marketed by the Computer Telephony sales channels
for office environments.
The Events Processing System collects information from the ILS
system and associates the data to logical, workable and productive
real time data for a customer's employees and assets. Specific
applications include: door monitoring, wandering patient alert,
staff presence indicators, badge button press (staff assist or
emergency assist), asset management and equipment tracking. The
system allows a facility to program events that will trigger alarms,
lock doors, light lights, open elevator doors, and more. The system
is completely programmable, which allows the customer to determine
which applications will best fit their needs.
Wireless Telephone Systems. The Healthcare Communications group
also markets the Ericsson Freeset, an in-building wireless
communications system which operates on the 900MHz bandwidth.
Its low power output (.75mW) makes it ideal for the healthcare
environment, which is very sensitive to high power devices such
as cellular telephones and 2-way radios that may interfere with vital
telemetry equipment. The Freeset system is extremely flexible in
providing complete coverage over a large area based on its ability
to add as many base stations as necessary to provide coverage. The
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system can grow to support up to 600 handsets, making it the system
of choice for large installations.
The Company also markets the Monarch'tm' 1.9GHz Wireless Telephone
System, which is an in-building wireless communications tool that
provides cellular-like mobility to a facility without expensive
airtime charges. The Monarch system operates on the 1.9GHz U-PCS
bandwidth set aside by the FCC strictly for personal communications
use which means the signal will not cause interference or be
interfered with by conventional telemetry equipment. The Monarch
system can support up to 2 base stations per system, providing a
coverage area of over 250,000 sqare feet in a typical office
environment. In an open warehouse environment, the coverage is
much greater. Each base station allows for eight simultaneous
conversations and the Monarch system can support a maximum of up
to 32 handsets.
Other Communication Priducts. The INFOSTAR'r'/StatLink'tm'
product is designed to provide call management and
integration of EXECUTONE nurse call systems to telephone
numbers, wireless telephones and pager devices.
INFOSTAR/StatLink has the flexibility to modify patient
call flow based on the specific requirements of the healthcare
facility. Calls can be routed on a 4-level priority basis to
any extension, telephone or site pager configured in the database.
The system is a communications solution that can be integrated
with any PBX. Patient priorities and requests can be managed
more efficiently and calls can be managed more efficiently
and calls can be completed on a more timely basis with less
strain on the staff and patients.
The INFOSTAR'r'/InfoSTAT'tm' product is a software package
intended for use in emergency departments to provide
complete communication of real time events and data.
Used as a daily operational tool, the InfoSTAT system
provides emergency staff with priority data and
conditions affecting the department. Staff can check at a
glance the status of treatment rooms, room and bed assignments,
hospital staff assignment and location, and patient status and
location. InfoSTAT is customized for each hospital and integrates
with a facility's existing administrative software such as ADT systems.
Call Center Management Products
The Company's call center management products consist of the following
systems, which can be integrated with the Company's computer telephone
systems and with each other to provide large-volume inbound, outbound
and internal call management. Computer-telephone integration ("CTI")
technology integrates the IDS'tm' call processing function with information
in a customer's computer database. Primarily used by large incoming call
centers to automatically identify incoming callers and by outbound centers
to contact and provide records of contacts, CTI limits the amount of time
that an agent spends contacting or identifying the caller, thereby
providing better customer service, reducing the number of required
agents and reducing telephone line and transmission expense.
Predictive Dialers and Scripting Products - The
INFOSTAR'r'/Predictive Dialer is an automated call system designed
to boost productivity in outbound call centers. The system integrates
telephone, data collection and transaction processing functions for those
customers who require high volume contact by telephone to transact
business, such as sales, credit and collections, blood banks and
fund-raising. Working with the host computer and the IDS telephone
system platform, the dialer automatically dials telephone numbers
pulled from the host computer data "live" calls. Available
representatives receive these calls and,
through CTI, can view screen information about the
customer from the database immediately after the customer
answers the phone. The system predicts the availability of
agents in order to reduce abandoned calls and increase agent
productivity, and reduces agent contact with busy signals, no
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answers, wrong numbers and answering machines. Management reports
provide instant and historical feedback on call distribution, list
management, data input integrity and file maintenance. Scripting
software allows the call center to create a script to guide its agents
through various call scenarios and prompt the input of desired information.
Automatic Call Distribution ("ACD") - ACD systems are
designed to increase responsiveness to inbound callers
and increase agent productivity. ACD systems provide the
capability to distribute or route incoming calls to available
agents based upon management's specifications, and allow the
supervisor of the call processing group to monitor call traffic
on-line via a computer terminal. The Company produces ACD software
for call centers of up to 500 agents in multiple shifts (225 in any
single shift), in five levels of sophistication, the highest of which
is "Custom Plus ACD." Custom Plus ACD provides the capability to
monitor traffic with color screens and graphics, and
greatly enhance the ability to store and retrieve
historical call data.
Sales and Marketing
The Company's distribution network consists of (1)
domestic independent distributors with approximately
180 locations operating under exclusive and nonexclusive
agreements throughout the United States and Canada; (2)
138 direct healthcare and call center sales and service
employees in the United States; ; (3) a National Accounts
group that uses the sales, installation, service and support
capabilities of EXECUTONE's distribution network to serve multiple
offices and departments of companies; (4) a Government Systems
group that uses the distribution network to serve offices of
federal, state and local government agencies; and (5) 24 independent
distributors operating in 17 other foreign countries.
For those distributors that have exclusive distribution
rights for specified products, retention of such rights
is subject to satisfaction of established criteria for
sales and service to customers on an ongoing basis. The
divesting of or acquisition of customer bases to or from
distributors in specific geographic territories may occur
in the normal course of the Company's business.
EXECUTONE's National Accounts business provides
uniformity in pricing, coordination, installation,
billing and service for National Accounts customers
such as Electronic Data Systems, Airborne Express,
Paychex, Inc., W. W. Grainger, Home Quarters Warehouse,
Inc., Bridgestone/Firestone, Carlson Companies, PetsMart
and TCI Cable. The National Accounts group coordinates the
sales, installation, service and support functions of independent
sales offices to serve the multiple offices and departments of
large companies.
The Company's Government Systems group addresses the
special procurement and administrative requirements of
federal, state and local government agencies. Sales are
made through a combination of master contracts and
competitively solicited proposals for large or complex
telecommunications requirements. Government Systems
coordinates the installation, service and support
activities of independent sales offices to provide
ongoing support to government agency offices nationwide.
Although the Company offers a broad range of products
through various sales channels nationwide, computer
telephony product purchases by Clarity, the purchaser
of the Company's direct sales and service organization
and the Company's largest distributor, represented a
significant portion of the Company's total revenues in
1996 and are expected to continue to represent a large
portion of the Company's revenues. The loss of Clarity
as a customer could have a material adverse effect on the
Company, assuming the Company could not replace the shipments
with other alternative distribution. The Company believes
that it has the means within a reasonable period of time to
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establish alternative distribution channels in most of EBS's
territory were that to become necessary. However, the Company
does not currently believe there is any significant risk of
losing Clarity as a customer because Clarity is dependent upon a
continued supply of the Company's proprietary products to service
and upgrade its large existing customer base.
Backlog consists primarily of products that have
been ordered and that will be shipped or installed
within 30 to 60 days of the order (other than call center and
healthcare orders, which have a longer lead time), or
systems the installation of which is not yet required by
the customer. Backlog as of December 31, 1996, was
$23,159,000 compared to $33,091,000 at December 31, 1995,
and the Company expects virtually all of such backlog to be
filled within the current fiscal year.
Product Maintenance
EXECUTONE warrants parts and labor on its systems,
typically for one year, and provides maintenance and
service after warranty expiration either on a contract
or time and materials basis. Most of the Company's
products are repaired at its 56,000-square foot repair
facility located in Poway, California.
Product Development and Engineering
As of March 1, 1997, EXECUTONE employed approximately 100
individuals engaged in product design and development.
The Company's product development program is designed to
anticipate and respond to customer needs through development
of new products and enhancement of existing products. During
1996, the Company's engineering efforts focused on
applications-oriented software products, including new releases
of computer telephone system, call center and healthcare
communications software. EXECUTONE continually strives to reduce
production costs by incorporating new technology into its design
and manufacturing operations. For the years ended December 31, 1996,
1995, and 1994, Company-sponsored product development and engineering
expenditures (including product management and testing) amounted to
approximately $13.8 million, $14.7 million, and $12.2 million,
respectively.
Manufacturing
Most of EXECUTONE's telephone products are manufactured
by Wong's Electronics Company, Ltd. ("Wong's") in
Malaysia, by Quality Telecommunication Products, also
referred to as Compania Dominicana de Telefonos
("Codetel"), in the Dominican Republic, and by the
Company directly in Poway, California. Many of the
printed circuit boards for the Company's products are
manufactured, and many products are assembled into
systems and system components, in the United States.
The Company's Manufacturing Services Agreement with
Wong's currently expires in February 1998 but is
automatically extended each year for an additional
one-year term unless either party gives notice of
termination three months prior to expiration of the
current term. The contract may be terminated earlier
by either party in the event of a material breach by the other party.
If the agreement between Wong's and EXECUTONE should be
terminated for any reason, or if Wong's is unable to ship
or has to reduce shipments, or if restrictions are imposed
materially limiting the importation of products produced by
foreign manufacturers, the Company could be affected adversely
until satisfactory alternative sources are in place. The
profitability of EXECUTONE's operations could be affected to
the extent it is unable to reflect the direct and indirect costs
of products purchased from Wong's in its pricing policies. The
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prices for products purchased by EXECUTONE from
its suppliers are payable in U.S. dollars.
The majority of EXECUTONE's specialized healthcare and
internal communication systems are produced in the United
States at the Company's facility in Poway, California or at
domestic subcontractors. The functions of repair, warehousing
and distribution of the Company's products are performed at the
Company's facilities in Poway.
Trademarks, Patents and Copyrights
Management believes that the continued success of
EXECUTONE is dependent upon the ability to design,
develop and market new products and new or enhanced
applications. The patentability of such new products or
applications is evaluated and patent applications are filed
where necessary to protect unique developments. The Company
currently holds ten utility patents, expiring at various times
between 2007 and 2013, has six U.S. patent applications pending,
and six patent applications pending in several foreign countries.
The Company has registered or applied to register its
trademarks when it believes registration to be important
to its ongoing business operations. The Company also generally
claims copyright protection for software, circuit designs, schematics
and technical documentation used in connection with its products,
and relies upon trade secret, contract and copyright laws to protect
its proprietary rights in its software, designs and documentation.
Certain of EXECUTONE's products incorporate technology
and software licensed from independent third parties.
Generally, these licenses require payment of a royalty
for each system sold that incorporates the licensed
technology or require that the Company purchase the
product from the licensor.
Government Regulation
Many of the Company's systems are designed to be
connected to the public telecommunications network
and as such are required to comply with certain rules
of the Federal Communications Commission ("FCC") pertaining
to telecommunications equipment. The Company has not
experienced any material adverse effect on its business or
operations as a result of such regulation and compliance.
Certain uses of outbound call processing systems are
regulated by federal and state law. Among other things, the
FCC has adopted rules pursuant to the Federal Telephone Consumer
Protection Act to protect residential telephone subscribers' privacy
rights to avoid receiving telephone solicitations to which they object.
Certain states have enacted similar laws limiting access to
telephone subscribers who object to receiving solicitations.
Although compliance with these laws may limit the potential use of
the Company's predictive dialer systems in some respects, the Company's
systems can be programmed to operate automatically in full compliance
with these laws through the use of appropriate calling lists and
calling campaign time parameters.
To the extent the Company markets its products
internationally, it is required to comply with applicable
foreign law, including certification of its products by
appropriate government regulatory organizations.
9
<PAGE>
Competition
The market segments in which the Company offers its
products and services are highly competitive. The under
400-desktop voice communications segment in the United
States, the primary market for the Company's Computer
Telephony sales channels, is served by many domestic and
foreign communications equipment and software
manufacturers and distributors, including Lucent
Technologies (the former equipment business of AT&T),
Nortel (formerly named Northern Telecom), Toshiba,
InterTel and Mitel, as well as numerous specialized
companies. The Company believes that it may be fourth in
telephone system shipments to the under 400-desktop voice
communications market, after AT&T/Lucent, Nortel, and
Toshiba, based on industry surveys of 1996 data.
However, such information may not be sufficient to make
an exact assessment of the Company's competitive position
relative to its competitors. Although the Company can be
competitive on price compared to several of these
companies, many of EXECUTONE's competitors have
substantially more capital, technology and marketing
resources than the Company.
The Company believes its call center products are in a
good competitive position although to date it has not
penetrated a significant portion of this market.
Principal competitors are EIS, Davox, Mosaix and Melita.
The Company's principal competitors in healthcare
communications are Hill-Rom Company, DuKane and Rauland-
Borg. The Company believes it has a strong competitive
position in nurse call and locator products.
The Company competes by offering a full array of
integrated telecommunication products and services to its
customers. The Company also competes on the basis of the
quality of its products, its customer service, nationwide
distribution and installation, and price.
Employees
As of March 1, 1997, EXECUTONE employed approximately 750
persons, directly and through its subsidiaries. Less
than 3% of the employees of the Company and its
subsidiaries are represented by unions, all of which
employees are represented by the International
Brotherhood of Electrical Workers. Management believes
that the Company's relations with its employees are good.
10
<PAGE>
ITEM 2. PROPERTIES
EXECUTONE's principal offices are located in a leased
facility in Milford, Connecticut. The Company has
warehouse, manufacturing and distribution facilities in
Poway, California. As of December 31, 1996, the Company
utilized 4 facilities in the United States with an
aggregate of approximately 273,000 square feet for its
ongoing operations.
The Company's facilities are occupied under lease
agreements. The current annual rent for the Company's
facilities is approximately $3 million. The Company also
subleases from Clarity small areas of 30 former district
sales offices, aggregating approximately 23,000 square
feet, for use by sales and technical employees for
approximately $600,000 per year. The Company has one
facility totaling approximately 14,000 square feet of
space that is no longer used in ongoing operations and is
subleased.
The Company believes its facilities are adequate and
generally suitable for its business requirements at the
present time and for the immediate future. The following
is a brief description of the primary facilities of the
Company.
Use Location Approximate Size
Corporate Headquarters Milford, Connecticut 150,000
and Research, Development square feet
and Engineering Facility
Distribution, Production & Poway, California 115,000
Repair Center and Warehouse square feet
Other, including warehouses Milford, Connecticut 30,800
and subleased offices space square feet
ITEM 3. LEGAL PROCEEDINGS
On October 16, 1996, 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 laws on the subject of Indian gaming, and
the NIL cannot be blocked by state action, 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.
The telephone operations of the NIL may not begin until
resolution of this proceeding and agreement of a network
carrier to carry the network traffic of the NIL. On
February 28, 1996, the Tribal Court ruled that all
requirements of IGRA have been satisfied, that the
Section 1084 letters are invalid, and that AT&T is
obligated to provide telephone service for the NIL. This
ruling and a related order dated May 1, 1996 are being
appealed to the Tribal Appellate Court and probably will
be appealed to the United States federal courts as well.
11
<PAGE>
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 should be
upheld on appeal. However, this litigation, as well as
other litigation which could be brought by states opposed
to the NIL, could delay commencement of 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.
The Company currently is a named defendant in a number of
lawsuits and is a party to a number of other proceedings
that have arisen in the normal course of its business.
Those lawsuits and proceedings relate primarily to the
collection of indebtedness owed to the Company, the
performance of products sold by the Company, and various
contract disputes. In the opinion of the Company, these
proceedings are not expected to have a material adverse
effect on the consolidated financial position, results of
operations or liquidity of the Company and, to the extent
they are not covered by insurance, reserves adequate to
satisfy such liabilities have been established.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
No matter was submitted to a vote of security holders in
the fourth quarter of the fiscal year covered by this
report.
12
<PAGE>
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company are as follows:
Name Age Position With Company
Alan Kessman 50 Chairman of the Board,
President and
Cheif Executive Officer
Michael W. Yacenda 45 Executive Vice President and
President, UniStar
Entertainment
Barbara C. Anderson 45 Vice President, General
Counsel and Secretary
James E. Cooke III 48 Vice President,
National Accounts
Anthony R. Guarascio 43 Vice President, Finance and
Chief Financial Officer
Israel J. Hersh 43 Vice President,
Software Engineering
Elizabeth Hinds 55 Vice President,
Human Resources
Robert W. Hopwood 53 Vice President and Vice
President-Operations,
Unistar Entertainment
Andrew Kontomerkos 51 Senior Vice President,
Hardware Engineering and
Production
Vic Northrup 40 Vice President,
Computer Telephony
Frank J. Rotatori 54 Vice President, Healthcare
Communications
Shlomo Shur 47 Senior Vice President,
Advanced Technology
Alan Kessman has served as Chairman and Chief Executive
Officer of the Company since 1988. Prior to that, he had
served as President and Chief Executive Officer of
ISOETEC Communications, Inc., a predecessor of the
Company ("ISOETEC"), since 1983. From 1978 to 1983, Mr.
Kessman served as President of three operating
subsidiaries of Rolm Corporation, and from 1981 to 1983,
he served as a Corporate Vice President of Rolm
Corporation, responsible for sales and service in the
eastern United States.
13
<PAGE>
Michael W. Yacenda has served as Executive Vice President
of EXECUTONE since January 1990. Prior to that time, he
was Vice President, Finance and Chief Financial Officer
of the Company from July 1988 to January 1990. He served
as a Vice President of ISOETEC from 1983 to 1988. From
1974 to 1983, Mr. Yacenda was employed by Arthur Andersen
& Co., a public accounting firm. Mr. Yacenda is a
certified public accountant.
Barbara C. Anderson has been Vice President, General
Counsel and Secretary since 1990. From 1985 to 1989, she
was Corporate Counsel of United States Surgical
Corporation, a manufacturer of medical devices.
James E. Cooke III has served as Vice President, National
Accounts since February 1996. Prior to that time, from
1992 until 1996, Mr. Cooke served as Division Manager of
Operations for the Company, and from 1988 through 1991,
Mr. Cooke was a District Manager for the Company. From
1985 until 1988, Mr. Cooke was the President of an
interconnect company, and from 1981 to 1985, he was a
General Manager and a Regional Manager of the Jarvis
Corporation. For eight years prior to that time, he
worked at Xerox Corporation in various sales and
management positions.
Anthony R. Guarascio has been Vice President, Finance and
Chief Financial Officer since January 1994, and prior
thereto was Vice President and Corporate Controller since
January 1990. From 1984 until 1990, Mr. Guarascio was
the Corporate Controller of the Company and ISOETEC.
Israel J. Hersh has been Vice President, Software
Engineering since February 1996. Mr. Hersh joined the
Company as Director of Software Development in 1984, and
was promoted to Senior Director of Software Engineering
in January 1994. Prior to his employment with the
Company, Mr. Hersh was a manager of the software
development department for T-Bar, Inc. Mr. Hersh has a
B.S. in Electrical Engineering from Tel Aviv University
and a MS in Electrical Engineering from Bridgeport
University.
Elizabeth Hinds has been Vice President, Human Resources
since January 1996. Prior to joining the Company, Ms.
Hinds was Vice President, Human Resources of Chilton
Company, a wholly-owned subsidiary of Capital
Cities/American Broadcasting Company, Inc. ("CC/ABC"),
from February 1993 until January 1996. Ms. Hinds was the
Director of Human Resources for CC/ABC from June 1987
until February 1993.
Robert W. Hopwood has been Vice President of the Company
and Vice President-Operations of its Unistar
Entertainment subsidiary since May 1996, and prior
thereto served as Vice President, Customer Care of the
Company from January 1990. From 1983 until 1990, Mr.
Hopwood was the Director of Technical Operations of the
Company and ISOETEC.
Andrew Kontomerkos has been Senior Vice President,
Hardware Engineering and Production since January 1994,
and prior thereto was Vice President, Hardware
Engineering since 1988. He served as a Vice President of
ISOETEC since 1983. From 1982 to 1983, he was a Vice
President and founder of SAM Communications, Inc., a
telecommunications research and development company which
was one of the predecessors to ISOETEC; that corporation
was merged into ISOETEC in 1983. From 1979 to 1982, Mr.
Kontomerkos was Director of Telecommunications Systems
14
<PAGE>
Development of TIE/communications, Inc., a manufacturer
of telecommunications systems.
Vic Northrup has been Vice President of the Company
since February 1997, and President of the Computer
Telephony business since May 1996. Prior thereto, he was
Senior Director of Sales and Operations and a district
general manager of the Company.
Frank J. Rotatori has been Vice President, Healthcare
Communications since February 1996. Prior thereto he was
Vice President, European Operations since February 1994,
and prior thereto was Director of Call Center Management
Products during 1992 and 1993, Vice President-Direct
Sales from 1990 through 1991 and Vice President-Customer
Service of the Company from 1988 to 1990. Mr. Rotatori
joined ISOETEC in 1986 as a regional manager. From 1982
to 1986, he served as General Manager and Eastern
Regional Manager for Rolm Corporation. For 13 years
prior to that time, he worked at Xerox Corporation in
various manufacturing, accounting, sales and service
management positions.
Shlomo Shur has been Senior Vice President, Advanced
Technology since January 1994, and prior thereto was Vice
President, Software Engineering since 1988. He served as
a Vice President of ISOETEC from 1983 to 1988. From 1982
to 1983, he was Vice President and a founder of SAM
Communications, Inc., a telecommunications research and
development company which was one of the predecessors to
ISOETEC; that corporation was merged into ISOETEC in
1983. From 1978 to 1982, Mr. Shur was Manager, Software
Development for TIE/communications, Inc., a manufacturer
of telecommunications systems.
15
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
Incorporated by reference to "Stock Data" in the
Registrant's 1996 Annual Report to Shareholders.
ITEM 6. SELECTED FINANCIAL DATA
Incorporated by reference to "Selected Financial Data" in
the Registrant's 1996 Annual Report to Shareholders.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Incorporated by reference to "Management's Discussion and
Analysis of Financial Condition and Results of
Operations" in the Registrant's 1996 Annual Report to
Shareholders.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Financial Statements are incorporated by reference to
the Financial Statements in the Registrant's 1996 Annual
Report to Shareholders. The Schedule appears at pages S-
1 through S-2 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
16
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT
The information regarding directors is incorporated by
reference to the Company's Proxy Statement for its Annual
Meeting of Shareholders scheduled to be held June 10,
1997.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by
reference to the Company's Proxy Statement for its Annual
Meeting of Shareholders scheduled to be held June 10,
1997.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
The information required by this item is incorporated by
reference to the Company's Proxy Statement for its Annual
Meeting of Shareholders scheduled to be held June 10,
1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS
The information required by this item is incorporated by
reference to the Company's Proxy Statement for its Annual
Meeting of Shareholders scheduled to be held June 10,
1997.
17
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
REPORTS ON FORM 8-K
(a)(1), (a)(2) and (d). The financial statements
required by this item and incorporated herein by
reference are as follows:
Report of Independent Public Accountants
Consolidated Balance Sheets - December 31, 1996 and 1995
Consolidated Statements of Operations - Years ended
December 31, 1996, 1995 and 1994
Consolidated Statements of Changes in Stockholders'
Equity - Three years ended December 31, 1996
Consolidated Statements of Cash Flows - Years ended
December 31, 1996, 1995 and 1994
Notes to Consolidated Financial Statements
The schedules to consolidated financial statements
required by this item and included in this report are as
follows:
Report of Independent Public Accountants on Schedule
Schedule II - Valuation and Qualifying Accounts
(a)(3) and (c). The exhibits required by this item and
included in this report or incorporated herein by
reference are as follows:
Exhibit No.
2-1 Agreement and Plan of Merger by and among
EXECUTONE Information Systems, Inc., Executone Newco,
Inc., and Unistar Gaming Corp., dated as of December 19,
1995. Incorporated by reference to the Registrant's
Current Report on Form 8-K dated January 3, 1996.
2-2 Asset Purchase Agreement among V Technology
Acquisition Corporation, EXECUTONE Information Systems,
Inc. and Vodavi, Inc. dated November 5, 1993, and
Amendment dated February 18, 1994. Incorporated by
reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1993.
2-3 Asset Purchase Agreement by and among Tone
Holdings, Inc. and Tone Acquisition Corporation,
EXECUTONE Network Services, Inc. and EXECUTONE
18
<PAGE>
Information Systems, Inc. dated as of April 9, 1996, and
Amendment No. 1 to Asset Purchase Agreement dated as of
May 31, 1996, by and among Clarity Telecom Holdings, Inc.
(formerly known as Tone Holdings, Inc.), Clarity Telecom,
Inc. (formerly known as Tone Acquisition Corporation),
EXECUTONE Network Services, Inc. and EXECUTONE
Information Systems, Inc. Incorporated by reference to
the Registrant's Annual Report on Form 10-K/A for the
year ended December 31, 1995 filed on June 4, 1996.
3-1 Articles of Incorporation, as amended through
December 18, 1995. Incorporated by reference to the
Registrant's Annual Report on Form 10-K for the year
ended December 31, 1995 filed on April 15, 1996.
3-2 Articles of Amendment dated and filed December
19, 1995, amending the Company's Articles of
Incorporation. Incorporated by reference to the
Registrant's Current Report on Form 8-K dated January 3,
1996.
3-3 Bylaws, as amended. Incorporated by reference
to the Registrant's Registration Statement on Form S-3
(File No. 33-62257) filed August 30, 1995.
4-1 Second Amended and Restated Loan and Security
Agreement dated as of August 30, 1994 and First Amendment
thereto dated January 1, 1995, between EXECUTONE
Information Systems, Inc., Continental Bank N.A. and the
other Lenders named therein. Incorporated by reference
to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1994.
4-2 Loan Agreement dated as of August 30, 1994,
between EXECUTONE Information Systems, Inc., certain
employees thereof, and the Lenders named therein.
Incorporated by reference to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1994.
4-3 First Amendment dated January 1, 1995, Second
Amendment dated September 29, 1995, and Third Amendment
dated December 29, 1995, to the Second Amended and
Restated Loan and Security Agreement by and among
EXECUTONE Information Systems, Inc., the Financial
Institutions Listed on the Signature Page Thereof, and
Bank of America Illinois. Incorporated by reference to
the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1995 filed on April 15, 1996.
4-10 Indenture dated March 1, 1986 with United
States Trust Company of New York relating to 7 1/2%
Convertible Subordinated Debentures of Vodavi Technology
Corporation due March 15, 2011. Incorporated by
reference to Vodavi Technology Corporation's Registration
Statement on Form S-1 (as amended) (Registration No. 33-
3827) filed on March 9, 1986 and amended April 1, 1986.
4-11 First Supplemental Indenture dated August 4,
1989 with United States Trust Company of New York
relating to 7 1/2% Convertible Subordinated Debentures due
March 15, 2011. Incorporated by reference to the
Registrant's Annual Report on Form 10-K for the year
ended December 31, 1989.
4-12 Specimen Certificate representing 7 1/2%
Convertible Subordinated Debentures. Incorporated by
reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1989.
10-1 1984 Employee Stock Purchase Plan of EXECUTONE
Information Systems, Inc. Incorporated by reference to
the Registrant's Registration Statement on Form S-8 (File
No. 33-23294) declared effective by the Commission on
August 23, 1988.
10-2 1986 Stock Option Plan of EXECUTONE Information
Systems, Inc. Incorporated by reference to the
Registrant's Registration Statement on Form S-8 (File No.
33-23294) declared effective by the Commission on August
23, 1988.
19
<PAGE>
10-3 1984 Stock Option Plan of EXECUTONE Information
Systems, Inc. Incorporated by reference to the
Registrant's Annual Report on Form 10-K for the year
ended December 31, 1990, as amended by Form 8 filed on
August 20, 1991.
10-4 401(k) Savings Plan of Vodavi Technology
Corporation dated December 27, 1985. Incorporated by
reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1989.
10-5 Stock Option Bonus Credit Plan of EXECUTONE
Information Systems, Inc. dated December 31, 1988.
Incorporated by reference to the Registrant's Annual
Report on Form 10-K for the year ended December 31,
1989.
10-6 1990 Directors' Stock Option Plan as amended
July 30, 1996. Filed herewith.
10-7 1994 Executive Stock Incentive Plan.
Incorporated by reference to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1994.
10-9 Volume Purchase Agreement dated January 31,
1992, between U. S. Sprint Communications Company
Limited Partnership and EXECUTONE Information Systems,
Inc. Incorporated by reference to the Registrant's
Annual Report on Form 10-K for the year ended December
31, 1991, as amended by Form 8 filed on June 12, 1992.
10-10 Amendments dated as of April 1, 1995, and 1993
to Volume Purchase Agreement dated January 31, 1992,
between U. S. Sprint Communications Company Limited
Partnership and EXECUTONE Information Systems, Inc.
Incorporated by reference to the Registrant's Annual
Report on Form 10-K/A for the year ended December 31,
1995 filed on August 29, 1996.
10-16 Manufacturing Services Agreement dated as of
January 10, 1995, between EXECUTONE Information Systems,
Inc. and Compania Dominicana de Telefonos, C por A
(Codetel). Incorporated by reference to the Registrant's
Annual Report on Form 10-K for the year ended December
31, 1995 filed on April 15, 1996.
10-17 Manufacturing Services Agreement dated February
9, 1990 between Wong's Electronics Co., Ltd. and
EXECUTONE Information Systems, Inc. Incorporated by
reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1990, as amended by Form
8 filed on August 20, 1991.
10-19 Warrant to Purchase 25,000 Shares of Common
Stock of EXECUTONE Information Systems, Inc. in favor of
Richard S. Rosenbloom dated June 23, 1992. Incorporated
by reference to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1992.
10-21 Management Agreement for the National Indian
Lottery dated January 16,1995. Incorporated by reference
to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1995 filed on April 15, 1996.
10-22 Distributor Agreement dated as of May 31, 1996,
between EXECUTONE Information Systems, Inc. and Clarity
Telecom, Inc. Incorporated by reference to the
Registrant's Annual Report on Form 10-K/A for the year
ended December 31, 1995 filed on June 4, 1996.
20
<PAGE>
11 Statement regarding computation of per share
earnings. Filed herewith.
13 1996 Annual Report to Shareholders of
EXECUTONE Information Systems, Inc. Filed herewith.
21 Subsidiaries of EXECUTONE Information Systems,
Inc. Filed herewith.
23.1 Consent of Arthur Andersen LLP. Filed herewith.
23.2 Consent of Hunton & Williams. Filed herewith.
27 Financial Data Schedule. Filed herewith.
Undertakings
For the purposes of complying with the rules governing
Form S-8 under the Securities Act of 1933, the
undersigned registrant hereby undertakes as follows,
which undertaking shall be incorporated by reference into
registrant's Registration Statements on the following
Form S-8 filings:
S-8 Reg. No. 2-91008 filed May 9, 1984 on 1983 Employee
Stock Purchase Plan (650,000 shares)
S-8 Reg. No. 33-959 filed October 17, 1985 on 1984 Stock
Option Plan (390,000 shares)
S-8 Reg. No. 33-6604 filed June 19, 1986 on 1983 Stock
Option Plan (350,000 shares)
S-8 Reg. No. 33-16585 filed August 24, 1987 on 1986 and
1983 Stock Option Plans (800,000 shares)
S-8 Reg. No. 33-23294 filed August 3, 1988 on 1986 Stock
Option Plan (7,000,000 shares) and Employee Stock
Purchase Plan (500,000 shares)
S-8 Reg. No. 33-42561 filed September 4, 1991 on 1984
Employee Stock Purchase Plan (350,000 shares) and
Directors' Stock Option Plan (100,000 shares)
S-8 Reg. No. 33-45015 filed January 2, 1992 on 1984
Employee Stock Purchase Plan (400,000 shares)
S-8 Reg. No. 33-57519 filed January 31, 1995 on 1984
Employee Stock Purchase Plan (1,000,000 shares).
Insofar as indemnification arising under the Securities
Act of 1933 (the "Act") may be permitted to directors,
officers and controlling persons of the registrant
pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification
is against public policy as expressed in the Securities
Act of 1933 and is, therefore, unenforceable. In the
event that a claim for indemnification against such
liabilities (other than the payment by the registrant of
expenses incurred or paid by a director, officer or
controlling person of the registrant in the successful
defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in
connection with the securities being registered, the
registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit
21
<PAGE>
to the court of appropriate jurisdiction the question
whether such indemnification by it is against public
policy as expressed in the Act and will be governed by
the final adjudication of such issue.
Reports on Form 8-K
The Registrant filed no reports on Form 8-K during the
quarter ended December 31, 1996.
22
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or
15(d) of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be
signed on its behalf by the undersigned thereunto
duly authorized.
EXECUTONE Information Systems, Inc.
By: _____________________________
Alan Kessman, Chairman, President
and Chief Executive Officer
March 28, 1997
Milford, Connecticut
Pursuant to the requirements of the Securities
and Exchange Act of 1934, this Report has been
signed below by the following persons on behalf
of the Registrant and in the capacities and on
the dates indicated.
March 28, 1997
______________________________
Alan Kessman
Chairman, President and Chief
Executive Officer
(Principal Executive Officer)
March 28, 1997
______________________________
Stanley M. Blau
Director
March 28, 1997
______________________________
Anthony R. Guarascio
Vice President-Finance, and Chief
Financial Officer
(Principal Financial and Accounting Officer)
March 28, 1997
______________________________
Thurston R. Moore
Director
March 28, 1997
______________________________
Richard S. Rosenbloom
Director
March 28, 1997
______________________________
Jerry M. Seslowe
Director
23
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
EXECUTONE Information Systems, Inc.:
We have audited in accordance with generally
accepted auditing standards, the financial
statements included in EXECUTONE Information
Systems, Inc. and subsidiaries' annual report to
stockholders incorporated by reference in this
Form 10-K, and have issued our report thereon
dated January 31, 1997. Our audit was made for
the purpose of forming an opinion on those
statements taken as a whole. The schedule listed
in Item 14 is the responsibility of the Company's
management and is presented for purposes of
complying with the Securities and Exchange
Commission's rules and are not part of the basic
financial statements. This schedule has been
subjected to the auditing procedures applied in
the audit of the basic financial statements and,
in our opinion, fairly states in all material
respects the financial data required to be set
forth therein in relation to the basic financial
statements taken as a whole.
ARTHUR ANDERSEN LLP
Stamford, Connecticut
January 31, 1997
S-1
<PAGE>
SCHEDULE II
<TABLE>
<CAPTION>
VALUATION AND QUALIFYING ACCOUNTS
(Amounts in Thousands)
Additions Deductions
Charged Charged Net
Balance at (Credited) (Credited) Writeoffs Balance at
Beginning to Costs to of End
of and Other Uncollect. of
Description Period Expenses Accounts Accounts Period
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1996
Deducted from asset accounts:
Allowance for doubtful
accounts $1,715 $1,921 $(551)* $(979) $2,106
Allowance for uncollectible
notes receivable 259 (82) 2,039* --- 2,216
Year ended December 31, 1995
Deducted from asset accounts:
Allowance for doubtful
accounts 1,335 1,872 --- (1,492) 1,715
Allowance for uncollectible
notes receivable 691 (432) --- --- 259
Year ended December 31, 1994
Deducted from asset accounts:
Allowance for doubtful
accounts 1,017 1,381 --- (1,063) 1,335
Allowance for uncollectible
notes receivable 1,084 (393) --- --- 691
* Adjustments related to sale of direct sales
organization
</TABLE>
S-2
<PAGE>
EXECUTONE INFORMATION SYSTEMS, INC.
EXHIBITS TO 1996 ANNUAL REPORT ON FORM 10-K
Exhibit No.
2-1 Agreement and Plan of Merger by and among
EXECUTONE Information Systems, Inc., Executone Newco,
Inc., and Unistar Gaming Corp., dated as of December 19,
1995. Incorporated by reference to the Registrant's
Current Report on Form 8-K dated January 3, 1996.
2-2 Asset Purchase Agreement among V Technology
Acquisition Corporation, EXECUTONE Information Systems,
Inc. and Vodavi, Inc. dated November 5, 1993, and
Amendment dated February 18, 1994. Incorporated by
reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1993.
2-3 Asset Purchase Agreement by and among Tone
Holdings, Inc. and Tone Acquisition Corporation,
EXECUTONE Network Services, Inc. and EXECUTONE
Information Systems, Inc. dated as of April 9, 1996, and
Amendment No. 1 to Asset Purchase Agreement dated as of
May 31, 1996, by and among Clarity Telecom Holdings, Inc.
(formerly known as Tone Holdings, Inc.), Clarity Telecom,
Inc. (formerly known as Tone Acquisition Corporation),
EXECUTONE Network Services, Inc. and EXECUTONE
Information Systems, Inc. Incorporated by reference to
the Registrant's Annual Report on Form 10-K/A for the
year ended December 31, 1995 filed on June 4, 1996.
3-1 Articles of Incorporation, as amended through
December 18, 1995. Incorporated by reference to the
Registrant's Annual Report on Form 10-K for the year
ended December 31, 1995 filed on April 15, 1996.
3-2 Articles of Amendment dated and filed
December 19, 1995, amending the Company's Articles of
Incorporation. Incorporated by reference to the
Registrant's Current Report on Form 8-K dated January 3,
1996.
3-3 Bylaws, as amended. Incorporated by reference
to the Registrant's Registration Statement on Form S-3
(File No. 33-62257) filed August 30, 1995.
4-1 Second Amended and Restated Loan and Security
Agreement dated as of August 30, 1994 and First Amendment
thereto dated January 1, 1995, between EXECUTONE
Information Systems, Inc., Continental Bank N.A. and the
other Lenders named therein. Incorporated by reference
to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1994.
4-2 Loan Agreement dated as of August 30, 1994,
between EXECUTONE Information Systems, Inc., certain
employees thereof, and the Lenders named therein.
Incorporated by reference to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1994.
4-3 First Amendment dated January 1, 1995, Second
Amendment dated September 29, 1995, and Third Amendment
dated December 29, 1995, to the Second Amended and
Restated Loan and Security Agreement by and among
EXECUTONE Information Systems, Inc., the Financial
Institutions Listed on the Signature Page Thereof, and
Bank of America Illinois. Incorporated by reference to
the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1995 filed on April 15, 1996.
E-1
<PAGE>
4-10 Indenture dated March 1, 1986 with United
States Trust Company of New York relating to 7 1/2%
Convertible Subordinated Debentures of Vodavi Technology
Corporation due March 15, 2011. Incorporated by
reference to Vodavi Technology Corporation's Registration
Statement on Form S-1 (as amended) (Registration No. 33-
3827) filed on March 9, 1986 and amended April 1, 1986.
4-11 First Supplemental Indenture dated August 4,
1989 with United States Trust Company of New York
relating to 7 1/2% Convertible Subordinated Debentures due
March 15, 2011. Incorporated by reference to the
Registrant's Annual Report on Form 10-K for the year
ended December 31, 1989.
4-12 Specimen Certificate representing 7 1/2%
Convertible Subordinated Debentures. Incorporated by
reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1989.
10-1 1984 Employee Stock Purchase Plan of EXECUTONE
Information Systems, Inc. Incorporated by reference to
the Registrant's Registration Statement on Form S-8 (File
No. 33-23294) declared effective by the Commission on
August 23, 1988.
10-2 1986 Stock Option Plan of EXECUTONE Information
Systems, Inc. Incorporated by reference to the
Registrant's Registration Statement on Form S-8 (File No.
33-23294) declared effective by the Commission on August
23, 1988.
10-3 1984 Stock Option Plan of EXECUTONE Information
Systems, Inc. Incorporated by reference to the
Registrant's Annual Report on Form 10-K for the year
ended December 31, 1990, as amended by Form 8 filed on
August 20, 1991.
10-4 401(k) Savings Plan of Vodavi Technology
Corporation dated December 27, 1985. Incorporated by
reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1989.
10-5 Stock Option Bonus Credit Plan of EXECUTONE
Information Systems, Inc. dated December 31, 1988.
Incorporated by reference to the Registrant's Annual
Report on Form 10-K for the year ended December 31,
1989.
10-6 1990 Directors' Stock Option Plan as amended on
July 30, 1996. Filed herewith.
10-7 1994 Executive Stock Incentive Plan.
Incorporated by reference to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1994.
10-9 Volume Purchase Agreement dated January 31,
1992, between U. S. Sprint Communications Company
Limited Partnership and EXECUTONE Information Systems,
Inc. Incorporated by reference to the Registrant's
Annual Report on Form 10-K for the year ended December
31, 1991, as amended by Form 8 filed on June 12, 1992.
10-10 Amendments dated as of April 1, 1995, and 1993
to Volume Purchase Agreement dated January 31, 1992,
between U. S. Sprint Communications Company Limited
Partnership and EXECUTONE Information Systems, Inc.
Incorporated by reference to the Registrant's Annual
Report on Form 10-K/A for the year ended December 31,
1995 filed on August 29, 1996.
E-2
<PAGE>
10-16 Manufacturing Services Agreement dated as of
January 10, 1996, between EXECUTONE Information Systems,
Inc. and Compania Dominicana de Telefonos, C por A
(Codetel). Incorporated by reference to the Registrant's
Annual Report on Form 10-K for the year ended December
31, 1995 filed on April 15, 1996.
10-17 Manufacturing Services Agreement dated February
9, 1990 between Wong's Electronics Co., Ltd. and
EXECUTONE Information Systems, Inc. Incorporated by
reference to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1990, as amended by Form
8 filed on August 20, 1991.
10-19 Warrant to Purchase 25,000 Shares of Common
Stock of EXECUTONE Information Systems, Inc. in favor of
Richard S. Rosenbloom dated June 23, 1992. Incorporated
by reference to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1992.
10-21 Management Agreement for the National Indian
Lottery dated January 16,1995. Incorporated by reference
to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1995 filed on April 15, 1996.
10-22 Distributor Agreement dated as of May 31, 1996,
between EXECUTONE Information Systems, Inc. and Clarity
Telecom, Inc. Incorporated by reference to the
Registrant's Annual Report on Form 10-K/A for the year
ended December 31, 1995 filed on June 4, 1996.
11 Statement regarding computation of per share
earnings. Filed herewith.
13 1996 Annual Report to Shareholders of
EXECUTONE Information Systems, Inc. Filed herewith.
21 Subsidiaries of EXECUTONE Information Systems,
Inc. Filed herewith.
23.1 Consent of Arthur Andersen LLP. Filed
herewith.
23.2 Consent of Hunton & Williams. Filed herewith.
27 Financial Data Schedule. Filed herewith.
E-3
<PAGE>
EXHIBIT 10-6
EXECUTONE Information Systems, Inc.
1990 DIRECTORS STOCK OPTION PLAN
(As Amended July 30,1996)
1. Purposes of the Plan. The purposes of this
Directors' Stock Option Plan are to attract and retain
the best available personnel for service as Directors of
the Company, to provide additional incentive to the
Outside Directors of the Company to serve as Directors
and to encourage their continued service on the Board.
All options granted hereunder shall be "nonstatutory
stock options."
2. Definitions. As used herein, the following
definitions shall apply:
(a) "Board" shall mean the Board of Directors of the
Company.
(b) "Code" shall mean the Internal Revenue Code of 1986,
as amended.
(c) "Common Stock" shall mean the Common Stock of the
Company.
(d) "Company" shall mean EXECUTONE Information Systems,
Inc., a Virginia corporation.
(e) "Continuous Status as a Director" shall mean the
absence of any interruption or termination of service as
a Director.
(f) "Director" shall mean a member of the Board.
(g) "Employee" shall mean any person, including
officers and Directors, employed by the Company or any
Parent or Subsidiary of the Company. The payment of a
Director's fee by the Company shall not be sufficient in
and of itself to constitute "employment" by the Company.
(h) "Exchange Act" shall mean the Securities Exchange
Act of 1934, as amended.
(i) "Option" shall mean a stock option granted pursuant
to the Plan.
(j) "Optioned Stock" shall mean the Common Stock subject
to an Option.
(k) "Optionee" shall mean an Outside Director who
receives an Option.
(l) "Outside Director" shall mean a Director who is not
an Employee.
(m) "Parent" shall mean a "parent corporation", whether
now or hereafter existing, as defined in Section 424 (a)
of the Code.
(n) "Plan" shall mean this 1990 Director's Stock Option
Plan.
(o) "Share" shall mean a share of Common Stock, as
adjusted in accordance with Section 11 of the Plan.
(p) "Subsidiary" shall mean a "subsidiary corporation",
whether now or hereafter existing, as defined in Section
425(f) of the Code.
1
<PAGE>
3. Stock Subject to the Plan. Subject to the provisions
of Section 11 of the Plan, the maximum aggregate number
of Shares which may be optioned and sold under the Plan
is 250,000 Shares of Common Stock. The Shares may be
authorized, or reacquired Common Stock.
If an Option should expire or become unexercisable for
any reason without having been exercised in full, the
unpurchased Shares which were subject thereto shall,
unless the Plan shall have been terminated, become
available for future grant under the Plan. If Shares
which were acquired under exercise of an Option are
subsequently repurchased by the Company, such Shares
shall not in any event be returned to the Plan and shall
not become available for future grant under the Plan.
4. Administration of and Grants of Options under the
Plan.
(a) Administrator. Except as otherwise required
herein, the Plan shall be administered by the Board.
(b) Procedures for Grants. All grants of Options
hereunder shall be automatic and nondiscretionary and
shall be made strictly in accordance with the following
provisions:
(i) No person shall have any discretion to select which
Outside Directors shall be granted Options or to
determine the number of Shares to be covered by Options
granted to Outside Directors.
(ii) Each Outside Director shall be automatically
granted an Option upon the effective date of this Plan or
such later date on which such person became a Director,
whether through election by the Shareholders of the
Company or appointment by the Board of Directors to fill
a vacancy.
(iii) Each Outside Director shall automatically receive,
upon his reelection each year, an additional Option.
(iv) The number of Shares to be subject to any Option
granted pursuant to the Plan shall be an amount necessary
to make such Option equal in value to $10,000 for each
Outside Director, and shall be determined using the
Black-Scholes Option valuation model. For this purpose
the Company's "Sigma" shall be the mean (rounded to the
nearest 5%) of the "Sigma's" of the following six
companies as of the date of grant: Pitney Bowes, AT&T,
Aspect, Harris, Nortel and Octel Communications; and the
per Share value shall be the fair market value per Share
on the date of grant. The number of Shares resulting
from this calculation shall be rounded to the nearest
hundred.
(v) The terms of an Option granted hereunder shall be as
follows:
(A) the term of the Option shall be five (5) years;
provided, however, if the Outside Director ceases to
serve as a Director, the Option may be exercised for
seven (7) months as provided in Section 9(b) and (c)
below.
(B) the Option shall be exercisable only while the
Outside Director remains a Director of the Company,
except as set forth in Section 9 hereof.
(C) the exercise price per Share shall be 120% of the
fair market value per Share on the date of grant of the
Option.
(D) any Option granted pursuant to subsection 4(b)(ii)
or (iv) above shall become exercisable in full
immediately upon grant, except that any Option granted to
an Outside Director upon his initial election or
appointment to the Board of Directors shall become
exercisable in full one year after the date of grant.
2
<PAGE>
(c) Powers of the Board. Subject to the provisions and
restrictions of the Plan, the Board shall have the
authority, in its discretion: (i) to determine, upon
review of relevant information and in accordance with
Section 8(b) of the Plan, the fair market value of the
Common Stock; (ii) to determine the exercise price per
Share of Options to be granted, which exercise price
shall be determined in accordance with Section 8(a) of
the Plan; (iii) to interpret the Plan; (iv) to prescribe,
amend and rescind rules and regulations relating to the
Plan; (v) to authorize any person to execute on behalf of
the Company any instrument required to effectuate the
grant of an Option previously granted hereunder; and (vi)
to make all other determinations deemed necessary or
available for the administration of the Plan.
(d) Effect of Board's Decision. All decisions,
determinations and interpretations of the Board shall be
final and binding on all Optionees and any other holder
of any Options granted under the Plan.
(e) Suspension or Termination of Option. If the Chief
Executive Officer of the Company or his designee
reasonably believes that an Optionee has committed an act
of misconduct, the Chief Executive Officer may suspend
the Optionee's right to exercise any Option pending a
determination of the Board of Directors (excluding the
Outside Director accused of such misconduct). If the
Board of Directors (excluding the Outside Director
accused of such misconduct) determines an Optionee has
committed an act of embezzlement, fraud, dishonesty,
nonpayment of an obligation owed to the Company, breach
of fiduciary duty or deliberate disregard of the Company
rules resulting in loss, damage or injury to the Company,
or if an Optionee makes an unauthorized disclosure of any
Company trade secret or confidential information, engages
in any conduct constituting unfair competition, induces
any Company customer to breach a contract with the
Company or induces any principal for whom the Company
acts as agent to terminate such agency relationship,
neither the Optionee nor his estate shall be entitled to
exercise any Option whatsoever. In making such
determination, the Board of Directors (excluding the
Outside Director accused of such misconduct) shall act
fairly and shall give the Optionee an opportunity to
appear and present evidence on Optionee's behalf at a
hearing before a committee of the Board.
5. Eligibility. Options may be granted only to Outside
Directors. All Options shall be automatically granted in
accordance with the terms set forth in Section 4(b)
hereof.
The Plan shall not confer upon any Optionee any rights
with respect to continuation of service as a Director or
nomination to serve as a Director, nor shall it interfere
in any way with any rights which the Director or the
Company may have to terminate his directorship at any
time.
6. Term of Plan. The Plan shall become effective upon
the earlier of (i) its adoption by the Board or (ii) its
approval by the Shareholders of the Company as described
in Section 17 of the Plan. It shall continue in effect
for a term of ten (10) years unless sooner terminated
under Section 13 of the Plan.
7. Term of Option. The term of each Option shall be
five (5) years from the date of grant thereof; provided,
however, if the Outside Director ceases to serve as a
Director, the Option may be exercised for seven (7)
months as provided in Section 9(b) and (c) below.
8. Exercise Price and Consideration.
(a) Exercise Price. The per Share exercise price for
the Shares to be issued pursuant to exercise of an Option
shall be 120% of the fair market value per Share on the
date of the grant of the Option.
3
<PAGE>
(b) Fair Market Value. The fair market value shall be
determined by the Board in its discretion; provided,
however, that where there is a public market for the
Common Stock, the fair market value per Share shall be
the closing bid price of the Common Stock in the over-
the-counter market on the date of grant, as reported in
The Wall Street Journal (or, if not so reported, as
otherwise reported by the National Association of
Securities Dealers Automated Quotation ("NASDAQ") System)
or, in the event the Common Stock is traded on the NASDAQ
National Market System or listed on a stock exchange, the
fair market value per Share shall be the closing price on
such system or exchange on the date of grant of the
Option, as reported in the Wall Street Journal.
(c) Form of Consideration. The consideration to be paid
for the Shares to be issued upon exercise of an Option
shall consist entirely of cash, check, other Shares of
Common Stock having a fair market value on the date of
surrender equal to the aggregate exercise price of the
Shares as to which said Option shall be exercised, which,
if acquired from the Company, shall have been held for at
least six months, or any combination of such methods of
payment.
9. Exercise of Option.
(a) Procedure for Exercising Rights as a Shareholder.
Any Option granted hereunder shall be exercisable at such
times as are set forth in Section 4(b) hereof; provided,
however, that no Options shall be exercisable until
Shareholder approval of the Plan in accordance with
Section 17 hereof has been obtained.
An Option may not be exercised for a fraction of a Share.
An Option shall be deemed to be exercised when written
notice of such exercise has been given to the Company in
accordance with the terms of the Options by the persons
entitled to exercise the Option and full payment for the
Shares with respect to which the Option is exercised has
been received by the Company. Full payment may consist
of any consideration and method of payment allowable
under Section 8(c) of the Plan. Until the issuance (as
evidenced by the appropriate entry on the books of the
Company or of a duly authorized transfer agent of the
Company) of the Stock Certificate evidencing such Shares,
no right to vote or receive dividends or any other rights
as a Shareholder shall exist with respect to the Optioned
Stock, notwithstanding the exercise of the Option. A
share certificate for the number of Shares so acquired
shall be issued to the Optionee as soon as practicable
after exercise of the Option. No adjustment will be made
for a dividend or other right for which the record date is
prior to the date the Stock Certificate is issued, except
as provided in Section 11 of the Plan.
Exercise of an Option in any manner shall result in a
decrease in the number of Shares which thereafter may be
available, both for the purpose of the Plan and for sale
under the Option, by the number of Shares as to which the
Option is exercised.
(b) Termination of Status as a Director. If an Outside
Director ceases to serve as a Director, for any reason
other than death, he may, but only within seven (7)
months after the date he ceases to be a Director of the
Company, exercise his Option to the extent that he was
entitled to exercise it at the date of such termination.
To the extent that he was not entitled to exercise an
Option at the date of such termination, or if he does not
exercise such Option (which he was entitled to exercise)
within the time specified herein, the Option shall
terminate.
(c) Death of Optionee. Notwithstanding the provisions
of Section 9(b) above, in the event of the death of an
Optionee:
4
<PAGE>
(i) during the term of the Option who is at the time of
his death a Director of the Company and who shall have
been in Continuous Status as a Director since the date of
grant of the Option, the Option may be exercised, at any
time within seven (7) months following the date of death,
by the Optionee's estate or by a person who acquired the
right to exercise the Option by bequest or inheritance,
but only to the extent of the right to exercise that
would have accrued had the Optionee continued living and
remained in Continuous Status as a Director for six (6)
months after the date of death or
(ii) within thirty (30) days after the termination of
Continuous Status as a Director, the Option may be
exercised, at any time within seven (7) months following
the date of death, by the Optionee's estate or by a
person who acquired the right to exercise the Option by
bequest or inheritance, but only to the extent of the
right to exercise that has been accrued at the date of
termination.
10. Nontransferability of Options. The Option may not
be sold, pledged, assigned, hypothecated, transferred, or
disposed of in any manner other than by will or by the
laws of descent or distribution and may be exercised,
during the lifetime of the Optionee only by the Optionee.
11. Adjustments Upon Changes in Capitalization or
Merger. Subject to any required action by the
Shareholders of the Company, the number of Shares of
Common Stock covered by such outstanding Option, and the
number of Shares of Common Stock which have been
authorized for issuance under the Plan but as to which no
Options have yet been granted or which have been returned
to the Plan upon cancellation or expiration of an Option,
as well as the price per Share of Common Stock covered by
each such outstanding Option, shall be proportionately
adjusted for any increase or decrease in the number of
issued Shares of Common Stock resulting from a stock
split, reverse stock split, stock dividend,
recapitalization or reclassification of the Common Stock,
or any other increase or decrease in the number of issued
Shares of Common Stock affected without receipt of
consideration by the Company. Such adjustment shall be
made by the Board, whose determination in that respect
shall be final, binding and conclusive; provided,
however, that conversion of any convertible securities of
the Company shall not be deemed to have been "effected
without receipt of consideration." Except as expressly
provided herein, no issuance by the Company of Shares of
stock of any class or securities convertible into Shares
of stock of any class, shall affect, and no adjustment by
reason thereof shall be made with respect to, the number
or price of Shares of Common Stock subject to an Option.
In the event of the proposed dissolution or liquidation
of the Company, the Option will terminate immediately
prior to the consummation of such proposed action, unless
otherwise provided by the Board. The Board may, in the
exercise of its sole discretion in such instances,
declare that any Option shall terminate as of the date
fixed by the Board and give such Optionee the right to
exercise his Option as to all or any part of the Optioned
Stock, including Shares as to which the Option would not
otherwise be exercisable. In the event of a proposed
sale of all or substantially all of the assets of the
Company, or the merger of the Company with or into
another corporation, the Option shall be assumed or, an
equivalent Option (with the same number and kind of
shares of stock or the same amount of property, cash or
securities as he would have been entitled to receive upon
the happening of any such corporate event as if he had
been, immediately prior to such event, the holder of the
number of shares covered by his Option) shall be
substituted by such successor corporation or a parent or
subsidiary of such successor corporation. In the event
that such successor corporation refuses to assume the
Option or to substitute an equivalent Option, the Board
shall, in lieu of such assumption or substitution,
provide that the Optionee shall have the right to
exercise the Option as to all of the Optioned Stock,
5
<PAGE>
including Shares as to which the Option would not
otherwise be exercisable. If the Board makes an Option
fully exercisable in lieu of assumption or substitution
in the event of a merger or sale of assets, the Board
shall notify the Optionee that the Option shall be fully
exercisable for a period of fifteen (15) days from the
date of such notice, and the Option will terminate upon
the expiration of such period.
12. Time of Granting Options. The date of grant of an
Option shall, for all purposes, be the date determined in
accordance with Section 4(b) hereof. Notice of the
determination shall be given to each Outside Director to
whom an Option is so granted within a reasonable time
after the date of such grant.
13. Amendment and Termination of the Plan.
(a) Amendment and Termination. The Board may amend or
terminate the Plan from time to time in such respects as
the Board may deem advisable; provided that, any
revisions or amendments requiring approval of the
Shareholders of the Company under the Code or Rule 16b-3
promulgated under the Securities Act of 1933 shall be
approved by such Shareholders in the manner described in
Section 17 of the Plan.
(b) Stockholder Approval. Stockholder approval of any
amendment requiring stockholder approval under Section
13(a) of the Plan shall be solicited as described in
Section 17(b) of the Plan.
(c) Effect of Amendment or Termination. Except as
provided in Section 11, any such amendment or termination
of the Plan shall not affect Options already granted, and
such Options shall remain in full force and effect as if
this Plan had not been amended or terminated, unless
mutually agreed otherwise between the Optionee and the
Board, which agreement must be in writing and signed by
the Optionee and the Company.
14. Conditions Upon Issuance of Shares. Shares shall
not be issued pursuant to the exercise of an Option
unless the exercise of such Option and the issuance and
delivery of such Shares pursuant thereto shall comply
with all relevant provisions of law, including, without
limitation, the Securities Act of 1993, as amended, the
Exchange Act, the rules and regulations promulgated
thereunder, state securities laws, and the requirements
of any stock exchange upon which the Shares may then be
listed, and shall be further subject to the approval of
counsel for the Company with respect to such compliance.
As a condition to the exercise of an Option, the Company
may require the person exercising such Option to
represent and warrant at the time of any such exercise
that the Shares are being purchased only for an
investment and without any present intention to sell or
distribute such Shares, if, in the opinion of counsel for
the Company, such a representation is required by any of
the aforementioned relevant provisions of law.
Inability of the Company to obtain authority from any
regulatory body having jurisdiction, which authority is
deemed by the Company's counsel to be necessary to the
lawful issuance and sale of any Shares hereunder, shall
relieve the Company of any liability in respect of the
failure to issue or sell such Shares as to which such
requisite authority shall not have been obtained.
15. Reservation of Shares. The Company, during the term
of this Plan, will at all times reserve and keep
available such number of Shares as shall be sufficient to
satisfy the requirements of the Plan.
16. Option Agreement. Options shall be evidenced by
written option agreements in such form as the Board shall
approve.
6
<PAGE>
17. Shareholder Approval.
(a) Adoption of the Plan shall be subject to approval by
the Shareholders of the Company within one year of Board
approval of the Plan. If such Shareholder approval is
obtained by written consent, it may be obtained by the
written consent of the holders of a majority of the
outstanding shares of the Company. If such Shareholder
approval is obtained at a duly held Shareholder's
meeting, it may be obtained by the affirmative vote of
the holders of a majority of the outstanding shares of
the Company present or represented and entitled to vote
thereon.
(b) Any required approval of the Shareholders of the
Company shall be solicited substantially in accordance
with Section 14(a) of the Exchange Act and the rules and
regulations promulgated thereunder.
18. Information to Optionees. The Company shall provide
each Optionee, during the period for which such Optionee
has one or more Options outstanding, copies of all annual
reports to Shareholders, proxy statements and other
information provided to all Shareholders of the Company.
7
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT 11
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
(In Thousands, Except Per Share Amounts)
Years Ended December 31,
1996 1995 1994
<S> <C> <C> <C>
Income (Loss) From Continuing Operations
Before Extraordinary Item $ 24,162 $(36,934) $6,734
Discontinued Operations:
Income From Operations, Net of Taxes --- --- 153
Gain on Disposal, Net of Taxes --- --- 604
Extraordinary Item, Net of Taxes (355) --- ---
Net Income (Loss) $ 23,807 $(36,934) $7,491
Weighted Average Number of Common
Shares Outstanding 51,712 46,919 43,705
Common Stock Equivalent Shares Assumed
to be Issued for Dilutive Stock Options and
Warrants $ 539 $ --- $3,992
Total Weighted Average Common and
Common Equivalent Shares Outstanding 52,251 46,919 47,697
Earnings (Loss) per Common Share:
Continuing Operations $ 0.46 $(0.79) $ 0.14
Discontinuing Operations 0.00 0.00 0.02
Extraordinary Item (0.01) 0.00 0.00
Net Income (Loss) $ 0.45 $(0.79) $ 0.16
</TABLE>
<PAGE>
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 (NIL). 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.
1996 COMPARED TO 1995
Results of Operations
1996 was a year of change for the Company. On May 31,
1996, the Company sold substantially all of its direct
sales and services organization, including its long-
distance reseller business (the DSOs), for
consideration valued at $69.6 million to Clarity
Telecom Holdings, Inc. d/b/a Executone Business
Solutions (Clarity). With the sale of the DSOs and
the sale of the Videoconferencing division, the year
as a whole is not comparable to 1995 other than on
overall measures of profitability such as operating or
net income. In addition, with the timing of the sale,
the first half of 1996 is not comparable to the second
half of 1996 either on a financial or operational
basis. 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 the Company. For the first six months
of the year, the management resources of the Company
were directed toward the completion of the sale
transaction, adversely affecting operating results.
For the second six months of 1996, the Company
operated on a post-sale standalone basis and has made
significant progress. The Company was able to achieve
its forecasted revenue and profit and has effectively
managed the transitional issues inherent in a
transaction of this magnitude. The following table
illustrates the financial highlights of 1996,
comparing the six-month period ended June 30, 1996 to
the six-month period ended December 31, 1996:
<TABLE>
<CAPTION>
Six-Month Six-Month Gain on Full
Period Ended Period Ended Sale of Year
6/30/96* 12/31/96* Business 1996
<S> <C> <C> <C> <C>
Revenues $118,948 $93,074 $ --- $212,022
Gross Profit 45,488 34,024 --- 79,512
Operating Income (Loss) (10,736) 7,295 --- (3,441)
Net Income (Loss) (7,071) 4,442 26,436 23,807
Earnings (Loss) Per Share $ (0.14) $ 0.09 $ 0.50 $ 0.45
</TABLE>
* Excluding gain on sale of businesses
1
<PAGE>
If the Company's operating performance for the last
six months of 1996 were annualized, operating income
would have been $14.6 million, compared to $7.6
million in 1995 (excluding the provision for
restructuring). Net income for 1996 (excluding the
gain on the sale of businesses) would have been $8.9
million (or $0.17 per common share) versus $2.9
million (or $0.06 per common share) for 1995
(excluding the provision for restructuring).
The Company believes that the sale of the DSOs 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 Company equipment sales to the
former direct sales offices. The sale of the DSOs
related primarily to the retail distribution channel
of the Computer Telephony division and also included
the entire Network Services division. After the sale,
the Computer Telephony division consists of telephony
product sales to independent distributors, of which
Clarity is the largest distributor, along with the
National Accounts and Federal Systems marketing
channels. The Company retains its Healthcare
Communications and Call Center Management (CCM)
businesses. The Company also retains its Unistar
business.
The Company recorded a pretax gain of $48.9 million
net of transaction, severance and other related costs
of which $47.5 million was recorded during the three-
month period ended June 30, 1996. An additional $1.4
million pretax gain was recorded during the three-
month period ended December 31, 1996 reflecting
purchase price adjustments. The proceeds were used to
repay the Company's bank borrowings and the excess was
invested in short-term cash investments.
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 should then 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.
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 March 31, 1996. 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 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.
Recognizing the lack of complete comparative financial
data, the Company provided forward-looking information
covering the last six months of 1996 in its filing on
Form 10-Q for the three-month period ended June 30,
1996. A comparison of the six-month period ended
December 31, 1996 to the forward-looking information
previously provided is as follows:
<TABLE>
<CAPTION>
Six-Months
Forward-Looking Ended 12/31/96
<S> <C> <C>
Revenues $92-$96 million $93,074
Gross Profit % 35%-36% 36.6%
Product Development
(as a % of sales) 7%-8% 6.9%
Selling, General & Admin.
(as a % of sales) 19%-20% 21.8%
Operating Income
(as a % of sales) 8%-10% 7.8%
</TABLE>
The Company's operating results were as forecast since
the sale of the DSOs. Operating results exceeded
expectations in Computer Telephony and met
expectations in Healthcare, which more than offset
unfavorable variances in CCM.
2
<PAGE>
Computer Telephony
Computer Telephony develops and distributes telephony
products that are easy to install, easy to maintain,
easy to use and create value for its customers.
Computer Telephony offers a complete portfolio of
applications built upon the IDS (Integrated Digital
System) family of digital telephone systems. Products
range from PBX's for small to medium-sized businesses
to standards-compliant computer telephony
applications, standalone and LAN-based applications,
including voice mail, unified messaging, automatic
call distribution (ACD) and wireless communications.
This business targets the under 400-extension market
with specific focus on locations having 20-250
extensions. Customers range from small companies with
fewer than ten employees to large national accounts
and government agencies.
Computer Telephony, including independent
distribution, National Accounts and Federal Systems,
remains the Company's largest business. Revenues for
1996, excluding revenues derived from the business
sold, were $122 million, of which $72 million was
generated during the last six months of 1996. Sales
to Clarity totaled $32 million during the seven-month,
post-sale period.
Healthcare Communications
Healthcare provides a full array of solutions that
enable healthcare facilities to realize a substantial
savings in operating costs without compromising the
quality of patient care. Integrated on the Healthcare
Communications Platform, healthcare products are
designed to improve patient care quality, prevent
technological obsolescence and increase staff
productivity. Products range from traditional nurse
call systems, intercoms and room status indicators to
leading-edge patient reporting systems, locating
systems and wireless technologies. All of these
products can be seamlessly integrated to enhance a
facility's communications and information networking.
Healthcare specifically targets hospitals,
surgicenters, nursing homes and assisted living
centers.
Revenues for 1996 were $30 million, of which $17
million was generated during the last six months of
1996. Selling, general and administrative costs were
higher than anticipated as the transition of post-sale
administrative functions such as billing and inventory
control was more costly than planned.
The Company recently introduced its new Healthcare
Communications Platform. The HCP is a single
platform for several healthcare products that is based
on the IDS telephone switch. It is an integrated
package of products communicating with each other via
common equipment. It can integrate various
applications and technologies including nurse call,
locator, telephony and voice mail. This integrated
system competes at a substantially lower cost per bed,
allowing the business to increase margins and
providing for potential future add-on products.
Call Center Management
CCM develops and sells sophisticated telephony
products that integrate a computerized digital
telephone system platform with high-volume inbound,
outbound and internal call processing systems. These
systems are installed in locations where call handling
and processing is mission-critical to the operation.
Such systems include automatic call distribution
systems, predictive dialers and scripting software to
assist agents handling calls.
CCM had disappointing results for the year and for the
period following the sale of the DSOs. Revenues for
1996 were $7.6 million, of which $4.1 million was
generated during the last six months of the year. The
market for call center products continues to grow and
pricing margins remain high. However, the Company was
unable to develop a sales organization that could
consistently maintain revenue quotas. The Company
believes it has products that are equal to or superior
to its competitors' products and will provide
excellent margins. The Company's challenge is to grow
sales in 1997 consistent with market opportunities.
Changes have been made toward improving the sales
organization in 1997 which include a focus to
concentrate on inbound and outbound applications that
have higher margins, with a de-emphasis on interactive
voice response systems.
3
<PAGE>
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, privately-held prior to the
acquisition, has an exclusive five-year contract to
design, develop, finance and manage the NIL through
its wholly-owned subsidiary, Unistar Entertainment,
Inc. (Unistar). See Note L 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.
The initial goal of this investment was to establish a
telephone lottery that could be played by any
individual of majority age, residing in one of the 36
states or the District of Columbia that currently
operates a state-run lottery. In the telephone-based
lottery of the 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. In 1996, the Company invested $2.1
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 $17.9 million, including $15.8
million in goodwill and $2.1 million in other assets.
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. 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 ruling is
being appealed and a hearing has been scheduled for
March 24, 1997 in Tribal Appellate Court. The Company
remains hopeful that a positive decision in Tribal
Appellate Court will accelerate a federal court decision
on the telephone-based lottery allowing the telephone
lottery to be operational by early 1998.
In February 1997, Unistar signed revised agreements
with CasinoWorld Holdings, Ltd. relating to software
development, system architecture and proprietary
technology and a revised agreement providing for an
equity investment in Virtual Gaming Technologies
(formerly Internet Gaming Technologies). See Note L
for the terms of these agreements. 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 NIL is scheduled to have a beta
site operating for a limited number of users playing
on the Internet by the end of March 1997. The Company
plans to expand the beta users during the second and
third quarters of 1997 and, depending on the results
of the beta tests, move toward a targeted national
launch during the fourth quarter of 1997. To
accomplish this, the Company expects to spend
approximately $7.4 million in 1997, prior to the
national launch. The Company will be capitalizing
costs relating to the development of the systems
required to operate the lottery. In addition, it will
defer certain costs associated with the lottery that
will be reimbursable from the lottery proceeds
pursuant to the Management Agreement with CDA.
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 lottery. Based upon opinions from outside
legal counsel, the Company also believes that the
legal decision rendered by the CDA Tribal Court will
ultimately be upheld on appeal. However, there is no
assurance of such a legal outcome. In the event that
a telephone lottery does not attain the level of
market acceptance anticipated by the Company or if the
CDA Tribal Court decision is not upheld on appeal, the
Company would have to reevaluate the viability of the
Unistar subsidiary to determine if the Company's
investment has been impaired.
4
<PAGE>
Other Matters
Interest expense decreased to $2.7 million in 1996
from $3.9 million in 1995 due to the use of a portion
of the cash proceeds resulting from the sale of the
DSOs to repay the entire outstanding balance on the
Company's revolving credit facility.
The Company accounts for income taxes in accordance
with FAS No. 109, "Accounting for Income Taxes". For
the year ended December 31, 1996, the Company recorded
a tax provision of $15.6 million. The tax provision
for the year decreased the deferred tax asset
reflecting a reduction in tax benefits to be utilized
in the future. As of December 31, 1996, the deferred
tax asset of $18.4 million represents the expected
benefits to be received from the utilization of tax
benefit carryforwards. The Company believes that the
deferred tax asset will more likely than not be
recognized in the carryforward periods. The Company
has accrued approximately $3.0 million in 1996 taxes,
relating primarily to the gain on the sale of the
DSOs, which is expected to be paid during 1997.
During 1996, the Company adopted FAS No. 123,
"Accounting for Stock-Based Compensation". In
compliance with the provisions of the new statement,
the Company has elected to continue to apply APB
Opinion 25 in accounting for its stock compensation
plans and, accordingly, has not recognized
compensation expense for its plans. If compensation
cost had been determined in accordance with FAS No.
123, net income would have been reduced by $0.1
million and $0.3 million for 1996 and 1995,
respectively. Earnings per share would have been
unchanged for both years (see Note H).
On February 20, 1997, the Company announced that its
Board of Directors has approved and will be
recommending to its shareholders a reverse 1-for-3
stock split. This action will be voted on at the
Company's annual meeting of shareholders. Subject to
shareholder approval of the reverse stock split, the
Board of Directors also approved a $10 million, two-
year stock repurchase program. The full or partial
execution of this program is dependent on the price of
the Company's common stock and prevailing market
conditions over that two-year period.
1995 COMPARED TO 1994
Results of Operations
Total revenues for the year ended December 31, 1995
were $296.4 million, a $4.4 million increase over the
comparable 1994 period. Revenues increased 2%
compared to 1994, primarily due to increases in system
upgrades and expansions, increased revenue from
maintenance contracts, increases in new installations
of healthcare products and in shipments to the
independent sales and service offices, partially
offset by lower volume generated by the network
services division and decreases in new telephony
installations.
Cost of revenues consists of direct manufacturing
costs, indirect installation and service costs and
other costs such as warehousing, software
manufacturing and quality inspection. Direct
manufacturing costs are the primary component of cost
of revenues and are accounted for as direct costs
related to specific revenues. Those costs other than
direct manufacturing costs are treated as fixed cost
overhead and are not allocated specifically to
revenues. Therefore, changes in gross profit can be
measured based upon the pricing margin (revenue less
direct manufacturing costs) on a product line basis
and by the overall level of fixed cost overhead
relative to total revenue. Gross profit, as a
percentage of revenues, decreased slightly from 41.9%
during 1994 to 41.5% during 1995 due to a combination
of factors including product mix, higher introductory
manufacturing costs for the healthcare products and a
lower absorption of fixed cost overhead.
Operating income, excluding the provision for
restructuring, decreased $4.9 million compared to 1994
and, as a percentage of revenues, was 2.6% compared to
4.3% in 1994. The decrease in operating income is
primarily due to increased operating expenses during
1995. Product development and engineering increased
$2.5 million during 1995 as the Company continued to
accelerate its investment in engineering for new
product development and application-specific software
products. Selling, general and administrative
expenses increased $2.8 million during the year,
primarily representing the full year cost impact of
the divisional supporting management and sales
structure.
5
<PAGE>
Interest expense increased during 1995 due to higher
average borrowing levels on the revolving credit
facility and increases in the Company's prime
borrowing rate during 1995. Other income, net
increased primarily as a result of the 1995 gains on
the sales of the customer bases in Wisconsin and Iowa
and the related direct sales offices, totaling $1.2
million.
During the first quarter of 1995, the Company was
involved in extensive negotiations to acquire the
Dictaphone division of Pitney Bowes (Dictaphone). In
April 1995, the acquisition was awarded to another
bidder. The Company incurred approximately $1 million
in fees and expenses related to the attempted
acquisition which were recognized in the second and
third quarters of 1995.
For the year ended December 31, 1995, the Company
recorded a net tax benefit of $2.3 million. This is
comprised of $4.2 million of tax benefit recognized as
a result of the non-goodwill related portion of the
restructuring provision, partially offset by the $1.9
million tax provision on earnings, excluding the
restructuring provision. No tax benefit was
recognized on the goodwill portion of the provision
for restructuring since it is not deductible for tax
purposes. The net tax benefit for the year was
recorded as an increase to the deferred tax asset
reflecting additional tax benefits to be utilized in
the future.
As of March 31, 1994, the Company sold its Vodavi
Communications Systems Division (VCS), which sold
telephone equipment to supply houses and dealers, a
different class of customer from continuing
operations, under the brand names STARPLUS and
INFINITE, for approximately $10.9 million. Proceeds
of the sale consisted of approximately $9.7 million in
cash, received in April 1994, and a $1.2 million note,
the proceeds of which were received in September 1995.
The proceeds were used to reduce borrowings under the
Company's revolving credit facility. The sale
resulted in an after-tax gain of $604,000 (net of
income tax provision of $403,000). Consolidated
financial statements for the year ended December 31,
1994 present VCS as a discontinued operation. Net
revenues of the discontinued operation for 1994,
through the date of sale, were $8.6 million.
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 B). 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. As a result of the change
in strategy, that 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.
6
<PAGE>
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 $50 million, $23 million and $30 million
as of December 31, 1996, 1995 and 1994, respectively.
At December 31, 1996 and 1995, cash and cash
equivalents amounted to $27.7 million and $8.1
million, respectively, or 32% and 9% of current
assets, respectively. The $19.6 million increase in
cash and cash equivalents was generated primarily by
$56.9 million in cash proceeds for the sale of the
Company's DSOs. During 1996, cash was used to repay
$16.6 million of debt, including all of the Company's
bank borrowings, repurchase $4.6 million of the
Company's common stock, fund $13.1 million in
operating activities, purchase $2.6 million in capital
equipment and fund $2.1 million relating to the
Company's investment in Unistar. Cash used by
operating activities was $13.1 million compared to
$3.9 million in 1995. The increase in cash used by
operating activities is primarily due to operating
losses generated during the transition period through
June 30, 1996 and a one-time growth in trade
receivables of $14.0 million due to the 60-day terms
extended to Clarity under its distributor agreement.
Total debt at December 31, 1996 was $14.7 million, a
decrease of $16.1 million from $30.8 million at
December 31, 1995. The decrease in debt is due to the
repayment of $15.4 million in bank borrowings and $1.2
million in other borrowings, partially offset by a
$0.3 million capital lease obligation incurred in
connection with equipment acquisitions and an increase
to the carrying value of the convertible subordinated
debentures of $0.3 million due to accretion.
Proceeds from the sale of the DSOs included $5.0
million of cash held in escrow and reported on the
consolidated balance sheet as restricted cash. These
funds will be released to the Company in April 1998,
subject to potential indemnity claims by Clarity.
The Company's secured credit facility (the Credit
Facility) was amended in December 1995. The $45
million Credit Facility expires in August 1999 and
consists of a revolving line of credit providing for
direct borrowings and up to $15 million in letters of
credit. Direct borrowings and letter of credit
advances are made available pursuant to a formula
based on the levels of eligible accounts receivable
and inventories. The Credit Facility agreement
contains certain
restrictive covenants which include, among other
things, a prohibition on the declaration or payment of
any cash dividends on common stock, minimum ratios of
operating income to interest and fixed charges, and a
maximum ratio of total liabilities to net worth as
well as certain restrictions on start-up expenditures
relating to Unistar and the NIL, if direct borrowings
are used. Interest rates are also subject to
adjustment based upon certain financial ratios.
During 1996, the Company was in compliance with all
such financial covenants. The Credit Facility is
secured by substantially all of the assets of the
Company. Refer to Note D of the Notes to Consolidated
Financial Statements.
As of February 21, 1997, there were no direct
borrowings, $13.1 million of letters of credit
outstanding and $19.9 million of additional borrowings
available under the Credit Facility. Required
principal payments for debt in 1997 are $0.9 million.
The Company believes that borrowings under the Credit
Facility and cash flow from operations will be
sufficient to meet working capital and other
requirements for 1997.
7
<PAGE>
SELECTED FINANCIAL DATA
The following is selected financial data for EXECUTONE
for the five years ended December 31, 1996.
(In thousands, except for per share amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
1996 1995 1994 (2) 1993 (2) 1992 (2)
<S> <C> <C> <C> <C> <C>
Revenues $212,022 $296,393 $291,969 $271,765 $253,024
Income (Loss) Before
Income Taxes From
Continuing Operations $39,782 $(39,221) $ 10,041 $ 7,580 $ 4,320
Income (Loss) From
Continuing Operations $24,162 $(36,934) $ 6,734 $ 4,903 $ 2,222
Income (Loss) From
Discontinued Operations,
Net of Taxes --- --- 757 298 (157)
Extraordinary Item - Gain (Loss) on
Extinguishment of Debt,
Net of Taxes (1) (355) --- --- --- 1,267
Net Income (Loss) $ 23,807 $(36,934) $ 7,491 $ 5,201 $ 3,332
EARNINGS (LOSS) PER SHARE:
Continuing Operations $ 0.46 $ (0.79) $ 0.14 $ 0.10 $ 0.05
Discontinued Operations --- --- 0.02 0.01 ---
Extraordinary Item (0.01) --- --- --- 0.03
Net Income (Loss) $ 0.45 $ (0.79) $ 0.16 $ 0.11 $ 0.08
Total Assets $152,009 $167,844 $189,481 $175,555 $179,294
Long-Term Debt (3) $ 13,837 $ 29,829 $24,698 $32,279 $43,752
Cash Dividends Declared
Per Share (4) $ --- $ --- $ --- $ --- $ ---
</TABLE>
(1) The 1996 extraordinary item relates to the
writeoff of deferred debt issue costs associated with
the Company's revolving credit facility repaid in June
1996. The 1992 extraordinary item relates to the
exchange of debentures for Preferred Stock and Common
Stock Purchase Warrants. Refer to Note D (b) of the
Notes to Consolidated Financial Statements.
(2) Discontinued operations are presented for VCS which
was sold in March 1994. Refer to Note M of the Notes
to Consolidated Financial Statements.
(3) Includes capitalized leases.
(4) The Company has not declared or paid any cash
dividends on its Common Stock. Refer to "Stock Data".
8
<PAGE>
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except for per share amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
1996 1995 1994
<S> <C> <C> <C>
REVENUES $212,022 $296,393 $291,969
COST OF REVENUES 132,510 173,536 169,497
Gross Profit 79,512 122,857 122,472
OPERATING EXPENSES:
Product development and engineering 13,773 14,703 12,222
Selling, general and administrative 69,180 100,520 97,755
Provision for restructuring and unusual items
(Note N) --- 44,042 ---
82,953 159,265 109,977
OPERATING INCOME (LOSS) (3,441) (36,408) 12,495
INTEREST EXPENSE (2,707) (3,920) (3,089)
NET GAIN ON SALE OF BUSINESSES (Note B) 44,060 --- ---
OTHER INCOME, NET 1,870 2,129 635
ACQUISITION COSTS (Note M) --- (1,022) ---
INCOME (LOSS) BEFORE INCOME TAXES
FROM CONTINUING OPERATIONS 39,782 (39,221) 10,041
PROVISION (BENEFIT) FOR INCOME TAXES:
Cash 4,200 350 400
Noncash (Note E) 11,420 (2,637) 2,907
15,620 (2,287) 3,307
INCOME (LOSS) FROM CONTINUING
OPERATIONS BEFORE EXTRAORDINARY
ITEM 24,162 (36,934) 6,734
Income from discontinued operations
(net of income tax provision of $102) --- --- 153
Gain on disposal of discontinued operations
(net of income tax provision of $403) --- --- 604
Extraordinary item - loss on extinguishment
of debt (net of income tax benefit of $238) (355) --- ---
NET INCOME (LOSS) $ 23,807 $(36,934) $7,491
EARNINGS (LOSS) PER SHARE:
CONTINUING OPERATIONS $0.46 $ (0.79) $ 0.14
DISCONTINUED OPERATIONS --- --- 0.02
EXTRAORDINARY ITEM (0.01) --- ---
NET INCOME (LOSS) $ 0.45 $ (0.79) $ 0.16
WEIGHTED AVERAGE NUMBER OF
SHARES OF COMMON STOCK AND
EQUIVALENTS OUTSTANDING 52,251 46,919 47,697
The accompanying notes are an integral part of these consolidated statements.
</TABLE>
9
<PAGE>
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
(In thousands) Years Ended December 31,
1996 1995 1994
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Income (loss) from continuing operations $24,162 $(36,934) $6,734
Adjustments to reconcile net income (loss) to net
cash (used) provided by operating activities:
Depreciation and amortization 4,242 6,093 7,463
Deferred income tax provision (benefit) 11,420 (2,637) 2,907
Net gain on sale of businesses (Note B (44,060) (1,087) ---
Provision for restructuring and unusual items
(Note N) --- 44,042 ---
Provision for losses on accounts receivable 1,921 1,440 893
Other, net (706) (521) 1,251
Changes in working capital items:
Accounts receivable (8,754) (4,205) (9,346)
Inventories 1,048 (3,121) (13,049)
Accounts payable and accruals (4,719) (9,131) 10,497
Other working capital items, net 2,375 2,177 (552)
NET CASH (USED) PROVIDED BY CONTINUING
OPERATIONS (13,071) (3,884) 6,798
Cash flows from discontinued operations --- --- (449)
NET CASH (USED) PROVIDED BY OPERATING
ACTIVITIES (13,071) (3,884) 6,349
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (2,534) (3,457) (6,091)
Dispositions (acquisitions) of businesses 56,948 125 (1,298)
Investment in Unistar (2,079) --- ---
Proceeds from sale of VCS --- 1,200 9,700
Other, net 298 822 (436)
NET CASH PROVIDED (USED) BY
INVESTING ACTIVITIES 52,633 (1,310) 1,875
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings (repayments) under revolving credit
facility (15,445) 4,478 (4,199)
Repayments of term note under credit facility --- --- (3,750)
Repayments of other long-term debt (1,134) (622) (1,781)
Repurchase of stock (4,554) (810) (8,450)
Proceeds from issuance of stock 819 1,641 10,399
Other borrowings 356 750 ---
NET CASH (USED) PROVIDED BY FINANCING
ACTIVITIES (19,958) 5,437 (7,781)
INCREASE IN CASH AND CASH EQUIVALENTS 19,604 243 443
CASH AND CASH EQUIVALENTS - BEGINNING
OF YEAR 8,092 7,849 7,406
CASH AND CASH EQUIVALENTS - END
OF YEAR $ 27,696 $ 8,092 $ 7,849
The accompanying notes are an integral part of these consolidated statements.
</TABLE>
10
<PAGE>
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
(In thousands, except for share amounts) December 31, December 31,
1996 1995
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 27,696 $ 8,092
Accounts receivable, net of allowance
of $2,106 and $1,715 38,992 48,531
Inventories (Note N) 16,814 32,765
Prepaid expenses and other current assets 3,099 5,290
Total Current Assets 86,601 94,678
RESTRICTED CASH 5,031 ---
PROPERTY AND EQUIPMENT, net 7,578 18,462
INTANGIBLE ASSETS, net (Notes L and N) 19,893 20,022
DEFERRED TAXES 18,434 29,616
OTHER ASSETS 14,472 5,066
$152,009 $167,844
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 882 $ 932
Accounts payable 31,416 30,676
Accrued payroll and related costs 3,398 6,870
Accrued liabilities 13,943 11,851
Deferred revenue and customer deposits 3,164 19,781
Total Current Liabilities 52,803 70,110
LONG-TERM DEBT 13,837 29,829
LONG-TERM DEFERRED REVENUE 22 2,805
Total Liabilities 66,662 102,744
STOCKHOLDERS' EQUITY:
Common stock: $.01 par value; 80,000,000 shares
authorized; 51,173,755 and 51,658,492 issued and
outstanding 512 517
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 76,113 79,668
Retained earnings (deficit) (since July 1, 1988) 1,422 (22,385)
Total Stockholders' Equity 85,347 65,100
$152,009 $167,844
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
11
<PAGE>
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands, except for share amounts)
<TABLE>
<CAPTION>
Total
Additional Retained Stock
Common Stock Preferred Stock Paid-In Earnings holder's
Shares Amount Shares Amount Capital (Deficit) Equity
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at
December 31, 1993
41,205,498 $412 --- $ --- $68,275 $7,058 $75,745
Proceeds from issuances of stock
from employee stock plans
5,716,651 57 11,303 11,360
Proceeds from common stock purchase warrants exercised
through bond conversion
1,507,000 15 1,056 1,071
Repurchase of stock
(2,781,255) (28) (8,422) (8,450)
Amortization of deferred
compensation 91 91
Net income 7,491 7,491
Balance at December 31, 1994
45,647,894 $456 --- $ --- $72,303 $14,549 $87,308
Proceeds from issuances of stock
from employee stock plans
1,934,492 19 1,613 1,632
Warrants exercised for common stock
363,549 4 (4) ---
Common and preferred stock issued
to acquire Unistar (Note L)
3,700,000 37 350,000 7,300 5,374 12,711
Common stock issued for
investment in DCC (Note G)
353,118 4 1,100 1,104
Repurchase of stock
(340,561) (3) (807) (810)
Amortization of deferred
compensation 89 89
Net loss (36,934) (36,934)
Balance at December 31, 1995
51,658,492 $517 350,000 $7,300 $79,668 $(22,385) $65,100
Proceeds from issuances of stock
from employee stock plans
810,036 8 839 847
Warrants exercised for common stock
199,431 2 7 9
Repurchase of stock
(1,494,204) (15) (4,536) (4,551)
Amortization of deferred
compensation 135 135
Net Income 23,807 23,807
Balance at December 31, 1996
51,173,755 $512 350,000 $7,300 $76,113 $1,422 $85,347
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
12
<PAGE>
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - NATURE OF THE BUSINESS AND FORMATION OF THE
COMPANY
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). 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.
The Company's products are manufactured primarily in
the United States, Malaysia, China and the Dominican
Republic.
The Company was formed in July 1988 through the merger
of ISOETEC Communications, Inc. (ISOETEC) with Vodavi
Technology Corporation (Vodavi). The merger of
ISOETEC into Vodavi was accounted for under the
purchase method of accounting and Vodavi was deemed to
have undergone a quasi-reorganization for accounting
purposes. As of July 1988, Vodavi's accumulated
deficit of approximately $49.7 million was eliminated.
Executone, Inc. was acquired in 1988 from Contel
Corporation (Contel) for promissory notes and cash.
NOTE B - 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 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 sales 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) relates primarily to the retail distribution
channel of the Computer Telephony division and
includes the Network Services division. After the
sale, the Computer Telephony division consists of
telephony product sales to independent distributors,
of which Clarity is the largest distributor, along
with the National Accounts and Federal Systems
marketing channels. The Company retains its Healthcare
Communications and Call Center Management (CCM)
businesses and the Unistar business.
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. 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 includes $5.0
million held in escrow. These funds are classified as
restricted cash and will be released to the Company in
April 1998, subject to potential indemnity claims by
Clarity.
During the seven-month period after the sale of the
DSOs, $31.7 million (15%) of the Company's revenues
represented sales to Clarity. As of December 31,
1996, $14.2 million (36%) of the Company's net
accounts receivables were from Clarity.
13
<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 equipment inventory. The Company recorded a
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 C - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation. The accompanying
consolidated financial statements include the accounts
of the Company and its subsidiaries. In consolidating
the accompanying financial statements, all significant
intercompany transactions have been eliminated.
Investments in affiliated companies owned more than
20%, but not in excess of 50%, are recorded under the
equity method. Certain prior year amounts have been
reclassified to conform to the current year's
presentation.
Use of Estimates. The preparation of financial
statements in conformity with generally accepted
accounting principles requires management to make
estimates and assumptions that affect the reported
amounts of assets and liabilities, 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.
Revenue Recognition. The Company recognizes revenue
on equipment sales and software licenses to
independent sales and service offices when shipped.
Revenue from equipment, software and installation
contracts with end-users is recognized when the
contract or contract phase for major installations is
substantially completed. Revenue derived from the
sale of service contracts is amortized ratably over
the service contract period on a straight-line basis.
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
period. Common stock equivalents, the convertible
preferred stock and the convertible debentures, which
are antidilutive have been excluded from the
computations.
Cash Equivalents. Cash equivalents include short-term
investments with original maturities of three months
or less.
Inventories. Inventories are stated at the lower of
first-in, first-out ("FIFO") cost or market and
consist of the following at December 31, 1996 and
1995:
<TABLE>
<CAPTION>
(Amounts in thousands) 1996 1995
<S> <C> <C>
Raw Material $ 3,493 $ 4,783
Finished Goods 13,321 27,982
$16,814 $32,765
</TABLE>
Intangible Assets. Intangible assets represent the
excess of the purchase price of the predecessor
companies acquired over the fair value of the net
tangible assets acquired. Effective April 1, 1995,
the carrying value of intangibles is evaluated
periodically in accordance with the provisions of FAS
No. 121, "Accounting for the Impairment of Long-Lived
Assets", by projecting the lowest level of future
undiscounted net cash flows of the underlying
businesses. If the sum of such cash flows is less
than the book value of the long-lived assets,
including intangibles, projected future cash flows are
discounted and intangibles are adjusted accordingly.
Prior to April 1, 1995, the carrying value of
intangibles was evaluated in accordance with the
provisions of APB 17, and was based upon aggregate
cash flows of the business as a whole. Amortization
is provided over periods ranging from 10 to 40 years.
Intangible assets at December 31, 1996 and 1995 are
net of accumulated amortization of $1.0 million and
$0.8 million, respectively (see Notes L and N).
14
<PAGE>
Property and Equipment. Property and equipment at
December 31, 1996 and 1995 consist of the following:
<TABLE>
<CAPTION>
(Amounts in thousands) 1996 1995
<S> <C> <C>
Land and building $ --- $ 1,364
Furniture and fixtures 1,992 7,052
Leasehold improvements 1,813 2,828
Machinery and equipment 20,253 38,093
24,058 49,337
Accumulated depreciation (16,480) (30,875)
Property and equipment, net $ 7,578 $ 18,462
</TABLE>
Depreciation is provided on a straight-line basis over
the estimated economic useful lives of property and
equipment which range from three to ten years for
equipment and thirty years for a building.
Amortization, principally of leasehold improvements,
is provided over the life of the respective lease
terms which range from three to ten years.
Income Taxes. The Company utilizes the liability
method of accounting for income taxes as set forth in
FAS No. 109, "Accounting for Income Taxes". Under the
liability method, deferred taxes are determined based
on the difference between the financial statement and
tax bases of assets and liabilities using enacted tax
rates in effect in the years in which the differences
are expected to reverse.
Product Development and Engineering. Product
development and engineering costs are expensed as
incurred.
Fair Value of Financial Instruments. The fair value
of the Company's Convertible Subordinated Debentures
at December 31, 1996 is approximately $14.3 million,
based upon market quotes. The carrying value of all
other financial instruments included in the
accompanying financial statements approximate fair
value as of December 31, 1996 based upon current
interest rates.
Noncash Investing and Financing Activities. The
following noncash investing and financing activities
took place during the three years ended December 31,
1996:
<TABLE>
<CAPTION>
(Amounts in thousands) 1996 1995 1994
<S> <C> <C> <C>
Note Receivable and Warrants for Sale of
DSOs (Note B) $8,100 $ --- $ ---
Restricted Cash Received for Sale of
DSOs (Note B) 5,031 --- ---
Common and Preferred Stock issued to
acquire Unistar (Note L) --- 12,711 ---
Notes receivable for 1995 disposition of direct sales
offices (Note M) --- 1,911 ---
Equity investment in DCC (Note G) --- 1,505 ---
Common shares exchanged to exercise options
and warrants 549 1,137 455
Capital leases for equipment acquisitions 302 437 686
Note receivable for disposition of VCS
division (Note M) --- --- 1,200
Common stock purchase warrants exercised
through bond conversion --- --- 1,071
Utilization of credits under a special
stock option incentive plan --- --- 737
</TABLE>
Refer to the consolidated statements of cash flows for
information on cash-related operating, investing and
financing activities.
15
<PAGE>
NOTE D - DEBT
The Company's debt is summarized below at December 31,
1996 and 1995:
<TABLE>
<CAPTION>
(Amounts in thousands) 1996 1995
<S> <C> <C>
Borrowings Under Revolving Credit Facility (a) $ --- $15,445
Convertible Subordinated Debentures (b) 12,317 12,098
Capital Lease Obligations (c) 1,499 2,412
Other 903 806
Total Debt 14,719 30,761
Less: Current Portion of Long-Term Debt 882 932
Total Long-Term Debt $13,837 $29,829
</TABLE>
(a) The Company's Credit Facility was amended in
December 1995. The amended $45 million Credit
Facility consists of a revolving line of credit
providing for direct borrowings and up to $15 million
in letters of credit. Direct borrowings and letter
of credit advances are made available pursuant to a
formula based on the levels of eligible accounts
receivable and inventories. To minimize interest on
the revolving line of credit, the Company has the
option to borrow money based upon an adjusted prime
borrowing rate (8.25% at December 31, 1996) or at an
adjusted eurodollar rate (7.7% at December 31, 1996).
The Company repaid all amounts outstanding under the
revolving credit facility in June 1996. At December
31, 1995, the Company had $11.0 million outstanding
subject to the adjusted eurodollar rate with the
balance at the adjusted prime borrowing rate. The
revolving line of credit expires in August 1999.
Approximately $22 million was available at December
31, 1996 under the revolving line of credit, including
approximately $13.1 million which was committed to
cover outstanding letters of credit. The unused
portion of the line of credit has a commitment fee of
0.375%. The Company's average outstanding
indebtedness under the revolving line of credit for
the years ended December 31, 1996 and 1995 was $6.5
million and $17.4 million, respectively, and the
average interest rate on such indebtedness was 7.9%
and 8.5%, respectively.
The Credit Facility agreement contains certain
restrictive covenants which include, among other
things, a prohibition on the declaration or payment of
any cash dividends on common stock, minimum ratios of
operating income to interest and fixed charges, and a
maximum ratio of total liabilities to net worth as
well as certain restrictions on start-up expenditures
relating to Unistar and the NIL, if direct borrowings
are used. Interest rates are also subject to
adjustment based upon certain financial ratios. The
Company was in compliance with all covenants in 1996.
The Credit Facility is secured by substantially all of
the assets of the Company.
(b) The Company's Convertible Subordinated Debentures
(the Debentures), issued in April 1986, are due March
15, 2011 and bear interest at 7 1/2%, payable March
15th and September 15th. The face value of the
outstanding Debentures at December 31, 1996 was $16.5
million. The face value of the Debentures was
adjusted to fair value in connection with the
Company's 1988 quasi-reorganization. The Debentures
are convertible at the option of the holder into
Common Stock of the Company at any time on or before
March 15, 2011, unless previously redeemed, at a
conversion price of $10.625 per share, subject to
adjustment in certain events. Subject to certain
restrictions, the Debentures are redeemable in whole
or in part, at the option of the Company, at par in
1996. The Debentures are also subject to annual
sinking fund payments of $1.5 million beginning March
15, 1997. In January 1992, $15 million principal
amount of Debentures with a book value of $10.1
million was exchanged for 674,865 shares of
Convertible Preferred Stock and 2,999,400 Common Stock
Purchase Warrants. Debentures reacquired by the
Company in the debt-for-equity exchange and in
connection with Warrant exercises were delivered in
lieu of cash in satisfying sinking fund requirements.
Thus, no cash sinking fund payment will be due until
March 2008.
(c) The Company has entered into capital lease
arrangements for office furniture, computer and test
equipment with a net book value of approximately $1.5
million and $2.3 million at December 31, 1996 and
1995, respectively. Such leases have been capitalized
using implicit interest rates which range from 2% to
12%.
16
<PAGE>
The following is a schedule of future maturities of
long-term debt at December 31, 1996:
<TABLE>
<CAPTION>
Years Ending December 31: (Amounts in thousands)
<S> <C>
1997 $ 882
1998 654
1999 246
2000 170
2001 26
Thereafter 12,741
$14,719
(d) For the years ended December 31, 1996, 1995 and
1994, the Company made cash payments of approximately
$2.6 million, $3.6 million and $2.8 million,
respectively, for interest expense on indebtedness.
NOTE E - INCOME TAXES
The components of the provision (benefit) for income
taxes applicable to income (loss) from continuing
operations for the three years ended December 31, 1996
are as follows:
</TABLE>
<TABLE>
<CAPTION>
(Amounts in thousands) 1996 1995 1994
<S> <C> <C> <C>
Current - Federal $ 1,100 $ 150 $ 200
- State 3,100 200 200
4,200 350 400
Deferred - Federal 11,005 (1,922) 2,363
- State 415 (715) 544
11,420 (2,637) 2,907
$15,620 $(2,287) $3,307
</TABLE>
The deferred tax provision for 1996 was primarily
offset by the utilization of net operating loss
carryforwards. For the year ended December 31, 1996,
the Company recorded a deferred income tax benefit of
$238,000 related to an extraordinary loss on the
extinguishment of debt.
For the year ended December 31, 1994, the Company
recorded a deferred income tax provision of $505,000
related to discontinued operations.
A reconciliation of the statutory federal income tax
provision (benefit) to the reported income tax
provision (benefit) on income (loss) from continuing
operations for the three years ended December 31, 1996
is as follows:
<TABLE>
<CAPTION>
(Amounts in thousands) 1996 1995 1994
<S> <C> <C> <C>
Statutory income tax provision (benefit) $13,924 $(13,335) $3,415
State income taxes, net of
federal income tax benefit 2,364 (338) 676
Impairment of intangible assets --- 11,392 ---
Amortization of intangible assets 44 171 457
Adjustment of valuation allowance --- --- (1,252)
Research and development credit (351) (148) (250)
Other (361) (29) 261
Reported income tax provision (benefit) $15,620 $ (2,287) $3,307
</TABLE>
17
<PAGE>
The components of and changes in the net deferred tax
asset are as follows:
<TABLE>
<CAPTION>
Deferred
December 31, (Expense) December 31,
(Amounts in thousands) 1995 Benefit 1996
<S> <C> <C> <C>
Net operating loss and tax
credit carryforwards $27,544 $ (7,935) $19,609
Inventory reserves 8,205 (3,231) 4,974
Accrued liabilities and
restructuring costs 582 564 1,146
Debenture revaluation (1,625) 94 (1,531)
Other (346) (674) (1,020)
34,360 (11,182) 23,178
Valuation allowance (4,744) --- (4,744)
Deferred tax asset $29,616 $(11,182) $18,434
</TABLE>
The deferred tax asset represents the benefits
expected to be realized from the utilization of pre-
and post-acquisition tax benefit carryforwards, which
include net operating loss carryforwards (NOLs), tax
credit carryforwards and the excess of tax bases over
fair value of the net assets of the Company. The
utilization of these tax benefits for financial
reporting purposes will not be reflected in the
statement of operations, but will be reflected as a
reduction of the deferred tax asset.
In order to fully realize the remaining deferred tax
asset of $18.4 million as of December 31, 1996, the
Company will need to generate future taxable income of
approximately $51 million prior to the expiration of
the NOLs and tax credit carryforwards. Although the
Company believes that it is more likely than not that
the deferred tax asset will be fully realized based on
current projections of future pre-tax income, a
valuation allowance has been provided for a portion of
the deferred tax asset. There was no significant
adjustment to the valuation allowance in 1996 and
1995. During 1994, the Company adjusted its valuation
allowance by $6.5 million, $5.2 million of which was a
reduction of goodwill as it related to pre-acquisition
tax benefits and $1.3 million of which reduced the
1994 provision for income taxes. The basis for the
adjustment in 1994 was a significant increase in pre-
tax income from $7.6 million in 1993 to $10.0 million
in 1994. Accordingly, historical earnings supported
the realization of the larger deferred tax asset. The
amount of the deferred tax asset considered
realizable, however, could be reduced if estimates of
future taxable income during the carryforward period
are reduced.
As of December 31, 1996, the Company has NOLs and tax
credit carryforwards (subject to review by the
Internal Revenue Service) available to offset future
income for tax return purposes of approximately $40.9
million and $4.5 million, respectively. A portion of
the NOLs and tax credit carryforwards were generated
prior to the formation of the Company and their
utilization is subject to certain limitations imposed
by the Internal Revenue Code. The NOLs expire as
follows: $18.9 million in 2004; $9.7 million in 2005;
$12.3 million in 2006.
A reconciliation of the Company's income (loss) before
taxes for financial reporting purposes to taxable
income for the three years ended December 31, 1996 is
as follows:
<TABLE>
<CAPTION>
(Amounts in thousands) 1996 1995 1994
<S> <C> <C> <C>
Income (loss) before taxes from continuing
operations $39,782 $(39,221) $10,041
Discontinued operations --- --- 1,262
Extraordinary Item (592) --- ---
Income (loss) before taxes for financial
reporting purposes 39,190 (39,221) 11,303
Differences between income (loss) before taxes for
financial reporting purposes and taxable income:
Permanent differences 105 28,600 1,070
Book taxable income (loss) 39,295 (10,621) 12,373
Net changes in temporary differences (8,990) 11,433 (5,016)
Taxable income $30,305 $ 812 $7,357
</TABLE>
18
<PAGE>
The permanent differences relate to the write-off (in
1995) and amortization of goodwill, which are not
deductible. Changes in temporary differences
principally relate to the taxable gain on the sale of
businesses (in 1996), the impairment in service stock
inventory (in 1995), inventory reserves and other
costs accrued for book purposes, but not deducted for
tax purposes until subsequently paid.
For the years ended December 31, 1996, 1995 and 1994,
the Company made cash payments of approximately $1.5
million, $0.2 million and $0.5 million, respectively,
for income taxes.
NOTE F - COMMITMENTS AND CONTINGENCIES
Operating Leases. The Company conducts its business
operations in leased premises under noncancellable
operating lease agreements expiring at various dates
through 2005. Rental expense under operating leases
amounted to $6.3 million, $9.6 million and $10.1
million for the years ended December 31, 1996, 1995
and 1994, respectively.
The following represents the future minimum rental
payments due under noncancellable operating leases
that have initial or remaining lease terms in excess
of one year as of December 31, 1996:
<TABLE>
<CAPTION>
Years Ending December 31, (Amounts in thousands)
<S> <C>
1997 $ 2,973
1998 3,126
1999 3,127
2000 3,127
2001 3,220
Thereafter 11,011
$26,584
</TABLE>
Litigation. The Company has various lawsuits, claims
and contingent liabilities arising from the conduct of
business; however, in the opinion of management, they
are not expected to have a material adverse effect on
the results of operations, cash flow or financial
position of the Company.
NOTE G - RELATED PARTY TRANSACTIONS
During 1995, the Company acquired 43% of the common
stock and certain other assets of Dialogic
Communications Corporation (DCC), a vendor of certain
call center products, in exchange for 353,118 shares
of the Company's common stock and $100,000 cash. This
investment is included in Other Assets and the related
equity income is included in Other Income, Net.
NOTE H - STOCK OPTIONS AND WARRANTS
The Company has established stock option plans under
which it is authorized to grant both incentive stock
options and non-qualified stock options to officers
and other key employees. Options are granted at a
price not less than the fair market value on the date
of the grant and generally become exercisable over a
four-year period and expire after five years. Shares
available for granting of future options under these
plans total 2.3 million as of December 31, 1996.
The Company also has non-plan options outstanding at
December 31, 1996 including options for 300,000 shares
granted to a director by a predecessor company at a
price of $1.13 per share. Deferred compensation of
$0.9 million was recorded for the excess of the fair
value over the exercise price at the date of grant in
1987 and was fully amortized during 1996. At December
31, 1996, all of the non-plan options were
exercisable. These options expire at various dates
through March 2001. Certain options include
registration rights for the shares issuable
thereunder.
19
<PAGE>
A summary of the status of the Company's stock option
plans, including non-plan options, as of December 31,
1996, 1995 and 1994 is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
<S> <C> <C> <C> <C> <C> <C>
Outstanding 1/1 2,858,577 $2.18 3,977,782 $1.33 6,140,022 $1.18
Granted 316,875 $2.65 1,027,500 $3.05 88,113 $2.80
Exercised (761,570) $1.28 (1,970,760) $0.92 (1,979,340) $0.90
Cancelled (441,397) $2.46 (175,945) $2.27 (271,013) $1.62
Outstanding 12/31 1,972,485 $2.54 2,858,577 $2.18 3,977,782 $1.33
Options exercisable
12/31 1,335,402 1,862,286 2,523,154
</TABLE>
Information relative to options outstanding at
December 31, 1996 is as follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
Weighted Weighted Weighted
Shares Average Average Shares Average
Exercises Outstanding Remaining Exercise Exercisable Exercise
Prices 12/31/96 Life Price 12/31/96 Price
<S> <C> <C> <C> <C> <C>
$1.13 - $ 2.00 708,736 0.8 yrs $1.43 643,736 $1.38
$2.25 - $ 2.50 206,250 4.5 $2.42 15,876 $2.50
$2.56 - $ 3.00 326,969 3.4 $2.87 202,760 $2.90
$3.10 - $20.43 730,530 3.7 $3.50 473,030 $3.69
$1.13 - $20.43 1,972,485 2.7 $2.54 1,335,402 $2.44
</TABLE>
The fair value of options granted during 1996 and 1995
was $1.20 and $1.09 per share, respectively. Fair
value was estimated using the Black-Scholes option-
pricing model with the following assumptions used for
both years: expected volatility of 66%, risk-free
interest rate of 6.2%, an expected option life of 5.0
years and no dividend yield.
The Company applies APB Opinion 25 in accounting for
its plans. Accordingly, no compensation cost has been
recognized for its stock option plans. If
compensation cost had been determined in accordance
with FAS No. 123, "Accounting for Stock-Based
Compensation," net income would have been reduced by
$0.1 million and $0.3 million for 1996 and 1995,
respectively. Earnings per share would have been
unchanged for both years.
As of December 31, 1996, the Company has warrants
outstanding which permit the holders to purchase a
total of 75,000 shares of Common Stock at prices
ranging from $1.25 to $2.63 per share, expiring
through February 2001. Warrants were exercised during
the year ended December 31, 1996 for 199,431 shares of
Common Stock at a weighted average of $0.04 per share.
Warrants were exercised during the year ended December
31, 1995 for 488,890 shares of Common Stock for $1.00
per share. Warrants were exercised during the year
ended December 31, 1994 for 860,919 shares of Common
Stock at prices ranging from $0.01 to $1.00 per share.
At December 31, 1996, 50,000 warrants were
exercisable.
20
<PAGE>
NOTE I - EMPLOYEE STOCK PURCHASE PLAN
A total of 2,750,000 shares of Common Stock are
authorized for issuance under the Company's employee
stock purchase plan (Employee Plan). The Employee
Plan permits eligible employees to purchase up to
1,000 shares of Common Stock at the lower of 85% of
the fair market value of the Common Stock at the
beginning or at the end of each six-month offering
period. Pursuant to such plan, 216,504, 229,636 and
209,512 shares were sold to employees during the three
years ended December 31, 1996, 1995 and 1994,
respectively. The weighted average fair value of
these purchase rights for 1996 and 1995 was $0.81 and
$0.97 per share, respectively. Fair value was
estimated using the Black-Scholes option pricing model
with the following assumptions used for both years:
expected volatility of 66%, risk-free interest rate of
6.0%, an expected term of six months and no dividend
yield.
The Company applies APB Opinion 25 in accounting for
the Employee Plan and, accordingly, no compensation
cost has been recognized. If compensation cost had
been determined in accordance with FAS No. 123, the
impact on net income and earnings per share would have
been immaterial for 1996 and 1995.
In 1994, the Company's shareholders adopted the 1994
Executive Stock Incentive Plan (Executive Plan), which
enabled officers and other key employees to purchase a
total of up to 3,000,000 shares of the Company's
Common Stock. During 1995 and 1994, participants
purchased 140,000 and 2,745,000 shares of Common
Stock, respectively, at fair market value, which were
financed through individual bank borrowings at market
interest rates by each participant, payable over five
years. The Company lends the employee 85% of the
interest due to the bank, with $980,000 and $759,000
of such loans outstanding as of December 31, 1996 and
1995, respectively. There were no amounts outstanding
as of December 31, 1994. The Company guarantees the
individual borrowings under a $6.7 million letter of
credit which has a minimal impact on the Company's
borrowing capability. Employee loans guaranteed by
the Company with letters of credit as of December 31,
1996 and 1995 were $6.5 million and $9.2 million,
respectively. These shares are held by the Company as
security for the guarantees under a loan and pledge
agreement. Sales of such shares by participants are
subject to certain restrictions, and, generally, they
may not be sold for five years.
During 1996, the Company repurchased 820,000 shares of
Common Stock from individuals participating in the
Executive Plan who were no longer employees of the
Company, primarily due to the sale of the DSOs. The
shares were repurchased because, as nonemployees, the
Company could no longer guarantee the bank loans for
these individuals or make advances of interest to the
banks on their behalf. The Company accepted the stock
being held as collateral as payment in full for the
purchase price plus all of the unpaid interest and
satisfied the indebtedness to the banks on behalf of
these individuals. In those instances where the value
of the stock was not sufficient to cover the purchase
price plus all of the unpaid interest, the Company
recorded $110,000 in compensation expense during the
year.
NOTE J - SAVINGS AND POSTRETIREMENT BENEFIT PLANS
The Company has a 401(k) Savings Plan under which it
matches employee contributions subject to the
discretion of the Company's Board of Directors. The
Company's matching contribution, consisting of shares
of its Common Stock purchased in the open market, is
equal to 25% of each employee's contribution, up to a
maximum of $660 per employee. The expense for the
matching contribution for the years ended December 31,
1996, 1995 and 1994 was approximately $540,000,
$687,000 and $500,000, respectively.
The Company has an obligation remaining from the
acquisition of Executone, Inc. to provide
postretirement health and life insurance benefits for
a group of fewer than 75 former Executone, Inc.
employees, including six current employees of the
Company. The Company does not provide postretirement
health or life insurance benefits to any other
employees. Effective January 1, 1993, the Company
adopted FAS No. 106, "Employers' Accounting For
Postretirement Benefits Other Than Pensions". This
standard requires that the expected cost of these
benefits must be charged to expense during the years
that employees render services. The Company adopted
the new standard prospectively and is amortizing the
transition obligation over a 20-year period.
21
<PAGE>
Postretirement benefit expense for the three years
ended December 31, 1996 consists of the following:
<TABLE>
<CAPTION>
(Amounts in thousands) 1996 1995 1994
<S> <C> <C> <C>
Interest on accumulated benefit obligation $214 $219 $217
Amortization of transition obligation 116 116 116
Amortization of unrecognized actuarial loss 20 20 23
$350 $355 $356
</TABLE>
The status of the plan at December 31, 1996 and 1995 is as follows:
<TABLE>
<CAPTION>
(Amounts in thousands) 1996 1995
<S> <C> <C>
Accumulated postretirement benefit obligation (APBO):
Retirees $2,875 $2,779
Active Employees 339 330
3,214 3,109
Unamortized transition obligation (1,861) (1,977)
Unrecognized net loss (466) (486)
Accrued liability $ 887 $ 646
</TABLE>
In determining the APBO as of December 31, 1996 and
1995, the weighted average discount rate used was 7%.
The Company used a healthcare cost trend rate of
approximately 11%, decreasing through 2006 and
leveling off at 6% thereafter. A 1% increase in the
healthcare trend rate would increase the APBO at
December 31, 1996 by approximately 2% and increase the
interest cost component of the postretirement benefit
expense for 1996 by approximately $10,000.
NOTE K - OTHER INCOME, NET
Other Income, Net consists of the following for the
three years ended December 31, 1996:
<TABLE>
<CAPTION>
(Amounts in thousands) 1996 1995 1994
<S> <C> <C> <C>
Interest income $1,117 $ 285 $ 287
Equity in earnings of DCC (Note G) 288 401 ---
Gains on sales of two direct sales offices --- 1,213 ---
Other, net 465 230 348
$1,870 $2,129 $ 635
</TABLE>
NOTE L - 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, privately-held prior to the
acquisition, has an exclusive five-year contract to
design, develop, finance and manage the National
Indian Lottery (NIL) 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 Coeur d'Alene Indian Tribe of
Idaho (CDA). In return for providing these management
services to the NIL, Unistar will be paid a fee equal
to 30% of the profits of the NIL. Unistar did not
have any assets or operations other than the NIL
contract prior to its acquisition by the Company.
22
<PAGE>
The purchase price was approximately $12.7 million and
was based upon the determination by an investment
banking firm of the value assigned to the common and
preferred stock. The common stock valuation was based
upon the value of the shares issued at the closing
date, discounted for restrictions on the sale of the
shares, which range from six to twenty-six months.
The preferred stock was valued based upon the number
of common shares which it was estimated that the
preferred shares may be converted into at some future
date. The excess of the purchase price over the value
of the net liabilities assumed has been allocated to
the management agreement with the CDA, is included in
intangible assets 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. 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).
Liquidation preferences for all Series A and Series B
preferred shares total $7.3 million as of December 31,
1996. Liquidation preference is based upon fair
market value of the Series A and Series B preferred
shares as determined by the investment banking firm
engaged by the Company, plus any dividends in arrears.
As of December 31, 1996, no dividends have accrued to
the preferred stockholders. The preferred stock had
no impact on earnings per share in 1996 and 1995 as it
is antidilutive.
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 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 has
been appealed and a hearing is scheduled for March 24,
1997 in the Tribal Appellate Court. Although the
Company also anticipates an appeal to 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 accrued $1 million in 1995 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 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. In 1996, total funding as
described above totaled $2.1 million 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, if
any, the Company estimates that the additional costs
to become operational may amount to between $7 million
and $12 million. The costs include capital
expenditures for computers and software to build the
telecommunications system, funds to
23
<PAGE>
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
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 will obtain 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.
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 $7 million to $12 million, will be approximately $2
million to $3 million. 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 investment in IGT will be 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 December 31, 1996, $485,000 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.
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 lottery. Based upon opinions from outside
legal counsel, the Company also believes that the
legal decision rendered by the CDA Tribal Court will
ultimately be upheld on appeal. However, there is no
assurance of such a legal outcome. In the event that
a telephone lottery does not attain the level of
market acceptance anticipated by the Company or if the
CDA Tribal Court decision is not upheld on appeal, the
Company would have to reevaluate the viability of the
Unistar subsidiary to determine if the Company's
investment has been impaired.
NOTE M - OTHER ACQUISITIONS/DISPOSITIONS
During the fourth quarter of 1995, the Company sold
its customer bases in Wisconsin and Iowa and the net
assets of the related direct sales offices for a total
of $2.1 million, consisting of $125,000 cash, a $1.8
million note, the proceeds of which were received in
February 1996, and a $150,000 note due in installments
by November 2001. These sales generated a gain of
approximately $1.2 million, which is included in Other
Income, Net for the year ended December 31, 1995.
During the first quarter of 1995, the Company was
involved in extensive negotiations to acquire the
Dictaphone division of Pitney Bowes. In April 1995,
the acquisition was awarded to another bidder. The
Company incurred approximately $1 million in fees and
expenses related to the attempted acquisition which
were recognized during the second and third quarters
of 1995.
In 1990, the Company acquired all the outstanding
shares of Isoetec Texas, Inc., an independent
distributor of the Company's products. The
transaction has been accounted for by the purchase
method. The purchase price was based upon a multiple
of 1989 pre-tax earnings of Isoetec Texas, Inc.,
subject to adjustment. The purchase price originally
recorded was based on cash payments to the former
owners of approximately $900,000, $250,000 of notes,
325,000 shares of common stock and liabilities assumed
of approximately $900,000.
24
<PAGE>
The Company brought an action against the former
owners of Isoetec Texas, Inc. alleging breach of
contract and fraud with respect to the calculation of
1989 pre-tax earnings and the purchase price. In
November 1991, pursuant to the purchase contract, an
arbitrator ruled that 1989 pre-tax earnings should be
reduced by an amount that resulted in a
reduction of the purchase price by approximately $2
million. This reduction was assumed in the original
purchase price calculation and, as such, did not
result in an adjustment to the recorded purchase
price. However, the arbitrator also awarded damages
of approximately $1.2 million to the former owners as
additional purchase price. At that time, the Company
did not adjust its purchase price calculation since it
believed that the arbitrator went beyond its authority
and decided to pursue the matter in court. In 1994,
after an appeal to the Fifth Circuit U.S. Court of
Appeals, the Company was required to pay $1.2 million
as additional purchase price and interest of $400,000.
In addition, the Company was required to issue an
additional 78,866 shares of common stock to settle all
remaining claims. These payments were adjustments to
the recorded purchase price.
As of March 31, 1994, the Company sold its Vodavi
Communications Systems Division ("VCS"), which sold
telephone equipment to supply houses and dealers, a different
class of customer from continuing operations, under
the brand names STARPLUS and INFINITE, for
approximately $10.9 million. Proceeds of the sale
consisted of approximately $9.7
million in cash, received in April 1994, and a $1.2
million note, the proceeds of which were received in
September 1995. The proceeds were used to reduce
borrowings under the Company's credit facility. The
sale resulted in an after-tax gain of $604,000 (net of
income tax provision of $403,000). Consolidated
financial statements for the year ended
December 31, 1994 present VCS as a discontinued
operation. Net revenue of the discontinued operation
for the year ended December 31, 1994 (through the date
of sale) was $8.6 million.
NOTE N - PROVISION FOR RESTRUCTURING
In July 1995, the Company reorganized its then-
existing business 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
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. As a
result of the change in strategy, the business
acquired in 1988 was de-emphasized. The Company
adopted FAS No. 121, 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 change in 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 projected usage,
incorporating the strategic direction of the Company.
25
<PAGE>
NOTE O - SELECTED QUARTERLY FINANCIAL DATA
The following is a summary of unaudited selected
quarterly financial data for the years ended December
31, 1996 and 1995:
<TABLE>
<CAPTION>
(In thousands, except for per share amounts)
Three Months Ended
March 31, June 30, September 30, December 31,
1996 1996 1996 1996
<S> <C> <C> <C> <C>
Revenues $66,966 $51,982 $44,791 $48,283
Gross Profit 26,520 18,969 16,458 17,565
Income (Loss) Before Income Taxes
and Extraordinary Item (8,969) 39,820 3,535 5,396
Income (Loss) Before
Extraordinary Item (5,358) 23,860 2,124 3,536
Net Income (Loss) (5,358) 23,860 2,124 3,181
Earnings (Loss) Per Share:
Income(Loss)Before
Extraordinary Item (0.10) 0.45 0.04 0.07
Extraordinary Item --- --- --- (0.01)
</TABLE>
(In thousands, except for per share amounts)
<TABLE>
<CAPTION>
Three Months Ended
March 31, June 30, September 30, December 31,
1995 1995 1995 1995
<S> <C> <C> <C> <C>
Revenues $70,808 $78,417 $74,164 $73,004
Gross Profit 28,349 32,021 30,504 31,983
Income (Loss) Before Income Taxes 200 (44,225) 2,205 2,599
Net Income (Loss) 120 (39,936) 1,323 1,559
Earnings (Loss) Per Share --- (0.86) 0.03 0.03
</TABLE>
The three months ended March 31, 1996 includes a loss
of $4,877 relating to the sale of the
Videoconferencing and Inmate Calling businesses (see
Note B). The three months ended June 30 and December
31, 1996 include a gain on the sale of businesses (See
Note B) of $47,495 and $1,442, respectively.
The three months ended June 30, 1995 includes a
provision for restructuring of $44,042 (see Note N)
and acquisition expenses of $1.0 million (see Note M).
26
<PAGE>
STOCK DATA
The number of holders of record of the Company's
Common Stock as of the close of business on January
31, 1997 was approximately 2,200. The Common Stock is
traded on the NASDAQ National Market System under the
symbol "XTON". As reported by NASDAQ on February 24,
1996, the closing sale price of the Common Stock on
the NASDAQ National Market System was $2 11/16. The
following table reflects in dollars the high and low
closing sale prices for EXECUTONE's Common Stock as
reported by the NASDAQ National Market System for the
periods indicated:
<TABLE>
<CAPTION>
Fiscal Period High Low
<S> <C> <C>
1996
First Quarter $3 7/16 $2 3/16
Second Quarter 3 3/4 2 5/8
Third Quarter 3 1/4 2 5/16
Fourth Quarter 3 1/16 2 3/8
1995
First Quarter $3 7/16 $2 15/16
Second Quarter 3 3/8 2 1/8
Third Quarter 2 7/8 2 1/8
Fourth Quarter 2 7/8 2 1/8
</TABLE>
It is the present policy of the Board of Directors to
retain earnings for use in the business and the
Company does not anticipate paying any cash dividends
on the Common Stock in the foreseeable future. The
Company's current bank credit agreement contains
provisions prohibiting the payment of dividends on the
Common Stock.
27
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of
EXECUTONE Information Systems, Inc.:
We have audited the accompanying consolidated balance
sheets of EXECUTONE Information Systems, Inc. (a
Virginia corporation) and subsidiaries as of December
31, 1996 and 1995, and the related consolidated
statements of operations, changes in stockholders'
equity and cash flows for each of the three years
ended December 31, 1996. These financial statements
are the responsibility of the Company's management.
Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally
accepted auditing standards. Those standards require
that we plan and perform the audit to obtain
reasonable assurance about whether the financial
statements are free of material misstatement. An
audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the
financial statements. An audit also includes
assessing the accounting principles used and
significant estimates made by management, as well as
evaluating the overall financial statement
presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to
above present fairly, in all material respects, the
financial position of EXECUTONE Information Systems,
Inc. and subsidiaries as of December 31, 1996 and
1995, and the results of their operations and their
cash flows for each of the three years ended December
31, 1996, in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
Stamford, Connecticut,
January 31, 1997
28
<PAGE>
STOCKHOLDER INFORMATION
CORPORATE HEADQUARTERS INDEPENDENT PUBLIC ACCOUNTANTS
EXECUTONE Information Systems, Inc. Arthur Andersen LLP
478 Wheelers Farms Road Champion Plaza
Milford, Connecticut 06460 400 Atlantic Street
(203) 876-7600 Stamford, Connecticut 06912-0021
http://www.executone.com
OUTSIDE COUNSEL
STOCK AND WARRANT TRANSFER AGENT Hunton & Williams
American Stock Transfer and Trust Company Riverfront Plaza
40 Wall Street 951 East Byrd Street
New York, New York 10005 Richmond, Virginia 23219
BOND TRANSFER AGENT ADDITIONAL INFORMATION
U.S. Trust Company of New York A copy of EXECUTONE's Annual
114 West 47th Street Report on Form 10-K, which is
New York, New York 10036-1532 filed with the Securities and
Exchange Commission, is
available without charge by
writing to:
David Krietzberg
Treasurer/Investor Relations
Corporate Headquarters
DIRECTORS AND OFFICERS
BOARD OF DIRECTORS
Alan Kessman Jerry M. Seslowe 2
Chairman of the Board Managing Director
Resource Holdings, Ltd.
Stanley M. Blau 1
Vice Chairman
Thurston R. Moore 1
Partner
Hunton & Williams
Richard S. Rosenbloom 2
David Sarnoff Professor of Business Administration
Harvard Business School
1 Audit committee member
2 Compensation committee member
OFFICERS
Alan Kessman Anthony R. Guarascio
President and Chief Executive Officer Vice President, Finance
Chief Financial Officer
Andrew Kontomerkos Michael W. Yacenda
Senior Vice President, Hardware Executive Vice President
Engineering and Production President, Unistar
Israel J. Hersh Vic Northrup
Vice President, Vice President,
Software Engineering Computer Telephony
Barbara C. Anderson Elizabeth Hinds
Vice President, General Counsel Vice President,
and Secretary Human Resources
Frank J. Rotatori James E. Cooke III
Vice President, Vice President,
Healthcare Communications National Accounts
Robert W. Hopwood Shlomo Shur
Vice President, Operations Senior Vice President,
Unistar Advanced Technology
29
SUBSIDIARIES OF
EXECUTONE INFORMATION SYSTEMS, INC.
<TABLE>
<CAPTION>
JURISDICATION OF %
NAME INCORPORATION OWNERSHIP BUSINESS
<S> <C> <C> <C>
Unistar Gaming Corporation Delware 100% 478 Wheelers Farms Rd
Holding Milford, CT 06460
Unistar Entertainment, Inc. Idaho 100% 478 Wheelers Farms Rd
Management Milford, CT 06460
All listed subsidiaries do business only under their corporte names listed
above. Certain inactive and immaterial subsidiaries, which if considered
in the aggregate as a single subsidiary would not constitute a "significant
subsidiary" as defined in Rule 1-02(w) of the Commission as of December 31,
1997, are not listed.
</TABLE>
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation
of our reports included or incorporated by reference in this Form 10-K into
the Company's previously filed Registration Statements File Nos. 33-45015,
33-42561, 33-23294, 33-16585, 33-6604, 33-959, 2-91008, 33-40623, 33-46874,
33-46875, 33-50628, 33-57519 and 33-63637, 333-7279 and 33-62257.
ARTHUR ANDERSEN LLP
Stamford, Connecticut
March 28, 1997
EXHIBIT 23.2
March 28, 1997
EXECUTONE Information Systems, Inc.
478 Wheelers Farms Road
Milford, CT 06460
Annual Report on Form 10-K for the Fiscal Year
Ended December 31, 1996 (File No. 000-11551)
Gentlemen:
This firm has reviewed the information set forth in the seventh
paragraph under "Recent Developments" under item 1., Business, and
the information set forth in the first paragraph under Item 3., Legal
Proceedings, of the Annual Report on Form 10-K for the fiscal year ended
December 31, 1996 of EXECUTONE Information Systems, Inc. (the "Company").
We understand that the information set forth therein as it relates to
the issue of the authorization of the National Indian Lottery under 25 U.S.C.
2701 et seg. is based upon the advice provided to the Company by this firm.
We consent to the summarization of such advice and the reference to us
in the prospectus.
Very truly yours,
HUNTON & WILLIAMS
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheet of Executone Information Systems, Inc. and
subsidiaries as of December 31, 1996 and the related consolidated statement
of operations for the year ended December 31, 1996 and is qualified in its
entirety by reference to such financial statements (see Exhibit 13).
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 27,696
<SECURITIES> 0
<RECEIVABLES> 41,098
<ALLOWANCES> 2,106
<INVENTORY> 16,814
<CURRENT-ASSETS> 86,601
<PP&E> 24,058
<DEPRECIATION> 16,480
<TOTAL-ASSETS> 152,009
<CURRENT-LIABILITIES> 52,803
<BONDS> 13,837
<COMMON> 512
0
7,300
<OTHER-SE> 77,535
<TOTAL-LIABILITY-AND-EQUITY> 152,009
<SALES> 212,022
<TOTAL-REVENUES> 212,022
<CGS> 132,510
<TOTAL-COSTS> 132,510
<OTHER-EXPENSES> 82,953
<LOSS-PROVISION> 1,921
<INTEREST-EXPENSE> 2,707
<INCOME-PRETAX> 39,782
<INCOME-TAX> 15,620
<INCOME-CONTINUING> 24,162
<DISCONTINUED> 0
<EXTRAORDINARY> (355)
<CHANGES> 0
<NET-INCOME> 23,807
<EPS-PRIMARY> 0.45
<EPS-DILUTED> 0.45
</TABLE>
