EXHIBIT 13.0
EXCERPTS FROM ANNUAL REPORT TO SECURITY HOLDERS
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Ernst & Young LLP, Independent Auditors
Shareholders and Board of Directors
Inter-Tel, Incorporated
We have audited the accompanying consolidated balance sheets of Inter-Tel,
Incorporated and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended December 31, 1997. 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, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
/s/Ernst & Young LLP
Phoenix, Arizona
February 20, 1998
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
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(In thousands, except share amounts) 1997 1996
ASSETS
CURRENT ASSETS
Cash and equivalents $ 88,805 $ 38,936
Accounts receivable, less allowances of
$3,722 in 1997 and $3,096 in 1996 32,234 29,998
Inventories, less allowances of $5,740 in
1997 and $2,979 in 1996 21,539 21,280
Net investment in sales-leases 9,196 8,243
Prepaid expenses and other assets 5,625 7,008
- --------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 157,399 105,465
PROPERTY, PLANT & EQUIPMENT 19,559 11,189
OTHER ASSETS` 18,030 15,957
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$ 194,988 $ 132,611
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LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 14,864 $ 8,915
Other current liabilities 18,721 16,841
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TOTAL CURRENT LIABILITIES 33,585 25,756
DEFERRED TAX LIABILITY 11,343 8,635
OTHER LIABILITIES 4,555 3,286
SHAREHOLDERS' EQUITY
Common stock, no par value - authorized 100,000,000
shares, issued and outstanding - 26,687,766 shares
in 1997 and 25,888,572 shares in 1996 99,229 59,875
Retained earnings 46,547 35,464
Currency translation adjustment (271) (359)
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145,505 94,980
Less receivable from Employee Stock Ownership Trust - (46)
- --------------------------------------------------------------------------------
TOTAL SHAREHOLDERS' EQUITY 145,505 94,934
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$ 194,988 $ 132,611
================================================================================
See accompanying notes.
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 1997, 1996 and 1995
- --------------------------------------------------------------------------------
(In thousands, except per share data) 1997 1996 1995
NET SALES $ 223,569 $ 185,884 $ 150,533
Cost of sales 122,363 104,966 87,696
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GROSS PROFIT 101,206 80,918 62,837
Research and development 7,998 6,581 5,764
Selling, general and administrative 69,942 56,386 43,578
Special charge -- 4,542 1,315
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OPERATING INCOME 23,266 13,409 12,180
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Other income 1,383 1,974 1,674
Interest expense (47) (77) (106)
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INCOME BEFORE INCOME TAXES 24,602 15,306 13,748
INCOME TAXES
Current 8,850 3,480 1,007
Deferred 1,070 2,784 4,242
- --------------------------------------------------------------------------------
9,920 6,264 5,249
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NET INCOME $ 14,682 $ 9,042 $ 8,499
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NET INCOME PER SHARE
Basic $ 0.59 $ 0.35 $ 0.37
Diluted $ 0.57 $ 0.34 $ 0.36
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Average common shares outstanding 24,836 25,780 23,056
Average common shares outstanding
assuming dilution 25,983 26,572 23,766
- --------------------------------------------------------------------------------
See accompanying notes.
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 1997, 1996 and 1995
- -------------------------------------------------------------------------------------------------------------------------
Currency Receivable
(In thousands, except Common Treasury Retained Translation From
share amounts) Stock Stock Earnings Adjustment ESOP Total
- -------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1994 $ 27,585 $ -- $ 17,923 $ (122) $ (264) $ 45,122
Issuance of 4,000,000 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
Stock repurchase (27,194) (27,194)
Exercise of stock options 642 4,533 (3,332) 1,843
Tax benefit from stock options 1,967 1,967
Net income 14,682 14,682
Gain on currency translation 88 88
Collection from ESOP 46 46
Stock issued under
Employee Stock Purchase Plan 256 256
Issuance of 3,000,000 shares of
common stock 36,489 22,661 59,150
Dividends (267) (267)
- -------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 $ 99,229 $ -- $ 46,547 $ (271) $ -- $ 145,505
=========================================================================================================================
See accompanying notes.
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 1997, 1996 and 1995
- ----------------------------------------------------------------------------------------------------------
(In thousands) 1997 1996 1995
OPERATING ACTIVITIES:
Net income $ 14,682 $ 9,042 $ 8,499
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 4,578 4,097 2,267
Provision for losses on receivables 4,104 3,746 1,594
Provision for inventory valuation 4,021 609 1,109
Net contribution to ESOP 46 113 105
Increase/(decrease) in other liabilities 1,269 (604) 1,111
(Gain)/loss on sale of property and equipment (25) 3,421 16
Deferred income taxes 1,070 2,784 4,242
Effect of exchange rate changes 88 (247) 10
Changes in operating assets and liabilities (1,633) (15,704) (18,141)
- ----------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 28,200 7,257 812
- ----------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES:
Additions to property and equipment (12,449) (6,951) (7,921)
Proceeds from sale of property and equipment 63 159 9
Cash used in acquisitions -- (1,780) --
- ----------------------------------------------------------------------------------------------------------
NET CASH USED IN INVESTING
ACTIVITIES (12,386) (8,572) (7,912)
- ----------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES:
Net proceeds from stock offering 59,150 -- 30,670
Proceeds from exercise of stock options 1,843 611 503
Proceeds from stock issued under the
Employee Stock Purchase Plan 256 -- --
Treasury stock purchases (27,194) -- --
- ----------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY
FINANCING ACTIVITIES 34,055 611 31,173
- ----------------------------------------------------------------------------------------------------------
INCREASE (DECREASE)
IN CASH AND EQUIVALENTS 49,869 (704) 24,073
CASH AND EQUIVALENTS AT BEGINNING
OF YEAR 38,936 39,640 15,567
- ----------------------------------------------------------------------------------------------------------
CASH AND EQUIVALENTS AT END OF YEAR $88,805 $ 38,936 $ 39,640
- ----------------------------------------------------------------------------------------------------------
See accompanying notes.
INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
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NOTE A -- SIGNIFICANT ACCOUNTING POLICIES
Description of Business. Inter-Tel is a single point of contact, full
service provider of digital business telephone systems, call processing
software, voice processing software, call accounting software, Internet Protocol
(IP) telephony software, computer telephone integration applications and long
distance calling services. Inter-Tel's products and services include the AXXESS
and Inter-Tel Axxent digital business communication software platforms, the
AXXESSORY Talk voice processing platform, the Inter-Tel Vocal'Net IP telephony
gateway, the Inter-Tel Vocal'Net Service Provider Software and Centralized
Accounting Software and Inter-Tel.net, an IP telephony packet switched long
distance service. The Company also provides maintenance, leasing and support
services for its products.
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 which range from 3 years to 12
years. 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, 1997 was $866,744.
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 $577,000; $437,000 and $318,000 in advertising costs during
1997, 1996, and 1995, respectively.
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.
Recently Issued Accounting Standards. In 1996, the Company adopted
Financial Accounting Standards Board ("FASB") Statement of Financial Accounting
Standards ("SFAS") Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" ("SFAS No. 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. SFAS 121 also addresses the accounting for long-lived assets
that are expected to be disposed of. The Company adopted SFAS 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 management information system ("MIS") 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.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share"
("SFAS No. 128"), adopted by the Company on December 31, 1997. SFAS No. 128
replaced the previously reported primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants, and
convertible securities. Diluted earnings per share is very similar to the
previously reported primary earnings per share. All earnings per share amounts
for all periods have been presented, and where necessary, restated to conform to
the SFAS No. 128 requirements. The impact of SFAS No. 128 on the calculation of
fully diluted earnings per share for each of the periods presented was not
material.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. SFAS No. 131 is effective for financial statements for fiscal years
beginning after December 15, 1997. The adoption of SFAS 131 will have no impact
on the Company's consolidated results of operations, financial position or cash
flows.
Recent Pronouncements. In October 1997, the American Institute of
Certified Public Accountants issued Statement of Position 97-2, "Software
Revenue Recognition" ("SOP 97-2"). SOP 97-2 provides guidance on when revenue
should be recognized and in what amounts for licensing, selling, leasing, or
otherwise marketing computer software. SOP 97-2 is effective for financial
statements for fiscal years beginning after December 15, 1997. Earlier
application for financial statements or information that has not been issued is
encouraged. The Company is in the process of evaluating if the adoption of
SOP97-2 will have an impact, if any, on its software revenue recognition
practices.
Contingencies. The Company is a party to certain litigation in the
normal course of business. Management does not anticipate that the resolution of
such matters will have a material adverse effect on the Company's consolidated
financial position.
Use of Estimates. The preparation of the consolidated financial
statements in conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. Actual results
could differ from those estimates.
Reclassifications. Certain reclassifications have been made to the 1996
and 1995 financial statements to conform to the 1997 presentation.
NOTE B -- ACQUISITIONS
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
telecommunication revenues for 1996 were approximately $9.0 million.
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:
Year Ended December 31
(In thousands) 1997 1996 1995
Sales of rental income $ 57,812 $ 42,985 $ 25,106
Sold income remaining
unbilled at end of year $ 99,900 $ 65,970 $ 37,256
Allowance for uncollectible
minimum lease payments
and recourse liability at
end of year $ 3,969 $ 2,706 $ 1,513
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.
NOTE D -- PROPERTY, PLANT & EQUIPMENT
December 31
(In thousands) 1997 1996
Computer systems and equipment $28,570 $20,236
Transportation equipment 1,665 1,737
Furniture and fixtures 4,043 3,301
Leasehold improvements 1,693 1,037
Land 2,619 321
----- -------
38,590 26,632
Less: Accumulated depreciation
and amortization 19,031 15,443
------ ------
$19,559 $11,189
====== ======
NOTE E -- OTHER ASSETS
December 31
(In thousands) 1997 1996
Net investment in sales-leases $13,402 $11,497
Excess of purchase price over net
assets acquired, net 4,380 4,334
Other assets 248 126
------ -------
$18,030 $15,957
======= =======
NOTE F-- OTHER CURRENT LIABILITIES
December 31
(In thousands) 1997 1996
Compensation and employee benefits $8,163 $6,176
Deferred revenues 2,947 2,889
Other accrued expenses 7,611 7,776
----- -------
$18,721 $16,841
======= =======
NOTE G -- CREDIT LINE
The Company maintains a $7,000,000 unsecured bank credit line at prime
rate to cover international letters of credit and for other purposes. The credit
agreement matures July 31, 1998 and contains certain restrictions and financial
covenants. At December 31, 1997, $390,000 of the credit line was committed under
letter of credit arrangements.
NOTE H -- LEASES
Rental expense amounted to $4,342,000; $3,538,000; and $2,995,000; in
1997, 1996 and 1995, respectively. Noncancellable operating leases are primarily
for buildings. Certain of the leases contain provisions for renewal options and
scheduled rent increases. At December 31, 1997, 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: 1998 --
$3,444,000; 1999 -- $2,570,000; 2000 -- $1,788,000; 2001 -- $1,230,000; 2002 --
$733,000; thereafter -- $2,610,000.
NOTE I -- INCOME TAXES
The Company accounts for income taxes under SFAS Statement No. 109,
"Accounting for Income Taxes" ("Statement No. 109"). Under Statement No. 109,
the liability method is used in accounting for income taxes. Under this method,
deferred tax assets and liabilities are determined (and classified as current or
long-term) based on differences between financial reporting and tax bases of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.
Significant components of the Company's deferred tax liabilities and
assets as of December 31, are as follows:
(In thousands) 1997 1996
Deferred tax liabilities:
Lease--sales and reserves $15,624 $ 12,502
Accelerated depreciation -- 179
------- --------
Total deferred tax liabilities 15,624 12,681
------- --------
Deferred tax assets:
Inventory basis differences 2,580 1,553
Accounts receivable reserves 1,357 1,135
Maintenance reserve 259 317
Accrued vacation pay 604 557
Foreign loss carryforwards 1,047 794
Other -- net 1,858 1,223
------- --------
Deferred tax assets 7,705 5,579
Less valuation reserve 1,047 794
------- --------
Net deferred tax assets 6,658 4,785
------- --------
Net deferred tax liabilities $ 8,966 $ 7,896
======= =======
During 1997 and 1996, the Company incurred losses of $722,000 and
$730,000 with respect to foreign operations. At December 31, 1997, the Company
had foreign loss carryforwards of approximately $3,100,000, which will begin to
expire in 1999. The valuation allowance increased by $253,000 in 1997 and
$248,000 in 1996 due to increases in foreign loss carryforward benefits.
Federal and state income taxes consisted of the following:
(In thousands) 1997 1996 1995
Federal $ 8,290 $ 5,414 $ 4,789
State 1,630 850 460
----- --- ---
$ 9,920 $ 6,264 $ 5,249
===== ===== =====
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:
1997 1996 1995
Federal tax at statutory rates
applied to pre-tax income 35% 34% 34%
State tax net of federal benefit 4 4 2
Valuation reserve increase
for foreign losses 1 2 2
Other - net -- 1 --
--- --- ---
40% 41% 38%
=== === ===
NOTE J -- EQUITY TRANSACTIONS
Stock Split. Retroactive adjustments have been made, as appropriate, to
Common Stock and per share amounts to reflect the 2-for-1 stock split effected
in the form of a stock dividend in October 1997.
Treasury Stock. During the second quarter of 1997, the Company
initiated a stock repurchase program under which the Board of Directors
authorized the repurchase of up to 1,470,000 shares (on a pre-Stock Split basis)
of the Common Stock. The Company expended approximately $27.2 million for stock
repurchases during 1997, which was funded primarily through existing cash
balances. The Company reissued shares through November through stock option
exercises and issuances. The proceeds received for the stock reissued was less
than its cost basis. Accordingly, the difference was recorded as a reduction to
retained earnings.
Public Stock Offering. In a public offering in December 1997, the
Company sold 3,000,000 shares of Common Stock. Net proceeds from the offering
were approximately $59,150,000. In conjunction with the offering, all remaining
treasury shares were reissued first and the remaining shares issued from
previously unissued Common Stock.
Dividend Policy. On September 24, 1997, the Company's Board of
Directors declared a cash dividend (the "Cash Dividend") of $0.01 for every
share of Common Stock, payable to
shareholders of record as of December 31, 1997, with dividend payments to
commence on or about January 15, 1998. Prior to the Cash Dividend, the Company
had declared no cash dividends on its Common Stock since incorporation.
Stock Option Plans. Under the Company's 1994 and 1997 Long-Term
Incentive Plans, 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. In some instances, predetermined
performance goals and share market value increases must be met to allow the
options to be exercised before the end of the option term.
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.
In November 1993, the Board of Directors authorized the Inter-Tel,
Incorporated Long-Term Incentive Plan ("the 1994 Long Term Plan"). A total of
2,000,000 shares of Common Stock has been reserved for issuance under the 1994
Long Term Plan. 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 or five years and expire five to ten years from the date of grant.
In July 1990, the Company adopted the Director Stock Option Plan ("the
Director Plan") and reserved a total of 500,000 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 5,000
shares of the Company's Common Stock. In addition, each Eligible Director shall
be granted an option to purchase 5,000 shares upon the date five (5) days after
such person became Director, and an additional option to purchase 5,000 shares
five (5) days after the date of 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.
In February 1997, the Board of Directors authorized the Inter-Tel,
Incorporated 1997 Long-Term Incentive Plan ("the 1997 Long Term Plan"). A total
of 2,400,000 shares of Common Stock has been reserved for issuance under the
1997 Long Term Plan. 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 or five years and expire ten years from the date of grant.
Option activity for the past three years under all plans is as follows:
Number of Shares
1997 1996 1995
Outstanding at beginning of year 2,192,300 1,695,000 1,649,000
Granted 1,523,000 788,000 321,024
Exercised (511,426) (205,000) (217,774)
Expired or canceled (241,350) (85,700) (57,250)
--------- -------- --------
Outstanding at end of year 2,962,524 2,192,300 1,695,000
--------- --------- ---------
Exercise price range $2.88-$25.88 $2.88-$10.22 $1.13-$7.25
Exercisable at end of year 587,774 578,700 334,166
Weighted-average fair value of
options granted $8.42 $2.36 $1.72
At December 31, 1997, the Company has reserved 4,400,050 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 SFAS No. 123 "Accounting for Stock-Based
Compensation," ("SFAS No. 123"). 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, 1997:
Options Outstanding Options Exercisable
Number Number
Outstanding at Weighted-Average Weighted Exercisable at Weighted
Range of December 31, Remaining Average December 31, Average
Exercise Price 1997 Contractual Life Exercise Price 1997 Exercise Price
$2.88 - $4.31 718,579 6 years $3.01 410,579 $3.01
$4.81 - $7.06 698,950 7 years $5.79 74,700 $6.43
$7.25 - $10.25 1,432,995 8 years $8.14 102,495 $8.41
$15.13 - $25.88 112,000 9 years $22.14 -- N/A
During 1997, the weighted average exercise price of options granted,
exercised, and expired or canceled was $8.42, $4.36 and $5.62, 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 1997, 1996
and 1995 consistent with the provisions of SFAS No. 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:
(in thousands, except per share amounts) 1997 1996 1995
Net income as reported $14,682 $9,042 $8,499
Pro forma net income $14,345 $8,950 $8,455
Pro forma earnings per diluted share $0.55 $0.34 $0.36
Pro forma results disclosed are based on the provisions of SFAS No. 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 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 1997, 1996 and 1995, respectively: risk free interest rates of
5.0% in each year; dividend yields of 0.25% in 1997 and 0% in 1996 and 1995;
volatility factors of the expected market price of the Company's stock averaged
.30; and a weighted average expected life of the option of 3.0 years for
employee stock options which vest over four to five year periods with a weighted
average vesting period of 2.5 years and 1.5 years for Company director options
which vest at the end of six months from the grant date.
1997 Employee Stock Purchase Plan. In April 1997, the Board of
Directors and stockholders adopted the Employee Stock Purchase Plan (the
"Purchase Plan") and reserved 500,000 shares for issuance to eligible employees.
Under the Purchase Plan, employees are granted the right to purchase shares of
Common Stock at a price per share that is 85% of the lesser of the fair market
value of the shares at: (i) the participant's entry date into each six-month
offering period, or (ii) the end of each six-month offering period. Employees
may designate up to 10% of their compensation for the purchase of stock. Under
the Plan, the Company sold 36,018 shares for approximately $256,000 ($7.12 per
share) to employees in 1997. At December 31, 1997, 463,982 shares remained
authorized under the Plan.
NOTE K - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
(in thousands, except per share amounts)
1997 1996 1995
Numerator:
Net Income $14,682 $9,042 $8,499
------ ----- -----
Denominator:
Denominator for basic earnings per
share - weighted average shares 24,836 25,780 23,056
Effect of dilutive securities:
Employee and director stock options 1,147 792 710
----- --- ---
Denominator for diluted earnings per
share - adjusted weighted average
shares and assumed conversions 25,983 26,572 23,766
------ ------ ------
Basic earnings per share $ 0.59 $ 0.35 $ 0.37
====== ====== ======
Diluted earnings per share $ 0.57 $ 0.34 $ 0.36
====== ====== ======
Options which are antidilutive because the exercise price was greater
than the average market price of the common shares, are not included in the
computation of diluted earnings per share. The number of options to purchase
shares of Common Stock that were outstanding during 1997 that were antidilutive
were immaterial, because the market price of the Company's stock was generally
higher during the course of the year than the prices at which options were
granted.
NOTE L -- 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 $491,000; $394,000 and $328,000
in 1997, 1996 and 1995, 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 307,000 shares of the Company's Common Stock
in July 1992. The loan was paid in full during 1997. As the principal amount of
the loan was repaid to the Company through Company annual contributions, the
equivalent number of shares released were allocated to employees' accounts to be
held until retirement. Total shares so allocated were 32,380; 69,424 and 64,580
in 1997, 1996 and 1995, respectively. Contributions to the ESOP totaled $62,500
in 1997, and $125,000 each 1996 and 1995 and are based upon the historic cost of
the shares purchased by the ESOP. After the final
allocation of shares in 1997, the ESOP plan was "frozen," so that all eligible
participants as of July 1, 1997 became 100% vested in their accounts, regardless
of length of service. No further purchases are anticipated through the ESOP, and
the Company does not anticipate making future allocations of shares from this
plan.
NOTE M -- 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.
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 N -- SUPPLEMENTAL CASH FLOW
(In thousands) 1997 1996 1995
Cash paid for:
Interest $ 47 $ 77 $ 106
Income taxes $ 5,914 $ 4,213 $ 1,885
-------- -------- --------
Changes in operating assets and liabilities:
Increase in receivables $ (7,294) $ (8,569) $(16,368)
Increase in inventories (4,280) (1,309) (5,997)
(Increase) decrease in prepaid
expenses and other assets 4,407 (6,268) (500)
Increase in long-term other assets (2,028) (4,024) (1,676)
Increase in accounts payable
and other current liabilities 7,562 4,466 6,400
-------- -------- --------
$ (1,633) $(15,704) $(18,141)
======== ======== ========
NOTE O -- QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
A summary of the quarterly results of operations for the years ended
December 31, 1997 and 1996 follows: (In thousands, except per share amounts)
1997 1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
Net sales $50,322 $54,823 $56,915 $61,508
Gross margin 22,170 24,401 26,298 28,336
Net income 2,670 3,424 3,978 4,610
Net income per share
Basic $0.10 $0.13 $0.17 $0.19
Diluted $0.10 $0.13 $0.16 $0.18
Average number of common
shares outstanding -- Basic 25,901 25,438 23,397 24,606
Average number of common
shares outstanding -- Diluted 26,450 26,623 24,682 26,179
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
Basic $0.11 $0.11 $0.10 $0.03
Diluted $0.11 $0.10 $0.10 $0.03
Average number of common
shares outstanding -- Basic 25,546 25,748 25,858 25,885
Average number of common
shares outstanding -- Diluted 26,341 26,567 26,607 26,579
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 Annual Report to Shareholders 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 the Company on the date hereof, and the Company assumes
no obligation to update any such forward-looking statements. 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 in "Factors That May Affect Results of Future Operations" and else where
in this 10-K.
General
Inter-Tel is a single point of contact, full service provider of
digital business telephone systems, IP telephony products, CTI applications,
voice processing software and long distance calling services. Inter-Tel's
products and services include the AXXESS and Inter-Tel Axxent digital business
communication platforms, the AXXESSORY Talk voice processing platform, the
Inter-Tel Vocal'Net IP telephony gateway and the Inter-Tel.net private IP
telephony network. The Company also provides maintenance, leasing and support
services for its products. 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 the 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, the cost and effect of acquisitions and the availability and cost of
products and components from the Company's suppliers. Historically, a
substantial portion of the Company's net sales in a given quarter have 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, the Company is subject
to seasonal variations 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 Vocal'Net Server, Inter-Tel Axxent system and Inter-Tel
VisualMail; enhancing the CTI capabilities of the AXXESS digital communications
platform; and expanding the capacity of the Company's AXXESS and AXXESSORY Talk
systems. Current efforts are related to the support of industry standard CTI
interfaces, the development of additional applications and features, the
enhancement of the Inter-Tel Vocal'Net Gateway Server and Service Provider
Package, and the development of a LAN-based Communications Server incorporating
the Company's Call Processing and Voice Processing software. New applications
under development also include Basic Rate ISDN, PBX networking, the
Inter-Tel.net private IP telephony service and enhanced 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 20.3%, 23.5%, and 21.5% in 1997, 1996 and
1995, respectively, over the preceding year.
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
1997 1996 1995
---- ---- ----
Net sales 100.0% 100.0% 100.0%
Cost of sales 54.7 56.5 58.3
---- ---- ----
Gross margin 45.3 43.5 41.7
Research and development 3.6 3.5 3.8
Selling, general and administrative 31.3 30.3 28.9
Special charge -- 2.5 0.9
---- ---- ----
Operating income 10.4 7.2 8.1
Interest and other income 0.6 1.1 1.1
Interest expense 0.0 0.0 0.1
Income taxes 4.4 3.4 3.5
---- ---- ----
Net income 6.6% 4.9% 5.6%
---- ---- ----
Year Ended December 31, 1997 Versus Year Ended December 31, 1996
Net Sales. Net sales increased 20.3% to $223.6 million in 1997 from
$185.9 million in 1996. Sales from the Company's direct sales offices and from
wholesale distribution accounted for approximately $26.3 million of the
increase. The remaining increases occurred in long distance sales and other
operations.
Gross Profit. Gross profit increased to $101.2 million, or 45.3% of net
sales in 1997 from $80.9 million, or 43.5% of net sales in 1996. This increase
was primarily a result of higher sales, as a percentage of total net sales, of
AXXESS digital communication platforms, call processing software and voice
processing software. In addition, gross margin increased based on a percentage
increase in sales through the Company's direct sales offices compared to its
dealer network.
Research and Development. Research and development expenses increased
to $8.0 million, or 3.6% of net sales in 1997 from $6.6 million, or 3.5% of net
sales, in 1996. These expenses in both 1997 and 1996 were directed principally
toward the continued development of the AXXESS and Inter-Tel Axxent software and
systems, unified messaging and voice processing software, Inter-Tel Vocal'Net
and certain 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. Selling, general and
administrative expenses increased to $69.9 million, or 31.3% of net sales in
1997 from $56.4 million, or 30.3% of net sales, in 1996. This reflected
increased selling, incentive, training and other compensation costs attributable
to the increased sales through the Company's direct sales offices, additional
personnel to support the direct dealer network and expansion of long distance
operations, development of the Inter-Tel.net network and expenses associated
with international operations. Such increase is also attributable to the hiring
of additional sales and technical training staff, expansion of its credit
management group, and increases in reserves for accounts receivable. The Company
expects that selling, general and administrative expenses will increase in
absolute dollars, but may vary as a percentage of net sales.
Interest and Other Income. Other income decreased approximately
$591,000 in 1997 principally as a result of lower levels of cash available for
investment.
Net Income. Net income increased 62.4% to $14.7 million, or $.57 per
diluted share, in 1997 compared to net income of $9.0 million, or $.34 per
diluted share, in 1996. Excluding the
special charge in 1996 related to the write-off of its MIS software, net income
would have been $11.8 million, or $.44 per diluted share.
Year Ended December 31, 1996 Versus Year Ended December 31, 1995
Net Sales. 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, with wholesale distribution sales
increasing approximately $12.2 million. The remaining increases occurred in long
distance sales and other operations.
Gross Profit. 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 transition to the direct dealer network and the expansion of AXXESS software
and systems sales.
Research and Development. 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, Inter-Tel Vocal'Net
and Inter-Tel Vocal'Net server, and certain CTI applications.
Selling, general and administrative. 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.
Special Charge. 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 $4.5 million ($.10 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.
Interest and Other Income. 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. Net income increased 6.4% to $9.0 million, or $.34 per
diluted share, in 1996 including the special charge recognized in the fourth
quarter compared to $8.5 million, or $.36 per diluted share, in 1995. Excluding
the special charges in both periods, net income would have been $11.8 million,
or $.44 per diluted share, for 1996 compared to $9.3 million, or $.39 per
diluted share for 1995. In addition, net income per diluted share in 1996 was
based on additional average shares outstanding in 1996, primarily reflecting the
public stock offering of 4.0 million shares of Common Stock in August 1995.
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 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 are currently not significant.
Liquidity and Capital Resources
At December 31, 1997, the Company had $88.8 million in cash and
equivalents, which represents a increase of approximately $49.9 million from
December 31, 1996. The Company maintains a $7.0 million unsecured revolving line
of credit with Bank One, Arizona, NA. This credit facility is annually renewable
and is available through July 31, 1998. Under the credit facility, the Company
has the option to borrow at a prime rate or adjusted LIBOR interest rate.
Historically, the credit facility has been used primarily to support
international letters of credit to suppliers. In December 1997, the Company
received net proceeds of approximately $59.2 million from a public stock
offering of 3,000,000 shares. The proceeds may be used to develop and expand
Inter-Tel.net and for potential acquisitions, strategic alliances, working
capital and general corporate purposes.
Net cash provided by operating activities totaled $28.2 million for the
year ended December 31, 1997, compared to $7.3 million for the same period in
1996. The increase in cash generated in 1997 was primarily the result of
profitable operations including non cash depreciation charges. In addition, cash
used in operating assets and liabilities declined significantly in 1997 to $1.6
million, compared to cash used of $15.7 million in 1996. During 1997, increases
in accounts receivable and inventory were principally funded by accounts
payable. The Company continues to expand its dealer network, which has required
and is expected to continue to require working capital for increased accounts
receivable and inventories.
Net cash used in investing activities, primarily in the form of capital
expenditures, totaled $12.5 million and $7.0 million in 1997 and 1996,
respectively. These capital expenditures were related primarily to the expansion
of facilities, equipment and management information systems used in operations.
Net cash provided by financing activities totaled $34.1 million in 1997
compared to $611,000 for the same period in 1996. During the second quarter of
1997, the Company initiated a stock repurchase program under which the Board of
Directors authorized the repurchase of up to 1,470,000 shares (on a pre-Stock
Split basis) of the Common Stock. The Company expended approximately $27.2
million for stock repurchases during 1997, which was funded primarily through
existing cash balances. The Company reissued shares through November through
stock option exercises and issuances. The proceeds received for the stock
reissued was less than its cost basis. Accordingly, the difference was recorded
as a reduction to retained earnings. The Company reissued all remaining
authorized, but then unissued shares upon the completion of the Company's
offering of 3,000,000 shares of Common Stock in December 1997. The Company
received net proceeds of $59.2 million from the offering. Such stock was
reissued from the offering at greater than the cost basis. The difference was
recorded as an increase to Common Stock.
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 $99.9 million remain unbilled at December 31, 1997. 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 and economic uncertainty. 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 the net proceeds from the Company's offering
of 3,000,000 shares of Common Stock completed on December 1, 1997 and its
working capital and credit facilities, together with cash generated from
operations, will be sufficient to develop and expand its Inter-Tel.net network,
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
the Inter-Tel.net network or additional acquisitions, the Company will seek, if
at all, additional financing. There can be no assurance that additional
financing will be available when required or on acceptable terms.
Impact of Recently Issued Accounting Standards
In February 1997, the Financial Accounting Standards Board (the "FASB")
issued SFAS No. 128, "Earnings Per Share" ("SFAS No. 128"), adopted by the
Company on December 31, 1997. Statement 128 replaced the previously reported
primary and fully diluted earnings per share with basic and diluted earnings per
share. Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants, and convertible securities. Diluted
earnings per share is very similar to the previously reported primary earnings
per share. All earnings per share amounts for all periods have been presented,
and where necessary, restated to conform to the Statement 128 requirements. The
impact of SFAS No. 128 on the calculation of fully diluted earnings per share
for each of the periods presented was not material.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131
establishes standards for the way that public business enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. SFAS No. 131 is effective for financial statements for fiscal years
beginning after December 15, 1997. The adoption of SFAS 131 will have no impact
on the Company's consolidated results of operations, financial position or cash
flows.