<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR QUARTER ENDED JULY 31, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-16231
XETA Corporation
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Oklahoma 73-1130045
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4500 S. Garnett, Suite 1000, Tulsa, Oklahoma 74146
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
918-664-8200
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the registrant (1) filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 .
---- ---
Number of shares outstanding of each of the registrant's classes of common
stock, as of the latest practicable date.
<TABLE>
<CAPTION>
Class Outstanding at September 1, 1998
- -------------------------------- --------------------------------
<S> <C>
Common Stock, $.10 par value 2,028,737
</TABLE>
Page 1 of 22 consecutive pages Exhibit
Index appears on Page 21.
<PAGE> 2
PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets - July 31, 1998 3
and October 31, 1997
Consolidated Statements of Operations - For the 4
Nine months ending July 31, 1998 and 1997
Consolidated Statements of Shareholder's Equity - 5
November 1, 1997 through July 31, 1998
Consolidated Statements of Cash Flows - For the 6
Nine months ending July 31, 1998 and 1997
Notes to Consolidated Financial Statements 7
</TABLE>
2
<PAGE> 3
XETA CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
July 31, 1998 October 31,1997
------------- ---------------
(Unaudited)
<S> <C> <C>
ASSETS
------
Current Assets:
Cash and cash equivalents $ 5,214,986 $ 6,011,841
Current portion of net investment in
sales-type leases 1,741,056 2,122,405
Other receivables, net 2,644,185 1,501,843
Inventories, net (Note 4) 2,338,329 1,498,748
Deferred tax asset, net (Note 7) 467,483 61,743
Prepaid expenses and other assets 84,496 75,827
------------ ------------
Total current assets 12,490,535 11,272,407
------------ ------------
Noncurrent Assets:
Net investment in sales-type leases,
less current portion above 1,185,991 1,381,818
Purchased long distance contracts, net (Note 2) 785,310 938,958
Property, plant & equipment, net (Note 5) 1,921,518 634,905
Capitalized software production costs, net of
accumulated amortization of $423,066 at July 31,
1998 and $333,066 at October 31, 1997 626,586 537,578
Other assets 78,174 54,197
------------ ------------
Total noncurrent assets 4,597,579 3,547,456
------------ ------------
Total assets $ 17,088,114 $ 14,819,863
============ ============
LIABILITIES & SHAREHOLDERS' EQUITY
----------------------------------
Current liabilities:
Accounts payable $ 1,171,379 $ 591,822
Unearned revenue (Note 6) 3,170,267 2,877,785
Accrued liabilities 768,240 739,696
Accrued federal and state income taxes 132,522 118,874
------------ ------------
Total current liabilities 5,242,408 4,328,177
------------ ------------
Unearned service revenue (Note 6) 662,714 603,433
------------ ------------
Noncurrent deferred tax liability, net (Note 7) 504,060 551,720
------------ ------------
Commitments (Note 2)
Shareholders' equity:
Common stock; $.10 par value; 10,000,000
shares authorized, 2,286,284 and 2,207,285
issued at July 31, 1998 and October
31, 1997, respectively 228,628 220,728
Paid-in capital 5,135,818 4,859,340
Retained earnings 6,796,039 4,516,205
------------ ------------
12,160,485 9,596,273
Less treasury stock, at cost (1,481,553) (259,740)
------------ ------------
Total shareholders' equity 10,678,932 9,336,533
------------ ------------
Total liabilities & shareholders' equity $ 17,088,114 $ 14,819,863
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
3
<PAGE> 4
XETA CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months For the Nine Months
Ending July 31, Ending July 31,
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Installation and service revenues $ 3,432,990 $ 2,594,940 $ 9,564,188 $ 6,658,807
Sales of systems 3,438,804 2,644,044 8,475,713 6,676,694
Long distance services 310,444 60,241 759,508 60,241
----------- ----------- ----------- -----------
Net sales and service revenues 7,182,238 5,299,225 18,799,409 13,395,742
----------- ----------- ----------- -----------
Installation and service cost 2,185,549 1,638,130 5,986,941 4,229,097
Cost of sales 2,486,024 1,857,779 5,766,507 4,429,782
Cost of long distance services 151,653 19,927 315,024 19,927
----------- ----------- ----------- -----------
Total cost of sales and service 4,823,226 3,515,836 12,068,472 8,678,806
----------- ----------- ----------- -----------
Gross profit 2,359,012 1,783,389 6,730,937 4,716,936
----------- ----------- ----------- -----------
Operating expenses:
Selling, general and administrative 1,121,156 915,044 3,233,424 2,586,568
Engineering, research and development,
and amortization of capitalized
software production costs 126,299 104,170 376,885 308,834
----------- ----------- ----------- -----------
Total operating expenses 1,247,455 1,019,214 3,610,309 2,895,402
----------- ----------- ----------- -----------
Income from operations 1,111,557 764,175 3,120,628 1,821,534
Interest and other income 171,341 159,301 505,206 494,671
----------- ----------- ----------- -----------
Income before provision for income
taxes 1,282,898 923,476 3,625,834 2,316,205
Provision for income taxes 477,000 332,000 1,346,000 829,000
----------- ----------- ----------- -----------
Net income $ 805,898 $ 591,476 $ 2,279,834 $ 1,487,205
=========== =========== =========== ===========
Earnings per share
Basic $ 0.39 $ 0.29 $ 1.12 $ 0.74
=========== =========== =========== ===========
Diluted $ 0.34 $ 0.25 $ 0.96 $ 0.63
=========== =========== =========== ===========
Weighted average shares outstanding 2,044,876 2,010,326 2,030,898 2,002,830
=========== =========== =========== ===========
Weighted average shares equivalents 2,360,603 2,373,982 2,369,203 2,354,147
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
4
<PAGE> 5
XETA CORPORATION
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
NOVEMBER 1, 1997 THROUGH July 31, 1998
(Unaudited)
<TABLE>
<CAPTION>
Common Stock Treasury Stock
------------------------------ -------------------------------
Number of
Shares Issued Paid-in Retained
& Outstanding Par Value Shares Amount Capital Earnings
------------- ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance -
October 31, 1997 2,207,285 $ 220,728 (189,747) $ (259,740) $ 4,859,340 $ 4,516,205
Stock options
exercised 78,999 7,900 85,000
Tax benefit of
stock options 191,478
Treasury stock
acquired (58,900) (1,221,813)
Net Income 2,279,834
------------ ------------ ------------ ------------ ------------ ------------
Balance -
July 31, 1998 2,286,284 $ 228,628 (248,647) $ (1,481,553) $ 5,135,818 $ 6,796,039
============ ============ ============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
5
<PAGE> 6
XETA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
For the Nine Months
Ending July 31,
1998 1997
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net Income $ 2,279,834 $ 1,487,205
----------- -----------
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 220,234 141,356
Amortization of capitalized software
production costs and long distance contracts 243,648 81,796
(Gain) loss on sale of assets 14,517 --
Provision for doubtful accounts receivable 67,000 27,000
Change in assets and liabilities:
(Increase) decrease in net investment in
sales-type leases 577,176 1,297,301
(Increase) in other receivables (1,209,342) (405,343)
(Increase) decrease in inventories (839,581) (477,720)
Decrease in prepaid income taxes -- 173,785
(Increase) decrease in deferred tax asset (405,740) 4,541
(Increase) decrease in prepaid expenses and
other assets (32,646) 8,422
Increase (decrease) in accounts payable 579,557 315,360
Increase (decrease) in unearned revenue 351,763 (193,955)
Increase in accrued income taxes 205,125 269,624
Increase (decrease) in accrued liabilities 28,544 99,229
Increase (decrease) in deferred tax liabilities (47,660) (95,714)
----------- -----------
Total adjustments (247,405) 1,245,682
----------- -----------
Net cash provided by
operating activities 2,032,429 2,732,887
----------- -----------
Cash flows from investing activities:
Purchases of long distance contracts (1,024,318)
Additions to capitalized software (178,998) (218,849)
Additions to property, plant & equipment (1,522,225) (295,643)
Proceeds from sale of assets 852 3,827
----------- -----------
Net cash used in
investing activities (1,700,371) (1,534,983)
----------- -----------
Cash flows from financing activities:
Purchase of treasury stock (1,221,813) --
Exercise of stock options 92,900 34,058
----------- -----------
Net cash provided by financing activities (1,128,913) 34,058
----------- -----------
Net increase in cash and
cash equivalents (796,855) 1,231,962
Cash and cash equivalents, beginning of period 6,011,841 3,549,101
----------- -----------
Cash and cash equivalents, end of period $ 5,214,986 $ 4,781,063
=========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 19,051 $ 855
Cash paid during the period for income taxes $ 1,572,799 $ 726,328
</TABLE>
The accompanying notes are an integral part of these statements.
6
<PAGE> 7
XETA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
July 31, 1998
(Unaudited)
(1) BASIS OF PRESENTATION
The consolidated financial statements included herein include the
accounts of XETA Corporation and its wholly-owned subsidiary, Xetacom, Inc.
Xetacom's operations have been insignificant to date. All significant
intercompany accounts and transactions have been eliminated.
The consolidated financial statements have been prepared by the
Company, without an audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. The Company believes that the disclosures made in these
financial statements are adequate to make the information presented not
misleading when read in conjunction with the consolidated financial statements
and the notes thereto included in the Company's latest financial statements
filed as part of the Company's Annual Report on Form 10-KSB, Commission File No.
0-16231. Management believes that the financial statements contain all
adjustments necessary for a fair statement of the results for the interim
periods presented. All adjustments made were of a normal recurring nature.
(2) COMMITMENT
In April 1997, the Company entered the long distance services market
through a sales sub-agency agreement with MCI and through a marketing alliance
with Americom Communications Services, Inc. ("Americom"). Simultaneously, the
Company purchased Americom's interest in existing long distance contracts at 71
hotels. Previous to the Company's purchase of these contracts, Americom had
obtained loans from the long distance carrier, which were secured by future
commissions to be earned. To effect the transfer of ownership in these
contracts, the Company guaranteed Americom's indebtedness. At July 31, 1998, the
amount of the guarantee was $229,919.
(3) REVOLVING CREDIT AGREEMENT
The company maintains a $1,000,000 revolving line of credit with its
bank. There are no outstanding advances under the credit agreement.
7
<PAGE> 8
(4) INVENTORIES
The following are the components of inventories:
<TABLE>
<CAPTION>
July 31, October 31,
1998 1997
----------- -----------
(Unaudited)
<S> <C> <C>
Raw materials $ 962,068 $ 712,546
Finished goods and spare parts 1,591,261 1,001,202
----------- -----------
2,553,329 1,713,748
Less reserve for excess and
obsolete inventory (215,000) (215,000)
----------- -----------
$ 2,338,329 $ 1,498,748
=========== ===========
</TABLE>
(5) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
<TABLE>
<CAPTION>
July 31, October 31,
1998 1997
----------- -----------
(Unaudited)
<S> <C> <C>
Computer field equipment $ 1,308,447 $ 1,105,379
Land 611,582 10,000
Construction in Progress 661,754 10,500
Office furniture 136,143 127,527
Other 261,583 232,828
----------- -----------
2,979,509 1,486,234
Less accumulated depreciation (1,057,991) (851,329)
----------- -----------
$ 1,921,518 $ 634,905
=========== ===========
</TABLE>
(6) UNEARNED INCOME
Unearned income consists of the following:
<TABLE>
<CAPTION>
July 31, October 31,
1998 1997
---------- ----------
(Unaudited)
<S> <C> <C>
Service contracts $1,280,982 $1,522,597
Warranty service 869,308 685,955
Systems shipped, but not installed 12,153 42,825
Customer deposits 947,960 508,359
Other deferred revenue 59,864 118,049
---------- ----------
Total current deferred revenue 3,170,267 2,877,785
Noncurrent unearned service revenues 662,714 603,433
---------- ----------
$3,832,981 $3,481,218
========== ==========
</TABLE>
8
<PAGE> 9
(7) INCOME TAXES
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are presented
below:
<TABLE>
<CAPTION>
July 31, October 31,
1998 1997
--------- ---------
(Unaudited)
<S> <C> <C>
Deferred tax assets:
Prepaid service contracts $ 318,780 $ 32,305
Nondeductible reserves 278,888 207,502
Other (39,352) 20,559
--------- ---------
Total deferred tax asset 558,316 260,366
--------- ---------
Deferred tax liabilities:
Unamortized capitalized software
development costs (213,039) (182,777)
Tax income to be recognized on sales-type
lease contracts (315,894) (501,606)
Other (65,960) (65,960)
--------- ---------
Total deferred tax liability (594,893) (750,343)
--------- ---------
Net deferred tax liability $ (36,577) $(489,977)
========= =========
</TABLE>
(8) INTEREST AND OTHER INCOME
Interest and other income recorded in the accompanying financial
statements, consists primarily of interest income earned from sales-type leases
and cash investments.
9
<PAGE> 10
(9) FOOTNOTES INCORPORATED BY REFERENCE
Certain footnotes are applicable to the consolidated financial
statements, but would be substantially unchanged from those presented in the
Company's Annual Report on Form 10-KSB, Commission File No. 0-16231, filed with
the Securities and Exchange Commission on January 29, 1998. Accordingly,
reference should be made to those statements for the following:
<TABLE>
<CAPTION>
Note Description
---- -----------
<S> <C>
1 Business and summary of significant accounting policies
3 Operator services business and purchased long distance contracts
4 Income taxes
6 Accrued liabilities
8 Stock options
9 Commitments
10 Major customers and concentrations of credit risk
11 Employment agreements
12 Contingency
13 Earnings per share
15 Retirement plan
</TABLE>
10
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Throughout fiscal 1998, XETA Corporation ("the Company") has posted record net
income and sales as the Company continues to penetrate the rapidly expanding
hospitality market with its products and services. Although all of the Company's
major revenue sources have shown increases for the year to date period, the
Company's PBX product and service offering continues to be its fastest growing
revenue stream. Management intends to continue to focus the Company on its
present course of expanding the Company's base of hospitality customers by
maintaining the Company's reputation for service quality, introducing new
products, and enhancing existing products. In addition, the Company is actively
evaluating possible synergistic acquisitions both inside and outside the
hospitality sector.
For the quarter ending July 31, 1998, the Company earned net income of $806,000
or $.34 per share (diluted) on net sales of $7.182 million compared to net
income of $591,000 or $.25 per share (diluted) on net sales of $5.299 million
for the third quarter of fiscal 1997. For the nine months ending July 31, 1998,
the Company earned net income of $2.280 million or $.96 per share (diluted) on
net sales of $18.799 million compared to net income of $1.487 million or $.63
per share (diluted) on net sales of $13.396 million.
The discussion which follows provides further analysis of the major factors and
trends which management believes had the most significant impact on the
financial condition of the Company as of July 31, 1998 and the results of
operations for the quarter and nine month periods then ended as compared to
those same periods a year ago. Also included in this discussion are the major
factors, trends and risks which management believes will affect the outlook for
the Company. This analysis should be read in conjunction with the Consolidated
Financial Statements and Notes thereto contained in this report.
FINANCIAL CONDITION
The Company's financial condition remains strong. Cash balances at July 31, 1998
were $5.215 million, which represented 31% of total assets and 49% of book
value. The Company's working capital on July 31, 1998 was $7.248 million and
there was no debt. Cash balances have decreased $797,000 during fiscal 1998.
Most of this decrease was associated with the Company's common stock repurchase
program during the year as well as acquisition of land and the initial
construction costs associated with the Company's relocation to a new, larger
facility.
Repurchases of stock totaled $1.222 million during the first nine months of the
year representing the purchase of 58,900 shares. These repurchases were made
pursuant to a previously announced stock buy-back program. The Company has begun
construction of a 37,000 square foot facility that will house all of the current
Tulsa operations. The total cost of the project is expected to be $3 million and
the Company's relocation should be complete by the end of the second quarter of
fiscal 1999. During fiscal 1998, the Company has spent $1.253 million on the new
facility, including $.602 million on the acquisition of land.
Partially offsetting the effect of the expenditures for the stock repurchases
and the construction of the new facility was cash earned from operations of
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<PAGE> 12
$2.032 million. This included net income of $2.280 million less adjustments to
net income of negative $.247 million. These adjustments included significant
increases in both accounts receivable and inventories, both of which are
primarily the result of the Company's rapid expansion during the year.
Management believes that cash flows from operations and existing working capital
will be sufficient to meet the Company's working capital needs in the immediate
future and to fund the remaining estimated construction and relocation costs
associated with the Company's move to a new facility. Management is continually
evaluating opportunities to expand the Company's operations in the hospitality
market as well as other opportunities that would diversify the Company's
operations into other markets. In addition to synergistic acquisitions, the
Company also regularly evaluates the formation of new alliances or distribution
agreements to expand the Company's distribution of its own products or to add
additional products to the Company's current product and service offerings.
Management believes additional sources of working capital, either debt, equity,
or both, would be available to the Company should existing cash balances be
insufficient to finance the consummation of a viable project that might result
from these evaluations.
RESULTS OF OPERATIONS
Revenues increased 36% and 40% for the three and nine month periods ending July
31, 1998, respectively, compared to those same periods in fiscal 1997. The
increases in the third quarter of fiscal 1998 compared to the third quarter of
fiscal 1997 included an increase in installation and service revenues of
$838,000 or 32%, an increase in systems sales of $795,000 or 30%, and an
increase in long distance services of $250,000 or 415%. For the nine month
period ending July 31, 1998 compared to the same period in fiscal 1997,
installation and service revenues increased $2.905 million or 44%, systems sales
increased $1.799 million or 27%, and long distance revenues increased $699,000
or 1161%. Note that the increases in long distance revenues experienced during
fiscal 1998 are not indicative of a future trend as this is a new revenue source
for the Company which did not begin until the third quarter of fiscal 1997.
The Company's revenues can also be examined by product line. Revenues generated
by sales and services of PBX systems increased 42% during the third quarter
compared to the third quarter of fiscal 1997 and increased 44% for the nine
month period ending July 31, 1998 compared to the same period in fiscal 1997.
Revenues from call accounting related activities, including both sales of
systems and services, were relatively unchanged in the third quarter of the
current year compared to the third quarter of last year, but have increased 13%
during the year to date periods. A discussion of these changes by product line
is presented more fully below.
PBX Systems Sales. Sales of PBX systems increased $819,000 or 36% in the third
quarter and increased $1.544 million or 28% for the first nine months of fiscal
1998. The growth in the sales of new PBX systems has been fueled by two major
factors, the continued broad acceptance of the Company's PBX product and service
offering and the robust growth of the overall hotel industry. The Company
continues to gain market share in this portion of its business by
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<PAGE> 13
providing competitive pricing of its PBX package and a high quality,
non-disruptive installation program. In addition, the Company is enjoying the
fruits of a very healthy and expanding hotel industry. Construction of new
hotels, primarily in the smaller, extended-stay segment of the market, is
helping to generate a general expansion of the market.
PBX Service Revenues. Service revenues from PBX related activities grew $812,000
or 50% during the third quarter and $2.659 million or 68% during the first nine
months of fiscal 1998. This growth reflects the high level of retention of PBX
service customers and the Company's success in securing new service contracts
from customers with previously installed Hitachi PBX systems. The growth in
revenues derived from PBX service customers has been a major factor in the
Company's success during the past three years. Management is committed to
ensuring that this growing base of recurring revenues is supported with trained
personnel and adequate administrative support to maintain the Company's
reputation for high quality service. Maintaining that reputation and
consequently, the base of customers enjoying the Company's service offering,
will be the key to the Company's success whether or not the current expansion in
the hospitality market continues.
Call Accounting Systems Sales. Sales of call accounting systems decreased
$18,000 or 5% in the third quarter, but have increased $268,000 or 24% for the
year to date period. Sales of call accounting systems have exceeded management's
expectations this year. This growth is being fueled by two factors: the
expansion of the hospitality market and the Company's long distance service
offering. As part of the long distance offering, customers have the option to
receive a call accounting system as part of the service. To compensate the
Company for the use of the system and service on it, a monthly fee approximately
equal to the price of a turnkey service agreement for their system is deducted
from the hotel's commissions. The Company allocates this monthly fee to call
accounting system sales and to service revenues to properly reflect the nature
of these revenues. Call accounting revenues earned from the Company's long
distance service offering are not expected to expand further. See further
discussion below under "Long Distance Services".
Call Accounting Service Revenues. Call accounting service revenues increased
$26,000 or 3% during the third quarter and $247,000 or 9% for the year to date
period. This increase reflects the growth in new customers from increased sales
of systems as discussed above and the Company's ability to consistently maintain
and increase its base of call accounting customers under service contracts.
Long Distance Services. Revenues earned from long distance services were
$310,000 in the third quarter and $760,000 for the first nine months of the
year. As noted above, revenues from the Company's long distance service offering
began during the third quarter of fiscal 1997 and were still "ramping-up" at
that time. The majority of the Company's long distance revenues are derived from
commissions earned from 71 contracts purchased from Americom Communications
Services, Inc. in April 1997. Additions to this beginning base of accounts has
not met management's expectations. Management does not expect future revenues or
gross profits to be significantly different from those currently being earned.
Gross Margins. Gross margins earned on total revenues were 33% in the third
quarter of fiscal 1998 compared to 34% in the third quarter of fiscal 1997.
Gross margins earned on total revenues for the nine month period ending July 31,
1998 were 36% compared to 35% for the same period in fiscal 1997. The gross
margins earned on systems sales declined slightly in both the third
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<PAGE> 14
quarter comparison (from 30% in 1997 to 28% in 1998) and the nine month
comparison (from 34% in 1997 to 32% in 1998). These lower margins reflect the
greater portion of smaller PBX systems sold during the third quarter of fiscal
1998. Most of these systems are being sold to the extended-stay market which is
highly price-driven and is very competitive. Gross margins earned on service
revenues decreased slightly during the third quarter, but has shown a slight
increase for the year to date period. The margins earned on service revenues
during these periods are within the historical range of 36% to 38% and
management believes these margins will be sustained for the remainder of the
current fiscal year. The gross margins earned on long distance services were 51%
during the third quarter of fiscal 1998 and were 58% for the nine month period
ending July 31, 1998. Comparisons to the previous year's long distance gross
margins are not meaningful due to the startup nature of those revenues in fiscal
1997.
Operating Expenses. Operating expenses increased $206,000 or 23% during the
third quarter of fiscal 1998 compared to the third quarter of fiscal 1997 and
increased $647,000 or 25% for the nine months ending July 31, 1998 compared to
the same period in fiscal 1997. These increases primarily reflect increases in
expenses that are directly related to the growth in revenues and profitability,
such as commissions and executive bonuses. However, they also reflect additional
sales and administrative personnel expense required to support the Company's
growth. Also reflected in these increases are accruals the Company has made
associated with the Company's relocation to a new facility.
Interest and Other Income. Interest and other income increased $12,000 or 8% in
the third quarter and $11,000 or 2% during the year-to-date period. The majority
of interest income earned by the Company is from interest on XETAPLAN
receivables. The Company's portfolio of these leases has been maturing at a
rapid rate, but during the second and third quarters of fiscal 1998 a
significant portion of the Company's call accounting sales were made through the
XETAPLAN program, either through new sales or through renewals of expiring
XETAPLANS. These new XETAPLANs are helping to reverse the decline in interest
income from this source. The Company also earns interest income on its idle cash
balances. The Company invests these balances in money market accounts.
Tax Expense. The Company has recorded a combined federal and state tax provision
of 37% of income before taxes throughout fiscal 1998 compared to a combined
provision of 36% used throughout fiscal 1997. The increase in the tax rate
reflects primarily the estimation of state taxes, which fluctuates based on the
Company's sales volumes in each state.
OUTLOOK AND RISK FACTORS
The statements contained in this section are based on current expectations. The
statements are forward-looking in nature and actual results may differ
materially. The Company's Form 10-KSB for the year ended October 31, 1997
contains an expanded discussion of risk factors that should be read in
conjunction with this report.
The Company continues to expand its market share in the hospitality industry,
which is currently a rapidly expanding and healthy market. In the near term,
management believes the Company will continue to enjoy strong sales of its
products and rapid growth of its customer base, especially for its PBX product
line. Throughout the first nine months of the year and up to the filing of
14
<PAGE> 15
this report, the Company's backlog of sales orders remained very strong.
Currently, a slow-down in the growth of the hospitality sector of the economy is
not predicted in the near-term; however, such a slow-down would likely
negatively impact the growth rate of the Company. Nevertheless, it is important
to note that as the Company's customer base is expanding, so is its recurring
base of service revenues. Historically, the Company has a very high customer
retention rate and the majority of those customers produce regular, monthly
service revenues for the Company. This base of recurring service revenues should
help cushion the effects of a slow-down in orders for new systems, if such a
slow-down should occur.
Recently, there has been a surge in consolidation of ownership of hotel
properties, particularly by real estate investment trusts ("REITS"), some of
which have tax-advantaged corporate structures. This consolidation has produced
some risks to the Company as industry personnel are shuffled and consolidated as
well. To date, the impact on the Company has been positive, but the ultimate
potential impact of these changes to the Company is still unknown. Recently,
changes to IRS regulations have been proposed that would significantly reduce
the tax-favored status enjoyed by several of the REITS. There is a general
consensus that these changes will be enacted into law. In response, one of the
largest hotel REITS, and a significant customer to the Company, has recently
announced that it will be converting to C-Corp status. Press reports speculate
that the other major hotel REITS, which have enjoyed the same tax-advantaged
status, will also make similar changes to their structure. While no assurance
can be given, at the present time management does not expect that these changes
will have a material, adverse impact on the Company.
The Company continues to invest significant resources into the development of
its XPANDER(R) system. The initial phase of the XPANDER(R) system is in
production; however, development continues on additional features and on other
XPANDER(R)-based products. To date, all installed XPANDER(R) systems are
operating satisfactorily. The market for XPANDER(R) is continuing to develop,
but the timing of its development has been slower than hoped. Management
continues to believe very strongly that a majority of business oriented hotels
will eventually convert to multiple telephone line access and that the
XPANDER(R) system will be the solution chosen by many hoteliers.
During the third quarter, the Company announced a new call accounting product,
the Virtual XL(TM) Series. This product, which consists of four new models of
the Company's XL(R) Series call accounting systems, enables the Company's
customers to access the system's screens and reports utilizing an Internet
browser. This access can be performed either on site through the hotel LAN or
remotely via an Internet or Intranet connection. The VIRTUAL XL(TM), which was
an offshoot from the development of the XPANDER(R) system, is a timely answer to
the trend toward centralized ownership and management of hotels as well as the
trend toward connectivity of hotel information systems. The Company has
installed several VIRTUAL XL(TM) systems that are operating satisfactorily.
While no assurance can be given as to future sales levels, management is
enthused with market reaction to this product to date.
Since the middle of 1997, the Company has been assessing the potential effect of
the year 2000 on its business. This evaluation is on-going and will continue up
to and through the beginning of that year. The issues surrounding the year 2000
("Y2k") are extremely complex for any supplier of personal computer ("PC")
products. PC motherboards and the internal software on those
15
<PAGE> 16
boards, called BIOS, can contain innumerable variations, which could affect
performance after December 31, 1999. In addition, the Company's proprietary
software is also susceptible to potential Y2k problems. The Company has
addressed these issues as described below. For its PC-based product lines, which
include the XL(R) and VIRTUAL XL(TM) Call Accounting Series, XPERT(R) Answer
Detection Systems and BUFFY+ call buffering systems, the Company has developed a
- - software upgrade which includes patches designed to compensate for all Y2k
issues for which the Company has become aware. This upgrade is available to all
of the Company's customers with XL(R) and VIRTUAL XL(TM) systems. For those
customers with service contracts on their systems, the upgrade will be provided
with their regular rate table update. Customers not under service contracts will
be required to pay a nominal fee to receive the upgrade. All of the Company's
customers are being contacted to make them aware of the software upgrade. In
addition to the upgrade for the Company's proprietary software, the Company will
be providing its customers with a test disk to enable the customer to test their
specific version of motherboard and BIOS to determine if they have additional
Y2k issues not addressed by the Company's software patch. Due to the extreme
complexity of this issue, there can be no assurance given that the Company's
response to these issues will be sufficient to prevent disruption in its
business on January 1, 2000. The Company's other major systems that are not
PC-based, such as the XD(R), XDM(R), XACT(R), and XXAM(R) systems, are not
expected to be affected by Y2k. The Company distributes Hitachi PBX systems and
Centigram voice mail systems as well as other micro-processor based ancillary
products which may be affected by Y2k issues as well. Currently, management is
satisfied that manufacturers of these systems are addressing this issue.
However, as with its own products, the Company cannot provide any assurances
that Centigram's and Hitachi's response to these issues will be sufficient to
prevent disruption of the Company's business on January 1, 2000.
The Company is involved in two matters of pending litigation (See "Legal
Proceedings" under Part II below). In one of these matters (Phonometrics), the
Company is only indirectly involved and based on the current status of the
litigation, management expects this matter to be resolved with no material
impact to the Company's financial statements. In the ABTS matter, the trial that
was previously scheduled for July was postponed and currently is not firmly
scheduled. There are several pre-trial matters still pending before the court
and although management desires very strongly to bring this matter to a
resolution, it will continue to work through the legal process to resolve and
further clarify as many of the issues as possible prior to the trial. No loss
contingencies, other than the estimated cost of bringing the ABTS matter to
trial, have been recorded in the financial statements. Should the ABTS case be
resolved unfavorably, the Company may have to record additional expenses that
could cause operating results to be materially lower than those expected.
16
<PAGE> 17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
ABTS
In June, 1995, Associated Business Telephone Systems ("ABTS") initiated
an action against the Company which is currently pending in the United
States District Court for the Northern District of Oklahoma. ABTS
claims' are based upon allegations of breach of contract including
alleged violations of certain exclusivity rights held by ABTS, and
tortious interference with ABTS' relationships with certain of its
customers, arising in connection with (i) a Distributor's Agreement
entered into between the Company and D & P Investments in 1986,
pursuant to which the Company sold to D & P Investments certain call
accounting systems (D & P has allegedly assigned its claims under this
agreement to ABTS), and (ii) a Maintenance Agreement between the
Company and ABTS pursuant to which the Company furnished maintenance
services for such systems. Other claims raised by ABTS, including a
breach of warranty claim, have been dismissed by the Court on summary
judgment motion or during a pretrial hearing held in June, 1998. The
Company has filed a counterclaim against ABTS and a third-party claim
against D & P Investments based upon breach of contract.
ABTS originally sought damages on its claims against the Company in the
aggregate amount of approximately $1,000,000. This damage claim has
been reduced as the Court has dismissed some of ABTS' claims. At
present, ABTS seeks damages on its remaining claims in the approximate
amount of $809,000. The Company seeks damages on its counterclaims
against ABTS in excess of $3,000,000. On August 19, 1998, the Court
re-opened discovery on the limited issue of damages. Such discovery is
presently being conducted by both sides in this matter.
The previously scheduled July 20th trial date was postponed by the
Court on its own motion due to the Court's problems with scheduling. A
new trial date has not been scheduled and likely will not be until the
additional discovery on damages has been concluded. The Company intends
to continue to vigorously defend ABTS' claims against it and to
vigorously pursue all of its counterclaims against ABTS.
PHONOMETRICS
For the past several years, the Company has been monitoring the
progress of numerous patent infringement lawsuits filed by
Phonometrics, Inc., a Florida corporation, against certain
telecommunications equipment manufacturers and hotels who use such
equipment. While the Company has not been named as a defendant in any
of these cases, several of its customers are named defendants and have
notified the Company that they seek indemnification under the terms of
their contracts with the
17
<PAGE> 18
Company. Because there are other equipment vendors implicated along
with the Company in the cases filed against its customers, the Company
has not assumed the outright defense of its customers in any of these
actions.
The cases filed by Phonometrics against the Company's customers are
pending in the Southern District of Florida (the "Florida litigation")
and the Northern District of California (the "California litigation").
In each of the lawsuits, Phonometrics is seeking damages of an
unspecified amount, based upon a reasonable royalty of the hotels'
profits derived from use of the allegedly infringing equipment during a
period commencing six years prior to the filing of the lawsuit and
ending October 30, 1990. Phonometrics is barred from seeking an
injunction against continued use of the equipment since the patent
expired in October, 1990.
With regard to the Florida litigation, the Florida court heard the
cases filed by Phonometrics against the equipment manufacturers, and
ruled against Phonometrics and in favor of the equipment manufacturers,
including Northern Telecom. The court then stayed the cases filed
against the hotels (which includes the cases involving the Company's
customers), pending the outcome of Phonometrics' appeal of the court's
decision in favor of Northern Telecom. In its order staying the hotel
cases, the Florida court stated that it would enter final judgment in
favor of all of the hotels in the event the appeals court upholds the
Florida court's decision against Phonometrics in the Northern Telecom
case. The California litigation was also stayed pending the outcome of
the Florida litigation.
On January 15, 1998, the United States Court of Appeals for the Federal
Circuit affirmed the Florida court's decision against Phonometrics and
in favor of Northern Telecom, finding that as a matter of law the
accused products cannot infringe Phonometrics' patent. Subsequently, on
February 17, 1998 Phonometrics sought to revive its case against
Northern Telecom by filing a motion with the Florida court seeking
leave to amend (for the second time) its complaint against Northern
Telecom. This motion was denied by the Florida Court on April 17, 1998
and on May 15, 1998 Phonometrics filed a notice of intent to appeal the
Court's decision denying its motion seeking leave to amend its
complaint. On August 11, 1998, the Court of Appeals dismissed
Phonometrics' notice of appeal for failure to prosecute.
While it appears that this latest defeat for Phonometrics will clear
the way for the lower Florida Court to follow through with its stated
intention of dismissing the hotel cases once the Northern Telecom
matter is finally concluded in favor of Northern Telecom, as of August
27, 1998, the docket sheet for the Florida hotel cases did not reflect
any recent activity and these cases remain stayed.
18
<PAGE> 19
Items 2, 3, 4, and 5 of Part II have been omitted because they are inapplicable
or the response thereto is negative.
Item 6.
(a) Exhibits - See the Exhibit Index.
(b) Reports on Form 8-K - During the quarter for which this report is
filed, the Registrant did not file any reports with the Securities and
Exchange Commission on Form 8-K.
19
<PAGE> 20
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.
XETA CORPORATION
(Registrant)
Dated: September 10, 1998 By: /s/ JACK R. INGRAM
-------------------------------
Jack R. Ingram
President
Dated: September 10, 1998 By: /s/ ROBERT B. WAGNER
-------------------------------
Robert B. Wagner
Vice President of Finance
20
<PAGE> 21
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEC. NO. DESCRIPTION
- -------- -----------
<S> <C>
(2) Plan of acquisition, reorganization, arrangement, liquidation or
succession - None.
(3) Articles of Incorporation and Bylaws - previously filed as Exhibits
3.1, 3.2, and 3.3 to the Registrant's Registration Statement on Form
5.1, Registration No. 33-7841.
(4) Instruments defining rights of security holders, including indentures -
previously filed as Exhibits 3.1, 3.2 and 3.3 to the Registrant's
Registration Statement on Form S-1, Registration No. 33-7841.
(10) Material Contracts - none
(11) Statement re: computation of per share earnings - Inapplicable.
(15) Letter re: unaudited interim financial information - Inapplicable.
(18) Letter re: change in accounting principles - Inapplicable.
(19) Report furnished to security holders - None.
(22) Published report regarding matters submitted to a vote of security
holders - None.
(23) Consents of experts and counsel
23.1 Consent of Arthur Andersen LLP
(24) Power of attorney - None.
(27) Financial Data Schedule
(99) Additional exhibits - None.
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our report
and to all references to our Firm included in or made a part of the Form S-8
made by Xeta Corporation on August 28, 1995. It should be noted that we have not
audited any financial statements of the Company subsequent to October 31, 1997
or performed any audit procedures subsequent to the date of our report.
ARTHUR ANDERSEN LLP
Tulsa, Oklahoma
September 9, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON
PAGES 3 AND 4 OF THE COMPANY'S 10 QSB FOR THE YEAR TO DATE AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> OCT-31-1998
<PERIOD-END> JUL-31-1998
<CASH> 5,214,986
<SECURITIES> 0
<RECEIVABLES> 2,644,185
<ALLOWANCES> 0
<INVENTORY> 2,338,329
<CURRENT-ASSETS> 12,490,535
<PP&E> 1,921,518
<DEPRECIATION> 0
<TOTAL-ASSETS> 17,088,114
<CURRENT-LIABILITIES> 5,242,408
<BONDS> 0
0
0
<COMMON> 228,628
<OTHER-SE> 10,450,304
<TOTAL-LIABILITY-AND-EQUITY> 17,088,114
<SALES> 7,182,238
<TOTAL-REVENUES> 7,182,238
<CGS> 4,823,226
<TOTAL-COSTS> 4,823,226
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,282,898
<INCOME-TAX> 477,000
<INCOME-CONTINUING> 805,898
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 805,898
<EPS-PRIMARY> .39
<EPS-DILUTED> .34
</TABLE>
