Executone March 31, 1998 10-Q Filing
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 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. Employer
incorporation or organization) Identification No.)
478 Wheelers Farms Road, Milford, Connecticut 06460
(Address of principal executive offices) (Zip Code)
(203) 876-7600
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15 (d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
The number of shares outstanding of registrant's Common Stock,
$.01 par value per share, as of April 30, 1998 was 49,721,084.
<PAGE>
INDEX
EXECUTONE Information Systems, Inc.
Page #
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
March 31, 1998 and December 31, 1997. 3
Consolidated Statements of Operations -
Three Months Ended March 31, 1998 and 1997. 4
Consolidated Statements of Cash Flows -
Three Months Ended March 31, 1998 and 1997. 5
Notes to Consolidated Financial Statements. 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 14
PART II. OTHER INFORMATION 19
SIGNATURES 21
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
March 31, December 31,
(In thousands, except for share amounts) 1998 1997
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 8,470 $ 7,727
Restricted cash --- 5,084
Accounts receivable, net of
allowance of $1,447 and $1,814 29,580 33,403
Inventories 23,550 20,436
Prepaid expenses and other current assets 3,656 4,091
Total Current Assets 65,256 70,741
PROPERTY AND EQUIPMENT, net 11,450 7,767
INTANGIBLE ASSETS, net 19,719 19,765
DEFERRED TAXES 20,230 18,577
OTHER ASSETS 20,069 22,014
$ 136,724 $ 138,864
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt $ 809 $ 951
Accounts payable 22,816 23,009
Accrued payroll and related costs 3,483 3,007
Accrued liabilities 12,641 13,123
Deferred revenue and customer deposits 3,275 2,541
Total Current Liabilities 43,024 42,631
LONG-TERM DEBT 14,557 14,643
OTHER LONG-TERM LIABILITIES 1,037 1,092
TOTAL LIABILITIES 58,618 58,366
STOCKHOLDERS' EQUITY:
Common stock: $.01 par value; 80,000,000
shares authorized; 49,721,084 and
49,660,359 issued and outstanding 497 497
Preferred stock: $.01 par value; Cumulative
Convertible Preferred Stock (Series A),
250,000 shares authorized, issued and
outstanding; Cumulative Contingently
Convertible Preferred Stock (Series B),
100,000 shares authorized, issued and
outstanding 7,300 7,300
Additional paid-in capital 71,586 71,500
Retained earnings (since July 1, 1988) (1,277) 1,201
Total Stockholders' Equity 78,106 80,498
$ 136,724 $ 138,864
The accompanying notes are an integral part of these consolidated
balance sheets.
</TABLE>
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EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
(In thousands, except for per share amounts) March 31,
1998 1997
<S> <C> <C>
REVENUES $ 33,903 $39,019
COST OF REVENUES 23,065 24,899
Gross Profit 10,838 14,120
OPERATING EXPENSES:
Product development and engineering 2,513 3,300
Selling, general and administrative 9,625 10,047
Provision for special charges (Note G) 2,344 ---
14,482 13,347
OPERATING INCOME (LOSS) (3,644) 773
INTEREST EXPENSE (508) (434)
OTHER INCOME, net 23 515
INCOME (LOSS) BEFORE INCOME TAXES (4,129) 854
PROVISION (BENEFIT) FOR INCOME TAXES (1,651) 342
NET INCOME (LOSS) $ (2,478) $ 512
EARNINGS (LOSS) PER SHARE $ (0.05) $ 0.01
AVERAGE DILUTED COMMON SHARES 49,698 50,229
The accompanying notes are an integral part of these consolidated
statements.
</TABLE>
4
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EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
(In thousands) March 31,
1998 1997
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (2,478) $ 512
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 877 820
Provision (benefit) for income taxes not
currently payable (receivable) (1,651) 342
Noncash items, including noncash interest
expense, noncash provision for losses on
accounts receivable and income from
equity investment 152 108
Change in working capital items:
Accounts receivable 3,808 4,472
Inventories (3,115) (1,633)
Accounts payable and accruals 1 (4,488)
Restricted cash 5,084 ---
Other working capital items 1,169 900
NET CASH PROVIDED BY OPERATING ACTIVITIES 3,847 1,033
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (241) (433)
Investment in UniStar (2,428) (1,516)
Other, net (230) (772)
NET CASH USED BY INVESTING ACTIVITIES (2,899) (2,721)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of other long-term debt (291) (304)
Repurchase of stock --- (4,716)
Proceeds from issuance of stock 86 134
NET CASH USED BY FINANCING ACTIVITIES (205) (4,886)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 743 (6,574)
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 7,727 27,696
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 8,470 $ 21,122
The accompanying notes are an integral part of these consolidated statements.
</TABLE>
5
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EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE A - NATURE OF THE BUSINESS
EXECUTONE Information Systems, Inc. (the Company) develops,
markets and supports voice and data communications systems.
Products and services include telephone systems, voice mail
systems, inbound and outbound call center systems, and
specialized healthcare communications systems. The Company's
UniStar Entertainment indirect subsidiary has an exclusive five-
year contract ending January 2003 with the Coeur d'Alene Tribe of
Idaho to design, develop, finance and manage the National Indian
Lottery. Executone's products and services are sold under the
EXECUTONE, INFOSTAR, IDS, LIFESAVER and INFOSTAR/ILS brand names
through a national network of independent distributors and
company direct sales and service employees.
NOTE B - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have
been prepared in accordance with generally accepted accounting
principles for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In
the opinion of management, all adjustments, which include normal
recurring adjustments, considered necessary for a fair
presentation of the results for the interim periods presented
have been included. Certain prior year amounts have been
reclassified to conform to the current year's presentation.
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts
of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
As of July 1, 1988, an accumulated deficit of approximately $49.7
million was eliminated.
NOTE C - INCOME TAXES
The Company accounts for income taxes in accordance with FAS No.
109, "Accounting for Income Taxes." The deferred tax asset
represents the benefits that are more likely than not to be
realized from the utilization of pre- and post-acquisition tax
benefit carryforwards, which include net operating losses, tax
credits and the excess of tax bases over the fair value of the
net assets of the Company.
For the three-month periods ended March 31, 1998 and 1997, the
Company made cash payments for income taxes of approximately
$54,000 and $335,000, respectively.
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NOTE D - EARNINGS PER SHARE
Earnings per share is based on the weighted average number of
shares of common stock and dilutive common stock equivalents
(which include stock options and warrants) outstanding during the
period. Common stock equivalents, the convertible preferred
stock and the convertible debentures which are antidilutive have
been excluded from the computations.
A reconciliation of the Company's earnings (loss) per share
calculations for the three-month periods ended March 31, 1998 and
1997, respectively, is as follows:
<TABLE>
<CAPTION>
Per Share
(in thousands, except for per share amounts) Income/(Loss) Shares Amount
<S> <C> <C> <C>
For the three months ended March 31, 1998:
Basic and Diluted Loss Per Share:
Net Loss $(2,478) 49,698 $(0.05)
For the three months ended March 31, 1997:
Basic Earnings Per Share:
Net Income $ 512 49,881 $ 0.01
Stock Options and Warrants 348
Diluted Earnings Per Share:
Net Income $ 512 50,229 $ 0.01
</TABLE>
The Company's Convertible Subordinated Debentures are convertible
into approximately 1.5 million shares of common stock as of March
31, 1998. The shares issuable upon conversion of the Debentures
were not included in the computation of diluted earnings per
share because they would be antidilutive for each of the periods
presented. Due to the net loss for the three months ended March
31, 1998, all stock options and warrants were antidilutive,
regardless of the exercise prices. Options to purchase
approximately 1.1 million shares of common stock as of March 31,
1997 were not included in the computation of diluted earnings per
share for that period because the exercise price was greater than
the average market price of the shares of common stock. The
convertible preferred stock issued in connection with the
acquisition of UniStar is antidilutive and has been excluded from
the above calculations (See Note F).
In 1997, the Company adopted FAS No. 128, "Earnings per Share,"
effective for periods ending after December 15, 1997. As a
result, the Company's reported earnings per share for prior
periods were restated. The effect of this accounting change had
no impact on reported earnings per share data as of March 31,
1997.
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NOTE E - INVENTORIES
Inventories are stated at lower of first-in, first-out (FIFO)
cost or market and consist of the following at March 31, 1998 and
December 31, 1997:
<TABLE>
<CAPTION>
(amounts in thousands) 3/31/98 12/31/97
<S> <C> <C>
Raw Materials $ 3,400 $ 4,672
Finished Goods 20,150 15,764
$23,550 $20,436
</TABLE>
NOTE F - UNISTAR
On December 19, 1995, the Company acquired 100% of the common
stock of Unistar Gaming Corporation (Unistar Gaming) for 3.7
million shares of the Company's common stock valued at $5.4
million and 350,000 shares of newly issued preferred stock valued
at $7.3 million. Unistar Gaming's subsidiary, UniStar
Entertainment, Inc. (UniStar), has an exclusive five-year
contract to design, develop, finance and manage the National
Indian Lottery (NIL) for the Coeur d'Alene Tribe of Idaho ("CDA"
or "the Tribe"). The NIL comprises a national telephone lottery
authorized by federal law and a compact between the State of
Idaho and CDA, as well as Internet-based lottery games. 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. The excess of the purchase price over the value of the net
liabilities assumed has been included in intangible assets and is
being amortized over the five-year term of the contract
commencing with the three-month period ended March 31, 1998.
The preferred stock consists of 250,000 shares of Cumulative
Convertible Preferred Stock, Series A (Series A Preferred Stock)
and 100,000 shares of Cumulative Contingently Convertible
Preferred Stock, Series B (Series B Preferred Stock). The Series
A Preferred Stock has voting rights equal to one share of common
stock and will earn dividends equal to 18.5% of the consolidated
retained earnings of UniStar as of the end of a fiscal period,
less any dividends paid to the holders of the Series A Preferred
Stock prior to such date. The Series B Preferred Stock has
voting rights equal to one share of common stock and will earn
dividends equal to 31.5% of the consolidated retained earnings of
UniStar as of the end of a fiscal period, less any dividends paid
to the holders of the Series B Preferred Stock prior to such
date. All dividends on Preferred Stock are payable (i) when and
as declared by the Board of Directors, (ii) upon conversion or
redemption of the Series A and Series B Preferred Stock or (iii)
upon liquidation. As of March 31, 1998, no dividends have accrued
to the preferred stockholders. The Series A and Series B
Preferred Stock is redeemable for a total of 13.3 million shares
of common stock (Series A Preferred Stock for 4.925 million
shares and Series B Preferred Stock for 8.375 million shares) at
the Company's option. In the event that UniStar meets certain
revenue and profit parameters, the Series A Preferred Stock is
convertible for up to 4.925 million shares of common stock and
the Series B Preferred Stock is convertible for up to 8.375
million shares of common stock (a total of an additional 13.3
million shares of common stock).
In an attempt to block the NIL, certain states filed letters
under 18 U.S.C. Section 1084 to prevent the long-distance
carriers from providing telephone service to the NIL. In 1995,
the CDA initiated legal action against AT&T Corporation (AT&T) to
compel the long-distance carriers to provide telephone
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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 law, that 18 U.S.C.
Section 1084 is inapplicable and, therefore, 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 Tribal Court found that the long-distance carriers
cannot refuse to provide the service requested in the action
based upon 18 U.S.C. Section 1084. This ruling and a related
order dated May 1, 1996 were subsequently appealed to the Tribal
Appellate Court, which on July 2, 1997 affirmed the lower Tribal
Court's May 1, 1996 ruling and analysis upholding the CDA's right
to conduct the telephone lottery. On August 22, 1997, AT&T filed
a complaint for declaratory judgment against the CDA in the U.S.
District Court for the District of Idaho. The CDA has answered
that complaint. In March 1998, the attorneys general of nineteen
states filed a motion for permission to submit a brief as amicus
curiae in the case with respect to the Tribal Court's
interpretation of IGRA and in support of the position taken by
AT&T.
On May 28, 1997, the State of Missouri brought an action in the
Missouri Circuit Court in Kansas City against UniStar and the CDA
to enjoin the NIL's US Lottery Internet instant games offered by
the CDA and managed by UniStar. The complaint also seeks civil
penalties, attorney's fees and court costs. The complaint
alleged that the US Lottery violates Missouri anti-gaming laws
and that the marketing and promotion of the US Lottery violate
the Missouri Merchandising Practices Act. The CDA and UniStar
removed the case to the U.S. District Court for the Western
District of Missouri, which denied the State's subsequent motion
to remand the case back to the state court. The Court also
subsequently granted a motion to dismiss by CDA based on
sovereign immunity. The Court denied the motion to dismiss
UniStar based on sovereign immunity, although the Court indicated
it might reconsider that decision. UniStar filed a motion for
reconsideration of its motion for dismissal. The State of
Missouri has filed an appeal to the Eighth Circuit Court of
Appeals relating to the dismissal of the CDA.
On January 28, 1998, the State of Missouri sought to dismiss
voluntarily the existing case against UniStar and filed the next
day, a new action against the Company, UniStar and two tribal
officials, with essentially the same allegations, in a state
court in a different district. The State obtained a temporary
restraining order from a state judge enjoining the marketing of
the Internet and telephone lottery in the State of Missouri. On
February 5, 1998, the U.S. District Court for the Eastern
District of Missouri ruled that this second case also should be
heard in federal court, transferred the second case to the
Western District of Missouri, where the original case had been
filed, and dissolved the state court's temporary restraining
order, effective February 9, 1998. A motion to dismiss the
second case based on the sovereign immunity of all the defendants
and a motion to abstain in favor of the jurisdiction of the CDA
Tribal Court are pending. The State of Missouri has filed an
appeal of the denial of its motion to remand the case to State
Court or in the alternative to grant a preliminary injunction.
On September 15, 1997, the State of Wisconsin filed an action in
the Wisconsin State Circuit Court for Dane County against the
Company, UniStar and the CDA, to permanently enjoin the US
Lottery offered by the Tribe on the Internet and managed by
UniStar. The complaint alleges that the offering of the US
Lottery violates Wisconsin anti-gambling laws and that legality
of the US Lottery has been misrepresented to Wisconsin residents
in violation of state law. In addition to an injunction, the
suit seeks restitution, civil penalties, attorneys' fees and
court costs. The Company, UniStar and the CDA have removed the
case to the U.S. District Court in Wisconsin. On February 18,
1998, the District
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Court dismissed the Tribe from the case based on sovereign
immunity and dismissed the Company based on the State's failure
to state a claim against the Company. Motions to dismiss the
case against UniStar were denied. UniStar has filed an appeal in
the Seventh Circuit Court of Appeals of the denial of its motion
to dismiss. The State of Wisconsin is appealing the dismissal of
the Tribe.
The Company believes, based on consultation with and opinions
rendered by outside legal counsel, that the favorable rulings of
the tribal courts will be affirmed by the Idaho federal court.
The Company believes that UniStar also will prevail in the
Missouri and Wisconsin lawsuits. However, there is no assurance
of such a legal outcome.
Bills have been introduced in the United States Congress which
could have a significant impact on NIL operations. Senate Bill
474 offered by Jon Kyl (the "Kyl Bill") seeks to amend 18 U.S.C.
Sections 1081 and 1084, which currently prohibit the interstate
transmission of bets and wagers on sporting events and contests.
The Kyl Bill would remove the current limitation to sporting bets
and wagers and extend Sections 1081 and 1084 to virtually all
forms of bets and wagers, as well as to lotteries and other
gaming, in an attempt to prohibit all gaming conducted over the
telephone and the Internet. The Kyl Bill was proposed in 1997
but was not voted on by the full Senate. There is a similar bill
pending in the House of Representatives. There is currently no
exception in any of the proposed bills for gaming conducted by an
Indian tribe that is authorized by IGRA. The Company is
supporting efforts to have such an exception included in the
bill. The Kyl Bill and the House counterpart seek to prohibit
the activities of the NIL and the activities of UniStar in
managing the NIL, which would have a material adverse effect on
UniStar's business.
Funding for UniStar capital expenditures, including the computers
and software to build the telecommunications system, is being
capitalized and depreciated over the life of the management
agreement. The guaranteed monthly advance of $25,000 to the CDA,
which began in January 1996, will be reimbursed when the NIL is
making profit distributions to UniStar. In addition, the Company
has capitalized other fundings, consisting primarily of direct
UniStar expenses, professional fees and other expenses, which the
Company believes are reimbursable in accordance with the terms of
the management agreement. Cumulative funding as described above
totals $10.2 million ($2.2 million for the three-month period
ended March 31, 1998) and is reflected in property and equipment
or other non-current assets, as appropriate.
The Company has also funded legal and other accrued liabilities
assumed as part of the acquisition of UniStar totaling, on a
cumulative basis, $2.6 million ($0.2 million for the three-month
period ended March 31, 1998). Such cash flows, which were
previously reflected as part of the change in working capital
items, are now reflected as part of the investment in UniStar in
the statement of cash flows. Prior year amounts have been
reclassified to conform to the current year's presentation. The
investment in UniStar reflected on the statement of cash flows
includes the deferred charges and assumed liabilities noted above
for a cumulative total of $12.8 million ($2.4 million for the
three-month period ended March 31, 1998). Since inception, the
Company has also funded various UniStar expenses totaling $1.6 million
(after depreciation and amortization), which are reflected in the
Company's consolidated net income. Cumulative cash expenditures
on UniStar, including UniStar expenses and excluding capital
lease obligations, total $13.7 million as of March 31, 1998.
Other than legal costs related to an appeal of the CDA Tribal
Court ruling or other actions by the states, if any, the Company
expects UniStar to be operating on a break-even cash basis by the
end of 1998. Assuming the current level of expenses is
maintained, the Company expects to fund an additional $4-$5
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million until the NIL is generating enough cash to fund its
operations. The costs include capital expenditures for computers
and software to build the telecommunications system, funds to
complete the building on the CDA reservation, which is the
operations center for the lottery, and various start-up and
operating expenses including personnel-related costs and
advertising expenses. The Company is also required to make a
guaranteed payment of $300,000 per year to the CDA, which is
included in the above estimates. The Company expects it will be
able to obtain additional financing for these costs, if
necessary.
In February 1997, the Company signed agreements with Virtual
Gaming Technologies (formerly Internet Gaming Technologies (IGT))
and CasinoWorld Holdings, Ltd. (CWH). The agreements required
the Company to invest $700,000 in IGT common stock in September
1996 under a previous agreement. In addition, the Company was
granted a 200,000-share, five-year option set at 15% more than
the price per share on the initial investment, or $3.45 per
share. CWH is providing project management services
overseeing the development of the software for the NIL, with the
Company contracting independently for system software
development. The Company will acquire all hardware for the system
without financial obligation by either IGT or CWH. Approximately
$700,000 in hardware costs were incurred as of
March 31, 1997. All of these system development costs are
included in the above estimate for expenditures through the end
of 1998.
The investment in IGT is being accounted for under the cost
method. All hardware costs incurred are being capitalized and
depreciated over the useful life of the assets. As of March 31,
1998, $2.3 million in progress payments have been made toward the
software system. Such payments are being capitalized and
depreciated over the life of the asset or term of the management
agreement, whichever is shorter.
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. In the
event that the telephone and Internet lotteries do not attain the
level of market acceptance anticipated by the Company or if the
outcome of the pending lawsuits or legislative proposals in
Congress is adverse, the Company would have to reevaluate its
investment in UniStar.
The Company periodically evaluates the recoverability of this
investment in UniStar in accordance with the provisions of FAS
No. 121, "Accounting for the Impairment of Long-Lived Assets" by
projecting future undiscounted net cash flows for the telephone
and Internet lotteries. If the sum of such cash flows is not
sufficient to recover the Company's investment in UniStar,
projected cash flows would then be discounted and the Company's
investment would be adjusted accordingly.
NOTE G - PROVISION FOR SPECIAL CHARGES
During the three-month period ended March 31, 1998, the Company
recorded a $2.3 million provision for special charges covering
severance and benefit continuation costs, professional fees and
other restructuring costs.
On January 8, 1998, Alan Kessman, Chairman and CEO of the Company
announced his intention to retire from the management of the day-
to-day operations of the Company. In accordance with the
diminishment of responsibility section of his employment
continuity agreement, Mr. Kessman will
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receive a severance payment of $1.3 million. The Company has
also retained an executive search firm to find a successor for
Mr. Kessman. Mr. Kessman has agreed to remain as Interim CEO
until the earlier of July 31, 1998 or the first date of employment
of the successor CEO. If the new CEO has not started by July 31,
1998, there is no definitive agreement between Mr. Kessman and the
Board of Directors for services beyond July 31, 1998. Through
March 31, 1998, the Company has incurred approximately $0.2 million
in expenses to recruit a new CEO.
In addition, the Company restructured current operations which
resulted in a workforce reduction during January and February
1998. The Company incurred approximately $0.6 million for
severance, benefits and other restructuring charges during the
three-month period ended March 31, 1998.
The Company hired Furman Selz LLC to advise the Company as to
certain financing and corporate restructuring options. Based
upon advice of Furman Selz and the recommendation of a special
committee of the Board of Directors, the Board has determined
that it is in the best interests of the shareholders of the
Company to separate the business of the Company's UniStar
subsidiary from the operations of its computer telephony and
healthcare communications businesses. At this time, it is
anticipated that, subject to completion of further analysis and
receipt of necessary approvals, the separation would be effected
through a taxable distribution to shareholders later this year.
During the three-month period ended March 31, 1998, the Company
incurred approximately $0.2 million in advisory expenses related
to preparation and review of corporate restructuring options.
Future expenses will be dependent upon the form and nature of the
corporate restructuring. The Company is also pursuing a plan to
retain and motivate key employees, the details of which are
expected to be concluded by June 1998.
NOTE H - AMENDED DISTRIBUTOR AGREEMENT
On March 30, 1998, the Company entered into an Amended and
Restated Distributor Agreement (the "Amended Agreement") with
Claricom, purchaser of the direct sales offices and the Company's
largest distributor. The Amended Agreement, effective April
1,1998 and continuing through December 31, 2001, provides, among
other things, that Claricom will be a non-exclusive distributor
of the Company's telephony products and that Claricom can market
products competing with those sold by the Company. Upon
execution of the Amended Agreement, Claricom released to the
Company the $5 million plus interest being held in escrow to
satisfy potential indemnity claims under the 1996 Asset Purchase
Agreement and waived all potential contract claims under the
prior distributor agreement.
NOTE I - OTHER MATTERS
For the three-month periods ended March 31, 1998 and 1997, the
Company made cash payments of approximately $0.8 million for
interest expense on indebtedness.
There were no non-cash financing activities for the three-month
periods ended March 31, 1998 and 1997.
For the three-month periods ended March 31, 1998 and 1997, more
than 10% of the Company's revenue were derived from a single,
independent distributor. Revenues from the distributor were $4.5
million and $10.1 million, respectively, for the three-month
periods ended March 31, 1998 and 1997 (see Note H).
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Refer to the Consolidated Statements of Cash Flows for
information on all cash-related operating, investing and
financing activities.
FAS No. 130, "Reporting Comprehensive Income", became effective
for fiscal years beginning after December 15, 1997. This
Statement does not apply to the Company because it had no items
of other comprehensive income in any of the periods presented.
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
The Company develops, markets and supports voice and data
communications systems. Products and services include telephone
systems, voice mail systems, inbound and outbound call center
systems and specialized healthcare communications systems. The
Company's UniStar Entertainment indirect subsidiary has the
exclusive right to design, develop and manage the National Indian
Lottery (NIL). The Company's products are sold under the
EXECUTONE, INFOSTAR, IDS, LIFESAVER and INFOSTAR/ILS brand names
through a national network of independent distributors and
company direct sales and service employees.
Revenues are derived from product sales to distributors, direct
sales of healthcare products, and direct sales to national
accounts and 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, national account and government
customers.
Results of Operations
Revenues for the three-month period ended March 31, 1998 were
$33.9 million, with an operating loss of $3.6 million and a net
loss of $2.5 million or ($.05) per common share. These results
include a $2.3 million charge, covering severance and benefits
continuation costs, professional fees and other restructuring
costs (see "Special Charges"). Revenues for the three-month
period ended March 31, 1997 were $39.0 million, with operating
income of $773,000 and net income of $512,000 or $.01 per common
share. Compared to the same period last year, the Company
increased revenues from its independent distributors, excluding
Claricom, by 20% along with increased healthcare and government
systems revenues. However, these were offset by the lower sales
to Claricom, purchaser of the direct offices in 1996 and the
Company's largest distributor.
Total revenue for the three-month period ended March 31, 1998 was
approximately $5 million less than the same period in 1997.
Revenues for the Computer Telephony group for the three-month
period ended March 31, 1998, including Independent Distribution,
National Accounts and Federal Systems, were $24.7 million, a
decrease of $5.5 million compared to the same period in 1997. The
decrease is primarily due to lower sales to Claricom.
Sales to Claricom during the three-month period ended March 31,
1998 were $4.5 million, a decrease of $5.5 million compared to
the three-month period ended March 31, 1997. In light of the
decline in purchases by Claricom, the Company amended its
distributor agreement with Claricom. Effective
April 1, 1998, Claricom became a non-exclusive distributor of the
Company's products in all parts of its territory (see "Other
Matters").
Healthcare revenues for the three-month period ended March 31,
1998 were $9.2 million, compared to $8.8 million for the same
period last year. The increase in revenue compared to prior year
is due to new installations and system upgrades and expansions.
14
<PAGE>
Gross profit margin for the three-month period ended March 31,
1998 was $10.8 million or 32.0 % of revenue, compared to gross
profit of $14.1 million or 36.2% of revenue for the same quarter
last year. The decrease in gross profit margin percentage is
primarily the result of lower volume and the resulting lower
absorption of fixed costs, as well as an unfavorable product mix
in Computer Telephony during the quarter.
Product development expenses were $2.5 million, which is $0.8
million less than the same quarter last year as a result of cost
reduction measures. The Company expects product development costs
to remain at the current spending levels.
Selling, general and administrative expenses for the three-month
period ended March 31, 1998 were $9.6 million or 28.4% of revenue,
which is $0.4 million less than the same period in 1997. As a
percentage of sales for the three-month period ended March 31,
1998, it is higher than the comparable period last year due to the
lower volume. Operating expenses for the three-month period ended
March 31, 1998 have generally decreased compared to the same
period in 1997, in part, due to staff reductions and other cost
saving measures, along with the effect of the low revenue for the
quarter.
Other income, net decreased $0.5 million during the three-month
period ended March 31, 1998, primarily due to interest income
generated by a lower level of cash available for overnight
investment compared to the same period last year along with lower
royalty income and income from equity investments.
Special Charges
During the three-month period ended March 31, 1998, the Company
recorded a $2.3 million provision for special charges covering
severance and benefit continuation costs, professional fees and
other restructuring costs.
On January 8, 1998, Alan Kessman, Chairman and CEO of the Company
announced his intention to retire from the management of the day-
to-day operations of the Company. In accordance with the
diminishment of responsibility section of his employment
continuity agreement, Mr. Kessman will receive a severance
payment of $1.3 million. The Company has also retained an
executive search firm to find a successor for Mr. Kessman. Mr.
Kessman has agreed to remain as Interim CEO until the earlier of
July 31, 1998 or the first date of employment of the successor CEO.
If the new CEO has not started by July 31, 1998, there is no
definitive agreement between Mr. Kessman and the Board of Directors
for services beyond July 31, 1998. Through March 31, 1998, the
Company has incurred approximately $0.2 million in expenses to
recruit a new CEO.
In addition, the Company restructured current operations which
resulted in a workforce reduction during January and February
1998. The Company incurred approximately $0.6 million for
severance, benefits and other restructuring charges during the
three-month period ended March 31, 1998.
The Company hired Furman Selz LLC to advise the Company as to
certain financing and corporate restructuring options. Based
upon advice of Furman Selz and the recommendation of a special
committee of the Board of Directors, the Board has determined
that it is in the best interests of the shareholders of the
Company to separate the business of the Company's UniStar
subsidiary from the operations of its computer telephony and
healthcare communications businesses. At this time, it is
anticipated that, subject to completion of further analysis and
receipt of necessary approvals, the separation would be effected
through a taxable distribution to shareholders later this year.
15
<PAGE>
During the three-month period ended March 31, 1998, the Company
incurred approximately $0.2 million in advisory expenses related
to preparation and review of corporate restructuring options.
Future expenses will be dependent upon the form and nature of the
corporate restructuring. The Company is also pursuing a plan to
retain and motivate key employees, the details of which are
expected to be concluded by June 1998.
UniStar
On December 19, 1995, the Company acquired 100% of the common
stock of Unistar Gaming, a privately-held company which, through
its wholly-owned subsidiary, UniStar Entertainment, Inc.
(UniStar), has an exclusive five-year contract to design,
develop, finance and manage the National Indian Lottery (NIL) for
the Coeur d'Alene Tribe of Idaho ("CDA" or "the Tribe"). See
Note F of the Notes to Consolidated Financial Statements for the
terms of the agreement with the Tribe.
The initial goal of the investment in UniStar was to establish
and manage 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 original telephone-based lottery, it was
contemplated that calls via an 800 number would be processed with
interactive voice response equipment or live agents located on
the Tribe's Reservation in Idaho using ACD software to process
nationwide lottery sales. The NIL business plan has evolved in
response to legal challenges to encompass Internet-based instant
lottery games, and as of January 1998, a local, non-toll-free
telephone and Internet-accessible weekly draw lottery. The
Company has made a significant investment in UniStar, which upon
acquisition created 8% dilution to the Company's stockholders
and, subsequent to the acquisition, has totaled an additional
$13.7 million in cash. During the three-month period ended March
31, 1998, the Company invested $2.4 million as part of the cost
to develop the software systems, building and other costs related
to the project, $2.2 million of which have been recorded as
assets on the balance sheet. The total UniStar investment as of
March 31, 1998 is $27.8 million, including $15.8 million in
goodwill and $10.2 million in property and equipment and other
non-current assets with the remainder consisting of funded
UniStar expenses. In the opinion of the Company's management,
this investment is justified based upon the potential returns.
The NIL conducts business under the US Lottery trade name. The US
Lottery began test marketing its Instant ticket games on the
Internet in July 1997 and, on April 3, 1998, announced five new
instant games on the Internet. On January 20, 1998, the US
Lottery launched its first Draw game, the "Super6", a national
weekly draw lottery. Tickets for the Super6 can be purchased
either over the Internet or by telephone. The US Lottery also
expects to announce a $10 million lottery jackpot as well as a
"Pick 3" draw game later this year. As of April 30, 1998, the
registered base of the US Lottery was approximately 22,000 people
with about 4,200 active players. Through April 30, 1998, the US
Lottery has generated cumulative revenues of $5.9 million. Ticket
purchases have increased by an average of 17% per month for the
first four months of 1998. Assuming this level of increased
ticket purchases continues through the end of the year, UniStar
expects the US Lottery will be generating revenues of
approximately $9 million per quarter. Due to advertising,
professional fees and other startup costs, the NIL has yet to
generate a profit. As a result, UniStar has not recognized any
revenue under the terms of the Management Agreement as of March
31, 1998. Assuming ticket purchases continue to increase by the
17% per month indicated above and the current level of expenses
is maintained, UniStar expects to be operating on a break-even
cash basis by the end of 1998.
16
<PAGE>
Concerning the UniStar legal issues, there has been some
favorable movement over the last six months. In the Missouri
case, the Tribe was dismissed from the original case based upon
sovereign immunity. The Court denied the motion to dismiss
UniStar based on sovereign immunity, although the Court indicated
it might reconsider that decision. UniStar filed a motion for
reconsideration of its motion for dismissal. Despite a second
attempt by the State of Missouri to move the case back to the
state courts, the US District Court for the Eastern District of
Missouri ruled that the case should be heard in federal court.
In the Wisconsin case, on February 18, 1998, the federal court
dismissed the Tribe from this case based on sovereign immunity,
and dismissed Executone due to the state's failure to state a
claim against Executone. Motions to dismiss the case against
UniStar were denied. UniStar has filed an appeal of this
decision in the Seventh Circuit Court of Appeals. In the action
by AT&T regarding the legality of the telephone lottery, in March
1998, the attorneys general of nineteen states filed a motion for
permission to submit a brief as amicus curiae in the case with
respect to the Tribal Court's interpretation of IGRA and in
support of the position taken by AT&T. The Company believes the
involvement of the attorneys general in this case will facilitate
the resolution of the legal objections put forth by many of the
state attorneys general to the telephone and Internet lotteries.
Based upon consultations with and opinions rendered by outside
legal counsel, the Company continues to believe that the
favorable rulings of the Tribal Appellate Court will be affirmed
by the federal courts.
The Company is monitoring the progress of any potential
legislative action in Washington. At this time, there are bills
pending in both the Senate and House to prohibit gaming conducted
over the telephone or the Internet. The Company is continuing to
support efforts to exclude gaming by an Indian tribe that is
authorized by IGRA from any such legislation.
Other Matters
On March 30, 1998, the Company entered into an Amended and
Restated Distributor Agreement with Claricom (the "Amended
Agreement"). The Amended Agreement, effective April 1, 1998 and
continuing through December 31, 2001, provides, among other
things, that Claricom will be a non-exclusive distributor of the
Company's telephony products and that Claricom can market
products competing with those sold by the Company. Upon
execution of the Amended Agreement, Claricom released to the
Company the $5 million plus interest being held in escrow to
satisfy potential indemnity claims under the 1996 Asset Purchase
Agreement and waived all potential contract claims under the
prior distributor agreement.
The Amended Agreement provides the opportunity to supplement
sales in the Claricom territories with additional distribution.
Other distributors are in the process of being identified to sell
the Company's products in certain parts of Claricom's territory.
The Company estimates it will take six months to a year from the
time a new distributor is assigned territory to grow product
sales to provide the level of penetration contemplated in the
original Claricom agreement.
FAS No. 130, "Reporting Comprehensive Income" became effective
for fiscal years beginning after December 15, 1997. This
Statement does not apply to the Company because it had no items
of other comprehensive income in any of the periods presented.
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 $17 million and $28 million
as of March 31, 1998 and December 31, 1997, respectively.
17
<PAGE>
At March 31, 1998 and December 31, 1997, cash and cash
equivalents amounted to $8.5 million and $7.8 million,
respectively, an increase of $0.7 million. The primary source of
cash was the release of $5.1 million held in escrow since the sale
of the direct offices in 1996. Excluding the escrow funds, net cash
of $1.2 million was used to fund operating activities. An
additional $2.4 million was used for UniStar expenditures for
software development and to fund NIL operating expenses,
primarily payroll-related, advertising and professional fees.
Capital expenditures, debt repayment and other miscellaneous
expenditures accounted for the remaining $0.8 million of cash
funding for the three-month period ended March 31, 1998. Excluding
the release of the cash held in escrow, the Company used $4.4 million
in cash during the period.
Total debt at March 31, 1998 was $15.4 million, an decrease of
$0.2 million from $15.6 million at December 31, 1997. The
decrease in debt is due to the repayment of $0.3 million in
capital lease obligations incurred in connection with equipment
acquisitions, partially offset by an increase to the carrying
value of the convertible subordinated debentures of $0.1 million
due to accretion.
The Company believes that its existing cash balances and cash
flow from operations will be sufficient to meet working capital
and other requirements for the next twelve months.
Forward-Looking Statements
The Company's forward-looking statements regarding projected
results for 1998 are based on assumptions, projections and
estimates regarding continuing growth of the economy, the
telecommunications industry in general and specific events that
may directly affect the Company's performance. The Company's
markets are very competitive and some of the Company's
competitors have greater financial resources that allow them to
price products aggressively. These assumptions, projections and
estimates include and relate to the ability of its distributors'
sales people to market the products effectively, the pricing of
products in the markets in which the Company competes, the
strength and effects of competition, the market's acceptance of
the products offered by the Company, the timing of customer
orders, decisions by intermediaries in the distribution channels
regarding sales hiring and training, pricing, advertising,
promotions and other areas affecting end-user demand for
products, and the lack of any material disruption of product
supply or demand. In addition, all forward-looking statements
regarding UniStar and the US Lottery are based on the assumptions
that the US Lottery will not be forced to delay, suspend or cease
operations due to any legal challenge or the enactment of
legislation adversely affecting its business. If actual events
differ materially from the Company's assumptions, projections and
estimates, the Company's actual results could vary significantly
from the performance projected in the forward-looking statements.
18
<PAGE>
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
As previously reported, on October 16, 1995, the Coeur d'Alene
Tribe filed an action entitled Coeur d'Alene Tribe v AT&T Corp.
in the Tribal Court, located in Plummer, Idaho (Case No. C195-
097), requesting a ruling that the Lottery to be developed and
managed by the Company's UniStar Entertainment subsidiary is
legal under IGRA, that IGRA preempts state laws on the subject of
Indian gaming, that Section 1084 is inapplicable and that the
states lack authority to issue Section 1084 notification letters
to any carrier, and an injunction preventing AT&T from refusing
to provide telephone service to the NIL. This action was
necessary because several network carriers have been sent Section
1084 letters under the Federal Communications Act by states
opposed to the NIL. These letters state that the NIL is illegal
under state and federal laws and prohibit the carriers from
carrying network traffic for the NIL. On February 28, 1996, the
Tribal Court ruled that all requirements of IGRA have been
satisfied, that Section 1084 is inapplicable and the states lack
jurisdiction to interfere with the NIL, and that AT&T cannot
refuse service to the NIL based upon Section 1084, an allegation
that the NIL is in violation of IGRA or the federal anti-lottery
statutes. This ruling and a related order dated May 1, 1996 were
appealed to the Tribal Appellate Court, which affirmed the lower
court ruling on July 2, 1997. On August 22, 1997, AT&T filed a
complaint for declaratory judgment against the CDA in the U.S.
District Courts for the District of Idaho. The CDA has answered
that complaint. In March 1998, the attorneys general of nineteen
states filed a motion for permission to submit a brief as amicus
curiae in the case with respect to the Tribal Court's
interpretation of IGRA and in support of the position taken by
AT&T. The Company has been advised by its outside counsel,
Hunton & Williams, that based upon such firm's review of the
applicable statutes, regulations and case law, it believes that
the Lottery is authorized under IGRA and that the favorable
rulings issued by the Coeur d'Alene Tribal Court on February 28
and May 1, 1996, and the Tribal Appellate Court on July 2, 1997,
should be affirmed by the federal courts.
On May 28, 1997, the Attorney General of the State of Missouri
brought an action in the Circuit Court of Jackson County,
Missouri, against the Coeur d'Alene Tribe and UniStar seeking to
enjoin Lottery games offered by the Tribe over the Internet and
managed by UniStar. The complaint alleged that the US Lottery
violates Missouri anti-gambling laws and that the marketing of
the games violates the state's Merchandising Practices Act and
also seeks restitution, a civil penalty, attorney's fees and
court costs. The Company believes, based on the Tribal Court
rulings and the opinion of its outside counsel referred to above,
that the Missouri suit has no merit and that the Lottery
activities are legal. UniStar and the Tribe have removed the
case to the U.S. District Court for the Western District of
Missouri, which denied the State's subsequent motion for remand
back to the state court. The Court also subsequently granted a
motion to dismiss by CDA based on sovereign immunity. The Court
denied the motion to dismiss UniStar based on sovereign immunity,
although the Court indicated it might reconsider that decision.
UniStar filed a motion for reconsideration of its motion for
dismissal. The State of Missouri has filed an appeal to the
Eighth Circuit Court of Appeals relating to the dismissal of the
CDA.
On January 28, 1998, the State of Missouri sought to dismiss
voluntarily the existing case against UniStar and filed the next
day, a new action against the Company, UniStar and two tribal
officials, with essentially the same allegations, in a state
court in a different district. The State obtained a temporary
restraining order from a state judge enjoining the marketing of
the Internet and telephone lottery in the State of Missouri. On
February 5, 1998, the U.S. District Court for the Eastern
District of Missouri ruled that this second case also should be
heard in federal court, transferred the second case to the
Western District of Missouri, where the original case had been
filed, and dissolved the state court's temporary restraining
order, effective February 9, 1998. A motion to dismiss the second
case based on the sovereign
19
<PAGE>
immunity of all the defendants and a motion to abstain in favor
of the jurisdiction of the CDA Tribal Court are pending. The
State of Missouri has filed an appeal of the denial of its motion
to remand the case to State Court or in the alternative to grant
a preliminary injunction.
On September 15, 1997, the State of Wisconsin, by its Attorney
General, filed an action in the Wisconsin State Circuit Court for
Dane County against the Company, its UniStar Entertainment
subsidiary and the Coeur d'Alene Tribe of Idaho, to permanently
enjoin the US Lottery offered by the Tribe on the Internet and
managed by UniStar. The complaint alleges that the offering of
the US Lottery violates Wisconsin anti-gambling laws and that
legality of the US Lottery has been misrepresented to Wisconsin
residents in violation of state law. In addition to an
injunction, the suit seeks restitution, civil penalties,
attorneys' fees and court costs. The Company, UniStar and the
CDA removed the case to the U.S. District Court in Wisconsin. On
February 18, 1998, the District Court dismissed the Tribe from
the case based on sovereign immunity and dismissed the Company
based on the State's failure to state a claim against the
Company. Motions to dismiss the case against UniStar were
denied. UniStar has filed an appeal in the Seventh Circuit Court
of Appeals of the denial of its motion to dismiss. The State of
Wisconsin is appealing the dismissal of the Tribe. Based upon
the ruling of the Tribal Appellate Court affirming the CDA's
right to conduct the telephone lottery and the opinion of outside
legal counsel, the Company believes that the US Lottery is legal.
UniStar and the CDA intend to defend the right of the Tribe to
offer the Lottery on the Internet. However, this litigation, as
well as other litigation which could be brought by states opposed
to the NIL or its on-line US Lottery games, could prevent or
delay full operations. Based upon the anticipated outcome of the
pending legal actions, the Company does not believe the outcome
of this litigation will have a material adverse effect on the
Company's consolidated financial position, results of operations
or liquidity.
Item 2. CHANGES IN SECURITIES
Not applicable.
Item 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
Item 5. OTHER INFORMATION
Not applicable.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
11 - Statement Regarding Computation of Per Share
Earnings (see Note D of Notes to Consolidated Financial
Statements in Part I, Item 1).
b) Reports on Form 8-K
None.
20
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
EXECUTONE Information Systems, Inc.
Dated: May 14, 1998 /s/ Alan Kessman
Alan Kessman
Chairman, President and
Chief Executive Officer
Dated: May 14, 1998 /s/ Anthony R. Guarascio
Anthony R. Guarascio
Vice President Finance and
Chief Financial Officer
21
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
financial statements included in the registrant's filing on Form 10-Q for the
quarterly period ended March 31, 1998 and is qualified in it's entirety by
reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 8,470
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<RECEIVABLES> 31,027
<ALLOWANCES> 1,447
<INVENTORY> 23,550
<CURRENT-ASSETS> 65,256
<PP&E> 23,846
<DEPRECIATION> 12,396
<TOTAL-ASSETS> 136,724
<CURRENT-LIABILITIES> 43,024
<BONDS> 14,557
0
7,300
<COMMON> 497
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<TOTAL-LIABILITY-AND-EQUITY> 136,724
<SALES> 33,903
<TOTAL-REVENUES> 33,903
<CGS> 23,065
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<OTHER-EXPENSES> 14,482
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<INTEREST-EXPENSE> 508
<INCOME-PRETAX> (4,129)
<INCOME-TAX> (1,651)
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