UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED COMMISSION FILE NUMBER:
DECEMBER 31, 2001 0-10211
INTER-TEL, INCORPORATED
INCORPORATED IN THE STATE OF ARIZONA I.R.S. NO. 86-0220994
1615 S. 52ND STREET
TEMPE, ARIZONA 85281
(480) 449-8900
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock
(24,190,130 shares outstanding as of March 8, 2002)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (S 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K - [ ].
The aggregate market value of the voting stock held by non-affiliates of
the registrant, based upon the last reported sales price of Inter-Tel's Common
Stock reported on the Nasdaq National Market System on March 8, 2002 was
approximately $351.8 million. Shares of Common Stock held by each executive
officer and director have been excluded in that such persons may be deemed to be
affiliates.
Items 10 (as to Directors), 11 and 12 of Part III incorporate by reference
information from the Registrant's Proxy Statement relating to its 2002 Annual
Meeting of Shareholders.
INTER-TEL, INCORPORATED
2001 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I Page
Item 1 Business 3
Item 2 Properties 22
Item 3 Legal Proceedings 23
Item 4 Submission of Matters to a Vote of Security Holders 23
PART II
Item 5 Market for the Registrant's Common Stock 23
and Related Shareholder Matters
Item 6 Selected Financial Data 24
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations 25
Item 7A Quantitative and Qualitative Disclosures About Market Risk 35
Item 8 Financial Statements and Supplementary Data 36
Item 9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 36
PART III
Item 10 Directors and Executive Officers of the Registrant 36
Item 11 Executive Compensation 36
Item 12 Security Ownership of Certain Beneficial Owners and Management 36
Item 13 Certain Relationships and Related Transactions 36
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 37
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PART I
ITEM 1. BUSINESS
THE COMPANY
THIS ANNUAL REPORT TO SHAREHOLDERS ON FORM 10-K ("10-K") CONTAINS
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE STATEMENTS
CONTAINED IN THIS 10-K THAT ARE NOT PURELY HISTORICAL ARE FORWARD-LOOKING
STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS
AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED,
INCLUDING WITHOUT LIMITATION STATEMENTS REGARDING THE COMPANY'S EXPECTATIONS,
BELIEFS, INTENTIONS OR STRATEGIES REGARDING THE FUTURE. ALL FORWARD-LOOKING
STATEMENTS INCLUDED IN THIS DOCUMENT ARE BASED ON INFORMATION AVAILABLE TO THE
COMPANY ON THE DATE HEREOF, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY
SUCH FORWARD-LOOKING STATEMENTS. THE CAUTIONARY STATEMENTS MADE IN THIS 10-K
SHOULD BE READ AS BEING APPLICABLE TO ALL RELATED FORWARD-LOOKING STATEMENTS
WHEREVER THEY APPEAR IN THIS DOCUMENT. THE COMPANY'S ACTUAL RESULTS COULD DIFFER
MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A
RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH UNDER "FACTORS THAT MAY
AFFECT FUTURE OPERATING RESULTS" BELOW AND ELSEWHERE IN THIS DOCUMENT. IN
EVALUATING THE COMPANY'S BUSINESS, SHAREHOLDERS AND PROSPECTIVE INVESTORS SHOULD
CONSIDER CAREFULLY THE FOLLOWING FACTORS IN ADDITION TO THE OTHER INFORMATION
SET FORTH IN THIS DOCUMENT.
Inter-Tel, incorporated in 1969, is a single point of contact, full service
provider of business communications systems, voice mail systems and networking
applications. We market and sell voice processing and unified messaging
software, call accounting software, Internet Protocol (IP) telephony software,
computer-telephone integration (CTI) applications, long distance calling
services, and other communications services. Our products and services include
the AXXESS by Inter-Tel and ECLIPSE(2) by Inter-Tel business communication
systems, with integrated voice processing and unified messaging systems, IP
telephony voice and data routers, and ClearConnect Talk-to-Agent e-commerce
software. We also provide maintenance, leasing and support services for our
products. Our customers include business enterprises, government agencies and
non-profit organizations. Our common stock is quoted on the Nasdaq National
Market System under the symbol "INTL."
We have developed a distribution network of direct sales offices, dealers
and value added resellers (VARs), which sell our products to organizations
throughout the United States and internationally, including to divisions of
Fortune 500 companies, large service organizations and governmental agencies. As
of December 31, 2001, we had 49 direct sales offices in the United States and
one in Japan, and a network of hundreds of dealers and VARs around the world
that purchase directly from us. We also maintain a wholesale distribution office
in the United Kingdom that supplies Inter-Tel's dealers and distributors
throughout the UK and parts of Europe. In January 2002, we acquired selected
assets and assumed certain selected liabilities of McLeod USA, Inc. (McLeod). As
a result, we added 5 new direct sales offices and we added personnel to 3 other
existing sales offices.
INDUSTRY BACKGROUND
Since the mid-1980s, the global telecommunications industry has been
characterized by rapid structural change caused by technological innovation,
economic factors and changes in government policies that encourage competition
and increase consumer choice. These changes are evidenced by the growing impact
of the Internet, deregulation, optical networking technology, broadband
connectivity, wireless and mobile communications and demand by enterprises for
cost-effective, multi-functional networks and applications.
As a result of the changes in the telecommunications industry, it is
expected that customers will demand more complex networks over the next several
years. In addition, network platforms are expected to become increasingly
multifunctional, supporting the convergence of voice, data and video
communications services, thus reducing the operating costs associated with
separate networks and facilitating the development of advanced, converged
applications.
Businesses increasingly recognize data networks such as the Internet as a
valuable and cost-efficient medium for internal and public communications. In
order to reduce their telecommunications costs, businesses are moving their
voice communications to packet-switched networks, such as corporate intranets
and the Internet. Although packet-switched networks can offer more efficiency
and value to businesses, the traditional telephone network remains the standard
for voice communications today. As a result, businesses that wish to
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take advantage of packet-switched networks for voice communications must still
be able to place and receive calls over the traditional telephone network with
customers, suppliers and others who rely solely on the traditional
circuit-switched telephone network for voice communications.
In addition, businesses typically make substantial investment in
traditional voice systems and networks and do not wish to abandon that
investment in order to implement entirely new converged voice and data
platforms. Rather than discarding an entire legacy system, many businesses
choose to supplement existing systems with new software and applications,
including remote telecommunications network management, enhanced voicemail and
packet-switched voice applications. For example, businesses may wish to route
external calls over their existing voice network and route internal calls
between offices over data networks, such as an intranet or the Internet, all
using the same telecommunications system. Consequently, there is a need for a
communication system that can interface with both packet-switched networks and
the traditional circuit-switched telephone network utilizing a business'
existing telecommunications infrastructure.
A new generation of telecommunications systems has emerged over the last
several years to address the challenges and inadequacies associated with
traditional circuit-switched private telephone systems. Many existing
telecommunications systems do not address the needs of businesses that wish to
transmit voice communications over both the traditional circuit-switched
telephone network and packet-switched data networks. We believe a significant
opportunity exists to provide businesses with an integrated solution that
delivers the benefits of integrated, multifunction communications systems using
both intranets and the Internet, as well as the traditional circuit-switched
telephone network and allows those businesses to migrate to a fully converged
voice, video and data network at their own pace.
STRATEGY
Inter-Tel's objective is to continue to strengthen its position as a
leading single-source provider of business communications equipment, software
applications and network services. Our strategy incorporates the following key
elements:
OFFER TOTAL COMMUNICATIONS SOLUTION
Inter-Tel offers a broad range of products and services that incorporate
advanced technologies and provide customers with a single source to
cost-effectively fulfill their business communications needs. We couple this
solution-oriented approach with a high level of customer service and support and
a commitment to quality throughout our operations. Our business communications
systems are integrated with our fully-integrated computer-telephone applications
and include voice mail, auto attendant, unified messaging, call center
applications, Interactive Voice Response (IVR), wireless applications, Automatic
Call Distribution (ACD), long distance and networking services, together with a
variety of other communications applications. Because of the modular design of
our systems and the high level of software content in our products, customers
can readily increase the size and functionality of their systems as their needs
change by adding new services, software and hardware applications, or by
upgrading to new systems or advanced versions of their existing systems. We
believe that our customers prefer to purchase business communications equipment
and services from a single source because of the convenience, consistency of
service, ease of upgrade, availability of financing alternatives and confidence
in the performance of integrated systems and services all incorporated into a
total solution package.
FACILITATE THE CONVERGENCE OF VOICE, VIDEO AND DATA NETWORKS
Inter-Tel's business communications systems allow our customers to migrate
their business communications systems to enable real-time voice communications
to be transmitted on digital packet-switched networks as well as traditional
circuit-switched telephone networks. In this regard, Inter-Tel's AXXESS and
ECLIPSE(2) systems, Versions 5.x and 6.x software, IP phones and Softphones for
work at home and remote office locations, IP telephony voice and data routers,
voice and data convergence applications, voice disaster recovery software
applications, Internet and wireless application protocol (WAP) software
applications and e-commerce voice enabled call center applications, allow
customers to incorporate the benefits of Internet protocol communication (or
communication over packet-switched networks) without replacing their existing
Inter-Tel business communications system infrastructure. Moreover, Inter-Tel's
Version 6.0 software released in the first quarter of 2002 uses Internet
Protocol and Asynchronous Transfer Mode, or ATM, to address larger system
configurations.
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LEVERAGE CUSTOMER BASE
We will continue to leverage our relationships with our approximately
500,000 business customers, to promote increased usage and deployment of our
products and services as they expand or change their organizations. In
particular, we intend to use our network of 54 (including the five new offices
from the purchase of certain selected McLeod assets and liabilities) direct
sales and service facilities, and our dealer and reseller channels to drive
recurring revenue from our customers. Existing customers accounted for a
significant portion of our 2001 net sales from maintenance services, software
additions and/or upgrades, support, training and hardware products such as video
conferencing, headsets (wired and wireless) and speaker-phones. Because our
business communications platform allows for system migration without the
complete change out of hardware, existing customers are sold enhancements and
new solutions through software-only upgrades. We believe that we can provide our
customers with the ability to enhance their business communications systems on a
cost-effective basis as voice, video and data communications convergence
applications evolve.
CONTINUE TO DEVELOP ADVANCED COMMUNICATIONS PRODUCTS AND EXPAND CAPACITY
Inter-Tel commits substantial research and development resources to provide
its customers with advanced telecommunications technologies on a cost-effective
basis. We have developed an extensive C++ and JAVA software library and we have
significant voice and data communications expertise. In many cases, we develop
new technologies as software and hardware upgrades or add-ons to existing
products. For example, our Version 6.0 software, which was released commercially
during the first quarter of 2002, will double the capacity of a single node to
1,024 ports as well as double the capacity of networked systems to 40,000 ports.
Our ongoing research and development efforts are directed towards the
development and creation of new products, applications and services for sale to
our existing customer base and to new customers. Through computer-telephony
applications and advanced network services, Inter-Tel provides technology that
is designed to enable its customers to improve their efficiency and enhance
their competitiveness.
EXPAND DISTRIBUTION CHANNELS
Inter-Tel continues to expand its distribution channels by growing our
network of direct dealers and direct sales offices, hiring additional direct
sales personnel and expanding into new international markets. We have
established sales relationships with hundreds of direct dealers in the United
States, United Kingdom, parts of Europe, Mexico and Asia. Inter-Tel has
increased its direct sales activity in recent periods through strategic
acquisitions of resellers of telephony products, data products and services.
These acquisitions, which we consider on an ongoing basis, increase the
geographic coverage of our direct sales force, support our dealer and
distributor channels and augment direct sales in areas that we have existing
direct sales offices. To increase sales within the dealer distribution channel
we provide dealers with support, on-site training, and we share best practices.
In addition, we provide access to Inter-Tel's demonstration rooms, located in
our direct sales office, as well as sales, technical and marketing support from
regional sales managers and sales engineers.
PRODUCTS AND SERVICES
Inter-Tel offers voice and data communications products and related
services for business enterprises, government agencies and non-profit
organizations. Our core products are business communications systems supporting
scalable networked installations, IP telephony products and services,
computer-telephony applications, unified messaging and voice processing
software. We also offer long distance calling services, network design and
implementation services, maintenance services, leasing and support services, and
we resell peripheral data and telecommunications products.
BUSINESS COMMUNICATIONS SYSTEMS
Inter-Tel has developed as its core product offering a business
communications system that consists of a hardware platform and a suite of
software applications that enables specific functionality. Inter-Tel sells its
business communications system to mid- and large-sized organizations under its
AXXESS by Inter-Tel (AXXESS) and ECLIPSE2 by Inter-Tel (ECLIPSE2) brand names.
The AXXESS and ECLIPSE(2) systems differ in terms of their appearance and some
functionality but are based upon the same software and architecture, which
incorporate open interfaces, employ the standard programming languages C++ and
JAVA, and are built on a computer-telephony interface that allows outside
computer applications to integrate with and monitor and control the operation of
the Inter-Tel communications system. The platforms support industry standard
computer-telephony interfaces, such as TAPI, TCP/IP, CSTA, and CT-Connect, as
well as robust proprietary interfaces that provide
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capabilities beyond those available through the standard interfaces. Our
software architecture enables customers to choose from a variety of server-level
or desktop applications.
AXXESS AND ECLIPSE(2). The AXXESS and the ECLIPSE(2) systems are designed
to enable businesses to customize their communications applications to enhance
their operations and increase productivity. These systems deliver integrated
voice processing, IP telephony and advanced call center applications, and
incorporate networking solutions that allow these applications to operate
transparently across multiple systems and locations. Our commercially-available
systems support up to 40,000 ports and include advanced capabilities such as
primary and basic rate ISDN, integrated call recording, voice prompts in
different languages, and a Microsoft Windows-based, touch screen sensitive,
attendant's console. Version 6.0 of the AXXESS and ECLIPSE(2) systems, released
in the first quarter of 2002, doubles the size of a single node to 1024 ports
and commercially supports up to 40,000 ports in a transparent network
environment. Our systems can be networked together using a combination of
point-to-point telephony circuits, voice-over-IP interfaces, or frame-relay
circuits depending on the customer's data and voice infrastructure.
The AXXESS and ECLIPSE(2) systems' industry standard computer-telephony
interfaces permit integration with desktop computers and network servers.
Examples of applications that are enabled by these computer-telephony interfaces
include:
* Database Look-up: uses caller identification to retrieve customer
information from a computer database and present it on a call center
agent's screen automatically;
* Advanced ACD Routing: uses caller identification, corporate database
information and current ACD queue status to determine where to route
customer calls for the highest possible level of customer service;
* Automated Outbound Calling: uses numbers pulled from a computer
database to initiate outbound calls for telemarketing agents; and
* Personal Call Routing: uses caller identification and customer
identification to screen and re-route calls to improve workplace
productivity.
The AXXESS and ECLIPSE(2) systems' telephones feature user-friendly, liquid
crystal displays, or LCDs, of up to 6-by-16 characters, with menu keys that
permit users to select from multiple menu choices or access additional menu
screens. These AXXESS and ECLIPSE(2) telephones also incorporate integrated
voice processing, which permits key selection and push-button selection of voice
processing commands, such as playback and record, to appear on the telephone's
LCD, as well as voice-prompted selections through the telephone keypad. Our
systems currently offer American English, British English, Japanese and Spanish
voice prompts and LCDs, and allow users to switch from one language to another
on a phone-by-phone basis. The software is also designed to support the addition
of other languages.
The AXXESS and ECLIPSE(2) systems' advanced software configures and uses
real-time digital signal processor semiconductor components, known as DSPs. We
employ DSPs and related software in our systems to decrease system costs, permit
higher functionality and increase system flexibility. The system's DSP resources
can be configured for different combinations of speakerphones, conference
capabilities, caller ID receivers and other DSP-based applications, depending on
the needs of an individual customer.
Inter-Tel has also developed and incorporated a Windows 2000-based Central
Processing Unit, or Server CPU into the AXXESS and ECLIPSE(2) systems. This
server-based CPU is designed to handle call processing with increased speed and
efficiency and provides enhanced computer-telephony interfaces. By combining
server-based technology with the core telephony functionality of the AXXESS and
ECLIPSE(2) systems, Inter-Tel's customers can benefit from the speed, efficiency
and enhanced functionality of a standards-based server while enjoying the
benefits of a traditional PBX, such as equipment maintenance during system
operation and cost-effective telephony interfaces. Because the Server CPU
integrates with existing Inter-Tel systems, customers can benefit from new
functionality and call handling capacity, while retaining most of their current
system investment.
Integrated with the AXXESS and ECLIPSE(2) systems, our Voice Processing
Unit provides an automated call attendant to guide callers tO the person or
information they need. An "electronic employee" answers incoming calls,
transfers calls, records messages, screens calls and returns calls using caller
identification software. The Voice Processing Unit also provides enhanced voice
mail and call routing announcements. Voice mail messages can be retrieved using
the Voice Processing Unit from any location in the world using a touch-tone
phone.
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IP TELEPHONY PRODUCTS
The emergence of high-performance, low-cost computers and the growth of the
Internet and other digital IP networks have enabled real-time voice
communications to be transmitted on digital packet-switched networks in addition
to traditional circuit-switched telephone networks. Because IP network telephony
converts all transmissions to the same type of packets, both voice and data can
use the same data circuits, thereby increasing efficiency and maximizing the use
of available bandwidth. Using IP telephony, bandwidth can be maximized to such
an extent that users may be able to reduce the overall number of circuits and
bandwidth they require.
With Inter-Tel's AXXESS and ECLIPSE(2) systems, users are able to enhance
their existing telephone systems with specific IP telephonY functionality or,
alternatively, base their entire communications systems on IP telephony. Our
systems are designed to enable our customers to preserve traditional
communications capabilities while delivering the benefits offered by new
technologies, such as packet-switched voice-over-IP.
IP PHONES AND IP SOFTPHONES. By using the Internet as part of a
communications solution, our phone systems can be accessed by our customers from
anywhere. Inter-Tel's IP phones, such as our IP PhonePlus and the IP Softphone,
are fully integrated with our AXXESS and ECLIPSE(2) systems, enabling users
anywhere--whether in a home office, in a satellite office, a hotel room, or at a
warehouse--to have access to the full functionality of the phone system,
including call transferring, conferencing, voice mail access, record-a-call and
computer-telephony integration.
IP TELEPHONY VOICE AND DATA ROUTERS. We market and sell a line of voice and
data routers. Voice and data routers are transition points between the public
circuit-switched telephone network and a packet-switched IP network, such as the
Internet. Our IP router products convert regular circuit-switched voice and
facsimile transmissions to or from the compressed data packets that travel over
packetized networks. The Inter-Tel voice and data routers enable phone-to-phone
and PC-to-phone calling over packet-switched IP networks.
IP NETWORKING MODULE. Our IP Networking Module product enables the
transparent networking capabilities of the AXXESS and ECLIPSE(2) systems over
Internet Protocol and frame-relay data networks, rather than using traditional
point-to-point lines. Whether our customers have 1 site or 63 sites, all of
their locations can interact seamlessly and transparently over IP networks:
practically anything that can be done using our systems in one location can be
done between geographically-dispersed locations. All the advanced features of
our systems remain in place when networking over IP, such as ACD hunt groups,
call center applications, paging zones, centralized attendants and tightly
integrated voice mail. By employing refined voice compression, jitter buffer and
echo cancellation technologies, calls consume minimal bandwidth on data networks
and provide clear connections.
COMPUTER-TELEPHONY PRODUCTS
COMPUTER-TELEPHONY APPLICATIONS AND ENABLING TECHNOLOGIES. Through computer
telephony (CT), Inter-Tel provides seamless integration between computers and
telephones. CT automates repetitive tasks, which can improve performance and
enhance customer service. Examples of typical CT applications with the AXXESS
and ECLIPSE2 systems include: viewing caller name, information and history
through a "pop-up" screen by interfacing with a company's database, performing
call handling tasks from a PC, and automatic call answering and routing.
The open architecture interfaces of our business communications systems
enable straight-forward integration with "off-the-shelf," shrink-wrapped
applications or custom software packages. Our architecture also enables our
systems' capabilities to be expanded because of the support available for
industry standard protocols. CT applications developed by Inter-Tel are based on
this open architecture at both the desktop and system levels. Through the use of
Microsoft's TAPI, Intel/Dialogic's CT-Connect and CSTA protocols, Inter-Tel's
software applications work with other off-the-shelf desktop and server
applications such as personal information managers, customer relationship
management (CRM) applications, help-desk applications, call routing or call
management.
If off-the-shelf applications do not fully address the needs of a
particular customer, Inter-Tel can develop custom CT applications or provide
professional consulting services for that customer to meet their needs.
Alternatively, the simple-to-use open architecture interfaces of our software
enable independent application developers and end-user management information
services departments to write custom CT applications to meet the customer's
specific needs.
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CALL CENTER SUITE. The Call Center Suite is a collection of
computer-telephony software applications that maximize the effectiveness and
productivity of call centers. The specific modules of the Call Center Suite
include server software, reporting functionality, desktop statistical reporting,
intelligent call routing and agent task information. Each module interfaces with
Inter-Tel's business communications systems to add cost-reducing functionality
to call centers. The applications in Inter-Tel's Call Center Suite can manage
automatic call distribution at peak efficiency or route incoming telephone calls
to a specific person based on various parameters. The Suite can also be used to
collect, analyze and report real-time call processing information.
CLEARCONNECT TALK-TO-AGENT. ClearConnect Talk-to-Agent is a voice-over-IP
product that enables customers to conduct voice conversations with sales agents
over the Internet, while connected to the business' Web site. Within seconds,
the voice-over-IP call is routed to an Automatic Call Distribution queue where
it can be routed to a customer service agent. With live conversations over the
Internet, customers are able to obtain answers to their questions quickly, and
our customer service agents can push Web pages directly to the customers for
increased agent productivity and enhanced revenue opportunities.
UNIFIED MESSAGING. Inter-Tel's Unified Messaging software works in
conjunction with a variety of messaging platforms, including Microsoft's
Exchange messaging application, Lotus' Notes, Lotus' cc:Mail, Novell's GroupWise
and other Internet mail applications such as AOL, Yahoo Mail, and Hotmail.
Designed to run on a Windows NT server, Inter-Tel's Unified Messaging Software
combines e-mail, voice mail and faxes into a single, centralized mail management
program. Messages are converted to standard file formats for access and
processing through a variety of devices for improved workplace productivity.
ENCORE BY INTER-TEL. Our Encore product is a business communications system
that addresses the small business market. Encore provides small organizations
with features and benefits associated with more expensive PBX systems. Encore
can be configured from two trunks and six stations up to eight trunks and 18
stations, with or without an optional integrated voice mail and automated
attendant. In addition, Encore can be programmed and maintained remotely,
minimizing the costs associated with on-site technician visits.
COMPUTER TELEPHONY PRODUCTS UNDER DEVELOPMENT
APPLICATIONS PLATFORM. Our Applications Platform product, planned for
commercial release in the first quarter or early in the second quarter of 2002,
is a highly flexible and robust computer-telephony and voice application
development product for enterprises. The Applications Platform enables creative
customization for Interactive Voice Response, or IVR, applications and is
comprised principally of two components: a run-time engine and an easy-to-use
graphical application development environment. The full-featured, turn-key
Applications Platform is being designed to include high-performance hardware,
state-of-the-art enabling technology, integrated IVR capabilities and an
application starter pack with two IVR applications for general business use.
These starter applications will provide end users with a sample of the type of
functionality the platform can support. Based on specific end user requirements,
customized IVR applications can also be created for the Applications Platform.
Customers can further enhance the functionality of their IVR applications by
deploying the optional automatic speech recognition and text-to-speech modules.
UNIFIED COMMUNICATOR. Our Inter-Tel Unified Communicator product, also
scheduled for commercial release in the first quarter or early in the second
quarter of 2002, is a Web-based user interface for the AXXESS and ECLIPSE(2)
systems. Unified Communicator is being designed tO offer features to end users
through a standard Web browser, or through a WAP Web client using a cellular
phone or wireless PDA. Using Unified Communicator, customers will be able to
perform call handling, message management and a number of related tasks on their
desktop phones from virtually anywhere. Unified Communicator will also enable
users to directly manage and control their personal features and the specific
features of the users' desktop AXXESS and ECLIPSE(2) systems' telephones. To
complement the Internet and WAP interfaces of UnifieD Communicator, a telephone
interface and a speech recognition engine will be available as separate modules.
By adding the appropriate module, users can call into the system and manage
their messages and call routing through either a touch-tone or speech interface.
OTHER SERVICES AND PRODUCTS
NETWORK AND LONG DISTANCE SERVICES. Through our subsidiary, Inter-Tel
NetSolutions, we resell a variety of telecommunications services, including
domestic and international calling services, calling card services, 800 calling
services, switched and dedicated services, Internet, frame-relay and voice and
video conferencing, disaster recovery solutions and customized billing. We also
provide long distance calling services
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through NetSolutions. Because many of our customers desire the convenience of
acquiring long distance calling services through the same vendor that they use
to purchase other telephony equipment and services, we also resell long distance
services to our customers through contracts we have established with major U.S.
long distance carriers.
We also support telecommunications applications such as T-1 access for
incoming toll-free traffic at call centers, switched long distance used at sales
offices and frame relay networks linking together multiple offices of an
enterprise.
NETWORKING TECHNOLOGIES INTEGRATION. Inter-Tel designs, installs and
supports an integrated, comprehensive solution for our customers' complex data
and telecommunications networks, from local area networks, or LANs, to
geographically dispersed wide area networks, or WANs.
By forming relationships with major manufacturers of hardware and software
technologies, Inter-Tel provides the routers, ATM, LAN and WAN switches,
wire-less WAN connections, file servers, intelligent hubs and other devices
required for the customer's intranet or for access to the Internet. We offer
pre-sale design support, project coordination for implementation, and
installation support on our full line of server-based telephony products and IP
telephony products and services.
PERIPHERAL PRODUCTS. Inter-Tel also distributes leading telecommunications
peripheral products, applications and services developed by third parties,
through our CommSource Division to our direct sales offices, dealers and VARs.
We offer a selection of third-party peripheral products including audio and
video conferencing, computer-telephony applications, battery backup, headsets,
surge protection, paging equipment, wireless communications, cabling solutions
and data multiplexers and routers. Our CommSource Division sells and distributes
products that we have endorsed as leading communications peripherals widely
deployed within organizations worldwide. Many of these products and services
interface with our telephone systems.
INTER-TEL.NET. Through July 23, 2001, we provided communications services
over data networks using IP with points of presence (POPs) in various cities in
the United States, Mexico and Hong Kong through our subsidiary, Inter-Tel.NET,
Inc.. Inter-Tel.NET developed an IP network of high capacity switches/gateways
and privately managed bandwidth, which could accommodate large volumes of
traffic. The managed network, routing structure and bandwidth capacity were
designed to create a cost-effective solution compared to traditional long
distance calling services. Through international alliances, Inter-Tel.NET also
participated with businesses in Asia, Europe, Mexico and South America to
provide international IP telephony service. Inter-Tel.NET's core customer base
includes telecommunication service providers, such as long distance carriers,
resellers, Competitive Local Exchange Carriers, or CLECs, and data network
providers that offer their end users access to voice, fax and other enhanced
services. Inter-Tel.NET utilizes other IP networks or traditional Long Distance
Carriers to complete the call where Inter-Tel.NET or one of its network partners
does not have a POP.
On July 24, 2001, Inter-Tel sold 83% of Inter-Tel.NET to Comm-Services
Corporation (Comm-Services) for a note in the principal amount of $4.95 million,
secured in part by stock and other marketable securities and 100% of the net
assets of Inter-Tel.NET. On December 30, 2001, Comm-Services entered into a
merger agreement with Vianet Technologies, Inc. (Vianet). Pursuant to the
merger, our 17% interest in Inter-Tel.NET was converted to 5.95 million shares,
or approximately 10% of Vianet, plus the full amount of the note. For more
information associated with the Inter-Tel.NET transactions, see "Notes to
Consolidated Financial Statements." For risks associated with our Inter-Tel.NET
business, see "Factors That May Affect Future Operating Results." See Note N to
the financial statements for more information about our segments.
SALES AND DISTRIBUTION
We have developed a distribution network of direct sales offices, dealers
and VARs that have traditionally marketed to small- to medium-size organizations
our products, which can support networked installations of up to 1,024 ports in
a single cabinet and 40,000 ports in a network configuration. With the advent of
Inter-Tel's new product releases, including Version 6.0 of the AXXESS and
ECLIPSE(2) systemS released in the first quarter of 2002, our distribution
network now markets to large organizations our products, which can support
networked installations of up to 40,000 ports. As of December 31, 2001,
Inter-Tel had 49 direct sales offices in the United States and one in Japan, and
a network of hundreds of dealers that purchase systems directly from us. We also
maintain a wholesale distribution office in the United Kingdom that supplies and
supports Inter-Tel's dealers and distributors throughout the United Kingdom and
in parts of Europe, and we have several dealers in Japan and in Mexico. In
January 2002, we acquired selected assets and assumed certain selected
liabilities of McLeod's key system, PBX and DataNet Operations. As a result of
the McLeod acquisition, we added five more direct sales offices in the United
States. The DataNet operation located in Sioux Falls, South Dakota is a LAN, WAN
and
9
network sales and service provider. We believe that the DataNet operation will
expand our product offerings to our larger customers and provide us with
increased revenue opportunities.
DISTRIBUTION CHANNELS
Our success depends in part upon the strength of our distribution channels
and our ability to maintain close access to our end user customers through our
distribution channels. In recent periods, we have sought to improve our access
to end users through strategic acquisitions of resellers of telephony products
and services located in markets in which we have existing direct sales offices
and in other markets. As of December 31, 2001, Inter-Tel's direct sales office
personnel and national and government accounts personnel consisted of 1,009 and
60 persons, respectively. Our sales through our direct sales offices and
government and national accounts group, as a percentage of total sales, have
increased from 52.9% of net sales in 2000 to 58.2% of net sales in 2001. Sales
to distributors, dealers, and VARs have decreased from 27.0% of net sales in
2000 to 22.8% of net sales in 2001. Sales through our long distance and network
services operations have decreased from 13.5% of net sales in 2000 to 11.3% of
net sales in 2001.
Direct dealers and VARs enter into exclusive or non-exclusive reseller
agreements with us for a term of one or more years. These agreements often
include requirements that the reseller meet or use their best efforts to meet
minimum annual purchase quotas. We generally provide support and other services
to our resellers under the terms of the agreements. We face intense competition
from other telephone system and voice processing system manufacturers for our
dealers' attention, as many of our dealers carry products that compete with our
products.
During the third quarter of 2001, we launched an exclusive business partner
program. This program is designed to reward dealers who sell only Inter-Tel
products to all new prospects and aggressively seek to upgrade their base. For
this commitment from the dealer, we have offered our expertise to help them
manage their business. This includes operational business reviews, shared human
resource forms and policies, additional sales, marketing and training support,
enhanced co-op benefits as well as special sales promotions and awards. In
addition, we will allow our branch sales offices to help dealers close business.
We believe that this program offers us an opportunity to expand our wholesale
channel of distribution.
LEASING SERVICES. Inter-Tel offers its Total Solutions program through our
subsidiary, Inter-Tel Leasing, Inc. The Total Solutions program enables an end
user to acquire a full range of telephony systems, applications, maintenance and
support services from affiliated vendors. This program provides a total system
financing package to the customer at a set monthly cost, with system expansion
available for an additional fee. The typical Total Solutions contract has a term
of 60 months, with the customer entitled to renew the contract at a specified
price for up to an additional 36 months.
Inter-Tel also offers a line of low-cost lease purchase financing. Lease
terms range from 24 to 84 months with $1.00, fixed and fair market value
purchase options. Inter-Tel can also customize financing packages to suit
customers with special financial needs. By offering this type of financing to
acquire our products and services, our customers are able to lease directly from
Inter-Tel or an authorized Inter-Tel dealer, thereby allowing us, or one of our
dealers to maintain a direct relationship with our customers. This direct
relationship allows Inter-Tel to provide maintenance and support services and
information regarding other Inter-Tel products and services.
INTERNATIONAL SALES. We currently have dealers in the United Kingdom, parts
of Europe, Japan and Latin America. International sales, which include business
communications systems and IP telephony and peripheral products, accounted for
approximately 2.6% of our net sales in both 2001 and 2000. In order to sell our
products to customers in other countries, Inter-Tel must comply with local
telecommunications standards. Our AXXESS and ECLIPSE(2) systems and IP telephony
products can be modified using our software to facilitate compliance with thesE
local regulations. In addition, the AXXESS and ECLIPSE(2) systems have been
designed to support multi-lingual functionality, and botH currently support
American English, British English, Japanese and Spanish languages. We are
currently working to expand our international dealer network.
CUSTOMER SERVICE AND SUPPORT
Customer service and support are critical components of customer
satisfaction and the success of our business. We operate a technical support
group that provides a range of support services to our distributors, dealers and
end user customers through the Internet and through a toll-free telephone
number. Inter-Tel provides on-site customer support and, using remote diagnostic
procedures, we have the ability to detect and
10
correct system problems from our technical support facilities. In 2000,
Inter-Tel began an initiative to greatly enhance our Internet, intranet and
extranet capabilities. Through this initiative, we re-designed our Web site to
offer to our direct sales offices and dealer channel state-of-the-art support
for sales and technical support activities. Our Web site also offers a wide
array of sales and technical information, including an on-line product and
service catalog, efficient order processing, portable-document-format sales
brochures, competitive information, on-line technical manuals,
frequently-asked-questions on important topics and convenient "touch-to-talk"
live operator help employing our own ClearConnect two-way voice-over-IP
technology. We intend to further develop our Web site to add additional
information and services. In 2001, Inter-Tel began an initiative to enhance the
technical knowledge database, the automated order system and the browser-based
sales proposal platform on our intranet and extranet.
We analyze feedback from our customer service call records to provide
direction for product and service enhancements. Our direct sales offices and
resellers can receive service activity reports summarizing the reasons that
technicians are asking for assistance and common issues that give rise to
technical inquiries. This allows our direct sales offices and resellers to track
trends in their service operations and to thereby provide better customer
service.
We believe that we can best serve our customers by continually improving
the quality of our systems, customer service and support, and other aspects of
our organization. Through our continuous improvement process initiated in 1991,
Inter-Tel implements quality processes throughout its business operations. We
have established formal procedures to ensure responsiveness to customer
requests, monitor response times and measure customer satisfaction. We have also
established means by which all end users, including customers of our resellers,
can request product enhancements directly from us. Inter-Tel supports its
dealers and VARs through an extensive training program offered at its
facilities, at dealer and third-party sites, a toll-free telephone number for
sales and technical support, an extranet site offering up-to-date sales and
support information, and the provision of end user marketing materials. We
typically provide a one year warranty on our systems to end users through our
direct offices. We offer eighteen-month warranties on our systems to the dealer
channel, which in turn are responsible for providing a warranty to their end
users.
RESEARCH AND DEVELOPMENT
We believe that our ability to enhance our current products, develop and
introduce new products on a timely basis, maintain technological competitiveness
and meet customer requirements are essential to our success. Inter-Tel's
research and development efforts over the last several years have been focused
primarily on the development of, and enhancements to, our AXXESS and ECLIPSE(2)
systems, including adding new applications, incorporating IP convergence
applications and IP telephones, developing Unified Messaging Software
applications, and expanding the telecommunications networking package to include
networking over IP and frame relay networks. Over the last several years, our
research and development efforts have also focused on the development of the
ClearConnect SoftPhone and the related ClearConnect Talk-to-Agent Web
communications software. Inter-Tel's current efforts are focused on developing
and enhancing the IP telephony products and applications for our AXXESS and
ECLIPSE(2) systems, increasing single-site node capacity using an ATM backbone,
enhancing our Unified Messaging Software, developing a speech-recognition and
text-to-speech enabled unified communications product, developing an advanced
IVR and CT application development tool, enhancing the IP digital telephones,
and enhancing Inter-Tel's server-based PBX offerings. As of December 31, 2001,
we had a total of 209 personnel engaged in research and development and related
technical service and support functions. Research and development expenses were
$17,556,000, $19,489,000, and $14,798,000 for 2001, 2000, and 1999.
MANUFACTURING
Inter-Tel manufactures substantially all of its systems through third party
subcontractors located in the United States, the People's Republic of China and
Mexico. These subcontractors use both standard and proprietary integrated
circuits and other electronic devices and components to produce telephone
switches, telephones and printed circuit boards to our engineering
specifications and designs. Our suppliers inspect and test the equipment before
delivering them to us, and in some cases our suppliers also perform systems
integration, software loading, final testing and shipment. Varian Associates, a
multinational electronics company, currently manufacturers a significant portion
of our products, including substantially all of the printed circuit boards used
in the AXXESS and ECLIPSE(2) systems, at Varian'S Tempe, Arizona and Poway,
California facilities. We provide Varian with forecasted schedules of our
manufacturing needs and revise the forecasts on a periodic
11
basis. We continuously monitor the quality of the products produced on our
behalf by our manufacturing subcontractors, and we are extending Inter-Tel's
continuous improvement process to our suppliers.
COMPETITION
The market for our products is highly competitive and has in recent periods
been characterized by rapid technological change, business consolidations and
decreasing prices. Our PABX and key systems products competitors include Avaya,
NorTel Networks, 3Com, Cisco Systems, Comdial, Iwatsu America, Inc., Mitel
Networks, NEC Corporation, Panasonic, Siemens and Toshiba. We also compete
against the regional Bell System operating companies (RBOCs), which typically
offer systems produced by one or more of our competitors listed above and also
typically offer Centrex systems in which automatic calling facilities are
provided through equipment located in the telephone company's central office. We
also compete with next-generation service providers, such as DSL providers and
cable companies, that offer bundled telephony and data services in an
application service provider telephony model.
In the market for voice processing applications including voice mail, we
compete against Captaris, Active Voice, ADC Telecommunication, InterVoice-Brite,
Lucent Technologies, Avaya, Nortel, Comdial and other competitors. In the market
for long distance services, we compete against AT&T, MCI WorldCom, Sprint, Qwest
and others. We also expect to compete with RBOCs, cable television companies,
satellite and other wireless broadband service providers for long distance
business. Key competitive factors in the sale of telephone systems and related
applications include price, performance, features, reliability, service and
support, name recognition and distribution capability. We believe that we
compete favorably in our markets with respect to the price, performance and
features of our systems, as well as the level of service and support that we
provide to our customers. However, certain of our competitors have significantly
greater resources, name recognition and distribution capabilities than we do.
In the market for IP telephony products geared toward the enterprise
markets, Inter-Tel competes with existing IP telephony providers such as Lucent,
Avaya, NorTel, Cisco Systems, 3Com, ADC and Motorola. Several of these
competitors have been active in developing and marketing IP telephony products
and have established relationships with customers within their markets. If the
market for IP telephony products becomes fully developed or develops at a rapid
rate, large computer companies such as IBM and Microsoft, or large telephone
companies such as AT&T, MCI WorldCom, Sprint or Qwest, could choose to develop
proprietary software designed to facilitate voice communication services over an
IP network.
As we compete for local telephone service, long distance service and IP
network access, we face additional competition from established foreign and
domestic long distance carriers, RBOCs and other providers. Many of these
competitors have larger marketing and sales organizations, significantly greater
financial and technical resources and a larger and more established customer
base than we do. In addition, RBOCs and other providers have greater name
recognition, more established positions in the market and long standing
relationships with customers.
INTELLECTUAL PROPERTY RIGHTS
We currently hold patents for 17 telecommunications and unified messaging
products. The remaining life of these patents ranges from 4 to 16 years in
duration. We have also applied to the U.S. Patent and Trademark Office for 6
additional patents. We also rely on copyright, trademark, trade secret law and
contractual provisions to protect our intellectual property.
EMPLOYEES
As of December 31, 2001, we had a total of 1,667 employees, of whom 578
were engaged in sales, marketing and customer support; 572 in quality,
manufacturing and related operations; 209 in research and development and
related technical service and support functions; and 308 in finance,
administration and management. We believe that our relations with our employees
are good.
12
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
RISKS RELATED TO OUR BUSINESS
OUR MARKET IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND TO COMPETE SUCCESSFULLY,
WE MUST CONTINUALLY INTRODUCE NEW AND ENHANCED PRODUCTS AND SERVICES THAT
ACHIEVE BROAD MARKET ACCEPTANCE.
The market for our products and services is characterized by rapid
technological change, evolving industry standards and vigorous customer demand
for new products, applications and services. To compete successfully, we must
continually enhance our existing telecommunications products, related software
and customer services, and develop new technologies and applications in a timely
and cost-effective manner. If we fail to introduce new products and services
that achieve broad market acceptance, or if we do not adapt our existing
products and services to customer demands or evolving industry standards, our
business could be significantly harmed. In addition, current competitors or new
market entrants may offer products, applications or services that are better
adapted to changing technology or customer demands and that could render our
products and services unmarketable or obsolete.
In addition, if the markets for computer-telephony (CT) applications,
Internet Protocol (IP) network products, or related products fail to develop or
continue to develop more slowly than we anticipate, or if we are unable for any
reason to capitalize on any of these emerging market opportunities, our
business, financial condition and operating results could be significantly
harmed.
OUR FUTURE SUCCESS LARGELY DEPENDS ON INCREASED COMMERCIAL ACCEPTANCE OF OUR
AXXESS AND ECLIPSE2 SYSTEMS, ENCORE PRODUCT, INTERPRISE PRODUCTS, NEW SPEECH
RECOGNITION AND INTERACTIVE VOICE RESPONSE PRODUCTS, AND RELATED
COMPUTER-TELEPHONY PRODUCTS.
During the past few years, we have introduced transparent networking and
unified messaging capabilities on our AXXESS and ECLIPSE2 systems and introduced
our Encore product and InterPrise family of voice and data convergence products.
In 2000, we introduced ClearConnect, a software-based telephone that runs on a
PC, ClearConnect Talk-to-Agent, an e-commerce "touch-to-talk" Web call product,
a line of IP voice terminals and IP soft phones that add IP telephony to the
AXXESS and ECLIPSE2 systems, and several other telephony-related products.
During the past 12 months, sales of our AXXESS business communications systems
and related software have comprised a substantial portion of our net sales. Our
future success depends, in large part, upon increased commercial acceptance and
adoption of the InterPrise and related computer-telephony products, the AXXESS
and ECLIPSE2 systems, Encore products, new speech recognition and Interactive
Voice Response products, as well as future upgrades and enhancements to these
products and networking platforms. We cannot assure you that these products or
platforms will achieve commercial acceptance in the future.
OUR PRODUCTS ARE COMPLEX AND MAY CONTAIN ERRORS OR DEFECTS THAT ARE DETECTED
ONLY AFTER THEIR RELEASE, WHICH MAY CAUSE US TO INCUR SIGNIFICANT UNEXPECTED
EXPENSES AND LOST SALES.
Our telecommunications products and software are highly complex. Although
our new products and upgrades are examined and tested prior to release, they can
only be fully tested when used by a large customer base. Consequently, our
customers may discover program errors, or "bugs," or other defects after new
products and upgrades have been released. Some of these bugs may result from
defects contained in component parts or software from our suppliers or other
third parties that are intended to be compatible with our products and over
which we have little or no control. Although we have test procedures and quality
control standards in place designed to minimize the number of errors and defects
in our products, we cannot assure you that our new products and upgrades will be
free of bugs when released. If we are unable to quickly or successfully correct
bugs identified after release, we could experience the following, any of which
would harm our business:
* costs associated with the remediation of any problems;
* costs associated with design modifications;
* loss of or delay in revenues;
* loss of customers;
* failure to achieve market acceptance or loss of market share;
* increased service and warranty costs;
* liabilities to our customers; and
* increased insurance costs.
13
THE COMPLEXITY OF OUR PRODUCTS COULD CAUSE DELAYS IN THE DEVELOPMENT AND RELEASE
OF NEW PRODUCTS AND SERVICES. AS A RESULT, CUSTOMER DEMAND FOR OUR PRODUCTS
COULD DECLINE, WHICH COULD HARM OUR BUSINESS.
Due to the complexity of our products and software, we have in the past
experienced and expect in the future to experience delays in the development and
release of new products or product enhancements. If we fail to introduce new
software, products or services in a timely manner, or fail to release upgrades
to our existing systems or products and software on a regular and timely basis,
customer demand for our products and software could decline, which would harm
our business.
BUSINESS ACQUISITIONS, DISPOSITIONS OR JOINT VENTURES ENTAIL NUMEROUS RISKS AND
MAY DISRUPT OUR BUSINESS, DILUTE SHAREHOLDER VALUE OR DISTRACT MANAGEMENT
ATTENTION.
As part of our business strategy, we consider acquisitions of, or
significant investments in, businesses that offer products, services and
technologies complementary to ours. Such acquisitions could materially adversely
affect our operating results and/or the price of our common stock. Acquisitions
also entail numerous risks, including:
* unanticipated costs and liabilities;
* difficulty of assimilating the operations, products and personnel of
the acquired business;
* difficulties in managing the financial and strategic position of
acquired or developed products, services and technologies;
* the diversion of management's attention from the core business;
* inability to maintain uniform standards, controls, policies and
procedures; and
* impairment of relationships with acquired employees and customers
occurring as a result of integration of the acquired business.
In particular, in 2000 we acquired certain assets and assumed certain
liabilities of Executone Information Systems, Inc. Our operating results were
adversely affected by several of the factors described above relating to the
Executone acquisition, including the risks related to unanticipated acquisition
costs and liabilities and impairment of employee and customer relationships, as
well as the erosion of gross and operating margins. For these and other reasons,
we wrote-off our investment in Executone during the second quarter of 2000.
In addition to the Executone losses discussed above, for the quarter ended
September 30, 2000, we also recorded a pre-tax loss of $2.0 million related to
our equity share of Cirilium's net losses. As of the close of the third quarter,
we wrote off our remaining investment in Cirilium of $2.0 million. Total pre-tax
losses from Cirilium from all sources were $8.6 million for 2000.
In January 2001, we acquired certain assets and assumed certain liabilities
of Convergent Technologies, Inc. In connection with the Convergent acquisition,
we hired over 200 Convergent employees and opened eight Inter-Tel branch offices
in previous Convergent locations. Among other risks and uncertainties, we have
experienced and may continue to experience the following difficulties or risks
associated with the Convergent acquisition:
* substantially all of Convergent's sales were of our competitor's
products and services, and these competitors have made it difficult
and expensive for us to service and maintain some of these products;
* a number of Convergent's customers have declined the assignment of
their maintenance contracts to us;
* a number of the employees hired by Inter-Tel have not integrated
successfully into the Inter-Tel business model; and
* many of the independent contractors who performed projects for
Convergent have not assumed similar roles with Inter-Tel.
In July 2001, Inter-Tel agreed to sell 83% of Inter-Tel.NET to
Comm-Services Corporation. In connection with this transaction, Inter-Tel
assessed the fair value of the net assets of Inter-Tel.NET as of June 30, 2001
under FAS 121 to arrive at an adjustment to the remaining investment in
Inter-Tel.NET. The charge recorded as of the close of the second quarter of 2001
totaled $5.4 million ($3.4 million after tax), associated with the impairment of
Inter-Tel's investment in Inter-Tel.NET. The recording of this charge adversely
affected our operating results for the second quarter of 2001. On December 30,
2001, Comm-Services entered into a merger agreement with Vianet Technologies,
Inc. (Vianet). Inter-Tel's 17% investment in Comm-Services was converted
14
to approximately 10% of Vianet stock. Our financial condition will be adversely
affected to the extent that the Vianet business is unsuccessful.
During 1999, 2000 and 2001, Inter-Tel.NET also entered into operating lease
agreements totaling approximately $6.5 million from an equipment vendor for
network equipment and software. The lease agreements required Inter-Tel.NET to
have vendor maintenance on their products. Inter-Tel originally guaranteed the
indebtedness. In the second quarter of 2001, Inter-Tel.NET notified the vendor
of network and network equipment problems encountered due to vendor equipment
and software recommended, supplied and financed by this vendor. Inter-Tel.NET
requested that the vendor not only solve the problems, but also compensate
Inter-Tel.NET for the problems and the resulting lost customers, lost revenues
and lost profits. Pursuant to Inter-Tel's sale of 83% of Inter-Tel.NET,
Comm-Services assumed the vendor lease and maintenance obligations and as such
Inter-Tel has not recorded any liability for these obligations. However, the
vendor has not released Inter-Tel from its guarantee of these obligations and
Inter-Tel has not released the vendor from Inter-Tel's claims, nor did we assign
our rights to these claims to Comm-Services. Our financial condition will be
adversely affected to the extent that payments made under the guarantee exceed
damages realized from our claim.
In January 2002, we acquired selected assets and liabilities of McLeodUSA,
Inc. (McLeod). In connection with the McLeod acquisition, we hired approximately
100 McLeod employees and opened two Inter-Tel branch offices in previous McLeod
locations. We cannot predict whether we will be able to integrate the employees
and business of McLeod into our operations successfully.
Finally, to the extent that shares of our stock or the rights to purchase
stock are issued in connection with any future acquisitions, dilution to our
existing shareholders will result and our earnings per share may suffer. Any
future acquisitions may not generate additional revenue or provide any benefit
to our business, and we may not achieve a satisfactory return on our investment
in any acquired businesses.
WE MAY NOT BE ABLE TO ADEQUATELY PROTECT OUR PROPRIETARY TECHNOLOGY AND MAY BE
INFRINGING UPON THIRD-PARTY INTELLECTUAL PROPERTY RIGHTS.
Our success depends upon our proprietary technology. We currently hold
patents for 17 telecommunication and unified messaging products and have also
applied to the U.S. Patent and Trademark Office for six additional patents. We
also rely on copyright and trade secret law and contractual provisions to
protect our intellectual property. Despite these precautions, third parties
could copy or otherwise obtain and use our technology without authorization, or
develop similar technology independently.
We cannot assure you that any patent, trademark or copyright that we own or
have applied to own, will not be invalidated, circumvented or challenged by a
third party. Effective protection of intellectual property rights may be
unavailable or limited in foreign countries. We cannot assure you that the
protection of our proprietary rights will be adequate or that competitors will
not independently develop similar technology, duplicate our services or design
around any patents or other intellectual property rights we hold. Litigation may
be necessary in the future to enforce our intellectual property rights, to
protect our trade secrets, to determine the validity and scope of the
proprietary rights of others, or to defend against claims of infringement or
invalidity. Litigation could be costly, absorb significant management time and
harm our business.
We are also subject to third party claims that our current or future
products or services infringe upon the rights of others. For example, we are
subject to proceedings alleging that certain of our key products infringe upon
third party intellectual property rights, including patents, trademarks,
copyrights or other intellectual property rights. We have viewed presentations
from one of our primary competitors, Lucent and subsequently Lucent's spin off
Avaya, alleging that our AXXESS business communications system utilizes
inventions covered by certain of their patents. We are continuing the process of
investigating this matter and we have made claims against Avaya and Lucent for
infringement of our patents. Additionally, we recently received a letter from
AT&T alleging that some of our IP products infringe upon intellectual property
protected by AT&T's patents. Although we have denied AT&T's allegations and
intend to defend our position vigorously, we cannot assure you that we will
ultimately prevail in this dispute. When any such claims are asserted against
us, among other means to resolve the dispute, we may seek to license the third
party's intellectual property rights. Purchasing such licenses can be expensive,
and we cannot assure you that a license will be available on prices or other
terms acceptable to us, if at all. Alternatively, we could resort to litigation
to challenge such a claim. Litigation could require us to expend significant
sums of cash and divert our management's attention. In the event that a court
renders an enforceable decision with respect to our intellectual property, we
may be required to pay significant damages, develop non-
15
infringing technology or acquire licenses to the technology subject to the
alleged infringement. Any of these actions or outcomes could harm our business.
If we are unable or choose not to license technology, or decide not to challenge
a third party's rights, we could encounter substantial and costly delays in
product introductions. These delays could result from efforts to design around
asserted third party rights or our discovery that the development, manufacture
or sale of products requiring these licenses could be foreclosed.
OUR IP NETWORK PRODUCTS MAY BE VULNERABLE TO VIRUSES, OTHER SYSTEM FAILURE RISKS
AND SECURITY CONCERNS, WHICH MAY RESULT IN LOST CUSTOMERS OR SLOW COMMERCIAL
ACCEPTANCE OF OUR IP NETWORK PRODUCTS.
Inter-Tel's IP telephony and network products may be vulnerable to computer
viruses or similar disruptive problems. Computer viruses or problems caused by
third parties could lead to interruptions, delays or cessation of service that
could harm our operations and revenues. In addition, we may lose customers if
inappropriate use of the Internet or other IP networks by third parties
jeopardize the security of confidential information, such as credit card or bank
account information or the content of conversations over the IP network. In
addition, user concerns about privacy and security may cause IP networks in
general to grow more slowly, and impair market acceptance of our IP network
products in particular, until more comprehensive security technologies are
developed.
WE HAVE MANY COMPETITORS AND EXPECT NEW COMPETITORS TO ENTER OUR MARKET, WHICH
COULD INCREASE PRICE COMPETITION AND SPENDING ON RESEARCH AND DEVELOPMENT AND
WHICH MAY IMPAIR OUR ABILITY TO COMPETE SUCCESSFULLY.
The markets for our products and services are extremely competitive and we
expect competition to increase in the future. Our current and potential
competitors in our primary business segments include:
* PABX and core systems providers such as Avaya, Cisco Systems, Comdial,
3Com, Iwatsu, Mitel, NEC, Nortel, Panasonic, Siemens, and Toshiba;
* large data routing and convergence companies such as 3Com and Cisco
Systems;
* voice processing applications providers such as ADC, InterVoice-Brite,
Active Voice (a subsidiary of NEC America), Avaya, Captaris (formerly
AVT) and Lucent;
* long distance services providers such as AT&T, MCI WorldCom, Qwest and
Sprint;
* large computer and software corporations such as IBM and Microsoft;
and
* regional Bell operating companies, or RBOCs, cable television
companies and satellite and other wireless broadband service
providers.
These and other companies may form strategic relationships with each other
to compete with us. These relationships may take the form of strategic
investments, joint-marketing agreements, licenses or other contractual
arrangements, which could increase our competitors' ability to address customer
needs with their product and service offerings.
Many of our competitors and potential competitors have substantially
greater financial, customer support, technical and marketing resources, larger
customer bases, longer operating histories, greater name recognition and more
established relationships in the industry than we do. We cannot be sure that we
will have the resources or expertise to compete successfully. Compared to us,
our competitors may be able to:
* develop and expand their product and service offerings more quickly;
* adapt to new or emerging technologies and changing customer needs
faster;
* take advantage of acquisitions and other opportunities more readily;
* negotiate more favorable licensing agreements with vendors;
* devote greater resources to the marketing and sale of their products;
and
* address customers' service-related issues more adequately.
Some of our competitors may also be able to provide customers with
additional benefits at lower overall costs or to reduce their gross margins
aggressively in an effort to increase market share. We cannot be sure that we
will be able to match cost reductions by our competitors. In addition, we
believe that there is likely to be consolidation in our markets, which could
lead to increased price competition and other forms of competition that could
cause our business to suffer.
16
OUR RELIANCE ON A LIMITED NUMBER OF SUPPLIERS FOR KEY COMPONENTS AND OUR
INCREASING DEPENDENCE ON CONTRACT MANUFACTURERS COULD IMPAIR OUR ABILITY TO
MANUFACTURE AND DELIVER OUR PRODUCTS AND SERVICES IN A TIMELY AND COST-EFFECTIVE
MANNER.
We currently obtain certain key components for our digital communication
platforms, including certain microprocessors, integrated circuits, power
supplies, voice processing interface cards and IP telephony cards, from a
limited number of suppliers and manufacturers. Our reliance on these limited
suppliers and contract manufacturers involves risks and uncertainties, including
the possibility of a shortage or delivery delay for some key components. We
currently manufacture our products through third-party subcontractors located in
the United States, the People's Republic of China, the United Kingdom and
Mexico. The Encore system is manufactured by an OEM partner in the United
Kingdom. Foreign manufacturing facilities are subject to changes in governmental
policies, imposition of tariffs and import restrictions and other factors beyond
our control. Varian currently manufactures a significant portion of our products
at Varian's Tempe, Arizona and Poway, California facilities, including
substantially all of the printed circuit boards used in the AXXESS and ECLIPSE2
systems, as well as substantially all of the Executone computer-telephony
products. We have experienced occasional delays in the supply of components and
finished goods that have harmed our business. We cannot assure that we will not
experience similar delays in the future.
Our reliance on third party manufacturers and OEM partners involves a
number of additional risks, including reduced control over delivery schedules,
quality assurance and costs. Our business may be harmed by any delay in delivery
or any shortage of supply of components or finished goods from a supplier. Our
business may also be harmed if we are unable to develop alternative or
additional supply sources as necessary. To date, we have been able to obtain
supplies of components and products in a timely manner even though we do not
have long-term supply contracts with any of our contract manufacturers. However,
we cannot assure you that we will be able to continue to obtain components or
finished goods in sufficient quantities or quality or on favorable pricing or
delivery terms in the future.
WE DERIVE A SUBSTANTIAL PORTION OF OUR NET SALES FROM OUR DEALER NETWORK AND IF
THESE DEALERS DO NOT EFFECTIVELY PROMOTE AND SELL OUR PRODUCTS, OUR BUSINESS AND
OPERATING RESULTS COULD BE HARMED.
We derive a substantial portion of our net sales through our network of
independent dealers. We face intense competition from other telephone, voice
processing, and voice and data router system manufacturers for these dealers'
business, as most of our dealers carry products that compete with our products.
Our dealers may choose to promote the products of our competitors to our
detriment. The loss of any significant dealer or group of dealers, or any event
or condition harming our dealer network, could harm our business, financial
condition and operating results.
EXPANDING OUR INTERNATIONAL SALES EFFORTS MAY EXPOSE US TO ADDITIONAL BUSINESS
RISKS, WHICH MAY RESULT IN REDUCED SALES OR PROFITABILITY IN OUR INTERNATIONAL
MARKETS.
We are in the process of attempting to expand our international dealer
network both in the countries in which we already have a presence and in new
countries and regions. International sales are subject to a number of risks,
including changes in foreign government regulations and telecommunication
standards, export license requirements, tariffs and taxes, other trade barriers,
difficulties in protecting our intellectual property, fluctuations in currency
exchange rates, difficulty in collecting receivables, difficulty in staffing and
managing foreign operations, and political and economic instability.
Fluctuations in currency exchange rates could cause our products to become
relatively more expensive to customers in a particular country, leading to a
reduction in sales or profitability in that country. In addition, the costs
associated with developing international sales may not be offset by increased
sales in the short term, or at all. Any of these risks could cause our products
to become relatively more expensive to customers in a particular country,
leading to reduced sales or profitability in that country. In addition, the
costs associated with developing an international dealer network may not be
offset by increased sales in the short term, if at all.
IF WE LOSE KEY PERSONNEL OR ARE UNABLE TO HIRE ADDITIONAL QUALIFIED PERSONNEL AS
NECESSARY, WE MAY NOT BE ABLE TO ACHIEVE OUR OBJECTIVES.
We depend on the continued service of, and our ability to attract and
retain, qualified technical, marketing, sales and managerial personnel, many of
whom would be difficult to replace. Competition for qualified personnel is
intense, and we have historically had difficulty hiring employees in the
timeframe that we desire, particularly skilled engineers. The loss of any of our
key personnel or our failure to effectively recruit additional key personnel
could make it difficult for us to manage our business, complete timely product
introductions or meet
17
other critical business objectives. For example, our inability to retain key
executives of Executone following our Executone acquisition impaired our ability
to benefit from the Executone business and to grow revenues from the Executone
assets. Moreover, our operating results will be impaired if we lose a
substantial number of key Convergent and McLeod employees. We cannot assure you
that we will be able to continue to attract and retain the qualified personnel
necessary for the development of our business.
WE MAY BE UNABLE TO MANAGE OUR GROWTH EFFECTIVELY, WHICH MAY HARM OUR BUSINESS.
The ability to operate our business in a rapidly evolving market requires
an effective planning and management process. The growth in our business has
placed, and is expected to continue to place, a significant strain on our
personnel, management systems, infrastructure and other resources. Our ability
to manage any future growth effectively will require us to successfully attract,
train, motivate and manage new employees, to integrate new employees into our
overall operations and to continue to improve our operational, financial and
management controls and procedures. Furthermore, we expect that we will be
required to manage an increasing number of relationships with suppliers,
manufacturers, customers and other third parties. If we are unable to implement
adequate controls or integrate new employees into our business in an efficient
and timely manner, our operations could be adversely affected and our growth
could be impaired which could harm our business.
THE INTRODUCTION OF NEW PRODUCTS AND SERVICES HAS LENGTHENED OUR SALES CYCLES,
WHICH MAY RESULT IN SIGNIFICANT SALES AND MARKETING EXPENSES.
In the past few years, we introduced the AXXESS and ECLIPSE2 ATM business
communications system and networking software, which are typically sold to
larger customers at a higher average selling price and often represent a
significant communications infrastructure capital expenditure by the prospective
enterprise customer. Accordingly, the purchase of our products typically
involves numerous internal approvals relating to the evaluation, testing,
implementation and acceptance of new technologies. This evaluation process
frequently results in a lengthy sales process, which can range from a few months
to more than 12 months, thereby subjecting our sales cycle to a number of
significant uncertainties concerning budgetary constraints and internal
acceptance reviews. The length of our sales cycle also may vary substantially
from customer to customer. While our customers are evaluating our products and
before placing an order with us, we may incur substantial sales and marketing
expenses and expend significant management effort. Consequently, if sales
forecasted from a specific customer for a particular quarter are not realized in
that quarter, our operating results could be materially adversely affected.
OUR OPERATING RESULTS HAVE HISTORICALLY DEPENDED ON A NUMBER OF FACTORS, AND
THESE FACTORS MAY CAUSE OUR OPERATING RESULTS TO FLUCTUATE IN THE FUTURE.
Our quarterly operating results have historically depended on, and may
fluctuate in the future as a result of, many factors including:
* volume and timing of orders received during the quarter;
* gross margin fluctuations associated with the mix of products sold;
* the mix of distribution channels;
* general economic conditions;
* patterns of capital spending by customers;
* the timing of new product announcements and releases by us and our
competitors;
* pricing pressures, the cost and effect of acquisitions, in particular
the Executone and Convergent acquisitions; and
* the availability and cost of products and components from our
suppliers.
In addition, we have historically operated with a relatively small backlog,
with sales and operating results in any quarter depending principally on orders
booked and shipped in that quarter. In the past, we have recorded a substantial
portion of our net sales for a given quarter in the third month of that quarter,
with a concentration of such net sales in the last two weeks of the quarter.
Market demand for investment in capital equipment such as business
communications systems and associated call processing and voice processing
software applications depends largely on general economic conditions, and can
vary significantly as a result of changing conditions in the economy as a whole.
We cannot assure you that historical trends for small backlog will continue in
the future.
Our expense levels are based in part on expectations of future sales and,
if sales levels do not meet expectations, our operating results could be harmed.
In addition, because sales of business communications systems through our
dealers typically produce lower gross margins than sales through our direct
sales
18
organization, operating results have varied, and will continue to vary based
upon the mix of sales through direct and indirect channels. Also, the timing and
profitability of lease resales from quarter to quarter could impact operating
results, particularly in an environment of fluctuating interest rates. Long
distance sales, which typically have lower gross margins than our core business,
have grown in recent periods at a faster rate than our overall net sales. As a
result, gross margins could be harmed if long distance calling services continue
to increase as a percentage of net sales. In addition, we experience seasonal
fluctuations in our operating results, as net sales for the first quarter is
frequently less than the fourth quarter and the third quarter is frequently less
than the second quarter. As a result of these and other factors, we have
historically experienced, and could continue to experience in the future,
fluctuations in sales and operating results on a quarterly basis.
OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE VOLATILE, IMPAIRING YOUR ABILITY
TO SELL YOUR SHARES AT OR ABOVE PURCHASE PRICE.
The market price for our common stock has been highly volatile. The
volatility of our stock could be subject to continued wide fluctuations in
response to many risk factors listed in this section, and others beyond our
control, including:
* announcements of developments relating to our business;
* fluctuations in our operating results;
* shortfalls in revenue or earnings relative to securities analysts'
expectations;
* announcements of technological innovations or new products or
enhancements by us or our competitors;
* announcements of acquisitions or planned acquisitions of other
companies or businesses;
* investors' reactions to acquisition announcements or our forecasts of
future results;
* general conditions in the telecommunications industry;
* the market for Internet-related products and services;
* changes in the national or worldwide economy;
* changes in legislation or regulation affecting the telecommunications
industry;
* an outbreak of hostilities or terrorist acts;
* developments relating to our and third party intellectual property
rights; and
* changes in our relationships with our customers and suppliers.
In addition, stock prices of technology companies in general, and for voice
and data communications companies of technology stocks in particular, have
experienced extreme price fluctuations in recent years which have often been
unrelated to the operating performance of affected companies. We cannot assure
you that the market price of our common stock will not experience significant
fluctuations in the future, including fluctuations that are unrelated to our
performance.
OUR CHAIRMAN OF THE BOARD OF DIRECTORS, CEO AND PRESIDENT CONTROLS 21.7% OF OUR
COMMON STOCK AND IS ABLE TO SIGNIFICANTLY INFLUENCE MATTERS REQUIRING
SHAREHOLDER APPROVAL.
As of March 1, 2002, Steven G. Mihaylo, Inter-Tel's Chairman of the Board
of Directors, Chief Executive Officer and President, beneficially owned
approximately 21.7% of the outstanding shares of the common stock. As a result,
he has the ability to exercise significant influence over all matters requiring
shareholder approval. In addition, the concentration of ownership could have the
effect of delaying or preventing a change in control of Inter-Tel.
RISKS RELATED TO OUR INDUSTRY
THE EMERGING MARKET FOR IP NETWORK TELEPHONY IS SUBJECT TO MARKET RISKS AND
UNCERTAINTIES THAT COULD CAUSE SIGNIFICANT DELAYS AND EXPENSES.
The market for IP network voice communications products has begun to
develop only recently, is evolving rapidly and is characterized by an increasing
number of market entrants who have introduced or developed products and services
for Internet or other IP network voice communications. As is typical of a new
and rapidly evolving industry, the demand for and market acceptance of, recently
introduced IP network products and services are highly uncertain. We cannot
assure you that packet-switched voice networks will become widespread. Even if
packet-switched voice networks become widespread in the future, we cannot assure
you that our products, including the Inter-Tel InterPrise product line and IP
telephony features of the AXXESS and ECLIPSE2 systems, will successfully compete
against other market players and attain broad market acceptance. Inter-Tel sold
83% of Inter-Tel.NET, an IP telephony provider, to Comm-Services in July 2001,
and our remaining
19
17% investment was subsequently converted to approximately 10% interest in
Vianet Technologies, Inc. via a merger between Comm-Services and Vianet.
Accordingly, Inter-Tel continues to maintain an investment of 10% in
Inter-Tel.NET through Vianet. Accordingly, our financial condition will be
adversely affected if the Inter-Tel.NET/Vianet business is unsuccessful.
Moreover, the adoption of packet-switched voice networks generally requires
the acceptance of a new way of exchanging information. In particular,
enterprises that have already invested substantial resources in other means of
communicating information may be reluctant or slow to adopt a new approach to
communications. If the market for IP network voice communications fails to
develop or develops more slowly than we anticipate, our IP network telephony
products could fail to achieve market acceptance, which in turn could
significantly harm our business, financial condition and operating results. This
growth may be inhibited by a number of factors, such as quality of
infrastructure; security concerns; equipment, software or other technology
failures; regulatory encroachments; inconsistent quality of service; poor voice
quality over IP networks as compared to circuit-switched networks; and lack of
availability of cost-effective, high-speed network capacity. Moreover, as
IP-based data communications and telephony usage grow, the infrastructure used
to support these IP networks, whether public or private, may not be able to
support the demands placed on them and their performance or reliability may
decline. The technology that allows voice and facsimile communications over the
Internet and other data networks, and the delivery of other value-added
services, is still in the early stages of development.
GOVERNMENT REGULATION OF THIRD PARTY LONG DISTANCE AND NETWORK SERVICE ENTITIES
ON WHICH WE RELY MAY HARM OUR BUSINESS.
Our supply of telecommunications services and information depends on
several long distance carriers, RBOCs, local exchange carriers, or LECs, and
competitive local exchange carriers, or CLECs. We rely on these carriers to
provide network services to our customers and to provide us with billing
information. Long distance services are subject to extensive and uncertain
governmental regulation on both the federal and state level. We cannot assure
that the increase in regulations will not harm our business. Our current
contracts for the resale of services through long distance carriers include
multi-year periods during which we have minimum use requirements and/or costs.
The market for long distance services is experiencing, and is expected to
continue to experience significant price competition, and this may cause a
decrease in end-user rates. We cannot assure you that we will meet minimum use
commitments, that we will be able to negotiate lower rates with carriers if
end-user rates decrease or that we will be able to extend our contracts with
carriers at favorable prices. If we are unable to secure reliable long distance
and network services from certain long distance carriers, RBOCs, LECs and CLECs,
or if these entities are unwilling or unable to provide telecommunications
services and billing information to us on favorable terms, our ability to expand
our own long distance and network services will be harmed. Carriers that provide
telecommunications services to us may also experience financial difficulties, up
to and including bankruptcies, which could harm our ability to offer
telecommunications services.
CONSOLIDATION WITHIN THE TELECOMMUNICATIONS INDUSTRY COULD INCREASE COMPETITION
AND REDUCE OUR CUSTOMER BASE.
During the past year, there has been a trend in the telecommunications
industry towards consolidation and we expect this trend to continue as the
industry evolves. As a result of this consolidation trend, new stronger
companies may emerge that have improved financial resources, enhanced research
and development capabilities and a larger and more diverse customer base. The
changes within the telecommunications industry may adversely affect our
business, operating results and financial condition.
REDUCTIONS IN SPENDING ON ENTERPRISE COMMUNICATIONS EQUIPMENT MAY MATERIALLY AND
ADVERSELY AFFECT OUR BUSINESS.
The overall economic slowdown has had a harmful effect on the market for
enterprise communications equipment. Our customers have reduced significantly
their capital spending on communications equipment in an effort to reduce their
own costs and bolster their revenues. The market for enterprise communications
equipment may continue to grow at a modest rate and our financial performance
has been and may continue to be materially and adversely affected by the
reductions in spending on enterprise communications equipment.
20
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding Inter-Tel's
directors and executive officers as of March 8, 2002.
Name Age Position
- ---- --- --------
Steven G. Mihaylo 58 Chairman of the Board of
Directors, Chief Executive Officer
and President
Norman Stout 44 Executive Vice President/Chief
Administrative Officer
Craig W. Rauchle 46 Executive Vice President/Chief
Operating Officer
Jeffrey T. Ford 40 Senior Vice President/Chief
Technology Officer
Kurt R. Kneip 39 Chief Financial Officer,
Vice President and Secretary
J. Robert Anderson 65 Director
Jerry W. Chapman 61 Director
Gary Edens 60 Director
C. Roland Haden 61 Director
MR. MIHAYLO, the founder of Inter-Tel, has served as Chairman of the Board
of Directors of Inter-Tel since September 1983, as President since May 1998 and
as Chief Executive Officer since Inter-Tel's formation in July 1969. Mr. Mihaylo
served as President of Inter-Tel from 1969 to 1983 and from 1984 to December
1994, and as Chairman of the Board of Directors from July 1969 to October 1982.
MR. STOUT was elected Executive Vice President, Chief Administrative
Officer and President of Inter-Tel Software and Services in June 1998. From
October 1994 to June 1998, he served as one of our directors. Prior to joining
Inter-Tel, Mr. Stout was Chief Operating Officer of Oldcastle Architectural
Products and since 1996, Mr. Stout also had served as President of Oldcastle
Architectural West. Mr. Stout was previously President of Superlite Block, a
subsidiary of Oldcastle Architectural Products and a manufacturer of concrete
products, since February 1993. Prior thereto he was employed by Boorhem-Fields,
Inc. of Dallas, Texas, a manufacturer of crushed stone, as Chief Executive
Officer from 1990 to 1993 and as Chief Financial Officer from 1986 to 1990.
Prior to that, Mr. Stout was a Certified Public Accountant with Coopers &
Lybrand. Mr. Stout holds a Bachelor of Science degree in Accounting from Texas
A&M and an MBA from the University of Texas.
MR. RAUCHLE was elected Chief Operating Officer in August 2001 and has been
our Executive Vice President since December 1994. He had been our Senior Vice
President and continues as President of Inter-Tel Technologies, Inc., our wholly
owned sales subsidiary. In addition, he currently is responsible for our
corporate strategic planning and mergers and acquisitions. Mr. Rauchle joined
Inter-Tel in 1979 as Branch General Manager of the Denver Direct Sales Office
and in 1983 was appointed the Central Region Vice President and subsequently the
Western Regional Vice President. From 1990 to 1992, Mr. Rauchle served as
President of Inter-Tel Communications, Inc. Mr. Rauchle holds a Bachelor of Arts
degree in Communications from the University of Denver.
MR. FORD was elected Senior Vice President in May 1998 and has served as
our Chief Technology Officer since 1997. He was elected President of Inter-Tel
Integrated Systems, Inc. ("IIS") in May 1998, after serving as Senior Vice
President of IIS for one year and Vice President of Software Engineering of
Inter-Tel Integrated Systems from 1993 to 1997. He joined Inter-Tel in 1983 as a
software design engineer. Mr. Ford holds a Bachelor of Science degree in
Computer Systems Engineering from Arizona State University and an SEP
certificate from the Stanford Graduate School of Business.
MR. KNEIP has served as our Vice President and Chief Financial Officer
since September 1993. He was elected Secretary and Treasurer in October 1994. In
May 1996 he was elected Assistant Treasurer, as John Abbott was elected
Treasurer. He joined Inter-Tel in May 1992 as Director of Corporate Tax, after
seven years
21
with the accounting firms of Ernst & Young and KPMG Peat Marwick. Mr. Kneip is a
Certified Public Accountant, and holds a Bachelor of Science degree in
Commercial Economics from South Dakota State University and a Masters Degree in
Professional Accountancy from the University of South Dakota.
MR. ANDERSON has served as one of our directors since February 1997. Mr.
Anderson held various positions at Ford Motor Company from 1963 to 1983, serving
as President of the Ford Motor Land Development Corporation from 1978 to 1983.
He served as Senior Vice President, Chief Financial Officer and a member of the
Board of Directors of The Firestone Tire and Rubber Company from 1983 to 1989,
and as Vice Chairman of Bridgestone/Firestone, Inc. from 1989 through 1991. He
most recently served as Vice Chairman, Chief Financial Officer and a member of
the Board of Directors of the Grumman Corporation from 1991 to 1994. Mr.
Anderson is currently semi-retired, and he is an active leader in various
business, civic and philanthropic organizations.
MR. CHAPMAN was elected as one of our directors in December 1999 and
previously served as one of our directors in the late 1980's and early 1990's.
He served with a local CPA firm from 1963 through 1969, at which time he joined
Ernst & Young (then Ernst & Ernst). He became a partner of Ernst & Young in 1977
and, until retiring from the firm in 1989, served as engagement partner on a
wide variety of audit, assurance and consulting engagements. Additionally, he
managed Ernst & Young's practices in Arizona as well as certain offices in the
adjoining southwest states from 1980 through 1989. He then operated his own
consulting firm through 1992 and joined Arthur Andersen in 1993 as a partner
specializing in providing business consulting services. He retired from Arthur
Andersen in 1999 and currently provides services for a small number of clients
requiring strategic and market-driven services.
MR. EDENS has served as one of our directors since October 1994. He was a
broadcasting media executive from 1970 to 1994, serving as Chairman and Chief
Executive Officer of Edens Broadcasting, Inc. from 1984 to 1994, when that
corporation's nine radio stations were sold. He is currently President of The
Hanover Companies, Inc., an investment firm. He is an active leader in various
business, civic and philanthropic organizations.
DR. HADEN has served as one of our directors since 1983. Dr. Haden has been
Vice Chancellor and Dean of Engineering of Texas A&M University since 1993.
Previously, he was Vice Chancellor of Louisiana State University, Dean of the
College of Engineering and Applied Sciences at Arizona State University, and
Vice President for Academic Affairs at Arizona State University. He earlier
served as department head at the University of Oklahoma. Dr. Haden has served on
a number of corporate boards, such as Square D Company and E-Systems, Inc., both
then Fortune 500 companies. His Ph.D. is in Electrical Engineering from the
University of Texas.
The Audit Committee of our Board of Directors consisted of Messrs. Chapman,
Anderson and Haden, through December 31, 2001. Pursuant to the Audit Committee
charter, the Audit Committee reviews, acts and reports to our Board of Directors
on various auditing and accounting matters, including the appointment of our
independent accountants, the scope of our annual audits, fees to be paid to our
independent accountants, the performance of our independent accountants and our
accounting and financial management practices. A report of the Audit Committee
is set forth below. The Audit Committee met five times during the last fiscal
year. All of the members of our Audit Committee are "independent" members in
accordance with the National Association of Securities Dealers.
The Compensation Committee consisted of Messrs. Anderson and Edens through
December 31, 2001. The Compensation Committee reviews employee compensation and
makes recommendations thereon to our Board of Directors and administers our
Stock Incentive Plans. The Compensation Committee also determines, upon review
of relevant information, the employees to whom options shall be granted. The
Compensation Committee met two times during the last fiscal year.
ITEM 2. PROPERTIES
We recently relocated our corporate headquarters to a 22,600 square foot
building located in Tempe, Arizona pursuant to a lease that expires in December
2003, and consolidated our two distribution centers from the existing Chandler,
Arizona and Poway, California locations to a 68,000 square foot building also in
Tempe, Arizona pursuant to a lease that expires in March 2006. The principal
product development and support
22
operations remain in a 96,000 square foot building located in Chandler, Arizona
pursuant to a lease that expires in May 2008. We also own a 70,000 square foot
facility located in Reno, Nevada that houses credit and lease finance
facilities, business development center and sales office. We also lease sales
and support offices in a total of 52 locations in the United States, including
approximately 147,000 square feet of office space in Milford, Connecticut
pursuant to the Executone acquisition (a portion of which has been subleased),
and two locations overseas. Our aggregate monthly payments under these leases
were approximately $563,000 at December 31, 2001. We believe that our facilities
will be adequate to meet our current needs and that additional or alternative
space will be available as necessary in the future on commercially reasonable
terms.
ITEM 3. LEGAL PROCEEDINGS
We are involved from time to time in litigation incidental to our business.
We believe that the outcome of current litigation will not have a material
adverse effect upon our business, financial condition or results of operations
and will not disrupt our normal operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
Inter-Tel Common Stock is traded over-the-counter (Nasdaq symbol: INTL) and
since February 1983 has been included in the Nasdaq National Market System. As
of March 8, 2002 there were of record approximately 1,684 shareholders of our
Common Stock. The following table sets forth high and low sales prices reported
by Nasdaq for each quarter in the last two years.
A dividend of $.01 per share of Common Stock has been paid to
shareholders of record for each quarter since December 31, 1997. In October
2001, the Board of Directors declared an increase to the quarterly cash dividend
to $.02 per share of Common Stock, effective December 31, 2001. The continuation
of this dividend policy will depend on our earnings, capital requirements for
growth, financial conditions and other factors.
2001 HIGH LOW 2000 HIGH LOW
- ---- ---- --- ---- ---- ---
First Quarter 13.125 6.8125 First Quarter 46.375 21.50
Second Quarter 14.74 7.75 Second Quarter 28.00 12.875
Third Quarter 16.95 9.90 Third Quarter 16 3125 11.00
Fourth Quarter 20.90 11.21 Fourth Quarter 13.25 6.1875
23
ITEM 6. SELECTED FINANCIAL DATA
FINANCIAL SUMMARY
(In thousands, except
per share amounts and ratios) For the years ended December 31,
- --------------------------------------------------------------------------------------------------------------------
2001 2000 1999 1998 1997
--------- --------- --------- --------- ---------
Net Sales $ 385,655 $ 402,723 $ 314,221 $ 274,504 $ 223,569
Cost of sales 211,161 243,685(2) 159,463 140,946 122,363
Research and development 17,556 19,489 14,798 11,373 7,998
Selling, general and
Administrative 131,157 127,468 98,430 86,554 69,942
Write-off in-process research
and development -- 5,433(2) -- 22,755(3) --
Other charges 5,357(1) 45,245(2) -- -- --
--------- --------- --------- --------- ---------
Operating (loss) income 20,424(1) (38,597)(2) 41,530 12,876(3) 23,266
--------- --------- --------- --------- ---------
Equity share of Cirilium losses -- (5,938) -- -- --
Write-off of Cirilium investment -- (2,045) -- -- --
Interest and other income 1,081 1,474 2,391 2,913 1,556
Gain (loss) on foreign translation
adjustments (337) (421) (46) 105 (173)
Interest expense (468) (213) (110) (60) (47)
--------- --------- --------- --------- ---------
(Loss) income before taxes 20,700(1) (45,740)(2) 43,765 15,834(3) 24,602
Income taxes 7,659 (16,817) 16,619 6,790 9,920
--------- --------- --------- --------- ---------
Net (loss) income 13,041(1) (28,923)(2) $ 27,146 $ 9,044(3) $ 14,682
--------- --------- --------- --------- ---------
Net (loss) income per share
Basic $ 0.53(1) $ (1.10)(2) $ 1.05 $ 0.34(3) $ 0.59
Diluted $ 0.52(1) $ (1.10)(2) $ 1.01 $ 0.32(3) $ 0.57
--------- --------- --------- --------- ---------
Weighted average basic
common shares 24,488 26,273 25,949 26,602 24,836
Weighted average diluted
common shares 25,240 26,273 27,004 27,846 25,983
--------- --------- --------- --------- ---------
BALANCE SHEET DATA
Total assets $ 227,462 $ 243,126 $ 247,517 $ 197,030 $ 194,988
Working capital 93,156 86,008 60,799 96,317 123,814
Shareholders' equity 126,837 136,436 168,121 142,686 145,505
--------- --------- --------- --------- ---------
KEY RATIOS
Current ratio 2.41 2.05 1.93 3.17 4.69
Dividends declared per share $ 0.05 $ 0.04 $ 0.04 $ 0.04 $ 0.01
Return on equity-continuing
Operations 9.6% (17.2)% 19.0% 6.2% 15.5%
Return on equity-excluding
Charges 12.0%(1) 7.8%(2) 19.0% 15.6%(3) 15.5%
--------- --------- --------- --------- ---------
(1) 2001 operating income includes a pre-tax charge of $5.4 million, which
reduced net income by $3.4 million, or $0.13 per share after tax. This
pre-tax charge reflects the write-down of our investment in Inter-Tel.NET
to net realizable value.
(2) 2000 operating income includes pre-tax charges of $66.8 million, which
reduced net income by $42.0 million, or $1.60 per share after tax. These
pre-tax charges reflect the write-off of the Executone acquisition of $50.9
million ($7.6 million of which is included in cost of sales) in the second
quarter, the write-off of IPRD in connection with the Executone purchase of
$5.4 million during the first quarter, the write-down to net realizable
value of Inter-Tel.NET assets of $2.0 million during the second quarter,
the equity share of Cirilium's losses of $5.9 million for the year, and
write-off of our investment in Cirilium of $2.6 million (including reserve
adjustments) during the third quarter. Without these charges, we would have
reported net income of $13.1 million ($0.50 per diluted share) for the year
ended December 31, 2000.
(3) 1998 operating income includes a special pre-tax charge of $22.8 million,
which reduced net income by $13.7 million or $.49 per diluted share after
tax. This charge reflects the write-off of in-process research and
development in connection with the purchase of certain assets and
liabilities of Telecom Multimedia Systems, Inc. ("TMSI"). Without this
write-off, we would have reported net income of $22.7 million ($.82 per
diluted share) for the year ended December 31, 1998.
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS AND OTHER PARTS OF THIS REPORT ON FORM 10-K CONTAIN
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE WORDS
"EXPECTS," "ANTICIPATES," "BELIEVES," "INTENDS," "WILL" AND SIMILAR
EXPRESSIONS IDENTIFY FORWARD-LOOKING STATEMENTS WHICH ARE BASED ON
INFORMATION AVAILABLE TO US ON THE DATE HEREOF, AND WE ASSUME NO OBLIGATION
TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS. OUR ACTUAL RESULTS COULD
DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING
STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING THOSE SET FORTH IN
"FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS" AND ELSEWHERE IN THIS
10-K.
GENERAL
Inter-Tel, incorporated in 1969, is a single point of contact, full service
provider of business communications systems, voice mail systems and networking
applications. We market and sell voice processing and unified messaging
software, call accounting software, Internet Protocol (IP) telephony software,
computer-telephone integration (CTI) applications, long distance calling
services, and other communications services. Our products and services include
the AXXESS by Inter-Tel and ECLIPSE(2) by Inter-Tel business communication
systems, with integrated voice processing and unified messaging systems, IP
telephony voice and data routers, and ClearConnect Talk-to-Agent e-commerce
software. We also provide maintenance, leasing and support services for our
products. Our customers include business enterprises, government agencies and
non-profit organizations. Our common stock is quoted on the Nasdaq National
Market System under the symbol "INTL."
We have developed a distribution network of direct sales offices, dealers
and value added resellers (VARs), which sell our products to organizations
throughout the United States and internationally, including to divisions of
Fortune 500 companies, large service organizations and governmental agencies. As
of December 31, 2001, we had 49 direct sales offices in the United States and
one in Japan, and a network of hundreds of dealers and VARs around the world
that purchase directly from us. We also maintain a wholesale distribution office
in the United Kingdom that supplies Inter-Tel's dealers and distributors
throughout the UK and parts of Europe. In January 2002, we acquired selected
assets and assumed certain selected liabilities of McLeod USA, Inc. (McLeod). As
a result, we added 5 new direct sales offices and added personnel to 3 other
existing offices. We integrated several of these offices into existing sales
offices during 2002.
Sales of systems through our dealers and VARs typically generate lower
gross margins than sales through our direct sales organization, although direct
sales typically require higher levels of selling, general and administrative
expenses. In addition, our long distance and network services typically generate
lower gross margins than sales of software and system products. Accordingly, our
margins may vary from period to period depending upon distribution channel and
product mix. In the event that sales through dealers or sales of long distance
services increase as a percentage of net sales, our overall gross margin could
decline.
Our operating results depend upon a variety of factors, including the
volume and timing of orders received during a period, the mix of products sold
and the mix of distribution channels, general economic conditions, patterns of
capital spending by customers, the timing of new product announcements and
releases by us and our competitors, pricing pressures, the cost and effect of
acquisitions and the availability and cost of products and components from our
suppliers. Historically, a substantial portion of our net sales in a given
quarter 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, we are subject to seasonal variations in our operating results, as net
sales for the first and third quarters are frequently less than those
experienced during the fourth and second quarters, respectively.
The markets served by us have been characterized by rapid technological changes
and increasing customer requirements. We have sought to address these
requirements through the development of software enhancements and improvements
to existing systems and the introduction of new products and applications.
Inter-Tel's research and development efforts over the last several years have
been focused primarily on the development of, and enhancements to, our AXXESS
and ECLIPSE(2) systems, including adding new applications, incorporating IP
convergence applications and IP telephones, developing Unified Messaging
Software applications, and expanding the telecommunications networking package
to include networking over IP and frame relay networks. Over the last several
years, our research and development efforts have also focused on the
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development of the ClearConnect SoftPhone and the related ClearConnect
Talk-to-Agent Web communications software. Inter-Tel's current efforts are
focused on developing and enhancing the IP telephony products and applications
for our AXXESS and ECLIPSE(2) systems, increasing single-site node capacity
using an Asynchronous Transfer Mode backbone using version 6.0 AXXESS AND
ECLIPSE2 SOFTWARE, enhancing our Unified Messaging Software, developing a
speech-recognition and text-to-speech enabled unified communications product,
developing an advanced IVR and CT application development tool, enhancing the IP
digital telephones, and enhancing Inter-Tel's server-based PBX offering.
We offer to our customers a package of lease financing and other services
under the name Total Solution (formerly, Totalease). Total Solution provides our
customers lease financing, maintenance and support services, fixed price
upgrades and other benefits. We finance this program through the periodic resale
of lease rental streams to financial institutions.
Net sales decreased 4.2% in 2001 compared to 2000. Net sales in 2000 and
1999 increased substantially by 28.2%, and 14.5%, respectively, over the
preceding years.
RESULTS OF OPERATIONS
The following table sets forth certain statement of operations data
expressed as a percentage of net sales for the periods indicated:
Year Ended December 31
-----------------------------
2001 2000 1999
----- ----- -----
Net sales 100.0% 100.0% 100.0%
Cost of sales 54.8 60.5 50.7
----- ----- -----
Gross margin 45.2 39.5 49.3
Research and development 4.6 4.8 4.7
Selling, general and administrative 34.0 31.7 31.3
Other charges 1.4 12.6 --
----- ----- -----
Operating income (loss) 5.3 (9.6) 13.2
Equity share of Cirilium's net losses -- (1.5) --
Write-off of Cirilium investment -- (0.5) --
Interest and other income 0.3 0.4 0.7
Loss on foreign translation adjustments (0.1) (0.1) --
Interest expense (0.1) (0.1) 0.0
Income taxes (benefit) 2.0 (4.2) 5.3
----- ----- -----
Net income (loss) 3.4% (7.2)% 8.6%
----- ----- -----
YEAR ENDED DECEMBER 31, 2001 VERSUS YEAR ENDED DECEMBER 31, 2000
NET SALES. Net sales decreased 4.2% to $385.7 million in 2001 from $402.7
million in 2000, representing a decrease of $17.1 million. Sales from
Inter-Tel.NET (in which Inter-Tel sold 83% in July 2001), accounted for $8.8
million of the decrease. Sales from our direct sales offices, including
government and national accounts, and from wholesale distribution accounted for
$9.4 million of the decrease. Sales from NetSolutions accounted for $1.0 million
of the decrease from 2000 to 2001. Net sales from lease financing increased to
$19.8 million in 2001 from $16.2 million in 2000. International revenues
decreased approximately $300,000 from 2000 to 2001.
Since July 24, 2001, the date of the sale of 83% of Inter-Tel.NET, we have
used the investment method of accounting for our remaining investment in
Inter-Tel.NET/Comm-Services. Accordingly, we have not recorded revenues or
expenses of Inter-Tel.NET since the date of sale. Excluding sales from
Inter-Tel.NET, net sales for 2001 decreased 2.2% to $371.7 million, compared to
$379.9 million in 2000. Inter-Tel.NET generated net sales of $14.0 million in
2001 compared to $22.8 million in 2000. The reduction in sales attributable to
Inter-Tel.NET was due primarily to our sale of 83% of Inter-Tel.NET on July 24,
2001. Accordingly, less than seven months of activity from Inter-Tel.NET was
reflected in the 2001 results as compared to the full year results of
Inter-Tel.NET reported in 2000.
The 2001 decrease in net sales was also attributable to delayed customer
buying decisions in 2001 related to a deterioration in macroeconomic conditions.
Inter-Tel recognized lower revenues due to lower sales volumes
26
of systems collectively through the direct sales offices, government and
national accounts group, dealer channel and foreign operations, offset partially
by sales increases in our lease finance operations. In some instances, prices of
various telecommunications systems decreased, and discounts or other promotions
that were offered to customers to generate sales resulted in lower revenues.
Please refer to Note N of Notes to Consolidated Financial Statements for
additional segment reporting information.
GROSS PROFIT. Gross profit increased 9.7% to $174.5 million, or 45.2% of
net sales in 2001, from $159.0 million, or 39.5% of net sales in 2000. Excluding
the Executone restructuring charge, gross profit increased 4.7% compared to
166.7 million, or 41.4% of net sales in 2000. This increase in gross profit was
primarily a result of lower sales from Inter-Tel.NET, which experienced negative
gross margins, an increase in sales, as a percentage of consolidated net sales,
through our direct sales channel compared to our dealer network, reduced product
costs and higher relative recurring revenues. Gross profit also increased as a
percentage of net sales, due in large part to items noted above. These increases
were offset by greater competitive pricing pressures in 2001 and by pricing
discounts on telephone system sales.
Excluding the operations of Inter-Tel.NET, gross profit for 2001 increased
1.4% to $180.4 million, or 48.5% of net sales, compared to $177.9 million, or
46.8% of net sales, in 2000. Inter-Tel.NET generated negative gross profit of
$5.9 million in 2001 compared to negative $11.2 million in 2000.
RESEARCH AND DEVELOPMENT. Research and development expenses decreased to
$17.6 million, or 4.6% of net sales in 2001, from $19.5 million, or 4.8% of net
sales in 2000. The decline is attributable in large part to the closure of the
Executone research and development operations in Milford, Connecticut in July
2000. Accordingly, our 2001 costs did not reflect the Executone expenses,
compared to seven months of activity in 2000. In 2001, research and development
expenses were directed principally toward the continued development of the
digital AXXESS and Eclipse2 software and systems (including version 6.0),
unified messaging and voice processing software, InterPrise IP router solutions,
Talk-to-Agent web e-commerce solutions, speech recognition and text-to-speech
applications, and certain CTI and IVR applications. We expect that research and
development expenses will increase in absolute dollars as we continue to develop
and enhance existing and new technologies and products. These expenses may vary,
however, as a percentage of net sales.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased to $131.2 million, or 34.0% of net sales in 2001, from $127.5
million, or 31.7% of net sales in 2000. The increase in these expenses reflected
an increase in costs associated with sales through our direct office channels
compared to our dealer network, increased reserves for accounts receivable, and
an increase in costs of maintaining additional facilities, including our new
facilities in the Phoenix metro area and the Convergent offices acquired in
January 2001. We expect that selling, general and administrative expenses will
increase in absolute dollars, but may vary as a percentage of net sales.
Excluding the operations of Inter-Tel.NET, selling, general and
administrative expenses increased to $128.7 million, or 34.6% of net sales for
2001, compared to $121.0 million, or 31.8% of net sales in 2000. Excluding
charges, Inter-Tel.NET incurred selling, general and administrative expenses of
$2.5 million in 2001 compared to $5.9 million in 2000.
OTHER CHARGES. In connection with the sale of its interest in Inter-Tel.NET
in July 2001, the Company recorded a pre-tax charge or $5.4 million during 2001,
which reduced net income by $3.4 million, or $0.13 per share after-tax. This
charge was associated with the impairment of our investment in Inter-Tel.NET.
The impairment was measured as the difference between the carrying value of
Inter-Tel's 17% interest in Inter-Tel.NET and the estimated fair market value of
the 17% interest in the net assets of Inter-Tel.NET.
We reported pre-tax charges of $66.8 million during 2000, which reduced net
income by $42.0 million, or $1.60 per share after tax. These pre-tax charges
reflected the write-off of the Executone acquisition of $50.9 million in the
second quarter, the write-off of in process research and development in
connection with the Executone purchase of $5.4 million during the first quarter,
the write-down to net realizable value of Inter-Tel.NET assets of $2.0 million
during the second quarter, the equity share of Cirilium's losses of $5.9 million
for the year, and write-off of Inter-Tel's investment in Cirilium of $2.6
million (including reserve adjustments) during the third quarter. Without these
charges, we would have reported net income of $24.2 million ($0.90 per diluted
share) for the year ended December 31, 2000. Refer to "Restructuring Charges"
below for additional information.
27
CHARGES AND WRITE-OFF OF IN PROCESS RESEARCH AND DEVELOPMENT. We reported a
pre-tax charge of $5.4 million during 2001, which reduced net income by $3.4
million, or $0.13 per share after tax. This pre-tax charge reflected the sale of
83% of our interest in Inter-Tel.NET and the write-down of our investment in
Inter-Tel.NET to anticipated net realizable value. Without this charges, we
would have reported net income of $16.4 million ($0.65 per diluted share) for
the year ended December 31, 2001.
INTEREST AND OTHER INCOME. Other income in both periods consisted primarily
of interest income and foreign exchange rate gains and losses. Interest and
other income decreased $393,000 in 2001 compared to the same period in 2000
principally as a result of lower levels of cash available for investment. During
2001, the Company recognized foreign exchange rate losses of $337,000 compared
to losses of $421,000 in 2000. Interest expense was $468,000 in 2001 compared to
$213,000 in 2000, primarily attributable to debt from assets financed for
Inter-Tel.NET operations. This debt was transferred upon the sale of 83% of
Inter-Tel.NET in July 2001.
INCOME TAXES. The 2001 income tax rate increased to 37.0% compared to 36.8%
for 2000. The rate was lower in 2000 because we received no tax benefits for a
component of the Cirilium losses that were capital losses during 2000 (lower tax
benefits were received to apply to 2000 net losses). In 2002, we anticipate an
effective tax rate comparable to or slightly higher than 2001.
NET INCOME. Including the charge recorded in 2001, net income increased to
$13.0 million, or $.52 per diluted share, in 2001 compared to net loss of $28.9
million, or a net loss of $1.10 per diluted share, in 2000 reflecting the
charges noted above associated with the Executone, Cirilium and Inter-Tel.NET
operations. Excluding the charges, net income would have been $16.4 million, or
$.65 per diluted share, in 2001.
Excluding the charges, all Cirilium losses and operations of Inter-Tel.NET,
the Company reported net income of $21.8 million, or $0.86 per diluted share, in
2001, compared to net income of $24.2 million, or $0.90 per diluted share, in
2000.
YEAR ENDED DECEMBER 31, 2000 VERSUS YEAR ENDED DECEMBER 31, 1999
NET SALES. Net sales increased 28.2% to $402.7 million in 2000 from $314.2
million in 1999, representing an increase of $88.5 million. Sales from our
direct sales offices, including government and national account, and from
wholesale distribution accounted for $61.5 million of the increase and the
network services group accounted for $21.2 million of the increase. In addition,
sales from Inter-Tel.NET increased to $22.8 million in 2000 from $2.8 million in
1999.
GROSS PROFIT. Gross profit including the Executone restructuring charge
increased 2.8% to $159.0 million, or 39.5% of net sales in 2000 from $154.8
million, or 49.3% of net sales, in 1999. Excluding the Executone restructuring
charge, gross profit increased 7.7% to 166.7 million, or 41.4% of net sales in
2000. This increase in gross profit was primarily a result of the large increase
in consolidated sales. However, gross profit decreased as a percentage of net
sales, due in large part to increases in sales of IP and long distance services,
which have lower gross margins than sales of our digital systems and software.
In addition, we experienced a lower proportion of sales through our direct sales
offices compared to our dealer network, and were impacted by pricing discounts
on telephone system sales.
RESEARCH AND DEVELOPMENT. Research and development expenses increased to
$19.5 million, or 4.8% of net sales in 2000 from $14.8 million, or 4.7% of net
sales, in 1999. The increase was attributable in large part to the purchase of
Executone and related research and development operations in Milford,
Connecticut in January 2000. Accordingly, our 2000 costs included seven months
of Executone activity, compared to none in 1999. In 2000, these expenses were
directed principally toward the continued development of the AXXESS and Eclipse2
business communication systems, unified messaging and voice processing software,
InterPrise IP router solutions, ClearConnect solutions and certain CTI
applications.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased to $127.5 million, or 31.7% of net sales, in 2000 from $98.4
million, or 31.3% of net sales, in 1999. The increase reflected increased costs
from continued development of the Inter-Tel.net network and related expenses,
increased reserves for accounts receivable, additional personnel to support the
direct dealer network, and selling, incentive, training and other compensation
costs at our direct sales office operations.
28
OTHER CHARGES AND IPRD WRITE-OFF. We reported pre-tax charges of $66.8
million during 2000, which reduced net income by $42.0 million, or $1.60 per
share after tax. These pre-tax charges reflected the write-off of the Executone
acquisition of $50.9 million in the second quarter, the write-off of IPRD in
connection with the Executone purchase of $5.4 million during the first quarter,
the write-down to net realizable value of Inter-Tel.NET assets of $2.0 million
during the second quarter, the equity share of Cirilium's losses of $5.9 million
for the year, and write-off of our investment in Cirilium of $2.6 million
(including reserve adjustments) during the third quarter. Without these charges,
we would have reported net income of $13.1 million ($0.50 per diluted share) for
the year ended December 31, 2001. Refer to "Restructuring Charges" below for
additional information.
INTEREST AND OTHER INCOME. Other income in both periods consisted primarily
of interest income and foreign exchange rate gains and losses. Other income
decreased approximately $1.3 million in 2000 principally as a result of lower
levels of cash available for investment.
INCOME TAXES. The 2000 income tax rate decreased to 36.8% compared to 38.0%
for 1999. We received no tax benefit for a component of the Cirilium losses
during 2000 that were capital losses.
NET INCOME. Including the charges recorded in 2000, net income decreased to
a loss of $28.9 million, or a loss of $1.10 per diluted share, in 2000 compared
to net income of $27.1 million, or $1.01 per diluted share, in 1999. Excluding
the charges, net income would have been $13.1 million, or $.50 per diluted
share, in 2000.
INFLATION/CURRENCY FLUCTUATION
Inflation and currency fluctuations have not previously had a material
impact on Inter-Tel's operations. International procurement agreements have
traditionally been denominated in U.S. currency. Moreover, a significant amount
of contract manufacturing has been or is expected to be moved to alternative
sources. The expansion of international operations in the United Kingdom and
Europe and increased sales, if any, in Japan and other parts of Asia could
result in higher international sales as a percentage of total revenues; however,
international revenues are currently not significant.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2001, cash and equivalents totaled $61.8 million, which
represented an increase of approximately $34.7 million from December 31, 2000.
We maintain a $25 million unsecured, revolving line of credit with BankOne
Arizona, NA, that is available through June 1, 2002. Under the credit facility,
we have the option to borrow at a prime rate or adjusted LIBOR interest rate.
Historically, we have used the credit facility primarily to support
international letters of credit to suppliers. During the year ended December 31,
2001, approximately $28.9 million of available cash was used to repurchase our
common stock and an additional $6.8 million of available cash was used to fund
acquisitions. During the prior year ended December 31, 2000, we used
approximately $6.7 million to repurchase shares of our Common Stock and an
additional $2.9 million of available cash in acquisitions and joint ventures.
Also during 2000, we expended approximately $11.0 million in the restructuring
of the Executone operations, including severance and related costs, the shut
down and consolidation of the Milford facility and the impairment of assets
associated with the restructuring. The remaining cash balances may be used for
acquisitions, strategic alliances, working capital and general corporate
purposes.
Net cash provided by operating activities totaled $75.0 million for the
year ended December 31, 2001, compared to $17.3 million for the same period in
2000. Cash provided by operating activities in 2001 primarily resulted from
income from operations after considering the non-cash portion of restructuring
charges and the non-cash depreciation and amortization expenses. Cash generated
by the change in operating assets and liabilities in 2001 was $16.1 million,
compared to cash used by the change in operating assets and liabilities of $29.0
million in 2000. At December 31, 2001, we achieved lower accounts receivable,
inventory, prepaid expenses and other current assets than at December 31, 2000,
which was primarily a result of close management of receivables and inventory
and working down elevated levels of working capital assets acquired in the
Executone acquisition. In addition, accounts payable at December 31, 2001 were
lower than prior year end consistent with the lower inventory levels achieved.
We expect to expand sales through our direct sales office and dealer networks,
which is expected to require the expenditure of working capital for increased
accounts receivable and inventories.
29
Net cash used in investing activities, primarily in the form of
acquisitions and capital expenditures totaled $14.6 million and $5.9 million for
the years ended December 31, 2001 and 2000, respectively. Cash used in
acquisitions and investments in joint ventures totaled approximately $6.8
million in 2001 compared to $2.9 million in 2000. Capital expenditures totaled
approximately $8.0 million for 2001 compared to $9.6 million in 2000. Net cash
used in investing activities in 2000 were partially offset by cash received of
$6.6 million from the disposition of the manufacturing operations of Executone.
We anticipate additional capital expenditures during 2002, principally relating
to expenditures for equipment and management information systems used in
operations, facilities expansion and acquisition activities.
Net cash used in financing activities totaled $25.7 million during 2001
compared to $3.5 million in 2000. We expended approximately $28.9 million and
$6.7 million for stock repurchases during 2001 and 2000, respectively, funded by
existing cash balances during each period. We issued long term debt, net of
repayments, of $1.8 million in 2001 and $1.0 million in 2000 primarily in the
form of long term capital leases to support capital additions to Inter-Tel.net
prior to our divestiture of our majority ownership in July, 2001. During 2001,
we reissued treasury shares through stock option exercises and issuances, with
the proceeds received totaling less than the cost basis of the treasury stock
reissued. Accordingly, the difference was recorded as a reduction to retained
earnings. Net cash used for cash dividends totaled $1.0 million in 2001 and $1.1
million during 2000, which was offset in each period by cash provided by the
exercise of stock options and stock issuances pursuant to our Employee Stock
Purchase Plan.
We offer to our customers lease financing and other services, including our
Total Solution (formerly Totalease) program, through our Inter-Tel Leasing, Inc.
subsidiary. We fund our Total Solution program in part through the sale to
financial institutions of rental income streams under the leases. Resold lease
rentals totaling $202.7 and $198.4 million remain unbilled at December 31, 2001
and December 31, 2000, respectively. We are obligated to repurchase such income
streams in the event of defaults by lease customers and, accordingly, maintain
reserves based on loss experience and past due accounts. Although we to date
have been able to resell the rental streams from leases under the Total Solution
program profitably and on a substantially current basis, the timing and
profitability of lease resales could impact our business and operating results,
particularly in an environment of fluctuating interest rates and economic
uncertainty. If we are required to repurchase rental streams and realizes losses
thereon in amounts exceeding our reserves, our operating results will be
adversely affected.
Inter-Tel received a gross cash award of $20 million in February 2002 in
settlement of a binding arbitration claim. Income taxes, attorney's fees, expert
witness costs, arbitration costs and additional costs and expenses, including
$1.3 million in bonus payments to employees who assisted in the litigation and
arbitration, totaled approximately $10.7 million in 2002. Accordingly, net
proceeds from this arbitration totaled approximately $9.3 million. This
transaction concluded in 2002; therefore no cash proceeds were included in the
2001 financial statements.
We believe that our working capital and credit facilities, together with
cash generated from operations, will be sufficient to develop and expand our
business operations, to finance acquisitions of additional resellers of
telephony products and other strategic acquisitions or corporate alliances, and
to provide adequate working capital for the next twelve months. However, to the
extent that additional funds are required in the future to address working
capital needs and to provide funding for capital expenditures, expansion of the
business or additional acquisitions, we will seek additional financing. There
can be no assurance that additional financing will be available when required or
on acceptable terms.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The methods, estimates and judgments we use in applying our most critical
accounting policies have a significant impact on the results we report in our
consolidated financial statements. We evaluate our estimates and judgments on an
on-going basis. We base our estimates on historical experience and on
assumptions that we believe to be reasonable under the circumstances. Our
experience and assumptions form the basis for our judgments about the carrying
value of assets and liabilities that are not readily apparent from other
sources. Actual results may vary from what we anticipate and different
assumptions or estimates about the future could change our reported results. We
believe the following accounting policies are the most critical to us, in that
they
30
are important to the portrayal of our financial statements and they require our
most difficult, subjective or complex judgments in the preparation of our
consolidated financial statements:
REVENUE RECOGNITION. We recognize revenue pursuant to Staff Accounting
Bulletin No. 101 "Revenue Recognition in Financial Statements." Accordingly,
revenue is recognized when all four of the following criteria are met: (i)
persuasive evidence that arrangement exists; (ii) delivery of the products
and/or services has occurred; (iii) the selling price is both fixed and
determinable and; (iv) collectibility is reasonably probable. Revenue derived
from sales of systems and services to end-user customers is recognized upon
installation of the systems and performance of the services, respectively.
Pre-payments for communications services are deferred and recognized as revenue
as the communications services are provided.
For shipments to dealers and other distributors, our revenues are recorded
as products are shipped and services are rendered, because the sales process is
complete. These shipments are primarily to third-party dealers and distributors
and title passes when goods are shipped (free-on-board shipping point).. Long
distance services revenues are recognized as service is provided.
SALES-LEASES. For our sales-type lease accounting, we follow the guidance
provided by FASB Statement No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities - A Replacement of FASB
Statement No. 125. We record the discounted present values of minimum rental
payments under sales-type leases as sales, net of provisions for continuing
administration and other expenses over the lease period. The costs of systems
installed under these sales-leases, net of residual values at the end of the
lease periods, are recorded as costs of sales. Gains or losses resulting from
the sale of rental income from such leases are recorded as net sales. We
maintain reserves against potential recourse following the resales based upon
loss experience and past due accounts. The allowance for uncollectible minimum
lease payments and recourse liability at the end of the year represent reserves
against the entire lease portfolio or allowance for collectibility from
customers. These reserves are either netted in the current and long-term
components of "Net investments in Sales-Leases" on the balance sheet, or
included in long-term liabilities on our balance sheet for off-book leases.
GOODWILL AND OTHER IDENTIFIABLE INTANGIBLES. We assess the impairment of
goodwill and other identifiable intangibles whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. Some
factors we consider important which could trigger an impairment review include
the following:
* Significant under-performance relative to historical, expected or
projected future operating results;
* Significant changes in the manner of our use of the acquired assets or
the strategy for our overall business;
* Our market capitalization relative to net book value, and
* Significant negative industry or economic trends.
When we determine that the carrying value of goodwill and other identified
intangibles may not be recoverable, we measure any impairment based on a
projected discounted cash flow method using a discount rate determined by our
management to be commensurate with the risk inherent in our current business
model. In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets,"
on January 1, 2002 we will cease to amortize goodwill arising from acquisitions
completed prior to July 1, 2001. Inter-Tel has tested goodwill for impairment
using the two-step process prescribed in SFAS 142. The first step is a screen
for potential impairment, while the second step measures the amount of the
impairment, if any. Inter-Tel has performed the first of the required impairment
tests for goodwill as of January 1, 2002 and has determined that the carrying
amount of goodwill is not impaired.
Inter-Tel has adopted SFAS 142 effective January 1, 2002. Application of
the nonamortization provisions of SFAS 142 is expected to result in an increase
in income from continuing operations before income taxes of approximately $1.8
million in 2002.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. We maintain allowances for doubtful
accounts for estimated losses resulting from the inability of our customers to
make required payments. If the financial condition of our customers or channel
partners were to deteriorate, resulting in an impairment of their ability to
make payments, additional
31
allowances may be required. Additional reserves or allowances for doubtful
accounts are recorded for our sales-type leases, discussed above in
"Sales-Leases."
INVENTORIES. We value our inventories at lower of cost or market. Cost is
determined by the first-in, first-out (FIFO) method, including material, labor
and factory overhead. Significant management judgment is required to determine
the reserve for obsolete or excess inventory. Inventory on hand may exceed
future demand either because the product is outdated, or obsolete, or because
the amount on hand is more than can be used to meet future need, or excess. We
currently consider all inventory that has no activity within one year as well as
any additional specifically identified inventory to be excess. We also provide
for the total value of inventories that we determine to be obsolete based on
criteria such as customer demand, product life-cycles, changing technologies and
market conditions. We write down our excess and obsolete inventory equal to the
difference between the cost of inventory and the estimated market value. At
December 31, 2001, our inventory reserves were $13.2 million of our $34.1
million gross inventories. If actual customer demand, product life-cycles,
changing technologies and market conditions are less favorable than those
projected by management, additional inventory write-downs may be required.
CONTINGENCIES. We are a party to various claims and litigation in the
normal course of business. Management's current estimated range of liability
related to various claims and pending litigation is based on claims for which
our management can estimate the amount and range of loss. Because of the
uncertainties related to both the amount and range of loss on the remaining
pending claims and litigation, management is unable to make a reasonable
estimate of the liability that could result from an unfavorable outcome. As
additional information becomes available, we will assess the potential liability
related to our pending litigation and revise our estimates. Such revisions in
our estimates of the potential liability could materially impact our results of
operation and financial position. We also received correspondence during 1999
from a major competitor and subsidiary inviting us to negotiate a license
agreement regarding the competitors' patents. We have continued to negotiate
with these competitors regarding their patent claims as well as make claim for
our patents. We received additional correspondence in 2000 alleging intellectual
property claims from another competitor. Inter-Tel responded by providing notice
of consent to transfer license previously granted by this competitor. We do not
anticipate that the resolution of such matters will have a material adverse
effect on our consolidated financial position.
OTHER CHARGES
INTER-TEL.NET AND ICA. During the second quarter of 2000, Inter-Tel recorded a
pre-tax charge associated with Inter-Tel.NET operations of $2.0 million ($1.2
million after-tax), related to the write-down to net realizable value of network
equipment and lease termination costs of certain redundant facilities. The
reserves established at the time of the write-down have been fully utilized as
of December 31, 2001. The following table summarizes the details of the
write-down and activity in the reserve balances from the date of the write-down
through December 31, 2001. Activity represents payments made or amounts written
off.
RESERVE
CASH/ OTHER 2000 2001 BALANCE
DESCRIPTION NON-CASH CHARGE ACTIVITY ACTIVITY AT 12/31/01
----------- -------- ------ -------- -------- -----------
(in thousands)
LEASE TERMINATION OBLIGATIONS
(NET OF ANTICIPATED RECOVERY):
Building leases Cash $ (144) $ 87 $ 57 $ --
IMPAIRMENT OF ASSETS:
Fixed assets Non-Cash (1,824) 1,824 -- --
TOTAL $(1,968) $ 1,911 $ 57 $ --
In March 2000, the Company's Inter-Tel.NET subsidiary acquired the stock of
Intercomm Americas, Inc. (ICA), an international IP communications reseller for
$580,000 cash and 750,000 shares of Inter-Tel.NET, with conversion rights into
Inter-Tel, Incorporated Common Stock. The acquisition purchase price was valued
at $1.2 million at March 2000.; The ICA shareholders did not intend to exercise
conversion rights. However, due to
32
market conditions, they decided to convert their Inter-Tel.NET shares to
Inter-Tel shares in July 2001. Based on the exercise of conversion rights in
July 2001, the valuation of purchase price of ICA increased to $6.2 million in
accordance with the provisions of the acquisition agreement. The conversion of
Inter-Tel.NET shares into Inter-Tel, Incorporated common stock was treated as an
acquisition by Inter-Tel of Inter-Tel.NET shares, rather than as an adjustment
to the original purchase price of ICA, as the conversion rights were part of the
original purchase agreement, even though the value of the conversion rights
could not be readily determined at that time. As a result, Inter-Tel made
adjustments totaling $4.85 million to goodwill based on the value of the
converted Inter-Tel shares as of June 30, 2001.
On July 24, 2001, Inter-Tel agreed to sell 83% of Inter-Tel.NET to
Comm-Services Corporation for a note of $4.95 million, secured by Comm Services
stock, other marketable securities of the shareholders of Comm Services and 100%
of the net assets of Inter-Tel.NET. The marketable securities held as collateral
may be exchanged for cash or other readily marketable assets as long as the fair
market value of the collateral exceeds $2.5 million. The note is due and payable
interest only from October 16, 2001 through July 15, 2002; then a principal
payment of $250,000 due July 15, 2002, monthly principal and interest payments
based on 1% of collected monthly revenues from July 16, 2002 to October 15, 2002
and based on 2% of collected monthly revenues from October 16, 2002 until paid
in full. Additionally, any funds due Comm-Services for services rendered can be
applied against the note. The note is due and payable on December 31, 2007, or
earlier in certain circumstances.
In connection with the sale of 83% of Inter-Tel.NET, we assessed the fair
value of the remaining 17% investment in Inter-Tel.NET. Pursuant to SFAS 121, we
recorded a charge as of the close of the second quarter of $5.4 million ($3.4
million after tax) associated with the impairment of our investment in
Inter-Tel.NET. The impairment was measured as the difference between the
carrying value of Inter-Tel's 17% interest in Inter-Tel.NET/Comm-Services and
the estimated current fair market value of the note plus the 17% ownership
interest in Inter-Tel.NET. The charge is primarily non-cash.
Inter-Tel's management has not participated in the management of
Inter-Tel.NET since the sale in July 2001. As a result, since July 24, 2001, we
have accounted for the remaining Inter-Tel.NET/Comm-Services investment using
the cost method of accounting. On December 30, 2001, Comm-Services entered into
a merger agreement with Vianet. Inter-Tel's 17% investment in Comm-Services was
converted to approximately 10% of Vianet stock. The $4.95 million loan was
assumed by Vianet and Inter-Tel continues to hold collateral from the former
shareholders of Comm-Services. Inter-Tel will account for the remaining 10%
investment in Vianet using the cost method of accounting. The net investment in
the notes receivable and 10% interest in Vianet (formerly Comm-Services) is
recorded in other assets for approximately $3.7 million.
During 1999, 2000 and 2001, Inter-Tel.NET entered into operating lease
agreements totaling approximately $6.5 million from an equipment vendor for
network equipment and software. The lease agreements required Inter-Tel.NET to
purchase vendor maintenance on their products. Inter-Tel originally guaranteed
the indebtedness. In the second quarter of 2001, Inter-Tel.NET notified the
vendor of network and network equipment problems encountered due to equipment
and software recommended by the vendor, and supplied and financed by this
vendor. Inter-Tel.NET requested that the vendor not only solve the problems, but
also compensate Inter-Tel.NET for the problems and the resulting lost customers,
lost revenues and lost profits. Pursuant to Inter-Tel's sale of 83% of
Inter-Tel.NET, Comm-Services assumed the vendor lease and maintenance
obligations and as such Inter-Tel has not recorded any liability for these
obligations. However, the vendor has not released Inter-Tel from its guarantee
of these obligations and Inter-Tel has not released the vendor from Inter-Tel's
claims, nor did we assign our rights to these claims to Comm-Services.
EXECUTONE. On January 1, 2000 Inter-Tel purchased certain computer telephony
assets and assumed certain liabilities of Executone Information Systems, Inc.
(Executone) for $44.3 million in cash plus related acquisition costs, subject to
purchase price adjustments as of the closing date. The Executone transaction was
accounted for using the purchase method of accounting. The aggregate purchase
price was allocated to the fair value of the assets and liabilities acquired, of
which $5.4 million ($3.4 million after taxes) was written-off as purchased
in-process research and development.
During the first quarter of 2000, the Executone division recognized losses
of approximately $2.5 million ($1.5 million after taxes, or $.06 per diluted
share) excluding the charge for in-process research and development. In
33
connection with the Executone acquisition, we sold Executone's manufacturing
assets and liabilities to Varian of Tempe, Arizona at a net book value of $6.6
million.
During the second quarter of 2000, the Executone division continued to
experience significant losses. The Executone division recognized pre-tax losses
during the second quarter and six months ended June 30, 2000 of $3.4 million, or
$2.1 million after-tax ($.08 per diluted share) and $5.9 million, or $3.6
million after-tax ($.14 per diluted share), respectively. As a result of these
losses, together with other considerations noted below, we decided to close the
primary Executone facility in Milford, Connecticut and to recognize a
restructuring charge related to the Executone operations. At the time the
original purchase was recorded, we had not anticipated closing the Milford
facility. After incurring higher than anticipated losses from Executone
operations and after a deterioration in the Executone business, including loss
of dealers and customers, delays in introduction and acceptance of new products,
we decided it was in the best interests of us and our shareholders to close the
Milford facility and consolidate operations into our metro-Phoenix, Arizona
facilities.
We have accounted for the restructuring of the Executone operations,
including severance and related costs, the shut down and consolidation of the
Milford facility and the impairment of assets associated with the restructuring.
We finalized our plan for the exiting of activities and the involuntary
termination or relocation of approximately 137 employees in connection with the
integration of Executone operations. Accrued costs associated with this plan
were estimates, although the original estimates made for the second quarter of
2000 for reserve balances have not changed significantly as of December 31,
2001.
Exit costs associated with the closure of the Milford facility also
included liabilities for building, furniture and equipment lease, and other
contractual obligations. We are liable for the lease on the Milford buildings
through January 2005. Various furniture leases run concurrently through March
2002. Other capital leases for computer and other equipment terminate on varying
dates through September 2002. To date, we have entered into sublease agreements
with third parties to sublease portions of the facility and equipment. The
reserve for lease and other contractual obligations is identified in the table
below.
The following tables summarize details of the restructuring charge in
connection with the Executone acquisition, including the description of the type
and amount of liabilities assumed, and activity in the reserve balances from the
date of the charge through December 31, 2001. Activity represents payments made
or amounts written off.
RESERVE
CASH/ RESTRUCTURING 2000 2001 BALANCE
DESCRIPTION NON-CASH CHARGE ACTIVITY ACTIVITY AT 12/31/01
----------- -------- ------ -------- -------- -----------
(In thousands)
PERSONNEL COSTS:
Severance and termination costs Cash $ (1,583) $ 1,558 $ 2 $ (23)
Other Plant closure costs Cash (230) 30 200 --
LEASE TERMINATION AND OTHER CONTRACTUAL
OBLIGATIONS (NET OF ANTICIPATED RECOVERY):
Building and equipment leases Cash (7,444) 1,348 1,489 (4,607)
Other contractual obligations Cash (1,700) -- 1,700 --
IMPAIRMENT OF ASSETS:
Inventories Non-Cash (3,454) 1,376 209 (1,869)
Prepaid inventory and other expenses Non-Cash (2,485) 2,485 -- --
Accounts receivable Non-Cash (1,685) 521 245 (919)
Fixed assets Non-Cash (3,151) 2,942 -- (209)
Net intangible assets Non-Cash (29,184) 29,184 -- --
TOTAL $(50,916) $ 39,444 $ 3,845 $ (7,627)
34
Included in the total Executone restructuring costs of $50.9 million is a $43.3
million restructuring charge for exit costs and asset impairment, and $7.6
million associated with the impairment of inventories, which has accordingly
been recorded as additional costs of sales. Refer to Management's Discussion and
Analysis for additional information.
CIRILIUM JOINT VENTURE. In December 1999, Inter-Tel entered into an agreement
with Hypercom Corporation to jointly form Cirilium. Cirilium comprised parts of
Hypercom's data and Inter-Tel's packet telephony experience, products and
services, including Inter-Tel's Vocal'Net gateway products and technology. We
accounted for the Cirilium losses using the equity method of accounting through
September 2000. In September 2000, we wrote-off our remaining investment in
Cirilium. Our Cirilium ownership interest of 19.9% has been fully written-off in
our financial statements, and we have not used the equity method of accounting
since the date of the write-off.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
141, "Business Combinations", and SFAS 142, "Goodwill and Other Intangible
Assets", effective for our fiscal year beginning January 1, 2002. Inter-Tel has
adopted SFAS 142 effective January 1, 2002. Application of the nonamortization
provisions of SFAS 142 is expected to result in an increase in income from
continuing operations before income taxes and trust distributions of
approximately $1.8 million in 2002. Inter-Tel has tested goodwill for impairment
using the two-step process prescribed in SFAS 142. The first step is a screen
for potential impairment, while the second step measures the amount of the
impairment, if any. Inter-Tel has performed the first of the required impairment
tests for goodwill as of January 1, 2002 and has determined that the carrying
amount of goodwill is not impaired.
In April 2001, the Emerging Issues Task Force (EITF) issued Issue 00-25,
Vendor Income Statement Characterization of Consideration Paid to a Reseller of
the Vendor's Products. EITF 00-25 addresses the accounting and income statement
classification of costs that a vendor incurs to or on behalf of a reseller in
connection with the reseller's purchase or promotion of the vendor's products.
The standard is effective for fiscal periods beginning after December 15, 2001
and will be adopted by us as of December 2002. It is not expected that the
adoption of this standard will have a material impact on our financial position,
results of operations or cash flows.
In July 2001, the FASB issued Statement No. 143, Accounting for Asset
Retirement Obligations. The standard applies to obligations associated with the
retirement of tangible long-lived assets. The standard is effective for fiscal
periods beginning after June 15, 2002 and will be adopted by us as of December
2003. It is not expected that the adoption of this standard will have a material
impact on our financial position, results of operations or cash flows.
In August 2001, the FASB issued Statement No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets (Statement) which supersedes FASB
Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of; however it retains the fundamental
provisions of that statement related to the recognition and measurement of the
impairment of long-lived assets to be "held and used." The standard is effective
for fiscal periods beginning after December 15, 2001 and will be adopted by us
as of December 2002. It is not expected that the adoption of this standard will
have a material impact on our financial position, results of operations or cash
flows.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about our market risk disclosures involves
forward-looking statements. Actual results could differ materially from those
projected in the forward-looking statements. We are exposed to market risk
related to changes in interest rates and foreign currency exchange rates. We do
not use derivative financial instruments.
INVESTMENT PORTFOLIO. We do not use derivative financial instruments in our
non-trading investment portfolio. Inter-Tel maintains a portfolio of highly
liquid cash equivalents typically maturing in three months or less as of the
date of purchase. Inter-Tel places its investments in instruments that meet high
credit quality standards, as specified in our investment policy guidelines.
Given the short-term nature of these investments, and that we
35
have no borrowings outstanding other than short-term letters of credit, we are
not subject to significant interest rate risk.
LEASE PORTFOLIO. We offer to our customers lease financing and other services,
including our Total Solutions program, through our Inter-Tel Leasing subsidiary.
We fund these programs in part through the sale to financial institutions of
rental income streams under the leases. Upon the sale of the rental income
streams, we continue to service the leases and maintain limited recourse on the
leases. We maintain reserves for loan losses on all leases based on historical
loss experience and specific account analysis. Although to date we have been
able to resell the rental streams from leases under our lease programs
profitably and on a substantially current basis, the timing and profitability of
lease resales could impact our business and operating results, particularly in
an environment of fluctuating interest rates and economic uncertainty. If we
were required to repurchase rental streams and realize losses thereon in amounts
exceeding our reserves, our operating results could be materially adversely
affected. See "Liquidity and Capital Resources" in Management's Discussion and
Analysis and Notes A and D to the financial statements for more information
regarding our lease portfolio and financing.
IMPACT OF FOREIGN CURRENCY RATE CHANGES. We invoice the customers of our
international subsidiaries primarily in the local currencies of our subsidiaries
for product and service revenues. Inter-Tel is exposed to foreign exchange rate
fluctuations as the financial results of foreign subsidiaries are translated
into U.S. dollars in consolidation. The impact of foreign currency rate changes
have historically been insignificant.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this Item is incorporated by reference to Exhibit
13.0.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
Certain information required by Part III is omitted from this report in
that the Registrant will file a definitive proxy statement pursuant to
Regulation 14A (the "Proxy Statement") not later than 120 days after the end of
the fiscal year covered by this Report, and the information included therein is
incorporated herein by reference to the extent stated below.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to directors and executive officers is included at the
end of Part I, Item 1 on this report under the caption "Directors and Executive
Officers of the Registrant."
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the
Company's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the
Company's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
36
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report:
1. FINANCIAL STATEMENTS
The following consolidated financial statements of Inter-Tel, Incorporated, and
subsidiaries, are incorporated by reference to Exhibit 13.0:
Report of Ernst & Young LLP, Independent Auditors
Consolidated balance sheets--December 31, 2001 and 2000
Consolidated statements of operations--years ended
December 31, 2001, 2000 and 1999
Consolidated statements of shareholders' equity--years
ended December 31, 2001, 2000 and 1999
Consolidated statements of cash flows--years ended
December 31, 2001, 2000 and 1999
Notes to consolidated financial statements
2. FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statement schedule of Inter-Tel,
Incorporated, and subsidiaries is filed as part of this Report and should be
read in conjunction with the Consolidated Financial Statements of Inter-Tel,
Incorporated and subsidiaries, and the notes thereto.
Schedule for the three years ended December 31, 2001:
Schedule II--Valuation and Qualifying Accounts Page No. 40
Schedules not listed above have been omitted because they are not
applicable or are not required or the information required to be set forth
therein is included in the Consolidated Financial Statements or notes thereto.
3. EXHIBITS
3.1(10) Articles of Incorporation, as amended.
3.2(16) By-Laws, as amended.
10.15(1) Registrant's form of standard Distributor Agreement.
10.16(1) Registrant's form of standard Service Agreement.
10.34(2) * 1984 Incentive Stock Option Plan and forms of Stock Option
Agreement.
10.35(3) Agreement between Registrant and Samsung Semiconductor and
Telecommunications Company, Ltd. dated October 17, 1984.
10.37(3) * Tax Deferred Savings Plan.
10.51(11) * 1990 Directors' Stock Option Plan and form of Stock Option
Agreement.
10.52(15) * Inter-Tel, Incorporated Long-Term Incentive Plan and forms of
Stock Option Agreements.
10.53(12) Agreement between Registrant and Maxon Systems, Inc. dated
February 27, 1990.
10.54(12) Agreement between Registrant and Varian Tempe Electronics
Center dated February 26, 1991.
10.55(12) Agreement between Registrant and Jetcrown Industrial Ltd.
dated February 18, 1993.
10.56(13) * Employee Stock Ownership Plan.
37
10.57(14) Loan and Security Agreement dated March 4, 1997 between Bank
One, Arizona, N.A. and Registrant and Modification Agreement
dated July 25, 1997.
10.58 (16) Development, Supply and License Agreement between Registrant
and QUALCOMM dated January 17, 1996.
10.59(17) * Inter-Tel, Incorporated 1997 Long-Term Incentive Plan.
10.60(17) * Inter-Tel, Incorporated 1997 Employee Stock Purchase Plan.
10.61(18) * Inter-Tel, Incorporated Acquisition Stock Option Plan and form
of Stock Option Agreement.
10.61(19) Computer Telephony Asset Purchase Agreement dated as of
October 17, 1999 by and between Executone Information Systems,
Inc., Inter-Tel, Incorporated and Executone Inter-Tel Business
Information Systems, Inc.
13.0 (20) Excerpts from Annual Report to Security Holders.
- ----------
(1) Incorporated by reference to Registrant's Registration Statement on Form
S-1 (File No. 2-70437).
(2) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (File No. 2-94805).
(3) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the year ended November 30, 1984 (File No. 0-10211).
(10) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the year ended December 31, 1988 (File No. 0-10211).
(11) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (File No. 33-40353).
(12) Incorporated by reference to Registrant's Registration Statement on Form
S-1 (File No. 33-70054).
(13) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (File No. 33-73620).
(14) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the year ended December 31, 1998 (File No. 0-10211).
(15) Incorporated by reference to Registrant's Proxy Statement dated March 23,
1994.
(16) Incorporated by reference to Registrant's Annual Report on Form 10-K for
the year ended December 31, 1995 (File No. 0-10211).
(17) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (File No. 333-41197).
(18) Incorporated by reference to Registrant's Registration Statement on Form
S-8 (File No. 333-67261).
(19) Incorporated by reference to Registrant's Report on Form 8-K (File No.
333-67261).
(20) Filed herewith, except as noted.
* Management contracts or compensatory plan or arrangement required to be
filed as an exhibit to this report on Form 10-K.
(b) Reports on Form 8-K. None.
(c) Exhibits.
13.0 Excerpts from Annual Report to Security Holders. Filed herewith.
23.0 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney.
See Item 14(a) 3 also.
(d) Financial Statement Schedules. The response to this portion of Item 14 is
submitted as a separate section of this report. See Item 8.
38
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant, Inter-Tel, Incorporated, has duly caused
this Report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INTER-TEL, INCORPORATED
BY: /S/ Steven G. Mihaylo
------------------------------------
Steven G. Mihaylo
Chairman and Chief Executive Officer
Dated: March 21, 2002
39