<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended January 31, 2000
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-16231
XETA Corporation
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Oklahoma 73-1130045
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
- ------------------------------- ----------------
incorporation or organization) Identification No.)
1814 W. Tacoma, Broken Arrow, OK 74012-1406
-------------------------------- ----------
(Address of principal executive offices) (Zip Code)
918-664-8200
----------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
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
--- ---
Number of shares outstanding of each of the registrant's classes of common
stock, as of the latest practicable date.
<TABLE>
<S> <C>
Class Outstanding at March 1, 2000
- -------------------------------- ----------------------------
Common Stock, $.05 par value 4,145,774
</TABLE>
<PAGE> 2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets - January 31, 2000 and October 31, 1999
Consolidated Statements of Operations - For the Three months ended
January 31, 2000 and 1999
Consolidated Statement of Shareholder's Equity - November 1, 1999
through January 31, 2000
Consolidated Statements of Cash Flows - For the Three months ended
January 31, 2000 and 1999
Notes to Consolidated Financial Statements
2
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XETA CORPORATION
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
January 31, 2000 October 31,1999
---------------- ---------------
(Unaudited)
<S> <C> <C>
Current Assets:
Cash and cash equivalents $ 563,210 $ 4,556,212
Current portion of net investment in
sales-type leases 2,734,665 2,577,141
Trade accounts receivable, net 22,527,383 4,432,647
Inventories, net 6,654,457 3,733,306
Deferred tax asset, net 983,624 622,595
Prepaid expenses and other assets 383,466 261,024
--------------- ---------------
Total current assets 33,846,805 16,182,925
--------------- ---------------
Noncurrent Assets:
Goodwill, net of amortization 20,386,546 --
Net investment in sales-type leases,
less current portion above 3,696,476 3,843,743
Purchased service and long distance contracts,
net -- 394,230
Property, plant & equipment, net 4,492,179 3,942,540
Capitalized software production costs, net of
accumulated amortization of $603,066 & $573,066 647,955 649,406
Other assets 379,467 303,633
--------------- ---------------
Total noncurrent assets 29,602,623 9,133,552
--------------- ---------------
Total assets $ 63,449,428 $ 25,316,477
=============== ===============
LIABILITIES & SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 4,600,000 $ --
Accounts payable 9,316,721 2,126,654
Unearned revenue 4,396,060 4,540,548
Accrued liabilities 2,197,162 1,494,737
Accrued federal and state income taxes 946,311 --
--------------- ---------------
Total current liabilities 21,456,254 8,161,939
--------------- ---------------
Noncurrent liabilities:
Long-term debt, less current portion above 20,633,333 --
Unearned service revenue 1,827,929 1,953,222
Noncurrent deferred tax liability, net 43,535 650,024
--------------- ---------------
22,504,797 2,603,246
--------------- ---------------
Commitments
Shareholders' equity:
Preferred stock; $.10 par value; 50,000 shares
authorized, 0 issued -- --
Common stock; $.05 par value; 10,000,000
shares authorized, 4,137,074 and 3,977,308
issued at January 31, 2000 and October
31, 1999, respectively 232,323 231,835
Paid-in capital 8,128,487 5,373,855
Retained earnings 13,372,226 11,851,761
Less treasury stock, at cost (2,244,659) (2,906,159)
--------------- ---------------
Total shareholders' equity 19,488,377 14,551,292
--------------- ---------------
Total liabilities & shareholders' equity $ 63,449,428 $ 25,316,477
=============== ===============
</TABLE>
The accompanying notes are an integral part of these statements.
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XETA CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months
Ended January 31,
2000 1999
------------ ------------
<S> <C> <C>
Commercial systems sales $ 9,138,998 $ --
Lodging systems sales 5,366,011 3,050,683
Installation and service revenues 6,045,018 3,995,599
------------ ------------
Net sales and service revenues 20,550,027 7,046,282
------------ ------------
Cost of commercial systems 6,513,865 --
Cost of lodging systems 3,389,274 1,773,881
Installation and services costs 4,386,834 2,523,141
------------ ------------
Total cost of sales and service 14,289,973 4,297,022
------------ ------------
Gross profit 6,260,054 2,749,260
------------ ------------
Operating expenses:
Selling, general and administrative 2,829,944 1,008,599
Engineering, research and development 182,614 102,634
Amortization 623,630 478,095
------------ ------------
Total operating expenses 3,636,188 1,589,328
------------ ------------
Income from operations 2,623,866 1,159,932
Interest expense (366,000) --
Interest and other income 244,599 147,607
------------ ------------
Subtotal (121,401) 147,607
Income before provision for income
taxes 2,502,465 1,307,539
Provision for income taxes 982,000 511,000
------------ ------------
Net income $ 1,520,465 $ 796,539
============ ============
Earnings per share
Basic $ 0.37 $ 0.20
============ ============
Diluted $ 0.31 $ 0.17
============ ============
Weighted average shares outstanding 4,081,788 4,059,066
============ ============
Weighted average shares equivalents 4,908,228 4,633,920
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
4
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XETA CORPORATION
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
NOVEMBER 1, 1999 THROUGH January 31, 2000
(Unaudited)
<TABLE>
<CAPTION>
Common Stock Treasury Stock
--------------------------- --------------------------
Number of
Shares Issued Paid-in Retained
& Outstanding Par Value Shares Amount Capital Earnings
------------- --------- ------ ------ ------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance -
October 31, 1999 4,636,702 $231,835 659,394 $(2,906,159) $5,373,855 $11,851,761
Treasury Stock given
in acquisition - - 150,000) 661,500 2,638,500 -
Stock options exercised 9,766 488 - - 19,145 -
Tax benefit of stock
Options - - - - 96,987 -
Net income - - - - - 1,520,465
--------- -------- ------- ----------- ---------- -----------
Balance at January
31, 2000 4,646,468 $232,323 509,394 $ 2,244,659 $8,128,487 $13,372,226
========= ======== ======= =========== ========== ===========
</TABLE>
The accompanying notes are an integral part of this statement.
5
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XETA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
For the Three Months
Ended January 31,
2000 1999
---------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income .............................................. $ 1,520,465 $ 796,539
---------- ---------
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation .......................................... 162,232 73,701
Amortization .......................................... 623,630 478,095
Gain on sale of assets ................................ (30,363) --
Provision for returns & doubtful accounts receivable... 31,000 9,000
Provision for excess and obsolete inventory ........... 50,000 --
Change in assets and liabilities. net of acquisition:
(Increase) in net investment In sales-type leases .... (10,257) (508,036)
(Increase) decrease in trade receivables ............. (2,711,175) 595,187
(Increase) decrease in inventories ................... 1,081,537 (322,977)
Increase in deferred tax asset ...................... (48,082) (19,659)
Increase in prepaid expenses and other assets ....... (53,993) (163,607)
Increase (decrease) in accounts payable ............. 579,155 (643,742)
Increase decrease) in unearned revenue .............. (2,048,433) 670,758
Increase in accrued income taxes .................... 1,043,298 507,532
Decrease in accrued liabilities ..................... (2,544,110) (382,111)
Decrease in deferred tax liabilities ................ (96,489) (62,325)
---------- ---------
Total adjustments ......................................... (3,972,051) 231,816
---------- ---------
Net cash provided by (used in)
operating activities ............................ (2,451,586) 1,028,355
---------- ---------
Cash flows from investing activities:
Purchase of UST, net of cash acquired ................. (23,608,478) --
Additions to capitalized software ..................... (28,550) (36,454)
Additions to property, plant & equipment .............. (201,828) (817,308)
Proceeds from sale of assets .......................... 44,472 --
---------- ---------
Net cash used in
investing activities ......................... (23,794,384) (853,762)
---------- ---------
Cash flows from financing activities:
Proceeds from issuance of debt ........................ 23,000,000 --
Principal payments on debt ............................ (766,667) --
Purchase of treasury stock ............................ -- (94,250)
Exercise of stock options ............................. 19,634 30,000
---------- ---------
Net cash provided by (used in)
financing activities ......................... 22,252,968 (64,250)
---------- ---------
Net increase (decrease) in cash and
cash equivalents ............................. (3,993,002) 110,343
Cash and cash equivalents, beginning of period ............. 4,556,212 3,238,210
--------- ---------
Cash and cash equivalents, end of period ................... $ 563,210 $ 3,348,561
========== ==========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest ................ $ 218,588 $ 7,101
Cash paid during the period for income taxes ............ $ 64,572 $ 85,452
Contingent consideration to be paid to UST shareholder... $ 3,000,000 $ --
Contingent liabilities acquired in UST acquisition ....... $ 2,000,000 $ --
Treasury shares given in UST acquisition ................ $ 3,300,000 $ --
</TABLE>
The accompanying notes are an integral part of these statements.
6
<PAGE> 7
XETA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
January 31, 2000
(Unaudited)
(1) BASIS OF PRESENTATION
The consolidated financial statements included herein include the accounts
of XETA Corporation, doing business as XETA Technologies, and its wholly-owned
subsidiaries, U.S. Technologies Systems, Inc. ("UST") and Xetacom, Inc. (the
"Company" or "XETA"). Xetacom's operations have been insignificant to date. All
significant intercompany accounts and transactions have been eliminated.
The accompanying consolidated financial statements have been prepared by
the Company, without an audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote
disclosures, normally included in annual financial statements prepared in
accordance with generally accepted accounting principles, have been condensed or
omitted pursuant to those rules and regulations. However, the Company believes
that the disclosures made are adequate to make the information presented not
misleading when read in conjunction with the consolidated financial statements
and the notes thereto included in the Company's latest financial statements
filed as part of the Company's Annual Report on Form 10-K, Commission File No.
0-16231. Management believes that the financial statements contain all
adjustments necessary for a fair statement of the results for the interim
periods presented. All adjustments made were of a normal recurring nature. The
results of operations for the interim periods are not necessarily indicative of
the results for the entire fiscal year. The results of the Company's newly
acquired subsidiary UST were only consolidated since December 1, 1999 and UST's
operating results have historically been subject to significant seasonal
fluctuations.
These statements should be read in conjunction with the audited financial
statements and notes thereto of XETA included in the Company's Annual Report on
Form 10K, which was filed with the SEC on January 28, 2000 and additionally the
Company's Form 8K-A filing on February 16, 2000 reflecting the proforma
operating results of the Company, including UST.
(2) ACQUISITION OF UST
On November 30, 1999, the Company successfully completed the acquisition of
UST, a Missouri Subchapter S corporation. The Company purchased all of the
outstanding common stock of UST 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 common stock according to the terms and conditions of each of the
purchase agreements which were negotiated separately with the sellers. 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 any breaches in
the representations and warranties made by the owners in the sale documents. The
transaction will be accounted for using the purchase method of accounting and
the associated goodwill will be amortized over 20 years. The accompanying
consolidated balance sheet as of January 31, 2000 includes preliminary
allocations of the purchase price and is subject to final
7
<PAGE> 8
adjustment. The accompanying operating results represent the results of
operations of the Company after consolidating UST's results from December 1,
1999 to January 31, 2000.
The unaudited pro forma information presented below consists of statement
of operations data as presented as if UST's results had been consolidated from
the first day of the period reported.
<TABLE>
<CAPTION>
Three Months Ending January 31,
-----------------------------------
2000 1999
--------------- ---------------
<S> <C> <C>
Revenues $ 24,594,000 $ 15,337,647
Net income $ 1,927,947 $ 1,000,532
Basic earnings per share $ .47 $ .24
Diluted earnings per share $ .39 $ .21
</TABLE>
Pro forma adjustments included in the amounts above primarily relate to
increased amortization and interest expense, additional general and
administrative expenses for increased compensation expense, and increased
federal and state tax expense based on the combined operations. The calculation
of basic and diluted earnings per share for the period ending January 31, 1999
assumes the issuance of 150,000 shares of common stock at the beginning of the
period reflecting the stock issued to one of the sellers in the purchase
transaction.
With this acquisition, the Company significantly extended its market beyond
its traditional boundries of the hospitality market. This expansion is part of
the Company's strategy to grow outside the relatively small niche of the lodging
industry and to be a part of the changes expected to occur in the
telecommunications industry as voice and data networks converge onto one
integrated platform.
(3) CREDIT FACILITY
Financing for the acquisition of UST was provided through a $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 either a) the London Interbank Offered Rate (which was 5.731% at
January 31, 2000 plus 1.5% to 2.5%, as determined by the ratio of the Company's
total funded debt to EBITDA (as defined in the credit facility) or b) the bank's
prime rate (which was 8.5% at January 31, 2000) plus up to .75%, as determined
by the ratio of the Company's total funded debt to EBITDA. Commitment fees of
.20% to .45% (based on certain financial ratios) are due on any unused borrowing
capacity under the credit facility. The Company makes monthly payments on the
term loan of $383,333. The term loan expires on November 30, 2004. Draws under
the acquisition portion of the credit facility are converted annually into five
year term loans, except during the third year of the facility in which any draws
are converted into a four year term loan.
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<PAGE> 9
(4) INVENTORIES
The following are the components of inventories:
<TABLE>
<CAPTION>
January 31, October 31,
2000 1999
------------- -------------
(Unaudited)
<S> <C> <C>
Raw materials $ 1,227,435 $ 1,268,635
Finished goods and spare parts 6,477,358 3,285,841
------------- -------------
7,704,793 4,554,476
Less reserve for excess and
obsolete inventory (1,050,336) (821,170)
------------- -------------
$ 6,654,457 $ 3,733,306
============= =============
</TABLE>
(5) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of the following:
<TABLE>
<CAPTION>
January 31, October 31,
2000 1999
------------- -------------
(Unaudited)
<S> <C> <C>
Building $ 2,468,925 $ 2,397,954
------------- -------------
Data processing & computer field equipment 2,513,806 1,694,056
Land 611,582 611,582
Office furniture 666,598 486,535
Autos and Trucks 113,553 9,486
Other 385,513 308,726
------------- -------------
6,759,977 5,508,339
Less accumulated depreciation (2,267,798) (1,565,799)
------------- -------------
$ 4,492,179 $ 3,942,540
============= =============
</TABLE>
(6) UNEARNED INCOME
Unearned income consists of the following:
<TABLE>
<CAPTION>
January 31, October 31,
2000 1999
------------- -------------
(Unaudited)
<S> <C> <C>
Service contracts $ 1,382,367 $ 1,575,385
Warranty service 1,501,548 1,363,187
Systems shipped, but not installed 46,344 123,729
Rebates due from vendors 539,940 --
Customer deposits 829,160 1,349,405
Other deferred revenue 96,701 128,842
------------- -------------
Total current deferred revenue 4,396,060 4,540,548
Noncurrent unearned service revenues 1,827,929 1,953,222
------------- -------------
$ 6,223,989 $ 6,493,770
============= =============
</TABLE>
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(7) INCOME TAXES
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are presented
below:
<TABLE>
<CAPTION>
January 31, October 31,
2000 1999
------------- -------------
(Unaudited)
<S> <C> <C>
Deferred tax assets:
Nondeductible reserves $ 1,311,529 $ 423,069
Prepaid service contracts 492,807 503,983
Unamortized cost of service contracts 79,764 102,094
Other 54,834 33,124
------------- -------------
Total deferred tax asset 1,938,934 1,062,270
------------- -------------
Deferred tax liabilities:
Tax income to be recognized on sales-type
lease contracts 752,601 802,581
Unamortized capitalized software
development costs 220,305 220,798
Unamortized cost of long distance and
Service contracts -- 66,320
Other 25,939 --
------------- -------------
Total deferred tax liability 998,845 1,089,699
------------- -------------
Net deferred tax asset (liability) $ 940,089 $ (27,429)
============= =============
</TABLE>
(8) INTEREST AND OTHER INCOME
Interest and other income recorded in the accompanying financial
statements, consists primarily of interest income earned from sales-type leases
and cash investments.
(9) SUBSEQUENT EVENT
On February 29, 2000, the Company completed the acquisition of the majority
of the net assets of Advanced Communications Technologies, Inc. ("ACT"). The
purchase price of the assets was book value plus $250,000 (estimated at $3.5
million in total). The Company made an initial payment of $3 million on February
29, 2000. A final true-up of the purchase price will be made within 60 days
based on the final book value of ACT at February 29, 2000. Funding for the
purchase price was provided by borrowings under the Company's credit facility.
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(10) FOOTNOTES INCORPORATED BY REFERENCE
Certain footnotes are applicable to the consolidated financial statements,
but would be substantially unchanged from those presented in the Company's
Annual Report on Form 10-K, Commission File No. 0-16231, filed with the
Securities and Exchange Commission on January 28, 2000. Accordingly, reference
should be made to those statements for the following:
<TABLE>
<CAPTION>
Note Description
- ---- -----------
<S> <C>
1 Business and summary of significant accounting policies
2 Accounts receivable
5 Accrued liabilities
6 Income taxes
9 Purchased Long Distance Contracts
10 Stock options
11 Earnings per share
12 Commitments
13 Major Customers and Concentration of Credit Risk
14 Employment Agreements
15 Contingency
16 Retirement plan
</TABLE>
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The unaudited consolidated results for the quarter ending January 31, 2000
reflect the operations of XETA Corporation (the "Company" or "XETA") for the
quarter and the operations of U.S. Technologies, Inc. from December 1, 1999 to
January 31, 2000. For the quarter ending January 31, 2000, the Company reported
net income of $1.520 million or $.31 per share (diluted) compared to net income
of $797,000 or $.17 per share (diluted) for the first quarter of fiscal 1999, a
91% increase. Revenues were $20.550 million during the first quarter of fiscal
2000 compared to $7.046 million in the first quarter of fiscal 1999, a 192%
increase.
The Company announced several significant developments since the end of fiscal
1999. On November 30, 1999, the Company closed on its previously announced
acquisition of U.S. Technologies Systems, Inc. ("UST"). The purchase price paid
for UST was $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. 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 any breaches in
the representations and warranties made by the owners in the sale documents.
Financing for the acquisition was provided through a recently established $40
million credit facility which is more fully described under "Financial
Condition" below.
On February 29, 2000, the Company successfully closed on the acquisition of
Advanced Communication Technologies, Inc. ("ACT"). The Company purchased
substantially all of the assets of ACT for book value plus $250,000. At the
February 29th closing, the Company paid $3 million for the estimated book value
of the assets as of January 31, 2000. A final true-up of the purchase price will
be made within 60 days of the closing based on the final book value of the
assets purchased as of February 29, 2000. The cash payment made at the closing
was provided by funds from the Company's credit facility with its bank.
The acquisitions of UST and ACT are in conjunction with the Company's strategy
to expand beyond the lodging market to become a nation-wide distribution channel
proficient in both voice and data communications products to the commercial
market. UST's operations are focused generally in the midsection of the U.S.
while ACT's primary markets were in Washington and Oregon, with some presence in
northern California. In addition, while significantly smaller and less
profitable than UST, ACT has expertise in data and networking applications and
has a strong service organization.
Also during the quarter, the Company announced a strategic partnership with
Darwin Networks to offer high-speed Internet access to the lodging industry.
Under the agreement, XETA is a sales agent for Darwin Networks to offer a
packaged system which includes XETA's Linux-based Virtual XL call accounting
system integrated with Darwin's Linux-based high-speed DSL Internet access
("HSIA") system. Guests staying at hotels with the XETA/Darwin system will be
able to access the Internet at high speeds through a plug and play connection
12
<PAGE> 13
in each hotel room while still using the same telephone line for voice
communications.
The Company also announced the hiring of Larry Patterson as Senior Vice
President, Operations. Patterson, formerly of Exxon International, will be
responsible for leading XETA's engineering, manufacturing, information
technology, purchasing, warehousing, services and repair functions.
The following discussion should be read in conjunction with the Consolidated
Financial Statements and the related notes thereto included elsewhere in this
report on Form 10Q. Except for the historical information contained herein, the
matters discussed in this quarterly report on Form 10Q may be considered
"forward-looking" statements within the meaning of Section 27A of the Securities
and Exchange Act of 1933, as amended and Section 21E of the Securities Exchange
Act of 1934, as amended. Such statements include declarations regarding the
intent, belief of current expectations of the Company and its management,
statements regarding the future results of recent acquisitions, and the
Company's gross margins. Prospective investors are cautioned that any such
forward-looking statements are not guarantees of future performance and involve
a number of risks and uncertainties. Actual results could differ materially from
those indicated by such forward-looking statements. Among the important factors
that could cause actual results to differ materially from those indicated by
such forward-looking statements are the risk factors identified in the Company's
Annual Report on Form 10K, which was filed on January 28, 2000 and those risk
factors presented below in this report.
FINANCIAL CONDITION
During the first quarter of fiscal 2000, the Company's capital structure changed
dramatically as a result of the establishment of the new credit facility and the
acquisition of UST. During the quarter, cash balances declined $3.993 million
consisting of cash used by operations of $2.452 million, cash provided by
financing activities of $22.253 million and cash used in investing activities of
$23.794 million.
Concurrent with the acquisition of UST, the Company established a $40 million
credit facility with its new bank. The credit facility consists of a $23 million
term loan which was used to purchase UST, a $12 million dollar acquisition
facility available for additional acquisitions, and a $5 million revolving
credit facility for working capital needs. See Note 3 of the Notes to
Consolidated Financial Statements for a further description of the terms of the
credit facility. The Company makes monthly payments on the term loan of
$383,333. The term loan expires on November 30, 2004. Draws under the
acquisition portion of the credit facility are converted annually into five year
term loans, except during the third year of the facility in which any draws are
converted into a four year term loan.
Management believes that it has sufficient credit capacity to pursue its growth
strategy, including additional acquisitions. The evaluation of potential
acquisition candidates is ongoing. These evaluations center on the target's cash
flows, installation and service capabilities, geographic reach, and product mix.
The purchase of some targets or the cumulative effect of purchasing several
targets could require additional capital in excess of the credit facility
currently in place. While no assurance can be given,
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<PAGE> 14
management believes that a wide variety of capital resources are available
including additional bank debt, subordinated debt, secondary equity offerings,
and combinations of all of the above.
RESULTS OF OPERATIONS
With the expansion of the Company's strategy to market products and services
beyond the lodging market, the Company is reporting its revenues from three
major sources: sales of systems to the commercial market, sales of systems to
the lodging market and installation and service activities derived from both
markets.
Commercial Systems Sales. Sales of systems to the commercial market (defined as
sales to non-lodging customers, primarily medium and large, multi-location
businesses) were $9.139 million during the quarter. These revenues were derived
from the operations of the Company's newly acquired subsidiary, UST, and
represent sales from the date of the acquisition to January 31, 2000, or two
months. On a pro forma basis, sales to the commercial market for the same two
months in fiscal 1999 were $5.693 million. The 61% increase (on a pro forma
basis) in revenues from the commercial market reflects continued market
penetration into large, Fortune 500(R) accounts and increases in sales to the
Federal government derived from UST's contract to provide Lucent products to
agencies based in the eastern half of the U.S. Since late 1998, UST has been
"partnering" with Lucent's direct sales force to sell and install communications
systems (PBX's) to Lucent customers. Under these "partnering" arrangements, UST
account executives work with Lucent National Account Managers ("NAM's") and
Global Account Managers ("GAM's") to jointly serve Lucent customers. UST adds
value to the Lucent 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.
Lodging Systems Sales. Sales of lodging systems increased $2.3 million or 76% in
the first quarter of fiscal 2000 compared to the first quarter of fiscal 1999.
This increase consisted of increases in sales of PBX systems of $2.2 million or
112% and an increase in call accounting sales of $191,000 or 23%. The increase
in sales of PBX systems reflects the market's continued acceptance of the
Company's PBX product and service offering, including the acceptance of the
Company's new Lucent product offering to the lodging sector. Sales of call
accounting systems, primarily the Company's Virtual XL system continued
strong through the end of calendar year 1999 reflecting the surge in orders for
this new product in 1999. As expected, the backlog and current order rate for
new call accounting systems has returned to historical levels. As discussed
above, the Company has partnered with Darwin Networks to provide HSIA to the
lodging industry. Under this arrangement, the Company will be selling call
accounting systems and software to the hotel as part of a packaged system with
Darwin. Additional revenues may be earned from usage fees and electronic
commerce conducted by guests using the system. Included in lodging systems sales
are $102,000 in revenues earned from the Company's long distance service
offering. Contracts to provide this service, which were purchased in 1997, are
now expiring and most of these contracts are not expected to be renewed by the
customers. Therefore revenues from this product line are expected to decline
throughout fiscal 2000.
14
<PAGE> 15
Installation and Service Revenues. Revenues earned from installation and service
revenues increased $2.049 million or 51% in the first quarter of fiscal 2000
compared to the first quarter of fiscal 1999. During the first quarter, the
Company earned $596,000 in installation and service revenues from its recently
acquired commercial division. The remaining increase of $1.453 million
represented increases in installation and service revenues from the lodging
division's activities. This increase was fueled by increases in service contract
revenues as well as increases in revenues earned from wiring activities. The
Company has experienced a significant increase in requests to provide turnkey
installation services, including wiring the hotel for phone service for both new
construction and retrofit applications. These wiring activities are typically
performed at lower margins than the Company's other installation and service
activities which has been a factor in the lowering of the overall margins earned
on installation and service revenues. See further discussion under "Gross
Margins" below.
Gross Margins. Total gross margins earned during the first quarter of fiscal
2000 were 30% compared to 39% in the first quarter of fiscal 1999. In general,
the decline in total gross margins reflects the greater proportion of sales of
PBX products and lower margins earned on installation and service activities.
Gross margins earned on commercial sales was 29% during the two months that the
Company operated the commercial division, formerly UST. These margins are
representative of the historical margins earned by UST in prior years. Gross
margins earned on sales of systems to the lodging industry were 37% in the first
quarter compared to 42% for the same quarter a year ago. This decline reflects
the higher proportion of sales of PBX systems in the first quarter of 2000
compared to 1999. As discussed above, the Company enjoyed a surge in orders
during 1999 for its Virtual XL system, which as a proprietary product, earns
a higher margin than the Company's PBX product line. This trend is expected to
continue during fiscal 2000, but could be offset somewhat by sales of systems
under the newly announced HSIA project.
Gross margins earned on installation and service revenues declined from 37% in
the first quarter of fiscal 1999 to 27% in the first quarter of fiscal 2000.
This decline is due to several factors. First, as discussed above, customer
demand for the Company to include wiring in its contracts has increased
significantly. Competitively, wiring is a lower-margin business than the other
service segments. However, management believes that it can increase the margins
earned on this segment of its business by implementing new cost estimating
procedures and by standardizing on fewer third party contractors. Second, the
margins earned on commercial installation and service activities is lower than
those traditionally earned by the Company's lodging division. Management was
aware of this fact at the time it purchased UST, therefore the impact of
commercial installation margins on the Company's overall margins was expected.
The Company is working diligently to execute one of the synergistic aspects of
the UST acquisition: to utilize XETA technicians to install commercial systems
at higher margins rather than using third party contractors. Finally, the
Company has not routinely increased its charges for service contracts and hourly
services. Consequently, as the cost of labor, benefits and travel have
increased, there has been increased pressure on the service margins. Management
is evaluating several alternatives to relieve this pressure including
initiatives to increase productivity and evaluating potential price increases.
No assurance can be given, but management believes that margins earned on
installation and service revenues can be increased from those experienced during
the first quarter of fiscal 2000.
15
<PAGE> 16
Operating Expenses. Total operating expenses increased $2.047 million or 129% in
the first quarter of fiscal 2000 compared to the first quarter of fiscal 1999.
Excluding amortization expense, operating expenses during the first quarter of
fiscal 2000 were 14.7%, as a percentage of revenues, compared to 15.8% in the
first quarter of fiscal 1999. Management is pleased with the reduction in
operating expenses as a percent of revenues and believes that it can continue to
hold operating costs (as a percent of revenues) at or below fiscal 1999 levels.
Amortization expense between the two periods consists of different components
and is therefore not comparable. The majority of amortization expense recorded
in fiscal 1999 related to the amortization of the purchase price of the PBX
service contracts purchased from Williams Communications Solutions in late 1998,
while the majority of the amortization expense expected to be recorded in fiscal
2000 will be related to the acquisition of UST. Note however, that the Company
did record additional amortization expense of $208,000 in the first quarter of
fiscal 2000 to write-off the remainder of its investment in the long distance
contracts purchased in fiscal 1997. See discussion regarding "Lodging Systems
Sales" above.
Interest Expense. Interest expense consists of interest on the Company's term
loan facility that was used to fund the acquisition of UST and other commitment
fees due on the unused portion of the facility. Previous to the establishment of
the credit facility in conjunction with the UST acquisition, the Company did not
have any outstanding debt.
Interest and Other Income. Interest and other income increased $97,000 or 66% in
the first quarter compared to the same period a year ago. This increase reflects
increased interest income from Xetaplan sales-type receivables and some one-time
other income earned during the quarter.
Tax Expense. The Company has recorded a combined federal and state tax provision
of 39% of income before taxes in both periods being presented. This rate
reflects the effective federal tax rate plus the estimated composite state
income tax rate.
OUTLOOK AND RISK FACTORS
The following discussion is an update to the "Outlook and Risk Factors"
discussed in the Company's Annual Report on Form 10K for the year ended October
31, 1999. The discussions in that report regarding "Growth Strategy and
Acquisitions", "Dealer Agreements", "Dependence on Key Personnel and
Recruiting", and the "U.S. Economy" are still considered current and should be
given equal consideration to the matters discussed below.
Lucent Divestiture. On March 1, 2000, Lucent Technologies, Inc. announced that
it would spin-off its PBX business (along with two other operating units) into a
new company. The transaction will not be finalized until around September, 2000.
However, the new company (as yet unnamed) will be operated by a new management
team immediately. This portion of Lucent is the product source for the Company's
PBX products sold through the commercial channel and partially through the
lodging channel. Management believes that on balance,
16
<PAGE> 17
this is a good development for the Company. There are no changes in
distribution strategy expected and no changes in products expected. While no
assurance can be given, management does not expect Lucent's divestiture of its
PBX business to have a material, negative impact on the Company's operating
results.
Year 2000 Issues. 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 as well as its internal
systems. Based on those evaluations, the Company developed 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
with a third matter recently dismissed. See "Legal Proceedings" under Part II
below for a further discussion of this litigation. Item 3 of Part I has been
omitted as inapplicable.
ITEM 3. 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 first quarter of fiscal 2000.
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. On November 30,
1999, the Company established a $40 million credit facility (see Note 3 to the
Consolidated Financial Statements for details of the Company's long-term debt).
The Company is 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.
17
<PAGE> 18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
There have been no material developments in 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, since
this case was last reported on in the Company's Annual Report on Form 10-K for
the fiscal year ended October 31, 1999 filed with the Commission on January 28,
2000.
Regarding the PHONOMETRICS litigation, on February 9, 2000, the United
States Court of Appeals entered a decision in Phonometrics' appeal of the
Florida district court's order dismissing Phonometrics' claims against various
hotels for failure to state a claim. The Court of Appeals ruled that as a matter
of procedure, the liberal pleading standards of the Federal Rules of Procedure
do not permit the dismissal of Phonometrics' complaint for failure to state a
claim, and remanded the matter to the Florida district court for further
proceedings. The Court of Appeals also ordered that each party bear its own
costs of the appeal. In rendering its decision, which spoke to a purely
procedural issue and not on the merits of Phonometrics' infringement claim, the
Court of Appeals noted that it was aware of the long history of this case and
that it "has great confidence in the district court's understanding of this
case." The Company will continue to monitor the proceedings in these actions. A
more detailed description of these cases is contained in the Company's Annual
Report on Form 10-K for the fiscal year ended October 31, 1999 filed with the
Commission on January 28, 2000.
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, was dismissed by the United States District
Court for the District of Colorado on January 14, 2000 following a settlement
agreement entered into between the parties 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
18
<PAGE> 19
dispose of this matter in an expeditious fashion and does not constitute any
admission of fault on the part of the Company.
Item 2. Changes in Securities and Use of Proceeds.
On November 30, 1999, the Company issued 150,000 shares of its Common
Stock, par value $.05 per share, to Mark A. Martin, a co-founder and former 50%
owner of U.S. Technologies Systems, Inc. ("UST), as part of the purchase price
paid by the Company to Mr. Martin to acquire 100% of the stock of UST from Mr.
Martin and from UST's co-founder and former co-owner Lawrence J. Hopp. The stock
was issued to Mr. Martin in reliance upon the exemption from registration
provided by Section 4(2) of the Securities Act of 1933, in that the stock was
issued in a privately-negotiated transaction and was not part of an overall plan
of financing made available to the general public.
Items 3, 4 and 5 of Part II have been omitted because they are inapplicable or
the responses thereto are negative.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits - See the Exhibit Index at Page 21.
(b) Reports on Form 8-K - The Company filed the following reports on
Form 8-K during the quarter for which this Report on Form 10-Q is
filed:
Date of Report Description
-------------- ------------------------------------
November 10, 1999 Announcement of execution of Stock Purchase
Agreements for the purchase of U. S.
Technologies Systems, Inc. (Item 5).
December 15, 1999 Acquisition of U. S. Technologies Systems, Inc.
(Item 2).
December 29, 1999 Y2K readiness discussion (Item 5).
19
<PAGE> 20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
XETA CORPORATION
(Registrant)
Dated: March 15, 2000 By: /s/ JACK R. INGRAM
-------------------------
Jack R. Ingram
Chief Executive Officer
Dated: March 15, 2000 By: /s/ ROBERT B. WAGNER
-------------------------
Robert B. Wagner
Vice President of Finance
20
<PAGE> 21
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEC No. Description
- ------- -----------
<S> <C> <C>
(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).
</TABLE>
<PAGE> 22
<TABLE>
<CAPTION>
SEC No. Description
- ------- -----------
<S> <C> <C>
(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.
(10) MATERIAL CONTRACTS -
10.1 HCX 5000(R) Authorized Distributor Agreement dated
April 1, 1999 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 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).
</TABLE>
<PAGE> 23
<TABLE>
<CAPTION>
SEC No. Description
- ------- -----------
<S> <C> <C>
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.
(15) LETTER RE: UNAUDITED INTERIM FINANCIAL INFORMATION -
Inapplicable.
(18) LETTER RE: CHANGE IN ACCOUNTING PRINCIPLES - Inapplicable.
(19) REPORT FURNISHED TO SECURITY HOLDERS - None.
(22) PUBLISHED REPORT REGARDING MATTERS SUBMITTED TO A VOTE OF
SECURITY HOLDERS -
None.
(23) CONSENTS OF EXPERTS AND COUNSEL
23.1 Consent of Arthur Anderson LLP
(24) POWER OF ATTORNEY - None.
(27) FINANCIAL DATA SCHEDULE
(99) ADDITIONAL EXHIBITS - None.
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our report on
Form 10K, dated December 10, 1999, 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
March 13, 2000
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON
PAGES 3 & 4 OF THE COMPANY'S 10Q FOR THE YEAR TO DATE AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> OCT-31-2000
<PERIOD-END> JAN-31-2000
<CASH> 563,210
<SECURITIES> 0
<RECEIVABLES> 22,527,383
<ALLOWANCES> 0
<INVENTORY> 6,654,457
<CURRENT-ASSETS> 33,846,805
<PP&E> 4,492,179
<DEPRECIATION> 0
<TOTAL-ASSETS> 63,449,428
<CURRENT-LIABILITIES> 21,456,254
<BONDS> 0
0
0
<COMMON> 232,323
<OTHER-SE> 19,256,054
<TOTAL-LIABILITY-AND-EQUITY> 63,449,428
<SALES> 20,550,027
<TOTAL-REVENUES> 20,550,027
<CGS> 14,289,973
<TOTAL-COSTS> 14,289,973
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 366,000
<INCOME-PRETAX> 2,502,465
<INCOME-TAX> 982,000
<INCOME-CONTINUING> 1,520,465
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,520,465
<EPS-BASIC> .37
<EPS-DILUTED> .31
</TABLE>
