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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended October 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-16231
XETA Corporation
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(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 Identification No.)
incorporation or organization)
1814 West Tacoma, Broken Arrow, Oklahoma 74012
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (918) 664-8200
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.05 par value
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(Title of Class)
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 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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant as of December 31, 1999 (based upon the
average bid and asked prices of such shares) was approximately $109,816,700.
The number of shares outstanding of the registrant's Common Stock as of
December 31, 1999 was 4,127,508 (excluding 509,394 treasury shares).
Exhibit Index appears at Page 23.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement to be filed with the Securities and
Exchange Commission in connection with the Annual Meeting of Shareholders to be
held April 11, 2000 are incorporated into Part III, Items 11 through 13 hereof.
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PART I
ITEM 1. BUSINESS
DEVELOPMENT AND DESCRIPTION OF BUSINESS
XETA Corporation (the "Company"), an Oklahoma corporation formed in 1981,
provides telecommunications products and services. Installation and service of
the Company's products represents an integral part of the Company's business.
From its inception the Company's primary focus has been to market its products
to the lodging industry. These products include various communications systems
and call accounting systems, which are the primary systems used by hotels to
provide telephone related services to their guests, to provide the information
necessary to bill guests for telephone calls, and to properly manage the
telecommunications environment at the hotel.
While the Company will continue to devote substantial resources to the
continued growth of its hospitality business, in July 1999, the Company
announced its plans to expand beyond the lodging industry and to build a
substantial distribution channel proficient in both voice and data
communications products to the broader commercial market. As part of this
expansion, the Company hired Jon A. Wiese, a former Corporate Officer and Vice
President of Lucent Technologies, Inc., to serve as the Company's President and
Chief Operating Officer effective August 2, 1999. The Company's previous
President, Jack R. Ingram, remains as CEO and Chairman of the Board.
The Company's desire to expand into the commercial market is fueled by
changes in technology which management expects will lead to significant changes
in the communications industry over the next few years. With the advent of
packet switching technology, it is expected that voice and data networks will
converge. This will require that telecommunications providers, such as the
Company, become more proficient with voice, data and converged networks. The
Company plans to build its commercial channel and its proficiency in these new
converged networks through a series of selective acquisitions supplemented with
internal growth.
Reflecting the Company's expanded strategy, on November 30, 1999, the
Company acquired 100% of the stock of U.S. Technologies Systems, Inc. ("USTI"),
a major dealer of Lucent Technologies' products to the commercial market. USTI
was acquired for $26 million in cash and 150,000 shares of XETA common stock.
Financing for the transaction was provided through a $23 million, five year term
loan which is part of a $40 million credit facility established simultaneously
with the closing of the USTI transaction.
On August 13, 1999, the Company effected a two-for-one stock split by
reducing the par value of the common stock to $.05 per share. All share amounts
reflected in this report have been restated accordingly to give effect to the
stock split. The number of issued and outstanding shares at October 31, 1999 was
3,977,308.
HOSPITALITY PRODUCTS
Communications Systems. Communications systems, also known as private
branch exchanges ("PBX's"), connect the hotel to outside telephone networks
operated by common carriers and route calls to, from and between extensions in
the hotel. The Company distributes the Hitachi 5000(R) Series Digital
Communications System and the Lucent Guestworks(TM) communications system under
nationwide, non-exclusive dealer agreements. Both the Hitachi and Lucent systems
are equipped with lodging specific software which integrates with nearly all
aspects of the hotel's operation. The Company also offers a variety of related
products such as voice mail systems, analog telephones, uninterruptable power
supplies, announcement systems, etc. These products are generally sold in
conjunction with the sale of new communications systems and, with the exception
of voice mail systems, are purchased from regional and national suppliers. The
Company sells voice mail systems under a nation-wide, non-exclusive
distributorship agreement with Baypoint Innovations, formerly Centigram
Communications Corporation. Sales of communication systems represented 35%, 36%,
and 41% of total revenues in fiscal 1999, 1998, and 1997, respectively.
The Company has developed a PBX related proprietary product marketed under
the name "XPANDER(R)", to respond to the growing demand for additional telephone
line access in hotel rooms by guests who desire to connect portable
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computers to computer networks such as the Internet, while still having the
ability to make and receive voice calls on a separate telephone line. To meet
this demand, hotels must either add more capacity to their existing
communications system, or replace their existing system with a larger one that
can accommodate more telephone extensions. Alternatively, hotels can use the
XPANDER(R) system, which is generally less expensive than the other options.
However, to date demand for XPANDER(R) systems has been weak as most hotels have
chosen to add additional lines in their rooms by increasing the size of their
existing communications systems. Management continues to believe that demand for
XPANDER(R) will increase and the Company continues to develop additional
features and capabilities of the system.
Call Accounting Products. Call accounting systems act as a strategic link
between a hotel's communications system and its guest billing system to enable
the hotel to earn revenue from guest calls. These systems capture certain
telephone usage information; use that information to calculate call charges,
markup and taxes; and then transmit the charges to the hotel's guest billing
system. All of the Company's call accounting products are designed and
manufactured by the Company and interface to virtually all types of PBX's and
hotel billing systems.
The Company markets its call accounting products as the Virtual XL(TM)
Series ("VXL"), XL(R) Series and XPERT(R) answer confirmation systems. The
Company sells its VXL(TM) and XL(R) systems under a variety of sizes to meet the
needs of small to large hotels. The VXL(TM) product line was introduced during
1998 and is designed to operate on a hotel's Local Area Network ("LAN") or a
hotel management company's Wide Area Network ("WAN"). If connected to a LAN or
WAN that is also connected to the Internet, the VXL(TM) can also be accessed via
an Internet connection. The connectivity features of the VXL(TM) provide for
much greater accessibility to the reporting features of the system. To reduce
the opportunity of unauthorized access, all of the Company's call accounting
systems have user codes and password protections.
Answer confirmation systems are a complimentary product to call accounting
and are designed to minimize guest charges for unanswered calls and to allow
hotels to bill for answered calls of short duration which would otherwise be
treated as unanswered and therefore not be billed. Most call accounting systems,
including the Company's systems, record and bill guests for calls which exceed a
designated duration. The Company's XPERT(R) systems provide confirmation of the
status of the call by monitoring trunk voltages associated with outgoing calls,
thereby improving the accuracy of the hotel's guest billings and reducing guest
complaints for improper charges.
All of the Company's call accounting products operate on personal
computer-based platforms. In the case of the XL(R) systems, the call accounting
and answer confirmation functions can, depending on the size of the system, be
combined into one integrated system, thereby reducing the customer's acquisition
and maintenance costs. Additionally, the XPANDER(R) system can operate the XL(R)
Series software while simultaneously providing additional telephone extensions.
The Company also has developed a buffering system, BUFFY+, to allow for the
capture of call information for later billing should the call accounting system
fail or become slowed by a high volume of calls or extensive requests for
reports.
Long Distance Services. The Company markets a variety of long distance
services to hospitality customers. The Company offers these services as an
authorized sales subagent pursuant to agreements with L.D. Communications, Inc.
("LDCI"), which has agreements with MCI Worldcom ("MCI"), for the sale of MCI's
long distance services. The Company's agreements with LDCI expire in April,
2000, but allow LDCI to terminate the agreements earlier should its underlying
contracts with MCI be terminated for any reason. The Company earns commissions
on calls made by guests at customer locations which have contracted for MCI's
long distance services through the Company. The Company markets long distance
services jointly with Americom Communications Services, Inc. ("Americom") under
a marketing alliance agreement. Americom is owned by Robert Jones, a co-founder
and former officer and director of the Company. The Company has not been able to
effectively compete in the marketing of long distance services (see
"Competition" below) and expects most of its long distance service contracts to
expire without renewal during fiscal 2000.
System Service and Warranty. The lodging industry is a 24 hour-per-day,
demanding environment in which any significant problem with the
telecommunications system can quickly rise to crisis status. In addition to
developing and building reliable systems, the Company has designed extensive
remote service capabilities into each of its systems and has built a national
network of Company technicians as well as third party service providers to meet
the needs of this environment. The remote service capabilities, which have been
a critical element of the Company's products since its inception, enable
technicians at the Company's Service Center to quickly diagnose, and in most
instances, correct system malfunctions without the need of an on-site service
call.
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The Company provides a one-year limited warranty, generally from the date
of installation, on its proprietary call accounting products and XPANDER(R)
systems. After the warranty period, service for such products is available under
remote and direct service agreements. Under a remote service agreement, coverage
of the equipment includes only those malfunctions which can be corrected via
modem or through verbal instructions given to the customer over the telephone.
Direct service agreements include remote service coverage plus on-site service
and parts and labor coverage for defects in equipment provided by the Company.
The Company's service agreements are generally for one year in duration. Due to
the critical nature of call accounting systems to the telephone revenues of the
hotel, the majority of the Company's customers elect to purchase service
agreements.
With regard to communications systems provided by the Company, the Company
either sells the equipment with the manufacturer's warranty, or provides its own
one-year warranty against defects in the equipment. Any labor costs associated
with fulfilling the warranty requirements are generally borne by the Company.
Subsequent to the warranty period, the Company provides a unique, hotel-oriented
service plan. This service plan includes parts and labor coverage on the
communications system plus a XETA call accounting system as well as other
service options designed to meet the specific needs of each customer and to
build a long-term relationship with that customer.
Revenues from installation and services provided by the Company represented
50%, 52% and 50% of consolidated revenues in fiscal years 1999, 1998 and 1997,
respectively.
COMMERCIAL PRODUCTS
The Company also sells Lucent telecommunications equipment to commercial
(non-lodging) customers through its newly-acquired division, USTI. USTI is a
Lucent Diamond Business Partner and sells and supports only Lucent
communications systems and phones. The Lucent family of communications systems
offered by the Company include Definity(R) Systems, Merlin Legend(R) Advanced
Solutions systems, and the Partner(R) Communications Systems product family, as
well as Lucent's Intuity(R) voice mail systems.
The Definity(R) family of systems is Lucent's primary communications
product for larger businesses. The Company distributes three versions of the
Definity(R): the Enterprise Communications Server, the ProLogix(TM) Solutions
system, and the Business Communications System. These three systems vary in the
number of lines and stations they can support as well as the features available.
The Merlin Legend(R) Advanced Solutions ("Legend") product is aimed at mid-range
businesses and supports up to 80 telephone lines and 200 stations. The Legend
system includes some of the features found in the Definity(R) product line and
therefore works well for businesses with growing needs or satellite offices of
larger companies. The Partner(R) family of communications systems is primarily
for small businesses, but contains some of the basic features found in larger
systems, such as connectivity to fax machines, credit card readers, answering
machines, and modems, but without special adapters. Within the Partner
Communications Systems product family, the Company distributes the Partner(R),
Partner(R) Plus, Partner(R) II, and the Partner(R) ACS Communications Systems.
Through its recent acquisition of USTI, the Company now has the opportunity
to provide installation and maintenance support on Lucent systems sold to the
commercial market. Prior to the acquisition, USTI's operating model was to
out-source most installation activities to third party vendors and most
maintenance activities to Lucent. One of the synergistic characteristics of the
USTI acquisition was the possibility of using the Company's existing nation-wide
service infrastructure to perform more of these installations and therefore
enhance operating margins. To that end, the Company is currently working to
increase its installation capabilities to begin installations of commercial
channel systems in the second fiscal quarter of 2000. Initial installation
activities will focus on the Definity(R) product line.
While service and maintenance after the installation is an important factor
in the commercial market, the need for 24 hour per day, seven day a week service
capabilities is not as critical as in the hospitality market. As a result, the
Company will be designing service packages for its commercial customers that are
more tailored to this market. In addition, because many of the sales of systems
to the commercial market are made through "partnering" arrangements with
Lucent's direct sales force (see further discussion of "partnering" under
"Marketing" below), the Company will be offering Lucent service contracts on
most "partnering" sales.
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SOFTWARE AND PRODUCT DEVELOPMENT
For the past several years, most of the Company's development efforts were
devoted to the XPANDER(R) system (see "Communications Systems" under
"Hospitality Products" above). The Company has developed both the hardware and
software for this system. During the past year, most XPANDER(R) development was
spent on enhancements to the system. Generally, these enhancements are being
made so that guest extensions hooked to the XPANDER(R) system perform and have
the same features as guest extensions hooked to the hotel's PBX. A by-product of
the Company's work on XPANDER(R) was the VXL(R) system which was introduced in
fiscal 1998 and represented a substantial portion of the increase in call
accounting sales enjoyed by the Company during fiscal 1999. The estimated amount
spent on research and development activities during the past three fiscal years
is presented in the financial statements contained in this report.
MARKETING
Hospitality. In marketing its products to the hospitality industry, the
Company utilizes its experience and reputation in the industry to build
long-term relationships with the wide-range of personnel (such as corporate
hotel chain personnel, property management officials, industry consultants,
hotels owners and on-site financial or operating officers) involved in the
decision making process for the purchase of hotel telecommunications equipment
and services. These relationships are one of the keys to the Company's past and
future success. The Company primarily uses its direct sales staff to market its
hospitality products and services. At December 31, 1999, the Company employed 14
persons directly involved in the sales and marketing of its lodging products and
services. In addition, since 1989 the Company has engaged Robert A. Jones
through Americom, as an independent agent to represent the Company's call
accounting products on an exclusive basis to some of the Company's major
customers, including Marriott Host/Marriott International. The Company considers
its relationship with Mr. Jones to be good and does not believe that its
relationship with Marriott Host/Marriott International is predicated on the
basis of its relationship with Mr. Jones. The Company has also engaged other
independent sales agents to represent its products to certain hotels or segments
of the market, but none of these agents represent products to major customers of
the Company.
While the lodging industry is currently enjoying the same favorable
economic cycle as the U.S. economy as a whole, historically tight budgetary
controls and lack of capital and borrowing ability characterize this sector of
the economy. As a result, early on the Company developed innovative and flexible
sales programs to help customers acquire the Company's products, primarily its
call accounting products. The most extensively used of these programs has been
the XETAPLAN program, under which the Company installs a call accounting and/or
answer confirmation system and maintains it for a period of three to five years
in exchange for a fixed periodic fee. This program enables the customer to avoid
an up front cash outlay and to budget the costs for the equipment and service
for the length of the agreement. Due to the nature and structure of the XETAPLAN
contract and the relevant accounting rules, most XETAPLAN agreements are
accounted for as sales of systems even though title to the equipment usually
remains with the Company.
In order to compete with other Hitachi and Lucent distributors as well as
other PBX vendors, the Company offers its PBX products and services with a
package of value-added services which include such amenities as providing an
XL(R) or VXL(TM) Series call accounting system, a specified number of free labor
hours each month and weekly appointments by certified technicians to correct
minor malfunctions or to perform routine maintenance. An expanding network of
trained service technicians and regional staff technicians also allows the
Company to provide continuity of service nationwide.
Commercial. The marketing of telecommunications products to the commercial
market requires much greater investments in promotion and advertising than in
the more specialized and smaller hospitality market. Traditionally, USTI's
primary business was to sell Lucent products to commercial customers in the
after-market (i.e., subsequent to the sale and installation of the
communications system by Lucent's direct sales and installation force). These
products were primarily new and used digital phones and new packets for
expansion of the customer's communications system. However, beginning in late
1998, USTI, as a result of changes in marketing strategy by Lucent, became
involved in "partnering" with Lucent's sales force to sell and install complete
communications systems to Lucent customers. Under these "partnering"
arrangements, USTI account executives work with Lucent National Account Managers
("NAM's") and Global Account Managers ("GAM's") to jointly serve Lucent
customers. USTI adds value to the NAM's and GAM's sales efforts by offering
speed of installation and cost-effective installation of smaller, outbound
systems that may be networked to larger, "home office" communications systems
served by Lucent's direct sales and service force.
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In addition to its efforts to partner with Lucent NAM's and GAM's, USTI
invests heavily in marketing to its own customer base, both through traditional
promotional activities such as trade shows, special pricing and brand name
promotions, and, more recently, through electronic commerce activities under its
"e-Tel"(TM) initiative. With e-Tel(TM), customers will have private, on-line
catalogs which have been developed for their specific needs and on premise
equipment. Pricing in the catalog will be customer-specific as well. Customers
will be able to order equipment on-line and check the status of their order as
it is processed, shipped and received. The Company believes that e-Tel(TM) and
other planned electronic commerce initiatives will be cost-effective tools to
attract, service, and retain customers.
At December 31, 1999, the Company employed 16 persons directly involved in
the sales and marketing of its commercial products and services.
MAJOR CUSTOMERS
Marriott Host/Marriott International and its affiliates, which include
Marriott's full service hotels as well as Residence Inn by Marriott, Courtyard
by Marriott, and Fairfield Inn by Marriott (collectively "Marriott") is a major
customer of the Company. Revenues from Marriott include sales of new PBX and
call accounting products as well as revenues earned from installation and
service activities. Management believes its relationship with Marriott to be
good.
COMPETITION
Hospitality. The Company believes that its most effective weapon in
competing in the hospitality market is its commitment to distinguish itself by
concentrating on the performance and reliability of its systems and by providing
the highest level of service possible. As a result, the Company has developed
innovative marketing and service programs (such as those discussed above) to
meet the unique needs of the lodging market. Competition in this market is
fierce and competitors range from large, well-known and well-financed companies
to small, regional or local distributors, many of whom do not concentrate their
efforts on the hospitality market but are simply located near the prospective
customer. While the Company believes that its reputation and nation-wide
presence contribute significantly to its success, there can be no assurance
given that the Company will be able to continue to expand its market share in
the future.
The competition for the type of long distance service provided by the
Company is also fierce and is dominated by very large, well-known companies,
primarily the large long distance carriers. Typically, these competitors are
able to secure these contracts by providing customers with large up-front cash
bonuses and large monthly commissions on calls made on the customer's
telephones. The Company has not been able to compete effectively on this basis
and as a result, no significant long distance contracts have been secured beyond
those purchased from Americom in fiscal 1997 (see "Long Distance Services" under
"Hospitality Products" above).
Commercial. Competition in the commercial market is intense at all levels
and ranges from large manufacturers of telecommunications systems such as
Nortel, Siemans, Toshiba, and Panasonic to local and regional dealers. Despite
this competition, USTI has been Lucent's top revenue producing dealer for the
last six years and has been Lucent's Dealer of the Year for three of the last
five years. Management of the Company believes that this market position has
been achieved and retained as a result of USTI's singular focus on being the
best Lucent solutions provider in the country. USTI distinguishes itself from
its competition through "Speed of Response" and "Quality" (i.e., consistent
excellence), and through its value propositions initiative, by which it can
serve a wide range of customers including small businesses all the way to
Fortune 500(R) companies. While USTI has been Lucent's largest dealer, the
market is ever changing and requires constant attention to customer needs and
changes in Lucent's strategic thrust. Therefore, no assurance can be given that
the Company will be successful in maintaining USTI's market leadership position
in the future.
MANUFACTURING
The Company assembles all of its proprietary products, which include its
PC-based call accounting systems and the XPANDER(R) system, from an inventory of
components, parts and sub-assemblies obtained from various suppliers. These
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components are purchased from a variety of regional and national distributors at
prices which fluctuate based on demand and volumes purchased. Some components,
although widely distributed, are manufactured by a single, usually foreign,
source and are therefore subject to shortages and price fluctuations if
manufacturing is interrupted. The Company maintains adequate inventories of
components to mitigate short-term shortages and believes the ultimate risk of
long-term shortages is minimal. All of the Company's call accounting products
are now based on PC technology, which is continually and rapidly changing. As a
result, some of the components originally designed for use in the Company's
systems have been phased out of production and replaced by more advanced
technology. To date, these substitutions have not forced the Company to
substantially redesign its systems and there has been minimal effect on overall
system cost. There can be no assurance given, however, that future obsolescence
of key components would not result in unanticipated delays in shipments of
systems due to redesign and testing of assemblies.
The Company uses outside contractors to assemble its proprietary printed
circuit boards. The components and blank circuit boards are purchased and
inventoried by the Company and supplied to the outside contractor for assembly
and quality control testing. The Company performs various quality control
procedures, including powering up completed systems and allowing them to
"burn-in" before being assembled into a final unit for a specific customer
location, and performing final testing prior to shipment.
EMPLOYEES
At December 31, 1999, the Company employed 263 employees, including 1
part-time employee.
COPYRIGHTS, PATENTS AND TRADEMARKS
The Company has never applied for patent protection on its hardware or
software technology with the exception of the technology for XPANDER(R), for
which the Company has a patent pending. The Company claims copyrights on all of
its proprietary circuit boards and software.
While the Company believes that the ownership of patents, copyrights and
registered trademarks is less significant to its success than its proprietary
technology, quality and type of service and technical expertise, the Company
recognizes that its reputation for quality products and services gives value to
its product names. Therefore, the Company has registered as United States
domestic trademarks the names "XETA," "XETAXCEL," "XACT," "XPERT," "XPERT+,"
"XL" and "XPANDER" for use in the marketing of its services and systems. All of
these marks are registered on the principal register of the United States Patent
and Trademark Office ("PTO"), with the exception of XPANDER(R) which is
registered on the supplemental register. The Company also has a pending
trademark application to register the mark "Virtual XL."
GOVERNMENT REGULATION
The Federal Communications Commission (the "FCC") and state governments
regulate the telecommunications industry. None of the Company's business
activities, however, are directly regulated by the FCC or the states. None of
the Company's products or services require approval from any governmental
agency.
The Company's computer products are subject to radio frequency emanation
and electrical safety standards imposed by the FCC. The cost of complying with
such standards, as well as with any applicable environmental laws, is
immaterial.
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ITEM 2. PROPERTIES
The Company's principal executive office and Service Center are located in
a newly constructed, 37,000 square foot, Company-owned, single story building
located in a suburban business park near Tulsa, Oklahoma. This facility also
houses the Company's warehouse and assembly areas to support its hospitality
sales channel. The building is located on a 13 acre tract of land. The property
is subject to a mortgage held by Bank One, Oklahoma, NA, to secure a $40 million
credit facility established by the Company in November, 1999.
Most of the Company's commercial channel operations are located in leased
facilities in an office park outside of St. Louis, Missouri. These operations
include commercial channel executive management, marketing, accounting,
purchasing, repair, warehousing, and installation support. The offices are
spread across three facilities located near each other. Due to the recent growth
of USTI, all the facilities are at maximum utilization. During January, 2000,
the St. Louis operations will be moved to two larger, leased facilities near
their present operations.
The Company leases other office space in Boulder, Dallas, Houston,
Indianapolis, Seattle, Tampa, Altamonte Springs, Florida, Marlton, New Jersey,
San Juan Capistrano and San Diego, California, and Haleiwa, Hawaii, from which
its regional sales staff operates. The Company has an installation office in
leased space in Atlanta as well. Additionally, the Company has informal office
arrangements with its regional technicians to allow for some storage of spare
parts.
ITEM 3. LEGAL PROCEEDINGS
The matter of ALLENDALE MUTUAL INSURANCE CO. V. XETA CORPORATION, HITACHI
TELECOM (USA), INC., PUBLIC SERVICE COMPANY OF COLORADO, AT&T, US WEST LONG
DISTANCE, INC., AND DOES 1-100, filed in the United States District Court for
the District of Colorado on July 30, 1998, was settled in November, 1999 for
$40,000. This case involved the failure of a Hitachi PBX system located in a
Marriott hotel in Denver, Colorado, for which XETA had assumed service
responsibilities. As a result of the system failure, Marriott made a claim with
the plaintiff, its insurance carrier, for property damage, business interruption
and loss of revenue in the amount of $926,518.84. The plaintiff paid Marriott's
claim, then filed this suit to recover said amount (plus attorney's fees and
costs) from the defendants. The plaintiff alleged that the defendants were
negligent in the manufacture, design, installation, inspection, service,
supervision, and provision of materials, electric power, telephone service, and
supplies in connection with the PBX system. Specifically with regard to the
Company, the plaintiff's claims were based upon theories of gross negligence,
breach of contract and product liability. In May, 1999, upon motion by the
plaintiff, the Court dismissed all of the defendants except for the Company. The
Company continued to vigorously defend its position that it was not responsible
for the failure of the PBX system and, after conducting further discovery, the
plaintiff agreed to settle its claims against the Company for $40,000. The
settlement amount reflects the "nuisance value" the Company's insurance carrier
was willing to pay to dispose of this matter in an expeditious fashion and does
not constitute any admission of fault on the part of the Company.
The matter of ASSOCIATED BUSINESS TELEPHONE SYSTEMS, INC., PLAINTIFF, VS.
XETA CORPORATION, DEFENDANT AND THIRD-PARTY PLAINTIFF, VS. D&P INVESTMENTS,
INC., THIRD PARTY DEFENDANT, filed in June, 1995, is still pending before the
United States District Court for the Northern District of Oklahoma. This matter
arises from a 1986 distributor's agreement between the Company and D&P, pursuant
to which the Company sold call accounting systems to D&P for resale, and a
maintenance agreement between the Company and ABTS pursuant to which the Company
furnished maintenance services for such systems. After having some of its claims
dismissed by the Court, ABTS' remaining claims are based on breach of contract
and tortious interference with certain customer relationships. The stated amount
of damages sought by ABTS in this matter is approximately $809,000. The Company
seeks in excess of $3 million in damages in its counterclaims against ABTS and
third-party claims against D&P. In November, 1999, during a pretrial conference,
ABTS and D&P disclosed to the Court that both of these companies had been
dissolved during the pendency of this litigation, without notice to the Company.
In view of this fact, and following ABTS' and D&P's failure to provide certain
financial information to the Company as ordered by the Court, the Court
postponed trial in this matter and granted the Company the right to conduct
discovery into the financial affairs of ABTS, D&P and ABTS' related companies.
The Company is currently conducting such discovery. The Company has also filed a
motion to dismiss ABTS' and D&P's claims for their continued failure to disclose
certain other documents requested in 1997. The Company intends to continue to
vigorously defend ABTS' claims against it and to pursue all of its counterclaims
and third-party claims against ABTS and D&P.
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Since 1994, the Company has been monitoring numerous patent infringement
lawsuits filed by PHONOMETRICS, INC., a Florida company, 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 call accounting customers are named defendants. These customers
have notified the Company that they will seek indemnification under the terms of
their contracts with the Company. However, because there are other equipment
vendors implicated along with the Company in the cases filed against its
customers, the Company has never assumed the outright defense of its customers
in any of these actions. Phonometrics seeks 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 such lawsuit and ending October 30, 1990.
All of the cases filed by Phonometrics against the Company's customers were
originally filed in, or transferred to, the United States District Court for the
Southern District of Florida. On October 26, 1998 the Florida Court dismissed
all of the cases filed against the hotels, following an appellate court's final
determination in Phonometrics' case against Northern Telecom that there was no
infringement of Phonometrics' patent. In its order dismissing Phonometrics'
complaints, the Florida court noted that Phonometrics failed to allege that the
hotels' call accounting equipment displays cumulative costs in real time as they
accrue, and displays these costs on a visual digital display, both of which are
necessary to establish infringement of Phonometrics' patent. Neither of these
elements are present in the Company's systems. On November 13, 1998,
Phonometrics filed an appeal of the Florida court's order dismissing these
cases, with the United States Court of Appeals for the Federal Circuit. The
parties have filed briefs in this matter and the case is now pending before the
Appeals Court.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
9
<PAGE> 10
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
The Company's Common Stock, $.05 par value, is currently traded on the
over-the-counter market and is reported in the National Association of
Securities Dealers Automated Quotation ("NASDAQ") System under the symbol
"XETA."
The high and low bid prices for the Company's Common Stock, as reported by
the National Association of Securities Dealers through its NASDAQ System, for
each of the quarters during the Company's two most recent fiscal years are set
forth below. These prices are adjusted to give retroactive effect to a
two-for-one stock split effective August 13, 1999. Furthermore, these prices
reflect inter-dealer prices, without adjustment for retail mark-ups, mark-downs
or commissions and may not necessarily represent actual transactions.
<TABLE>
<CAPTION>
1999 1998
---- ----
High Low High Low
------ ------ -------- -----
Quarter Ending:
- ---------------
<S> <C> <C> <C> <C>
January 31 9 7/8 7 5/8 11 13/16 8 5/8
April 30 9 5/8 7 1/2 12 11/16 8 5/8
July 31 22 7/8 9 1/32 11 11/16 9 3/8
October 31 22 1/2 13 1/2 9 3/4 6 1/2
</TABLE>
The Company has never paid cash dividends on its Common Stock. Payment of
cash dividends is dependent upon the Company's earnings, capital requirements,
overall financial condition and other factors deemed relevant by its Board of
Directors. The Company is currently committed to reinvesting its available
capital in the future growth and success of the Company. It is therefore
unlikely that the Company would pay cash dividends in the foreseeable future.
As of December 31, 1999, the latest practicable date for which such
information is available, the Company had 112 shareholders of record. In
addition, based upon information received annually from brokers holding stock in
the Company on behalf of beneficial owners, the Company has approximately 3,440
beneficial shareholders.
No sales of unregistered securities were made by the Company during its
1999 fiscal year.
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<PAGE> 11
ITEM 6. SELECTED FINANCIAL DATA.
Selected financial data for the last five fiscal years is presented below.
All amounts except share and per share amounts are in thousands.
<TABLE>
<CAPTION>
For the Year Ending October 31 1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Results of Operations:
Installation and service revenues $ 18,766 $ 13,220 $ 9,355 $ 6,888 $ 7,112
Sales of systems 17,857 11,232 9,238 6,552 5,273
Long distance services 640 995 167 -- --
---------- ---------- ---------- ---------- ----------
Total Revenues 37,263 25,447 18,760 13,440 12,385
Cost of installation and services 12,206 8,536 5,884 4,385 3,279
Cost of systems sales 10,856 7,505 6,015 4,072 3,928
Cost of long distance services 211 411 59 -- --
---------- ---------- ---------- ---------- ----------
Total cost of sales 23,273 16,452 11,958 8,457 7,207
Gross Profit 13,990 8,995 6,802 4,983 5,178
Operating expenses 7,622 4,757 4,139 3,156 3,127
Income from operations 6,368 4,237 2,663 1,827 2,050
Interest and other income 665 671 667 662 377
---------- ---------- ---------- ---------- ----------
Income before taxes 7033 4,908 3,330 2,489 2,427
Provisions for taxes 2,750 1,855 1,190 904 913
---------- ---------- ---------- ---------- ----------
Net income 4,283 3,053 2,140 1,585 1,514
========== ========== ========== ========== ==========
Earnings per share - Basic $ 1.07 $ .75 $ .53 $ .40 $ .42
Earnings per share - Diluted .93 .65 .45 .34 .34
Weighted average shares outstanding 4,010,624 4,059,966 4,012,510 3,942,122 3,598,796
Weighted average equivalent shares 4,627,221 4,685,080 4,730,488 4,668,632 4,457,832
As of October 31 1999 1998 1997 1996 1995
---------- ---------- ---------- ---------- ----------
Balance Sheet Data:
Working capital $ 8,021 $ 5,122 $ 6,944 $ 5,435 $ 3,242
Total assets 25,316 $ 18,292 14,820 12,364 10,597
Long term debt -- -- -- -- --
Shareholders' equity 14,551 11,185 9,337 7,071 4,823
</TABLE>
11
<PAGE> 12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
For the fiscal year ending October 31, 1999, the Company reported record
net income and revenues of $4.283 million and $37.263 million, respectively.
These results represented a 40% increase in net income and a 46% increase in
total revenues over the previous year. The results for fiscal 1999 reflect the
Company's traditional focus on providing telecommunications products and
services to the lodging industry.
During fiscal 1999, there were several developments that will have
significant impact on the future operating results and financial condition of
the Company. In July, 1999, the Company announced an expanded growth strategy to
expand beyond the lodging market into the distribution of telecommunications
products to commercial businesses on a nation-wide scale. Pursuant to this
expanded strategy, the Company hired a new President, and, after the close of
the fiscal year, announced the successful closing of a significant acquisition.
These developments are discussed in more detail below.
Management believes that advances in technology will drive significant
changes in the distribution of telecommunications products over the next three
to five years. The most fundamental of these advances is the development of
packet switching technology. This technology is the mechanism by which data
currently travels over the Internet. However, with further development of packet
switching, acceptable quality voice transmission over public (Internet) and
private networks will also be possible, and at significantly lower transmission
costs than traditional voice calls. In addition to lower transmission costs, the
costs of acquiring, upgrading and maintaining networks will also decline as
voice and data networks converge onto one hardware and software platform.
Management believes that once the quality issues are resolved and the cost
savings are a reality, the market will quickly transition to converged networks.
These converged networks will be more complex and more software oriented than
the separate networks that voice and data dealers are serving currently.
To respond to these changes, the Company plans to aggressively build a
nation-wide distribution channel, proficient in both voice and data
communications products to the commercial market. Management intends to fuel
this growth through a series of selective acquisitions supplemented with
internal growth, focusing first on establishing a nation-wide presence in voice
networks through the acquisition and subsequent expansion of existing
distribution channels, most likely existing Lucent Technologies dealers. From
that nation-wide footprint, capabilities in data and converged networks can be
added through more acquisitions and internal growth.
Concurrent with the adoption of this growth strategy, the Company hired Jon
A. Wiese as its President effective August 2, 1999. The Company's previous
President, Jack Ingram, remains CEO and Chairman. Mr. Wiese previously served as
Corporate Officer and Vice President of the USA Sales and Service Division of
Lucent Technologies, Inc. and is a recognized industry leader within the
telecommunications industry. Immediately after Mr. Wiese's arrival, the Company
began evaluating potential acquisition candidates based on a variety of factors
including market share, growth potential, geographic coverage, and proficiency
in voice networks. On November 30, 1999, the Company purchased 100% of the
outstanding stock of U.S. Technologies Systems, Inc. ("USTI") for $26 million in
cash and 150,000 shares of XETA common stock. At the closing, the Company paid
$23 million in cash plus the common stock to USTI's owners. The remaining $3
million is subject to various hold-back provisions, $2 million of which can be
satisfied through the achievement of certain growth targets with the remainder
being held for two years as an indemnity against breaches in representations and
warranties made by the owners in the sale documents. The Company began
consolidating the results of USTI's operations effective December 1, 1999.
Financing for the acquisition was provided through a $40 million credit facility
which is more fully described under "Liquidity and Capital Resources" below.
Management believes that the USTI acquisition is a key first step in
executing its expanded growth strategy. USTI is Lucent's largest dealer, focuses
primarily on voice applications, has a nation-wide sales presence, and an
excellent reputation in the marketplace. USTI's pro forma revenues for the 12
months ending October 31, 1999 were $39.5 million. While the Company has devoted
significant financial and management resources to its strategy of developing a
major distribution channel to the commercial market, the Company's commitment to
the continued growth of its lodging business is undiminished.
The discussion below provides further analysis of the developments
discussed above as well as other major factors and trends which management
believes had the most significant impact on the results of operations for the
years ending
12
<PAGE> 13
October 31, 1999 and 1998 compared to the previous years, and the financial
condition of the Company for the years then ended.
RESULTS OF OPERATIONS
Year ending October 31, 1999 compared to October 31, 1998. The 46% increase
in total revenues consisted of an increase in installation and service revenues
of 42%, an increase in sales of systems of 59%, and a decrease in long distance
revenues of 36%. Alternatively, the Company's results can be reviewed by product
lines. During fiscal 1999, revenues earned from communications systems (or
"PBX's") related activities, including sales of new systems, installations and
service, increased $8.267 million, or 45%. Revenues from call accounting related
activities increased $3.904 million or 63%, and revenues from the Company's long
distance service offering declined $355,000 or 36%. All of the Company's
revenues during fiscal 1999 were earned from the lodging market. The following
discussion analyzes the Company's revenues by product line.
Sales of PBX systems increased $3.860 million or 42% while revenues earned
from PBX installation and service activities increased $4.407 million or 49%.
This growth in revenues is attributable to the continued acceptance of the
Company's PBX product and service offering and the robust U.S. economy. The
lodging market continues to view the Company as the market leader in providing
PBX products and services to hotels. The Company is the largest distributor of
the Hitachi communications system. During fiscal 1999, the Company began its
marketing of the Lucent Guestworks(R) communications system. While sales of
Hitachi systems still far outweighed sales of Lucent products in 1999, sales and
installations of Lucent systems increased steadily during the last half of
fiscal 1999 and the first quarter of fiscal 2000. Management is satisfied with
the progress of is Lucent PBX offering. The strength of the U.S. economy
continues to be beneficial to the Company as it has fueled continued new
construction of hotels, significant remodeling projects and expansions of
existing PBX systems to accommodate multiple phone line access in hotels.
During fiscal 1999, the Company experienced a surge in orders for call
accounting systems resulting in an increase in revenues from systems sold of
$2.765 million or 139%. Revenues from call accounting installation and service
activities increased $1.139 million or 27% during fiscal 1999. This surge in
orders was primarily due to the broad market acceptance of the Company's Virtual
XL(TM) call accounting system. This system, in addition to performing the normal
call accounting functions found in the Company's XL(R) Series systems, can be
connected to public and private networks allowing remote access by hotel
management to reporting functions. Many of the orders received for the Virtual
XL(TM) systems were upgrades of existing systems from the Company's existing
customer base; however, the Company also received significant orders from new
customers during fiscal 1999. Installations from this surge in orders will be
completed during the first quarter of fiscal 2000. Revenues from sales of call
accounting products should then return to historical levels.
Revenues from the Company's long distance service offering declined
$355,000 or 36% due to an erosion in the usage of 0+ services used by guests and
customer hotels. The Company entered this line of business primarily through the
acquisition of a group of contracts in April, 1997. Due to competitive factors,
the Company was not able to expand this portion of its business. Currently, the
contracts purchased in 1997 are beginning to expire and the Company has been
notified that most, if not all, of these customers will not be renewing their
agreements. Therefore, management expects revenues from this product line to
decline throughout fiscal 2000.
Gross margins earned on total revenues increased to 38% in fiscal 1999
compared to 35% in fiscal 1998. The gross margins earned on installation and
service revenues were unchanged in fiscal 1999 at 35% compared to fiscal 1998.
However, the Company has experienced pressure on the gross margins earned on
installation and service revenues during fiscal 1999 and 1998, and both years'
margins are lower than historical levels. Management is analyzing this trend and
is hopeful that efficiencies can be gained through the improvement of some
processes and the elimination or reduction of some less profitable installation
activities. Additional alternatives, such as price increases for some of its
services are also under consideration. No assurance can be given, however, that
gross margins earned on installation and service revenues will not continue to
face downward pressures. The gross margins earned on systems sales increased to
39% from 33% in fiscal 1999 compared to 1998. This increase was primarily due to
the favorable mix of systems sales toward higher margin call accounting systems.
As discussed above, management expects sales of its call accounting systems to
return to historical levels during fiscal 2000 and gross margins on total
systems sales would be expected to continue to trend toward the lower margins
earned on PBX systems. The gross margins earned on long distance services in
fiscal 1999 were 67% compared to 59% in fiscal 1998. The gross margin earned on
this revenue source during fiscal 1999 benefited from lower
13
<PAGE> 14
overall long distance revenues because the revenues were insufficient to trigger
payments to the Company's marketing alliance partner.
Total operating expenses, including selling, general, and administrative
("SGA"), engineering, research and development ("Engineering"), and amortization
increased $2.865 million or 60% in fiscal 1999. However, of this increase,
$1.555 million was attributable to an increase in amortization expense. Most of
the increase in amortization was related to the Company's purchase of PBX
service contracts in September, 1998. The purchase price paid for these
contracts was $1.533 million, as adjusted at final closing in 1999, and was
amortized over the average life of the contracts, which was approximately one
year. Ignoring amortization expense, the costs of SGA and Engineering activities
represented 15.2% of revenues in fiscal 1999 and 17.2% of fiscal 1998 revenues.
Interest income was relatively unchanged between 1999 and 1998. The Company
earns interest income from its sale-type lease contracts with customers and from
cash investments. Interest income earned from additions to its sale-type lease
receivables was offset by decreases in interest income earned on cash balances
due to lower average cash on hand in fiscal 1999.
The Company recorded a provision for federal and state income taxes of
$2.750 million or 39% of pre-tax income compared to $1.855 million or 38% in
fiscal 1998. The increase in the effective tax rate reflects an increase in the
Company's estimated multi-state tax rate.
Year ending October 31, 1998 compared to October 31, 1997. For the fiscal
year ending October 31, 1998, the Company reported record net income and
revenues of $3.053 million and $25.447 million, respectively, representing a 43%
increase in net income and a 36% increase in revenues. The 36% increase in
revenues consisted of a 41% increase in installation and service revenues, a 22%
increase in sales of systems, and a 495% increase in long distance revenues. By
product line, during fiscal 1998 revenues earned from PBX related activities,
including sales of new systems, installations and service, increased $5.0
million or 38%, revenues from call accounting related activities increased
$824,000 or 15%, and revenues from the Company's long distance service offering
increased $828,000 or 495%. The following discussion analyzes the Company's
revenues by product line.
Sales of PBX systems increased $1.588 million or 21% while revenues from
PBX installation and service activities increased $3.447 million or 61% during
fiscal year 1998. The growth in revenues earned from PBX related activities was
fueled by broad acceptance of the Company's PBX product and service offering and
the robust growth of the overall hotel industry. Both of these trends generated
significant sales of PBX systems for the Company.
Included in the increase in revenues from call accounting related
activities was an increase in sales of call accounting systems of $407,000 or
26% and an increase in call accounting service revenues of $417,000 or 11%.
Sales of call accounting systems were stronger than expected as construction of
new hotels and overall spending on hotel technology helped to fuel sales of new
systems. This, in turn, generated increased installation and service revenues.
Also contributing to the increase in call accounting related revenues for fiscal
1998 were revenues earned from customers under the Company's long distance
service offering. The Company provided call accounting equipment and service to
its long distance customers and a portion of the long distance commissions
earned from those customers has allocated to call accounting systems and service
revenues. Fiscal 1998 was the first full year of operations for the Company's
long distance services, therefore revenues from this source showed a substantial
increase over the previous year.
Revenues from the Company's long distance service offering increased
$828,000 or 495% in fiscal 1998 compared to fiscal 1997. Note that revenues from
long distance service began during the third quarter of fiscal 1997 and
therefore did not represent a full year of operations for comparison purposes.
Substantially all of the long distance service revenues earned were from those
contracts that were purchased by the Company upon its entry into this market in
April, 1997.
Gross margins on total revenues decreased to 35% in fiscal 1998 from 36% in
fiscal 1997. The gross margin earned on installation and service revenues was
35% in fiscal 1998 compared to 37% in fiscal 1997. Management believes this
decline was due to increases in staffing and increased utilization of third
party technicians as the Company responded to the continued rapid growth of its
business. The gross margin earned on systems sales in fiscal 1998 was 33%
compared to 35% in fiscal 1997. This decline was attributable to a decline in
gross margins earned on the sale of PBX systems reflecting sales of smaller
systems primarily to smaller, extended-stay hotels. This segment of the market
is highly price-
14
<PAGE> 15
driven and is very competitive. The gross margin earned on long distance
services was 59% in fiscal 1998 compared to 65% earned in fiscal 1997.
Operating expenses increased 15% in fiscal 1998 compared to fiscal 1997.
This increase included an increase in amortization expense related to the 1997
purchase of long distance contracts for a full year compared to only five months
in fiscal 1997. Amortization in fiscal 1998 also included one partial month of
amortization of the purchase of PBX service contracts from Williams
Communications Solutions, LLC, which was consummated in September, 1998. Also
increasing in fiscal 1998 were general and administrative expenses related to
increases in personnel and accrued costs related to the Company's relocation.
Lastly, costs such as commissions and executive bonuses increased in conjunction
with increases in sales and net profits. Partially offsetting those increases
was a decrease in legal fees as the activity surrounding the ABTS case was
substantially less in fiscal 1998 than in fiscal 1997.
Interest income increased 6% in fiscal 1998 compared to fiscal 1997. This
increase was primarily related to increases in interest income earned from cash
investments, as cash balances remained high for most of the year (until the
acquisition of PBX service contracts in September 1998). Interest income earned
from XETAPLAN contracts remained steady as many of the expiring XETAPLAN
contracts were renewed preventing a decline in interest income from this source.
The Company recorded a provision for federal and state income taxes of
$1.855 million or 38% of pre-tax income compared to $1.190 million or 36% in
fiscal 1997. The increase in the effective tax rate was made to more
appropriately reflect the estimated multi-state tax provision.
LIQUIDITY AND CAPITAL RESOURCES
As a result of the acquisition of USTI and the related establishment of a
$40 million credit facility with a bank, the Company's financial condition
changed significantly subsequent to October 31, 1999. The credit facility was
formulated into three portions, a 5 year term loan of $23 million for the cash
paid at the closing of the USTI acquisition, $12 million available for future
acquisitions subject to certain requirements, and a $5 million revolver
available for working capital needs. Borrowing under the acquisition portions of
the facility is based upon a multiple of EBITDA, as defined in the facility,
including the EBITDA of the target company. The interest rate charged on
borrowings under the facility is based on a margin above LIBOR or Prime, with
the margin adjusted for specific ranges of leverage as determined by the
Company's debt ratio, as defined in the agreement. At December 31, 1999, the
Company owed $22.6 million under the term loan. No other advances had been made
under the facility as of that date.
During fiscal 1999, the Company's cash balances increased $1.318 million
reflecting cash earned from operations of $4.250 million offset by cash used in
investing activities of $1.826 million and cash used in financing activities of
$1.105 million. Investing activities consisted primarily of cash used for the
completion of the construction of the Company's new facilities. This facility,
completed in March, 1999, houses the Company's administration functions,
assembly and warehousing operations, and Service Center. Financing activities
consisted principally of $1.158 million spent on stock repurchases during the
first half of the fiscal year. After reflecting the effect of the 2-for-1 stock
split on August 13, 1999, the Company repurchased 130,300 shares at an average
price of $8.89 under its repurchase program. This program has been dormant since
the Company announced its expansion strategy in June, 1999.
Management believes that it has sufficient credit capacity to pursue its
growth strategy, including additional acquisitions. Management continues to
evaluate potential acquisition targets, some of which could exceed the credit
facility currently in place. While no assurance can be given, management
believes that the Company could expand its credit facility provided the
potential target company has strong cash flows and is capable of expansion. In
addition, the Company's increased size, in terms of revenues and market
capitalization, have significantly improved the Company's access to equity
markets.
OUTLOOK AND RISK FACTORS
The statements in this section entitled "Outlook and Risk Factors," as well
as other statements throughout this report regarding trends or future
performance or events, are based on management's current expectations. These
statements are
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<PAGE> 16
forward-looking and actual results may differ materially. All such statements
should be read in conjunction with the risk factors discussed herein and
elsewhere in this report.
Growth Strategy and Acquisitions. The Company's planned expansion beyond
the lodging market into the general commercial market for voice and data
products as well as its acquisition of USTI presents a variety of new risk
factors to the Company. The voice and data markets for commercial businesses are
substantial in size and are populated by many well known companies, such as
Williams Communications Group and Exp@nets, who are larger and better
capitalized than the Company. Additionally, as emphasis shifts from parallel
communications networks (i.e., separate data and voice infrastructures running
side by side) to converged networks that integrate both communications onto a
single network infrastructure, the Company will face competition from other
companies who are pursuing a strategy similar to the Company's. This convergence
of voice and data networks has already produced and is likely to continue to
produce business combinations between traditional suppliers of
telecommunications or voice networking and data networking companies. Such
business combinations may result in companies with strong competitive positions
and products, which could significantly impact the Company's business, operating
results or financial condition. Additionally, the shift to converged networks is
a developing environment that is driven by technological changes which continue
to evolve. The Company's ability to accurately predict and timely respond to
such a changing environment is critical to the success of its business plan.
The Company is currently integrating its existing operations with those of
USTI and attempting to realize the expected synergies related to the
acquisition. Achieving the benefits of an acquisition depend, in part, upon
whether the integration of the acquired business is accomplished in an efficient
and effective manner. While the Company is devoting significant time and effort
into the execution of the USTI integration, there can be no assurance that the
products, distribution channels, customer support operations, management
information systems, key personnel or other key aspects of USTI's business, or
the business of other companies acquired by the Company in the future, will be
effectively assimilated into the Company's business or product offerings. The
failure to effectively integrate USTI or future acquired companies and their
products could have a material adverse effect upon the Company's business,
operating results, or financial condition and upon the investment community's
perception of the Company's ability to carry out its growth strategy.
The Company's use of debt and possibly equity capital to finance
acquisitions may increase the level of risk associated with the Company's
financial condition and could dilute earnings per share on the Company's core
operations from those which would otherwise be reported.
Dealer Agreements. The Company sells communications systems under dealer
agreements with Hitachi Telecom (USA), Inc. ("Hitachi") and Lucent Technologies.
The Company is Hitachi's largest dealer and considers its relationship with
Hitachi to be good. The Company and USTI have separate dealer agreements with
Lucent for distribution of Lucent systems to the commercial market and the
lodging sector, respectively. Combined with USTI, the Company is also Lucent's
largest dealer and considers its relationship with Lucent to be good. The
agreements with both Hitachi and Lucent contain certain volume commitments to
earn the pricing structure provided in the dealer agreements. Should the Company
fail to meet those requirements, future profit margins could suffer.
Dependence on Key Personnel and Recruiting. The success of the Company will
depend in part upon a number of key management and technical employees. The loss
of the services of key employees could have a material adverse effect on the
Company's business, operating results or financial condition. In addition,
recruiting and retaining top personnel experienced in the industry, as well as
skilled installation and service technicians, is highly competitive. If the
Company cannot successfully recruit and retain such personnel, the Company's
financial results may be adversely affected.
U.S. Economy. Both the lodging and commercial distribution channels
operated by the Company are somewhat dependent on the strength of the U.S.
economy. Should the economy experience a downturn which results in lower
occupancy rates and lower per room revenues in the lodging sector and lower
amounts of capital available for information technology expenditures in general,
the Company's operating results could be materially different than currently
forecasted by management.
Y2K. Between the middle of 1997 and December 31, 1999, the Company spent
considerable effort to assess the potential impact of the year 2000 ("Y2K") on
its business. These actions included evaluating the Y2K readiness of its
proprietary products, its distributed products, and its internal systems. Based
on those evaluations, the Company developed
16
<PAGE> 17
and implemented appropriate remedial procedures, including the notification of
its customers as necessary, and took measured actions to prepare for potential
unforeseen problems on and immediately after December 31, 1999. Like most
businesses who had prepared diligently for Y2K, the Company experienced no
significant problems with either its products or internal systems and none of
its operations were interrupted in any way as a result of Y2K issues.
Pending Litigation. The Company is involved in two matters of pending
litigation (See "Legal Proceedings" under Part I above). No loss contingencies,
other than the estimated costs of bringing one of the cases to trial, have been
recorded in the financial statements. Should the outcome of either of these
matters be unfavorable, however, the Company may have to record expenses which
might cause operating results to be materially lower than those expected.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risks relating to the Company's operations result primarily from
changes in interest rates. The Company did not use derivative financial
instruments for speculative or trading purposes during the 1999 fiscal year.
Interest Rate Risk. The Company's cash equivalents, which consist of
highly-liquid, short-term investments with an average maturity of less than 51
days, are subject to fluctuating interest rates. A hypothetical 10 percent
change in such interest rates would not have a material effect upon the
Company's consolidated results of operations or cash flows. Subsequent to its
1999 fiscal year end, the Company established a $40 million credit facility (see
Note 17 to the Consolidated Financial Statements for details of the Company's
long-term debt). The Company will be exposed to market risk from changes in
interest rates related to this credit facility which is based upon either LIBOR
or the bank's prime rate.
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<PAGE> 18
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
<TABLE>
<CAPTION>
INDEX TO FINANCIAL STATEMENTS OF THE COMPANY PAGE
- -------------------------------------------- ----
<S> <C> <C>
Report of Independent Public Accountants F-1
Consolidated Financial Statements
Consolidated Balance Sheets - October 31, 1999 and 1998 F-2
Consolidated Statements of Operations - For
the Years Ended October 31, 1999, 1998 and 1997 F-3
Consolidated Statements of Shareholders' Equity -
For the Years Ended October 31, 1999, 1998 and 1997 F-4
Consolidated Statements of Cash Flows - For the
Years Ended October 31, 1999, 1998 and 1997 F-5
Notes to Consolidated Financial Statements F-6
</TABLE>
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Xeta Corporation:
We have audited the accompanying consolidated balance sheets of Xeta Corporation
(an Oklahoma corporation) and subsidiary as of October 31, 1999 and 1998, and
the related consolidated statements of operations, shareholders' equity and cash
flows for each of the three years in the period ended October 31, 1999. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Xeta Corporation and
subsidiary as of October 31, 1999 and 1998, and the results of their operations
and their cash flows for each of the three years in the period ended October 31,
1999, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Tulsa, Oklahoma
December 10, 1999
F-1
<PAGE> 20
XETA CORPORATION
CONSOLIDATED BALANCE SHEETS
OCTOBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,556,212 $ 3,238,218
Current portion of net investment in sales-type leases 2,577,141 1,500,095
Trade accounts receivable 4,432,647 3,561,201
Inventories, net 3,733,306 2,022,256
Deferred tax asset, net 622,595 575,587
Prepaid expenses and other 261,024 73,895
------------ ------------
Total current assets 16,182,925 10,971,252
------------ ------------
NONCURRENT ASSETS:
Net investment in sales-type leases, less current portion 3,843,743 1,210,939
Property, plant and equipment, net 3,942,540 2,817,370
Purchased service and long distance contracts, net of accumulated
amortization of $2,162,938 and $346,891 394,230 2,537,437
Capitalized software production costs, net of accumulated
amortization of $573,066 and $453,066 649,406 655,370
Other 303,633 99,618
------------ ------------
Total noncurrent assets 9,133,552 7,320,734
------------ ------------
Total assets $ 25,316,477 $ 18,291,986
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 2,126,654 $ 1,747,009
Unearned revenue 4,540,548 3,096,217
Accrued liabilities 1,494,737 824,454
Accrued income taxes -- 181,876
------------ ------------
Total current liabilities 8,161,939 5,849,556
------------ ------------
UNEARNED SERVICE REVENUE 1,953,222 730,314
------------ ------------
NONCURRENT DEFERRED TAX LIABILITY, net 650,024 526,881
------------ ------------
COMMITMENTS
SHAREHOLDERS' EQUITY:
Preferred stock; $.10 par value; 50,000 shares authorized, 0 issued -- --
Common stock; $.05 par value; 10,000,000 shares authorized, 4,636,702
issued 231,835 228,628
Paid-in capital 5,373,855 5,135,818
Retained earnings 11,851,761 7,568,905
Less- Treasury stock, at cost (2,906,159) (1,748,116)
------------ ------------
Total shareholders' equity 14,551,292 11,185,235
------------ ------------
Total liabilities and shareholders' equity $ 25,316,477 $ 18,291,986
============ ============
</TABLE>
The accompanying notes are an integral
part of these consolidated balance sheets.
F-2
<PAGE> 21
XETA CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Years
Ended October 31,
------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
INSTALLATION AND SERVICE REVENUES $ 18,766,095 $ 13,219,687 $ 9,355,360
SYSTEM SALES 17,857,086 11,232,402 9,237,813
LONG DISTANCE SERVICES 639,871 995,143 167,307
------------ ------------ ------------
NET SALES, INSTALLATION AND SERVICE REVENUES 37,263,052 25,447,232 18,760,480
------------ ------------ ------------
INSTALLATION AND SERVICE COSTS 12,206,057 8,535,823 5,884,096
COST OF SYSTEMS SALES 10,856,142 7,505,397 6,014,731
COST OF LONG DISTANCE SERVICES 210,493 411,491 59,385
------------ ------------ ------------
TOTAL COST OF SALES, INSTALLATION AND SERVICE 23,272,692 16,452,711 11,958,212
------------ ------------ ------------
Gross profit 13,990,360 8,994,521 6,802,268
------------ ------------ ------------
OPERATING EXPENSES:
Selling, general and administrative 5,136,228 3,992,470 3,629,250
Engineering 366,750 255,593 120,076
Research and development 183,372 127,778 240,189
Amortization 1,936,057 381,521 149,512
------------ ------------ ------------
Total operating expenses 7,622,407 4,757,362 4,139,027
------------ ------------ ------------
INCOME FROM OPERATIONS 6,367,953 4,237,159 2,663,241
INTEREST AND OTHER INCOME, net 664,903 670,541 667,069
------------ ------------ ------------
INCOME BEFORE PROVISION FOR INCOME TAXES 7,032,856 4,907,700 3,330,310
PROVISION FOR INCOME TAXES 2,750,000 1,855,000 1,190,000
------------ ------------ ------------
NET INCOME $ 4,282,856 $ 3,052,700 $ 2,140,310
============ ============ ============
INCOME PER SHARE - BASIC $ 1.07 $ .75 $ .53
============ ============ ============
INCOME PER SHARE - DILUTED $ .93 $ .65 $ .45
============ ============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING 4,010,624 4,059,966 4,012,510
============ ============ ============
WEIGHTED AVERAGE EQUIVALENT SHARES 4,627,221 4,685,080 4,730,488
============ ============ ============
</TABLE>
The accompanying notes are an integral
part of these consolidated statements.
F-3
<PAGE> 22
XETA CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE THREE YEARS ENDED OCTOBER 31, 1999
<TABLE>
<CAPTION>
Common Stock
---------------------------- Treasury Stock
Number of --------------------------- Paid-in Retained
Shares Issued Par Value Shares Amount Capital Earnings
------------- ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT OCTOBER 31, 1996 2,182,653 $ 218,265 189,747 $ (259,740) $ 4,736,413 $ 2,375,895
Stock options exercised 24,632 2,463 -- -- 43,828 --
Tax benefit of stock options -- -- -- -- 79,099 --
Net income -- -- -- -- -- 2,140,310
------------ ------------ ------------ ------------ ------------ ------------
BALANCE AT 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 purchased -- -- 74,800 (1,488,376) -- --
Net income -- -- -- -- -- 3,052,700
------------ ------------ ------------ ------------ ------------ ------------
BALANCE AT OCTOBER 31, 1998 2,286,284 228,628 264,547 (1,748,116) 5,135,818 7,568,905
Stock options exercised 32,067 3,207 -- -- 49,469 --
Tax benefit of stock options -- -- -- -- 188,568 --
Treasury Stock purchased -- -- 65,150 (1,158,043) -- --
Two-for-one stock split 2,318,351 -- 329,697 -- -- --
Net income -- -- -- -- -- 4,282,856
------------ ------------ ------------ ------------ ------------ ------------
BALANCE AT OCTOBER 31, 1999 4,636,702 $ 231,835 659,394 $ (2,906,159) $ 5,373,855 $ 11,851,761
============ ============ ============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE> 23
XETA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Years
Ended October 31,
--------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,282,856 $ 3,052,700 $ 2,140,310
------------ ------------ ------------
Adjustments to reconcile net income to net cash
provided by operating activities-
Depreciation 430,599 299,192 209,531
Amortization 1,936,057 381,521 149,512
Loss on sale of assets -- 14,577 3,859
Provision for doubtful accounts receivable 36,000 76,000 36,000
Provision for excess and obsolete inventory 496,170 -- 33,666
Change in assets and liabilities-
(Increase) decrease in net investment in sales-type
leases (3,709,850) 793,189 1,450,807
Increase in other receivables (907,446) (2,135,358) (21,364)
Increase in inventories (1,723,570) (523,508) (490,918)
(Increase) decrease in deferred tax asset (47,008) (513,844) 31,154
(Increase) decrease in prepaid expenses and other
assets (391,144) (43,489) 358,671
Increase in accounts payable 379,645 1,155,187 220,349
Increase (decrease) in unearned revenue 2,667,239 345,313 (182,074)
Increase in accrued liabilities 670,283 84,758 72,858
Increase in accrued income taxes 6,692 254,479 197,973
Increase (decrease) in deferred tax liabilities 123,143 (24,839) (40,264)
------------ ------------ ------------
Total adjustments (33,190) 163,178 2,029,760
------------ ------------ ------------
Net cash provided by operating activities 4,249,666 3,215,878 4,170,070
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of long distance contracts (156,500) (1,860,000) (1,024,318)
Additions to property, plant and equipment (1,555,769) (2,497,096) (453,390)
Additions to capitalized software production costs (114,036) (237,781) (275,913)
Proceeds from sale of assets -- 852 --
------------ ------------ ------------
Net cash used in investing activities (1,826,305) (4,594,025) (1,753,621)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Purchase of treasury stock (1,158,043) (1,488,376) --
Exercises of stock options and warrants 52,676 92,900 46,291
------------ ------------ ------------
Net cash (used in) provided by financing
activities (1,105,367) (1,395,476) 46,291
------------ ------------ ------------
Net increase (decrease) in cash and cash
equivalents 1,317,994 (2,773,623) 2,462,740
CASH AND CASH EQUIVALENTS, beginning of year 3,238,218 6,011,841 3,549,101
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, end of year $ 4,556,212 $ 3,238,218 $ 6,011,841
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for income taxes $ 2,675,135 $ 2,116,908 $ 1,115,290
============ ============ ============
Noncash tax benefit of options exercised $ 188,568 $ 191,478 $ 79,099
============ ============ ============
</TABLE>
The accompanying notes are an integral
part of these consolidated statements.
F-5
<PAGE> 24
XETA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE YEARS ENDED OCTOBER 31, 1999
1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BUSINESS
Xeta Corporation (Xeta or the Company) develops, manufactures and markets call
accounting systems and is a nation-wide distributor of third-party manufactured
PBX systems. Historically, Xeta has marketed its products and services primarily
to the lodging industry and thus has been dependent upon the condition of the
hospitality economic sector. However, as a result of the recent acquisition of
U.S. Technologies Systems, Inc. (as more fully described at Note 17 to these
financial statements), Xeta will be marketing its products to commercial
enterprises beginning in fiscal 2000.
Xetacom, Inc. (Xetacom), a wholly owned subsidiary of the Company, provides long
distance telephone services to the lodging industry. Xetacom's operations have
been insignificant to date.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents at October 31, 1999, consist of money market accounts
and commercial bank accounts.
LEASE ACCOUNTING
A portion of the Company's revenues have been generated using sales-type leases.
The Company sells systems to end-users under these sales-type leases to be paid
over three, four and five-year periods. Because the present value (computed at
the rate implicit in the lease) of the minimum payments under these sales-type
leases equals or exceeds 90 percent of the fair market value of the systems
and/or the length of the lease exceeds 75 percent of the estimated economic life
of the equipment, the Company recognizes the net effect of these transactions as
a sale as required by generally accepted accounting principles.
Interest and other income is primarily the recognition of interest income on the
Company's sales-type lease receivables and income earned on short-term cash
investments. Interest income from a sales-type lease represents that portion of
the aggregate payments to be received over the life of the lease which exceeds
the present value of such payments using a discount factor equal to the rate
implicit in the underlying leases.
F-6
<PAGE> 25
REVENUE RECOGNITION
The Company recognizes revenue from sales-type leases as discussed above under
the caption "Lease Accounting." Service revenue is recognized monthly over the
life of the related sales-type lease or service agreement on a straight-line
basis. Revenue from sales and installations of call accounting systems is
generally recognized 75 percent upon shipment of the system with the remaining
25 percent recognized upon installation where the Company is responsible for
installation. Revenue from sales of PBX systems are generally recognized 100
percent upon installation. Service and installation costs are expensed as
incurred.
PROPERTY, PLANT AND EQUIPMENT
The Company capitalizes the cost of all significant property, plant and
equipment additions including equipment manufactured by the Company and
installed at customer locations under PBX service agreements. Depreciation is
computed over the estimated useful life of the asset or the terms of the lease
for leasehold improvements, whichever is shorter, on a straight-line basis. When
assets are retired or sold, the cost of the assets and the related accumulated
depreciation are removed from the accounts and any resulting gain or loss is
included in income. Maintenance and repair costs are expensed as incurred.
RESEARCH AND DEVELOPMENT AND CAPITALIZATION OF SOFTWARE PRODUCTION COSTS
The Company capitalizes software production costs related to a product upon the
establishment of technological feasibility as defined by generally accepted
accounting principles. Amortization is provided on a product-by-product basis
based upon the estimated useful life of the software (generally seven years).
All other research and development costs (including those related to software
for which technological feasibility has not been established) are expensed as
incurred.
INCOME TAXES
Several items of income and expense, including certain sales revenues under
sales-type leases, are included in the financial statements in different years
than they are included in the income tax returns. Deferred income taxes are
recorded for the tax effect of these differences.
WARRANTY AND UNEARNED REVENUE
The Company typically provides a one-year warranty from the date of installation
of its systems. The Company defers a portion of each system sale to be
recognized as service revenue during the warranty period. The amount deferred is
generally equal to the sales price of a maintenance contract for the type of
system under warranty and length of the warranty period.
The Company also records deposits received on sales orders, prepayments for
maintenance contracts and sales revenues attributable to systems shipped but not
installed as deferred revenues.
F-7
<PAGE> 26
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and 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.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes standards for reporting
about operating segments in the annual financial statements and requires
reporting of selected information about operating segments in interim financial
reports issued to stockholders. It also establishes standards for related
disclosures about products and services, geographic areas and major customers.
This Statement did not have a significant impact on the consolidated financial
statements as the Company has only one operating segment.
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133 (SFAS 133),"Accounting for Derivative Instruments and Hedging Activities."
SFAS No. 133 establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either an asset or
liability measured at its fair value. SFAS No. 133 requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement. Companies must formally document, designate and
assess the effectiveness of transactions that receive hedge accounting. SFAS No.
133, as amended by SFAS No. 137 is effective for fiscal years beginning after
June 15, 2000. SFAS No. 133 cannot be applied retroactively and must be applied
to (a) derivative instruments and (b) certain derivative instruments embedded in
hybrid contracts that were issued, acquired or substantively modified after
December 31, 1997. The Company has not yet quantified the impact of adopting
SFAS No. 133 on its financial statements and has not determined the timing of or
method of the adoption of SFAS No. 133. However, as of October 31, 1999, the
Company had no outstanding derivative instruments.
RECLASSIFICATIONS
Certain reclassifications have been made to the 1999 income statement to conform
with the 1998 or 1997 presentations. These reclassifications had no effect on
net income.
STOCK SPLIT
The Company declared a two-for-one stock split which was effective on August 13,
1999. All share and per share amounts contained in these financial statements
and footnotes have been restated to reflect the stock split.
F-8
<PAGE> 27
STATEMENTS OF CASH FLOWS
During 1999, $483,650 of spare parts inventory acquired as part of the purchased
service contracts was reclassified from purchased service and long-distance
contracts to inventory.
2. ACCOUNTS RECEIVABLE:
Trade accounts receivable consist of the following at October 31:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Gross trade receivables $4,617,815 $3,729,714
Less- reserve for doubtful accounts 185,168 168,513
---------- ----------
Net trade receivables $4,432,647 $3,561,201
========== ==========
</TABLE>
Adjustments to the reserve for doubtful accounts consist of the following:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Balance, beginning of period $ 168,513 $ 118,722
Provision for doubtful accounts 36,000 76,000
Net write-offs (19,345) (26,209)
---------- ----------
Balance, end of period $ 185,168 $ 168,513
========== ==========
</TABLE>
3. INVENTORIES:
Inventories are stated at the lower of cost (first-in, first-out) or market and
consist of the following components at October 31:
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
Raw materials $1,268,635 $1,092,278
Finished goods and spare parts 3,285,841 1,254,978
---------- ----------
4,554,476 2,347,256
Less- reserve for excess and obsolete inventory 821,170 325,000
---------- ----------
Inventories, net $3,733,306 $2,022,256
========== ==========
</TABLE>
Adjustments to the reserve for excess and obsolete inventories consist of the
following:
<TABLE>
<CAPTION>
1999 1998
-------- --------
<S> <C> <C>
Balance, beginning of period $324,998 $215,000
Provision for excess and obsolete inventories 496,172 109,998
Inventories written off -- --
-------- --------
Balance, end of period $821,170 $324,998
======== ========
</TABLE>
F-9
<PAGE> 28
4. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment consist of the following at October 31:
<TABLE>
<CAPTION>
Estimated
Useful
Lives 1999 1998
--------- ------------- ------------
<S> <C> <C> <C>
Building 20 $ 2,397,954 $ 1,565,601
Data processing and computer field equipment 3-5 1,694,056 1,368,075
Land - 611,582 611,582
Office furniture 5 438,815 136,143
Other 3-7 365,932 271,171
------------- ------------
Total property, plant and equipment 5,508,339 3,952,572
Less-accumulated depreciation 1,565,799 1,135,202
------------- ------------
Total property, plant and equipment, net $ 3,942,540 $ 2,817,370
============= ============
</TABLE>
5. ACCRUED LIABILITIES:
Accrued liabilities consist of the following at October 31:
<TABLE>
<CAPTION>
1999 1998
------------ -----------
<S> <C> <C>
Bonuses $ 849,863 $ 555,135
Vacation 126,679 102,679
Commissions 192,463 104,656
Payroll 147,197 --
Other 178,535 61,984
------------ -----------
$ 1,494,737 $ 824,454
============ ===========
</TABLE>
6. UNEARNED REVENUE:
Unearned revenue consists of the following at October 31:
<TABLE>
<CAPTION>
1999 1998
------------- ------------
<S> <C> <C>
Service contracts $ 1,575,385 $ 1,245,506
Warranty service 1,363,187 951,238
Customer deposits 1,349,405 688,778
Systems shipped but not installed 123,729 69,364
Other 128,842 141,331
------------- ------------
Total current unearned revenue 4,540,548 3,096,217
Noncurrent unearned service revenue 1,953,222 730,314
------------- ------------
$ 6,493,770 $ 3,826,531
============= ============
</TABLE>
F-10
<PAGE> 29
7. INCOME TAXES:
Income tax expense is based on pretax financial accounting income. Deferred
income taxes are computed using the liability method and are provided on all
temporary differences between the financial basis and the tax basis of the
Company's assets and liabilities.
The income tax provision for the years ending October 31, 1999, 1998 and 1997,
consists of the following:
<TABLE>
<CAPTION>
1999 1998 1997
------------- ------------- ------------
<S> <C> <C> <C>
Current provision - federal $ 2,176,000 $ 1,584,000 $ 1,199,110
Deferred provision (benefit) - federal 76,000 (77,000) (9,110)
State income taxes 498,000 348,000 --
------------- ------------- ------------
Total provision $ 2,750,000 $ 1,855,000 $ 1,190,000
============= ============= ============
</TABLE>
The reconciliation of the statutory income tax rate to the effective income tax
rate is as follows:
<TABLE>
<CAPTION>
Year Ended
October 31,
--------------------------
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Statutory rate 34% 34% 34%
State income taxes 7% 7% 0%
Other (2)% (3)% 2%
---- ---- ----
Effective rate 39% 38% 36%
==== ==== ====
</TABLE>
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities as of October 31 are
presented below:
<TABLE>
<CAPTION>
1999 1998
------------ -----------
<S> <C> <C>
Deferred tax assets:
Prepaid service contracts $ 503,983 $ 347,322
Nondeductible reserves 423,069 315,585
Unamortized cost of service contracts 102,094 --
Other 33,124 35,078
------------ -----------
Total deferred tax asset 1,062,270 697,985
------------ -----------
Deferred tax liabilities:
Tax income to be recognized on sales-type lease contracts 802,581 250,479
Unamortized capitalized software development costs 220,798 222,826
Unamortized cost of long distance and service contracts 66,320 175,974
------------ -----------
Total deferred tax liability 1,089,699 649,279
------------ -----------
Net deferred tax asset (liability) $ (27,429) $ 48,706
============ ===========
</TABLE>
F-11
<PAGE> 30
8. CREDIT AGREEMENTS:
Until November 30, 1999, the Company had maintained a $1,000,000 revolving line
of credit with its bank. No advances had ever been made under the line of
credit. Concurrent with the closing of the acquisition of U.S. Technologies
Systems, Inc. on November 30, 1999, the Company entered into a $40 million
credit facility with a new bank. This credit facility is more fully described in
Note 17 to these financial statements.
9. PURCHASED SERVICE AND LONG DISTANCE CONTRACTS:
In September 1998, the Company purchased substantially all of the Hitachi PBX
service contracts from Williams Communications Solutions, LLC (WCS) for
$1,533,000. The Company took responsibility for the 94 service contracts and 9
warranty customers between October 15, 1998 and December 1, 1998 based on a
predetermined schedule. The Company amortized the purchase price over the
estimated useful life of the contracts which was approximately one year. In
addition to the service contracts, the Company also purchased WCS' spare parts
inventory.
In April 1997, the Company purchased existing long distance contracts at 71
hotels for $1,108,000 from its marketing alliance partner in the long-distance
services business, Americom Communications Services, Inc. (Americom). The
purchase price included a payment for the contracts of $1,024,000, which has
been capitalized, and reimbursement of certain equipment fees on installed
equipment. The capitalized costs are being amortized ratably over the estimated
future life of the contracts.
10. STOCK OPTIONS:
The Company had a stock option plan (the Plan) for officers and key employees.
The Plan expired on April 18, 1998. Under the terms of the Plan, the Board of
Directors determined the option price, not to be less than fair market value, at
the date of grant.
Options granted under the Plan generally expire ten years from the date of grant
and are exercisable at a rate of 33 1/3 percent per year after a one-year
waiting period.
<TABLE>
<CAPTION>
Outstanding Options
-------------------
Price Per
Number Share
------ --------
<S> <C> <C>
Balance, October 31, 1997 190,670 $.50-3.28
Granted 80,000 $8.75
Exercised (97,998) $.50-3.28
---------
Balance, October 31, 1998 172,672 $.50-8.75
Exercised (4,134) $3.28-8.75
---------
Balance, October 31, 1999 168,538 $.50-8.75
=========
</TABLE>
F-12
<PAGE> 31
At October 31, 1999 and 1998, options to purchase 115,196 and 81,000 shares,
respectively, are exercisable.
The Company has also granted options outside the Plan to certain officers and
directors. These options generally expire ten years from the date of grant and
are exercisable over the period stated in each option. The table below presents
information regarding options granted outside the Plan.
<TABLE>
<CAPTION>
Outstanding Options
--------------------
Price Per
Number Share
------ --------
<S> <C> <C>
Balance, October 31, 1997 920,000 $.50-.77
Exercised (60,000) $.50
-----------
Balance, October 31, 1998 860,000 $.50-.77
Exercised (60,000) $.50
Granted 400,000 $11.88
-----------
Balance, October 31, 1999 1,200,000 $.50-11.88
===========
</TABLE>
Accounting for stock options issued to employees is governed by Statement of
Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock Based
Compensation." Generally, SFAS 123 requires companies to record in their
financial statements the compensation expense, if any, related to stock options
issued to employees. Under an alternative accounting method adopted by the
Company, SFAS 123 allows the Company to only disclose the impact of issued stock
options as if the expense had been recorded in the financial statements. Had the
Company recorded compensation expense related to its stock option plans in
accordance with SFAS 123, the Company's net income and earnings per share would
have been reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
For the Year Ended
October 31,
------------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
NET INCOME:
As reported $ 4,282,856 $ 3,052,700 $ 2,140,310
Pro forma $ 4,088,298 $ 2,945,408 $ 2,122,572
EARNINGS PER SHARE:
As reported - Basic $ 1.07 $ .75 $ .53
As reported - Diluted $ .93 $ .65 $ .45
Pro forma - Basic $ 1.02 $ .73 $ .53
Pro forma - Diluted $ .88 $ .63 $ .45
</TABLE>
The fair value of the options granted was estimated at the date of grant using
the Modified Black-Scholes European pricing model with the following
assumptions: risk free interest rate (5.38% to 5.85%), dividend yield (0.00%),
expected volatility (81.81% to 107.47%), and expected life (6 years).
F-13
<PAGE> 32
11. EARNINGS PER SHARE:
The Company adopted Statement of Financial Accounting Standards No. 128 (SFAS
128), "Earnings Per Share," effective December 31, 1997, and all earnings per
share amounts disclosed herein have been calculated under the provisions of SFAS
128. All basic earnings per common share were computed by dividing net income by
the weighted average number of shares of common stock outstanding during the
reported period. A reconciliation of net income and weighted average shares used
in computing basic and diluted earnings per share is as follows:
<TABLE>
<CAPTION>
For the Year Ended October 31, 1999
---------------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------- ------------- ---------
<S> <C> <C> <C>
Basic EPS
Net income $ 4,282,856 4,010,624 $1.07
============ =====
Dilutive effect of stock options 616,597
Diluted EPS -----------
Net income $ 4,282,856 4,627,221 $ .93
============ =========== =====
</TABLE>
<TABLE>
<CAPTION>
For the Year Ended October 31, 1998
---------------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------- ------------- ---------
<S> <C> <C> <C>
Basic EPS
Net income $ 3,052,700 4,059,966 $ .75
============ =====
Dilutive effect of stock options 625,114
Diluted EPS -----------
Net income $ 3,052,700 4,685,080 $ .65
============ =========== =====
</TABLE>
<TABLE>
<CAPTION>
For the Year Ended October 31, 1997
---------------------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------- ------------- ---------
<S> <C> <C> <C>
Basic EPS
Net income $ 2,140,310 4,012,510 $ .53
============ =====
Dilutive effect of stock options 717,978
Diluted EPS -----------
Net income $ 2,140,310 4,730,488 $ .45
============ =========== =====
</TABLE>
F-14
<PAGE> 33
12. COMMITMENTS:
Minimum future annual payments to be received and paid under various leases are
as follows:
<TABLE>
<CAPTION>
Sales-Type
Lease Payments Operating
October 31, Receivable Leases
------------- ----------
<S> <C> <C>
2000 $ 3,181,647 $ 68,466
2001 2,705,244 51,303
2002 1,507,979 43,804
2003 157,458 14,727
2004 80,713 --
------------- ----------
7,633,041 $ 178,300
==========
Less-Imputed interest 1,212,157
-------------
Present value of minimum payments $ 6,420,884
=============
</TABLE>
The Company incurred operating lease costs of approximately $220,000 and
$264,000 in 1999 and 1998, respectively.
On October 30, 1997, the Company's Board of Directors adopted a stock buy-back
program in which management was authorized to spend up to one-third of net
income for fiscal 1997 and for each subsequent fiscal quarter thereafter until
the program is terminated. During fiscal 1999, the percentage of each quarter's
net income allocated to the buy-back program was increased to one-half plus a
one-time allocation of $500,000. During fiscal 1998, the Company purchased
149,600 shares at an average price of $9.95. During fiscal 1999, the Company
purchased 130,300 shares at an average price of $8.89. While the buy-back
program remains in place, the Company has not repurchased any shares since its
announced expansion plans. In addition, the Company's new credit agreement (See
notes 8 and 17) places limits on the amount of shares that could be repurchased
under the buy-back plan.
13. MAJOR CUSTOMERS AND CONCENTRATIONS OF CREDIT RISK:
Marriott International/Marriott Host ("Marriott") is a major customer of the
Company. The Company has systems installed at various Marriott owned or managed
hotels under the brands "Marriott," "Residence Inn by Marriott," "Courtyard by
Marriott," and "Fairfield Inn by Marriott." Revenues from Marriott represented
14 percent and 22 percent of the Company's revenues for the years ended October
31, 1999 and 1998, respectively. Marriott has been a major customer of the
Company since 1986 and management considers its relationship with Marriott to be
good. However, the loss of Marriott as a customer would have a material adverse
effect on the Company's operating results and financial condition.
During fiscal 1998, revenues earned from Starwood Hotels and Resorts and from
Prime Hospitality were 11 percent and 10 percent, respectively. Both of these
companies are relatively new customers to the Company. The Company considers its
relationship with both to be good.
F-15
<PAGE> 34
The Company's products are designed and marketed to meet the specific
telecommunications needs of the lodging industry and the Company extends credit
to its customers in the normal course of business, including under its
sales-type lease program. As a result, the Company is subject to changes in the
economic and regulatory environments or other conditions which, in turn, may
impact the Company's overall credit risk. However, because the Company's
products are essential, revenue-producing assets of the customer and because the
ultimate credit risk typically rests with the individual hotel where the
equipment is installed, management considers the Company's credit risk to be
satisfactorily diversified and that the allowance for doubtful accounts is
adequate to absorb estimated losses at October 31, 1999 and 1998.
14. EMPLOYMENT AGREEMENTS:
During fiscal 1997, the Company's Board of Directors adopted a bonus plan for
certain officers of the Company. Under the plan, annual bonuses are earned based
upon after-tax net income. In addition, the Chief Executive Officer and
President are eligible for a quarterly bonus based upon after-tax net income,
subject to a maximum of $10,000 per quarter. In accordance with an employment
agreement, the Company's Vice President of Marketing and Sales earns an annual
salary, commissions and bonuses. Commissions and bonuses earned under the
agreement are based on total net revenues and the increase, if any, in annual
net revenues.
Bonuses, commissions and other payments earned under such agreements were
$1,114,000, $793,000, and $608,000 for the years ending October 31, 1999, 1998,
and 1997, respectively.
In conjunction with the Company's expansion beyond the lodging market, the Board
of Directors adopted a new bonus plan for fiscal year 2000 that includes the
executive management team and other key employees. The bonus plan provides for
an annual bonus to be paid to eligible employees if a specified growth rate in
EPS is achieved. An additional bonus pool is created equal to one-third of
pre-tax net income once the specified growth rate is achieved. The required
growth rate in EPS needed to earn any bonuses in fiscal 2000 is 25%.
15. CONTINGENCY:
The matter of Associated Business Telephone Systems, Inc., plaintiff, vs. XETA
Corporation, defendant and third-party plaintiff, vs. D&P Investments, Inc.,
third party defendant, filed in June, 1995, is still pending before the United
States District Court for the Northern District of Oklahoma. This matter arises
from a 1986 distributor's agreement between the Company and D&P, pursuant to
which the Company sold call accounting systems to D&P for resale, and a
maintenance agreement between the Company and ABTS pursuant to which the Company
furnished maintenance services for such systems. After having some of its claims
dismissed by the Court, ABTS' remaining claims are based on breach of contract
and tortious interference with certain customer relationships. The stated amount
of damages sought by ABTS in this matter is approximately $809,000. The Company
seeks in excess of $3 million in damages in its counterclaims against ABTS and
third-party claims against D&P. In November, 1999, during a pretrial conference,
ABTS and D&P disclosed to the Court that both of these companies had been
dissolved during the pendency of this litigation, without notice to the Company.
In view of this fact, and following ABTS' and D&P's failure to provide certain
financial information to the Company as ordered by the Court, the Court
postponed trial in this matter and granted the Company the right to conduct
discovery into the financial affairs of ABTS, D&P and ABTS'
F-16
<PAGE> 35
related companies. The Company is currently conducting such discovery. The
Company has also filed a motion to dismiss ABTS' and D&P's claims for their
continued failure to disclose certain other documents requested in 1997. The
Company intends to continue to vigorously defend ABTS' claims against it and to
pursue all of its counterclaims and third-party claims against ABTS and D&P.
Since 1994, the Company has been monitoring numerous patent infringement
lawsuits filed by Phonometrics, Inc., a Florida company, 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 call accounting customers are named defendants. These customers
have notified the Company that they seek indemnification under the terms of
their contracts with the Company. However, because there are other equipment
vendors implicated along with the Company in the cases filed against its
customers, the Company has never assumed the outright defense of its customers
in any of these actions. Phonometrics seeks 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 such lawsuit and ending October 30, 1990.
All of the cases filed by Phonometrics against the Company's customers were
originally filed in, or transferred to, the United States District Court for the
Southern District of Florida. On October 26th, 1998 the Florida Court dismissed
all of the cases filed against the hotels, following an appellate court's final
determination in Phonometrics' case against Northern Telecom that there was no
infringement of Phonometrics' patent. In its order dismissing Phonometrics'
complaints, the Florida court noted that Phonometrics failed to allege that the
hotels' call accounting equipment displays cumulative costs in real time as they
accrue, and displays these costs on a visual digital display, both of which are
necessary to establish infringement of Phonometrics' patent. Neither of these
elements are present in the Company's systems. On November 13, 1998,
Phonometrics filed an appeal of the Florida court's order dismissing these
cases, with the United States Court of Appeals for the Federal Circuit. The
parties have filed briefs in this matter and the case is now pending before the
Appeals Court.
In the opinion of management, the ultimate outcome of these cases will not
result in an amount that is material to the October 31, 1999 balance sheet or
the results of its operations.
16. RETIREMENT PLAN:
The Company began a 401(k) retirement plan ("Plan") on November 1, 1994. In
addition to employee contributions, the Company makes discretionary matching and
nonelective contributions to the Plan based on percentages set by the Board of
Directors. Contributions made by the Company to the Plan were $167,689, $160,000
and $129,000 for the years ending October 31, 1999, 1998 and 1997, respectively.
17. SUBSEQUENT EVENT:
On November 30, 1999, the Company successfully completed the acquisition of U.S.
Technologies Systems, Inc.("USTI"), a Missouri corporation. The Company
purchased all of the outstanding common stock of USTI for $26 million in cash
plus 150,000 shares of XETA common stock. At closing, the Company paid the
sellers $23 million in cash plus the Xeta shares according to the terms and
conditions of each of the purchase agreements which were negotiated separately
with the sellers. The remaining $3 million will be paid during the first
F-17
<PAGE> 36
two years after closing pending satisfaction of the applicable earn-out
provisions. The transaction will be accounted for using the purchase method of
accounting and the associated goodwill will be amortized over 20 years.
Financing for the acquisition was provided through a recently established $40
million credit facility with a bank. The $23 million paid at closing was funded
with a 5-year term loan. Of the remaining $17 million, $12 million is available
for future acquisitions and $5 million is available for working capital under a
revolving credit agreement. Interest on all the funded portions of the facility
accrues at a base rate plus a margin that is determined from time to time based
on the Company's debt/EBITDA ratio, as defined in the credit agreement. The base
interest rate is the bank's prime rate or LIBOR, as chosen by the Company. The
Company also pays a quarterly commitment fee on the unused portion of facility.
At December 10, 1999, the interest rate on the term loan was 8.48%. No amounts
had been drawn on the remaining portions of the credit facility.
18. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
The following quarterly financial data has been prepared from the financial
records of the Company without an audit, and reflects all adjustments which, in
the opinion of management, were of a normal, recurring nature and necessary for
a fair presentation of the results of operations for the interim periods
presented.
<TABLE>
<CAPTION>
For the Fiscal Year Ended October 31, 1999
-------------------------------------------------------------
Quarter Ended
-------------------------------------------------------------
January 31, April 30, July 31, October 31,
1999 1999 1999 1999
------------- ----------- ----------- -----------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Net sales $ 7,046 $ 9,241 $ 9,789 $ 11,187
Gross profit 2,749 3,595 3,601 4,045
Operating income 1,160 1,764 1,653 1,791
Net income 797 1,156 1,111 1,219
Basic EPS $ 0.19 $ 0.29 $ 0.28 $ 0.31
Diluted EPS $ 0.17 $ 0.25 $ 0.24 $ 0.27
</TABLE>
<TABLE>
<CAPTION>
For the Fiscal Year Ended October 31, 1998
-------------------------------------------------------------
Quarter Ended
-------------------------------------------------------------
January 31, April 30, July 31, October 31,
1998 1998 1998 1998
------------- ----------- ----------- -----------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Net sales $ 5,051 $ 6,566 $ 7,182 $ 6,648
Gross profit 1,976 2,396 2,359 2,264
Operating income 919 1,091 1,112 1,115
Net income 691 783 806 773
Basic EPS $ 0.17 $ 0.19 $ 0.20 $ 0.19
Diluted EPS $ 0.15 $ 0.17 $ 0.17 $ 0.16
</TABLE>
F-18
<PAGE> 37
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS; COMPLIANCE WITH SECTION 16(a) OF THE
EXCHANGE ACT.
The directors, executive officers and significant employees of the Company
are set forth below. All officers and members of the Board of Directors serve
for a term of one year or until their successors are duly elected and qualified.
Directors may be removed by holders of 66 2/3% of the Company's outstanding
voting shares.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Jack R. Ingram 56 Chief Executive Officer and Chairman of the
Board
Jon A. Wiese 43 President
Robert B. Wagner 38 Vice President of Finance, Chief Financial
Officer, Treasurer, Secretary and
Director
Donald E. Reigel 45 Vice President of Sales, Hospitality Division
Mark A. Martin 39 Vice President of Sales, Commercial Channel
Division
Tom R. Crofford 48 Vice President of Engineering
Charles H. Rowland 58 Vice President of Manufacturing
Thomas A. Luce 43 Vice President of Service
Ron B. Barber 45 Director
Donald T. Duke 50 Director
Dr. Robert D. Hisrich 55 Director
Ronald L. Siegenthaler 56 Director
</TABLE>
A brief account of the business experience for the past five years of the
individuals listed above follows.
MR. INGRAM has been President of the Company since July 1990 and a director
of the Company since March 1989. Mr. Ingram's business experience prior to
joining the Company was concentrated in the oil and gas industry. Mr. Ingram
holds a Bachelor of Science Degree in Petroleum Engineering from the University
of Tulsa.
MR. WIESE joined the Company on August 2, 1999 as President. Mr. Wiese was
employed by Lucent since 1989 and held various executive offices since 1990,
including President and Corporate Officer of Lucent's International Division
based in Brussels. From 1997 until taking the position with the Company, he
served as Vice President and Corporate Officer at Lucent and was responsible for
its USA sales and service division where he had full P&L responsibility and
managed twelve Vice Presidents and 17,000 Lucent employees. His functional
responsibilities in this division included marketing, sales, service, human
resources, finance, information technology, and order and asset management. Mr.
Wiese holds a Bachelor of Science degree in finance and a Master of Business
Administration degree in marketing from Oklahoma State University. He is also a
1994 graduate of the Cultural Transformation Program at the London School of
Business.
MR. WAGNER joined the Company in July 1988 as Chief Accounting Officer. He
became the Company's Vice President of Finance and Chief Financial Officer in
March, 1989, and a member of the Board of Directors in March 1996. Mr. Wagner is
a Certified Public Accountant licensed in Oklahoma and received his Bachelor of
Science Degree in Accounting from Oklahoma State University.
19
<PAGE> 38
MR. REIGEL joined the Company in June 1993 as PBX Product Sales Manager. He
was promoted to Vice President of Marketing and Sales in June 1995. Prior to his
employment with the Company, Mr. Reigel served as a national accounts sales
manager for WilTel Communications Systems for approximately a year and a half.
He has been active in the development of major national accounts in the
telecommunications industry since 1987. Mr. Reigel received his Bachelor of
Science Degree in Business from the University of Colorado.
MR. MARTIN joined the Company in November, 1999 in conjunction with the
Company's acquisition of USTI. He. co-founded USTI in 1986 and continually
served in different executive positions with USTI, including President, CEO and
Chairman of the Board, until USTI was acquired by the Company. Mr. Martin holds
a Bachelor of Science Degree in Business Administration from St. Louis
University.
MR. CROFFORD joined the Company in October 1982 as a design engineer and
has been its Vice President of Engineering since January 1988. Mr. Crofford has
worked in the field of computer engineering since 1977. He is a member of the
Institute of Electrical and Electronics Engineers.
MR. ROWLAND joined the Company in December 1982 as Production Manager and
was promoted to Vice President of Manufacturing in January 1984. Mr. Rowland has
more than 20 years electronic manufacturing experience, including production
testing, assembly line layout and production control management.
MR. LUCE joined the Company in November 1982 as Installment Director. He
was later promoted to Director of Installation and Service and became Vice
President of Service in June 1986.
MR. BARBER has been a director of the Company since March 1987. He has been
engaged in the private practice of law since October 1980 and is a shareholder
in the law firm of Barber & Bartz, a Professional Corporation, in Tulsa,
Oklahoma, which serves as counsel to the Company. Mr. Barber is also a Certified
Public Accountant licensed in Oklahoma. He received his Bachelor of Science
Degree in Business Administration (Accounting) from the University of Arkansas
and his Juris Doctorate Degree from the University of Tulsa.
MR. DUKE has been a director of the Company since March 1991. He is
President of Duke Energy Co. L.L.C., an oil and gas consulting and investment
firm. Mr. Duke has been in senior management in the oil and gas industry since
1980, including time as President and Chief Operating Officer of Hadson
Petroleum (USA), Inc., a domestic oil and gas subsidiary of Hadson Corporation,
where he was responsible for all phases of exploration and production, land,
accounting, operations, product marketing and budgeting and planning. Mr. Duke
has a Bachelor of Science Degree in Petroleum Engineering from the University of
Oklahoma.
DR. HISRICH has been a director of the Company since March 1987. He
occupies the A. Malachi Mixon III Chair in Entrepreneurial Studies and is
Professor of Marketing and Policy Studies at the Weatherhead School of
Management at Case Western Reserve University in Cleveland, Ohio. Prior to
assuming such positions, he occupied the Bovaird Chair of Entrepreneurial
Studies and Private Enterprise and was Professor of Marketing at the College of
Business Administration for the University of Tulsa. He is also a marketing and
management consultant. He is a member of the Board of Directors of the Bovaird
Supply Company, Jameson Inn, Inc., and Noteworthy Medical Systems, Inc., a
member of the Editorial Boards of the Journal of Venturing and the Journal of
Small Business Management, and a member of the Board of Directors of Enterprise
Development, Inc. Dr. Hisrich received his Bachelor of Arts Degree in English
and Science from DePaul University and his Master of Business Administration
Degree (Marketing) and Ph.D. in Business Administration (Marketing, Finance, and
Quantitative Methods) from the University of Cincinnati.
MR. SIEGENTHALER has been a director of the Company since its
incorporation. He also served as its Executive Vice President from July 1990
until March, 1999. Since 1974, through SEDCO Investments, a partnership in which
Mr. Siegenthaler is a partner, and as an individual, Mr. Siegenthaler has been
involved as partner, shareholder, officer, director, or sole proprietor of a
number of business entities with significant involvement in fabrication and
marketing of steel, steel products and other raw material, real estate, oil and
gas, and telecommunications. Mr. Siegenthaler received his Bachelor's Degree in
Liberal Arts from Oklahoma State University.
20
<PAGE> 39
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Based solely upon a review of Forms 3 and 4 and amendments thereto
furnished to the Company during its most recent fiscal year and Forms 5 and
amendments thereto furnished to the Company with respect to its most recent
fiscal year and written representations made to the Company by its directors and
officers and by certain beneficial owners of more than ten percent of its Common
Stock, the Company knows of no director, officer, or beneficial owner of more
than ten percent of the Company's Common Stock who has failed to file on a
timely basis reports of beneficial ownership of the Company's Common Stock as
required by Section 16(a) of the Securities Exchange Act of 1934, as amended.
ITEM 11. EXECUTIVE COMPENSATION.
That portion of the Company's definitive Proxy Statement appearing under
the caption "Executive Compensation," to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A on or before February 28, 2000
and to be used in connection with the Company's Annual Meeting of Shareholders
to be held April 11, 2000 is hereby incorporated by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
That portion of the Company's definitive Proxy Statement appearing under
the caption "Security Ownership of Certain Beneficial Owners and Management," to
be filed with the Securities and Exchange Commission pursuant to Regulation 14A
on or before February 28, 2000 and to be used in connection with the Company's
Annual Meeting of Shareholders to be held April 11, 2000 is hereby incorporated
by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
That portion of the Company's definitive Proxy Statement appearing under
the caption "Related Transactions," to be filed with the Securities and Exchange
Commission pursuant to Regulation 14A on or before February 28, 2000 and to be
used in connection with the Company's Annual Meeting of Shareholders to be held
April 11, 2000 is hereby incorporated by reference.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) (1) Financial Statements - See Index to Financial Statements at
Page 18 of this Form 10-K.
(2) Financial Statement Schedule - None.
(3) Exhibits - See Exhibit Index at Page 23 of this Form 10-K.
(b) The Company filed no report on Form 8-K during the last quarter of the
fiscal year ended October 31, 1999.
(c) See Exhibit Index at Page 23 of this Form 10-K.
(d) See Index to Financial Statements at Page 18 of this Form 10-K.
21
<PAGE> 40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
XETA CORPORATION
JANUARY 27, 2000 BY: /s/ Jack R. Ingram
------------------------------------------
JACK R. INGRAM, CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
JANUARY 27, 2000 /s/ Jack R. Ingram
------------------------------------------
JACK R. INGRAM, CHIEF EXECUTIVE OFFICER AND
DIRECTOR
JANUARY 27, 2000 /s/ Jon A. Wiese
------------------------------------------
JON A. WIESE, PRESIDENT
JANUARY 27, 2000 /s/ Robert B. Wagner
-------------------------------------------
ROBERT B. WAGNER, VICE PRESIDENT OF FINANCE,
CHIEF FINANCIAL OFFICER, AND DIRECTOR
JANUARY 27, 2000 /s/ Donald T. Duke
-------------------------------------------
DONALD T. DUKE, DIRECTOR
JANUARY 27, 2000 /s/ Ronald L. Siegenthaler
-------------------------------------------
RONALD L. SIEGENTHALER, DIRECTOR
22
<PAGE> 41
EXHIBIT INDEX
SEC No. Description
- ------- -----------
(2) PLAN OF ACQUISITION, REORGANIZATION, ARRANGEMENT, LIQUIDATION OR
SUCCESSION -
2.1 Stock Purchase Agreement dated as of August 1, 1999, between Mark A.
Martin, individually, and Mark A. Martin, Trustee under Living Trust
of Mark A. Martin dated April 4, 1994, and XETA Corporation
-Incorporated by reference to Exhibit 2.1 to the Registrant's Form 8-K
filed on December 15, 1999 (File No. 0-16231).
2.2 Stock Purchase Agreement dated as of August 1, 1999, between Lawrence
J. Hopp, individually, and Lawrence J. Hopp, Trustee under Living
Trust of Lawrence J. Hopp dated October 13, 1994, and XETA Corporation
-Incorporated by reference to Exhibit 2.2 to the Registrant's Form 8-K
filed on December 15, 1999 (File No. 0-16231).
(3) (i) ARTICLES OF INCORPORATION - Amended and Restated Certificate of
Incorporation of the Registrant -- Incorporated by reference to
Exhibits 3.1 and 3.2 to the Registrant's Registration Statement on
Form S-1, filed on June 17, 1987 (File No. 33-7841).
Amendment No. 1 to Amended and Restated Certificate of Incorporation
-- Incorporated by reference to Exhibit 4.2 to the Registrant's
Post-Effective Amendment No. 1 to Registration Statement on Form S-8,
filed on July 28, 1999 (File No. 33-62173).
(ii) BYLAWS - Amended and Restated Bylaws of the Registrant, First
Amendment and Second Amendment - Incorporated by reference to Exhibit
3(ii) to the Registrant's Annual Report on Form 10-KSB for the fiscal
year ended October 31, 1994, filed on January 30, 1995 (File No.
0-16231).
Third Amendment to Amended and Restated Bylaws - Incorporated by
reference to Exhibit 4.4 to the Registrant's Post-Effective Amendment
No. 1 to Registration Statement on Form S-8 filed on July 28, 1999
(File No. 33-62173).
(4) INSTRUMENTS DEFINING RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES
- None other than the Amended and Restated Certificate of Corporation
of the Registrant, as amended, and Amended and Restated Bylaws of the
Registrant, as amended, as identified in Exhibit 3(i) and 3(ii) to
this report.
(9) VOTING TRUST AGREEMENT - None.
(10) MATERIAL CONTRACTS -
10.1 HCX 5000(R) Authorized Distributor Agreement dated ApriL 1, 1998
between Hitachi Telecom (USA), Inc. and XETA
Corporation--Incorporated by reference to Exhibit 10 to the
Registrant's Form 10-QSB for the quarter ended April 30, 1998,
filed on June 15, 1998 (File No. 0-16231).
10.2 Asset Purchase Agreement dated September 18, 1998 between
Williams Communications Solutions, LLC and XETA
Corporation-Incorporated by reference to Exhibit (2) to the
Registrant's Form 8-K, filed on October 2, 1998 (File No.
0-16231).
10.3 Dealer Agreement Among Lucent Technologies, Inc.; Distributor,
Inacom Communications, Inc.; and XETA Corporation for Business
Communications Systems-Incorporated by reference to Exhibit 10.1
to the Registrant's Form
<PAGE> 42
10-Q for the quarter ended April 30, 1999, filed on June 11, 1999
(File No. 0-16231).
10.4 Stock Purchase Option dated June 17, 1999 granted to Jon A. Wiese
Incorporated by reference to Exhibit 10.2 to the Registrant's
Form 10-Q for the quarter ended July 31, 1999, filed on September
14, 1999 (File No. 0-16231).
10.5 Credit Agreement dated as of November 30, 1999 among XETA
Corporation, the Lenders, the Agent and the
Arranger--Incorporated by reference to Exhibit 2.3 to the
Registrant's Form 8-K filed on December 15, 1999 (File No.
16231).
10.6 Real Estate Mortgage on the Registrant's Broken Arrow, Oklahoma
property-Incorporated by reference to Exhibit 2.5 to the
Registrant's Form 8-K filed on December 15, 1999 (File No.
0-16231).
10.7 Pledge and Security Agreement relating to November 30, 1999
Credit Agreement - Incorporated by reference to Exhibit 2.4 to
the Registrant's Form 8-K filed on December 15, 1999 (File No.
0-16231).
10.8 Subsidiary Guaranty by U.S. Technologies Systems, Inc. of
November 30, 1999 Credit facility - Incorporated by reference to
Exhibit 2.6 to the Registrant's Form 8-K filed on December 15,
1999 (File No. 0-16231).
(11) STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS - Inapplicable.
(12) STATEMENT RE: COMPUTATION OF RATIOS - Inapplicable.
(13) ANNUAL REPORT TO SECURITY HOLDERS, FORM 10-Q OR QUARTERLY REPORT TO
SECURITY HOLDERS - Inapplicable.
(18) LETTER RE: CHANGE IN ACCOUNTING PRINCIPLES - Inapplicable.
(21) SUBSIDIARIES OF THE REGISTRANT
(22) PUBLISHED REPORT REGARDING MATTERS SUBMITTED TO A VOTE OF SECURITY
HOLDERS - None.
(23) CONSENTS OF EXPERTS AND COUNSEL
23.1 Consent of Arthur Anderson LLP
(24) POWER OF ATTORNEY - None.
(27) FINANCIAL DATA SCHEDULE
(99) ADDITIONAL EXHIBITS - None.
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF THE COMPANY
U.S. Technologies Systems Inc., a Missouri corporation
XETACOM, Inc., an Oklahoma corporation
<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, 1999,
or performed any audit procedures subsequent to the date of our report.
ARTHUR ANDERSEN LLP
Tulsa, Oklahoma
January 28, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON
PAGES 3 AND 4 OF THE COMPANY'S 10-K FOR THE YEAR TO DATE AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> OCT-31-1999
<PERIOD-END> OCT-31-1999
<CASH> 4,556,212
<SECURITIES> 0
<RECEIVABLES> 4,432,647
<ALLOWANCES> 0
<INVENTORY> 3,733,306
<CURRENT-ASSETS> 16,182,925
<PP&E> 3,942,540
<DEPRECIATION> 0
<TOTAL-ASSETS> 25,316,477
<CURRENT-LIABILITIES> 8,161,939
<BONDS> 0
0
0
<COMMON> 231,835
<OTHER-SE> 14,319,457
<TOTAL-LIABILITY-AND-EQUITY> 25,316,477
<SALES> 37,263,052
<TOTAL-REVENUES> 37,263,052
<CGS> 23,272,692
<TOTAL-COSTS> 23,272,692
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 7,032,856
<INCOME-TAX> 2,750,000
<INCOME-CONTINUING> 4,282,856
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,282,856
<EPS-BASIC> 1.07
<EPS-DILUTED> .93
</TABLE>
