EXHIBIT 13.0 ANNUAL REPORT TO SECURITY HOLDERS
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
SHAREHOLDERS AND BOARD OF DIRECTORS
INTER-TEL, INCORPORATED
We have audited the accompanying consolidated balance sheets of Inter-Tel,
Incorporated and subsidiaries as of December 31, 2001 and 2000, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the three years in the period ended December 31, 2001. Our audits also
included the financial statement schedule listed in the Index at Item 14(a) 2.
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Inter-Tel,
Incorporated and subsidiaries at December 31, 2001 and 2000, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
/s/ ERNST & YOUNG LLP
Phoenix, Arizona
February 13, 2002
1
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2001 and 2000
- --------------------------------------------------------------------------------
(In thousands, except share amounts) 2001 2000
--------- ---------
ASSETS
CURRENT ASSETS
Cash and equivalents $ 61,795 $ 27,103
Accounts receivable, less allowances of
$11,858 in 2001 and $17,187 in 2000 45,962 61,482
Inventories, less allowances of $13,202
in 2001 and $11,897 in 2000 20,848 35,060
Net investment in sales-leases 13,799 14,629
Income taxes receivable 3,257 9,157
Deferred income taxes 8,467 13,116
Prepaid expenses and other assets 4,891 7,668
--------- ---------
TOTAL CURRENT ASSETS 159,019 168,215
PROPERTY, PLANT & EQUIPMENT 23,835 32,723
EQUIPMENT HELD UNDER LEASE, NET 70 423
GOODWILL AND OTHER INTANGIBLES 18,659 18,389
NET INVESTMENT IN SALES-LEASES 21,735 22,808
OTHER ASSETS 4,144 568
--------- ---------
$ 227,462 $ 243,126
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 21,812 $ 35,438
Other current liabilities 44,051 46,769
--------- ---------
TOTAL CURRENT LIABILITIES 65,863 82,207
DEFERRED TAX LIABILITY 17,390 5,222
LEASE RECOURSE LIABILITY 8,890 7,697
RESTRUCTURING RESERVE 3,060 5,760
OTHER LIABILITIES 5,422 5,804
SHAREHOLDERS' EQUITY
Common stock, no par value - authorized 100,000,000
shares; issued and outstanding - 24,166,430 shares
in 2001 and 25,950,969 shares in 2000 108,968 109,132
Less: Shareholder loans (942) (1,018)
Retained earnings 54,877 44,099
Accumulated other comprehensive income 151 (280)
--------- ---------
163,054 151,933
Less: Treasury stock at cost - 2,995,393 shares in
2001 and 1,210,854 shares in 2000 (36,217) (15,497)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 126,837 136,436
--------- ---------
$ 227,462 $ 243,126
--------- ---------
See accompanying notes.
2
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2001, 2000 and 1999
- --------------------------------------------------------------------------------
(In thousands, except per share data) 2001 2000 1999
--------- --------- ---------
NET SALES $ 385,655 $ 402,723 $ 314,221
Cost of sales 211,161 236,046 159,463
Cost of sales - Executone restructuring -- 7,639 --
--------- --------- ---------
GROSS PROFIT 174,494 159,038 154,758
Research and development 17,556 19,489 14,798
Selling, general and administrative 131,157 127,468 98,430
In-process research and development -- 5,433 --
Other charges 5,357 45,245 --
--------- --------- ---------
154,070 197,635 113,228
--------- --------- ---------
OPERATING INCOME (LOSS) 20,424 (38,597) 41,530
--------- --------- ---------
Equity share of Cirilium Corp.'s net Losses -- (5,938) --
Write-off of Cirilium Corp. investment -- (2,045) --
Interest and other income 1081 1,474 2,391
Loss on foreign translation adjustments (337) (421) (46)
Interest expense (468) (213) (110)
--------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES 20,700 (45,740) 43,765
INCOME TAXES
Current (3,647) (9,904) 19,966
Deferred 11,306 (6,913) (3,347)
--------- --------- ---------
7,659 (16,817) 16,619
--------- --------- ---------
NET INCOME (LOSS) $ 13,041 $ (28,923) $ 27,146
--------- --------- ---------
NET INCOME (LOSS) PER SHARE
Basic $ 0.53 $ (1.10) $ 1.05
Diluted $ 0.52 $ (1.10) $ 1.01
--------- --------- ---------
Weighted average basic common shares 24,488 26,273 25,949
Weighted average diluted common shares 25,240 26,273 27,004
--------- --------- ---------
See accompanying notes.
3
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 2001, 2000 and 1999
- --------------------------------------------------------------------------------
Accumulated
Other Share-
Common Treasury Retained Comprehensive Holder
(In thousands) Stock Stock Earnings Income (loss) Loans Total
--------- --------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1998 $ 104,539 $ (15,851) $ 54,194 $ (196) $ -- $ 142,686
Stock repurchase (6,700) (6,700)
Exercise of stock options 8,027 (4,420) 3,607
Tax benefit from stock options 2,421 2,421
Shareholder loans (1,116) (1,116)
Stock issued under
Employee Stock Purchase Plan 896 (45) 851
Adjustment to shares previously
Issued in acquisition (107) (107)
Net income 27,146 27,146
Gain on currency translation 373 373
---------
Comprehensive income 27,519
Dividends (1,040) (1,040)
--------- --------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 1999 106,853 (13,628) 75,835 177 (1,116) 168,121
Stock repurchase (6,711) (6,711)
Exercise of stock options 3,496 (1,468) 2,028
Tax benefit from stock options 1,852 1,852
Shareholder loan repayments 98 98
Stock issued under
Employee Stock Purchase Plan 1,346 (293) 1,053
Issuance of shares in acquisition 427 427
Net loss (28,923) (28,923)
Loss on currency translation (457) (457)
---------
Comprehensive loss (29,380)
Dividends (1,052) (1,052)
--------- --------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 2000 109,132 (15,497) 44,099 (280) (1,018) 136,436
Stock repurchase (28,905) (28,905)
Exercise of stock options 1,806 (509) 1,297
Tax benefit from stock options 263 263
Shareholder loan repayments 76 76
Stock issued under
Employee Stock Purchase Plan 1,057 (91) 966
Issuance of treasury shares in
conversion of subsidiary stock (427) 5,322 (471) 4,424
Net income 13,041 13,041
Gain on currency translation 431 431
---------
Comprehensive income 13,472
Dividends (1,192) (1,192)
--------- --------- --------- --------- --------- ---------
BALANCE AT DECEMBER 31, 2001 $ 108,968 $ (36,217) $ 54,877 $ 151 $ (942) $ 126,837
--------- --------- --------- --------- --------- ---------
See accompanying notes.
4
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2001, 2000 and 1999
- --------------------------------------------------------------------------------
(In thousands) 2001 2000 1999
-------- -------- --------
OPERATING ACTIVITIES:
Net income (loss) $ 13,041 $(28,923) $ 27,146
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation of fixed assets 8,742 9,724 7,653
Amortization of intangibles 2,775 3,022 1,470
Provision for losses on receivables 12,100 11,720 8,396
Provision for inventory valuation 1,614 1,653 1,508
Increase in other liabilities 3,547 9,111 6,106
Loss on sale of property and equipment: (39) 157 197
Deferred income taxes (benefit) 11,306 (6,913) (3,347)
Effect of exchange rate changes 431 (457) 373
Purchased in-process research and development -- 5,433 --
Non-cash portion of other charges 5,357 41,783 --
Changes in operating assets and liabilities 16,132 (28,971) (16,122)
-------- -------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES 75,006 17,339 33,380
-------- -------- --------
INVESTING ACTIVITIES:
Additions to property and equipment (7,988) (9,597) (12,486)
Additions to operating leases -- (122) (3,115)
Proceeds from sale of property and equipment
and operating leases 173 39 2,904
Cash received from disposition of business segment -- 6,602 --
Cash used in acquisitions and joint ventures (6,789) (2,855) (59,960)
-------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES (14,604) (5,933) (72,657)
-------- -------- --------
FINANCING ACTIVITIES:
Cash dividends paid (983) (1,054) (1,040)
Proceeds from exercise of stock options 1,373 2,126 2,491
Proceeds from stock issued under the
Employee Stock Purchase Plan 966 1,053 851
Proceeds from term debt 3,387 3,319 --
Payments on term debt (1,548) (2,262) (223)
Treasury stock purchases (28,905) (6,711) (6,700)
-------- -------- --------
NET CASH USED IN FINANCING ACTIVITIES (25,710) (3,529) (4,621)
-------- -------- --------
INCREASE (DECREASE) IN CASH AND
EQUIVALENTS 34,692 7,877 (43,898)
CASH AND EQUIVALENTS AT BEGINNING
OF YEAR 27,103 19,226 63,124
-------- -------- --------
CASH AND EQUIVALENTS AT END OF YEAR $ 61,795 $ 27,103 $ 19,226
======== ======== ========
See accompanying notes.
5
INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001, 2000 and 1999
- --------------------------------------------------------------------------------
NOTE A - SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS. Inter-Tel, incorporated in 1969, is a single point
of contact, full service provider of business communications systems, voice mail
systems and networking applications. We market and sell voice processing and
unified messaging software, call accounting software, Internet Protocol (IP)
telephony software, computer-telephone integration (CTI) applications, long
distance calling services, and other communications services. Our products and
services include the AXXESS by Inter-Tel and ECLIPSE(2) by Inter-Tel business
communication systems, with integrated voice processing and unified messaging
systems, IP telephony voice and data routers, and ClearConnect Talk-to-Agent
e-commerce software. We also provide maintenance, leasing and support services
for our products. Our customers include business enterprises, government
agencies and non-profit organizations. Our common stock is quoted on the Nasdaq
National Market System under the symbol "INTL."
PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include
the accounts of Inter-Tel, Incorporated and all significant subsidiaries.
Intercompany accounts and transactions have been eliminated in consolidation.
CASH AND EQUIVALENTS. Cash and equivalents include all highly liquid
investments with a remaining maturity of three months or less at date of
acquisition. Excess cash and equivalents are primarily invested in mutual funds
comprised of foreign and domestic high quality dollar denominated money market
instruments rated A-1 by Standard & Poor's Ratings Group, or equivalent.
INVENTORIES. Inventories, consisting principally of telephone systems,
computer equipment and related components, are stated at the lower of cost
(first-in, first-out method) or market.
PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment is stated at
cost. Depreciation is computed using the straight-line method over the estimated
useful lives of the related real and personal property which range from 3 years
to 30 years. Leasehold improvements are depreciated over the shorter of the
related lease terms or the estimated useful lives of the improvements. Within
the category "computer systems and equipment," including database and enterprise
software, WAN and LAN equipment and software, personal computers, servers and
related software, the range for estimated useful lives is 3 years to 7 years.
See Note E for additional information.
GOODWILL AND OTHER INTANGIBLE ASSETS. Purchase prices of acquired
businesses and technology that are accounted for as purchases have been
allocated to the assets and liabilities acquired based on the estimated fair
values on the respective acquisition dates. Based on these values, the excess
purchase prices over the fair value of the net assets acquired ("goodwill") were
being amortized over 3 to 40 years through December 31, 2001.
At December 31, 2001, goodwill, net of accumulated amortization, totaled
$13.7 million. Other acquisition-related intangibles, net of accumulated
amortization, totaled $5.0 million at December 31, 2001. Accumulated
amortization through December 31, 2001 was $7.6 million. This amount includes
$5.0 million of amortization of goodwill and $2.6 million of amortization of
other acquisition-related intangibles. Other acquisition-related intangibles,
comprised primarily of developed technology, customer lists and non-competition
agreements, are amortized on a straight-line basis over periods ranging from
5-17 years. See Note F for additional information.
In June 2001 the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards (SFAS) 141, "Business Combinations," and 142,
"Goodwill and Other Intangible Assets." SFAS 141 requires that the purchase
method of accounting be used for all business combinations initiated after June
30, 2001. SFAS 141 also includes guidance on the initial recognition and
measurement of goodwill and other intangible assets arising from business
combinations completed after June 30, 2001. SFAS 142 prohibits the amortization
of goodwill and intangible assets with indefinite useful lives. SFAS 142
requires that these assets be reviewed for impairment at least annually.
Intangible assets with finite lives will continue to be amortized over their
6
estimated useful lives. Additionally, SFAS 142 requires that goodwill included
in the carrying value of equity method investments no longer be amortized.
Inter-Tel has adopted SFAS 142 effective January 1, 2002. Application of
the nonamortization provisions of SFAS 142 is expected to result in an increase
in income from continuing operations before income taxes of approximately $1.8
million in 2002. Inter-Tel has tested goodwill for impairment using the two-step
process prescribed in SFAS 142. The first step is a screen for potential
impairment, while the second step measures the amount of the impairment, if any.
Inter-Tel has performed the first of the required impairment tests for goodwill
as of January 1, 2002 and has determined that the carrying amount of goodwill is
not impaired.
SALES-LEASES. The discounted present values of minimum rental payments
under sales-type leases are recorded as sales, net of provisions for continuing
administration and other expenses over the lease period. The costs of systems
installed under these sales-leases, net of residual values at the end of the
lease periods, are recorded as costs of sales. Gains or losses resulting from
the sale of rental income from such leases are recorded as net sales. Refer to
Note D for additional information.
INCOME TAXES. Deferred income taxes result from temporary differences in
the recognition of revenues and expenses for financial reporting and income tax
purposes.
ADVERTISING. The cost of advertising is expensed as incurred. We incurred
$596,000; $513,000; and $559,000 in advertising costs during 2001, 2000, and
1999, respectively.
REVENUE RECOGNITION. We recognize revenue pursuant to Staff Accounting
Bulletin No. 101 "Revenue Recognition in Financial Statements." Accordingly,
revenue is recognized when all four of the following criteria are met: (i)
persuasive evidence that arrangement exists; (ii) delivery of the products
and/or services has occurred; (iii) the selling price is both fixed and
determinable and; (iv) collectibility is reasonably probable. Revenue derived
from sales of systems and services to end-user customers is recognized upon
installation of the systems and performance of the services, respectively,
allowing for use by our customers of these systems. Pre-payments for
communications services are deferred and recognized as revenue as the
communications services are provided.
For shipments to dealers and other distributors, our revenues are recorded
as products are shipped and services are rendered, because the sales process is
complete. These shipments are primarily to third-party dealers and distributors
and title passes when goods are shipped (free-on-board shipping point). Long
distance services revenues are recognized as service is provided.
SHIPPING AND HANDLING COSTS. EITF 00-10 "Accounting for Shipping and
Handling Fees and Costs," addresses the accounting for shipping and handling
fees and costs. Our policy is primarily not to bill customers for shipping
costs, unless the customer requests priority shipping. Any amounts billed are
recorded net in cost of goods sold. Billed shipping and handling costs in 2001
represented less than $1.16 million, or 0.3% of net sales, and are not a
significant component of our operations.
STOCK BASED COMPENSATION. We grant stock options for a fixed number of
shares to employees with an exercise price equal to the fair market value of the
shares at the date of grant. We account for stock option grants in accordance
with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," ("APB 25") and related Interpretations, in accounting for stock
based awards to employees. Under APB 25, we generally recognize no compensation
expense with respect to such awards.
FOREIGN CURRENCY TRANSLATION. For our foreign operations, the local
currency is the functional currency. All assets and liabilities are translated
at period-end exchange rates and all income statement amounts are translated at
an average of month-end rates. Adjustments resulting from this translation are
recorded in accumulated other comprehensive income.
CONTINGENCIES. We are a party to various claims and litigation in the
normal course of business. However, it is management's opinion that the results
of these matters will not have a material adverse impact on our financial
position, results of operations or future cash flows.
7
USE OF ESTIMATES. The preparation of the consolidated financial statements
in conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements and accompanying notes. Actual
results could differ from those estimates.
RECLASSIFICATIONS. Certain reclassifications have been made to the 2000 and
1999 financial statements to conform to the 2001 presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
141, "Business Combinations", and SFAS 142, "Goodwill and Other Intangible
Assets", effective for our fiscal year beginning January 1, 2002. Inter-Tel has
adopted SFAS 142 effective January 1, 2002. Application of the nonamortization
provisions of SFAS 142 is expected to result in an increase in income from
continuing operations before income taxes of approximately $1.8 million in 2002.
Inter-Tel has tested goodwill for impairment using the two-step process
prescribed in SFAS 142. The first step is a screen for potential impairment,
while the second step measures the amount of the impairment, if any. Inter-Tel
has performed the first of the required impairment tests for goodwill as of
January 1, 2002 and has determined that the carrying amount of goodwill is not
impaired.
In April 2001, the Emerging Issues Task Force (EITF) issued Issue 00-25,
Vendor Income Statement Characterization of Consideration Paid to a Reseller of
the Vendor's Products. EITF 00-25 addresses the accounting and income statement
classification of costs that a vendor incurs to or on behalf of a reseller in
connection with the reseller's purchase or promotion of the vendor's products.
The standard is effective for fiscal periods beginning after December 15, 2001
and will be adopted by us as of January 2002. It is not expected that the
adoption of this standard will have a material impact on our financial position,
results of operations or cash flows.
In July 2001, the FASB issued Statement No. 143, Accounting for Asset
Retirement Obligations. The standard applies to obligations associated with the
retirement of tangible long-lived assets. The standard is effective for fiscal
periods beginning after June 15, 2002 and will be adopted by us as of January
2003. It is not expected that the adoption of this standard will have a material
impact on our financial position, results of operations or cash flows.
In August 2001, the FASB issued Statement No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets (Statement) which supersedes FASB
Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of; however it retains the fundamental
provisions of that statement related to the recognition and measurement of the
impairment of long-lived assets to be "held and used." The standard is effective
for fiscal periods beginning after December 15, 2001 and will be adopted by us
as of January 2002. It is not expected that the adoption of this standard will
have a material impact on our financial position, results of operations or cash
flows.
NOTE B - ACQUISITIONS, DISPOSITIONS AND RESTRUCTURING CHARGES
CONVERGENT. On January 26, 2001, Inter-Tel Technologies, Inc., our wholly-owned
subsidiary, acquired certain assets of Convergent Communications Services, Inc.
(Convergent) for cash plus the assumption of various specific liabilities and
related acquisition costs. The Company acquired segments of the voice customer
base, accounts receivable, specified inventory and fixed assets, and assumed
liabilities for warranty, maintenance and specified leased premises costs. The
Convergent transaction was accounted for using the purchase method of
accounting.
The adjusted purchase price paid by us in the Convergent transaction
included cash of $3.9 million plus assumption of specific liabilities totaling
$6.3 million. The final purchase price was adjusted pursuant to a settlement
agreement with Convergent representatives which specified the return of $6.7
million to Inter-Tel, representing funds from escrow and other amounts owed to
Inter-Tel by Convergent that were previously set aside by the bankruptcy court,
as well as adjustments for assets to be acquired and liabilities to be assumed.
The settlement payments only required adjustments or reallocations based on the
specified assets acquired and liabilities assumed in connection with the
purchase, and differences have been represented as adjustments to the
8
net assets acquired. The Company recorded goodwill of $880,000 and other
intangible assets of $120,000 in connection with this acquisition. Goodwill and
intangibles were amortized through December 31, 2001. The net goodwill balance
of $810,000 as of December 31, 2001 will no longer be amortized, but accounted
for in accordance with SFAS 141 and 142. The net balance of $98,000 in other
intangible assets will continue to be amortized for five years from the date of
the acquisition.
MASTERMIND. On October 19, 2001, Inter-Tel Integrated Systems, Inc., our
wholly-owned subsidiary, acquired certain of the assets and assumed certain
stated liabilities from MasterMind Technologies, Inc., a Virginia corporation
(MasterMind), for $2.0 million. $1.79 million was paid at or before closing with
the balance placed into a bonus pool with earnout provisions for MasterMind
shareholders and employees based on performance parameters. The portion relating
to employees who have joined Inter-Tel will be charged to expenses. The Company
recorded amortizable intangible technology assets totaling $1.4 million in
connection with this acquisition. These technology assets are being amortized
over 5 years.
Each of the acquisitions discussed above was accounted for using the
purchase method of accounting. The results of operations of each of these
acquisitions have been included in our accompanying consolidated statements of
operations from the date of acquisitions.
INTER-TEL.NET AND ICA. During the second quarter of 2000, Inter-Tel recorded a
pre-tax charge associated with Inter-Tel.NET operations of $2.0 million ($1.2
million after-tax), related to the write-down to net realizable value of network
equipment and lease termination costs of certain redundant facilities. The
reserves established at the time of the write-down have been fully utilized as
of December 31, 2001. The following table summarizes the details of the
write-down and activity in the reserve balances from the date of the write-down
through December 31, 2001. Activity represents payments made or amounts written
off.
RESERVE
CASH/ OTHER 2000 2001 BALANCE
DESCRIPTION NON-CASH CHARGE ACTIVITY ACTIVITY AT 12/31/01
----------- -------- ------ -------- -------- -----------
(In thousands)
LEASE TERMINATION OBLIGATIONS
(NET OF ANTICIPATED RECOVERY):
Building leases Cash $ (144) $ 87 $ 57 $ --
IMPAIRMENT OF ASSETS:
Fixed assets Non-Cash (1,824) 1,824 -- --
TOTAL $(1,968) $ 1,911 $ 57 $ --
In March 2000, the Company's Inter-Tel.NET subsidiary acquired the stock of
Intercomm Americas, Inc. (ICA), an international IP communications reseller for
$580,000 cash and 750,000 shares of Inter-Tel.NET, with conversion rights into
Inter-Tel, Incorporated Common Stock. The acquisition purchase price was valued
at $1.2 million at March 2000. The ICA shareholders did not intend to exercise
conversion rights. However, due to market conditions they decided to convert
their Inter-Tel.NET shares to Inter-Tel shares in July 2001. Based on the
exercise of conversion rights in July 2001, the valuation of purchase price of
ICA increased to $6.2 million in accordance with the provisions of the
acquisition agreement. The conversion of Inter-Tel.NET shares into Inter-Tel,
Incorporated common stock was treated as an acquisition by Inter-Tel of
Inter-Tel.NET shares, rather than as an adjustment to the original purchase
price of ICA, as the conversion rights were part of the original purchase
agreement, even though the value of the conversion rights could not be readily
determined at that time. As a result, Inter-Tel made adjustments totaling $4.85
million to goodwill based on the value of the converted Inter-Tel shares as of
June 30, 2001.
On July 24, 2001, Inter-Tel agreed to sell 83% of Inter-Tel.NET to
Comm-Services Corporation for a note of $4.95 million, secured by Comm-Services
stock, other marketable securities of the shareholders of Comm- Services and
100% of the net assets of Inter-Tel.NET. The marketable securities held as
collateral may be exchanged for cash or other readily marketable assets as long
as the fair market value of the collateral exceeds
9
$2.5 million. The note is due and payable interest only from October 16, 2001
through July 15, 2002; then a principal payment of $250,000 due July 15, 2002,
monthly principal and interest payments based on 1% of collected monthly
revenues from July 16, 2002 to October 15, 2002 and based on 2% of collected
monthly revenues from October 16, 2002 until paid in full. Additionally, any
funds due Comm-Services for services rendered can be applied against the note.
The note is due and payable on December 31, 2007, or earlier in certain
circumstances.
In connection with the sale of 83% of Inter-Tel.NET, we assessed the fair
value of the remaining 17% investment in Inter-Tel.NET. Pursuant to SFAS 121, we
recorded a charge as of the close of the second quarter of $5.4 million ($3.4
million after tax) associated with the impairment of our investment in
Inter-Tel.NET. The impairment was measured as the difference between the
carrying value of Inter-Tel's 17% interest in Inter-Tel.NET/Comm-Services and
the estimated current fair market value of the note plus the 17% ownership
interest in Inter-Tel.NET. The charge is primarily non-cash.
Inter-Tel's management has not participated in the management of
Inter-Tel.NET since the sale in July 2001. As a result, since July 24, 2001, we
have accounted for the remaining Inter-Tel.NET/Comm-Services investment using
the cost method of accounting. On December 30, 2001, Comm-Services entered into
a merger agreement with Vianet. Inter-Tel's 17% investment in Comm-Services was
converted to approximately 10% of Vianet stock. The $4.95 million loan was
assumed by Vianet and Inter-Tel continues to hold collateral from the former
shareholders of Comm-Services. Inter-Tel will account for the remaining 10%
investment in Vianet using the cost method of accounting. The net investment in
the note receivable and 10% interest in Vianet (formerly Comm-Services) is
recorded in other assets for approximately $3.7 million.
During 1999, 2000 and 2001, Inter-Tel.NET entered into operating lease
agreements totaling approximately $6.5 million from an equipment vendor for
network equipment and software. The lease agreements required Inter-Tel.NET to
purchase vendor maintenance on their products. Inter-Tel originally guaranteed
the indebtedness. In the second quarter of 2001, Inter-Tel.NET notified the
vendor of network and network equipment problems encountered due to equipment
and software recommended by the vendor, and supplied and financed by this
vendor. Inter-Tel.NET requested that the vendor not only solve the problems, but
also compensate Inter-Tel.NET for the problems and the resulting lost customers,
lost revenues and lost profits. Pursuant to Inter-Tel's sale of 83% of
Inter-Tel.NET, Comm-Services assumed the vendor lease and maintenance
obligations and as such Inter-Tel has not recorded any liability for these
obligations. However, the vendor has not released Inter-Tel from its guarantee
of these obligations and Inter-Tel has not released the vendor from Inter-Tel's
claims, nor did we assign our rights to these claims to Comm-Services.
EXECUTONE. On January 1, 2000 Inter-Tel purchased certain computer telephony
assets and assumed certain liabilities of Executone Information Systems, Inc.
(Executone) for $44.3 million in cash plus related acquisition costs, subject to
purchase price adjustments as of the closing date. The Executone transaction was
accounted for using the purchase method of accounting. The aggregate purchase
price was allocated to the fair value of the assets and liabilities acquired, of
which $5.4 million ($3.4 million after taxes) was written-off as purchased
in-process research and development.
During the first quarter of 2000, the Executone division recognized losses
of approximately $2.5 million ($1.5 million after taxes, or $.06 per diluted
share) excluding the charge for in-process research and development. In
connection with the Executone acquisition, we sold Executone's manufacturing
assets and liabilities to Varian of Tempe, Arizona at a net book value of $6.6
million.
During the second quarter of 2000, the Executone division continued to
experience significant losses. The Executone division recognized pre-tax losses
during the second quarter and six months ended June 30, 2000 of $3.4 million, or
$2.1 million after-tax ($.08 per diluted share) and $5.9 million, or $3.6
million after-tax ($.14 per diluted share), respectively. As a result of these
losses, together with other considerations noted below, we decided to close the
primary Executone facility in Milford, Connecticut and to recognize a
restructuring charge related to the Executone operations. At the time the
original purchase was recorded, we had not anticipated closing the Milford
facility. After incurring higher than anticipated losses from Executone
operations and after a deterioration in the Executone business, including loss
of dealers and customers, delays in introduction and acceptance of new products,
we decided it was in the best interests of us and our shareholders to close the
Milford facility and consolidate operations into our metro-Phoenix, Arizona
facilities.
10
We have accounted for the restructuring of the Executone operations,
including severance and related costs, the shut down and consolidation of the
Milford facility and the impairment of assets associated with the restructuring.
We finalized our plan for the exiting of activities and the involuntary
termination or relocation of approximately 137 employees in connection with the
integration of Executone operations. Accrued costs associated with this plan
were estimates, although the original estimates made for the second quarter of
2000 for reserve balances have not changed significantly as of December 31,
2001.
Exit costs associated with the closure of the Milford facility also
included liabilities for building, furniture and equipment lease, and other
contractual obligations. We are liable for the lease on the Milford buildings
through January 2005. Various furniture leases run concurrently through March
2002. Other capital leases for computer and other equipment terminate on varying
dates through September 2002. To date, we have entered into sublease agreements
with third parties to sublease portions of the facility and equipment. The
reserve for lease and other contractual obligations is identified in the table
below.
The following tables summarize details of the restructuring charge in
connection with the Executone acquisition, including the description of the type
and amount of liabilities assumed, and activity in the reserve balances from the
date of the charge through December 31, 2001. Activity represents payments made
or amounts written off.
RESERVE
CASH/ RESTRUCTURING 2000 2001 BALANCE
DESCRIPTION NON-CASH CHARGE ACTIVITY ACTIVITY AT 12/31/01
----------- -------- ------ -------- -------- -----------
(In thousands)
PERSONNEL COSTS:
Severance and termination costs Cash $ (1,583) $ 1,558 $ 2 $ (23)
Other Plant closure costs Cash (230) 30 200 --
LEASE TERMINATION AND OTHER CONTRACTUAL
OBLIGATIONS (NET OF ANTICIPATED RECOVERY):
Building and equipment leases Cash (7,444) 1,348 1,489 (4,607)
Other contractual obligations Cash (1,700) -- 1,700 --
IMPAIRMENT OF ASSETS:
Inventories Non-Cash (3,454) 1,376 209 (1,869)
Prepaid inventory and other expenses Non-Cash (2,485) 2,485 -- --
Accounts receivable Non-Cash (1,685) 521 245 (919)
Fixed assets Non-Cash (3,151) 2,942 -- (209)
Net intangible assets Non-Cash (29,184) 29,184 -- --
TOTAL $(50,916) $ 39,444 $ 3,845 $ (7,627)
Included in the total Executone restructuring costs of $50.9 million is a
$43.3 million restructuring charge for exit costs and asset impairment, and $7.6
million associated with the impairment of inventories, which has accordingly
been recorded as additional costs of sales. Refer to Management's Discussion and
Analysis for additional information.
CIRILIUM JOINT VENTURE. In December 1999, Inter-Tel entered into an agreement
with Hypercom Corporation to jointly form Cirilium. Cirilium comprised parts of
Hypercom's data and Inter-Tel's packet telephony experience, products and
services, including Inter-Tel's Vocal'Net gateway products and technology. We
accounted for the Cirilium losses using the equity method of accounting through
September 2000. In September 2000, we wrote-off our remaining investment in
Cirilium. Our Cirilium ownership interest of 19.9% has been fully written-off in
our financial statements, and we have not used the equity method of accounting
since the date of the write-off.
11
MCLEOD. During the first quarter of 2002, Inter-Tel acquired certain assets and
assumed certain liabilities of McLeod USA, Inc. (McLeod) for cash of $8 million
plus the assumption of various specific liabilities and related acquisition
costs. Generally, Inter-Tel acquired the voice customer base in Minnesota, Iowa
and Colorado and the DataNet operations in South Dakota, which also includes the
related accounts receivable, inventory and fixed assets along with assumption of
scheduled specific liabilities for warranty and maintenance obligations. The
acquisition closed in January 2002 and the company has up to 90 days from the
date of closing to dispute the existence of any scheduled acquired assets and
$500,000 was placed in escrow to cover potential purchase price adjustments. We
expect to record goodwill in connection with this acquisition, although the
amount has not been fully quantified. This transaction was accounted for using
the purchase method of accounting.
NOTE C - PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT CHARGE
During the first quarter of 2000, Inter-Tel completed the acquisition of
Executone (see NOTE B). The aggregate purchase price of the Executone
acquisition was allocated to the fair value of the assets and liabilities
acquired, of which $5.4 million ($3.4 million after taxes), or $0.13 per diluted
share, was written-off as purchased in-process research and development.
NOTE D - NET INVESTMENT IN SALES-LEASES
Net investment in sales-leases represents the value of sales-leases
presently held under our Total Solution program. We currently sell the rental
income from some of the sales-leases. We maintain reserves against potential
recourse following the resales based upon loss experience and past due accounts.
Activity during the years was as follows:
Year Ended December 31
------------------------------
(In thousands) 2001 2000 1999
-------- -------- --------
Sales of rental income $ 86,788 $ 95,127 $ 83,405
Sold income remaining unbilled
at end of year $202,715 $198,361 $163,728
Allowance for uncollectible minimum
lease payments and recourse liability
at end of year $ 10,513 $ 8,870 $ 6,734
Sales of rental income represents the gross selling price or total present
value of the payment stream on the sale of the rental income to third parties.
Sold income remaining unbilled at the end of the year representsthe total
balance of off-book leases that are not included in our balance sheet. The
allowance for uncollectible minimum lease payments and recourse liability at the
end of the year represent reserves against the entire lease portfolio or
allowance for collectibility from customers. These reserves are either netted in
the current and long-term components of "Net investments in Sales-Leases" on the
balance sheet, or included in long-term liabilities on our balance sheet for
off-book leases.
We do not expect to incur any significant losses from the recourse
provisions related to the sale of rental income. Inter-Tel is compensated for
administration and servicing of rental income sold.
At December 31, 2001, future minimum lease payments related to the lease
portfolio are: 2002 -- $14,483,000; 2003 -- $14,278,000; 2004 -- $5,023,000;
2005 - $2,235,000; 2006 -- $1,313,000; thereafter - $3,000.
NOTE E - PROPERTY, PLANT & EQUIPMENT
December 31
-----------------
(In thousands) 2001 2000
------- -------
Computer systems and equipment $42,313 $47,047
Transportation equipment 2,872 2,909
Furniture and fixtures 5,056 4,839
Leasehold improvements 3,770 3,101
12
Building 7,297 7,297
Land 2,629 2,629
------- -------
63,937 67,822
Less: Accumulated depreciation and amortization 40,102 35,099
------- -------
Net property, plant & equipment $23,835 $32,723
======= =======
EQUIPMENT HELD FOR LEASE
Operating leases (telephone equipment) 1,712 $ 1,923
Less: Accumulated depreciation and amortization 1,642 1,500
------- -------
Net Equipment held for lease $ 70 $ 423
======= =======
NOTE F - GOODWILL AND OTHER INTANGIBLES
December 31
-----------------
(In thousands) 2001 2000
------- -------
Goodwill $18,681 $17,515
Less: Accumulated amortization 5,025 2,642
------- -------
Net Goodwill 13,656 14,873
Acquired developed technology 5,786 4,347
Customer lists and non-competition agreements 1,841 1,721
------- -------
Subtotal of Other intangibles 7,627 6,068
Less: Accumulated amortization 2,624 2,552
------- -------
Net Other intangibles 5,003 3,516
======= =======
Net Goodwill and other intangibles $18,659 $18,389
======= =======
NOTE G - OTHER ASSETS
December 31
-----------------
(In thousands) 2001 2000
------- -------
Note receivable and investment in Vianet
(formerly Inter-Tel.Net) $ 3,669 $ --
Other assets 475 568
------- -------
$ 4,144 $ 568
======= =======
NOTE H - OTHER CURRENT LIABILITIES
December 31
-----------------
(In thousands) 2001 2000
------- -------
Compensation and employee benefits $12,947 $12,284
Restructuring Charge 1,389 2,318
Deferred revenues 6,445 6,308
Miscellaneous taxes payable 3,994 8,147
Other accrued expenses 19,276 17,712
------- -------
$44,051 $46,769
======= =======
NOTE I - CREDIT LINE
We maintain a $25,000,000 unsecured bank credit line at prime rate to cover
international letters of credit and for other purposes. The credit agreement
matures June 1, 2002 and contains certain restrictions and financial covenants.
At December 31, 2001, $544,841of the credit line was committed under letter of
credit arrangements.
13
NOTE J - LEASES
Rental expense amounted to $9,679,000; $8,818,000; and $6,254,000; in 2001,
2000, and 1999, respectively. Noncancellable operating leases are primarily for
buildings. Certain of the leases contain provisions for renewal options and
scheduled rent increases. At December 31, 2001, future minimum commitments under
noncancellable leases, including our new headquarters facility and a 15 year
lease for our research and development facility and 63 month lease for our
distribution and support facility, are: 2002 -- $9,567,000; 2003 -- $7,798,000;
2004 -- $7,153,000; 2005 - $3,234,000; 2006 -- $1,630,000 thereafter -
$1,071,000.
NOTE K - INCOME TAXES
We account for income taxes under Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). Under SFAS 109,
the liability method is used in accounting for income taxes. Under this method,
deferred tax assets and liabilities are determined (and classified as current or
long-term) based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.
Significant components of our deferred tax liabilities and assets as of
December 31 are as follows:
December 31
-------------------
(In thousands) 2001 2000
-------- --------
DEFERRED TAX LIABILITIES:
Other $ 4,944 $ --
Lease--sales and reserves 32,027 24,057
-------- --------
TOTAL DEFERRED TAX LIABILITIES 36,971 24,057
-------- --------
DEFERRED TAX ASSETS:
Inventory basis differences 3,285 2,976
Accounts receivable reserves 2,789 3,039
Accrued vacation pay 1,223 980
Book over tax depreciation 771 2,787
Foreign loss carryforwards 956 1,358
In-process R&D write-off 6,581 7,950
Restructuring reserves 3,036 9,006
Lease Receivable 3,995 3,371
Other - net 6,226 1,842
-------- --------
Deferred tax assets 28,862 33,309
Less valuation reserve 814 1,358
-------- --------
Net deferred tax assets 28,048 31,951
-------- --------
NET DEFERRED TAX ASSETS (LIABILITIES) $ (8,923) $ 7,894
======== ========
During 2001, 2000 and 1999, we recorded a loss of $437,000, income of
$226,000, and losses of $341,000 respectively, from foreign operations. At
December 31, 2001, we had foreign loss carryforwards of approximately
$2,500,000, which will begin to expire in 2002. The valuation allowance in 2001
decreased by $544,000 and increased by $79,000 in 2000 due to expiration of
foreign loss carryforwards and increases in foreign loss carryforward benefits.
Federal and state income taxes (benefit) consisted of the following:
(In thousands) 2001 2000 1999
-------- -------- --------
Federal $ 5,076 $(15,101) $ 13,832
State 2,583 (1,716) 2,787
-------- -------- --------
$ 7,659 $(16,817) $ 16,619
======== ======== ========
14
The principal reasons for the difference between total income tax expense
(benefit) and the amount computed by applying the statutory federal income tax
rate to income before taxes are as follows:
2001 2000 1999
-------- -------- --------
Federal tax at statutory rates
Applied to pre-tax income 35% (35)% 35%
State tax net of federal benefit 5 (4) 3
Credit for research activities (5) -- --
Other - net 2 2 --
---- ---- ----
37% (37)% 38%
==== ==== ====
NOTE L - EQUITY TRANSACTIONS
TREASURY STOCK. During the first quarter of 2001, we initiated a stock
repurchase program under which the Board of Directors authorized the repurchase
of up to 4,000,000 shares of our Common Stock. During the third quarter of 2000,
we initiated a stock repurchase program under which the Board of Directors
authorized the repurchase of up to 2,000,000 shares of Inter-Tel Common Stock.
Under these authorizations, we purchased approximately 2,523,000 shares and
expended approximately $28.9 million for stock repurchases during 2001, which
was funded primarily through existing cash balances. We also expended
approximately $6.7 million and $6.7 million for repurchases of approximately
562,000 and 558,000 shares of Inter-Tel's Common Stock during 2000 and 1999,
respectively, which was funded primarily through existing cash balances. We
reissued approximately 671,000, 379,000 and 740,000 shares in 2001, 2000 and
1999, respectively, through stock option and employee stock purchase plan
exercises and issuances, and stock issued in conversion of subsidiary stock
through an acquisition. The proceeds received for the stock reissued were less
than our cost basis. Accordingly, the difference was recorded as a reduction to
retained earnings.
DIVIDEND POLICY. On October 23, 2001, our Board of Directors increased the
cash dividend (the "cash dividend") from $0.01 to $0.02 for every share of
Common Stock, payable quarterly to shareholders of record beginning December 31,
2001, with dividend payments to commence on or about 15 days after the end of
each fiscal quarter. From December 31, 1997 through the third quarter of 2001,
we paid quarterly cash dividends of $0.01 for every share of Common Stock to
shareholders of record. We have made quarterly dividend payments for each
quarter since the dividend was declared in September 1997. Prior to the cash
dividend, we had declared no cash dividends on our Common Stock since
incorporation.
STOCK OPTION PLANS. In July 1990, we adopted the Director Stock Option Plan
("the Director Plan") and reserved a total of 500,000 shares of Common Stock for
issuance thereunder. In July 2001, subject to shareholder approval at the annual
shareholders' meeting in April 2002, the board of directors extended the term of
the Director Plan to 2010. Options must be granted at not less than 100% of the
fair market value of our stock at the dates of grant. Commencing with the
adoption of the Plan, each Eligible Director received a one-time automatic grant
of an option to purchase 5,000 shares of our Common Stock. In addition, each
Eligible Director shall be granted an option to purchase 5,000 shares upon the
date five (5) days after such person became Director, and an additional option
to purchase 5,000 shares five (5) days after the date of the regularly scheduled
board meeting following the close of our third quarter. All options granted
through 2001 had a five-year term and fully vest at the end of six months from
the grant date.
In November 1993, the Board of Directors authorized the Inter-Tel,
Incorporated Long-Term Incentive Plan ("the 1994 Long Term Plan"). A total of
2,000,000 shares of Common Stock has been reserved for issuance under the 1994
Long Term Plan to selected officers and key employees. Options must be granted
at not less than 100% of the fair market value of our stock at the dates of
grant. Options generally vest over four or five years and expire five to ten
years from the date of grant.
In February 1997, the Board of Directors authorized the Inter-Tel,
Incorporated 1997 Long-Term Incentive Plan ("the 1997 Long Term Plan"). A total
of 2,400,000 shares of Common Stock has been reserved for issuance under the
1997 Long Term Plan to selected officers and key employees. Option must be
granted at not less than 100% of the fair market value of our stock at the dates
of grant. Options generally vest over four or five years and expire ten years
from the date of grant. In March 2000, the Board of Directors authorized an
amendment to the
15
1997 Long Term Plan to add 1,250,000 more shares of Common Stock to the 1997
Long Term Plan for issuance to selected officers and key employees and to limit
our ability to reprice options under the 1997 Long Term Plan.
On February 27, 2001 our Board of Directors authorized an amendment of the
Long Term Plan, approved by the stockholders, that provides for an automatic
increase in the number of shares of Common Stock reserved thereunder on the
first day of each fiscal year equal to the lesser of (a) 2.5% of the outstanding
shares on that date, (b) 750,000 shares (subject to appropriate adjustment for
all stock splits, dividends, subdivisions, combinations, recapitalizations and
like transactions) or (c) a lesser amount as determined by the Board of
Directors (the "Renewal Feature"). For 2002, based on shares outstanding at
January 1, 2002 and as approved by the Board of Directors in February 2002, this
renewal feature provided for an increase of 604,161 shares for issuance under
the Long Term Plan.
Under the 1994 and 1997 Long Term Plans, in some instances, predetermined
performance goals and share market value increases must be met to allow the
options to be exercised before the end of the option term.
In April 1998, the Board of Directors authorized the Inter-Tel,
Incorporated Acquisition Stock Option Plan (the Acquisition Plan). A total of
82,428 shares of Common Stock was reserved for issuance under the Acquisition
Plan to selected key employees hired as a result of the acquisition of TMSI. New
options must be granted at not less than 100% of the fair market value of our
stock at the dates of grant. Options generally vest over four or five years and
expire ten years from the date of grant. A portion of the options granted were
replacements for options held to purchase shares of stock of the selling
company; such replacement grants retained the original terms, including grant
dates for vesting purposes and the original grant prices, adjusted using the
applicable conversion ratio of the fair value of Inter-Tel's stock compared to
that of the selling company.
In March 2000, the Board of Directors authorized an additional 216,000
shares of Common Stock for issuance under the Acquisition Plan to selected
employees hired as a result of the acquisition of Executone. Options must be
granted at not less than 100% of the fair market value of our stock at the dates
of grant. Options vest over five years and expire ten years from the date of
grant.
In February 2001, the Board of Directors authorized an additional 300,000
shares of Common Stock for issuance under the Acquisition Plan to selected
employees hired as a result of the acquisition of Convergent. In addition, in
October 2001, the Board of Directors authorized an additional 150,000 shares of
Common Stock for issuance under the Acquisition Plan to selected employees hired
as a result of the acquisition of Mastermind Technologies. Options in each
instance must be granted at not less than 100% of the fair market value of our
stock at the dates of grant. Options vest over five years and expire ten years
from the date of grant.
Option activity for the past three years under all plans is as follows:
Number of Shares
--------------------------------------------
2001 2000 1999
------------ ------------ ------------
Outstanding at beginning of year 3,143,292 2,486,696 2,948,032
Granted 2,007,500 1,213,500 491,750
Exercised (210,633) (279,654) (615,986)
Expired or canceled (372,214) (277,250) (337,100)
------------ ------------ ------------
Outstanding at end of year 4,567,945 3,143,292 2,486,696
------------ ------------ ------------
Exercise price range $2.24-$43.44 $2.24-$43.44 $2.24-$26.00
Exercisable at end of year 1,458,388 1,188,356 979,630
Weighted-average grant price of
options granted $12.26 $13.65 $11.44
Weighted-average fair value of
options granted during the year $6.42 $6.83 $5.15
At December 31, 2001, we have reserved 4,921,435 shares of Common Stock for
issuance in connection with the stock option plans.
16
As permitted under Statement of Financial Accounting Standards No. 123 (FAS
123) "Accounting for Stock-Based Compensation," we have elected to follow
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations, in accounting for stock based awards to
employees. Under APB 25, we generally recognize no compensation expense with
respect to such awards.
The following table summarizes information about stock options outstanding
at December 31, 2001:
OPTIONS OUTSTANDING
Number Weighted-Average Weighted
Range of Outstanding Remaining Average
Exercise Price at 12-31-01 Contractual Life Exercise Price
- -------------- ----------- ---------------- --------------
$ 2.24 - $ 4.31 244,203 3 years $ 3.00
$ 4.81 - $ 7.06 231,100 5 years $ 5.58
$ 7.25 - $13.44 3,066,200 8 years $10.43
$15.13 - $43.44 1,026,442 7 years $21.46
OPTIONS EXERCISABLE
Number Weighted-Average Weighted
Range of Exercisable Remaining Average
Exercise Price at 12-31-01 Contractual Life Exercise Price
- -------------- ----------- ---------------- --------------
$ 2.24 - $ 4.31 244,203 3 years $ 3.00
$ 4.81 - $ 7.06 173,300 5 years $ 5.69
$ 7.25 - $13.44 620,700 8 years $10.09
$15.13 - $43.44 420,185 7 years $22.05
During 2001, the weighted average exercise price of options granted,
exercised, and expired or canceled was $10.14, $8.05 and $15.02, respectively.
Had compensation cost for our stock option plans been determined based on
the fair value at the grant date for awards in 2001, 2000 and 1999 consistent
with the provisions of SFAS 123, the estimated fair value of the options would
be amortized to expense over the option's vesting period and our net income and
net income per share for the year ended December 31 would have been as follows:
(in thousands, except per share amounts) 2001 2000 1999
-------- -------- --------
Net (loss) income as reported $ 13,041 $(28,923) $ 27,146
Pro forma net (loss) income $ 10,595 $(30,480) $ 26,043
Pro forma (loss) income per diluted share $ 0.42 $ (1.16) $ 0.96
Pro forma results disclosed are based on the provisions of SFAS 123 using
the Black-Scholes option valuation model and are not likely to be representative
of the effects on pro forma net income for future years. In addition, the
Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
our employee stock options have characteristics significantly different from
those of traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in our opinion, the estimating
models do not necessarily provide a reliable single measure of the fair value of
our employee stock options.
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model using the low end of reasonable assumptions
for input variables rather than attempting to identify a best-point estimate.
The option pricing model utilized the following weighted average assumptions for
2001, 2000 and
17
1999, respectively: risk free interest rates of 4.5% for 2001 and 5.5% for 2000
and 1999; dividend yields of .50% for 2001 and .25% for 2000 and 1999;
volatility factors of the expected market price of our stock averaged .766 for
2001 and .30 for 2000 and 1999; and a weighted average expected life of the
option of 4 to 5 years for employee stock options which vest over four to five
year periods with a weighted average vesting period of 2.5 years and 1.5 years
for director options which vest at the end of six months from the grant date.
1997 EMPLOYEE STOCK PURCHASE PLAN. In April 1997, the Board of Directors
and stockholders adopted the Employee Stock Purchase Plan (the Purchase Plan)
and reserved 500,000 shares for issuance to eligible employees. Under the
Purchase Plan, employees are granted the right to purchase shares of Common
Stock at a price per share that is 85% of the lesser of the fair market value of
the shares at: (i) the participant's entry date into each six-month offering
period, or (ii) the end of each six-month offering period. Employees may
designate up to 10% of their compensation for the purchase of stock. Under the
Plan, we sold 108,742 shares for approximately $966,000 ($8.89 per share) to
employees in 2001, 105,485 shares for approximately $980,000 ($9.29 per share)
to employees in 2000, and 67,431 shares for approximately $851,000 ($12.62 per
share) to employees in 1999. At December 31, 2001, 136,670 shares remained
authorized under the Plan.
STOCK OPTION LOANS. During 1999, selected officers and employees of
Inter-Tel were offered loans to acquire Inter-Tel common stock. Promissory Notes
were established to cover the cost of exercise of stock options, including
applicable taxes, or the cost of Inter-Tel common stock purchased in the open
market during May and June of 1999. The loans are interest-only notes with
balloon payments due on or before March 15, 2004. The loans bear interest at the
mid-term applicable federal interest rate, compounded annually. Interest
payments are due on or before March 15 of each anniversary beginning on March
15, 2000. The notes are full recourse loans and we retain the common stock
certificates as collateral. The outstanding balance of loans at December 31,
2001 totaled $942,417.
NOTE M - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
(In thousands, except per share amounts) 2001 2000 1999
-------- -------- --------
Numerator:
Net income (loss) $ 13,041 $(28,923) $ 27,146
-------- -------- --------
Denominator:
Denominator for basic earnings per
Share - weighted average shares 24,488 26,273 25,949
Effect of dilutive securities:
Employee and director stock options 752 -- 1,055
-------- -------- --------
Denominator for diluted earnings per
Share - adjusted weighted average
shares and assumed conversions 25,240 26,273 27,004
-------- -------- --------
Basic income (loss) per share $ 0.53 $ (1.10) $ 1.05
======== ======== ========
Diluted income (loss) per share $ 0.52 $ (1.10) $ 1.01
======== ======== ========
Options that are antidilutive because the exercise price was greater than
the average market price of the common shares, are not included in the
computation of diluted earnings per share. For the year ended December 31, 2000,
689,000 shares were excluded from the computation of diluted EPS above because
they were antidilutive for 2000.
18
NOTE N - RETIREMENT PLANS
We have two retirement plans for the benefit of our employees. Under our
401(k) Retirement Plan, participants may contribute an amount not exceeding 15
percent of compensation received during participation in the Plan. We make
voluntary annual contributions to the Plan based on a percentage of
contributions made by Plan participants of up to 10 percent of compensation.
Contributions to the Plan totaled $1,476,000; $1,381,000; and $780,000; in 2001,
2000 and 1999, respectively.
In 1992, we initiated an Employee Stock Ownership Plan (ESOP), advancing
$500,000 to the ESOP Trust for the purpose of purchasing Common Stock of the
Company. The Trust purchased 307,000 shares of Inter-Tel Common Stock in July
1992. The loan was paid in full during 1997. As the principal amount of the loan
was repaid to Inter-Tel through Company annual contributions, the equivalent
number of shares released were allocated to employees' accounts to be held until
retirement. Total shares so allocated were 32,380 in 1997. Contributions to the
ESOP totaled $62,500 in 1997, and are based upon the historic cost of the shares
purchased by the ESOP. After the final allocation of shares in 1997, the ESOP
plan was "frozen," so that all eligible participants as of July 1, 1997 became
100% vested in their accounts, regardless of length of service. No further
purchases are anticipated through the ESOP, and we do not anticipate making
future allocations of shares from this plan.
NOTE O - SEGMENT INFORMATION
Inter-Tel adopted Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131") in the fiscal year ended December 31, 1998. SFAS 131 establishes standards
for reporting information regarding operating segments in annual financial
statements and requires selected information for those segments to be presented
in interim financial reports issued to stockholders. SFAS 131 also establishes
standards for related disclosures about products and services and geographic
areas. Operating segments are identified as components of an enterprise about
which separate discrete financial information is available for evaluation by the
chief operating decision maker, or decision making group, in making decisions as
to how to allocate resources and assess performance. The Company's chief
decision maker, as defined under SFAS 131, is the Chief Executive Officer.
Prior to 2000, we had viewed our operations as principally one segment:
telephone systems, telecommunications software and hardware, and related long
distance calling services. These services are provided through the Company's
direct sales offices and dealer network to business customers throughout the
United States, Europe, Asia, Mexico and South America. As a result, financial
information disclosed previously represented substantially all of the financial
information related to the Company's principal operating segment.
During 2000, the operations of Executone were identified separately in the
first and second quarters of 2000. Beginning in the 3rd quarter and directly as
a result of the charge and reorganization associated with the Executone
operations, we no longer account for or directly report the Executone operations
on a stand-alone basis. The operations have been integrated with the Company's
existing wholesale, and national and government account, operations.
In December 1999, Inter-Tel entered into an agreement with Hypercom
Corporation to jointly form Cirilium Corporation ("Cirilium"). Cirilium
comprises parts of Hypercom's data and Inter-Tel's packet telephony products and
services, including Inter-Tel's Vocal'Net gateway products and technology. As of
the close of the third quarter of 2000, we wrote off our remaining investment
and basis in Cirilium of $2.0 million. Total pre-tax losses from Cirilium from
all sources were $8.6 million ($0.21 per diluted share) during 2000. As a result
of the write-off, we do not expect to report the operations of Cirilium as a
separate business segment. Refer to the table below for a summary of the
operations for 2000.
During 2000, we determined that the operations of Inter-Tel.NET,
Inter-Tel's former IP long distance subsidiary, would be separately disclosed as
a business segment. The operations represented a more significant component of
the consolidated operations in 2000 compared to prior years and had a
significant impact on the revenues and net losses. On July 24, 2001, Inter-Tel
agreed to sell 83% of Inter-Tel.NET to Comm-Services Corporation. As a result,
since July 24, 2001, we have accounted for the remaining 17%
Inter-Tel.NET/Comm-Services investment using the cost method of accounting. On
December 30, 2001, Comm-Services entered into
19
a merger agreement with Vianet. Inter-Tel's 17% investment in
Inter-Tel.NET/Comm-Services was converted to approximately 10% of Vianet stock.
Inter-Tel will account for the remaining 10% investment in Vianet using the cost
method of accounting.
Commencing the third quarter of 2001, we began disclosing as a separate
business segment operating results relating to local and long distance resale
services. Inter-Tel offers these services to its customers as part of a total
telephony solution approach. Results of operations for this segment, if the
operations were not included as part of the consolidated group, could differ
materially, as the operations are integral to the total telephony solution
offered by us to our customers.
For the year ended December 31, we generated income from business segments,
including charges, as follows:
RESALE OF
LOCAL AND
EXECUTONE LONG
PRINCIPAL (CHARGES DISTANCE
(In thousands, except per share amounts) SEGMENT ONLY) CIRILIUM INTER-TEL.NET SERVICES TOTAL
--------- --------- --------- ------------- --------- ---------
2001
- ----
Net sales $ 346,094 $ -- $ -- $ 13,986 $ 25,575 $ 385,655
Gross profit (loss) 173,823 -- -- (5,892) 6,563 174,494
Charge (see Note B) -- -- -- (5,357) -- (5,357)
Operating income (loss) 30,911 -- -- (13,718) 3,231 20,424
Interest and other income 970 -- -- (1) 112 1,081
Loss on foreign translation adjustments (337) -- -- -- -- (337)
Interest expense (293) -- -- (173) (2) (468)
Net income (loss) $ 19,688 $ -- $ -- $ (8,752) $ 2,105 $ 13,041
Net income (loss) per diluted share (1) $ 0.78 $ -- $ -- $ (0.36) $ 0.08 $ 0.52
Weighted average diluted shares (1) 25,240 25,240 25,240 24,488 25,240 25,240
Total assets $ 215,340 $ -- $ -- $ -- $ 12,122 $ 227,462
Depreciation and amortization 9,247 -- -- 2,114 156 11,517
2000
- ----
Net sales $ 353,313 $ -- $ -- $ 22,834 $ 26,576 $ 402,723
Cost of goods sold - Executone restructuring -- (7,639) -- -- -- (7,639)
Gross profit (loss) 173,328 (7,639) -- (11,212) 4,561 159,038
Charges and write-off of IPRD (see Notes B
and C) -- (48,710) -- (1,968) -- (50,678)
Operating income (loss) 37,546 (56,349) (574) (19,087) (133) (38,597)
Equity share of Cirilium losses -- -- (5,938) -- -- (5,938)
Write-off of Cirilium investment -- -- (2,045) -- -- (2,045)
Interest and other income 1,423 -- -- 2 49 1,474
Loss on foreign translation adjustments (421) -- -- -- -- (421)
Interest expense (128) -- -- (85) -- (213)
Net income (loss) $ 24,294 $ (35,631) $ (5,411) $ (12,122) $ (53) $ (28,923)
Net income (loss) per diluted share (1) $ 0.90 $ (1.36) $ (0.21) $ (0.46) $ (0.00) $ (1.10)
Weighted average diluted shares (1) 26,962 226,273 26,273 26,273 26,273 26,273
Depreciation and amortization 10,664 -- -- 1,878 204 12,746
(1) Options that are antidilutive because the exercise price was greater than
the average market price of the common shares are not included in the
computation of diluted earnings per share when a net loss is recorded. See Note
L for additional information.
Our revenues are generated predominantly in the United States. Total
revenues generated from U.S. customers totaled $375.6 million, $392.1 million,
and $306.5 million, of total revenues for the years ended December 31, 2001,
2000 and 1999, respectively. Revenues from international sources were primarily
generated from customers located in the United Kingdom, Europe, Asia, Mexico and
South America. In 2001, 2000 and 1999, revenues from customers located
internationally accounted for 2.6%, 2.6%, and 2.5% of total revenues,
respectively.
20
NOTE P - FINANCIAL INSTRUMENTS
CONCENTRATION OF CREDIT RISK. Financial instruments that potentially
subject Inter-Tel to significant concentrations of credit risk consist
principally of cash investments, trade accounts receivable, and net investment
in sales-leases. We maintain cash and equivalents not invested in money market
funds with a major bank in our marketplace. We perform periodic evaluations of
the relative credit standing of the financial institution. Concentrations of
credit risk with respect to trade accounts receivable and net investment in
sales-leases are limited due to the large number of entities comprising our
customer base.
FAIR VALUE OF FINANCIAL INSTRUMENTS. The carrying amount of cash and
equivalents, accounts receivable, net investment in sales-leases, and accounts
payable reported in the consolidated balance sheets approximate their fair
value.
NOTE Q - SUPPLEMENTAL CASH FLOW
(In thousands) 2001 2000 1999
-------- -------- --------
CASH PAID FOR:
Interest $ 468 $ 213 $ 65
Income taxes paid (received) $(11,398) $ 4,788 $ 12,405
-------- -------- --------
CHANGES IN OPERATING ASSETS AND LIABILITIES:
(Increase) decrease in receivables $ 2,064 $ (8,472) $(13,208)
(Increase) decrease in inventories 14,647 (15,034) (656)
(Increase) decrease in prepaid expenses
and other assets 15,620 (20,640) (8,277)
(Increase) decrease in long-term
other assets 1,583 14,717 (13,525)
Increase (decrease) in accounts payable
and other current liabilities (17,782) 458 19,544
-------- -------- --------
$ 16,132 $(28,971) $(16,122)
======== ======== ========
NOTE R - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
A summary of the quarterly results of operations for the years ended
December 31, 2001 and 2000 follows:
(In thousands, except per share amounts)
2001 1ST QTR 2ND QTR 3RD QTR 4TH QTR
- ---- --------- --------- --------- ---------
Net sales $ 93,702 $ 103,835 $ 93,487 $ 94,630
Gross profit 39,648 44,920 43,276 46,650
Net income 1,948 185 4,378 6,531
Net income per share--Basic $ 0.08 $ 0.01 $ 0.18 $ 0.27
Net income per share--Diluted $ 0.08 $ 0.01 $ 0.18 $ 0.26
Weighted average basic
common shares 25,500 24,389 23,949 24,116
Weighted average diluted
common shares 25,843 24,910 24,804 25,334
2000 1ST QTR 2ND QTR 3RD QTR 4TH QTR
- ---- --------- --------- --------- ---------
Net sales $ 96,363 $ 101,089 $ 102,650 $ 102,621
Gross profit 41,540 30,410 43,798 43,290
Net (loss) income (1,221) (34,162) 2,084 4,376
Net (loss) income per share--Basic $ (0.05) $ (1.30) $ 0.08 $ 0.17
Net (loss) income per share--Diluted $ (0.05) $ (1.30) $ 0.08 $ 0.17
Weighted average basic
common shares 26,249 26,371 26,435 26,039
Weighted average diluted
common shares 26,249 26,371 26,940 26,368
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NOTE S - SUBSEQUENT EVENT
In May 2001, Inter-Tel entered into an agreement to submit a lawsuit filed
by Inter-Tel in 1996 to binding arbitration. The arbitration was completed in
January 2002 and as a result of the arbitration, Inter-Tel received a gross cash
award of $20 million in February 2002. Income taxes, attorney's fees, expert
witness costs, arbitration costs and additional costs and expenses, including
$1.3 million in bonus payments to employees who assisted in the litigation and
arbitration, totaled approximately $10.7 million in 2002. Accordingly, net
proceeds from this arbitration totaled approximately $9.3 million. This
transaction concluded in 2002; therefore no cash proceeds were included in the
2001 financial statements.
Included in the $1.3 million total bonus payments to employees for
assistance in the litigation and arbitration were payments to executive officers
totaling $740,000 in February 2002. Payments of $250,000, $225,000, $225,000 and
$40,000 were made to Steven G. Mihaylo, Norman Stout, Craig Rauchle and Jeff
Ford, respectively, in connection with this settlement.
This transaction will be included in the 2002 first quarter results. No
cash was received and no income was included in 2001 from this arbitration.
However, Inter-Tel incurred costs and expenses, including attorney's fees,
totaling approximately $1.3 million from 1997 through 2001 that were expensed
through operations in each period. Such expenses are not included in the net
award indicated above.
22
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
COL. A COL. B COL. C COL. D COL. E
--------- -------- -------- -------- ---------
ADDITIONS
Charged to
Balance at Charged to Other Charged to Balance
Beginning Costs & Accounts Deductions at End
DESCRIPTION of Period Expenses Describe Describe of Period
----------- --------- -------- -------- -------- ---------
YEAR ENDED DECEMBER 31, 2001
Deducted from asset accounts:
Allowance for doubtful accounts $17,187 $ 6,260 $ 207 (4) $11,796 (1, 2) $11,858
Allowance for lease accounts $ 8,870 $ 5,840 $ -- $ 4,197 (2) $10,513
Inventory allowance $11,897 $ 1,614 $ 2,000 (4) $ 2,309 (3) $13,202
YEAR ENDED DECEMBER 31, 2000
Deducted from asset accounts:
Allowance for doubtful accounts $ 8,814 $ 6,793 $ 4,994 (4) $ 3,414 (2) $17,187
Allowance for lease accounts $ 6,734 $ 4,927 $ -- $ 2,791 (2) $ 8,870
Inventory allowance $ 5,849 $ 1,653 $ 6,278 (4) $ 1,883 (3) $11,897
YEAR ENDED DECEMBER 31, 1999
Deducted from asset accounts:
Allowance for doubtful accounts $ 4,604 $ 4,623 $ 2,628 (4) $ 3,041 (2) $ 8,814
Allowance for lease accounts $ 5,716 $ 3,773 $ -- $ 2,755 (2) $ 6,734
Inventory allowance $ 5,453 $ 1,508 $ 83 (4) $ 1,195 (3) $ 5,849
- ----------
(1) Includes $4.6 million related to 2000 acquisitions and included in balance
at end of period 2000 (see item 4 below). Additionally, this includes $1.9
million transferred to Comm-Services with sale of Inter-Tel.NET that was
also included in balance at end of period.
(2) Uncollectible accounts written off, net of recoveries.
(3) Inventory written off.
(4) Acquired in purchase transaction.
23