UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED COMMISSION FILE NUMBER:
DECEMBER 31, 2002 0-10211
INTER-TEL, INCORPORATED
INCORPORATED IN THE STATE OF ARIZONA I.R.S. NO. 86-0220994
1615 S. 52ND STREET
TEMPE, ARIZONA 85281
(480) 449-8900
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock
(24,925,633 shares outstanding as of March 7, 2003)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (S 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K - [ ].
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [ ] No [X].
The aggregate market value of the voting stock held by non-affiliates of the
registrant, based upon the last reported sales price of Inter-Tel's Common Stock
reported on the Nasdaq National Market System on June 30, 2002 was approximately
$319.6 million. Shares of Common Stock held by each executive officer and
director have been excluded in that such persons may be deemed to be affiliates.
Items 10 (as to Directors), 11 and 12 of Part III incorporate by reference
information from the Registrant's Proxy Statement relating to its 2003 Annual
Meeting of Shareholders.
INTER-TEL, INCORPORATED
2002 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
Page
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Item 1 Business 3
Item 2 Properties 23
Item 3 Legal Proceedings 24
Item 4 Submission of Matters to a Vote of Security Holders 24
PART II
Item 5 Market for the Registrant's Common Stock
and Related Shareholder Matters 25
Item 6 Selected Financial Data 26
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations 28
Item 7A Quantitative and Qualitative Disclosures About Market Risk 40
Item 8 Financial Statements and Supplementary Data 41
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 41
PART III
Item 10 Directors and Executive Officers of the Registrant 42
Item 11 Executive Compensation 42
Item 12 Security Ownership of Certain Beneficial Owners and Management 42
Item 13 Certain Relationships and Related Transactions 42
Item 14 Controls and Procedures 42
PART IV
Item 15 Exhibits, Financial Statement Schedules and Reports on Form 8-K 43
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PART I
ITEM 1. BUSINESS
THE COMPANY
THIS ANNUAL REPORT TO SHAREHOLDERS ON FORM 10-K ("10-K") CONTAINS
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE STATEMENTS
CONTAINED IN THIS 10-K THAT ARE NOT PURELY HISTORICAL ARE FORWARD-LOOKING
STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS
AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED,
INCLUDING WITHOUT LIMITATION STATEMENTS REGARDING THE COMPANY'S EXPECTATIONS,
BELIEFS, INTENTIONS OR STRATEGIES REGARDING THE FUTURE. ALL FORWARD-LOOKING
STATEMENTS INCLUDED IN THIS DOCUMENT ARE BASED ON INFORMATION AVAILABLE TO THE
COMPANY ON THE DATE HEREOF, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY
SUCH FORWARD-LOOKING STATEMENTS. THE CAUTIONARY STATEMENTS MADE IN THIS 10-K
SHOULD BE READ AS BEING APPLICABLE TO ALL RELATED FORWARD-LOOKING STATEMENTS
WHEREVER THEY APPEAR IN THIS DOCUMENT. THE COMPANY'S ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A
RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH UNDER "FACTORS THAT MAY
AFFECT FUTURE OPERATING RESULTS" BELOW AND ELSEWHERE IN THIS DOCUMENT. IN
EVALUATING THE COMPANY'S BUSINESS, SHAREHOLDERS AND PROSPECTIVE INVESTORS SHOULD
CONSIDER CAREFULLY THE FOLLOWING FACTORS IN ADDITION TO THE OTHER INFORMATION
SET FORTH IN THIS DOCUMENT.
Inter-Tel, incorporated in 1969, is a single point of contact, full service
provider of converged voice and data 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, local and
long distance calling services, and other communications services. Our products
and services include the AXXESS by Inter-Tel, ECLIPSE2 by Inter-Tel and Encore
by Inter-Tel business communication systems, with integrated voice processing
and unified messaging systems, IP telephony voice and data routers, and
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."
We have developed a distribution network of direct sales offices, dealers
and value added resellers (VARs), which sell our products to organizations
throughout the United States and internationally, primarily targeting
small-to-medium enterprises, service organizations and governmental agencies. As
of December 31, 2002, we had fifty-two (52) direct sales offices in the United
States, one (1) in Japan, and a network of hundreds of dealers and VARs around
the world that purchase directly from us. We also maintain a wholesale
distribution office in the United Kingdom that supplies Inter-Tel's dealers and
distributors throughout the UK and parts of Europe. In December 2002, we also
acquired Swan Solutions Limited, a research and development and software sales
office in the United Kingdom.
PRODUCTS AND SERVICES
Inter-Tel is focused on the enterprise telecommunications market and has a
track record of technological innovation and leadership. Inter-Tel serves
business enterprise customers, such as manufacturers, healthcare providers, the
automotive industry, financial institutions, government agencies, non-profit
organizations and other service organizations with value-driven solutions. Our
core products include converged business communications systems supporting
scalable networked installations, IP telephony products and services, computer
telephony applications, unified messaging and voice processing software. We also
offer a complete line of managed services, including custom development, local
and long distance calling services, network design and implementation services,
maintenance services, leasing and support services. In addition, we resell
peripheral data and telecommunications products.
STANDARDS-BASED ARCHITECTURE
Inter-Tel intends to continue developing standards-based IP telephony
solutions. In the first quarter of 2003, Inter-Tel introduced support of Media
Gateway Control Protocol (MGCP) and Session Initiation Protocol (SIP) in our
Axxess and Eclipse communication platforms. SIP and MGCP are industry-standard
protocols for transmitting voice over IP networks. Through our support of these
two standard protocols, the Axxess and Eclipse products can interoperate with
other industry-standard devices such as SIP and MGCP gateways for converting IP
voice calls to standard telephone lines, and for using standard SIP telephones
as
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extension numbers on the system. Support of SIP also allows our Axxess and
Eclipse systems to interoperate with public SIP networks and services like MSN
Passport and to use MS-Messenger as an extension number on the system. Our
future product strategy is focused on continuing to provide support for these
and other industry-standard interfaces.
BUSINESS COMMUNICATION APPLICATIONS FOR THE SMALL-TO-MEDIUM ENTERPRISE
As an integral part of our Managed Services offerings, Inter-Tel provides
an extensive lineup of applications designed for business use, enhanced
productivity and operational performance. Our portfolio of applications
encompasses: Converged Voice and Data Tools, Customer Relationship Tools and
Mobility Tools. Inter-Tel's applications can automate repetitive tasks, enable
call handling tasks from a personal computer (PC), generate historical and real
time call statistics, enable intelligent call routing, manage communications via
Web browser or Wireless Application Protocol (WAP) device and more. Specific
applications are highlighted in additional detail below.
CONVERGED VOICE AND DATA TOOLS
Inter-Tel's applications include seamless integration of multiple locations
in one transparent network, which creates the virtual enterprise of an
organization. Inter-Tel's solutions for combined voice and data communication
systems or, "converged" solutions focus on fully-featured applications that link
businesses with applications through our unified computer telephony (CT) link.
Since the needs of each individual end-user differ, Inter-Tel supports various
types of endpoints for receiving, initiating and managing your calls. Inter-Tel
designs digital telephones and IP telephones for office applications, wireless
phones and soft-phones for customers who are mobile inside and outside of the
office, and touch-to-talk e-commerce software for customers wishing to place a
voice call from a web site. Inter-Tel's IP applications integrate robust
features and functionality such as call center applications that enable
businesses to implement distributed networking across multiple locations, agent
desktop applications, intelligent routing, and productivity management
applications designed for business department managers. Additionally, our
customers can benefit from alternatives to traditional, more expensive,
point-to-point T-1 lines by adding Inter-Tel's IP communications applications to
their systems.
Our converged voice and data applications, such as desktop solutions and
call center applications using Automatic Call Distribution (ACD), can also help
expand an enterprise's capabilities. Advanced software applications, such as
Unified Messaging, Unified Communicator and networking capabilities, can help
increase productivity and workflow efficiency. Alternatively, our customers can
add a human touch to their e-business by deploying ClearConnect Talk to Agent.
Inter-Tel's Open Architecture Interface (OAI) and support for industry
standards-based connectivity, such as Computer Software Telephony Application
(CSTA), Telephony Applications Protocol Interface (TAPI) and Intel/Dialogic
CT-Connect allow our customers to integrate with their existing applications,
such as Customer Relationship Management (CRM), Hotel Property Management
Systems (PMS), Personal Information Management (PIM) software such as Microsoft
Outlook and more.
CUSTOMER RELATIONSHIP TOOLS
Inter-Tel's customer relationship tools help our customers maintain and
improve their business relationships. Our solutions help businesses provide
user-friendly Web interfaces, expedite call routing to the correct person or
department, enable 24x7 access to products and services and improve customer
care.
MOBILITY TOOLS
Inter-Tel offers several solutions for organizations with traveling
employees or enterprises with multiple facilities and mobile resources. Our
mobility tools connect mobile and remote professionals to help increase
productivity and streamline resources. For example, one of Inter-Tel's
applications allows call center managers on the move or working remotely to stay
connected to their call center. Additionally, our Unified Communicator
application gives users the ability to manage their address book, monitor the
status of their workgroup and their call routing through multiple user
interfaces, including WAP-enabled cell phones, Web browsers and handheld PDAs.
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CONVERGED COMMUNICATIONS PLATFORMS
AXXESS & ECLIPSE CONVERGED COMMUNICATIONS SYSTEMS
Designed for small to medium enterprises, the Axxess and Eclipse converged
systems provide tightly integrated voice processing, IP telephony functionality
and transparent networking throughout an organization. With an Inter-Tel
converged system, our customers can network up to sixty-three (63) systems
together with full-feature transparency, allowing customers to choose between
traditional T-1 lines, frame relay, managed bandwidth or the Internet to network
sites. Our commercially available systems support up to 40,000 ports, which
enables flexible growth options.
The Axxess and Eclipse converged systems differ in terms of their
appearance and, to a lesser extent, functionality, but are based on the same
architecture. They incorporate open interfaces, employ the standard programming
languages C++ and JAVA, and are built on a computer telephony interface, which
enables the integration of outside applications. Our converged systems combine
IP, digital, analog and wireless into a single platform--giving our customers a
choice of technologies based on their organizations' needs. The distributed
architecture enables the connectivity of several phones in an office, hundreds
of phones in a building or on a campus, remote and telecommuting associates, or
even geographically-dispersed offices.
Axxess and Eclipse converged systems are based on open architecture
interfaces and standard protocols. The open architecture allows for seamless
integration of CT applications, development and customization. The modular
platform can be tailored around the way an organization does business with the
flexibility to modify the solution with growth or change.
Tightly integrated with the Axxess and Eclipse converged platforms, our
suite of IP, software and digital endpoints deliver exceptional voice quality,
powerful features and intuitive interfaces. Whether our customers have
associates onsite, mobile or working from remote locations, our endpoints help
them to perform their functions with continuity.
IP TELEPHONY
Inter-Tel's platforms unify the varying technologies our customers deploy.
With analog, digital, wireless and Voice over IP (VoIP) built into the same
platform, our customers may choose from a variety of solutions--at a pace
suitable for their organizations. Whether our customers want to blend
traditional and IP solutions or deploy full IP solutions, Inter-Tel offers a
collection of applications and endpoints that enable them to benefit from IP
telephony.
We believe that seamlessly connecting multiple phone systems together is
cost-effective for our customers. Our Axxess and Eclipse converged systems were
designed around distributed, open architectures for maximum efficiency and
reliability. All advanced features of Axxess and Eclipse systems, such as ACD
hunt groups, call center applications, paging zones, centralized attendants and
tightly integrated voice mail remain in place even when an organization is
networking over IP.
By using IP-based phones and data networks, our customers can connect their
local employees, remote staff and satellite offices as if they were all located
in a single site. Our IP phones enable users anywhere to have access to advanced
features, such as transferring calls, conferencing, accessing voice mail,
record-a-call and more. Even call center agents working off-site do not
sacrifice functionality. They can be members of ACD hunt groups or call routing
patterns, and supervisors can monitor their calls as if they were in the same
office. Additionally, our IP phones eliminate the need for a separate phone
system in geographically dispersed locations.
IP NETWORKING
Inter-Tel's IP Resource Card (IPRC) and IP Networking Module allow our
customers to transparently network their locations over IP or Frame Relay
networks. The IPRC is a multipurpose card for IP-based communications.
Controlled through software, the IPRC can be used to network multiple locations
without the need for a separate gateway, to connect IP endpoints or to connect
remote IP gateways.
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Inter-Tel's InterPrise gateways help connect remote office locations and
facilities into a single, cost-effective IP network. InterPrise gateways deliver
reliable, high-quality voice and data communications to small branch offices, as
well as main corporate facilities, eliminating costly intra-company long
distance telephone charges.
IP-BASED ENDPOINTS
Inter-Tel's IP PhonePlus and IP SoftPhone enable remote associates and
satellite offices to seamlessly connect to an organization's data network. These
IP phones fully integrate with the Axxess and Eclipse Converged Communications
Systems so users have access to features such as ACD hunt groups and voice mail.
SOFTWARE-BASED ENDPOINTS
Inter-Tel offers several software-based endpoint solutions that increase
the productivity and enhance the communications of mobile and remotely-based
employees. Whether our customers are deploying IP or traditional telephony, our
soft phones give users control of the features and functionality of Axxess and
Eclipse on desktop PCs or laptops. Users can initiate, answer, transfer,
conference and forward calls and more--all with the click of a mouse. Advanced
applications, such as Information Control Center, allow users to view the
real-time status of associates and enable them to process calls quickly via
touch screen, mouse or keyboard.
DIGITAL ENDPOINTS
To complement our Axxess and Eclipse converged systems, Inter-Tel offers a
variety of fully-featured digital endpoints to suit most organizations' needs.
Our digital phones deliver exceptional voice quality, advanced digital features
and a range of programmable keys for high-speed, high-quality call processing.
The user-friendly, liquid crystal displays (LCDs), with up to 6-by-16
characters, lead users through system features and capabilities--serving as
built-in user guides. Menu-driven, one-touch "soft keys" reduce the time it
takes to initiate and receive calls, retrieve messages, leave messages and
access features.
SPECIFIC CONVERGED APPLICATIONS
VOICE PROCESSING
Integrated with the Axxess and Eclipse Converged Communications Platforms,
our Voice Processing Software provides an automated attendant to guide callers
to the person or information they need. This "electronic employee" answers
incoming calls, transfers calls, records messages, screens calls and returns
calls using caller identification software. The Voice Processing Software
provides Call Routing Announcements, voice mail, the ability to record a call
and various call handling functions. Additionally, voice mail messages can be
retrieved using the Voice Processing Software from any location in the world
using a touchtone phone. Inter-Tel offers Voice Processing in two
varieties--embedded in the PBX and in an external server.
UNIFIED MESSAGING
Designed to run in a Microsoft Windows(R) environment, our Unified
Messaging Software combines e-mail, voice mail and fax into a single, mail
management program. Depending on the level of integration our customers choose,
messages are either converted to standard file formats, or seamlessly integrated
so that users can view, access and process messages through a variety of
devices, including Microsoft's Exchange messaging application, Lotus Notes and
cc:Mail and Novell's GroupWise, as well as other Internet mail APPLICATIONS.
UNIFIED COMMUNICATOR
Inter-Tel's Unified Communicator provides our customers with control of
their endpoints through multiple user interfaces including speech recognition,
touchtone, PC Web browser and WAP devices. Unified Communicator provides users
with a powerful set of tools designed to enhance the control and flexibility of
the desktop environment. Users can control how and where they can be reached by
routing calls to their current location, or by forwarding calls to a specified
number. They can access their Personal Address Book and the System Directory,
control availability and location, check availability of fellow
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associates and initiate calls from a Web browser or WAP-enabled device. Our
mobile customers can manage communications through speech recognition or with a
touchtone phone if a Web browser is unavailable.
APPLICATIONS PLATFORM: IVR
Inter-Tel's Applications Platform is a highly scaleable, flexible platform
that enables the customization of applications according to the specific needs
of an organization. It includes a signaling and services engine, plus a
graphical service creation environment. Inter-Tel's Interactive Voice Response
(IVR) integrates computer, telephony, Automatic Speech Recognition (ASR) and
Text-To-Speech (TTS) capabilities, and allows for customization for almost every
type of environment. Inter-Tel's IVR platform includes a starter pack with two
IVR applications for general business purposes, and can be expanded or
customized. Our customers have the choice of having their custom applications
developed by an authorized Inter-Tel reseller or engaging Inter-Tel's Custom
Solutions group.
Interactive Voice Response can be deployed as a front-end to Automatic Call
Distribution (ACD) systems, which can ask questions that help routing and enable
more intelligent and informed call processing. By using IVRs as front-ends,
recordings can be used for repetitive messages, and transactions can even be
performed without involving customer service personnel.
CALL CENTER SUITE
Call Center Suite is a collection of modular CT software applications that
help businesses optimize call center and workgroup performance. Whether an
organization has a department workgroup environment with extensions or a call
center with agents at a single or multiple locations, Call Center Suite offers a
wide range of solutions. Combined with a flexible infrastructure, the suite of
applications encompass Management Tools for reporting and activity monitoring,
plus Agent and Workgroup Tools to aid in increasing productivity and delivering
consistent customer service.
INFORMATION CONTROL CENTER (FORMERLY ATTENDANT CONSOLE)
Inter-Tel's Information Control Center, formerly Attendant Console,
provides attendants and employees with knowledge of station and hunt group
status, such as Do-Not-Disturb messages, forwarding information and busy or
available status. The unique user-friendly interface allows users to view the
real-time status of associates, enabling them to process calls quickly via touch
screen, mouse or keyboard.
CLEARCONNECT TALK TO AGENT
ClearConnect Talk to Agent is a Voice over IP application that enables
customers to conduct voice conversations with agents or representatives over the
Internet, while connected to an enterprise's Web site. Within seconds, a call is
initiated to the business for immediate sales, service and support. With
ClearConnect Talk to Agent, because the calls are placed over the Internet, an
enterprise can reduce its toll-free telephone expenses. Additionally, employees
also have the ability to "push" Web pages to customers to present products or
services they may have missed on their Web site for enhanced revenue
opportunities.
COMPUTER TELEPHONY (CT) ENABLERS
Inter-Tel's CT Enablers, Open Architecture Interface (OAI), TAPI Service
Provider, Intel/Dialogic CT-Connect interface and Computer Supported Telephony
Application (CSTA) Service Provider, allow for smooth integrations with
"off-the-shelf", shrink-wrapped applications or custom developed software
packages that help organizations increase customer satisfaction and employee
productivity.
Open Architecture Interfaces allow our converged systems to easily
integrate with off-the-shelf or custom software applications. There are two
types of Open Architecture Interfaces: Desktop OAI and System OAI. The
flexibility of our open platform allows for seamless integration of CT
applications, customization and development, which protect our customers'
investments as technology evolves and their needs change.
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Inter-Tel's support for industry standards, such as CSTA, TAPI and
Intel/Dialogic CT-Connect allow our Converged Communications Systems to
integrate with Customer Relationship Management (CRM) database software
applications in order to maximize telephony features such as screen pops,
outbound dialing, etc.
SMALL BUSINESS COMMUNICATIONS SYSTEMS
INTER-TEL ENCORE. Inter-Tel expands its communications systems offerings
with Encore, a business communications system that addresses the small business
and residential market. Encore provides small organizations and residences with
features and benefits associated with more expensive PBX systems. Encore can be
configured from two (2) trunks and six (6) stations up to eight (8) trunks and
eighteen (18) stations, with or without an optional integrated voice mail and
automated attendant. In addition, Encore can be programmed and maintained
remotely, minimizing the costs associated with on-site technician visits.
OTHER SERVICES AND PRODUCTS
Inter-Tel offers a broad range of products and a complete and comprehensive
Managed Services program that incorporates advanced technologies while providing
customers a single source provider to cost-effectively fulfill their business
communications needs. The Inter-Tel Managed Services program offers business
solutions for professional services, provisioning and facilities management, and
custom development services.
We couple this solution-oriented approach with a high level of customer
service and support and a commitment to quality throughout our operations. Our
business communications systems are integrated with our fully-integrated
computer-telephone applications and include voice mail, auto attendant, unified
messaging, call center applications, Interactive Voice Response (IVR), wireless
applications, Automatic Call Distribution (ACD), long distance and networking
services, together with a variety of other communications applications.
Because of the modular design of our systems and the high level of software
content in our products, customers can readily increase the size and
functionality of their systems as their needs change by adding new services,
software and hardware applications, or by upgrading to new systems or advanced
versions of their existing systems.
We believe that our customers prefer to purchase business communications
systems and services from a single-source because of the convenience,
consistency of service, ease of upgrade, availability of financing alternatives
and confidence in the performance of integrated systems and services all
incorporated into a total managed services solution package.
NETWORK, LOCAL AND LONG DISTANCE SERVICES.
Through our subsidiaries, Inter-Tel NetSolutions and Network Services
Agency, we resell a variety of telecommunications services, including domestic
and international calling services, calling card services, 800 calling services,
switched and dedicated services, Internet, frame-relay and voice and video
conferencing, disaster recovery solutions and customized billing. We resell
these services through our agreements with major U.S. long distance carriers or
regional Bell System operating companies (RBOCs).
We support telecommunications applications such as T-1 access for incoming
toll-free traffic at call centers, switched long distance and frame relay
networks linking together multiple offices of an enterprise. Customers who
desire the convenience of acquiring long distance and other related calling
services through the same vendor they use to purchase separate telephony
equipment and services can do so with Inter-Tel.
NETWORKING TECHNOLOGIES INTEGRATION.
Inter-Tel Datanet designs, installs and supports an integrated,
comprehensive solution for our customers' complex data and telecommunications
networks, from local area networks, or LANs, to geographically dispersed wide
area networks, or WANs.
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By forming relationships with major manufacturers of hardware and software
technologies, Inter-Tel provides the routers, ATM, LAN and WAN switches,
wire-less WAN connections, file servers, intelligent hubs and other devices
required for the customer's intranet or for access to the Internet. We offer
pre-sale design support, project coordination for implementation, and
installation support on our full line of server-based telephony products and IP
telephony products and services.
CUSTOM PROFESSIONAL SERVICES AND SOLUTIONS
Inter-Tel Custom Solutions (ICS) is an Inter-Tel professional services
group that delivers to our customers a broad range of turnkey custom IVR and CT
solutions built with our industry-leading software and hardware products. ICS
can also customize CT applications and extend the capabilities of existing
Inter-Tel converged platforms and Call Center Suite installations, as well as
assist in the integration of third-party hardware and software that may be
required to deliver complete call center telephony solutions.
ICS is also a resource for pre-sales help, specifying and selling the
Inter-Tel Applications Platform, or IVR product line, the foundation on which
both ICS and our channel partners can deploy flexible and customized
speech-enabled IVR solutions for all market sectors and business applications.
Additionally, the ICS team provides support and coordination of on-site
installations and/or remote installation support, as well as comprehensive sales
engineering and sales support services for all of the above, including customer
calls, visits and videoconferences, product demonstrations, request for proposal
and requirements analysis, functional specification development, quotations and
full sales cycle support.
NATIONAL, GOVERNMENT AND EDUCATION ACCOUNTS
Inter-Tel's National, Government, and Education Accounts Division (NGEA)
services the nation's largest commercial companies; the Federal Government and
its agencies; state, municipal and local governments; and educational
institutions throughout the United States. NGEA offers the full line of
Inter-Tel converged communications solutions to its customers, as well as
consulting, financial planning and assistance.
NGEA support programs, including the Special Handling (R) Program and
Managed Services Rental Program, are comprehensive and flexible, providing
companies, government agencies, and educational bodies superior technical
solutions, with a level of support and care that allows them to concentrate on
building future infrastructure needs, while supporting previously installed
products.
PERIPHERAL PRODUCTS
Through our CommSource Division, Inter-Tel distributes leading
telecommunications peripheral products, applications and services developed by
third parties to our direct sales offices, dealers and VARs. We offer a
selection of products including the following: analog and cordless telephones;
audio-conferencing, bridges and accessories; call accounting; call
logging/recording; CT Products; data equipment; headsets; installation
equipment; message-on-hold; paging equipment; power protection and backup;
premise wireless and videoconferencing, systems and other accessories. Our
CommSource division sells and distributes products that we have endorsed as
leading communications peripherals widely deployed within organizations
worldwide. Many of these products and services interface with our telephone
systems.
SALES AND DISTRIBUTION
We have developed a distribution network of direct sales offices, dealers
and VARs. As of December 31, 2002, Inter-Tel had fifty-two (52) direct sales
offices in the United States, one (1) in Japan, and a network of hundreds of
dealers that purchase systems directly from us. We maintain a wholesale
distribution office in the UK that supplies and supports Inter-Tel's dealers and
distributors throughout the UK and other parts of Europe, and we have dealers in
Japan and Mexico.
DISTRIBUTION CHANNELS
Our success depends in part upon the strength of our distribution channels
and our ability to maintain close access to our end user customers through our
distribution channels. In recent periods, we have sought to improve our access
to end users through strategic acquisitions of resellers of telephony products
and services, some of which are located in markets in which we have existing
direct sales offices. As of
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December 31, 2002, Inter-Tel's direct sales office personnel and national and
government accounts personnel consisted of 1,052 and forty-nine (49) persons,
respectively. Sales through our direct sales offices and government and national
accounts group, as a percentage of total sales, decreased from 58.2% of net
sales in 2001 to 56.8% of net sales in 2002, excluding sales from our DataNet
division purchased in our McLeod acquisition in 2002, which generated 3.5% of
consolidated sales in 2002. Sales to distributors, dealers, and VARs have
decreased from 22.8% of net sales in 2001 to 22.1% of net sales in 2002. Sales
through our long distance and network services operations have increased from
7.7% of net sales in 2001 to 9.6% of net sales in 2002.
Direct dealers and VARs enter into reseller agreements with us for a term
of one or more years. These agreements often include requirements that the
reseller meet, or use their best efforts to meet, minimum annual purchase
quotas. We generally provide support and other services to our resellers under
the terms of the agreements. We face intense competition from other telephone
system and voice processing system manufacturers for our dealers' attention, as
many of our dealers carry other products that compete with our products.
We offer additional incentives, programs and support resources to dealers
that agree to sell Inter-Tel systems and solutions on an exclusive basis. We
launched an exclusive business partner program during 2001. This program was
designed to reward dealers who sell only Inter-Tel products to all new prospects
and aggressively seek to upgrade their non-Inter-Tel customer base. For this
commitment from the dealers, we have offered our expertise to help them manage
their business. This includes operational business reviews, shared human
resource forms and policies, additional sales, marketing and training support,
enhanced co-op benefits as well as special sales promotions and awards. In
addition, we allow exclusive dealers to use our branch sales offices and
demonstration rooms to help them close business. We believe that this program
offers us an opportunity to expand our wholesale channel of distribution.
LEASING SERVICES
Inter-Tel offers its Total Solutions (formerly TotaLease) program through
our subsidiary, Inter-Tel Leasing, Inc. The Total Solutions program enables end
users to acquire a full range of telephony systems and applications designed and
manufactured by Inter-Tel, as well as maintenance and support services. This
program provides a total system financing package to the customer at a set
monthly cost, with system expansion available for an additional fee. The typical
Total Solutions contract has a term of sixty (60) months, and allows the
customer to renew the contract at a specified price for up to an additional
thirty-six (36) months.
Inter-Tel also offers a line of low-cost lease purchase financing. Lease
terms range from twenty-four (24) to eighty-four (84) months with $1.00, fixed
and fair market value purchase options. Inter-Tel can also customize financing
packages to suit customers with special financial needs. By offering this type
of financing to acquire our products and services, our customers are able to
lease directly from Inter-Tel or an authorized third-party leasing company
supporting an Inter-Tel dealer, thereby allowing us, or one of our dealers to
maintain a direct relationship with our customers. This direct relationship
allows Inter-Tel to provide maintenance and support services and information
regarding other Inter-Tel products and services.
INTERNATIONAL SALES
We currently have dealers in the UK, parts of Europe, Japan and Latin
America, and we are currently working to expand our international dealer
network. International sales, which include business communications systems and
IP telephony and peripheral products, accounted for approximately 2.7% and 2.6%
of our net sales in 2002 and 2001, respectively. In order to sell our products
to customers in other countries, Inter-Tel must comply with local
telecommunications standards. Our AXXESS and ECLIPSE2 systems and IP telephony
products can be modified using our software to facilitate compliance with these
local regulations. In addition, the AXXESS and ECLIPSE2 systems have been
designed to support multi-lingual functionality, and both currently support
American English, British English, Japanese and Spanish languages.
CUSTOMER SERVICE AND SUPPORT
Customer service and support are critical components of customer
satisfaction and the success of our business. We operate a technical support
group that provides a range of support services to our distributors, dealers and
end user customers through the Internet and through a toll-free telephone
number. Inter-Tel provides on-site customer support and, using remote diagnostic
procedures, we have the ability to
10
detect and correct system problems from our technical support facilities. In
2000, Inter-Tel began an initiative to greatly enhance our Internet, intranet
and extranet capabilities. Through this initiative, we re-designed our Web site
to offer to our direct sales offices and dealer channel state-of-the-art support
for sales and technical support activities. Our Web site also offers a wide
array of sales and technical information, including an on-line product and
service catalog, efficient order processing, portable-document-format sales
brochures, competitive information, on-line technical manuals,
frequently-asked-questions on important topics and convenient "touch-to-talk"
live operator help employing our own ClearConnect two-way voice-over-IP
technology. In 2001, Inter-Tel began an initiative to enhance the technical
knowledge database, the automated order system and the browser-based sales
proposal platform on our intranet and extranet, and we have continued this
development through 2002. We intend to further develop our Web site to add
additional information and services.
We analyze feedback from our customer service call records to provide
direction for product and service enhancements. Our direct sales offices and
resellers can receive service activity reports summarizing the reasons that
technicians are asking for assistance and common issues that give rise to
technical inquiries. This allows our direct sales offices and resellers to track
trends in their service operations and to thereby provide better customer
service.
We believe that we can best serve our customers by continually improving
the quality of our systems, customer service and support, and other aspects of
our organization. Through our continuous improvement process initiated in 1991,
Inter-Tel implements quality processes throughout its business operations. We
have established formal procedures to ensure responsiveness to customer
requests, monitor response times and measure customer satisfaction. We have also
established means by which all end users, including customers of our resellers,
can request product enhancements directly from us. Inter-Tel supports its
dealers and VARs through an extensive training program offered at Inter-Tel's
facilities, at dealer and third-party sites, a toll-free telephone number for
sales and technical support, an extranet site offering up-to-date sales and
support information, and end-user marketing materials. We typically provide a
one-year warranty on our systems to end users. We offer eighteen-month
warranties on our systems to the dealer channel, which in turn are responsible
for providing a warranty to their end users.
RESEARCH AND DEVELOPMENT
We believe that our ability to enhance our current products, develop and
introduce new products on a timely basis, maintain technological competitiveness
and meet customer requirements are essential to our success. Inter-Tel's
research and development efforts over the last several years have been focused
primarily on the development of, and enhancements to, our AXXESS and ECLIPSE2
systems, including adding new applications, incorporating IP convergence
applications and IP telephones, developing Unified Messaging Software
applications, and expanding the telecommunications networking package to include
networking over IP and frame relay networks. Over the last several years, our
research and development efforts have also focused on developing and enhancing
convergence applications for our AXXESS and ECLIPSE2 systems, increasing
single-site node capacity using an ATM backbone, enhancing our UnifieD Messaging
Software, developing a speech-recognition and text-to-speech enabled unified
communications product, developing an advanced IVR and CT application
development tool, enhancing our IP digital telephones, and enhancing Inter-Tel's
server-based PBX offerings. More recently, Inter-Tel's research and development
efforts have been focused on support of industry standard MGCP and SIP
functionality on our AXXESS and ECLIPSE2 systems.
Our SIP Server product, planned for commercial release in the first quarter
of 2003, provides a foundation for standards-based communications within a
converged environment. Session Initiation Protocol (SIP) allows Call Processing
to communicate with third-party SIP phones and voice-enabled routers, Microsoft
Windows(R) XP and Microsoft Passport(R) network.
As of December 31, 2002, we had a total of 217 personnel engaged in
research and development and related technical service and support functions.
Research and development expenses were $19,340,000, $17,556,000, and
$19,489,000, for 2002, 2001, and 2000, respectively.
11
MANUFACTURING
Inter-Tel manufactures substantially all of its systems through third party
subcontractors located in the United States, the People's Republic of China,
United Kingdom and Mexico. These subcontractors use both standard and
proprietary integrated circuits and other electronic devices and components to
produce our communications systems, physical endpoints and printed circuit
boards to our engineering specifications and designs. Our suppliers inspect and
test the equipment before delivery, and in some cases our suppliers also perform
systems integration, software loading, final testing and shipment. Varian, Inc.
a multinational electronics company, currently manufacturers a significant
portion of our products, including substantially all of the printed circuit
boards used in the AXXESS and ECLIPSE2 systems, at Varian's Tempe, Arizona
facility. We provide our manufacturing contractors with forecasted scheduleS of
our manufacturing needs and revise the forecasts on a periodic basis. We
continuously monitor the quality of the products produced on our behalf by our
manufacturing subcontractors.
COMPETITION
The market for our products is highly competitive and has in recent periods
been characterized by rapid technological change, business consolidations and
decreasing prices. Competitors for our converged communication products geared
toward the enterprise market include Avaya, Nortel Networks, 3Com, Cisco
Systems, Comdial, Iwatsu America, Inc., Mitel Networks, NEC Corporation,
NextiraOne, Panasonic, Siemens, Toshiba and Vodavi. Several of these competitors
have been active in developing and marketing IP networking products and have
established relationships with customers within their markets. If the market for
IP telephony products becomes fully developed or develops at a rapid rate, large
computer companies such as IBM and Microsoft, or large telephone companies such
as AT&T or Sprint, could choose to develop proprietary software designed to
facilitate voice communication services over an IP network.
We also compete against the RBOCs, which typically offer systems produced
by one or more of our competitors listed above and also typically offer Centrex
systems in which automatic calling facilities are provided through equipment
located in the telephone company's central office. We also compete with
next-generation service providers, such as DSL providers and cable companies
that offer bundled telephony and data services in an application service
provider telephony model.
In the market for voice processing applications, including voice mail, we
compete against Captaris, Active Voice (subsidiary of NEC America),
InterVoice-Brite, Avaya, Nortel Networks, Comdial and other competitors. In the
market for long distance services, we compete against AT&T, Sprint, Qwest and
others. We also expect to compete with RBOCs, cable television companies,
satellite and other wireless broadband service providers for long distance
business. Key competitive factors in the sale of converged communications
systems and related applications include price, performance, features,
reliability, service and support, brand recognition and distribution capability.
We believe that we compete favorably in our markets with respect to the price,
performance and features of our systems, as well as the level of service and
support that we provide to our customers. However, certain of our competitors
have significantly greater resources, brand recognition and distribution
capabilities than we do.
As we compete for local telephone service, long distance service and IP
network access, we face additional competition from established foreign and
domestic long distance carriers, RBOCs and other providers. Many of these
competitors have larger marketing and sales organizations, significantly greater
financial and technical resources and a larger and more established customer
base than we do. In addition, RBOCs and other providers have greater name
recognition, more established positions in the market and long standing
relationships with customers.
INTELLECTUAL PROPERTY RIGHTS
We currently hold patents for nineteen (19) telecommunications and unified
messaging products. The remaining life of these patents ranges from eight (8)
months to fifteen (15) years in duration. We have also applied to the U.S.
Patent and Trademark Office for eleven (11) additional patents. We also rely on
copyright, trademark, trade secret law and contractual provisions to protect our
intellectual property.
12
EMPLOYEES
As of December 31, 2002, we had a total of 1,773 employees, of whom 633
were engaged in sales, marketing, e-business and customer support; 229 in direct
sales office and wholesale administrative and other management personnel; 579 in
manufacturing, quality and related operations, including direct sales office
operations personnel; 217 in research and development and related technical
service and support functions; and 115 in finance, information systems,
administration and executive management. We believe that our relations with our
employees are good.
ACCESS TO INFORMATION
Our Internet address is www.Inter-Tel.com. We make available at this
address, free of charge, our annual report on Form 10-K, quarterly reports on
Form 10-Q, current reports on Form 8-K and amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as
reasonably practicable after we electronically file such material with, or
furnish it to, the SEC.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
RISKS RELATED TO OUR BUSINESS
OUR OPERATING RESULTS HAVE HISTORICALLY DEPENDED ON A NUMBER OF FACTORS, AND
THESE FACTORS MAY CAUSE OUR OPERATING RESULTS TO FLUCTUATE IN THE FUTURE.
Our quarterly operating results have historically depended on, and may
fluctuate in the future as a result of, many factors including:
* volume and timing of orders received during the quarter;
* gross margin fluctuations associated with the mix of products sold;
* the mix of distribution channels;
* general economic conditions;
* patterns of capital spending by customers;
* the timing of new product announcements and releases by us and our
competitors;
* pricing pressures, the cost and effect of acquisitions;
* the availability and cost of products and components from our
suppliers; and
* national and regional weather patterns.
In addition, we have historically operated with a relatively small backlog,
with sales and operating results in any quarter depending principally on orders
booked and shipped in that quarter. In the past, we have recorded a substantial
portion of our net sales for a given quarter in the third month of that quarter,
with a concentration of such net sales in the last two weeks of the quarter.
Market demand for investment in capital equipment such as business
communications systems and associated call processing and voice processing
software applications depends largely on general economic conditions, and can
vary significantly as a result of changing conditions in the economy as a whole.
We cannot assure you that we can continue to be successful operating with a
small backlog or whether historical backlog trends will continue in the future.
Our expense levels are based in part on expectations of future sales and,
if sales levels do not meet expectations, our operating results could be harmed.
In addition, because sales of business communications systems through our
dealers typically produce lower gross margins than sales through our direct
sales organization, operating results have varied, and will continue to vary
based upon the mix of sales through direct and indirect channels. Also, the
timing and profitability of lease resales from quarter to quarter could impact
operating results, particularly in an environment of fluctuating interest rates.
Long distance sales, which typically have lower gross margins than our core
business, have grown in recent periods at a faster rate than our overall net
sales. As a result, gross margins could be harmed if long distance calling
services continue to increase as a percentage of net sales. In addition, we
experience seasonal fluctuations in our operating results, as net sales for the
first quarter is frequently less than the fourth quarter and the third quarter
is frequently less than the second quarter. As a result of these and other
factors, we have historically experienced, and could continue to experience in
the future, fluctuations in sales and operating results on a quarterly basis.
13
OUR MARKET IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND TO COMPETE SUCCESSFULLY,
WE MUST CONTINUALLY INTRODUCE NEW AND ENHANCED PRODUCTS AND SERVICES THAT
ACHIEVE BROAD MARKET ACCEPTANCE.
The market for our products and services is characterized by rapid
technological change, evolving industry standards and vigorous customer demand
for new products, applications and services. To compete successfully, we must
continually enhance our existing telecommunications products, related software
and customer services, and develop new technologies and applications in a timely
and cost-effective manner. If we fail to introduce new products and services
that achieve broad market acceptance, or if we do not adapt our existing
products and services to customer demands or evolving industry standards, our
business could be significantly harmed. In addition, current competitors or new
market entrants may offer products, applications or services that are better
adapted to changing technology or customer demands and that could render our
products and services unmarketable or obsolete.
In addition, if the markets for computer-telephony (CT) applications,
Internet Protocol (IP) network products, or related products fail to develop or
continue to develop more slowly than we anticipate, or if we are unable for any
reason to capitalize on any of these emerging market opportunities, our
business, financial condition and operating results could be significantly
harmed.
OUR FUTURE SUCCESS LARGELY DEPENDS ON INCREASED COMMERCIAL ACCEPTANCE OF OUR
AXXESS AND ECLIPSE2 SYSTEMS, ENCORE PRODUCT, NEW SPEECH RECOGNITION AND
INTERACTIVE VOICE RESPONSE PRODUCTS, AND RELATED COMPUTER-TELEPHONY PRODUCTS.
During the past few years, we have introduced transparent networking and
unified messaging capabilities on our AXXESS and ECLIPSE2 systems and introduced
our Encore product and InterPrise family of voice and data convergence products.
In 2000, we introduced Unified Communicator, a web-based, speech-recognition and
WAP software application for controlling and managing your calls and contacts;
Inter-Tel Application Platform, a highly flexible speech-recognition,
text-to-speech and CTI application generation platform; enhanced convergence
features on the AXXESS and ECLIPSE2 systems; and several other telephony-related
products. During the past 12 months, sales of our AXXESS business communications
systems and related software have comprised a substantial portion of our net
sales. Our future success depends, in large part, upon increased commercial
acceptance and adoption of the Application Platform, the Unified Communicator
and related computer-telephony products, the AXXESS and ECLIPSE2 systems, Encore
products, MGCP and SIP standards-based functionality, new speech recognition and
Interactive Voice Response products, as well as future upgrades and enhancements
to these products and networking platforms. We cannot assure you that these
products or platforms will achieve commercial acceptance in the future.
OUR PRODUCTS ARE COMPLEX AND MAY CONTAIN ERRORS OR DEFECTS THAT ARE DETECTED
ONLY AFTER THEIR RELEASE, WHICH MAY CAUSE US TO INCUR SIGNIFICANT UNEXPECTED
EXPENSES AND LOST SALES.
Our telecommunications products and software are highly complex. Although
our new products and upgrades are examined and tested prior to release, they can
only be fully tested when used by a large customer base. Consequently, our
customers may discover program errors, or "bugs," or other defects after new
products and upgrades have been released. Some of these bugs may result from
defects contained in component parts or software from our suppliers or other
third parties that are intended to be compatible with our products and over
which we have little or no control. Although we have test procedures and quality
control standards in place designed to minimize the number of errors and defects
in our products, we cannot assure you that our new products and upgrades will be
free of bugs when released. If we are unable to quickly or successfully correct
bugs identified after release, we could experience the following, any of which
would harm our business:
* costs associated with the remediation of any problems;
* costs associated with design modifications;
* loss of or delay in revenues;
* loss of customers;
* failure to achieve market acceptance or loss of market share;
* increased service and warranty costs;
* liabilities to our customers; and
* increased insurance costs.
14
THE COMPLEXITY OF OUR PRODUCTS COULD CAUSE DELAYS IN THE DEVELOPMENT AND RELEASE
OF NEW PRODUCTS AND SERVICES. AS A RESULT, CUSTOMER DEMAND FOR OUR PRODUCTS
COULD DECLINE, WHICH COULD HARM OUR BUSINESS.
Due to the complexity of our products and software, we have in the past
experienced and expect in the future to experience delays in the development and
release of new products or product enhancements. If we fail to introduce new
software, products or services in a timely manner, or fail to release upgrades
to our existing systems or products and software on a regular and timely basis,
customer demand for our products and software could decline, which would harm
our business.
BUSINESS ACQUISITIONS, DISPOSITIONS OR JOINT VENTURES ENTAIL NUMEROUS RISKS AND
MAY DISRUPT OUR BUSINESS, DILUTE SHAREHOLDER VALUE OR DISTRACT MANAGEMENT
ATTENTION.
As part of our business strategy, we consider acquisitions of, or
significant investments in, businesses that offer products, services and
technologies complementary to ours. Such acquisitions could materially adversely
affect our operating results and/or the price of our common stock. Acquisitions
also entail numerous risks, some of which we have experienced and may continue
to experience, including:
* unanticipated costs and liabilities;
* difficulty of assimilating the operations, products and personnel of
the acquired business;
* difficulties in managing the financial and strategic position of
acquired or developed products, services and technologies;
* difficulties in maintaining customer relationships, in particular
where a substantial portion of the target's sales were derived from
our competitor's products and services, and these competitors have
made it difficult and expensive for us to service and maintain these
products;
* difficulty of assimilating the vendors and independent contractors of
the acquired business;
* the diversion of management's attention from the core business;
* inability to maintain uniform standards, controls, policies and
procedures; and
* impairment of relationships with acquired employees and customers
occurring as a result of integration of the acquired business.
In particular, in recent years our operating results were adversely
affected by several of the factors described above, in the form of substantial
acquisition-related charges, operating losses or impairment losses from the
Executone acquisition, Cirilium Corporation joint venture and Inter-Tel.NET
operations. Refer to Management's Discussion and Analysis and notes to the
consolidated financial statements for additional information regarding these
transactions.
We completed four acquisitions during 2001 and 2002. During 2001, we
acquired certain assets and assumed certain liabilities of Convergent
Communication Services, Inc. (Convergent) and Mastermind Technologies, Inc.
(Mastermind). During 2002, we acquired certain assets and assumed certain
liabilities of McLeodUSA Integrated Business Systems, Inc. (McLeod) and we
acquired 100% of the stock of Swan Solutions Limited (Swan) in the United
Kingdom. These acquisitions are subject to similar risks and uncertainties as
indicated above.
Finally, to the extent that shares of our stock or the rights to purchase
stock are issued in connection with any future acquisitions, dilution to our
existing shareholders will result and our earnings per share may suffer. Any
future acquisitions may not generate additional revenue or provide any benefit
to our business, and we may not achieve a satisfactory return on our investment
in any acquired businesses.
WE MAY NOT BE ABLE TO ADEQUATELY PROTECT OUR PROPRIETARY TECHNOLOGY AND MAY BE
INFRINGING UPON THIRD-PARTY INTELLECTUAL PROPERTY RIGHTS.
Our success depends upon our proprietary technology. We currently hold
patents for nineteen (19) telecommunication and unified messaging products and
have also applied to the U.S. Patent and Trademark Office for eleven (11)
additional patents. We also rely on copyright and trade secret law and
contractual provisions to protect our intellectual property. Despite these
precautions, third parties could copy or otherwise obtain and use our technology
without authorization, or develop similar technology independently.
We cannot assure you that any patent, trademark or copyright that we own or
have applied to own, will not be invalidated, circumvented or challenged by a
third party. Effective protection of intellectual property rights may be
unavailable or limited in foreign countries. We cannot assure that the
protection of our proprietary rights will be adequate or that competitors will
not independently develop similar technology, duplicate our services or design
around any patents or other intellectual property rights we hold. Litigation
15
may be necessary in the future to enforce our intellectual property rights, to
protect our trade secrets, to determine the validity and scope of the
proprietary rights of others, or to defend against claims of infringement or
invalidity. Litigation could be costly, absorb significant management time and
harm our business.
We are also subject to third party claims that our current or future
products or services infringe upon the rights of others. For example, we are
subject to proceedings alleging that certain of our key products infringe upon
third party intellectual property rights, including patents, trademarks,
copyrights or other intellectual property rights. We have viewed presentations
from Avaya, one of our primary competitors, alleging that our AXXESS business
communications system utilizes inventions covered by certain of their patents.
We are continuing the process of investigating this matter and we have made
claims against Avaya and Lucent for infringement of our patents. While we do not
believe these matters, collectively, would have a material adverse impact on our
financial position and future results of operations, the ultimate outcomes by
their nature are uncertain.
When any such claims are asserted against us, among other means to resolve
the dispute, we may seek to license the third party's intellectual property
rights. Purchasing such licenses can be expensive, and we cannot assure you that
a license will be available on prices or other terms acceptable to us, if at
all. Alternatively, we could resort to litigation to challenge such a claim.
Litigation could require us to expend significant sums of cash and divert our
management's attention. In the event that a court renders an enforceable
decision with respect to our intellectual property, we may be required to pay
significant damages, develop non-infringing technology or acquire licenses to
the technology subject to the alleged infringement. Any of these actions or
outcomes could harm our business. If we are unable or choose not to license
technology, or decide not to challenge a third party's rights, we could
encounter substantial and costly delays in product introductions. These delays
could result from efforts to design around asserted third party rights or our
discovery that the development, manufacture or sale of products requiring these
licenses could be foreclosed.
OUR IP NETWORK PRODUCTS MAY BE VULNERABLE TO VIRUSES, OTHER SYSTEM FAILURE RISKS
AND SECURITY CONCERNS, WHICH MAY RESULT IN LOST CUSTOMERS OR SLOW COMMERCIAL
ACCEPTANCE OF OUR IP NETWORK PRODUCTS.
Inter-Tel's IP telephony and network products may be vulnerable to computer
viruses or similar disruptive problems. Computer viruses or problems caused by
third parties could lead to interruptions, delays or cessation of service that
could harm our operations and revenues. In addition, we may lose customers if
inappropriate use of the Internet or other IP networks by third parties
jeopardize the security of confidential information, such as credit card or bank
account information or the content of conversations over the IP network. In
addition, user concerns about privacy and security may cause IP networks in
general to grow more slowly, and impair market acceptance of our IP network
products in particular, until more comprehensive security technologies are
developed.
WE HAVE MANY COMPETITORS AND EXPECT NEW COMPETITORS TO ENTER OUR MARKET, WHICH
COULD INCREASE PRICE COMPETITION AND SPENDING ON RESEARCH AND DEVELOPMENT AND
WHICH MAY IMPAIR OUR ABILITY TO COMPETE SUCCESSFULLY.
The markets for our products and services are extremely competitive and we
expect competition to increase in the future. Our current and potential
competitors in our primary business segments include:
* PABX and converged systems providers such as Avaya, Cisco Systems,
Comdial, 3Com, Iwatsu, Mitel, NEC, NextiraONe, Nortel, Panasonic,
Siemens, Toshiba and Vodavi;
* large data routing and convergence companies such as 3Com and Cisco
Systems;
* voice processing applications providers such as ADC, InterVoice-Brite,
Active Voice (a subsidiary of NEC America), Avaya, and Captaris
(formerly AVT);
* long distance services providers such as AT&T, MCI WorldCom, Qwest and
Sprint;
* large computer and software corporations such as IBM, Intel and
Microsoft; and
* regional Bell operating companies, or RBOCs, cable television
companies and satellite and other wireless broadband service
providers.
These and other companies may form strategic relationships with each other
to compete with us. These relationships may take the form of strategic
investments, joint-marketing agreements, licenses or other contractual
arrangements, which could increase our competitors' ability to address customer
needs with their product and service offerings.
16
Many of our competitors and potential competitors have substantially
greater financial, customer support, technical and marketing resources, larger
customer bases, longer operating histories, greater name recognition and more
established relationships in the industry than we do. We cannot be sure that we
will have the resources or expertise to compete successfully. Compared to us,
our competitors may be able to:
* develop and expand their product and service offerings more quickly;
* adapt to new or emerging technologies and changing customer needs
faster;
* take advantage of acquisitions and other opportunities more readily;
* negotiate more favorable licensing agreements with vendors;
* devote greater resources to the marketing and sale of their products;
and
* address customers' service-related issues more adequately.
Some of our competitors may also be able to provide customers with
additional benefits at lower overall costs or to reduce their gross margins
aggressively in an effort to increase market share. We cannot be sure that we
will be able to match cost reductions by our competitors. In addition, we
believe that there is likely to be consolidation in our markets, which could
lead to having even larger and more formidable competition and other forms of
competition that could cause our business to suffer.
OUR RELIANCE ON A LIMITED NUMBER OF SUPPLIERS FOR KEY COMPONENTS AND OUR
INCREASING DEPENDENCE ON CONTRACT MANUFACTURERS COULD IMPAIR OUR ABILITY TO
MANUFACTURE AND DELIVER OUR PRODUCTS AND SERVICES IN A TIMELY AND COST-EFFECTIVE
MANNER.
We currently obtain certain key components for our digital communication
platforms, including certain microprocessors, integrated circuits, power
supplies, voice processing interface cards and IP telephony cards, from a
limited number of suppliers and manufacturers. Our reliance on these limited
suppliers and contract manufacturers involves risks and uncertainties, including
the possibility of a shortage or delivery delay for some key components. We
currently manufacture our products through third-party subcontractors located in
the United States, the People's Republic of China, the United Kingdom and
Mexico. Foreign manufacturing facilities are subject to changes in governmental
policies, imposition of tariffs and import restrictions and other factors beyond
our control. Varian, Inc. currently manufactures a significant portion of our
products at Varian's Tempe, Arizona facility, including substantially all of the
printed circuit boards used in the AXXESS and ECLIPSE2 systems,. We have
experienced occasional delays in the supply of components and finished goods
that have harmed our business. If inventory levels are not adequately maintained
and managed we are at risk of not having the appropriate inventory quantities on
hand to meet sales demand. We cannot assure that we will not experience similar
delays in the future.
Our reliance on third party manufacturers and OEM partners involves a
number of additional risks, including reduced control over delivery schedules,
quality assurance and costs. Our business may be harmed by any delay in delivery
or any shortage of supply of components or finished goods from a supplier. Our
business may also be harmed if we are unable to develop alternative or
additional supply sources as necessary. To date, we have been able to obtain
supplies of components and products in a timely manner even though we do not
have long-term supply contracts with any of our contract manufacturers. However,
we cannot assure you that we will be able to continue to obtain components or
finished goods in sufficient quantities or quality or on favorable pricing or
delivery terms in the future.
WE DERIVE A SUBSTANTIAL PORTION OF OUR NET SALES FROM OUR DEALER NETWORK AND IF
THESE DEALERS DO NOT EFFECTIVELY PROMOTE AND SELL OUR PRODUCTS, OUR BUSINESS AND
OPERATING RESULTS COULD BE HARMED.
We derive a substantial portion of our net sales through our network of
independent dealers. We face intense competition from other telephone, voice
processing, and voice and data router system manufacturers for these dealers'
business, as most of our dealers carry other products that compete with our
products. Our dealers may choose to promote the products of our competitors to
our detriment. We have developed programs and expended capital to incentivize
our dealers to promote our products, and we cannot assure you that these
techniques will be successful. The loss of any significant dealer or group of
dealers, or any event or condition harming our dealer network, could harm our
business, financial condition and operating results.
17
EXPANDING OUR INTERNATIONAL SALES EFFORTS MAY EXPOSE US TO ADDITIONAL BUSINESS
RISKS, WHICH MAY RESULT IN REDUCED SALES OR PROFITABILITY IN OUR INTERNATIONAL
MARKETS.
We are in the process of attempting to expand our international dealer
network both in the countries in which we already have a presence and in new
countries and regions. International sales are subject to a number of risks,
including changes in foreign government regulations and telecommunication
standards, export license requirements, tariffs and taxes, other trade barriers,
difficulties in protecting our intellectual property, fluctuations in currency
exchange rates, difficulty in collecting receivables, difficulty in staffing and
managing foreign operations, and political and economic instability. In
particular, the terrorist acts of September 11, 2001, and continued turmoil in
the Middle East and North Korea, have created an uncertain international
economic environment and we cannot predict the impact of these acts, any future
terrorist acts or any related military action on our efforts to expand our
international sales. Fluctuations in currency exchange rates could cause our
products to become relatively more expensive to customers in a particular
country, leading to a reduction in sales or profitability in that country. In
addition, the costs associated with developing international sales may not be
offset by increased sales in the short term, or at all. Any of these risks could
cause our products to become relatively more expensive to customers in a
particular country, leading to reduced sales or profitability in that country.
In addition, the costs associated with developing an international dealer
network may not be offset by increased sales in the short term, if at all.
IF WE LOSE KEY PERSONNEL OR ARE UNABLE TO HIRE ADDITIONAL QUALIFIED PERSONNEL AS
NECESSARY, WE MAY NOT BE ABLE TO ACHIEVE OUR OBJECTIVES.
We depend on the continued service of, and our ability to attract and
retain, qualified technical, marketing, sales and managerial personnel, many of
whom would be difficult to replace. Competition for qualified personnel is
intense, and we have historically had difficulty hiring employees in the
timeframe that we desire, particularly skilled engineers. The loss of any of our
key personnel or our failure to effectively recruit additional key personnel
could make it difficult for us to manage our business, complete timely product
introductions or meet other critical business objectives. For example, our
inability to retain key executives of Executone following our Executone
acquisition impaired our ability to benefit from the Executone business and to
grow revenues from the Executone assets. Moreover, our operating results will be
impaired if we lose a substantial number of key employees from recent
acquisitions, including personnel from McLeod, Swan, Mastermind and Convergent.
We cannot assure you that we will be able to continue to attract and retain the
qualified personnel necessary for the development of our business.
WE MAY BE UNABLE TO ACHIEVE OR MANAGE OUR GROWTH EFFECTIVELY, WHICH MAY HARM OUR
BUSINESS.
The ability to operate our business in a rapidly evolving market requires
an effective planning and management process. Our efforts to achieve growth in
our business has placed, and is expected to continue to place, a significant
strain on our personnel, management systems, infrastructure and other resources.
In addition, our ability to manage any potential future growth effectively will
require us to successfully attract, train, motivate and manage new employees, to
integrate new employees into our overall operations and to continue to improve
our operational, financial and management controls and procedures. Furthermore,
we expect that we will be required to manage an increasing number of
relationships with suppliers, manufacturers, customers and other third parties.
If we are unable to implement adequate controls or integrate new employees into
our business in an efficient and timely manner, our operations could be
adversely affected and our growth could be impaired which could harm our
business.
THE INTRODUCTION OF NEW PRODUCTS AND SERVICES HAS LENGTHENED OUR SALES CYCLES,
WHICH MAY RESULT IN SIGNIFICANT SALES AND MARKETING EXPENSES.
In the past few years, we introduced the AXXESS and ECLIPSE2 ATM business
communications system and networking software, which are typically sold to
larger customers at a higher average selling price and often represent a
significant communications infrastructure capital expenditure by the prospective
enterprise customer. Accordingly, the purchase of our products typically
involves numerous internal approvals relating to the evaluation, testing,
implementation and acceptance of new technologies. This evaluation process
frequently results in a lengthy sales process, which can range from a few months
to more than 12 months, thereby subjecting our sales cycle to a number of
significant uncertainties concerning budgetary constraints and internal
acceptance reviews. The length of our sales cycle also may vary substantially
from customer to customer. While our customers are evaluating our products and
before placing an order with us, we may incur substantial sales and marketing
expenses and expend significant management effort. Consequently, if sales
forecasted from a specific customer for a particular quarter are not realized in
that quarter, our operating results could be materially adversely affected.
18
WE RELY HEAVILY UPON THIRD-PARTY PACKAGED SOFTWARE SYSTEMS TO MANAGE AND RUN OUR
BUSINESS PROCESSES AND TO PRODUCE OUR FINANCIAL STATEMENTS. FROM TIME TO TIME WE
UPGRADE THESE SYSTEMS TO ENSURE CONTINUATION OF SUPPORT AND TO EXPAND THE
FUNCTIONALITY OF THE SYSTEMS TO MEET OUR BUSINESS NEEDS. THE RISKS ASSOCIATED
WITH THE UPGRADE PROCESS INCLUDE DISRUPTION OF OUR BUSINESS PROCESSES, WHICH
COULD HARM OUR BUSINESS.
We currently run third-party applications for data processing in our
distribution center operations, shipping, materials movement, customer service,
invoicing, financial record keeping and reporting, and other operations and
administration. The nature of the software industry is to upgrade software
systems to make architectural changes, increase functionality and address
software bugs. Over time, older versions of the software become less supported
by our vendors for financial and other reasons and eventually become obsolete.
Oracle provides notice of the dates that Oracle will de-support the software and
companies are expected to either make plans to upgrade to newer versions or
operate without Oracle support. While these third-party vendors provide advanced
notice of product upgrade schedules and take other steps to make the upgrade
process as straight-forward as possible, we are subject to risks associated with
the process. Our software systems could become unstable following an upgrade
process and impact our ability to process data properly in these systems,
including timely and accurate shipment of products, invoicing our customers
properly and the production of accurate and timely financial statements. We also
cannot assure you that these software upgrades or enhancements will operate as
intended or be free from bugs. We upgraded our Oracle applications during the
fourth quarter of 2002 and expect to affect similar software upgrades in the
future. If we are unable to successfully integrate the new software into our
information systems, our operations, customer service and financial reporting
could be adversely affected and could harm our business.
OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE, IMPAIRING YOUR ABILITY
TO SELL YOUR SHARES AT OR ABOVE PURCHASE PRICE.
The market price for our common stock has been highly volatile. The
volatility of our stock could be subject to continued wide fluctuations in
response to many risk factors listed in this section, and others beyond our
control, including:
* announcements of developments relating to our business;
* fluctuations in our operating results;
* shortfalls in revenue or earnings relative to securities analysts'
expectations;
* announcements of technological innovations or new products or
enhancements by us or our competitors;
* announcements of acquisitions or planned acquisitions of other
companies or businesses;
* investors' reactions to acquisition announcements or our forecasts of
future results;
* general conditions in the telecommunications industry;
* the market for Internet-related products and services;
* changes in the national or worldwide economy;
* changes in legislation or regulation affecting the telecommunications
industry;
* threats of or outbreaks of war, hostilities or terrorist acts;
* developments relating to our intellectual property rights and the
intellectual property rights or third parties;
* changes in our relationships with our customers and suppliers; and
* national and regional weather patterns.
In addition, stock prices of technology companies in general, and for voice
and data communications companies in particular, have experienced extreme price
fluctuations in recent years which have often been unrelated to the operating
performance of affected companies. We cannot assure you that the market price of
our common stock will not experience significant fluctuations in the future,
including fluctuations that are unrelated to our performance.
19
WE ARE CURRENTLY SUBJECT TO GOVERNMENT INVESTIGATIONS AND IN THE FUTURE WE MAY
BE SUBJECT TO LITIGATION, WHICH IF THEY RESULT IN ANY CONVICTIONS, SANCTIONS OR
PENALTIES AGAINST US, COULD HARM OUR BUSINESS.
Divisions of the United States Department of Justice are investigating
other companies' and Inter-Tel's participation in a federally-funded "E-Rate
program" to connect schools and libraries to the Internet. The Justice
Department has not provided Inter-Tel with a description of the evidence on
which the investigations are based.
Inter-Tel is presently unable to predict or determine the final outcome of,
or to estimate the potential range of loss (if any) with respect to, the
investigations. If Inter-Tel is convicted of any crime or subjected to
sanctions, or if penalties, damages or other monetary remedies are assessed
against Inter-Tel in connection with any investigations, our business and
operating results could be materially and adversely affected.
Inter-Tel is also subject to litigation in the ordinary course of business.
We cannot assure you that any adverse outcome in connection with such litigation
would not impair our business or financial condition.
OUR CHAIRMAN OF THE BOARD OF DIRECTORS, CEO AND PRESIDENT CONTROLS 21.1% OF OUR
COMMON STOCK AND IS ABLE TO SIGNIFICANTLY INFLUENCE MATTERS REQUIRING
SHAREHOLDER APPROVAL.
As of March 7, 2003, Steven G. Mihaylo, Inter-Tel's Chairman of the Board
of Directors, Chief Executive Officer and President, beneficially owned
approximately 21.1% of the outstanding shares of the common stock. As a result,
he has the ability to exercise significant influence over all matters requiring
shareholder approval. In addition, the concentration of ownership could have the
effect of delaying or preventing a change in control of Inter-Tel.
RISKS RELATED TO OUR INDUSTRY
REDUCTIONS IN SPENDING ON ENTERPRISE COMMUNICATIONS EQUIPMENT MAY MATERIALLY AND
ADVERSELY AFFECT OUR BUSINESS.
The overall economic slowdown has had a harmful effect on the market for
enterprise communications equipment. Our customers have reduced significantly
their capital spending on communications equipment in an effort to reduce their
own costs and bolster their revenues. The market for enterprise communications
equipment may continue to grow at a modest rate or possibly not grow at all, and
our financial performance has been and may continue to be materially and
adversely affected by the reductions in spending on enterprise communications
equipment.
THE EMERGING MARKET FOR IP NETWORK TELEPHONY IS SUBJECT TO MARKET RISKS AND
UNCERTAINTIES THAT COULD CAUSE SIGNIFICANT DELAYS AND EXPENSES.
The market for IP network voice communications products has begun to
develop only recently, is evolving rapidly and is characterized by an increasing
number of market entrants who have introduced or developed products and services
for Internet or other IP network voice communications. As is typical of a new
and rapidly evolving industry, the demand for and market acceptance of, recently
introduced IP network products and services are highly uncertain. We cannot
assure you that packet-switched voice networks will become widespread. Even if
packet-switched voice networks become widespread in the future, we cannot assure
that our products, including the IP telephony features of the AXXESS and
ECLIPSE2 systems, our IP endpoints and IP applications will successfully compete
against other market players and attain broad market acceptance.
Moreover, the adoption of packet-switched voice networks and importance of
development of products using industry standards such as MGCP and SIP, generally
require the acceptance of a new way of exchanging information. In particular,
enterprises that have already invested substantial resources in other means of
communicating information may be reluctant or slow to adopt a new approach to
communications. If the market for IP network voice communications fails to
develop or develops more slowly than we anticipate, our IP network telephony
products could fail to achieve market acceptance, which in turn could
significantly harm our business, financial condition and operating results. This
growth may be inhibited by a number of factors, such as quality of
infrastructure; security concerns; equipment, software or other technology
failures; regulatory encroachments; inconsistent quality of service; poor voice
quality over IP networks as compared to circuit-switched networks; and lack of
availability of cost-effective, high-speed
20
network capacity. Moreover, as IP-based data communications and telephony usage
grow, the infrastructure used to support these IP networks, whether public or
private, may not be able to support the demands placed on them and their
performance or reliability may decline. The technology that allows voice and
facsimile communications over the Internet and other data networks, and the
delivery of other value-added services, is still in the early stages of
development.
GOVERNMENT REGULATION OF THIRD PARTY LONG DISTANCE AND NETWORK SERVICE ENTITIES
ON WHICH WE RELY MAY HARM OUR BUSINESS.
Our supply of telecommunications services and information depends on
several long distance carriers, RBOCs, local exchange carriers, or LECs, and
competitive local exchange carriers, or CLECs. We rely on these carriers to
provide network services to our customers and to provide us with billing
information. Long distance services are subject to extensive and uncertain
governmental regulation on both the federal and state level. We cannot assure
that the increase in regulations will not harm our business. Our current
contracts for the resale of services through long distance carriers include
multi-year periods during which we have minimum use requirements and/or costs.
The market for long distance services is experiencing, and is expected to
continue to experience significant price competition, and this may cause a
decrease in end-user rates. We cannot assure you that we will meet minimum use
commitments, that we will be able to negotiate lower rates with carriers if
end-user rates decrease or that we will be able to extend our contracts with
carriers at favorable prices. If we are unable to secure reliable long distance
and network services from certain long distance carriers, RBOCs, LECs and CLECs,
or if these entities are unwilling or unable to provide telecommunications
services and billing information to us on favorable terms, our ability to expand
our own long distance and network services will be harmed. Carriers that provide
telecommunications services to us may also experience financial difficulties, up
to and including bankruptcies, which could harm our ability to offer
telecommunications services.
CONSOLIDATION WITHIN THE TELECOMMUNICATIONS INDUSTRY COULD INCREASE COMPETITION
AND REDUCE OUR CUSTOMER BASE.
There has been a trend in the telecommunications industry towards
consolidation and we expect this trend to continue as the industry evolves. As a
result of this consolidation trend, new stronger companies may emerge that have
improved financial resources, enhanced research and development capabilities and
a larger and more diverse customer base. The changes within the
telecommunications industry may adversely affect our business, operating results
and financial condition.
TERRORIST ACTIVITIES AND RESULTING MILITARY AND OTHER ACTIONS COULD HARM OUR
BUSINESS.
Terrorist attacks in New York and Washington, D.C. in September of 2001
disrupted commerce throughout the world. The continued threat of terrorism and
the potential for military action and heightened security measures in response
to this threat may cause significant disruption to commerce throughout the
world. To the extent that disruptions result in a general decrease in corporate
spending on information technology or advertising, our business and results of
operations could be harmed. We are unable to predict whether the threat of
terrorism or the responses thereto will result in any long-term commercial
disruptions or if such activities or responses will have a long-term adverse
effect on our business, results of operations or financial condition.
Additionally, if any attacks were to affect the operation of the Internet or key
data centers, our business could be harmed. These and other developments arising
out of the attacks may make the occurrence of one or more of the factors
discussed under "Factors That May Effect Future Operating Results" more likely
to occur.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The names of the executive officers and directors of Inter-Tel and their
ages, titles, and biographies as of the date hereof are set forth below.
STEVEN G. MIHAYLO; AGE 59; CHAIRMAN OF THE BOARD OF DIRECTORS, CHIEF
EXECUTIVE OFFICER AND PRESIDENT. Mr. Mihaylo, the founder of Inter-Tel, has
served as Chairman of the Board of Directors of Inter-Tel since September 1983,
as President since May 1998 and as Chief Executive Officer since Inter-Tel's
formation in July 1969. Mr. Mihaylo served as President of Inter-Tel from 1969
to 1983 and from 1984 to December 1994, and as Chairman of the Board of
Directors from July 1969 to October 1982.
21
NORMAN STOUT; AGE 45; EXECUTIVE VICE PRESIDENT AND CHIEF ADMINISTRATIVE
OFFICER. Mr. Stout was elected Executive Vice President, Chief Administrative
Officer and President of Inter-Tel Software and Services in June 1998. As Chief
Administrative Officer, Mr. Stout is responsible for Inter-Tel's strategic
planning, mergers and acquisitions, leasing business and centralized corporate
support functions including finance, treasury, accounting, human resources,
legal, MIS and eCommerce. From October 1994 to June 1998, he served as one of
our directors. Prior to joining Inter-Tel, Mr. Stout was Chief Operating Officer
of Oldcastle Architectural Products and since 1996, Mr. Stout also had served as
President of Oldcastle Architectural West. Mr. Stout was previously President of
Superlite Block, a subsidiary of Oldcastle Architectural Products and a
manufacturer of concrete products, since February 1993. Prior thereto he was
employed by Boorhem-Fields, Inc. of Dallas, Texas, a manufacturer of crushed
stone, as Chief Executive Officer from 1990 to 1993 and as Chief Financial
Officer from 1986 to 1990. Prior to that, Mr. Stout was a Certified Public
Accountant with Coopers & Lybrand. Mr. Stout holds a Bachelor of Science degree
in Accounting from Texas A&M and an MBA from the University of Texas.
CRAIG W. RAUCHLE; AGE 47; EXECUTIVE VICE PRESIDENT AND CHIEF OPERATING
OFFICER. Mr. Rauchle was elected Chief Operating Officer in August 2001 and has
been our Executive Vice President since December 1994. As Chief Operating
Officer, Mr. Rauchle is responsible for Inter-Tel's sales and support functions,
marketing, procurement, distribution and research and development activities. He
had been our Senior Vice President and continues as President of Inter-Tel
Technologies, Inc., our wholly owned sales subsidiary. Mr. Rauchle joined
Inter-Tel in 1979 as Branch General Manager of the Denver Direct Sales Office
and in 1983 was appointed the Central Region Vice President and subsequently the
Western Regional Vice President. From 1990 to 1992, Mr. Rauchle served as
President of Inter-Tel Communications, Inc. Mr. Rauchle holds a Bachelor of Arts
degree in Communications from the University of Denver.
JEFFREY T. FORD; AGE 41; SENIOR VICE PRESIDENT AND CHIEF TECHNOLOGY
OFFICER. Mr. Ford was elected Senior Vice President in May 1998 and has served
as our Chief Technology Officer since 1997. He was elected President of
Inter-Tel Integrated Systems, Inc. (IIS) in May 1998, after serving as Senior
Vice President of IIS for one year and Vice President of Software Engineering of
Inter-Tel Integrated Systems from 1993 to 1997. He joined Inter-Tel in 1983 as a
software design engineer. Mr. Ford holds a Bachelor of Science degree in
Computer Systems Engineering from Arizona State University and an SEP
certificate from the Stanford Graduate School of Business.
KURT R. KNEIP; AGE 40; CHIEF FINANCIAL OFFICER, SENIOR VICE PRESIDENT AND
SECRETARY. Mr. Kneip has served as our Chief Financial Officer since September
1993. He has served as Senior Vice President since February 2003 and as Vice
President from September 1993 to February 2003. He was elected Secretary and
Treasurer in October 1994. In May 1996 he was elected Assistant Treasurer, as
John Abbott was elected Treasurer. He joined Inter-Tel in May 1992 as Director
of Corporate Tax, after seven years with the accounting firms of Ernst & Young
and KPMG Peat Marwick. Mr. Kneip is a Certified Public Accountant, and holds a
Bachelor of Science degree in Commercial Economics from South Dakota State
University and a Masters Degree in Professional Accountancy from the University
of South Dakota.
J. ROBERT ANDERSON; AGE 66; DIRECTOR. Mr. Anderson has served as one of our
directors since February 1997. Mr. Anderson held various positions at Ford Motor
Company from 1963 to 1983, serving as President of the Ford Motor Land
Development Corporation from 1978 to 1983. He served as Senior Vice President,
Chief Financial Officer and as a member of the Board of Directors of The
Firestone Tire and Rubber Company from 1983 to 1989, and as Vice Chairman of
Bridgestone/Firestone, Inc. from 1989 through 1991. He most recently served as
Vice Chairman, Chief Financial Officer and as a member of the Board of Directors
of the Grumman Corporation from 1991 to 1994. He currently serves on the boards
of GenCorp, Inc. and B-G Corp. Mr. Anderson is currently semi-retired, and he is
an active leader in various business, civic and philanthropic organizations.
JERRY W. CHAPMAN; AGE 62; DIRECTOR. Mr. Chapman was elected as one of our
directors in December 1999 and previously served as one of our directors from
1989 to 1992. A CPA, he served with a local firm from 1963 through 1969, at
which time he joined Ernst & Ernst, a predecessor entity of Ernst & Young LLP.
He became a partner of Ernst & Young in 1977 and, until retiring from the firm
in 1989, served as engagement partner on a wide variety of audit, assurance and
consulting engagements. Additionally, he managed Ernst & Young's practices in
Arizona as well as various offices in the adjoining southwest states from 1980
through 1989. He then operated his own consulting firm through 1992 and joined
Arthur
22
Andersen in 1993 as a partner specializing in providing business consulting
services. He retired from Arthur Andersen in 1999 and currently provides
services for a small number of clients requiring strategic and market-driven
services.
GARY EDENS; AGE 61; DIRECTOR. Mr. Edens has served as one of our directors
since October 1994. He was a broadcasting media executive from 1970 to 1994,
serving as Chairman and Chief Executive Officer of Edens Broadcasting, Inc. from
1984 to 1994, when that corporation's nine radio stations were sold. He is
currently President of The Hanover Companies, Inc., an investment firm. He is an
active leader in various business, civic and philanthropic organizations.
DR. C. ROLAND HADEN; AGE 62; DIRECTOR. Dr. Haden has served as one of our
directors since 1983. Dr. Haden was Vice Chancellor and Dean of Engineering of
Texas A&M University from 1993 until his retirement on August 31, 2002.
Previously, he was Vice Chancellor of Louisiana State University, Dean of the
College of Engineering and Applied Sciences at Arizona State University, and
Vice President for Academic Affairs at Arizona State University. He earlier
served as department head at the University of Oklahoma. Dr. Haden has served on
a number of corporate boards, such as Square D Company and E-Systems, Inc., both
then Fortune 500 companies. He currently serves on the board of Crosstex Energy,
GP, LLC of Dallas. Dr. Haden holds a Ph.D. in Electrical Engineering from the
University of Texas.
The Board of Directors of the Company held a total of four (4) regularly
scheduled meetings during the fiscal year ended December 31, 2002.
The Audit Committee of the Board of Directors consisted of directors
Chapman, Anderson and Haden, through February 11, 2002. Effective February 12,
2002, director Edens was elected as a member of the Audit Committee. The Audit
Committee amended its charter on February 17, 2003 and a copy of the amended
charter is attached as Exhibit A to our Proxy Statement. Pursuant to the Audit
Committee charter, the Audit Committee reviews, acts and reports to the Board of
Directors of the Company on various auditing and accounting matters, including
the appointment of the Company's independent accountants, the scope of the
Company's annual audits, fees to be paid to the Company's independent
accountants, the performance of the Company's independent accountants, the
sufficiency of the Company's internal controls and the Company's accounting and
financial management practices. The Audit Committee met five (5) times during
the last fiscal year. All of the members of the Audit Committee are
"independent" members as defined under Rule 4200(a)(15) of the National
Association of Securities Dealers.
The Compensation Committee consisted of directors Anderson and Edens
through December 31, 2002. The Compensation Committee reviews employee
compensation and makes recommendations thereon to the Board of Directors and
administers the Company's Stock Incentive Plans. The Compensation Committee also
determines, upon review of relevant information, the employees to whom options
shall be granted. The Compensation Committee met two (2) times during the last
fiscal year.
During the fiscal year ended December 31, 2002, each director attended all
of the Board meetings. Each member of the Board who served on one or more of the
above-listed committees attended all of the committee(s) on which such director
served, in person or by consent.
ITEM 2. PROPERTIES
Our corporate headquarters in Tempe, Arizona is located in a 22,600 square
foot building pursuant to a lease that expires in August 2003, with an option to
renew. Our 68,000 square foot operations and distribution center is also located
in Tempe, Arizona pursuant to a lease that expires in March 2006. The principal
product development and support operations remain in a 96,000 square foot
building located in Chandler, Arizona pursuant to a lease that expires in May
2008. We also own a 70,000 square foot facility located in Reno, Nevada that
houses credit and lease finance facilities, a business development center and a
sales office. We also lease sales and support offices in a total of 57 locations
in the United States, including approximately 147,000 square feet of office
space in Milford, Connecticut that we acquired in the Executone acquisition (a
portion of which has been subleased), and three locations overseas. In February
2003, we consolidated three Phoenix, Arizona area offices with an aggregate of
31,300 square feet into a single Phoenix location of 35,000 square feet pursuant
to a lease, which expires in July 2008. This reduced our total number of office
locations to 55 in the United States. Our aggregate monthly payments under these
leases were approximately $793,000 at December 31, 2002. We believe that our
facilities will be adequate
23
to meet our current needs and that additional or alternative space will be
available as necessary in the future on commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
We are involved from time to time in litigation incidental to our business.
We believe that the outcome of current litigation will not have a material
adverse effect upon our business, financial condition or results of operations
and will not disrupt our normal operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
24
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
Inter-Tel Common Stock is traded over-the-counter (Nasdaq symbol: INTL) and
since February 1983 has been included in the Nasdaq National Market System. As
of March 7, 2003 there were of record approximately 2,340 shareholders of our
Common Stock. The following table sets forth high and low sales prices reported
by Nasdaq for each quarter in the last two years.
2002 HIGH LOW 2001 HIGH LOW
- ---- ---- --- ---- ---- ---
First Quarter 22.77 14.98 First Quarter 13.13 6.81
Second Quarter 21.70 15.57 Second Quarter 14.74 7.75
Third Quarter 27.00 15.65 Third Quarter 16.95 9.90
Fourth Quarter 28.98 17.03 Fourth Quarter 20.90 11.21
A dividend of $.01 per share of Common Stock has been paid to shareholders
of record for each quarter since December 31, 1997. In October 2001, the Board
of Directors declared an increase to the quarterly cash dividend to $.02 per
share of Common Stock, effective December 31, 2001. In July 2002, the Board of
Directors declared an increase to the quarterly cash dividend to $.03 per share
of Common Stock, effective September 30, 2002. The continuation of this dividend
policy and the amount (if any) of the quarterly dividend paid to our
shareholders will depend on our earnings, capital requirements for growth,
financial conditions and other factors.
NO SALES OF UNREGISTERED SECURITIES
We have not made any sales of unregistered securities during the past three
years, except for sales of our common stock to employees exercising their stock
options during the period prior to the effectiveness of a registration statement
on Form S-8 relating to such sales.
EQUITY COMPENSATION PLAN INFORMATION
Information regarding Inter-Tel's equity compensation plans, including both
shareholder approved plans and non-shareholder approved plans, is set forth in
the section entitled "Equity Compensation Plan Information" in Inter-Tel's
Notice of Annual Meeting of Shareowners and Proxy Statement, to be filed within
120 days after Registrant's fiscal year end of December 31, 2002 (the "Notice
and Proxy Statement"). The table required by S-K 201(d) is set forth under Item
12 and is incorporated by reference to the proxy statement.
25
ITEM 6. SELECTED FINANCIAL DATA FINANCIAL SUMMARY
The following selected consolidated financial data should be read in
conjunction with Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and Item 8, "Financial Statements and
Supplementary Data." The table contains selected consolidated financial data for
the years ended December 31, 1998, 1999, 2000, 2001 and 2002, derived from our
audited consolidated financial statements.
(In thousands, except
per share amounts and ratios) For the years ended December 31,
--------------------------------------------------------------------------
2002 2001 2000 1999 1998
--------- --------- --------- --------- ---------
Net Sales $ 381,456 $ 385,655 $ 402,723 $ 314,221 $ 274,504
Cost of sales 186,983 211,161 243,685(3) 159,463 140,946
Research and development 19,340 17,556 19,489 14,798 11,373
Selling, general and administrative 128,284 128,604 124,664 97,163 85,897
Amortization of goodwill -- 1,876 2,228 856 339
Amortization of purchased
intangible assets 1,122 677 576 411 318
In-process research and development -- -- 5,433(3) -- 22,755(4)
Other charges -- 5,357(2) 45,245(3) -- --
--------- --------- --------- --------- ---------
Operating (loss) income 45,727 20,424(2) (38,597)(3) 41,530 12,876(4)
========= ========= ========= ========= =========
Litigation settlement (net of costs
except for taxes) 15,516(1) -- -- -- --
Write-down of investment in
Inter-Tel.NET/Vianet (1,200) -- -- -- --
Equity share of Cirilium Corp.'s
net losses -- -- (5,938)(3) -- --
Write-off of Cirilium Corp.
investment -- -- (2,045)(3) -- --
Interest and other income 1,936 1,081 1,474 2,391 2,913
Foreign currency transaction gain
(loss) 330 (337) (421) (46) 105
Interest expense (156) (468) (213) (110) (60)
--------- --------- --------- --------- ---------
Income (loss) before income taxes
(benefit) 62,153(1) 20,700(2) (45,740)(3) 43,765 15,834(4)
Income taxes (benefit) 23,516 7,659 (16,817) 16,619 6,790
--------- --------- --------- --------- ---------
Net income (loss) $ 38,637(1) $ 13,041(2) $ (28,923)(3) $ 27,146 $ 9,044(4)
========= ========= ========= ========= =========
Net income (loss) per share
Basic $ 1.58(1) $ 0.53(2) $ (1.10)(3) $ 1.05 $ 0.34(4)
Diluted $ 1.49(1) $ 0.52(2) $ (1.10)(3) $ 1.01 $ 0.32(4)
--------- --------- --------- --------- ---------
Weighted average basic common
shares 24,444 24,488 26,273 25,949 26,602
Weighted average diluted common
shares 25,864 25,240 26,273 27,004 27,846
--------- --------- --------- --------- ---------
BALANCE SHEET DATA
Total assets $ 282,062 $ 227,462 $ 243,126 $ 247,517 $ 197,030
Working capital 131,624 93,156 86,008 60,799 96,317
Shareholders' equity 173,903 126,837 136,436 168,121 142,686
--------- --------- --------- --------- ---------
KEY RATIOS
Current ratio 2.80 2.41 2.05 1.93 3.17
Dividends declared per share $ 0.10 $ 0.05 $ 0.04 $ 0.04 $ 0.04
Return on beginning equity 30.5% 9.6% (17.2)% 19.0% 6.2%
Return on beginning equity-excluding
charges and litigation settlement 23.6%(1) 12.0%(2) 7.8%(3) 19.0% 15.6%(4)
Net cash provided by operating
activities $ 77,195 $ 75,006 $ 17,339 $ 33,380 $ 31,751
========= ========= ========= ========= =========
26
- ----------
(1) 2002 income before taxes includes $15.5 million of proceeds, net of related
expenses from a binding arbitration settlement, which increased net income
by $9.5 million, or $0.37 per share after tax. Without this settlement, we
would have reported net income of $29.1 million ($1.13 per diluted share)
for the year ended December 31, 2002.
(2) 2001 operating income includes a pre-tax charge of $5.4 million, which
reduced net income by $3.4 million, or $0.13 per share after tax. This
pre-tax charge reflects the write-down of our investment in Inter-Tel.NET
to net realizable value.
(3) 2000 operating income includes pre-tax charges of $66.8 million, which
reduced net income by $42.0 million, or $1.60 per share after tax. These
pre-tax charges reflect the write-off of the Executone acquisition of $50.9
million ($7.6 million of which is included in cost of sales) in the second
quarter, the write-off of IPRD in connection with the Executone purchase of
$5.4 million during the first quarter, the write-down to net realizable
value of Inter-Tel.NET assets of $2.0 million during the second quarter,
the equity share of Cirilium's losses of $5.9 million for the year, and
write-off of our investment in Cirilium of $2.6 million (including reserve
adjustments) during the third quarter. Without these charges, we would have
reported net income of $13.1 million ($0.50 per diluted share) for the year
ended December 31, 2000.
(4) 1998 operating income includes a special pre-tax charge of $22.8 million,
which reduced net income by $13.7 million or $.49 per diluted share after
tax. This charge reflects the write-off of in-process research and
development in connection with the purchase of certain assets and
liabilities of Telecom Multimedia Systems, Inc. Without this write-off, we
would have reported net income of $22.7 million ($.82 per diluted share)
for the year ended December 31, 1998.
27
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS AND OTHER PARTS OF THIS REPORT ON FORM 10-K CONTAIN
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE WORDS
"EXPECTS," "ANTICIPATES," "BELIEVES," "INTENDS," "WILL" AND SIMILAR EXPRESSIONS
IDENTIFY FORWARD-LOOKING STATEMENTS, WHICH ARE BASED ON INFORMATION AVAILABLE TO
US ON THE DATE HEREOF, AND WE ASSUME NO OBLIGATION TO UPDATE ANY SUCH
FORWARD-LOOKING STATEMENTS. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN
FACTORS, INCLUDING THOSE SET FORTH IN "FACTORS THAT MAY AFFECT FUTURE OPERATING
RESULTS" AND ELSEWHERE IN THIS FORM 10-K.
GENERAL
Inter-Tel, incorporated in 1969, is a single point of contact, full service
provider of converged voice and data 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, local and
long distance calling services, and other communications services. Our products
and services include the AXXESS by Inter-Tel, ECLIPSE2 by Inter-Tel and Encore
by Inter-Tel business communication systems, with integrated voice processing
and unified messaging systems, IP telephony voice and data routers, and
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."
We have developed a distribution network of direct sales offices, dealers
and value added resellers (VARs), which sell our products to organizations
throughout the United States and internationally, including to divisions of
Fortune 500 companies, large service organizations and governmental agencies. As
of December 31, 2002, we had 52 direct sales offices in the United States and
one in Japan, and a network of hundreds of dealers and VARs around the world
that purchase directly from us. We also maintain a wholesale distribution office
in the United Kingdom that supplies Inter-Tel's dealers and distributors
throughout the UK and parts of Europe. In December 2002, we also acquired Swan
Solutions Limited, a research and development and software sales office in the
United Kingdom.
Sales of systems through our dealers and VARs typically generate lower
gross margins than sales through our direct sales organization, although direct
sales typically require higher levels of selling, general and administrative
expenses. In addition, our long distance services and Datanet products typically
generate lower gross margins than sales of software and system products.
Accordingly, our margins may vary from period to period depending upon
distribution channel and product mix. In the event that sales through dealers or
sales of long distance services increase as a percentage of net sales, our
overall gross margin could decline.
Our operating results depend upon a variety of factors, including the
volume and timing of orders received during a period, the mix of products sold
and the mix of distribution channels, general economic conditions, patterns of
capital spending by customers, the timing of new product announcements and
releases by us and our competitors, pricing pressures, the cost and effect of
acquisitions and the availability and cost of products and components from our
suppliers. Historically, a substantial portion of our net sales in a given
quarter has been recorded in the third month of the quarter, with a
concentration of such net sales in the last two weeks of the quarter. In
addition, we are subject to seasonal variations in our operating results, as net
sales for the first and third quarters are frequently less than those
experienced during the fourth and second quarters, respectively.
The markets we serve have been characterized by rapid technological changes
and increasing customer requirements. We have sought to address these
requirements through the development of software enhancements and improvements
to existing systems and the introduction of new systems, products, and
applications. Inter-Tel's research and development efforts over the last several
years have been focused primarily on the development of, and enhancements to,
our AXXESS and ECLIPSE2 systems, including adding new applications,
incorporating IP convergence applications and IP telephones, developing Unified
Messaging Software applications, developing speech recognition and
text-to-speech applications, developing and enhancing call center applications,
developing Unified Communications Software
28
applications, and expanding the telecommunications networking package to include
networking over IP and frame relay networks. Inter-Tel's current efforts are
focused on developing and enhancing the convergence applications for our AXXESS
and ECLIPSE2 systems, enhancing our server-PBX offering, enhancing our unified
communications applications, developing new IP endpoint technology, and
enhancing our call center applications.
We offer to our customers a package of lease financing and other services
under the name Total Solution (formerly, Totalease). Total Solution provides our
customers lease financing, maintenance and support services, fixed price
upgrades and other benefits. We finance this program through the periodic resale
of lease rental streams to financial institutions. Refer to Note E of Notes to
Consolidated Financial Statements for additional information regarding our
program.
RESULTS OF OPERATIONS
The following table sets forth certain statement of operations data
expressed as a percentage of net sales for the periods indicated:
Year Ended December 31
--------------------------------
2002 2001 2000
------ ------ ------
Net sales 100.0% 100.0% 100.0%
Cost of sales 49.0 54.8 60.5
------ ------ ------
Gross profit 51.0 45.2 39.5
Research and development 5.1 4.6 4.8
Selling, general and administrative 33.6 33.3 31.0
Amortization of goodwill and intangibles 0.3 0.7 0.7
In-process research and development -- -- 1.3
Other charges -- 1.4 11.2
------ ------ ------
Operating income (loss) 12.0 5.3 (9.6)
Litigation settlement 4.1 -- --
Equity share of Cirilium Corp.'s net losses -- -- (1.5)
Write-off of Cirilium Corp. investment -- -- (0.5)
Write-down of Inter-Tel/Vianet investment (0.3) -- --
Interest and other income 0.5 0.3 0.4
Foreign currency transaction gains (losses) 0.1 (0.1) (0.1)
Interest expense -- (0.1) (0.1)
Income taxes (benefit) 6.2 2.0 (4.2)
------ ------ ------
Net income (loss) 10.1% 3.4% (7.2)%
====== ====== ======
YEAR ENDED DECEMBER 31, 2002 VERSUS YEAR ENDED DECEMBER 31, 2001
NET SALES. Net sales decreased 1.1% to $381.5 million in 2002 from $385.7
million in 2001, representing a decrease of $4.2 million. The decrease in net
sales was primarily attributable to the fact that sales from Inter-Tel.NET (of
which Inter-Tel sold 83% of its interest in July 2001) were not included in
2002. Inter-Tel.NET sales were $14.0 million in 2001. Sales from our direct
sales offices were relatively flat in 2002 compared to 2001 including sales from
McLeod offices acquired in 2002. Excluding the McLeod acquisition, sales in this
division declined by approximately 5.4%. Sales from our government and national
accounts division decreased $7.1 million, or 25.6%, in 2002 compared to 2001.
The DataNet division, which sells networking products through our direct sales
offices, government and national accounts division and dealer channel, was
purchased in the 2002 McLeod acquisition, and accounted for $13.5 million in
sales in 2002. Sales to our dealer network decreased by 4.1% in 2002, due
primarily to the impact of the McLeod acquisition, since, prior to 2002, McLeod
was a dealer that purchased $4.2 million from Inter-Tel in 2001. Excluding the
McLeod acquisition, sales to the dealer network increased 1.5%.
Sales from our long distance resale and network services divisions
increased $7.1 million in 2002 compared to 2001. Net sales from lease financing
increased 3.2% in 2002 compared to 2001 and international revenues increased by
less than 1% in 2002 compared to 2001.
29
Since July 24, 2001, the date of the sale of 83% of Inter-Tel.NET, we have
used the cost method of accounting for our remaining investment in
Inter-Tel.NET/Comm-Services. Accordingly, we have not recorded revenues or
expenses of Inter-Tel.NET since the date of sale. The reduction in sales
attributable to Inter-Tel.NET was due entirely to our sale of 83% of this
subsidiary.
The 2002 decrease in net sales from our direct sales offices, government
and national accounts division and dealer channel was also attributable to
delayed customer buying decisions related to a continued deterioration in
industry and macroeconomic conditions, among other factors as follows. Inter-Tel
recognized lower revenues due to lower sales volumes of systems collectively
through the direct sales offices, government and national accounts group and
dealer channel, offset in part by sales increases in our long distance and
network services divisions, sales from acquired McLeod operations, and to a
lesser extent, lease finance and international operations. In some instances,
prices of various telecommunications systems decreased, and discounts or other
highly competitive promotions that were offered to customers to generate sales
resulted in lower revenues through both our direct and indirect channels. Sales
of communications systems were heavily impacted by delayed buying decisions, in
particular in our national accounts division and direct sales offices. Although
sales to new customers declined during 2002, recurring revenues to existing
customers increased as a percentage of total sales.
Sales from long distance and network services increased in 2002 compared to
2001 and represented the divisions with our largest percentage sales increases.
Sales increased in our long distance division by 17.5%, despite downward price
pressure and significant competition. Increased sales volume has allowed
NetSolutions, our long distance resale division, to offer more competitive
pricing, which improved sales to our existing customer base. Network services
revenues increased 66% in 2002 compared to 2001, on higher volume of sales and
commissions on local and network services such as T-1 access, frame relay and
other voice and data circuit services. Please refer to Note P of Notes to
Consolidated Financial Statements for additional segment reporting information.
GROSS PROFIT. Gross profit increased 11.4% to $194.5 million, or 51.0% of
net sales in 2002, from $174.5 million, or 45.2% of net sales, in 2001. The
increases in gross profit and gross margins were the result of several different
factors. Gross profit and gross margin in 2002 improved as a result of no longer
including the results of Inter-Tel.NET, which experienced negative gross margins
of $5.9 million during 2001. Gross profit and margins also increased in 2002 as
compared to 2001 as a result of a higher proportion of recurring revenues from
existing customers, including increased maintenance and services revenues as a
percentage of total sales, higher software content in our products, cost
containment efforts, product design improvements, efficiencies achieved with our
manufacturing vendors and a more favorable sales channel mix.
During 2002, recurring revenues from existing customers in our direct sales
and national and government accounts channels increased as a percentage of total
sales from these same channels from approximately 44% in 2001 to more than 46%
in 2002. Existing customers accounted for a significant portion of our 2002 net
sales from maintenance and other services, software additions and/or upgrades,
support, training and hardware products such as video conferencing, headsets
(wired and wireless), networking products and speakerphones. Our business
communications platforms allow for system migration without the complete
change-out of hardware, which enables us to offer enhancements and new solutions
through software-only upgrades to our existing customers. Our gross margins are
generally higher with recurring revenues because we incur less materials costs
relative to new installations. Accordingly, our gross profit and margins
improved in 2002 as a result of this recurring revenue percentage increase.
Sales from NetSolutions increased by 17.5%, or $4.5 million, compared to
2001. Although gross margins are generally lower in this division than our
consolidated margins, the margins improved slightly in 2002 relative to 2001,
based in part on our ability to negotiate more favorable pricing with vendors on
higher resale volumes. In addition, sales from our network services division
increased 66%, or 2.6 million, in 2002 compared to 2001. This division generally
receives commissions on network services we sell as an agent for RBOCs. These
sales carry little to no equipment costs and generated margins of approximately
91% in 2002. The increase in sales from this division therefore improved our
consolidated gross profit and margins.
30
The increases in gross margin noted above were offset in part by continued
competitive pricing pressures in our direct sales offices, government and
national accounts and dealer channels in 2002, including pricing discounts or
special competitor promotions on telephone system and software sales and related
equipment.
RESEARCH AND DEVELOPMENT. Research and development expenses increased 10.2%
to $19.3 million, or 5.1% of net sales in 2002, from $17.6 million, or 4.6% of
net sales in 2001. The increase is attributable in large part to the
acquisitions of Mastermind in late October 2001 and Swan in early December 2002.
The increase is also attributable, to a lesser extent, to increased research and
development spending related to convergence applications and new IP endpoint
development. In 2002, research and development expenses were directed
principally toward the continued development of the AXXESS and Eclipse2 software
and systems (including versions 6.0 and 7.0), unified messaging and voice
processing software, speech recognition and text-to-speech applications, call
center applications, unified communications applications, IP endpoint
development, and certain CTI and IVR applications. We expect that research and
development expenses will increase in absolute dollars as we continue to develop
and enhance existing and new technologies and products. These expenses may vary,
however, as a percentage of net sales.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses decreased slightly in absolute dollars to $128.3 million in 2002,
compared to $128.6 million in 2001. However, these expenses increased as a
percentage of net sales to 33.6% in 2002 compared to 33.3% in 2001. This
decrease in absolute dollars was primarily due to the reduction in total net
sales of $4.2 million in 2002 compared to 2001. The increase in these expenses
as a percentage of net sales is in large part attributable to the sale of 83% of
Inter-Tel.NET operations in July 2001. Selling, general and administrative
expenses for Inter-Tel.NET were 16.8% of net sales when compared to the
consolidated average. Accordingly, when these operations were no longer included
in our consolidated results, our selling, general and administrative expenses
increased as a percentage of net sales.
Inter-Tel.NET incurred selling, general and administrative expenses,
excluding amortization, of $2.3 million during 2001. Excluding the operations of
Inter-Tel.NET for comparative purposes, selling, general and administrative
expenses decreased as a percentage of net sales reflecting the lower percentage
of total sales generated through our combined direct sales offices and
government and national accounts divisions, including the acquired McLeod
operations in January 2002. Selling, general and administrative expenses also
decreased as a percentage of net sales due to lower depreciation and bad debt
costs relative to total sales. In addition, the growth in sales from the resale
of long distance calling services and Datanet products led to lower selling,
general and administrative costs relative to total sales. We expect that for the
foreseeable future selling, general and administrative expenses will increase
sequentially in absolute dollars assuming that we increase sales and continue to
enhance existing and develop new technologies and products. These expenses may
vary, however, as a percentage of net sales.
AMORTIZATION OF GOODWILL AND PURCHASED INTANGIBLE ASSETS. We adopted SFAS
No. 142 effective the beginning of fiscal 2002. In accordance with SFAS 142, we
ceased amortizing goodwill. We are required to perform goodwill impairment tests
on an annual basis and between annual tests in certain circumstances. As of
December 31, 2002, no impairment of goodwill has been recognized. There can be
no assurance that future goodwill impairment tests will not result in a charge
to earnings. Although amortization of goodwill ceased for 2002, goodwill
amortization totaled $1.9 million in 2001, reflecting amortization from
acquisitions completed prior to 2002. For additional information regarding SFAS
142, see "Goodwill and Other Intangible Assets" in Note A of Notes to
Consolidated Financial Statements.
Amortization of purchased intangible assets included in operating expenses
was $1.1 million in 2002 compared to $677,000 for 2001. The increases in the
amortization of purchased intangible assets for 2002 compared to 2001 was
primarily related to the additional amortization from recent acquisitions. For
additional information regarding purchased intangible assets, see Note A
"Goodwill and Other Intangible Assets" and Note B "Acquisitions, Dispositions
and Restructuring Charges " to Consolidated Financial Statements.
OTHER CHARGES. We recorded no charges in 2002. In connection with the sale
of 83 percent of our interest in Inter-Tel.NET in July 2001, we recorded a
pre-tax charge or $5.4 million during 2001, which reduced net income by $3.4
million, or $0.13 per share after-tax. This charge was associated with the
impairment of our remaining investment in Inter-Tel.NET. The impairment was
measured as the difference
31
between the carrying value of Inter-Tel's remaining 17% interest in
Inter-Tel.NET and the estimated fair market value of the 17% interest.
LITIGATION SETTLEMENT, NET OF COSTS EXCEPT TAXES. In May 2001, Inter-Tel
entered into an agreement to submit to binding arbitration a lawsuit we filed in
1996. The arbitration was completed in January 2002 and, as a result of the
arbitration, Inter-Tel received a one-time gross cash award of $20 million in
February 2002. Direct costs for attorney's fees, expert witness costs,
arbitration costs and additional payments and expenses, totaled approximately
$4.5 million in 2002, excluding income taxes, for a net award of approximately
$15.5 million. The estimated net proceeds from this arbitration settlement were
approximately $9.5 million after taxes, or $0.37 per diluted share for the year
ended December 31, 2002.
INTEREST AND OTHER INCOME. In 2002 the other component of this caption
included an expense of approximately $1.2 million related to the write-down of
Inter-Tel's investment in Inter-Tel.NET/Vianet. Other than the write-down, other
income in all periods consisted primarily of interest income and foreign
currency transaction gains and losses. Interest and other income increased
approximately $855,000 in 2002 compared to 2001 based on a higher level of
invested funds, due in part to cash received from the litigation settlement
noted above, offset by expenditures relating to the McLeod and Swan
acquisitions. During 2002, we recognized foreign currency transaction gains of
$330,000, an improvement of $667,000 compared to losses of $337,000 in 2001.
Interest expense was $156,000 in 2002, a decrease of $312,000 compared to
$468,000 in 2001, due primarily to reduced interest on capital leases held by
Inter-Tel.NET, 83% of which was sold in July 2001.
INCOME TAXES. Our effective income tax rate for 2002 increased to 37.8%
compared to 37.0% for 2001. The rate increased primarily as a result of higher
marginal tax rates anticipated from higher net income. We expect the full-year
2003 tax rates to be comparable to or slightly higher than the effective tax
rate for 2002.
NET INCOME/(LOSS). Net income for 2002, including the litigation settlement
in 2002, increased to $38.6 million, or $1.49 per diluted share, compared to
2001 net income of $13.0 million, or $0.52 per diluted share, including the
charge for the impairment of the investment in Inter-Tel.NET.
Excluding the 2002 litigation settlement, we would have reported net income
of $29.1 million, or $1.13 per diluted share in 2002. Excluding both the 2001
charge and entire 2001 business operations of Inter-Tel.NET, we reported net
income of $21.8 million, or $0.86 per diluted share, in 2001. The increase is
the result of higher gross profit and increased operating efficiencies described
in further detail above.
YEAR ENDED DECEMBER 31, 2001 VERSUS YEAR ENDED DECEMBER 31, 2000
NET SALES. Net sales decreased 4.2% to $385.7 million in 2001 from $402.7
million in 2000, representing a decrease of $17.1 million. Sales from
Inter-Tel.NET (of which Inter-Tel sold 83% of its interest in July 2001),
accounted for $8.8 million of the decrease. Reduced sales from our direct sales
offices, including government and national accounts, and from wholesale
distribution accounted for $9.4 million of the decrease. Reduced sales from
NetSolutions accounted for $1.0 million of the decrease from 2000 to 2001. Net
sales from lease financing increased to 21.8% in 2001 compared to 2000.
International revenues decreased approximately $300,000 from 2000 to 2001.
Since July 24, 2001, the date of the sale of 83% of Inter-Tel.NET, we have
used the investment method of accounting for our remaining investment in
Inter-Tel.NET/Comm-Services. Accordingly, we have not recorded revenues or
expenses of Inter-Tel.NET since the date of sale. Excluding sales from
Inter-Tel.NET, net sales for 2001 decreased 2.2% to $371.7 million, compared to
$379.9 million in 2000. Inter-Tel.NET generated net sales of $14.0 million in
2001 compared to $22.8 million in 2000. The reduction in sales attributable to
Inter-Tel.NET was due primarily to our sale of 83% of Inter-Tel.NET on July 24,
2001. Accordingly, less than seven months of activity from Inter-Tel.NET was
reflected in the 2001 results as compared to the full year results of
Inter-Tel.NET reported in 2000.
The 2001 decrease in net sales was also attributable to delayed customer
buying decisions in 2001 related to a deterioration in macroeconomic conditions.
Inter-Tel recognized lower revenues due to lower sales volumes of systems
collectively through the direct sales offices, government and national accounts
group, dealer channel and foreign operations, offset partially by sales
increases in our lease finance
32
operations. In some instances, prices of various telecommunications systems
decreased, and discounts or other promotions that were offered to customers to
generate sales resulted in lower revenues. Please refer to Note P of Notes to
Consolidated Financial Statements for additional segment reporting information.
GROSS PROFIT. Gross profit increased 9.7% to $174.5 million, or 45.2% of
net sales in 2001, from $159.0 million, or 39.5% of net sales in 2000. Excluding
the Executone restructuring charge, gross profit increased 4.7% compared to
166.7 million, or 41.4% of net sales in 2000. This increase in gross profit was
primarily a result of lower sales from Inter-Tel.NET, which experienced negative
gross margins, an increase in sales, as a percentage of consolidated net sales,
through our direct sales channel compared to our dealer network, reduced product
costs and higher relative recurring revenues. Gross profit also increased as a
percentage of net sales, due in large part to the factors described in net sales
above. Greater competitive pricing pressures and pricing discounts on telephone
system sales offset these increases in 2001.
Excluding the operations of Inter-Tel.NET, gross profit for 2001 increased
1.4% to $180.4 million, or 48.5% of net sales, compared to $177.9 million, or
46.8% of net sales, in 2000. Inter-Tel.NET generated negative gross profit of
$5.9 million in 2001 compared to negative $11.2 million in 2000.
RESEARCH AND DEVELOPMENT. Research and development expenses decreased to
$17.6 million, or 4.6% of net sales in 2001, from $19.5 million, or 4.8% of net
sales in 2000. This decline is attributable in large part to the closure of the
Executone research and development operations in Milford, Connecticut in July
2000. Accordingly, our 2001 costs did not reflect the Executone expenses,
compared to seven months of activity in 2000. In 2001, research and development
expenses were directed principally toward the continued development of the
digital AXXESS and Eclipse2 software and systems (including version 6.0),
unified messaging and voice processing software, InterPrise IP router solutions,
Talk-to-Agent web e-commerce solutions, speech recognition and text-to-speech
applications, and certain CTI and IVR applications.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased to $131.2 million, or 34.0% of net sales in 2001, from $127.5
million, or 31.7% of net sales in 2000. The increase in these expenses reflected
an increase in costs associated with sales through our direct office channels
compared to our dealer network, increased reserves for accounts receivable, and
an increase in costs of maintaining additional facilities, including our new
facilities in the Phoenix metro area and the Convergent offices acquired in
January 2001.
Excluding the operations of Inter-Tel.NET, selling, general and
administrative expenses increased to $128.7 million, or 34.6% of net sales for
2001, compared to $121.0 million, or 31.8% of net sales in 2000. Excluding
charges, Inter-Tel.NET incurred selling, general and administrative expenses of
$2.5 million in 2001 compared to $5.9 million in 2000.
OTHER CHARGES. In connection with the sale of our interest in Inter-Tel.NET
in July 2001, we recorded a pre-tax charge or $5.4 million during 2001, which
reduced net income by $3.4 million, or $0.13 per share after-tax. This charge
was 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 and the estimated fair market value of
the 17% interest in the net assets of Inter-Tel.NET.
We reported pre-tax charges of $66.8 million during 2000, which reduced net
income by $42.0 million, or $1.60 per share after tax. These pre-tax charges
reflected the write-off of the Executone acquisition of $50.9 million in the
second quarter, the write-off of in process research and development in
connection with the Executone purchase of $5.4 million during the first quarter,
the write-down to net realizable value of Inter-Tel.NET assets of $2.0 million
during the second quarter, the equity share of Cirilium's losses of $5.9 million
for the year, and write-off of Inter-Tel's investment in Cirilium of $2.6
million (including reserve adjustments) during the third quarter. Without these
charges, we would have reported net income of $24.2 million ($0.90 per diluted
share) for the year ended December 31, 2000.
CHARGES AND IN PROCESS RESEARCH AND DEVELOPMENT. We reported a pre-tax
charge of $5.4 million during 2001, which reduced net income by $3.4 million, or
$0.13 per share after tax. This pre-tax charge reflected the sale of 83% of our
interest in Inter-Tel.NET and the write-down of our investment in Inter-Tel.NET
to anticipated net realizable value. Without this charges, we would have
reported net income of $16.4 million ($0.65 per diluted share) for the year
ended December 31, 2001.
33
INTEREST AND OTHER INCOME. Other income in both periods consisted primarily
of interest income and foreign currency transaction gains and losses. Interest
and other income decreased $393,000 in 2001 compared to the same period in 2000
principally as a result of lower levels of cash available for investment. During
2001, we recognized foreign currency transaction losses of $337,000 compared to
losses of $421,000 in 2000. Interest expense was $468,000 in 2001 compared to
$213,000 in 2000, primarily attributable to debt from assets financed for
Inter-Tel.NET operations. This debt was transferred upon the sale of 83% of
Inter-Tel.NET in July 2001.
INCOME TAXES (BENEFIT). The 2001 effective income tax rate increased to
37.0% compared to 36.8% for 2000. The rate was lower in 2000 because we received
no tax benefits for a component of the Cirilium losses that were capital losses
during 2000 (lower tax benefits were received to apply to 2000 net losses).
NET INCOME (LOSS). Including the charge recorded in 2001, net income
increased to $13.0 million, or $.52 per diluted share, in 2001 compared to net
loss of $28.9 million, or a net loss of $1.10 per diluted share, in 2000
reflecting the charges noted above associated with the Executone, Cirilium and
Inter-Tel.NET operations. Excluding the charges, net income would have been
$16.4 million, or $.65 per diluted share, in 2001.
Excluding the charges, all Cirilium losses and operations of Inter-Tel.NET,
the Company reported net income of $21.8 million, or $0.86 per diluted share, in
2001, compared to net income of $24.2 million, or $0.90 per diluted share, in
2000.
2001 AND 2000 OTHER CHARGES.
Set forth herein is a further description of the items reflected in other
charges during the years ended December 31, 2001 and 2000.
INTER-TEL.NET/COMM-SERVICES/VIANET. 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.
On July 24, 2001, Inter-Tel sold 83% of the stock of Inter-Tel.NET, Inc. to
Comm-Services Corporation for a note of $4.95 million, collateralized by
Comm-Services stock, other marketable securities of the shareholders of
Comm-Services and 100% of the net assets of Inter-Tel.NET. 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 2001 of $5.4 million ($3.4 million after
tax) associated with the impairment of our investment in Inter-Tel.NET. After
the impairment charge, the carrying value of our investment (the note receivable
from Comm-Services plus the 17% ownership interest in Comm-Services) totaled
$3.7 million as of December 31, 2001. The charge was 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 and as a result, the loan for the
purchase was assumed by Vianet and Inter-Tel continued to hold collateral from
the former shareholders of Comm-Services until March 2003. During 2002, the net
investment in the notes receivable and 10% interest in Vianet (formerly
Comm-Services) was written down by $1.2 million and was recorded in other assets
at a carrying value of approximately $2.5 million as of December 31, 2002, which
approximated management's estimate of the related collateral value at that time.
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 February 2003, we executed an agreement with Vianet and
this vendor releasing Inter-Tel from its guarantee of any and all of these
obligations, and Inter-Tel and Vianet released
34
the vendor from claims arising from the failure of the network equipment and
software previously leased. As part of this agreement, Inter-Tel also received
payment from the Vianet shareholders of $1.45 million, in exchange for the
release of the remaining collateral and as payment of the loan. Inter-Tel also
retained a collateral interest in a Vianet shareholder's variable forward option
contract that matures in July 2003 for an amount up to $250,000. We have not
recorded an asset for this right as the amount is not guaranteed or reasonably
estimable based on the fluctuations of future stock prices. The value received
in this transaction was equivalent to our remaining investment value, less
accruals for potential obligations to the vendor discussed above.
Inter-Tel also retains its ownership interest in Vianet and will account
for the remaining investment interest of approximately 10% in Vianet using the
cost method of accounting.
EXECUTONE. On January 1, 2000 Inter-Tel purchased certain computer
telephony assets and assumed certain liabilities of Executone Information
Systems, Inc. (Executone). 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. 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, we decided to close the primary
Executone facility in Milford, Connecticut and to recognize a restructuring
charge related to our exit plan and closure of the Executone operations. 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 the employees. 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, 2002.
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 other furniture, computer and equipment leases
terminated on varying dates through September 2002. To date, we have entered
into sublease agreements with third parties to sublease portions of the
facility. The reserve for lease and other contractual obligations is identified
in the table below.
The total restructuring charge from this event totaled $50.9 million. 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, 2002. Activity represents payments made or
amounts written off.
35
RESERVE
CASH/ RESTRUCTURING 2000 2001 2002 BALANCE
DESCRIPTION NON-CASH CHARGE ACTIVITY ACTIVITY ACTIVITY AT 12/31/02
----------- -------- ------ -------- -------- -------- -----------
(In thousands)
PERSONNEL COSTS:
Severance and termination
Costs Cash $ (1,583) $ 1,558 $ 2 $ 20 $ (3)
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 2,594 (2,013)
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 88 (831)
Fixed assets Non-Cash (3,151) 2,942 -- 53 (156)
Net intangible assets Non-Cash (29,184) 29,184 -- -- --
TOTAL $(50,916) $ 39,444 $ 3,845 $ 4,624 $ (3,003)
Included in the total Executone restructuring costs of $50.9 million is a
$43.3 million restructuring charge for exit costs and asset impairment included
in other charges, 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.
INFLATION/CURRENCY FLUCTUATION
Inflation and currency fluctuations have not previously had a material
impact on Inter-Tel's operations. International procurement agreements have
traditionally been denominated in U.S. currency. Moreover, a significant amount
of contract manufacturing has been or is expected to be moved to alternative
sources. The expansion of international operations in the United Kingdom and
Europe and increased sales, if any, in Japan and other parts of Asia could
result in higher international sales as a percentage of total revenues; however,
international revenues do not currently represent a significant portion of our
total revenues.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2002, cash and equivalents and short-term investments
totaled $125.8 million, which represented an increase of approximately $64.0
million from the $61.8 million total at December 31, 2001. We maintain a $10
million unsecured, revolving line of credit with BankOne, NA, which is available
through June 1, 2003. Under the credit facility, we have the option to borrow at
a prime rate or adjusted LIBOR interest rate. Historically, we have used the
credit facility primarily to support international letters of credit to
suppliers and we intend to renew this facility again in 2003. During the year
ended December 31, 2002, we received approximately $9.5 million in net after-tax
proceeds ($15.5 million pre-tax and net of related expenses) from the settlement
of an arbitration claim (Refer to "Litigation Settlement" in "Management's
Discussion and Analysis, Year Ended December 31, 2002 Versus Year Ended December
31, 2001"). During the year ended December 31, 2002, we expended approximately
$13,000 to repurchase our common stock, compared to $28.9 million used to
repurchase common stock in 2001. During 2002, we expended $11.4 million to fund
acquisitions, compared to $6.8 million in 2001. A portion of our cash
36
balances may be used for, among other things, acquisitions, strategic alliances,
working capital and general corporate purposes.
Net cash provided by operating activities totaled $77.2 million for the
year ended December 31, 2002, compared to $75.0 million for the same period in
2001. Cash provided by operating activities in 2002 primarily resulted from net
income plus non-cash charges for depreciation and amortization expenses and
provision for losses on receivables and leases. Cash generated by the change in
operating assets and liabilities in 2002 was $15.5 million, compared to cash
generated by the change in operating assets and liabilities of $21.0 million in
2001. At December 31, 2002, we achieved lower net accounts receivable,
inventory, prepaid expenses and other current assets than at December 31, 2001,
which was primarily a result of close management of receivables and inventory
and working down elevated levels of working capital assets acquired in the
Executone acquisition. We expect to expand sales through our direct sales office
and dealer networks, which is expected to require the expenditure of working
capital for increased accounts receivable and inventories.
Net cash used in investing activities totaled $56.6 million, primarily in
the form of acquisitions and capital expenditures, as well as $37.9 million used
to purchase short-term investments net of sales and maturities, compared to net
cash used in investing activities of $17.6 million in 2001, including $3.0
million used to purchase short-term investments. Cash used in acquisitions and
investments in joint ventures totaled approximately $11.4 million in 2002
compared to $6.8 million in 2001. Capital expenditures totaled approximately
$7.6 million for 2002 compared to $8.0 million in 2001. Net cash used in
investing activities in 2000 was partially offset by cash received of $6.6
million from the disposition of the manufacturing operations of Executone. We
anticipate additional capital expenditures during 2003, principally relating to
expenditures for equipment and management information systems used in
operations, facilities expansion and acquisition activities.
Net cash provided by financing activities totaled $5.5 million during 2002
compared to the use of $25.7 million in 2001. We expended approximately $13,000
and $28.9 million for stock repurchases during 2002 and 2001, respectively,
funded by existing cash balances during each period. Repayment of our long-term
debt for the year 2002 was $481,000, while we issued long-term debt, net of
repayments, of $1.8 million in 2001 primarily in the form of long-term capital
leases to support capital additions to Inter-Tel.NET prior to our divestiture of
our majority ownership in July, 2001. During 2002, we reissued treasury shares
through stock option exercises and issuances, with the proceeds received
totaling less than the cost basis of the treasury stock reissued. Accordingly,
the difference was recorded as a reduction to retained earnings. Net cash used
for cash dividends totaled $2.2 million in 2002 and $1.0 million during 2001.
Cash provided by the exercise of stock options and stock issuances pursuant to
our Employee Stock Purchase Plan totaled $8.2 million in 2002 and $2.3 million
in 2001.
We offer to our customers lease financing and other services, including our
Total Solution (formerly Totalease) program, through our Inter-Tel Leasing, Inc.
subsidiary. We fund our Total Solution program in part through the sale to
financial institutions of rental payment streams under the leases. Sold lease
rentals totaling $205.8 and $202.7 million remained unbilled at December 31,
2002 and December 31, 2001, respectively. We are obligated to repurchase such
income streams in the event of defaults by lease customers and, accordingly,
maintain reserves based on loss experience and past due accounts. Although we to
date have been able to resell the rental streams from leases under the Total
Solution program profitably and on a substantially current basis, the timing and
profitability of lease resales could impact our business and operating results,
particularly in an environment of fluctuating interest rates and economic
uncertainty. If we are required to repurchase rental streams and realize losses
thereon in amounts exceeding our reserves, our operating results will be
adversely affected.
We believe that our working capital and credit facilities, together with
cash generated from operations, will be sufficient to develop and expand our
business operations, to finance acquisitions of additional resellers of
telephony products and other strategic acquisitions or corporate alliances, and
to provide adequate working capital for at least the next twelve months.
However, to the extent that additional funds are required in the future to
address working capital needs and to provide funding for capital expenditures,
expansion of the business or additional acquisitions, we will seek additional
financing. There can be no assurance that additional financing will be available
when required or on acceptable terms.
37
CONTRACTUAL OBLIGATIONS
We had the following contractual obligations outstanding as of December 31,
2002:
Amount of Commitment Expiration Per Period
-------------------------------------------------------
(in thousands) Less Than 1 After 5
Total Year 1-3 Years 4-5 Years Years
----- ---- --------- --------- -----
Operating lease obligations, primarily for $28,819 $ 9,390 $13,939 $ 5,142 $ 348
building and equipment leases
Letters of credit 545 545 -- -- --
------- ------- ------- ------- -------
$29,364 $ 9,935 $13,939 $ 5,142 $ 348
======= ======= ======= ======= =======
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The methods, estimates and judgments we use in applying our most critical
accounting policies have a significant impact on the results we report in our
consolidated financial statements. We evaluate our estimates and judgments on an
on-going basis. We base our estimates on historical experience and on
assumptions that we believe to be reasonable under the circumstances. Our
experience and assumptions form the basis for our judgments about the carrying
value of assets and liabilities that are not readily apparent from other
sources. Actual results may vary from what we anticipate and different
assumptions or estimates about the future could change our reported results. We
believe the following accounting policies are the most critical to us, in that
they are important to the portrayal of our financial statements and they require
our most difficult, subjective or complex judgments in the preparation of our
consolidated financial statements:
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.
SALES-LEASES. For our sales-type lease accounting, we follow the guidance
provided by FASB Statement No. 13, Accounting for Leases and FASB Statement No.
140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities - A Replacement of FASB Statement No. 125. We
record the discounted present values of minimum rental payments under sales-type
leases as sales, net of provisions for continuing administration and other
expenses over the lease period. We record the lease sales at the time of system
sale and installation pursuant to Staff Accounting Bulletin No. 101, as
discussed above for sales to end user customers, and upon receipt of the
executed lease documents. 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. The net rental streams are sold to funding sources
on a regular basis with the income streams discounted by prevailing like-term
rates at the time of sale. Gains or losses resulting from the sale of net rental
payments from such leases are recorded as net sales. We establish and maintain
reserves against potential recourse following the resales based upon historical
loss experience, past due accounts and specific account analysis. The allowance
for uncollectible minimum lease payments and recourse liability at the end of
the year represent reserves against the entire lease portfolio. Management
reviews the adequacy of the allowance on a regular basis and adjusts the
allowance as required. These reserves are either netted in the accounts
receivable, 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-balance sheet leases.
38
GOODWILL AND OTHER INTANGIBLE ASSETS. We assess the impairment of goodwill
and other identifiable intangibles whenever events or changes in circumstances
indicate that the carrying value may not be recoverable. Some factors we
consider important which could trigger an impairment review include the
following:
* Significant under-performance relative to historical, expected or
projected future operating results;
* Significant changes in the manner of our use of the acquired assets or
the strategy for our overall business;
* Our market capitalization relative to net book value, and
* Significant negative industry or economic trends.
When we determine that the carrying value of goodwill and other identified
intangibles may not be recoverable, we measure any impairment based on a
projected discounted cash flow method using a discount rate determined by our
management to be commensurate with the risk inherent in our current business
model. In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
on January 1, 2002, we ceased amortizing goodwill arising from acquisitions
completed prior to July 1, 2001. 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 October 1, 2002 and has determined that the carrying
amount of goodwill is not impaired.
Inter-Tel has adopted SFAS 142 effective January 1, 2002. Application of
the nonamortization provisions of SFAS 142 resulted in an increase in income
from continuing operations before income taxes of approximately $1.8 million in
2002.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. We maintain allowances for doubtful
accounts for estimated losses resulting from the inability of our customers to
make required payments. Additional reserves or allowances for doubtful accounts
are recorded for our sales-type leases, discussed above in "Sales-Leases." We
establish and maintain reserves against estimated losses based upon historical
loss experience, past due accounts and specific account analysis. Management
reviews the level of the allowances for doubtful accounts on a regular basis and
adjusts the level of the allowances as needed. At December 31, 2002, our
allowance for doubtful accounts for accounts receivable were $12.2 million of
our $54.7 million in gross accounts receivable. If the financial condition of
our customers or channel partners were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances may be
required.
INVENTORIES. We value our inventories at lower of cost or market. Cost is
determined by the first-in, first-out (FIFO) method, including material, labor
and factory overhead. Significant management judgment is required to determine
the reserve for obsolete or excess inventory. Inventory on hand may exceed
future demand either because the product is outdated, or obsolete, or because
the amount on hand is more than can be used to meet future need, or excess. We
currently consider all inventory that has no activity within one year as well as
any additional specifically identified inventory to be excess. We also provide
for the total value of inventories that we determine to be obsolete based on
criteria such as customer demand, product life-cycles, changing technologies and
market conditions. We write down our excess and obsolete inventory equal to the
difference between the cost of inventory and the estimated market value. At
December 31, 2002, our inventory reserves were $10.6 million of our $21.9
million gross inventories. If actual customer demand, product life-cycles,
changing technologies and market conditions are less favorable than those
projected by management, additional inventory write-downs may be required.
CONTINGENCIES. We are a party to various claims and litigation in the
normal course of business. Management's current estimated range of liability
related to various claims and pending litigation is based on claims for which
our management can estimate the amount and range of loss. Because of the
uncertainties related to both the amount and range of loss on the remaining
pending claims and litigation, management is unable to make a reasonable
estimate of the liability that could result from an unfavorable outcome. As
additional information becomes available, we will assess the potential liability
related to our pending litigation and revise our estimates. Such revisions in
our estimates of the potential liability could materially impact our results of
operations and financial position.
39
Divisions of the United States Department of Justice are investigating
other companies' and Inter-Tel's participation in a federally-funded "E-Rate
program" to connect schools and libraries to the Internet. The Justice
Department has not provided Inter-Tel with a description of the evidence on
which the investigations are based. Inter-Tel is presently unable to predict or
determine the final outcome of, or to estimate the potential range of loss (if
any) with respect to, the investigations. If Inter-Tel is convicted of any crime
or subjected to sanctions, or if penalties, damages or other monetary remedies
are assessed against Inter-Tel in connection with any investigations, our
business and operating results could be materially and adversely affected. Based
upon the information known at this time, we do not expect the investigations to
result in a material adverse impact upon the Company's business or financial
condition. Nevertheless, the early nature of the investigations makes it
difficult to determine whether the likelihood of a material adverse outcome is
unlikely.
RECENT ACCOUNTING PRONOUNCEMENTS
In August 2001, the Financial Accounting Standards Board ("SFAS") issued
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets",
which addresses financial accounting and reporting for the impairment or
disposal of long-lived assets and supersedes SFAS No. 121, "Accounting for the
Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets to be
Disposed Of," and the accounting and reporting provisions of APB Opinion No. 30,
"Reporting the Results of Operations" for a disposal of a segment of a business.
SFAS No. 144 was effective for fiscal years beginning after December 15, 2001,
with earlier application encouraged. The Company's adoption of SFAS No. 144 had
no effect on the Company's financial position or results of operation.
In June 2002, the Financial Accounting Standards Board issued SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146
supersedes Emerging Issues Task Force ("EITF") No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(Including Certain Costs Incurred in a Restructuring)." SFAS No. 146 eliminates
the provisions of EITF No. 94-3 that required a liability to be recognized for
certain exit or disposal activities at the date an entity committed to an exit
plan. SFAS No. 146 requires a liability for costs associated with an exit or
disposal activity to be recognized when the liability is incurred. SFAS No. 146
is effective for exit or disposal activities that are initiated after December
31, 2002. The Company does not expect the adoption of this statement to have a
material impact on its results of operations or financial position.
In December 2002, the Financial Accounting Standards Board issued SFAS No.
148, "Accounting for Stock-Based Compensation -- Transition and Disclosure."
SFAS No. 148 amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition to SFAS No. 123's
fair value method of accounting for stock-based employee compensation. Statement
148 also amends the disclosure provisions of SFAS No. 123 and APB Opinion No.
28, "Interim Financial Reporting," to require disclosure in the summary of
significant accounting policies of the effects of an entity's accounting policy
with respect to stock-based employee compensation on reported net income and
earnings per share in annual and interim financial statements. While SFAS No.
148 does not amend SFAS No. 123 to require companies to account for employee
stock options using the fair value method, the disclosure provisions of SFAS No.
148 are applicable to all companies with stock-based employee compensation,
regardless of whether they account for that compensation using the fair value
method of SFAS No. 123 or the intrinsic value method of APB Opinion No. 25. As
allowed by SFAS No. 123, the Company has elected to continue to utilize the
accounting method prescribed by APB Opinion No. 25 and has adopted the
disclosure requirements of SFAS No. 123 as of December 31, 2002. We do not
expect the adoption of this statement to have an impact on our results of
operations or financial position.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about our market risk disclosures involves
forward-looking statements. Actual results could differ materially from those
projected in the forward-looking statements. We are exposed to market risk
related to changes in interest rates and foreign currency exchange rates. We do
not use derivative financial instruments.
INVESTMENT PORTFOLIO. We do not use derivative financial instruments in our
non-trading investment portfolio. Inter-Tel maintains a portfolio of highly
liquid cash equivalents typically maturing in three months or
40
less as of the date of purchase. Inter-Tel places its investments in instruments
that meet high credit quality standards, as specified in our investment policy
guidelines.
The Company also maintains short-term investments, which are all classified
as available for sale, and have been recorded at fair value, which approximates
cost. Short-term investments include certificates of deposit, auction rate
certificates, auction rate preferred securities, municipal preferred securities
and mutual funds. The auction rate securities are adjustable-rate securities
with dividend rates that are reset periodically by bidders through periodic
"Dutch auctions" generally conducted every 7 to 49 days by a trust company or
broker/dealer on behalf of the issuer. The Company believes these securities are
highly liquid investments through the related auctions; however, the
collateralizing securities have stated terms of up to thirty (30) years. These
instruments are rated A or higher by Standard & Poor's Ratings Group, or
equivalent. The Company's short-term investments are intended to establish a
high-quality portfolio that preserves principal, meets liquidity needs, avoids
inappropriate concentrations and delivers an appropriate yield in relationship
to the Company's investment guidelines and market conditions. Given the
short-term nature of these investments, and that we have no borrowings
outstanding other than short-term letters of credit, we are not subject to
significant interest rate risk.
LEASE PORTFOLIO. We offer to our customers lease financing and other
services, including our Total Solutions program, through our Inter-Tel Leasing
subsidiary. We fund these programs in part through the sale to financial
institutions of rental payment streams under the leases. Upon the sale of the
rental payment streams, we continue to service the leases and maintain limited
recourse on the leases. We maintain reserves for loan losses on all leases based
on historical loss experience, past due accounts and specific account analysis.
Although to date we have been able to resell the rental streams from leases
under our lease programs profitably and on a substantially current basis, the
timing and profitability of lease resales could impact our business and
operating results, particularly in an environment of fluctuating interest rates
and economic uncertainty. If we were required to repurchase rental streams and
realize losses thereon in amounts exceeding our reserves, our operating results
could be materially adversely affected. See "Liquidity and Capital Resources" in
Management's Discussion and Analysis and Notes A and D of Notes to Consolidated
Financial Statements for more information regarding our lease portfolio and
financing.
IMPACT OF FOREIGN CURRENCY RATE CHANGES. We invoice the customers of our
international subsidiaries primarily in the local currencies of our subsidiaries
for product and service revenues. Inter-Tel is exposed to foreign exchange rate
fluctuations as the financial results of foreign subsidiaries are translated
into U.S. dollars in consolidation. The impact of foreign currency rate changes
have historically been insignificant.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is incorporated by reference to
Exhibit 13.0.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
41
PART III
Certain information required by Part III is omitted from this report in
that the Registrant will file a definitive proxy statement pursuant to
Regulation 14A (the "Proxy Statement") not later than 120 days after the end of
the fiscal year covered by this Report, and the information included therein is
incorporated herein by reference to the extent stated below.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to directors and executive officers is included at
the end of Part I, Item 1 on this report under the caption "Directors and
Executive Officers of the Registrant."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the
Company's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the
Company's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
ITEM 14. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
conducted an evaluation of the effectiveness of the design and operation of our
disclosure controls and procedures, as defined in Rules 13a-14(c) and 15d-14(c)
under the Securities Exchange Act of 1934, as amended, within 90 days of the
filing date of this report (the "Evaluation Date"). Based on this evaluation,
our principal executive officer and principal financial officer concluded as of
the Evaluation Date that our disclosure controls and procedures were effective
such that the material information required to be included in our Securities and
Exchange Commission ("SEC") reports is recorded, processed, summarized and
reported within the time periods specified in SEC rules and forms relating to
Inter-Tel, including our consolidated subsidiaries, and was made known to them
by others within those entities, particularly during the period when this report
was being prepared.
In addition, there were no significant changes in our internal controls or
in other factors that could significantly affect these controls subsequent to
the Evaluation Date. We have not identified any significant deficiencies or
material weaknesses in our internal controls, and therefore there were no
corrective actions taken.
42
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. FINANCIAL STATEMENTS
The following consolidated financial statements of Inter-Tel, Incorporated, and
subsidiaries, are incorporated by reference to Exhibit 13.0:
Report of Ernst & Young LLP, Independent Auditors
Consolidated balance sheets--December 31, 2002 and 2001
Consolidated statements of operations--years ended December 31, 2002,
2001 and 2000
Consolidated statements of shareholders' equity--years ended December 31,
2002, 2001 and 2000
Consolidated statements of cash flows--years ended December 31, 2002, 2001
and 2000 Notes to consolidated financial statements
2. FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statement schedule of Inter-Tel,
Incorporated, and subsidiaries is filed as part of this Report and should be
read in conjunction with the Consolidated Financial Statements of Inter-Tel,
Incorporated and subsidiaries, and the notes thereto.
Schedule for the three years ended December 31, 2002:
Schedule II--Valuation and Qualifying Accounts Page No. 50
Schedules not listed above have been omitted because they are not
applicable or are not required or the information required to be set forth
therein is included in the Consolidated Financial Statements or notes thereto.
3. EXHIBITS
3.1(10) Articles of Incorporation, as amended.
3.2(16) By-Laws, as amended.
10.15(1) Registrant's form of standard Distributor Agreement.
10.16(1) Registrant's form of standard Service Agreement.
10.34(2)* 1984 Incentive Stock Option Plan and forms of Stock Option
Agreement.
10.35(3) Agreement between Registrant and Samsung Semiconductor and
Telecommunications Company, Ltd. dated October 17, 1984.
10.37(3)* Tax Deferred Savings Plan.
10.51(11)* 1990 Directors' Stock Option Plan and form of Stock Option
Agreement.
10.52(15)* Inter-Tel, Incorporated Long-Term Incentive Plan and forms of
Stock Option Agreements.
10.53(12) Agreement between Registrant and Maxon Systems, Inc. dated
February 27, 1990.
10.54(12) Agreement between Registrant and Varian Tempe Electronics
Center dated February 26, 1991.
10.55(12) Agreement between Registrant and Jetcrown Industrial Ltd. dated
February 18, 1993.
10.56(13)* Employee Stock Ownership Plan.
10.57(14) Loan and Security Agreement dated March 4, 1997 between Bank
One, Arizona, N.A. and Registrant and Modification Agreement
dated July 25, 1997.
43
10.58(16) Development, Supply and License Agreement between Registrant
and QUALCOMM dated January 17, 1996.
10.59(17)* Inter-Tel, Incorporated 1997 Long-Term Incentive Plan.
10.60(18)* Inter-Tel, Incorporated 1997 Employee Stock Purchase Plan.
10.61(19)* Inter-Tel, Incorporated Acquisition Stock Option Plan and form
of Stock Option Agreement.
10.61(20) Computer Telephony Asset Purchase Agreement dated as of
October 17, 1999 by and between Executone Information Systems,
Inc., Inter-Tel, Incorporated and Executone Inter-Tel Business
Information Systems, Inc.
13.0(21) Excerpts from Annual Report to Security Holders.
- ----------
(1) Incorporated by reference to Registrant's Registration Statement on Form
S-1 (File No. 2-70437).
(2) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (File No. 2-94805).
(3) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the year ended November 30, 1984 (File No. 0-10211).
(10) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the year ended December 31, 1988 (File No. 0-10211).
(11) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (File No. 33-40353).
(12) Incorporated by reference to Registrant's Registration Statement on Form
S-1 (File No. 33-70054).
(13) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (File No. 33-73620).
(14) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the year ended December 31, 1998 (File No. 0-10211).
(15) Incorporated by reference to Registrant's Proxy Statement dated March 23,
1994 and to Registrant's Registration Statement on Form S-8 (File No.
33-83826).
(16) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the year ended December 31, 1995 (File No. 0-10211).
(17) Incorporated by reference to Registrant's Registration Statements on Forms
S-8 (File Nos. 333-41197 and 333-85098).
(18) Incorporated by reference to Registrant's Registration Statements on Forms
S-8 (File Nos. 333-41197 and 333-87474).
(19) Incorporated by reference to Registrant's Registration Statements on Forms
S-8 (File Nos. 333-56872, 333-67261 and 333-85098).
(20) Incorporated by reference to Registrant's Report on Form 8-K (File No.
333-67261).
(21) Filed herewith, except as noted.
* Management contracts or compensatory plan or arrangement required to be
filed as an exhibit to this report on Form 10-K.
(b) Reports on Form 8-K. None.
44
(c) Exhibits.
13.0 Excerpts from Annual Report to Security Holders. Filed herewith.
21.0 Subsidiaries of Inter-Tel, Incorporated.
23.0 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney.
99.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
99.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
See Item 15(a) 3 also.
(d) Financial Statement Schedule. The response to this portion of Item 15 is
submitted as a separate section of this report. See Item 8.
45
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant, Inter-Tel, Incorporated, has duly caused
this Report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INTER-TEL, INCORPORATED
BY: /s/ Steven G. Mihaylo
------------------------------------
Steven G. Mihaylo
Chairman and Chief Executive Officer
Dated: March 19, 2003
46
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AS ADOPTED
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Steven G. Mihaylo, certify that:
1. I have reviewed this annual report on Form 10-K of Inter-Tel, Incorporated;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ STEVEN G. MIHAYLO
------------------------------------
Steven G. Mihaylo
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
Date: March 19, 2003 (PRINCIPAL EXECUTIVE OFFICER)
47
CERTIFICATION OF CHIEF FINANCIAL OFFICER AS ADOPTED
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Kurt R. Kneip, certify that:
1. I have reviewed this annual report on Form 10-K of Inter-Tel, Incorporated;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
/s/ KURT R. KNEIP
------------------------------------
Kurt R. Kneip,
SENIOR VICE PRESIDENT AND CHIEF
FINANCIAL OFFICER
Date: March 19, 2003 (PRINCIPAL FINANCIAL OFFICER)
48
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
COL. A COL. B COL. C COL. D COL. E
--------- ---------- -------- -------- ------
ADDITIONS
Charged
Balance at Charged to Other Charged to Balance
Beginning to Costs Accounts Deductions at End of
DESCRIPTION of Period & Expenses Describe Describe Period
----------- --------- ---------- -------- -------- ------
YEAR ENDED DECEMBER 31, 2002
Deducted from asset accounts:
Allowance for doubtful accounts $ 11,858 $ 4,177 $ 517 (4) $ 4,393 (2) $ 12,159
Allowance for lease accounts 10,736 6,356 -- 4,040 (2) 13,052
Inventory allowance 13,202 1,526 -- 4,170 (3) 10,558
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 9,200 5,840 -- 4,304 (2) 10,736
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 6,891 4,927 -- 2,618 (2) 9,200
Inventory allowance 5,849 1,653 6,278 (4) 1,883 (3) 11,897
- ----------
(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 or sold.
(4) Acquired in purchase transaction.
49