MARKET FOR THE REGISTRANT'S COMMON STOCK AND
RELATED STOCKHOLDER MATTERS
Inter-Tel common stock is traded over-the-counter (symbol INTL) and
since February 1983 has been included in the Nasdaq National Market System. As
of February 1, 1997 there were of record approximately 1,000 shareholders of the
Company's common stock. The Company believes there are approximately 2,000
additional beneficial holders of the Company's common stock. The following table
sets forth high and low closing prices reported by Nasdaq.
Inter-Tel has never paid a cash dividend on its common stock and
presently does not intend to do so. Future dividend policy will depend on
Company earnings, capital requirements for growth, financial conditions and
other factors.
1996 High Low
First Quarter 18 1/2 11 3/8
Second Quarter 28 3/8 17 1/2
Third Quarter 26 5/8 16
Fourth Quarter 24 1/2 12
1995 High Low
First Quarter 13 6 7/8
Second Quarter 16 1/8 11 9/16
Third Quarter 19 3/4 14 7/8
Fourth Quarter 17 3/8 13 7/8
29
SELECTED FINANCIAL DATA
Financial Summary (1)
(In thousands, except
per share amounts and ratios) For the years ended December 31,
1996 1995 1994 1993 1992
Net sales $185,884 $150,533 $123,878 $103,373 $88,120
Cost of sales 104,966 87,696 74,033 63,088 54,031
Research & development 6,581 5,764 4,537 4,114 3,928
Selling, general and
administrative 56,386 43,578 36,502 29,682 25,040
Special charge 4,542 (2) 1,315 (3) -- -- --
- - ----------------------------------------------------------------------------------------------------------
Operating income 13,409 (2) 12,180 (3) 8,806 6,489 5,121
- - ----------------------------------------------------------------------------------------------------------
Interest and other income 1,974 1,674 904 282 680
Interest expense (77) (106) (122) (449) (736)
- - ----------------------------------------------------------------------------------------------------------
Income before income taxes 15,306 (2) 13,748 (3) 9,588 6,322 5,065
Income taxes 6,264 5,249 3,648 2,381 1,901
- - ----------------------------------------------------------------------------------------------------------
Net income $9,042 (2) $8,499 (3) $5,940 $3,941 $3,164
- - ----------------------------------------------------------------------------------------------------------
Net income per share $0.68 (2) $0.71 (3) $0.54 $0.44 $0.37
- - ----------------------------------------------------------------------------------------------------------
Average shares outstanding 13,395 12,001 10,900 9,030 8,660
- - ----------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA
Total assets $132,611 $118,767 $67,748 $57,467 $37,838
Working capital 79,709 75,623 37,220 34,244 12,484
Long-term debt -- -- -- 188 2,184
Shareholders' equity 94,934 85,117 45,122 38,605 19,375
- - ----------------------------------------------------------------------------------------------------------
KEY RATIOS
Current ratio 4.09 4.36 3.25 3.32 1.87
Term debt/equity -- -- -- -- 0.11
Return on equity-continuing operations 0.11 0.19 0.15 0.20 0.19
- - ----------------------------------------------------------------------------------------------------------
(1) Financial data for all periods have been restated to reflect the acquisition
of Florida Telephone Systems, Inc. in May 1996 accounted for as a pooling of
interests.
(2) Operating income includes a special charge of $4.5 million, which reduced
net income by $2.7 million or $.20 per share. This special charge reflects the
decision by the Company to replace its MIS system software. Without this special
charge, the Company would have reported operating income of approximately $18.0
million and net income of approximately $11.8 million, or $.88 per share in the
year ended December 31, 1996.
(3) Operating income includes a special charge of $1.3 million, which reduced
net income by $815,000, or $.07 per share. This special charge reflects the
costs associated with integrating the operations of entities acquired in May
1995. Without this special charge, the Company would have reported operating
income of approximately $13.5 million and net income of approximately $9.3
million, or $.78 per share, in the year ended December 31, 1995.
30
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
Inter-Tel is a single point of contact, full service solutions
integrator providing AXXESS and Axxent digital business communication platforms,
AXXESSORY Talk voice processing platforms, call processing and voice processing
software along with various other productivity enhancing software applications,
computer telephone integration, and network services and long distance calling
services, as well as maintenance, leasing and support services. The Company's
Common Stock is quoted on the NASDAQ National Market System under the symbol
INTL.
The Company has developed networks of direct sales offices, dealers and
value added resellers (VARs) which sell the Company's products. In recent
periods, the Company has focused on expanding its direct sales capabilities and
its dealer and VAR network. The Company has acquired a number of resellers of
telephony products and integrated these operations with its existing direct
sales operations in the same geographic areas and in other strategic markets.
Sales of systems through the Company's dealers and VARs typically
generate lower gross margins than sales through the Company's direct sales
organization, although direct sales typically require higher levels of selling,
general and administrative expenses. In addition, the Company's long distance
and network services typically generate lower gross margins than sales of
software and system products. Accordingly, the Company's 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, the Company's overall gross margin could decline.
The Company's 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 mix of distribution channels, general economic conditions,
patterns of capital spending by customers, the timing of new product
announcements and releases by the Company and its competitors, pricing pressures
and the availability and cost of products and components from the Company's
suppliers. In addition, the Company is subject to seasonality in its 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 served by the Company have been characterized by rapid
technological changes and increasing customer requirements. The Company has
sought to address these requirements through the development of software
enhancements and improvements to existing systems and the introduction of new
products and applications. The Company's research and development efforts over
the last several years have been focused primarily on developing new products
such as the Inter-Tel Axxent system, enhancing the CTI capabilities of the
AXXESS digital communications platform, as well as expanding the capacity of the
Company's AXXESS and AXXESSORY Talk systems. Current efforts are related to
support of industry standard CTI interfaces, development of additional
applications and features, the development of an internet voice server
(Vocal'Net), and the development of a LAN-based Communications Server
incorporating the Company's Call Processing and Voice Processing software. New
applications under development include Basic Rate ISDN,
31
networking, and unified messaging. The software-based architecture of the AXXESS
system facilitates maintenance and support, upgrades, and incorporation of
additional features and functionality.
The Company offers to its customers a package of lease financing and
other services under the name Totalease. Totalease provides to customers lease
financing, maintenance and support services, fixed price upgrades and other
benefits. The Company finances this program through the periodic resale of lease
rental streams to financial institutions.
Net sales of the Company have increased substantially in each of the
past three years. Such increases were 23.5%, 21.5% and 19.8% in 1996, 1995 and
1994, respectively, over the preceding year. All periods have been restated to
reflect the acquisition of Florida Telephone Systems, Inc. in May 1996, which
was accounted for as a pooling of interests.
Results of Operations
The following table sets forth certain statement of operations data of
the Company expressed as a percentage of net sales for the periods indicated:
Year Ended December 31
1996 1995 1994
---- ---- ----
Net sales 100.0% 100.0% 100.0%
Cost of sales 56.5 58.3 59.8
----- ----- -----
Gross margin 43.5 41.7 40.2
Research and development 3.5 3.8 3.6
Selling, general and administrative 30.3 28.9 29.5
Special charge 2.5 0.9 0.0
----- ----- -----
Operating income 7.2 8.1 7.1
Other income 1.1 1.1 0.7
Interest expense 0.0 0.1 0.1
Income taxes 3.4 3.5 2.9
----- ----- -----
Net income 4.9% 5.6% 4.8%
----- ----- -----
Year Ended December 31, 1996 Versus Year Ended December 31, 1995
Net sales increased 23.5% to $185.9 million in 1996 from $150.5 million
in 1995. Sales from direct sales offices accounted for approximately $14.7
million of the increase, and increased sales from wholesale distribution
accounted for approximately $12.2 million of the increase. The remaining
increases occurred in long distance sales and other operations.
Gross profit increased to $80.9 million, or 43.5% of net sales in 1996
from $62.8 million, or 41.7% of net sales in 1995. This reflected the continuing
transition to the dealer network and the expansion of AXXESS software and
systems sales.
Research and development expenses increased to $6.6 million, or 3.5% of
net sales in 1996 from $5.8 million, or 3.8% of net sales, in 1995. These
expenses in both 1996 and 1995 were directed principally to the continued
development of the AXXESS and Inter-Tel Axxent software and systems, unified
messaging and voice processing software, Vocal'Net
32
and Vocal'Net server, and CTI applications. The Company expects that research
and development expenses will continue to increase in absolute dollars as the
Company continues 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 expenses increased to $56.4
million, or 30.3% of net sales in 1996, from $43.6 million, or 28.9% of net
sales, in 1995. This reflected increased incentive and other compensation, costs
associated with the implementation of the Company's information systems,
additional personnel to support the direct dealer network and expanded long
distance operations, and expenses associated with the expansion of international
operations. The Company expects that selling, general and administrative
expenses will increase in absolute dollars, but may vary as a percentage of net
sales.
During the fourth quarter of 1996, the Company decided to replace its
MIS system software with an integrated solution from a more established vendor
and accordingly wrote off the software license and implementation costs relating
to the system software being replaced. The special pre-tax charge of $4.5
million ($.20 per share after tax), reflects the costs associated with the
Company's decision to abandon its current MIS software in favor of different
system software.
Other income increased in 1996 principally from the investment of the
funds received from the August 1995 public offering and funds generated through
operating cash flow.
Net income increased 6.4% to $9.0 million, or $.68 per share, in 1996
including the special charge recognized in the fourth quarter, compared to $8.5
million, or $.71 per share, in 1995. Excluding the special charges in both
periods, net income would have been $11.8 million, or $.88 per share, for 1996
compared to $9.3 million, or $.78 per share for 1995. In addition, net income
per share in 1996 is based on an additional 2.0 million average shares
outstanding in 1996, reflecting the August 1995 public stock offering.
Year Ended December 31, 1995 Versus Year Ended December 31, 1994
Net sales increased 21.5% to $150.5 million in 1995 from $123.9 million
in 1994. Sales from direct sales offices accounted for approximately $9.5
million of the increase, with wholesale distribution sales increasing
approximately $11.2 million. The remaining increases occurred in long distance
sales and other operations.
Gross profit increased to $62.8 million, or 41.7% of net sales in 1995
from $49.8 million, or 40.2% of net sales in 1994. This reflected the transition
to the direct dealer network and the expansion of AXXESS software and systems
sales.
Research and development expenses increased to $5.8 million, or 3.8% of
net sales in 1995 from $4.5 million, or 3.6% of net sales, in 1994. These
expenses in both 1995 and 1994 were directed principally to the continued
development of the AXXESS and Inter-Tel Axxent software and systems, unified
messaging and voice processing software applications and CTI applications.
Selling, general and administrative expenses increased to $43.6
million, or 28.9% of net sales in 1995, from $36.5 million, or 29.5% of net
sales, in 1994. This reflected
33
increased incentive and other compensation, costs associated with the
implementation of new information systems, additional personnel to support the
direct dealer network and expanded long distance operations, and expenses
associated with expansion of operations of the Company's Asian subsidiary.
The special pre-tax charge of $1.3 million ($.07 per share after tax),
reflects the costs associated with integrating the operations of American Telcom
Corp. of Georgia, Inc. and Access West, Inc. The special charge principally
includes costs associated with redundancy in inventories, equipment abandonment,
the combination and relocation of business operations, employee reductions and
the write-off of intangible assets.
Other income increased in 1995 principally from the investment of the
funds received from the August 1995 public offering and funds generated through
operating cash flow.
Net income increased 43.1% to $8.5 million, or $.71 per share, in 1995
after a special charge recognized in the second quarter, from $5.9 million, or
$.54 per share, in 1994. Without the special charge, net income would have been
$9.3 million, or $.78 per share, for the year. In addition, net income per share
in 1995 is based on an additional 2 million average shares outstanding in August
1995, reflecting the 1995 public stock offering.
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 domestic
sources. The expansion of international operations in the United Kingdom and
Europe and anticipated increased sales in Japan and Asia and elsewhere could
result in higher international sales as a percentage of total revenues, but
international revenues are currently not significant.
Liquidity and Capital Resources
The Company continues to expand its dealer and direct sales network,
which has required and is expected to require working capital for increased
accounts receivable and inventories. During 1996, receivables and inventories
increased approximately $909,000. This increase was principally funded by cash
flow from operations and existing cash balances. The Company also expended
approximately $7.0 million during 1996 for property and equipment, which was
principally funded by operating cash flow. At December 31, 1996, the Company had
$38.9 million in cash and equivalents, which represents a decrease of
approximately $704,000 from December 31, 1995.
The Company has a loan agreement with Bank One, Arizona, NA which
provides for a $5.0 million, unsecured revolving line of credit. The credit
facility is annually renewable and is available through April 30, 1997. Under
the credit facility, the Company has the option to borrow at a prime rate or
adjusted LIBOR interest rate. During the year ended December 31, 1996, the
credit facility was used primarily to support international letters of credit to
suppliers. In August 1995, the Company received approximately $30.7 million from
a public offering. The proceeds were used to finance acquisitions, for working
capital, capital expenditures and other general corporate purposes.
34
The Company offers to its customers lease financing and other services,
including its Totalease program, through its Inter-Tel Leasing subsidiary. The
Company funds its Totalease program in part through the sale to financial
institutions of rental income streams under the leases. Resold Totalease rentals
totaling $66.0 million remain unbilled at December 31, 1996. The Company is
obligated to repurchase such income streams in the event of defaults by lease
customers and, accordingly, maintains reserves based on loss experience and past
due accounts. Although the Company to date has been able to resell the rental
streams from leases under the Totalease program profitably and on a
substantially current basis, the timing and profitability of lease resales could
impact the Company's business and operating results, particularly in an
environment of fluctuating interest rates. If the Company is required to
repurchase rental streams and realizes losses thereon in amounts exceeding its
reserves, its operating results will be adversely affected.
The Company believes that its working capital and credit facilities,
together with cash generated from operations, will be sufficient to fund
purchases of capital equipment, finance cash acquisitions which the Company may
consider and provide adequate working capital for the foreseeable future.
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, the Company will seek
additional financing. There can be no assurance that additional financing will
be available when required or on acceptable terms.
35
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Ernst & Young LLP, Independent Auditors
Shareholders and Board of Directors
Inter-Tel, Incorporated
We have audited the accompanying consolidated balance sheets of Inter-Tel,
Incorporated and subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Inter-Tel,
Incorporated and subsidiaries at December 31, 1996 and 1995, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
/s/Ernst & Young LLP
Phoenix, Arizona
February 28, 1997
36
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1996 and 1995
(In thousands)
- - ------------------------------------------------------------------------------------------------------
1996 1995
ASSETS
CURRENT ASSETS
Cash and equivalents $ 38,936 $ 39,640
Accounts receivable, less allowances of
$3,096 in 1996 and $1,822 in 1995 29,998 29,789
Inventories, less allowances of $2,979 in
1996 and $2,499 in 1995 21,280 20,580
Net investment in sales-leases 8,243 3,629
Prepaid expenses and other assets 7,008 4,501
- - ------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 105,465 98,139
PROPERTY, PLANT & EQUIPMENT 11,189 11,813
OTHER ASSETS` 15,957 8,815
- - ------------------------------------------------------------------------------------------------------
$ 132,611 $ 118,767
- - ------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 8,915 $ 11,262
Other current liabilities 16,841 11,254
- - ------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 25,756 22,516
DEFERRED TAX LIABILITY 8,635 7,228
OTHER LIABILITIES 3,286 3,906
SHAREHOLDERS' EQUITY
Common stock, no par value - authorized 30,000,000
shares, issued and outstanding -- 12,944,286 shares
in 1996 and 12,812,874 shares in 1995 59,875 58,966
Retained earnings 35,464 26,422
Currency translation adjustment (359) (112)
- - ------------------------------------------------------------------------------------------------------
94,980 85,276
Less receivable from Employee Stock Ownership Trust (46) (159)
- - ------------------------------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 94,934 85,117
- - ------------------------------------------------------------------------------------------------------
$ 132,611 $ 118,767
- - ------------------------------------------------------------------------------------------------------
See accompanying notes.
37
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 1996, 1995 and 1994
(In thousands, except per share data)
- - ------------------------------------------------------------------------------------------------------
1996 1995 1994
---- ---- ----
NET SALES $185,884 $150,533 $123,878
Cost of sales 104,966 87,696 74,033
- - ------------------------------------------------------------------------------------------------------
GROSS PROFIT 80,918 62,837 49,845
Research and development 6,581 5,764 4,537
Selling, general and administrative 56,386 43,578 36,502
Special charge 4,542 1,315 --
- - ------------------------------------------------------------------------------------------------------
OPERATING INCOME 13,409 12,180 8,806
- - ------------------------------------------------------------------------------------------------------
Other income 1,974 1,674 904
Interest expense (77) (106) (122)
- - ------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 15,306 13,748 9,588
INCOME TAXES
Current 3,480 1,007 2,929
Deferred 2,784 4,242 719
- - ------------------------------------------------------------------------------------------------------
6,264 5,249 3,648
- - ------------------------------------------------------------------------------------------------------
NET INCOME $9,042 $8,499 $5,940
- - ------------------------------------------------------------------------------------------------------
NET INCOME PER SHARE $ 0.68 $ 0.71 $ 0.54
- - ------------------------------------------------------------------------------------------------------
Average number of common
shares outstanding 13,395 12,001 10,900
- - ------------------------------------------------------------------------------------------------------
See accompanying notes.
38
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 1996, 1995 and 1994
(In thousands)
- - ----------------------------------------------------------------------------------------------------------------------
Currency Receivable
Common Retained Translation From
Stock Earnings Adjustment ESOP Total
----- -------- ---------- ---- -----
- - ----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1993 $ 27,254 $ 11,983 $ (293) $ (369) $ 38,575
Exercise of stock options 187 187
Tax benefit from stock options 103 103
Stock issued in acquisition 41 41
Net income 5,940 5,940
Gain on currency translation 171 171
Collection from ESOP 105 105
- - ----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1994 27,585 17,923 (122) (264) 45,122
Issuance of 2,000,000 shares
of common stock 30,670 30,670
Exercise of stock options 503 503
Tax benefit from stock options 208 208
Net income 8,499 8,499
Gain on currency translation 10 10
Collection from ESOP 105 105
- - ----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 58,966 26,422 (112) (159) 85,117
- - ----------------------------------------------------------------------------------------------------------------------
Exercise of stock options 611 611
Tax benefit from stock options 417 417
Escrow share cancellation from
prior stock acquisition (119) (119)
Net income 9,042 9,042
Loss on currency translation (247) (247)
Collection from ESOP 113 113
- - ----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 $ 59,875 $ 35,464 $ (359) $ (46) $ 94,934
- - ----------------------------------------------------------------------------------------------------------------------
See accompanying notes.
39
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1996, 1995 and 1994
(In thousands)
- - -----------------------------------------------------------------------------------------------------------
1996 1995 1994
---- ---- ----
OPERATING ACTIVITIES:
Net income $ 9,042 $ 8,499 $ 5,940
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 4,097 2,267 1,663
Provision for losses on receivables 3,746 1,594 957
Provision for inventory valuation 609 1,109 561
Net contribution to ESOP 113 105 105
(Decrease)/increase in other liabilities (604) 1,111 603
Loss/(Gain) on sale of property and equipment 3,421 16 (18)
Deferred income taxes 2,784 4,242 719
Effect of exchange rate changes (247) 10 171
Changes in operating assets and liabilities (15,704) (18,141) (5,911)
- - -----------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 7,257 812 4,790
- - -----------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Additions to property and equipment (6,951) (7,921) (3,882)
Proceeds from sale of property and equipment 159 9 63
Cash used in acquisitions (1,780) -- (131)
- - -----------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING
ACTIVITIES (8,572) (7,912) (3,950)
- - -----------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Payments on long-term debt -- -- (172)
Net proceeds from stock offering -- 30,670 --
Proceeds from exercise of stock options 611 503 187
- - -----------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY
FINANCING ACTIVITIES 611 31,173 15
- - -----------------------------------------------------------------------------------------------------------
INCREASE (DECREASE)
IN CASH AND EQUIVALENTS (704) 24,073 855
CASH AND EQUIVALENTS AT BEGINNING
OF YEAR 39,640 15,567 14,712
- - -----------------------------------------------------------------------------------------------------------
CASH AND EQUIVALENTS AT END OF YEAR $ 38,936 $ 39,640 $ 15,567
- - -----------------------------------------------------------------------------------------------------------
See accompanying notes.
40
INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
- - --------------------------------------------------------------------------------
NOTE A -- SIGNIFICANT ACCOUNTING POLICIES
Description of Business: The Company is in the business of developing
and providing telephone systems, voice processing CTI, and network and long
distance calling services to businesses principally throughout the United
States, as well as providing leasing, support and maintenance services through a
direct sales and reseller network.
Principles of Consolidation: The consolidated financial statements
include the accounts of Inter-Tel, Incorporated and all significant subsidiaries
(the Company). Intercompany accounts and transactions have been eliminated in
consolidation.
Cash and Equivalents: Cash and equivalents include all highly liquid
investments with a remaining maturity of three months or less at date of
acquisition. Excess cash and equivalents are primarily invested in mutual funds
comprised of foreign and domestic high quality dollar denominated money market
instruments rated A-1 by Standard & Poor's Ratings Group, or equivalent.
Inventories: Inventories, consisting principally of telephone systems,
computer equipment and related components, are stated at the lower of cost
(first-in, first-out method) or market.
Property, Plant and Equipment: Property, plant and equipment is stated
at cost. Depreciation is computed using the straight-line method over the
estimated useful life of the related property. Leasehold improvements are
depreciated over the shorter of the related lease terms or the estimated useful
lives of the improvements.
Excess of Purchase Price Over Net Assets Acquired: Purchase prices of
acquired businesses that are accounted for as purchases have been allocated to
the assets and liabilities acquired based on the estimated fair values on the
respective acquisition dates. Based on these values, the excess purchase prices
over the fair value of the net assets acquired are being amortized over 3 to 40
years. Accumulated amortization through December 31, 1996 was $571,390.
Sales-Leases: The discounted present values of minimum rental payments
under sales-type leases are recorded as sales, net of provisions for continuing
administration and other expenses over the lease period. The costs of systems
installed under these sales-leases, net of residual values at the end of the
lease periods, are recorded as costs of sales. Gains or losses resulting from
the sale of rental income from such leases are recorded as adjustments to the
original sales amounts.
Income Taxes: Deferred income taxes result from temporary differences
in the recognition of revenues and expenses for financial reporting and income
tax purposes.
Advertising: The cost of advertising is expensed as incurred. The
Company incurred $437,000; $318,000; and $431,000 in advertising costs during
1996, 1995 and 1994, respectively.
41
Stock Based Compensation: The Company grants stock options for a fixed
number of shares to employees with an exercise price equal to the fair market
value of the shares at the date of grant. The company accounts for stock option
grants in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," ("APB 25") and accordingly,
recognizes no compensation expense for these stock option grants.
In 1996 the Company adopted Financial Accounting Standards Board
("FASB") Statement No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of" ("Statement 121"), which requires
impairment losses to be recorded on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by those assets are less than the assets' carrying amount.
Statement 121 also addresses the accounting for long-lived assets that are
expected to be disposed of. The Company adopted Statement 121 in the first
quarter of 1996 and the adoption did not have a material impact to the
operations of the Company. During the fourth quarter of 1996, the Company
decided to replace its MIS system software with an integrated solution from a
more established vendor and accordingly wrote off the software license and
implementation costs relating to the system software being replaced. The special
pre-tax charge of $4.5 million reflects the costs associated with the Company's
decision to abandon its current MIS software in favor of different system
software.
Use of Estimates: The preparation of the financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Net Income Per Share: Net income per share is based on the weighted
average number of common shares outstanding during each year and common stock
equivalents.
Reclassifications: Certain reclassifications have been made to the 1995
and 1994 financial statements to conform to the 1996 presentation.
NOTE B -- ACQUISITIONS
Pooling of Interests: The financial statements for periods prior to
1996 have been restated to include the accounts of Florida Telephone Systems,
Inc. ("Florida Telephone"). This corporation was acquired by the Company in a
pooling of interests transaction in May 1996, in which 48,193 shares of
Inter-Tel common stock were issued. Florida Telephone did not constitute a
significant subsidiary as defined by the Securities and Exchange Commission. In
the consolidated statements of income, net sales and net income
increased/(decreased) as a result of the restatement as follows:
42
(In thousands, except per share amounts) Year Ended December 31
1995 1994
Net sales $ 1,687 $ 1,261
Net income $ 48 $ (9)
Net income per share $ 0.00 $ 0.00
Total shareholders' equity was increased by $63,000 as of January 1,
1994 as a result of the restatement.
Purchase Transaction: Effective November 29, 1996, the Company acquired
100% of the stock of NTL Corporation ("ComNet") for cash and a short-term note.
The transaction has been accounted for as a purchase transaction, and
accordingly the results of its operations have been included in the consolidated
results of operations since the transaction date. The purchase price has been
allocated to the assets and liabilities based on fair values at acquisition. The
purchase price over net assets acquired (goodwill) is being amortized over 5 to
10 years, based on the lives of the underlying assets. The acquisition did not
include certain components of ComNet's business. Accordingly, separate operating
results for ComNet's telecommunications business are not available. ComNet's
telecom revenues for 1996 and 1995 were approximately $9.0 million and $7.5
million, respectively.
NOTE C -- NET INVESTMENT IN SALES-LEASES
Net investment in sales-leases represents the value of sales-leases
presently held under the Company's Totalease program. The Company currently
sells the rental income from some of the sales-leases. The Company maintains
reserves against potential recourse following the resales based upon loss
experience and past due accounts. Activity during the years was as follows:
(In thousands) Year Ended December 31
1996 1995 1994
Sales of rental income $ 42,985 $ 25,106 $ 12,423
Sold income remaining
unbilled at end of year $ 65,970 $ 37,256 $ 19,894
Allowance for uncollectible
minimum lease payments
and recourse liability at
end of year $ 2,706 $ 1,513 $ 1,198
The Company does not expect any significant losses from the recourse
provisions related to the sale of rental income. The Company is compensated for
administration and servicing of rental income sold.
43
NOTE D -- PROPERTY, PLANT & EQUIPMENT
December 31
(In thousands) 1996 1995
Computer systems and equipment $20,236 $19,261
Transportation equipment 1,737 1,910
Furniture and fixtures 3,301 2,722
Leasehold improvements 1,037 724
Land 321 130
------- -------
26,632 24,747
Less: Accumulated depreciation
and amortization 15,443 12,934
------- -------
$11,189 $11,813
======= =======
NOTE E -- OTHER ASSETS
December 31
(In thousands) 1996 1995
Net investment in sales-leases $11,497 $6,108
Excess of purchase price over net
assets acquired, net 4,334 1,217
Other assets 126 1,490
------- ------
$15,957 $8,815
======= ======
NOTE F-- OTHER CURRENT LIABILITIES
December 31
(In thousands) 1996 1995
Compensation and employee benefits $ 6,176 $ 5,528
Deferred revenues 2,889 2,136
Other accrued expenses 7,776 3,590
------- -------
$16,841 $11,254
======= =======
NOTE G -- CREDIT LINE
The Company maintains a $5,000,000 unsecured bank credit line at prime
rate to cover international letters of credit and for other purposes. The credit
agreement matures April 30, 1997 and contains certain restrictions and financial
covenants. At December 31, 1996, $2,528,131 of the credit line was committed
under letter of credit arrangements.
NOTE H -- LEASES
Rental expense amounted to $3,538,221; $2,994,895; and $2,555,298 in
1996, 1995 and 1994, respectively. Noncancellable operating leases are primarily
for buildings. Certain of the leases contain provisions for renewal options and
scheduled rent increases. At December 31, 1996, future minimum commitments under
noncancellable leases, including a five year lease for its headquarters facility
and a 15 year lease for its distribution and support facility, are: 1997 --
$2,823,397; 1998 -- $2,420,669; 1999 -- $1,923,048; 2000 -- $1,447,318; 2001 --
$845,154; thereafter -- $2,248,287.
44
NOTE I -- INCOME TAXES
The Company accounts for income taxes under Financial Accounting
Standards Board Statement No. 109, "Accounting for Income Taxes" ("Statement
109"). Under Statement 109, the liability method is used in accounting for
income taxes. Under this method, deferred tax assets and liabilities are
determined (and classified as current or long-term) based on differences between
financial reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the differences
are expected to reverse.
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax liabilities and assets as of December
31, are as follows:
(In thousands) 1996 1995
Deferred tax liabilities:
Lease--sales and reserves $ 12,502 $ 8,927
Accelerated depreciation 179 161
-------- -------
Total deferred tax liabilities 12,681 9,088
-------- -------
Deferred tax assets:
Inventory basis differences 1,553 1,614
Accounts receivable reserves 1,135 611
Maintenance reserve 317 316
Accrued vacation pay 557 424
Foreign loss carryforwards 794 546
Other -- net 1,223 1,011
-------- -------
Deferred tax assets 5,579 4,522
Less valuation reserve 794 546
-------- -------
Net deferred tax assets 4,785 3,976
-------- -------
Net deferred tax liabilities $ 7,896 $ 5,112
-------- -------
During 1996 and 1995, the Company incurred losses of $730,000 and
$857,000 with respect to foreign operations. At December 31, 1996, the Company
had foreign loss carryforwards of approximately $2,400,000 which will begin to
expire in 1999. The valuation allowance increased by $248,000 in 1996 and
$191,000 in 1995 due to increases in foreign loss carryforward benefits.
Federal and state income taxes consisted of the following:
(In thousands) 1996 1995 1994
Federal $ 5,414 $ 4,789 $ 3,045
State 850 460 603
------- ------- -------
$ 6,264 $ 5,249 $ 3,648
------- ------- -------
The principal reasons for the difference between total income tax
expense and the amount computed by applying the statutory federal income tax
rate to income before taxes are as follows:
45
1996 1995 1994
Federal tax at statutory rates
applied to pre-tax income 34% 34% 34%
State tax net of federal benefit 4 2 3
Valuation reserve increase
for foreign losses 2 2 3
Other - net 1 -- (2)
--- ----- ----
41% 38% 38%
--- ----- ----
NOTE J -- EQUITY TRANSACTIONS
In a public offering in August 1995, the Company sold 2,000,000 shares
of previously unissued common stock.
Under the Company's Long-Term Incentive Plan, selected officers and key
employees are granted options to purchase common stock of the Company at not
less than fair market value at date of grant. The options are exercisable at the
end of their ten year term, but may become exercisable in annual installments if
predetermined performance goals and share market value increases are met. During
1994, previously granted options to purchase 420,000 shares at prices of $7.50
to $9.25 per share were canceled and options to purchase 605,000 shares were
granted to an expanded group of optionees at the then fair market value of $6.00
per share.
Under other previous stock option plans, directors, officers and key
employees may purchase common stock of the Company at amounts not less than the
fair market value at the date of grant. These options generally have a term of
five to ten years and are exercisable over four to five years commencing one
year from the date of grant, except for director stock option grants, which are
exercisable commencing six months from the date of grant.
On November 19, 1993, the Board of Directors authorized the Inter-Tel,
Incorporated Long-Term Incentive Plan ("the Long Term Plan"). A total of
1,000,000 shares of common stock has been reserved for issuance under the Long
Term Plan. Options must be granted at not less than 100% of the fair market
value of the Company's stock at the dates of grant. Options generally vest over
four years and expire five to ten years from the date of grant.
On July 26, 1990, the Company adopted the Director Stock Option Plan
("the Director Plan") and reserved a total of 250,000 shares of common stock for
issuance thereunder. Commencing with the adoption of the Plan, each Eligible
Director received a one-time automatic grant of an option to purchase 2,500
shares of the Company's common stock. In addition, each Eligible Director shall
be granted an option to purchase 2,500 shares upon the date five (5) days after
such person became Director, and an additional option to purchase 2,500 shares
five (5) days after the date of annual reelection as Director. All options
granted have a five year term and fully vest at the end of six months from the
grant date. Option activity for the past three years under all plans is as
follows:
46
Number of Shares
1996 1995 1994
Outstanding at beginning of year 847,500 824,500 720,250
Granted 394,000 160,512 627,000
Exercised (102,500) (108,887) (98,750)
Expired or canceled (42,850) (28,625) (424,000)
-------- -------- --------
Outstanding at end of year 1,096,150 847,500 824,500
--------- ------- -------
Exercise price range $5.75-$20.44 $2.25-$14.50 $1.12-$9.63
Exercisable at end of year 289,350 167,083 75,000
Weighted-average fair value of
options granted during 1996 and 1995 $4.71 $3.43 N/A
At December 31, 1996, the Company has reserved 1,257,238 shares of
Common Stock for issuance in connection with the stock option plans.
For the stock option plans discussed above, the Company has adopted the
disclosure only provisions of Statement of Financial Accounting Standards No.
123 ("SFAS 123"), "Accounting for Stock-Based Compensation." Accordingly, no
compensation cost has been recognized in the accompanying financial statements
for the stock option plans.
The following table summarizes information about stock options outstanding at
December 31, 1996:
Options Outstanding Options Exercisable
Number Number
Outstanding at Weighted-Average Weighted Exercisable at Weighted
Range of December 31, Remaining Average Exercise December 31, Average Exercise
Exercise Price 1996 Contractual Life Price 1996 Price
$5.75 - $8.63 589,200 4 years $5.97 247,900 $5.99
$9.63 - $14.13 209,450 6 years $12.72 24,950 $12.17
$14.50 - $20.44 297,500 5 years $16.91 16,500 $17.35
During 1996, the weighted average exercise price of options granted,
exercised, and expired or canceled was $16.27, $7.63 and $11.33, respectively.
Had compensation cost for the Company's stock option plans been
determined based on the fair value at the grant date for awards in 1995 and 1996
consistent with the provisions of SFAS 123, the estimated fair value of the
options would be amortized to expense over the option's vesting period and the
Company's net income and net income per share would have been decreased to the
pro forma amounts indicated below for the year ended December 31:
1996 1995
Net income as reported $9,042 $8,499
Pro forma net income $8,815 $8,420
Pro forma earnings per share $0.66 $0.70
Pro forma results disclosed are based on the provisions of SFAS 123
using the Black-Scholes option valuation model and are not likely to be
representative of the effects on pro forma net income for future years. In
addition, The Black-Sholes option valuation model
47
was developed for use in estimating the fair value of traded options which have
no vesting restrictions and are fully transferable. In addition, option
valuation models require the input of highly subjective assumptions including
the expected stock price volatility. Because the company's employee stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the estimating models
do not necessarily provide a reliable single measure of the fair value of its
employee stock options.
The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model using the low end of reasonable
assumptions for input variables rather than attempting to identify a best-point
estimate. The option pricing model utilized the following weighted average
assumptions for 1996 and 1995, respectively: risk free interest rates of 5.0% in
each year; dividend yields of 0% in each year; volatility factors of the
expected market price of the Company's stock varied among the individual option
grants under the plan due to the date of the grant and the stock and exercise
price at the time of the grant and ranged from .367 to .449; and a weighted
average expected life of the option of 2.5 years for employee stock options
which vest over a four year period with a weighted average vesting period of 2.5
years, and 1.5 years for Company director options which vest at the end of six
months from the grant date.
NOTE K -- RETIREMENT PLANS
The Company has two retirement plans for the benefit of all of its
employees. Under its 401(k) Retirement Plan, participants may contribute an
amount not exceeding 15 percent of compensation received during participation in
the Plan. The Company makes voluntary annual contributions to the Plan based on
a percentage of contributions made by Plan participants of up to 10 percent of
compensation. Contributions to the Plan totaled $394,000; $328,000 and $248,000
in 1996, 1995 and 1994, respectively.
In 1992, the Company initiated an Employee Stock Ownership Plan (ESOP),
advancing $500,000 to the ESOP Trust for the purpose of purchasing common stock
of the Company. The Trust purchased 153,500 shares of the Company's common stock
in July 1992. The loan is to be repaid over 5 years with 7.5% interest. As the
principal amount of the loan is repaid to the Company through Company annual
contributions, the equivalent number of shares released are allocated to
employees' accounts to be held until retirement. Total shares so allocated were
34,712; 32,290; and 30,037; in 1996, 1995 and 1994, respectively. Contributions
to the ESOP totaled $125,000 each in 1996, 1995 and 1994 and are based upon the
historic cost of the shares purchased by the ESOP.
NOTE L -- FINANCIAL INSTRUMENTS
Concentration of Credit Risk: Financial instruments that potentially
subject the Company to significant concentrations of credit risk consist
principally of cash investments, trade accounts receivable, and net investment
in sales-leases. The Company maintains cash and equivalents not invested in
money market funds with a major bank in its marketplace. The Company performs
periodic evaluations of the relative credit standing of the financial
institution. Concentrations of credit risk with respect to trade accounts
receivable and net investment in sales-leases are limited due to the large
number of entities comprising the Company's customer base.
48
Fair Value of Financial Instruments: The carrying amount of cash and
equivalents, accounts receivable, net investment in sales-leases, and accounts
payable reported in the consolidated balance sheets approximate their fair
value.
NOTE M -- SUPPLEMENTAL CASH FLOW
(In thousands)
1996 1995 1994
Cash paid for:
Interest $ 77 $ 106 $ 122
Income taxes $ 4,213 $ 1,885 $ 1,673
-------- -------- -------
Changes in operating assets and liabilities:
Increase in receivables $ (8,569) $(16,368) $ (4,258)
Increase in inventories (1,309) (5,997) (1,984)
(Increase) decrease in prepaid
expenses and other assets (6,268) (500) 1,131
Increase in long-term
other assets (4,024) (1,676) (2,402)
Increase in accounts
payable and other current
liabilities 4,466 6,400 1,602
-------- -------- -------
$(15,704) $(18,141) $(5,911)
======== ======== =======
49
NOTE N -- QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
A summary of the quarterly results of operations for the years ended
December 31, 1996 and 1995 follows:
(In thousands, except per share amounts)
1996 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
Net sales $42,213 $43,736 $47,435 $52,500
Gross margin 19,312 19,108 19,616 22,882
Net income 2,899 2,784 2,689 670
Net income per share $.22 $.21 $.20 $.05
Average number of
shares outstanding 13,293 13,431 13,443 13,429
1995 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
Net sales $35,018 $36,924 $38,132 $40,459
Gross margin 14,274 15,259 15,919 17,385
Net income 1,834 1,342 2,500 2,823
Net income per share $.17 $.12 $.20 $.21
Average number of
shares outstanding 11,116 11,239 12,343 13,306
The 1995 quarterly results for net income per share, when totaled, do
not equal the net income per share for the year ended December 31, 1995. The
1995 sum of quarterly results for net income per share total $.70, although the
total net income per share was actually $.71 per share. See note A for more
information regarding the 1996 fourth quarter special charge.
50