UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended Commission File Number:
September 30, 2002 0-10211
INTER-TEL, INCORPORATED
Incorporated in the State of Arizona I.R.S. No. 86-0220994
1615 S. 52nd Street
Tempe, Arizona 85281
(480) 449-8900
Common Stock
(24,643,095 shares outstanding as of September 30, 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 periods 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 [ ]
INDEX
INTER-TEL, INCORPORATED AND SUBSIDIARIES
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed consolidated balance sheets-- September 30, 2002
and December 31, 2001 3
Condensed consolidated statements of operations-- three and
nine months ended September 30, 2002 and September 30, 2001 4
Condensed consolidated statements of cash flows -- three and
nine months ended September 30, 2002 and September 30, 2001 5
Notes to condensed consolidated financial statements -
September 30, 2002 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk 29
Item 4. Controls and Procedures 29
PART II. OTHER INFORMATION 30
SIGNATURES 31
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
(In thousands, except share amounts) 2002 2001
--------- ---------
(Unaudited) (Note A)
ASSETS
CURRENT ASSETS
Cash and equivalents $ 108,200 $ 61,795
Accounts receivable, less allowances of $12,712
in 2002 and $11,858 in 2001 43,959 45,962
Inventories, less allowances of $11,172 in 2002
and $13,202 in 2001 16,140 20,848
Net investment in sales-leases 13,697 13,799
Income taxes receivable 1,735 3,257
Deferred income taxes 9,672 8,467
Prepaid expenses and other assets 5,664 4,891
--------- ---------
TOTAL CURRENT ASSETS 199,067 159,019
PROPERTY, PLANT & EQUIPMENT 24,197 23,905
GOODWILL, NET 17,734 13,711
PURCHASED INTANGIBLE ASSETS, NET 4,456 4,948
NET INVESTMENT IN SALES-LEASES 23,694 21,735
OTHER ASSETS 2,772 4,144
--------- ---------
$ 271,920 $ 227,462
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 24,626 $ 21,812
Other current liabilities 46,060 44,051
--------- ---------
TOTAL CURRENT LIABILITIES 70,686 65,863
DEFERRED TAX LIABILITY 20,366 17,390
LEASE RECOURSE LIABILITY 10,618 8,890
RESTRUCTURING RESERVE 2,060 3,060
OTHER LIABILITIES 6,261 5,422
SHAREHOLDERS' EQUITY
Common Stock, no par value-authorized 100,000,000
shares; issued - 27,161,823 shares; outstanding -
24,643,095 shares at September 30, 2002 and
24,166,430 shares at December 31, 2001 110,673 108,968
Less: shareholder loans (338) (942)
Retained earnings 81,740 54,877
Accumulated other comprehensive income 317 151
--------- ---------
192,392 163,054
Less: Treasury stock at cost - 2,518,728 shares in
2002 and 2,995,393 shares in 2001 (30,463) (36,217)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 161,929 126,837
--------- ---------
$ 271,920 $ 227,462
--------- ---------
See accompanying notes
3
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In thousands, except Three Months Nine Months
per share amounts) Ended September 30, Ended September 30,
---------------------- ----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
NET SALES $ 96,665 $ 93,487 $ 282,682 $ 291,025
Cost of sales 47,615 50,211 140,104 163,181
--------- --------- --------- ---------
GROSS PROFIT 49,050 43,276 142,578 127,844
Research & development 4,871 4,445 13,726 12,996
Selling, general and administrative 32,194 31,626 95,717 97,082
Amortization of goodwill -- 431 -- 1,243
Amortization of purchased intangible assets 269 212 795 636
Nonrecurring charge -- -- -- 5,357
--------- --------- --------- ---------
37,334 36,714 110,238 117,314
--------- --------- --------- ---------
OPERATING INCOME 11,716 6,562 32,340 10,530
Litigation settlement (net of costs except for
taxes) -- -- 15,516 --
Interest and other income 411 294 1,364 508
Write-down of investment in Inter-Tel.NET/Vianet -- -- (1,200) --
Gain (loss) on foreign translation adjustments 73 140 273 (255)
Interest expense (34) (51) (114) (453)
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 12,166 6,945 48,179 10,330
INCOME TAXES 4,623 2,568 18,206 3,820
--------- --------- --------- ---------
NET INCOME $ 7,543 $ 4,377 $ 29,973 $ 6,510
--------- --------- --------- ---------
NET INCOME PER SHARE-BASIC $ 0.31 $ 0.18 $ 1.23 $ 0.26
NET INCOME PER SHARE-DILUTED $ 0.29 $ 0.18 $ 1.17 $ 0.26
--------- --------- --------- ---------
Average number of common shares
Outstanding - Basic 24,544 23,949 24,331 24,612
Average number of common shares
Outstanding - Diluted 26,033 24,804 25,715 25,185
--------- --------- --------- ---------
See accompanying notes.
4
INTER-TEL, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three Months Nine Months
(In thousands) Ended September 30, Ended September 30,
---------------------- ----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
OPERATING ACTIVITIES
Net income $ 7,543 $ 4,377 $ 29,973 $ 6,510
Adjustments to reflect operating activities:
Depreciation 1,753 2,047 5,465 6,908
Amortization of goodwill and purchased intangibles 269 643 796 1,879
Amortization of patents included in R&D expenses 55 55 166 166
Non-cash portion of nonrecurring charge -- -- -- 5,357
Provision for losses on receivables 2,747 3,062 7,931 8,879
Provision for inventory valuation 607 232 902 1,141
Increase in other liabilities 379 807 1,705 1,640
(Gain) loss on sale of property and equipment 77 (34) 53 21
Deferred income taxes 1,514 7,525 1,772 12,972
Effect of exchange rate changes 130 28 166 461
Changes in operating assets and liabilities (1,547) 9,363 7,184 10,104
--------- --------- --------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 13,527 28,105 56,113 56,038
INVESTING ACTIVITIES
Additions to property and equipment (2,406) (1,107) (5,178) (7,743)
Proceeds from disposal of property and equipment 3 41 289 87
Cash refunded from (used in) acquisitions 13 6,000 (7,912) (6,093)
--------- --------- --------- ---------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES (2,390) 4,934 (12,801) (13,749)
FINANCING ACTIVITIES
Cash dividends paid (521) (222) (1,454) (742)
Payments on term debt (75) (327) (412) (1,420)
Treasury stock purchases (6) (1,337) (11) (28,680)
Proceeds from term debt -- -- -- 3,387
Proceeds from stock issued under the ESPP -- -- 475 508
Proceeds from exercise of stock options 3,156 411 4,495 867
--------- --------- --------- ---------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 2,554 (1,475) 3,093 (26,080)
--------- --------- --------- ---------
INCREASE IN CASH AND EQUIVALENTS 13,691 31,564 46,405 16,209
CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 94,509 11,748 61,795 27,103
--------- --------- --------- ---------
CASH AND EQUIVALENTS AT END OF PERIOD $ 108,200 $ 43,312 $ 108,200 $ 43,312
--------- --------- --------- ---------
See accompanying notes.
5
INTER-TEL, INCORPORATED AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
September 30, 2002
NOTE A--BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation of the results for the interim periods
presented have been included. Operating results for the three and nine months
ending September 30, 2002 are not necessarily indicative of the results that may
be expected for the year ended December 31, 2002. The balance sheet at December
31, 2001 has been derived from the audited financial statements at that date,
but does not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's annual report on Form 10-K for the year ended
December 31, 2001.
Certain prior year amounts have been reclassified to conform to the current
period presentation.
ADOPTION OF ACCOUNTING STANDARDS. On January 1, 2002, we adopted Statement of
Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" ("SFAS
No. 141"), and SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS No.
142"). When we account for acquired businesses as purchases, we allocate
purchase prices to the assets and liabilities acquired based on the estimated
fair values on the respective acquisition dates. Based on these values, any
excess purchase price over the fair value of the net assets acquired is
allocated to goodwill.
Prior to January 1, 2002, we amortized goodwill over the useful life of the
underlying asset, not to exceed 40 years. On January 1, 2002, we began
accounting for goodwill under the provisions of SFAS Nos. 141 and 142. As of
September 30, 2002 and December 31, 2001, we had the following intangible
assets:
(in thousands) September 30, 2002 December 31, 2001
------------------ -----------------
Goodwill $24,561 $20,538
Less: Accumulated Amortization 6,827 6,827
------- -------
Goodwill, net 17,734 13,711
Purchased Intangible Assets 6,240 5,770
Less: Accumulated Amortization 1,784 822
------- -------
Purchased Intangible Assets, net 4,456 4,948
Total Intangible Assets 30,801 26,308
Less: Accumulated Amortization 8,611 7,649
------- -------
Total Intangible Assets, net $22,190 $18,659
------- -------
Application of the non-amortization provisions of SFAS No. 142 resulted in an
increase in income before income taxes of approximately $0.4 million and $1.3
million in the quarter and nine months ended September 30, 2002, respectively.
In assessing the recoverability of our goodwill and other intangibles, we
must make assumptions about estimated future cash flows and other factors to
determine the fair value of the respective assets. If these estimates or their
related assumptions change in the future, we may be required to record
impairment charges for these assets not previously recorded. Some factors we
consider important which could trigger an impairment review include the
following:
6
* Significant underperformance relative to expected historical 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.
We have tested goodwill for impairment using the two-step process prescribed in
SFAS No. 142. The first step is a screen for potential impairment, while the
second step measures the amount of the impairment, if any. We performed the
first of the required impairment tests for goodwill as of January 1, 2002, and
determined that the carrying amount of our goodwill is not impaired. During the
quarter ended September 30, 2002, we did not record any impairment losses
related to goodwill and other intangible assets.
RECENT ACCOUNTING PRONOUNCEMENT.
In October 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
144"). SFAS 144 establishes a single accounting model, based on the framework
established in Statement of Financial Accounting Standards No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of" ("SFAS 121"), for long-lived assets to be disposed of by sale, and resolves
implementation issues related to SFAS 121. The Company adopted SFAS 144
effective January 1, 2002. We do not expect the adoption of this standard to
have a material impact on our operating results and financial condition.
NOTE B--EARNINGS PER SHARE AND DIVIDENDS
Diluted earnings per share assume that outstanding common shares were increased
by shares issuable upon the exercise of all outstanding stock options to which
market price exceeds exercise price less shares which could have been purchased
with related proceeds, if the effect would not be antidilutive.
The following table sets forth the computation of basic and diluted earnings per
share:
Three Months Ended Nine Months Ended
(In thousands, except ------------------------------ ------------------------------
per share amounts) Sept. 30, 2002 Sept. 30, 2001 Sept. 30, 2002 Sept. 30, 2001
-------------- -------------- -------------- --------------
Numerator: Net income $ 7,543 $ 4,377 $29,973 $ 6,510
======= ======= ======= =======
Denominator:
Denominator for basic earnings per
share - weighted average shares 24,544 23,949 24,331 24,612
Effect of dilutive securities:
Employee and director stock options 1,489 855 1,384 573
------- ------- ------- -------
Denominator for diluted earnings per
share - adjusted weighted average
shares and assumed conversions 26,033 24,804 25,715 25,185
======= ======= ======= =======
Basic earnings per share $ 0.31 $ 0.18 $ 1.23 $ 0.26
======= ======= ======= =======
Diluted earnings per share $ 0.29 $ 0.18 $ 1.17 $ 0.26
======= ======= ======= =======
DIVIDEND POLICY. On July 23, 2002, our Board of Directors increased the cash
dividend (the "cash dividend") from $0.02 to $0.03 for every share of Common
Stock, payable quarterly to shareholders of record beginning September 30, 2002,
with dividend payments to commence on or about 15 days after the end of each
fiscal quarter. From December 31, 1997 through the third quarter of 2001, we
paid quarterly cash dividends of $0.01 for every share of Common Stock to
shareholders of record, and from December 31, 2001 through the second quarter of
2002, we paid quarterly cash dividends of $0.02 per share. We have made
quarterly dividend payments for each quarter since the dividend was first
declared in September 1997. Prior to the cash dividend, we had declared no cash
dividends on our Common Stock since incorporation.
7
NOTE C - ACQUISITIONS, DISPOSITIONS AND NONRECURRING CHARGES
MCLEOD. On January 24, 2002, we acquired certain assets of McLeodUSA Integrated
Business Systems, Inc. ("McLeod") for cash plus the assumption of various
specific liabilities and related acquisition costs. Inter-Tel acquired McLeod's
voice customer base in Minnesota, Iowa and Colorado and DataNet operations in
South Dakota, which also included the related accounts receivable, inventory and
fixed assets along with assumption of scheduled specific liabilities for
warranty and maintenance obligations. The aggregate purchase price of $7.9
million was allocated to the fair value of the assets and liabilities acquired.
We recorded goodwill of approximately $4.0 million and other purchased
intangible assets of $0.5 million, for a total of $4.5 million, in connection
with the McLeod acquisition. The goodwill balance will be accounted for in
accordance with SFAS 141 and 142. The balances included in the $0.5 million in
other purchased intangible assets will be amortized over periods ranging from
two to five years from the date of the acquisition. During the third quarter and
nine months ended September 30, 2002, the amortization of purchased intangible
assets from McLeod was approximately $38,000 and $100,000, respectively.
INTER-TEL.NET/VIANET. On July 24, 2001, Inter-Tel sold 83% of its Inter-Tel.NET
subsidiary to Comm-Services Corporation for a promissory 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. Inter-Tel's
management has not participated in the management of Inter-Tel.NET since the
sale in July 2001. 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 note was assumed by
Vianet and Inter-Tel maintains its collateral interests as set forth above.
Inter-Tel has accounted for the remaining 10% investment in Vianet (formerly
Comm-Services) using the cost method of accounting.
The net investment in the note receivable and 10% interest in Vianet was
recorded in other assets for approximately $3.7 million as of December 31, 2001.
Inter-Tel assessed the value of this investment at March 31, 2002 and wrote-down
this investment by $600,000 to approximately $3.1 million as of March 31, 2002.
Inter-Tel assessed the value of this investment again at June 30, 2002 and
wrote-down this investment by $600,000 to approximately $2.5 million as of June
30, 2002. A principal payment of $250,000 was due September 22, 2001. Interest
accruing under the note was due and payable from October 16, 2001 through July
15, 2002; thereafter monthly principal and interest payments were due based on
1% of collected monthly revenues from July 16, 2002 to October 15, 2002 and
based on 2% of collected monthly revenues are due from October 16, 2002, until
paid in full. The note is fully due and payable on December 31, 2007, or earlier
in certain circumstances.
The marketable securities held as collateral may be exchanged for cash or other
readily marketable assets. At all times, the fair market value of the collateral
securities are required to equal or exceed $2.5 million, in addition to the
collateral value of Vianet stock and the net assets of Inter-Tel.NET. Some of
the underlying securities have been transferred to cash or marketable securities
and this collateral has fallen to $2.3 million. The debtor is required under the
agreement to cure this deficiency by contributing cash for other readily
marketable assets sufficient to raise the total collateral to $2.5 million, and
we are currently pursuing enforcement of this agreement provision. We have
notified Vianet (see discussion regarding merger of Vianet with Comm-Services)
of default in the payment of the $250,000 principal payment due under the note
on September 22, 2001 and negotiations are ongoing for curing the default and/or
modifying the payment terms under the note and pledging additional collateral to
make up the collateral shortfall in marketable securities. Any funds due to
Vianet/Comm-Services for services rendered can be and have been applied to the
note, interest due on the note or other payments due to Inter-Tel.
In connection with the sale of 83% of Inter-Tel.NET, we assessed the fair value
of the remaining 17% investment in Inter-Tel.NET. Pursuant to SFAS 121, we
recorded a charge as of the close of the second quarter of 2001 of $5.4 million
($3.4 million after tax) associated with the impairment of our investment in
Inter-Tel.NET. 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 was primarily non-cash.
8
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 loss of
customers, revenues and profits. Pursuant to Inter-Tel's sale of 83% of
Inter-Tel.NET, Comm-Services assumed the vendor lease and maintenance
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. In April
2002, Inter-Tel received a notice letter from the financing affiliate of the
Inter-Tel.NET equipment vendor notifying Inter-Tel of default in lease payments
due the financing affiliate. Inter-Tel responded to the affiliate advising them
that Inter-Tel was no longer the Lessee of the equipment, of the correct name
and address of the Lessee of the equipment and of the losses to Inter-Tel
because of the non performance of the equipment and vendor related third party
software providers' breach of contract.
EXECUTONE RESTRUCTURING CHARGE. During the second quarter of 2000, we recognized
a restructuring charge related to acquired Executone operations. We 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 as identified in the
table below. 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 in 2002.
Exit costs associated with the closure of the Milford facility also included
liabilities for building, furniture and equipment lease, and other contractual
obligations. We are liable for the lease on the Milford buildings through
January 2005. Various furniture leases ran concurrently through March 2002.
Other capital leases for computer and other equipment terminated 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 table summarizes details of the restructuring charge taken in the
second quarter of 2000 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 September 30, 2002.
(in thousands) 2002 Reserve
Cash/ Restructuring 2000 2001 Activity Balance
Description Non-Cash Charge Activity Activity 9/30/02 At 9/30/02
----------- -------- ------ -------- -------- ------- ----------
Personnel Costs:
Severance and termination costs Cash $ (1,583) $ 1,558 $ 2 $ 10 $ (13)
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 1,946 (2,661)
Other contractual obligations Cash (1,700) -- 1,700 -- --
Impairment of Assets:
Inventories Non-Cash (3,454) 1,376 209 1,540 (329)
Prepaid inventory and other expenses Non-Cash (2,485) 2,485 -- -- --
Accounts receivable Non-Cash (1,685) 521 245 38 (881)
Fixed assets Non-Cash (3,151) 2,942 -- 53 (156)
Net intangible assets Non-Cash (29,184) 29,184 -- -- --
Total $ (50,916) $ 39,444 $ 3,845 $ 3,587 $ (4,040)
9
NOTE D - SEGMENT INFORMATION
Inter-Tel adopted Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131") in the fiscal year ended December 31, 1998. SFAS 131 establishes standards
for reporting information regarding operating segments in annual financial
statements and requires selected information for those segments to be presented
in interim financial reports issued to shareholders. SFAS 131 also establishes
standards for related disclosures about products and services and geographic
areas. Operating segments are identified as components of an enterprise about
which separate discrete financial information is available for evaluation by the
chief operating decision maker, or decision making group, in making decisions as
to how to allocate resources and assess performance. Inter-Tel's chief
decision-maker, as defined under SFAS 131, is the Chief Executive Officer.
We currently view our operations as primarily composed of two segments: (1)
telephone systems, telecommunications software and hardware, and (2) local and
long distance calling services. These products and services are provided through
our direct sales offices and dealer network to business customers throughout the
United States, Europe, Asia and Mexico. As a result, financial information
disclosed represents substantially all of the financial information related to
our two principal operating segments. Results of operations for the local and
long distance calling services segment, if the operations were not included as
part of the consolidated group, could differ materially, as the operations are
integral to the total telephony solution offered by us to our customers.
In addition to the two primary segments discussed above, the Inter-Tel.NET
operations/investment, Inter-Tel's former IP long distance subsidiary, is
separately disclosed as a business segment. The operations represented a more
significant component of the consolidated operations in 2000 compared to prior
years and had a significant impact on the revenues and net losses. On July 24,
2001, Inter-Tel agreed to sell 83% of Inter-Tel.NET to Comm-Services
Corporation. As a result, since July 24, 2001, we have accounted for the
remaining 17% Inter-Tel.NET/Comm-Services investment using the cost method of
accounting. On December 30, 2001, Comm-Services entered into a merger agreement
with Vianet. Inter-Tel's 17% investment in Inter-Tel.NET/Comm-Services was
converted to approximately 10% of Vianet stock. Inter-Tel will account for the
remaining 10% investment in Vianet (formerly Comm-Services) using the cost
method of accounting. Inter-Tel assessed the value of this investment at March
31, 2002 and wrote-down this investment by $600,000 to approximately $3.1
million as of March 31, 2002. Inter-Tel assessed the value of this investment
again at June 30, 2002 and wrote-down this investment by $600,000 to
approximately $2.5 million.
For the quarters and nine months ended September 30, 2002 and 2001, we generated
income from business segments, including our investment in Inter-Tel.NET/Vianet,
as follows:
Three Months Ended September 30, 2002
---------------------------------------------------------------------
Resale of
Local and
long
Principal Inter-Tel.NET/ distance Litigation
(In thousands, except per share amounts) Segment Vianet services Settlement Total
------- ------ -------- ---------- -----
Net sales $ 88,842 -- $ 7,823 $ -- $ 96,665
Gross profit 46,802 -- 2,248 -- 49,050
Operating income 10,680 -- 1,036 -- 11,716
Interest and other, net 369 -- 42 -- 411
Gain on foreign translation adjustments 73 -- -- -- 73
Interest expense (34) -- -- -- (34)
Net income 6,875 -- 668 -- 7,543
Net income per diluted share 0.26 -- 0.03 -- 0.29
Weighted average diluted shares 26,033 26,033 26,033 -- 26,033
Total assets 257,383 -- 14,537 -- 271,920
Depreciation and amortization 2,062 -- 15 -- 2,077
10
Three Months Ended September 30, 2001
---------------------------------------------------------------------
Resale of
Local and
long
Principal Inter-Tel.NET/ distance Litigation
(In thousands, except per share amounts) Segment Vianet services Settlement Total
------- ------ -------- ---------- -----
Net sales $ 85,526 $ 1,214 $ 6,747 $ -- $ 93,487
Gross profit (loss) 36,588 (482) 7,170 -- 43,276
Operating income 6,719 (923) 766 -- 6,562
Interest and other, net 261 6 27 -- 294
Gain on foreign translation adjustments 140 -- -- -- 140
Interest expense (49) 0 (2) -- (51)
Net income (loss) 4,457 (578) 498 -- 4,377
Net income (loss) per diluted share (1) 0.18 (0.02) 0.02 -- 0.18
Weighted average diluted shares (1) 24,804 23,949 24,804 -- 24,804
Total assets 208,960 -- 10,030 -- 218,990
Depreciation and amortization 2,450 256 38 -- 2,744
Nine Months Ended September 30, 2002
---------------------------------------------------------------------
Net sales $ 260,936 -- $ 21,746 $ -- $ 282,682
Gross profit 136,303 -- 6,275 -- 142,578
Charge (see Note B) -- -- -- -- --
Operating income 29,453 -- 2,887 -- 32,340
Interest and other, net 1,254 (1,200) 110 15,516 15,680
Gain on foreign translation adjustments 273 -- -- -- 273
Interest expense (114) -- -- -- (114)
Net income (loss) 19,365 (756) 1,868 9,496 29,973
Net income (loss) per diluted share (1) .75 (0.03) 0.07 0.37 1.17
Weighted average diluted shares (1) 25,715 24,331 25,715 25,715 25,715
Total Assets 257,383 -- 14,537 -- 271,920
Depreciation and amortization 6,362 -- 65 -- 6,427
Nine Months Ended September 30, 2001
---------------------------------------------------------------------
Resale of
Local and
long
Principal Inter-Tel.NET/ distance Litigation
(In thousands, except per share amounts) Segment Vianet services Settlement Total
------- ------ -------- ---------- -----
Net sales $ 257,938 $ 13,986 $ 19,101 $ -- $ 291,025
Gross profit (loss) 128,625 (5,592) 4,811 -- 127,844
Charge (see Note B) -- (5,357) -- -- (5,357)
Operating income 21,172 (13,118) 2,476 -- 10,530
Interest and other, net 448 (1) 61 -- 508
Loss on foreign translation adjustments (255) -- -- -- (255)
Interest expense (278) (173) (2) -- (453)
Net income (loss) 13,325 (8,379) 1,564 -- 6,510
Net income (loss) per diluted share (1) 0.53 (0.34) 0.06 -- 0.26
Weighted average diluted shares (1) 25,185 24,612 25,185 -- 25,185
Total assets 208,960 -- 10,030 -- 218,990
Depreciation and amortization 6,836 1,994 122 -- 8,952
(1) Options that are antidilutive are not included in the computation of diluted
earnings per share when a net loss is recorded.
Our revenues are generated predominantly in the United States. Total revenues
generated from U.S. customers totaled $94.3 million or 97.5% of total revenues,
and $91.2 million or 97.6% of total revenues for the quarters ended September
30, 2002 and 2001, respectively. Total revenues generated from U.S. customers
totaled $275.3 million or 97.4% of total revenues, and $283.3 million or 97.4%
of total revenues for the nine months ended September 30, 2002 and 2001,
respectively. Our revenues from international sources were primarily generated
from customers located in the United Kingdom, Europe, Asia and South America. In
the first nine months of 2002 and 2001, revenues from customers located
internationally accounted for 2.6% and 2.6% of total revenues, respectively.
11
PART I.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Quarterly Report to Shareholders on Form 10-Q ("10-Q") contains
forward-looking statements that involve risks and uncertainties. The statements
contained in this 10-Q 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-Q
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 Results of Future Operations" below and elsewhere in this 10-Q.
OVERVIEW
Inter-Tel, incorporated in 1969, is a leading provider in the United States
of business enterprise telephone systems and related software applications. We
market and sell call processing, voice processing, unified messaging, Internet
Protocol (IP) telephony, networking, productivity-enhancing CRM and IVR, voice
recognition and related Computer Telephone (CT) integration software and
applications. Inter-Tel resells long distance calling services and is also in
the managed services and voice and data convergence market, with a line of voice
and data routers, IP phones and e-commerce Web software, which allow Inter-Tel
to handle networked applications as large as 40,000 ports. Our products and
services include the AXXESS by Inter-Tel, ECLIPSE(2) by Inter-Tel and Encore by
Inter-Tel business communication systems, with integrated software and
applications listed above. 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 September 30, 2002, we had 52 direct sales offices in the United States and
one in Japan, and a network of hundreds of dealers and VARs around the world
that purchase directly from us. We also maintain a wholesale distribution office
in the United Kingdom that supplies Inter-Tel's dealers and distributors
throughout the UK and parts of Europe.
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 costs and effects 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 we serve are characterized by rapid technological change and
evolving customer requirements. We have sought to address these requirements
through the development of software enhancements and improvements to existing
12
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, enhancing our IP convergence
applications and IP telephones, developing Unified Messaging Software
applications and enhancing our telecommunications networking package. Over the
last several years, we have also focused our research and development efforts on
the development of our Unified Communicator software application, call center
and IVR applications, the ClearConnect SoftPhone and the related ClearConnect
Talk-to-Agent web communications software. We are currently devoting resources
to developing and enhancing the convergence products and applications for our
AXXESS and ECLIPSE(2) systems, supporting industry-standard VoIP protocols such
as MGCP and SIP and enhancing our Unified Messaging Software. In addition, we
are developing new speech-recognition and text-to-speech enabled applications,
developing advanced IVR and CT applications, enhancing our IP digital
telephones, and enhancing our server-based PBX offerings.
We offer to our customers a package of lease financing and other services
under the name TotalSolution (formerly Totalease). TotalSolution 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.
RESULTS OF OPERATIONS
The following table sets forth certain statement of operations data of the
Company expressed as a percentage of net sales for the periods indicated:
Three Months Ended Sept. 30, Nine Months Ended Sept. 30,
---------------------------- ---------------------------
2002 2001 2002 2001
----- ----- ----- -----
NET SALES 100.0% 100.0% 100.0% 100.0%
Cost of sales 49.3 53.7 49.6 56.1
----- ----- ----- -----
GROSS PROFIT 50.7 46.3 50.4 43.9
Research and development 5.0 4.8 4.9 4.5
Selling, general and administrative 33.3 33.8 33.9 33.4
Amortization of goodwill -- 0.5 -- 0.4
Amortization of purchased intangible assets 0.3 0.2 0.3 0.2
Nonrecurring charge -- -- -- 1.8
----- ----- ----- -----
OPERATING INCOME 12.1 7.0 11.4 3.6
Litigation settlement (net of costs except
for taxes -- -- 5.5 --
Interest and other income 0.4 0.3 0.5 0.2
Write-down of investment in
Inter-Tel.NET/Vianet -- -- (0.4) --
Gain (loss) on foreign translation adjustments 0.1 0.1 0.1 (0.1)
Interest expense (0.0) (0.1) (0.0) (0.2)
----- ----- ----- -----
Income before income taxes 12.6 7.4 17.0 3.5
Income taxes 4.8 2.7 6.4 1.3
----- ----- ----- -----
Net income 7.8% 4.7% 10.6% 2.2%
----- ----- ----- -----
Included in the table above for 2001 is a nonrecurring charge recorded in
connection with the sale of the Company's interest in Inter-Tel.NET. The Company
recorded a nonrecurring charge as of the close of the second quarter of $5.4
million ($3.4 million after tax) associated with the impairment of the Company's
investment in Inter-Tel.NET. The impairment was measured by 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. In 2001, the charge was recorded in operating income.
13
NET SALES. Net sales for the third quarter of 2002 increased 3.4% to $96.7
million, compared to $93.5 million in the third quarter of 2001, including the
operations of Inter-Tel.NET through July 24, 2001. Since the sale of 83% of our
interest in Inter-Tel.NET in July 2001, we have not recorded operating revenues
or expenses from Inter-Tel.NET. Net sales attributable to Inter-Tel.NET
operations were $1.6 million for the third quarter of 2001. Excluding sales from
Inter-Tel.NET in the third quarter of 2001, net sales in 2002 increased 5.2%
compared to $91.8 million in 2001. Net sales decreased 2.9% to $282.7 million in
the first nine months of 2002, compared to $291.0 million in the first nine
months of 2001. Net sales attributable to Inter-Tel.NET operations were $14.0
million for the first seven months of 2001. Excluding sales from Inter-Tel.NET
in the first nine months of 2001, net sales in 2002 increased 2.0% compared to
2001. Since July 24, 2001, the date of the sale of our 83% interest in
Inter-Tel.NET, we have used the cost method of accounting for our remaining
investment in Vianet (which merged with Inter-Tel.NET's successor entity,
Comm-Services).
The third quarter increase in net sales was primarily attributable to sales
from our network services group and acquired McLeod operations. The increases
were largely offset because, as discussed above, the 2002 results included no
revenues from the operations of Inter-Tel.NET. For the third quarter of 2002, we
experienced an increase of $2.6 million in sales of business telephone software,
systems and related data products on a combined basis through our direct sales
offices, government and national accounts and wholesale distribution compared to
2001. Sales from McLeod operations represented an increase of approximately $5.9
million in the third quarter of 2002 compared to 2001. Although net sales
increased slightly, our 2002 net sales were negatively impacted by delayed
customer buying decisions related to deterioration in macroeconomic conditions
and increased competitive pressures. In some instances, prices of various
telecommunications systems decreased, and discounts or other promotions that we
offered to customers to generate sales resulted in lower revenues.
Sales from our network services group, including NetSolutions and Network
Services agency, increased $1.5 million, and sales from our leasing operations
increased by $575,000 in the third quarter of 2002 compared to 2001. These
increases were largely offset by sales decreases of $1.6 million attributable to
the sale of our interest in Inter-Tel.NET in the third quarter of 2001. Please
refer to Note D of Notes to Consolidated Financial Statements for additional
segment reporting information.
GROSS PROFIT. Gross profit for the third quarter of 2002 increased 13.3% to
$49.1 million, or 50.7% of net sales, from $43.3 million, or 46.3% of net sales
in the third quarter of 2001, which included operating results for
Inter-Tel.NET. Excluding Inter-Tel.NET results, gross profit increased 12.1% in
the third quarter of 2002, compared to $43.8 million, or 47.6% of net sales in
the third quarter of 2001. Gross profit increased 11.5% to $142.6 million, or
50.4% of net sales, in the first nine months of 2002 compared to $127.8 million,
or 43.9% of net sales, in the first nine months of 2001 including Inter-Tel.NET.
Excluding Inter-Tel.NET, gross profit for the nine months ended September 30,
2002 increased 6.9%, compared to $133.4 million, or 48.2% of net sales, in the
first nine months of 2001. The increase in gross profit as a percentage of sales
(or gross margin) was primarily attributable to the sale of our 83% interest in
Inter-Tel.NET, which generated negative margins in 2001. Inter-Tel.NET generated
negative gross profit of $(482,000) and $(5.6 million), in the third quarter and
nine months ended September 30, 2001, respectively.
The increases in gross profit as a percentage of sales (or gross margin)
were also attributable to a higher amount of software in system solutions, cost
reductions, including reduced costs from suppliers on products sold,
implementation of design improvements into the manufacturing process and
efficiencies achieved from a higher percentage of orders placed using the
Internet. We also generated a higher percentage of sales from recurring revenues
on sales to existing business telephone customers, which improved margins
because of lower materials costs. Margins also improved despite competitive
pricing pressures throughout the business and despite increased sales from long
distance services, which generate lower margins compared to sales of business
telephone software and systems. Our gross margins may vary in the future
depending on a number of factors, including the mix of products sold and
services provided, the mix of new systems sales relative to recurring revenues
from our existing customer base, the mix of sales through direct sales offices
and dealer network, as well as macroeconomic and competitive influences.
RESEARCH AND DEVELOPMENT. Research and development expenses for the third
quarter of 2002 increased 9.6% to $4.9 million, or 5.0% of net sales, compared
to $4.4 million, or 4.8% of net sales, for the third quarter of 2001. Research
and development expenses increased 5.6% to $13.7 million, or 4.9% of net sales,
14
in the first nine months of 2002 compared to $13.0 million, or 4.5% of net
sales, in the first nine months of 2001. These increases were primarily
attributable to increased expenses associated with engineering personnel we
hired in connection with our purchase of assets from Mastermind Technologies,
Inc. in October 2001. Research and development expenses also increased as a
result of development associated with enhancing convergence features, software
solutions and applications and devices on our AXXESS by Inter-Tel and ECLIPSE2
by Inter-Tel communications platforms, as well as development of voice-enabled
and speech recognition vertical market applications, including the Unified
Communicator application. We expect that for the foreseeable future research and
development expenses will increase sequentially in absolute dollars as we
continue to enhance existing and develop new technologies and products. These
expenses may vary, however, as a percentage of net sales.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses, excluding amortization, for the third quarter of 2002 increased 1.8%
to $32.2 million, compared to $31.6 million, for the second quarter of 2001.
However, these expenses decreased as a percentage of net sales to 33.3% of net
sales in the third quarter of 2002 compared to 33.8% of net sales in 2001.
Selling, general and administrative expenses, excluding amortization, decreased
1.4% to $95.7 million, or 33.9% of net sales, in the first nine months of 2002,
compared to $97.1 million, or 33.4% of net sales, in the first nine months of
2001. The increase in absolute dollars for the quarter ended September 30, 2002
was primarily due to higher net sales compared to the same period in 2001. The
decrease in absolute dollars for the nine months ended September 30, 2002
compared to 2001 was primarily due to lower net sales for the 2002 period,
reflecting in part the sale of our 83% interest in Inter-Tel.NET in July 2001.
Excluding the operations of Inter-Tel.NET in 2001, selling, general and
administrative expenses for the third quarter of 2002 increased 3.2% compared to
$31.2 million, or 34.0% of net sales, in 2001. Excluding the operations of
Inter-Tel.NET in 2001, selling, general and administrative expenses for the nine
months ended September 30, 2002 increased 0.7% compared to $95.0 million, or
34.3% of net sales, in 2001.
Selling, general and administrative expenses also increased in absolute
dollars as a result of a higher percentage of total sales generated through our
direct sales offices and government and national accounts divisions, including
the acquired McLeod operations in January 2002. In addition to reduced expenses
attributable to the sale of Inter-Tel.NET in 2001, selling, general and
administrative expenses decreased as a percentage of net sales in 2002 compared
to 2001, due in part to lower depreciation and bad debt costs relative to total
sales. In addition, the growth in sales from the resale of long distance calling
services and Datanet products led to lower selling, general and administrative
costs relative to total sales. We expect that for the foreseeable future
selling, general and administrative expenses will increase sequentially in
absolute dollars as we continue to enhance existing and develop new technologies
and products. These expenses may vary, however, as a percentage of net sales.
AMORTIZATION OF GOODWILL AND PURCHASED INTANGIBLE ASSETS. We adopted SFAS
No. 142 effective the beginning of fiscal 2002. In accordance with SFAS 142, we
ceased amortizing goodwill. We are required to perform goodwill impairment tests
on an annual basis and between annual tests in certain circumstances. As of
September 30, 2002, no impairment of goodwill has been recognized. There can be
no assurance that future goodwill impairment tests will not result in a charge
to earnings. For additional information regarding SFAS 142, see "Adoption of
Accounting Standard" in Note A of Notes to the Condensed Consolidated Financial
Statements.
Amortization of purchased intangible assets included in operating expenses
was $269,000 in the third quarter of 2002, compared to $212,000 in the second
quarter of 2001. Amortization of purchased intangible assets included in
operating expenses was $795,000 for the nine months ended September 30, 2002,
compared to $636,000 for the nine months ended September 30, 2001. The increases
in the amortization of purchased intangible assets for the quarter and nine
months ended September 30, 2002 compared to the same periods in 2001 were
primarily related to the additional amortization from recent acquisitions. For
additional information regarding purchased intangible assets, see Note A
"Adoption of Accounting Standard" and Note C "Acquisitions, Dispositions and
Restructuring Charges " to the Condensed Consolidated Financial Statements.
15
NONRECURRING CHARGE. In connection with the sale of our interest in
Inter-Tel.NET in July 2001, we recorded a nonrecurring charge as of the close of
the second quarter of 2001 of $5.4 million ($3.4 million after tax) associated
with the impairment of the Company's 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.
LITIGATION SETTLEMENT. In May 2001, Inter-Tel entered into an agreement to
submit to binding arbitration a lawsuit we filed in 1996. The arbitration was
completed in January 2002 and, as a result of the arbitration, Inter-Tel
received a gross cash award of $20 million in February 2002. Direct costs for
attorney's fees, expert witness costs, arbitration costs and additional payments
and expenses, totaled approximately $4.5 million in the first nine months of
2002, excluding income taxes, for a net award of approximately $15.5 million.
The estimated net proceeds from this arbitration settlement were approximately
$9.5 million after taxes, or $0.37 per diluted share for the nine months ended
September 30, 2002.
INTEREST AND OTHER INCOME. Other income in of 2002 included an expense of
approximately $1.2 million related to the write-down of Inter-Tel's investment
in Inter-Tel.NET/Vianet in the first six months of 2002, but no additional
expenses were recorded in the third quarter of 2002. Other than the write-down,
other income in all periods consisted primarily of interest income and foreign
exchange rate gains and losses. Interest income increased approximately $724,000
in the nine months ended September 30, 2002 compared to 2001 based on a higher
level of invested funds, due in part to cash received from the litigation
settlement noted above, offset by expenditures relating to the McLeod
acquisition. During the first nine months of 2002, we recognized foreign
exchange rate gains of $273,000, an improvement of $528,000 compared to losses
of $255,000 in 2001. Interest expense was $114,000 in the first nine months of
2002, a decrease of $339,000 compared to $453,000 in 2001.
INCOME TAXES. Our income tax rate for the first nine months of 2002
increased to 37.8% compared to 37.0% for 2001. The rate increased primarily as a
result of higher marginal tax rates anticipated from the receipt of the cash
litigation settlement award. We expect the full-year 2002 tax rate to be higher
than the tax rate effective for 2001.
NET INCOME/(LOSS). Net income for the third quarter was $7.5 million ($0.29
per diluted share) compared to net income of $4.4 million ($0.18 per diluted
share) for the third quarter of 2001, including the 2001 Inter-Tel.NET
operations. Net income for the nine months ended September 30, 2002 was $30.0
million ($1.17 per diluted share), including the 2002 litigation settlement,
compared to net income of $6.5 million ($0.26 per diluted share) for the first
nine months of 2001, including the 2001 nonrecurring charge and Inter-Tel.NET
operations.
Excluding the 2001 operations of Inter-Tel.NET, we reported net income of
$7.5 million, or $0.29 per diluted share in the third quarter of 2002, compared
to net income of $5.0 million, or $0.20 per diluted share, in the third quarter
of 2001. Excluding the 2002 litigation settlement and 2001 operations of
Inter-Tel.NET, we reported net income of $20.5 million, or $0.80 per diluted
share in the first nine months of 2002, compared to net income of $14.9 million,
or $0.59 per diluted share, in the first nine months of 2001. These increases in
both periods are the result of higher gross profit and increased operating
efficiencies.
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 moved to domestic sources. The expansion of
international operations in the United Kingdom and Europe and increased sales,
if any, in Japan and Asia and elsewhere could result in higher international
sales as a percentage of total revenues; however, international revenues are
currently not a significant component of our consolidated operations.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2002, we had $108.2 million in cash and cash equivalents,
which represented an increase of approximately $46.4 million from our cash
position as of December 31, 2001. We maintain a $10 million unsecured, revolving
16
line of credit with Bank One, N.A. that is available through June 1, 2003. Under
this 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. Inter-Tel received a gross
cash award of $20 million in February 2002 in settlement of a dispute submitted
to binding arbitration. Costs relating to attorney's fees, expert witnesses, and
arbitration and additional costs and expenses, totaled approximately $4.5
million in the first nine months of 2002, resulting in a net award of $15.5
million before income taxes. During the first nine months of 2002, $7.9 million
of available cash, net, was used to fund acquisitions. During the first nine
months of 2001, approximately $28.7 million of available cash was used to
repurchase our common stock and an additional $6.1 million of available cash,
net, was used to fund acquisitions. In the first nine months of 2001, $12.1
million of available cash was used to fund acquisitions, of which $6.0 million
was subsequently returned to us from an escrow account to reduce the net cash
used in the Convergent acquisition. Proceeds from the exercise of stock options
yielded an increase in net cash of $4.5 million for the first nine months of
2002, compared to $867,000 for the nine months ended September 30, 2001. The
remaining cash balances and credit facility may be used for potential
acquisitions, strategic alliances, working capital, stock repurchases and/or
general corporate purposes.
Net cash provided by operating activities totaled $56.1 million for the
nine months ended September 30, 2002, compared to cash provided by operating
activities of $56.0 million for the same period in 2001. Cash provided by
operating activities in 2002 was primarily the result of cash generated from
operations, including non-cash depreciation and amortization charges of $6.4
million, as well as proceeds from the litigation settlement discussed above.
Cash generated by the change in operating assets and liabilities in 2002 was
$7.2 million, compared to $10.1 million in 2001. Of the $7.2 million change in
operating assets and liabilities, $1.7 million was due to the tax benefits from
the exercise of the stock options. At September 30, 2002, we achieved lower
accounts receivable and inventory than at December 31, 2001, which was primarily
a result of close management of receivables and inventory. At September 30,
2002, cash generated by the change in net deferred taxes was $1.8 million,
compared to $13.0 million in 2001. Net cash provided by operating activities was
partially offset by increases in prepaid expenses at September 30, 2002,
primarily reflecting amounts assumed from the McLeod acquisition. We expect to
expand sales through our direct sales office and dealer networks, which is
expected to require the expenditure of working capital for increased accounts
receivable and inventories.
Net cash used in investing activities totaled $12.8 million for the nine
months ended September 30, 2002, compared to $13.7 million for the same period
in 2001. During the nine months ended September 30, 2002, net cash used in
acquisitions totaled approximately $7.9 million and capital expenditures
approximately $5.2 million, compared to net cash used in acquisitions of
approximately $6.1 million in the first nine months of 2001. Capital
expenditures totaled approximately $7.7 million in the first nine months of
2001, $3.8 million of which was attributable to assets used in the Inter-Tel.NET
network, 83% of which was disposed of in July 2001. We anticipate incurring
additional capital expenditures during the remainder of 2002, principally
relating to expenditures for equipment and management information systems,
facilities expansion and acquisition activities.
Net cash provided by financing activities totaled $3.1 million in the nine
months ended September 30, 2002, compared to net cash used in financing
activities of $26.1 million for the same period in 2001. Net cash proceeds from
the exercise of stock options and stock issued under our Employee Stock Purchase
Plan totaled $5.0 million and $1.4 million in the first nine months of 2002 and
2001, respectively, which was offset in each period by cash used for dividends
totaling approximately $1.5 million and $742,000. During 2002, we reissued
treasury shares through stock option exercises and issuances, with the proceeds
received totaling less that the cost basis of the treasury stock reissued.
Accordingly, the difference was recorded as a reduction to retained earnings.
During the first nine months of 2001, we purchased treasury stock using
approximately $28.7 million. We issued long-term debt, net of repayments, of
$2.0 million in 2001 primarily in the form of long-term capital leases to
support capital additions to Inter-Tel.NET prior to our divestiture of our
majority ownership in July 2001.
We offer to our customers lease financing and other services, including our
TotalSolution (formerly Totalease) program, through our Inter-Tel Leasing, Inc.
subsidiary. We fund our TotalSolution program in part through the sale to
financial institutions of rental income streams under the leases. Resold
TotalSolution rentals totaling $204.0 million and $202.7 million remained
unbilled at September 30, 2002 and December 31, 2001, respectively. We are
obligated to repurchase such income streams in the event of defaults by lease
17
customers on a limited recourse basis and, accordingly, maintain reserves based
on loss experience, past due accounts, specific account analysis and total
portfolio analysis. Although to date we have been able to resell the rental
streams from leases under the TotalSolution 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.
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, we may
seek additional financing in the future to address working capital needs and to
provide funding for capital expenditures, expansion of the business or
additional acquisitions. 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 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, past due accounts, specific account analysis and total
portfolio analysis. 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.
18
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, on January 1, 2002 we ceased amortizing
goodwill arising from acquisitions completed prior to July 1, 2001. Inter-Tel
has tested goodwill for impairment using the two-step process prescribed in SFAS
No. 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 No. 142 effective January 1, 2002. Application
of the nonamortization provisions of SFAS 142 has resulted in an increase in
income from continuing operations before income taxes of approximately $1.3
million in 2002 for the nine months ended September 30, 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 allowances may be required. At September 30, 2002, our
allowance for doubtful accounts were $12.7 million of our $56.7 million gross
accounts receivable. 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 and
labor. 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
September 30, 2002, our inventory reserves were $11.2 million of our $27.3
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 do not anticipate that the resolution of such matters will have
a material adverse effect on our consolidated financial position.
19
FACTORS THAT MAY AFFECT RESULTS OF FUTURE OPERATIONS
THIS REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE
MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE
SECURITIES EXCHANGE ACT OF 1934. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM
THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF MANY RISK
FACTORS INCLUDING, WITHOUT LIMITATION, THOSE SET FORTH UNDER "FACTORS THAT MAY
AFFECT FUTURE RESULTS OF OPERATIONS" BELOW. 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.
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, voice
and data convergence products, speech recognition and text-to-speech
applications, 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, SPEECH
RECOGNITION AND INTERACTIVE VOICE RESPONSE PRODUCTS, AND RELATED
COMPUTER-TELEPHONY PRODUCTS.
During the past few years, among other development efforts, we enhanced our
transparent networking and voice and data convergence capabilities on our AXXESS
and ECLIPSE2 systems, introduced our Encore product and introduced our Unified
Communicator and Applications software packages. During the past 12 months,
sales of our AXXESS and ECLIPSE2 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 our voice and data convergence features, new computer-telephony
products, Encore products, Interprise products, new speech recognition and
Interactive Voice Response products, continued popularity and sales of the
AXXESS and ECLIPSE2 systems, 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, or will
maintain current levels of sales.
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;
20
* failure to achieve market acceptance or loss of market share;
* increased service and warranty costs;
* liabilities to our customers; and
* increased insurance costs.
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, or add to our distribution channels. Such
acquisitions could materially adversely affect our operating results and/or the
price of our common stock. Acquisitions also entail numerous risks, including:
* inability to complete acquisition transactions timely or at all;
* unanticipated costs and liabilities;
* difficulty of integrating 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;
* impairment of relationships with acquired employees and customers
occurring as a result of integration of the acquired business; and
* difficulties or risks associated with the service and maintenance of
competitors' products.
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 and integrated these offices into our direct sales organization.
However, for future acquisitions, we cannot predict whether we will be able to
fully integrate the employees and business of acquired entities into our
operations successfully.
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 to
approximately 10% of Vianet stock. As of March 31, 2002, we assessed the value
of our investment in Vianet and we recorded an expense of $600,000 related to
the write-down of this investment. Inter-Tel assessed the value of this
investment again at June 30, 2002 and wrote-down this investment by $600,000 to
approximately $2.5 million. We notified Vianet of default in principal payment
of $250,000 due under a note issued to us by Comm-Services, and we are
negotiating with Comm-Services/Vianet to cure this default and/or to modify the
terms of payment under this note. Our financial condition would 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
21
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. 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. In April 2002, Inter-Tel received a
notice letter from the financing affiliate of the Inter-tel.NET equipment vendor
notifying Inter-Tel of default in lease payments due the financing affiliate.
Subsequently, Inter-Tel responded to the affiliate advising them that Inter-Tel
was not the lessee of the equipment, of the correct name and address of the
current lessee of the equipment and of the losses to Inter-Tel because of the
non performance of the equipment and vendor related third party software
providers' breach of contract. Our financial condition would be adversely
affected to the extent that payments made under the guarantee exceed damages
realized from our claim.
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 eighteen (18) telecommunication and unified messaging products and
have also applied to the U.S. Patent and Trademark Office for six (6) 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. Although we
generally exclude coverage where infringement arises out of the combination of
our products with others, we may be required to indemnify some of our customers
for some of the costs and damages of patent infringement in circumstances where
our product separately creates a potential infringement liability. 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 may be unaware of
intellectual property rights of others that may cover some of our technology. We
have viewed presentations from one of our primary competitors alleging that our
AXXESS business communications system utilizes inventions covered by certain of
their patents. We are continuing the process of investigating this matter and we
have made claims against the competitor for infringement of our patents. 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, be subject to an injunction against the use of our
proprietary systems, be required to develop non-infringing technology or acquire
licenses to the technology subject to the alleged infringement. Any of these
actions or outcomes could harm our business. If we are unable or choose not to
license technology, or decide not to challenge a third party's rights, we could
encounter substantial and costly delays in product introductions. These delays
could result from efforts to design around asserted third party rights or our
discovery that the development, manufacture or sale of products requiring these
licenses could be foreclosed.
22
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, IP and core systems providers such as Avaya, Cisco Systems,
Comdial, Iwatsu, Mitel, NEC, Nortel, Siemens, 3Com and Toshiba;
* large data routing and convergence companies such as Cisco Systems and
3Com;
* 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; o
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 continue 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.
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
23
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 facility, including substantially all of the printed
circuit boards used in the AXXESS and ECLIPSE2 systems. We have experienced
occasional delays in the supply of components and finished goods that have
harmed our business. 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 sales and
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, long-standing
relationships between our potential customers and their local providers, 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. International operations
may require the expenditure of significant amounts of time or money to build
brand identity or loyalty in locations where our brand is not recognized
currently, without any certainty that we will be successful. 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.
IF WE LOSE KEY PERSONNEL OR ARE UNABLE TO HIRE ADDITIONAL QUALIFIED PERSONNEL AS
NECESSARY, WE MAY NOT BE ABLE TO ACHIEVE OUR OBJECTIVES.
We depend on the continued service of, and our ability to attract and
retain, qualified technical, marketing, sales and managerial personnel, many of
whom would be difficult to replace. Competition for qualified personnel is
intense, and we have historically had difficulty hiring employees in the
timeframe that we desire, particularly skilled engineers. The loss of any of our
key personnel or our failure to effectively recruit additional key personnel
could make it difficult for us to manage our business, complete timely product
introductions or meet other critical business objectives. For example, our
inability to retain key executives of Executone following our Executone
acquisition impaired our ability to benefit from the Executone business and to
grow revenues from the Executone assets. Moreover, our operating results will be
impaired if we lose a substantial number of key employees from recent
acquisitions. 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.
24
WE MAY BE UNABLE TO MANAGE OUR GROWTH EFFECTIVELY, WHICH MAY HARM OUR BUSINESS.
The ability to operate our business in an uncertain and evolving market
requires an effective planning and management process. While growth has been
difficult to achieve in the current economy, and in particular, in the
telecommunications industry, we have attempted to grow our business and maintain
existing customers, while controlling costs. As a result, this has stretched our
resources. An upturn in the economy or the potential increase in business from
customers who have been delaying capital spending decisions could place
additional significant strains 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 new versions of, or completed
significant upgrades to, 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. Moreover, our sales cycle
has lengthened in recent periods, as our prospective customers are reevaluating,
and in some cases deferring, purchasing decisions in light of the recent
economic downturn. 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 ability to resell lease income streams to third party financial
institutions,
* the cost and effect of acquisitions;
* the cost of defending pending or threatened litigation; 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
25
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 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;
* changes in the national or worldwide economy;
* announcements of technological innovations or new products or
enhancements by us or our competitors;
* short interest in our common stock;
* 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 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 21.6% OF OUR
COMMON STOCK AND IS ABLE TO SIGNIFICANTLY INFLUENCE MATTERS REQUIRING
SHAREHOLDER APPROVAL.
As of September 30, 2002, Steven G. Mihaylo, Inter-Tel's Chairman of the
Board of Directors, Chief Executive Officer and President, beneficially owned
approximately 21.6% 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.
26
RISKS RELATED TO OUR INDUSTRY
REDUCTIONS IN SPENDING ON ENTERPRISE COMMUNICATIONS EQUIPMENT MAY MATERIALLY AND
ADVERSELY AFFECT OUR BUSINESS.
The overall economic slowdown has had a harmful effect on the market for
enterprise communications equipment. Our customers have reduced significantly
their capital spending on communications equipment in an effort to reduce their
own costs and bolster their revenues. To the extent that economic conditions do
not improve and enterprise communications spending does not improve or
deteriorates, our revenue and operating results may be adversely affected. The
market for enterprise communications equipment may not grow or 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.
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 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 17%
investment was subsequently converted to approximately 10% interest in Vianet
Technologies, Inc. through a merger between Comm-Services and Vianet.
Accordingly, Inter-Tel continues to maintain an investment of 10% in
Inter-Tel.NET through Vianet. 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 all timely or complete tariff filings will be met, 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
27
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.
ITEM 3. 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 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 TotalSolutions program (formerly Totalease), 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, past due accounts, specific account analysis and
total portfolio 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 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 4. CONTROLS AND PROCEDURES
During the 90 day period prior to the filing of this quarterly report, an
evaluation was performed under the supervision and with the participation of our
management, including our Chief Executive Officer (CEO) and Chief Financial
Officer (CFO), of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c)
under the Securities Exchange Act of 1934, as amended). Our CEO and CFO believe
based on the evaluation that the design and operation of our disclosure controls
and procedures are effective to ensure that material information relating to
Inter-Tel, Incorporated is made known to them by others within the Company
during the period in which this Report of Form 10-Q was being prepared. There
have been no significant changes in our internal controls or, to our knowledge,
in other factors that could significantly affect internal controls subsequent to
that evaluation.
28
INTER-TEL, INCORPORATED AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM l. LEGAL PROCEEDINGS
We are involved from time to time in litigation and arbitration matters
incidental to our business, and as part of normal business operations. Inter-Tel
Integrated Systems, Inc. (IISI), a wholly-owned subsidiary of Inter-Tel,
Incorporated, recently received a complaint filed on July 22, 2002 in the
Arizona Federal District Court by OCIS Ltd., a former reseller of Vocal'Net and
Axxess products in the UK, alleging that IISI caused monetary damages in the
amount of $159 million to the dealer by denying it the ability to resell a large
amount of Vocal'Net product to a specified customer. We do not believe that we
have any liability for any of the alleged damages to this reseller. We believe
that the claims are without merit and we are vigorously defending ourselves in
this matter.
ITEM 2. CHANGES IN SECURITIES--Not Applicable
ITEM 3. DEFAULTS ON SENIOR SECURITIES--Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDER--Not Applicable
ITEM 5. OTHER INFORMATION--Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits:
Exhibit 3.1: Articles of Incorporation, as amended (1)
Exhibit 3.2: By-laws, as amended (2)
Exhibit 99.1: Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
Exhibit 99.2: Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
(1) Incorporated by reference to Registrant's Annual Report on Form
10-K for the year ended December 31, 1988 (File No. 0-10211).
(2) Incorporated by reference to Registrant's Annual Report on Form
10-K for the year ended December 31, 1995 (File No. 0-10211).
Reports on Form 8-K: None
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTER-TEL, INCORPORATED
Date: November 8, 2002 /s/ Steven G. Mihaylo
----------------------------------------
Steven G. Mihaylo,
Chairman of the Board,
Chief Executive Officer and President
Date: November 8, 2002 /s/ Kurt R. Kneip
----------------------------------------
Kurt R. Kneip,
Vice President
and Chief Financial Officer
30
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Steven G. Mihaylo, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Inter-Tel,
Incorporated.
2. Based on my knowledge, this report does not contain any untrue
statement of material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this report.
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this report (the "Evaluation Date"); and
c. presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and audit
committee of the registrant's board of directors:
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 8, 2002
By: /s/ Steven G. Mihaylo
------------------------------------
Name: Steven G. Mihaylo
----------------------------------
Title: Chief Executive Officer
---------------------------------
31
CERTIFICATION OF CHIEF FINANCIAL OFFICER
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Kurt R. Kneip, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Inter-Tel,
Incorporated.
2. Based on my knowledge, this report does not contain any untrue
statement of material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this report.
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this report (the "Evaluation Date"); and
c. presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and audit
committee of the registrant's board of directors:
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: November 8, 2002
By: /s/ Kurt R. Kneip
------------------------------------
Name: Kurt R. Kneip
----------------------------------
Title: Chief Financial Officer
---------------------------------
32